UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

FORM 10-K

 

 

 

 

 

PROLOGIS

(Exact name of registrant as specified in its charter)

 

 

4545 Airport Way

Denver, CO 80239

(Address of principal executive offices and zip code)

 

(303) 567-5000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: NONE

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

(Check one)     Large Accelerated Filer þ          Accelerated Filer o          Non-accelerated Filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes o     No þ

 

Based on the closing price of the registrant’s shares on June 30, 2006, the aggregate market value of the voting common equity held by non-affiliates of the registrant was $12,721,119,420.

 

At February 22, 2007, there were outstanding approximately 256,237,200 common shares of beneficial interest of the registrant.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement for the 2007 annual meeting of its shareholders are incorporated by reference in Part III of this report.

 

 

TABLE OF CONTENTS

 

Certain statements contained in this discussion or elsewhere in this report may be deemed “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates”, variations of such words and similar expressions are intended to identify such forward-looking statements, which generally are not historical in nature. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future — including statements relating to rent and occupancy growth, development activity and changes in sales or contribution volume of developed properties, general conditions in the geographic areas where we operate and the availability of capital in existing or new property funds — are forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be attained and therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Some of the factors that may affect outcomes and results include, but are not limited to: (i) national, international, regional and local economic climates, (ii) changes in financial markets, interest rates and foreign currency exchange rates, (iii) increased or unanticipated competition for our properties, (iv) risks associated with acquisitions, (v) maintenance of real estate investment trust (“REIT”) status, (vi) availability of financing and capital, (vii) changes in demand for developed properties, and (viii) those additional factors discussed under “Item 1A. Risk Factors”. Unless the context otherwise requires, the terms “we”, “us” and “our” refer to ProLogis and our consolidated subsidiaries.

 

We are the world’s largest owner, manager and developer of industrial distribution facilities. Our business strategy is designed to achieve long-term sustainable growth in cash flow and a high level of return for our shareholders. We manage our business by utilizing the ProLogis Operating System^®, an organizational structure and service delivery system that we built around our customers. When combined with our international network of distribution properties, the ProLogis Operating System enables us to meet our customers’ distribution space needs on a global basis. We believe that by integrating international scope and expertise with a strong local presence in our markets, we have become an attractive choice for our targeted customer base, the largest global users of distribution space.

 

We are organized under Maryland law and have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). Our world headquarters is located in Denver, Colorado. Our European headquarters is located in the Grand Duchy of Luxembourg with our European customer service headquarters located in Amsterdam, the Netherlands. Our regional offices in Asia are located in Tokyo, Japan and Shanghai, China. Our common shares were first listed on the New York Stock Exchange (“NYSE”) in March 1994 and currently trade under the ticker symbol “PLD”.

 

A copy of this Annual Report on Form 10-K, as well as our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such reports are available, free of charge, on the Internet in the Investor Relations section of our website (www.prologis.com). All required reports are made available on the website as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (the “SEC”). Any references to our website address do not constitute incorporation by reference of the information contained in the website and such information should not be considered to be part of this document.

 

Business Strategy and Global Presence

 

We were formed in 1991 as an owner of industrial distribution space operating in the United States with a primary objective of differentiating ourselves from our competition by focusing on our corporate customers’ distribution space requirements on a national, regional and local basis and providing customers with consistent levels of service throughout the United States. As our customers’ needs expanded to markets outside the

United States, so did our portfolio and our management team. We currently have operations in North America, Europe and Asia. Our business strategy is to hold certain investments on a long-term basis and generate income from leasing space to our customers, develop properties primarily for contribution to property funds in which we maintain an ownership interest and manage those property funds and the properties they own. Since our inception, we have grown and expect to continue to do so through the development and selective acquisition of properties, individually and as portfolios, in targeted markets. In September 2005, we completed a merger whereby Catellus Development Corporation (“Catellus”) was merged into one of our subsidiaries (the “Catellus Merger”). In connection with the Catellus Merger, we added approximately $4.5 billion of real estate assets to our direct owned investments. As of December 31, 2006, our direct owned real estate investments totaled $14.0 billion.

 

At December 31, 2006, our total portfolio of properties owned, managed and under development, including direct-owned properties and properties owned by property funds and other joint ventures, consisted of 2,466 properties aggregating 422.0 million square feet and serving 4,709 customers in 80 markets in North America, Europe and Asia.

 

Distribution facilities are a crucial link in the modern supply chain, and they serve three primary purposes for supply-chain participants: (i) ensure accurate and seamless flow of goods to their appointed destinations; (ii) function as processing centers for goods; and (iii) enable companies to store enough inventory to meet unexpected surges in demand and to cushion themselves from the impact of a break in the supply chain.

 

The primary business drivers across the globe continue to be the need for greater distribution network efficiency and state-of-the-art facilities to support the growing business of global trade. After 15 years in operation, our focus on our customers’ expanding needs and improving their supply-chain operations has enabled us to become the world’s largest owner, manager and developer of industrial distribution facilities.

 

Our business is primarily organized into three reportable business segments: (i) property operations, (ii) fund management and (iii) CDFS business. The following discussion of our business segments should be read in conjunction with “Item 1A. Risk Factors”, our property information presented in “Item 2. Properties”, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 18 to our Consolidated Financial Statements in Item 8.

 

The property operations segment represents the direct long-term ownership of industrial distribution and retail properties. Our investment strategy in the property operations segment focuses primarily on the ownership and leasing of generic industrial distribution properties in key distribution markets.

 

Investments

 

At December 31, 2006, our property operations segment consisted of 1,473 operating properties aggregating 204.7 million square feet in North America, Europe and Asia. The properties are primarily distribution properties, other than 27 retail properties located in North America and aggregating 1.1 million square feet.

 

During 2006, we increased our investments in our property operations segment through the acquisition of 74 properties, aggregating 13.5 million square feet representing an investment of $735.4 million, through various individual and/or portfolio acquisitions. These properties were acquired primarily in the CDFS business segment for future contribution to an unconsolidated property fund. It is our policy to hold acquired properties for long-term investment, although we often reduce our ownership to less than 100% through the contribution to a property fund resulting in the realization of a portion of the development or repositioning profits. We also acquire properties through tax deferred exchanges that result in our holding the properties for long-term investment. In addition, we have increased our investment in the property operations segment through the development of distribution and retail properties, which are pending contribution to a property fund or sale to

a third party, as further discussed below. Included in this segment at December 31, 2006 were 205 operating properties aggregating 49.8 million square feet at a total investment of $3.1 billion that were developed or acquired in the CDFS business segment but are included in the property operations segment’s assets pending contribution or sale.

 

We partially offset the increases in our investments by the disposition of 92 properties from this segment aggregating 7.7 million square feet with an investment of $207.5 million at the time of disposition, which were sold to third parties or contributed to property funds, and the disposal of 70 properties from the CDFS business segment, as discussed below.

 

On a continuing basis, we are engaged in various stages of negotiations for the acquisition and/or disposition of individual properties or portfolios of properties.

 

Results of Operations

 

We earn rent from our customers under long-term operating leases, including reimbursement of certain operating costs, in our properties that we own directly in North America, Europe and Asia. We expect to grow our revenue through increases in properties owned and increases in occupancy rates and rental rates in our existing properties. Our strategy is to achieve these increases primarily through the acquisition of distribution properties, continued focus on our customers’ global needs for distribution space in the three continents in which we operate, and use of the ProLogis Operating System. The costs of our property management function for both our direct-owned portfolio and the properties owned by the property funds and managed by us are all reported in rental expenses in the property operations segment.

 

Market Presence

 

At December 31, 2006, the 1,473 properties aggregating 204.7 million square feet in the property operations segment were located in 39 markets in North America (33 markets in the United States, five markets in Mexico and one market in Canada), 22 markets in 11 countries in Europe and six markets in four countries in Asia. Our largest markets for the property operations segment in North America (based on investment in the properties) are Atlanta, Chicago, Dallas/Fort Worth, New Jersey and San Francisco (East and South Bay), and Southern California. Our largest investment in the property operations segment in Europe is in the United Kingdom and our largest investment in Asia is in Japan. Direct-owned properties in Europe and Asia primarily consist of properties that were developed or acquired in the CDFS business segment that are pending contribution or sale. See “— Operating Segments — CDFS Business” and “Item 2. Properties”.

 

Competition

 

In general, numerous other distribution properties are located in close proximity to our properties. The amount of rentable distribution space available in any market could have a material effect on our ability to rent space and on the rents that we can earn. In addition, in many of our submarkets, institutional investors and owners and developers of properties (including other REITs) compete for the acquisition, development and leasing of space. Many of these entities have substantial resources and experience. Competition in acquiring existing properties and land, both from institutional capital sources and from other REITs, has been very strong over the past several years. We believe we have differentiated ourselves from our competitors, as we are the largest owner, manager and developer of industrial distribution facilities, which has allowed us to operate on a consistent basis as a provider of state-of-the-art facilities in what we believe are the key global markets.

 

Property Management

 

Our business strategy includes a customer service focus that enables us to provide responsive, professional and effective property management services at the local level. To enhance our management services, we have developed and implemented proprietary operating and training systems to achieve consistent levels of performance and professionalism in all markets and to enable our property management team members to give

the proper level of attention to our customers throughout our network. We manage substantially all of our direct-owned operating properties, other than the retail properties.

 

Customers

 

We have developed a customer base that is diverse in terms of industry concentration and represents a broad spectrum of international, national, regional and local distribution space users. At December 31, 2006, we had 3,314 customers occupying 175.7 million square feet of distribution and retail space. Our largest customer and 25 largest customers accounted for 2.2% and 18.4%, respectively, of our annualized collected base rents at December 31, 2006.

 

Employees

 

We employ approximately 1,270 persons. Our employees work in North America (approximately 780 persons), in 12 countries in Europe (approximately 300 persons) and in five countries in Asia (approximately 190 persons). Of the total, approximately 615 employees are assigned to the property operations segment. We have approximately 340 employees who work in corporate positions and are not assigned to a segment who may assist with property operations segment activities. We believe our relationships with our employees are good, and our employees are not generally represented by collective bargaining agreements.

 

Future Plans

 

Our current business plan allows for the expansion of our network of operating properties as necessary to: (i) address the specific expansion needs of customers; (ii) initiate or enhance our market presence in a specific country, market or submarket; (iii) take advantage of opportunities where we believe we have the ability to achieve favorable returns; and (iv) expand our direct-owned business.

 

We intend to fund our investment activities in the property operations segment in 2007 primarily with operating cash flow from this segment, borrowings on existing or new credit facilities, additional debt and equity financing and the proceeds from contributions and dispositions of properties.

 

The fund management segment represents the long-term investment management of property funds and the properties they own. We utilize our leasing and property management expertise to efficiently manage the properties and the funds. The costs of the property management function for both our direct-owned portfolio and the properties owned by the property funds are reported in the property operations segment and the costs of the fund management function are included in general and administrative expenses.

 

Our property fund strategy:

 

 

Investments

 

As of December 31, 2006, we had investments in and advances to 13 property funds totaling $981.8 million with ownership interests ranging from 11.3% to 50.0%. These investments are in North America — ten aggregating $416.8 million; Europe — one at $430.8 million; and Japan — two aggregating $134.2 million. These property funds own, on a combined basis, 843 distribution properties aggregating 181.3 million square feet with a total entity investment (not our proportionate share) in operating properties of $12.3 billion. We act as manager of each property fund.

 

During 2006, the property funds had the following activities:

 

 

See Note 4 to our Consolidated Financial Statements in Item 8 for more information on these activities.

 

Results of Operations

 

We recognize our proportionate share of the earnings or losses from our investments in unconsolidated property funds operating in North America, Europe and Asia. Along with the income recognized under the equity method, we include fees and incentives earned for services performed on behalf of the property funds and interest earned on advances to the property funds in this segment. We earn certain fees for services provided to the property funds, such as property management, asset management, acquisition, financing and development fees. We may earn incentives depending on the return provided to the fund partners over a specified period of time. We expect growth in income recognized to come from newly created property funds and growth in existing property funds. The growth in the existing property funds is expected to come primarily from additional properties the funds will acquire, generally from us, and increased rental revenues in the property funds due, in part, to our leasing and property management efforts from our property operations segment.

 

Market Presence

 

At December 31, 2006, the property funds on a combined basis owned 843 properties aggregating 181.3 million square feet located in 37 markets in North America (the United States and Mexico), 27 markets in 11 countries in Europe and five markets in Asia (Japan).

 

Competition

 

As the manager of the property funds, we compete with other fund managers for institutional capital throughout the capital markets. As the manager of the properties owned by the property funds, we compete with the other distribution properties located in close proximity to the properties owned by the property funds. The amount of rentable distribution space available in any market could have a material effect on the ability to rent space and on the rents that can be earned in the fund properties.

 

Property Management

 

We manage the properties owned by the property funds in our property operations segment utilizing our leasing and property management experience and the ProLogis Operating System. Our business strategy includes a customer service focus that enables us to provide responsive, professional and effective property management services at the local level. To enhance our management services, we have developed and implemented proprietary operating and training systems to achieve consistent levels of performance and professionalism in all markets and to enable our property management team members to give the proper level of attention to our customers throughout our network.

 

Customers

 

We have developed a customer base that is diverse in terms of industry concentration and represents a broad spectrum of international, national, regional and local distribution space users in both our direct-owned properties and those properties we manage on behalf of the property funds. At December 31, 2006, the property funds, on a combined basis, had 1,523 customers occupying 174.7 million square feet of distribution space. The largest customer and 25 largest customers of the property funds, on a combined basis, accounted for 2.7% and 24.7%, respectively, of the total combined annualized collected base rents at December 31, 2006.

 

Employees

 

The property funds generally have no employees of their own. We have approximately 45 employees who work in corporate positions assigned to the management of the property funds in our fund management segment. Employees in our property operations segment are responsible for the management of the properties owned by the property funds. Our other 340 corporate employees may assist with these activities as well. We believe that our relationships with our employees are good, and our employees are generally not represented by a collective bargaining agreement.

 

Future Plans

 

We expect an overall increase in our investments in the property funds. We expect to achieve this increase through the existing property funds’ acquisition of properties that have been developed or acquired by us in the CDFS business segment, as well as from third parties. We also expect growth from property funds that may be formed in the future. We expect the fee income we earn from the property funds and our proportionate share of net earnings of the property funds will increase as the portfolios owned by the property funds increase.

 

Our CDFS business segment primarily encompasses our development of real estate properties that are subsequently contributed to a property fund in which we have an ownership interest and act as manager, or sold to third parties. Additionally, we acquire properties with the intent to rehabilitate and/or reposition the

property in the CDFS business segment prior to it being contributed to a property fund. We also engage in mixed-use development activities.

 

Investments

 

At December 31, 2006, we had 114 distribution and retail properties aggregating 30.0 million square feet under development with a total expected cost at completion of $2.2 billion. Our properties under development at December 31, 2006 include:

 

 

In addition, at December 31, 2006, we had 205 operating properties aggregating 49.8 million square feet with a current investment of $3.1 billion that we had previously developed or acquired in the CDFS business segment. These properties and their results of operations are currently included in the property operations segment pending contribution or sale. This brings our total pipeline of direct-owned potential CDFS business disposition properties to $5.3 billion at December 31, 2006.

 

In addition to the properties under development and completed properties that we own directly, unconsolidated joint ventures in which we have an ownership interest had four distribution properties under development in Europe and China aggregating 0.5 million square feet with a total expected cost at completion of $22.6 million.

 

At December 31, 2006, we directly held 6,204 acres of land for future development with a current investment of $1.4 billion. The land is in North America (4,648 acres), Europe (1,397 acres) and Asia (159 acres). This land is primarily held for the future development of properties to be contributed to a property fund or sold to a third party, although some of the land will be sold as is or further developed and sold to third parties. In addition, we also directly control, through either letter of intent or option, another 4,092 acres in North America (1,758 acres), Europe (1,896 acres) and Asia (438 acres). The CDFS joint ventures in which we have an ownership interest also own or control another 625 acres for the future development of distribution properties within the venture.

 

During 2006, we had investment activity in the CDFS business segment as follows:

 

 

 

Results of Operations

 

We recognize income primarily from the contributions of developed and rehabilitated/repositioned properties to the property funds and from dispositions to third parties. In addition, we: (i) earn fees from our customers or other third parties for development activities that we provide on their behalf; (ii) recognize interest income on notes receivable related to asset dispositions; (iii) recognize net gains from the disposition of land parcels; and (iv) recognize our proportionate share of the earnings or losses generated by CDFS joint ventures in which we have an investment. We expect increases in this segment to come primarily from the continued development of high-quality distribution and retail properties in our key markets in North America, Europe and Asia, resulting in the contribution to property funds or sale to third parties. In addition, we expect to increase our land and mixed-use development activities for development fees and sales to third parties. Due to the nature of the income recognized in the CDFS business segment, the level and timing of income will vary between periods.

 

Market Presence

 

Our CDFS business segment operates in substantially all of the markets as our property operations segment. At December 31, 2006, we had properties under development in 23 markets in North America (18 in the United States, four in Mexico and one in Canada), in 16 markets in ten countries in Europe and in seven markets in two countries in Asia. At December 31, 2006, the land positions owned by us were located in 34 markets in North America (28 in the United States, five in Mexico and one in Canada), 19 markets in 11 countries in Europe and six markets in three countries in Asia.

 

Competition

 

In general, numerous other distribution properties are located in close proximity to our properties. The amount of rentable distribution space available in any market could have a material effect on our ability to rent space and on the rents that we can charge. In addition, in many of our submarkets, institutional investors and owners and developers of properties (including other REITs) compete for the acquisition, development and leasing of space. Many of these entities have substantial resources and experience. Competition in acquiring existing properties and land, both from institutional capital sources and from other REITs, has been very strong over the past several years. We believe we have competitive advantages due to the strategic locations of our land positions owned or under control, our personnel who are experienced in the land entitlement process, our global experience in the development of distribution properties, our relationships with key customers established by our local personnel and our global customer base.

 

North America — there are a number of other national, regional and local developers engaged in the distribution property development markets where we conduct business. We compete with these developers for land acquisition and development opportunities. The market in North America is very competitive and is driven by the supply of new developments, access to capital and interest rate levels. A key component of our success in the CDFS business segment in North America will continue to be our ability to develop and timely lease properties that will generate profits when contributed or sold and our ability to continue to access capital that allows for the continued acquisition of our properties by the property funds. We believe our existing land bank positions us to timely respond to development opportunities as they arise.

 

Europe — our competition in the CDFS business segment in Europe primarily comes from local and regional developers in our target markets. As in North America, the market in Europe is very competitive and is driven by the supply of new developments, access to capital and interest rate levels. During 2006, in addition to other land acquisitions, we added substantially to our land position in the United Kingdom, through a portfolio acquisition that will support more than 3.5 million square feet of distribution property development in the East and West Midlands, the country’s primary area for distribution and logistics.

 

Asia — our competition in the CDFS business segment in Asia comes primarily from local and regional developers. We face competition when trying to acquire land or, in the case of China, land rights. In late 2006, the central government of China promulgated a new policy to tighten the control of land administration. According to the new policy, the government will set the minimum price of industrial land use rights. All industrial land use rights will only be granted through an auction and bidding process. This new policy may make it more difficult and costly for us, as well as existing and future competitors, to acquire the land use rights necessary for development in China.

 

Customers

 

We use the customer relationships that we have developed in our property operations segment and the ProLogis Operating System in marketing our CDFS business. Approximately half of the space leased in the newly developed properties in our CDFS business segment continues to be with repeat customers.

 

Employees

 

We employ approximately 270 employees that are assigned to the CDFS business segment. Our employees assigned to another business segment or working at a corporate level may assist with CDFS business segment activities as well. We believe that our relationships with our employees are good and our employees are generally not represented by collective bargaining agreements.

 

Seasonal Nature of the Business

 

The demand for the properties that are developed or acquired in the CDFS business segment is not seasonal in nature. However, development activities may be impeded by weather in certain markets, particularly during the winter months, affecting the scheduling of development activities and potentially delaying construction starts and completions.

 

Future Plans

 

We intend to continue to conduct the business of the CDFS business segment substantially as we have in the past. To be successful in the CDFS business segment, we believe we must be able to: (i) develop, acquire and rehabilitate or reposition and lease properties on a timely basis; and (ii) have access to capital available to acquire our CDFS business properties. With respect to the first requirement for success, we have demonstrated that we have the ability to develop and acquire properties that can be contributed or disposed of to generate profits. The ability to lease our properties is dependent on customer demand. Properties contributed to property funds must generally meet specified leasing criteria. We experienced stronger leasing activity in 2006 than in prior years and expect absorption of available space to continue to be strong throughout 2007. Our market research and customer feedback indicate that consolidation and reconfiguration of supply chains driven by the need for distribution space will continue to favorably influence the demand for distribution properties that we plan to offer in the CDFS business segment in 2007. In addition, we believe the limited supply of state-of-the-art distribution space in locations that minimize transportation costs, but allow for high levels of service to the customer and our position of being a single-source provider of distribution space will provide opportunities within this operating segment. We believe we have differentiated ourselves from our competitors by providing high quality customer service on a global basis. As noted earlier, approximately half of the space leased in our newly developed CDFS business segment properties is leased to repeat customers.

 

We expect to increase our development activities in all three continents. We expect the growth to be through direct owned development, as well as investments in CDFS joint ventures. We currently invest in CDFS joint ventures in North America, Europe and Asia that develop and own distribution properties and retail properties. In addition, we expect to increase our mixed-use development activities where we may complete the entitlement process and develop the land and infrastructure in return for development fees, the rights to receive tax increment financing (“TIF”) bonds, profit participation on land sales, title to the land, or a combination thereof.

 

We intend to utilize the capital generated through the contributions and sales of properties, the proceeds from private or public debt and equity issuances and borrowings on existing or new credit facilities to fund our future CDFS business activities. Further, we intend to actively pursue other sources of committed capital to form new property funds that will acquire our CDFS business properties not currently subject to exclusivity. We have commitments to contribute properties to certain existing property funds. See Note 4 to our Consolidated Financial Statements in Item 8 for further discussion.

 

There can be no assurance that if the existing property funds do not continue to acquire the properties we have available, we will be able to secure other sources of capital such that we can contribute or sell these properties in a timely manner and continue to generate profits from our development activities in a particular reporting period.

 

Other

 

We have other segments that do not meet the threshold criteria to disclose as a reportable segment. At December 31, 2006, these operations include primarily the management of land subject to ground leases. During 2006, we sold 21 properties out of these other segments, primarily office buildings and a hotel property, all of which were acquired in the Catellus Merger.

 

Senior Management

 

Our Chief Executive Officer, Jeffrey H. Schwartz, and our President and Chief Operating Officer, Walter C. Rakowich head our management team. Mr. Schwartz and Mr. Rakowich also serve as members on our Board of Trustees (the “Board”).

 

In addition to the leadership and oversight provided by Messrs. Schwartz and Rakowich, Ted R. Antenucci is our President of Global Development, Dessa M. Bokides is our Chief Financial Officer, our General Counsel and Secretary is Edward S. Nekritz and John P. Morland is Managing Director of Global Human Resources. In addition, our investments and operations are overseen by John R. Rizzo, Managing Director of Global Development, Charles Sullivan, Managing Director for North America Capital Management, Larry Harmsen, Managing Director for North America Capital Deployment, Silvano Solis, Regional Director — Mexico, Gary E. Anderson, Europe President and Chief Operating Officer, Masato Miki and Mike Yamada, Japan Co-Presidents and Ming Z. Mei, China President. Further, in North America, generally two senior members of the management team lead each of our six regions (Central, Midwest, Mexico, Northeast/Canada, Pacific and Southeast), one of whom is responsible for operations and one of whom is responsible for capital deployment. A senior officer who has both operations and capital deployment responsibilities leads each of the four regions in Europe (Northern Europe, Central Europe, Southern Europe and the United Kingdom). We also have teams dedicated to our fund management business in each of the continents in which we operate.

 

We maintain a Code of Ethics and Business Conduct applicable to our Board and all of our officers and employees, including the principal executive officer, the principal financial officer, and the principal accounting officer, or persons performing similar functions. A copy of our Code of Ethics and Business Conduct is available on our website, www.prologis.com. In addition to being accessible through our website, copies of our Code of Ethics and Business Conduct can be obtained, free of charge, upon written request to Investor Relations, 4545 Airport Way, Denver, Colorado 80239. Any amendments to or waivers of our Code of Ethics and Business Conduct that apply to the principal executive officer, the principal financial officer, or the principal accounting officer, or persons performing similar functions, and that relate to any matter enumerated in Item 406(b) of Regulation S-K, will be disclosed on our website.

 

The reference to our website does not constitute incorporation by reference of the information contained in the website and such information should not be considered part of this document.

 

ProLogis Operating System

 

Our management team is responsible for overseeing the ProLogis Operating System, the cornerstone of our business strategy, to allow us to achieve long-term sustainable growth in cash flow and a high level of return for our shareholders. The ProLogis Operating System is a proprietary property management and customer service delivery system that we designed to assist our professional management team in providing a unique and disciplined approach to serving existing and prospective customers. We believe that, through the ProLogis Operating System, we are, and will continue to be, well positioned to leverage our customer relationships to generate additional business opportunities.

 

Capital Management and Capital Deployment

 

Within the ProLogis Operating System, we have a team of professionals who are responsible for managing and leasing our properties and those owned by the property funds that we manage. These capital management team members are part of the Market Services Group. We have market officers who are primarily responsible for understanding and meeting the needs of existing and prospective customers in their respective markets. In addition, the market officers, along with their team of property management and leasing professionals, use their knowledge of local market conditions to assist the Global Services Group in identifying and accommodating those customers with multiple market requirements and assisting in the marketing efforts directed at those customers. The market officers’ ability to serve customers in the local market is enhanced by their access to our national and international resources. The focus of the market officers is on: (i) creating and maintaining relationships with customers, potential customers and industrial brokers; (ii) managing the capital invested in their markets; (iii) leasing our properties; and (iv) identifying potential acquisition and development opportunities in their markets.

 

Capital deployment is the responsibility of a team of professionals who focus on ensuring that our capital resources are deployed in an efficient and productive manner that will best serve our long-term objective of increasing shareholder value. The team members responsible for capital deployment evaluate acquisition, disposition and development opportunities in light of the market conditions in their respective regions and our overall goals and objectives. Capital deployment officers work closely with the Global Development Group to create master-planned distribution parks utilizing the extensive experience of the Global Development Group team members. The Global Development Group incorporates the latest technology with respect to building design and systems and has developed standards and procedures that we strictly adhere to in the development of all properties to ensure that properties we develop are of a consistent quality.

 

Customer Service

 

The Global Solutions Group provides services to a targeted customer base that has been identified as large users of distribution space. The Global Solutions Group’s primary focus is to position us as the preferred provider of distribution space to these targeted customers. The professionals in the Global Solutions Group also seek to build long-term relationships with our existing customers by addressing their distribution and logistics needs. The Global Solutions Group provides our customers with outsourcing options for network optimization tools, strategic site selection assistance, business location services, material handling equipment and design consulting services.

 

Executive Committee Members

 

Jeffrey H. Schwartz* — 47 — Chief Executive Officer of ProLogis since January 2005. Mr. Schwartz was President of International Operations of ProLogis from March 2003 to December 2004 and he was Asia President and Chief Operating Officer from March 2002 to December 2004. Mr. Schwartz was President and Chief Executive Officer of Vizional Technologies, Inc., previously an unconsolidated investee of ProLogis from September 2000 to February 2002. From October 1994 to August 2000, Mr. Schwartz was with ProLogis, most recently as Vice Chairman for International Operations. Prior to originally joining ProLogis in October 1994, Mr. Schwartz was a founder and managing partner of The Krauss/Schwartz Company, an industrial real estate developer in Florida. Mr. Schwartz was appointed to the Board in August 2004.

 

Walter C. Rakowich* — 49 — President and Chief Operating Officer of ProLogis since January 2005 and Chief Financial Officer from December 1998 until September 2005. Mr. Rakowich was Managing Director of ProLogis from December 1998 to December 2004. Mr. Rakowich has been with ProLogis in various capacities since July 1994. Prior to joining ProLogis, Mr. Rakowich was a consultant to ProLogis in the area of due diligence and acquisitions and he was a Principal with Trammell Crow Company, a diversified commercial real estate company in North America. Mr. Rakowich was appointed to the Board in August 2004.

 

Ted R. Antenucci* — 42 — President of Global Development of ProLogis since September 2005. Prior to joining ProLogis, Mr. Antenucci was President of Catellus Commercial Development Corp. from September 2001 to September 2005, with responsibility for all development, construction and acquisition activities. Prior thereto, Mr. Antenucci served as Executive Vice President of Catellus Commercial Group from April 1999 to September 2001, where he managed the company’s industrial development activities throughout the western United States, including northern and southern California, Denver, Chicago, Dallas, and Portland.

 

Dessa M. Bokides* — 47 — Executive Vice President and Chief Financial Officer of ProLogis since September 2005. Prior to joining ProLogis, Ms. Bokides was the Vice President-Finance and Treasurer for Pitney Bowes, Inc., a global provider of mailstream solutions. From 1996 to 1999, Ms. Bokides was the Global Head and Managing Director of the Rating Advisory and Capital Strategy Group at Deutsche Bank Securities and a Managing Director on the Deutsche Bank debt capital markets desk. From 1987 to 1996, Ms. Bokides was employed by Goldman Sachs where she was Head of Commitment products and served on the firm-wide risk steering committee.

 

Edward S. Nekritz* — 41 — General Counsel of ProLogis since December 1998 and Secretary of ProLogis since March 1999, where he oversees the provision of all legal services for ProLogis and is responsible for ProLogis’ Risk Management and Asset Services departments. Mr. Nekritz has been with ProLogis in varying capacities since September 1995. Prior to joining ProLogis, Mr. Nekritz was an attorney with Mayer, Brown & Platt (now Mayer, Brown, Rowe and Maw).

 

Gary E. Anderson — 41 — Europe — President and Chief Operating Officer since November 2006 where he is responsible for investments and development in the 12 European countries in which ProLogis operates. From 2003 to 2006, Mr. Anderson was the Managing Director responsible for investments and development in the company’s Southwest and Mexico Regions. Prior to 2003, Mr. Anderson was a Market Officer for ProLogis from 1996 to 2003 and responsible for developing ProLogis’ global expansion strategy from 1995 to 1996.

 

Ming Z. Mei — 34 — China President of ProLogis since January 2007, where he is responsible for capital management and development activities in China. Mr. Mei was a Managing Director from December 2005 to January 2007, a Senior Vice President from December 2004 to December 2005, and a First Vice President from 2003 to December 2004 with similar responsibilities in China. Prior to joining ProLogis in March 2003, Mr. Mei was Director of Finance and Business Development for the Asia Pacific Region of Owens Corning, a global building materials manufacturing company.

 

Masato Miki — 42 — Japan Co-President of ProLogis since March 2006, where he is responsible for acquisitions, finance operations and fund management in Japan. Mr. Miki was Managing Director from December 2004 to March 2006 and Senior Vice President of ProLogis from January 2004 to December 2004 with similar responsibilities in Japan and he has been with ProLogis since August 2002. Prior to joining ProLogis, Mr. Miki was Vice President of Mitsui Fudosan Investment Advisors, Inc., an affiliate of Mitsui Fudosa Co., Ltd., a comprehensive real estate company in Japan.

 

John P. Morland — 48 — Managing Director of Global Human Resources since October 2006, where he is responsible for strategic human resources initiatives to align ProLogis’ human capital strategy with overall business activities. Most recently, Mr. Morland was with Barclays Global Investors at its San Francisco headquarters from April 2000 to March 2005, where he was the Global Head of Compensation.

 

Robert J. Watson — 57 — Chief Executive Officer of ProLogis European Properties since September 2006. Mr. Watson was North America President and Chief Operating Officer from January 2004 to September 2006 and President and Chief Operating Officer — Europe of ProLogis from December 1998 to January 2004

and has been with ProLogis in various capacities since November 1992. Prior to joining ProLogis, Mr. Watson was the Regional Partner for Southwest United States Real Estate with Trammell Crow Company, a diversified commercial real estate company in North America.

 

Mike Yamada — 53 — Japan Co-President of ProLogis since March 2006, where he is responsible for development and leasing activities in Japan. Mr. Yamada was Managing Director from December 2004 to March 2006 and Senior Vice President of ProLogis from January 2004 to December 2004 with similar responsibilities in Japan and he has been with ProLogis since April 2002. Prior to joining ProLogis, Mr. Yamada was a Senior Officer of Fujita Corporation, a construction company in Japan.

 

* These individuals are designated as Executive Officers under Item 401 of Regulation S-K.

 

We are exposed to various environmental risks that may result in unanticipated losses that could affect our operating results and financial condition. A majority of the properties acquired by us were subjected to environmental reviews either by us or the previous owners. While some of these assessments have led to further investigation and sampling, none of the environmental assessments has revealed an environmental liability that we believe would have a material adverse effect on our business, financial condition or results of operations. See Note 17 to our Consolidated Financial Statements in Item 8 and Item 1A. Risk Factors.

 

We carry comprehensive insurance coverage. We determine the type of coverage and the policy specifications and limits based on what we deem to be the risks associated with our ownership of properties and other of our business operations in specific markets. Such coverage includes property, liability, fire, flood, earthquake, environmental, terrorism, extended coverage and rental loss. We believe that our insurance coverage contains policy specifications and insured limits that are customary for similar properties, business activities and markets and we believe our properties are adequately insured. However, an uninsured loss could result in loss of capital investment and anticipated profits.

 

ITEM 1A. Risk Factors

 

Our operations and structure involve various risks that could adversely affect our financial condition, results of operations, distributable cash flow and the value of our common shares. These risks include, among others:

 

General Real Estate Risks

 

General economic conditions and other events or occurrences that affect areas in which our properties are geographically concentrated, such as California, may impact financial results.

 

We are exposed to the general economic conditions, the local, regional, national and international economic conditions and other events and occurrences that affect the markets in which we own properties. Our operating performance is further impacted by the economic conditions of the specific markets in which we have concentrations of properties. Approximately 29.5% of our North American properties (based on our investment before depreciation in our direct-owned portfolio) are located in California. Properties in California may be more susceptible to certain types of natural disasters, such as earthquakes, brush fires, flooding and mudslides, than properties located in other markets and a major natural disaster in California could have a material adverse effect on our operating results. We also have significant holdings in certain markets of our direct-owned portfolio located in Atlanta, Chicago, Dallas/Fort Worth, New Jersey, Japan and the United Kingdom. Our operating performance could be adversely affected if conditions become less favorable in any of the markets in which we have a concentration of properties. Conditions such as an oversupply of distribution space or a reduction in demand for distribution space may impact operating conditions. Any material oversupply of distribution space or material reduction in demand for distribution space could adversely affect our results of operations, distributable cash flow and the value of our securities. In addition,

the property funds in which we have an ownership interest have concentrations of properties in the same markets.

 

Real property investments are subject to risks that could adversely affect our business.

 

Real property investments are subject to varying degrees of risk. While we seek to minimize these risks through geographic diversification of our portfolio, market research and our property management capabilities, these risks cannot be eliminated. Some of the factors that may affect real estate values include:

 

 

Our investments are concentrated in the industrial distribution sector and our business would be adversely affected by an economic downturn in that sector or an unanticipated change in the supply chain dynamics.

 

Our investments in real estate assets are primarily concentrated in the industrial distribution sector. This concentration may expose us to the risk of economic downturns in this sector to a greater extent than if our business activities included a more significant portion of other sectors of the real estate industry.

 

Our real estate development strategies may not be successful.

 

We have developed a significant number of distribution properties since our inception and intend to continue to pursue development activities as opportunities arise. In addition, we currently own approximately 6,204 acres of land for potential future development of distribution properties and other commercial real estate projects. Such development activities generally require various government and other approvals and we may not receive such approvals. We will be subject to risks associated with such development activities including, but not limited to:

 

 

Our business strategy associated with contributing properties to property funds we manage or disposing of properties to third parties may not be successful.

 

We have contributed to property funds, or sold to third parties, a significant number of distribution properties in recent years and we intend to continue to contribute and sell properties as opportunities arise, particularly from our CDFS business segment, which is an integral part of our business strategy. Our ability to contribute or sell properties on advantageous terms is affected by competition from other owners of properties that are trying to dispose of their properties, current market conditions, including the capitalization rates applicable to our properties, and other factors beyond our control. Our ability to develop and timely lease properties will impact our ability to contribute or sell these properties. Continued access to debt and equity capital, in the private and public markets, by the property funds is necessary in order for us to continue our strategy of contributing properties to property funds. Should we not have sufficient properties available that meet the investment criteria of current or future property funds, or should the property funds have limited or no access to capital on favorable terms, then these contributions could be delayed resulting in adverse effects on our liquidity and on our ability to meet projected earnings levels in a particular reporting period. Failure to meet our projected earnings levels in a particular reporting period could have an adverse effect on our results of operations, distributable cash flow and on the value of our securities. Further, our inability to redeploy the proceeds from our divestitures in accordance with our investment strategy could have an adverse effect on our results of operations, distributable cash flow, our ability to meet our debt obligations in a timely manner and the value of our securities in subsequent periods.

 

Our growth will depend on future acquisitions of distribution properties, which involves risks that could adversely affect our operating results and the value of our securities.

 

We acquire distribution properties in both our property operations and CDFS business segments. The acquisition of properties involves risks, including the risk that the acquired property will not perform as anticipated and that any actual costs for rehabilitation, repositioning, renovation and improvements identified in the pre-acquisition due diligence process will exceed estimates. There is, and it is expected there will continue to be, significant competition for investment opportunities that meet our investment criteria as well as risks associated with obtaining financing for acquisition activities.

 

Our operating results and distributable cash flow will depend on the continued generation of lease revenues from customers.

 

Our operating results and distributable cash flow would be adversely affected if a significant number of our customers were unable to meet their lease obligations. We are also subject to the risk that, upon the expiration of leases for space located in our properties, leases may not be renewed by existing customers, the space may not be re-leased to new customers or the terms of renewal or re-leasing (including the cost of required renovations or concessions to customers) may be less favorable to us than current lease terms. In the event of default by a significant number of customers, we may experience delays and incur substantial costs in enforcing our rights as landlord. A customer may experience a downturn in its business, which may cause the loss of the customer or may weaken its financial condition, resulting in the customer’s failure to make rental payments when due or requiring a restructuring that might reduce cash flow from the lease. In addition, a customer of any of our properties may seek the protection of bankruptcy, insolvency or similar laws, which could result in the rejection and termination of such customer’s lease and thereby cause a reduction in our available cash flow.

 

Our ability to renew leases or re-lease space on favorable terms as leases expire significantly affects our business.

 

Our results of operations, distributable cash flow and the value of our securities would be adversely affected if we were unable to lease, on economically favorable terms, a significant amount of space in our operating properties. We had 5.9 million square feet of distribution and retail space with leases that either expired on December 31, 2006 or were on a month-to-month basis at that date and we have 24.8 million square feet of distribution and retail space (out of a total of 175.7 million occupied square feet) with leases that expire in 2007 in our direct-owned properties. Our unconsolidated investees had a combined 3.4 million

square feet of distribution space with leases that either expired on December 31, 2006 or were on a month-to-month basis at that date and a combined 19.5 million square feet of distribution space (out of a total of 177.8 million occupied square feet) with leases that expire in 2007. The number of distribution and retail properties in a market or submarket could adversely affect both our ability to re-lease the space and the rental rates that can be obtained in new leases.

 

The fact that real estate investments are not as liquid as other types of assets may reduce economic returns to investors.

 

Real estate investments are not as liquid as other types of investments and this lack of liquidity may limit our ability to react promptly to changes in economic or other conditions. In addition, significant expenditures associated with real estate investments, such as mortgage payments, real estate taxes and maintenance costs, are generally not reduced when circumstances cause a reduction in income from the investments. Like other companies qualifying as REITs under the Code, we must comply with the safe harbor rules relating to the number of properties that can be disposed of in a year, the tax basis and the costs of improvements made to these properties, and meet other tests that enable a REIT to avoid punitive taxation on the sale of assets. Thus, our ability at any time to sell assets, or contribute assets to property funds or other entities in which we have an ownership interest may be restricted.

 

Our insurance coverage does not include all potential losses.

 

We and our unconsolidated investees currently carry comprehensive insurance coverage including property, liability, fire, flood, earthquake, environmental, terrorism, extended coverage and rental loss as appropriate for the markets where each of our properties and business operations are located. The insurance coverage contains policy specifications and insured limits customarily carried for similar properties, business activities and markets. We believe our properties and the properties of our unconsolidated investees, including the property funds, are adequately insured. However, there are certain losses, including losses from floods, earthquakes, acts of war, acts of terrorism or riots, that are not generally insured against or that are not generally fully insured against because it is not deemed economically feasible or prudent to do so. If an uninsured loss or a loss in excess of insured limits occurs with respect to one or more of our properties, we could experience a significant loss of capital invested and potential revenues in these properties and could potentially remain obligated under any recourse debt associated with the property.

 

We are exposed to various environmental risks that may result in unanticipated losses that could affect our operating results and financial condition.

 

Under various federal, state and local laws, ordinances and regulations, a current or previous owner, developer or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances at, on, under or in its property. The costs of removal or remediation of such substances could be substantial. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release or presence of such hazardous substances.

 

A majority of the properties we have acquired were subjected to environmental reviews either by us or by the predecessor owners. While some of these assessments have led to further investigation and sampling, none of the environmental assessments have resulted in the recognition of an environmental liability, other than as discussed below.

 

In connection with the Catellus Merger, we acquired certain properties in urban and industrial areas that may have been leased to or previously owned by commercial and industrial companies that discharged hazardous materials. In accordance with purchase accounting, we recorded a liability for the estimated costs of environmental remediation to be incurred in connection with certain operating properties acquired and properties previously sold by Catellus. This liability was established to cover the environmental remediation costs, including cleanup costs, consulting fees for studies and investigations, monitoring costs and legal costs relating to cleanup, litigation defense, and the pursuit of responsible third parties. In addition, we may incur environmental remediation costs associated with certain land parcels we acquire in connection with the development of the land. We establish a liability at the time of acquisition to cover such costs. We purchase various environmental insurance policies to mitigate our exposure to environmental liabilities. We are not

aware of any environmental liability that we believe would have a material adverse effect on our business, financial condition or results of operations.

 

We cannot give any assurance that other such conditions do not exist or may not arise in the future. The presence of such substances on our real estate investments could adversely affect our ability to sell such investments or to borrow using such investments as collateral and may also have an adverse effect on our distributable cash flow.

 

Risks Related to Financing and Capital

 

Our operating results and financial condition could be adversely affected if we do not continue to have access to capital.

 

As a REIT, we are required to distribute at least 90% of our taxable income to our shareholders. Consequently, we are, as are all REITs, largely dependent on external capital to fund our development and acquisition activities. We have been accessing debt and equity capital, in both the private and public markets, through the establishment of property funds that acquire our properties. Our ability to access capital through the property funds is dependent upon a number of factors, including general market conditions and competition from other real estate companies. Further, we generate significant profits as a result of the contributions of properties to the property funds. To the extent that capital is not available to the property funds to allow them to acquire our properties, these profits may not be realized or realization may be delayed, which could result in an earnings stream that is less predictable than some of our competitors and result in us not meeting our projected earnings and distributable cash flow levels in a particular reporting period. Our ability to contribute or sell properties from our development pipeline and recognize profits from our development activities will be jeopardized and our ability to meet projected earnings levels and generate distributable cash flow would be adversely affected should the existing equity commitments to the property funds not be available (due to investor default or otherwise) such that these property funds cannot acquire the properties that we expect to have available for contribution. This impact would occur in the short-term and would continue until we are able to sell the properties to third parties or until we could secure another source of capital to finance the properties. Failure to meet our projected earnings and distributable cash flow levels in a particular reporting period could have an adverse effect on our financial condition and on the market price of our securities.

 

Our operating results and financial condition could be adversely affected if we are unable to make required payments on our debt or are unable to refinance our debt.

 

We are subject to risks normally associated with debt financing, including the risk that our cash flow will be insufficient to meet required payments of principal and interest. There can be no assurance that we will be able to refinance any maturing indebtedness, that such refinancing would be on terms as favorable as the terms of the maturing indebtedness, or otherwise obtain funds by selling assets or raising equity to make required payments on maturing indebtedness. If we are unable to refinance our indebtedness at maturity or meet our payment obligations, the amount of our distributable cash flow and our financial condition would be adversely affected and we may lose the property securing such indebtedness. Our unsecured credit facilities bear interest at variable rates. Increases in interest rates would increase our interest expense under these agreements.

 

Covenants in our credit agreements could limit our flexibility and adversely affect our financial condition.

 

The terms of our various credit agreements and other indebtedness require us to comply with a number of customary financial and other covenants, such as maintaining debt service coverage and leverage ratios and maintaining insurance coverage. These covenants may limit our flexibility in our operations, and breaches of these covenants could result in defaults under the instruments governing the applicable indebtedness even if we had satisfied our payment obligations. If we are unable to refinance our indebtedness at maturity or meet our payment obligations, the amount of our distributable cash flow and our financial condition would be adversely affected.

 

Federal Income Tax Risks

 

Failure to qualify as a REIT could adversely affect our cash flows.

 

We have elected to be taxed as a REIT under the Code commencing with our taxable year ended December 31, 1993. In addition, we have a consolidated subsidiary that has elected to be taxed as a REIT and certain unconsolidated investees that are REITs, and are subject to all the risks pertaining to the REIT structure, discussed herein. To maintain REIT status, we must meet a number of highly technical requirements on a continuing basis. Those requirements seek to ensure, among other things, that the gross income and investments of a REIT are largely real estate related, that a REIT distributes substantially all of its ordinary taxable income to shareholders on a current basis and that the REIT’s equity ownership is not overly concentrated. Due to the complex nature of these rules, the available guidance concerning interpretation of the rules, the importance of ongoing factual determinations and the possibility of adverse changes in the law, administrative interpretations of the law and changes in our business, no assurance can be given that we will qualify as a REIT for any particular year.

 

If we fail to qualify as a REIT, we will be taxed as a regular corporation, and distributions to shareholders will not be deductible in computing our taxable income. The resulting corporate income tax liabilities could materially reduce our cash flow and funds available for reinvestment. Moreover, we might not be able to elect to be treated as a REIT for the four taxable years after the year during which we ceased to qualify as a REIT. In addition, if we later requalified as a REIT, we might be required to pay a full corporate-level tax on any unrealized gains in our assets as of the date of requalification and to make distributions to our shareholders equal to any earnings accumulated during the period of non-REIT status.

 

Potential adverse effect of REIT distribution requirements could adversely affect our financial condition.

 

To maintain qualification as a REIT under the Code, a REIT must annually distribute to its shareholders at least 90% of its REIT taxable income, excluding the dividends paid deduction and our net capital gains. This requirement limits our ability to accumulate capital. We may not have sufficient cash or other liquid assets to meet the distribution requirements. Difficulties in meeting the distribution requirements might arise due to competing demands for our funds or to timing differences between tax reporting and cash receipts and disbursements, because income may have to be reported before cash is received, because expenses may have to be paid before a deduction is allowed or because deductions may be disallowed or limited, or the Internal Revenue Service (the “IRS”) may make a determination that adjusts reported income. In those situations, we might be required to borrow funds or sell properties on adverse terms in order to meet the distribution requirements and interest and penalties could apply which could adversely affect our financial condition. If we fail to make a required distribution, we would cease to be taxed as a REIT.

 

Prohibited transaction income could result from certain property transfers.

 

We contribute properties to property funds and sell properties to third parties from the REIT and from taxable REIT subsidiaries (“TRS”). Under the Code, a disposition of a property from other than a TRS could be deemed a prohibited transaction. In such case, a 100% penalty tax on the resulting gain could be assessed. The determination that a transaction constitutes a prohibited transaction is based on the facts and circumstances surrounding each transaction. The IRS could contend that certain contributions or sales of properties by us are prohibited transactions. While we do not believe the IRS would prevail in such a dispute, if the IRS successfully argued the matter, the 100% penalty tax could be assessed against the gains from these transactions. Additionally, any gain from a prohibited transaction may adversely affect our ability to satisfy the income tests for qualification as a REIT.

 

Liabilities recorded for pre-existing tax audits may not be sufficient.

 

We are subject to pending audits by the IRS and the California Franchise Tax Board of Catellus’ 1999 through 2002 income tax returns, including certain of its subsidiaries and partnerships. We have recorded an accrual that represents our best estimate of the liabilities that may arise from these audits. The audits may result in an adjustment in which the actual liabilities or settlement costs, including interest and potential

penalties, if any, may prove to be more than the liability we have recorded. See Note 7 to our Consolidated Financial Statements in Item 8.

 

Uncertainties relating to Catellus’ estimate of its “earnings and profits” attributable to C-corporation taxable years may have an adverse effect on our distributable cash flow.

 

In order to qualify as a REIT, a REIT cannot have at the end of any REIT taxable year any undistributed earnings and profits that are attributable to a C-corporation taxable year. A REIT has until the close of its first full taxable year as a REIT in which it has non-REIT earnings and profits to distribute these accumulated earnings and profits. Because Catellus’ first full taxable year as a REIT was 2004, Catellus was required to distribute these earnings and profits prior to the end of 2004. Failure to meet this requirement would result in Catellus’ disqualification as a REIT. Catellus distributed its accumulated non-REIT earnings and profits in December 2003, well in advance of the 2004 year-end deadline, and believed that this distribution was sufficient to distribute all of its non-REIT earnings and profits. However, the determination of non-REIT earnings and profits is complicated and depends upon facts with respect to which Catellus may have less than complete information or the application of the law governing earnings and profits, which is subject to differing interpretations, or both. Consequently, there are substantial uncertainties relating to the estimate of Catellus’ non-REIT earnings and profits, and we cannot be assured that the earnings and profits distribution requirement has been met. These uncertainties include the possibility that the IRS could upon audit increase the taxable income of Catellus, which would increase the non-REIT earnings and profits of Catellus. There can be no assurances that we have satisfied the requirement that Catellus distribute all of its non-REIT earnings and profits by the close of its first taxable year as a REIT, and therefore, this may have an adverse effect on our distributable cash flow.

 

There are potential deferred and contingent tax liabilities that could affect our operating results or financial condition.

 

Palmtree Acquisition Corporation, our subsidiary that was the surviving corporation in the Catellus Merger, is subject to a federal corporate level tax at the highest regular corporate rate (currently 35%) and potential state taxes on any gain recognized within ten years of Catellus’ conversion to a REIT from a disposition of any assets that Catellus held at the effective time of its election to be a REIT, but only to the extent of the built-in-gain based on the fair market value of those assets on the effective date of the REIT election (which was January 1, 2004). Gain from a sale of an asset occurring more than 10 years after the REIT conversion will not be subject to this corporate-level tax. We do not currently expect to dispose of any asset of the surviving corporation in the merger if such a disposition would result in the imposition of a material tax liability unless we can affect a tax-deferred exchange of the property. However, certain assets are subject to third party purchase options that may require us to sell such assets, and those assets may carry deferred tax liabilities that would be triggered on such sales. We have recorded deferred tax liabilities related to these built-in-gains. There can be no assurances that our plans in this regard will not change and, if such plans do change or if a purchase option is exercised, that we will be successful in structuring a tax-deferred exchange.

 

Other Risks

 

We are dependent on key personnel.

 

Our executive and other senior officers have a significant role in our success. Our ability to retain our management group or to attract suitable replacements should any members of the management group leave is dependent on the competitive nature of the employment market. The loss of services from key members of the management group or a limitation in their availability could adversely affect our financial condition and cash flow. Further, such a loss could be negatively perceived in the capital markets.

 

Share prices may be affected by market interest rates.

 

The annual distribution rate on common shares as a percentage of our market price may influence the trading price of such common shares. An increase in market interest rates may lead investors to demand a higher annual distribution rate than we have set, which could adversely affect the value of our common shares.

The depreciation in the value of the foreign currency in countries where we have a significant investment may adversely affect our results of operations and financial position.

 

We have pursued, and intend to continue to pursue, growth opportunities in international markets and often invest in countries where the U.S. dollar is not the national currency. As a result, we are subject to foreign currency risk due to potential fluctuations in exchange rates between foreign currencies and the U.S. dollar. A significant depreciation in the value of the foreign currency of one or more countries where we have a significant investment may have a material adverse effect on our results of operations and financial position. Although we attempt to mitigate adverse effects by borrowing under debt agreements denominated in foreign currencies and through the use of derivative contracts, there can be no assurance that those attempts to mitigate foreign currency risk will be successful.

 

We are subject to governmental regulations and actions that affect operating results and financial condition.

 

Many laws and governmental regulations apply to us, our unconsolidated investees and our properties. Changes in these laws and governmental regulations, or their interpretation by agencies or the courts, could occur. Further, economic and political factors, including civil unrest, governmental changes and restrictions on the ability to own assets and transfer capital across borders in the countries in which we have invested, can have a major impact on us as a global company.

 

ITEM 1B. Unresolved Staff Comments

 

None.

 

ITEM 2. Properties

 

We have directly invested in real estate assets that are primarily generic industrial distribution properties. In Japan, our distribution properties will generally be multi-level centers, which is common in Japan due to the high cost and limited availability of land. Our properties are typically used for storage, packaging, assembly, distribution and light manufacturing of consumer and industrial products. Based on the square footage of operating properties directly owned by us in our property operations segment at December 31, 2006, our properties are 99.5% distribution properties, including 92.0% of properties used for bulk distribution, 6.6% used for light manufacturing and assembly and 0.9% for other purposes, primarily service centers, while the remaining 0.5% of our properties are retail.

 

At December 31, 2006, we have direct ownership of 1,473 operating properties, including 1,446 distribution properties located in North America, Europe and Asia and 27 retail properties in North America. In North America, properties that are owned directly by us are located in 33 markets in 24 states and the District of Columbia in the United States, in 5 markets in Mexico and in 1 market in Canada. In Europe, the properties owned directly by us are located in 22 markets in 11 countries. In Asia, the properties that are owned directly by us are located in 6 markets in 4 countries.

 

We define our markets based on the concentration of properties in a specific area. A market, as defined by us, can be a metropolitan area, a city, a subsection of a metropolitan area, a subsection of a city or a region of a state or country.

 

The information in the following tables is as of December 31, 2006 for the operating properties, properties under development and land directly owned by us including 147 buildings owned by entities we consolidate but own less than 100%. All of the operating properties are included in our property operations segment, while properties under development and land are included in the CDFS business segment. No individual property or group of properties operating as a single business unit amounted to 10% or more of our consolidated total assets at December 31, 2006. No individual property or group of properties operating as a single business unit generated income equal to 10% or more of our consolidated gross revenues or total income for the year ended December 31, 2006. The table does not include properties that are owned by property funds or by our other unconsolidated investees which are discussed under “— Unconsolidated Investees.”

 

 

 

The following is a summary of our direct-owned investments in real estate assets at December 31, 2006:

 

 

 

 

 

At December 31, 2006, our investments in and advances to unconsolidated investees totaled $1.3 billion. Our investments in and advances to property funds in the fund management segment totaled $981.8 million at December 31, 2006. Our investments in and advances to CDFS joint ventures operating in the CDFS business segment totaled $203.3 million at December 31, 2006 and our investments in other unconsolidated investees totaled $114.5 million at December 31, 2006.

 

Property Funds

 

At December 31, 2006, we had ownership interests ranging from 11.3% to 50% in 13 property funds that are presented under the equity method. The property funds primarily own operating properties and our investments in the property funds are included in our fund management segment. We act as manager of each property fund. The information provided in the table below (dollars and square footage in thousands) is for the total entity in which we have an ownership interest, not just our proportionate share. See “Item 1. Business” and Note 4 to our Consolidated Financial Statements in Item 8.

 

 

 

 

  CDFS joint ventures

 

At December 31, 2006, we had ownership interests in several entities that perform CDFS business activities and are presented under the equity method. These entities develop and invest in distribution properties, retail properties and residential development in North America, Europe and China. On a combined basis, these entities own 32 completed distribution properties and have four distribution properties under development. The information provided in the table below (dollars in thousands) is for the total entity in which we have an ownership interest, not just our proportionate share, as of December 31, 2006.

 

 

 

See Note 4 to our Consolidated Financial Statements in Item 8 for additional information.

 

From time to time, we and our unconsolidated investees are parties to a variety of legal proceedings arising in the ordinary course of business. We believe that, with respect to any such matters that we are currently a party to, the ultimate disposition of any such matter will not result in a material adverse effect on our business, financial position or results of operations.

 

Not applicable.

 

Our common shares are listed on the NYSE under the symbol “PLD”. The following table sets forth the high and low sale prices, as reported in the NYSE Composite Tape, and distributions per common share, for the periods indicated.