Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Prologis (NYSE:PLD)

Q2 2011 Earnings Call

July 28, 2011 10:00 am ET

Executives

Guy Jaquier - Chief Executive Officer of Private Capital

Tracy Ward - Vice President, Investor Relations

Walter Rakowich - Co-Chief Executive Officer, Trustee and Chairman of Executive Committee

Gary Anderson - Chief Executive Officer of Europe & Asia

Michael Curless - Managing Director of Global Investments

Thomas Olinger - Chief Integration Officer

Hamid Moghadam - Chairman, Co-Chief Executive Officer and Member of Executive Committee

William Sullivan - Chief Financial Officer

Analysts

Jeffrey Spector - BofA Merrill Lynch

George Auerbach - ISI Group Inc.

Jamie Feldman - UBS

John Guinee - Stifel, Nicolaus & Co., Inc.

Sloan Bohlen - Goldman Sachs Group Inc.

Ki Kim - Macquarie Research

David Rodgers - RBC Capital Markets, LLC

Steven Benyik - Jefferies & Company, Inc.

Chris Canton

Paul Morgan - Morgan Stanley

Steven Frankel - Green Street Advisors, Inc.

Michael Bilerman - Citigroup Inc

Ross Nussbaum - UBS Investment Bank

Michael Mueller - JP Morgan Chase & Co

Suzanne Kim - Crédit Suisse AG

Srikanth Nagarajan - FBR Capital Markets & Co.

Operator

Good morning. My name is Ashley, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Prologis Second Quarter Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to Ms. Tracy Ward. Ma'am, you may begin.

Tracy Ward

Thank you, Ashley. Good morning, everyone. Welcome to our second quarter 2011 conference call. Our press release and supplemental are available on our website at prologis.com under Investor Relations. This morning we'll hear from Hamid Moghadam, Co-CEO and Chairman, to comment on our company's strategy and the market environment, then from Bill Sullivan, CFO, who will cover results and guidance. Additionally we are joined today by Walt Rakowich, Gary Anderson, Mike Curless, Guy Jaquier, Gene Reilly and Tom Olinger.

Before we begin prepared remarks, I'd like to quickly state that this conference call will contain forward-looking statements under federal securities laws. These statements are based on current expectations, estimates and projections about the market and the industry in which Prologis operates, as well as management's belief and assumption. Forward-looking statements are not guarantees of performance, and actual operating results may be affected by a variety of factors. For a list of those factors, please refer to the forward-looking statement notice in our 10-K or SEC filing. I’d also like to state that our second quarter results press release and supplemental do contain financial measures, such as FFO and EBITDA, that are non-GAAP measures, and in accordance with Reg G, we have provided a reconciliation to those measures.

As we have done in the past to provide a broader range of investors and analysts with the opportunity to ask questions, we will ask you to please limit your questions to one at a time. Hamid, will you please begin?

Hamid Moghadam

Good morning, everyone, and thank you, for joining us today. We are pleased to be hosting our first earnings call as a combined company. Over the past few months, Walt and I have spent a lot of time visiting our offices around the globe. And I can tell you our team is very enthusiastic and energized about this merger. It's great to see how well and how quickly the 2 organizations have come together.

As we plot our course for the future, we've established a clear strategy for the new company. Our priorities are: First, to strengthen our financial position and to build 1 of the top 3 balance sheets in the industry; second, to align our portfolio with our investment strategy, while serving the needs of our customers; third, to refine our private capital business and to position us for substantial growth; and fourth, to build the most effective and efficient organization in the business and become the employer of choice among top professionals interested in real estate as a career.

I'd like to take a few minutes to expand on each of these things. First, by streamlining the company's overhead structure, reducing our leverage and focusing our portfolio on our target markets, we plan to achieve substantial savings in operational expenses as well as our overall cost of capital. This added financial flexibility will position us to capitalize on market opportunities across the entire business cycle. Also by adopting the best practices from both companies and by incorporating the lessons of the past few years, we've created a sophisticated framework for evaluating and managing risk on an integrated basis across the different aspects of our business. You will hear more from us on this in the coming months, but as an example, we've introduced a private capital model into our development activities in Brazil and China. This strategy lowers our balance sheet exposure to land and development, mitigates our net currency exposure and allows us to develop more of our financial resources to meeting the needs of our customers around the world, while reducing the overall risks of our business.

Second, in order to align our portfolio with our asset allocation strategy, we performed a comprehensive review of our markets, which we have now categorized into 2 main segments. Global markets comprise roughly 30 of the largest, most liquid markets tied to global trade and represent approximately 80% of our overall platform. These markets are defined by large population centers with high per-capita consumption rates. They typically feature major seaports, airports and other transportation infrastructure. While initial returns might be lower, global markets tend to outperform in terms of growth and total return. Examples of global markets would be Los Angeles, Tokyo, London and Sao Paolo.

Regional markets consist of about 50 regional logistic corridors and represent 13% of our platform. These markets also benefits from large populations and strong local demand, but they're not as directly tied to the global supply chain and are often less supply constrained than global markets. We intend to hold only the highest quality Class A product in our regional markets, examples of which include Orlando, Prague and Nagoya. Properties in regional markets typically trade at higher yields than equivalent quality assets in global markets. Our global customers have substantial space needs in both of these market segments. Each of which provides a unique investment opportunity for the company and our partners. We also own a small number of assets in other markets such as New Orleans, Turin and Seoul, which we plan to exit in an orderly fashion in next few years. These other markets account for only 7% of our platform.

By segmenting our markets in this manner, we are able to construct a strategy that includes culling the portfolio for buildings and potentially submarkets that are no longer a strategic fit for the company. Exiting these markets will also allow us to recycle capital into new developments, to upgrade the age and quality of our portfolio over time, to delever the balance sheet and to monetize our land bank. Going forward, we expect our assets outside the U.S. will be held predominantly in funds. New developments in these regions particularly in emerging markets will be in conjunction with our private capital partners. Our long-term capital allocation decisions will be governed by opportunities as they evolve over time with a focus on overall risk management. As always, we'll employ our one portfolio policy in the way we operate all of our assets. In other words, our private capital partners will get the full benefit of our integrated operating model including our customer franchise, our 600 million-square-foot global footprint, as well as industry leading portfolio-wide programs, such as our recently announced rooftop solar initiative. We believe these investor benefits are unparalleled in the real estate business today.

Third, let's talk through the near term priorities for our private capital business. As a combined company, we have about $26 billion of Assets Under Management in 22 funds and ventures around the world, with over $3 billion of available investment capacity. Over the next 18 months, we plan to add to this capacity by forming a few new funds, as well as raising incremental capital for existing open-end funds in the U.S. and Europe. Currently, our top priority in fund formation is Japan, where we have a sizable portfolio of the highest-quality logistic facilities in the market, together with the best management team in the business. We believe Japan will present significant development and investment opportunities over the next few years. We plan to rationalize our private capital business in conjunction with our investors and this plan is well underway.

As we look at our product offerings across our funds, not all of these funds are profitable for our new company. Some provide fee structures that fall short of our cost of managing the fund assets. Others include the unworkable operating requirements and oversight. In some cases this means terminating or restructuring unprofitable relationships. In other cases, it means combining some funds to gain operational efficiencies that will benefit all investors. In yet a number of other cases, this means defining a differentiated and compelling growth strategy for the venture. In every case, however, we'll work very closely with our partners and fund investors to make sure that they're active participants in these decisions. As always, our actions will be guided by our strong commitment to transparency, leading governance policies, and a high level of financial alignment with our investors. In the short run, you may see the number of funds and our Assets Under Management decrease while we build the foundation for future growth.

Finally, Walt and I believe that we have a unique opportunity to capitalize on the best attributes of our former companies, and to build a strong culture of empowerment, speed and accountability that will attract and retain the best talent in the industry. Risk management and world-class operational efficiency will continue to be important areas of emphasis for us as we build a new Prologis.

As I mentioned earlier, I'm incredibly impressed with how well our teams have come together, which has been evident in how they've been collaborating. I've watched team members work seamlessly over the past few months, as we successfully accomplished our objectives with PEPR, closed the merger, completed the bond exchange and the follow-on equity offering, revamped our investment committee process, even prepared for this earnings call and just yesterday, secured a $500 million capital commitment from one of the most respected pension funds in the country.

Now I'd like to shift gears and offer some comments on the key demand drivers for our business. First, global GDP continues to signal demands for industrial real estate. Our business is very strong in Asia and Latin America. The U.S. is improving and Europe is mixed, but steady overall. While global GDP growth in the first half of the year came in below consensus, we have not seen it slow demand for industrial real estate. We looked hard to find evidence of a slowing market, but if anything, we appear to be a little ahead of our expectations, and you can see this in our leasing results for the quarter. We believe this has more to do with the rapid pace of inventory rebuilding which has more than made up for the lower economic growth rate in the first 6 months. U.S. inventories have now been increasing for 6 consecutive quarters and are more than halfway back to their pre-crisis level. Based on the most recent data, we expect further rebuilding of inventories for the balance of the year, with an expectation that will surpass the previous peak in early 2012. As the global recovery broadens across the major economies and as inventory restocking continues, we expect to see increased demand for industrial real estate that should translate to approximately 150 million square feet of net absorption in the U.S. in 2011.

As you know, absorption in the second quarter was also ahead of expectations. This should come as no surprise as we have about 10 million more people living in this country than we did before the crisis. This outlook is further supported by positive signs from our customers, which have requirements for major distribution centers all over the world. Space utilization continues to increase, and we're also seeing a meaningful uptick in build-to-suit activity with potential multi-market opportunities in some significant cases. These opportunities are led by our larger, better capitalized customers who want to achieve operational efficiencies by consolidating smaller facilities or to expand globally into underserved market -- markets in preparation for growth. The momentum with smaller and medium-sized customers is lagging somewhat, but still positive.

Given our global platform and long-term relationships with customers, we have the unique ability to serve as their strategic partner for real estate across the globe and across the business cycle. As you can tell, Walt and I are very pleased with the progress we've made in the first few months of the new company. We're excited about the opportunities we see ahead. We believe that the new Prologis has come at the right time and has positioned in all the right places to make the most of these opportunities. Let me turn the call over to Bill so he can walk you through our results and update you on our guidance.

William Sullivan

Thanks, Hamid. This morning, I have plan to cover 3 aspects of the company's reporting structure and financial performance: First, our new supplemental; second, our results for the quarter; and third, guidance for the back half of the year, as well as how to think about the company going forward.

By now you have seen our new supplemental reporting package. Our goal in creating this package was to align how we report externally, with how we manage the business internally. We have taken what we believe is the best of both worlds from each company. For example, we adopted legacy AMB's holistic view of the owned and managed portfolio. This means our operating metrics are presented without regard to ownership. From legacy Prologis, we adopted the NAV disclosure format, as we believe it gives the financial community comprehensive data to value the company. As you think about a go-forward view of the combined company, we believe the current supplemental provides the right level of detail to help model expectations.

Now let me turn to the second quarter financials. We realize there's a lot of noise in the numbers, and it is difficult to compare our reported results of either of legacy Prologis or AMB. With Prologis as the accounting acquirer, second quarter combines 2 months of standalone legacy Prologis and 1 month of combined company results. Also during the quarter, we consolidated SGP, PEPR and completed an equity offering. Before I get into detail on the quarter's Core FFO, let me remind everyone that Core FFO as we define it: excludes merger and integration expenses, impairment charges, as well as disposition or acquisition-related gains or losses. In the second quarter, we had significant adjustments in each category. First, we recorded $103 million or $0.33 per share of integration and transaction costs associated with the acquisition of the PEPR interest and the merger. We expect to continue to incur severance and transition costs associated with the merger between now and year end 2012, and will report these expenses on a separate line item.

Second, we recorded $104 million or $0.34 per share of impairment charges, the vast majority of which related to our NA3 Fund, where our partner is Lehman. In conjunction with our evaluation fund rationalization process, we deemed the valuation trajectory of this venture to be insufficient to ultimately recover our entire investment, despite widespread recoveries in values over the last 6 to 9 months.

Finally, our impairment adjustment was essentially offset by approximately $107 million or $0.34 per share of net gains on acquisitions and dispositions of investments in real estate, mainly related to the consolidation of PEPR onto our balance sheet. As a reminder, the impact of the purchase accounting adjustments from the merger, while non-cash, are included in our definition of Core FFO. We continue to expect these to negatively impact FFO through 2014 with an estimated annual drag of between $0.02 and $0.03 per share. This is principally due to increased stock-compensation expense associated with the mark-to-market of legacy AMB stock at optional levels, reduced NOI from the mark-to-market of leases and amortization of the fair market value of the investment management contracts. All of which is partially offset by the favorable effect of the mark-to-market of legacy AMB debt.

Let me now give you insight as to how we view the quarter, and what things would have looked like had we been able to report a full quarter's worth of operations in our current merged and consolidated status. For the quarter, Core FFO was $0.35 per share, modestly ahead of our internal expectations. The results were higher than forecasted primarily due to higher occupancy, lower-than-expected rent change at rollover and modestly lower interest expense. To put things in perspective, we have analyzed the quarter's operating results from a variety of viewpoints. In doing so, we estimate that taking into account a full quarter of legacy AMB, a full quarter of consolidated PEPR and adjusting for the change in share counts associated with both the merger and the equity offering, our Core FFO on a pro forma basis for the quarter would have been approximately $0.38 per fully diluted share.

Turning now to capital markets initiatives. We are highly focused on our delevering objectives and have already taken significant steps towards our stated goals. During the quarter, we amended and recast our global lines of credit, as well as completed an equity offering. As we have mentioned previously, our use of proceeds from the offering was to reduce leverage in light of our acquisition of PEPR. At the end of the quarter, our share of total enterprise debt was $14 billion. We expect this number to decrease substantially throughout 2012, as we implement on our fund rationalization strategy and create new funds with a particular focus on our second Japan fund. Additionally, we will continue to implement on other asset dispositions and contributions, which we have communicated in numerous investor presentations over the past 2 months.

Let me turn now to our guidance for the rest of 2011. Based on our performance in Q2 and our expectations for continued recovery in the overall macro economy and operating environment, we are reiterating our second half Core FFO guidance of $0.78 to $0.82 per share and expect to end the year near the top end of our range. Our shares in units outstanding on a fully diluted basis are expected to total approximately 463 million, reflecting the merger and the equity offering. As we move through 2011, we expect to see an increase in FFO relative to Q2, principally as a result of increased occupancy in the operating portfolio and the completion and lease up of a number of properties currently under development. We expect our operating portfolio occupancy to increase between 100 and 150 basis points by year end. This NOI pick up from the occupancy gains will be tempered to an extent by the loss of NOI from asset sales and fund contributions that are targeted for Q3 and Q4 of this year. For the second half, we're maintaining our development start and acquisition guidance of $900 million to $1.35 billion, that we've provided in connection with our equity offering. This includes $600 million to $800 million in development starts and $300 million to $550 million of acquisitions, principally in the funds.

We now expect dispositions and contributions to be $1.2 billion to $1.5 billion with roughly 75% coming off the balance sheet and 25% inside the funds. We're feeling good about this volume as we currently have north of $950 million of these dispositions closed under LOI or PSA or committed to by a fund. This is a $300 million increase from previous guidance driven largely by the U.S. Logistics Fund's intention and desire to acquire a substantial portion of the former SGP assets in the fourth quarter.

To wrap up, we feel really good about how things have come together in the merger process. We're highly focused on implementing the deleveraging strategy, and I cannot be prouder of the efforts put forth by the combined teams to bring all of this to fruition. With that, let me turn it back to the operator to open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from Ki Bin Kim with Macquarie.

Ki Kim - Macquarie Research

Going back to your comments on being more positive of hitting your higher end of the guidance for 2011. What gives you confidence that you'll hit that? Is it more on the operations side? Or is it cost of capital? Or can you give some more details kind of...

William Sullivan

Ki, this is Bill Sullivan. I think it's more operational. I really think it's focused on the fact that we're slightly ahead of our occupancy expectations at the end of the quarter, and we feel good, absent some nasty macro factor, but we feel pretty good about what's happening in the overall operations, and so we're really looking at that occupancy gain. The NOI that we'll lose from some of the disposition activity is really later of the year, it's more fourth quarter focused, but we feel good about hitting the top end of the guidance.

Operator

Your next question comes from Steven Frankel with Green Street Advisors.

Steven Frankel - Green Street Advisors, Inc.

Just a question on development, particularly with Japan, you guys continue to ramp up activity there. What do you think the ultimate pace could be in Japan? Is the future fund also going to include development opportunities within the fund itself?

Hamid Moghadam

Let me start and I'm sure Gary will have some comments on this. I think the opportunities we're seeing in Japan, simply stated, are today in excess of our capital-allocation abilities. In other words there is more profitable development opportunity in Japan than we feel comfortable allocating capital to, off the balance sheet. That's why the priority is on forming the Japan fund because really it's a tremendous market, particularly for post-earthquake where the benefits of modern facilities has become very evident to customers there. Gary?

Gary Anderson

100% right. There's a huge amount of functioning absolute space in Japan right now, and that trend that's been going on for last decade is continuing. The tragedy has actually accelerated the pace. You've got companies who are actually flying to quality facilities because there's a tremendous flight to quantity, and we're going to benefit from that. At the same time, what's happening is you're getting redundancy built into the supply chain. Companies, instead of having facilities just in Sendai, are also putting them in Sendai and Tokyo. The fact of the matter is that we got a fantastic development team in Japan. They've developed a huge chunk of the Class A space and a lot of this new development is going to nurture Prologis going forward.

Operator

Your next question comes from Paul Morgan with Morgan Stanley.

Paul Morgan - Morgan Stanley

Can you just talk a little bit about the -- your momentum in terms of discussions on build-to-suit as you kind of gradually ramp for this develop pipeline. You mentioned a little bit about sort of where you're seeing activity, but a little more color there, as well as the kind of space needs and the industries involved there?

Michael Curless

This is Mike Curless. We're seeing quite an uptick in build-to-suit activity, particularly in North America and Europe. In terms of North America we have some $300 million in proposals out, spanning over 10 proposals right now or a magnitude $400 million in Europe on a, call it, 50 proposals and particularly North America, this is a significant uptick compared to what we've seen in the last couple of years. I think it's largely driven by a few things, a lot more activity from our customers coming from the 3PL world, food business, e-commerce, retailers, we're seeing a lot of multi-market activity which is -- we think bodes well for us given our global footprint and our big development, that's across the country. And there's a real dirt of large product available right now that would otherwise have accommodated some of those large requirements in the past. So anyway, we'll continuing to see good activity in North America and Europe has been very active in terms of build-to-suits.

Operator

Your next question comes from Ross Nussbaum with UBS.

Ross Nussbaum - UBS Investment Bank

I'm trying to reconcile some of the disclosure on Page 12 of your supplemental, and in particular, the overall leasing activity for the combined company from Q1 to Q2 looks like it was up 6% nearly 35 million feet, but the same-store leasing looks like it was sequentially down by 1.8%, and I'm trying to reconcile sort of those numbers against the commentary on sort of where fundamentals are in 2Q.

William Sullivan

I mean, Ross, in combining the former completed and development portfolio for AMB, were leasing up in that development portfolio. You saw some of them strong leasing activity in Europe et cetera, and so the overall numbers don't surprise when we had good lease up in our development portfolio, nearly 1,400,000 square feet in the second quarter. And so I'm not sure there's much of a disconnect there.

Operator

Your next question comes from Sloan Bohlen with Goldman Sachs.

Sloan Bohlen - Goldman Sachs Group Inc.

Hamid, maybe a question for you just on the pace with regard to dispositions and how that seems to have picked up a little bit. Is that a function of the depth of the buyer market and I guess to that point, are more comfortable on the price or are the funding capabilities for those potential buyers have they improved? Maybe just add a little detail there.

Hamid Moghadam

I got to tell you, people continue to be very underallocated to industrial and there is been a short -- and there's a lot of pent-up demand because people haven't really filled those allocation in the last couple of years. Institutions because really nobody unless they had to sell has been selling any properties. So there's a lot of capital that is out there for industrial deals, and we have some very good quality properties. So they're just -- we have a lot of confidence that we can execute our plan, both in terms of pace and in terms of pricing.

Operator

Your next question comes from Michael Bilerman.

Michael Bilerman - Citigroup Inc

I have a request and a question. The request is Bill, you talked about the $0.38 of FFO Core basis for the quarter. It would be great if you can just provide a worksheet for the 2Q income statement that puts that together so that the Street and investors can model forward based on that income statement for the third and fourth quarters. In terms of the question, Hamid, I just wanted to come back to the equity raise that you completed and this is more of a question of timing. And I think that when you were doing the merger, and you and Walt both said, look, there's no noose around our neck, there's no need desperate need for capital. We want to move to a top 3 balance sheet, we want to be there, but there's immediate need to raise equity at what would be a bad price, and then a lot of the things that you had in progress, the fund formation, selling assets would be value enhancing, and clearly from the results perspective, you sort of had an inclination that you, yourselves, would be coming in ahead of plan. And so I guess why take, why do the step of raising a substantial net equity that you did, at a price that probably you would probably want to it higher at a later point if there was no immediate need, no debt covenant issues, nothing that would have caused it, and just wait?

Hamid Moghadam

Okay. I'll let Bill answer your first question and Walt and I will take a stab at the second question.

William Sullivan

Yes, hey Michael, putting out the pro forma's a complicated little exercise, but let me just give you some food for thought on that. First of all, in -- and when we file the 10-Q, we're going to have some condensed pro forma information, so I'd think you can get a little insight in that. It will not be as broad as anyone on this call would like. We'll also be filing a new prospectus to bring that up to speed in September. That will have a more detailed set of pro forma financials. But if you wanted to do sort of the back of the envelope, you could sort of take our numbers and account for the new share count and what you'll get is increased FFO representative of 463 million shares. You can go through the math, take AMB's first quarter, look at 2 month's worth of net data and add it to what you see in these reported results. PEPR just recorded -- reported their results today, take 2/3 of that, add it to these results, and you get a pretty good run rate on a line item basis. And the only thing you'd have to factor into that, really, just to get a big picture, is that we have G&A savings that are inert to the future. And so you'd reduce some of the G&A associated with that, but I think if you went and did the back to the envelope on that, you'd come to a pretty good run rate that gets you to $0.38 per share. And then take a look at that for future expectations.

Hamid Moghadam

Michael on the equity question, what we talked about before is what we've talked about consistently. The company did not have a need to raise equity. We have a couple of different dials available to us to delever, dispositions would be one, fund formations would be the other, and equity would be the third. So there was no desperate need. That wasn't like, the market was deteriorating and were running out to raise equity. There was no secret -- double secret plan to say one thing and do another thing. It was -- really the decision to do equity was that every conversation that we were having all it focused on was on equity. As opposed to, all the other aspects of our business plan, which as you can see now, and now that we've reported to have been going really well, both in terms of operations, private capital, all the other aspects of the business. So we have a pretty ambitious deleveraging plan ahead of us that requires a lot of fund formation and dispositions. If we are off on our timing, if we are off on our execution, I figure whatever we gave up on the equity raise will more than make up on the terms that we'll get on the other activities. And we can be very patient -- and patient and execute really well. Bill did you want to...

William Sullivan

I'd just add to that, Michael, from a risk management standpoint, again, we levered up to buy PEPR, in an environment where all of a sudden there was a lot of noise around the European debt crisis, the U.S. Government and extending the debt ceiling et cetera, et cetera. I believe it was incredibly prudent to raise the equity that we did, in light of sort of the overall macro factors. And to me, it's -- relative to the overall size of the company, it was sort of a non-event. And I think it's just risk management and prudence in that regard, and I'm very excited that we did it.

Hamid Moghadam

Walt, did you want to add anything there?

Walter Rakowich

No, well, I'll just also say, Michael, keep in mind that as Hamid said, there were so many discussions about equity that, in fact, over the 2 or 3-day period of time during they read our stock and following it quite substantially, and I think what we also said was, not at this price, it didn't make any sense. And it did rebound over the course of the next couple of weeks as well. So put all of that into context and I think we felt good about the decision we made.

Operator

Your next question from Suzanne Kim with Credit Suisse.

Suzanne Kim - Crédit Suisse AG

Just a little more color on the dispositions, you increased your guidance, I'm just trying to figure out a geographic breakdown of your disposition target. And also timing wise, I mean, are they weighted towards third or fourth quarter?

Michael Curless

This is Mike Curless. Typically our dispositions would have always been weighted towards the fourth quarter and as Sully mentioned, we have, right at $1 billion, we're in very good shape, we're either closed, under contract or committed. And I'd say in terms of geographical diversification, it's primarily in North America and Europe, and we feel comfortable that these numbers are going to come in well within guidance.

Operator

Your next question from John Guinee.

John Guinee - Stifel, Nicolaus & Co., Inc.

Can you repeat the information on the impairment charge again?

William Sullivan

Well the overall impairment charge was about $104 million. And the vast majority -- it really related to, really, 2 things, John, one of which was NA3, where we took a sizable write-down relative to what we think the recovery value is on the NA3 Fund. And again, I said, that was the vast majority of that charge. And the other was really related to a small incremental impairment relative to our Korea operations, which we've communicated the last 6 or so months we were going to exit. We hope to be exiting those activities in Q3.

Operator

Your next question from Steven Benyik with Jefferies & Company.

Steven Benyik - Jefferies & Company, Inc.

I guess, I was hoping you guys could provide some further breakdown on the $10 million in incremental mergers synergy in terms of how much is actually coming from G&A versus the lower line of credit costs or lower amortization and how much would ultimately flow through to cash flow?

Thomas Olinger

Steve, this is Tom, virtually all of the synergies will result in real cash savings. The incremental increase is really spread across all 3 of those items, between G&A related to personnel, non-personnel related, as well as the amortization of intangible -- or tangible assets, mostly fixed assets and IT assets, corporate infrastructure, lower amortization and some additional savings from fees associated with the lines. Not the interest savings, but just the fees, facility fees et cetera on the lines. So It's pretty well split between those all 3.

Operator

Your next question from Sri Nagarajan.

Srikanth Nagarajan - FBR Capital Markets & Co.

Sri Nagarajan of FBR. Just all eyes on Europe these days, perhaps you could quantify the impact of FFO on a full quarter run rate of PEPR there? As well as any impact on, say 1% in occupancy if you can.

William Sullivan

Well, on PEPR -- PEPR just released its second quarter earnings, and so you can go on that website and take a look at PEPR's results. And again we've consolidated it for one month -- during this quarter, approximately one month. And so I think you could just take sort of 2/3 of the PEPR results and add it to this component, you'll see the full quarter effect. Those are publicly disclosed numbers, I'm sorry, you can get from that aspect. Gary?

Gary Anderson

Yes, why don't I just give you a little bit of color on sort of what's happening in Europe in general to give you some tone. There's obviously been a lot of noise around the sovereign debt crisis and that may have led to some slower decision making, but the reality is if you step back and think about what's happening in Europe generally the positive trends, I think, is sort of undeniable values are stable to up, rents are stable to up, really almost across-the-board. Occupancies were up a 100 basis points last quarter, 230 basis points over the last 3 quarters. There's still limited supply and strong build in demand that we're taking advantage of. So all in all, aside from sort of the macro noise that you're hearing, we're feeling pretty good about the European marketplace.

Operator

Your next question from George Auerbach with ISI Group.

George Auerbach - ISI Group Inc.

Just a follow up on Michael's question, Bill, can you just provide us with a run rate cash NOI figure for the portfolio today at 90.7% occupancy, given the moving pieces of PEPR plus AMB plus SGP less the dispositions?

William Sullivan

Not off the top of my head. A lot of these pro forma questions et cetera, let us sort of regroup. We'll give our best shot guys. I mean, I guess, it's probably too late for your desires, but I mean, by Q3 this is going to be really clear. We'll put something together.

Operator

Your next question comes from Michael Mueller with JP Morgan.

Michael Mueller - JP Morgan Chase & Co

Bill, just a question about guidance in terms of clarifying it. I was under the impression that guidance had a full run rate of all the expected synergies in there, is that the case or is it just the synergies that are in place now?

William Sullivan

Well the guidance has -- how do I say this? The guidance has the synergies as we expect them to come through, and so we are -- we still have some duplicative costs in 2011 that go away in 2012. Those are in our G&A numbers as we incur them, so the vast majority of the transition costs are out, but we'll incur a modest amount of cost in 2011 that are in the G&A. So that G&A number will improve modestly overtime, but we're going to identify in a separate line item, which we'll add back to get to Core FFO. The transition and synergy costs associated with the people that are continuing to provide services that will ultimately go away, and hopefully then clears it up.

Operator

.

Your next question from Jeff Spector with Bank of America.

Jamie Feldman - UBS

This is Jamie Feldman, I'm here with Jeff. Hamid, can you give us a little bit more color on your commentary about restructuring some of the funds that you made in your prepared remarks? I just want to make sure I heard that correct. And also, if I did, can you talk about maybe any impact it may have on future earnings and kind of what funds you're talking about and the magnitude?

Hamid Moghadam

I'll start, then maybe Guy can fill in some of the details. So as we look at the combined Fund Management platform, I think the important message is that, I think it's unparalleled, certainly in the Investor Real Estate business. I would go further and say it's on unparalleled, and for any operating company and certainly in the top 3 or 4 Global Fund Management platforms around. So it's really a good business and we think it's going to be powerful growth engine for the company and you saw evidence of that yesterday in terms of what happened over in Oregon, and I think we're just getting warmed up. So that's the big comment. In order to get there, these companies started in the Fund Management business in different ways from different directions with different needs. And it's really, really important when you're in this business, that you treat all your investors consistently and you operate your portfolio with no bias towards one fund versus another, or your balance sheet assets. So really the first thing you heard from me is that we're going to run everything, we don't have favored children, all our children we love equally, and all our funds are going to be run as one portfolio, because the power is in the platform and the scale of the platform. Secondly, we are not in the business of providing Fund Management services for free or at a loss, so to the extent that the proper cost -- we don't expect to make a lot of money, by the way, in our ongoing asset management business, we expect to cover our costs, but not make a lot of money. Our real money is made in our per months and our incentive fees. But to the extent that there are relationships in place, that either don't pay sufficient funds or have owner risks oversight and guidance, they want to micromanage an operating company, for example, we will modify these arrangements or move on in a very thoughtful and respectable manner to investors so that everybody's interests are protected. And we are in the midst of a lot of that dialogue. We also have certain platforms around the world where we have multiple funds that before we're competing with one another. There will be some level of overlap between some of the funds, although our strategies can be somewhat differentiated between these funds. But as differentiated as they may be, there could be smaller areas of overlap, and we have put in place an allocation process that has been good -- well articulated and communicated in terms of how assets are allocated between these funds. So basically, that's where it all falls together. In terms of what it all means for the business, it means that we could shrink by a few billion dollars, and I mean a few, like $1 billion or $2 billion, before we start growing by a lot more than that going forward in the management business. Guy, please?

Guy Jaquier

Yes, just a couple other comments. One is that, there's certain funds where we don't have the discretion we want to run the assets the way we want to do it. So if you think about it where we have a number of different assets, we're trying to lease them, and one building we have to go to a partner and get approval to sign a lease. That just creates problems for us. Similarly, if you want to go build out PIs and with one partner, we have to get a special type of contractor to build out PIs, it just becomes very inefficient for us. There are also some funds that are -- over the next couple years going to be close end funds that are nearing the end of their life. And we're in discussions to either liquidate those funds or potentially roll those funds into other funds. So I think it's a little early to speculate on which ones, how many and all that. But suffice to say in our guidance, we're really not projecting any future efficiencies or synergies from some fund consolidations.

Operator

Your next question comes from Paul Morgan with Morgan Stanley.

Chris Canton

It's Chris Canton on with Paul. Just a follow-up question on expected fund contributions over the course of next 18 months. I mean you mentioned your payment is your highest priority, I'm wondering what else is high on the list. And also, how will the assets be valued in Japan contribution and with respect to PEPR will you have an opportunity for a new appraisal on those assets?

Hamid Moghadam

Okay, the priorities are -- the biggest priorities are Japan. At some point we need to do something with our platform in Canada. Brazil, we have one fund in place and we're being very successful in almost going through that. I think we have, maybe another couple of quarters of traversing [ph] that fund, the business is going very well there. So we'll be thinking about Brazil too at some point. Obviously PEPR is premature to talk about, because PEPR is still a public company and has other shareholders in it, but at some point that could become a priority. And remember, we have these evergreen vehicles in terms of the open-end funds that are going to be raising capital and growing and they're going to have a dynamic business plan. So all of those are priorities. The other platform, and this goes back some time, but you remember that we did the [indiscernible] fund in Mexico. Our business in Mexico is going quite well. It's at the higher scale now, and at some point we need to start thinking about the next vehicle for Mexico or an expansion of the existing vehicle. So -- but I would say, Mexico and Canada are probably 2012 priorities, end of 2012 priorities. The real emphasis is Japan now for the next 12 months, and the open-end funds. Guy, do you want to add to that?

Guy Jaquier

Yes. And then the second part of your question is, any fund contributions will be done at fair market value. I mean any time we're transferring asset off our balance sheet into a fund, we do have to get third party appraisals and there's a review process, but it's basically a fair market value.

Hamid Moghadam

And there is independent oversight on that.

Guy Jaquier

Correct.

Operator

Your next question from Michael Bilerman.

Michael Bilerman - Citigroup Inc

In terms of the split of the portfolio that you provide on Page 22, this was the old Prologis summary where you break it out between greater than 75% leased, and under 75% leased, and clearly those above 75% are basically almost full, it's really that the stuff that was developed and came into the core portfolio not fully leased. And so I'm just curious, when you look at that 45 million square feet, it's almost $3 billion of value. There's obviously a lot less to lease in that portfolio. And so, I mean, could you talk a little bit about the developments coming in line in the back half of the year, but how should we think about this $3 billion of real estate? Does this represent a lot of those non-core markets that you want to get out of? How much of it's really core assets that you really want to see the leasing get up, and in terms of then the timing of that happening.

William Sullivan

Michael, let me try to take that. I think it's pretty well spread in terms of what the 45 million square feet represents. But in my guidance, it's -- I can get back to you guys on what the spread is. But when I look at it -- and the reason we didn't put the NOI in there effectively was because with that portfolio or that set of assets in its current leasing status, it's really eating operating costs today, and so it's really tough to get to the pro forma. And to put things in perspective, there's about 32 million of the 45 million square feet that are in the Americas, about 12 million in Europe, and about 1 million in Asia. And if you -- when we looked at it in terms of -- and we put out here average investment balance per square foot of $62, that's about $55 a foot in the Americas, about $73 a foot in Europe and $140 a foot in Asia, which obviously, is Japan-focused. And then in that, some of the major -- some of these assets are in the major markets. It's heavily weighted towards northern New Jersey and New York, and Dallas, Southern California, Chicago, et cetera. And so from a per square foot basis, we're pretty comfortable that there's value there.

Operator

Your next question from Dave Rodgers with RBC Capital Markets.

David Rodgers - RBC Capital Markets, LLC

In the context of selling stabilized assets, redeploying some or most of that capital, maybe through development in the coming years and taking into consideration your comments about lower fund capital maybe for just a year or 2, where's your fixed charge coverage today, and I guess where would you like to keep that on a combined basis? If it was in the packet, I didn't see it and so I apologize.

William Sullivan

Yes, I think -- again when you look at those numbers we have here, because we all have the debt at the end, but we don't have the full quarter of operations, we want the fixed charge coverage -- count, it's just one more detail count you guys would go through with me and ask me on a fixed life. Today it's slightly north of 2x in the grand scheme of things. We've clearly indicated we want that fixed charge coverage count to be in the 2.5x to 3x. When you look at the debt reduction expectations we have throughout 2012, we will be there and we feel real good about that.

Operator

Your next question from John Guinee.

John Guinee - Stifel, Nicolaus & Co., Inc.

Quick question [indiscernible] operating numbers, it looks to me like going forward including some lease up, you ought to expect about 17% of the portfolio coming up for re-lease every year. And maybe, TI, leasing commission and base building CapEx coming in at about 12% of cash NOI, are those good numbers going forward?

Hamid Moghadam

We think so. They've been pretty steady if you look at these companies. The reason we provided it, it was a new disclosure, is because when you get to 600 million feet, those numbers are remarkably stable. So that's the way we should really look at this company as top down. Thank God, we don't have to get into what's going on in San Francisco on the third quarter on a 400 square-foot lease. So this is really good to look at it top down. And I had -- the 2 metrics I would look at is on releasing cost, looking at per square foot numbers, those are reliable, and then the percentage of NOI that's going to CapEx, which includes building improvements. Those are the 2 metrics I'd look at.

William Sullivan

Again, if you look at the CapEx number, it's over the [indiscernible], basically you're looking at 15% to 16%, again, reflecting CapEx. And John, the 12% maybe a sort of at the high-end of the -- I'd think about a 10% to 12% of NOI.

John Guinee - Stifel, Nicolaus & Co., Inc.

Okay, and Bill, one other question, just -- how on earth did the Lehman Fund impairment charge get kicked down the block for 2 or 3 years then come up post-merger?

William Sullivan

Well candidly, if you went back, John, and looked at a disclosure we had back in January of 2010, over -- where we talked about -- now this was public information, we put a Slide in one of the investor presentations that we put out on our website that identified our over-levered funds, okay? And at that point, we talked about the Eaton Vance funds NA2 and NA3. And at that point in time, we said, look, we think -- and you can go through the math on that slide, and you'll see the magnitude of what our carrying value was below fair market value. And our point in discussion at that time was, we think values are going to recover, these are long-term holds relative to NA2 and NA3. We took the impairment of that time relative to Eaton Vance because we highly focused on exiting those funds and did not believe values would come back in an appropriate timeframe. As we now fast forward to mid 2011, and we look at NA2 as an example, that value has come back strongly. And in fact, it's at or above carrying value. And so we feel really good about that. When you look at NA3, it's much more heavily focused and [indiscernible] in Las Vegas and Reno than value trajectory just hasn't come back at the same fashion. And candidly, we talked about some of these funds we're not getting the appropriate management fees or there's issues and complications of what to do with the fund, NA3 is certainly a poster child for that. And it's time to deal with the issue.

Operator

Your next question comes from Jeff Spector with Bank of America.

Jeffrey Spector - BofA Merrill Lynch

Hamid, I appreciate your comments earlier talking about the rapid pace of inventory rebuilding we've seen. And I just wanted to see if you could talk a little bit more about that going forward, and how investors can get comfortable that, that will continue?

Hamid Moghadam

It's probably that you guys are tired of hearing me talk about this because I've been talking about it for over a year going back to our Analyst Meeting in September, in New York. But inventories were down from the peak about 8% at the trough. And through the first quarter, we were more than 4% recovered from that, so more than halfway back. The preliminary numbers, and as you know, those numbers are lagging. But that's sort of the first quarter's latest numbers we have. But based on some of the monthly numbers that are highly correlated with the inventory number, we think we've gained another point or 2, and therefore we're going to -- if we add the data today, we'd say that we're back about 6 of those 8 points. And so we think we are 75% back, and it's not a big prediction to know that we're going to get back to normal because the retailers were just running too lean and it was not sustainable. Also, as you heard me say, population is almost 10 million people more and while employment is a real issue and has a dampening effect on consumption, the fact is a lot of the things that go through our warehouses are highly non-discretionary, and correlated with population growth. So I don't think it's a big stretch or a leap to call a full recovery of the inventory number. Also we're seeing the air freight numbers normalize, and airfreight as you've heard me say before, is a very good early indicator of people running very lean on inventories because they miss sales and they got it airfreighted in. So airfreight is normalizing, which means it's growing, but growing at a more normal pace as oppose to a crazy pace like a year ago. So all those and different things point to inventories getting somewhat more normalized, and that sort of 8% rebound in restocking really overwhelms the difference between a 3% GDP growth, and a 2% GDP growth, which is what everybody wants to talk about. So in terms of the driver of our business, it's really inventory levels. And ultimately, once we get to a normalized level, we're right along with GDP, but we got a ways to go before we get on that track.

Operator

Your next question from George Auerbach with ISI Group.

George Auerbach - ISI Group Inc.

Bill, the spreads in the quarter were down 6% on renewal leasing, what are your expectations for the rest of the year, and 2012 for renewal spreads?

William Sullivan

I think it's better -- I mean, I can go through them, but I think it's better for Hamid have the operating growth along through the renewal spreads.

Guy Jaquier

Yes, sure. George, as Ed mentioned at the beginning, it's really difficult to reconcile these numbers with the Legacy Prologis or AMB, so there's some noise in there. But first of all, I'd suffice it to say, that our same-store numbers and the rent spreads are -- came in better than expected. And the out performances is probably impacted somewhat on definitional changes, but it's better than expected and we think it's going to continue. Now you've heard us talk in the past on the AMB side, when we see that turning positive and how many years are we out there. I'm not going to give you an estimate to what's going to happen this year because frankly, we have a lot of work to do on the numbers. But I think those spreads are going to turn positive, my guess would be sort of towards to the end of the next year, which is a different outlook than you'd hear me say at a quarter ago or so.

Hamid Moghadam

And just to be clear that outlook is not only different, it's better than our previous outlook because of this. And we think that the definitional changes maybe account for about half of the improvements, but half the improvements are real. So -- and you just kind of have to bear with us for about a quarter before we scrub all those numbers and can present them in a totally comparable...

William Sullivan

And they're directly comparable, of course, to Legacy Prologis.

Operator

Your last question is from Ki Bin Kim with Macquarie.

Ki Kim - Macquarie Research

Just 2 quick questions. One, about going back to your fund free structures. Could you talk a little bit more about what the fee structures looked like in the past and what it looks like today, in terms of manual fees, and also promote feelings? And last quick one, any change your mark-to-market on land inventory after the merger?

Hamid Moghadam

Well, Bill, why don't you talk about the land? And Guy, you can talk about the funds.

William Sullivan

Let me -- Ki, just touch on the land. We had a little bit of a decrease in the carrying value of historic [indiscernible] the land, and that really relates to -- when you look at an impairment analysis that you would go through is different than a fair market value analysis on the overall portfolio of land, because if you're going to hold land for future development, it's incredibly tough to, in essence, compare it, okay? Because you'd go through this kind of cash flow and this land worth, it's valued at a 0% return, et cetera. And in fair market value analysis, clearly you and put in the development profit and whatnot. But I would say this, it's too -- we have to scrub the whole purchase accounting analysis in detail in the upcoming weeks. And certainly, we intend to scrub it thoroughly by the end of August. And so the valuations are going to move around a little bit, undoubtedly, as we scrub through that detail. I think it's a better question to address when we get to the end of Q3, because by that time I expect we would have very little future movement in that valuation analysis .

Guy Jaquier

And relative to your question on where market fees are, in gross asset value they're somewhere between 60 and 75 basis points with some quantity discounts for larger investors. Commenting on promotes, it's really -- it really depends on the fund and objectives of the fund, depends on what level of leverage you have, whether it's a core fund or it's a development fund. But round numbers, it's somewhere 15% and 20% profits over the appropriate benchmark.

Hamid Moghadam

I'd like to thank all of you for participating in this Conf Call. And to summarize, Walt and I are pleased with the results for the quarter which are modestly ahead of our expectations. We're very proud of the fact that our teams were able to accomplish all this despite of all the pressures and distractions of the merger, which are thankfully behind us. We're very appreciative of the efforts of our talented teams around the globe and are excited about what the rest of the year holds for the company. I also want to emphasize the 3 key takeaways from today's call. First, while we still have a lot of work cut out for us, our overall progress on integration is on target, and actually ahead of plan in most cases. Second, from what we can see the recovery in our business is also on track. We continue to lookout for signs of a slowdown, but frankly, we don't see it. And third, we're just beginning to unlock the full potential of the new Prologis and are excited about our prospects. That you again, for joining us for our inaugurary [ph] call, and we look forward to reporting back to you next quarter.

Operator

That concludes today's conference. Thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Prologis' CEO Discusses Q2 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts