For The Fiscal Year Ended December 31, 2004
Table of Contents
Index to Financial Statements

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-K

 


 

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2004

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission file number 1-14516

 


 

PRENTISS PROPERTIES TRUST

(Exact name of registrant as specified in its charter)

 


 

Maryland   75-2661588

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

3890 West Northwest Highway,

Suite 400, Dallas, Texas

  75220
(Address of Registrant’s Principal Executive Offices)   (Zip Code)

 

(214) 654-0886

(Registrant’s telephone number, including area code)

 


 

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

 

Title of each class


 

Name of each exchange on which registered


Common Shares of Beneficial Interest,

par value $.01 per share

  New York Stock Exchange, Inc.
Preferred Share Purchase Rights   New York Stock Exchange, Inc.

 

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

 

None

(Title of class)

 


 

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  x    No  ¨

 

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.  x

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).    Yes  x    No  ¨

 

As of June 30, 2004, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $1,387,303,301.

 

As of March 14, 2005, the number of Common Shares of Beneficial Interest outstanding was 45,188,482 and the number of outstanding Participating Cumulative Redeemable Preferred Shares of Beneficial Interest, Series D, was 3,773,585.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III incorporates by reference the Company’s Definitive Proxy Statement to be filed with respect to the Annual Meeting of Shareholders to be held on May 11, 2005.

 



Table of Contents
Index to Financial Statements

PRENTISS PROPERTIES TRUST

 

INDEX

 

Item No.


   Form 10-K
Report
Page


Forward-Looking Statements    3
PART I     
1.    Business    4
2.    Properties    9
3.    Legal Proceedings    17
4.    Submission of Matters to a Vote of Security Holders    17
PART II     
5.    Market for Company’s Common Equity and Related Shareholder Matters    18
6.    Selected Financial Data    20
7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    23
7A.    Quantitative and Qualitative Disclosures About Market Risk    63
8.    Financial Statements and Supplementary Data    64
9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    64
9A.    Controls and Procedures    64
PART III     
10.    Trustees and Executive Officers of the Company    65
11.    Executive Compensation    65
12.    Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters    65
13.    Certain Relationships and Related Transactions    65
14.    Principal Accountant Fees and Services    65
PART IV     
15.    Exhibits, Financial Statement Schedules, and Reports on Form 8-K    65
Signatures    72

 

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Index to Financial Statements

FORWARD-LOOKING STATEMENTS

 

This Form 10-K and the documents incorporated by reference into this Form 10-K may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. When used in this Form 10-K, words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “predict,” “project,” and similar expressions, as they relate to us or our management, identify forward-looking statements. Such forward-looking statements are based on the beliefs of our management as well as assumptions made by us and information currently available to us. These forward-looking statements are subject to certain risks, uncertainties and assumptions, including risks, uncertainties and assumptions related to the following:

 

   Our failure to qualify as a REIT under the Internal Revenue Code of 1986, as amended;       Competition in markets where we have properties;
   Possible adverse changes in tax and environmental laws, as well as the impact of newly adopted accounting principles on our accounting policies and on period-to-period comparison of financial results;       Our dependence on key personnel whose continued service is not guaranteed;
   Potential liability for uninsured losses and environmental contamination;       Changes in our investment, financing and borrowing policies without shareholder approval;
   Our properties are illiquid assets;       The effect of shares available for future sale on the price of common shares;
   Factors that could result in the poor operating performance of our properties including tenant defaults and increased costs such as taxes, insurance, utilities and casualty losses that exceed insurance limits;       Limited ability of shareholders to effect change of control;
   Changes in market conditions including market interest rates and employment rates;       Conflicts of interest with management, our board of trustees and joint venture partners could impact business decisions;
   Our incurrence of debt and use of variable rate and derivative financial instruments;       Our third-party property management, leasing, development and construction business and related services;
   Our real estate acquisition, redevelopment, development and construction activities;       Risks associated with an increase in the frequency and scope of changes in state and local tax laws and increases in the number of state and local tax audits;
   The geographic concentration of our properties;       Cost of compliance with the Americans with Disabilities Act and other similar laws related to our properties; and
   Changes in market conditions including capitalization rates applied in real estate acquisitions;       Other risk factors identified herein;

 

If one or more of these risks or uncertainties materialize, or if any underlying assumption proves incorrect, actual results may vary materially from those anticipated, expected or projected. Such forward-looking statements reflect our current views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or individuals acting on our behalf are expressly qualified in their entirety by this paragraph. You should refer to the section entitled “Risk Factors” beginning on page 51 of this Form 10-K for a discussion of risk factors that could cause actual results to differ materially from those indicated by the forward-looking statements. You are cautioned not to place undue reliance on our forward-looking statements, which speak only as of the date of this Form 10-K or the date of any document incorporated by reference into this Form 10-K. We do not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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Index to Financial Statements

PART I

 

Item 1. Business

 

Overview

 

We are a self-administered and self-managed Maryland REIT. We acquire, own, manage, lease, develop and build primarily office properties throughout the United States. We are self-administered in that we provide our own administrative services, such as accounting, tax and legal, internally through our own employees. We are self-managed in that we internally provide all the management and maintenance services that our properties require through employees, such as, property managers, leasing professionals and engineers. We operate principally through our operating partnership, Prentiss Properties Acquisition Partners, L.P. and its subsidiaries, and two management service companies, Prentiss Properties Resources, Inc. and its subsidiaries and Prentiss Properties Management, L.P. The ownership of the operating partnership was as follows at December 31, 2004:

 

2004

(units in thousands)


  

Common

Units


   %

   

Series D

Convertible

Preferred

Units


   %

 

Prentiss Properties Trust

   45,063    97.12 %   3,774    100.00 %

Third Parties

   1,335    2.88 %   —      0.00 %
    
  

 
  

Total

   46,398    100.00 %   3,774    100.00 %
    
  

 
  

 

As of December 31, 2004, we owned interests in a diversified portfolio of 133 primarily suburban Class A office and suburban industrial properties as follows:

 

    

Number of

Buildings


  

Net Rentable

Square Feet(1)


          (in millions)

Office properties

   106    17.5

Industrial properties

   27    2.2
    
  

Total

   133    19.7
    
  

(1) Includes 100% of the net rentable square feet of our wholly-owned, consolidated joint venture and unconsolidated joint venture properties, which totaled 17.2 million, 989,000 and 1.6 million, respectively. Our pro rata share of net rentable square feet totals 18.4 million and includes 504,000 and 669,000 from our consolidated and unconsolidated joint venture properties, respectively.

 

As of December 31, 2004, our properties were 88% leased to approximately 950 tenants. In addition to managing properties that we own, we manage approximately 9.8 million net rentable square feet in office, industrial and other properties for third parties.

 

Our primary business is the ownership and operation of office and industrial properties throughout the United States. Our organization which includes approximately 475 employees consists of a corporate office located in Dallas, Texas and five regional offices each of which operates under the guidance of a member of our senior management team. The following are the 10 markets in which our properties are located with the first market being the location of each regional office:

 

Region


  

Market


Mid-Atlantic    Metropolitan Washington, DC
Midwest    Chicago, Suburban Detroit
Southwest    Dallas/Fort Worth, Austin, Denver
Northern California    Oakland, Silicon Valley
Southern California    San Diego, Los Angeles

 

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Index to Financial Statements

We have determined that our reportable segments are those that are based on our method of internal reporting, which disaggregates our business based upon our five geographic regions. For revenues, income from continuing operations and total asset information on each of our segments, see Note (19) to our Consolidated Financial Statements.

 

Recent Developments

 

On January 13, 2005, Prentiss Office Investors, L.P. completed a five-year interest rate swap agreement in a notional amount of $20.0 million. The interest rate swap effectively locks 30-day LIBOR at 4.00% on $20.0 million of our variable rate borrowings. The interest rate swap is effective February 1, 2005 and matures February 1, 2010.

 

On February 14, 2005, Prentiss Office Investors, L.P., which is owned 51% by our operating partnership and its affiliates and 49% by Stichting Pensioenfonds ABP, acquired from an unrelated third party, a two building office complex with approximately 197,000 net rentable square feet. The properties are located in Herndon, Virginia and were acquired for gross proceeds of $51.5 million. Each partner contributed their pro rata share of the purchase price to Prentiss Office Investors, L.P. for the acquisition. Amounts contributed from the operating partnership were funded with proceeds from our revolving credit facility.

 

On March 10, 2005, we entered into a Purchase Agreement pursuant to which a trust, which was formed by us on February 24, 2005 (the “Trust”), will issue $26,250,000 and $25,000,000 of trust preferred equity securities (the “Capital Securities”) to each of Taberna Preferred Funding I, Ltd. and Merrill Lynch International, respectively in a private placement pursuant to an applicable exemption from registration. The transactions contemplated by the Purchase Agreement will occur on or before March 15, 2005. The Capital Securities will mature on March 30, 2035 (all dates listed in this summary assume a closing date of March 15, 2005), but may be redeemed at our option beginning on March 30, 2010. The Capital Securities will require quarterly distributions by the Trust to the holders of the Capital Securities, at a variable rate which will reset quarterly at the LIBOR rate plus 1.25%. Distributions will be cumulative and will accrue from the date of original issuance but may be deferred by us for up to 20 consecutive quarterly periods.

 

The proceeds of the Capital Securities received by the Trust, along with proceeds of $1,586,000 received by the Trust from the issuance of common securities (the “Common Securities”) by the Trust to Prentiss Properties Limited, Inc., a company subsidiary, will be used to purchase $52,836,000 of junior subordinated notes (the “Notes”), to be issued by Prentiss Properties Acquisition Partners, L.P. pursuant to an indenture (the “Indenture”) to be entered into, as of the closing date provided above, between Prentiss Properties Acquisition Partners, L.P. and JPMorgan Chase Bank, N.A., as trustee.

 

The Notes will mature on March 30, 2035, but we may redeem the Notes, in whole or in part, beginning on March 30, 2010 in accordance with the provisions of the Indenture. The Notes bear a variable rate which will reset quarterly at the LIBOR rate plus 1.25%. Interest is cumulative and will accrue from the date of original issuance but may be deferred by us for up to 20 consecutive quarterly periods.

 

Business and Growth Strategies

 

Our primary objective is to maximize shareholder value through increases in distributable cash flow per share and appreciation in the value of our common shares. We intend to achieve this objective through a combination of external and internal growth, while maintaining a conservative balance sheet and pursuing a strategy of financial flexibility.

 

External Growth

 

Acquisitions

 

Acquisitions are a key component of our external growth strategy. We selectively pursue acquisitions in our core markets when long-term yields make acquisitions attractive.

 

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Index to Financial Statements

We invest opportunistically and pursue assets that are:

 

    managed by us and owned by our existing management clients which become available for sale;

 

    performing at a level believed to be substantially below potential due to identifiable management weaknesses or temporary market conditions;

 

    encumbered by indebtedness that is in default or is not performing;

 

    held or controlled by short-term owners (such as assets held by insurance companies and financial institutions under regulatory pressure to sell);

 

    contain below market leases, which may be re-leased in the near term to improve cash flow;

 

    have good long-term growth prospect; or

 

    are consistent with our product and market strategies.

 

We believe that we are particularly well-positioned to acquire properties because of our:

 

    presence in and knowledge of our 10 markets across the United States;

 

    a diversified base of approximately 950 tenants;

 

    existing relationships with 23 different third-party management clients;

 

    access to capital as a public company, including our revolving credit facility;

 

    reputation as a buyer with the ability to execute complicated transactions;

 

    fully-integrated operations which allow rapid response to opportunities;

 

    UPREIT structure, whereby sellers may contribute properties in exchange for units in our operating partnership in a tax deferred transaction; and

 

    relationships with real estate brokers, institutional owners, and third-party management clients, which often allow preferential access to opportunities.

 

In evaluating potential acquisition opportunities, we rely on the experience of our employees and on our internal research capabilities in considering a number of factors, including:

 

    macro-economic issues that impact the market in which the property is located;

 

    location and competition in the property’s market;

 

    occupancy of and demand for properties of a similar type in the same market;

 

    the construction quality and condition of the property;

 

    the potential for increased cash flow after benefiting from our renovations, refurbishment and upgrades;

 

    purchase price relative to replacement costs; and

 

    the potential to generate revenue growth at or above levels of economic growth in the property’s market.

 

Further, we believe that our development expertise enables us to identify the potential for improvement in an acquisition opportunity, which might not be apparent to a buyer without similar expertise.

 

During the year ended December 31, 2004, we acquired, from unrelated third parties, 8 office buildings totaling approximately 2.3 million net rentable square feet. The following table sets forth the segment, market, month of acquisition, number of buildings, net rentable square feet and acquisition price of the buildings acquired. See “Item 2. Properties” for additional information relating to our properties.

 

Acquired Properties


  

Segment


  

Market


  

Month of

Acquisition


  

Number of

Buildings


  

Net Rentable

Square Feet(1)

(in thousands)


  

Acquisition

Price(2)

(in millions)


Cityplace Center    Southwest    Dallas/Ft. Worth    April 2004    1    1,296    $ 123.3
The Bluffs(3)    Southern Calif.    San Diego    May 2004    1    69      17.7
5500 Great America Parkway    Northern Calif.    Silicon Valley    May 2004    3    306      34.8
2101 Webster    Northern Calif.    Oakland    Oct. 2004    1    459      65.7
Lakeside Point I & II(3)    Midwest    Chicago    Oct. 2004    2    198      32.6
                   
  
  

                    8    2,328    $ 274.1
                   
  
  


(1) Net rentable square feet defines the area of a property for which a tenant is required to pay rent, which includes the actual rentable area plus a portion of the common areas of the property allocated to a tenant.

 

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Index to Financial Statements
(2) Acquisitions were funded with proceeds from our revolving credit facility, debt assumption, property sales and proceeds generated from the sale of common shares.
(3) Acquisitions were acquired by Prentiss Office Investors, L.P. Prentiss Office Investors, L.P. is owned 51% by our operating partnership and 49% by Stichting Pensioenfonds ABP, an unrelated third party. The net rentable square feet and acquisition price is presented at 100%. Each partner contributed their pro rata share of the purchase price of each property to Prentiss Office Investors, L.P. prior to acquisition.

 

On July 15, 2004, we acquired from an unrelated third party, approximately 7.7 acres of land in Del Mar, California for gross consideration of $15.1 million. The acquisition was funded with proceeds from our revolving credit facility.

 

Development

 

Similar to acquisitions, development is another key component of our external growth strategy. We intend to capitalize on our development capabilities by selectively developing and redeveloping properties in markets with favorable current and projected long-term growth characteristics and supply-demand imbalances. We control all aspects of the development process, including site selection, project concept, design and construction, financing, leasing and property management. We intend to develop primarily office properties with levels of pre-leasing appropriate for market conditions.

 

In evaluating potential development opportunities, we rely on the experience of our employees and on our internal research capabilities in considering a number of factors, including:

 

    macro-economic issues that impact the market in which the development is to be located;

 

    location and competition in the property’s market;

 

    occupancy of and demand for properties of a similar type in the same market; and

 

    the potential to generate revenue growth at or above levels of economic growth in the property’s market.

 

During the year ended December 31, 2004, we began construction of a two building, 158,000 net rentable square foot Class A office project located in Del Mar, California. The project which is currently 50% pre-leased is expected to be completed in July 2005 for an estimated project cost of approximately $48.1 million. The project is owned by Prentiss/Collins Del Mar Heights, LLC, a consolidated joint venture which is owned 70% by our operating partnership and 30% by Collins Corporate Center, LLC, an unrelated third party.

 

Internal Growth

 

We seek to maximize the profitability of our properties by renewing leases, maintaining high occupancy rates, increasing rental revenues, and reducing operating costs.

 

We strive to achieve increases in rental revenues by negotiating leases that include increases in rent during the lease term, by replacing expiring leases with new leases at higher rental rates and by improving occupancy rates. We also seek to renew existing leases, which reduces the costs of lease rollovers, reduces rental revenue fluctuations and enhances long-term relationships with national tenants that may have space needs in our other markets.

 

We strive to achieve reductions in operating costs by performing many functions, e.g., engineering, tax and legal, in-house instead of hiring third parties and by employing both internal and external benchmarking and best practices methodologies. Our benchmarking program compares operating costs and efficiencies of each property with other office and industrial properties. Under the program, we conduct periodic evaluations of key performance indicators at each building and compare the results to a variety of benchmarks, e.g., specific buildings, portfolios, regions and the industry. Our best practices methodology involves continuously analyzing benchmarking data,

 

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Index to Financial Statements

investigating properties that perform better than the norm and regularly disseminating and sharing information with respect to the best practices employed at the better performing properties throughout our management system. By employing these methodologies, we believe that we can continue to capitalize on opportunities to reduce operating costs and operate the properties more efficiently and effectively.

 

We use centralized cash management, national alliances with service providers, a sophisticated budgeting system and state-of-the-art information systems to improve efficiency and increase profits.

 

Asset managers in each region develop a strategy and marketing position for each property. Each property is evaluated using sophisticated valuation software to determine the overall effect of property-level decisions such as lease structures and capital expenditures on asset value. Asset managers also work with property managers and engineers to determine where improvements, such as lighting retrofits and energy management system upgrades, will maximize returns.

 

Third-Party Management

 

At December 31, 2004, we, through our subsidiaries, managed or performed property-related services for 158 office, industrial and other properties owned by 23 third-party management clients. These properties are located throughout the United States and contain approximately 9.8 million net rentable square feet.

 

Our management business serves a broad base of clients, including major financial institutions and pension funds, large corporate users, real estate advisory firms and real estate investment groups. In addition to property management and leasing, we offer our clients a full range of fee-based services, including tenant construction, leasing, insurance, accounting, tax, acquisition, disposition, facilities management, and corporate and asset management services.

 

Competition

 

We operate in five regions: Mid-Atlantic, Midwest, Southwest, Northern California and Southern California and compete with many local, regional and national competitors in the office and industrial sectors. These five regions comprise 10 markets nationwide. The markets in which we operate are not dominated by any one owner or by us. In each market we compete on a number of factors including rental rates, tenant concessions, quality and location of buildings, quality of property management, and other economic and non-economic factors. Our competitors may have greater financial resources than are available to us and/or they may be willing to rent space at lower rental rates or provide greater leasing concessions. Our major competitors in each region include the following companies:

 

Segment


  

Competitors


Mid-Atlantic    Boston Properties, CarrAmerica Realty Corp., Corporate Office Properties Trust, Equity Office Properties, Trizec Properties, Inc., Vornado Realty Trust
Midwest    CarrAmerica Realty Corp., Duke Realty Corp., Equity Office Properties, Hines, John Buck Co., Marvin Herb, Tishman Speyer, Transwestern, Trizec Properties, Inc.
Southwest    CarrAmerica Realty Corp., Crescent Real Estate Equities, Equity Office Properties, Lincoln Property Co., Trammell Crow Co., Trizec Properties, Inc.
Northern California    Boston Properties, CarrAmerica Realty Corp., Equity Office Properties, RREEF, Shorenstein Co.
Southern California    Arden Realty, CarrAmerica Realty Corp., Equity Office Properties, Kilroy Realty Corp., Lowe Enterprises, RREEF

 

Corporate Governance

 

We have implemented the following corporate governance initiatives to address certain legal requirements promulgated under the Sarbanes-Oxley Act of 2002, as well as the New York Stock Exchange corporate governance listing standards:

 

    Our board of trustees determined that Ronald G. Steinhart, Dr. Leonard M. Riggs, Jr. and Barry J.C. Parker each qualify as an “audit committee financial expert” as such term is defined under Item 401 of Regulation S-K. Our board of trustees has also made an affirmative determination that each of Messrs. Steinhart, Riggs and Parker is “independent” as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act;

 

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Index to Financial Statements
    Our audit committee established “Audit Committee Complaint Procedures” for the receipt, retention and treatment of complaints regarding accounting, internal accounting control or auditing matters, including the anonymous submission by employees of concerns regarding questionable accounting or auditing matters.

 

    Our board of trustees updated our Code of Conduct to comply with the Sarbanes-Oxley Act of 2002 and the listing standards of the New York Stock Exchange. Our Code of Conduct governs business decisions made and actions taken by our trustees, officers and employees. A copy of this Code is available on our website at http://www.prentissproperties.com and we will disclose on this website any amendment to or wavier of any provision of the Code applicable to our trustees and executive officers that would otherwise be required to be disclosed under the rules of the SEC or the New York Stock Exchange. A copy of the Code is also available in print to any shareholder upon written request addressed to Investor Relations, Prentiss Properties Trust, 3890 West Northwest Highway, Suite 400, Dallas, Texas 75220.

 

    Our board of trustees established an Ethics Hotline that employees may use to anonymously report possible violations of the Code of Conduct, including concerns regarding questionable accounting, internal accounting controls or auditing matters.

 

    Our board of trustees has established and adopted charters for each of its Audit, Compensation and Nominating and Corporate Governance Committees. Each committee is comprised of three (3) independent trustees. A copy of each of these charters is available on our website at http://www.prentissproperties.com and is available in print to any shareholder upon written request addressed to Investor Relations, Prentiss Properties Trust, 3890 West Northwest Highway, Suite 400, Dallas, Texas 75220.

 

    Our board of trustees has adopted Corporate Governance Guidelines, a copy of which is available on our website at http://www.prentissproperties.com and is available in print to any shareholder upon written request addressed to Investor Relations, Prentiss Properties Trust, 3890 West Northwest Highway, Suite 400, Dallas, Texas 75220.

 

Available Information

 

We file annual, quarterly and special reports, proxy statements and other information with the SEC. You may read and copy any document we file at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room. Our SEC filings are also available to the public at the SEC’s web site at http://www.sec.gov. No information from this web page is incorporated by reference herein. Our web site is http://www.prentissproperties.com. You may also obtain copies of our annual, quarterly and current reports, proxy statements, Code of Conduct, the Charters of our Audit, Compensation, and Nominating and Corporate Governance Committees of our board of trustees and certain other information filed with the SEC, as well as amendments thereto, free of charge from our web site. These documents are posted to our web site as soon as reasonably practicable after we have filed or furnished these documents to the SEC.

 

Item 2. Properties

 

At December 31, 2004, we owned interests in 133 properties totaling 19.7 million net rentable square feet with no individual property representing either 10% or more of our total assets at December 31, 2004 or gross revenues for the year ended December 31, 2004. The properties consist of 106 office properties comprising approximately 17.5 million net rentable square feet and 27 industrial properties comprising approximately 2.2 million net rentable square feet. As of December 31, 2004, all of these properties are wholly-owned by us (through our subsidiaries), except the following:

 

  (1) 2291 Wood Oak Drive, Corporate Lakes III, Camino West Corporate Park, Carlsbad Airport Plaza, La Place Court, Pacific Ridge Corporate Centre, Pacific View Plaza, The Bluffs and Lakeside Point I & II, which are owned by Prentiss Office Investors, L.P., a joint venture, in which we own a 51% controlling interest and consolidate with and into the accounts of our operating partnership;

 

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Index to Financial Statements
  (2) the Broadmoor Austin properties, which are held pursuant to a 100% leasehold interest by Broadmoor Austin Associates, a joint venture, in which we own a 50% non-controlling interest and account for using the equity method of accounting;

 

  (3) the 1676 International Drive and 8260 Greensboro properties, which are owned by Tysons International Partners, a joint venture, in which we own a 25% non-controlling interest and account for using the equity method of accounting;

 

  (4) One Northwestern Plaza, a property in which we own a 100% leasehold interest and consolidate with and into the accounts of our operating partnership; and

 

  (5) 6600 Rockledge Drive, a property in which we own a 98.9% leasehold interest and consolidate with and into the accounts of our operating partnership.

 

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Index to Financial Statements

The following table presents specific information about our consolidated properties as of December 31, 2004:

 

Property Name


   Building
Type


   Market

   Year(s)
Built/
Renovated


   Number
of
Buildings


  

Net

Rentable
Square

Feet(2)


  

Total Base
Rent for

Year

Ended
12/31/04(3)


   Percent
Leased
As of
12/31/04


                         (in thousands)    (in thousands)     
2291 Wood Oak Drive (1)    Office    Metro. Wash., DC    1999    1    228    $ 4,728    100
2411 Dulles Corner Road    Office    Metro. Wash., DC    1990    1    177      4,703    96
3130 Fairview Park Drive    Office    Metro. Wash., DC    1999    1    183      5,654    100
3141 Fairview Park Drive    Office    Metro. Wash., DC    1988    1    192      3,430    92
4401 Fair Lakes Court    Office    Metro. Wash., DC    1988    1    59      1,343    95
6600 Rockledge Drive    Office    Metro. Wash., DC    1981    1    156      4,712    100
7101 Wisconsin Avenue    Office    Metro. Wash., DC    1975    1    237      3,737    60
8521 Leesburg Pike    Office    Metro. Wash., DC    1984    1    151      1,246    89
12601 Fair Lakes Circle    Office    Metro. Wash., DC    1995    1    264      4,992    100
13825 Sunrise Valley Drive    Office    Metro. Wash., DC    1989    1    106      2,759    98
Calverton Office Park    Office    Metro. Wash., DC    1981-1987    3    307      5,281    52
Campus Point    Office    Metro. Wash., DC    1985    1    172      2,985    100
Fairmont Building    Office    Metro, Wash., DC    1964/1997    1    124      2,695    93
Greenwood Center    Office    Metro. Wash., DC    1985    1    150      3,555    100
Oakwood Center    Office    Metro, Wash., DC    1982    1    128      2,824    98
Park West at Dulles Corner    Office    Metro, Wash., DC    1997    1    152      4,184    100
Plaza 1900    Office    Metro, Wash., DC    1989    1    203      5,011    100
Research Office Center I-III    Office    Metro. Wash., DC    1986-2000    3    439      10,098    87
Willow Oaks I-III    Office    Metro. Wash., DC    1986-2002    3    569      8,387    79
                   
  
  

    
Total Mid-Atlantic Region                   25    3,997      82,324     
                   
  
  

    
123 North Wacker Drive    Office    Chicago    1986    1    541      9,232    92
410 Warrenville Road    Office    Chicago    1999    1    60      798    100
701 Warrenville Road    Office    Chicago    1988    1    67      1,165    93
1717 Deerfield Road    Office    Chicago    1985    1    141      1,403    100
Bannockburn Centre    Office    Chicago    1999    1    257      4,745    100
Corporate Lakes III (1)    Office    Chicago    1990    1    124      1,985    100
Corporetum Office Campus    Office    Chicago    1984-1987    5    322      1,876    84
Lakeside Point I & II (1)    Office    Chicago    1990/1998    2    198      520    100
O’Hare Plaza II    Office    Chicago    1986    1    236      4,632    71
One O’Hare Centre    Office    Chicago    1984    1    380      3,654    74
Salton    Office    Chicago    2001    1    59      1,132    100
Chicago Industrial    Industrial    Chicago    1987-1988    4    682      2,339    82
One Northwestern Plaza    Office    Sub. Detroit    1989    1    242      3,265    89
                   
  
  

    
Total Midwest Region                   21    3,309      36,746     
                   
  
  

    
Barton Skyway I-IV    Office    Austin    1999-2002    4    787      14,111    97
Cielo Center    Office    Austin    1984    3    271      4,192    90
Spyglass Point    Office    Austin    1999    1    59      949    100
Bachman East & West    Office    Dallas/Fort Worth    1986    2    196      3,189    90
Burnett Plaza    Office    Dallas/Fort Worth    1983    1    1,025      16,066    96
Cityplace Center    Office    Dallas/Fort Worth    1988    1    1,296      12,295    87
Cottonwood Office Center    Office    Dallas/Fort Worth    1986    3    165      1,417    90
IBM Call Center    Office    Dallas/Fort Worth    1998    1    150      2,232    100
Lakeview Center    Office    Dallas/Fort Worth    2000    1    101      1,451    100
Millennium Center    Office    Dallas/Fort Worth    1999    1    99      901    0
Park West C2    Office    Dallas/Fort Worth    1989    1    349      7,665    85
Park West C3    Office    Dallas/Fort Worth    1985    1    339      4,776    79
Park West E1    Office    Dallas/Fort Worth    1982    1    183      3,183    100
Park West E2    Office    Dallas/Fort Worth    1985    1    201      1,767    10
Walnut Glen Tower    Office    Dallas/Fort Worth    1985    1    464      8,186    95
WestPoint Office Building    Office    Dallas/Fort Worth    1998    1    150      2,508    91
Carrara Place    Office    Denver    1982    1    234      2,978    89

 

11


Table of Contents
Index to Financial Statements

Property Name


   Building
Type


   Market

   Year(s)
Built/
Renovated


   Number
of
Buildings


  

Net

Rentable
Square

Feet(2)


  

Total Base
Rent for

Year

Ended
12/31/04(3)


   Percent
Leased
As of
12/31/04


                         (in thousands)    (in thousands)     

Highland Court

   Office    Denver    1986    1    93      1,328    84

Orchard Place I & II

   Office    Denver    1980    2    105      2,052    94
PacifiCare Building    Office    Denver    1983    1    198      2,584    79
Panorama Point    Office    Denver    1983    1    79      781    82
                   
  
  

    
Total Southwest Region                   30    6,544      94,611     
                   
  
  

    
2101 Webster    Office    Oakland    1985    1    459      2,228    78
Lake Merritt Tower I    Office    Oakland    1990    1    204      5,595    95
The Ordway    Office    Oakland    1970    1    531      15,202    99
World Savings Center    Office    Oakland    1985    1    272      6,852    99
5500 Great America Parkway    Office    Silicon Valley    1999    3    306      27    72
                   
  
  

    
Total Northern California Region                   7    1,772      29,904     
                   
  
  

    
Los Angeles Industrial    Industrial    Los Angeles    1973-1983    18    1,253      7,081    88
Camino West Corporate Park (1)    Office    San Diego    1991    1    54      1,007    93
Carlsbad Airport Plaza (1)    Office    San Diego    1987    1    62      1,277    94
Carlsbad Pacifica    Office    San Diego    1986    1    49      1,176    69
Carlsbad Pacific Center I-III    Office    San Diego    1986-2002    3    130      3,155    93
Del Mar Gateway    Office    San Diego    2001    1    164      5,207    100
Executive Center Del Mar    Office    San Diego    1998    2    113      3,176    83
La Place Court (1)    Office    San Diego    1988    2    81      1,577    90
Pacific Ridge Corporate Centre (1)    Office    San Diego    1999    2    121      2,772    92
Pacific View Plaza (1)    Office    San Diego    1986    1    52      1,230    96
Plaza I & II    Office    San Diego    1988-1989    2    89      2,027    89
The Bluffs (1)    Office    San Diego    2002    1    69      957    91
The Campus    Office    San Diego    1988    1    45      959    93
San Diego Industrial    Industrial    San Diego    1985-1988    5    268      3,452    100
                   
  
  

    
Total Southern California Region                   41    2,550      35,053     
                   
  
  

    
Total Consolidated Properties                   124    18,172    $ 278,638     
                   
  
  

    

(1) Property or properties owned by Prentiss Office Investors, L.P., of which we own a 51% controlling interest. Net rentable square feet and total base rent is presented at 100%.
(2) Net rentable square feet defines the area of a property for which a tenant is required to pay rent, which includes the actual rentable area plus a portion of the common areas of the property allocated to a tenant.
(3) Total base rent for the year ended December 31, 2004 includes the fixed rental amount due for the year ended December 31, 2004 under contractual lease obligations, which excludes (1) lease termination payments; (2) parking rent; (3) future contractual or contingent rent escalations; and (4) additional rent payable by tenants for items such as common area maintenance, real estate taxes and other expense reimbursements.

 

12


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Index to Financial Statements

The following table presents specific information about our unconsolidated properties as of December 31, 2004:

 

Property Name


   Building
Type


   Market

   Year(s)
Built/
Renovated


   Number
of
Buildings


  

Net

Rentable
Square

Feet(3)


  

Total Base
Rent for

Year

Ended
12/31/04(4)


   Percent
Leased
As of
12/31/04


                         (in thousands)    (in thousands)     
1676 International Drive(1)    Office    Metro. Wash., DC    1999    1    295    $ 8,544    100
8260 Greensboro(1)    Office    Metro. Wash., DC    1980    1    156      2,309    70
                   
  
  

    
Total Mid-Atlantic Regions                   2    451      10,853     
                   
  
  

    
Broadmoor Austin(2)    Office    Austin    1991    7    1,112      20,359    100
                   
  
  

    
Total Southwest Region                   7    1,112      20,359     
                   
  
  

    
Total Unconsolidated Properties                   9    1,563    $ 31,212     
                   
  
  

    
Total Properties                   133    19,735    $ 309,850     
                   
  
  

    

(1) Properties owned by Tysons International Partners of which we own a 25% non-controlling interest. Net rentable square feet and total base rent is presented at 100%.
(2) Properties owned by Broadmoor Austin Associates of which we own a 50% non-controlling interest. Net rentable square feet and total base rent is presented at 100%.
(3) Net rentable square feet defines the area of a property for which a tenant is required to pay rent, which includes the actual rentable area plus a portion of the common areas of the property allocated to a tenant.
(4) Total base rent for the year ended December 31, 2004 includes the fixed rental amount due for the year ended December 31, 2004 under contractual lease obligations, which excludes (1) lease termination payments; (2) parking rent; (3) future contractual or contingent rent escalations; and (4) additional rent payable by tenants for items such as common area maintenance, real estate taxes and other expense reimbursements.

 

At December 31, 2004, we had $785.7 million and $191.1 million of mortgages on our consolidated and unconsolidated properties, respectively. Our pro rata share of the combined debt for both consolidated and unconsolidated properties totals $807.0 million representing 66.5% of our total pro rata outstanding indebtedness. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” for a discussion of mortgage debt related to our properties.

 

13


Table of Contents
Index to Financial Statements

Our properties are leased to local, national and foreign companies engaged in a variety of businesses including, but not limited to, computer systems design, management, scientific, insurance, broadcasting and telecommunications, legal services, and information services. As of December 31, 2004, we had approximately 950 tenants, with our largest 20 tenant’s representing 32% of our total net rentable square feet leased and 37% of base rental revenue of our wholly-owned plus our pro rata share of both consolidated and unconsolidated joint venture properties as follows:

 

    

Tenant


  

Square

Feet

Leased

(000’s)


  

Percentage

of Company

Leased

Sq. Ft.


 

Annualized

Base

Rental Revenue

(000’s)


 
1    International Business Machines    973    6%   $ 18,576  
2    Kaiser Foundation Health Plan    382    2%   $ 11,848  
3    7-11, Inc.    504    3%   $ 9,425  
4    Northrop Grumman Corporation    267    2%   $ 7,247  
5    General Services Administration – U.S. Govt.    301    2%   $ 5,786  
6    AT & T    205    1%   $ 5,328  
7    CGI Group, Inc.    264    2%   $ 5,008  
8    R.R. Donnelley    257    2%   $ 4,872  
9    Aspen Systems Corporation    208    1%   $ 4,625  
10    Burlington Resources    199    1%   $ 4,266  
11    Perot Systems    161    1%   $ 4,253  
12    Americredit    238    1%   $ 4,165  
13    World Savings & Loan    157    1%   $ 4,056  
14    Brandes Investments    128    1%   $ 4,000  
15    National Union Fire Insurance (AIG)    193    1%   $ 3,915  
16    Thomson Corporation    210    1%   $ 3,671  
17    HMS Host    102    1%   $ 3,365  
18    Host Celanese    185    1%   $ 3,337  
19    Verizon Communications    182    1%   $ 3,209  
20    The Lewin Group    103    1%   $ 3,179  
     Total % of portfolio leased square feet               32 %
     Total % of portfolio base rental revenue               37 %

 

Approximately 64% of our total leased rentable square footage is under full service gross leases under which tenants typically pay for all real estate taxes and operating expenses above those for an established base year or expense stop. Our remaining square footage is under triple net and modified gross leases. Triple net and modified gross leases are those where tenants pay not only base rent, but also some or all real estate taxes and operating expenses of the leased property. Tenants generally reimburse us the full direct cost, without regard to a base year or expense stop, for use of lighting, heating and air conditioning during non-business hours, and for on-site monthly employee and visitor parking. We are generally responsible for structural repairs. Our in-place leases have terms, on average, ranging from five to seven years in length.

 

14


Table of Contents
Index to Financial Statements

The following table sets forth a 10-year schedule of the lease expirations for leases in place at our properties as of December 31, 2004. The square feet and annualized base rent represents our wholly-owned properties plus our pro rata share of both consolidated and unconsolidated joint venture properties.

 

Office Properties(1)


  2005

    2006

    2007

    2008

    2009

    2010

    2011

    2012

    2013

    2014

    Thereafter

 
Mid-Atlantic Region                                                                                        

Square Feet Expiring (000’s)

    309       647       608       299       538       197       495       111       9       164       139  

Square Feet as a % of NRA

    8 %     16 %     15 %     7 %     13 %     5 %     12 %     3 %     0 %     4 %     3 %

Annualized Base Rent in Expiring Year (000’s)

  $ 8,249     $ 16,730     $ 15,100     $ 8,256     $ 14,772     $ 5,220     $ 11,849     $ 3,534     $ 232     $ 4,641     $ 4,310  

Annualized Base Rent PSF in Expiring Year

  $ 26.70     $ 25.86     $ 24.84     $ 27.61     $ 27.46     $ 26.50     $ 23.94     $ 31.84     $ 25.78     $ 28.30     $ 31.01  

Number of Leases Expiring

    39       40       35       18       38       12       12       3       2       5       4  
Midwest Region                                                                                        

Square Feet Expiring (000’s)

    116       197       137       191       181       144       405       203       236       61       301  

Square Feet as a % of NRA

    5 %     8 %     6 %     8 %     7 %     6 %     16 %     8 %     10 %     2 %     12 %

Annualized Base Rent in Expiring Year (000’s)

  $ 2,226     $ 4,326     $ 3,349     $ 3,354     $ 3,663     $ 2,848     $ 9,896     $ 4,612     $ 5,107     $ 1,369     $ 6,345  

Annualized Base Rent PSF in Expiring Year

  $ 19.19     $ 21.96     $ 24.45     $ 17.56     $ 20.24     $ 19.78     $ 24.43     $ 22.72     $ 21.64     $ 22.44     $ 21.08  

Number of Leases Expiring

    28       23       23       19       24       9       10       9       9       9       8  
Southwest Region                                                                                        

Square Feet Expiring (000’s)

    527       610       1,049       470       892       380       1,098       143       650       109       323  

Square Feet as a % of NRA

    7 %     9 %     15 %     7 %     13 %     5 %     15 %     2 %     9 %     2 %     5 %

Annualized Base Rent in Expiring Year (000’s)

  $ 9,423     $ 12,350     $ 19,827     $ 7,701     $ 18,381     $ 7,018     $ 22,512     $ 3,130     $ 11,922     $ 1,897     $ 5,475  

Annualized Base Rent PSF in Expiring Year

  $ 17.88     $ 20.25     $ 18.90     $ 16.39     $ 20.61     $ 18.47     $ 20.50     $ 21.89     $ 18.34     $ 17.40     $ 16.95  

Number of Leases Expiring

    54       39       45       47       44       16       13       5       9       4       3  
Northern California Region                                                                                        

Square Feet Expiring (000’s)

    106       101       231       205       216       81       335       55       0       220       16  

Square Feet as a % of NRA

    6 %     6 %     13 %     12 %     12 %     5 %     19 %     3 %     0 %     12 %     1 %

Annualized Base Rent in Expiring Year (000’s)

  $ 3,453     $ 2,865     $ 6,670     $ 6,187     $ 6,195     $ 2,854     $ 11,025     $ 1,609     $ 0     $ 3,823     $ 541  

Annualized Base Rent PSF in Expiring Year

  $ 32.58     $ 28.37     $ 28.87     $ 30.18     $ 28.68     $ 35.23     $ 32.91     $ 29.95     $ 0.00     $ 17.38     $ 33.81  

Number of Leases Expiring

    32       15       21       11       17       3       2       2       0       1       1  
Southern California Region                                                                                        

Square Feet Expiring (000’s)

    126       111       117       87       95       51       128       1       12       14       0  

Square Feet as a % of NRA

    15 %     14 %     14 %     11 %     12 %     6 %     16 %     0 %     1 %     2 %     0 %

Annualized Base Rent in Expiring Year (000’s)

  $ 3,325     $ 2,810     $ 3,255     $ 2,424     $ 2,775     $ 1,775     $ 4,461     $ 58     $ 469     $ 497     $ 0  

Annualized Base Rent PSF in Expiring Year

  $ 26.39     $ 25.32     $ 27.82     $ 27.86     $ 29.21     $ 34.80     $ 34.85     $ 58.00     $ 39.08     $ 35.50     $ 0.00  

Number of Leases Expiring

    48       37       33       13       17       5       2       1       1       2       0  

 

15


Table of Contents
Index to Financial Statements

Office Properties


  2005

    2006

    2007

    2008

    2009

    2010

    2011

    2012

    2013

    2014

    Thereafter

 
Total Office Properties                                                                                        

Square Feet Expiring (000’s)

    1,184       1,666       2,142       1,252       1,922       853       2,461       513       907       568       779  

Square Feet as a % of NRA

    7 %     10 %     13 %     8 %     12 %     5 %     15 %     3 %     6 %     4 %     5 %

Annualized Base Rent in Expiring Year (000’s)

  $ 26,676     $ 39,081     $ 48,201     $ 27,922     $ 45,786     $ 19,715     $ 59,743     $ 12,943     $ 17,730     $ 12,227     $ 16,671  

Annualized Base Rent PSF in Expiring Year

  $ 22.53     $ 23.46     $ 22.50     $ 22.30     $ 23.82     $ 23.11     $ 24.28     $ 25.23     $ 19.55     $ 21.53     $ 21.40  

Number of Leases Expiring

    201       154       157       108       140       45       39       20       21       21       16  

Industrial

Properties(1)


  2005

    2006

    2007

    2008

    2009

    2010

    2011

    2012

    2013

    2014

    Thereafter

 
Midwest Region                                                                                        

Square Feet Expiring (000’s)

    13       202       28       267       50       0       0       0       0       0       0  

Square Feet as a % of NRA

    2 %     30 %     4 %     39 %     7 %     0 %     0 %     0 %     0 %     0 %     0 %

Annualized Base Rent in Expiring Year (000’s)

  $ 92     $ 711     $ 165     $ 988     $ 262     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0  

Annualized Base Rent PSF in Expiring Year

  $ 7.08     $ 3.52     $ 5.89     $ 3.70     $ 5.24     $ 0.00     $ 0.00     $ 0.00     $ 0.00     $ 0.00     $ 0.00  

Number of Leases Expiring

    1       2       2       1       1       0       0       0       0       0       0  
Southern California Region                                                                                        

Square Feet Expiring (000’s)

    306       144       429       184       290       22       0       0       0       0       0  

Square Feet as a % of NRA

    20 %     9 %     28 %     12 %     19 %     1 %     0 %     0 %     0 %     0 %     0 %

Annualized Base Rent in Expiring Year (000’s)

  $ 2,190     $ 1,957     $ 2,962     $ 1,403     $ 2,164     $ 172     $ 0     $ 0     $ 0     $ 0     $ 0  

Annualized Base Rent PSF in Expiring Year

  $ 7.16     $ 13.59     $ 6.90     $ 7.63     $ 7.46     $ 7.82     $ 0.00     $ 0.00     $ 0.00     $ 0.00     $ 0.00  

Number of Leases Expiring

    7       3       6       4       8       1       0       0       0       0       0  
Total Industrial Properties                                                                                        

Square Feet Expiring (000’s)

    319       346       457       451       340       22       0       0       0       0       0  

Square Feet as a % of NRA

    14 %     16 %     21 %     20 %     15 %     1 %     0 %     0 %     0 %     0 %     0 %

Annualized Base Rent in Expiring Year (000’s)

  $ 2,282     $ 2,668     $ 3,127     $ 2,391     $ 2,426     $ 172     $ 0     $ 0     $ 0     $ 0     $ 0  

Annualized Base Rent PSF in Expiring Year

  $ 7.15     $ 7.71     $ 6.84     $ 5.30     $ 7.14     $ 7.82     $ 0.00     $ 0.00     $ 0.00     $ 0.00     $ 0.00  

Number of Leases Expiring

    8       5       8       5       9       1       0       0       0       0       0  

(1) Net rentable square feet (NRA) defines the area of a property for which a tenant is required to pay rent, which includes the actual rentable area plus a portion of the common areas of the property allocated to a tenant.

 

16


Table of Contents
Index to Financial Statements

Insurance

 

We have and will keep in force comprehensive insurance, including liability, fire, workers’ compensation, extended coverage, rental loss and, when available on reasonable commercial terms, flood, wind, earthquake and terrorism insurance, with policy specifications, limits, exclusions and deductibles customarily carried for similar properties. We currently maintain insurance to cover environmental conditions and business interruption if and when they occur. This policy covers both governmental and third-party claims associated with the covered environmental conditions. Our real property insurance policies exclude earthquake coverage for properties located within California. As a result, we maintain a separate $125 million blanket earthquake policy on the properties we own in Northern and Southern California. Our real property insurance policies exclude terrorism coverage. However, we maintain a separate $100 million blanket stand-alone terrorism policy on the properties we own. Certain types of losses, however, generally of a catastrophic nature, such as acts of war, are either uninsurable or the cost of obtaining insurance is so high that it is more prudent to accept the risk of loss. If more terrorists incidents occur, however, future insurance policies purchased by us may expressly exclude hostile acts, and it may then become economically unfeasible to obtain insurance covering terrorist attacks. In the event of such terrorist acts or other catastrophic losses, we would expect our insurance premiums to increase thereafter, which may have an adverse impact on our cash flow. We believe that our properties as of the date of this filing are adequately insured in accordance with industry standards.

 

Item 3. Legal Proceedings

 

Neither we nor our affiliates (other than in a representative capacity) are presently subject to any material litigation. To our knowledge, no litigation has been threatened against us or our affiliates other than routine actions and administrative proceedings, substantially all of which are expected to be covered by liability insurance and which, in the aggregate, are not expected to have a material adverse effect on our business or financial condition.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

No matter was submitted to a vote of our security holders during the fourth quarter of 2004 through the solicitation of proxies or otherwise.

 

17


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Index to Financial Statements

PART II

 

Item 5. Market for Registrant’s Common Equity and Related Shareholder Matters

 

Market Information

 

Our common shares commenced trading on the NYSE on October 17, 1996 under the symbol “PP.” As of March 14, 2005, the last reported sales price per common share on the NYSE was $36.10 per common share. The following table sets forth the high and low sales price per common share reported on the NYSE as traded for the periods indicated.

 

Period


   High

   Low

2004

         

Fourth Quarter

   39.87    34.79

Third Quarter

   37.43    32.94

Second Quarter

   37.31    29.25

First Quarter

   36.92    32.41

2003

         

Fourth Quarter

   32.99    29.58

Third Quarter

   31.41    28.79

Second Quarter

   30.09    26.85

First Quarter

   28.28    25.27

 

Holders

 

At March 14, 2005, we had approximately 472 holders of record and approximately 13,001 beneficial owners of our common shares. The number of beneficial owners does not include beneficial owners for whom Cede & Co. or others act as nominee. As of March 14, 2005, all of our 3,773,585 Series D Preferred Shares, which are convertible into our common shares subject to certain limitations, were held by Security Capital Preferred Growth, Incorporated. In addition, the common units of limited partnership interest in the operating partnership, which are redeemable for common shares subject to limitations, were held by 19 entities or persons.

 

Dividends

 

We have adopted a policy of paying regular quarterly distributions on our common shares and cash distributions have been paid on our common shares with respect to each such period since our inception. The following table sets forth information regarding the declaration and payment of distributions by us in 2004 and 2003.

 

18


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Index to Financial Statements

Period Which Distribution Relates


   Distribution
Record
Date


   Distribution
Payment
Date


   Per Share
Distribution
Amount


2004

                

Fourth Quarter

   12/27/04    1/7/05    $ 0.560

Third Quarter

   9/30/04    10/08/04    $ 0.560

Second Quarter

   6/30/04    7/09/04    $ 0.560

First Quarter

   3/31/04    4/09/04    $ 0.560

2003

                

Fourth Quarter

   12/26/03    1/9/04    $ 0.560

Third Quarter

   9/30/03    10/10/03    $ 0.560

Second Quarter

   6/30/03    7/11/03    $ 0.560

First Quarter

   3/31/03    4/11/03    $ 0.560

 

For tax purposes, the foregoing distributions represent an approximate 45.8% and 36.3% return of capital in 2004 and 2003, respectively. In order to maintain our qualification as a REIT, we must make annual distributions to our shareholders of at least 90% of our taxable income, excluding net capital gains. During the years ended December 31, 2004 and 2003, we declared distributions totaling $2.24 per share. Under certain circumstances we may be required to make distributions in excess of cash available for distribution in order to meet such REIT distribution requirements. In such event, we presently would expect to borrow funds, or to sell assets for cash, to the extent necessary to obtain cash sufficient to make the distributions required to retain our qualification as a REIT for federal income tax purposes.

 

We declared a cash distribution for the first quarter of 2005 in the amount of $.56 per share, payable on April 8, 2005 to holders of record on March 31, 2005. We currently anticipate that we will maintain at least the current distribution rate for the immediate future, unless actual results of operations, economic conditions or other factors differ from our current expectations. Future distributions, if any, paid by us will be at the discretion of our board of trustees and will depend on our cash flow, our financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code and such other factors as our board of trustees deems relevant.

 

Securities Authorized for Issuance under Equity Compensation Plans

 

The following table sets forth certain information, as of December 31, 2004, with respect to all compensation plans previously approved by our security holders, as well as equity compensation plans not previously approved by our security holders.

 

    

Number of Securities

To be Issued Upon
Exercise of

Outstanding Options,
Warrants and Rights


    Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights


   

Number of Securities
Remaining Available
For Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in

Far Left Column)


 

Equity compensation plans approved by security holders

   647,251     $ 30.11     2,186,610  

Equity compensation plans not approved by security holders

   80,952 (1)       (1)     (1)

Total

   728,203     $ 30.11     2,186,610  
    

 


 


(1) Pursuant to our Key Employee Share Option Plan, officers and other selected key employees of our operating partnership or Prentiss Properties Resources, Inc. and its subsidiaries who earn bonuses have the option of deferring the payment of such bonuses. Such deferred compensation may be used to purchase various mutual funds and/or our common shares. Pursuant to the participant’s election, we purchase shares on the open market and place them in a trust for the benefit of such participant. The trust may deliver to the participant shares or

 

19


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Index to Financial Statements

the fair market value of such shares beginning six months from the date they were placed in the trust. The purpose of the deferred compensation plan is to provide a vehicle for the payment of compensation otherwise payable to the participants, in a form that will provide incentives and rewards for meritorious performance and encourage the recipients’ continuance as our employees. During the 2000 plan year we provided a discount of 15% on the purchase price of our common shares purchased by participants in the plan. For the plan years thereafter, we did not provide for a discount on our common shares. As of December 31, 2004, the investments included 80,952 of our common shares purchased in the open market.

 

Period


   Total Number of Shares
Purchased (1)


  

Average Price Paid

per Share


  

Total Number of
Shares Purchased as
Part of Publicly
Announced

Plans or Programs


  

Maximum Number

of Shares that May
Yet Be Purchased

Under the

Plans or Programs (2)


October 1, 2004 – October 31, 2004

   5,218    $ 36.10    —      997,200

November 1, 2004 – November 30, 2004

   —      $ —      —      —  

December 1, 2004 – December 31, 2004

   —      $ —      —      —  

Total

   5,218    $ 36.10    —      997,200

(1) During October 2004, we purchased 1,218 of our common shares pursuant to our Key Employee Share Option Plan and we received 4,000 of our common shares due to the forfeiture of stock grants. The purchases described in this footnote were not made pursuant to a publicly announced plan or program.
(2) During 1998, our board of trustees authorized the repurchase of up to 2.0 million common shares in the open market or negotiated private transactions. On January 4, 2000, the board of trustees authorized a 1.5 million-share increase in the share repurchase program bringing the total authorization to 3.5 million common shares. On May 9, 2001, the board of trustees authorized an additional 1.0 million-share increase in the share repurchase program bringing the total authorization to 4.5 million shares. Since inception of the repurchase program, through December 31, 2004, we have purchased 3,502,800 common shares and pursuant to current authorization, we have the ability to repurchase an additional 997,200 in the future.

 

Item 6. Selected Financial Data

 

The following section sets forth our selected financial data. The following data should be read in conjunction with our historical Consolidated Financial Statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-K.

 

The selected historical consolidated financial data has been derived from our audited financial statements and notes thereto.

 

20


Table of Contents
Index to Financial Statements

Operating Data:

(in thousands, except per share amounts)


   Year Ended December 31,

 
   2004

    2003

    2002

    2001

    2000

 

Rental income

   $ 356,825     $ 314,718     $ 307,487     $ 287,389     $ 288,728  

Service business and other income

     13,909       16,769       4,386       5,042       4,555  
    


 


 


 


 


Total revenues

     370,734       331,487       311,873       292,431       293,283  
    


 


 


 


 


Property operating expenses and real estate taxes

     131,087       111,857       110,354       95,997       98,252  

General and administrative and personnel costs

     11,803       10,988       10,361       10,396       9,790  

Expenses of service business

     9,998       10,513       —         —         —    

Depreciation and amortization

     92,315       72,483       61,944       52,804       53,592  
    


 


 


 


 


Total operating expenses

     245,203       205,841       182,659       159,197       161,634  
    


 


 


 


 


Interest expense and amortization of financing costs

     (70,380 )     (69,516 )     (66,300 )     (63,804 )     (70,050 )

Merger termination fee, net

     —         —         —         17,000       4,091  
    


 


 


 


 


Income from continuing operations before equity in income of unconsolidated joint ventures, loss on securities, impairment and minority interests

     55,151       56,130       62,914       86,430       65,690  

Equity in income of unconsolidated joint ventures

     2,429       2,555       3,154       3,131       3,843  

Loss on investment in securities

     (420 )     —         —         —         (1,000 )

Loss from impairment of mortgage loan

     (2,900 )     —         —         —         —    

Impairment loss on real estate property

     —         —         —         (4,765 )     —    

Minority interests(1)

     (2,744 )     (10,227 )     (10,450 )     (16,894 )     (14,928 )
    


 


 


 


 


Income from continuing operations

     51,516       48,458       55,618       67,902       53,605  
    


 


 


 


 


Income from discontinued operations

     3,354       6,034       10,966       16,611       16,489  

Gain/(loss) from disposition of discontinued operations

     11,957       (4,457 )     8,430       —         —    

Loss from debt defeasance related to sale of real estate

     (5,316 )     —         —         —         —    

Minority interests related to discontinued operations (1)

     (310 )     (53 )     (733 )     (707 )     (730 )
    


 


 


 


 


Discontinued operations

     9,685       1,524       18,663       15,904       15,759  
    


 


 


 


 


Income before gain on sale of properties

     61,201       49,982       74,281       83,806       69,364  
    


 


 


 


 


Gain on sale of properties including land and an interest in a real estate partnership

     1,222       9,435       —         18,660       221  
    


 


 


 


 


Net income

   $ 62,423     $ 59,417     $ 74,281     $ 102,466     $ 69,585  

Preferred dividends

     (10,052 )     (8,452 )     (8,358 )     (7,887 )     (7,151 )
    


 


 


 


 


Net income applicable to common shareholders

   $ 52,371     $ 50,965     $ 65,923     $ 94,579     $ 62,434  
    


 


 


 


 


Basic earnings per common share:

                                        

Income from continuing operations applicable to common shareholders

   $ 0.96     $ 1.23     $ 1.23     $ 2.14     $ 1.29  

Discontinued operations

   $ 0.22     $ 0.04     $ 0.49     $ 0.43     $ 0.43  
    


 


 


 


 


Net income applicable to common shareholders – basic

   $ 1.18     $ 1.27     $ 1.72     $ 2.57     $ 1.72  
    


 


 


 


 


Weighted average number of common shares outstanding – basic

     44,330       40,068       38,409       36,736       36,273  

Diluted earnings per common share:

                                        

Income from continuing operations applicable to common shareholders

   $ 0.96     $ 1.23     $ 1.22     $ 2.12     $ 1.28  

Discontinued operations

   $ 0.22     $ 0.04     $ 0.49     $ 0.39     $ 0.43  
    


 


 


 


 


Net income applicable to common shareholders – diluted

   $ 1.18     $ 1.27     $ 1.71     $ 2.51     $ 1.71  
    


 


 


 


 


Weighted average number of common shares and common share equivalents outstanding – diluted

     44,529       40,270       38,649       40,849       36,515  

 

21


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Index to Financial Statements

Balance Sheet Data:

(in thousands)


   As of or For the Year Ended December 31,

 
   2004

    2003

    2002

    2001

    2000

 

Operating real estate, before accumulated depreciation

   $ 2,130,364     $ 2,052,679     $ 1,932,028     $ 1,807,039     $ 1,869,694  

Operating real estate, after accumulated depreciation

     1,896,357       1,841,735       1,753,236       1,660,690       1,743,064  

Cash and cash equivalents

     8,586       5,945       5,080       5,845       5,452  

Total assets

     2,333,539       2,199,093       2,122,289       2,030,593       2,117,875  

Mortgages and notes payable

     1,191,911       1,029,035       1,011,027       907,734       1,007,800  

Mandatorily redeemable preferred units

     —         10,000       —         —         —    

Total liabilities

     1,329,168       1,162,229       1,141,731       1,024,607       1,132,858  

Minority interest

     60,782       124,623       136,325       186,186       178,753  

Shareholders’ equity

     943,589       912,241       844,233       819,800       806,264  

Other Data:

(in thousands)


                              

Cash flow from operations

   $ 158,249     $ 133,625     $ 160,611     $ 160,424     $ 161,961  

Cash flow from investing

     (79,004 )     (142,304 )     (160,505 )     (52,854 )     (173,211 )

Cash flow from financing

     (76,604 )     9,544       (871 )     (107,177 )     3,389  

Distributions declared per common share

   $ 2.240     $ 2.240     $ 2.215     $ 2.090     $ 1.895  

Funds from operations(2)

     144,709       139,246       144,911       155,814       138,402  

Property Data:

(square feet in thousands)


                              

Number of properties

     133       137       137       146       181  

Total net rentable square feet (3)

     18,358       17,762       17,627       17,597       19,497  

Leased%

     88 %     91 %     93 %     94 %     96 %

(1) Represents limited partners’ interests in the operating partnership as well as limited partners’ interests in certain real estate partnerships.
(2) Funds from operations is a widely recognized measure of REIT operating performance. Funds from operations is a non-GAAP financial measure and, as defined by the National Association of Real Estate Investment Trusts, means net income, computed in accordance with GAAP excluding extraordinary items, as defined by GAAP, and gains (or losses) from sales of property, plus depreciation and amortization on real estate assets, and after adjustments for unconsolidated partnerships, joint ventures and subsidiaries. We believe that funds from operations is helpful to investors and our management as a measure of our operating performance because it excludes depreciation and amortization, gains and losses from property dispositions, and extraordinary items, and, as a result, when compared year over year, reflects the impact on operations from trends in occupancy rates, rental rates, operating costs, development activities, general and administrative expenses, and interest costs, providing perspective not immediately apparent from net income. In addition, our management believes that funds from operations provides useful information to the investment community about our financial performance when compared to other REITs since funds from operations is generally recognized as the industry standard for reporting the operating performance of REITs. However, our funds from operations may not be comparable to funds from operations reported by other REITs that do not define funds from operations exactly as we do. We believe that in order to facilitate a clear understanding of our operating results, funds from operations should be examined in conjunction with net income as presented in our consolidated financial statements and notes thereto included elsewhere in this Form 10-K. We believe that net income is the most directly comparable GAAP financial measure to funds from operations. Funds from operations does not represent cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income as an indication of our performance or to cash flows as a measure of liquidity or our ability to make distributions. Funds from operations does not reflect either depreciation and amortization costs or the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties, which are significant economic costs that could materially impact our results of operations. The following is a reconciliation of net income to funds from operations:

 

22


Table of Contents
Index to Financial Statements

Funds from operations

(in thousands)


   Year Ended December 31,

 
   2004

    2003

    2002

    2001

    2000

 

Net income

   $ 62,423     $ 59,417     $ 74,281     $ 102,466     $ 69,585  

Adjustments:

                                        

Real estate depreciation and amortization(A)

     95,429       79,972       73,368       64,190       63,328  

Minority interest share of depreciation and amortization

     (4,682 )     —         —         —         —    

Real estate depreciation and amortization of unconsolidated joint ventures

     2,985       2,960       3,103       3,550       2,816  

Minority interests(B)

     1,733       1,875       2,589       4,268       2,894  

Gain on sale of real estate

     (13,179 )     (4,978 )     (8,430 )     (18,660 )     (221 )
    


 


 


 


 


Funds from operations (C)(D)

   $ 144,709     $ 139,246     $ 144,911     $ 155,814     $ 138,402  
    


 


 


 


 



(A) Includes real estate depreciation and amortization included in continuing operations and real estate depreciation and amortization included in discontinued operations.
(B) Represents the minority interests applicable to the common unit holders of the operating partnership.
(C) Funds from operations for the years ended December 31, 2001 and 2000 includes merger termination fees of $17.0 million and $4.1 million, respectively. The fees are not considered extraordinary items under generally accepted accounting principles, and therefore have not been deducted from net income in deriving our funds from operations.
(D) Impairment losses and debt defeasance related to real estate are not added back in our reconciliation of net income to funds from operations; therefore, for periods in which impairment losses or debt defeasance are recognized, funds from operations is negatively impacted. We recognized impairment losses on real estate of $1.8 million and $2.9 million during the years ended December 31, 2003 and 2002, respectively. We recognized impairment loss on a mortgage loan of $2.9 million for the year ended December 31, 2004. We recognized debt defeasance of $5.3 million during the year ended December 31, 2004. The impairment losses totaling $1.8 million and $2.9 million for the years ended December 31, 2003 and 2002 respectively are included in the line item “income from discontinued operations” in our consolidated statements of income.
(3) Total net rentable square feet represents 100% of our wholly-owned properties plus our pro rata share of our consolidated and unconsolidated joint venture properties.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our Selected Financial Data and our historical Consolidated Financial Statements and related notes thereto. Historical results set forth in our Selected Financial Data and Consolidated Financial Statements should not be taken as an indication of our future operations.

 

Overview

 

We are a self-administered and self-managed Maryland REIT. We acquire, own, manage, lease, develop and build primarily office properties throughout the United States. We are self-administered in that we provide our own administrative services, such as accounting, tax and legal, internally through our own employees. We are self-managed in that we internally provide all the management and maintenance services that our properties require through employees, such as, property managers, leasing professionals and engineers. We operate principally through our operating partnership, Prentiss Properties Acquisition Partners, L.P. and its subsidiaries, and two management service companies, Prentiss Properties Resources, Inc. and its subsidiaries and Prentiss Properties Management, L.P.

 

23


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Index to Financial Statements

As of December 31, 2004, we owned interests in a diversified portfolio of 133 primarily suburban Class A office and suburban industrial properties as follows:

 

    

Number of

Buildings


  

Net Rentable

Square Feet (1)


          (in millions)

Office properties

   106    17.5

Industrial properties

   27    2.2
    
  

Total

   133    19.7
    
  

(1) Includes 100% of the net rentable square feet of our wholly-owned, consolidated joint venture and unconsolidated joint venture properties, which totaled 17.2 million, 989,000 and 1.6 million respectively. Our pro rata share of net rentable square feet totals 18.4 million and includes 504,000 and 669,000 from our consolidated and unconsolidated joint venture properties, respectively.

 

As an owner of real estate, the majority of our income and cash flow is derived from rental income received pursuant to tenant leases for space at our properties; and thus, our earnings would be negatively impacted by a deterioration of our rental income. One or more factors could result in a deterioration of rental income including (1) our failure to renew or execute new leases as current leases expire, (2) our failure to renew or execute new leases with rental terms at or above the terms of in-place leases, and (3) tenant defaults.

 

Our failure to renew or execute new leases as current leases expire or to execute new leases with rental terms at or above the terms of in-place leases is dependent on factors such as (1) the local economic climate, which may be adversely impacted by business layoffs or downsizing, industry slowdowns, changing demographics and other factors and (2) local real estate conditions, such as oversupply of office and industrial space or competition within the market.

 

Our industry’s performance is generally predicated on a sustained pattern of job growth. In 2004, while the overall United States economy began to demonstrate economic growth, there were few indications that the economy was creating jobs at a pace sufficient to generate significant increases in demand for our office space. We continued to operate in a period of weak fundamentals, evidenced by relatively high vacancy and correspondingly lower rental rates.

 

As a result of the recent weak economic climate, the office real estate markets have been materially impacted by higher vacancy rates. In 2003, vacancy rates appeared to peak in many of our markets and some positive net absorption of space started to occur. During 2004, all of our markets, with the exception of Downtown Chicago, experienced positive net absorption of space. In addition, the overall vacancy rates are down as compared to 2003. Although there is a slight improvement in the economic climate, we do not expect any material improvement in the leasing conditions for 2005. In the face of challenging market conditions, we have followed a disciplined approach to managing our operations. We are constantly reviewing our portfolio and the markets in which we operate to identify potential asset acquisitions, opportunities for development and where we believe significant value can be found, asset dispositions.

 

The occupancy in our portfolio of operating properties decreased to 88% at December 31, 2004 compared to 91% at December 31, 2003 and 93% at December 31, 2002. Market rental rates have declined in each of our markets from peak levels and there may be additional declines in 2005. Rental rates on our office space that was re-leased in 2004 and 2003 decreased an average of 8% and 9%, respectively, in comparison to rates that were in effect under expiring leases.

 

Our organization consists of a corporate office located in Dallas, Texas and five regional offices each of which operates under the guidance of a member of our senior management team. The following table presents regional revenues for the year ended December 31, 2004, and the markets in which our properties are located within each region. The first market represents the location of each regional office.

 

24


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Index to Financial Statements

Region


   Revenues

  

Market


     (in thousands)     

Mid-Atlantic

   $ 97,586    Metropolitan Washington, DC

Midwest

     60,114    Chicago, Suburban Detroit

Southwest

     130,831    Dallas/Fort Worth, Austin, Denver

Northern California

     39,485    Oakland, Silicon Valley

Southern California

     40,474    San Diego, Los Angeles
    

    

Total

   $ 368,490     
    

    

 

In addition to the $368.5 million of regional revenues, during the year ended December 31, 2004, we recognized $2.2 million of revenue consisting of reimbursements from employees for their share of health care related costs of $515,000, interest income of $523,000 representing the portion not allocated to our regions and the balance of $1.1 million relating primarily to income derived from services performed for third parties not allocated to our regions.

 

At December 31, 2004, our pro rata share of in-place leases totaled 16.2 million square feet, or 88% of the net rentable square feet of our properties. Our leases range in term from 1 month to 17 years with an average term of 5 to 7 years. The 16.2 million square feet of in-place leases expire as follows:

 

    

Square Feet

Expiring


      
     (in thousands)       

2005

   1,503    9.3 %

2006

   2,012    12.4 %

2007

   2,599    16.1 %

2008

   1,703    10.5 %

2009

   2,262    14.0 %

Thereafter

   6,103    37.7 %
    
  

     16,182    100.0 %
    
  

 

If one or more tenants fail to pay their rent due to bankruptcy, weakened financial condition or otherwise, our income, cash flow and ability to make distributions would be negatively impacted. At any time, a tenant may seek the protection of the bankruptcy laws, which could result in delays in rental payments or in the rejection and termination of such tenant leases.

 

2004 Real Estate Transactions

 

Joint Venture Arrangement

 

On January 22, 2004, Prentiss Office Investors, L.P. was established to acquire office properties in our core markets of Washington D.C./Northern Virginia, Chicago, Dallas/Ft. Worth, Northern California and San Diego/Orange County. The partnership was initially wholly owned by the operating partnership and its affiliates and was seeded by the transfer of several recent acquisitions including, 2291 Wood Oak Drive a single office building containing approximately 228,000 net rentable square feet located in Herndon, Virginia, Corporate Lakes III a single office building containing approximately 124,000 net rentable square feet located in Chicago, Illinois and seven office buildings containing approximately 370,000 net rentable square feet located in Carlsbad, California.

 

25


Table of Contents
Index to Financial Statements

Pursuant to a joint venture agreement, effective February 1, 2004, Stichting Pensioenfonds ABP, a Netherlands based pension fund and unrelated third party, acquired a 49% limited partnership interest in Prentiss Office Investors, L.P. for proceeds totaling $68.9 million. As a result of the transaction, we recorded a gain on sale of $1.2 million. The joint venture is consolidated with and into the accounts of the operating partnership. Proceeds from the transaction were used to repay a portion of the outstanding borrowings under our revolving credit facility.

 

Acquisitions

 

During the year ended December 31, 2004, we acquired, from unrelated third parties, 8 office buildings totaling approximately 2.3 million net rentable square feet as detailed below:

 

Acquired Properties


   Segment

   Market

  

Month of

Acquisition


  

Number of

Buildings


  

Net Rentable

Square Feet(1)

(in thousands)


  

Acquisition

Price(2)

(in millions)


Cityplace Center

   Southwest    Dallas/Ft. Worth    April 2004    1    1,296    $ 123.3

The Bluffs(3)

   Southern Calif.    San Diego    May 2004    1    69      17.7

5500 Great America Parkway

   Northern Calif.    Silicon Valley    May 2004    3    306      34.8

2101 Webster

   Northern Calif.    Oakland    Oct. 2004    1    459      65.7

Lakeside I & II(3)

   Midwest    Chicago    Oct. 2004    2    198      32.6
                   
  
  

                    8    2,328    $ 274.1
                   
  
  


(1) Net rentable square feet defines the area of a property for which a tenant is required to pay rent, which includes the actual rentable area plus a portion of the common areas of the property allocated to a tenant.
(2) Acquisitions were funded with proceeds from our revolving credit facility, debt assumption, property sales and proceeds generated from the sale of common shares.
(3) Acquisitions were acquired by Prentiss Office Investors, L.P., the joint venture described above. The net rentable square feet and acquisition price is presented at 100%. Each partner contributed their pro rata share of the purchase price of each property to Prentiss Office Investors, L.P. prior to acquisition.

 

On July 15, 2004, we acquired from an unrelated third party, approximately 7.7 acres of land in Del Mar, California for gross consideration of $15.1 million. The acquisition was funded with proceeds from our revolving credit facility. The land is unrelated to our development project which is also located in Del Mar, California.

 

Dispositions

 

During the year ended December 31, 2004, we sold, to unrelated third parties, 4 industrial buildings containing approximately 91,000 net rentable square feet and 8 office buildings containing approximately 1.2 million net rentable square feet as detailed below:

 

Properties Sold


   Segment

   Market

  

Month of

Disposition


  

Number of

Buildings


  

Net Rentable

Square Feet

(in thousands)


  

Gross

Proceeds(1)

(in millions)


Natomas Corporate Center

   Northern Calif.    Sacramento    May 2004    6    566    $ 80.7

Shadowridge Business Center

   Southern Calif.    San Diego    July 2004    4    91      10.2

One Westchase Center

   Southwest    Houston    Aug. 2004    1    466      44.2

1800 Sherman Avenue

   Midwest    Chicago    Nov. 2004    1    136      18.2
                   
  
  

                    12    1,259    $ 153.3
                   
  
  


(1) Proceeds from property sales were used to repay a portion of the outstanding borrowings under our revolving credit facility and to complete a defeasance of a mortgage loan collateralized by the Natomas Corporate Center properties.

 

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Index to Financial Statements

Development

 

During the year ended December 31, 2004, we transitioned a parcel of land from land held for development to construction in progress. The construction, which has an estimated total project cost of $48.1 million, includes a two building office project located in Del Mar, California and will contain approximately 158,000 net rentable square feet upon completion. The project which is currently 50% pre-leased is owned by Prentiss/Collins Del Mar Heights, LLC, a joint venture, owned 70% by our operating partnership and its affiliates and 30% by Collins Corporate Center, LLC, an unrelated third party. The accounts of Prentiss/Collins Del Mar Heights, LLC are consolidated with and into the accounts of our operating partnership. The December 31, 2004 carrying amount of this development project was $23.4 million.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements. Our consolidated financial statements include the accounts of Prentiss Properties Trust, our operating partnership and our other consolidated subsidiaries. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the reporting period. Actual results could differ from our estimates.

 

The significant accounting policies used in the preparation of our consolidated financial statements are fully described in Note (2) to our audited consolidated financial statements for the year ended December 31, 2004, included elsewhere in this Form 10-K. However, certain of our significant accounting estimates are considered critical accounting estimates because the estimate requires our management to make assumptions about matters that are highly uncertain at the time the estimate is made and different estimates that reasonably could have been used in the current period, or changes in the estimates that are reasonably likely to occur from period to period, would have a material impact on our financial condition, changes in financial condition or results of operations. We consider our critical accounting policies and estimates to be those used in the determination of the reported amounts and disclosure related to the following:

 

  (1) Impairment of long-lived assets and the long-lived assets to be disposed of;

 

  (2) Allowance for doubtful accounts;

 

  (3) Depreciable lives applied to real estate assets and improvements to real estate assets;

 

  (4) Initial recognition, measurement and allocation of the cost of real estate acquired; and

 

  (5) Fair value of derivative instruments.

 

Impairment of long-lived assets and long-lived assets to be disposed of

 

Real estate, leasehold improvements and land holdings are classified as long-lived assets held for sale or long-lived assets to be held and used. In accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we record assets held for sale at the lower of the carrying amount or fair value, less cost to sell. With respect to assets classified as held and used, we periodically review these assets to determine whether our carrying amount will be recovered. All of our long-lived assets were classified as held and used at December 31, 2004. Our operating real estate, which comprises the majority of our long-lived assets, had a carrying amount of $1.9 billion at December 31, 2004. A long-lived asset is considered impaired if its carrying amount exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Upon impairment, we would recognize an impairment loss to reduce the carrying value of the long-lived asset to our estimate of its fair value. Our estimate of fair value and cash flows to be generated from our properties requires us to make assumptions related to future occupancy of our properties, future rental rates, tenant concessions, operating expenditures, property taxes, capital improvements, the ability of our tenants to perform pursuant to their lease obligations, the holding period of our properties and the proceeds to be generated from the eventual sale of our properties. If one or more of our assumptions proves incorrect or if our assumptions change, the recognition of an impairment loss on one or more properties may be necessary in the future.

 

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Index to Financial Statements

The recognition of an impairment loss would negatively impact earnings. The table below details impairment losses on real estate properties recognized during the three years ended December 31, 2004.

 

     Year Ended December 31,

 

(in thousands)


   2004

   2003

    2002

 

Impairment loss recognized

   —      $ 1,792 (1)   $ 2,855 (1)

(1) Included in the line item “income from discontinued operations” in the accompanying consolidated statements of income.

 

Allowance for doubtful accounts

 

Accounts receivable are reduced by an allowance for amounts that we estimate to be uncollectible. Our receivable balance is comprised primarily of accrued rental rate increases to be received over the life of in-place leases as well as rents and operating cost recoveries due from tenants. We regularly evaluate the adequacy of our allowance for doubtful accounts considering such factors as credit quality of our tenants, delinquency of payment, historical trends and current economic conditions. At December 31, 2004, we had total receivables of $62.0 million and an allowance for doubtful accounts of $6.2 million, resulting in a net receivable balance of $55.8 million. Of the $62.0 million in total receivables, $50.7 million represents accrued rental rate increases to be received over the life of in-place leases. It is our policy to reserve all outstanding receivables that are 90-days past due along with a portion of the remaining receivable balance that we feel is uncollectible based on our evaluation of the outstanding receivable balance. In addition, we increase our allowance for doubtful accounts for accrued rental rate increases, if we determine such future rent is uncollectible. Actual results may differ from these estimates under different assumptions or conditions. If our assumptions, regarding the collectibility of accounts receivable, prove incorrect, we may experience write-offs in excess of our allowance for doubtful accounts which would negatively impact earnings. The table below presents the net increase/(decrease) to our allowance for doubtful accounts during the periods, amounts written-off as uncollectible during the periods and our allowance for doubtful accounts at December 31, 2004, and 2003 and 2002.

 

     Year Ended December 31,

 

(in thousands)


   2004

    2003

    2002

 

(Decrease)/increase in allowance for doubtful accounts

   $ (3,779 )   $ 2,274     $ 4,626  
    


 


 


Amounts written off during the period

     (6,847 )     (1,289 )     (802 )
    


 


 


Allowance for doubtful accounts at period end

   $ 6,207     $ 9,986     $ 7,712  
    


 


 


 

During the year ended December 31, 2002, our earnings were negatively impacted by a charge of $5.4 million resulting from our concern over the collectibility of certain tenant receivables. A significant portion of the charge related to our concern that accrued rental rate increases would not be collectible. Our concern was due in part to the impending bankruptcy of several significant tenants (bankruptcy tenants) as well as a deterioration of credit with certain other tenants. During 2002, we wrote-off approximately $197,000 and $605,000 of the receivables due from the bankruptcy tenants and other receivables, respectively.

 

During the year ended December 31, 2003, we recognized a charge to earnings of $3.6 million, a significant portion of which resulted from increased receivables due from the bankruptcy tenants. During 2003, we wrote-off approximately $667,000 and $622,000 of the receivables due from the bankruptcy tenants and other receivables, respectively.

 

During 2004, our earnings were negatively impacted by a charge of $3.0 million. The charge consisted of a $2.9 million allowance established for a note receivable that we determined to be partially uncollectible and other collectibility concerns of $1.7 million, partially offset by a $1.6 million allowance reversal resulting from the emergence from bankruptcy and recapitalization of one bankruptcy tenant. During 2004, we wrote-off approximately $1.5 million, $2.9 million and $2.4 million of the receivables due from the bankruptcy tenants, our note receivable and other receivables, respectively.

 

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Index to Financial Statements

As a result of the significant write-offs taken during the year ended December 31, 2004, a large portion of which related to the bankruptcy tenants and was allowed for in prior periods, accompanied by the allowance reversal attributable to the bankruptcy tenant’s emergence from bankruptcy, our allowance for doubtful accounts have decreased $3.8 million from December 31, 2003 to December 31, 2004.

 

Depreciable lives applied to real estate assets and improvements to real estate assets

 

Depreciation on buildings and improvements is provided under the straight-line method over an estimated useful life of 30 to 40 years for office buildings and 25 to 30 years for industrial buildings. Significant betterments made to our real estate assets are capitalized and depreciated over the estimated useful life of the betterment. If our estimate of useful lives proves to be materially incorrect, the depreciation and amortization expense that we currently recognize would also prove to be materially incorrect. A change in our estimate of useful lives would therefore result in either an increase or decrease in depreciation and amortization expense and thus, a decrease or increase in earnings. The table below presents real estate related depreciation and amortization expense, including real estate depreciation and amortization expense included in income from continuing operations as well as discontinued operations, for the three years ended December 31, 2004.

 

     Year Ended December 31,

(in thousands)


   2004

   2003

   2002

Real Estate depreciation and amortization from continuing operations

   $ 91,756    $ 72,199    $ 61,855

Real Estate depreciation and amortization from discontinued operations

   $ 3,673    $ 7,773    $ 11,513

 

Initial recognition, measurement and allocation of the cost of real estate acquired

 

We allocate the purchase price of properties acquired to tangible assets consisting of land and building and improvements, and identified intangible assets and liabilities generally consisting of (i) above- and below-market leases, (ii) in-place leases and (iii) tenant relationships. We allocate the purchase price to the assets acquired and liabilities assumed based on their relative fair values in accordance with Statement of Financial Accounting Standards No. 141, “Business Combinations.” These fair values are derived as follows:

 

Amounts allocated to land are derived from (1) comparable sales of raw land, (2) floor area ratio (FAR) specifics of the land as compared to other developed properties (average land cost per FAR) and (3) our other local market knowledge.

 

Amounts allocated to buildings and improvements are calculated and recorded as if the building was vacant upon purchase. We use estimated cash flow projections and apply discount and capitalization rates based on market knowledge. Depreciation is computed using the straight-line method over the estimated life of 30 to 40 years for office buildings and 25 to 30 years for industrial buildings.

 

We record above-market and below-market in-place lease values for acquired properties based on the present value (using a market interest rate which reflects the risks associated with the leases acquired) of the difference between (1) the contractual amounts to be paid pursuant to the in-place leases and (2) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease for above-market leases and the initial term plus the term of the fixed rate renewal option, if any for below-market leases. We perform this analysis on a lease (tenant) by lease (tenant) basis. The capitalized above-market lease values are amortized as a reduction to rental income over the remaining non-cancelable terms of the respective leases. The capitalized below-market lease values are amortized as an increase to rental income over the initial term plus the term of the fixed rate renewal option, if any, of the respective leases.

 

Other intangible assets, in-place leases and tenant relationships, are calculated based on an evaluation of specific characteristics of each tenant’s lease. Our estimates of fair value for other intangibles includes an estimate of carrying costs during the expected lease-up periods for the respective spaces considering current market conditions and the costs to execute similar leases. In estimating the carrying costs that would have otherwise been incurred had the leases not been in place, we include such items as real estate taxes, insurance and other operating expenses as well as lost rental revenue during the expected lease-up period based on current market conditions.

 

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Index to Financial Statements

Costs to execute similar leases include leasing commissions, legal and other related costs. The value of in-place leases is amortized to expense over the remaining non-cancelable term of the respective leases. Should a tenant terminate its lease, the unamortized portion of the in-place lease value would be charged to expense in current period earnings.

 

Based on our estimates of the fair value of the components of each real estate property acquired between January 1, 2003 and December 31, 2004, we allocated the purchase price as follows:

 

     Year Ended December 31,

 

(in thousands)


   2004

    2003

 

Land

   $ 46,597     $ 33,173  

Buildings and improvements

   $ 183,250     $ 107,506  

Tenant Improvements and leasing commissions

   $ 29,641     $ 28,159  

Below market lease value

   $ (7,122 )   $ (833 )

Above market lease value

   $ 2,342     $ 3,241  

In-place lease value at market

   $ 21,099     $ 7,425  

Above market debt

   $ (1,651 )   $ —    

 

During the year ended December 31, 2004, we acquired a parcel of land for gross consideration of $15.1 million, which is included as land held for development on our consolidated balance sheet.

 

Fair value of derivative instruments

 

In accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted, beginning January 1, 2001, we record all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability of expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

 

For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in earnings. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized currently in earnings. We assess the effectiveness of each hedging relationship by comparing the changes in fair value or cash flows of the derivative hedging instrument with the changes in fair value or cash flows of the designated hedged item or transaction. For derivatives not designated as hedges, changes in fair value are recognized in earnings.

 

Our objective in using derivatives is to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we use interest rate swaps as part of our cash flow hedging strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts in exchange for fixed-rate payments over the life of the agreements without the exchange of the underlying principal amount. During 2004, such derivatives were used to hedge the variable cash flows associated with a portion of our variable-rate debt.

 

As of December 31, 2004, we did not have any derivatives designated as fair value hedges. Additionally, we do not use derivatives for trading or speculative purposes, and currently, we do not have any derivatives that are not designated as hedges.

 

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Index to Financial Statements

To determine the fair value of our derivative instruments, we use a variety of methods and assumptions that are based on market conditions and risks existing at each balance sheet date. For the majority of financial instruments including most derivatives, standard market conventions and techniques such as discounted cash flow analysis, option pricing models, replacement cost, and termination cost are used to determine fair value. All methods of assessing fair value result in a general approximation of value, and such value may never actually be realized. Future cash inflows or outflows from our derivative instruments depend upon future borrowing rates. If assumptions about future borrowing rates prove to be materially incorrect, the recorded value of these agreements could also prove to be materially incorrect. Because we use the derivative instruments to hedge our exposure to variable interest rates, thus effectively fixing a portion of our variable interest rates, changes in future borrowing rates could result in our interest expense being either higher or lower than might otherwise have been incurred on our variable-rate borrowings had the rates not been fixed. The table below presents the amount by which cash payments made under our interest rate swap agreements exceeded cash receipts from our agreements during the three years ended December 31, 2004. The table also presents the estimated fair value of our in-place swap agreements as of December 31, 2004, 2003 and 2002.

 

     Year Ended December 31,

 

(in thousands)


   2004

    2003

    2002

 

Net cash paid under our interest rate swap agreements

   $ (10,557 )   $ (9,743 )   $ (8,232 )

Fair value of interest rate swaps

   $ (1,046 )   $ (8,074 )   $ (16,776 )

 

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Index to Financial Statements

Results of Operations

 

Comparison of the Year Ended December 31, 2004 to the Year Ended December 31, 2003

 

The table below presents our consolidated statements of income for the years ended December 31, 2004 and 2003:

 

Consolidated Statements of Income

(in thousands)


   Year Ended December 31,

 
   2004

    2003

 

Revenues:

                

Rental income

   $ 356,825     $ 314,718  

Service business and other income

     13,909       16,769  
    


 


       370,734       331,487  
    


 


Operating expenses:

                

Property operating and maintenance

     91,681       80,583  

Real estate taxes

     39,406       31,274  

General and administrative and personnel costs

     11,803       10,988  

Expenses of service business

     9,998       10,513  

Depreciation and amortization

     92,315       72,483  
    


 


       245,203       205,841  
    


 


Other expenses:

                

Interest expense

     68,037       67,232  

Amortization of deferred financing costs

     2,343       2,284  
    


 


Income from continuing operations before equity in income of unconsolidated joint ventures, loss on investment in securities, impairment, and minority interests

     55,151       56,130  

Equity in income of unconsolidated joint ventures

     2,429       2,555  

Loss on investment in securities

     (420 )     —    

Loss from impairment of mortgage loan

     (2,900 )     —    

Minority interests

     (2,744 )     (10,227 )
    


 


Income from continuing operations

     51,516       48,458  

Discontinued operations:

                

Income from discontinued operations

     3,354       6,034  

Gain/(loss) from disposition of discontinued operations

     11,957       (4,457 )

Loss from debt defeasance related to sale of real estate

     (5,316 )     —    

Minority interests related to discontinued operations

     (310 )     (53 )
    


 


       9,685       1,524  

Income before gain on sale of land and an interest in a real estate partnership

     61,201       49,982  

Gain on sale of land and an interest in a real estate partnership

     1,222       9,435  
    


 


Net income

   $ 62,423     $ 59,417  

Preferred dividends

     (10,052 )     (8,452 )
    


 


Net income applicable to common shareholders

   $ 52,371     $ 50,965  
    


 


 

Included below is a discussion of the significant events or transactions that have impacted our results of operations when comparing the year ended December 31, 2004 to the year ended December 31, 2003.

 

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Index to Financial Statements

Acquisition of Real Estate. Acquisitions are a key component of our external growth strategy. We selectively pursue acquisitions in our core markets when long-term yields make acquisitions attractive. Between January 1, 2003 and December 31, 2004, we acquired nineteen office properties containing in the aggregate approximately 3.4 million net rentable square feet as presented below:

 

Acquired Properties


  

Segment


  

Market


  

Month of

Acquisition


  

Number of

Buildings


  

Net Rentable

Square Feet (1)

(in thousands)


  

Acquisition

Price

(in millions)


Park West C3

   Southwest    Dallas/Ft. Worth    Feb. 2003    1    339    $ 28.1

410 Warrenville Road

   Midwest    Chicago    May 2003    1    60      8.7

Corporate Lakes III(2)

   Midwest    Chicago    June 2003    1    124      22.6

2291 Wood Oak Drive(2)

   Mid-Atlantic    Metro. Wash., D.C.    Aug. 2003    1    228      52.2

Camino West Corporate Park(2)

   Southern Calif.    San Diego    Nov. 2003    1    54      8.9

Carlsbad Airport Plaza(2)

   Southern Calif.    San Diego    Nov. 2003    1    62      10.5

La Place Court(2)

   Southern Calif.    San Diego    Nov. 2003    2    81      13.6

Pacific Ridge Corporate Centre(2)

   Southern Calif.    San Diego    Nov. 2003    2    121      23.9

Pacific View Plaza(2)

   Southern Calif.    San Diego    Nov. 2003    1    52      10.2

Cityplace Center

   Southwest    Dallas/Ft. Worth    April 2004    1    1,296      123.3

The Bluffs(3)

   Southern Calif.    San Diego    May 2004    1    69      17.7

5500 Great America Parkway

   Northern Calif.    Silicon Valley    May 2004    3    306      34.8

Lakeside Point I & II(3)

   Midwest    Chicago    Oct. 2004    2    198      32.6

2101 Webster

   Northern Calif.    Oakland    Oct. 2004    1    459      65.7
                   
  
  

                    19    3,449    $ 452.8
                   
  
  


(1) Net rentable square feet defines the area of a property for which a tenant is required to pay rent, which includes the actual rentable area plus a portion of the common areas of the property allocated to a tenant.
(2) Properties were acquired by the operating partnership and its affiliates and subsequently transferred to our Prentiss Office Investors, L.P. joint venture on January 22, 2004.
(3) Acquisitions were acquired by Prentiss Office Investors, L.P. The net rentable square feet and acquisition price is presented at 100%. Each partner contributed their pro rata share of the purchase price of each property to Prentiss Office Investors, L.P. prior to acquisition.

 

Leasing of Development Projects. Our results of operations, for the year ended December 31, 2004, have increased due to an increase in occupancy at a development project located in our Mid-Atlantic region which includes approximately 182,000 net rentable square feet. The project was 100% leased at December 31, 2004 and 35% rent paying for the year ended December 31, 2004, compared to 29% leased at December 31, 2003 and 29% rent paying for the year ended December 31, 2003.

 

Real Estate Dispositions. During the period January 1, 2003 through December 31, 2004, we disposed of four industrial properties containing 91,000 net rentable square feet and nineteen office properties containing 2.2 million net rentable square feet. The industrial properties were sold on July 23, 2004. Two office properties, containing 339,000 net rentable square feet, within our Southwest region were sold on June 26, 2003. Nine office properties containing 644,000 net rentable square feet were sold on July 24, 2003, representing our only real estate assets located within the Atlanta area, a market within our Mid-Atlantic region. Six office properties containing 566,000 net rentable square feet were sold on May 20, 2004, representing our only real estate assets in the Sacramento area, a market within our Northern California region. On August 23, 2004, we sold our only remaining real estate asset in the Houston, Texas area, a market within our Southwest region. The property contained 466,000 net rentable square feet. The remaining 136,000 net rentable square feet included the disposition on November 19, 2004 of an office building in the Chicago area, a market within our Midwest region.

 

Other Significant Real Estate Transactions. On January 22, 2004, Prentiss Office Investors, L.P. was established to acquire office properties in our core markets of Washington D.C./Northern Virginia, Chicago, Dallas/Ft. Worth, Northern California and San Diego/Orange County. The partnership was initially wholly owned by the operating partnership and its affiliates and was seeded by the transfer of several recent acquisitions as highlighted in the table above.

 

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Table of Contents
Index to Financial Statements

Pursuant to a joint venture agreement, effective February 1, 2004, Stichting Pensioenfonds ABP, a Netherlands based pension fund and unrelated third party, acquired a 49% limited partnership interest in Prentiss Office Investors, L.P. for proceeds totaling $68.9 million. As a result of the transaction, we recorded a gain on sale of $1.2 million. The joint venture is consolidated with and into the accounts of the operating partnership. Proceeds from the transaction were used to repay a portion of the outstanding borrowings under our revolving credit facility.

 

The following is a discussion of the material changes in our consolidated statements of income and a discussion of the impact that the significant events or transactions, as described above, had on one or more line items of our consolidated statements of income when comparing the year ended December 31, 2004 to the year ended December 31, 2003.

 

Rental Income. Rental income increased by $42.1 million, or 13.4%. The real estate acquisitions and development properties coming on-line resulted in increases of $37.7 million and $311,000, respectively. Additionally, our other properties experienced a $4.1 million increase primarily due to an increase in termination fee income of $4.7 million and an increase in operating cost recoveries of $1.3 million for the year ended December 31, 2004 compared to the year ended December 31, 2003. These increases were partially offset by a decrease in rental income of $2.3 million relating primarily to decreased occupancy and rental rate declines for newly executed leases.

 

Service Business and OtherIincome. Service business and other income decreased $2.9 million, or 17.1%, primarily due to a decrease in interest income resulting from the repayment of a note receivable on February 4, 2004 and the reduction of consulting fee income due to the completion of consulting contracts early in 2004.

 

Property Operating and Maintenance. Property operating and maintenance costs increased by $11.1 million, or 13.8%. The real estate acquisitions and development properties coming on-line resulted in increases of $10.9 million and $137,000, respectively. Property operating and maintenance expenses related to our other properties increased by $100,000. Property operating and maintenance expense at our other properties experienced increases due to increased utility cost and other operating expenses, offset by a decrease in bad debt expense.

 

Real Estate Taxes. Real estate taxes increased by $8.1 million, or 26.0%. The real estate acquisitions and development properties coming on-line resulted in increases of $4.5 million and $85,000, respectively. Real estate taxes related to our other properties increased by $3.6 million. The increase was primarily due to refunds received during the year ended December 31, 2003.

 

Expenses of Service Business. Expenses of service business decreased by $515,000, or 4.9%, primarily due to a decrease in income tax expense offset by an increase in compensation related expenses.

 

General and administrative and personnel costs. General and administrative and personnel costs increased by $815,000, or 7.4%, primarily due to an increase in compensation related expenses, which resulted from an increase in amounts due participants related to our deferred compensation and share incentive plans.

 

Depreciation and Amortization. Depreciation and amortization increased by $19.8 million, or 27.4%. The real estate acquisitions and development properties coming on-line resulted in increases of $15.0 million and $212,000, respectively. Other properties increased by $4.6 million which is attributable to the depreciation and amortization expense related to capital expenditures incurred at our properties subsequent to acquisition.

 

Interest Expense. Interest expense increased by $805,000, or 1.2%, primarily as a result of an increase in weighted average borrowings outstanding for the year ended December 31, 2004 compared to the year ended December 31, 2003. The increase was partially offset by a decrease in the weighted average interest rate paid on outstanding borrowings from 6.61% in 2003 to 6.22% in 2004 and an increase in capitalized interest from $416,000 in 2003 to $659,000 in 2004.

 

Loss on Investment in Securities. Loss on investment in securities of $420,000 resulted from a loss recorded on an investment we made in August 2000. We invested $423,000 in Narrowcast Communications, a provider of an electronic tenant information service known as Elevator News Network. On May 11, 2004, we received a letter notifying us that Narrowcast Communications was being dissolved. Included with the letter was a check totaling $3,000 representing a partial return of our investment. As a result, during the second quarter of 2004, we recognized a loss of $420,000 representing our remaining investment in the entity.

 

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Index to Financial Statements

Loss on impairment of mortgage loan. Loss on impairment of mortgage loan of $2.9 million, relates to a $4.4 million note receivable associated with a real estate sales transaction completed in 2001. On December 22, 2004, we received correspondence from the borrower indicating an inability to fulfill their total obligation under the note. Due to the fact that our note receivable is subordinate to a first mortgage totaling approximately $12.0 million, we initiated an evaluation of the underlying real estate. Our evaluation was to determine whether the fair value of the property, less cost to sell would be sufficient to satisfy both the first mortgage and our note receivable. In our opinion, the fair value of the underlying real estate would not be sufficient to satisfy both the first mortgage and our note receivable and thus in the preparation of our financial statements, we recognized a $2.9 million write-down of the note.

 

Minority Interests. Minority interests decreased $7.5 million, or 73.2%, primarily due to a decrease in the proportionate share of net income attributable to the Series E and Series B Cumulative Redeemable Perpetual Preferred unitholders as a result of the repurchase of these units on February 4, 2004 and February 24, 2004, respectively.

 

Discontinued Operations. Discontinued operations increased by $8.2 million, primarily as a result of the gain from the sale of properties of $12.0 million for the year ended December 31, 2004 compared to a loss on the sale of properties of $4.5 million for the year ended December 31, 2003, partially offset by a loss from debt defeasance of $5.3 million recognized during the year ended December 31, 2004. Discontinued operations were also impacted by an impairment loss of $1.8 million recognized during the year ended December 31, 2003 and the timing of sale of the properties.

 

Gain on Sale of Land and Partnership Interest. Gain on sale of land and partnership interest decreased by $8.2 million, or 87.0%. During the year ended December 31, 2004, we sold an interest in a real estate partnership resulting in a gain of approximately $1.2 million. During the year ended December 31, 2003, we disposed of three land parcels resulting in a gain on sale of $9.4 million.

 

35


Table of Contents
Index to Financial Statements

Comparison of the Year Ended December 31, 2003 to the Year Ended December 31, 2002

 

The table below presents our consolidated statements of income for the years ended December 31, 2003 and 2002:

 

Consolidated Statements of Income

(in thousands)


   Year Ended December 31,

 
   2003

    2002

 

Revenues:

                

Rental income

   $ 314,718     $ 307,487  

Service business and other income

     16,769       4,386  
    


 


       331,487       311,873  
    


 


Operating expenses:

                

Property operating and maintenance

     80,583       75,235  

Real estate taxes

     31,274       35,119  

General and administrative and personnel costs

     10,988       10,361  

Expenses of service business

     10,513       —    

Depreciation and amortization

     72,483       61,944  
    


 


       205,841       182,659  
    


 


Other expenses:

                

Interest expense

     67,232       64,468  

Amortization of deferred financing costs

     2,284       1,832  
    


 


Income from continuing operations before equity in income of unconsolidated joint ventures and unconsolidated subsidiaries and minority interests

     56,130       62,914  

Equity in income of unconsolidated joint ventures and unconsolidated subsidiaries

     2,555       3,154  

Minority interests

     (10,227 )     (10,450 )
    


 


Incoming from continuing operations

     48,458       55,618  

Discontinued operations:

                

Income from discontinued operations

     6,034       10,966  

(Loss)/gain from disposition of discontinued operations

     (4,457 )     8,430  

Minority interests related to discontinued operations

     (53 )     (733 )
    


 


       1,524       18,663  

Income before gain on sale of land

     49,982       74,281  

Gain on sale of land

     9,435       —    
    


 


Net income

   $ 59,417     $ 74,281  

Preferred dividends

     (8,452 )     (8,358 )
    


 


Net income applicable to common shareholders

   $ 50,965     $ 65,923  
    


 


 

Included below is a discussion of the significant events or transactions that have impacted our results of operations when comparing the year ended December 31, 2003 to the year ended December 31, 2002.

 

Acquisition of Real Estate. Acquisitions are a key component of our external growth strategy. We selectively pursue acquisitions in our core markets when long-term yields make acquisitions attractive. Prior to March 2002, we owned a 20% non-controlling interest in the joint venture owning the Burnett Plaza property, a 1.0 million net rentable square foot office building located in our Southwest Region. Our 20% interest was accounted for using the equity method of accounting and thus, our share of the results of operations from the property were included in the line item “equity in income of joint ventures and unconsolidated subsidiaries” on our consolidated statements of income. On March 7, 2002, we purchased from Burnett Plaza – VEF III, L.P., an affiliate of Lend Lease Real Estate Investments, its 80% interest in the joint venture for a purchase price of approximately $51.2 million and the assumption of their pro rata share of joint venture debt. Subsequent to this purchase, the results of operations for the Burnett Plaza property are consolidated into the results of operations of our operating partnership.

 

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Table of Contents
Index to Financial Statements

In addition to the acquisition of the Burnett Plaza property, between January 1, 2002 and December 31, 2003, we acquired twelve wholly-owned office properties containing in the aggregate approximately 1.4 million net rentable square feet as presented below.

 

Acquired Properties


   Segment

   Market

  

Month of

Acquisition


  

Number of

Buildings


  

Net Rentable

Square Feet(1)

(in thousands)


  

Acquisition

Price

(in millions)


12601 Fair Lakes Circle

   Mid-Atlantic    Metro. Wash., D.C.    Nov. 2002    1    264    $ 55.1

Park West C3

   Southwest    Dallas/Ft. Worth    Feb. 2003    1    339      28.1

410 Warrenville Road

   Midwest    Chicago    May 2003    1    60      8.7

Corporate Lakes III(2)

   Midwest    Chicago    June 2003    1    124      22.6

2291 Wood Oak Drive(2)

   Mid-Atlantic    Metro. Wash., D.C.    Aug. 2003    1    228      52.2

Camino West Corporate Park(2)

   Southern Calif.    San Diego    Nov. 2003    1    54      8.9

Carlsbad Airport Plaza(2)

   Southern Calif.    San Diego    Nov. 2003    1    62      10.5

La Place Court(2)

   Southern Calif.    San Diego    Nov. 2003    2    81      13.6

Pacific Ridge Corporate Centre(2)

   Southern Calif.    San Diego    Nov. 2003    2    121      23.9

Pacific View Plaza(2)

   Southern Calif.    San Diego    Nov. 2003    1    52      10.2
                   
  
  

                    12    1,385    $ 233.8
                   
  
  


(1) Net rentable square feet defines the area of a property for which a tenant is required to pay rent, which includes the actual rentable area plus a portion of the common areas of the property allocated to a tenant.
(2) Properties were acquired by the operating partnership and its affiliates, and subsequently transferred to our Prentiss Office Investors, L.P. joint venture on January 22, 2004.

 

Leasing of Develpment Projects. Our results of operations, for the year ended December 31, 2003, have been bolstered by increased occupancy at three development projects. The projects include approximately 182,000 net rentable square feet in our Mid-Atlantic Region, 223,000 net rentable square feet in our Southwest Region and 40,000 net rentable square feet in our Southern California Region. The projects were approximately 71% leased and rent paying at December 31, 2003.

 

Real Estate Dispositions. During the period January 1, 2002 through December 31, 2003, we disposed of seven industrial properties containing 875,000 net rentable square feet and fourteen office properties containing 1.2 million net rentable square feet. The industrial properties were sold on September 10, 2002 and included all of the industrial properties within our Mid-Atlantic Region. Three office properties containing 194,000 net rentable square feet were sold on October 17, 2002 and represented our only office holdings within the Los Angeles area, a market within our Southern California Region. Two office properties, containing 339,000 net rentable square feet, within our Southwest region were sold on June 26, 2003. The remaining 644,000 net rentable square feet included the disposition on July 24, 2003 of nine office properties representing our only properties within the Atlanta area, a market within our Mid-Atlantic region.

 

Other Significant Real Estate Transactions. On November 22, 1999, we acquired 123 North Wacker, a 540,000 net rentable square foot office property located in our Midwest Region for a purchase price of approximately $87.3 million. The property was primarily leased to a single tenant whose intention was to vacate the property in September 2001 upon the expiration of the in-place lease. Our intention was to convert and market the building for lease as a multi-tenant property. The property, which was vacated as intended incurred significant leasing activity during 2002 and 2003. The property was approximately 88% leased at December 31, 2003 compared to 81% leased at December 31, 2002.

 

The following is a discussion of the material changes in our consolidated statements of income and a discussion of the impact that the significant events or transactions, as described above, had on one or more line items of our consolidated statements of income when comparing the year ended December 31, 2003 to the year ended December 31, 2002.

 

37


Table of Contents
Index to Financial Statements

Rental Income. Rental income increased by $7.2 million, or 2.4%. The real estate acquisitions and development properties coming on-line resulted in increases of $21.1 million and $2.3 million, respectively. The leasing of our 123 North Wacker property resulted in an increase of $2.5 million. The increases were offset by a decrease of $18.7 million from our other properties relating primarily to occupancy and rental rate declines in our portfolio and a decrease in termination fee income recognized for the year ended December 31, 2003 compared to the year ended December 31, 2002.

 

Property Operating and Maintenance. Property operating and maintenance costs increased by $5.3 million, or 7.1%. The real estate acquisitions and development properties coming on-line resulted in increases of $5.6 million and $1.4 million, respectively. The leasing of our 123 North Wacker property resulted in an increase of $383,000. Property operating and maintenance expenses related to our other properties decreased by $2.0 million. The decrease in property operating and maintenance expenses at our other properties primarily due to the decrease from the year ended December 31, 2002 to the year ended December 31, 2003 of bad debt expenses recognized at our properties

 

Real Estate Taxes. Real estate taxes decreased by $3.8 million, or 10.9%. The real estate acquisitions and development properties coming on-line resulted in increases of $1.3 million and $59,000, respectively. The increases were offset by decreases of $4.5 million and $757,000 from our other properties and our 123 North Wacker property, respectively. The decrease primarily resulted from real estate tax refunds received and lower estimates of current year taxes resulting from lower property tax assessments across our portfolio.

 

Service Business and Other Income/Expenses of Service Business. Service business and other income and the expenses of service business increased as a result of the acquisition of the remaining interest in Prentiss Properties Resources, Inc. and the resulting consolidation of the accounts with and into the accounts of the operating partnership. During the year ended December 31, 2002, our pro rata share of the results of operations of Prentiss Properties Resources, Inc. were included in the line item “equity in income of joint ventures and unconsolidated subsidiaries” in our consolidated statement of income.

 

Depreciation and Amortization. Depreciation and amortization increased by $10.5 million, or 17.0%. The real estate acquisitions and development properties coming on-line resulted in increases of $5.9 million and $2.0 million, respectively. The leasing of our 123 North Wacker property resulted in an increase of $1.1 million. Other properties increased by $1.5 million which is attributable to the depreciation and amortization expense related to capital expenditures incurred at our properties subsequent to acquisition.

 

Interest Expense. Interest expense increased by $2.8 million, or 4.3%, primarily as a result of an increase in weighted average borrowings outstanding for the year ended December 31, 2003 compared to the year ended December 31, 2002 accompanied by a decrease in capitalized interest from $3.4 million in 2002 to $416,000 in 2003. The increase was partially offset by a decrease in the weighted average interest rate paid on outstanding borrowings from 6.78% in 2002 to 6.61% in 2003.

 

Discontinued Operations. Discontinued operations decreased by $17.1, primarily as a result of the loss from the sale of properties of $4.5 million for the year ended December 31, 2003 compared to a gain on the sale of properties of $8.4 million for the year ended December 31, 2002. Also contributing to the decrease is the shortened period of time the assets were in our portfolio during 2003 versus 2002.

 

Gain on Sale of Land. During the year ended December 31, 2003, we disposed of three parcels of land resulting in a gain on sale of $9.4 million.

 

Liquidity and Capital Resources

 

Cash and cash equivalents were $8.6 million and $5.9 million at December 31, 2004 and December 31, 2003, respectively. The increase in cash and cash equivalents is a result of net cash flows provided by operating activities exceeding net cash used in investing and financing activities.

 

38


Table of Contents
Index to Financial Statements

Cash flows provided by operating activities totaled $158.2 million for the year ended December 31, 2004 compared to $133.6 million for the year ended December 31, 2003. The change in cash flows from operating activities is attributable to (1) the factors discussed in our analysis of results of operations for the year ended December 31, 2004 compared to December 31, 2003 and (2) the timing of receipt of revenues and payment of expenses which is evidenced by cash outflows of only $4.1 million in 2004 compared to $21.6 million in 2003 related to the changes in assets and liabilities.

 

Net cash used in investing activities totaled $79.0 million for the year ended December 31, 2004 compared to $142.3 million for the year ended December 31, 2003. The decrease in net cash used in investing activities of $63.3 million is due primarily to an increase in cash generated from the sale of real estate of $65.9 million, an increase of $69.3 million in proceeds from the sale of a joint venture interest in a real estate partnership, an increase in cash generated from the repayment of notes receivable of $11.5 million, partially offset by an increase of $59.7 million in cash used to purchase real estate, an increase of $19.2 million used for capital expenditures related to in service properties and an increase of $4.3 million in cash used in the development and redevelopment of real estate.

 

Net cash used in financing activities totaled $76.6 million for the year ended December 31, 2004 compared to net cash provided of $9.5 million for the year ended December 31, 2003. The increase in net cash used in financing activities of $86.1 million is due primarily to an increase of $105.0 million of cash used for the redemption of preferred units, an increase of $64.5 million in net cash used for distributions, a decrease in cash generated from the sale of common shares of $34.3 million, an increase in cash used to pay debt defeasance cost on the extinguishment of debt of $5.3 million, partially offset by an increase in net borrowings of $97.2 million and an increase in capital contributions from consolidated joint ventures of $26.9 million.

 

Net cash flow from operations represents the primary source of liquidity to fund distributions, debt service, capital improvements and non-revenue enhancing tenant improvements. We expect that our revolving credit facility will provide for funding of working capital and revenue enhancing tenant improvements, unanticipated cash needs as well as acquisitions and development costs. Our principal short-term liquidity needs are to fund normal recurring expenses, debt service requirements and the minimum distributions required to maintain our REIT qualification under the Internal Revenue Code.

 

Our net cash flow from operations is generally derived from rental revenues and operating expense reimbursements from tenants and, to a limited extent, from fees generated by our office and industrial real estate management service business. Our net cash flow from operations is therefore dependent upon the occupancy level of our properties, the collectibility of rent from our tenants, the level of operating and other expenses of our properties, and other factors. Material changes in these factors may adversely affect our net cash flow from operations. Such changes, in turn, would adversely affect our ability to fund distributions, debt service, capital improvements and non-revenue enhancing tenant improvements. In addition, a material adverse change in our net cash flow from operations may affect the financial performance covenants under our revolving credit facility. If we fail to meet any of our financial performance covenants, our revolving credit facility may become unavailable to us, or the interest charged on the revolving credit facility may increase. Either of these circumstances could adversely affect our ability to fund working capital and revenue enhancing tenant improvements, unanticipated cash needs, acquisitions and development costs.

 

In order to qualify as a REIT for federal income tax purposes, we must distribute at least 90% of our taxable income, excluding capital gains. We expect to make distributions to our shareholders primarily based on our cash flow from operations distributed by our operating partnership. We anticipate that our short-term liquidity needs will be fully funded from cash flows provided by operating activities and, when necessary to fund shortfalls resulting from the timing of collections of accounts receivable in the ordinary course of business, from our revolving credit facility. In the event that our cash flow needs exceed cash flows provided by operating activities, we may be forced to incur additional debt or sell real estate properties to fund such cash flow needs.

 

We expect to meet our long-term liquidity requirements for the funding of activities, such as development, real estate acquisitions, scheduled debt maturities, major renovations, expansions and other revenue enhancing capital improvements through long-term secured and unsecured indebtedness and through the issuance of additional debt and equity securities. We also intend to use proceeds from our revolving credit facility to fund real estate acquisitions, development, redevelopment, expansions and capital improvements on an interim basis.

 

39


Table of Contents
Index to Financial Statements

Debt Financing

 

As of December 31, 2004, we had outstanding total consolidated indebtedness of approximately $1.2 billion. The amount of indebtedness that we may incur, and the policies with respect thereto, are not limited by our declaration of trust and bylaws, and are solely within the discretion of our board of trustees, limited only by various financial covenants in our credit agreements. It is our general policy to limit combined indebtedness including our pro rata share of consolidated and unconsolidated joint venture debt so that, at the time such debt is incurred, it does not exceed 50% of our total market capitalization. As of December 31, 2004, we had outstanding total indebtedness, including our pro rata share of consolidated and unconsolidated joint venture debt, of approximately $1.2 billion, or approximately 38.8% of total market capitalization based on a common share price of $38.20 per common share. Our credit agreements limit total indebtedness to 55% of total assets and require an interest coverage ratio of at least 2 to 1.

 

On February 19, 2004, we renewed our $300 million revolving credit facility, including an extension of the maturity date from May 23, 2005 to February 19, 2007. The interest rate on the facility will fluctuate based on our overall leverage with a range between 30-day LIBOR plus 112.5 basis points and 30-day LIBOR plus 160 basis points. The pricing on the renewed facility represents a 12.5 basis point to 15.0 basis point pricing reduction across the leverage grid. The facility was substantially oversubscribed with initial commitments of $370 million. Banking participants in the revolving credit facility include Bank One as Administrative Agent; Bank of America as Syndication Agent; Commerzbank, EuroHypo and Societe General as Documentation Agents; PNC Bank, Sun Trust and Union Bank of California as Co-Agents; and Comerica Bank, KeyBank, Mellon Bank, and SouthTrust Bank as Lenders. On June 25, 2004, we exercised an accordion feature within our revolving credit facility expanding the facility’s overall borrowing capacity from $300 million to $375 million. Other terms of the facility remain unchanged.

 

On March 2, 2004, we negotiated an interest rate reduction on our $75.0 million unsecured term loan with Commerzbank AG. The interest rate which is based on overall leverage was reduced from 30-day LIBOR plus 125 to 175 basis points to 30-day LIBOR plus 112.5 to 160 basis points. In addition, the term loan which had an original maturity date of March 15, 2006 was extended to March 15, 2009.

 

On May 20, 2004, in connection with a real estate sales transaction, we exercised our right to complete a voluntary defeasance of the mortgage loan collateralized by the sold properties. Pursuant to the defeasance, we transferred the mortgage loan with an outstanding principal balance of $35.8 million to an unrelated successor entity. The buyer of the properties transferred proceeds totaling $41.1 million representing the proceeds necessary to acquire U.S. treasuries sufficient to cover the debt service of the mortgage loan from the defeasance date through maturity of the loan. We recognized a loss from debt defeasance of $5.3 million during the period which we included in discontinued operations. The amount used to repay the mortgage loan was funded with proceeds received from the properties sold.

 

On July 23, 2004, Prentiss Office Investors, L.P., completed a five-year, $10.7 million loan collateralized by a 69,000 net rentable square foot office building in San Diego, California. The loan, which is interest only until maturity, has an interest rate that fluctuates between 130 and 150 basis points over 30-day LIBOR depending on the property’s occupancy, and matures July 23, 2009. Proceeds from the loan were used to fund a pro rata capital distribution to the joint venture partners based on their ownership interest in Prentiss Office Investors, L.P. Our operating partnership used proceeds received from the capital distribution to repay a portion of the outstanding borrowings under our revolving credit facility.

 

On July 29, 2004, Prentiss Office Investors, L.P, completed a five-year $85.0 million loan, collateralized by nine office buildings owned by various subsidiaries of Prentiss Office Investors, L.P. located in Illinois, California and Virginia. The interest rate on the loan is 85 basis points over 30-day LIBOR and the monthly payments are interest only, with the principal of $85.0 million payable at its maturity on August 1, 2009. Proceeds from the loan were used to fund a pro rata capital distribution to the joint venture partners based on their ownership interest in Prentiss Office Investors, L.P. Our operating partnership used proceeds received from the capital distribution to repay a portion of the outstanding borrowings under our revolving credit facility.

 

40


Table of Contents
Index to Financial Statements

On August 16, 2004, Prentiss/Collins Del Mar Heights, LLC, completed a three-year, $34.0 million construction loan with two one-year extension options to fund a portion of its 158,000 net rentable square foot office development project in Del Mar, California. Construction of the development project commenced during the second quarter of 2004. The loan which has an interest rate of 140 basis points over 30-day LIBOR matures September 1, 2007. The interest rate will drop 10 basis points if certain economic and occupancy targets are achieved. Borrowings under the construction loan, which totaled $8.9 million at December 31, 2004, were used to fund a portion of the development cost incurred to date.

 

On October 1, 2004, a $33.2 million, 6.92% fixed rate borrowing collateralized by a building located in Dallas, Texas was open for repayment without penalty. We repaid the outstanding balance using proceeds from our revolving credit facility.

 

On October 8, 2004, in connection with a property acquisition, we assumed a $46.0 million, 8.22% amortizing mortgage loan with a maturity date of November 1, 2005. We recorded the debt at $47.7 million representing our estimate of the fair market value of the debt on the date of acquisition. The fair value of the debt was calculated using an effective interest rate of 3.7% which represents our estimate of a market interest rate that we could have achieved on a 1-year collateralized mortgage loan on the date of acquisition.

 

On December 21, 2004, Prentiss Office Investors, L.P, completed a five-year $20.0 million loan, collateralized by two office buildings located in Waukegan, Illinois. The interest rate on the loan is 110 basis points over 30-day LIBOR and the monthly payments are interest only, with the principal of $20.0 million payable at its maturity on December 1, 2009. Proceeds from the loan were used to fund a pro rata capital distribution to the joint venture partners based on their ownership interest in Prentiss Office Investors, L.P. Our operating partnership used proceeds received from the capital distribution to repay a portion of the outstanding borrowings under our revolving credit facility.

 

During the period, we repaid approximately $40.4 million of our $70.4 million collateralized term loan scheduled to mature on September 30, 2004. The remaining $30.0 million was extended for a period of three years to mature on September 30, 2007 at 30-day LIBOR plus 115 basis points. The loan was previously collateralized by four properties including Willow Oaks I & II, 8521 Leesburg Pike, and the IBM Call Center. The amendment released the Willow Oaks properties from the collateral pool.

 

41


Table of Contents
Index to Financial Statements

The following table sets forth our mortgages and notes payable, including our unconsolidated joint venture debt, as of December 31, 2004.

 

Borrower/Description


  

Current
Balance

(000’s)


  

Amortization


  

Interest Rate


  

Maturity


Consolidated Entities

                     

Burnett Plaza Associates

                     

Burnett Plaza

   $ 66,000    None    LIBOR+1.500%    July 9, 2005

PL Properties Associates, L.P.

                     

Park West C2

     32,926    30 yr    6.63%    November 10, 2010

Prentiss Properties Acquisition Partners, L.P.

                     

2101 Webster

     47,039    None    3.70%    November 1, 2005

Highland Court

     4,354    25 yr    7.27%    April 1, 2006

Plaza I & II

     6,861    18 yr    7.75%    January 1, 2007

Revolving Credit Facility

     217,500    None    LIBOR + 1.250%    February 19, 2007

Collateralized Term Loan (1)

     30,000    None    LIBOR + 1.150%    September 30, 2007

Unsecured Term Loan – EuroHypo I

     100,000    None    LIBOR + 1.250%    May 22, 2008

Unsecured Term Loan – Commerz

     75,000    None    LIBOR + 1.250%    March 15, 2009

7101 Wisconsin Avenue

     20,095    30 yr    7.25%    April 1, 2009

Unsecured Term Loan – EuroHypo II

     13,760    30 yr    7.46%    July 15, 2009

The Ordway

     47,425    30 yr    7.95%    August 1, 2010

World Savings Center

     28,202    30 yr    7.91%    November 1, 2010

One O’Hare Centre

     39,112    30 yr    6.80%    January 10, 2011

3130 Fairview Park Drive

     21,926    30 yr    7.00%    April 1, 2011

Research Office Center I-III

     43,419    28 yr    7.64%    October 1, 2011

Bannockburn Centre

     25,838    30 yr    8.05%    June 1, 2012

Del Mar Loan

     43,375    30 yr    7.41%    June 1, 2013

Prentiss Properties Corporetum, L.P.

                     

Corporetum Office Campus

     24,350    30 yr    7.02%    February 1, 2009

Prentiss Properties Real Estate Fund I, L.P.

                     

PPREFI Portfolio Loan (2)

     180,100    None    7.58%    February 26, 2007

Prentiss Office Investors, L.P. (3)

                     

The Bluffs

     10,700    None    LIBOR + 1.300%    July 23, 2009

Collateralized Term Loan – Mass Mutual (4)

     85,000    None    LIBOR + 0.850%    August 1, 2009

Lakeside Point I & II

     20,000    None    LIBOR + 1.100%    December 1, 2009

Prentiss/Collins Del Mar Heights, LLC (5)

                     

High Bluff Ridge Construction Loan

     8,929    None    LIBOR + 1.400%    September 1, 2007
    

              

Total Consolidated Outstanding Debt

   $ 1,191,911               
    

              

Unconsolidated Entities

                     

Broadmoor Austin Associates

                     

Broadmoor Austin (6)

   $ 131,979    16 yr    7.04%    April 10, 2011

Tysons International Partners (7)

                     

1676 International Drive

     43,530    28 yr    7.68%    August 30, 2010

8260 Greensboro

     15,583    28 yr    7.83%    August 30, 2010
    

              

Total Unconsolidated Outstanding Debt

   $ 191,092               
    

              

Total Debt

   $ 1,383,003               
    

              

 

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Table of Contents
Index to Financial Statements
(1) The Term Loan is collateralized by the following two properties: 8521 Leesburg Pike and the IBM Call Center.
(2) The PPREFI Portfolio Loan is collateralized by the following 36 properties: the Los Angeles industrial properties (18 properties), the Chicago industrial properties (four properties), the Cottonwood Office Center (three properties), Park West E1 and E2 (two properties), One Northwestern Plaza, 3141 Fairview Park Drive, 13825 Sunrise Valley Drive, O’Hare Plaza II, 1717 Deerfield Road, 2411 Dulles Corner Road, 4401 Fair Lakes Court, the WestPoint Office Building and the PacifiCare Building.
(3) Our operating partnership and its affiliates own a 51% interest in Prentiss Office Investors, L.P. The accounts of Prentiss Office Investors, L.P. are consolidated with and into the accounts of the operating partnership. The amounts shown reflect 100% of the debt balance.
(4) The Term Loan is collateralized by the following 9 properties: Camino West Corporate Park, Carlsbad Airport Plaza, La Place Court (2 properties), Pacific Ridge Corporate Centre (2 properties), Pacific View Plaza, Corporate Lakes III, and 2291 Wood Oak Drive.
(5) Our operating partnership and its affiliates own a 70% interest in Prentiss/Collins Del Mar Heights, LLC. The accounts of Prentiss/Collins Del Mar Heights, LLC are consolidated with and into the accounts of the operating partnership. The amount shown reflects 100% of the debt balance.
(6) We own a 50% non-controlling interest in the entity that owns the Broadmoor Austin properties, which interest is accounted for using the equity method of accounting. The amount shown reflects 100% of the non-recourse mortgage indebtedness collateralized by the properties.
(7) We own a 25% non-controlling interest in the entity that owns the 1676 International Drive and 8260 Greensboro properties, which interest is accounted for using the equity method of accounting. The amount shown reflects 100% of the non-recourse mortgage indebtedness collateralized by the properties.

 

The majority of our fixed rate secured debt contains prepayment provisions based on the greater of a yield maintenance penalty or 1.0% of the outstanding loan amount. The yield maintenance penalty essentially compensates the lender for the difference between the fixed rate under the loan and the yield that the lender would receive if the lender reinvested the prepaid loan balance in U.S. Treasury Securities with a similar maturity as the loan.

 

Under our loan agreements, we are required to satisfy various affirmative and negative covenants, including limitations on total indebtedness, total collateralized indebtedness and cash distributions, as well as obligations to maintain certain minimum tangible net worth and certain minimum interest coverage ratios. Our credit agreements limit total indebtedness to 55% of total assets and require a debt service coverage ratio of at least 2 to 1. Our credit agreements provide for a 30-day period to cure a default caused by our failure to punctually and properly perform, observe and comply with the covenants contained therein. The agreements also provide for an additional 75-day period if such failure is not capable of being cured within 30-days and we are diligently pursuing the cure thereof. We were in compliance with these covenants at December 31, 2004.

 

Hedging Activities

 

To manage interest rate risk, we may employ options, forwards, interest rate swaps, caps and floors or a combination thereof depending on the underlying interest rate exposure. We undertake a variety of borrowings: from revolving credit facilities, to medium- and long-term financings. To manage overall interest rate exposure, we use interest rate instruments, typically interest rate swaps, to convert a portion of our variable rate debt to fixed rate debt. Interest rate differentials that arise under these swap contracts are recognized as interest expense over the life of the contracts.

 

We may employ forwards or purchased options to hedge qualifying anticipated transactions. Gains and losses are deferred and recognized in net income in the same period that the anticipated transaction occurs, expires or is otherwise terminated.

 

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Beginning on the effective date, each swap effectively locks in our cost of funds at the swap rate paid (before the spread over LIBOR) on variable rate borrowings in amounts equal to the respective notional amounts of the swap agreement.

 

The following table summarizes the notional amounts and fair values of our derivative financial instruments outstanding at December 31, 2004 and highlights those swap agreements executed during the year ended December 31, 2004. The notional amount provides an indication of the extent of our involvement in these instruments as of the balance sheet date, but does not represent exposure to credit, interest rate or market risks.

 

Notional Amount


  

Swap Rate

Paid

(Fixed)


  

Swap Rate Received

(Variable) at

December 31, 2004


  

Swap Maturity


   Fair Value

 
                    (in thousands)  
$ 25.0 million    4.345%    2.400%    July 2005    $ (212 )
$ 15.0 million    4.345%    2.400%    July 2005      (127 )
$ 20.0 million    5.985%    2.400%    March 2006      (676 )
$ 30.0 million    5.990%    2.400%    March 2006      (1,015 )
$ 50.0 million    2.270%    2.400%    August 2007      1,500  
$ 25.0 million    2.277%    2.400%    August 2007      746  
$ 70.0 million (1)(2)    4.139%    2.400%    August 2008      (1,136 )
$ 30.0 million    3.857%    2.400%    September 2008      (175 )
$ 30.0 million (2)    3.819%    2.400%    October 2008      (134 )
$ 20.0 million (2)    3.819%    2.400%    October 2008      (89 )
$ 50.0 million (2)    3.935%    2.400%    May 2009      (286 )
$ 30.0 million (2)    3.443%    2.400%    October 2009      558  
                   


Total

                  $ (1,046 )
                   



(1) The interest rate swap agreement was executed by our Prentiss Office Investors, L.P. joint venture.
(2) The interest rate swap agreement was completed during the year ended December 31, 2004.

 

Capital Improvements

 

Our properties require periodic investments of capital for tenant-related capital expenditures and for general capital improvements. The majority of capital required relates to tenant-related capital expenditures and is dependent upon our leasing activity. Our leasing activity is a function of the percentage of our in-place leases expiring in current and future periods accompanied by our exposure to tenant defaults and our ability to increase the average occupancy of our portfolio. For the year ended December 31, 2004 capital expenditures related to our in-service properties totaled $54.4 million.

 

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Equity Financing

 

During the year ended December 31, 2004, 2,496,462 common shares of beneficial interest, par value $.01, were issued. The table below details the common shares issued during the period, common shares placed in or removed from treasury during the period and the common shares outstanding at December 31, 2004:

 

Common shares outstanding at December 31, 2003

   42,613,294  

Common shares issued:

      

Dribble Plan (1)

   1,634,300  

Share options exercised

   612,020  

Conversion of operating partnership units

   113,200  

1996 Share Incentive Plan

   97,450  

Employees’ Share Purchase Plan

   29,683  

Dividend Reinvestment and Share Purchase Plan (2)

   6,154  

Trustees’ Share Incentive Plan

   3,655  
    

     2,496,462  

Common shares placed in/removed from treasury:

      

Common shares surrendered in connection with share options exercised

   (125,963 )

Restricted share grants forfeited

   (4,000 )

Common shares removed from treasury pursuant to our Key Employee Share Option Plan

   2,095  
    

Common shares outstanding at December 31, 2004

   44,981,888  
    


(1) On June 10, 2002, we entered into a securities sales agreement with Brinson Patrick Securities Corporation which we refer to as the Dribble Plan. Under the Dribble Plan we may sell, with Brinson Patrick acting as our sales agent, up to 3,000,000 of our common shares at the then market price directly to the public. During the year ended December 31, 2004, we issued 1,634,300 common shares through the Dribble Plan resulting in net proceeds of $54.1 million. The proceeds were used to repay a portion of the outstanding borrowings under our revolving credit facility. On May 28, 2004, we entered into an additional securities sales agreement with Brinson Patrick Securities Corporation covering 2,000,000 of our common shares in the form of the Dribble Plan that was adopted on June 10, 2002. Shares will be issuable pursuant to the May 28, 2004 Dribble Plan after all shares have been issued under the original Dribble Plan.
(2) We have a Dividend Reinvestment and Share Purchase Plan which allows investors an option to purchase common shares by making optional cash investments of $100 to $5,000 in a given month for current shareholders or $500 to $5,000 for persons who are not current shareholders. The plan also allows shareholders to purchase our common shares by reinvesting all or a portion of cash dividends received on our common or preferred shares. Purchases of greater than $5,000 can be accomplished by us granting a waiver to the $5,000 limit. During the year ended December 31, 2004, pursuant to our Dividend Reinvestment and Share Purchase Plan, we issued 6,154 common shares resulting in net proceeds of $214,000. The proceeds were used to repay a portion of the outstanding borrowings under our revolving credit facility.

 

On February 4, 2004, pursuant to a unit repurchase agreement between our operating partnership and Brandywine Operating Partnership, L.P., we repurchased from Brandywine Operating Partnership, L.P. our outstanding 7.50% Series E Preferred Units and 26,768 common units held by Brandywine Operating Partnership, L.P. The Series E Preferred Units, which were classified as mandatorily redeemable preferred units, a liability, on our consolidated balance sheet, were repurchased at their liquidation value of $10.0 million plus accrued and unpaid dividends of $70,055. The common units, which were classified within minority interest in operating partnership on our consolidated balance sheet, were repurchased for $891,803 representing a per unit price of $33.316, calculated as the average of the daily market price of our common shares for the 10 consecutive trading days prior to the date of repurchase. Concurrent with the repurchase, Brandywine Operating Partnership, L.P. repaid two promissory notes totaling $8.9 million and accrued and unpaid interest of $282,308 due to our operating partnership. An amount totaling $1.7 million, representing the difference between the units repurchased and the proceeds from the promissory notes was paid by our operating partnership to Brandywine Operating Partnership, L.P. using funds from our revolving credit facility.

 

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Using proceeds from our revolving credit facility, on February 24, 2004, we repurchased the operating partnership’s outstanding 8.30% Series B Cumulative Redeemable Perpetual Preferred Units, which were classified within minority interest in operating partnership on our consolidated balance sheet, for approximately $96.2 million, which included accrued and unpaid dividends of $1.2 million. An amount totaling $1.6 million representing the original issuance cost of the Series B Cumulative Redeemable Perpetual Preferred Units was subtracted from net income in arriving at net income applicable to common shareholders in accordance with EITF Topic No. D-42.

 

Off-Balance Sheet Arrangements

 

At December 31, 2004 we had the following off-balance sheet arrangements: (1) a non-controlling 50% interest in Broadmoor Austin Associates, a real estate joint venture and (2) a 25% non-controlling interest in Tysons International Partners, a real estate joint venture.

 

Our investment in unconsolidated joint ventures represents less than .6% of our consolidated total assets as of December 31, 2004 and approximately 1.5% of our cash flow from operations for the year ended December 31, 2004. Our investments, however, do provide us with several benefits including increased market share, important customer relations and a possible capital source to fund future real estate projects.

 

Broadmoor Austin Associates and Tysons International Partners represent real estate joint ventures which own and operate office properties in Austin, Texas and Tysons Corner, Virginia, respectively. We act as managing venture partner and have the authority to conduct the business affairs of each joint venture, subject to approval and veto rights of the other venture partner. We account for our interest in these joint ventures using the equity method of accounting.

 

The following information summarizes the financial position at December 31, 2004 for the investments in which we held an interest at December 31, 2004:

 

Summary of Financial Position:

(in thousands)


   Total Assets

   Total Debt(1)

   Total Equity

    Company’s
Investment


Broadmoor Austin Associates

   $ 97,962    $ 131,979    $ (34,814 )   $ 4,217

Tysons International Partners

   $ 89,268    $ 59,113    $ 28,914       8,726
                          

                           $ 12,943
                          


(1) The mortgage debt, all of which is non-recourse, is collateralized by the individual real estate property or properties within each venture, the net book value of which totaled $164.9 million at December 31, 2004. Our pro rata share of the non- recourse mortgage debt totaled $80.8 million at December 31, 2004.

 

The following information summarizes the results of operations for the year ended December 31, 2004 for our unconsolidated joint ventures:

 

Summary of Operations:

(in thousands)


   Total
Revenue


   Net
Income


   

Company’s

Share of Net
Income/(Loss)


 

Broadmoor Austin Associates

   $ 20,015    $ 5,058     $ 2,529  

Tysons International Partners

   $ 11,985    $ (399 )     (100 )
                   


                    $ 2,429  
                   


 

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Contractual Obligations and Commercial Commitments

 

We have contractual obligations including mortgages and notes payable and ground lease obligations. The table below presents, as of December 31, 2004, our future scheduled principal repayments of mortgages and notes payable and ground lease obligations of our consolidated properties: