MEMORANDUM June 7, 2007 TO: FROM: SUBJECT: MEMBERS, PORT COMMISSION Hon. Ann Lazarus, President Hon. Kimberly Brandon, Vice President Hon. Rodney Fong Hon. Michael Hardeman Hon. Stephanie Shakofsky Monique Moyer Executive Director Request approval of business terms for a proposed Fifth Amendment to Lease L-11320 with BAE Systems San Francisco Ship Repair, Inc. for a portion of Pier 70 and authorization of Executive Director, or her designee, to negotiate and enter into the proposed Fifth Amendment. DIRECTOR S RECOMMENDATION: APPROVE ATTACHED RESOLUTION On May 22, 2007, the Port Commission heard an informational presentation on the proposed amendment to BAE San Francisco Ship Repair s lease at Pier 70. Staff has negotiated business terms with BAE SFSR and is seeking approval of the transaction. Exhibit A attached hereto presents the negotiated business terms. Also attached as Exhibit B is a copy of the May 17, 2007 staff report that discusses the project. Prepared by: For: Kathleen Diohep, Project Manager Planning & Development Peter Dailey, Deputy Director, Maritime THIS PRINT COVERS CALENDAR ITEM NO. 11B
PORT COMMISSION CITY & COUNTY OF SAN FRANCISCO RESOLUTION NO. 07-49 Charter Section B3.581 empowers the Port Commission with the power and duty to use, conduct, operate, maintain, manage, regulate and control Port area of the City and County of San Francisco; and BAE San Francisco Ship Repair Inc. (BAE SFSR), a California corporation, currently leases approximately 16 acres of land and 11 acres of water at Pier 70 where it, through predecessor companies, has conducted ship repair operations since 1987 pursuant to Port Lease L-11320 which has been amended four different times (as amended, the Lease ), and currently employs about 250 skilled laborers year-round representing ten different trade unions; and The Lease provides BAE SFSR the right to renegotiate rent terms effective as of December 17, 2007, and the right to terminate the lease if negotiations are unsatisfactory to them; and BAE SFSR approached the Port with an opportunity to upgrade Drydock #2 to serve post-panamax vessels through a partnership with Princess Cruises, a mutual customer of the Port and BAE SFSR; and Enhanced ship repair capabilities in San Francisco support the Port s efforts to increase its cruise calls; and Port staff and BAE SFSR have negotiated in good faith for many months, and Staff believes the parties have now reached mutually agreeable terms, as set forth in the Staff Report; and These mutually agreeable terms include a rent structure with a minimum rent plus percentage rent that allows the Port to participate in anticipated increases in business revenues, requires specific improvements to Dry Dock # 2 and establishes a rent credit mechanism; and Port staff recommends that the Port Commission approve the proposed business terms for a Fifth Amendment to the Lease; and authorize the Executive Director, or her designee, to negotiate and enter into a Fifth Amendment to the Lease on the terms and conditions outlined in the Staff Memorandum accompanying this Resolution; and
Resolution No 07-49 Page 2 RESOLVED, On May 29, 2007, the San Francisco Planning Department determined that the proposed Drydock #2 modifications and the Fifth Amendment to BAE SFSR s lease were categorically exempt from review under the California Environmental Quality Act; and Based on staff s recommendation and its own review, the Port Commission finds that the proposed Fifth Amendment to Lease L-11320 is in the best interest of the Port; now, therefore, be it That the San Francisco Port Commission hereby approves the proposed business terms of the Fifth Amendment to the Lease and authorizes the Executive Director or her designee, in consultation with the City Attorney, to negotiate a Fifth Amendment to Lease L-11320 with BAE Systems San Francisco Ship Repair, Inc. on terms and conditions consistent with the Staff Memorandum accompanying this Resolution, and in a form approved by the City Attorney. I hereby certify that the foregoing resolution was adopted by the Port Commission at its meeting of June 12, 2007. Secretary
EXHIBIT A SUMMARY OF AGREED BUSINESS TERMS FIFTH AMENDMENT TO BAE SAN FRANCISCO SHIP REPAIR LEASE AT PIER 70 Term: December 17, 2007 until December 16, 2017 Minimum Rent: Percentage Rent: Termination Rights: 2008-2012: $950,000 per year 2013-2017: $1,050,000 per year 3.3 percent of gross revenues paid on total annual revenue over $28,787,879 in years 2008 through 2012 and $31,818,182 in years 2013 through 2017. BAE SFSR will have the right to terminate the lease with 180 days prior written notice at any time after January 1, 2014 if BAE SFSR s annual gross revenues fall below $25,000,000 for any calendar year. The rights of termination that exist in the lease that can be exercised on December 17, 2007 and December 16, 2012 will be eliminated. Rent Credit: A total of up to $3 million of rent credits for authorized improvements to Drydock #2 will be allowed. Actual costs, without interest, will be allowed as Rent Credits, to be applied against Percentage Rent in excess of the current annual minimum rent due and payable. Rent Credits may never be used to reduce the Minimum Rent due and payable for any calendar year. Annual credits are limited to $300,000 with a potential provision for carry forward of unused Rent Credits to future years if there is not sufficient percentage rent to fund the full $300,000 annual rent credit. Any unused Rent Credits remaining at the expiration of the lease shall automatically be extinguished without further obligation or payment to the Tenant. Princess License: The Minimum Rent, Percentage Rent and Rent Credit provisions are conditioned on BAE SFSR securing and performing under a license agreement with Princess Cruises that requires the modifications to Drydock #2 to serve post-panamax ships. Drydock Modifications: The following modifications to expand the capabilities of Drydock #2 are eligible for Rent Credits: Install six new sponsons on the outboard wing-walls to increase stability Initial increase in mooring capacity by adding structural reinforcement between existing dolphin pilings within the Shipyard and strengthening Drydock mooring attachments One-time dredging of the Drydock sump to accept the larger footprint of the new sponsons
Initial modification of the internal wing-wall structures to accommodate the extension of two fin stabilizers within the Drydock envelope Drydock #2 Maintenance: Master Plan: Reversion Area: Insurance: Drydock #2 will be maintained through 2017 to ensure a mutually agreed continuing lifting capacity at the sole cost of BAE SFSR, as certified by a mutually agreed upon commercial certification service or regulatory agency. Coordinated with the Port s overall planning for Pier 70, BAE SFSR will work with the Port to develop a master plan for its facility needs at Pier 70, excluding use of the Reversion Area after 2012. A consultant for BAE SFSR and a designated point of contact for the master planning must be identified by July 1, 2007. Initial inputs to the Port s Master Plan must be submitted by September 1, 2007 and BAE SFSR s master plan developed by June 30, 2008. Port will provide specifications for items to be addressed in the Master Plan. BAE SFSR will commit funding up to, but not exceeding, $100,000 for out-ofpocket costs for development of its master plan. BAE SFSR will continue operations in the Reversion Area until December 16, 2010 with an option for extended use of the area until December 16, 2012 if an adequate relocation plan acceptable to the Port is submitted to the Port in a timely manner. BAE SFSR agrees to provide a plan for relocation of its existing shipyard operations located in the Reversion Area to locations within the primary leasehold by June 1, 2010. The relocation plan will be developed in concert with the criteria established by the Port s Master Plan. An additional $20 million of insurance coverage will be provided under an umbrella policy to cover sudden and accidental pollution. Environmental Oversight Costs: The Security Deposit under the lease shall also be used by the Port to offset the environmental administrative costs associated with any notice of violation issued by a regulatory agency. Additional Security Deposit: In addition to the existing security deposit, a letter of credit for at least $500,000 will be maintained throughout the lease term to serve as additional security for the lease commitments.
EXHIBIT B MEMORANDUM May 17, 2007 TO: FROM: SUBJECT: MEMBERS, PORT COMMISSION Hon. Ann Lazarus, President Hon. Kimberly Brandon, Vice President Hon. Rodney Fong Hon. Michael Hardeman Hon. Stephanie Shakofsky Monique Moyer Executive Director Informational Presentation regarding proposed Fifth Amendment to Lease L-11320 with BAE San Francisco Ship Repair, Inc. at Pier 70 DIRECTOR S RECOMMENDATION: INFORMATIONAL ONLY NO ACTION REQUIRED SUMMARY Ship repair has been a leading San Francisco industry since the Gold Rush. Next month, Port staff will ask the Port Commission to approve a Fifth Amendment to the Port s lease with BAE San Francisco Ship Repair Inc. (BAE SFSR) a subsidiary of BAE Systems Inc. BAE SFSR operates the shipyard at Pier 70. This informational presentation is to inform the Port Commission and the public regarding this opportunity. We plan to bring the lease amendment to the Port Commission for approval in June. The proposed Fifth Amendment of the Lease is the start of a unique commercial partnership between the Port, BAE SFSR and Princess Cruises, the Port s largest cruise customer. Princess Cruises will team with BAE SFSR and the Port to fund modifications to the Port s floating Drydock #2. These modifications will allow the Drydock to serve Post-Panamax cruise and tanker vessels. Princess Cruises and other cruise lines will soon have a U.S. West Coast ship repair option to drydock their newest vessels. BAE SFSR approached the Port with a proposal to upgrade Drydock #2 with $5 million of improvements. $3 million of these improvements will be initially funded by Princess Cruises. This joint investment will result in enhancements to the Port s asset as well as encourage cruise calls from Princess Cruises and other cruise lines. This Print Covers Calendar Item No. 9A
The proposed lease amendment modifies rent terms and provides for rent credits for the remaining ten years of the shipyard lease with BAE SFSR at Pier 70 to support investments in Drydock # 2 to serve Post-Panamax cruise and tanker vessels. The Port will receive increased revenue both on a guaranteed basis and potentially through participation in the shipyard revenue growth. Over the ten year term, the annual minimum rent will total $10 million with a potential for significant additional revenue from growing ship repair volumes. If BAE SFSR s gross revenue exceeds certain annual targets, it can receive up to $300,000 per year of rent credits predicated on the investment of $3 million of improvements to Drydock #2. Princess Cruises Investment Princess Cruises is one of the world s leading cruise brands and has been the Port s largest cruise customer for two decades. With the addition of three new vessels in 2008, they ll be operating 18 vessels around the world. Their headquarters are in Santa Clarita, California and they are a part of Carnival Corporation. Princess Cruises and other cruise lines are in need of West Coast drydock and ship repair options for their new generation of Post-Panamax vessels (ships that are too large to fit through the Panama Canal). These ships currently operate in Europe. The Port s floating Drydock #2, in spite of being of the largest repair drydock in the Americas, is still not able to handle the newest generation of very large cruise and tanker vessels. If a drydock was not available on the West Coast, a damaged vessel would have limited repair options that could result in considerable expense and revenue loss. A viable Post-Panamax ship repair option in San Francisco will result in bigger vessels being deployed to serve all West Coast markets. Princess Cruises has agreed to provide BAE SFSR $3 million to upgrade Drydock #2. BAE SFSR has committed to an additional $1-2 million investment to strengthen the Drydock. BAE SFSR will undertake the Drydock #2 modifications by November 2007 to meet the terms of its agreement with Princess Cruises. Princess Cruises will be redeploying two Post-Panamax ships to the West Coast in 2008. Background Ship repair operations employee a highly skilled, well compensated workforce. BAE SFSR currently employs an average of 250 skilled craftsmen year-round, representing ten different trade unions. During peak periods of repair activity, the yard has recently provided jobs for over 1,000 people. BAE SFSR is the resulting entity after BAE Systems acquired United Defense Industries in 2005. United Defense Industries acquired Southwest Marine (the parent company of San Francisco Drydock) in July 2002. BAE SFSR is a subsidiary of BAE Systems Ship Repair. Nationally, BAE Systems Ship Repair, Inc. is a group of four strategically located, full-service shipyards in Norfolk, VA; San Diego, CA; San Francisco, CA; and Honolulu, HI. BAE Systems Ship Repair s public information staff informed the Port that these shipyards currently service 55 percent of the U.S. Navy Surface Fleet. The company also maintains vessels for Military Sealift Command, Maritime Administration, US Coast Guard and US Army. It boasts a significant commercial market share, servicing container vessels, mega yachts and most major cruise lines.
Its San Francisco, San Diego and Hawaii shipyards dominate the West Coast repair market, and generated annual revenues of over $250 million in 2006. BAE SFSR currently leases 16.5 acres of land and 16 acres of water at Pier 70, where it has conducted ship repair operations pursuant to the Lease since 1987. Over the years, the original lease has been modified by four amendments (as amended, the Lease ). Twenty-one buildings, two floating drydocks, and seven functional cranes also comprise the leasehold. Currently, BAE SFSR pays rent of 3.3 percent of gross revenues with an annual guaranteed minimum of $850,000. Last year, BAE SFSR had gross revenues over $44 million and paid net rent of $1,266,000 after deduction of a $200,000 rent credit. Rent credits are drawn from a Capital Improvements Fund equivalent to fifty percent of the total annual rent the Port is eligible to receive between the minimum of $850,000 and a maximum of $1,250,000. The Capital Improvements Fund received $453,002 from 2003 to 2006 and is expected to be funded for an additional $200,000 in calendar year 2007. Rent credits are used to reimburse BAE SFSR for specified capital projects. The Lease provides BAE SFSR with the right to renegotiate rent terms effective on each fifth anniversary with the next eligible date being December 17, 2007. BAE SFSR then has a right to terminate the Lease upon 90 days notice if negotiations are unsatisfactory to them. On February 14, 2007, BAE SFSR proposed new rent terms which initiated negotiations resulting in the proposed business terms. Ship Repair Market BAE SFSR is one of seven ship repair yards on America s West Coast that compete for the maintenance and repair of mid and large size vessels. In 2006, the sum total revenues of all seven businesses approximated $675 million, with BAE SFSR capturing about a six percent market share. Of these seven yards, however, there are few comparable operations, as two of the seven own their own land and shoreline; and three lease small landside parcels (two are less than 3 acres each) and share drydocks that are controlled by the federal government with other repair firms in the area. One of BAE Systems Ship Repair, Inc. s subsidiaries, BAE Systems San Diego Ship Repair, Inc. most closely resembles BAE SFSR s operation, but the San Diego yard cannot handle ships as large as San Francisco accommodates. The BAE San Diego operation leases about half the space and pays half the rent that BAE SFSR does, but consistently experiences a much higher volume of work because of its proximity to the San Diego naval bases. BAE San Diego s average vessel repair mix is 85 percent government work and 15 percent commercial. San Francisco s most marketable features in the ship repair business are its floating drydock (the largest repair drydock in all the Americas), and its central-coastal geographic location, which makes it an effective location for both the northbound and southbound migratory cruise and tanker fleets. BAE SFSR has made a successful transition over the past fifteen years away from being highly dependent on defense work, to being highly competitive in the commercial ship repair markets. When the Bay Area base closures occurred in the early nineties, Southwest Marine (the original tenant under the Lease) lost nearly 80 percent of its business. Since then, the core business of the shipyard operation at Pier 70 has shifted to a mix of tanker, cruise, tug & barge, plus emergency cargo ship repairs. Along with these vessels, there has been a steady resurgence of defense and government vessel repairs over the past four years, to a point where
defense work last year accounted for nearly 50 percent of BAE SFSR s gross revenues. This defense spending resurgence has only added to the total volume of work generated by BAE SFSR each year as represented by this table of gross revenues reported since the last amendment to the Lease: BAE SFSR Annual Gross Revenues 2002 $24,000,000 2003 $25,843,736 2004 $28,887,910 2005 $38,635,648 2006 $44,423,716 Port staff is not aware of anything occurring in the marketplace or the global balance of activity that indicates a change in this upward trend. Since 1998, the Port has grown its cruise ship program from 28 calls per year to 81 calls and nearly a quarter of a million passengers last year. This new cruise business has generated millions of dollars of revenue for local businesses and the City of San Francisco, but remains highly dependent upon and related to our commercial repair facilities. The increase in cruise ship calls combined with Drydock #2 s enhanced service capacity will create revenue opportunities for BAE SFSR, and will position San Francisco as a prominent, full-service cruiseport. Existing Lease Terms At each of the last two amendments (1997 and 2002), in response to the changing market, the Port has provided rent concessions and has required capital improvements in return. Since the most recent lease amendment, the ownership of the shipyard has changed twice and current management has succeeded in substantially increasing revenues. Leading up to 2002, San Francisco Drydock (SFD) (as the operation was then called) experienced declining revenues ranging from a high of $40.8 million (1996) to a low of $21.9 million (2001). As a result, SFD approached the Port to seek rent relief and to secure rent credits for specific capital improvements to buildings, piers, bathrooms, paving, and cathodic protection of the Drydocks. The Fourth Amendment to the lease, executed in 2003, had several key economic terms designed to sustain San Francisco s ship repair industry, support that labor force, as well as assist SFD during a difficult period of market fluctuation, including: Reduction of the Minimum Annual Guarantee base rent to $850,000 per year from the prior annual rent of $1,250,000. Establishment of a percentage rent mechanism where the rent is the greater of $850,000 or 3.3 percent of gross sales Creation of an improvement fund accruing 50 percent of the annual rent due over $850,000 up to $200,000 per year to fund rent credits for specific capital enhancements.
Modifications to the leasehold area to remove unreinforced masonry buildings requiring relocation of some shipyard operations by eliminating the major expense of seismic upgrades. The terms of the Fourth Amendment will expire on December 17, 2007. If there is no replacement rent agreement, the following lease terms apply: The Reversion Area of 2.2 acres including Buildings 36 and 52 returns to the Port The annual rent reverts to a fixed rent of $1.2 million subject to compounded CPI adjustments dating back to the origin date of lease. The estimated CPI adjusted value as of December 2007 will be approximately $2.2 million a year The Capital Improvement Fund mechanism of the Fourth Amendment expires, and future enhancements to Drydock #2 will no longer be eligible for reimbursement BAE SFSR has the right to terminate the lease with 90 days notice BAE SFSR has indicated that, if the guaranteed rent increased to $2.2 million a year, then it can no longer operate at Pier 70 and will exercise its option to terminate 90 days after the December 17 2007 expiration of the Fourth Amendment. Proposed Restructuring of Lease Arrangement Port staff has negotiated extensively with BAE SFSR for the last several months and has arrived at a business proposal that we believe meets the needs of the Port, BAE SFSR and Princess Cruises. The Port is willing to increase the annual rent credits from $200,000 to $300,000 to fund additional investments in Drydock #2 as requested by BAE SFSR. As evidence of the Port s commitment to the shipyard and the cruise industry, the terms provide for: Up to $3 million of rent credits for Drydock modifications to serve Post-Panamax vessels, including non-cruise vessels, over the remaining ten years of the lease BAE SFSR s percentage rent remains at 3.3 percent of gross revenue A potential for a five year extension in use of the Reversion Area through December 16, 2012 An early termination right after January 1, 2014 if BAE SFSR experiences a significant reduction in gross revenue In exchange for these economic concessions, the proposed transaction includes: Completion of drydock modifications in 2007 by BAE SFSR BAE SFSR secures the agreement with Princess Cruises for investment in Drydock #2 A ten year commitment to the leasehold and rental rate terms including elimination of a right to renegotiate in 2012 An increase in the guaranteed rent from $850,000 to $950,000 for the first five years and $1,050,000 for the last five years of the term An increase in the security deposit of an additional $505,000 to be held in a separate account A master plan for BAE SFSR s leasehold that augments the Port s master plan for the 65- acre Pier 70 area
Maintenance of Drydock #2 at a lifting capacity of 54,000 tons Addition of new City and certain Port requirements to the lease Facilities Maintenance The Port and BAE SFSR s predecessor in interest, Southwest Marine, Inc., entered into a thirtyyear lease agreement on December 17, 1987. Originally the master leasehold area was limited to 16.0 acres of water and piers, plus 10.3 acres of land including buildings, landside cranes, and two floating drydocks. The lease terms continue to require that the Tenant maintain the premises in as good condition and repair as when leased or as subsequently improved, including but not limited to the exterior, interior, substructure and foundation The Port is currently working with BAE SFSR to review the maintenance of buildings and structures. The improvements to the drydock will improve its lifting capacity and allow for greater stability when lifting large ships. Sponsons will be added to the drydock walls to improve its stability. Dredging and wingwall modifications are necessary in addition to the sponsons. These improvements to the Drydock will last beyond the remaining term of the lease. The lease amendment is specific in requiring a consistent level of maintenance of Drydock #2 to insure that it will continue to be able to lift 54,000 tons through the duration of the lease. Coordination with Pier 70 Master Plan and Future Leasing The Fourth Amendment stated that 2.2 acres on the western boundary of the leasehold would revert back to the Port in December 2007. BAE SFSR has requested that this reversion area be leased for an additional five years to allow more time to relocate its operations from the area. The proposed terms allow BAE SFSR three more years of use of the Reversion Area with an option to extend the use for an additional two years (until the end of 2012). In order to provide use of the area for the full five years, BAE SFSR will need to participate in the overall master planning process for the 65-acre Pier 70 area and is required to develop a master plan for its leasehold facilities by June 2008. By 2010, a relocation plan is required showing how the shipyard will operate without the Reversion Area. The extended term for the Reversion Area allows BAE SFSR to defer the capital cost of building facilities to accommodate the operations currently in Buildings 36 and 52. However, the Reversion Area will be needed for other uses following the master planning for the 65-acre Pier 70 facility. The master planning for the area and for the shipyard may identify new facility options for BAE SFSR s operations. As BAE SFSR approaches the end of its 2017 term, and as the master planning for the greater area is implemented, the Port expects to have additional negotiations with BAE SFSR about its leasehold and future term. Nothing in the current lease amendment would forestall consideration of a new lease for a term lasting beyond 2017 that fits the Port s overall plans for the Pier 70 area and BAE SFSR s requirements.
Advisory Group Review On March 21, 2007, staff and BAE SFSR representatives briefed the Central Waterfront Advisory Group on plans to modify Drydock #2 to respond to cruise industry ship repair needs. The Advisory Group expressed its strong support of the proposed modifications and voted to support in concept the necessary lease amendments provided they would be financially viable for the Port. Next Steps Implementation of this proposal to upgrade Drydock #2 to serve post-panamax ships includes the following steps: Negotiation of a definitive Fifth Amendment to the lease and execution by BAE SFSR. Determination that the lease amendment and the modifications to the dry-dock are consistent with the California Environmental Quality Act by the City s Planning Department. The Port requested this determination on May 14, 2007 and anticipates it will be secured prior to the June 12, 2007 Port Commission meeting. Port Commission approval of the Fifth Amendment, scheduled for June 12, 2007. Execution of any updated agreement between BAE SFSR and Princess Cruises. Amendments to two San Francisco Bay Conservation Development Commission (BCDC) permits are required for the improvements. Permit M77-17, which authorizes the use of the dry-dock, would need to be amended to allow for the approximately 2,880 square feet of extra fill. Permit M93-13 would need to be amended to allow for additional dredging under the sponsons. The Port will submit these permit modifications by May 24, 2007. Finally, the lease amendment will require the Port to approve the final plans for the Drydock #2 modifications prior to construction and will require Port inspections and approval of the work prior to use of any rent credits. Prepared By: Gerry Roybal, Maritime Marketing Manager Kathleen Diohep, Project Manager, Planning & Development For: Peter Dailey, Deputy Director, Maritime