SAN FRANCISCO PUBLIC LIBRARY AIRPORT COMMISSION: Concession Audit of Host International, Inc. San Francisco PublicLibrary Food and Beverage Facilities Government Information Center San Francisco PublicLibrary DOCUMENTS DEPT. 100 Larkin Street, 5th Floor SanFrancisco, CA 84102 MAY REFERENCE BOOK 2 5 2006 SAN FRANCISCO Not to be taken from the Library PUBLIC LIBRARY AIRPORT COMMISSION: Concession Audit of Host International, Inc. Food and Beverage Facilities DOCUMENTS DEPT. MAY 2 5 2006 SAN FRANCISCO PUBLIC LIBRARY Financial Audits Division May 23, 2006 04002 i CITY AND COUNTY OF SAN FRANCISCO OFFICE OF THE CONTROLLER Ed Harrington FINANCIAL AUDITS DIVISION Controller Monique Zmuda Deputy Controller May 23, 2006 Audit Number 04002 San Francisco Airport Commission P.O. Box 8097 San Francisco International Airport San Francisco, CA 94128-8097 President and Members: The Office ofthe Controller (Controller) presents its report concerning the audit ofthe food and beverage concessions ofHost International, Inc. (Host) at the San Francisco International Airport. Host had a lease to operate the concessions, as well as the commissary and in-flight kitchen that provided in-flight meals to airlines. The lease required Host to pay as rent to the Airport Department (Airport) the greater of a minimum annual rent or a specified percentage ofHost's gross revenues from these operations. Host's lease expired in August 2004. Reporting Period: June 1, 2003, through May 31, 2004 Rent Paid: $4,829,096 Additional Rent Due: $319,384 Results: Because our audit tests revealedthat Host significantly underreported some sales for the one-year period we audited, we expanded our tests to include periods outside our reporting period to identify any otherrevenues Host underreported. Our tests revealed that Host underpaid its rent by at least $319,384 mainly from not reporting: • $2.5 million in sales and revenues from the operation of airline clubs. • $1.3 million in sales earned by one ofHost's sub-lessees. Because Host significantly underpaid its rent, Host also owes the Airport: • $193,511 in interest as ofJanuary 2006. • $54,000 for the cost ofthis audit. Host's response is attached to this report. The Controller's Financial Audits Division will be working with the Airport Department to follow up on the status of the recommendations made in this report. Respectfully submitted, Noriaki Hirasuna Director 4-7500 CityHall•1Dr.CarltonB.GoodlettPlace•Room316•SanFranciscoCA 94102-4694 FAX415-554-7466 3 1223 07661 9817 INTRODUCTION BACKGROUND Host International, Inc. (Host) had a long-term lease with the Airport Commission (commission) to operate food and beverage facilities in San Francisco International Airport (SFO) terminals and to operate the in-flight kitchen from the commissary building, which Host used to provide in-flight meals for airlines departing from SFO. The lease also allowed Host to provide vending machines that sold food and beverages in the terminals. The commission entered the lease on June 17, 1975, and entered a lease modification on February 17,1992. The lease expired on August 31, 2004. The lease modification required Host to submit to the Airport Department (Airport) monthly and annual reports showing Host's gross revenues derived from its own operations and from those of its sub-lessees. The lease modification also required Host to pay the Airport the greaterof a minimum annual rent or a specified percentage ofthe gross revenues. For its food and beverage facilities, Host was to pay rent equal to 15.24 percent of gross revenues from the sale of alcoholic beverages and 9.24 percent of gross revenues from the sale offood and non-alcoholic beverages, including those dispensed through vending machines. During our audit period, the annual minimum rent for the food and beverage facilities was $3,500,074. Forits commissary and in-flight sales, Host was to pay rent equal to 5 percent of gross revenues or the minimum rent. For the period we reviewed, the monthly minimum rent was $6,853. SCOPE AND METHODOLOGY The purpose ofour audit was to determine whether Host complied with the reporting and payment provisions ofits lease with the commission. Our audit period was June 1, 2003, through May 31, 2004. However, because we identified significant amounts of underreporting of some sales by Host, we extended some ofour tests to cover the periods before and after these dates to identify amounts that Host owes the Airport for unreported revenues. To conduct the audit, we reviewed the applicable terms ofthe lease and the adequacy ofHost's procedures for recording, summarizing, and reporting its gross revenues to the Airport. To determine whetherHost accurately reported its gross revenues, we tested a sample ofHost's daily sales reports and monthly sales summaries. We also analyzed Host's previous years' sales to assess the reasonableness of Host's reported gross revenues forthe period underreview. Finally, we determined whether Host has any outstanding payments due to the Airport for the period we reviewed. 2 AUDIT RESULTS HOST DID NOT REPORT ALL SALES AND UNDERPAID ITS RENT From June 1, 2003, through May 31, 2004, Host International, Inc. (Host) reported $47,974,516 in revenues and paid $4,829,096 in rent to the Airport. Although Host correctly reported the sales ofits main food and beverage concessions at SFO, we discovered that Host did not report any ofthe revenues it earned from operating airline clubs and the sales of one ofits sub- lessees forthe one-year period we reviewed. Because ofthis, we extended our tests to include the periods before and after the audit period to identify the extent to which Host underreported these revenues. As shown in the table below, our audit revealed that Host did not report $2,545,778 in revenues it earned from operating airlines clubs as well as $1,308,246 in sales ofa sub- lessee. We also identified other errors Host made in paying its rent. Aftermaking the adjustments for these errors, we concluded that Host owes the Airport at least $319,384 in additional rent. The appendix at the end ofthe report provides the full details of underreported revenues and underpaid rent. Further, because Host did not pay this rent when due, it also owes the Airport $193,511 in interest, calculated through January 2006. Moreover, because the underpayment was more than two percent ofits annual rent, the lease requires Host to reimburse the Airport for the costs ofthis audit, which we estimate to be $54,000. TABLE Underreported Revenues and Underpaid Rent Underreported Percentage Under (Over) Sales Rent Paid Rent Airline Clubs $2,545,778 15.24% $387,976 Sub-Lessee Sales 1,308,246 9.24% 120,882 Unapproved Rent Credits 53,002 In-flight and Commissary Minimum Rent (10,750) Excess Minimum Rent (231,726) Total $3,854,024 $319,384 This amount includes airline payments from September2002, which is theearliest month that Host hadrecords available. Host is still liable for airline payments itreceived prior to this month. 3 Host Did Not Report More Than $2.5 Million in Airline Club Revenues Host did not report to the Airport revenues of at least $2,545,778 that Host earned from operating airline clubs, and underpaid the associated rent by at least $387,976. The airline club revenues consisted ofthe following: • Patron sales, which are revenues from the sale offood and beverages to airline club patrons. • Airline payments, which are revenues from airlines paying Host the amount it cost Host to operate the airline clubs in excess ofthe patron sales and liquorprovided by the airlines. Host's operating costs included stafflabor charges, goods and supplies, a management fee, and a concession fee that was the percentage rent for alcoholic beverages applied to patron sales. Host Did Not Report Patron Sales Although Host had previously reported patron sales from the airline clubs as revenues subject to rent, Host did not include these sales as part ofthe gross revenues it reported to the Airport starting in February 2002. In reviewing Host's records forthe period from February 2002 through August 2004, we found that Host did not report $1,344,800 in patron sales and owes the Airport $204,947 in rent. Host's manager stated that Host believed that airline club revenues were not subject to percentage rent because these receipts were reimbursements from airlines for Host's services. Although Host's original lease did not specifically identify airline club revenues as subject to percentage rent, the lease modification (Section 5.01.a.3.) defined gross revenues as the full amount of all orders for goods or services accepted by the lessee from the leased premises. Based on this definition, we concluded that airline club sales are subject to percentage rent. Further, Host's invoices to the airlines included a 15.24 percent fee on the amounts paid by airline club patrons, which is Host's percentage rent for alcoholic beverages. In charging this fee, Host appeared to be taking the position that it had to pay the percentage rent on patron sales. Host provided us information on patron sales, but did not separate the food and non-alcoholic beverage sales from the alcoholic beverage sales. Host informed us that most ofits patron sales were for alcoholic beverages. Because Host was not able to separate the 4