Airport Commission : concession audit of SFO Equities, LLC, dba Burger King

SAN FRANCISCO PUBLIC LIBRARY

3 1223 07805 8238

San Francisco Public Library

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San Francisco Public Library
100 Larkir. Street. 5th Floor
San Francisco, CA 94102

REFERENCE BOOK

AIRPORT COMMISSION:

Concession Audit of

SFO Equities, LLC, dba Burger King

Not to be taken from the Library

D
REF

647.9579
Sa578csf

C

DOCUMENTS DEPT

FEB - 4 2CCS

SAN FRANCISCO
PUBLIC LIBRARY

January 31, 2008

AIRPORT COMMISSION

Concession Audit of

SFO Equities, LLC, dba Burger King

DOCUMENTS DEPT

FEB - 4 2CC8 January 31, 2008

SAN FRANCISCO
PUBLIC LIBRARY

CONTROLLER'S OFFICE
CITY SERVICES AUDITOR

The City Services Auditor was created within the Controller's Office through an amendment to the
City Charter that was approved by voters in November 2003. Under Appendix F to the City Charter,
the City Services Auditor has broad authority for:

• Reporting on the level and effectiveness of San Francisco's public services and
benchmarking the city to other public agencies and jurisdictions.

• Conducting financial and performance audits of city departments, contractors, and functions
to assess efficiency and effectiveness of processes and services.

• Operating a whistleblower hotline and website and investigating reports of waste, fraud, and
abuse of city resources.

• Ensuring the financial integrity and improving the overall performance and efficiency of city
government.

The audits unit conducts financial audits, attestation engagements, and performance audits.
Financial audits address the financial integrity of both city departments and contractors and provide
reasonable assurance about whether financial statements are presented fairly in all material aspects
in conformity with generally accepted accounting principles. Attestation engagements examine,
review, or perform procedures on a broad range of subjects such as internal controls; compliance
with requirements of specified laws, regulations, rules, contracts, or grants; and the reliability of
performance measures. Performance audits focus primarily on assessment of city services and
processes, providing recommendations to improve department operations.

We conduct our audits in accordance with the Government Auditing Standards published by the U.S.
Government Accountability Office (GAO). These standards require:

• Independence of audit staff and the audit organization.

• Objectivity of the auditors performing the work.

• Competent staff, including continuing professional education.

• Quality control procedures to provide reasonable assurance of compliance with the auditing
standards.

Audit Team: Cynthia Fong, Audit Manager

Edvida Moore, Associate Auditor

3 1223 07805 8238

OFFICE OF THE CONTROLLER

CITY AND COUNTY OF SAN FRANCISCO

Ed Harrington
Controller

Monique Zmuda

Deputy Controller

January 31, 2008

San Francisco Airport Commission
P.O. Box 8097

San Francisco International Airport
San Francisco, CA 94128-8097

President and Members:

The Controller's Office, City Services Auditor presents its report concerning the audit of SFO
Equities, LLC, dba Burger King. Effective September 2004, SFO Equities began operating two
Burger King fast food facilities at the San Francisco International Airport under a 10-year lease
with the Airport Commission. The first Burger King, located in the food court on the mezzanine
of Domestic Terminal 3, began operations on September 1, 2004; the other, located at Gate 74
of Terminal 3, Boarding Area F, began operations on September 18, 2004. Although the lease
as originally signed was intended to expire in 2016, SFO Equities' lease with the Airport
Commission for the Burger King facilities was terminated and assigned to Burger King
Corporation effective July 12, 2007.

Reporting Period: September 1 , 2004, through July 31 , 2007
Rent Paid: $495,482

SFO Equities correctly reported gross revenues of $5,664,725 to the Airport Department
(Airport); however, SFO Equities underpaid its concession rent by $43,416. The major factor
contributing to this was SFO Equities' use of a September 1 to August 31 lease year in its
calculations of percentage rent rather than the January 1 to December 31 lease year stated in
its lease with the Airport.

The responses from the Airport and SFO Equities are attached to this report.
Respectfully submitted,

Results:

Harriet Richardson
Director of Audits

415-554-7500

City Hall • 1 Dr. Carlton B. Goodlett Place • Room 316 • San Francisco CA 94102-4694

FAX 415-554-7466

Mayor

Board of Supervisors
Civil Grand Jury
Budget Analyst
Public Library
SFO Equities, LLC
Burger King Corporation

John R. Martin, Director, San Francisco International Airport

INTRODUCTION

Background

Objectives

Scope and Methodology

SFO Equities, LLC,1 operated two Burger King fast food
facilities at the San Francisco International Airport (SFO)
under Lease 03-0189 with the Airport Commission
(Commission). SFO Equities opened the Burger King
facility located in the food court on the mezzanine of
Domestic Terminal 3 for operations on September 1, 2004.
The second Burger King facility, located at Gate 74 of
Terminal 3, Boarding Area F, began operations on
September 18, 2004. The lease requires SFO Equities to
pay the Airport the greater of a minimum annual guarantee
or a tiered percentage rent of 8 to 12 percent of annual total
gross revenues.

The objectives of this audit were to determine whether:

• The monthly statements of gross revenues that Burger
King submitted to the Airport accurately reflect its gross
revenues based on monthly and daily records.

• Burger King paid the proper amount of rent, according
to the terms of its lease agreement.

• Burger King currently has no overdue amounts payable
to the Airport for the audit period.

Our audit covered the period from September 1 , 2004,
through July 31, 2007. To conduct the audit, we examined
the applicable terms of the permits and lease and the
adequacy of SFO Equities' procedures for collecting,
recording, summarizing, and reporting its gross revenues to
the Airport. To determine whether SFO Equities accurately
reported its gross revenues to the Airport, we compared its
reported gross revenues to those recorded in its internal
monthly summary records for all months of the audit period.
We tested, on a sample basis, SFO Equities' monthly sales
records, 18 days' worth of daily sales reports, and bank
statements. We also determined whether SFO Equities had
any outstanding payments due to the Airport for the audit
period.

1 SFO Equities is a subsidiary of WSE Group, which holds other lease agreements with the Airport.

Auditor's Comments The Airport agrees with our audit findings (see Appendix A),
on Airport's and SFO However, in its response to the audit (see Appendix B),
Equities' Responses SFO Equities states that it paid rent to the Airport correctly,

based not upon the calendar year, but rather, upon the
September 2004 opening of its Burger King facilities.
However, the lease specifically defines the term "lease
year" as "the period commencing on January 1 and ending
on December 31 of each year." While SFO Equities'
contention is true that restaurants may open for business
on dates other than January 1, Section 4.3(e) of the rent
states "the minimum annual guarantee [rent] with respect to
the first lease year shall be prorated, based on a 365-day
year, to reflect the fact that the first lease year shall be less
than a full 12-month period" (thus allowing for an opening
that falls on a date other than January 1). The other issues
that SFO Equities addresses in its response to the audit
report emphasize the fact that the Airport and SFO Equities
need to discuss, and reach a common understanding
about, the terms of their lease agreement.

Section 20.4 of the lease requires a written instrument for
terms or provisions of the lease to be changed, waived,
discharged or terminated. No such written instrument that
would have permitted SFO Equities to deviate from the
terms of its lease with the Airport was executed during the
audit period. As such, we stand by our audit findings.

We conducted this performance audit in accordance with
generally accepted government auditing standards. Those
standards require that we plan and perform the audit to
obtain sufficient, appropriate evidence to provide a
reasonable basis for our findings and conclusions based on
our audit objectives. We believe that the evidence obtained
provides a reasonable basis for our findings and
conclusions based on our audit objectives.

RESULTS

SFO Equities Underpaid SFO Equities accurately reported $5,664,725 in gross
its Rent to the Airport revenues to the Airport. It paid the Airport $495,482 in

percentage rent, an underpayment of $43,416.

SFO Equities made errors in The lease requires SFO Equities to pay the Airport a base
calculating percentage rent rent per lease year. The lease specifically defines the term

"lease year" as "the period commencing on January 1 and
ending on December 31 of each year." Base rent is the
greater of the minimum annual guarantee (MAG) or the
percentage rent. The lease defines percentage rent as the
sum of:

a) 8 percent of gross revenues achieved up to and
including $750,000, plus,

b) 1 0 percent of gross revenues achieved from
$750,000.01 up to and including $1,200,000,
plus,

c) 12 percent of gross revenues achieved over
$1,200,000.

SFO Equities underpaid its rent by $43,416 because:

• It did not use the prescribed lease year of January 1
through December 31 to calculate percentage rent due
to the Airport. Instead, SFO Equities used a lease year
of September 1 through August 31. This caused SFO
Equities to apply the tiered percentage rent rates to
gross revenues at incorrect intervals, resulting in a
calculation of $504,289 as the amount of rent due for
the audit period. Using the correct lease year, we
determined that total percentage rent due for the audit
period should have been $538,898 ($34,609 greater
than the amount that SFO Equities had calculated).

• Although SFO Equities calculated rent due at $504,289,
it paid the Airport only $495,462 in percentage rent,
which was $8,807 less than it determined was due to
the Airport.

• These errors resulted in an underpayment to the Airport
for percentage rent of $43,416 ($34,609 plus $8,807).

Exhibit 1 shows the effect of these errors on percentage
rent due to the Airport for each lease year (or portion
thereof) included in the audit period.

Airport accounting reinforced
SFO Equities' error in
calculating percentage rent

SFO Equities' controller requested help from her contact in
the Airport Accounting Division on the proper method for
calculating percentage rent. SFO Equities had been using
September 1 as the beginning of its lease year, and the
Accounting Division did not inform SFO Equities that the
lease requires a lease year beginning January 1. Instead,
the Accounting Division prepared a schedule for SFO
Equities demonstrating the mechanics of percentage rent
calculation, but using the incorrect lease year.

Contract language
should be more specific
to avoid ambiguity

There were several instances in which SFO Equities did not
comply with the terms of its lease agreement with the
Airport. However, the Airport Revenue Development and
Management Office (property management office) did not
apply any of the requisite penalties stated in the lease.

• Although scheduled to open for business on the rent
commencement date (RCD), September 1, 2004, the
Burger King franchise located at Gate 74 did not open
for business until September 18, 2004. The delay
occurred because SFO Equities had installed a
ventilator at the Gate 74 location that the Airport
considered inadequate for effectively removing food
odors; therefore, the Airport asked SFO Equities to
install a better ventilator.

Section 2.3 of the lease imposes a late opening charge
of $500 for each day after the RCD until the day on
which the tenant opens the facility for business. Not only
did the Airport not apply this $8,500 penalty ($500 x 17
days), it also prorated SFO Equities' MAG (from $6,060
to $4,167) for September 2004. If it were determined
that SFO Equities were responsible for the delay, then
an additional $1 ,893 would be due to the Airport.

More specific contract language would have helped
determine if the delay resulted from the inadequacy of
the ventilator that SFO Equities initially installed, or from
the Airport's request that the ventilator be upgraded.
Clarifying the language would also preclude the Airport
from choosing whether or not to apply a penalty.

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Transfer of lease to
Burger King Corporation

• SFO Equities was often late in submitting its percentage
rent payments to the Accounting Division. This was
evidenced by the numerous delinquent and/or three-day
demand notices that the property management office
had to issue to SFO Equities for payment.

The lease imposes a service charge equal to the lesser
of 1.5 percent per month or the maximum rate permitted
by law. However, the property management office
entered into several installment payment plans with
SFO Equities' president and waived the late payment
service charges.

• Section 4.5 of the lease, Annual Report and
Adjustment, states:

Within ninety (90) days after the end of each lease
year, Tenant shall submit to director an unqualified
year-end financial report certified by a certified
public accountant (CPA) or a year-end financial
report certified by Tenant's chief financial officer, if
such officer is approved by the director
[emphasis added], showing gross revenues
achieved with respect to the prior Lease Year.

While SFO Equities did submit an Annual Report of
Gross Revenue to the Airport Director for each lease
year, the report was not certified by SFO Equities' CPA
or its chief financial officer. Instead, the report was
signed by the SFO Equities' controller. Even if it could
be said that the controller was, in fact, the chief financial
officer, there was no record that the controller had been
approved by the Airport Director for the purpose of
certifying the year-end financial report. Despite this, the
Airport accepted the report as submitted by SFO
Equities. Note that in the annual report of gross
revenue, SFO Equities correctly identifies the lease year
as beginning with January and ending in December.
Despite SFO Equities' apparent awareness of what
constitutes a lease year, it computed percentage rent
due to the Airport using an incorrect lease year.

Effective July 12, 2007, under Airport Commission
Resolution No. 07-0103, the City approved a consent to
transfer the lease from SFO Equities (Assignor) to Burger
King Corporation (Assignee). The terms and conditions of

10

the resolution state, in part:

3. Following the transfer, Assignor and
Assignee shall be responsible for the
Tenant's entire obligation under the Lease,
including but not limited to any
obligations that accrued before the date
of the transfer [emphasis added].

4. Upon the occurrence and during the
continuance of a default under the lease, City
shall have the right to collect the rent
attributable to the Premises directly from
Assignee, without waiving any of City's rights or
remedies against Assignor with respect to such
default. City shall have no obligation to seek
Assignor's consent. ...

Recommendations Based on the terms and conditions of the resolution

approving assignment of the lease from SFO Equities, LLC,
to Burger King Corporation, the following recommendations
are equally applicable to both entities. The Airport should:

1. Bill and collect $43,416 from Burger King Corporation
for SFO Equities' underpaid percentage rent.

2. Review all lease agreements with SFO Equities' parent
company, WSE Group, Inc., to ensure that all of its
subsidiaries use the correct lease year to calculate
percentage rent due to the Airport. In any instances
where the percentage rent due has been incorrectly
calculated, bill WSE Group, Inc., for the balance due.

3. Ensure that Burger King Corporation uses the correct
lease year to calculate percentage rent due to the
Airport.

4. Work with the appropriate City personnel to draft more
specific contract language for this and similar leases.

11

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APPENDIX A: DEPARTMENT RESPONSE

Sm Francisco international Airport

■

(tCANODt iOMMS
: : . Mrtlk

January 7. 2008

.Vis. Harriett Richardson
Director of Audits
City Hall

1 Dr. Carlton B. Goodlett Place. Room 3 16
San Francisco, C A 94102-4694

Subject: Audit of SFO Equities. LLC, dba Burger King
Dear Ms. Richardson:

We have reviewed the subject audit and offer the following response to your
recommendations:

1 . The Airport will invoice SFO Equities. LLC or Burger King Corporation
S43.416 in reflection of the audit findings.

2. The Airport will review and ensure that rent was calculated and paid correctly
for the other VVSE Group, Inc. lease (Boarding Area B Casual Bar and Dining
dba San Francisco Legends).

3. The Airport will remind Burger King Corporation of the lease year and that the
minimum annual guarantee and percentage rent structure is applied to lease

4. The Airport is in the process of updating lease agreement language and will be
more explicit about percentage rent structures during lease years which are less
than twelve months.

Thank you for your work on this audit.

Sincerely.

Cheryl Nashir

Associate Deputy Airport Director
Revenue Development and Management

/

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APPENDIX B: AUDITEE RESPONSE

SFO EQUITIES, LLC

January 7, 2C08

Harriet Richardson, Director of Audits
Controller's City Services Auditor
City Hall, Room 476
# 1 Dr. Carlion B. Goodlelt Place
San Francisco, CA 9-H02-4694

Dear Ms. Richardson:

Wc are in receipt of your audit review of SFO Equities, LLC's operations of two Burger King
Restaurants located at San Francisco Airport. This review began May 24, 2007 and concluded with your
results being received in writing on December 20, 2CC7.

We have reviewed your audit report and we do not agree with your findings on the underpayment of
rents. SPO Equities, LLC paid rent on the "lease year" which commenced on the tbtc of the restaurants
opening September 2C04 and not on a calendar year as you state in your findings. We correctly paid all
rents due Airport Properties. There is no way to pay rents based on a calendar year as restaurant
openings happen at all different times of the year - not just on January 1 of any calendar year.

I have enclosed as a sample the method used to report rents to the airport each month since September
2004. This spreadsheet was forwarded to me by K'O Castellanos, SF Airport Acctg Division and we
would update and submit this report monthly. At no time was 1 ever contacted by anyone at SF Airport
Acctg Division that E was completing a form incorrectly or reporting any revenues incorrectly.

You also noted that in the annual report of gross revenue. SFO Equities identifies the lease year as
beginning with January. The annual report of gross revenue is a blank form provided by the airport each
year with instructions staling that you are to fill in with the beginning month that fits with your
restaurant opening and continue on the form for a 12 month period. As our copy showed, our first
completed revenue line was September 2004 and continued on from there.

In regards to the delay in opening Gate 74 Burger King, the delay was not a result of SFO Equities" faulty
"ventilator" as you state in your audit report. The airport installed the Smoke Hog (ventilator, as you
stated) and there were problems associated with its operation which caused the delay. Again, it was not
our Burger King approved equipment that caused the delay. Therefore, we disagree with your findings
that we violated our lease thus making us subject to the S500 per day fine.

E hope that this clarifies points that we disagree with in your audit report. As always, please feel free to
contact me at (wCj 3*8-0$56 with any questions you might nave.

Regards,

S , ,

Robbi Hollon
Controller

RHdooi

Enclosures

533 AIRPORT BLVD. SUITE 523 • BUR LING AME, CA • 94010
PHONE: 630,348-0556 • FAX: 630,348-0557

B-1

SFO Equities. LLC

Burger King

Statement of Sales and Rent Due

September 2005 tn August 2006

This spread sheet v»»s created by ivo Casteflanos @ SFO

T1

T3

T1

T3

Gate 74

Mezzanine

Combined

%

1

Safes

Sales

Sales

Allocation

Allocation

Sep-05

90 202 40

51.655 23

141 857.63

64%

36%

Oct-OS

92.976.93

50.57503

143.55) 96

65%

35%

Nov-05

90,297.47

50 090 67

) 40.3BS 14

36%

Dec-05

103.072 76

60.073.56

163 146 32

63%

37%

Jan-06

84.786 45

51,622 08

136.4V6 53

38%

Feb-06

79,512,72

45,58258

125,095 30

64%

36%

Maf-06

000

000

Apr-06

0 00

0 00

May-06

0 00

0 00

Jun-06

0 00

0 00

Jul-06

0.00

000

Aug 06

0 00

0 00

Total To-Date

540 848 73

309 599 15

850 447 88

J 00%
100%
100%
100%
100%
100%

Monthly Percentage Rent Calculation:

up to S750 .000 S%
S"50 0O0uptoS1.200.0O0 10%
> $1,200 000 12%

Total Current month

Sates
24.647 42
100.447 88

125,095.30

Percent
1.971 79
10.044.79

12,016 58

n

Sa/ss Sa.'es

Allocation Allocation

'253 31 7)8.49

6.384 64 3.660.15

Total
1.971 79
10,044 79

' 637 95 4.378*64 11.016 56

Less minimum monthly - BWGa1e74
Less minimum monthly BK;'Mezz

(3.340 00) | 3 340.00}
(2 720 00)

•2 72Q.OO)

Balance due and remitted herewith >\ S5.956.S8 I 4.M7.99 1,«SS,&4 5,356.53

Annual Report of Gross Revenue

XYZ, Inc./ XYZ Restaurant

(Company Name / Facility Name)

Month

January
February
March
April
May
June
July-
August
September
October
November
December

Year 2000

Year 2001

Year 2002

$225.00
$1, 000 . 00
Total $1,225.00

$555, 555 . 00
$333, 333 . 00
$222,222.00
$111,111.00
$999, 999 . 00
$888, 888 . 00
$222,222.00
$444,888.00
$999, 000.00
$111, 999.00
$111, 222 . 00
$111, 000.00
$5,113, 440.00

$1.11, 111 .00
$111, 111.00
$100, 000.00
$122,222.00
$222,222.00
$333, 332 .00
$111 , 111 . 00
$555, 555.00
$666, 666. 00
$777,777.00
$222, 222 .00
$999, 999. 00
$4, 335, 330.00

Jane Smith, CFO

CPA or CFO of Company *

U J

0

I

* Report must be certified by Company's CPA (Certified Public Accountant) or by its CFO (Chief
Financial Officer).

Annual Report of Gross Revenue

SFO Equities, LLC Burger King Locations Terminal 3
(Company Name / Facility Name)

Month

Year 2004

Year 2005

Year 2006

January

not opened

123,27965

79,577.37

February

not opened

111,902.02

66,275.59

March

not opened

127,861.30

70,043,41

April

not opened

110,340 94

59,828.30

May

not opened

120,167,74

61,087.77

June

not opened

123,362.10

65,543.47

July

not opened

126,919.87

67,687.57

August

not opened

115,591.18

65,231.70

September

46,051.20

94,237.60

October

124,143.47

88,978.58

November

134,213.42

77,538.65

December

135,901.49

91,083 51

Total

792,147.92

1,494,699.98

0.00

CPA of CFO of Company *

* Report must be certified by Company's CPA (Certified Public Accountant) or its
CFO (Chief Financial Officer).