Attachment 05 for Audit Meeting held May 09, 2016 1:00PM at Pier 69

05

INTERNAL AUDIT REPORT

LEASE AND CONCESSION AGREEMENT AUDIT

CRUISE TERMINALS OF AMERICA (CTA)

January 01, 2013 December 31, 2015

ISSUE DATE: MAY 9, 2016
REPORT NO. 2016-04

Cruise Terminals of America INTERNAL AUDIT
January 01, 2013 December 31, 2015
EXECUTIVE SUMMARY

AUDIT OBJECTIVES AND SCOPE
The purpose of the audit was to determine whether:
1. Maritime Cruise Operations and Finance monitoring controls were adequate and effective to ensure:
Cruise Terminals of America completely and accurately reported percentage rent to the Port.
Capital and Per Passenger maintenance allowance expenses were reviewed and approved.
2. Lessee complied with significant lease provisions, as amended.
We reviewed and analyzed records for the period January 01, 2013 December 31, 2015. Details of our
audit's scope and methodology are on page 6.

BACKGROUND

The Port of Seattle owns cruise terminals at Piers 66 and 91. Cruise Terminals of America (CTA) has
entered into a lease agreement with the Port to lease and operate the cruise terminal facilities in
exchange for percentage rent payable to the Port. The lease agreement establishes a landlord tenant
relationship between CTA and the Port.
Prior to May 2003, the Port of Seattle contracted with CTA to manage the Port's cruise operations. In
2003, Port Management and CTA transitioned the management agreement to a lease agreement. In
2005, the Port and CTA entered into a new lease agreement that provided greater financial benefit to
the Port in exchange for an extended lease term to CTA. In 2012, the Port and CTA amended the
agreement to simplify certain lease provisions, further advance the Port's financial benefit and extend
the term of the lease thru December 31, 2019.
In 2015, according to portseattle.org/cruise, cruise ship terminals at Pier 66 and Terminal 91 served
seven major cruise lines including Carnival, Celebrity Cruises, Holland America Line, Norwegian Cruise
Line, Princess Cruises, Oceania Cruises and Royal Caribbean. Each ship call brought approximately $2.5
million to the local economy. Overall, the Seattle cruise industry generates approximately 3,647 jobs
and $441 million in annual business revenue.

AUDIT RESULT

Monitoring controls performed by Maritime Cruise Operations and Finance are designed appropriately
and operating effectively. The lessee materially complied with significant provisions of the Lease
Agreement. Management's preventative controls over the lease process are not adequate. See Finding
1.

Cruise Terminals of America INTERNAL AUDIT
January 01, 2013 December 31, 2015

TABLE OF CONTENTS

EXECUTIVE SUMMARY ................................................................................................................................................. 2
TRANSMITTAL LETTER.................................................................................................................................................. 4
BACKGROUND ............................................................................................................................................................... 5
FINANCIAL HIGHLIGHTS .............................................................................................................................................. 6
HIGHLIGHTS AND ACCOMPLISHMENTS ..................................................................................................................... 6
AUDIT SCOPE AND METHODOLOGY ............................................................................................................................ 6
CONCLUSION ................................................................................................................................................................ 7
SCHEDULE OF FINDINGS AND RECOMMENDATIONS ............................................................................................... 8
1. THERE IS NO FORMAL PROCESSS TO EVALUATE WHETHER LEASE AGREEMENT RENT SECURITY IS
ADEQUATE TO PROTECT THE PORT FROM RISK OF LOSS. ................................................................................. 8

Cruise Terminals of America INTERNAL AUDIT
January 01, 2013 December 31, 2015

TRANSMITTAL LETTER
Audit Committee
Port of Seattle
Seattle, Washington

We have completed an audit of Cruise Facility Lease Agreement between the Port of Seattle and Cruise
Terminals of America. We reviewed information for the period January 01, 2013 December 31, 2015.
We conducted the audit in accordance with Generally Accepted Government Auditing Standards and
the International Standards for the Professional Practice of Internal Auditing. 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.
We extend our appreciation to the management and staff of Maritime Cruise Department, Maritime
Finance & Budget, and Accounting and Financial Reporting for their assistance and cooperation during
the audit.

Joyce Kirangi, CPA, CGMA
Internal Audit, Director

AUDIT TEAM RESPONSIBLE MANAGEMENT TEAM
Margaret Songtantaruk, Senior Auditor Michael McLaughlin, Director Cruise & Maritime Operations
Joseph Anderson, Internal Auditor Marie Ellingson, Cruise Services Manager
Debbie Stave, Manager Maritime Finance & Budget
Rudy Caluza, Director, Accounting and Financial Reporting

Cruise Terminals of America INTERNAL AUDIT
January 01, 2013 December 31, 2015

BACKGROUND
The Port of Seattle owns cruise terminals at Piers 66 and 91. Cruise Terminals of America (CTA) has
entered into a lease agreement with the Port to lease and operate the cruise terminal facilities, in
exchange for percentage rent payable to the Port. The lease agreement establishes a landlord tenant
relationship between CTA and the Port.
Prior to May 2003, the Port of Seattle contracted with CTA to manage the Port's cruise operations. In
2003, Port Management and CTA transitioned the management agreement to a lease agreement. In
2005, the Port and CTA entered into a new lease agreement that provided greater financial benefit to
the Port in exchange for an extended lease term to CTA. In 2012, the Port and CTA amended the
agreement to simplify certain lease provisions, further advance the Port's financial benefit and extend
the term of the lease thru December 31, 2019.
Internal Audit conducted a limited scope review of the CTA management services agreement with the
Port of Seattle in 2008. The report noted the Port's monitoring system was inadequate. We performed
a second audit of the CTA agreement in 2011 of the period beginning January 1, 2009, through
December 31, 2010. The report noted:
Lessee did not report gross revenue in accordance with the lease agreement.
Lessee contracted shuttle and parking services to its affiliates without seeking Port
approval
Port of Seattle management did not properly administer the terms of the agreement with
CTA due to the agreements complex provisions.
In 2015, according to portseattle.org/cruise, cruise ship terminals at Pier 66 and Terminal 91 served
seven major cruise lines including Carnival, Celebrity Cruises, Holland America Line, Norwegian Cruise
Line, Princess Cruises, Oceania Cruises and Royal Caribbean. Each ship call brought approximately $2.5
million to the local economy. Overall, the Seattle cruise industry generates approximately 3,647 jobs
and $441 million in annual business revenue.
Maritime Cruise Operations, in conjunction with Maritime Finance & Budget, and Accounting and
Financial Reporting (AFR), has primary responsibility at the Port of Seattle for administering and
monitoring the agreement to ensure compliance by CTA.

Cruise Terminals of America INTERNAL AUDIT
January 01, 2013 December 31, 2015
FINANCIAL HIGHLIGHTS
FINANCIAL HIGHLIGHTSFINANCIAL HIGHLIGHTS FINANCIAL HIGHLIGHTS
AGREEMENT PERCENTAGE RENT T91 FACILITY
TOTALS
YEAR PAID CHARGE
2013 $11,575,806 $1,235,469 $12,811,275
2014 $11,491,310 $1,146,758 $12,638,068
2015 $12,998,190 $1,093,904 $14,092,094
TOTALS $36,065,306 $3,476,131 $39,541,437
Data Source: PeopleSoft Financials
HIGHLIGHTS AND ACCOMPLISHMENTS
During the course of the audit, we noted that Maritime Cruise Operations and Finance achieved the
following significant accomplishments.
Amended and simplified key provisions within the Cruise Facility Lease Agreement, which
eliminated the need for the Port of Seattle to monitor CTA's detailed accounting records.
Built and maintain strong working relationships with Cruise Terminals of America
management through the establishment of weekly and quarterly operations and finance
meetings.

AUDIT SCOPE AND METHODOLOGY
We reviewed information for the period January 1, 2013 December 31, 2015. We utilized a risk-based
audit approach from planning to testing. We gathered information through document requests,
interviews, observation, and data analysis, for Internal Audit to obtain a complete understanding of the
significant provisions of the agreement between the Port of Seattle and Cruise Terminals of America
and the respective operations.
We applied additional detailed audit procedures to areas with the highest likelihood of significant
negative impact as follows:
1. We performed control test procedures to evaluate the design and effectiveness of the two key
monitoring controls performed by Maritime Cruise Operations and Finance that ensure:
Cruise Terminals of America completely and accurately reported percentage rent
Capital and Per Passenger allowances are appropriately administered
2. We verified the lessee materially complied with significant lease provisions, as amended through
execution of audit procedures that confirmed:
Lessee completely and accurately calculated and reported Percentage Rent and the
Terminal 91 Facility Surcharge to the Port
Lessee maintained Insurance coverage in full force at specified amounts.
Lessee obtained and had in force Rent Security (i.e. Surety) at specified amount

Cruise Terminals of America INTERNAL AUDIT
January 01, 2013 December 31, 2015
Lessee materially remitted all Percentage Rent payments timely
Lessee timely provided its annual plan to the Port of Seattle
Maritime Operations appropriately administered the Maintenance Allowance

CONCLUSION
Monitoring controls performed by Maritime Cruise Operations and Finance are designed appropriately
and operating effectively. The lessee materially complied with significant provisions of the Lease
Agreement. Management's preventative controls over the lease process are not adequate. See Finding
1.

Cruise Terminals of America INTERNAL AUDIT
January 01, 2013 December 31, 2015
SCHEDULE OF FINDINGS AND RECOMMENDATIONS
1. THERE IS NO FORMAL PROCESSS TO EVALUATE WHETHER LEASE AGREEMENT
RENT SECURITY IS ADEQUATE TO PROTECT THE PORT FROM RISK OF LOSS.
The Port of Seattle has leased its cruise terminals to Cruise Terminals of America (CTA) to operate
the cruise business. To secure tenant's full performance of the agreement, including payments of
rent and other amounts, the Port under Article 5 of the lease agreement requires CTA to obtain
rent security of $300,000. That rent security amount has remained constant since inception of the
first Cruise Facility lease in 2003, and we verified that CTA was in compliance.
Per state law and Port Policy, the amount of the rent security required from a tenant varies and is
dependent on total amount of rent payments. CTA's percentage rent and fees paid to the Port were
approximately $12,811,275, $12,638,068, and $14,092,094 for the years ending 2013, 2014, and
2015 respectively.
RCW 53.08.085 - Lease of Property - Security of Rent - requires rent security of one-sixth the
total rent, but not less than one year's rent or more than three years' rent with the port
commission having the discretion to adjust or waive rent security.
Port Procedure RE-2 - provides a guideline that agreements of five years or more shall
require rent security of six months' rent with the Executive Director or designee having the
discretion to adjust the amount or form of security in appropriate circumstances.
Based on the above state law and Port procedure, we determined that CTA's rent security was less
than the established guidelines and the deviation from those guidelines was not documented or
expressly approved by the Port Commission in connection with the 2005 Cruise Facility Lease
Agreement.
We found Port management had no process or established controls to reassess the adequacy of the
rent security or reexamine compliance with state and Port requirements related to rent security in
connection with the 2005 Cruise Facility Lease Agreement. The lack of formal process to reassess
risk and reexamine compliance allowed management to overlook the significance of the Cruise
Facility Lease Agreement rent security provision.
Recommendations
We recommend Port management:
1. Evaluate the lease process and strategically design and implement key control(s) to ensure
that agreements are only approved when:
Risk is set to an acceptable level
The Port is in compliance with applicable laws and Port policies or procedures and
deviations are documented and explicitly presented to decision makers.
2. Amend the agreement language if determined necessary.

Cruise Terminals of America INTERNAL AUDIT
January 01, 2013 December 31, 2015
Management Response
We appreciate the auditors' observations and recommendations. RCW 53.08.085 and Port Policy
RE-2 provide for discretion to adjust or require a security deposit by the Port Commission or CEO,
respectively. When the Commission approved the original agreement with CTA, the amount of the
security was approved accordingly. A subsequent action just a few years into the agreement
merely changed the instrument from a management agreement to a lease. A second subsequent
action afterward extended the lease agreement for an additional two years. Neither of the two
actions occurring during the term of the original agreement was intended to renegotiate the full
substance of the agreement. Rather, they resulted in refinements to the financial and operational
benefit of the Port. Nevertheless, we value the insight offered by the auditor. Upon possible
negotiations toward a new agreement when the current one expires, management will ensure full
diligence to update a risk assessment to inform any required adjustments to the security deposit
amount.
Port management acknowledges that the Port Commission does not appear to have been expressly
notified of the amount of the lease security when it acted to approve the updated Cruise Facility
Lease Agreement on December 13, 2005. While it has been over ten years since the Port
Commission acted to approve the lease, the November 2, 2005 memorandum requesting
authorization for the agreement does not reference the amount of the security.
However, this lease security amount was expressly approved by the Port Commission when it acted
to approve the prior lease with the same tenant, Cruise Terminals of America, LLC ("CTA"). The
Port originally selected CTA as a management agent for the opening of the Port's cruise terminal
at Pier 66, and the parties signed Management Agreement on March 24, 2000. Primarily in order to
realize on operational efficiencies with the opening of a second cruise terminal, the Port elected
to convert that management agreement into a lease. And the resultant Cruise Facility Lease
Agreement was presented to and approved by the Port Commission on March 11, 2003. In
connection with that Commission action, Port management clearly indicated that the lease
security was $300,000.
The lease in question the second Cruise Facility Lease Agreement was not a new deal. On the
contrary, the term of the first Cruise Facility Lease Agreement extended for over two more years,
through December 31, 2007. Instead, the revised lease agreement was brought to the Port
Commission in the middle of the term of that first agreement with the stated purpose of providing
"an increase in net proceeds to the Port." Although cast as a new lease, the December 21, 2005
contract was not a wholesale remaking of the agreement between the Port and CTA. Instead, the
revised lease primarily improved the financial return to the Port, extended the term of the
agreement, and made provisions for the relocation of the Port's second and third cruise berths at
Terminal 30. The new lease intentionally did not re-examine the other terms. As such, Port
management believes there was a clear appreciation, and tacit approval, of the lease security
amount by Port Commission when it acted to approve the revised Cruise Facility Lease Agreement
on December 13, 2005.
And in any event, Port management believes that the lease security is adequate for the risks

Cruise Terminals of America INTERNAL AUDIT
January 01, 2013 December 31, 2015
associated with this lease agreement. It is the Port that establishes the tariff rates charged to the
cruise lines utilizing the leased facilities. While leasing the cruise facilities, CTA essentially acts as
a conduit, paying the vast majority of those tariff proceeds to the Port as rent. And given that CTA
is a partnership of three of the most stable and well-represented business partners in the Port's
waterfront business, the risk of CTA somehow absconding with the tariff proceeds without paying
the Port is trivial. Port management held this belief when the original Cruise Facility Lease
Agreement was submitted to the Port Commission for approval on March 11, 2003 and continues to
hold that belief today.

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