Los Angeles World Airports

LAX

LA!Ontario

Van Nnys

City of Los Angeles

Antonio R. Villara igosa Mayor

Board of Airport Commissioners

Mir.hael A. Lawson Presidenl

Valeria C. Velasco Vice President

Joseph A. Aredas Robert D. Beyer Boyd Highl Ann M. Hollister Fernando M. Torres-Gil

Gina Marie LlnUsey Executive Directo1

' \

AugustS, 201 2

The Honorable City Council of the City of Los Angeles City Hall, Room 395 Los Angeles, CA 90012

Reference: CF 12-1231

This is to hereby transmit for your information the Mayor approved City Administrative Officer's report regarding the DFS Group, LP I Duty Free Merchandise Concession Agreement.

Sincerely,

G~~ommiss ion Executive Assistant I ~~at~~~~F AIRPORT COMMISSIONERS

Attachments

1. Wn!ld W1 Los Angelos 1 hr(lrr11 90045-5803 Mall P .l 1 l{.. r '1~ Ln 1111:..,t h

TRANSMiTTAL TO

Gina Marie Lindsey, Executive Director Department of Airports

FROM

The Mayor

0150-03519-0016

DATE COUNCIL FILE NO.

AUG 0 8 2012 COUNCIL DISTRICT

11

Request to Award a 10mYear Agreement, with Three One~Year Options, to DFS Group LP. for the Development and Operation of the Duty Free Merchandise

Concessions at the Los Angeles International Airport

Transmitted for further processing, including Council consideration. See the City rt attached.

MAS:WDC: 10130007t

CAO 649-d

REPORT FROM

Date:

To:

From:

Reference:

Subject:

SUMMARY

OFFICE OF TH CITY ADMINISTRATIVE OFFICER

August 03, 2012 CAO File No. 0150-03519-0016 Council File No. Council District: i 1

The Mayor

Miguel A. Santana, City Administrative Offic~;¥ Q. £2._ Transmittal from the Department of Airports dated August 1, 2012; referred by the Mayor for report

LOS ANGELES WORLD AIRPORT AWARD OF A 10-YEAR AGREEMENT, WITH THREE ONE~ YEAR OPTIONS, TO DFS GROUP l.P. FOR MANAGEMENT OF DUTY FREE MERCHANDiSE CONCESSIONS IN PASSENGER TERMINALS AT THE LOS ANGELES INTERNATIONAL AIRPORT

The Los Angeles World Airports (LAWA; Department) requests approval to award a contract to DFS Group LP. (DFS Group), a subsidiary of LVMH Moet Hennessy Louis Vuitton, based in Los Angeles, for a period of 10 years (with three additional one-year renewal options), to design, construct, and operate 13 duty free concessions in passenger Terminals 1 through 8 and the Bradley West Core of the Tom Bradley lnternationa! Terminal (TBIT) at the Los Angeles International Airport (LAX). If approved, the proposed agreement, subject to City Attorney approval as to form, will become effective no sooner than 30 days prior to the opening of the Bradley West Core project (estimated to be in early 2013) and conclude in 2023 (excluding any optional renewals that may be exercised).

The DFS Group is the current duty free operator at LAX managing 13 duty free stores and one public location in Hollywood, California. The original five-year agreement, which has been extended to the present time, was approved by the Board of Airport Commissioners (BOAC) in May 2000.

The proposed agreement is the last of three concession agreements for LAX that are being implemented this year (the two earlier agreements were for a Terminal Commercial Manager to develop, lease, and manage retail concessions in Terminals 1, 2, 3, 6, TBIT, and the Theme Building). According to the DFS Group proposal, when fully implemented, the duty free merchandise concession agreement will provide LAWA with $100 million in revenue for the "first fully developed year" (the 12-month period following completion of all design and construction work and where the spaces are fully operational for airline passengers) and an average of $150 million annually over the 1 0-year term.

Selected through a Request for Proposal (RFP) process that began in November 2011 and for which eight proposals were received, DFS Group wi!! be required to invest a minimum of $25 million in

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initial improvements to the concession spaces and an additional $17 million in mid~term refurbishments. In addition to the $42 million in concession space improvements, the DFS Group will provide LA WA with rental payments of at least $30 million per year in each of the first two years and $33 million per year thereafter with annual increases adjusted to reflect the Consumer Price Index (CPI). The range of $30 to $33 million in proposed annual rental payments exceeds the current duty free operation's average annual rent of $29.1 million paid to LAWA over the last 10 years.

The timing of the award is crucial to the scheduled opening of the new Bradley West terminal in 20 12~ 13 in that the duty free concessions will provide ( 1) revenue for repaying bonds that were issued to finance the Bradley West construction, and (2) a quality shopping experience for airline passengers that will compare favorably with other of the world's leading airports. Items such as fragrances, cosmetics, tobacco products, wine, and spirits will be offered from famous retailers like Hermes, Gucci, Chloe, Burberry, Salvatore Ferragamo, Balenciaga, and Bottega Veneta.

The 1 0-year term was determined by LAWA to be optimal in that it will (1) enable the Department to balance a higher revenue stream with the optimum debt service in order to service the bonds issued to finance the Bradley West project; and (2) avoid an accelerated write-down of the DFS Group's considerable investment that might otherwise constrain its ability to fully compensate LAWA. In addition to the revenue due to LAWA from the duty free concessions, DFS Group will invest a minimum of $42 million in improvements ($25 million initially and $17 million at mid-term) over the term of the Agreement.

The proposed contract includes a termination clause for convenience allowing the Department to terminate the agreement, with not less than 180 days prior written notice, in instances where airport operations-whether for convenience or efficiency-require use of the space.

Pursuant to Charter Section 606, the Board of Airport Commissioners (BOAC; Board) may authorize the Department to proceed with executing the Duty Free Merchandise Concession Agreement, subject to the approval of the Council. The above~referenced aspects of the proposed Agreement, and this report, are based upon revised information received from the Department subsequent to the initial request submittal.

BACKGROUND

Contractor Selection Process and Evaluation Criteria

On November 2, 2011, the Department released a Request for Proposals (RFP) to obtain the services of a Duty Free Operator (DFO) for LAX Terminals 1 through 8 and the Bradley West Core of the Tom Bradley International Terminal. As with the TCM solicitation, the Department posted the draft RFP in order to obtain comments from the industry. Comments on a draft of the agreement were also solicited from interested parties. On April 2, 2012, LAWA received eight proposals, all of which were determined to be responsive to the established requirements.

According to LAWA staff, the eight proposals were scored basec! upon eight criteria (an explanation of the scoring criteria is included as an Attachment to this report) and a maximum total of 100 points,

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as outlined below:

CRITERIA POINTS Qualifications and Experience 15 Financial Capability 10 -Marketinq and Merchandising Plan 20 Improvements and Investment Plan 10 Management and Operations Plan 10 Financial Return to LAWA- Proposed Guarantee 15 Financial Return to LAWA -1 0-Year Pro-Forma (including proposed percentage rent on duty paid) 15 Financial Return to LAWA- Proposed Continqent Rent 5

TOTAL POINTS 100

PAGE

3

A five-person Evaluation Panel conducted oral interviews with representatives from all eight firms between May 22 and May 25, 2012. The composition of the Panel was as follows:

® Chief Operating Officer- Department of Airports ® Deputy Executive Director, Administration- Department of Airports ® Deputy Executive Director, Commercial Development- Department of Airports ® Airport Executive Assistant - External Affairs - Department of Airports ® Airport Executive Assistant - Finance - Department of Airports

During the Evaluation Panel scoring, five LAWA staff members were used as evaluators. The Evaluation Panels for two recent Terminal Concession Manager (TCM) awards incorporated LAWA staff and staff from other City departments to provide additional experience and greater flexibility. The combination of Department and non-Department staff has proven to be effective in evaluating complex RFPs. According to the Department, an outside evaluator was not used for the duty free concessions process because of the unavailability of high-level staff. While availability conflicts can and will arise, efforts should be made to ensure that there is the availability of non~department personnel to assist with the evaluation of contract awards of the magnitude of the duty free concessions.

The Department used a 100 point maximum scoring criteria for the selection process. In the recent TCM awards, the Department used a 200 point scoring scale, which could provide a greater degree of flexibility and thereby enable raters to better distinguish between the complexities and distinctiveness of each proposal. It is, therefore, recommended that a scoring system using a higher number of total points be used for the evaluation of these types of contracts in the future.

Upon conclusion of the oral interviews, the Evaluation Panel used the above criteria and accompanying scores to develop the final rankings as follows:

Proposer Rank

DFS Group P. 1

World Duty Free Group Nuance Dufry Shilla/AR! Heinemann Lotte Duty Free Americas

2 3 4 5 6 7 8

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According to the Department, both the number and quality of the proposals submitted exceeded expectations, surpassing even those of previous competitive processes for concessions.

While scoring lower than other of the proposers (due to mathematical errors), in an average of the three "Financial Return to LAWA" RFP categories, the DFS Group (1) forecast the highest rental payments to LAWA, and (2) performed better than its competition in the following categories: Qualifications and Experience, Marketing and Merchandising Plan, Improvements and Investment Plan, and Management and Operations Plan.

A review of the contractor selection process revealed the following with respect to the merits of the selection:

@ The DFS Group's projected overall revenue (Minimum Annual Guaranteed Rent, Percentage Rent, and Contingent Rent) to LAWA, both short- and long-term, exceeds that of the remaining seven proposers

e Given the fact that the DFS Group is the current duty free operator, a minimal learning curve will be required to achieve maximum profits and revenue to LAWA; as the current operator, DFS Group will also be able to work within an accelerated timetable for the opening of the duty free shops (March 2013 is the estimated opening)

@ The DFS Group has a track record of success in Los Angles and at LAX (some proposers have either not done business in Los Angeles or have more familiarity with non-airport duty free operations)

eo The DFS Group identified both the positions required to manage the duty free concessions at LAX and the individual staff to be assigned

<~~~ The DFS Group's Marketing and Merchandising Plan, Improvements and Investment Plan, and Management and Operations Plan were detailed and reflected considerable knowledge of the current and changing Los Angeles market demographics, as well as those of the international market

'II! The DFS Group operates a duty free warehouse in Los Angeles, whereas other of the proposers did not have such facilities in place

* The DFS Group's proposal reflected a more precise market analysis of the Los Angeles area and LAX

Protest Received Regarding Contract Award

Included in LAVVA's RFP package is a procedure for registering protests regarding a contract award. The Department received one such protest, covering three areas of concern, in response to its

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recommended award to the DFS Group. Consistent with past practices, the protest was referred to the City Attorney who, in turn, reviewed the complaint, the RFP criteria, and whether the Department followed the requirements of the selection process in order to determine the merits of the protest.

Consideration of the award and the related protest is scheduled for the Board of Airport Commissioner's meeting of August 6, 2012. With respect to the specifics of the protest, the Department advises that the City Attorney ( 1) has determined that the protest is without merit, and (2) can provide additional information upon request

Capita! Projects Affecting the DIJ..IIty Free Concessions

The Los Angeles International Airport Master Plan was approved by Council in December 2004 and by the Federal Aviation Administration in May 2005. Subsequently, the Board adopted an LAX Development Program for capital projects to modernize the airport with a budget of approximately $3.3 billion during its early years. The location for several of the capital improvement projects is the Tom Bradley International Terminal and surrounding acreage. Additionally, there are a number of capital projects that will enhance other terminals as well as facilities and spaces within the LAX central terminal area. As with the retail concessions, the duty free concessions are an integral part of the airport's development program. As such, it is proposed that the DFO will develop and operate 13 duty free shops utilizing approximately 37,600 square feet of concession space (7,900 square feet of which will be used for storage space in the TBIT) in eight passenger terminals and the Bradley West Core of the Tom Bradley International Terminal, in effect, nearly doubling the square footage available for duty free concession operations from that of the current layout

Duties and Responsibilities of the DIJ..IIty Free Operator

Highlights of the DFO responsibilities at LAX as enumerated in the RFP include:

® Implementing the proposed development and merchandising plan for all duty free stores "' Developing a comprehensive transition and phasing plan to ensure duty free merchandise is

provided to meet customer needs during the construction period <» Coordinating with the incumbent duty free operator to ensure a smooth transition of

operations, where applicable «> Coordinating facilities development and operations with other affected parties (e.g., the

Terminal Concessions Manager, other airport tenants) e Obtaining all governmental authorizations required for the delivery, warehousing, transport,

storage, distribution, and sale of duty free goods ® Making improvements (subject to review and approval by LAWA) designed to industry

standards that are appropriate to a best-in-class international airport ® Ensuring continuity of service to the traveling public during construction ~~~ Managing design and construction of the premises ® Ensuring ongoing reinvestment in the premises * Marketing and promoting duty free and duty paid (merchandise sold on a taxable basis and

on which a!l duties or excise taxes, if any, have been paid) sales, where applicable

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.., Developing and maintaining (and modifying when passenger composition dictates) a merchandising plan and sales plan tailored to the unique demands of international travelers

w Preparing and implementing business plans and quality control plans 1/li Meeting financial, ACDBE program, and local hiring commitments .., Delivering pre-sold and/or pre-ordered in-bond merchandise on both a tax free and duty free

basis to off-airport sites and over the Internet to outbound international passengers, groups, or airlines, as permitted by law

PROPOSED CONTRACT AND JUSTiFICATION

The Department's justification for releasing a new RFP for the duty free concessions is threefold: (1) rather than negotiating an extension to the existing contract, it was determined to be in the City's best interest to encourage competition; (2) with the investment required for the new duty free shops in the TBIT and Bradley West project, it was determined that it would not be economically feasible to continue operating under the structure and provisions of the existing duty free concessions contract; and (3) a new rent structure is needed to guarantee higher revenues to LAWA in order to support the repayment of bonds issued to finance construction of the Bradley West project.

Contract T errms

The proposed 1 0-year contract period is considered optimal by the Department for two reasons: first, because the projected concessions revenue from the Bradley West project represent an important part of the Department's Plan of Finance formulated to issue the bonds to finance the project, LAWA's intent was to balance a higher revenue stream with a reasonable debt service, thereby requiring a term of 10 years; and (2) since the level of investment by the DFS Group is considerable (at least $42 million over five years), the investments must be depreciable over the useful life of the agreement; to avoid an accelerated write-down of the cost and, thereby, constraints on the DFS Group's ability to compensate LAWA, a 1 0-year term was determined to be the most beneficia! for both parties.

In addition to the primary 1 0-year term, the Agreement allows for three one-year renewal options to be exercised at the discretion of the Department and with the concurrence of the DFS Group.

During the term of the Agreement, the DFS Group will be responsible for utilities, trash removal, and custodial services for its shops and storage area as well as any additional charges incurred by LAWA as a result of the DFS Group's operations.

Estimated Revenue

With the proposed duty free merchandise concession agreement, one of the anticipated benefits is increased revenue to LAWA from larger concession space (a total of approximately 37,600 square feet), which is divided between 13 locations. The estimated annual revenue, which will average $150 million over the 10~year term, is based upon the greater of (1) a Minimum Annual Guarantee (MAG) or (2) Performance Rent as follows:

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® Guaranteed Rent (for each of the 10 years, the MAG is the greater of the three options):

$30 million per year for the first two years and, thereafter, $33 million increasing annually by a CPI (Consumer Price Index) adjustment Ninety percent of the prior year's rent payments to LAWA, unless, commencing in the third year, international enplaned passengers at LAX have decreased more than 20 percent from the prior year $6.25 per international enplaned passenger commencing in the third year; thereafter, the rate increases per the CPI

e Performance Rent (comprised of two components: Percentage Rent and Contingent Rent):

Percentage Rent is the sum of the amount for the total of gross sales in specific product categories multiplied by each product's percentage rate as illustrated in the following table:

Percentage Rent Product Category Percentage Multiplier

Duty Free (Tobacco, Spirits, Wine} 35%

Duty Free (Electronics, Fashion Branded Boutiques) 25%

AI! Other Duty Free Products 30%

Duty Paid Approved Branded Specialty Retail or Other

Approved Duty Paid Products 30%

All Other Gross Revenues Not Included Above 30%

Contingent Rent is equal to ten percent of the gross sales that exceed $17 5 million in any given year.

ln summary, the estimated annual revenue to LAWA for the first fully developed year, as well as for the 1 0-year term, is derived from a combination of ( 1) the MAG, (2) the Percentage Rent (in instances where it exceeds the MAG), and (3) the Contingent Rent (if annual sales exceed $175 million). Estimated revenue from the latter two components, Percentage Rent and Contingent Rent, is based upon projected sales from the DFS Group as contained in their proposaL

In instances where the minimum annual sales are less than $175 million, the revenue to LAWA would consist of the MAG and Percentage Rent, to the extent that Percentage Rent exceeds the MAG.

The Department's increased revenue estimates are based upon the following:

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"' A 62 percent increase in the area for duty free shops which, in turn, will allow for designated space for product retailers that are not able to be represented under the current space limitations

® Unlike the current configuration, moving the present duty free concessions behind the security check points

w Obtaining higher rental revenue from the restructuring of the concessions agreement ® Revising the merchandise plan to accommodate changes in the international passenger

demographics 0 Eliminating various constraints on the duty free operations (e.g., some branded retailers

require certain spacing, layouts, and proximity to competitors to accommodate their product positioning)

Upon execution of the Agreement, the DFS Group must provide a Faithful Performance Guarantee (as a letter of credit), initially for $7.5 million (25 percent of the $30 million Minimum Annual Guarantee) to be adjusted annually based upon future payments to LAWA.

Alternatives to Approving the Concession Agreement

According to the Department, there are no viable alternatives to approving the proposed Duty Free Merchandise Concession Agreement with the DFS Group L. P. in that, if the proposal is not accepted and an agreement executed soon, one of three things could occur: (1) opening of the duty free shops in the new Bradley West Core would be delayed; (2) significant revenue would be lost to LAWA as a result of any delays in opening; and (3) with the need to coordinate the opening of the Bradley West terminal with the closing of the TBIT concourses, duty free shops will be affected in both terminals; unless the new duty free shops are opened in concert with the Bradley West terminal's opening, not only will additional revenue to LAWA be lost but the expectations by international passengers of improved concessions will not be met.

Compiiance with City Adminilstrative Requirements

The DFS Group has been assigned a Business Tax Registration Certificate number and must have approved insurance documents on file with the Department, in the terms and amounts requested, prior to being issued a Notice to Proceed. The proposed Duty Free Merchandise Concession Agreement must be approved by the City Attorney as to form.

The DFS Group has submitted the Contractor Responsibility Program Questionnaire and Pledge of Compliance and a signed Labor Peace Agreement. In accordance with the agreement, the DFS Group is required to comply with the provisions of the following standard City contract requirements: Affirmative Action Program; Child Support Obligations Ordinance; Living Wage Ordinance; and the First Source Hiring Program for all non-trade LAX airport jobs.

According to Department staff, there have been no objections to th]s proposed Agreement by the affected City labor unions.

Department staff have determined work specified in the proposed duty free concessions

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agreement is not subject to the provisions of Charter Section 1022 (Use of Independent Contractors). The DFS Group is subject to the provisions of Bidder Contributions, City Ethics Commission Form 55 pertaining to the City's contract bidder campaign contribution and fundraising restrictions (Charter Amendment H) that became effective in April2011. In addition, staff from the Department of Public Works, Office of Contract Compliance must determine that the DFS Group is in full compliance with the provisions of the Equal Benefits Ordinance prior to execution of the contract

The Department's Procurement Services staff reviewed the duty "free concessions operation and established a goal of 20 percent for the ACDBE (Airport Concessions Disadvantaged Business Enterprise) participation. Staff reports that the DFS Group has exceeded that goal by proposing a 25 percent participation level.

With respect to compliance with the requirements of the California Environmental Quality Act (CEQA), the issuance of permits, leases, agreements or other entitlements granting use of existing facilities at a municipal airport involving negligible or no expansion of use beyond that previously existing or permitted is exempt from the requirements pursuant to Article Ill, Class 1 (18) (c) of the Los Angeles City CEQA Guidelines. Pursuant to Charter Section 606 and the Los Angeles Administrative Code Section 1 0.5, the proposed Concession Agreement, being that it is for a period longer than five years, must be approved by the CounciL

RECOMMENDATIONS

That the Mayor:

1. Approve, subject to City Attorney approval as to form, the proposed 1 0-year Duty Free Merchandise Concession Agreement between the Los Angeles World Airports and DFS Group L.P. for the development and operation of duty free and duty paid merchandise concessions at the Los Angeles International Airport;

2. Return the proposed Agreement to the Los Angeles World Airports for further processing, including Council consideration; and

3. Direct General Managers of City departments to make available appropriate staff to provide assistance to other City departments conducting contract award evaluations.

FISCAL IMPACT STATEMENT

Approval of the proposed agreement will result in approximately $100 million in revenue for LAWA for the first fully developed year and an estimated $150 million annually over the 10-year term. This Agreement complies with the Department of Airports adopted Financial Policies. Approval of the proposed Duty Free Merchandise Concession Agreement with the DFS Group L.P. will have no impact on the City's General Fund.

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TIME LIMIT FOR COUNCIL ACTION

Pursuant to Charter Section 606, "Process for Granting Franchises, Permits, Licenses and Entering Into Leases," and the Los Angeles Administrative Code Section 1 0.5, "Limitation and Power to Make Contracts," unless the Council takes action disapproving a contract that is longer than five years within 30 days after submission to Council, the contract shall be deemed approved.

Attachment

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