Tuesday, January 20, 2004 City, Queen Mary in $2 million dispute   By Jason Gewirtz Staff writer Finances of ship, relationship with leaseholder puzzle city LONG BEACH Last year, city finance officials expected nearly $1 million in rent from the company that runs the Queen Mary. They got zero. Since then, the city has been embroiled in a stalemate with Joseph Prevratil, who leases and operates the city-owned icon. And the financial issues are so convoluted, the city's top administrator has called in outside help to solve them. At issue are: Nearly $2 million in rent credits for expenses Prevratil says he has incurred since 2000. City officials did not challenge the credits at the time but are now auditing the claims. A crucial lease amendment that was never finalized because the city and Prevratil thought they had agreed to different terms. Prevratil's sale of part of his company in August to a group of overseas investors whose identity the city doesn't know. City managers and elected officials who declined to pursue questions raised more than two years ago about the Queen Mary's finances. To Prevratil, once considered a savior of the historic ocean liner, the dispute is confounding. "I really feel like I've been taken advantage of,' he says. But those involved at City Hall say the issues should not be surprising to Prevratil, whose long history with the ship has included many clarifications of the city's complex lease. "If you look at the players here,' says City Auditor Gary Burroughs, himself a key player, "this is not an easy puzzle to solve.' The Queen Mary has been fraught with challenges ever since the city bought it for $3.5 million in 1967, at the end of its seagoing lifetime. Converted into a hotel, tourist attraction and marketing vehicle, the ship struggled to make money. Operators changed several times before the city, in 1978, transferred the ship's ownership to the City Council- appointed Harbor Commission. The commission gave it back in 1992 after The Walt Disney Co. abandoned plans to build a theme park around the site. The next year found the Queen Mary at a crossroads. A group of investors from Hong Kong offered $20 million, intending to move the ship overseas. A competing offer from RMS Foundation, headed by Prevratil and funded by FHP founder Robert Gumbiner, would keep the ship in Long Beach. The city chose Prevratil's group, offering a five-year lease to run the ship. Prevratil was no stranger to the Queen Mary, having run it from 1983 to 1988 under then- owner Wrather Corp. The decision to keep the ship in Long Beach wasn't entirely popular. Burroughs, among others, said the city should simply take the money from Hong Kong. But city leaders looked at more than money. As City Attorney Bob Shannon recalls, the council decided that the Queen Mary itself might be a money loser, but it held a greater value for the city. "At some point, it was determined that, apart from a tourist destination, the Queen Mary was an icon,' Shannon says. Still, city leaders didn't relish the costs of maintaining their unique symbol. So they crafted a lease with Prevratil designed to limit the city's costs while encouraging development on city- owned land surrounding the site. Lease changes In 1995, Prevratil came back to the council seeking 20 more years on his lease. He said the extension was crucial to his securing financing for the surrounding development. The council granted his wish. At the time, Prevratil incorporated a company called Queen's Seaport Development Inc. as his operation's profit-making arm. QSDI then subleased the ship's operation back to RMS Foundation, a nonprofit, tax-exempt entity. Today, RMS Foundation operates the ship's tours, on-board hotel and restaurants for QSDI. The for-profit QSDI holds the master lease over the entire, 55- acre Queen Mary property and oversees its development. In 1998, Prevratil was back at City Hall seeking financing for a new development plan. He asked that his lease be extended through 2061. The council again signed off on the extension, making a few tweaks to the lease in the process. The amended 1998 lease, at 66 pages, is far from riveting bed-time reading. But several of its key sections set the stage for the controversy to come. The lease requires Prevratil to pay $25,000 per month in base rent to the city. It also requires him to pay up to 5 percent of certain gross receipts, due once a year. With an eye toward the surrounding development, the lease also allows Prevratil to receive a credit off his revenue-related rent. That credit is equal to 9 percent of whatever money he spends to develop the area around the ship. Profits scarce Development plans for the area have come and gone. In 1998, Prevratil's plans included a skating rink, a luxury yacht marina, a flying saucer- shaped science fiction museum and a 120-room "boutique' hotel. Later, it included plans for a music museum backed by Dick Clark. Visitor interest in the Queen Mary has fluctuated with the economy, making development of the surrounding area key to the ship's long-term success, Prevratil says. With other attractions near the ship, the Queen Mary would have a fighting chance at economic survival, he says. Without that development, the ship has struggled. Since 1998, QSDI has reported profits in just one calendar year 2000 largely a result of heightened interest after the movie "Titanic' was released, Burroughs says. Combined, QSDI and the RMS Foundation lost nearly $3.2 million in 2002, the last year reported. Prevratil, meanwhile, has borrowed heavily to keep things running. Since taking over the ship, the amount owed on numerous loans has reached nearly $25 million, according to his financial statements. Enter Carnival But shortly after he signed the 1998 lease, a potential gold mine cruised into the picture. The city had long lobbied Carnival Cruise Lines to relocate from its berth in San Pedro to a site next to the Queen Mary. The company's arrival would mean hundreds of thousands of visitors and a potential tourist boon for the city's historic ship. When Carnival eventually was lured its first cruise from Long Beach was in 2003 city officials praised Prevratil's role in sealing the deal. With Carnival in the mix, the development plans outlined in the 1998 lease took a decidedly different turn. Carnival's passenger terminal was to be built inside the former Spruce Goose Dome next to the Queen Mary. A parking structure would be needed, and utility lines and an energy plant were required to be moved to accommodate the garage. To secure Carnival's arrival, Prevratil agreed to spend money on renovations to the Dome and relocation costs for the utilities and energy plant. But the 1998 lease anticipated a skating rink and museums. It said nothing about a cruise terminal and the related issue of eligible rent credits. So, the council turned to Burroughs, the city auditor, to help negotiate yet another lease amendment to clarify the issue. Burroughs, the city's auditor since 1992, had as much Queen Mary knowledge as anyone at City Hall. He'd been immersed in the muddy situation since 1993, when the city considered selling the ship. Efforts to amend the latest lease would prove even muddier. Lease change On Nov. 12, 2002, the City Council received a memo from the city's finance director, Bob Torrez, outlining terms of a proposed amendment. In addition to the Carnival-related expenses, it sought to clean up other elements of the 1998 agreement. City officials wanted quarterly financial statements from Prevratil, instead of annual ones, and they wanted access to all of Prevratil's financial books and records, "regardless of perceived relevance to the master lease.' The 1998 lease had required QSDI to keep Prevratil as its CEO through Dec. 31, 2003. With the date approaching and the 65-year-old Prevratil at retirement age, the city sought the right to approve the appointment of Prevratil's successor. City finance officials, who had worked with Burroughs on the amendment terms, wrote a four- page memo outlining them for the council. Based on the memo's language, the council ordered the city manager to execute the amendment, a process that was to include a formal signing by both sides. That was as far as the amendment ever got. A main reason for the delay, as city officials would later learn, was a second document at play on Nov. 12. Before the council received its memo, Prevratil's lender, Bar K Inc. of Lafayette, in northern California, had drawn up its own document, outlining its interpretation of the terms. Bar K's President, Barney Ng, met with Burroughs to discuss the proposal. When they were finished, he asked Burroughs to sign off on the document, which he planned to send to Prevratil and Howard Bell, the Queen Mary's chief financial officer. After the council had discussed the issue in a closed session Nov. 12, but before it voted publicly that night, Burroughs signed the letter. That document has become central to the dispute. From the city attorney's perspective, the Bar K letter differed in several key areas from what the council thought it had approved: The Nov. 12 council memo authorized $1.5 million in additional rent credits for Prevratil's Carnival-related expenses. The Bar K letter makes reference to $1.5 million in credits without specifying Carnival. The council memo states that those rent credits would be allowed only if the city manager deemed that the city's Tidelands Fund, which counts on roughly $1 million in annual Queen Mary revenue, could take the financial hit. The Bar K letter makes no mention of that agreement. The Bar K letter goes on to cite at least $2.2 million in Carnival-related expenses for which Prevratil can receive credit. The council memo makes no mention of any additional amount. To Prevratil, the Bar K letter had authorized up to $3.7 million in rent credits. In fact, Burroughs' signature was enough for Ng to lend Prevratil $4 million to cover his immediate Carnival-related costs. To Shannon, the council memo authorized just $1.5 million and only at the discretion of the city manager. According to the city attorney, the Bar K letter has no legal significance. "Under no circumstances would the city auditor have the power to bind the city,' Shannon says. But Prevratil says the letter was clear to him and his attorneys. Burroughs had been authorized to negotiate a deal, and his signature was proof of the terms, regardless of the council memo, he says. "(My lender) loaned $4 million based on that $3.7 million,' Prevratil says. "If the city is going to renege on that ... then that's a problem.' No check The confusion came to a head the next time Prevratil's rent came due. Prevratil pays his $25,000 base rent on a monthly basis. But each March, he pays the portion of his rent related to his revenue from the previous year. Along with the rent check, Prevratil also submits an annual statement prepared by outside auditors, detailing his finances. When the statement covering 2002 arrived in March 2003, it included a line that caught city leaders' attention. On the eighth page of the 20-page report, Prevratil's auditors said the company had "effectively amended its lease agreement with the city. As a result of the proposed amendment, management does not expect to pay rent in excess of the $25,000 monthly minimum for the foreseeable future.' Prevratil's accounting showed that he owed $881,834 in revenue-related rent for 2002. But when the city asked for the check, Prevratil said he owed nothing. Yet, Prevratil's financial statements claimed $827,169 in applicable rent credits for 2002 based on the terms of the original 1998 lease. By Prevratil's own accounting, he still would have owed the city more than $50,000 in rent. But Prevratil says he didn't pay anything because QSDI could have sought even more rent credits to cover the difference if it wanted. "The important point here is no one asked me for $50,000,' he says. Still, the numbers raised flags across City Hall, including the office of finance director Torrez. "My reaction was to go to the city manager and propose that all of us involved with the Queen Mary get together with Joe Prevratil and discuss this thing,' Torrez says. March 2003, however, was a politically unstable time at City Hall. Former City Manager Henry Taboada had been fired the previous fall, and the search was on for a new city manager. Jerry Miller, Taboada's No. 2 man, took over the interim post and declined to seek the permanent job. In May, the council came calling and asked Miller to take the city manager's job for good. He accepted. On May 20, Miller was sworn into office. On May 21, he told Prevratil that the city wanted its money. Pay up In a letter written that day, Miller said Prevratil owed the city $956,056 in revenue-related rent for 2002, based on the city's interpretation of the figures in Prevratil's financial statement. As for the $827,169 in rent credits, the city said that "they are not documented or detailed under the existing lease and thus, cannot be reviewed as appropriate.' The letter concluded with a request for the rent and a not- so-subtle reference to a lease provision that failure to pay rent is a sign of default. Shannon says the letter was not technically a default notice, as the city had no real plans to evict Prevratil. "It was intended to get Joe's attention,' Shannon says. It did. Prevratil says he was shocked by the correspondence. "Why, after 21 years in this city, wouldn't somebody pick up the phone and say, 'You know Joe, we don't agree with this?" he asks. On May 29, Prevratil arrived at City Hall for a meeting. For the first time in months, the city manager, city auditor, city attorney and city finance officials sat down together to clear up confusion over the lease. New twist The issue was a misunderstanding, Prevratil said. He owed nothing, he said, because the rent credits he was allowed to take under the 1998 lease offset the rent he would otherwise owe. Based on the buried warning in Prevratil's financial statement about no rent being due "for the foreseeable future,' city finance officials and attorneys say they thought something else. They believed Prevratil wasn't paying rent because he thought Burroughs had signed a $3.7 million cushion in the lease amendment. Regardless, Prevratil gave the discussion a new twist. He said Miller's letter was threatening his ability to secure additional financing for a new development plan for the land surrounding the Queen Mary. "If they had not rescinded that letter, we would have had to go to court,' Prevratil says. Since there were larger areas of the lease amendment still in dispute, he argued, why not withdraw the letter until those items were settled? His argument was successful. Soon after the meeting, Miller withdrew his May 21 letter. The issues behind the rent credits remained unresolved. Pointing fingers Prevratil's $827,169 rent credit request for 2002 was the third consecutive year in which he sought such relief. In 2000, he had asked for $432,712. In 2001, it was $677,514, according to his financial statements. From the beginning, city financial officials, an administrator assigned to the lease and at least one former city auditor say they questioned the numbers. Mike Killebrew, the city's budget bureau manager, says he grew concerned the first year because Prevratil sought credits for items for which he provided no documentation. Killebrew says he also questioned what specific projects Prevratil was claiming credit for under the lease. The first time Prevratil applied for rent credits, in March 2001, Killebrew says he questioned those credits with his supervisor, Torrez. Torrez says he raised the issue with his supervisor at the time, Taboada. "The decision was out of our hands at that point,' Torrez says. In a recent phone interview, Taboada says finance officials were constantly aware of the ship's finances, watching out for the city's bottom line. But he does not recall any warnings about rent credits. "I can't remember him ever saying, 'Boss, you've got a problem you've got to deal with," Taboada says. When Prevratil applied for more credits the next year, Killebrew says he raised the same concerns. "We could never figure out where the numbers came from,' Killebrew says. Again, he says, he received no response. Meanwhile, Ron Walker, the city's Queen Mary lease administrator, says he was raising the same concerns in 2001 and 2002. He says he brought his concerns to Taboada, who then turned to Burroughs. "We never got a direction back from the auditor's office that something was out of order,' Walker says. But at least one employee inside the auditor's office was convinced there was a problem. Former Deputy City Auditor Earl Hobbs had also come calling on Prevratil, seeking rent credit documentation. By Hobbs' account, QSDI had shorted the city as much as $800,000 in 2000 rent based on Prevratil's rent payments and rent credits. Details of Hobbs' concerns became public in December 2002 when Hobbs, who was fired the previous June, sued the city over his termination. The case is pending. Burroughs says Hobbs raised the issue with him but was unable to back up his claims. Hobbs never broached the topic with him again, Burroughs says. Burroughs says Taboada also never raised any questions with him on the rent credit issue. "We had not audited those things because nobody raised a question,' Burroughs says. For his part, Taboada says that when his staff had questions about any financial aspects of the lease, he turned to Burroughs. But he doesn't recall any major disagreements on the subject. "All I know is that whenever there were questions as to the numbers, Gary was brought into the picture,' Taboada says. Disputed credit Prevratil, meanwhile, disputes the city's questions about his rent credits. At all times, he says, city finance officials and auditors had access to his books. And any credits he took, he says, fell within the guidelines of his lease with the city. "I never did anything in a vacuum,' he says. Both Taboada and Burroughs, he says, were aware of the rent credits he took. City attorneys now say the documentation Prevratil has supplied is not sufficient. Documents received by the Press- Telegram from the city, through a public records request, support that assertion. The newspaper requested all documents related to Prevratil's rent credits. In response, the city provided what it says is its Queen Mary rent credit file a hodgepodge of records with limited detail about credits applied for or received. Prevratil later provided the Press-Telegram with a list he says represents those credits. It details accounting of the $432,712 in credits he took in 2000. But the totals for 2001 and 2002 don't match the totals in the financial statements QSDI presented to the city for those years. The statements provided to the city say QSDI took $677,514 in credits for 2001; Prevratil's list details $567,414 in credits. In 2002, financial statements say QSDI took $827,169 in credits; Prevratil's list details $778,976 in credits. Bell, the ship's CFO, says QSDI disputes its own auditor's calculations and only applied for the lower number in both cases. City officials say they can't account for the difference. "Welcome to Joe Prevratil's accounting,' Burroughs says. "I don't have an answer for you.' Whatever the real numbers, the lease allows credit only for off-ship improvements. Prevratil's list includes credit for developments aboard the ship. Among the items on Prevratil's list: $107,865 in credits taken in 2000 for a Queen Mary marketing and "branding' study performed by consultant Faith Popcorn. $436,900 in credits taken since 2001 for work related to the Ghosts and Legends attraction on the ship. $171,565 in credits taken since 2000 for work related to the Scorpion submarine attraction, which sits adjacent to the ship but within the ship area as defined in the lease. $833,874 in waterfront development credits, including work related to the Spruce Goose Dome for Carnival; engineering, architectural and other studies for 1998 development plans; and utility site work related to Carnival's arrival. 'Crown jewel' Killebrew and Torrez say some of Prevratil's claims don't comply with the lease, including Ghosts and Legends, an interactive attraction near the ship's bow. Prevratil argues that the lease makes reference to "development costs' for the Queen Mary area and that, in some cases, there's a fine line. "The Queen Mary is the crown jewel of the project,' he says. "Yes, I think our accountants can split hairs over is it technically on the ship or technically off the ship. The important point is, it's all one project.' The Faith Popcorn credits have also caught the city's attention. Prevratil hired Popcorn to help with "branding' issues as QSDI considered its development plans for the ship area. Popcorn's work included identifying the Queen Mary's marketing strong points and suggestions on how to tie the ship's nostalgic, authentic and romantic elements to the area's development plans, Prevratil says. The work is eligible for a rent credit, Prevratil says, because it represented a "soft cost' of development allowed under the generally accepted accounting principles that govern the lease. "The vast majority of what we've taken it on is clearly capital expense items,' he says. Finance officials say it doesn't appear to qualify under the lease. In October, as the dispute continued to linger, Burroughs began an audit of all the past rent credits Prevratil has sought. It's the first formal city review since Prevratil applied for credits in 2001. Asked why he waited until fall 2003 to examine the issue, Burroughs says it didn't rise to a level worth reviewing until then. Burroughs says he has reviewed Prevratil's documents supporting his rent credits, but would not release them until his review is complete. He also declines to comment on his interpretation of the credits until his review is complete in the next few weeks. Bigger problems? In the midst of Burroughs' review, the still-unresolved rent payment for 2002 and the still-unresolved issues over the proposed lease amendment, Miller called for outside help. In December, the council authorized him to hire the Staubach Co. to review all aspects of the city's lease with QSDI and to recommend how to move forward on the unresolved issues. Miller was authorized to spend up to $20,000 on the review. "In my view, I stepped into something that's sort of a tangle of knots,' Miller says. Miller says he has questions about past city oversight of the Queen Mary's lease. Since inheriting the matter, he has vowed to untangle the knots. "There were a number of things I was very concerned had been approached in a more lax manner than I thought were appropriate,' Miller says. The Staubach report is expected to be complete in March. Prevratil says the review doesn't concern him to a point. "If there's some ambiguity with this lease, let's clear it up,' he says. "If the study's a witch hunt, that's a different story.' For Burroughs' part, there appear to be bigger issues at stake than rent credits and lease amendments. For him, the ship is once again at a crossroads. From the beginning, the ship has been a financial drain, but one that city officials have been willing to support for the larger, more ambassadorial purpose the ship provides. But as the ship ages further, and as the people who initially marveled at its arrival age further as well, the city will have to decide whether the costs will be worth the effort, he says. Those issues will only get more complex, he argues. "This ship,' he says, "is only going to become a bigger problem if we don't begin to deal with it today.'