minnesota orchestra financial review, june 10 2013

7/30/2019 Minnesota Orchestra Financial Review, June 10 2013

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CONFIDENTIAL

Financial Analysis of the

Minnesota Orchestra

June 10, 2013


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TABLE OF CONTENTS

PageExecutive Summary 3

Introduction 5

The Orchestras Financial Situation 6

The Orchestras Strategic Business Plan 8

Conclusion 15

AppendicesI. Scope of the Financial AnalysisII. Background Information About AKA|Strategy


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EXECUTIVE SUMMARYOrchestras nation-wide are confronted with serious, endemic financial challenges that aregrowing in scope and impact. The Minnesota Orchestra has had a history of growingannual operating budget deficits, totaling over $22 million in the three year period ofFY2010 through FY2012, an amount equal to two thirds of the Orchestras FY2012

operating budget of $31.5 million. The reason for the larger and larger operating deficitsis straightforward:

The Orchestra negotiated a new contract with its musicians in FY2007 thatsignificantly increased its fixed operating expenses (hard costs) in a budget thatwas increasingly dependent upon contributed revenue (soft funding), making itparticularly vulnerable to adverse financial circumstances.

The Great Recession hit the Orchestra hard: in FY2009 the market value of itsendowment decreased by about 30% and its contributed revenue fell by 17% fromthe pre-recession annual average.

The Orchestra reduced administrative and overhead expenses in the six-year ofFY2008 through FY2013 by about $1.5 million in an effort to reduce the deficits.

Contributions were not sufficient to close a growing gap between operatingrevenue and expenses. These growing deficits were increasingly funded throughlarger and larger annual exceptional draws from the endowment.

The exceptional draws, in turn, reduced the market value of the endowment,already battered by the recession, which resulted in lower endowment draws overtime and placed ever growing pressure on the operating budget.

Alarmed by the steady worsening of its financial circumstances, the Orchestra undertooka thorough review of its overall financial architecture over a two year period, culminatingin the development of a Strategic Business Plan approved by the Board on November 2,2011. The Plan seeks to achieve a sound balance between artistic quality and financialsustainability and puts the Orchestra on a break-even basis by balancing the operatingbudget; limiting spending from its endowment to 5% of market value on a trailing threeyear average; and adjusting estimated fundraising and ticket sales to realisticallysustainable levels.

The Strategic Business Plan calls for the generation of about $2.1 million of annual

incremental net revenue; staff and overhead reductions of about $1.5 million annually;and a sizeable reduction in total musicians expense almost half of the Orchestrasoperating expensesthrough an unspecified set of possible changes.

The overall logic of the Strategic Business Plan is sound, as are the underlying financialassumptions in it. The Orchestras independently audited financial statements for thepast half decade are unqualified.


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It is important to consider the projected sizable decrease in musicians expense in thecontext of the Orchestras overall financial situation. Total musicians labor expenseincreased some $1.5 million between FY2007 and FY2012 through contractuallymandated annual increases while all other operating expenses except touring and debtservice decreased by $700 thousand. It is unrealistic to think the Orchestra can fundraise

its way out of its current financial difficulties. Further exceptional draws from itsendowment only complicates its problems. Musicians expense is the one untouched areaof the operating budget

Even with the projected sizable reductions in total musicians operating expense, theStrategic Business Plan only partially addresses several long-term financial obligations.These include (1) underfunding of its frozen defined benefit plans for musicians andstaff and of the American Federation of Musicians multi-employer musician definedbenefit plan in which it participates and (2) some $9.3 million of taxable bonds due inApril 2015. Meeting at least some of these obligations will result in draws from itsendowment above the 5% level.

In addition, there is no contingency in the projected operating budget or provision forcontract terms with the musicians union that may result in annual savings less than thoseprojected in the business plan.

Like other nonprofit organizations, the Orchestras personnel costs inevitably rise fasterthan operating revenue, all things being equal and thus has only limited opportunities torealize steady increases in productivity While the Strategic Business Plan projectssteady state budgets for the next several years, the Orchestra will continue to beconfronted with serious and persistent budget pressures going forward.

Only gifted artistic and executive leadership, skilled and transparent financialmanagement, shared understanding and collegial responsibility by the Orchestra and themusicians and the ongoing support of a generous community will allow this superbsymphony orchestra to have the solid financial base that it requires to ensure continuedartistic excellence that is widely and appropriately recognized and appreciated.


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INTRODUCTIONOne of the leading symphony orchestras in the United States, the Minnesota Orchestrahas suffered from serious difficult financial challenges for at least the past decade. Inparticular, it incurred chronic annual operating budget deficits that were largely financedby a combination of repeated fundraising initiatives to underwrite operations and

exceptional draws from its endowment above its stipulated endowment spending policy.These financial challenges became more serious in the past five years, resulting incumulative operating budget deficits of more than $22 million in the three-year period ofFY2010 through FY2012, an amount equal to two thirds of the Orchestras FY2012operating budget of $31.5 million.

Alarmed by the steady worsening of its financial circumstances and worried about theshort- and longer-term consequences of such overspending, the Orchestra undertook athorough review of its financial circumstances and its overall financial architecture overthe two-year period of FY2010 and FY2011. The result of this review was thedevelopment of a Strategic Business Plan, which was adopted by the Orchestras Board

of Directors in November 2011. The Plan seeks to achieve a sound balance betweenartistic quality and financial sustainability by realigning the Orchestras operatingexpenses, eliminating dependence on exceptional draws from its endowment andrefocusing its fundraising efforts.

One outcome of the Plan was to ask the Orchestras musicians to accept a sizablereduction in compensation to help balance the operating budget upon the expiration of itscontract with the musicians union on October 1, 2012. The Orchestra and the musiciansunion have been unable to negotiate the terms of a new collective bargaining agreement,with the result that the 2012-2013 concert season was cancelled.

At the heart of the difficulties that have prevented both parties from agreeing on newcontractual termsand doing so on a timely basis are different perspectives about theOrchestras current and prospective financial circumstances and whether the changesproposed by the Orchestra are equitable, appropriate and sound.

In an effort to constructively develop an objective view of the Orchestras financials andas a step toward finding a mutually acceptable basis for structuring a new agreement, theOrchestra retained AKA|Strategy to undertake a financial analysis of the Orchestra.1

1 There were extensive efforts to have the independent financial analysis jointly sponsored and funded bythe Orchestra and the musicians union, but the two parties were not able to reach agreement on the preciseterms of the scope of work. As a result, the Orchestra decided to proceed on its own.

Appendix I summarizes the scope of the independent financial analysis and provides backgroundinformation on key Orchestra financial and strategy documents that are the basis for the analysis. AppendixII provides background information on AKA|Strategy and its Managing Director, Anthony Knerr, theauthor of this report.


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THE ORCHESTRAS FINANCIAL SITUATIONAn unfortunate confluence of two different sets of issues has produced the Orchestrascurrent financial situation.

Significant Secular Trends Among American Symphony Orchestras

Orchestras nation-wide are confronted with serious, endemic financial challenges that aregrowing in scope and impact.

Orchestras overall have limited opportunities to increase productivity (an issuediscussed below), a situation that results in ongoing cost pressures and structuralbudget deficits. That so many of Americas leading symphony orchestras arefacing financial stress, including sizable operating deficits and bankruptcy, is notsurprising, though alarming and dispiriting.

Attendance at classical music events in the United States has been steadilydecreasing over the past decade, resulting in a significant and continuing decline

in classical music ticket revenue. Classical music does not presently enjoy thestatus and popularity in the United States that it did several decades ago. Thereappear to be a number of causes for this shift, including many more entertainmentopportunities, greater popularity of other musical forms and styles, morecompetition for leisure time, aging audience, often static programming anddeclining arts education in schools, among others. It is likely that interest, supportand participation in classical music programming will continue to decline in thecoming years.

While some orchestras appear to have been more successful in combatting thesepowerful secular trendsparticularly those in very large metropolitan areas no

major American orchestra is immune from these challenges, as evidenced by thenumber of the countrys largest orchestras negotiating significant contractualchanges with their musicians in the past several years.

The More Specific Financial Circumstances of the Minnesota Orchestra

Overall, the operating climate for the Orchestra was generally favorable during the periodof FY2002 to FY2007: the national and local economies were robust; the Orchestraenjoyed widespread respect and support; attendance was strong; and the Orchestrasartistic quality, reputation and status were growing handsomely. With the appointment ofa new Music Director on September 1, 2001, the Orchestra expanded its touringnationally and internationally to considerable critical acclaim.

Even though the Orchestra reported deficits it was able to balance its budget during theseyears through a combination of recurring special fundraising efforts to underwriteoperating expenses; significant, though not unreasonable, exceptional draws from itsendowment; and assumption of $11 million of debt in 2005


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In this context of generally favorable financial and environmental circumstances, theOrchestra negotiated a new five-year contract with its musicians in FY2007 thatincreased their salaries by 26%. This increase added approximately $2.3 million to theannual expense base of its operating budget.

Shortly thereafter the Great Recession had a dual negative impact on the Orchestra: themarket value of its endowment declined by some 30%, from $106.3 million to $74.0million in FY2009, and contributed revenue decreased by 17% from the pre-recessionannual average of $8.0 million in FY2006-FY2008 to an annual average of about $6.8million in FY2009-2010. Complicating the situation was continuing flat ticket revenue inpart because of reduced interest in and attendance at classical music concerts, a problemendemic to virtually all major symphony orchestras.

Recognizing the growing seriousness of its financial problems, the Orchestra acted toreduce administrative and overhead expenses during the six-year period of FY2008through FY2013.

Operating expenses were decreased through the elimination of 12 full-time andseven part-time positions; salary reductions for the management team and allother staff; multi-year staff wage freezes; reduction in staff pension contributionby the Orchestra from 7% to 4%; and reduction of employer contributions to staffhealth insurance.

Overall, reductions in management and staff expense implemented in FY2010totaled about $900 thousand annually. Further reductions in management andstaff expense implemented in FY2012 totaled an additional $550 thousand, for acumulative total reduction of approximately $1.45 million.

In addition, the Orchestra asked for and received concessions from the musiciansin FY2010. These included a wage freeze, of which the three fiscal yearcumulative savings from contractual increases was $1.4M, and a reduction inOrchestra contributions to musicians pension from 7% to 5% going forward,which reduced the expense base of the operating budget by $220 thousand

The combination of the secular trends affecting all symphony orchestras in general andthe Orchestras specific financial challenges resulted in growing imbalances between itsoperating revenue and expenses. Operating deficits increased from $5.4 million inFY2009 to $6.6 million in FY2010, $7.1 million in FY2011 and $8.7 million in FY2012.

The combination of funding operating deficits and the impact of the Great Recessionresulted in the market value of the endowment declining from $93.4 million at the end ofFY2008 to $59.0 million at the end of FY2012, a 37% drop.2

2 In addition to its endowment, the Orchestra is the beneficiary of a designated fund at the Saint PaulFoundation, pursuant to which amounts contributed to it are held as a separate fund designated for thebenefit of the Orchestra. The Foundation makes distributions to the Orchestra annually. The market valueof the Orchestras interest in the Foundation was $1.2 million at the end of FY2012.


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The reason for the larger and larger operating deficits was quite straightforward. TheOrchestra negotiated a new contract with the musicians that significantly increased itsfixed operating expenses (hard costs) in a budget that was increasingly dependent uponcontributed revenue (soft funding), making it particularly vulnerable to adverse

financial circumstances. Contributions were already being used to fund the Orchestrastotal operating costs but were not sufficient to close a growing gap between operatingrevenue and expenses. These growing deficits were increasingly funded through largerannual exceptional draws from the endowment. The exceptional draws, in turn, reducedthe market value of the endowment, already battered by the recession, which resulted inlower endowment draws over time and placed ever growing pressure on the operatingbudget.

And so the financial difficulties of the Orchestra steadily and inextricably grew larger andmore serious. If not corrected, its growing operating budget deficits could ultimatelyresult in the Orchestra completely spending down its endowment.

THE STRATEGIC BUSINESS PLAN

The overriding objective of the Strategic Business Plan is to put the Orchestra on abreak-even basis for at least the three-year period of FY2014 through FY2016.Achieving such a state of financial equilibrium requires balancing the annual operatingbudget, limiting spending from its endowment to 5% of market value on a trailing threeyear average basis and revising expectations of fundraising and ticket sales to realisticallysustainable levels.

Overview of the Strategic Business Plan

The Strategic Business Plan has a multi-prong approach to balancing the budget acombination of sustainable increases in contributed revenue and more modest increasesin earned revenue with substantial reductions in operating expenses under the logic thatthere are significant limits to realistic, sustainable growth in total operating revenue andthe operating expense base must be brought into balance with projected revenue.

The key components of the Strategic Business Plan designed to achieve financialequilibrium are as follows:

A variety of initiatives projected to generate about $2.1 million of annualincremental net revenue going forward;3

The Orchestra is also the beneficiary, but not the trustee, of a trust agreement with Oakleaf Trust for theMinnesota Orchestra that entitles it to certain income distributions each year. The market value of theOrchestras interest in Oakleaf was $66.5 million at the end of FY2012; the distribution from the Trust inFY2012 was $3.0 million.

3 These initiatives include (1) an estimated total of $2.4 million of additional contributed revenue(incremental endowment draw of $1 million generated by a $20 million increase in the endowment byFY2016, $700 thousand of additional fundraising results above the base case and $700 thousand of


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Staff and overhead expense reductions to produce approximately $1.5 million ofsavings annually;4 and

Projected reduction in total musicians expense the largest component of theOrchestras operating expenses, comprising some 49% of the FY2012 operatingbudget of $4.6 million. This reduction, amounting to a 30% decrease inmusicians expense, would be achieved through an unspecified combination ofchanges in the number of musicians, the number of concerts and the length of theconcert season as well as changes to base salary and add-on compensationarrangements and benefits.

The overall logic of the Strategic Business Plan is sound; its independently auditedfinancial statements for the past half decade are unqualified.5 The Orchestra has had ahistory of overestimating its ability to generate revenue, particularly contributed revenue,hoping that it would be able to close the ever-growing gap in the operating budget

through fundraising. But the combination of adverse economic circumstances and limitson donor capacity and interest have hindered the Orchestras efforts to reliably bridge thegap in more recent years. The flaws of the Orchestras earlier approach are evident,particularly in the current economic environment and the systemic challenges to leadingsymphony orchestras in the United States.

It is important to consider the projected significant decrease in musicians expense in thecontext of the Orchestras overall financial situation.

Overall, total musicians labor expense increased $1.5 million between FY2007and FY2012 (from $13.8 million to $15.3 million, an annual average increase of

2.2%), while all other operating expenses except touring and debt service (whichrepresent 47.8% of the annual operating budget) decreased by $0.7 million overthe same period (from $15.6 million to $14.9 million, an annual average decreaseof 0.9%).

It is unrealistic to think that the Orchestra can fundraise its way out of its currentfinancial difficulties. Other portions of the expense budget have already beenreduced. But since the modest concessions reached with the union in FY2010,

incremental funding to implement a new tour strategy); and (2) an estimated total of $1.45 million ofearned revenue ($600 thousand from funding for additional non-orchestra concerts, $300 thousand from

new international touring fees, $300 thousand from additional hall rentals and food/beverage income and$250 thousand from changes in ticket pricing). This total of $3.85 million of incremental annual revenue, a17% increase on estimated baseline revenue, is offset by an estimated $1.7 million of incremental costs torealize the incremental revenue, for an estimated net annual increase of $2.1 million.

4 The Strategic Business Plan lists some possible ongoing opportunitiesto reset expenses that includefurther restructuring of administrative staffing, additional reductions in concert production expenses andmore decreases in marketing expenses. Firm decisions of these reductions have not yet been made.

5 Appendix I provides pertinent background information about the audited financial statements.


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total musicians expense has not only been untouched, but has grown bothnominally and as a percent of total expenses because of contractually stipulatedannual increases for the musicians.

In seeking to balance the budget and achieve financial equilibrium, it is surelyappropriate for the Orchestra to also seek to reduce the single largest operatingexpense in its budget.

Key Assumptions in the Strategic Business Plan

Overall, the underlying financial assumptions in the Strategic Business Plan for the nextseveral fiscal years on the projected reduced expense base appear to be reasonable,appropriate and prudent.

Total revenues and operating expenses are projected to grow in FY2014 throughFY2016 by 2% for inflation, a rate that seems reasonable in view of currentgeneral rates of inflation in the United States. (Cost increases in any expense

category or decreases in any revenue category would thus have to be realizedelsewhere in order for the budget to remain balanced.)

It seems unlikely that earned revenue from classical music ticket sales will growmore than 2% in the next three to five years (or beyond then) upon settlementwith the musicians union and may well continue to decrease on a year-to-yearbasis.

The average annual investment return on the endowment is projected to be 8% forthe three-year period and spending from the endowment restricted to 5% of atrailing three year average.6

This targeted level of total annual average investment return is reasonable, ifambitious, in the current and possible future capital market environment andwill depend in large measure on thoughtful asset allocation with regular re-balancing and well articulated policies with respect to risk tolerance.7

An endowment spending rule of 5% of a trailing three year average is broadlyin line with policies of major U.S. endowments.

Total musicians expense is projected to grow annually by 1% in FY2014 throughFY2016 from the lower base assumed in the Strategic Business Plan.

6 As noted above, the endowment is projected to increase by $20 million through new paid-in contributionsover the three-year period. Gifts to the Orchestras endowment raised over the past two years are investedseparately from its primary endowment fund and are ring fenced, or restricted, so that they are notavailable to fund operating deficits.

7 The financial analysis did not include a review of the Orchestras current investment philosophy andpolicies, asset allocation or risk parameters.


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Total management/administration expenses are projected to grow by 1% inFY2014 and management/administration by one FTE position in FY2015 andFY2016, respectively. This assumption provides for extremely modest growthabove inflation over the next three years and will continue to place pressure onstaff to be highly productive.

With balanced operating budgets, full transparency in its financial planning andreporting, active, focused fundraising efforts, and a re-negotiated contract with themusicians union, the Orchestra should be able to achieve annual contributedrevenue at its pre-recession totals of $8.0 million and with skill and luck, upwardsof $9.0 million, the level projected in the Strategic Business Plan.

Caveats Aboutthe OrchestrasProjected Budgets

Several caveats about the projected budgets in the Strategic Business Plan:

The Orchestra is currently in the process of preparing its FY2014 operatingbudget.

The Orchestra asserts that the projected FY2015 and FY2016 budgets,prepared in accordance with the business plan, will hold true even given thecancellation of the performance season this fiscal year.

The Orchestra further asserts that the overall impact of not being able tonegotiate the terms of a new collective bargaining agreement with themusicians union and cancelling the 2012-2013 concert season is a deficit of$500K to $1.5M as a result of moving Symphony Ball from FY2013 to thebeginning of FY2014 and the potential loss of a portion or all of the

Minnesota State Arts Board funding.

Data are not available for verification of the assertions above in this financialanalysis.

The Orchestra faces several long-term financial obligations that are only partiallyaddressed in the strategic business plan, as follows:

The Orchestras frozen defined benefit plans for musicians and staff arepresently underfunded by some 25% to 30%. The Orchestra plans to makecatch-up payments annually, with the goal of fully funding the plans by

FY2017, at which point it intends to explore immunizing or annuitizing them.These catch-up payments are included in the strategicbusiness plan but arefunded through withdrawals from the endowment above the 5% spending rate.As a result, the total annual spending rate from the endowment is estimated at7.5% through FY2017. That the Orchestras total estimated annualendowment spending rate is higher than the projected 5%if only for the nextthree fiscal years suggests that it is continuing to engage in a budgetingpractice that partially led it to its current financial state.


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The Orchestra participates in an American Federation of Musicians multi-employer musician defined benefit plan that is severely underfunded. Thepension plan and the amount of the Orchestras contributions are contractualmatters that must be negotiated with the union. The Orchestra presently

estimates that the current withdrawal liability to exit from the plan would beapproximately $25 million. The Orchestra is monitoring the status of the planand the options available for dealing with the liability.

The Orchestra presently has $9.3 million of taxable bonds due in April 2015and $1.7 million of tax exempt bonds due in April 2019. It is presentlyexploring alternatives to reduce its indebtedness in ways that would strengthenits overall financial situation. In the absence of an attractive alternative, theOrchestra plans to pay off the $9.3 million debt by a withdrawal from itsendowment in April 2015, a move that would further reduce availablespending from the endowment. Debt service on these two obligations is

included in the Strategic Business Plan as is payment of the $9.3 million debtfrom the endowment.8

There is no contingency in the operating budget and thus no cushion to protectagainst such possible unforeseen problems as, for instance, lower than estimatedattendance and/or fundraising results or higher than expected health benefits,energy and/or insurance expenses. To the degree that such outcomes arise, theOrchestra may need to borrow against its endowment and reserve funds, therebyhindering its effort to achieve financial sustainability.

Likewise, there is no provision for contract terms with the musicians union thatresult in annual operating savings less than that projected in the Strategic BusinessPlan. If final financial terms reached through collective bargaining with the unionwere to result in total musicians expense higher than that projected in theStrategic Business Plan, the Orchestra would need to determine how best to meetsuch a difference on a sustainable basis going forward without damaging itsefforts to balance its operating budget and achieve longer-term financialsustainability.

There is no reason to believe that additional marketing efforts will reverse seculardownward trends in ticket sales and earned income over the next several years.During the stalemate between the Orchestra and the union and, most importantly,

upon contract settlement, thoughtful, imaginative outreach and communicationson a continuing basis are necessary to prevent further erosion in ticket sales andphilanthropic support.

Because of rapidly growing annual operating deficits in recent years, balancing thebudget on a break-even basis and seeking short- and longer-term financial equilibrium

8 The net impact of paying off these bonds on the operating budget is essentially neutral since the reductionin spending from the endowment is offset by the decrease in interest payments on the bonds going forward.


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is a daunting task under the best of circumstances. To do so in a single year, aspredicated in the Strategic Business Plan, is certainly aggressive, rather like goingcompletely cold turkey after years of growing budgetary challenges and wideningdeficits.

Observations About the Orchestras Financial PlanningSeveral comments about the Orchestras financial planning:

Fundraising Going ForwardThe Orchestra faces a number of challenges with respect to increasing contributedrevenue over the course of the next several years and beyond:

There may well be limitations to the Orchestras current donor and prospectivedonor pool. A younger generation of philanthropically inclined individuals is lesslikely to support the Orchestra than the current generation because their interestslie elsewhere. Current corporate and foundation support may also be lessinterested or inclined to support the Orchestra, for a variety of reasons.

Donor fatigue and distress over the cancellation of the 2012-13 season and theevident inability of the Orchestra and the union to amicably and promptly reachagreement on new financial terms may cause some donors to hold back on theirsupport. Other donors may be concerned that the Orchestra was not a thoughtfulsteward of its endowment funds. Considerable effort will be required to movedonor relations forward to rejuvenate and revitalize the Orchestras donor base.

Once the Orchestra and the union have reached agreement on a new contract, itwill be important for both sides to mount collaborative efforts to embrace theOrchestras ticketholders and longstanding supporters, as well as to identify and

cultivate a new generation of supporters who will be excited about the artisticquality and energy of the Orchestra and understand its importance locally,nationally and internationally.

The Renovation of Orchestra HallIt has been noted by some observers that the Orchestra proceeded with the renovation ofOrchestra Hall during this period of increasing budget deficits and, subsequently, thecancelled 2012-2013 season, raising some $49 million to date from the Board, otherindividuals, corporations and the State of Minnesota, as part of a $110 million multi-year,multi-objective campaign.9 Some have questioned both the wisdom of proceeding withthe renovation and why those funds could not have been used instead to balance the

operating budget.

Several observations:

9 As of April 30, 2013, the Orchestra had raised approximately $98 million of the $110 million Campaignfinancial goal and about $49 million of the total $52 million cost of the renovation of Orchestra Hallincluded in the Campaign.


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Although this financial analysis did not look extensively into the decision toundertake the renovation, the Orchestra indicated that the condition of the Hallwas a significant limitation: the lobby space was cramped; there was insufficientspace for food and beverage service and hospitality service (an increasinglyimportant amenity at cultural and performing arts performances and a significant

source of incremental revenue); and the Hall was generally off-putting to manypatrons and concert-goers.

The Board spent considerable time discussing, analyzing and ultimately decidingupon the renovation, scaling back rather considerably earlier approaches thatwould have been far more extensive.10 The decision to proceed was notundertaken casually, and the Board ultimately decided that the renovation wouldbe an essential step in increasing the attractiveness and hence interest in theOrchestra and in helping to generate incremental revenues.

That said, it is yet too early to tell whether the renovation will ultimately result inpositive outcomes for the Orchestra.

A significant portion of the funds raised to renovate the Hall came from donorsthat Orchestra indicates were interested only or primarily in the renovation projectand would not have otherwise given for operations or to the endowment.

In any case, some $48.5 million of the total raised to date in the campaign is foroperations, endowment and tours.

The Thorny Problem of ProductivityLike other nonprofit organizations, orchestras have only limited opportunities to realize

steady increases in productivity. Labor required to perform the standard orchestrarepertoire is essentially frozen, while the compensation of musicians typically increasesat least at the rate of inflation and more or less in step with that of other highly trainedprofessionals.

Universities face many of the same financial pressures as symphony orchestras in thatthey too have no built-in ability to achieve annual productivity gains as do many privatesector organizations. Unlike symphony orchestras, however, universities have far moretools by which to meet this central financial challenge: they have greater diversity offunding streams (tuition revenues, research funding, auxiliary enterprises, licensing ofintellectual property, among others); it is easier for them to adjust the size and focus of

their programs and initiatives; they have a built-in prospect pool of alumni from whom totry to raise funding (a pool which continually grows); and their programs have greatermarket appeal to applicants and their families (at least at some institutions and in somedisciplines). Furthermore, technology may enable universities and colleges to reduce

10 The Orchestra had contemplated renovation of Orchestra Hall for more than 10 years. Initial plans werefor a $175 million renovation; the scope was reduced to $95 million in FY2007 and ultimately resized to$52 million.


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costs over time through various delivery mechanisms, including distance learning, amongother approaches. In addition, major universities have the advantage of massive scale,financial aid support and research funding from the federal government and perceivedvalue as economic engines of innovation and discovery.11

By contrast, symphony orchestras have only a few levers by which to balance theirbudgets: earned revenue through ticket sales to concerts, philanthropic support and, to afar less degree, recording income. In addition, most orchestras are local in character andimpact, even those that tour extensively in the United States and abroad, so that the poolfor contributed revenue is almost exclusively local and regional in character. That said,those orchestras that have alternate permanent sites (such as Tanglewood for the BostonSymphony, Blossom Festival and Florida for the Cleveland Orchestra and HollywoodBowl for the Los Angeles Philharmonic) have a strategic advantage in that they are ableto increase their audience, offer different programs and provide their musicians withadditional concert performances.

The terrible problem facing all orchestras (and most non-profit arts and culturalorganizations for that matter) is that even though their operating budgets may be balancedin any one year or period of years, their inability to increase productivity over time meansonly a temporary respite: their personnel costs will inevitably rise faster than theiroperating revenue, all things being equal. Thus while the Orchestra has projectedbalanced operating budgets for the next several years, this state is only temporary. TheOrchestra will continue to be confronted with serious and persistent budget pressuresgoing forward.

CONCLUSION

The Orchestra has prepared a thoughtful and analytically reasonable Strategic BusinessPlan that seeks to promptly balance its operating budget and achieve financialequilibrium and thus reverse a recent pattern of growing and unsustainable annualoperating deficits funded through ever larger exceptional draws from its endowment.

The Orchestras growing financial challenges of the past half decade arose principallyfrom its having negotiated a new five-year contract with its musicians that increased theirsalaries by more than 26% (later reduced to a 19% increase through concessions inFY2010) just before the Great Recession. The impact of the Great Recession was asizable decrease in the market value of the Orchestras endowment and a steep decline inits contributed revenue. The combination of these factors damaged the Orchestras

11Even so, universities and colleges are struggling mightily to generate incremental income to offset theirinability to realize significant, continuing productivity gains. Thus, tuition rates have risen substantiallyfaster than the rate of general inflation over the past decade; an increasing number of lower-cost contractpart-time adjunct faculty are teaching courses that previously were taught by higher-cost full-time tenuredor tenure-track faculty; fundraising campaigns are more frequent with (seemingly) ever higher financialgoals; and intercollegiate athletics are financially important for at least some institutions.


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fragile finances that had been annually bolstered through repeated special fundraisingefforts and special draws from its endowment.

In the years immediately after the Great Recession, the Orchestra sought to balance itsoperating expenses with its operating revenue through adjustments in programming and

sizable reductions in administrative and management expense. It also negotiated certainconcessions in the new musicians contract. But these steps were not sufficient to solveits financial problems in view of endemic pressures on all symphony orchestras and aweak economic recovery.

The one expense area not substantially touched over the last several years has been totalmusicians expense, which was growing under the terms of the contract while otheroperating expenses declined. Having exhausted other courses of action, the OrchestrasStrategic Business Plan calls for a substantial decrease in musicians expense to balanceits budget. While this decrease may appear to be draconian in size and timing, theOrchestra has no other recourse but to bring that cost element in line and construct a

smaller operating budget that can be supported by a realistic view of fundraising andearned revenue.

Indeed, the Orchestras financial circumstances are presently such that even the sizableprojected reduction in musicians compensation in the Strategic Business Plan does notallow the Orchestra to achieve true financial equilibrium: it is still projected to useexceptional draws though smaller than recent ones to fund certain pension expensesover the next several fiscal years and possibly to retire taxable bonds in FY2013. Inaddition, the Orchestra has no contingency in its strategic business plan to meetunexpected adverse financial circumstances or to fund reductions in musicians expensesmaller than those projected in the Strategic Business Plan.

Only gifted artistic and executive leadership, skilled and transparent financialmanagement, shared understanding and collegial responsibility by the Orchestra and themusicians and the ongoing support of a generous community will allow this superbsymphony orchestra to have the solid financial base that it requires to ensure continuedartistic excellence that is widely and appropriately recognized and appreciated.


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Attachment I

Scope of the Financial Analysis

The objective of the independent financial analysis is to review, analyze and test the

underlying assumptions and conclusions of the Orchestras financial and business plansfor their reasonableness, cogency and appropriateness and in so doing, provide anindependent analysis of them.

The following steps were undertaken in the review:

Review and analysis of extensive Orchestra print and electronic materials,including the Orchestras audited financial statements for at least the past threefiscal years; its financial and business plan(s) and supporting assumptions andanalyses; and pertinent programmatic, strategic, development/fundraising andcontextual information.12

Confidential individual interviews with several informed individuals who couldcomment knowledgeably about the Orchestras financial planning and providepertinent contextual and background information.

Preparation of this report.Two sets of documents were central to the financial analysis, as follows:

Audited Financial StatementsThe Orchestras audited financial statements, prepared by LarsonAllen LLP of

Minneapolis for FY2007, FY2008, FY2009, FY2010, FY2011 and FY2012, areunqualified. LarsonAllen did not identify any control or related issues during the audits.The Orchestras Board Audit Committee reviewed and approved each of the auditedfinancial statements on a timely basis in a meeting principally devoted to doing so; theCommittee also held an executive session with LarsonAllen at each of these meetings.Upon recommendation of the Audit Committee, the full Board also reviewed andapproved each of the audited financial statements on a timely basis.13

Strategic Business PlanThe Orchestras financial plan is laid out in Vision for a Sound Future: StrategicBusiness Plan Summary, Fiscal Years 2012-2015 (dated November 2, 2011). The

Strategic Business Plan was unanimously adopted by the Board of the Orchestra onNovember 2, 2011.

12 The independent financial analysis was to have also included whatever print or electronic analyses andreviews of the Orchestras financial situation and forward planning that the union has prepared, but nonewas forthcoming upon request.

13 AKA conducted a confidential telephone interview with Larry Adams, CPA, the LarsonAllen partner incharge of the Orchestras audit, to discuss the audits and the audit process.


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The Strategic Business Plan gives an overview of the Orchestras current financialsituation; lays out a vision for its future; lists key targets for FY2012 throughFY2015; and presents a summary balance sheet.

A companion document, Business Plan Operating Budget Methodology, lays outthe derivation of projected breakeven operating budgets for FY2013 (a transitionyear) and FY2014 through FY2016, including key assumptions for each of themajor revenue and expense areas, in considerable detail. An overview of themethodology in this document:

The approved FY2012 operating budget was converted into an all-in FY2012operating budget that removes such special events and activities as touringand bridge campaign contributions but adds endowment fundraising coststhat had been previously funded directly from the endowment;

The all-in FY2012 operating budget was adjusted to a breakeven FY2012operating budget by adding $3.2 million of net additional revenues andachieving $5.3 million of net expense savings, the result of which would be abalanced operating budget;

The breakeven FY2012 operating budget was moved forward to FY2013, atransition year with Orchestra Hall closed for renovations and the Orchestraplaying a more limited concert schedule (when this budget was prepared, itwas not expected that the Orchestra would not be playing in FY2013 becauseof the contract dispute with the musicians union); and

Projected FY2014, FY2015 and FY2016 operating budges were developed onthe basis of the FY2013 transitional budget with specific assumptions aboutinflation and other changes.

The Strategic Business Plan was developed through nearly a two-year long Boardplanning process overseen and coordinated by a Board Finance Sub-Committee that wastasked by the Board with analyzing the financial situation of the Orchestra anddeveloping a plan to put the Orchestra on a firm financial basis in both the short- andlonger-term.

The Sub-Committee met regularly in 2010 and considered at each of its meetingdetailed analyses of a specific financial and business issue earned revenue(February 5, 2010), contributed revenue (March 26, 2010), endowment revenue(May 3, 2010) and operating expenses and debt (June 22, 2010). Following this,the Sub-Committee analyzed aspects of a new business model for the Orchestra an overview of the new business model (October 11, 2010), administrative costsin the new business model (November 10, 2010) and operating costs modeling(December 13, 2010).


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These reports extensively analyze the Orchestras current financial situation andthe factors leading to it; provide selective comparative information from otherleading orchestras; delineate a number of key objectives for putting the Orchestraon a sustainable financial foundation and model several alternatives for doing so;and lay out a new business model designed to achieve true breakeven operating

results on a going forward basis.

The Strategic Business Plan Summary was developed in 2011 and incorporatesthe more detailed work of the Sub-Committee reports while providing top levelbackground information on local and national arts trends, proposing a vision for asound future for the Orchestra and suggesting strategies to achieve the vision.

A variety of other documents and materials were reviewed in the course of the analysis.


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Attachment II

Background Information About AKA|Strategy

Established in 1990 as Anthony Knerr & Associates, AKA|Strategy (AKA) assists

leading nonprofit institutions in the United States and Europe successfully solve complexstrategic, financial and business issues.

AKA has assisted numerous nonprofit organizations with financial analysis andplanning, often with complex balance sheets, operating statements, assetstructures and relationships with financial institutions.

AKA has assisted a number of leading performing arts organizations, includingthe Budapest Festival Orchestra, Carnegie Hall, Kennedy Center, MariinskyTheatre (Kirov Opera and Ballet), New York Collegium and the SalzburgFestival, with a variety of complex strategic issues.

Anthony Knerr, the principal author of this financial analysis, is Managing Director ofAKA. He was previously Executive Vice President for Finance and Treasurer ofColumbia University and the chief architect of the University balancing its budget after13 years of operating deficits. He earlier was Vice Chancellor for Budget and Planning atthe City University of New York and responsible for guiding the university systemthrough the New York City fiscal crisis. In both positions, he oversaw all aspects ofbudgeting, accounting, financial analysis, audit and all related financial planning andoperations. He also prepared Yale Universitys first long-range financial plan, which setthe course for the University achieving (and maintaining) financial equilibrium. The planwas prepared during a period of serious labor unrest at the University.

The firms Web site www.akastrategy.com provides background information,including a description of client assignments and several case studies of client projects,and Anthony Knerrs bio.

minnesota orchestra financial review, june 10 2013

Documents