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FCE issues 10-K Amendment: ticket sales way down; Forest City Ratner earns 5% development fee on arena; sponsors get suites

After 5 pm yesterday, and well past most journalistic deadlines, Forest City Enterprises filed an amendment to its Annual Report on Form 10-K--initially filed 3/30/09--for the fiscal year ended 1/31/09, concerning its subsidiary Nets Sports and Entertainment (NSE), and it has some very interesting information.

The consolidated financial statements, for the years ending June 30, 2009, 2008, and 2007, presumably had to be prepared for the sale of the majority interest of the team to Mikhail Prokhorov, but it's unclear to me why such information was not required to be made public any sooner.

Among the details in the report:
  • the Nets earned $26 million in ticket sales last year, a huge drop--30% and 35%, respectively--from the unaudited figures of $37.4 million in 2008 and $40 million in 2007
  • an affiliate of Forest City Enterprises/Ratner is earning a development fee not to exceed 5% of total project costs, and has already been paid $28 million
  • certain arena sponsors have been given use of luxury suites as part of their license agreements, apparently as a sweetener
  • if the Master Closing on the transaction--the sale of bonds, acquisition of certain property, and start of condemnation--does not occur by November 30, a $5 million initial loan payment is due then
  • the company does not consider litigation a cause for concern
  • costs of gone steadily up for arena land and related costs
  • only at the very end is the deal with Prokhorov mentioned, as a "Subsequent Event"
[Update: the not-so-cordial fellow behind NetsDaily reminds me that the drop in ticket sales was reported in July by CBSSports.com as down $11.4 million, as well as on NetsDaily, though I'll point out that the actual numbers, as well as the two-year figures, had not been reported in full. He also points out that the development fee isn't new; indeed, the New York Times reported in July 2007 on the 5% fee; what's new is the size of the fee so far, which is a significant chunk of the ultimate $40 million, assuming an $800 million arena.]

Below, I've reproduced some of the major graphs from the report, with some contrasting numbers highlighted. Click to enlarge. Below the graphics are some verbatim passages from the report.

Consolidated Balance Sheets


Consolidated Statement of Operations


Consolidated Statements of Members' Equity (Deficit)


Consolidated Statements of Cash Flows


Arena Land and Related Costs

The Company is in the process of developing the Arena. The Company’s capitalization policy on development properties is guided by SFAS No. 34, “Capitalization of Interest Cost,” and SFAS No. 67, “Accounting for Costs and the Initial Rental Operations of Real Estate Properties.” Costs incurred in the land acquisition and planning process, including interest on land loans, amortization of deferred loan costs related to the land loans and real estate taxes have been capitalized. The Arena is located within a master plan of a larger land re-development project (“Atlantic Yards Project”) being proposed by an affiliated entity (“Atlantic Yards Development Company”) and unaffiliated governmental authorities. Accordingly, there are certain costs, including land costs and related loans and master planning costs, that are common to and benefit both developments. These shared costs, land costs and related loans are allocated based on the ratio of the square footage of the Arena relative to the square footage of the Atlantic Yards Project.

Debt: Land Loans

Brooklyn Arena, along with an affiliated entity developing the Atlantic Yards Project, has financing loan agreements (the “First Secured Loan”) for land being acquired in connection with the development of the Arena. As of June 30, 2008, the First Secured Loan payable balance was $140,060,488. On July 3, 2007, Brooklyn Arena, along with an affiliated entity, obtained an additional loan from the first loan lender (the “Second Secured Loan”) of $36,831,106, which was outstanding as of June 30, 2009 and 2008. On February 11, 2009, the date both the First and Second Secured loans (the “Loans”) were set to expire, the Loans were amended to extend the due date to February 11, 2011. In addition, the First Secured Loan required a pay down of $15 million, reducing the aggregate amount outstanding on the Loans to $161,891,594 as of June 30, 2009. As of June 30, 2009 and 2008, Brooklyn Arena’s portion of the Loans was $18.6 million and $20.3 million, respectively. Brooklyn Arena’s share of interest, which is capitalized, was $1,024,872 and $1,042,935 for the years ended June 30, 2009 and 2008, respectively.

Master Closing

The terms of the amendment call for certain events to take place in the event of the Master Closing. Master Closing generally occurs upon the closing of the sale of bonds to finance the construction of the Arena, the closing on the acquisition of certain property and the start of condemnation by the Empire State Development Corporation (the “State”) of the project site. The loan terms call for a pay down at the time of Master Closing of an amount equal to the greater of the amount needed to bring the outstanding total loan balance down to $120 million or 50% of the appraised value of the underlying land. In addition, at the time of Master Closing, a fee of 0.90% of the post Master Closing loan balance is due. If Master Closing has not occurred by November 30, 2009, the loan calls for a pay down of $5 million.

Arena Development Agreement

Brooklyn Arena entered into a Development Agreement with an affiliate of a member (the “Developer”), pursuant to which it hired the Developer to plan, develop and oversee construction of the Arena for a fee not to exceed 5% of the total project cost at completion. Through June 30, 2009 and 2008, approximately $28 million and $21 million, respectively, of development fees were incurred.

Arena Land and Related Costs

The Company has borrowed from affiliates for Arena-related costs not financed through land loans. At June 30, 2009 and 2008, approximately $83.4 million and $85.3 million of loans from affiliates were outstanding, respectively and are included in Due to affiliates in the accompanying Consolidated Balance Sheets. The loans accrue interest at the affiliates’ weighted average cost of capital, as defined, which averaged approximately 8% for the years ended June 30, 2009 and 2008. For the years ended June 30, 2009 and 2008, interest expense totaled $6.2 million and $6.8 million, respectively, and was all capitalized.

Member Loans

NS&E obtained member loans on various dates from January 2007 to June 2009 totaling $34,600,000 and in July and August 2009 obtained additional member loans totaling $24,200,000 to fund the operations of the team for the 2009-2010 season ending June 30, 2010, with the balance, if any, to be funded by the various means available to the Company. The loans mature at various dates from December 2011 to August 2013 and bear interest at various rates ranging from 5.5% to 20%. Member loans including accrued interest totaled $37,145,448 and $10,884,906 for the years ended June 30, 2009 and 2008. Interest expense incurred on loans totaled approximately $2,000,000, $749,000 and $136,000 for the years ended June 30, 2009, 2008 and 2007, respectively.

Arena Land and Development Agreements

Brooklyn Arena and an affiliate have entered into a Funding Agreement with the State pursuant to which the New York City Economic Development Corporation (the “City”) will contribute, through the State, $100 million to acquire land for the Arena (the “City Funding Agreement”). The State will also contribute $100 million for infrastructure costs, which are recorded in an affiliate’s books. Brooklyn Arena is allocated its share of the net infrastructure costs based on the methodology discussed in Note 1 “Arena Land and Related Costs.”

In connection with the City Funding Agreement, Brooklyn Arena and the affiliate have entered into a Purchase and Sale Agreement (the “Agreement”) with the State pursuant to which the State will purchase or condemn properties owned by them for $100 million. The cost related to these properties is included in the accompanying Consolidated Balance Sheets as Arena land and related costs. Upon the State’s condemnation of project land at the Master Closing, the properties will be leased back to Brooklyn Arena or its affiliates. In the event that the project is abandoned, terminated or permanently enjoined, Brooklyn Arena or its affiliates are obligated to reimburse all amounts funded under the Funding Agreements plus interest to the State and liquidated damages as defined in the City Funding Agreement. The properties under the Agreement would be re-conveyed back to Brooklyn Arena or the affiliate. As of June 30, 2009 the City funded, through the State, $85 million for Arena land, and as of June 30, 2008, the City had funded $40 million, toward the purchase of the land, which is presented as Land sale – deposit payable in the accompanying Consolidated Balance Sheets.

The Metropolitan Transit Authority was not party to the above agreements but is an owner of part of the site on which the Arena would be built. On September 14, 2005, the affiliate entered into a term sheet with the Metropolitan Transit Authority to acquire its land for $100 million. On June 22, 2009, the term sheet was amended as follows: following the closing of the sale of bonds to finance the construction of the Arena, and the State’s acquisition of title through condemnation for the project site, expected in the fourth quarter 2009, the affiliate will pay $20 million for the land upon which the Arena would be built. In addition, the affiliate will pay for the air rights of non-arena parcels an amount equal to the net present value of $80 million as of January 1, 2010, discounted at 6.5% per year payable as follows: four annual installments of $2 million commencing on June 1, 2012 through 2015 and fifteen annual installments of approximately $11 million commencing on June 1, 2016 through 2030. These affiliated costs will be part of the Arena development and will be allocated to the Arena based on the methodology as discussed in Note 1 “Arena Land and Related Costs.”


Litigation

The Company is also involved in certain claims and litigation related to its operations and development. Based on the facts known at this time, management has consulted with legal counsel and is of the opinion that the ultimate outcome of all such claims and litigation will not have a material adverse effect on the financial condition, results of operations or cash flows of the Company.

Naming Rights

On January 17, 2007, Brooklyn Arena and Basketball (collectively, the “Brooklyn Parties”) entered into a Naming Rights Agreement (the “NR Agreement”) with Barclays Services Corporation (“Barclays”), where, in exchange for certain fees and other considerations, the Arena will be named Barclays Center, and Barclays will be entitled to certain additional sponsorship, branding, promotional, media, hospitality, and other rights and entitlements in association with the Arena, Basketball and the Atlantic Yards Project. The NR Agreement expires on June 30 following the twentieth anniversary of the opening date of the Arena, subject to certain extension rights as defined in the NR Agreement. The NR Agreement also contains certain Arena construction commencement and Arena opening deadlines, as defined in the NR Agreement. If Brooklyn Arena fails to achieve these deadlines, Barclays is entitled to termination and other rights, as defined in the NR Agreement.

Suite License Agreements

As of June 30, 2009, Brooklyn Arena entered into suite license agreements with various companies and, in addition, granted a suite license as an entitlement to certain sponsors of the Arena within sponsorship agreements entered into by the Brooklyn Parties with such sponsors. Each suite license entitles the licensee the use of a luxury suite in the Arena, with most such luxury suites containing seats for viewing most events at the Arena (although one such suite license agreement applies only to Nets games at the Arena). The suite license agreements commence on the first date when the Arena is open to the general public and expire at various terms ranging from one to 20 years (i.e., for a suite license granted within the confines of a sponsorship agreement, the term of the suite license agreement will be coterminous with the term of the sponsorship agreement). As of June 30, 2009, NS&E has received advance deposits on suite license agreements of $375,600, which is included in Deferred revenue, long term in the accompanying Consolidated Balance Sheets.

Also, the suite license agreements call for the payment of the first license year fee to be made in advance of the opening of the Arena. Suite contracts currently have no impact on Basketball’s revenues, as deposits received for suites are accounted for as deferred revenue. These deposits are refundable, contingent upon the construction of the Arena.


Sponsorship and Product Availability Agreements

As of June 30, 2009, the Brooklyn Parties entered into sponsorship and product availability agreements (“Agreements”) with various entities, primarily with respect to the Arena and Basketball (after its planned relocation to the Arena). These Agreements entitle such sponsors to certain sponsorship, promotional, media, hospitality and other rights and entitlements in association with the Arena and Basketball, and expire at various terms ranging from three to ten years from the Opening Date of the Arena, as defined in each such Agreement. These Agreements may be terminated, without penalty, based on a failure to construct and open the Arena.
In addition, Basketball has entered into several sponsorship agreements relating to the Nets and its play of NBA games at the IZOD Center. These agreements have terms ranging from one year to a term that is coterminous with the Nets’ final season of play at the IZOD Center.


Subsequent Event

On September 23, 2009, NS&E and an affiliate signed a letter of intent with an affiliate of an international private investment fund (“Newco”) to create a strategic partnership for the development of the Atlantic Yards Project, a 22-acre residential and commercial real estate project in Brooklyn, and the Barclays Center, the future home for the Nets.

In accordance with the agreement, Newco will invest $200,000,000 and make certain other contingent funding commitments to acquire through the issuance of newly-issued units a 45% interest in Brooklyn Arena and 80% interest in Brooklyn Basketball, and the right to purchase up to 20% of the Atlantic Yards Development Company, which will develop the non-arena real estate. Following the completion of the transaction, NS&E would own a 55% interest in Brooklyn Arena and 20% interest in Brooklyn Basketball.

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