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New FY 2020 fiscal report shows Barclays Center operating income $16.5M behind estimates. But FY 2019 was worse. In both years, a reserve account funded bond payments.

Battered by the coronavirus pandemic, the Barclays Center operating company is struggling financially, with net operating revenues in FY 2020 (ending June 30) some $16.5 million behind estimates, insufficient to cover required bond payments, much less deliver profits.

The relatively good news, perhaps, for Brooklyn Events Center, is that this fiscal year, in which the arena was shuttered for three-and-a-half months, was not as fiscally painful as FY 2019, and pre-pandemic operations showed improvement.

In that year, the arena was burdened by an onerous lease with the New York Islanders and contractual provisions that steered more revenue to the Brooklyn Nets--but also which generated a separate reserve account to ensure those bond payments would be made.

In FY 2020, according to recently released documents, net operating income (NOI)--subtracting operating expenses from revenues--was $12.5 million, well below the required $22.7 million to pay off arena construction, described as "Interest expense-financing lease obligation" in the chart below. That's largely due to an unprofitable second half of the fiscal year.
Note further explanation below

However, the arena company was able to barely cover bond payments, thanks to "other income" left over from the Mikhail Prokhorov era, which ended last September upon the sale of the Brooklyn Nets and arena company to Joe Tsai. See below for more explanation.

Such an inability to cover debt service with revenue fell far short of projections, and surely won’t bolster the arena bonds, which were downgraded to junk (not investment grade) by Moody's in October 2019 and by Standard & Poor’s in June 2019.

That said, the arena company won't go bust. Billionaire Tsai, according to a February 2020 investor presentation, has signed an Operating Support Agreement with the NBA, that “guarantees Team and Arena obligations,” presumably re-assuring bond investors.

What about this fiscal year?

The FY 2021 forecast, for the year ending June 30, 2021, looks murky. Given that the Barclays Center still hasn’t reopened, and faces full or partial constraints on audiences for the foreseeable future, it’s unclear how much revenue might be available to pay off $23-$25.5 million in bonds. 

Based on 2016 estimates, it would be $25.5 million--see below--but this past year's interest expense of $22.7 million lagged behind the $24.8 million estimated, so there's apparently an adjustment factor.

From 2016 Official Statement (bond prospectus)

As stated in the FY 2020 financial report, "The duration of ongoing regulatory bans on mass gatherings is uncertain and difficult to predict, as is consumer demand for attending live events once regulatory bans on mass gatherings are lifted."

That leaves question marks regarding the Brooklyn Nets and New York Liberty, along with concerts and other events. Tsai, as noted by NetsDaily, thinks next season could be “a little bit tricky” but expects "a very nice rebound" after that.

A note on the analysis

Keep in mind that the fiscal reports present the arena awash in red ink, as depreciation (how much of a tangible asset's value has been used up) and amortization (similar to depreciation, but for intangible assets) are calculated, thus ensuring accounting losses and, presumably tax benefits.

I’m focusing on cash flow, since that’s how arena financials were originally presented. So I look at total revenues and total operating expenses, which delivers net operating income, or NOI. Then I see if there's enough NOI to cover the interest expense on the construction bonds. In neither year was there enough--though the arena company had cash assigned to pay off those bonds.

Note that, while the annual financial reports do delineate required Payments in Lieu of Taxes (PILOTs), which consist of bond payments as well as funds that go back to the arena, PILOTs are not detailed on the charts delineating revenue and expenses.

Also note a difference between the Tsai and Prokhorov eras. According to the FY 2020 report, "the financial information for such periods is presented under two different historical-cost bases of accounting. The financial statements for the Predecessor Period and Successor Period are not comparable." So direct comparisons with previous fiscal years, as shown below, should be taken with a grain of salt.

FY 2019 results

According to my calculations, Brooklyn Events Center’s net operating income in FY 2019—revenues adjusted by operating expenses—was a loss of more than $1.5 million, given total revenue of $142.1 million and operating expenses of $143.6 million. 

That, of course, couldn't cover the obligation to pay $23.73 million of interest on arena bonds. (The 2016 forecast had estimated the interest at $24.1 million.) So the loss seemingly extends the red ink to $25.2 million.

Note that fiscal struggle was expected, not just related to the Islanders deal, but also because, upon the first phase of Prokhorov's sale of the Nets to Tsai, the NBA required that certain revenues from Nets games, worth initially $15 million a year, be reallocated from the arena to the team.
Arena operators did have other cash available to pay that $23.73 million in arena debt and to make up for that $1.5 million loss. 

There was $12.8 million in interest income, cash flow coming from the $345 million Prokhorov was required by the NBA to put toward the arena after the first phase of the Nets sale, to counterbalance that loss of Nets revenue. 

In fact, according to a May 2018 investor presentation, excerpted above, the annual supplemental reserve for FY 2019 should've been $39 million, sufficient to pay the $37.2 million in required Payments in Lieu of Taxes (PILOTs). Those PILOTs are divided into interest paid to bondholders and an O&M (operations & management) reimbursement, funds that go back to the arena company to pay for arena upkeep.

FY 2020 results

In FY 2020, following the sale of the Brooklyn Nets and arena operating company by Mikhail Prokhorov to Joe Tsai, arena managers were more optimistic.

According to a 2/12/20 presentation to investors, excerpted below, net operating income was expected to improve enormously, with a $15.7 million gain thanks to a revision in the deal structure with the Nets, and a $12.2 million boost thanks to the Islanders, who’d be renting the arena, rather than having the arena guarantee payment in exchange for keeping revenue.

That would help drive $29 million in net operating income, which—combined with $8.349 million from the reserve account established by Prokhorov—would deliver $37.342 million, easily enough to cover required bond payments. 

Arena operators predicted a Debt Service Coverage Ratio (DSCR) of 1.5x, meaning 50% more revenue than needed to pay off the bonds.

As of the February presentation, they were reasonably on track, with $14.237 million in NOI. “Profits from events have reached all-time highs in FY 2020,” they said, noting that “Private events (e.g. Samsung Product Launch) have become significant source of revenue.”

Moreover, “Suites have started to grow again in FY 2020 and will be driven by team performance, which we anticipate to grow in the coming years,” the document said, indicating the expected improvement once superstar Kevin Durant joined Kyrie Irving as a starter.

That, of course, was derailed by the pandemic. After that profitable first half of the fiscal year, in the second half, the arena company's operating expenses exceeded revenues by $2.1 million, according to financial documents released in August.

The new FY 2020 fiscal report breaks it down differently, divided into Prokhorov’s Predecessor Period (July 1-Sept. 17, 2019) and Tsai’s Successor Period (Sept. 18, 2019-June 30, 2020).

As noted in the chart below, operating revenues in each period exceeded expenses. Combined over those two periods, revenues reached $85.1 million, with operating expenses of $72.6 million, leaving $12.5 million in net operating income, nearly $16.5 million below the forecast.

So that $12.5 million was not enough to cover the $22.7 million in required debt, leaving a $10.2 million shortfall.
That said, the document suggests that, from another angle, the arena company did barely reach the black, at least regarding cash flow (and disregarding depreciation and amortization). 

“The liquidation of [Prokhorov's] reserve account resulted in a realized gain of $8,470,154 in the Predecessor Period," the report states. That sum could be considered income and, presumably, be used to pay off debt. Separately, there was about $2.18 million in interest income.

All told, that additional $10.6 million should've been enough to cover that $10.2 million in debt. Note that the $19.9 million originally scheduled to be delivered to the arena company from the reserve fund was truncated. 

Why? Upon the completion of the sale from Prokhorov to Tsai, and the latter's takeover of the arena company, the reserve fund was liquidated and delivered to Tsai as team owner in compensation for restoring the original deal in which the arena company kept certain Nets revenues.

Previous forecasts

The Barclays Center has lagged well behind forecasts. Consider that, according to 2016 forecasts produced when the arena bonds were refinanced, the operating company was supposed to reap $50.3 million in net revenue in FY 2019 and $51.8 million in FY 2020, easily enough to cover interest payments. The results never came close.

Supplementing the chart published higher up in the article, the interest can be calculated another way: taking the payments in lieu of taxes (PILOTs) and subtracting the O&M (operations & management) reimbursement, a segment of the PILOTs that goes back to the arena company to pay for arena upkeep.

That would've guaranteed the arena a decent cushion to pay off arena bonds, with a Debt Service Coverage Ratio pushing 2.0x.