CONFIDENTIAL

Financial Analysis of the Minnesota Orchestra

June 10, 2013

TABLE OF CONTENTS Page 3 5 6 8 15

Executive Summary Introduction The Orchestras Financial Situation The Orchestras Strategic Business Plan Conclusion

Appendices I. Scope of the Financial Analysis II. Background Information About AKA|Strategy

3 EXECUTIVE SUMMARY Orchestras nation-wide are confronted with serious, endemic financial challenges that are growing in scope and impact. The Minnesota Orchestra has had a history of growing annual operating budget deficits, totaling over $22 million in the three year period of FY2010 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 deficits is straightforward: The Orchestra negotiated a new contract with its musicians in FY2007 that significantly increased its fixed operating expenses (hard costs) in a budget that was increasingly dependent upon contributed revenue (soft funding), making it particularly vulnerable to adverse financial circumstances. The Great Recession hit the Orchestra hard: in FY2009 the market value of its endowment decreased by about 30% and its contributed revenue fell by 17% from the pre-recession annual average. The Orchestra reduced administrative and overhead expenses in the six-year of FY2008 through FY2013 by about $1.5 million in an effort to reduce the deficits. Contributions were not sufficient to close a growing gap between operating revenue and expenses. These growing deficits were increasingly funded through larger 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 over time and placed ever growing pressure on the operating budget.

Alarmed by the steady worsening of its financial circumstances, the Orchestra undertook a thorough review of its overall financial architecture over a two year period, culminating in 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 financial sustainability and puts the Orchestra on a break-even basis by balancing the operating budget; limiting spending from its endowment to 5% of market value on a trailing three year average; and adjusting estimated fundraising and ticket sales to realistically sustainable 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 Orchestras operating expenses through an unspecified set of possible changes. The overall logic of the Strategic Business Plan is sound, as are the underlying financial assumptions in it. The Orchestras independently audited financial statements for the past half decade are unqualified.

4 It is important to consider the projected sizable decrease in musicians expense in the context of the Orchestras overall financial situation. Total musicians labor expense increased some $1.5 million between FY2007 and FY2012 through contractually mandated annual increases while all other operating expenses except touring and debt service 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 its endowment only complicates its problems. Musicians expense is the one untouched area of the operating budget Even with the projected sizable reductions in total musicians operating expense, the Strategic Business Plan only partially addresses several long-term financial obligations. These include (1) underfunding of its frozen defined benefit plans for musicians and staff and of the American Federation of Musicians multi-employer musician defined benefit plan in which it participates and (2) some $9.3 million of taxable bonds due in April 2015. Meeting at least some of these obligations will result in draws from its endowment above the 5% level. In addition, there is no contingency in the projected operating budget or provision for contract terms with the musicians union that may result in annual savings less than those projected in the business plan. Like other nonprofit organizations, the Orchestras personnel costs inevitably rise faster than operating revenue, all things being equal and thus has only limited opportunities to realize steady increases in productivity While the Strategic Business Plan projects steady state budgets for the next several years, the Orchestra will continue to be confronted with serious and persistent budget pressures going forward. Only gifted artistic and executive leadership, skilled and transparent financial management, shared understanding and collegial responsibility by the Orchestra and the musicians and the ongoing support of a generous community will allow this superb symphony orchestra to have the solid financial base that it requires to ensure continued artistic excellence that is widely and appropriately recognized and appreciated.

5 INTRODUCTION One of the leading symphony orchestras in the United States, the Minnesota Orchestra has suffered from serious difficult financial challenges for at least the past decade. In particular, it incurred chronic annual operating budget deficits that were largely financed by 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 in cumulative operating budget deficits of more than $22 million in the three-year period of FY2010 through FY2012, an amount equal to two thirds of the Orchestras FY2012 operating budget of $31.5 million. Alarmed by the steady worsening of its financial circumstances and worried about the short- and longer-term consequences of such overspending, the Orchestra undertook a thorough review of its financial circumstances and its overall financial architecture over the two-year period of FY2010 and FY2011. The result of this review was the development 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 between artistic quality and financial sustainability by realigning the Orchestras operating expenses, eliminating dependence on exceptional draws from its endowment and refocusing its fundraising efforts. One outcome of the Plan was to ask the Orchestras musicians to accept a sizable reduction in compensation to help balance the operating budget upon the expiration of its contract with the musicians union on October 1, 2012. The Orchestra and the musicians union 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 new contractual terms and doing so on a timely basis are different perspectives about the Orchestras current and prospective financial circumstances and whether the changes proposed by the Orchestra are equitable, appropriate and sound. In an effort to constructively develop an objective view of the Orchestras financials and as a step toward finding a mutually acceptable basis for structuring a new agreement, the Orchestra retained AKA|Strategy to undertake a financial analysis of the Orchestra.1

There were extensive efforts to have the independent financial analysis jointly sponsored and funded by the Orchestra and the musicians union, but the two parties were not able to reach agreement on the precise terms 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 background information on key Orchestra financial and strategy documents that are the basis for the analysis. Appendix II provides background information on AKA|Strategy and its Managing Director, Anthony Knerr, the author of this report.

6 THE ORCHESTRAS FINANCIAL SITUATION An unfortunate confluence of two different sets of issues has produced the Orchestras current financial situation. Significant Secular Trends Among American Symphony Orchestras Orchestras nation-wide are confronted with serious, endemic financial challenges that are growing in scope and impact. Orchestras overall have limited opportunities to increase productivity (an issue discussed below), a situation that results in ongoing cost pressures and structural budget deficits. That so many of Americas leading symphony orchestras are facing financial stress, including sizable operating deficits and bankruptcy, is not surprising, though alarming and dispiriting. Attendance at classical music events in the United States has been steadily decreasing over the past decade, resulting in a significant and continuing decline in classical music ticket revenue. Classical music does not presently enjoy the status and popularity in the United States that it did several decades ago. There appear to be a number of causes for this shift, including many more entertainment opportunities, greater popularity of other musical forms and styles, more competition for leisure time, aging audience, often static programming and declining arts education in schools, among others. It is likely that interest, support and participation in classical music programming will continue to decline in the coming years. While some orchestras appear to have been more successful in combatting these powerful secular trends particularly those in very large metropolitan areas no major American orchestra is immune from these challenges, as evidenced by the number of the countrys largest orchestras negotiating significant contractual changes 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 period of FY2002 to FY2007: the national and local economies were robust; the Orchestra enjoyed widespread respect and support; attendance was strong; and the Orchestras artistic quality, reputation and status were growing handsomely. With the appointment of a new Music Director on September 1, 2001, the Orchestra expanded its touring nationally and internationally to considerable critical acclaim. Even though the Orchestra reported deficits it was able to balance its budget during these years through a combination of recurring special fundraising efforts to underwrite operating expenses; significant, though not unreasonable, exceptional draws from its endowment; and assumption of $11 million of debt in 2005

7 In this context of generally favorable financial and environmental circumstances, the Orchestra negotiated a new five-year contract with its musicians in FY2007 that increased their salaries by 26%. This increase added approximately $2.3 million to the annual expense base of its operating budget. Shortly thereafter the Great Recession had a dual negative impact on the Orchestra: the market value of its endowment declined by some 30%, from $106.3 million to $74.0 million in FY2009, and contributed revenue decreased by 17% from the pre-recession annual average of $8.0 million in FY2006-FY2008 to an annual average of about $6.8 million in FY2009-2010. Complicating the situation was continuing flat ticket revenue in part because of reduced interest in and attendance at classical music concerts, a problem endemic to virtually all major symphony orchestras. Recognizing the growing seriousness of its financial problems, the Orchestra acted to reduce administrative and overhead expenses during the six-year period of FY2008 through FY2013. Operating expenses were decreased through the elimination of 12 full-time and seven part-time positions; salary reductions for the management team and all other staff; multi-year staff wage freezes; reduction in staff pension contribution by the Orchestra from 7% to 4%; and reduction of employer contributions to staff health insurance. Overall, reductions in management and staff expense implemented in FY2010 totaled about $900 thousand annually. Further reductions in management and staff expense implemented in FY2012 totaled an additional $550 thousand, for a cumulative total reduction of approximately $1.45 million. In addition, the Orchestra asked for and received concessions from the musicians in FY2010. These included a wage freeze, of which the three fiscal year cumulative savings from contractual increases was $1.4M, and a reduction in Orchestra 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 and the Orchestras specific financial challenges resulted in growing imbalances between its operating revenue and expenses. Operating deficits increased from $5.4 million in FY2009 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 Recession resulted in the market value of the endowment declining from $93.4 million at the end of FY2008 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 Paul Foundation, pursuant to which amounts contributed to it are held as a separate fund designated for the benefit of the Orchestra. The Foundation makes distributions to the Orchestra annually. The market value of the Orchestras interest in the Foundation was $1.2 million at the end of FY20 12.

The reason for the larger and larger operating deficits was quite straightforward. The Orchestra negotiated a new contract with the musicians that significantly increased its fixed operating expenses (hard costs) in a budget that was increasingly dependent upon contributed revenue (soft funding), making it particularly vulnerable to adverse financial circumstances. Contributions were already being used to fund the Orchestras total operating costs but were not sufficient to close a growing gap between operating revenue and expenses. These growing deficits were increasingly funded through 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 over time and placed ever growing pressure on the operating budget. And so the financial difficulties of the Orchestra steadily and inextricably grew larger and more serious. If not corrected, its growing operating budget deficits could ultimately result 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 a break-even basis for at least the three-year period of FY2014 through FY2016. Achieving such a state of financial equilibrium requires balancing the annual operating budget, limiting spending from its endowment to 5% of market value on a trailing three year average basis and revising expectations of fundraising and ticket sales to realistically sustainable levels. Overview of the Strategic Business Plan The Strategic Business Plan has a multi-prong approach to balancing the budget a combination of sustainable increases in contributed revenue and more modest increases in earned revenue with substantial reductions in operating expenses under the logic that there are significant limits to realistic, sustainable growth in total operating revenue and the operating expense base must be brought into balance with projected revenue. The key components of the Strategic Business Plan designed to achieve financial equilibrium are as follows: A variety of initiatives projected to generate about $2.1 million of annual incremental net revenue going forward;3

The Orchestra is also the beneficiary, but not the trustee, of a trust agreement with Oakleaf Trust for the Minnesota Orchestra that entitles it to certain income distributions each year. The market value of the Orchestras interest in Oakleaf was $66.5 million at the end of FY2012; the distribution from the Trust in FY2012 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 by FY2016, $700 thousand of additional fundraising results above the base case and $700 thousand of

Staff and overhead expense reductions to produce approximately $1.5 million of savings annually;4 and Projected reduction in total musicians expense the largest component of the Orchestras operating expenses, comprising some 49% of the FY2012 operating budget of $4.6 million. This reduction, amounting to a 30% decrease in musicians expense, would be achieved through an unspecified combination of changes in the number of musicians, the number of concerts and the length of the concert season as well as changes to base salary and add-on compensation arrangements and benefits.

The overall logic of the Strategic Business Plan is sound; its independently audited financial statements for the past half decade are unqualified.5 The Orchestra has had a history 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 limits on donor capacity and interest have hindered the Orchestras efforts to reliably bridge the gap in more recent years. The flaws of the Orchestras earlier approach are evident, particularly in the current economic environment and the systemic challenges to leading symphony orchestras in the United States. It is important to consider the projected significant decrease in musicians expense in the context of the Orchestras overall financial situation. Overall, total musicians labor expense increased $1.5 million between FY2007 and 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 (which represent 47.8% of the annual operating budget) decreased by $0.7 million over the same period (from $15.6 million to $14.9 million, an annual average decrease of 0.9%). It is unrealistic to think that the Orchestra can fundraise its way out of its current financial difficulties. Other portions of the expense budget have already been reduced. 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 of earned 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, a 17% increase on estimated baseline revenue, is offset by an estimated $1.7 million of incremental costs to realize 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 include further restructuring of administrative staffing, additional reductions in concert production expenses and more 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.

10 total musicians expense has not only been untouched, but has grown both nominally and as a percent of total expenses because of contractually stipulated annual increases for the musicians. In seeking to balance the budget and achieve financial equilibrium, it is surely appropriate for the Orchestra to also seek to reduce the single largest operating expense in its budget.

Key Assumptions in the Strategic Business Plan Overall, the underlying financial assumptions in the Strategic Business Plan for the next several 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 through FY2016 by 2% for inflation, a rate that seems reasonable in view of current general rates of inflation in the United States. (Cost increases in any expense category or decreases in any revenue category would thus have to be realized elsewhere in order for the budget to remain balanced.) It seems unlikely that earned revenue from classical music ticket sales will grow more than 2% in the next three to five years (or beyond then) upon settlement with the musicians union and may well continue to decrease on a year-to-year basis. The average annual investment return on the endowment is projected to be 8% for the three-year period and spending from the endowment restricted to 5% of a trailing three year average.6 This targeted level of total annual average investment return is reasonable, if ambitious, in the current and possible future capital market environment and will depend in large measure on thoughtful asset allocation with regular rebalancing and well articulated policies with respect to risk tolerance.7 An endowment spending rule of 5% of a trailing three year average is broadly in line with policies of major U.S. endowments.

Total musicians expense is projected to grow annually by 1% in FY2014 through FY2016 from the lower base assumed in the Strategic Business Plan.

As noted above, the endowment is projected to increase by $20 million through new paid-in contributions over the three-year period. Gifts to the Orchestras endowment raised over the past two years are invested separately from its primary endowment fund and are ring fenced, or restricted, so that they are not available to fund operating deficits.
7

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

11 Total management/administration expenses are projected to grow by 1% in FY2014 and management/administration by one FTE position in FY2015 and FY2016, respectively. This assumption provides for extremely modest growth above inflation over the next three years and will continue to place pressure on staff to be highly productive. With balanced operating budgets, full transparency in its financial planning and reporting, active, focused fundraising efforts, and a re-negotiated contract with the musicians union, the Orchestra should be able to achieve annual contributed revenue at its pre-recession totals of $8.0 million and with skill and luck, upwards of $9.0 million, the level projected in the Strategic Business Plan.

Caveats About the Orchestras Projected Budgets Several caveats about the projected budgets in the Strategic Business Plan: The Orchestra is currently in the process of preparing its FY2014 operating budget. The Orchestra asserts that the projected FY2015 and FY2016 budgets, prepared in accordance with the business plan, will hold true even given the cancellation of the performance season this fiscal year. The Orchestra further asserts that the overall impact of not being able to negotiate the terms of a new collective bargaining agreement with the musicians 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 the beginning 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 financial analysis.

The Orchestra faces several long-term financial obligations that are only partially addressed in the strategic business plan, as follows: The Orchestras frozen defined benefit plans for musicians and staff are presently underfunded by some 25% to 30%. The Orchestra plans to make catch-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 strategic business plan but are funded through withdrawals from the endowment above the 5% spending rate. As a result, the total annual spending rate from the endowment is estimated at 7.5% through FY2017. That the Orchestras total estimated annual endowment spending rate is higher than the projected 5% if only for the next three fiscal years suggests that it is continuing to engage in a budgeting practice that partially led it to its current financial state.

12

The Orchestra participates in an American Federation of Musicians multiemployer musician defined benefit plan that is severely underfunded. The pension plan and the amount of the Orchestras contributions are contractual matters that must be negotiated with the union. The Orchestra presently estimates that the current withdrawal liability to exit from the plan would be approximately $25 million. The Orchestra is monitoring the status of the plan and the options available for dealing with the liability. The Orchestra presently has $9.3 million of taxable bonds due in April 2015 and $1.7 million of tax exempt bonds due in April 2019. It is presently exploring alternatives to reduce its indebtedness in ways that would strengthen its overall financial situation. In the absence of an attractive alternative, the Orchestra plans to pay off the $9.3 million debt by a withdrawal from its endowment in April 2015, a move that would further reduce available spending from the endowment. Debt service on these two obligations is included in the Strategic Business Plan as is payment of the $9.3 million debt from the endowment.8

There is no contingency in the operating budget and thus no cushion to protect against such possible unforeseen problems as, for instance, lower than estimated attendance and/or fundraising results or higher than expected health benefits, energy and/or insurance expenses. To the degree that such outcomes arise, the Orchestra may need to borrow against its endowment and reserve funds, thereby hindering its effort to achieve financial sustainability. Likewise, there is no provision for contract terms with the musicians union that result in annual operating savings less than that projected in the Strategic Business Plan. If final financial terms reached through collective bargaining with the union were to result in total musicians expense higher than that projected in the Strategic Business Plan, the Orchestra would need to determine how best to meet such a difference on a sustainable basis going forward without damaging its efforts to balance its operating budget and achieve longer-term financial sustainability. There is no reason to believe that additional marketing efforts will reverse secular downward 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 communications on a continuing basis are necessary to prevent further erosion in ticket sales and philanthropic support.

Because of rapidly growing annual operating deficits in recent years, balancing the budget 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 reduction in spending from the endowment is offset by the decrease in interest payments on the bonds going forward.

13 is a daunting task under the best of circumstances. To do so in a single year, as predicated in the Strategic Business Plan, is certainly aggressive, rather like going completely cold turkey after years of growing budgetary challenges and widening deficits. Observations About the Orchestras Financial Planning Several comments about the Orchestras financial planning: Fundraising Going Forward The Orchestra faces a number of challenges with respect to increasing contributed revenue over the course of the next several years and beyond: There may well be limitations to the Orchestras current donor and prospective donor pool. A younger generation of philanthropically inclined individuals is less likely to support the Orchestra than the current generation because their interests lie elsewhere. Current corporate and foundation support may also be less interested or inclined to support the Orchestra, for a variety of reasons. Donor fatigue and distress over the cancellation of the 2012-13 season and the evident inability of the Orchestra and the union to amicably and promptly reach agreement on new financial terms may cause some donors to hold back on their support. Other donors may be concerned that the Orchestra was not a thoughtful steward of its endowment funds. Considerable effort will be required to move donor relations forward to rejuvenate and revitalize the Orchestras donor base. Once the Orchestra and the union have reached agreement on a new contract, it will be important for both sides to mount collaborative efforts to embrace the Orchestras ticketholders and longstanding supporters, as well as to identify and cultivate a new generation of supporters who will be excited about the artistic quality and energy of the Orchestra and understand its importance locally, nationally and internationally.

The Renovation of Orchestra Hall It has been noted by some observers that the Orchestra proceeded with the renovation of Orchestra Hall during this period of increasing budget deficits and, subsequently, the cancelled 2012-2013 season, raising some $49 million to date from the Board, other individuals, 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 with the renovation and why those funds could not have been used instead to balance the operating budget. Several observations:

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

14 Although this financial analysis did not look extensively into the decision to undertake the renovation, the Orchestra indicated that the condition of the Hall was a significant limitation: the lobby space was cramped; there was insufficient space for food and beverage service and hospitality service (an increasingly important amenity at cultural and performing arts performances and a significant source of incremental revenue); and the Hall was generally off-putting to many patrons and concert-goers. The Board spent considerable time discussing, analyzing and ultimately deciding upon the renovation, scaling back rather considerably earlier approaches that would have been far more extensive.10 The decision to proceed was not undertaken casually, and the Board ultimately decided that the renovation would be an essential step in increasing the attractiveness and hence interest in the Orchestra and in helping to generate incremental revenues. That said, it is yet too early to tell whether the renovation will ultimately result in positive outcomes for the Orchestra. A significant portion of the funds raised to renovate the Hall came from donors that Orchestra indicates were interested only or primarily in the renovation project and 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 for operations, endowment and tours.

The Thorny Problem of Productivity Like other nonprofit organizations, orchestras have only limited opportunities to realize steady increases in productivity. Labor required to perform the standard orchestra repertoire is essentially frozen, while the compensation of musicians typically increases at least at the rate of inflation and more or less in step with that of other highly trained professionals. Universities face many of the same financial pressures as symphony orchestras in that they too have no built-in ability to achieve annual productivity gains as do many private sector organizations. Unlike symphony orchestras, however, universities have far more tools by which to meet this central financial challenge: they have greater diversity of funding streams (tuition revenues, research funding, auxiliary enterprises, licensing of intellectual 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 to try to raise funding (a pool which continually grows); and their programs have greater market appeal to applicants and their families (at least at some institutions and in some disciplines). 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 were for a $175 million renovation; the scope was reduced to $95 million in FY2007 and ultimately resized to $52 million.

15 costs over time through various delivery mechanisms, including distance learning, among other approaches. In addition, major universities have the advantage of massive scale, financial aid support and research funding from the federal government and perceived value as economic engines of innovation and discovery.11 By contrast, symphony orchestras have only a few levers by which to balance their budgets: earned revenue through ticket sales to concerts, philanthropic support and, to a far less degree, recording income. In addition, most orchestras are local in character and impact, even those that tour extensively in the United States and abroad, so that the pool for contributed revenue is almost exclusively local and regional in character. That said, those orchestras that have alternate permanent sites (such as Tanglewood for the Boston Symphony, Blossom Festival and Florida for the Cleveland Orchestra and Hollywood Bowl for the Los Angeles Philharmonic) have a strategic advantage in that they are able to increase their audience, offer different programs and provide their musicians with additional concert performances. The terrible problem facing all orchestras (and most non-profit arts and cultural organizations for that matter) is that even though their operating budgets may be balanced in any one year or period of years, their inability to increase productivity over time means only a temporary respite: their personnel costs will inevitably rise faster than their operating revenue, all things being equal. Thus while the Orchestra has projected balanced operating budgets for the next several years, this state is only temporary. The Orchestra will continue to be confronted with serious and persistent budget pressures going forward.

CONCLUSION The Orchestra has prepared a thoughtful and analytically reasonable Strategic Business Plan that seeks to promptly balance its operating budget and achieve financial equilibrium and thus reverse a recent pattern of growing and unsustainable annual operating deficits funded through ever larger exceptional draws from its endowment. The Orchestras growing financial challenges of the past half decade arose principally from its having negotiated a new five-year contract with its musicians that increased their salaries by more than 26% (later reduced to a 19% increase through concessions in FY2010) just before the Great Recession. The impact of the Great Recession was a sizable decrease in the market value of the Orchestras endowment and a steep decline in its contributed revenue. The combination of these factors damaged the Orchestras

11

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

16 fragile finances that had been annually bolstered through repeated special fundraising efforts and special draws from its endowment. In the years immediately after the Great Recession, the Orchestra sought to balance its operating expenses with its operating revenue through adjustments in programming and sizable reductions in administrative and management expense. It also negotiated certain concessions in the new musicians contract. But these steps were not sufficient to solve its financial problems in view of endemic pressures on all symphony orchestras and a weak economic recovery. The one expense area not substantially touched over the last several years has been total musicians expense, which was growing under the terms of the contract while other operating expenses declined. Having exhausted other courses of action, the Orchestras Strategic Business Plan calls for a substantial decrease in musicians expense to balance its budget. While this decrease may appear to be draconian in size and timing, the Orchestra 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 and earned revenue. Indeed, the Orchestras financial circumstances are presently such that even the sizable projected reduction in musicians compensation in the Strategic Business Plan does not allow the Orchestra to achieve true financial equilibrium: it is still projected to use exceptional draws though smaller than recent ones to fund certain pension expenses over the next several fiscal years and possibly to retire taxable bonds in FY2013. In addition, the Orchestra has no contingency in its strategic business plan to meet unexpected adverse financial circumstances or to fund reductions in musicians expense smaller than those projected in the Strategic Business Plan. Only gifted artistic and executive leadership, skilled and transparent financial management, shared understanding and collegial responsibility by the Orchestra and the musicians and the ongoing support of a generous community will allow this superb symphony orchestra to have the solid financial base that it requires to ensure continued artistic excellence that is widely and appropriately recognized and appreciated.

17
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 plans for their reasonableness, cogency and appropriateness and in so doing, provide an independent 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 three fiscal years; its financial and business plan(s) and supporting assumptions and analyses; and pertinent programmatic, strategic, development/fundraising and contextual information.12 Confidential individual interviews with several informed individuals who could comment knowledgeably about the Orchestras financial planning and provide pertinent contextual and background information. Preparation of this report.

Two sets of documents were central to the financial analysis, as follows: Audited Financial Statements The Orchestras audited financial statements, prepared by LarsonAllen LLP of Minneapolis for FY2007, FY2008, FY2009, FY2010, FY2011 and FY2012, are unqualified. LarsonAllen did not identify any control or related issues during the audits. The Orchestras Board Audit Committee reviewed and approved each of the audited financial statements on a timely basis in a meeting principally devoted to doing so; the Committee also held an executive session with LarsonAllen at each of these meetings. Upon recommendation of the Audit Committee, the full Board also reviewed and approved each of the audited financial statements on a timely basis.13 Strategic Business Plan The Orchestras financial plan is laid out in Vision for a Sound Future: Strategic Business Plan Summary, Fiscal Years 2012-2015 (dated November 2, 2011). The Strategic Business Plan was unanimously adopted by the Board of the Orchestra on November 2, 2011.
12

The independent financial analysis was to have also included whatever print or electronic analyses and reviews of the Orchestras financial situation and forward planning that the union has prepared, but none was forthcoming upon request.
13

AKA conducted a confidential telephone interview with Larry Adams, CPA, the LarsonAllen partner in charge 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 financial situation; lays out a vision for its future; lists key targets for FY2012 through FY2015; and presents a summary balance sheet. A companion document, Business Plan Operating Budget Methodology, lays out the derivation of projected breakeven operating budgets for FY2013 (a transition year) and FY2014 through FY2016, including key assumptions for each of the major revenue and expense areas, in considerable detail. An overview of the methodology in this document: The approved FY2012 operating budget was converted into an all-in FY2012 operating budget that removes such special events and activities as touring and bridge campaign contributions but adds endowment fundraising costs that had been previously funded directly from the endowment; The all-in FY2012 operating budget was adjusted to a breakeven FY2012 operating budget by adding $3.2 million of net additional revenues and achieving $5.3 million of net expense savings, the result of which would be a balanced operating budget; The breakeven FY2012 operating budget was moved forward to FY2013, a transition year with Orchestra Hall closed for renovations and the Orchestra playing a more limited concert schedule (when this budget was prepared, it was not expected that the Orchestra would not be playing in FY2013 because of the contract dispute with the musicians union); and Projected FY2014, FY2015 and FY2016 operating budges were developed on the basis of the FY2013 transitional budget with specific assumptions about inflation and other changes.

The Strategic Business Plan was developed through nearly a two-year long Board planning process overseen and coordinated by a Board Finance Sub-Committee that was tasked by the Board with analyzing the financial situation of the Orchestra and developing a plan to put the Orchestra on a firm financial basis in both the short- and longer-term. The Sub-Committee met regularly in 2010 and considered at each of its meeting detailed 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 costs in the new business model (November 10, 2010) and operating costs modeling (December 13, 2010).

19 These reports extensively analyze the Orchestras current financial situation and the factors leading to it; provide selective comparative information from other leading orchestras; delineate a number of key objectives for putting the Orchestra on 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 incorporates the more detailed work of the Sub-Committee reports while providing top level background information on local and national arts trends, proposing a vision for a sound 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 complex strategic, financial and business issues. AKA has assisted numerous nonprofit organizations with financial analysis and planning, often with complex balance sheets, operating statements, asset structures and relationships with financial institutions. AKA has assisted a number of leading performing arts organizations, including the Budapest Festival Orchestra, Carnegie Hall, Kennedy Center, Mariinsky Theatre (Kirov Opera and Ballet), New York Collegium and the Salzburg Festival, with a variety of complex strategic issues.

Anthony Knerr, the principal author of this financial analysis, is Managing Director of AKA. He was previously Executive Vice President for Finance and Treasurer of Columbia University and the chief architect of the University balancing its budget after 13 years of operating deficits. He earlier was Vice Chancellor for Budget and Planning at the City University of New York and responsible for guiding the university system through the New York City fiscal crisis. In both positions, he oversaw all aspects of budgeting, accounting, financial analysis, audit and all related financial planning and operations. He also prepared Yale Universitys first long-range financial plan, which set the course for the University achieving (and maintaining) financial equilibrium. The plan was 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.