A Painting of the League, Part 1: Introduction and Finances
November 25, 2015
I hope you put down your charcoal, paint and materials during the next few days to read, discuss and think about your upcoming vote for League President and Board. I do love drawing, painting, and sculpture, and I'm also a busy investor and entrepreneur in New York City, but I am particularly concerned about the League election this year. I know Members have received many emails recently, but I feel the 140 year old Lady League, now shackled in banded beams and scaffolding, is weary and warrants serious attention before her December 2nd sentencing.
The upcoming vote is not just about electing a President and Board for a year. The vote will also play a pivotal role in determining: if and how the League's constitution and bylaws are changed; whether plans continue for major $30+ million dollar construction; and whether the necessary experience and talent is put in place to significantly improve fundraising and reduce the growth of the annual operating losses. It is very probable that the election outcome will significantly determine the League's financial risk profile, character and mission for many years or decades to come.
I have had several careers, but for the past 15 years I have primarily been an investor and analyzed hundreds of companies and institutions and made predictions about their future. Almost every day I analyze and think about possible investments and predict their future success by researching the management team, financials, competition, technology, products and services. Although the League is a non-profit institution, it must have good management, financials and services if it is to compete long term with hundreds of excellent charitable organizations for donations from sophisticated high net worth individuals and foundations. I've analyzed the League because, not only do I care for it as a Life Member, I needed to decide whether the League should be a significant beneficiary of my estate.
In this letter, I will primarily focus on the League's finances during the past ten years that Sal has been President. When analyzing financials it is very important to not just look at one year in isolation, but look at many years side-by-side to see trends and relationships. I'm going to present a few color tables and charts that show financial trends and relationships over the past ten years and will offer some opinions based on my experience. My analysis is dependent upon the accuracy of the League's annual financial reports. I don't know how many of their past reports were independently audited and how often the accountant and auditor were changed.
The League now has about $82M (M=million) in cash and investments. About $53M of that $82M came from two asset sales of air and cantilever rights. The League has about $1M in short term liabilities and the following discussion assumes liabilities remain about $1M going forward. I assume going forward there will not be significant property and art work sales that generate significant League revenue. I'm not going to discuss what the sale of the remaining League lot, property and air rights are worth. The $82M represents about $20,500 in cash and investments for each of the approximately 4,000 Members.
Every month at the League students pay tuition, instructors teach, and employees improve the website. These kind of activities are 'operations' and create revenue and expenses. Let us examine the two largest operating revenue categories and the two largest expense categories. The two largest operating revenue categories (in other words, what brings the most money in) are: Tuition; and Donor Contributions. The two largest operating expense categories (in other words, where money is being spent) are: Administration salaries, payroll taxes and fringe benefits (referred to in this letter as 'Administration expenses'); and Instructor expenses. Instructors at the League are independent contractors, not salaried employees. Below is a 10 year table and chart of these four categories.
Disproportionate Growth in
Administration Expenses Now $520,000 Annually
The numbers from the table are displayed on the chart in 4 solid colored and jagged lines. The Donor Contributions solid line in mustard yellow is the most uneven. The dotted lines represent the best linear fit of the corresponding colored solid lines (software can be good at drawing some types of lines). The four dotted lines help us to more clearly see the trends and are represented by linear formulas that can be used to estimate the future.
The Instructor expense dotted line in green is growing slower than the Tuition revenue dotted line in red, faster than the Donor Contributions revenue dotted line in yellow, and significantly slower than the Administration expenses dotted line in blue. Administration expenses, represented by the blue dotted line, is growing significantly faster than the other three dotted lines. In 2006 the Administration expenses represented 33.1% of total operating expenses, and in 2015, it had grown to 39.7%, resulting in a 6.6% increase in share of operating expenses over the ten years. This 6.6% increase in share of operating expenses means that in 2015, the Administration expense was approximately $520,000 larger than it would have been if it was at the lower 33.1% level of 2006 ($3.125M vs $2.603M). Total operating expenses are growing, and the Administration is taking a bigger slice of a bigger pie each year.
In this letter I have not included an estimated $300,000 of 2015 legal expenses in the 2015 operating expenses because the lawsuit legal costs are not a permanent expense and I am analyzing structural trends (I will speak about the merit of the lawsuit, which I support, in 'A Painting of the League, Part 2: Constitution and Bylaws'). There have been many complaints about the lawsuit and its expenses. The lawsuit expenses are temporary, but the additional $520,000 in Administration expense is an annual expense for the foreseeable future and if things don't change it will continue to grow.
Why have Administration expenses increased so rapidly when the number of monthly students has remained between 1,500 and 2,200 for over 15 years? What justifies Administration expenses increasing significantly faster than Instructor expenses? What justifies an administration employee headcount increase of over 35% in ten years (from 76 in 2006 to 106 in 2013 the latest number available)? What are all these salaried employees doing?
Why has the Administration expense increased so much more rapidly than Donor Contributions when raising money should be one of the top priorities of Sal and Ira? A Board member recently blamed this lamentable fund raising performance on 'the lawsuit' and Rosina Florio. The lawsuit has been going on for less than two years and Sal has been in office for 10. Ira has been Director for about 15 years. Our President has been very busy analyzing and selling League assets for many years and is busy reworking and 'modernizing' our Constitution, but he is just now finally 'in the early stages of integrating the idea' of fundraising and 'putting the necessary infrastructure in place.' Serious fund raising should have been in place many years ago.
If the past 10 year trends continue, Administration expenses will exceed $4M five years from now in 2020, and 8 years from now in 2023 the Administration expense alone will consume all tuition revenue and be more than twice the Instructor expense. That's right - the projections show that in eight years all the tuition money from students that are taught by Instructors will be eaten up by Administration. Only in very poorly run non-profits and governmental organizations do administration expenses eat up all the revenue generated by those providing the service. Truly absurd. Our 'Bernie Sanders' instructor doesn't want to talk about the serious constitutional and misrepresentation issues brought on by the cantilever transaction, and he is okay with this wealth transfer? Below is a table of future estimates of the four categories discussed above.
The League Must Not Spend $30.7M of the $82M
on Major Building Construction. Here's Why:
I believe one of the most important metrics that Members should track annually is the amount of cash and investments owned by the League at the end of each year and how this money will be utilized during the next year. The current $82M in cash and investments can either be invested so that it can generate annual interest and gains to pay for things like the annual operating loss, or it can be spent.
Ask the candidates 'What do you think we should do with the $82M?' Does a candidate want to invest it all or part of it? If a candidate wants to spend part of it, how much will they spend and what are they going to spend it on? How much money will remain at the end of the year to generate interest and gains in the next year?
No need to be confused when accountants, the Board or others split up the $82M into categories with labels because the labels can shift and change. Primarily keep your eye on the total amount of cash and investments at the beginning and end of each year and how the President and Board intend to invest or spend it, instead of worrying about how the different parts are labeled (e.g. 'Endowment', 'Unrestricted Funds', 'Board-Designated Funds', 'Temporarily Restricted Funds').
Sal and the Board want to spend $30.7M of the $82M in cash and investments for major construction, which would leave a balance of $51.3M. Marne and her Board candidates want the $82M dedicated to generating investment income and gains that will ensure tuition remains low while funding more modest improvements to the existing building, and will pay for any major construction projects from new donor funds (not from the $82M).
To choose the best path for the $82M we need to look at past and predicted annual operating losses and compare them to annual expected investment returns. Last year the League's operating revenue was around $5.1M (this number does not include revenue from investment gains and asset sales). Last year the League's operating expenses totaled about $7.9M. If we subtract the $7.9M in expenses from the $5.1M in revenue we find that the League had a $2.8M adjusted operating loss in 2015. Below is a table and chart of operating revenue, expenses and losses for the past 10 years.
Like the previous line chart, the solid lines represent actual numbers and the corresponding dotted lines are the linear estimation for that category. We can see that the top expense dotted line in blue is growing faster upward than the middle revenue dotted line in green. The result of expenses growing faster than revenue is that the bottom dotted line in red (which represents the annual operating loss) slopes downward faster than the operating revenue dotted line in green slopes upward. The League's operating expenses and losses during the past ten years grew significantly faster than US big city salary, inflation and CPI indexes.
If the past 10 year trends continue, annual operating losses will reach $4M eight years from now in 2023, will reach $5M six years later in 2029, and will reach $6M five years after that in 2034. To pay for the projected $5M annual operating loss 14 years from now the League would need a minimum of $100M in investments if we assume an average 5% return on investments. Below is a table of some estimated future operating numbers.
We need to choose a prudent expected annual rate of return on the League's investments. A 5% annual rate of return is a rule of thumb for non-profits. Let us look at the past performance of the League's investments and the broad stock market. Return on investments can fluctuate widely from year to year. For example, the annual return on the League's cash and investments was negative 20.8% in the year ending May 2009 and positive 17.2% in the year ending May 2011. A negative 20.8 % annual return on $82M would result in an annual loss of $17M and an end-of-year balance of $65M, while a positive annual 17.2% return would result in an annual gain of $14M and an end of year balance of $96M. That is a large potential $31M swing in the possible end-of-year balance. The markets can be volatile, and in 2000-2002 and 2008 the US stock market experienced significant losses. The simple average annual return on League's cash and investments has been approximately 4.5% for the past 15 years and 6.8% for the past 10 years. The broad market S&P 500 index has had an inflation-adjusted return over the long run of approximately 7%.
I believe the League should lean toward conservative management of its investment portfolio because: it has no remaining assets to sell; it relies heavily on paying for annual operating losses with investment gains; annual contributions have not been growing as fast as expenses; and there is major construction risk occurring next to the League for several years.. Planning for a 5% or 6% average annual investment return on the League's cash and investments is prudent. The high end of 6% would be significantly higher than the 15 year League simple average of 4.5% and a little lower than the S&P 500 long term average. If we select an average 6% annual return on investments we can calculate the expected annual dollar amount that investments will produce. If all $82M is invested, it should generate an average of $4.9M each year ($82M*.06). If $51.3M is invested, it should generate on average $3.1M each year ($51.3M*.06).
Now we have a feel for how much money $82M and $51.3M should generate in investment income each year. Time to compare the expected annual investment income to the expected annual operating losses we discussed above. I have built two tables below. Both tables assume the past ten year annual operating loss trends continue, all investment interest and gains are spent each year, and a 6% annual investment return. The top table models the short-term (next year or two), and the bottom table models 8 years from now when the annual operating loss is expected to reach $4M a year
The top table shows that short-term (in the next year or two), if all $82M is invested, there should be $2.1M in investment gains annually available after paying the $2.8M annual operating loss. In my opinion all of this $2.1M is needed because the annual operating loss doesn't include other possible annual expenses such as: significantly improving and upgrading current studios and galleries during the next few years; unexpected expenses due to construction next to the League, and temporary lawsuit expenses (which I have not included in operating expenses). The top table also shows that if only $51.3M is invested, there should be only $300,000 available for other expenses. The bottom table shows that in eight years, even if the entire $82M is invested, almost all investment interest and gains will go towards paying the $4M in expected annual operating losses.
In my opinion any major capital building programs should be funded from new donor contributions, and not from the current $82M. Yet Sal and the Board have designated $30.7M of it for major capital construction. I'm certain there are many commercial real estate contractors and developers in New York City that would love to take a bite out of the $82M, but Members should vote to shield the $82M from major construction projects like adding floors to the League's 123-year-old building.
I support Marne Rizika for President and the ASL 2025 Board candidates, and I support their platform.
I believe they will be the best stewards of the League's Constitution and Bylaws, and the $82M in cash and investments.
I believe they offer the best hope for significantly reducing the growing annual operating losses and significantly increasing donor contributions.
I believe they will radically improve financial and operating information available to Members and potential donors.
I believe Marne has the skills and temperament to be an excellent League President.