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Robert D. Goldwater, President and Executive Director,
DC Sports and Entertainment Commission
Response to Office of the Chief Financial Officer’s Audit
June 24, 2003

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DC SPORTS AND ENTERTAINMENT COMMISSION
2400 EAST CAPITOL STREET, SE, WASHINGTON, DC 20003
TEL: (202) 547-9077, FAX: (202) 547-7460, WWW.DCSEC.COM

June 24, 2003

Mr. Ben Lorigo
Executive Director
Office of Integrity and Oversight
Office of the Chief Financial Officer
District of Columbia
941 North Capitol Street NE
Suite 840
Washington, D.C. 20002

Re: D.C. Sports and Entertainment Commission's Response To the Report on Analysis of the Financial Operations Of the D.C. Sports and Entertainment Commission Issued by the Office of the Chief Financial Officer

Dear Mr. Lorigo:

This letter is written to provide review and comment on the "Report on Analysis of the Financial Operations of the D.C. Sports and Entertainment Commission" ("Report")

Before a discussion of the substance of the Report, we wish to express the Commission's extreme disappointment that that OIO issued its Report without giving the Commission opportunity for review and comment in accordance with the process that we had agreed to. Further, we were dismayed that this failure to adhere to an agreed upon process essentially repeated a similar action that happened last year in connection with OIO's report on the Commission's procurement practices and that we were assured would not happen again. Even more disturbing is that despite the fact that Report reads "THIS REPORT IS AN INTERNAL DOCUMENT FOR OFFICIAL PURPOSES ONLY AND MAY NOT BE RELEASED WITHOUT THE PRIOR WRITTEN APPROVAL OF THE CHIEF FINANCIAL OFFICER" and that it had relatively small distribution, we were informed the Washington Post had a copy less than 24 hours after the Commission received a copy of the Report by fax and before the Commission received its official copy in the mail.

Since OIO failed to provide the Commission with the opportunity for review and comment prior to the issuance of the Report, this letter is intended to address the failure of the review and comment process and substantive issues in both the "Draft Report on Analysis of the Financial Operations of the D.C. Sports and Entertainment Commission" ("Draft Report") issued May 29, 2003 and the Report itself.

1. History of Audit

After more than seven months of review, including a number of instances over the past several months at which we were informed that field work had been completed, OIO emailed a Draft Report to the Commission's Chief Financial Officer, Scott Burrell, on May 29, 2003 and requested a written response by June 4, 2003, less than a week's time. OIO became aware on May 29 that Mr. Burrell was out of the country when the Draft report was emailed and would not be available until June 3, 2003. During this period, OIO did not feel compelled to deliver the Draft Report to or follow up with anyone else at the Commission. While the Commission accepted the Draft Report's general position taat in the absence of significant reductions in spending and/or increases in revenue there will be a continuing decline in and possible exhaustion of the Commission's Unrestricted Net Asset balance, the Draft Report contained numerous errors, misstatements, and miscalculations. The Commission proposed to meet with OIO staff to address these issues in order to avoiding commenting on them in a written response and to develop a more accurate Draft Report.

OIO agreed to this approach and, on June 5, 2003, Mr. Burrell met with Muhamed Yussef and Michael Hart from OIO. At that meeting, OIO staff indicated they would 1) incorporate those issues and. comments with which they agreed into a revised draft; 2) that they would provide Mr. Burrell with a copy of the revised draft for review prior to suing that revised draft report; and 3) that the Commission would have the opportunity to submit a written response to the revised draft. Although OIO took the opportunity to remove or change certain errors and misstatements from the Report, OIO failed to follow through with its commitment to allow the Commission to review and comment on the Report.

Since OIO failed to honor its commitment to allow the Commission to comment on the Report, failed to adequately reflect certain issues raised in the June 5, 2003 meeting, and added certain information to the Report that was not contained in the Draft Report, the Commission is taking this opportunity to comment on both the Draft Report and Report.

II. Comments on the Draft Report

Because of the circumstances surrounding the release of the Report, OIO's failure to provide the Commission an opportunity for review and comment, and the fact that the errors in the Draft Report serve to demonstrate OIO's general lack of understanding of the Commission's operations and its financial statements and analyses, we believe it is relevant to review some of the errors contained in the Draft Report and subsequently modified in the final Report.

A. The Draft Report contains a statement that the Commission's FY2002 net operating loss ("NOL") was influenced by the "fact that the Sports Commission did not budget funds for unexpected capital outlays such as the Grand Prix." This statement demonstrates a lack of understanding by OIO of the Commission's financial. statements, the role of budgets, and accrual accounting. Whether the expenditure was budgeted or not has absolutely no impact on the FY2002 NOL. In addition, as we pointed out to OIO staff on several occasions, the operating results from the Grand Prix, even after taking into account depreciation related to parking lot repaving, actually had a positive impact on the FY2002 bottom line. After addressing this error in the June 5, 2003 meeting, the statement was removed from the Report.

B. The Draft Report contains a statement that "the Sports Commission has been using its cash to cover the losses in the last few years. This caused the cash balance to steadily decline each year, from FY00 to FY02 and, as expected, in FY03 and FY04." A cursory review of the Commission's financial statements would reveal that the decrease of $14.1 million in Unrestricted Net Assets (which measures unencumbered cash) between FY2000 and FY2002 was attributable to capital expenditures of $11.4 million and cash operating losses $2.7 million. Although OIO amended this statement in the Report, the Report does contain the incorrect statement that the "Commission's Unrestricted Net Assets balance has been declining over the last few years because of the continued operating losses." It is remarkable that this statement appeared in the Report after a similar statement was removed from the Draft Report and after the Commission demonstrated to OIO staff that the decrease in the Commission's Unrestricted Net Assets is primarily attributable to investments in capital assets and that only in FY2002 did the Commission's NOL result in a decrease in Unrestricted Net Assets. We can only speculate as to whether this was an editing oversight, a failure to appreciate the difference between Unrestricted Net Assets and the cash and investment balance, or something else.

C. Attachment A in the Draft Report miscalculated the Commission's projected Unrestricted Net Assets for FY2003 and FY2004. At an April 10, 2003 meeting attended by Commission and OCFO staff, including you and Dr. Gandhi, the Commission pointed out the errors in this calculation and provided OIO staff with information on how to correctly perform the calculation. Despite this effort, the calculation of projected Unrestricted Net Assets in Attachment A was wrong. Due to this error, OIO calculated that projected Unrestricted Net Assets at the end of FY2004 would be negative $1,047,452. It then reported erroneously, both with respect to the correct calculation and to its incorrect calculation, that ending FY2004 Unrestricted Net Assets would be positive $1 million. The draft also qualified concern about an FY2004 $1 million Unrestricted Net Asset balance by asserting that the Commission's cash and investment position was expected to be $2.8 million at the end of FY2004. This statement again demonstrates a lack of understanding of the relationship between Unrestricted Net Assets (measuring unencumbered cash) and the cash and investment balance (which may or may not be available to spend). Since Unrestricted Net Assets is one of the primary measures of the Commission's financial health, OIO's failure to grasp the concept is disturbing. Attachment A has been amended in the Report to include only the calculation of PY2002 Unrestricted Net Assets made by the Commission.

It is apparent that OIO used the June 5, 2003 meeting to revise the Draft Report to eliminate these potentially embarrassing mistakes. In return for this demonstration of comity by the Commission, OIO reneged on its promise to allow the Commission to review and comment on a revised draft.

III. Comments on the Report

A. Costing and Pricing of Events

1. Costing and Pricing. The Report recommends that the Commission determine an appropriate cost driver to use in allocating overhead costs to events in determining pricing for the goods and services provided by the Commission and that doing so would allow the Commission to "arrive at realistic estimates for its revenue generating activities." In addition, the Report recommends that the Commission cease analyzing potential events based on direct revenues and expenses because it views this as a "short-term remedy." As discussed in further detail below, pricing the goods and services offered by the Commission is much more complex that merely basing prices on the underlying direct and indirect costs and OIO's recommendation completely disregards the effects of the market on pricing. In addition, OIO made no inquiry into the accuracy of the Commission's estimates of revenue generating activities and to suggest that they are somehow not realistic is unwarranted. Moreover, the analysis and pricing of events based on direct revenues and expenses is not, as suggested by the Report, a "short-term remedy." In fact, it is not a remedy at all but rather an analytical tool for considering individual events. As we informed OIO on numerous occasions and as discussed further below, we have a series of financial schedules that merge the direct event related revenues and expenses with non-event related revenues and expenses to provide an overall picture of the Commission's financial results. We believe this information provides a much more comprehensive and clearer picture than what OIO has recommended.

While we agree that the relationship between net revenues generated by event activities and Commission overhead expenses is a key component to analyzing and managing the Commission's financial performance and, in fact, pointed out the importance of this relationship to OIO, we do not agree that allocating overhead costs is the best way to approach this issue.

Currently, the Commission uses an eight-column income statement, which we provided to OIO, to analyze, forecast, and manage financial performance. This income statement includes four columns (Administration, Stadium, Armory, Parking) for overhead and non-event revenues and expenses and four columns (Stadium, Armory, Parking Lots, and Outside Events) for event revenues and expenses (the four event categories are further broken down by type of event and then to individual event). These statements allow the Commission to determine the amount of net revenue generated by event activities and analyze whether that net revenue, along with non-event revenues, is sufficient to cover overhead expenses. This data is much more comprehensive than the Commission produced prior to the implementation of its new accounting system at the end of FY2001 and is more than sufficient to analyze the relationship between net event revenue and overhead expenses.

It should be clear that, despite the assertion to the contrary in the Draft Report, failure to perform this allocation of indirect expenses to event data did not have any impact on the Commission's FY2002 loss. The NOL resulted from there being insufficient net revenues from events to cover the Commission's overhead and allocating overhead expenses to event analyses would not change that fact.

OIO began its examination of this issue by asking whether the Commission contemplated personnel costs when developing event pricing, a question that highlighted OIO's lack of even. the most basic knowledge of the event and facility management business. After showing OIO the detailed event revenue and expenses P&L statements, explaining the process for estimating expenses and revenues related to a proposed event, and cautioning that the market ultimately set the price the Commission could charge, OIO shifted its focus to the overhead allocation issue.

Despite our repeated requests that OIO indicate how it believes indirect cost allocation would improve the Commission's financial management, the Report fails to address the issue at all. The Report merely states that "losses are being generated because events are not contributing enough revenue to fully cover indirect costs. If the indirect costs were allocated to the specific events, those events would have shown either smaller profits or greater losses." While this statement is true, it does not address how such a fully allocated analysis would benefit the Commission or how it could improve the Commission's decision-making process. Initially, CIO suggested that the Commission should not undertake events that after the allocation of overhead appeared to be "unprofitable." The Commission explained that given that a majority of its overhead is relatively fixed, it is prudent for the Commission to accept events where the incremental revenues exceed the direct incremental costs. Relying on a fully loaded analysis to make decisions regarding events could result in the Commission turning down events with positive incremental net revenue that could be used to cover overhead.

In a reversal of the position originally espoused in the Draft Report, OIO concedes in the Report that in the short term the Commission should not decline events with direct revenues in excess of direct costs, but that it should do so in the long term. This statement again misses the point. The Commission's event analyses are to provide historic event-specific operating information and to be used as a tool for both pricing potential events and developing budgets and forecasts. In the case of forecasts and budgets, overhead is analyzed adequately and separately from event revenues and expenses. In the case of events, the relevant question is "do we do this event or not" and the accompanying relevant analysis is whether the direct revenues exceed the direct costs.

In addition, there are certain functional problems with the recommendation to allocate overhead expenses to events. Since the overhead component and the size, number and mix of events have historically been quite variable, it would take substantial effort to devise, monitor, and mange an overhead allocation scheme. Moreover, any allocation scheme would be arbitrary and artificial. Based on these considerations and the negligible usefulness of allocating overhead costs to event data discussed above, we believe that performing direct costing would be an inefficient use of the Commission's limited resources.

2. Managing Overhead Costs. We do agree, and in fact pointed OIO in this direction, that one of the key components of any analysis of the Commission's financial operations is the relationship between net event revenue and overhead. We also agree that part of that analysis in the medium-to-long term should include analysis of the Commission's mission, how that mission is to be funded and if there is a business model to generate that funding. In addition, we believe that in the near term a more prudent course of action than developing an artificial overhead allocation scheme would be to focus on OIO's other suggested courses of action, including:

Cutting redundant costs to reduce overall expenses;
Holding more events to earn additional incremental revenues;
Negotiating higher prices to help cover more indirect costs;
Re-evaluate and possibly reduce event-staffing levels;
Raise ticket prices, parking rates, and/or concession prices for events.

These are all good suggestions and the Commission has and continues to consider and implement these and other measures. For instance, at the end of FY2001, the Commission had 72 full-time employees. It currently has 52 full-time employees. While the reduction in staff has made many tasks more difficult and has limited the Commission's agility, these reductions were actions the Commission was compelled to do in a responsible, business-like manner based on revenue projections. We also have performed several reviews of the Commission's operating expenses in an effort to make targeted reductions in overhead. While we did not discover any redundant costs, we did identify certain items that are being reduced or eliminated in light of our current revenue projections.

It should go without saying that the Commission attempts to maximize revenue on every event. We attempt to rent the facilities and provide services at the highest rates that we can without losing the opportunity or damaging the long-term financial viability of tenants and promoters. In addition, we are constantly looking for new and better events, but it should be noted that both the Armory and Stadium are each only useable eight-to-nine months per year and the priority is for weekend dates. While we have focused on trying to attract and develop more mid-week events, especially at the Armory, weekends, which are almost fully booked, are much more desirable.

Although the Commission typically does not control ticket revenue or ticket prices, the Commission did raise parking rates in 2001, again in 2003, and is currently reassessing parking rates in cooperation with its new parking operator. Prior to each season, the Commission engages in in-depth analysis and reviews pricing with its food and beverage concessionaire, Aramark, and has adopted reasonable increases and operational improvements each year. As with promoter pricing, these activities are designed to maximize revenue and raising prices too steeply will result in a decrease in overall revenue.

B. Going Concern

The Report suggests that, if the financial results do not improve, the Commission could be in a state of financial risk and that various stakeholders should review the Commission's mission in light of the current state of its facilities and the marketplace. While we agree with both of these conclusions, there are certain issues in this section of the Report that need to be addressed.

In several instances, the Report questions the Commission's ability to operate as a going concern. While we agree that the FY2002 and projected FY2003 operating results are contributing to a deteriorating financial position, we are not sure that this raises a going concern issue and we want to make certain that OIO's use of this term of art is not misplaced. A going concern issue is typically raised when an entity's losses result in a negative equity situation. While it is true that the Commission has experienced several years of net operating losses and a substantial reduction in its Unrestricted Net Assets due to both these operating loses and capital outlays, it has relatively few fixed costs that need must be covered (for instance the, Commission has no debt or significant lease obligations) and still has substantial capital assets (net book value of $15.2 million as of 9/30/02). Accordingly, the Commission could avoid a going concern issue by downsizing, selling its assets or borrowing against them. To be sure, a drastic reduction in size would involve difficult choices and a reduction in the scope of its mission and selling assets or borrowing against them would also present a difficult situation. This is to say that we agree that the Commission's recent operating results are a cause for concern,. but that they do not necessarily represent a going concern issue as indicated in the Report.

The Report also suggests that the Commission's "mission cannot be sustained on the basis of its historic operating record." As pointed out. to OIO staff and as is demonstrated for FY2001 in Report Table 1, with the exception of FY2002, the Commission's operations have produced a positive cash flow in each year of its existence. Given the cash loss in FY2002 and expected in FY2003 along with the investment in capital improvements over the last several years, there has been a reduction in the Commission's Unrestricted Net Assets. This reduction does not, however, support the conclusion that the Commission's mission is not supportable on a forward going basis. We do agree that the Commission needs to improve on the operating results of the past two years, but also believe that it is not unreasonable to conclude that the Commission's current mission is sustainable.

The Report also notes that "[t]he basic assumption underlying the Sports Commission's forecasts for FY03 and FY04 is that the Agency will pay its outstanding bills and collect receivables shortly after the end of the fiscal year (that is within Month 13 of the closing period)." It appears that CIO has misconstrued a statement made by Commission staff in yet another failed attempt to explain the concept of Unrestricted Net Assets and the relationship to cash balances. Commission staff explained that one way to think about the difference between Unrestricted Net Asset balance and the cash and investment balance was to assume that all receivables were collected and all debts were paid. We never suggested that we would actually do this but rather, given the short-term nature of both the Commission's non capital assets and liabilities, this was a way to conceptualize both measures and how to reconcile them.

As a final and most important note, the Commission's management, Budget and Finance Committee and Board of Directors have for some time been well aware of the financial challenges facing the Commission. Both the Board and the Committee have reviewed a number of budget revisions, cost saving plans, and new revenue goals recommended by management. As a member of the Commission's Board of Directors, the District's Chief Financial Officer is well aware of these activities. Again, we agree with the Report's conclusion that the Commission faces a number of financial challenges and that significant decreases in expenses and/or increases in revenues are warranted. We want to make clear, however, that these are issues that the Commission had been focused on well before OIO began, let alone concluded, its review.

C. Grand Prix Paving

While it is true that the minutes of the June 27, 2002 Board meeting, at which the Board considered the increases in the scope and cost of the Lots 6 and 7 repair and resurfacing project, do not reflect the amount of those increases, the materials reviewed by CIO include the schedules distributed to the Board prior to that meeting that show an estimated final cost of $5,064,000. It should be noted that the initial paving agreement was not a fixed price contract but a time and materials contract and when, as noted in the Report, the scope of the project expanded due to additional storm drainage and environmental work and the unsuitability in many areas of the sub-grade, the project's costs necessarily and understandably increased. While we do not dispute that the documentation of the Board's action could have been better, it is clear from the materials that the Board was well aware of the scope of the cost increases beyond the price included in its initial review and approval of the project.

D. Other Matters

The Report completely mischaracterizes nearly all the issues related to OIO's request for documents relating to expenditures referenced in the media. Based on newspaper reports, OIO made an extremely unfocused and broad request for a number of unrelated documents. Given that responding to that request would take a significant commitment of resources by the Commission's small accounting staff, the Commission suggested that, rather than a broad request for a number of random and unrelated documents, OIO choose a more methodical and accepted approach, such as auditing a particular account for a particular period. In the alternative, the Commission offered to provide OIO with the box of documents provided to the Washington Post with both the caution that the documents would be difficult to review in that context and the offer to review each document with OIO staff OIO decided to review the box of documents, bun declined the Commission's offer to assist in the review. Accordingly, OIO's inability to draw any conclusions from ins review of these materials is due no the nature of ins unfocused approach and its refusal to review the documents with Commission staff.

The Commission's reluctance no provide the requested documents in no way reflects any shortcoming in record keeping, bun rather the conclusion than the financial challenges faced by the Commission cannot be men when Commission staff are required to spend significant amounts of time on tasks that have no positive impact on the Commission's business. In an effort to avoid devoting significant resources to hunting for documents that might be relevant no OIO's unfocused request, we proposed providing a set of documents that had already been segregated and copied. Until we received the Draft Report, there was no indication by OIO that such a proposal was inadequate.

In addition Attachment C Part Two was not included in the Draft Report and appears only in the Report. With respect no the "Description" column, it is not surprising that so many items are labeled "Purpose cannon be determined" given that OIO staff declined the Commission's offer to review the materials with OIO staff and answer any questions regarding the materials. The inclusion of this list at this juncture and the thinly veiled editorializing in the description column is, unfortunately, consistent with the rest of OIO's questionable and indefensible practices in this process.

IV. Conclusion

While we do not disagree with OIO's ultimate conclusion that in the absence of an increase in revenue and/or a decrease in expenditures there is a concern regarding the Commission's mission's declining Unrestricted Net Asset balance, the process and the recommendations included in the Report leave much no be desired. Why this process required over seven months and the commitment of significant Commission staff time, not to mention OIO staff time, to reach a conclusion that is clear from even a most cursory review of the Commission's financial statements is difficult to understand, as was the unexplained explained sudden urgency to complete and distribute the Report. Furthermore, in is e remarkable that after all this time and effort, OIO's recommendations essentially urge the Commission, on the one hand, to raise revenues and cut expenses yet simultaneously to engage in a time-consuming overhead allocation of little real value and also include a complaint that the Commission was reluctant to spend numerous hours of staff time responding to a fishing expedition for a collection of unrelated documents.

As a member of the Commission's Board of Directors, the Chief Financial Officer's Office has participated in developing and approving the Commission's budget, including recent revisions, and in approving the Commission's new financial reporting processes. Since all of the materials that OIO staff requested and reviewed had already been provided to or were available through the CFO's office, the scope and need for this "analysis of the financial operations" of the Commission is a matter that should be addressed in an appropriate forum.

As we have indicated, much of the Report's content came directly from the Commission itself in an effort to give OIO a full picture not only of the Commission's finances and operations, but of the challenges it faces. Despite OIO's poor job of synthesizing and presenting that information in the Draft Report, the Commission continued to cooperate with OIO only to be disappointed that OIO reneged on its promise and deliberately chose to provide the most reasonable of standard courtesies that would have allowed the Commission an opportunity to review and comment on the Report. Further, it is apparent there was an intentional or unintentional leak of the Report to the media similar to last year, an action for which the Commission will ask for an appropriate inquiry regarding the motivation, timing and distribution for the release of the Report. We were hopeful that this process would yield some concrete benefits yet it appears that this exercise was not necessarily undertaken solely to perform a thorough and substantive analysis of the Commission. In any event, we continue to welcome constructive insights, guidance, and recommendations from the Chief Financial Officer's office.

Sincerely,
Robert D. Goldwater
President and Executive Director
D.C. Sports and Entertainment Commission

cc: John L. Richardson, Chairman, Board of Directors
Dr. Natwar M. Gandhi, Chief Financial Officer
John Ross
Scott Burrell
Board of Directors

Robert D. Goldwater, President and Executive Director, DC Sports and Entertainment Commission Response to Office of the Chief Financial Officer’s Audit June 24, 2003

DC SPORTS AND ENTERTAINMENT COMMISSION 2400 EAST CAPITOL STREET, SE, WASHINGTON, DC 20003 TEL: (202) 547-9077, FAX: (202) 547-7460, WWW.DCSEC.COM