Sphere Entertainment Co. quarterly report, Q3 FY2020

Business Context and Reporting Period

Madison Square Garden Entertainment Corp. filed an unaudited Form 10-Q for the three and nine months ended March 31, 2020. The source metadata refers to “2019 Q3,” but the filing clearly covers fiscal 2020 third-quarter periods and compares them with the periods ended March 31, 2019. The company became an independent public company on April 17, 2020 after its spin-off from Madison Square Garden Sports Corp. Historical financial statements are combined carve-out statements and include allocations of corporate expenses that may not reflect costs as a standalone company.

The business includes iconic live-entertainment venues, Christmas Spectacular, Boston Calling, Tao Group Hospitality, and the development of MSG Sphere venues in Las Vegas and London. The company reported one operating segment through March 31, 2020; it expected to report Entertainment and Tao Group Hospitality as separate segments after the spin-off.

Financial Metrics

Metric	Three Months Ended March 31, 2020	Three Months Ended March 31, 2019	Nine Months Ended March 31, 2020	Nine Months Ended March 31, 2019
Revenue	$199.9 million	$250.0 million	$767.0 million	$832.4 million
Operating income (loss)	$(145.5) million	$(18.6) million	$(146.0) million	$12.5 million
Net income (loss)	$(150.8) million	$(12.6) million	$(128.6) million	$36.2 million
Net income (loss) attributable to the company	$(128.6) million	$(11.9) million	$(104.7) million	$43.0 million
Adjusted operating income (loss)	$(7.2) million	$17.9 million	$70.2 million	$125.7 million
Net cash provided by operating activities	Not provided for the quarter	Not provided for the quarter	$137.0 million	$45.0 million

Quarterly revenue declined 20% and nine-month revenue declined 8%. The quarterly operating margin was approximately negative 72.8%, versus negative 7.4% in the prior-year quarter. The nine-month operating margin was approximately negative 19.0%, versus positive 1.5% in the prior-year period. Quarterly net loss attributable to the company was approximately 64.3% of revenue, compared with approximately 4.8% in the prior-year quarter.

Major revenue sources for the nine months were event-related and entertainment dining and nightlife offerings of $561.0 million, sponsorship, signage and suite licenses of $172.4 million, and other revenue of $33.7 million.
Cash, cash equivalents and restricted cash totaled $1.022 billion at March 31, 2020, including $1.004 billion of cash and cash equivalents and $331.0 million of short-term investments.
Total debt, net of deferred financing costs, was $34.8 million, consisting primarily of the Tao term loan and a BCE note. The Tao revolving facility had no outstanding balance at March 31, 2020.
Total operating lease liabilities were $246.3 million following adoption of the new lease standard.
Total assets were $3.827 billion and total liabilities were $988.2 million at March 31, 2020.
Nine-month capital expenditures were $326.6 million, substantially related to MSG Sphere development. Net cash used in investing activities was $478.0 million, while financing activities provided $266.9 million.

Material Changes Versus the Prior Comparable Period

Revenue decreased $50.2 million in the quarter and $65.3 million for the nine months, primarily because of venue closures, event cancellations, lower sponsorship and suite-license revenue, lower sporting-event revenue, and reduced concert activity.
Direct operating expenses fell 16% in the quarter and 7% for the nine months, but the reductions did not offset lost revenue. Selling, general and administrative expenses increased 1% quarterly and 12% for the nine months, driven largely by MSG Sphere personnel, content-development and technology costs.
The company recorded $102.2 million of non-cash impairment charges in the quarter and nine months, including $80.7 million of Tao Group Hospitality goodwill impairment, $11.6 million of right-of-use asset impairment, $6.4 million of property and equipment impairment, and $3.5 million of tradename impairment.
Adjusted operating income declined from $17.9 million to an adjusted operating loss of $7.2 million for the quarter and decreased 44% for the nine months.
Miscellaneous expense included a $17.2 million unrealized loss on the Townsquare investment in the quarter, compared with a $5.3 million unrealized gain in the prior-year quarter.
Operating cash flow increased to $137.0 million from $45.0 million, primarily because of working-capital movements, including deferred revenue, accrued liabilities and promoter-related balances. Cash flow does not indicate comparable underlying profitability because it included significant non-cash impairment and working-capital effects.
The company acquired an additional 15% of Tao Group Hospitality in January 2020, increasing its ownership to 77.5%, through an issuance of 102 Madison Square Garden Sports Corp. Class A shares.
On March 24, 2020, the company agreed to sell the Forum in Inglewood for $400.0 million, subject to customary adjustments. The transaction closed May 1, 2020 and generated approximately $322.0 million of cash after transaction costs and income tax, including approximately $258.0 million of net proceeds after working-capital adjustments.

Guidance, Outlook, Risks and Unusual Items

COVID-19 materially disrupted the business. As of the filing date, virtually all venue operations were suspended, events were postponed or cancelled through June, Boston Calling 2020 was cancelled, and virtually all Tao Group Hospitality venues were closed.
Management stated that the timing of reopening, event rescheduling, attendance demand, future revenue, cash flow and the ultimate financial impact of COVID-19 could not be reasonably estimated. Expense reductions were expected to be insufficient to offset revenue losses.
The company expected additional impairment charges could arise, particularly if Tao Group Hospitality closed venues because landlords did not provide adequate lease concessions.
MSG Sphere Las Vegas construction was temporarily suspended in April 2020 because of COVID-19-related supply-chain disruption. The company no longer expected to open the venue in calendar 2021. Its current cost estimate was approximately $1.660 billion, with approximately $349.0 million incurred through March 31, 2020. London Sphere cost estimates and an opening date were not yet determined.
The company expected to continue increasing investment in MSG Sphere personnel, content and technology, resulting in higher future expenses. It planned to seek approximately $400.0 million of new long-term financing for the Las Vegas project, although additional financing could be required and was not assured.
Tao Group Hospitality was in compliance with its credit covenants at March 31, 2020, but management expected it would not comply as of June 30, 2020 absent an amendment or waiver. The company was negotiating with lenders and had committed to provide capital if necessary to service Tao debt obligations.
Management believed available liquidity was sufficient for the next 12 months, including approximately $1.004 billion of cash and $331.0 million of short-term investments. However, approximately $223.0 million of cash represented advance customer proceeds potentially subject to refunds, credits, make-goods or rescheduled events.
The company established up to $200.0 million of delayed-draw term loan facilities for Madison Square Garden Sports Corp. subsidiaries. Full utilization would reduce the company’s cash by $200.0 million.
A share repurchase program authorizing up to $350.0 million became effective after the spin-off; no shares had been repurchased as of the filing.
Other risks included construction delays and cost overruns, dependence on Christmas Spectacular and discretionary consumer spending, venue competition, interest-rate and foreign-currency exposure, litigation, related-party arrangements, standalone public-company costs, and the tax treatment of the spin-off.

Investor Verification Priorities

Verify the post-quarter COVID-19 recovery trajectory, venue reopening status, event cancellations and refunds, and the effect on sponsorship, suite-license, ticketing and Tao revenues.
Verify Tao Group Hospitality’s covenant compliance, lender amendments or waivers, liquidity needs and any additional impairment charges.
Verify MSG Sphere Las Vegas construction progress, revised opening expectations, total project costs, financing commitments and remaining capital requirements.
Verify the final cash proceeds and accounting effects of the Forum sale, including working-capital and tax adjustments.
Reconcile reported historical results with post-spin-off standalone results, including corporate allocations, transition-service fees, related-party transactions and the change to two reportable segments.
Monitor customer advance proceeds and potential refund, credit, make-good and rescheduling obligations.
Assess whether the company’s liquidity assessment remains adequate after potential draws under the Madison Square Garden Sports Corp. delayed-draw facilities and continued operating losses.