HomeMy WebLinkAbout2000-04-10 City Council (11)City of Palo Alto
Manager’,s RepPr., t
TO:HONORABLE CITY COUNCIL 6
FROM:CITY MANAGER DEPARTMENT: ADMINISTRATIVE
SERVICES
DATE:APRIL 10, 2000 CMR:200:00
SUBJECT:REVIEW OF CABLE CO-OP’S PAST PERFORMANCE RELATED
TO THE 1986 FRANCHISE AGREEMENT, AMENDED IN 1991
This is an informational report and no Council action is required.
BACKGROUND
In 1983, a JPA was entered into by Palo Alt0, Menlo Park, East Palo Alto, Atherton, and
portions of San Mateo and Santa Clara Counties, for the purpose of obtaining cable
television service for the residents, businesses, and institutions within these jurisdictions.
The JPA gives the City of Palo Alto sole authority to grant and administer the cable
television franchise, on behalf of all the JPA member communities.
In 1986, a cable television franchise agreement was executed with Cable Co-op, and
amended in 1991. This agreement will expire on March 24, 2001. During the period that
begins thirty-six months prior to the expiration of a franchise agreement, the cable company
may request that the franchise authority commence proceedings to determine whether or not
to renew the franchise. In July 1998, Cable Co-op made this request and in September
1998, the Palo Alto Council adopted a resolution agreeing to begin renewal proceedings.
After conducting a competitive proposal process, the City retained the services of a cable
communications consultant, The Buske Group, to assist City staff with the franchise renewal
proceedings. In addition, the City has contracted with a law firm that specializes in cable
communications law.
The City has undertaken a three-phase franchise renewal process. Phase One includes
development of a renewal plan and timeline; and education of City staff, elected officials,
and key members of the community regarding the process, applicable laws, and regulations.
This phase has been completed. Phase Two establishes the basis for negotiating a new or
renewed franchise agreement. It includes an assessment of the cable plant, an evaluation of
the past performance of the cable operator to identify problems if any, and an analysis of
future community cable related needs and interests. The City is currently in Phase Two.
CMR:200:00 Page 1 of 4
Phase Three, building upon the information gathered in Phase Two, establishes the desired
outcomes for the renewal process and includes actual negotiation of a new or renewed
franchise agreement.
The purpose of this report is to focus on the review of Cable Co-op’s past performance,
which is part of Phase Two of the franchise renewal process.
DISCUSSION
The past performance evaluation has many components including: a detailed evaluation of
Cable Co-op’s compliance with the existing franchise agreement; a review of customer
satisfaction with the services provided by Cable Co-op; an audit of franchise fee payments;
and a technical assessment of the cable system. The City’s cable communications
consultant, The Buske Group, is coordinating the various components of Phase Two, and
has hired a number of experts to assist with the process. The components of the past
performance review are discussed in greater detail below.
Contract Compliance Review: The contract compliance review consists of a compilation 0f
all Cable Co-op’s obligations under the existing franchise agreement and an examination of
whether Cable Co-op has met those obligations. A key part of this review includes an
assessment of its compliance with its obligations related to public, education and
government (PEG) access and local origination channels. The contract compliance review
is important to the franchise renewal process because it can result in immediate
improvements in service. In addition, one of the reasons a franchise renewal request may be
denied is because of significant past noncompliance.
Customer Satisfaction: The process of ascertaining customer satisfaction with the current
cable provider includes a review of all available complaint files held by the City and Cable
Co-op, an analysis of how Cable Co-op tracks and responds to customer complaints, a
statistically valid telephone survey, and a public hearing.
During the recently completed telephone survey, approximately 400 people in the franchise
area, selected at random, were asked questions about their satisfaction with Cable Co-op.
Those individuals that were not Cable Co-op subscribers were asked to describe why they
do not subscribe. The phone survey was conducted by Group W Communications, an
organization with extensive experience in the area of public opinion polling and strategic
planning.
The public hearing provides the community with another opportunity to comment on the
past performance of Cable Co-op, including but not limited to performance related to picture
and sound quality, cable modem services, and customer service matters. The public hearing
is integral to the franchise renewal process because it identifies issues that matter to the
customers in the delivery of cable services, information that can be used in negotiating a
~renewed or new franchise agreement, regardless of the provider.
CMR:200:00 Page 2 of 4
Franchise Fee Audit: The franchise fee audit conducted by KFA associates has been
completed. KFA Associates has assisted several city and county governments in ongoing
monitoring and regulation of cable television systems, including financial performance and
franchise fee payment reviews. Franchise fee payments to the JPA communities were
$582,667 in 1996, $617,884 in 1997, and $695,516 in 1998. The franchise fee payment
review identified underpayment of franchise fees of an average of $57,000 from 1996 to
1998. Some significant areas of underpayment include Cable Co-op’s treatment of itemized
franchise fees, its not including late fees in its calculation of gross revenues, and its
exclusion of advertising sales revenue from its calculation of grOSS revenues. The City has
issued a demand for payment of the amounts owed. (The letter to Cable Co-op requesting
payment and KFA’s report are included as Attachment A).
Technical Assessment: The assessment of the cable plant is currently being conducted by
Columbia Telecommunications Corporation, a nationally recognized engineering firm that
specializes in telecommunications engineering. Its work includes on-site examination of the
existing cable system, inspection of all key electronic facilities, and analysis of Cable Co-
op’s required proof of performance testing data.
RESOURCE IMPACT
The examination of past performance of Cable Co-op has identified an underpayment of
franchise fees in the amount of $214,364 for the period January 1, 1996 through September
30, 1999. The City is pursuing payment of the amount owed.
POLICY IMPLICATIONS
This report does not represent any change to existing City policy.
TIMELINE
The information gathered in Phase Two of the franchise renewal proceedings, which
includes the past performance review, will be used to begin negotiating a new franchise
agreement. Staff plans to complete Phase Two in May 2000 and begin negotiations at that
time.
ENVIRONMENTAL REVIEW
This is not a project under the California Environmental Quality Act (CEQA)I
ATTACHMENTS
Attachment A: Letter and KFA Report
CMR:200:00 Page 3 of 4
PREPARED BY:Melissa Cavallo, Assistant Director
Shannon Gaffney, Senior Financial Analyst
REVIEWED BY: Grant Kolling, Senior Assistant City Attorney
DEPARTMENT HEAD:
CAR~ YEATS; Director
A~Cninistrative Services
CITY MANAGER APPROVAL:
SON
Assistant City Manager
cc:Mr.
Mr.
Ms.
Ms.
Mr.
Ms.
Mr.
Ms.
Ms.
Mr.
Mr.
Mr.
Russell Averhart, Director of Administrative Services, City of East Palo Alto
Walter Callahan, Deputy Director, Public Works, San Mateo County
Uma Chokkalingam, Finance Director, City of Menlo Park
Jan Dolan, City Manager, City of Menlo Park
Ralph Freedman, City Manager, Town of Atherton
Monica Hudson, City Manager, City of East Palo Alto
John Maltbie, County Executive, County of San Mateo
Jan Thomson, Stanford University
Salani Wendt, City Clerk, City of East Palo Alto
David Wheaton, Asst. City Manager, City of Menlo Park
Richard Wittenberg, County Executive, County of Santa Clara
Ron Kirkeeng, CEO & General Manager, Cable Co-op
Ms. Nicolasa A. Bloom, Director of Government Affairs,
AT&T Broadband & Internet Services
Ms. Susan Ritchie, AT&T Broadband & Internet Services
CMR:200:00 Page 4 of 4
ATTACHMENT A City Palo Alto
Office of the City Attorney
February 22, 2000
RETURN RECEIPT REQUESTED
CERTIFIED MAIL #P415-432-74~
Ronald Kirkeeng
CEO/General Manager
Cable Co-op-
3200 Park Boulevard
Palo Alto, CA 94306
RE: ~abl~ Co-op Franchis~ Fees
Dear Mr. Kirkeenq:
I~ have attached for your consideration and action on
behalf of Cable Co-op a report written by KFA Services in
connection with its audit of Cable Co-op’s accounting records and
franchise fee payments for the period January I, 1996 through,
September 30, 1999.
The report, which the City has received from its cable
television consffltant, The Buske Group, discloses that Cable Co-op
has underpaid franchise fees for the period in question in the sum
of two hundred fourteen thousand three hundred and sixty-four
dollars ($214,364.00).
Demand is hereby made for the immediate payment of the
sum of $214,364. If Cable Co-op fails to pay within .the time
required under Section.10.5 of the Amended and Restated Franchise
Agreement, Cable Co-op is required to pay an additional sum of
money representing accrued interest, late charges and other
authorized fees and charges required to be .paid by Cable Co-op
under the referenced Franchise Agreement and by California law.
Cable Co-op is required forthwith to report revenues and
pay franchise fees consistent with the manner in which the
underpayment of franchise fees has been determined by KFS Services,
beginning October I, 1999. The franchise fees for the quarterly
period ending December 31, 1999 shall be determined again if they
were calculated and reported in a manner inconsistent with the
methodology used by KFS Services. The underpayment of franchise
fees plus such additional sums mentioned in paragraph three.of this
letter, if not paid in a timely manner, must be remitted to the
City in accordance with the terms and conditions of the Franchise
Agreement.
00222 syn 0071822
P,O. ~ox 10250,
Palo Alto, CA 94303
650.329.2171
650.329,2646 fax
Ronald~Kirkeenq
CEO/General Manager
February 22, 2000
Page ~
RE: Cable Co-op Franchise Fees"
The attached KFS Services report and cover letter to Ms.
Sue Buske soon will be delivered to the Palo Alto City Council and
the members of the Joint Powers Agency. A public discussion of the
franchise agreement contract compliance, issues, including Cable Cot
op’s failure to pay the sum mentioned in the second.paragraph
above, will be held before.th~ Council in the very near future.
If Cable Co-op should contest this demand for/payment or
an~ other action proposed herein to be taken by the City-or
required to be taken by CaDle Co-op,.kindly state the legal basis
for.your objection and advise me at your earliest convenience.
Your assistance and cooperation are appreciated.
Sincerely,
ARIEL PIERRE cALONNE
y Attorne~
GRANT KOLLING
Senior Asst. City Attorney
GK:syn
Attachment
June Fleming, City Manager .:
Donna Rogers, City Clerk
Carl Yeats, .Director Of Administrati4e Services
Arie! Pierre .Calonne, City Attorney
Sue Buske, The Buske Group
Tillman Lay, Esq.
00222 syn 0071822
KFA Services
6710-128th Street SW
Edmonds,Washington 98026
(425) 745-6860
Ms. Sue Buske
The Buske Group
3001 J St., Suite 201
Sacramento, CA 95816
Dear Sue:
December 14, 1999
Per your request, we have we have performed certain review procedures in
connection with the accounting records and franchise fee payments of the Cable
Communications Cooperative of Palo Alto, Inc. (’"the Cable Co-op"), for the period
January 1, 1996 through September 30, 1999.
The purpose of this work was to determine if the Cable Co-op’s franchise fee
calculations and payments to the City of Palo Alto (on behalf of the Joint Powers) were
consistent with company accounting records and with the current franchise agreement.
This work did not constitute an examination of the Cable Co-op’s fmancial
statements or accounts in accordance with generally accepted auditing standards and,
therefore, we are not expressing any opinion regarding th.e accuracy or appropriateness of
such statements or accounts.
Specifically, we have:
reviewed the relevant sections of the franchise agreement regarding franchise fee
payments and the definition of gross revenue on which the payment calculations
are based,
reviewed the franchise fee payments sent to Palo Alto during the past three and
three-quarter years,
reviewed the Cable Co-op ratesand channel lineups for the past several years as
well as sample recent billing statements,
\.
discussed the Cable Co-op’s franchise fee calculation procedures with company
staff,
compared gross revenue as reported to Palo Alto, with amounts reported through
the Cable Co-op’s monthly subscriber billing reports and with amounts recorded
in the Cable Co-op’s general ledger, for selected months during the period under
review,
Ms. Sue Buske
December 14, 1999
Page 2 of 12
reviewed the billing report information and general ledger accounts relied on for
franchise fee calculations to determine if all sources of revenue were included or
whether there have been any inappropriate exclusions, deductions, or adjustments,
* ¯ reviewed certain supplemen ..t~ry materials related to programmer agreements and
payments, and
verified the Cable Co-op’s actual franchise fee calculations for the period under
review.
Note that these review procedures assume that the Cable Co-op’s underlying
accounting systems and records are materially accurate. Since the Cable Co-op’s
independent auditors examine those systems and records when the auditors certify the Cable
Co-op’s overall f’mancial statements, such an assumption is a reasonable and cost effective
one. ’-
The franchise agreement requires payment of annual franchise fees in the amount of
5% of the Cable Co-op’s "Gross Revenues". This is defined in Section 1.25 of the franchise
agreement as:
"Gross Revenues" means all revenue, as determined in accordance wi.th generally
accepted accounting principles, which is actually received, directly or indirectly, by
the Company and by each Affiliated Person from or in connection with the
distribution of any Service over the System or the provision of any Service Related
Activity in connection with the System. Gross Revenue shall also include the gross .
revenue of any other Person which is actually received directly or indirectly from or
in connection with the distribution of any Service over the System or the provision of
any Service Related Activity to the extent that said revenue is actually received,
through any means which is intended to have the effect of avoiding the payment of
compensation that wouM otherwise be paid to the City for the Franchise granted
herein as reasonably determined by the City Auditor. Gross Revenue shall also
include installation charges whether or not attributable to the cost of equipment,
excluding refundable converter deposits, which bear interest. Gross Revenue, for
purposes of Section 10.1 and Section 10.1.05 hereof, shall not include: ~) the revenue
of any Person, including without limitation a supplier of programming tb the
Company, to the extent that said revenue is also included in the Gross Revenue of the
Company; (ii) the revenue of the Company or any other Person which is actually
received directly from the sale of any merchandise or services (other than the
Services) through any Service distributed over the System; (iiO taxes imposed by law
on Subscribers which the Company is obligated to collect and pay in full to the
applicable taxing authorities, including, without limitation, sales taxes and use
taxes; (iv) subject to Section 10.1.05 hereof, amounts collected by the Company from
Subscribers on behalf of Leased or Access Channel programmers, other than
Affiliated Persons, to the extent that said amounts are passed on by the Company to
Ms. Sue Buske
December 14, 1999
Page 3 of 12
said programmers; (v) the revenue of any Affiliated Person which represents
standard and reasonable amounts paid by the Company to said Affiliated Person for
ordinary and necessary business expenses of the Company, including, without
limitation, professional service fees and insurance premiums; (vi) any investment
income earned by the Company,. (vii) thatportion of thej’ee dTaid by the Company to
an Affiliated Person which exceeds the revenue of the Company from said Service;
(viii) refunds or credits given to Subscribers, including member equity contributions,
patronage refunds, and other subscriber distributions, except for refunds or credits
due to interruptions in Service or as otherwise required by this Restated Agreement,~
(ix) bad debts attributable to Subscribers which are deducted from Company.income
in accordance with generally accepted accounting principles; (x) the value of barter
transactions which in the aggregate in any twelve (12) month period are de minimis
in relation to the Gross Revenue for such period; or (xi) all revenues deri~ed from
subscribers located outside the Service Area.
Note that Sections 1.38 and 1.40 further def’me:
"Service" means any Basic Service, any Enhanced Service, or any other service,
whether or not originated by the Company, which is offered to any Subscriber in
conjunction with, or which is distributed over, the System.
"Service Related Activity " means any activity or function associated with the
production or distribution of any Service over the System, including, without
limitation, use of studio or other facilities and equipment, billing, audience
promotion, or installation or lease of equipment.
In general, wi. "th respect to those types of revenue that the Cable Co-op has actually
been reporting and the payment calculations based on those types of revenue, we found only
two material problems. Specifically, it appears that, in certain years, the Cable Co-op did not
correctly or fully incorporate:
Cable modem service revenues, and
Bad debt deductions.
However, based on the Gross Revenue definition above, we identified the foll~’wing
types of revenue received by the Cable Co-op that the Cable Co-op has consistently not
included in its reported revenue and franchise fee calculations:
Itemized franchise fees,
Itemized FCC regulatory fees,
Administrative (late) fees,
Construction revenues,
Cable store revenue,
Ms. Sue Buske
December 14, 1999
Page 4 of 12
Advertising sales revenues
Home shopping channel revenues, and
Programming launch payments
Cable modem service revenues
From the inception of cable modem service in 1997 to mid-1998, the Cable Co-op
used a different system for billing subscribers and recording its cable modem revenues than
the system used for its regular cable, service offerings. Subsequently, it shifted to using the
same billing system, although with separate billings and separate accounting reports.
Comparison of the total cable modem service revenue amounts recorded in the Cable
Co-ops general ledger for 1998 and for January to September 1999 indicated larger total
amounts than had been reported to the City and included in franchise" fee calculations. While
we did not attempt to fully trace the sources of the discrepancies, Co-op staff indicated that
errors may have occurredduring or as a result of the transition to the new billing system.
They agreed that the general ledger amounts should be a more reliable source for total cable
modem gross revenues.
Thus, comparing general ledger amounts to franchise fee report amounts for the
review period, the total amounts of unreported revenue and the associated franchise fees
payments owing are:
1996 1997 1998 Jan-Sep1999
Cable modem service
revenue:
Per general ledger NA NA1 $672,764 $908,635
As reported NA NA $660,670 $870,775Net unreported NA NA $12,094 $37,860
Franchise fees owed $0 $0 $605 $1,893
Total
$1,581,399
$1,531,445
$49,954
$2,498
Bad debt deductions
In accordance with the franchise agreement definition of Gros~ Revenue, the Cable
Co-op deducts, from its earned revenue, amounts written off as bad debt each month, i.e., not
received within a reasonable period and not expected to be received. However, during some
of the periods it was unclear What the source of the reported write-off amounts was and
whether amounts subsequently received against the write-offs were n~tted out. When
~ At year-end 1997, as well as later in 1998, the Cable Co-op paid the City franchise fee adjustments related to
underreported revenue for 1997. With respect to cable modem service revenue, these eliminated the
underreporting for 1997.
Ms. Sue Buske
December 14, 1999
Page 5 of 12
compared to total net bad debt expense recorded in the general ledger, it appears the Co-op,
on balance, understated bad debts during the review period. This again appears to be
unintentional - it leads to overpayment of franchise fees to the City.
For the review, period, the total amounts of unreported deductions2 and the associated
franchise fees owed by (to) the Cable Co-op are:
1996 1997 1998 Jan-Sep 1999 Total
Bad debt expense:
Per general ledger ($134,036)NA3 ($150,685)($131,810)($416,531)Asreported ($154,366)N___&A($140,717)($10,518)($305,601)Net unreported $20,330 NA ($9,968)($121,292)($110,930)
Franchise fees owed $1,016 $0 ($498)($6,065)($5,547)
Itemized franchise fees
Franchise fees are paid by the Cable Co-op in exchange for the pdv!lege of
constructing and operating a cable system using municipally owned rights-of-way. Under
generally accepted accounting principles4, such fees are simply expenses of the cable
operator necessary to generate its gross revenue and deductible from gross revenue to arrive
at net income.
To the extent an operator chooses to display an amount labeled as "franchise fee" on
a subscriber’s bill - as the Cable Co-op does - these amounts are simply part of a cable
operator’s service revenues that it has chosen to itemize in order to distinguish that portion of
its revenue used to pay this expense item from theremainder of its revenue which is used to
pay all of the cable operator’s other expenses and/or provide a profit.
Unfortunately, the Cable Co-op, as part of its regular accounting system, does not
treat itemized franchise fees as revenue, nor does it treat franchise fee payments as an
expense. Rather, it erroneously treats these fees as though they were sales taxes imposed
directly on subscribers by a government agency and which are simply collected by the. Co-op
and transferred to the government agency. Consistent with this view, the Cable Co-op"
excludes itemized franchise fees from gross revenue on which franchise fee payments are
calculated per the exclusion in the Gross Revenue definition:
2 Shown as a negative number.
3 As part of the year-end 1997 franchise fee adjustment mentioned earlier, the Cable Co-op incorporated total
bad debt expense as recorded in its general ledger. Thus, no further adjustment for bad debt expense is
necessary for that year.4 See, e.g., Statement of Financial Accounting Standards No. 51, issued by the Financial Accounting Standards
Board.
Ms. Sue Buske
December 14, 1999
Page 6 of 12
Gross Revenues ... shall not include ... (iiO taxes imposed by law on Subscribers
which the Company is obligated to collect and pay in full to the applicable taxing
authorities, including, without limitation, sales taxes and use taxes
It is debatable whether franchise fees are taxes at all, but, in any event, the City
certainly does not impose franchise fees on cable system subscribers, and the Cable Co-op is
not a collection agent for the City with respect to the fees5. Indeed, the Cable Co-op is not
even required to itemize this expense on its billings, although federal law allows such
itemization and the Cable Co-op has chosen to do so. Thus, the above exclusion is not
applicable to itemized franchise fees6.
For the review period, the total amounts of unreported revenue and the associated
firanchise fees payments owing are:
Itemized franchise fees
Franchise fees owed
1996 1997 1998 Jan-Sep1999 Total
$584,056 $649,400 $676,441 $534,204 $2,444,101
$29,203 $32,470-$33,822 $26,710 $122,205
Itemized FCC regulatory fees
FCC regulatory fees are also simply an expense of the Cable Co-op - fees charged to
the Cable Co-op by the FCC. The FCC does not impose these fees directly on subscribers
and, indeed, the Cable Co-op would have to pay these fees even if it collected no revenue
whatsoever from its subscribers. The amounts are viewed by the FCC as a component of
basic service tier rates and can be, but are not required to be, itemized on subscriber bills.
The Cable Co-op-does separately display these amounts on its subscriber bills. However,
like itemized franchise fees, it is not appropriate to deduct or exclude the itemized revenue
amounts, corresponding to FCC regulatory fee expense, from Gross Revenues as defined in
the franchise.
5 In its decision re City of Dallas vs. the FCC (96-60427), the 5a’ Circuit Federal Court of Appeals stated:
Franchise fees are not a tax, however, but essentially a form of rent: the price paid to rent use of
public right-of-ways .... Furthermore, even if franchise fees were treated as a tax, the~,would still be
treated as a normal expense of doing business unless the tax was imposed directly upo~ the subscriber.
Courts have held that gross revenue generally includes revenues collected for taxes .... A second
argument that cable operators are acting as mere conduits is based "upon the format of cable bills.
Under the Cable Act of 1984, a cable operator is allowed to identify the cost of government regulation
on their subscriber bills. This format does not, however, transform a cost imposed on cable operators
into a cost imposed upon cable subscribers .... When franchising agreements impose fees directly upon
cable operators, any money collected to pay those fees will be part of the operator’s gross revenue ...
6 This is in contrast to the utility user tax which, under its ordinance, the City of East Palo Alto does levy
directly on subscribers and for which the Cable Co-op is a collection agent of that city. The Cable Co-op
appropriately excludes itemized utility user taxes from the gross revenue on which franchise fee payments are
based.
Ms. Sue Buske
December 14, 1999
Page 7 of 12
For the review period, the total amounts of unreported revenue and the associated
franchise fees payments owing are:
Itemized FCC fees
Franchise fees owed
1996 1997 1998 Jan-Sep 1999 Total
$1.1,846 $14,241 $12,44~$9,968 $48,496
$592 $712 $622 $499 $2,425
Administrative (late) fees
These are amounts charged to subscribers who are late in paying their regular service
billings. Any subscriber who wishes to continue to receive cable service is required to pay
these additional charges. Plainly, these are revenues received "from. or in eonneetlon with
the distribution of any Service over the System or the provision of any Service Related
Activity in connection with the System". These are not payments for’some unrelated product
or service - but for the desire to receive cable service, no subscriber would pay these fees.
Co-op staff suggested that there may be additional administrative costs incurred by
the Cable Co-op in dealing with late payments. Whether this is the case or not, however, is
not relevant to the issue of whether late fees are includable in gross revenues on which
franchise fees are calculated. It is no more appropriate to offset or deduct any such
administrative costs from gross revenue than it is to offset or deduct the expense of running
the regular billing system from regular service charges and gross revenue.
Nor does it appear that any of the explicit exemptions listed in the franchise definition
of gross revenues are applicable to late fees.
For the review period, the total amounts of unreported revenue and the associated
franchise fees payments owing are:
Administrative (late) fees
Franchise fees owed
1996 1997 1998 Jan-Sep 1999 Total
$98,005 $104,027 $103,231 $87,995. $393,2_58
$4,900 $5,201 $5,162 $4,400 ~19,663
Construction revenues
These monies are received by the Cable Co-op for non-standard service installations
- situations where, for example, a potential business or residential subscriber is located at a
longer distance from existing cable plant than normal or where extensive, non-standard
wiring inside a building is required. However, although this activity has a higher cost and
results in higher charges to a subscriber, this type of installation isnot conceptually different
than a standard service installation. As such, construction revenues appear to be explicitly
includable as gross revenues from a Service Related Activity ("any activity or function
Ms. Sue Buske
December 14, 1999
Page 8 of 12
associated with the ... distribution of any Service over the System, including..., installation
or lease of equipment").
Co-op staff again suggested that, because these charges are intended to reimburse the
Co-op for the additional costs of these non-standard installations., the associated revenue
should not be included in the gross revenues on which franchise fees are calculated. This
approach, however, is explicitly rejected by the franchise’s gross revenues definition:
Gross Revenue shall also include installation charges whether or not attributable to
the cost of equipment.
For the review period, the total amounts of unreported revenue and the associated
franchise fees payments owing are:
Construction revenues
Franchise fees owed
1996 1997 1998 Jan-Sep1999 Total
$0 $31,746 $1,934 $15,365 $49,045
$0 $1,587 $97 $768 $2,452
Cable store revenues
These revenues come from sales of small cable equipment items, such as special
connector cables, A/B switches, or remote control units, which technicians in the field may
sell at the time of installation or service or which a subscriber may pick up at the Cable
Co-op’s main office7.
These amounts again appear to clearly fall within the meaning of "from or in
connection with the distribution of any Service over the System or the provision of any
Service Related Activity in connection with the System". Subscribers obtain these items to
enable or enhance their cable service and would not be obtaining these items from the Cable
Co-op but for their receipt of cable service.
We also note that these revenues do not appear to fall within the exemption provided
by "Gross Revenue... shall not include... (ii) the revenue of the Company... whichis
actually received directly from the sale of any merchandise ... through any Service
distributed over the System". These items are not advertised or sold through television
service; they are sold, in person, by Cable Co-op staff.
7 Note that the Co-op does not operate a separate electronics retail store selling an array of merchandise to
subscribers and non-subscribers alike.
Ms. Sue Buske
December 14, 1999
Page 9 of 12
For the review period, the total amounts of unreported revenue and the associated
franchise fees payments owing are:
Cable store revenue
Franchise fees owed
1996 1997 1998 Jan-Sep 1999 Total
,$7,155 ,$9,715 $5,547 $1,932 $24,349
$358 $486 $277 $96 $1,217
Advertising sales revenue
The Cable Co-op receives revenue from advertisers in exchange for carrying, i.e.,
distributing, advertising - a form of programming - over the cable system. We believe this
fits within the defmition of Service:
... any other service, whether or not originated by the Compbny, which is offered to
any Subscriber in conjunction with, or which is distributed over, the System
[emphasis added]
While these revenues are received from business or other advertisers, rather than
from subscribers, nothing in the definition of Gross Revenues on which franchise fees are
based suggests that only subscriber revenue was to be included.
We also note that these revenues do not appear to fall within the exemption provided
by "Gross Revenue ... shall not include ... (ii) the revenue of the Company... which is
actually received directly from the sale of any ... services (other than the Services) through
any Service distributed over the System". As discussed above, advertising carried on the
cable system is a Service and, thus, associated revenue is not excludable.
Even if one viewed carriage of such advertising as a "small s" service, rather than a
"capital S" Service, carriage of advertising is not sold through the television services carded
by the cable system; subscribers are not the potential market for "carriage of advertising"
services. For the Cable’Co-op, an independent company has sales staff who directly or
indirectly market available time slots for advertising to the businesses that wish to have their
ads distributed over the Cable Co-op’s system.
For the review period, the total amounts of unreported revenue and the associated
franchise fees payments owing are:
Advertising sales revenue
Franchise fees owed
1996 1997 1998 Jan-Sep 1999 Total
$205,247 $233,356 $336,734 $263,155 $1,038,492
$10,262 $11,668 $16,837 $13,158 $51,925
Ms. Sue Buske
December 14, 1999
Page 10 of 12
Home shopping channel revenues
These revenues are received from programmers - e.g., the QVC shopping channel in
the Cable Co-op’s case - in exchange for carriage of home shopping programming as a
Service on the Cable Co-op’s system. Plainly, this revenue is "from or in connection with
the distribution of any Service over the System".
Cable Co-op staff has suggested that these revenues fall within the exemption
provided by "Gross Revenue... shall not include ... (ii) the revenue of the Company ...
which is actually received directly from the sale of any merchandise ... through any Service
distributed over the System". This view is based on the ~act that the amount of money
received by the Co-op is a function of QVC’s sales revenue derived from customers in the
zip codes covered by the Cable Co-op’s system. However, "the Company", i.e., the Cable
Co-op is not itself selling merchandise over the cable system to anyone and, thus, the
revenue is not received directly from the sale of merchandise. At most, there is an indirect
linkage to the sale of merchandise, i.e., a mathematical relationship between the value of
merchandise sold by others and the amount of money that the Co-op receives for distribution
of a cable service. Thus, we do not believe that, under the existing franchise agreement,
these home shopping channel revenues should be excluded from the Gross Revenues on
which franchise fees are based.
For the review period, the total amounts ofurtreported revenue and the associated
franchise fees payments owing are:
Home shopping channel
revenues
Franchise fees owed
1996 1997 1998 Jan-Sep1999
$72,309 $41,016 -$43,601 $33,560
Total
$190,486
$3,615 $2,051 $2,180 $1,678 $9,524
Programming launch payments
Some programmers have, in recent years, paid cable operators initial lump sum
amounts to secure carriage on cable systems. The Cable Co-op added a number of n~w
channels to its system during the last three years, one of whose programmers paid the Cable
Co-op a substantial amount in consideration for the Cable Co-op’s launch of the "Animal
Planet" Basic Service. As with other revenue items discussed above, it is clear that this
amount was "from or in connection with the distribution of any Service over the System".
In general, these payments are variously characterized in programming agreements as
launch support, launch incentives, launch bonus payments, or marketing support. In some
cases, a cable operator is supposed to submit actual marketing expense invoices to receive
payment, but in other cases no specific expenditures or receipts appear to be required. In this
specific case, the only documentation provided regarding the initial carriage of Animal
Ms. Sue Buske
December 14, 1999
Page t I of 12
Planet, ,,! not suggest any linkage between the per subscriber "launch support" or "launch
incenti, ~~’ to be paid and any marketing expendituress.
Nonetheless, the Cable Co-op’s view appears to be that these payments are not
revenue, but simply reimbursements of marketing expenses. In the Animal Planet case,
however, less than one quarter of the amount received was supported by actual marketing
expenditures and recorded in the Cable Co-op’s books as an offset to marketing expenses;
the remainder was recorded as a credit to programming expense.
We believe that, in this case, the payment from Animal Planet was received in
exchange for a service, namely in exchange for distribution of the Animal Planet channel as a
Service over the cable system and marketing/promotion activities connected with such.
distribution. Thus, in accordance with generally accepted accounting principles, the payment
was revenue earned by the Cable Co-op.
Furthermore, franchise fees are calculated as a percentage of gross revenue, not net
income after deduction of expenses. Thus, the fact that the Cable Co-op incurred some
additional marketing expenses in connection with the launch of Animal Planet is not a reason ¯
to offset or deduct such expenses from the gross revenue on which franchise fees are based.
For the review period, the total amounts of unreported revenue and the associated
franchise fees payments owing are:
Programmer launch
payments
Franchise fees owed
1996 1997 1998 Jan-Sep1999 Total
$0 $0 $160,026 $0 $160,026
$0 $0 $8,001 $0 $8,001
8 The Cable Co-op did not have a copy of the actual underlying programming contract and, as of this writing,
has not been able to obtain one from other parties involved in the arrangement.
Ms. Sue Buske
December 14, 1999
Page 12 of 12
Summary
In summary, the total mounts of unreported revenue and other adjustments discussed
above, as well as the total franchise fees owing, for the review period are:
Cable modem service ’
revenue
Bad debt expense
Itemized franchise fees
1996 1997 1998 Jan-Sep 1999 Total
$0 $0 $12,094 $37,860 $49,954
$20,330 $0 ($9,968)($1211292) ($110,930)
$584,056 $649,400 $676,441 $534,204 $2,444,101
$11,846 $14,241 $12,441 $9,968 $48,496
$98,005 $104,027 $103,231.$87,995 $393,258
$0 $31,746 $t,934 $15,365 $49,045
$7,155 $9,715 $5,547 $1,932 $24,349
$205,247 $233,356 $336,734 $263,155 $1,038,492
$72,309 $41,016 $43,601 $33,560 $190,486
Itemized FCC fees
Administrative (late) fees
Construction revenues
Cable store revenue
Advertising sales revenue
Home shopping channel
revenues
Programmer launch
payments
Total revenue
Franchise fees owed
$0 $0 $160,026 $0 $160,026
$998,948 $1,083,501 $1,342,081 $862,747 $4,287,277
$49,948 $54,175 $67,104 $43,137 ~;214,3641
We also note that it appears that the Cable Co-op has been excluding many of these
revenue types from the franchise fee payment calculations for some years prior to the review
period. Since FCC fees did not exist prior to late 1994 and may not have been itemized until
later, such revenue is not likely to be significant. Launch payments, if any, are likely to be
de minimus in prior periods. However, the City may wish to request that the Co-op provide
an accounting of 1) itemized franchise fees, 2) administrative (late) fees, 3) construction
revenue, 4) cable store revenue, 5) advertising sales revenue, and 6) home shopping channel
revenues, for prior years and provide payment of associated franchise fees. \ .
Please call me if you have any questions regarding this letter or need any further
assistance.
Sinc~r,~ours,
Michael S. Katz