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HomeMy WebLinkAbout2.a. Settlement AgreementAGENDA ITEM: Settlement Agreement AGENDA SECTION: Discussion PREPARED BY: Dawn Weitzel, Assistant City Administrator AGENDA NO. 2a ATTACHMENTS: Letter from Charter in response to the audit APPROVED BY: RECOMMENDED ACTION: Discussion 4 ROSEMOUNT CITY COUNCIL City Council Work Session: July 12, 2006 EXECUTIVE SUMMARY ISSUE: In response to the Franchise Fee Review Audit conducted in 2005, Apple Valley, Farmington and Rosemount are currently considering a settlement agreement and mutual release with Charter Communications. Lakeville has recently concluded negotiations with Charter and the settlement agreement is structured on then negotiations. BACKGROUND: At the June 15, 2005 Work Session cable Coordinator Mark Moore and Attorney Bob Vose of Kennedy and Graven met with Council to discuss the results of a franchise fee review conducted by FILB Tauges Redpath, Ltd This fast audit covered January 1, 2001 until December 31, 2003 and involved fourteen procedural areas. The final results of the reports indicated that the Cities could potentially be owed $70,000 collectively by Charter. In response to the audit Tucker Carlson, Director of Government Relations for Charter Communications, contended that Charter did not owe the Cities any money and suggested that money my actually be owed to them. The closing statement of his letter states that he would, however, be willing to consider the matter closed (see attachment). After seeing the negotiated settlement by the City of Lakeville, the Cable Commission determined that each individual City should meet to discuss settlements based upon Lakeville's agreement Because the agreement has yet to be negotiated with Charter, it will be provided to Council under separate cover. Bob Vose will be present at the work session to discuss the settlement agreement and mutual release. SUMMARY: Staff requests Council's direction in the settlement agreement and mutual release with Charter Communications. August 4, 2005 Mr Thomas Lawell Chairm an AVFR Cable Commission 7100 West 147 Street Apple Valley, MN 56124 RE: Rosemount Franchise Fee Audit RECEIVED 4U6 0 5 2005 Dear Mr. Lawell, Charter Cable Partners, LLC (formerly Marcus Cable Partners) doing business as Charter Communications has had an opportunity to review the issues raised in your desk review audit report dated February 15, 2005 (report) completed by HLB Tautges Redpath (auditor) of Charter Communications operations as they pertain to the payment of Franchise Fees to the City of Rosemount (City) Charter Communications appreciates the opportunity to address the issues raised by the City's auditor. The auditor addresses 14 subject areas in his report For the sake of clarity, we will comment on each of the 14 subject areas raised by the auditor in the order they appear in the report 1. Review of the accounting system controls over the revenues and cash receipts transaction cycle and the financial reporting cycle. No issues to address 2. Compare all subscriber fees, including installation/reconnection charges, pay per -view, remote control, guides. etc., from billings /receipts reports to franchise fee worksheets. No issues to address. 3. Review of procedures for allocating and reporting Home Shopping Revenues and analysis of the allocation between the City of Rosemount and other Minnesota service areas. No issues to address. 4. Obtain financial information, including general ledgers. tax returns, Form 10- K's and financial statements of the franchise company, and perform a reconciliation, to the extent practicable, of revenues reported in the financial information with revenues reflected in the detail records of the franchise company. No issues to address No issues to address The auditor references certain items here, which he substantively addresses in connection with Section 9 of his report. 9. Testing of Unarmlied Revenues The auditor's report identifies in the Confidential Data Section a number of account items and asserts that each should be included in the franchise fee calculation. Most of the financial impact of the items on this list is associated with the issue of launch fees and marketing reimbursement. Based on the entire list, the report claims the City is entitled to an additional franchise fee payment of $7,126 02 Initially we will address the items other than launch and marketing reimbursement. Many of the items on the list reflect revenue in relatively small amounts Charter acknowledges that identified items (See Attachment B) should be included in the franchise fee calculations. Our analysis of the identified items shows the city is entitled to an additional payment of $124.79. However, we note that the auditor asserts that additional items relating to bad debt should have been included This position is directly contrary to the auditor's position expressed earlier in Section 5 of the report with respect to bad debt. As noted above, Charter had not been taking the adjustment to revenue for bad debt to which it was entitled prior to year end 2003. The items on the auditor's list relating to bad debt are all adjustments to bad debt Since Charter was not including bad debt expense prior to 2003, these adjustments to bad debt were not included either. However, Charter included these items in the amount it recorded as an adjustment for bad debt in December 2003. The auditor double- counted bad debt items for the months of January November 2003 and added them to the December 2003 total. The auditor then triple counted these entries by including them in his list of unapplied amounts. (See Attachment A) Charter agrees that bad debt expense should be included for all years in the audit, and these items are also appropriately included in the calculations of the total amount of bad debt expense (See Attachment C) The auditor also includes an entry for "Other CBN Revenue" on the list of items he claims should have been included This assertion is incorrect because the only revenue in this account relates to Internet revenues on commerciallbusiness accounts Thus, it does not reflect revenue from cable service and are properly excluded In addition, there are several other entries that the auditor overlooked in evaluating adjustments to the franchise fee associated with "unapplied revenue If the items listed in Attachment B are to be included in the calculations, then the following items should have also be included. Basic Revenue Adjustment Expanded Service Basic Plus Equipment Rent Adjustment Coupon Redemption Discounts Contra Revenue Dish Buy Back This was also the accepted view by the accounting profession when a special task force set up by the Financial Accounting Standards Board was asked to confer and determine if there was an existing consensus as to the proper characterization of payments by a vendor to a customer. The Emerging Issues Task Force charged with examining this issue concluded that there was a consensus that as a general rule, "cash consideration received by a customer from a vendor is presumed to be a reduction of the prices of the vendor's products and services." This is based on the notion that "vendor's providing of sales incentives and cash considerations to a reseller is so integral to the determination of the prices of a vendor's product that the cash consideration cannot be separated from the reseller's purchase of the vendor's products or services. (EITF Issue No 02 -16, Issue Summary, p. 3 n. 1.) There were two relevant exceptions to the general rule. The first was that if the cash consideration represented "a reimbursement of a specific, incremental, identifiable cost incurred by the customer in selling the vendor's product or services," then such cash consideration represented a reimbursement of such costs and should be characterized as a reduction of those costs. The second exception addressed the situation where the cash consideration represented a payment for assets or services delivered to the vendor that were "separable from the customer's purchase of the vendor's products." (November 21, 2002 EITF Meeting Minutes, p. 3.) It was only in this Iatter case of a payment for unrelated assets or services, that payments were understood by the business and accounting communities (and the government) as giving rise to revenue. The SEC has determined that all of Charter's launch and marketing support falls within the general rule that this support is not revenue. Charter previously included a portion of the launch fees as advertising revenue, because in some cases, Charter provided cross channel advertising as part of the same carriage agreement under which launch and marketing incentives were provided. This practice, however, was challenged by the SEC during its review of Charter's accounting practices, which the SEC initiated in September 2002 as part of its Fortune 500 Review. The process entailed a thorough review by KPMG and Charter of Charter's financial documents, including all of Charter's carriage agreements. The facts and results of this review were shared with the SEC both verbally and in a detailed written document. After reviewing the findings presented by Charter and KPMG, the SEC determined that no portion of launch fees could be included by Charter as revenue because the revenue earning event, i.e promotion of the new channel, could not be separated from the carriage agreement. Moreover, the SEC determined that Charter could not demonstrate that advertising services provided to programmers are specifically required by Charter's carriage agreements. Based on these findings, among others, the SEC required Charter to book all launch incentives as a reduction of the fee charged by the programmer for carriage of service over the life of the carriage agreement, and not as revenue. This determination has a side benefit to Charter's basic service customers, as it has the effect of reducing the costs that Charter may include in its rate base 1 Additional information regarding the FASB and the EITF can be found Into /www.fasb org. or attributable to the provision of Cable Service by the Grantee within the City Because the contested amounts are not "revenue" under any commonly accepted definition of the term, they also are not "Gross Revenue" as that term is defined in the applicable franchise agreements. It appears the auditor is employing an improper reading of the contractual definition of "Gross Revenue" to magically convert that which is not even "revenue" into "Gross Revenue" on which the auditor alleges Charter must pay franchise fees. While this may be financially beneficial to the City, such an interpretation is contrary common sense. Launch and marketing incentives are not attributable to the provision of Cable Service, because, as stated above, a programmer does not pay for the right of carriage Rather, a cable operator pays for the right to carry programming. Launch and marketing incentives are simply a reduction in the price paid for the programming. The definition of gross revenue under the franchise agreement simply cannot be read in a manner that would include amounts that are not even commonly understood to be revenue The fact that the parties used the term "Gross Revenue" implies that they intended the term to include only amounts that are actually revenue There is a difference between deducting an expense from revenue, which is contrary to the notion of gross revenue, and looking at a transaction as a whole to determine whether there is revenue in the first place. The fundamental flaw in the auditor's claim is that it appears to have looked at only parts of transactions taken out of context and in the process have manufactured "phantom revenue If such phantom revenue were allowed to be treated as real revenue, parties to a transaction could artificially inflate their revenues merely by the way they structure their transactions Party A could give Party 13 $100 million, and Party 13 could in return give Party A $100 million 3 The substance of such a nonsense transaction is that neither party gained anything in revenue. Yet under the City's approach each party would have received $100 million in revenue. This is an absurd result and therefore should not be followed Mondou v. Lincoln Mut. Casualty Co., 283 Mich. 353, 358 (1938) "Worship of the literal should not overcome common sense or be used to bring about an absurdity if it can be avoided McGannon v. Michigan Millers'Mut. Fire Ins. Co., 127 Mich. 636, 649 (1901) "Like all contracts made between private parties, and like all statutes, for that matter, they must receive a reasonable interpretation, which will not work injustice or lead to absurd consequences The Federal Cap on Franchise Fees Under applicable federal and state law, the maximum franchise fee that may be imposed on a cable operator by a franchising authority is set at five percent of the cable operator's gross revenues In particular Section 622(b) of the Communications Act, 47 U.S.C. 542(b) provides For any twelve -month period, the franchise fees paid by a cable operator If 3 Indeed, a telephone companies were criticized a couple of years ago for engaging in a similar practice, whereby they would exchange fiber lease nghts with another company, and each would claim revenue for the sale of their own fiber lease and claim depreciation of a capital expense for the purchase of the other's fiber lease ascertained by looking to common sources of definitions, i.e., "[d]ictionary definitions, industry practice, and accounting standards Id. at 395. Significantly, the Dallas court itself recognized that generally accepted accounting principles "GAAP apply to the interpretation of the meaning of the term "Gross Revenues For example, the Fifth Circuit relied on the Financial Accounting Standards Board's Statement of Financial Accounting Standards No 51 to establish that cable franchise fees are "costs" Id. Fundamentally, to be consistent with any accounting standard, Gross Revenues must be derived from amounts that are actually "revenue As discussed above, it is clear that launch and marketing incentives are not revenue under dictionary definitions, industry practice and accounting standards. Consequently, under the Fifth Circuit's holding in Dallas, they are also not "gross revenues" on which the franchise fee cap is based Thus, in the City, where Charter is already paying the maximum franchise fee of 5% of gross revenues, inclusion of launch and marketing incentives, which are not revenue, within the gross revenues on which Charter pays franchise fees would cause Charter to breach the cap in violation of federal law. 10. Testing of Payments for Timeliness The auditor states the payment for the third quarter of 2003 was received by the City on 12/31/03 was 32 days late The auditor asserts that the City is entitled to interest on the 32 days the franchise fee payment was overdue in the amount of $137 92, and further recommends that the City could impose a late payment penalty of $1,600 Charter has not been able to confirm the accuracy of the statement that the payment was late. Our accounting records reflect that the check and letter was prepared on a timely basis, but we are not able to verify the date they were actually received by the City. We do not have any letters from the City inquiring about the status of the payment, and the first indication of concerns about the timing of the payment was in the auditor's report. Assuming the statement is accurate, we believe the auditor's recommendations are unreasonable The assessment of a $50 per day penalty would clearly be unreasonable in proportion to the harm if any to the City from the overdue payment. In addition, the franchise indicates that the franchise fee payments are due 60 days after the end of the quarter The dates of receipt of payment listed by the auditor indicates that most payments were made in less than 30 days If a single late payment justifies assessment of interest, then consideration must be given to the corresponding interest that should be due to Charter for the payments that were made prior to the due dates. 11. General Trend Analysis Internet Access Revenue a. Internet Access Revenue Page 10 The report claims the City is due a reimbursement of $3,319 16 for franchise fee on Internet Access Revenue from 2001 and 2002. As was noted in a letter to the City dated March 29, 2002, the FCC ruled (FCC 02 -77) that cable modem services are "interstate information services" and not "cable services" subject to franchise fees. Subsequent to that letter, the United Charter does not take issue if the City wishes to test further customer invoices. However it must be noted that there seems to be some faulty math by the auditor They calculated bills from multiple years and failed to account for the floating true -up amounts implemented for non subscriber revenues. 13. Catch up Check Remittances The auditor recommends City inquiry towards the implementation of late fees on the payments received The auditor correctly identified the reason for the October 2001 check in the amount of $502.73. As noted in the supporting documentation the check represented payment for Advertising Revenues that had been inadvertently excluded from our payment calculation in January and June 2001. This was a result of a glitch within our automated system which failed to include the manual revenue at the time of the original calculation. The February 2004 payment of $3,537 53 represented fees due on National Ad Sales Revenue. These revenues were received, and had been recorded, on a Holding Company ledger beginning in 2000. It was determined that they should be allocated to the system level for the purpose of franchise fee calculations. They were allocated on the basis of' subscribers and additional fees for the years 2000 through 2004 were paid to the City. 14. Traced Amounts Through Charter's Financial Accounting System The report identifies two items the auditor couldn't trace through the financial statements. The items identified by the auditor were miscoded on the particular statement. The auditor then arbitrarily and inappropriately includes additional contra revenue items in this section and claims the City is due a payment of $42 26 As commented on above, these types of adjustments are reflected as contra revenue. Contra revenue represents revenue items that are booked as revenue one month (the purchase of a PPV movie) and then credited the next (a discount coupon for the PPV movie) Again, these items are always appropriate to include in the calculation of franchise fees because they reflect revenue that was not actually received by the Company Charter Communications hopes you find the attached answers, and supporting confidential documents, fully responsive to the issues raised in the report. If the City requires further information please notify me in writing. Otherwise Charter Communications will consider this matter closed. Arne "Tucker" Carlson Director of Government Relations Charter Communications SMN/NE KMA CITY OF ROSEMOUNT FRANCHISE FEE REVIEW February 2005 CITY OF ROSEMOUNT FRANCHISE FEE REVIEW TABLE OF CONTENTS Independent Accountant's Report Section I Procedures and Results Section II Summary of Recommendations HLB Tautges Redpath, Ltd. Certified Public Accountants and Consultants Members of the City Council City of Rosemount Rosemount, Minnesota INDEPENDENT ACCOUNTANT'S REPORT We have applied certain agreed -upon procedures, as discussed below, to the franchise fee reports submitted by Charter Communications to the City of Rosemount for the period January 1, 2001 to December 31, 2003. Our review was made solely to assist you in evaluating the degree of compliance by Charter Communications with the terms of the franchise ordinance. It is understood that in accordance with the Confidentiality Agreement with Charter Communications, our report is solely for your information and is not to be used for any purpose by anyone who is not a member of the City Council in the City of Rosemount, or an otherwise authorized representative, and Charter Communications. The procedures we performed are summarized as follows: 1. Review of the accounting system controls over the revenues and cash receipts transaction cycle and the financial reporting cycle. 2. Comparison of subscriber fees, including installation/reconnection charges, pay per view, remote control, guides, etc. from billings /receipts reports to franchise fee worksheets. 3. Review of procedures for allocating and reporting Home Shopping Revenues and analysis of the allocation between the City of Rosemount and other Minnesota service areas. 4. Obtain financial information, including general ledgers, tax returns, and financial statements of the franchise company, and perform a reconciliation, to the extent practicable, of revenues reported in the financial information with revenues reflected in the detail records of the franchise company. 5. Review of procedures for reporting refunds and bad debts. 6. Compare all franchise fee worksheets with franchise fee payment schedules submitted to the franchise authonty. 7. Test methodology of identifying new, disconnect, change of service, bulk accounts and full service in a timely manner. 4810 White Bear Parkway White Bear Lake, Minnesota 55110 1303 South Frontage Road Suite 13 Hastings, Minnesota 55033 651 426 7000 651 426 5004 Fax 651 480 4990 651 426 5004 Fax HLB Tautges Redpath, Ltd is a member of E hternational, a world wide organization of accounting firms and business advisors www hlbtrcom 5881951 8 Review Chart of Accounts to test for revenue items not included In the franchise fee allocation. 9. Testing ofunapplied revenue. 10. Testing of payments for timeliness. 11. Trend Analysis. 12. Franchise Fee Bill testing for randomly selected individual customers. 13. Catch -up Check Remittances. 14. Traced Amounts through Charter's Financial Accounting System. Section 1 of this report details the above procedures and results. A summary of recommendations is presented in Section II. Because the above procedures do not constitute an examination in accordance with auditing standards generally accepted in the United States of America, we do not express an opinion on the City of Rosemount's or Charter Communications' financial statements. Had we performed additional procedures or had we made an examination in accordance with auditing standards generally accepted in the United States of America, other matters might have came to our attention that would have been reported to you. This report relates only to the accounts and items specified above and does not extend to any financial statements of the City of Rosemount or Charter Communications. February 15, 2005 lite 7;44 444' t-*t HLB TAUTGES REDPATH, LTD. Certified Public Accountants 2 I SECTION I City of Rosemount Franchise Fee Review- Procedures and Results 1) Review of the accounting system controls over the revenues and cash receipts transaction cycle and the financial reporting cycle. Procedure: We obtained an understanding of accounting system controls, billing processes, month -end cut -offs, and the cash receipts transaction cycle and reporting cycle from Charter Communications personnel. Results: We have obtained an understanding adequate to perform our testing procedures. 2) Compare all subscnber fees, including mstallation/reconnection charges, pay per -view, remote control, guides, etc., from billings /receipts reports to franchise fee worksheets. Procedure: We tested this at Charter Communications with information provided to us, and the testing from the billing receipt books to franchise reports was accurate. Results This is a desk review item, and it may not "prove" much, as this testing merely ties one report to the other. We would need to test the actual billing /receipts books (subledger) detail (i.e., the support documentation for their subledger) to determine if all revenues related to the City of Rosemount have been included in the franchise fee calculation. We compared three franchise fee worksheets to what was remitted to the City of Rosemount for the corresponding quarter. No exceptions were noted. 3) Review of procedures for allocating and reporting Home Shopping Revenues and analysis of the allocation between the City of Rosemount and other Minnesota service areas. Per our conversation with Charter Communications, they allocate both Home Shopping Revenue and advertising revenue based on the number of subscribers. The Cable Company computes Home Shopping Revenues using a percentage that is approximately equal to the number of subsenbers in Rosemount divided by the number of subscribers in the 8576 -2100 area. This area includes the following cities: Fanbault, Farmington, Lakeville, Apple Valley, Rosemount, Redwing, Northfield town and Empire Township. City of Rosemount Franchise Fee Review Procedures and Results 4) Obtain financial information, including general ledgers, tax returns, Form 10 -K's and financial statements of the franchise company, and perform a reconciliation, to the extent practicable, of revenues reported m the financial information with revenues reflected in the detail records of the franchise company. Procedure: After discussing this with Charter Communications, it was determined that this step isn't practical Any financial statements and tax returns of the franchise company (Charter Communications) are not detailed by location specific enough to the City of Rosemount that it does us any relevance to test this area or try to do trend analysis. We have instead relied on specific revenue testing (see step 5, 8 and 9). Results: No further testing recommended. 5) Procedure• Test the reporting of bad debts, refunds, and NSF checks on the summary of revenue worksheets provided by Charter Communications to the city of Rosemount on a quarterly basis. Results We found that Charter deducted bad debt expense of $11,367.76 in the fourth quarter of 2003. This was the only instance in which Charter deducted bad debt expense during the time period tested. Based on the Franchise Agreement, Charter is not allowed to deduct had debt expense from the gross revenue calculation. The agreement clearly states in Section 1,2m: .The term gross revenues shall not include bad debt, or any taxes on services furnished by Grantee which are imposed by any municipality, state, or other governmental unit and collected by Grantee for such governmental unit The Agreement states that Charter is not required to include bad debt in its franchise fee calculation, in other words, Charter is only required to pay franchise fees on cash received. The Agreement does not state that Charter is allowed to deduct bad debt expense from the franchise fee calculation. How can there be a deduction for bad debt expense if Charter never paid franchise fees on the uncollected amounts? Furthermore, it is inconsistent that they would have chosen to deduct bad debt only one time in three years. 4 City of Rosemount Franchise Fee Review Description Amount Fourth Quarter 2003 bad debt reduction $11,367.76 5% Franchise Fee 5 00% Estimated Underpayment $568.39 Results: No exceptions noted. Procedures and Results Based on a franchise fee of 5 it appears the total omitted from the payment to the City was $568.39, calculated as follows: Recommendations: We recommend that Charter reimburse the City for franchise fees omitted from the calculation due to the deduction of bad debt expense. 6) Compare all franchise fee worksheets with franchise fee payment schedules submitted to the franchise authority. Procedure. Obtained an understanding of the recording of franchise fees from the individual subscriber level through to the franchise fee submitted to the City. That process is as follows Individual customer billings are generated in Charter's financial system on a statement titled "Subscriber Statement Ledger." This ledger details customer charges by service code and payments made by customers. Subscriber Statement Ledgers are then aggregated by service code on a "Financial Summary Report." The Financial Summary Report also totals detailed service codes into more general service areas (i.e. all types of installs are detailed out and then totaled into a description called installs) Service area totals from the Financial Summary Report are then aggregated and brought up to a "Franchise Validation By FTA" report. The Franchise Validation By FTA Report is a summary of what is in Charter's general ledger and what is sent to the City. Amounts are then pulled from the Franchise Validation By FTA report onto the "Summary of Revenues Subject to Franchise Fee" report, which is sent to the City. Procedure We compared these franchise fee worksheets with franchise fee payment schedules for one quarter, each from 2001, 2002 and 2003. City of Rosemount Franchise Fee Review 7) Test methodology of identifying new, disconnect, change of service, bulk accounts and full service in a timely manner. Procedure Charter Communications personnel gave us a general understanding of how the process works, it is generally prorated from the date of the change in service. We tested certain accounts that had service interruptions, disconnects or initial connections, and found that these accounts were prorated on the billings or in most cases, if it was a disconnect, the billing was stopped or cut -off on the day that service terminated. Results No exceptions noted, no further testing recommended. 8) Chart of Accounts Several questions arise from of the chart of accounts analysis: Procedures and Results Procedure. Charter Communications provided us with detail reports that listed more accounts than are mcluded in the franchise fee calculation. We were also provided with a revenue tie -out from the Charter Communications general ledger that listed the amounts in each account listed with the portion traced to the Franchise Fee payment sheet. Results: The revenues as listed in the Charter Communications general ledger City of Rosemount account did trace directly to the franchise fee payment sheet. As part of our audit procedures, we examined all of the revenue accounts in the Charter Communications chart of accounts. We determined that several other accounts should be included in the gross revenue franchise fee calculation. Our testing procedures disclosed that numerous line items in the Charter Communications ledger summaries are not included in the calculation of franchise fees. We understand that certain of these items, such as sales tax may not be required to be included in the franchise fee calculation However, there are several items that should be included in the calculation, or at the Least there is no provision in the Franchise Ordinance definition of gross revenue that would allow these items to be excluded. See next section, Testing of Unapplied Revenue for further detail. 6 9) Testing of Unapplied Revenue Procedure: We reviewed Charter's Franchise Validation by FTA reports for 2003, 2002 and 2001. The purpose of our testing was to review revenue items that are not included in the franchise fee calculation. We understand that certain items are not required to be included in the franchise fee calculation based on the definition of gross revenues as provided in the franchise agreement. Those excluded items include: State sales tax City tax local option PT Dish buy back Deferred customer acquisition cost FCC fees We also noted that following accounts that appear to be balance sheet accounts, not revenue accounts and therefore would not be required to be included in the franchise fee calculation. A/R trade .A/R other A/R reconciling item Procedures and Results However, notwithstanding the above excluded items, we noted the following items, which are revenue items, are not included in the franchise fee calculation. The definition of gross revenues, according to the franchise ordinance, is as follows: "Gross Revenues" means all revenue received directly or indirectly by the Grantee, its affiliates, subsidiaries, parents, or any Person in which Grantee has a financial interest of five percent ON or more, arising from or attributable, to the provision of Cable Service by the Grantee within the City including, but not limited to, monthly fees charged to Subscribers for Basic Cable Service; monthly fees charged to Subscribers for any optional service; monthly fees charged to Subscribers for any tier of service other than Basic Cable Service. Installation, disconnection and reconnection fees, leased Channel fees, converter and remote revenues; advertising revenues, and revenues from home shopping Channels. Gross Revenues shall be the basis for computing the Franchise Fees imposed pursuant to Section 1.20 hereof Grantee shall not be required to pay a franchise fee on gross revenues derived from any Person receiving free Cable Service pursuant to a Franchise 7 City of Rosemount Franchise Fee Review Procedures and Results Agreement Gross Revenues shall include franchise fees collected by Grantee on behalf of the city The following revenue accounts should be included in the "Franchise Fee Calculation:" The calculation is based on data provided by and examined at Charter Communications. Results: We understand that Charter does not consider launch fee reimbursements to be a revenue item. However, launch fees are posted to an operating account in Charter's financial reconciliation Also, the fact that Charter may choose to use the launch reimbursement to pay for other new channel related items does not change the fact that they are revenues received "directly or indirectly by the grantee" as provided in the definition of gross revenue in the Franchise Ordinance. Recommendation: We recommend that Charter reimburse the City for the above listed unapplied revenue items. The amount of the underpayment is $7,126.02. Launch Fees, Marketing Reimbursements and Other Rebates Generally accepted accounting principles (GAAP) define revenue as inflows or other enhancements of assets of an entity or settlements of zts liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations See City of Dallas v FCC, 118F 3d 393 395 (5"' Cir 1997); In re City of Pasadena, 16 FCC Red 18192, para 15 (gross revenues are denved from "all money collected" by the cable operator) Launch fees, marketing reimbursements and rebates meet the definition of revenue above, as they are all "activities that constitute the entity's ongoing major or central operations." Emerging Issues Task Force Statement 01 -14 further supports this classification of such items as revenue. The Task Force agreed that income statement characterization as revenue of reimbursements received for out -of- pocket expenses incurred is also consistent with the guidance in SOP 81 -1 8 City of Rosemount Franchise Fee Review Testing of Payments for Timeliness Procedure. Reviewed all quarterly payments from Charter Communications for all four quarters of each year (2001. 2002, 2003) to verify that payments from Charter were made during the time frame (60 days from quarter end for Rosemount). Results: One exception noted. Rosemount received their third quarter 2003 franchise fee payment on December 31, 2003, or 92 days after the quarter end. The payment is 32 days late. The Franchise does not specify the interest rate owed the City for late payments. A reasonable amount of interest would be the applicable federal rate, which approximates 5 The penalty for violating the franchise requirement is $50.00 per day If a penalty were to be imposed, the penalty for the late fee in this instance would total $1,600.00. Recommendation Request interest for the 32 days in which the franchise fee payment was late This amounts to $137 92, computed as such: $31,463.34 x 5% x (32/365) Additionally, we recommend that the City seek penalties as provided for in the Franchise Agreement for violating the Franchise Agreement. The amount of the penalty is $1,600.00. A review of payments for timeliness (60 days) is as follows: Date of Payment From Year Quarter Charter 2003 1 4/30/2003 2003 2 7/29/2003 2003 3 12/31/2003 2003 4 1/22/2004 2002 1 4/29/2002 2002 2 7/26/2002 2002 3 10/26/2002 2002 4 1/29/2003 2001 1 4/16/2001 2001 2 7/27/2001 2001 3 10/15/2001 2001 4 1/26/2002 Procedures and Results City of Rosemount Franchise Fee Review 11) General Trend Analysis Internet Access Revenues Procedures and Results Procedure: Compared all 2003, 2002 and 2001 amounts submitted to the City for consistency and reasonableness Results We found that Internet Access revenues were only included in the amounts submitted to the City for the months of July and August 2001 and March 2002. The amounts were substantial in July and August 2001, S6,734.19 and $6,802 42, respectively. For March 2002, the amount submitted was $83 98 Charter stopped payment on intemet services after March 15, 2002. however, it would be expected that the City would have received Internet service revenues for every month until March 15, 2002 A summary of Internet charges that Charter did not pay franchise fees on is as follows: The calculation is based on data provided by and examined at Charter Communications. Recommendations: We recommend that Charter reimburse the City for the amount of intemet access revenue not applied to franchise fees of $3,319.16. General Trend Analysis Advertising and Home Shopping Revenue Procedures: In January and June 2001 we found that Charter did not submit Advertising or Home Shopping revenue to the City. It was later found that Charter submitted the following payment with a separate check for the missing months in October 2001: The calculation is based on data provided by and examined at Charter i Communications. In Section 7b the Franchise Ordinance states: Any payments due under this provision shall be payable quarterly. The payments shall be made within sixty (60) days of the end of each of Grantee's current fiscal quarters together with a report in form reasonably acceptable to City and Grantee which shows the basis for the computation The amounts above are the same as those remitted to the City in October 2001. We found that the monthly Ad Sales and Home Shopping revenues do not total the $36,212.01 and $6,786.65 figures shown in the column descriptions. We reviewed these remittances for Lakeville and the AFRCC cities and found that the column titles were all the same. They all showed the $36,212.01 and $6,786.65 figures and in no remittance did the monthly amounts 10 City of Rosemount Franchise Fee Review Procedures and Results agree to the column figures. We reviewed the amounts further to see if a portion of the column descriptions were allocated between the Cities, however, we found that the sum for all of the Cities does not agree with the amounts in the descriptions. Recommendations. We recommend the City inquire as to any late fees that may be assessed on the payment since it was received over 60 days past quarter end. We also recommend that Charter provide support documentation for the amounts remitted for January and June 2001. General Trend Analysis Advertising Revenue Analysis: The dollars amount in advertising revenue range from $3,728 to $21,741 in the three years tested as shown below: The calculation is based on data provided by and examined at Charter Communications. Results. Advertising revenue as a percent of total revenue has risen from 3.74% to 8.20% from 2001 to 2003 as shown above. We understand that Charter reimbursed the City for an advertising omission on February 13, 2004. However, we do not have any support documentation for how the amount of the omission was amved at or if the City was fully reimbursed for advertising revenue for that period. Recommendation: The amount of advertising revenue has increased 2.5 times (150 from 2001 to 2003. The number of cable subscnbers has increased by approximately 5% in the same time period. It does not make sense that advertising revenue has had that dramatic of an increase. We recommend that Charter provide support documentation for the increase and reimburse the City for any unreported advertising revenues in 2001 and pnor years. We also recommend that Charter provide detailed accounting of how it arrived at its "Advertising Omission" amount of $70,750.63 provided in its letter to the City dated February 13, 2004. General Trend Analysis Other Revenue In 2003, Other Revenue totaled $6,918.30. In 2002 and 2001, Other Revenue totaled $0 and c$14.89 respectively. It appears that Other Revenue has been applied inconsistently throughout the time frame tested. Also, the franchise fee ordinance does not permit Charter to deduct for negative revenues. This also raises concem that other negative revenues are being applied to accounts and reducing the amount submitted to the City. 11 Procedures and Results Recommendation We recommend that Charter provide detail as to what comprises the other revenue accounts that franchise fees were paid on in 2003 and provide an explanation as to why there was no other revenue in 2002 or 2001. 12) Franchise Fee Bill Testing Procedures Obtained bills for thirteen randomly selected Charter Customers. Tested a total of sixteen billings from the thirteen customers selected. Recalculated the franchise fee based on the amount of gross revenues related to video services. Also, calculated the franchise fee on the fee for each customer. The total franchise fee per bill should have been 5.57 Results For Bills #7 and 11 a, Charter's calculation differed from ours by $.18. This difference was due to Charter not including the 30 Day Processing fee in their calculation. This difference resulted in the City not receiving 5% on processing fee revenue. There were six instances in which our calculation differed from the amount billed by $.01. These differences are considered purely due to rounding. Recommendations: We recommend that the City test a larger sample of bills to verify all amounts have the appropriate franchise fee charged. Also, we recommend that the City request a reimbursement for all amounts that should have been charged a franchise fee and were not. 13) Catch -up Check Remittances Procedures We reviewed supporting documentation remitted to the City and found that catch -up payments for $502.73 and $3,537.33 were made in both October 2001 and February 2004, respectively. The payment in October 2002 was for Ad Sales and Home Shopping and the payment in February 2004 was for advertising revenue, such as time purchased by local merchants for commercial spots. These payments should have been made more than sixty days earlier. In Section 7b the franchise agreement states: Any payments due under this provision shall be payable quarterly. The payments shall be made within sixty (60) days of the end of each of Grantee's current fiscal quarters together with a report in form reasonably acceptable to City and Grantee which shows the basis for the computation. 12 City of Rosemount Franchise Fee Review Recommendations We recommend the City inquire as to any late fees that may be assessed on the payment since it was received over 60 days past quarter end. 14) Traced Amounts Through Charter's Financial Accounting System. Procedures and Results Procedure: Verified amounts carried forward from the Financial Summary Report to the Franchise Validation By FTA report and through to the Summary of Revenues Subject to Franchise Fee report sent to the City for April 2001. Results: We found two amounts that did not carry forward from the Financial Summary Report "EFT Customer" for $2.00 and the "Man Ref Add" for $1 96 These two line items were negative on the report, however, this may raise concern that not all amounts carry- forward through the accounting system properly. It does not appear the amounts were omitted from the calculation because they were negative, and thus not considered gross revenue, because the following negative amounts carried forward: The calculation is based on data provided by and examined at Charter Communications. The franchise agreement does not allow Charter to deduct for negative revenues, which would be considered expenses, so the above items should not be included in the calculation. The total omitted from payment to the City was $42.26, calculated as follows: The calculation is based on data provided by and examined at Charter Communications. An analysis of each month from each year would likely reveal more dollars. Recommendations: We recommend the City seek reimbursement for the items listed above and we recommend the City review a larger sample to verify all amounts were brought forward properly to the Summary of Revenues Subject to Franchise Fee report sent to the City. SECTION II City of Rosemount Franchise Fee Review Test the Reporting of Bad Debts and Refunds Procedure No. 5 Timeliness of Payments Procedure No. 10 1. We recommend that Charter reimburse the City for franchise fees omitted from the calculation due to the deduction of bad debt expense in the amount of $568.39. (page 5) Testing of Unapplied Revenue Procedure No. 9 Summary of Recommendations 2 We recommend that Charter reimburse the City for the revenue items in the amount of $7,126.02. (page 8) 3. We recommend that Charter pay interest for the 32 days in which the franchise fee payment was late for 3` quarter 2001 The amount is $137.92. Additionally, we recommend that the City seek penalties as provided for in the Franchise Agreement for violating the Franchise Agreement. The amount of the penalty is $1,600.00 (page 9) General Trend Analysis Procedure No. 11 4. We recommend that Charter reimburse the City for the amount of internet access revenue not applied to franchise fees in the amount of $3,319 16. (page 10) 5. We recommend the City inquire as to any late fees that may be assessed on the payment since it was received over 60 days past quarter end We also recommend that Charter provide support documentation for the amounts remitted for January and June 2001. (page 11) 6. We recommend that Charter provide support documentation for the increase and reimburse the City for any unreported advertising revenues in 2001 and pnor years. We also recommend that Charter provide a detailed accounting of how it amved at its "Advertising Omission" amount of $70,750.63 provided in it's letter to the City dated February 13, 2004. (page 11) 7. We recommend that Charter provide detail as to what comprises the other revenue accounts that franchise fees were paid on in 2003 and provide an explanation as to why there was no other revenue in 2002 or 2001. (page 12) 14 City of Rosemount Franchise Fee Review Franchise Fee Bill Testni Procedure No. 12 Summary of Recommendations 8. We recommend that the City test a larger sample of bills to verify all amounts have the appropriate franchise fee charged Also, we recommend that the City request a reimbursement for all amounts that should have been charged a franchise fee and were not (page 12) Catch -up Remittances Procedure No. 13 9. We recommend the City inquire as to any late fees that may be assessed on the payment since it was received over 60 days past quarter end. (pagcs 12 -13) Traced Amounts Through Charter's Financial Accounting System Procedure No. 14 10. We recommend the City seek reimbursement for the items listed and we recommend the City review a larger sample to verify all amounts were brought forward properly to the Summary of Revenues Subject to Franchise Fee report sent to the City. (page 13) 15