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HomeMy WebLinkAboutCC AG PKT 2010-02-22 #DAGENDA STAFF REPORT DATE: February 22, 2010 TO: Honorable Mayor and City Council THRU: David Carmany, City Manager FROM: Robbeyn Bird, CPA Director of Administrative Services SUBJECT: REPORT ON FRANCHISE FEE COMPLIANCE REVIEW OF TIME WARNER FOR THE PERIOD FROM AUGUST 1, 2006 THROUGH DECEMBER 31, 2007 SUMMARY OF REQUEST: Staff requests that the City Council receive and file the Report on Franchise Fee Compliance Review of Time Warner (TWC). BACKGROUND: On September 8, 2008, the City Council approved a professional services agreement between Diehl Evans and Company and the City to conduct an audit of the Time Warner franchise agreement. This project has been delayed numerous times due Time Warner being non- responsive to the requests submitted by our franchise agreement compliance auditors, Diehl Evans and Company. Page 3 of the attached report provides an executive summary of the compliance review. The projected franchise fees that have been under reported for the period covered are $28,222. There were numerous reasons that provided a basis for calculating the under reporting of franchise fees including, Failure of TWC to Define "Gross Receipts Failure of TWC to Submit Questionnaires or Representation Letters ➢ Failure of TWC to Respond to Cable Launch Fee Document Requests 9 Failure of TWC to Provide Agreements Related to Leisure World Failure of TWC to Explain or Document its "Bundle Discount" Methodology Failure of TWC to Provide Certain Documentation Re: Advertising Revenues Agenda Item Page 2 Due to TWC's non - cooperativeness, the scope of this compliance audit was limited and Diehl Evans and Company found it necessary to make certain assumptions in order to quantify the under reporting of revenue. FINANCIAL IMPACT: For the period of time covered by the report, Diehl Evans calculated that cable franchise fees were under reported to the City in the amount of $28,222. RECOMMENDATION: That the City Council receive and file the Report on Franchise Fee Compliance Review of Time Warner (TWC). SUBMITTED BY: �►oj Robbeyn bird, CPA Director of Administrative Services NOTED AND APPROVED: C!!P David Carman j, City Manager Attachments: A. Report on Franchise Fee Compliance Review of Time Warner Cable CITY OF SEAL BEACH REPORT ON FRANCHISE FEE COMPLIANCE REVIEW OF TIME WARNER CABLE FOR THE PERIOD FROM AUGUST 1, 2006 THROUGH DECEMBER 31, 2007 CITY OF SEAL BEACH FRANCHISE FEE COMPLIANCE REVIEW OF TIME WARNER CABLE TABLE OF CONTENTS APRIL 30, 2009 Cover Letter Pa e s Independent Accountants' Report on Applying Agreed -Upon Procedures 2 Executive Summary Summary of Scope Limitations and Failure of Time Warner Cable to Respond to Certain Document and Information Requests 4-5 Summary of Procedures Summary of Findings and Recommendations Attachments I — Memorandum dated October 29, 2008 — Analysis of the "Definition of Gross Receipts" 2 — Subscriber Revenue Questionnaire 3 — Advertising Revenue Questionnaire for Time Warner Cable's Corporate Headquarters G 7 -8 4 — Cable Launch Fee Document Request Form DIEHL, EVANS & COMPANY, LLP CERTIFIED PUBLIC ACCOUNTANTS & CONSULTANTS MICHAI.1 R. LUDIN, CPA A PARTNERSHIP INCLUDING ACCOUNTANCY CORPORATIONS CRAIG W. SPRAKER, CPA NITIN P. PATEL. CPA ROBERT L CALLANAN, CPA 5 CORPORATE PARK, SUITE 100 "PHILIP H. HOLTKAMP, CPA IRVINE, CALIFORNIA 92606 -5165 'HARVEY MSC OEDER, CPA (949) 399 -0600 • FAX (949) 399 -0610 KFNNETH R AMES, CPA www.diehlevans.com - WILLIAM C. PENr4 CPA •A PROFESSIONAL CORPORATION Cover Letter April 30, 2009 City Council City of Seal Beach Seal Beach, California We have completed our franchise fee compliance review of Time Warner Cable (referred to in this report as "Time Warner" or "TWC ") for the period from August 1, 2006 through December 31, 2007. Our independent accountants' report on this review is included herein on page 2. An Executive Summary of our findings is included at page 3. The details of our procedures, findings and recommendations are contained on pages 6 through 8. In connection with this review, we had major scope limitations, due to the failure of Time Warner to respond to our questionnaires and certain document and information requests. These matters are summarized on pages 4 and 5 herein. Also, in connection with this engagement, our firm executed a Nondisclosure Agreement with Time Warner. In order to protect the confidential and proprietary nature of certain information obtained from Time Warner during this review, we have only included summarized information within this report. We thank the City Of Seal Beach for retaining our firm for this engagement. Please contact us if you have any questions regarding the procedures, findings or recommendations herein. Very truly yours, Diehl, Evans & Company, LLP By William S. Morgan, CPA Director of Consulting Services -1- OTHER OFFICES AT: 2965 ROOSEVELT STREET 613 W. VALLEY PARKWAY, SUITE 330 CARLSBAD, CALIFORNIA 92008 -2389 ESCONDIDO, CALIFORNIA 92025 -2598 (760) 729 -2343 • FAX (760) 729 -2234 (760) 741 -3141 • FAX (760) 741 -9890 DIEHL, EVANS & COMPANY, LLP CERTIFIED PUBLIC ACCOUNTANTS & CONSULTANTS A PARTNERSHIP INCLUDING ACCOUNTANCY CORPORATIONS 5 CORPORATE PARK, SUITE 100 IRVINE, CALIFORNIA 92606 -5165 (949) 399 -0600 • FAX (949) 399 -0610 ww w.diehlev,ins.com April 30, 2009 INDEPENDENT ACCOUNTANTS' REPORT ON APPLYING AGREED -UPON PROCEDURES City Council City of Seal Beach Seal Beach, California MIC:IIAEL R LUDIN, CPA CRAIG w.SPRAKFR,CPA N1TIN P. PATEL, CPA ROBERT J.CALLAN.-N,CPA -PHILIP H. HOLTKAMP, CPA "THOMAS M. PERLOWSKI. CPA "HARVEY L SCHROEDER, CPA KENNETH R. AMES, CPA 'WILLIAM C. PEN= CPA +A PROFESSIONAL CORPORATION We have performed the procedures enumerated herein, which were agreed to by the management of the City of Seal Beach (the City), solely to assist the City in evaluating the propriety of cable franchise fees paid by Time Warner Cable to the City for the period from August 1, 2006 through December 31, 2007. This agreed -upon procedures engagement was conducted in accordance with attestation standards established by the American Institute of Certified Public Accountants. The sufficiency of the procedures is solely the responsibility of the management of the City. Consequently, we make no representation regarding the sufficiency of the procedures described herein, either for the purpose for which this report has been requested or for any other purpose. Our procedures, findings and recommendations are presented herein on pages 6 through 8. We were not engaged to, and did not conduct, an examination of Time Warner Cable's franchise fee payments to the City for the period from August 1, 2006 through December 31, 2007. Accordingly, we do not express an opinion on such franchise fee payments. Had we performed additional procedures, other matters might have come to our attention that would have been reported to the City. This report is intended solely for the information and use of the City and is not intended to be and should not be used by anyone other than the City. -2- OTHER OFFICES AT: 2965 ROOSEVELT STREET 613 W. VALLEY PARKWAY, SUITE 330 CARLSBAD, CALIFORNIA 92008 -2389 ESCONDIDO, CALIFORNIA 92025 -2598 (160) 729 -2343 • FAX (760) 729 -2234 (760) 741 -3141 • FAX (760) 741 -9890 CITY OF SEAL BEACH EXECUTIVE SUMMARY ESTIMATED UNDER REPORTED GROSS RECEIPTS AND AND FRANCHISE FEES FROM AUGUST 1, 2006 THROUGH DECEMBER 31, 2007 Under Reported Revenue Category Amount Subscriber Revenues $ 181,693 Advertising Revenues 258,737 Cable Launch Revenues 124,008 Total Estimated Under Reported Gross Revenues 564,438 Times: Franchise Fee Rate (5 %) 0.05 Estimated Under Reported Franchise Fees $ 28,222 -3- SUNMIARY OF SCOPE LIMITATIONS AND FAILURE OF TIME WARMER CABLE TO RESPOND TO CERTAIN DOCUMENT AND INFORMATION REQUESTS This engagement commenced on October 29, 2008. In connection with this engagement, our firm submitted two questionnaires to TWC officials, as well as various document and information requests. On March 10, 2009, our firm notified TWC officials via e-mail regarding the outstanding documents and information needed to complete our review. On March 19, 2009, our firm notified TWC officials via a -rnail that April 3, 2009 would be the final due date for receiving documents and information related to this review. Accordingly, we have prepared this report based on the documents and information received from TWC through April 3, 2009. This section of the report summarizes the major areas of noncompliance by Time Warner. Failure of TWC to Define "Gross Receipts" On October 29, 2008, Mr. William Morgan of our firm prepared a Memorandum analyzing the various cable ordinances, resolutions and agreements governing the "Definition of Gross Receipts" for purposes of computing cable franchise fees. A copy of that Memorandum is included at Attachment 1 to this report. This Memorandum was forwarded to TWC officials, with a request that company officials provide an opinion to our firm as to whether cable franchise fees should be calculated based on a basis of Generally Accepted Accounting Principles (GAAP) or on a cash receipts basis of accounting. TWC officials did not provide any response to our request. Observation: As noted at the conclusion of our Memorandum at Attachment 1, it is the position of our firm that cable franchise fees should be calculated and reported based on a cash receipts basis of accounting, and the findings in this report reflect this position. Failure of TWC to Submit Ouestionnaires or Representation Letters At the beginning of this engagement, our firm submitted to Time Warner officials two questionnaires — a "Subscriber Revenue Questionnaire" (see copy at Attachment 2) and an "Advertising Revenue Questionnaire" to be completed by officials at Time Warner's Corporate Headquarters (see copy at Attachment 3). Caveat: At the outset of this engagement, Ms. Kristy Hennessey, a. TWC Vice President of Community & Government Affairs, advised our firm orally and via e-mail that it was TWC's policy not to respond to questionnaires. Accordingly, during the engagement, we requested of Ms. Hennessey if Time Warner would consider providing our firm "management representation letters ", in lieu of responding to our questionnaires. We never received a response from Ms. Hennessey to our request. Noted below is a discussion of why it is critical for our firm to receive either signed questionnaires or management representation letters in connection with this review. The City of Seal Beach has approximately 10,000 cable subscribers. During the period from August 1, 2006 through December 31, 2007, TWC recorded thousands of individual transactions with these subscribers. This engagement is an "agreed -upon procedures review ", whereby we perform certain review and analytical procedures requested by City management. Under this type of engagement, our firm randomly tested a very small percentage of the individual transactions during the period (less than 1 %). Accordingly, in order to provide City officials with some (but not absolute) assurance that all cable - related gross receipts have been properly reported to the City, we requested that either our questionnaires be completed, signed and returned, or that management representation letters be provided. TWC did not respond to either request. -4- Failure of TWC to Respond to Cable Launch Fee Document Requests When a new cable network is "launched" on a cable system such as Time Warner, the cable network will often offer to pay the cable operator "launch fees" to join the cable system. In connection with this engagement, our firm sent TWC a "Cable Launch Fee Document Request Form ", a copy of which is included at Attachment 4 to this report. The only information provided by TWC in response to this request was "channel line -up cards" for the period of our review. This information is inadequate for us to properly analyze any possible under reported cash receipts from launch fees. Accordingly, this constitutes an additional scope limitation in connection with this review. Failure of TWC to Provide Agreements Related to Leisure World In connection with this engagement, the City Manager requested that our firm review certain agreements affecting TWC's operations within Leisure World and the Golden Rain Foundation. We inquired of TWC officials if we could review these agreements. Also, if the agreements were confidential and proprietary, we inquired if we could review these agreements without taking photocopies. TWC officials never responded to our requests. Failure of TWC to Explain or Document its `Bundle Discount' Methodologv Time Warner and other cable companies offer "bundle discounts" for customers that subscribe to cable, internet and phone services. The "bundle discount" must then be allocated among cable, internet and phone revenues. If too great a portion of the discount is netted against cable revenues, then the amount of cable gross receipts reported to a city could be understated. TWC officials did not provide adequate information on the methodology used to compute bundle discounts. Because of this scope limitation, we were unable to determine if bundle discounts were allocated in an equitable manner between cable, internet and phone revenues. Failure of TWC to Provide Certain Documentation Re: Advertising Revenues During our review, we meet with Mr. Barry Feldstein, TWC's Vice President of Finance. In this meeting, Mr. Feldstein represented to our firm that TWC's advertising revenues have declined in recent years. We requested that Mr. Feldstein provide us evidence of such a decline in revenues. No such documentation was provided. This is a scope limitation with respect to our review of advertising revenues. Effect of Scope Limitations on this Report As a result of the above scope limitations, we have included in this report certain arbitrary estimates of under reported cable revenues. Also, because of the Nondisclosure Agreement executed between our firm and Time Warner, details of the computations have been provide to TWC officials, but only summary information has been included in this report. -5- SUMMARY OF PROCEDURES Noted below are the procedures performed during this engagement that were agreed upon by City management for the period from August 1, 2006 through December 31, 2007: 1. We sent a document and information request to the City. 2. We sent the following document and information requests to Time Warner Cable: • Analysis of "Definition of Gross Receipts" • Subscriber Revenue Questionnaire • Advertising Revenue Questionnaire for Corporate Headquarters • Cable Launch Fee Document Request Form • Other Document and Information Requests 3. We reviewed the supporting books and records for subscriber revenues at the El Segundo offices of Time Warner Cable. We compared amounts reported to the City of Seal Beach with amounts recorded on the Subscriber Billing Reports (CPSM 318 Reports). We performed analytical procedures to verify the reasonableness of reported revenues. 4. We checked the mathematical accuracy of amounts reported on the franchise fee reports submitted from Time Warner to the City. 5. We met with Time Warner officials at the company's Cypress, CA office to review the books and records supporting advertising revenues. We tested the computation of advertising revenue allocations to the City of Seal Beach. 6. We tested 25 addresses provided by City officials to determine if these were included in Time Warner's "Homes Passed" database, and if these were subscribers, that amounts were properly billed to the customer. 7. We prepared a report of our findings and recommendations. -6- SUMMARY OF FINDINGS AND RECOMMENDATIONS As a result of our review, we have the following findings and recommendations. Subscriber Revenues As more fully discussed on pages 4 and 5, Time Warner Officials did not sign and return our Subscriber Revenue Questionnaire (Attachment 1), which provides a space for company officials to sign that all subscriber revenues have been properly reported. Company officials also declined to provide a written representation letter that all subscriber revenues have been properly reported. Accordingly, we have arbitrarily assumed that subscriber revenues have been under reported by 2 %. The under reported amount would be: Subscriber revenues for 17 month review period $ 8,198,307 Times: 2% x 2% $ 163,966 Other under reported subscriber revenues are as follows: • Late Fees (estimated amount) 5,000 • FCC Regulatory Fees ( $ 265 per month x 17 months) 4,505 • October 2006 subscriber revenues 5.142 • March 2007 subscriber revenues 3,080 Total Estimated Under Reported Subscriber Revenues S 181 With respect to the testing of the 25 addresses, we identified five homes that were not cable subscribers, nor were they included on TWC's database of "Homes Passed ". We recommend that TWC officials physically inspect these properties to determine if the households are using a satellite dish service, or if they are possibly using some type of illegal or pirated equipment to bring in cable service. Advertising Revenues We have estimated that Time Warner Cable has under reported advertising revenues for the seventeen -month reporting period by $ 223,001.'Detail computations have not been included in our report, due to the confidential and proprietary nature of the computations. Also, because Time Warner has not signed and returned our Advertising Revenue Questionnaire (Attachment 3), we have estimated that $ 35,736 of advertising revenues from the Corporate headquarters have not been reported. Accordingly, our total estimated under reported advertising revenue is $ 258,737. 7- Cable Launch Fee Revenues As noted previously in this report, we have concluded that Time Warner Cable should be reporting Gross Receipts based on a "cash receipts" basis of accounting, rather than Generally Accepted Accounting Principles (GAAP). Under a cash receipts basis of accounting, any cable launch fees (and other similar credits) should be reported for franchise fee purposes. (A detail discussion of this subject is included at Attachment 4). We have estimated under reported cable launch revenues based on prior year reviews of Time Warner Cable for other municipal clients, as follows: 2006: $ 4.00 per subscriber x 10,334 subscribers = $ 41,336 2007: $ 8.00 per subscriber x 10,334 subscribers = 82,672 Total Estimated Under Reported Cable Launch Fee Revenue $124 MEMORANDUM From: Bill Morgan To: Kristy Hennessey, Tom Nagle Date: October 29, 2008 Re: City of Seal Beach — Definition of "Gross Revenues" Discussion of Cable Ordinances, Resolutions and Franchise Agreements Cable Ordinance 1418 (Ord. 1418) was adopted by the City on December 11, 1997. Ord, 1418, Section 23A -17, paragraph 11, provides the following definition: "Gross Annual Cable Services Revenues" means the annual gross revenues received by a Grantee from all operations of the cable television system within the City, excluding uncollected bad debts, refundable deposits, rebates and credits, and further excluding any sales, excise, or other taxes or charges collected for direct pass - through to the local, state or federal government." Note: The remainder of the gross revenue definition in Ord. 1418 relates to the reporting of franchise fees on franchise fee revenues, which was decided by the "Dallas" decision in 1997.) On November 10, 1997, the City entered into a Cable Franchise Agreement with Comcast Cablevision (Comcast) pursuant to the terms of Ord. 1418. Section 1.5 of the Cable Franchise Agreement, paragraphs (a) and (b), provide that, in the event that there are any material conflicts between the terms and conditions in the Cable Franchise Agreement and Ord. 1418, then the Cable Franchise Agreement shall prevail. Also, under Section 2.2 of the Cable Franchise Agreement, the Franchise Fee is to be based on 5% of "Gross Annual Cable Service Receipts ". On August 14, 2000, pursuant to Resolution 4828, the City Council consented to the transfer of the cable franchise from Comcast to Adelphia. 'Under the transfer, Adelphia assumed all of Comcast's obligations. On November 14, 2005, pursuant to City Resolution 5385 and an Assignment and Assumption Agreement, the cable franchise was transferred from Adelphia to Time Warner Cable. Discussion of Cable Ordinances, Resolutions and Franchise Agreements (Continued) On November 5, 2007, City Ordinance 1563 was passed, adding Section 6.10.085 to the Municipal Code. This section is applicable to holders of a new State Video Franchise. Under this Ordinance, franchise fees are to be computed at "5% of the gross revenues of the state video franchise holder. The term "gross revenues" is defined as set forth in Public Utilities Code Section 5860 ". Note: The definition of "gross revenues" for a State Video Franchise holder was clarified under AB 1715, Section 5 (d). This bill was signed into law by the California governor on July 20, 2007. Analysis Ordinance 1418 and the Comcast Cable Franchise Agreement were drafted and adopted concurrently in 1997. (The Cable Franchise Agreement makes specific reference to Ord. 1418.) It is apparent that the Cable Franchise Agreement is referencing the Gross Revenue definition in Ord. 1418, even though Ord. 1418 uses the term "Revenues" and the Cable Franchise Agreement uses the term "Receipts ". Also, if there is any conflict between the Ord.1418 and the Cable Franchise Agreement, the Franchise Agreement prevails. Since 1997, the cable franchise has been transferred two times, but the definition of Gross Revenues was not revised in the transfer agreements. Finally, the definition of Gross Revenues pursuant to Ordinance 1563, related to State Video Franchise holders, is not applicable to this review. Definition of "Gross Revenues" for Purposes of this Review Ordinance 1418 measures gross revenues based on cash receipts. Also, there is no mention of Generally Accepted Accounting Principle (GAAP) in this definition. Accordingly, for purposes of the franchise fee compliance review of Time Warner Cable for the period August 1, 2006 through December 31, 2007, we will use a cash receipts method of accounting, rather than GAAP. CITY OF SEAL BEACH SUBSCRIBER REVENUE QUESTIONNAIRE Please provide representations below that the gross receipts related to the following categories of cable revenue have been fully reported to the City of Seal Beach for the period from August 1, 2006 through December 31, 2007: Yes No 1. Revenues include on the cable subscribers monthly bill, including basic services, digital services, premium services, high - definition services, on -demand and pay - per -view services, equipment rentals, music services and installation charges. 2. Other miscellaneous receipts: • Late fees • Return check fees • Unreturned equipment fees • Name change charges • Cable TV Guide revenues • Sales of customer equipment • MTV trap fees • Inside wiring maintenance • Franchise fees on franchise fee revenue • FCC regulatory fees 3. Commercial and Bulk Accounts: • Commercial buildings • Industrial buildings • Apartments • Multiple Dwelling Units (MDUs) _ • Hotels /motels _ • Hospitals • Other (specify): 4. All cable - related receipts from within Leisure World Written Representations by Time Warner Cable Management To the best of our knowledge and belief, the gross receipts reported to the City of Seal Beach for the period from August 1, 2006 through December 31, 2007 are true and correct. By: _ Title: Date: By: _ Title: Date: CITY OF SEAL BEACH ADVERTISING REVENUE QUESTIONNAIRE Purpose of Questionnaire Diehl, Evans & Company, LLP has been retained by the City of Seal Beach, CA to perform a franchise fee compliance review of payments made by Time Warner Cable to the City for the period from August 1, 2006 through December 31, 2007. The purpose of this questionnaire is to obtain information from officials at Time Warner Cable's Corporate Headquarters regarding the accounting for, and reporting of, national advertising revenues to the City of Seal Beach. Ouestions for Corporate Office 1. Advertising Revenues Recorded on the Books of Corporate Headquarters: a. To the best of your knowledge, were any advertising revenues recorded on the General Ledger at Time Warner Cable's Corporate Office? Yes No If yes, please attach a separate schedule indicating the type and dollar amount of such advertising revenues, including but not limited to: • National advertising revenues • Direct mail advertising sent to cable customers • Political advertising revenues • Video -On -Demand (VOD) advertising • Interactive Advertising (ads targeted to interactive digital customers) • Advertising displayed on any Time Warner Cable electronic programming guide • Any portion of programming contracts providing for the advertising of cable networks b. If the answer to question La. is yes, to the best of your knowledge, were any of these advertising revenues allocated to cities in Southern California, including the City of Seal Beach? Yes No 2. Revenues Recorded on National Cable Communications (NCC): NCC is jointly owned by Time Warner Cable, Comcast and Cox Communications. Have national advertising revenues generated through NCC from the Seal Beach geographic area been allocated to the City of Seal Beach? Yes No Questions for Corporate Office (Continued) 3. Advertising Revenues Recorded on the Books of Corporations "Affiliated" With Time Warner Cable: To the best of your knowledge, were there any gross advertising revenues generated from the geographic area which includes Seal Beach, California that were received by any corporation affiliated with Time Warner Cable, which were not reported to the City of Seal Beach? Yes No If yes, please provide a separate schedule providing the naive of the affiliated corporation (or corporations) on which the advertising revenues were recorded, the geographic or market area covered by such activity, the total basic cable subscribers covered by that geographic area, and calculations as to how such revenues are (or should be) allocated to Time Warner Cable's Southern California operation and to the City of Seal Beach. Written Representation By the Management of Time Warner Cable To the best of our knowledge and belief, gross advertising revenues related to the City of Seal Beach, CA for the period from August 1, 2006 through December 31, 2007 have been accurately and fairly reported to the City of Seal Beach. By: _ Title: Date: By: _ Title: Date: CITY OF SEAL BEACH CABLE LAUNCH FEE DOCUMENT REQUEST FORINI Definition of "Gross Revenues" For Purposes of Our Review Pursuant to Cable Ordinance 1418, adopted by the City on December 11, 1997, Section 23A -17, paragraph 11, provides the following definition: "Gross Annual Cable Services Revenues" means the annual gross revenues received by a Grantee from all operations of the cable system within the City, excluding uncollected bad debts, refundable deposits, rebates and credits, and further excluding any sales, excise, or other taxes or charges collected for direct pass - through to the local, state or federal government." (Our bolding.) General Discussion of Cable Launch Fees and Marketing Credits When a new channel is launched on a cable system, the cable operator and cable network will enter into a programming agreement. Under a typical programming agreement, a cable company agrees to carry a network's channel on its cable system over a multi -year period, and the cable operator agrees to pay a specified amount per subscriber per month to the network for the right to carry such programming. The amount per month is generally based on the programmers "rate card ", or an adjusted amount based on negotiations between the cable company and the network. Also, in connection with the launch of a new network, it is not uncommon for the cable network to offer incentives, such as cable launch fees and marketing credits. Such fees may be intended to provide general compensation to the cable company, or to reimburse the cable company for up =front promotional costs that are incurred to launch the new channel. General Legal Position of U.S. Cable Companies With Respect to the Reporting of Cable Launch Fees and Other Marketing Credits for Franchise Fee Purposes On prior cable franchise fee reviews of U. S. cable companies conducted by Diehl, Evans & Company, LLP (DE &CO), cable company attorneys have generally taken the following legal positions with respect to cable launch fees and other marketing credits: a. For financial reporting purposes, the cable company must adhere to Generally Accepted Accounting Principles (GAAP), which are set forth by the Financial Accounting Standards Board (FASB) and the SEC. Under GAAP and SEC reporting rules, cable launch fees and similar marketing credits are not classified as "gross revenue ", but rather are treated as a reduction of programming costs. b. Also, according to some cable company attorneys, launch fees are considered to be either: A "discount" off of the cable network's standard "rate card ", (i.e., a negotiated reduction of programming costs), or s A "reimbursement" for promotional costs incurred by the cable operator when the network is launched or repositioned. For purposes of this document request, we have assumed that Time Warner Cable will be taking a legal position similar to the position set forth above. City's Position With Respect to the Reporting of Cable Launch Fees and Other Marketing Credits For Franchise Fee Purposes The City will look to definition of "Gross Revenues" in Ordinance 1418 as a guide to assessing franchise fees on cable launch fees or other marketing credits. Using a cash receipts method of accounting, the City will use the following criteria for assessing franchise fees for the period from August 1, 2006 through December 31, 2007: • Generally, any cable launch fees received in cash are considered Gross Receipts, and thus subject to reporting. • Any cable launch fees or marketing credits not received in cash, but rather credited against programming costs, would not be reportable to the City. • Any cable launch fees or marketing credits that are specifically identified in the programming agreement as a cost reimbursement would not be reportable to the City. Definition of "Gross Revenues" For Franchise Fee Purposes, Per the Fifth Circuit Court In the 1997 Fifth Circuit Court decision "City of Dallas vs. FCC," 118 F.3d 393, the Court considered various definitions and phrases in defining the term "gross revenues" for purposes of reporting franchise fees. While the Court did reference GAAP in its considerations, this was not the primary test for defining gross revenues. Among other definitions and phrases were the following: • The Court referenced the "gross revenues" definition in Black's Law Dictionary, meaning "receipts of a business before deduction for any purpose except those items specifically exempted." • Also, the Court referenced definitions of "gross revenues" in two previous court cases. In Veterans Rehabilitation Center, Inc., the term gross revenues means "gross receipts of a business before deduction for any purpose except those items specifically exempted." And in Lane Electric Cooperative, the term "all gross revenue... is to be construed in the broadest sense i.e., all money received." The Circuit Court used the following three phrases to express its opinion: • "We hold that cable operator's gross revenue includes all revenues, without deduction." • "The phrase "gross revenue" has a generally accepted meaning: unless expressly limited by the terms of a statute, regulation or contract, gross revenues means all amounts received from operation of a business, without deduction." • "In conclusion, gross revenue normally includes all revenue collected from any source." Accordingly, the Court concluded that amounts "collected" or "received" (i.e., cash receipts) would be the proper basis for reporting revenues subject to franchise fees. The Court further stated that the definition of gross receipts could be determined by contract. Information and Documents Requested in Connection With This Review Considering the above discussion, in connection with our review, please provide us with the following information and documents: 1. A listing of all channels launched or repositioned in the geographic area covered by the City of Seal Beach during the period from August 1, 2006 through December 31, 2007. 2. A schedule of all cable launch fees received in cash by Time Warner Cable, or any affiliate, for the period August 1, 2006 through December 31, 2007, related to channels launched or repositioned in the geographic area of the City of Seal Beach. The schedule should disclose the total Iaunch fees received for each channel for the period and the amount applicable to the Seal Beach franchise. 3. In order to ascertain what launch fees are general cash receipts to the Time Warner Cable, versus what fees are true expense reimbursements, we will need to examine copies of the underlying agreements or contracts with programmers. (If Time Warner Cable officials are agreeable to this procedure, we will select a sample of such contracts to review.) We understand that these documents may be confidential and proprietary. Thus, we are requesting that Mr. William S. Morgan of Diehl, Evans & Company, LLP (DE &CO) review these agreements and contracts at a Time Warner Cable office, without taking copies. Mr. Morgan will merely make notes for his files. Also, if necessary, DE &CO is willing to enter into a separate confidentiality or nondisclosure agreement with Time Warner Cable related to the review of cable programming agreements (assuming that the terms of the agreement are acceptable to the City Attorney and Diehl, Evans & Company, LLP).