Pop Quiz Answers to the Verizon NY 2019 Annual Report

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PART 1: Pop Quiz: Can You Answer Basic Questions About the Verizon NY 2019 Annual Report?

Please Download the Verizon NY 2019 Annual Report.

Welcome to Part II: THE BASICS

  • On June 8th, 2020, the Verizon NY 2019 Annual Report was published and it is the financial report of New York State’s primary public telecommunications utility, just like other state-based utilities such as water, gas or electric.
  • Verizon also filed a Motion with the NY Public Service Commission to hide, (they call it ‘redact’), basic financial and business data.
  • IRREGULATORS CALL FOR AN INVESTIGATION: On June 30th, 2020, the IRREGULATORS filed comments to block Verizon NY’s Motion and are now calling for an investigation.

NOTE: 5-Year Analysis: We have decided to show that this pattern of cross-subsidies did not start in 2019, but has been a constant theme with identical deformed financial FCC formulas being applied. In fact, this pattern started in 2001, so the issues extend back for 2 decades.

And, we need to be clear, based on previous FCC reports, and our examining other states over the last decade, we believe that the FCC formulas of harm are still in use, even though the state may not even know this. We know of no state that still publishes basic financial data, nor any state that audited the financials for at least 10+ years.

Opening Chart: Over a 5-year period, 2015–2019, Local Service paid the majority of all construction & maintenance, marketing and corporate operations expenses, while the other lines of business are getting a free ride.

Basic Summary: Analysis of the Verizon NY 2019 Annual Report.

REFERENCE POINTS: A Library of Research has been put together covering this area since 2010.

ANSWERING THE QUESTIONS

We took the liberty of changing the order of the questions to help discuss the issues.

  • Question 1: If Local Service are revenues mainly from the copper-based phone lines, which have been barely maintained, why did it pay $1.2 billion in Construction & Maintenance expenses in just 2019, in just New York?
  • Question 3: If Local Service is only 21% of revenues why is it paying 61%, or over $½ billion of Corporate Operations expense? And why is it paying $205 million in Marketing, when the service is no longer being advertised, and in some areas, no longer available?

ANSWER: Corrupted FCC Formulas Are being Applied.

At the core, the FCC’s accounting formulas are in use in this annual report and based on checking other states, it appears that these FCC rules are still in use throughout the US.

The FCC’s accounting rules, known as “USOA”, “Uniform System of Accounts” were applied to the revenues and expenses of the state public telecommunications utilities and were supposed to allocate the expenses into the different lines of business. This was supposed to protect basic phone customers. In 2001, these accounting formulas were set to have the percentage of expenses for each line of business match the year 2000 — literally. Incredibly, even though the technology and communications services had dramatic changes, (there was no serious video streaming or even high-speed broadband in 2000), over the next 2 decades, these formulas were never changed or even examined.

The impact has been to make the entire US wired infrastructure appear unprofitable, while making the wireless and backhaul business of Verizon et al. very profitable.

Over time, Local Service has had a decline in revenues. In 2000 it was 65% of the total revenues and it paid 65% of the expenses; by 2019, the category of Local Service is only 21% of the revenues, but as you can see from the 5 year analysis diagram in the opening, somehow, Local Service has been left holding the bag:

  • Local Service in 2019 paid 61% of the Corporate Operations expense because it has been doing that since 2001. This is the percentage of expenses allocated for Corporate Operations expense for the last 5 years. Even when the total amount varies by a billion dollars, the percentage is set to reflect the year 2000. See a pattern?
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As we uncovered, for whatever the reasons, (which are never mentioned), the Corporate Operations charges to the operating expenses can change dramatically. While Local Service always paid the same percentage, the total varied by $2.1 billion.

Over the last 5 years, Local Service paid a whopping $5.1 billion, over $1 billion annually, in Corporate Operations Expenses, regardless of what the revenues were.

  • “75–25%” Rule: In this case, some of the expenses are being charged at 75% of the total based on the ‘75–25%’ rule, where 75% of the conduit and wires are allocated to the Local Service (‘intrastate’) portion and only 25% is allocated to the other services, such as Backhaul, which have been classified as “interstate”. (The classification issues are a very telecom-wonk and complicated discussion).

Documentation: Over the last decade, we documented the FCC’s cost accounting formulas and their creation of cross-subsidies in exacting detail for accountants and forensic auditors, as well as provide a more general, be very detailed history of how rates were traditionally set.

Secrets of “Backhaul” (Also Called “Special Access”, or “Business Data Services”)

  • Question 2: If Backhaul is 48% of revenues, over $1.9 billion dollars, more than double the revenues of Local Service, how did it pay ½ of what Local Service paid for construction and maintenance?

The Short Answer Is: The distortions from the FCC’s accounting formulas are responsible. We put together a separate report on Backhaul, (to be released, August 2020) which is now a very important but misunderstood area. These are the guts of the networks and wireless can’t work without a fiber optic wire attached, and with small cells that are placed every 1–2 city blocks.

The Big Secret: Backhaul Are Mostly the Same Physical Wires as Phone Service, But ‘Reclassified’. One must realize that this has all been a shell game. The companies had to know that they were manipulating the financial books and what the consequences are.

What is also unknown is that the besides the accounting there has been an additional shell game of ‘classification’, where one wire that was for phone service is suddenly reclassified as an ‘information service’ or ‘interstate’ service, and different regulations are applied, but also different accounting formulas. Making ‘interstate’ service be highly profitable, while ‘intra-state’ Local Service has been artificially made highly unprofitable, has been underway for the last decade.

  • Question 5: Backhaul has EBITDA profits of 55%, while Local Service lost $1.9 billion. If Backhaul paid its fair share of Corporate Operations and construction, how much of the expenses would be shifted?

But there is a much larger issue surrounding Backhaul. As we pointed out, the price of America’s wireless and broadband services are now 3–14 times more expensive than other countries worldwide and the Digital Divide, at its core, is created because low income families can’t afford broadband and wireless services, even if it is available.

The history of backhaul shows that in 2001, (the second AT&T, 1984–2005) AT&T had complained that (what would become AT&T, then-SBC), SBC had been getting large profit margins for the utility networks that AT&T needed to rent in order to offer their local, long distance and ISP service. Historically, this service should have had profit margins of 11.25%, but it had kept going up continually. Now, in 2019, we see that Verizon NY backhaul has a profit margin, EBITDA, of 55%, for a service that is using the existing utility networks and is subsidized by low-income families and rural customers via excess rate increases, creates a circle wheel of harms, as the spokes each have their own digs.

We will come back to a recalculation of backhaul expenses, but, at the core, America can’t solve the Digital Divide if those who control the critical wired infrastructure can control the bottom-line price for all services- and backhaul is at the core of this issue.

  • Question 4: How much of the Verizon NY construction budgets, especially those charged to Local Service, were diverted to build out the wireless networks?

Wireline-Wireless cross-subsidies have been the subject of multiple, separate reports that we created and they supply research pertaining to the wireline cross-subsidies of the wireless networks. In New York, we have documented that there were related rate increases for “massive deployment of fiber optics”, which, was then diverted to wireless.

In our 2016 SPECIAL REPORT “Proving Verizon’s Wireline Networks Diverted Capex for Wireless Deployments Instead of Wiring Municipalities, and Charged Local Phone Customers for It.”, based on annual reports, press releases and other Verizon supplied data, we found that Verizon New York put in 5,515 cell sites as part of the wireline capital expenditures from 2010–2012. Based on our cell site cost model, Verizon New York spent $2.8 billion on these deployments. “Verizon NY Capex” are the actual capital expenditures, based on Verizon New York’s Annual Reports. When comparing this, it would appear that Verizon New York, the wired utility, had about 80% of the construction budget diverted to fund these wireless build-outs over this three year period.

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We found an identical pattern in every Verizon state. This cross-subsidy was also found by the NY Attorney General’s Office in 2012. Moreover, we put together a collection of quotes from executives, etc. documenting that Verizon knows that the wireline networks have been subsidizing the wireless deployments.

SEE NEW REPORT: 15 Quotes: The Wireline-Wireless Bait-&-Switch Overcharged America and Caused the Digital Divide.

  • Question 6: If Local Service expenses were reset to pay actual expenses incurred, how much of Local Service, in just 2019, based on just these factors, was overcharged and could be used to solve the Digital Divide and bring fiber optic services to the entire state?

A) No change

B) $965 million dollars

C) $1.6 billion dollars

D) There needs to be an audit

E) These FCC legacy formulas do not matter (whatever that means?)

ANSWER: How Much; By the Numbers

If Verizon New York Local Service expenses were reset to pay actual expenses incurred, we estimate that between $1.1-$1.6 billion was overcharged in just 2019, using a limited number of factors. We believe that this could be used to solve the Digital Divide and bring fiber optic services to the entire state.

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In this model, the ‘Low Scenario’ shows that Verizon Local Service had $1.6 billion in expenses that were overcharged. I.e., Local Service was overcharged in each of the expense categories based on the FCC accounting formulas that have been applied to construction, corporate operations and marketing expenses.

  • Construction has historically been $75-$125 million for the copper-based phone services; it was charged $1.2 billion.
  • Corporate Operations expenses were $½ billion in 2019, vs it should have been $150-$250 million, based on historical models.
  • NOTE: In 2017, Corporate Operations expense had risen to $1.8 billion charged to Local Service. This would add an additional $1.3 billion of overcharging for just 2017 and just New York.
  • Marketing for a service that isn’t being sold we put at $20 million, against $205 million that was paid, 54%.

IMPORTANT: Local Service is a line of business of Verizon NY; this is not direct overcharging of local phone customers, which is actually much higher. As we discussed elsewhere, local phone customers paid over $3,100.00 per line as of 2018 if they had the service since 2006.

OTHER QUESTIONS

  • Question: Are the Verizon NY Financials for 2019 indicative of what happened over the last 5 years?
  • Question: Are these financial reports similar to the financial results in the other Verizon states, or AT&T and CenturyLink’s state utilities?
  • Question: How does IRREGULATORS v FCC relate to these findings and what can cities, states and citizens do about it?

It is clear that the FCC’s formulas have inflated profit margins, and not from good deeds but by being bad and putting the majority of basic expenses into Local Service.

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  • Local Service was charged almost $868 million dollars in just 5 years for MARKETING while the other lines of business, like FiOS video paid 15%.
  • Local Service paid the majority of construction and maintenance which was double what ‘Backhaul’ paid.
  • Because of the FCC deformed accounting formulas, the pattern of cross-subsidy is evident and unchanged as the percentage that was applied year by year to each expense category for each line of business was unchanging.
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OTHER ANSWERS

  • The 2019 Annual Report is Indicative of the Other Reports. The next chart proves beyond a shadow of doubt that the 2019 Annual Report is a continuation of the previous reports. This is a 5 year breakout of the expenses by line of business, as well as the percentage paid by each line of business on the right.
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  • The 2019 Annual Report Should Match All of the Other States: The FCC Accounting Financial Anomalies Are Nationwide. We know that the last available data from the FCC was for the year 2007 for the other state utilities, but we’ve obtained info on other states that shows that the FCC formulas are still in play; no state ever upturned these rules publicly and it appears the telcos never changed their accounting practices.
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This is taken directly from the 5 year analysis and incorporating the previous methodology.

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Local Service, over the last 5 years, was charged over $12.5 billion in Construction and Maintenance, Marketing and Corporate Operations expenses.

But, using historical expenses, it should have paid, at best, $1.7 billion, an overcharge of $10.8 billion.

If Local Service paid the percentage of expenses based on the percentage of revenues, than, Local Service (at 21%) was overcharged $3.6 billion.

Wireless Overcharge: If 80% of the construction budget was improperly used for wireless, then, Wireless construction from Local Service was $5.3 billion.

A Litany of Other Expenses and Overcharges

  • These inflated expenses created losses for Local Service and this was used as an excuse for rate increases since 2006, (and for the “massive deployment of fiber optics”).
  • This lowered the tax payments as well as gave Verizon tax benefits.
  • The other lines of business, like wireless, have been underpaying, and should be paying $750-$1 billion more, annually, for use of the networks as well as for the construction of their wireless networks.
  • Some charges, like charging Local Service $868 million for “Marketing”, over the last 5 years, when there is virtually no marketing for local phone service, is one of many areas that should be investigated.

Now Multiply This by America.

New York has represented 6–7% of the US wireline networks from time immemorial. We used 7% for this calculation.

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Since the accounting formulas were the same and we can find no evidence that the rules are not in use, even when the State Commission or companies or Advocates don’t realize this has been happening, we estimate that:

Nationwide:

  • Local Service category has paid $28 billion in these 3 expense areas
  • Should have paid between $4.9 billion to $12.3 billion.
  • Overcharged $15.6 to $22.9 billion dollars in just 2019.

Rough 5 Year Calculation:

  • Local Service category has paid $140 billion in these 3 expense areas
  • Should have paid between $24.5 billion to $61.5 billion
  • Overcharged $78 to $114.5 billion dollars in just 2019

If this is even partially happening, the amount of money to close the Digital Divide is there and has been for the last decade, but the regulators never stopped the cross-subsidies.

NOTE: These overcharging calculations have many caveats, as it will require actual audits of the financial books in other states to determine the extent of the problem. But we have a set of 2 decades of financial reports from Verizon New York as well as our analysis. We also demonstrated that the other states matched NY using the last available FCC data, as well as FOIL requests and other state documents to realize this is a national problem.

IRREGULATORS v FCC: The Big Win. Over the last five years we filed more than 18 separate pleadings and reports to stop the continuing use of these obsolete and now deformed rules. The FCC refused to take action, claiming that the rules didn’t apply, even though the companies still use them and the state commissions still accept them to the detriment of utility customers.

On April 15th 2019, the IRREGULATORS challenged the FCC in the DC Court of Appeals. The Court, on March 13th, 2020, clearly stated that the FCC has no jurisdiction over the state utility accounting.

IRREGULATORS v FCC: The States are now independent from the FCC and clearly have the authority to pick up the mantle and act to investigate and halt these cross-subsidies.

Written by

New Networks Institute,Executive Director, & Founding Member, IRREGULATORS; Telecom analyst for 38 years, and I have been playing the piano for 63 years.

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