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PHONE COMPANY DISPUTES OVER-EARNINGS CLAIM

June 25, 2002 – Investigators delving into the financial operations of Innovative Telephone called on the Public Services Commission on Tuesday to order a rebate for customers. However, lawyers representing the phone company argued such action is not justified, because reports of excess profits were based on faulty calculations made by the investigative team.
"Based on our analysis and our report, we are satisfied that the company has over-earned and [customers] are entitled to a one-time rebate," said Anthony J. Zarillo, lead consultant for AUS Pathways. AUS is a New Jersey-based consultant firm contracted by the PSC to conduct a mandatory rate investigation of the phone company.
Zarillo and his associates also called on Innovative to submit to a cost-of-service study, which he said would produce data that would allow the company to set rates that are "fair, reasonable and just, not only to the consumer but also to the company."
Innovative attorney Gregory J. Vogt disputed claims that Innovative reaped close to $760,000 in excess profits beyond the 11.5 percent cap set by the PSC. Vogt said portions of the report submitted by AUS and its accountants contained miscalculations that led to that conclusion and that Innovative's earnings were actually "very low." "My point is that their exhibit had errors in their reports and their computations," he said.
Hearing examiner Frederick Watts, who is an attorney, ordered the accountants from the financial services firm Ernst & Young to correct the errors and submit the updated figures when the hearing resumed on Wednesday morning. Zarillo admitted there was an error in the calculations but said the revised figures will show the error was in favor of phone subscribers and that Innovative had over-earnings higher than first thought.
The phone company, the Water and Power Authority and the two companies that have the exclusive franchise for ferry services between St. Thomas and St. John are regulated as public utilities by the PSC, which thus can set limits on how much profit they can earn. But Zarillo said on Tuesday that it ultimately is up to the regulators to decide what to do in a case where a company shows excess profit. "The amount of dollars that will go back to the consumers is based on the amount the commission thinks is fair and equitable," he said.
The seven-hour hearing at the PSC headquarters on St. Thomas included testimony from four witnesses, starting with Frank J. Hanley, president of AUS. Hanley described the methodology used to compute Innovative's capital costs, taking into account the size of the company, the unique aspects of doing business on an island, and the potential impact of weather, business fluctuations, and the ups and down of the tourism-dependent economy.
Vogt raised the question of whether it is reasonable to consider the ability to attract future investors in figuring capital costs. The approached was supported by a witness for Innovative. Future investments are key to ensuring Innovative's financial health, said Randall S. Billingsley, associate professor of finance at Virginia Polytechnic Institute and State University. Billingsley said allowing phone company profits as high as 13.84 percent is "the way to insure Innovative could continue to attract investors and ensure its capital."
Vogt also argued that increased competition by cellular phone and other wireless companies must play a part in determining capital costs. Hanley noted that other phone companies are facing competition from wireless services and said. "It's no more relevant here than it is anyplace else."
But almost nowhere else, Hanley said, has he come across a company that receives substantial tax benefits of the type Innovative was granted nearly five years ago by the Industrial Development Commission (today the Economic Development Commission). "I don't know anyplace else in general where you could have prolonged cessation of taxes like you have with the IDC. It's like manna from heaven," he said.
Vogt argued that an unfriendly business climate brought on by sectors of the V.I. government had led to diversion of some of the tax benefits for other purposes. Hanley challenged him to come up with specifics, which did not happen during Tuesday's hearing.
Testimony by accountants hired to test Innovative's business systems indicated that the company is using standard accounting practices. "As described in the notes to the 2000 financial statements, the accounting policies of the company conform to generally accepted accounting practices appropriate to the telephone industry as prescribed by Part 32 Uniform System of Accounts," said David J. Milkosky, a partner in Ernst & Young.
But Milkosky said he could not conduct a complete analysis without reviewing financial data from the utility's parent company, Innovative Communication Corp. Data collected by visiting accountants identified "certain significant and/or unusual month-to-month fluctuations in revenue and expense items," he said in a prepared statement read at the hearing. "There were questions and information requests that the company was unable to respond to prior to the presentation of the [report]."
During a break in the proceedings, Innovative spokesman Tom Dunn said ICC would challenge the request for such data. "The only contentious issue that came up is that Innovative would not release ICC's financial information. Our position is that this is a look at the telephone company, and we have released all information with regards to the telephone company, and they have acknowledged that," he said.
But Watts weighed in on the side of the investigators and urged Innovative to reconsider. "I'm faced with the testimony that these financials are needed to do some cross-checking, and my accountants are telling me they need it," he said.
Zarillo said it was in the ICC's best interest to cooperate, the concern being that transactions between the phone company, the parent company and other ICC affiliate companies had to factor into the amount of services and resources rendered overall. He also said that a clear knowledge of this factor could be revealed through a cost-of-services study and was of potential benefit to the company itself. Calling for such a study does not indicate suspected wrongdoing, he said, adding, "It just seems to me to be good common business sense."
Vogt raised the issue of the cost of conducting a cost-of-services study, suggesting it would wind up being passed along to customers. Zarillo said the best way to determine the cost would be for the PCS to put the job out for bid. He was joined in his appeal for such a study by Rene Enriques, Ernst & Young senior manager, who also presented an analysis of the financial information collected by field representatives who visited Innovative during a 12-month test period.
Vogt challenged the calculations on gross receipts taxes in one submission, saying the error tainted all the information where the figure appeared. Enriques was directed to submit corrected figures when the hearing resumed on Wednesday.
Watts is expected to issue his ruling on the rate hearing in August, after which Innovative will be given time to prepare a response. PSC decisions on whether to grant a rebate to telephone customers, and if so, how much, would not come until after that.

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