Report: BT Debt Violations Began in 2005
The outside consultant hired by the state Department of Public Service alleges that Burlington Telecom was in violation since it was first issued a certificate of public good in September 2005 — nearly three years earlier than city officials have since acknowledged.
The long-awaited report is highly critical of city and BT officials who, for years, ignored the findings and recommendations of their independent auditor — Sullivan, Powers and Company. The auditor wanted BT to track spending better, to improve oversight of external contractors hired to build out the BT network and to repay funds according to its certificate of public good (CPG) issued by the Vermont Public Service Board.
The consultant hired by the DPS — Larkin and Associates — implies that BT may have overpaid for installation services and equipment. It offered no ballpark dollar figure, but did suggest that the PSB require BT to provide the board with a more detailed list of its assets.
That may be occurring right now, given that the city of Burlington has terminated its lease with CitiCapital, and the financier is now in the early stages of repossessing BT's equipment and fiberoptic cable.
Earlier this year, I noted in "Fair Game" that BT was in the process of recouping money from several contractors and repricing other services going forward. At the time, it had recouped a relatively small amount — $40,000.
Download the full report here: Download BT REPORT FINAL
The Department of Public Service will post the attachments to the report on its website later today. When they become available, I will provide a link.
The report presents a stark picture of how entrenched city officials had become around BT's expenses and looming debt to both CitiCapital and city taxpayers. It also said that BT and the city relied too heavily on overly rosy projections and hypotheses rather than on BT's business reality.
Contrary to ongoing statements that taxpayers were never put at risk, the report finds city officials have calculated how much it would cost taxpayers to cover BT's debt. According to one email cited in the report, Chief Administrative Officer Jonathan Leopold told the credit ratings agency Moody's in July 2010 that if BT ceases to be a city-led venture the $17 million debt would become a liability against the city's general fund.
"According to the memo," the report states, "in that event the city would have the authority to issue general obligation bonds to convert the Pooled Cash obligation to long term debt. That financing would be 20 years with annual debt services of $1.2 million."
The report claims Leopold's email calculates the cost to taxpayers — a tax rate increase of less than 3.4 cents or 4.7 percent. The report also states: "The communication then states that a '4.7 percent increase, if it becomes necessary, represents a reasonable and not overly burdensome tax rate.'"
The report also finds that it's likely the Burlington International Airport and the city's General Fund fueled the overspending, but that any eventual debt to the "cash pool" will be borne by taxpayers and not the airport itself. However, the report states it could find no evidence that the city commingled funds from other sources.
The consultant also alleges that city officials excluded a key finding from an outside report provided to the city council in early 2008. That report, called the "Shanahan report" included a finding that BT would exceed its borrowing capacity under the CitiCapital lease in March 2008.
City officials have not yet responded to the report's findings and recommendations.
"We're still in the process of reviewing the report," said Joe Reinert, spokesman for Mayor Bob Kiss.
The consultant makes the following recommendations:
• The PSB require BT to conduct a physical inventory of assets (both installed and uninstalled) and to report to the Board concerning this, along with BT’s detailed plan to use the equipment purchased through June 30, 2010 that has not yet been installed.
• That the PSB require BT to provide a plan for bringing BT into compliance with all violated provisions of BT’s CPG, including Condition No. 60.
• The PSB require BT to address issues enumerated in the report and to provide an operating plan detailing how BT expects to become profitable and cash-flow positive, including details on any restructuring of the CitiCapital lease financing that BT has been able to obtain.
• The PSB consider revoking BT’s CPG if the Board is not satisfied that BT has a realistic plan to bring BT into compliance with all violated provisions of BT’s CPG, including Condition No. 60, and a viable plan for addressing the enumerated issues.
On Wednesday, city officials told the PSB that it is in talks with private equity firms and in-state telecom providers to replace equipment that is now owned by CItiCapital. Two weeks ago, the city terminated its lease with CitiCapital. The financier is now in the process of determing what equipment it will repossess and when. It's also unclear what additional legal action CitiCapital will take to recoup its losses under the lease agreement.
I've posted below the report's focal points (in bold) along with the consultant's abbreviated observations and conclusions (in italics):
A. When BT first violated Condition No. 60 of their CPG
BT has been non-compliant with Condition No. 60 since BT was issued its CPG on September 13, 2005 and it remains non-compliant as of June 30, 2010 due to management's failure to monitor compliance and to develop and execute a successful business plan. BT’s claim that it first violated Condition No. 60 in March 2007 is not accurate.
B. Total amount of money BT has borrowed from the City of Burlington including the current balance owed to the City
The amount due from BT to the City related to BT’s Pooled Cash fund draws is at a minimum $16,936,492. The total amount as of any particular date since September 25, 2005 cannot be readily determined due to the manner in which the City and BT record transactions. It is evident from the analysis in Exhibit LA-1 that transactions continue to flow through the Pooled Cash account, but it does appear that any new postings are in effect repaid within two months because the balance due the City continues to remain at $16.9 million.
We believe that a separate liability account should be reflected on BT’s books for its obligation to repay its cumulative Pooled Cash fund draws. BT should also refrain from recording any further adjustments to this account unless an actual payment is made.
C. Source of City or other City Department funds used to support BT
At any point in time, City departments have positions in the Pooled Cash fund that are either a surplus, where the department has provided cash to the Pooled Cash fund, or a draw, where the department, such as BT, has drawn cash from the Pooled Cash fund. BT operations have been supported by the Pooled Cash fund during the entire period that BT has operated under the CPG.
The actual source of the $16.9 million accumulated by BT through June 2010 varied during the period under review. As noted above, during portions of the period of review it appears the General Fund and the Airport’s surplus cash provided the primary funding source for BT’s cash draws from the Pooled Cash fund. Due to the fluctuations in the sources of cash supplied to the Pooled Cash fund, which can be significant, and the manner in which the Pooled Cash fund operates, it would, in our opinion, be inaccurate to conclude that the Airport will be out the amount of cash that it had deposited in the Pooled Cash fund. It appears that if BT is unable to repay the full $16.9 million and default occurs, the default will fall upon the City’s general fund and ultimately the taxpayers of the City of Burlington.
D. Amount of money BT has repaid the City, and interest or principal payments
It cannot be readily determined from either the City's or BT’s books of record how much of the $16.9 million is borrowed funds and how much is interest. The accounting entries make no specific reference to whether a reduction to the Pooled Cash balance is principal or interest. The fact that BT failed to record interest and payroll in a timely manner suggests that the interest calculation itself is understated and the books are in error.
E. Estimated monthly cash flow requirements that BT needs to cover its operating and debt service expenses as compared to its monthly revenue
BT continues to believe that it will be able achieve a positive cash flow despite its past performance. There is a pattern of having consultants hired by the City or BT making acknowledgement of BT’s then-current cash-flow-negative situation and inability to turn a profit, then making rosy projections of BT’s becoming profitable in some future period, typically by adding more customers and increasing revenue, and/or by obtaining larger amounts of financing. The past projections of BT becoming profitable and cash flow positive have not materialized.
The Blue Ribbon Committee and the consultants reporting to the BRC, on the other hand, appear to present a more candid and realistic assessment of BT’s prospects. The Blue Ribbon Committee concluded that BT is not viable in relationship to its current debt load of $51 million and its ability to generate earnings to pay off this debt.
Larkin finds it troubling that BT and officers of the City continue to believe that BT can achieve a positive cash flow and will be able to service its debt.
F. Is BT still borrowing money from the City or another entity to cover its operating or debt service expenses?
It appears that the statement that after October 2, 2009, BT has debited (i.e., drawn) funds from the Pooled Cash fund but has re-paid these funds within 60 days is accurate. Based on the available information, since October 2, 2009, BT’s Pooled Cash fund draw has stabilized at approximately $16.9 million. However, that amount has not been repaid and the prospects of BT having the ability to repay the $16.9 million Pooled Cash fund draw appear grim.
BT has appeared to stabilize its combined debt obligation of $50.4 million. However, because BT has yet to establish a positive cash flow sufficient to meet its operating needs, let alone the ability to reduce its debt obligation and cover interest payment requirements, there is concern that the new account “Due to G.F. Telecom” could begin to accumulate an increasing amount of borrowed funds in addition to the $16.9 million already owed to the city.
G. The nature and extent of any commingling of BT funds with City funds
The Pooled Cash fund represents a commingling of funds between BT and the City. In the City’s presentation of BT’s Pooled Cash fund position, the City attempted to count funds held in BT’s escrow accounts as an offset to BT’s Pooled Cash fund draw. This attempt to reflect escrowed funds against the outstanding balance owed the City is inappropriate since the funds were restricted for use in paying its obligation to CitiCapital.
Our investigation did not reveal commingling of BT and City funds beyond the Pooled Cash fund.
H. Has the City used any of BT’s capital or operating revenues for City cash needs or operations
Other than observing City charges to BT for a PILOT and for other City services, such as excavation inspections, etc., and BED charges to BT for pole attachments and other services provided by BED to BT, our review did not reveal instances of the City using BT’s capital or operating revenue for City cash needs.
The fact that BT is providing services to various City departments at below-market rates that may be below BT’s cost of service, which could be viewed as a form of cross-subsidization, is a problem. The providing of service at below cost and/or below market rates results in BT absorbing either the cost of the service and/or eliminating margin designed to cover administrative costs. BT should not be allowed to provide discounted services to City departments, which, in essence, is a violation of Condition No. 12. Condition No. 12, as discussed earlier, states that the services would be priced at a reasonable level with respect to the cost of providing that service.
I. Amount of BT’s accounts payable for invoices 30, 60, 90, and 120+ days overdue
BT appears to be current on its obligations to vendors. However, it is delinquent on the amount due the City as required under Condition No. 60. In addition, as noted elsewhere in this report, while BT is not “invoiced” for labor charges, BT’s recording of labor charges and interest charges on its books has in some instances been delayed by several months. While this may be viewed as an advantage to BT, it means that BT’s accounting records are not current.
J. City of Burlington’s Pooled Cash management system and its cash flow funding of BT from BT’s inception to current
BT’s draw on the City’s Pooled Cash management system has stabilized at approximately $16.9 million through June 30, 2010. However, if BT were not part of and supported by the City there would be going concern issues with respect to BT. Neither BT nor the City has demonstrated that BT has the ability to repay the $16.9 million it has drawn from the Pooled Cash fund in violation of Condition No. 60. BT became noncompliant with Condition No. 60 because there was insufficient oversight and application of controls during the start- up and build out. Despite many warning signs, such as insufficient revenues and excessive expenses that resulted in operating losses, BT continued to forge ahead as if there was no end to the funding for the project. Despite warnings of violations and questioning of expenses the process continued as if there was no need for concern. Despite the growing negative balance in the Pooled Cash account BT just kept on spending. The concerns and issues identified by Larkin have been affirmed by the Blue Ribbon Committee, the consultants hired by the City to review BT’s issues, and by the City’s independent auditor.
K. Whether BT actually expended the funds drawn from the Pooled Cash fund and the purposes for which such funds were expended.
The $44 million of increased debt and draw down of investments/escrow was used to increase gross plant by $33.3 million and expended on $10.4 million of operating expenses. The remaining difference of approximately $0.3 million ($44 million less the $33.3 million spent on plant and the $10.4 million spent on expenses) represents other changes to the balance sheet.
BT has relied on the $33.5 million of external financing from the CitiCapital lease arrangement and the $16.9 million of borrowing from the Pooled Cash fund to fund the plant additions and pay operating expenses because BT’s revenues were not sufficient to meet even the cost of operations during this five year time period
Based on the response to DPS 1-30 and the audited June 30, 2009 financial statements, the following table summarizes the amount of net loss BT has recorded in each year for which audited financial statement information is available :
In each year of its existence, BT’s revenues from the provision of service have been insufficient to cover its costs, and BT has incurred a net loss. The funds to finance those losses were from the cash advances from the Pooled Cash account and/or debt proceeds from financing.
L. Concerns regarding BT’s accounting
There are a number of concerns regarding BT’s accounting. This discussion is organized into three major areas:
1. Management letter issues - material weaknesses and other significant deficiencies in internal control.
2. Issues with lack of controls over vendor contractors and other Plant Build-Out spending.
3. Issues with BT’s delayed or erroneous recording of costs.
Larkin is of the opinion that BT exercised only limited oversight of its construction expenditures. This lack of oversight contributed to BT experienc ing improper classification of payments and very limited review of expenditures which may have resulted in an overpayment for services during the construction and purchases of equipment that appear to be in excess of the system needs based on the BT customer base. Also this lack of sufficient oversight contributed to BT’s purchase of substantial quantities of units in excess of the number of customers.
We recommend that a physical inventory of equipment purchased by BT be prepared and presented to the Vermont Public Service Board. The inventory should identify the equipment purchases that have been installed to date, and the reason and use for extra purchases. BT should also describe its plan for using extra equipment purchased to date that has not been installed.
* Update *
Comments of Department of Public Service Commissioner David O'Brien comments:
“This is further evidence that Burlington Telecom and the City of Burlington’s leadership have knowingly withheld and manipulated information to cover the fundamental financial flaws in the case for Burlington Telecom.
"It is clear that Burlington’s Administration has put their interests before the interests of the taxpayers. Unfortunately, they continue to misrepresent the facts in what can only be a considered a campaign to ignore a painful reality —that Burlington Telecom is not viable. It is my hope that the voters and city council take action before more money is lost. It is truly sad that all the warning signs were ignored and that City officials deceived regulators and the general public that now places a tremendous financial burden on unsuspecting businesses and residents of Burlington."
Comments of Mayor Bob Kiss
"The City is reviewing the Larkin report and will fully respond once that review is completed. The report deserves a thorough review of its assumptions, claims, and conclusions.
"The City has received the comments of Public Service Department Commissioner David O’Brien. Mr. O’Brien’s statements are irresponsible, inaccurate and inappropriate. Mr. O’Brien attended the Dec. 8 status conference with the PSB at which the City discussed its plans for BT’s future. Burlington Telecom is cash flow positive and is in serious discussions with a number of strong financial partners about the process of acquiring replacement equipment to address the termination of the CitiCapital Lease agreement.
"Mr. O’Brien’s statements are clearly intended to be harmful to this effort as well as Burlington Telecom as an enterprise providing vital services to residents and businesses in the City. The City is actively engaged in addressing BT’s financial status and CPG with the intent of preserving Burlington Telecom as a telecommunications and economic asset."