First of two parts
June 18, 2002 – The Virgin Islands' telephone company appears to have, in comparison to the nation's other local telephone service providers, much higher than average expenses, much higher than average profits and, despite massive ongoing subsidies from Washington, a much higher basic monthly service rate than what is paid by the vast majority of users.
The evidence supporting these conclusions comes from a three-month study of mainland and insular telephone company data and interviews with public and private officials. It does not rely on any privately held Innovative Telephone financial records, or on conversations with current or former Innovative employees or any V.I. government personnel.
Research into the local phone company's finances included searches of federal data sets, notably those of the Department of Agriculture's Rural Utilities Service, and examination of the web sites of the Federal Communications Commission and two obscure FCC-sponsored not-for-profit entities that administer subsidies to local phone companies — the National Exchange Carrier Association (NECA) and the Universal Service Administrative Company (USAC).
It also involved field trips to the Virginia Corporation Commission, a regulatory body in Richmond, Virginia, and to three small telephone companies in rural Virginia, all of which get much smaller subsidies than Innovative.
There also were telephone interviews with numerous officials of other telephone companies, state and federal regulators, and NECA and USAC officials.
Innovative Telephone does not operate in a vacuum; it functions within a complex nationwide public/private setting and also within a historical setting that influences its current circumstances. An understanding of these settings is needed in order to understand Innovative's finances, which as those of a privately held company are not subject to public scrutiny.
Historical context of federal subsidies
Some long-existing patterns in telecommunications finances have a bearing on how much customers pay for different kinds of telephone services and on how much profit can be made by local telephone providers. An element of social planning is involved, although this is rarely discussed.
Back in the days of the AT&T monopoly, Ma Bell had decided that long-distance calls (not considered a necessity under most circumstances) should bear a heavy portion of the costs of phone service, and that residential service (a more pressing need for all families) should play a lesser financial role than commercial service. Put another way, long-distance calls subsidized local ones, while charges to businesses helped pay for residential service.
These decisions were not maternalistic, however. It is in the interest of the long-distance carriers that there be as many residential phone lines as possible, the better to generate long-distance calls. Similarly, it is in the interest of the business phone users in their dealings with the public that the residential network be as complete as possible.
In the days before the 1984 break-up of Ma Bell (called "divestiture" in the industry), AT&T made all of the decisions about how these subsidies were to be made.
"We used to get a monthly check in the mail from Ma Bell," a rural phone company executive said. "We did not apply for it or provide a lot of data, and we had no impact on the size of the check – it just arrived."
Now, with the FCC looking over their shoulders, at least in concept, NECA and USAC handle the congressionally mandated Universal Service Fund subsidies paid out to rural and insular carriers under a dense cloud of regulations and formulas. (These subsidies are funded by all of the nation's phone users via charges on their monthly bills. However, the regulations and explanations thereof seem to be written for industry insiders, notably for those with double degrees in accounting and electrical engineering, and not for the consumer.)
On another front, Congress decided in the early 1950s that the federal government should make low-cost or no-cost loans to rural telephone cooperatives serving areas that the major phone companies did not want to serve (on the grounds that they would not be sufficiently profitable). In many instances, the long-term loans made early on were on very favorable terms; examination of the financial reports of the small rural phone companies in Virginia turned up numerous indications of old, but still active, loans at the interest rate of 2 percent.
Somewhere along the way, the decision was made in Washington that all island territories would be deemed rural areas for these purposes. Thus, private rural and insular corporations, including the old V.I. Telephone Corp. — Vitelco, could and did make use of the low-cost loans. What is now the Rural Utilities Service handles the loan program for the U.S. Department of Agriculture.
Vitelco and Innovative finances
The table at the right and the chart below show what the Source was able to glean about the Virgin Islands telephone company's finances. It indicates that in the mid-1990s (when the data are complete) 
However, the federal subsidy and the net income (profit) did not differ greatly one from the other in any of those years. Put another way: Without the subsidy, Vitelco would have been approximately breaking even for those years; with the subsidy, it was securing a profit of about 20 percent of its gross. (For 1993-97, profits totaled $63,498,000, and subsidies totaled $64,726,000.) A profit margin of 20 percent of gross is an attractive rate for any stable, low-risk operation, such as a telephone monopoly.
There is no reason to assume that after 1997, when the profit-and-loss figures became hidden, the profit margin did not stay the same — or perhaps increase, as the federal subsidies did. The annual subsidies that had grown from $11 million in 1990 to nearly $16 million in 1997 have increased to an estimated total of more than $25 million this year.
Another indication of the prosperity of the phone company can be seen by examining the annual Rural Utilities Service report for 1997, when Vitelco profits were last reported. In that year, RUS indicated a return on equity of 
The Source examined a 10 percent sample of reports from local telephone company borrowers of RUS funds in 1997 and found that seven out of the sample of 88 had returns on equity of better than 38 percent. The other 80 had lesser returns, usually much lesser. Two of the seven companies that did better than Vitelco in the sample were tiny. One had a total of two employees; Vitelco had 406 that year.
What has happened to the local phone company's profits in the years since cannot be ascertained. Innovative Telephone is a privately held firm, a subsidiary of Innovative Communication Corp., also privately held; hence there is no annual report for stockholders. Also, there is an anomaly in the FCC rules that allows Innovative not to file annual financial reports, while requiring it of many other monopoly telephone firms: The FCC classifies monopoly systems into two categories by size; the bigger systems have to report their finances to the FCC, but the smaller ones do not. And the V.I. Public Services Commission has to date refused to release whatever financial information it has on the subject.
Jeffrey Prosser and Cornelius Prior Jr. as owners of Atlantic Tele-Network bought Vitelco from International Telephone and Telegraph for $87 million in 1987. In 1997, in a split that gave ATN to Prior, Prosser became the telephone company's sole owner. Perhaps his a
ggressive leadership has led to greater profits; perhaps not. But whether profits have kept growing or not, two things are clear:
– In 1999, the company's gross revenues were double those of 1997.
– The federal subsidy has continued to increase in size.
The profit and loss statements disappear after 1997 because in the following year, apparently, Vitelco paid off its debt to the Rural Utilities Service. The 1997 RUS Statistical Report showed the profit and loss figures for Vitelco as well as a balance of $54 million remaining to be paid. Presumably the balance was paid off in 1998 — and thus there was no need for a profit and loss statement in the 1998 report. Vitelco meanwhile began borrowing money from the National Rural Utilities Cooperative Finance Corp., a not-for-profit bank established with the encouragement of RUS.
As the Source has reported previously (See "Does Prosser have money problems?"), Prosser has borrowed nearly $600 million from CFC to pay off its RUS debt and to invest in off-island ventures in Jamaica, St. Martin and elsewhere. The interest Innovative pays the Cooperative Finance Corp. is not known exactly, but 8 percent is what CFC charges on average.
"Why did Innovative give up those nice low-interest Rural Utilities Service loans?" the Source asked a USDA official who agreed to answer if not identified.
"Mr. Prosser apparently preferred paying more interest to having his finances made public." was the response.
A high-cost operation
While the margin of Innovative's recent profits can be only the subject of informed speculation, the high cost of the telephone company's operation can be clearly documented.
The High Cost Loop program of national subsidies, to be discussed more thoroughly in Part 2 of this series, is based on phone company costs; if there are high costs, there are high subsidies. The subsidy is for the costs of operating a local telephone system, including the installation and maintenance of the phone lines; the money comes from a federally sponsored fund that derives its revenues from surcharges on telephone customers' bills across the nation.
Innovative is getting $22.07 per month per line from the High Cost Loop program this year. (See "Innovative Telephone heavily subsidized".) Working backward from that figure and using the NECA formula, the company's costs as measured by NECA come to $53 per line per month. The national average cost is about $20 per line per month. For rural phone companies, NECA's estimated average is $28 per line per month. Innovative thus is reporting costs 2.5 times those of the national average, and nearly double those of the rural average, despite relatively low USVI wages and low USVI taxes.
Another way of looking at the relative cost and efficiency of a local phone company is to calculate the number of telephone lines per worker. Verizon, which serves more than 3 million customers in Virginia, has 532 lines per worker in the state, but also significant economies of scale. Innovative has, according to NECA, 68,283 lines and 400 workers, which comes out to 170 lines per worker.
A company whose economies of scale would be less than those of Innovative is Virginia's Ntelos, which has around 40,000 lines, which works out to 424 lines per worker. Then there is the tiny 4,061-line system of the Buggs Island Telephone Cooperative. It has 10 workers, and thus 406 lines per worker, or about two and a half times as many lines as Innovative has per worker.
Next: How Innovative gets such big subsidies and how they affect consumer rates
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