NZ On Air's funding of NZ Idol

November 2004, letter to Deborah Coddington MP.

8 November 2004

Ms Deborah Coddington MP
ACT Party
Parliament Buildings
WELLINGTON

Dear Ms. Coddington

NZ IDOL

1. Further to our letter of 7 October 2004, we are now able to address the concerns you raised about NZ On Air's funding of the NZ Idol programme. Your concerns were as follows:

  • the authority of NZ On Air to fund the NZ Idol programme;
  • the nature of the funding agreement between NZ On Air and Television New Zealand (TVNZ);
  • the delay in signing this agreement; and
  • the ability of NZ On Air to secure repayment of the funding it provided to TVNZ.

2. You also asked us to examine some issues you had identified in relation to this funding.

3. The purpose of this letter is to communicate our findings in relation to the concerns you have raised. Our findings are based on discussions with NZ On Air and a review of the relevant documentation.

Introduction

NZ On Air

4. NZ On Air is a Crown Entity that is responsible for developing New Zealand identity and culture by promoting television and radio programmes about New Zealand and New Zealand interests. Its role and functions are set out in the Broadcasting Act 1989. Under section 36 of this Act, NZ On Air is able to make funds available, on such terms and conditions as it thinks fit, for the production of programmes to be broadcast. Funding decisions are made by a Board of Directors who meet six times a year.

5. When NZ On Air receives a funding application for the production of a programme, staff prepare a paper for the Board with a recommendation that the Board either agrees to or rejects the application. Once the Board has agreed to fund a programme, NZ On Air staff then draft a funding agreement and negotiate the terms of the agreement, usually with the programme producer.

6. The funding agreements usually include a clause that states that if a programme generates revenue (for example, from the sale of the rights to the programme overseas), then NZ On Air will receive a percentage of that net revenue1 calculated on a pro rata basis along with any other investors in the programme.

7. NZ On Air usually splits its revenue entitlement with the programme producer on an 80/20 basis; i.e. NZ On Air gets 80% of net revenue, the producer 20%. When NZ On Air has recouped its initial costs, the producer's share of net revenue then increases to 30%2.

Application for funding for NZ Idol

8. On 11 July 2003, South Pacific Pictures (the producers) applied to NZ On Air for funding to produce the NZ Idol programme. This application was supported by a letter from TVNZ (the broadcaster) confirming its commitment to the NZ Idol programme. The amount of funding requested from NZ On Air was $450,000.

9. NZ On Air staff prepared a paper (the staff paper) recommending that the NZ On Air Board (the Board) agree to this application. In support of its recommendation to the Board, this paper referred to:

  • the success overseas of programmes like the proposed NZ Idol programme;
  • the aspirational and inspirational elements of the programme particularly for young viewers;
  • the fact that the proposed programme meets many of the NZ on Air's objectives in the arts and performance areas (arts and performance areas are identified by NZ On Air as 'special interest' areas and NZ on Air's objectives in relation to them are covered by section 39 (d) (ii) of the Broadcasting Act that provides for the'availability of a balanced range of programmes providing for varied interests in the community'); and
  • the likelihood of the programme being of a high quality with broad audience appeal.

10. At its meeting on 13 and 14 August 2003, the Board of NZ On Air agreed to contribute $450,000 towards the production of NZ Idol on condition that:

  • "it will be a genuine talent show that has positive aspirational and inspirational qualities for young people; and
  • NZ On Air's contribution will take the form of a loan with the requirement that this loan is first-out in the event that any revenue results from the programme".

11. We expected the likelihood of NZ On Air recouping its funding contribution was a relevant consideration for the Board and, as such, would have expected some written information about this aspect of the proposal to have been presented to the Board. We did not find any such information.

12. The budget submitted by the producer did not contain a section on the revenue the programme was likely to generate and only focussed on the estimated production costs.

13. The staff paper only highlighted the expensive nature of producing this programme and the fact that the budget submitted by the producer did not contain a section on the revenue the programme was likely to generate from the interactive (text messaging and landline phonecalls) audience-voting element.

14. The Board told us that there was a very full discussion of the NZ Idol application, including discussion about the nature of the programme and related financial aspects, at its meeting on 13 and 14 August 2003. The Board also questioned the programme producer and TVNZ about their proposal at this meeting.

15. The Board also told us that sponsorship revenue and the potential for revenue to be generated through audience voting was assessed against the size of the production deficit being underwritten by TVNZ. The amount to be sought from sponsorship was considered to be very ambitious and still left a shortfall in production costs.

16. The Board considered that it was difficult to estimate the likely revenue from phone and text voting and that due to the uncertainty about this, the right for NZ On Air to recoup its funding contribution from this source of potential revenue should be secured. This led to the inclusion of the condition in the funding agreement that NZ On Air would receive repayment in the event that any revenue resulted from the programme.

17. We note that the minutes of the Board meeting do not record the discussion because only decisions are recorded in the minutes of Board meetings (refer also to paragraphs 30 - 31).

The authority of NZ On Air to fund the NZ Idol programme

18. The Broadcasting Act sets the parameters for NZ On Air's funding decisions. NZ On Air advised us that the authority to fund the NZ Idol programme was within section 36 of this Act, specifically:

(a) "to reflect and develop New Zealand identity and culture by - …

(i) promoting programmes about New Zealanders and New Zealand interests; and …

(c) to ensure that a range of broadcasts is available to provide for the interests of - …

(ii) youth …and

(v) minorities in the community including ethnic minorities".

19. We were advised that section 39 of the Act (that deals with 'matters to be taken into account in relation to funding proposals') was also relevant to the Board in its consideration of this funding application.

20. We are satisfied that NZ On Air acted in accordance with the Broadcasting Act in agreeing to fund the NZ Idol programme.

The nature of the funding agreement

21. As noted above, the Board agreed to the funding application for the NZ Idol programme on the condition that it take "the form of a loan with the requirement that this loan is first-out in the event that any revenue results from the programme".

22. NZ On Air typically funds producers of television programmes. In this case, NZ On Air entered into a funding agreement with the broadcaster, TVNZ, rather than the producers, South Pacific Pictures. This was primarily because the producers were of the view that they were unable to enter an agreement that would have required them to repay the funding from revenue which they had no control over raising. TVNZ was responsible for raising the revenue that would be used to repay NZ On Air - this revenue was to come from sponsorship of the programme, text and phone voting and from website activity associated with the programme.

23. Having decided to enter an agreement with TVNZ, NZ On Air then prepared a first draft of what was called a 'loan agreement'. This was in line with what the Board agreed at its meeting on 13 and 14 August 2003. However, TVNZ were unwilling to enter a loan agreement because of the complications such an agreement would have involved. These complications related to:

  • the requirement for loans to be approved by the full TVNZ Board;
  • TVNZ's policy to enter loan agreements only for capital purchases; and
  • the requirement to treat funding received under a loan agreement differently for tax purposes to funding received under other types of agreements.

24. Because of these factors, the Chief Executive of NZ On Air decided to change the nature of the funding agreement for the NZ Idol programme from a 'loan agreement' to a more standard 'production and funding agreement'. The Chief Executive was satisfied that the Board's intentions (in relation to the conditions to be placed on the funding) could still be achieved with a standard production and funding agreement. Therefore, formal approval from the Board for the change in the nature of the funding agreement was not sought.

25. A key issue, therefore, in relation to the concerns you have raised is whether the production and funding agreement did, in fact, meet with the Board's intentions when it decided to fund the production of the NZ Idol programme. The Board has confirmed that it was satisfied that the funding agreement signed between NZ On Air and TVNZ did meet the Board's intentions and was consistent with its decision recorded in the minutes of its meeting.

26. We are satisfied that the Board's primary intention was to fund the production of the programme. NZ On Air receiving repayment of the funding was secondary to this primary intention.

27. While the use of the term 'loan' in the Board's agreement to fund this programme was understandable, it was not strictly accurate. A loan is a sum of money that is, quite clearly, to be repaid, whereas in this instance, repayment was only a possibility, and was dependent on conditions being met.

28. The Board agrees that the minute of the Board's decision to approve this funding proposal, and particularly the use of the word 'loan' in the minute could prove to be confusing to the public.

29. This minute also stated "NZ On Air's contribution will take the form of a loan with the requirement that this loan is first-out in the event that any revenue results from the programme". The Board has stated that the use of the term "revenue" in this minute reflected "film/television terminology" and was intended to convey what might be more commonly understood by the term "profit". In our view, the minute would have more accurately reflected the Board's intentions had it contained the term "profit" or "net revenue" as opposed to "revenue".

30. Minutes of Board meetings are official records of decisions made at those meetings and may need to be relied upon by external parties. It is important, therefore, that they accurately reflect the exact nature of the Board's decisions so that anyone reading the minutes, including those external to the organisation, can easily understand the nature of the decisions recorded. This is particularly important where the minutes taken do not include any details of the discussions that support the decisions that are taken.

31. We will be recommending that NZ On Air ensures that the wording used to record future Board decisions to fund the production of programmes should better reflect the exact nature of the Board's intentions to avoid any potential confusion that inaccurate wording may cause to others.

32. As stated above in paragraph 24, the funding agreement changed from a 'loan' to a more standard 'production and funding agreement'. This production and funding agreement differed from the standard type of agreement described in paragraphs 6-7 above. NZ On Air negotiated to receive 100% of programme revenue3 as opposed to the usual 80/20 split of net revenue. As we discuss later, NZ On Air was entitled to receive 100% of programme revenue once that revenue exceeded a certain threshold4 (refer paragraphs 38-40).

33. These changes had the effect of putting NZ On Air in a more favourable position than the usual production and funding agreement entered into, and were designed to maximise the probability of NZ On Air funding being repaid, were the programme to be a commercial success.

34. Further, between the time of the funding decision and the finalisation of the agreement, the total production costs had increased due to TVNZ deciding to increase the number of shows in the television series. This increase in production costs had the effect of increasing the shortfall underwritten by TVNZ. However, the threshold over which NZ On Air was to receive repayment remained the same.

The delay in signing the agreement between NZ On Air and TVNZ

35. As stated in your letter, there was a delay in the signing of the agreement between NZ On Air and TVNZ. NZ On Air has informed us that this was due mainly to the fact that contract negotiations took longer than usual because of the need to enter an agreement with the broadcaster rather than the producers, and also because of the nature of the funding agreement as outlined above. NZ On Air has a policy of not paying out any funding until a funding agreement has been signed. In this instance:

  • Board agreement to fund the programme was given at its meeting on 13 and 14 August 2003;
  • the funding agreement between NZ On Air and TVNZ was signed on 29 April 2004; and
  • the first payment (of $350,000) was made to TVNZ on 18 August 2004.

36. Even though the programme was produced and aired prior to the agreement between NZ On Air and TVNZ being signed, this was done so at the risk of TVNZ. Had the agreement not been signed then TVNZ would have had to cover the element of the production costs that NZ On Air had been asked to fund.

37. NZ On Air has a policy of withholding a minimum of 5% of funding until a final report is received from the producers, or in this case, the broadcaster. We consider this to be good practice. In relation to this agreement, NZ On Air did not pay the remaining balance of $100,000 of the agreed funding and has, in fact, received a refund of part of its original payment to TVNZ. This issue is covered in more detail in paragraphs 52 - 54 below.

The ability of NZ On Air to secure repayment of the funding it provided to TVNZ

38. We were told that the $450,000 that NZ On Air agreed to fund represented only a small percentage of the total production costs, and that a much bigger shortfall in the funding required for the production of this programme was being underwritten by TVNZ. The production and funding agreement between NZ On Air and TVNZ included a condition stating that NZ On Air would receive repayment once TVNZ had recovered the amount it had underwritten to meet the shortfall in funding for the production costs. (We refer to this amount as the threshold.)

39. NZ On Air has told us that it is standard practice for investors in television programmes to receive repayment of their investment only when shortfalls in production costs have been met. In this instance, NZ On Air was to receive repayment of its funding contribution to the NZ Idol programme once TVNZ had recovered the funding it provided to underwrite the shortfall in production costs.

40. Therefore, the condition in the funding agreement relating to NZ On Air being first-out in the event that any revenue results from the programme was included on the understanding that:

  • "any revenue" referred to any revenue once production costs had been met; and
  • "first-out" referred to first-out once TVNZ had recovered its funding to underwrite the shortfall in production costs.

41. While the Board may well have understood and intended these 'conditions' in the agreement, it is not clear from the minute of the Board's decision that this is what the Board had intended.

42. The Board is satisfied that the process followed had not adversely affected the outcome and that the Board's overall intentions were met by the agreement. The Board is also satisfied that the aired programme met NZ On Air's objectives in that it was of a high quality and had broad audience appeal. NZ On Air has informed us that research it has recently commissioned indicates that NZ Idol was one of the most watched and enjoyed NZ On Air funded programmes of the last year.

Type of revenue

43. As stated above in paragraph 30, the funding agreement included a threshold which revenue was to exceed before NZ On Air was to receive any repayment of its contribution. The funding agreement specified the type of revenue that was included in the agreement; namely revenue from sponsorship of the programme, text and phone voting and from website activity associated with the programme.

44. Advertising revenue was excluded from the funding agreement. This is in line with standard NZ On Air policy and is based upon the fact that the broadcaster pays the producer a licence fee to be able to air a programme. This fee represents the broadcaster's estimate of a programme's commercial value, i.e. the revenue the broadcaster might expect to generate from commercials aired during the screening of a programme. NZ On Air informed us that this business model is fundamental to the concept of a free-to-air television network because, in the absence of the subscriptions received under the 'user-pays' model, advertising revenue is the main source of revenue for a free-to-air television network. In this instance, TVNZ paid a substantial licence fee for the NZ Idol programme in addition to the amount it had underwritten.

Reporting under the funding agreement

45. As per the production and funding agreement, TVNZ provided NZ On Air with an interim management report on 6 April 2004. This report included a projected revenue figure (excluding advertising revenue) that was slightly less than half of the shortfall in production costs. This shortfall was underwritten by TVNZ. As outlined above, the agreement between TVNZ and NZ On Air stated that this shortfall had to be met before NZ On Air would be entitled to receive any repayment of its funding. Upon receipt of TVNZ's interim report in April 2004, NZ On Air management indicated that it would be unlikely to recover any of its funding in relation to this programme.

46. Under the production and funding agreement, TVNZ was obliged to provide NZ On Air on a fortnightly basis:

  • "copies of any reports received by TVNZ from the producer in relation to the Programme, including any that relate to Programme Revenue;
  • all Programme Revenue received or generated by TVNZ under the terms and conditions of the SPP Agreement5; and
  • a production report describing production progress, cash flow and budget progress and outlining reasons for any significant departure from production and/or financial targets".

47. The following clause was also included in the agreement:

  • "Within 60 days after completion of production of the programme TVNZ shall prepare and deliver to NZ On Air complete financial statements representing a true and fair view of the costs of producing the Programme and accounting for the expenditure of the Budgeted Costs".

48. TVNZ did not provide NZ On Air with any of the fortnightly reports that were due under the agreement. NZ On Air received an interim report in April 2004, and a report showing the final costs of the programme on 3 August 2004. This was within the 60-day deadline required by the production and funding agreement. NZ On Air received a report showing final revenue figures on 6 October 2004.

49. By failing to provide two or more of the fortnightly reports, TVNZ breached its agreement with NZ On Air. NZ On Air has advised us that it did make verbal requests to TVNZ for an updated cost report.

50. It is a matter of concern that NZ On Air did not receive these fortnightly reports that it required to be able to effectively monitor performance against the agreement.

51. While we are satisfied from the work conducted as part of our annual audit of NZ On Air that its contract monitoring is generally undertaken to a high standard, this was not the case in this particular instance. We understand that NZ On Air has already discussed this issue with TVNZ. The NZ On Air Audit Committee has also discussed options for improving contract monitoring arrangements and the provision of reports in the future.

Final production costs and revenue figures

Production costs

52. The final report from TVNZ showed that actual production costs for NZ Idol were less than budgeted. Clause 1.3 of Schedule 1 of the production and funding agreement stated that:

"budget cash surplus means the amount calculated by deducting the actual cash costs of producing the Programme from the budgeted cash costs provided that such sum shall not be less than 0".

53. Under the agreement, NZ On Air was to receive 100% of any budget cash surplus (NZ On Air's usual position is to receive only 80% of budget cash surpluses). On 6 October 2004, TVNZ confirmed that NZ On Air was due a refund of $206,041 (against the total agreed funding of $450,000).

54. Therefore, NZ On Air's total funding contribution to the production of the NZ Idol programme is $243,959.

Revenue figures

55. On 6 October 2004 TVNZ sent NZ On Air details of the total revenue, excluding advertising revenue, generated by the NZ Idol programme. Although the production costs were less than expected, they still greatly exceeded revenue. The total revenue was slightly less than half the amount of the shortfall in production costs that had been underwritten by TVNZ6.

56. Therefore, NZ On Air will not receive any further repayment of its funding contribution to this programme because the amount of revenue generated (of the type specified in the funding agreement) falls well short of the threshold over which NZ On Air was to receive repayment.

57. In summary, then, NZ On Air's funding contribution has turned out to be $243,959. This is less than the amount originally agreed ($450,000). NZ On Air's initial payment to TVNZ was for $350,000 and a refund has been made to NZ On Air to account for that. However, no further repayments are likely to be made to NZ On Air.

Looking Forward

58. Under section 43(b) of the Broadcasting Act, NZ On Air is able to audit, or to contract an independent audit of, recipients of its funding. The decision to do so rests with NZ On Air's Audit Committee. NZ On Air has advised us that an audit will be conducted.

59. In addition, we will be recommending that NZ On Air should conduct a review of the processes followed in this instance to identify lessons learned for the future. This review should focus particularly on the specific matters raised in this letter, namely the processes required to:

  • ensure that the wording used to record future Board decisions to fund the production of programmes should better reflect the exact nature of the Board's intentions to the extent that a lay reader will be able to understand the meaning of what is recorded; and
  • improve contract monitoring, particularly in relation to ensuring that reports due under funding agreements are received.

Other Issues

60. On page two of your letter, you also highlighted a number of other 'key issues'. We address below those that have not already been covered in this letter. In addressing these issues, we use the term 'loan' as this is how the funding is described in your letter. As explained above, the funding was not given in the form of a loan.

What was the total value of the loan, i.e. was interest charged or to be charged?

The total value of the 'loan' was to be $450,000, but as explained above, turned out to be $243,959. There was no interest charged on the 'loan' but NZ On Air ensured it retained an entitlement to revenue beyond repayment of its original investment.

How was the loan treated for tax purposes?

NZ On Air is a public authority for tax purposes, and is therefore exempt from income tax under section CB3 of the Income Tax Act 1994. However, as both NZ On Air and TVNZ are registered for GST, the transaction was treated as a supply of goods and services in accordance with section 5(6D) of the Goods and Services Tax Act 1985. As a result, NZ On Air was entitled to claim an input tax deduction in relation to the payment made to TVNZ.

Is NZ On Air permitted under the Broadcasting Act to lend money for production costs to broadcasters?

As stated in paragraph 4, under section 36 of this Act, NZ On Air is able to make funds available, on such terms and conditions as it thinks fit, for the production of programmes to be broadcast. It is therefore able to provide funding for the production costs of programmes to broadcasters and does so routinely on the basis outlined in paragraphs 6 to 7.

Is NZ On Air in breach of the Broadcasting Act if it converts the loan to a grant?

The change in the nature of the funding agreement from a loan to a production and funding agreement was not in breach of the Broadcasting Act. NZ On Air has advised us that it does not administer grants, rather that it distributes funds in the form of "equity investments" that give NZ On Air the opportunity to receive a share of the revenue from sales of programmes and associated merchandise once all production shortfalls are met. In the case of the funding of the NZ Idol programme, the use of the word 'loan' in the record of the Board's approval to fund the programme has proved to be confusing and not an accurate description of the nature of the funding agreement that was actually signed.

Is NZ On Air considering advancing more money to TVNZ for a further series of NZ Idol?

NZ On Air has not received an application from TVNZ to fund a further series of NZ Idol and is not therefore considering this matter.

Is NZ On Air advancing monies to other broadcasters or production companies as unsecured loans, if yes, is this a wise use of taxpayers' money?

The functions of NZ On Air and the matters to be taken into account in relation to funding proposals are set out in sections 36 and 39 of the Broadcasting Act respectively. We are not aware that NZ On Air is advancing monies to other broadcasters or production companies as unsecured loans. However, it would be acting within its mandate were it to do so as long as the other relevant requirements within the Act had been met. As stated in paragraph 20 above, in our view, NZ On Air acted in accordance with the Broadcasting Act in deciding to fund the NZ Idol programme.

I trust this letter addresses satisfactorily the concerns you raised. I would be happy to meet with you to discuss these matters further if required.

Yours sincerely

[signed]

Gareth Ellis
Sector Manager

Copy: Chair, NZ On Air
Chief Executive, NZ On Air
Chief Executive, TVNZ

1 NZ On Air has stated that net revenue refers to the revenue, less shortfalls in the funding of production costs, generated from sales of the completed programme and associated merchandising as specified in the production and funding agreement.

2 The 80/20 split is a "default" position. NZ On Air has policy guidelines under which the producer may negotiate a higher percentage of NZ On Air's net revenue entitlement. This negotiation may, for example, be predicated on the producer taking a bigger up-front risk in financing the programme, in return for a more significant share of back-end reward.

3 Programme revenue was defined to be more extensive than net revenue and to include any sources of revenue that might be generated before, during and after transmission (for example, revenue from sponsorship and text voting).

4 This threshold constituted the amount of the shortfall in production costs that was met by TVNZ.

5 Under the SPP Agreement between TVNZ, South Pacific Pictures and others, TVNZ agreed to contribute towards the programme an amount equivalent to the agreed NZ On Air funding.

6 The total revenue figure included an estimate of revenue expected to be generated from sales of merchandise. TVNZ has indicated that no material change to this estimate is expected.