19981119Order No 27798.pdf

Offi.ce ofthe Secretary
Service Date
November 19, i998
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE JOINT APPLICATION )
OF UNITED WATER IDAHO INC. AND SOUTH )
couNTY WATER COMPAI\-Y, NC.FORAN )
ORDER APPROVING THE SALE AND )
TRANSFER OF THE COMMON STOCK OF )
souTH couNTY WATER COMPAI\"Y, rNC. TO )
CASE NO. UWr-W-e8-2
oRDER NO. 27798
UNITED WATER IDAHO INC.)
)
A joint Application in Case No. UWI-W-98-2 was filed with the Idaho Public Utilities
Commission (Commission) on June 12,1998 by United Water Idaho Inc (United Water; IJWI) and
South County Water Company, Inc. (South County) for an order approving the sale and transfer of
the common stock of South County to United Water. The negotiated and proposed purchase price
is $2,810,000. United Water also requests Commission approval of certain rate and ratemaking
matters, including a schedule for a five-year phase-in of rates for South County customers and the
right of United Water to include in its rate base in future rate proceedings the fuIl purchase price
which includes the depreciated original cost of South County's assets plus an acquisition adjustment.
By this Order, as more particularly described and qualified below, the Commission
approves the sale and transfer of South County common stock to United Water, denies the request
of South County to include $312,867 of contributed plant in the sale price, approves a purchase price
of $2,497,133 adjusted to the closing date, authorizes the rate basing of said amount by United Water
and approves a six year phase-in of rates for existing South County customers.
United Water provides water service to approximately 58,000 customers in and around
the city of Boise and operates under Commission Certificate of Public Convenience and Necessity
No. 143 (as amended). South County provides service to approximately 3,825 customers in Ada
County and operates under Commission Certificate of Public Convenience and Necessity No. 274
(as amended). Tr.p. 116. As represented in the Application and repeated in South County's
testimony, the owners of South County desire to sell the water system because they are reluctant to
undertake the risks of continued operations arising from increasingly stringent water qualrty
regulations, increasingly complex utility regulations, and increasingly complex operational and
ORDER NO 27798 -1-
technical requirements. Because of its small size, South County contends it has experienced, and
in the absence of this sale, would continue to experience difficulties in maintaining its current quallty
of service and obtaining adequate financing for operations, maintenance and future necessary system
improvements. South County is a closely held Subchapter S corporation. The shareholders decision
to sell the South County Water Company was also influenced by the advanced age of the majority
of shareholders and a financial institution requirement of personal shareholder guarantee of South
County indebtedness.
A public hearing in this case was held in Boise, Idaho on September 17,1998. The
following parties appeared by and through their respective counsel:
Dean J. Miller, Esq.
Barton L. Kline, Esq.
Scott D. Woodbury, Esq.
Sale Consequences to IIWI and South County Water Customers
Analysis of this transaction by the parties included the following enumeration of
identified benefits and consequences accruing to both UWI and South County customers:
The purchase of South County by UWI and interconnection of the two water systems at
an estimated interconnection cost of $6,000, will result in operational efficiencies through shared
water supply and storage (e.g., constant pressure during power outages, Tr. p. 78); will provide
improved financial and technical ability to operate the South County system in the future, to make
needed system improvements, plan for growth, to replace aging facilities and comply with regulatory
requirements, and will provide a revenue benefit to existing UWI ratepayers as South County rates
are phased into current UWI rates. Tr pp. 15, 16, 154,155,161,179,181, 201.
The physical effects of interconnection will depend upon the hydraulic characteristics of
the system after interconnection. Tr. p. 157. As a result of planned chlorination of all South County
source wells by United Water to safeguard and improve water quallty and to comply with an
expected ground water disinfectant rule, South County customers may perceive a change in water
taste and smell. Tr. pp. 14, 7 5, 157. Also available to South County customers, although perhaps
noticeable only if needed or utilized, will be emergency electrical backup, faster response to system
problems (SCADA) and UWI resource experts, full-time maintenance crews/material inventory,
United Water Idaho Inc.
South County Water Company
Commission Staff
-2-oRDER NO. 27798
personnel trained and certified in water system distribution, water treatment and cross connection
control, and an in-house state certified laboratory. Tr. pp. 14,157.
If the United Water requested phase-in rates are approved as opposed to an immediate
flash cut to UWI rates, South County customers will realize an estimated phase-in benefit of
approximately $1.75 million (Year 1, $700,000;Year 2, $525,000;Year 3, $350,000; and Year 4,
$175,000). Tr.pp. 184, 185.
Recognizing the value of establishing a dialogue with customers of acquired water
systems, United Water commits to form a customer "liaison team" for South County during the
transitional period. Tr. p. 19. To ensure that South County customers are schooled in conservation
and the efficient use of water, the Company will provide and offer in the South County area its (l)
residential water audit progranq (2) water efficient landscaping classes, (3) school programs, and (a)
other related water information. Tr. pp. 2l-28.
Regarding water quality in the South County system, South County notes that it is
presently experiencing problems with iron, manganese and hydrogen sulfide. Of 14 production
wells, two wells are not used at all, one because of sand and low production, and the other because
of high iron. Both however are reportedly tested and remain in standby readiness, Tr. p. 123. South
County has five wells with iron problems and one well with a hydrogen sulfide problem which it
treats by chlorination. Tr.pp. 117, 120. South County expressed concern over problems
encountered with water qualrty, the ever increasing burden of regulation, and the Safe Drinking
Water Act requirements (customer confidence reports, additional water testing, capacity
development requirements). South County knows there are solutions but states it lacks the
experience and money to bring them about. Tr. p. 96.
Growth in the South County customer base and a need to increase fire protection and
address water quality concerns is estimated to require $875,000 capital investment for distribution
analysis & study, mapping, storage, source well, and telemetry within the next two years. Exhibit
2,Tr. p. 12. This investment would cause an increase in rates equivalent to the first year phase-in
rate increase proposed in the sale. Tr. pp 31,35,40,201,202,214,215, Exhibit 108. It was
represented that the economic effect of interconnection of South County with United Water may
avoid the need for $306,000 of capital cost. Exhibit2,Tr. p. 12.
oRDER NO. 27798 -3-
The difficulty presented by this sale, Staffnotes, is that South County is a low cost, well
operated system. Although this transaction is not being proposed to resolve any immediate problem
or deficiency, it was represented that its approval may assure that high quality service will continue.
Tr. pp. 81, 160. Arguably South County, Staffcontends, could continue to successfully operate the
systenl continue to borrow against personal assets, hire necessary technical expertise and raise rates.
Tr. p. 16l . But Staff queried, should the owners be required to do so?
The customers of South County appear generally to be quite satisfied with their present
water service and water qualrty. The written comments and testimony of South County customers
reflect frustration and opposition to the proposed sale based on a perceived lack of immediate benefit
to customers and to a greater extent based on the expected increase in their rates should the sale be
approved and how that increase will affect water's affordability. Despite the increase in rates that
a sale will bring to its customers, South County believes the customers will be better served in the
long run by United Water and that service, water qualrty and system dependability will improve if
the sale to United Water is approved. Tr. p. 106.
Commission Findings
The Commission has reviewed and considered the filings of record, transcript and
exhibits in Case No. UWI-W-98-2, including the letters and comments received from South County
customers. We have reviewed our Orders in Case No. U-1 lI7-1, the South County Certificate case.
We have also reviewed and considered the relevant statutory authority (Idaho Code $ 6l-526) and
Commission Rules (IDAPA 31.01.01.112) regarding amendments to Certificates of Public
Convenience and Necessity for existing utilities.
We are faced in this case with the proposed purchase of a comparatively low-cost water
company (South County) by a relatively higher cost water company (United Water). The fact that
there is a significant difference in the respective costs of service and related rates and charges has
caused many South County customers to oppose the sale which, if approved, will result in higher
rates to them. The difference in cost of service and rates, however, provides insufficient reason to
deny the sale. This Commission has approved the tariff rates for each utility in general rate
proceedings based on indMdual review and assessment of the respective systems, investment and
expense. Regarding rates alone, the evidence reflects that even should the Application be denied,
ORDER NO. 27798 -4-
South County customers will experience significant increases in rates within the next two years for
substantial required improvements.
The regulatory, operational and personal reasons expressed by South County as
prompting the decision to sell by its stockholders cannot be casually dismissed. Although
consistently a well-run company, clearly South County faces operational and regulatory challenges
today and in the future that will be more technically and physically demanding. It is the assessment
of Mr. Stokes, president of South County, that on a going-forward basis the customers of South
County would be better served by United Water. South County customers have had the benefit for
24yews of continuous system management and ownership. The present ownership, many advanced
in age, desire to sell and bring an end to their venture. The fact that their water system is a regulated
entity should not preclude them from selling. Based on the record, and as reflected and described
below, however, we find that for Commission approval the sale terms must be adjusted and changed.
Purchase Price
Pursuant to a Stock Purchase Agreement dated June 5, 1998, the stated purchase price
for the South County Water system is $2,810,000. The purchase price consists of the following
elements:
Book Value South County Assets (6130197) $1,488,122 (Incl. $10,000 legal fees)
$ 312,867
$1,009,011
$2,810,000
Tr.pp. 10,192.
Book Value: S 1.488. I 22 (6/30/971
The stated depreciated book value of South County assets of $ 1,488, 122 as of 6/30197 ,
is undisputed. Tr. p. 190. Stafffound no discrepancies in South County Water records which it
found accurately presented South County investment and water system plant in service. Tr. p. 190.
Staffproposes that for rate base purposes, the plant valuation on the date of closing be used. Tr. p.
208.
We find: We find the stated depreciated book values for South County assets to be
consistent and reasonable and we further find reasonable the rate basing of same by United Water
on its books in an amount adjusted to the calculated plant valuation on the South County books on
Plant Held for Future Use
Acquisition Adjustment (Premium)
TOTAL
ORDER NO. 27798 -5-
the date of closing the sale with related depreciationlanortization based on remaining scheduled life
of assets appropriate for the respective classes of property and investment.
Plant Heldfor Future (rse: 8i12.867
South County seeks as part of the negotiated sales price to include or add to South
County plant value $312,867 in "unclassified plant," an arnount that dates back to South County's
original certificate application in 1974 (Case No. U-l I l7-l) and which South County contends was
wrongfully excluded. The Commission-approved valuation in the South County certificate case was
$325,125, the net amount reflected in the underlying purchase and sale agreements with Idaho Land
Developers ($278,625; Exhibit 104) and Green Acre Properties ($46,500; Exhibit 106). Tr. pp. 130,
131; Order No. 1 1762 @yJlbit a). The net valuation approved by the Commission was accepted in
that case by South County in a filed "affidavit of unqualified acceptance" (Exhibit 6; Exhibit 104).
Tr. pp. 104, 196, 197. Reconsideration was not requested and the Commission's Order was not
appealed. It is undisputed, South County contends, that the $312,867 represents facilities and utility
plant whichwere provided to and used by South County customers since 1975. Commenting on its
proposal to include the value of an amount rejected by the Commission?4 years ago, South County
responds that this is the last opportunity the Company shareholders will have to obtain some value
for the plant. Tr. pp. 109, I ll,ll2.
Contending that South County stockholders have no equity invested in contributed
property, Commission Staff opposes both rate basing of the $312,867 and inclusion of the amount
in the sales price. Tr. p.2I9. Sta^ffnotes that in the South County certificate case, Mr. Stokes
himself recommended that the Commission treat a portion of the water system development costs
as contributed property, i.e.,$257,719. Exhibit 102. South County in that case recommended arate
base of only $202,465. Tr. p.217; Exhibit 102.
Staff represents that in meetings with South County and United Water preceding the
UWVSouth County Purchase and Sale Agreement and this filing, it was agreed that South County
would carry the burden of proof in persuading the Commission to include the $312,867 of
contributed property in the sale price after 24 years. Tr. p. 233. The Commission was reminded by
Staffofthe presumptionthat developers recover the cost ofwater systems in the sale of lots. Tr. p.
234. Should the $312,867 be excluded from South County rate base, United Water notes that there
ORDER NO. 27798 -6-
is no Company proposal that an equivalent amount simply be added to the acquisition adjustment.
Tr.pp. 43,44.
We find: We find no justification to include an additional $312,867 in the plant value.
The proper treatment for this was determined 24 years ago and was not then nor has it since been
challenged. The Commission's prior decision is final and non-appealable. Contributed property was
then and is still appropriately excluded from rate base. The requested addition to rate base was not
a capital investment of South County stockholders. We therefore find it reasonable to reduce the
amount ofthe authorized purchase price by $312,867 and to deny United Water's proposed related
rate basing of said amount. Subtracting $312,867 from the proposed purchase price of $2,810,000
results in an adjusted purchase price of $2,497,133.
Acquisition fustment (Premiw\t $,1.009.01 I
As a condition precedent in the underlying Stock Purchase Agreement, United Water
must be permitted in future rate proceedings to earn on the total purchase price, a price which
includes an acquisition premium of $1,009,01 l. Tr. pp. 9, 40. The Company proposes a 4}-year
amortization ofthe acquisition adjustment. Tr. p. 9. Staffdoes not oppose the Company proposed
ratemaking treatment of the acquisition adjustment and related amortization. Tr. pp.204-206,209.
Staff contends the acquisition premium request by UWI is supported by the reduced return and
expenses incurred by United Water relative to South County. Analysis shows that an additional
$744,268 in rate base can be supported by reduction in return and expenses. (Tr. Exh. l.) When
added to the $306,000 of avoided investment (Tr. Exh. 2), a purchase premium of over $1,009,000
could be justified.
Regarding standard accounting practice for purchase of existing regulated water systems,
Staffrepresents that purchase of water system assets would be recorded at the original cost of the
seller. The seller's accumulated depreciation, contributions in aid of construction (CIAC) and other
customer advances would also be transferred to the buyer. Any premium paid in excess of the net
book value of the assets would be recorded as an acquisition adjustment. Tr. p.204.
Regarding regulatory treatment of acquisition adjustments, Staff notes that in normal
practice the acquisition adjustment would not be recognized in the calculation of rate base nor would
depreciationlarrortization expense of the acquisition adjustment be included in the revenue
ORDER NO. 27798 -7-
requirement. For approval of different accounting treatment the purchasing utility needs to receive
the express authorization of the Commission. Tr. p.204.
We find: We find the acquisition premium of $1,009,01I to be reasonable. We find
the acquisition premium is a result of negotiated arms-length bargaining and find it reasonable to
approve this amount as an element of the authorized purchase price. On the specific facts of this
case, we also find it reasonable to authorrze the rate basing of the acquisition premium amount,
amortized over 40 years, a period tied to the life of the related assets. In authorizing the ratebasing
of the acquisition premiurn, we note that we depart from traditional ratemaking procedures. It is not
lightly that we do so and we do not intend that this be perceived as establishing precedent for future
acquisitions. We find Staffanalysis regarding the appropriateness of approving and rate basing the
acquisition premium to be persuasive. United Water's investment for South County customers
based on a purchase price of $2,497,133 is approximately $653 per customer, considerably less than
the Company's average investment per customer, $1,467. With the proposed phase-in of rates we
adopt as described below, the Company will be foregoing additional customer associated revenue
and may in the first year actually earn less than its authorized 9.l2oh return. In structuring such a
phase-in the Commission recognizes the perceived hardship imposed on South County customers
by an immediate flash-cut to United Water rates. We also acknowledge that the Company, in
exchange for a one year shortfall, receives a long term benefit in being permitted to rate base its
acquisition premium. We find that such a phase-in provides an equitable transitional benefit to
existing South County customers.
Rate Phase-In and Related Return on Investment Analysis
In this case United Water proposes a five year phase-in period for transition of South
County customers to United Water rates. (Year l,600A UWI tariffrate; Year 2,7lo/o;Year 3,80Yo;
Year 4,9OYo;Year 5, 1009y'0.) At full phase-in South County customers will realize an increase in
their rates of over 100%. Tr. p. 154. The 5-year rate phase-in period, United Water contends, will
minimize rate shock and provide South County customers with the opportunity to change their water
consumption patterns and avail themselves of alternative irrigation water services in areas where
such waters are available. Tr. pp. 18, 40,41,136.
It is noted that under present rates the average South County customer uses 324 ccf
annually. That is considerably more water per year than the 220 ccf Unrted Water customers use.
oRDER NO. 27798 -8-
Tr. pp. 17, 18, 21. At current levels of consumption and at l00Yo of existing [JW[ rates, average
winter/summer monthly charges to South County customers would increase by approximately $11
and $33, respectively. A change from monthly to bi-monthly billing will make the impact of the
increase seem more acute. Tr. p. 158.
While the Company's Application made no proposal as to the rates that new customers
in the South County service area should pay during a phase-in period, during the hearing Mr. Linam
said he would leave it to the Commission to decide. He did note that he saw a little problem with
neighbors paying different rates. Tr. pp. 55-57.
Staff expressed its opposition to de-averaged rates for South County customers,
contending that such rates would be inequitable to other UWI customers with averaged rates. Tr.
p. l7l. Staffsupports rate uniformity and United Water's proposed rate phase-in. Tr. pp. 154, 162.
The proposed purchase of South County by United Water, Staffcalculates, will have no
adverse effect on existing United Water customers. Exhibit 107. Assuming continuation of present
consumption levels and a flash cut to present UWI rates the $2,810,000 purchase price would
produce an overall rate of return on investment to United Water of 28.3Yo. At present South County
rates the Company could invest only $2,197,000 and realize its authorized 9.l2Yo overall rate of
return. At 60yo of LIWI rates the Company could invest as much as $4,23 0,000 and realize a 9 .l2Yo
return. Tr.pp. 198, 199.
Testimony reflected that United Water would reilize its authorized return on investment
(presently 9.12%) withanincreaseinthefirstyearof only 13.8% to SouthCountyrates. The
Commission questioned the Company as to why the first year phase-in was greater than 13.8Yo. Tr.
p. 16. The Company responded that the move to 60Yo of UWI rates in the first year was not an iron
clad method but simply a reasonable approach to move South County customers to parity within four
years. Tr. pp. 69,70. Also discussed in response to Commission questioning was the Company's
receptiveness to extending the phase-in period beyond five years, possibly a year or two. Tr. pp. 81,
82.
With the proposed additional UWI investment for distribution analysis and study,
mapping, storage and telemetry, ($569,000; Exhibit 2) the Company's total investment in South
County would increase to $3,379,000. The resultant return at fuIl (fWI rates would be 23.65Yo, at
South County rates 6.l7Yo, and at 600/o IJWI rates 11.25%. Tr. p. 200. Should the disputed
ORDER NO. 27798 -9-
$312,867 be excluded from the sales price, the overall return at 60Yo UWI rates would increase from
1l .25% to 12.32Yo. At 100% UW[ rates the return would increase from 23 .65oh to 25 .99o/o.
We find: The difference in rates charged by South County and United Water has been
the principal reason expressed by customers opposing the transaction. We find the Company
proposal to phase-in rates to be a responsible and reasonable method of addressing customer
concerns and mitigating the rate shock that would otherwise result. Certainly without the
Company's phase-in proposal our decision in this case would have been more difficult. We find a
required transition to fuIl United Water rates to be reasonable and necessary. United Water is
essentially an integrated water system with averaged rates. The de-averaging of rates for an isolated
geographic area or customer segment presents unacceptable issues of inequity and discrimination.
Although the Company has proposed a five-year transition, we find it reasonable to provide South
County customers with a longer period up-front to assess their water usage, to possibly adjust their
water consumption habits and to connect (if available) to other irigation sources.
The rate phase-inthatwe find reasonable to approve for existing South County customers
is a six-year phase-in period. Year 1 will be, at existing South County rates, but changed to bi-
monthly billing. Year 2 will be at 60Yo of [JW['s tariffrate; Year 3 at 70oh;Year 4 at 80Yo; Year 5
at90Yo; Year 6 at 100%). The extra year adds approximately $988,000 to the estimated five-year
$1,750,000 difference between phase-in and immediate full UWI rates, and results in a net savings
to South County customers of $2,738,000. The phase-in period that we authorize is available only
to existing and not to new customers. We find that new customers in the South County area, whether
new by the result of new construction or sale/purchase, are not subject to rate shock and cannot be
perceived as having any reasonable expectation of lower South County rates.
Certificate Nos. 143 and274
We find: In considering the benefits accruing to both South County (phase-in rates,
program expense, and a myriad of intangible operational benefits) and United Water customers
(revenue exceeding cost of service), we find that the proposed sale/transfer under the terms approved
is inthe public interest. We find that United Water possesses the technical, managerial and financial
ability to provide reliable and adequate service to South County customers. We find that United
Water is able to provide quality water, that it has the ability to serve present and future growth in the
South County area,thatit has the ability to address critical water supply issues such as fire protection
ORDER NO. 27798 -10-
and backup capability, and that it has the ability and wherewithal to accommodate unforeseen
circumstances and emergencies.
We find that the Company's filing satisfies the underlying statutory and procedural
requirements for certificate applications. Assuming United Water and South County accept the
changes directed by the Commission and go forward with the sale and transfer, we find that the
public interest will be served by allowing United Water to amend its Certificate of Public
Convenience and Necessity No. 143 to include the area presently served by South County
(Application. Exhibits 3 & 4; Idaho Code $$ 6l-526 and 61-528; Commission Rules of Procedure,
IDAPA 31.01 .0l.ll2), to authorize United Water to provide water service to existing and future
customers in said area, and to cancel South County's Certificate of Public Convenience and
Necessity No. 274 and its related obligation to provide water service.
CONCLUSIONS OF LAW
The Commission has jurisdiction over United Water Idaho Inc. and South County Water
Company, [nc., water companies, and the issues presented in Case No. UWI-W-98-2 pursuant to the
power and authority granted under Idaho Code, Title 61 and the Commission's Rules of Procedure,
IDAPA 31.01.01.000 et seq.
ORDER
In consideration ofthe foregoing and as more particularly described and qualified above,
IT IS FIEREBY ORDERED and the Commission does hereby deny the request of South County
Water Company to add $312,867 of contributed plant to its rate base and book value.
IT IS FURTFIER ORDERED and the Commission does hereby approve the sale and
transfer of South County cofllmon stock to United Water for an authorized purchase price of
$2,497,133 adjusted to the closing date (depreciated original cost of South County's assets plus
acquisition premium) and authorizes the rate basing of said amount in future rate proceedings by
United Water.
IT IS FURTI{ER ORDERED and the Commission does hereby approve a transitional
sixyear phase in of rates for existing South County area customers. United Water is directed to file
related tariffsheets for Commission approval.
oRDER NO. 27798 -t l-
IT IS FURTIIER ORDERED that as of the date of closing the South County Water
Company Certificate of Public Convenience and Necessity No. 274 is canceled and the obligation
of South County to provide water service to the related certificated area is terminated.
IT IS FURTHER ORDERED that as of the date of closing the Certificate of Public
Convenience and Necessity No. 143 of United Water Idaho Inc. be amended to reflect addition of
the particular areapreviously described and reflected in South County Certificate No. 274. United
Water Idaho Inc. is directed to prepare and file an amended Certificate for Commission approval.
THIS IS A FINAL ORDER. Any person interested in this Order may petition for
reconsiderationwithintwenty-one (21) days of the service date of this Order. Within seven (7) days
after any person has petitioned for reconsideration, any other person may cross-petition for
reconsideration. See ldaho Code $ 6l-626.
DONE by Order of the Idaho Public Utilities Commission at Boise, Idaho this P//-
day of November 1998.
ATTEST:
Commission Secretary
vld/O:IIWI-W-98-2.sw
ORDER NO. 27798
SEN, PRESIDENT
LSON, COMMISSIONER
MARSHA H. SMITH, COMMISSIO
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