20000313Cooley Direct Testimony.doc

Q. Please state your name and business address.
A. My name is Douglas B. Cooley and my business
address is P.O. Box 83720, Boise, Idaho 83720-0074.
Q. By whom are you employed and in what capacity?
A. I am employed by the Idaho Public Utilities
Commission as a Telecommunications Analyst.
Please give a brief description of your
educational background and relevant work experience.
I graduated from Utah State University in 1996
with a Bachelor of Science degree in Civil Engineering. I also received a Master's degree in Business Administration from Utah State University in 1998. I have completed a Regulatory Studies program offered through NARUC at Michigan State University. I have been employed as a Telecommunications Analyst with the Idaho Public Utilities Commission since August of 1998.
What is the purpose of your testimony in this
case?
The purpose of my testimony is to examine the
public interest aspects of the sale of U S WEST's northern Idaho exchanges to Citizens Telecommunications Company of Idaho (Citizens) and to make a recommendation to the Commission concerning the public interest issues involved such as rates, treatment of the gain, and approval or denial of the sale. In addition, I will submit testimony in support of two separate stipulation agreements that were reached between Staff and U S WEST as well as Staff and Citizens. In making my analysis, I have examined the accuracy of the data which was submitted by the purchasing company, the financial viability of the purchasing company, and the probable effects of the sale on the customers in the sale exchanges and on the Idaho Universal Service Fund (IUSF).
Specifically, which exchanges will Citizens
purchase from U S WEST?
The eight exchanges are Cottonwood, Craigmont,
Grangeville, Kamiah, Kooskia, Lapwai, Lewiston, and Nez Perce. The Lewiston exchange also includes the Clarkston area in Washington. A map of these exchanges is included as Exhibit No. 101.
ACCURACY OF THE DATA
Beginning with the accuracy of the data
submitted by the purchasing company, did you find any problems with its financial projections?
No significant problems were encountered
concerning the projections submitted in Exhibit H of the Joint Application. It should be noted that Citizens' projections for revenues and expenses included the customers in Clarkston, Washington. Although the revenues and expenses associated with the Clarkston customers will remain in the Washington jurisdiction, my estimates accounted for Clarkston in order to make a similar comparison.
Q. What method did you use in making your analysis
of Citizens' projections?
I estimated U S WEST North's 1998 revenues and expenses by including Clarkston, Washington customers. I then estimated a 4% annual growth factor and compared my projections for revenues and expenses to Citizens'.
How were your 1998 and 1999 estimates for total
revenues derived?
Because Citizens proposes to keep the same
study area and rates that are currently on file for
U S WEST North, I was able to use the 1998 Annual Report of U S WEST North to gather the starting revenue data that I needed. In order to account for Clarkston, as Citizens did in its projections of revenues, I accepted Citizens' estimate that approximately 17% of total revenues come from the Clarkston customers. With almost 25% of the access lines in Clarkston, this seems reasonable. I then used a growth factor of 4% to estimate total revenues and total expenses for 1999.
Q. How did you come up with 4% growth?
A. Based on the historical average growth rates
reported in U S WEST North's annual reports for the years 1992 through 1998, I found it reasonable to predict a similar rate for future growth in these exchanges. This closely matches the 4.4% growth factor Citizens used through the year 2002 and assumes rates will not change before 2002.
What components go into the calculation of
total intrastate revenues?
Total intrastate revenues are comprised of three main sources: local exchange service, intrastate message telecommunication service (MTS), and switched access charges. Local exchange service includes charges for installation and provision of basic exchange service as well as other vertical services such as Custom and CLASS calling features, plus Centrex and private data lines. Intrastate MTS charges are collected when a customer uses the local exchange company's network to make toll calls within the state. Switched access charges are paid by interexchange carriers (IXCs) that use the LEC's facilities to originate or terminate intrastate long distance calls. Exhibit No. 102 of my testimony contains a projection for U S WEST North's 1999 total revenue composition. There are other miscellaneous sources of revenue such as billing and collection arrangements that have a relatively small impact on total revenues.
How did your revenue estimates compare with
Citizens' projections?
Citizens' revenue projections for the years
2000 through 2002 appear conservative but reasonable.
How did you check Citizens' operating expense
projections?
I reviewed U S WEST North's Annual Reports for the years 1996 through 1998. I then compared the operating expenses to the corresponding year's Idaho access line count and arrived at an average operating expense per line of approximately $235. I applied this number to the estimated line counts, including Clarkston, for 1998 and 1999.
Q. Did Citizens' projected operating expenses appear reasonable?
A. Citizens appears to have projected realistic estimates of what it will cost to maintain and operate these exchanges.
What did you find regarding Citizens'
projections for depreciation and net operating income for these exchanges?
Citizens' depreciation and amortization
projections are reasonable. These expenses increase as Citizens increases its capital investment in these exchanges. Citizens estimates an annual net operating income over $2 million for these exchanges through the year 2002. Based on my analysis, I believe these projections for net operating income are conservative but reasonable.
FINANCIAL VIABILITY
Did you investigate Citizens' financial fitness
with regard to acquiring and operating these eight Idaho exchanges?
Yes. I reviewed Mr. Lafferty's testimony and
his response to Interrogatory No. 7. Citizens plans to acquire approximately 1,000,000 access lines from
U S WEST and GTE throughout the western United States of which U S WEST of northern Idaho is a portion. Once these acquisitions are complete, Citizens will be the nation's second largest independent telecommunications company. Citizens has made arrangements to fund these purchases by divesting other Citizens-owned utility companies such as gas, electric and water businesses. Citizens sold its water and wastewater operations for approximately $835 million in October of 1999 and has recently announced a sale agreement to divest its electric utility operations for $535 million.
As a result of these anticipated transactions,
Standard & Poor's reduced Citizens' bond rating from
AA-/A-1+ to A+/A-1 in August of 1999. However, most investment analysts forecast earnings growth for Citizens as the Company is able to improve its operating efficiency by focusing solely on telecommunications, thereby accomplishing economies of scale that benefit the Company and customers.
According to a January, 2000 issue of Value
Line (Exhibit No. 103), Citizens' financial summaries showed that its projected net profit margin for 2002-2004 is 7.1% with $2.6 billion in revenues reflecting a net profit of $185 million. Currently, Citizens appears to be a relatively low-risk company as demonstrated by a beta of .70 (1.0 = market). The 2002-2004 projected long-term debt ratio of 49.5% is comparable to the industry average of 50%.
Citizens may go through a financial transition as it continues to divest its other utility operations to acquire telecommunication access lines. However, at this time, Staff believes that Citizens has the financial means and operating history required to absorb this sale.
SALE TRANSACTION
What analysis have you done regarding the
purchase price for the proposed sale?
I calculated the effective purchase price per
Idaho access line to be approximately $2,454 and the effective sale price to net book cost ratio to be 2.86:1. Exhibit No. 104 of my testimony contains a basic analysis of this purchase. It also contains a brief comparison to a previous case (GNR-T-94-4) wherein several U S WEST exchanges in Idaho were sold. In that case, the average purchase price per access line was approximately $3,882 and the average sale price to net book cost ratio was 1.68:1.
Why is the price to net book value ratio
significant?
Simply because Citizens, unless it can
demonstrate an economic benefit to customers, will only be allowed to include the net book value of the purchased property in its Idaho intrastate rate base. The larger the ratio, the larger the disparity between what Citizens will be financing versus what it will be able to earn on.
Have you calculated the gain that would result
from the proposed sale?
Staff has reviewed and accepted the amount of the gain recorded in Exhibit 1 of Mr. Grate's testimony in the Joint Application. The amount of intrastate gain after income taxes is $24,880,000.
What do you propose for the disposition of the
gain?
The Commission Staff and U S WEST have
reached an agreement that the amount of the gain that will flow to Idaho ratepayers is $12,440,000. (Exhibit No. 106)
STIPULATIONS
Q. You are testifying to a stipulation agreement between Staff and U S WEST. (Exhibit No. 106) Why was a stipulation agreement between Staff and U S WEST in the public interest for this case?
A. Staff and U S WEST had several issues surrounding the calculation and ownership of the gain that results from this sale. U S WEST believed it has legal precedent to support its position that all of the sale proceeds should benefit its shareholders, while Staff believed it has legal precedent to argue that a significant portion of the gain should flow to Idaho ratepayers. To avoid lengthy and expensive litigation, both parties agreed that the public interest would be best served by reaching a joint settlement.
Q. Does the settlement with U S WEST address the treatment of the gain from this sale?
Yes. Staff and U S WEST agreed that a "settlement amount" equal to fifty-percent of the gain, or $12,440,000, will flow back to Idaho customers as described in the stipulation.
Q. Does the stipulation with U S WEST address how the gain will be used?
A. Yes. At the time of closing, a $7.5 million regulatory liability will be recorded on Citizens' books. Furthermore, U S WEST will deposit the remaining amount ($4,940,000) of the "settlement amount" into the new Idaho Universal Service Fund.
Q. Why was a separate stipulation agreement between Staff and Citizens in the pubic interest? (Exhibit No. 107)
A. First, Staff required Citizens' cooperation with the handling of the $7.5 million regulatory liability account that flowed from the gain on the sale. Citizens will receive this amount from U S WEST.
Second, Staff and Citizens had some separate
issues surrounding Citizens owning and operating these exchanges that were settled.
Q. What were some of the points of the stipulation agreement between Citizens and Staff?
A. First, the $7.5 million regulatory liability account will be used for the replacement of the central office switch in Lewiston. Staff believes that $7.5 million will adequately cover the cost of replacing Lewiston's switch as well as providing a $50 one-time credit on customers’ bills. It is my understanding that Avista Communications of Idaho, Inc., the lone remaining intervenor in this case, would also prefer to see the switch replaced within the first year of ownership. Citizens' use of remaining funds, if any, will be addressed with the Commission.
Second, Citizens will adopt U S WEST's rates
for these eight exchanges and will establish a rate cap for both local exchange line and intrastate switched access rates that will exist for 24 months from the time the sale closes.
How was the $7.5 million agreed to in the
stipulation, derived?
A. Staff believes $7.5 million will adequately cover the estimated intrastate cost to replace the Lewiston switch. This would also allow the Commission to provide a one-time bill credit of $50 per line, amounting to approximately $1.7 million.
Q. Does the stipulation agreement between Staff and Citizens address how Citizens will invest in the network?
A. Yes. Citizens has testified that it intends to spend approximately $20.25 million in these exchanges. Citizens will file a capital deployment plan for the Idaho portion of these exchanges that will be comprised of two phases:
1. Within six months after the closing date,
Citizens will submit an assessment of the
exchanges as well as its priority plan for the next two years of expenditures.
The second stage of Citizens' business
plan will be a report to the
Commission within eighteen months of the
closing date. This report will be a
specific accounting of capital investments
to date as well as a specific outline of
Citizens' plans to spend the remainder of
the $20.25 million in the next eighteen
months. Status reports will be submitted
at the end of years 1, 2 and 3.
Q. Were any other issues resolved within the stipulation agreement with Citzens?
A. Yes. Citizens agrees that it will continue to interconnect with other telecommunication providers as well as honor existing interconnection agreements. Also, Citizens agrees that the acquisition premium paid to
U S WEST in this sale will not be recovered in rate base unless, at some future time, a measurable economic benefit to customers is demonstrated to the Commission.
Q. Do you support both of the stipulation agreements reached between Staff and each company?
A. Yes. From the customers' standpoint, this sale will provide a new, more efficient switch with more capacity and modern capabilities of advanced services. In addition, companies that interconnect with the new Lewiston switch will also enjoy the benefits of the upgraded equipment. The Citizens stipulation provides for this new switch at no additional cost to the customers. The customers will also have their rates set equal to or less than U S WEST's current rates for a period of two years.
Also, the above stipulations provide the
Commission with a mechanism to monitor Citizens' investment pledge of approximately $20.25 million over the next three years.
Q. Regarding the ratepayers' portion of the gain on the sale, what other options did you evaluate?
Due to the significant amount of the gain and the presence of local exchange competition, Staff considered several options. Staff discussed an enrichment to the Link-Up America program as well as providing customer refunds.
To maximize the long term benefits of the gain, Staff also considered putting the gain towards accumulated depreciation. This would lower Citizens' revenue requirement below what it would be otherwise and thereby lessen the potential for future rate increases for the customers in these exchanges. Whether money is earmarked for a switch or is applied to accumulated depreciation, the customers will receive a benefit from the gain that will not have to be recovered in rate base. By stipulating to a switch replacement, Staff believes the customers will receive a benefit from the gain that is more specific and immediate than applying funds to accumulated depreciation. Also, applying money to accumulated depreciation may impact Citizens' federal USF eligibility.
Q. Why did Staff determine that use of the sale proceeds to replace the Lewiston switch and to increase the state USF fund balance were in the public interest?
A. After considering the probable results of various options, I believe the public interest is best served by replacing the Lewiston switch and depositing the remaining amount into the Idaho USF for two reasons. First, modernizing the central office switch in Lewiston will be a noticeable long-term benefit to all classes of customers, including companies wanting to interconnect with Citizens. Also, this plan will benefit the new Idaho USF and thereby lessen the impact to Idaho's per-customer surcharges. Specifically, any amount contributed to the new Idaho USF would help offset the increased surcharges projected under the new Idaho USF model.
PUBLIC INTEREST FACTORS
Q. How do you anticipate customers will be affected if the sale is approved?
This sale should benefit customers in these eight exchanges. As mentioned in the stipulations, one obvious benefit is the investment of approximately $20.25 million Citizens has planned for improving the network in these exchanges. I believe this investment represents more improvement to the network than customers would have realized under U S WEST's continued ownership. One important part of these improvements is the purchase of a new central office switch in Lewiston. This will benefit these communities as well as those companies that interconnect with Citizens by providing a switch that is faster, has more capacity, and can more readily provide advanced services.
Also, by adopting the rates of U S WEST North,
the transition to new ownership should be relatively smooth for those customers.
Finally, Citizens proposes to have
approximately 35 employees serve this area. This matches the current number of U S WEST employees for this region. Therefore, I do not foresee any significant potential for service quality problems under Citizens' ownership. Staff member Carol Cooper's testimony addresses Citizens' service history in Idaho.
Does Citizens appear to be a potential
candidate for Idaho Universal Service Fund funding at some time in the future?
At this time, it is difficult to determine what
Citizens' potential for future Idaho USF disbursements will be. Because the Commission plans to restructure its state universal service program to be compatible with the federal Universal Service Fund and Idaho Code ( 62-610 A-F, the new criteria for Idaho USF eligibility has not yet been determined. I would note that, although I cannot foresee anything that would preclude Citizens from such funding if it qualifies under the applicable standards, Citizens has not applied for Idaho USF in the past.
Q. How will Citizens' network investments affect its Idaho USF eligibility?
A. It is possible that Citizens' pledge to spend $20.25 million in capital investments may affect its potential for Idaho USF in these exchanges. Exhibit
No. 105 of my testimony shows that one possible effect of this capital investment would be to increase Citizens' revenue requirement by approximately $6.75 per customer per month. Relative to the current rates, it appears Citizens' investment may drive some residential rates close to or above the current USF threshold rate. Despite these estimates, it remains difficult to predict whether or not the Idaho USF will be affected as a direct result of this sale.
RECOMMENDATIONS
What is your recommendation regarding whether
the Commission should approve the sale?
I believe the sale is in the public interest
and therefore recommend approval of the proposed sale.
Are there any other recommendations you would
make in this case?
A. Yes, I have several additional recommendations:
I recommend that U S WEST's Certificate of
Public Convenience and Necessity be transferred to Citizens and be made effective coincident with the closing of the sale. In addition, I recommend that Citizens be granted the corresponding designation as an eligible telecommunication carrier (ETC) for the study area defined by the same eight wire centers that U S WEST was granted ETC status in Order 27270. By requesting these items in the Joint Application, Citizens has proposed to accept the responsibilities pursuant to Section 214 of the Communications Act of 1934 as amended by the 1996 Telecommunications Act for the eight exchanges being transferred. It is my understanding that Citizens will, like U S WEST North, operate these exchanges as a separate study area with a separate revenue requirement.
Also, I recommend that the Commission
adopt the stipulation agreements that were reached between the Staff and U S WEST and between the Staff and Citizens.
Next, I recommend that U S WEST and
Citizens be required to provide a full accounting for the transaction to the Commission within 90 days after the transfer.
In accordance with FCC rules,
U S WEST will begin charging customers in Lewiston, Lapwai, and Cottonwood a $0.43 surcharge for local number portability (LNP). This surcharge will begin in March of 2000. It is Staff's position that it will be inappropriate for Citizens to continue this surcharge under its ownership. Staff believes that the availability of LNP is part of the purchase price and would therefore not be recovered from the ratepayers.
I recommend that, from the $7.5 million
Regulatory liability account stipulated to
with Citizens, an amount equal to $50 per
line be specified for one-time credits to
customers’ bills.
Could you summarize your position of whether or
not this sale should be approved?
Yes. It is my position that Idaho customers
will be positively affected if this sale is approved. Citizens has a good operating history in Idaho and has, in my opinion, demonstrated the technical and financial ability to acquire and maintain these Idaho exchanges. In addition, Citizens' projections of revenues, expenses, and capital investments appear reasonable. Also, it does not appear likely that Citizens will require disbursements from the Idaho Universal Service Fund as a direct result of this purchase.
Q. Does this conclude your testimony?
A. Yes, it does.

USW-T-99-25/CTC-T-99-02 COOLEY, D (Di) 16
03/13/00 Staff

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