U-1034-99 Worthan Testimony.pdf

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BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
INTERMOUNTAIN GASCOMP AN
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Case No. U-1034-99
PREPARED TESTIMONY OF RUSSELL L. WORTMA
Q. Please state your name, business address and position with
Intermountain Gas Company.
A. My name is Russell L. Worthan. My business address is 555 South Cole
Road, Boise, Idaho, and I am Treasurer and Assistant Secretary of
Intermountain Gas Company.
Q. What is your educational background?
A. I am a graduate of Idaho State University with a Bachelor of Science
degree majoring in accounting. I have attended various courses and
seminars dealing with utility industry related matters.
Q. How long have you been employed by Intermountain Gas Company and what
positions have you held with the Company?
A. I have been employed by Intermountain since i 963 and have held various
management positions. Those positions include experience in the
Operating Divisions, Customer Accounting, Data Processing and General
Accounting. In March, 1972, I was elected Assistant Treasurer and in
June, 1979, I was elected to the position of Treasurer.
Q. Will you briefly describe your responsibilities?
A. In my capacity as Treasurer, I have overall responsi.bili ty for the
supervision, direction and control of financial planning and
forecasting, corporate insurance, cash management and general
ratemaking. In addition, my duties include raising capital to finance
Company operations and construction of facilities necessary to provide
servi.ce to present and future customers.
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Q. Are you in continual communication with members of the financial
community?
A. Yes. With respect to short-term financings, my activities and
responsibilities include negotiation of lines of credit with commercial
banks. With regard to the longer-term securities, I am in contact with
a number of analysts employed by investment banking firms, insurance
companies and other organizations interested in securities actively
follow Intermountain Gas Company. In association with the Chief
Executive Officer, my responsibilities include keeping these people
informed of the Company's financial progress, arranging meetings with
our management which may include tours of our area or visiting them in
their respective offices.
The leading investment banks and commercial banking firms have public
utility departments whose principal function is to develop financing
approaches for present and potential public utility clients. Through
my contact with the financial community, investment banking reports and
articles issued by firms, I am able to keep informed on trends in
interest rates, financing costs, security ratings and other financial
developments in the public utility industry.
Q. Have you previously given testimony before this Commission?
A. Yes, I have testified before this Commission on several occasions.
Q. What is the purpose of your testimony in this case?
A. My testimony and exhibits will cover the Company's cost of debt,
preferred stock and the appropriate capital structure for the Company.
I will also testify as to the Company's overall rate of return
requirements and will discuss the major financial factors which
demonstrate our need for prompt rate relief. Finally, I will testify
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shown in Column (g), Line 7. This weighted cost is carried forward to
Mr. Schultz' Exhibit No.6, Schedule 2, Page 1.
Q. Mr. Worthan, in preparing your Exhibit 3 on the cost of capital, have
you deviated in the methodology adopted by this Commission in Case No.
U-I034-95?
A. The only deviation from the previous case is the calculation of the
interest rate used on the average short-term borrowings. In prior
years the Company had compensating balance requirements with all banks
in which it maintained a line of credit. In December, 1981, the
Company was able to negotiate its 1982 line of credit with only three
of its seven banks for the same $7,500,000 line with pricing
arrangements requiring no compensating or idle balances. Instead a
commitment fee based on ~ of 1% of total line will be paid by the
Company with all borrowing priced at 105% of the prime rate. This
change will allow the Company to pass on to its ratepayers some
$130,000 in reduced interest costs.
Q. Mr. Worthan, as the Financial Officer for your Company, would you
please discuss the major issues in this case and why it was necessary
for Intermountain to file for rate relief at this time?
A. Mr. Smith has pointed out that the Commission did respond in a very
timely manner in granting rate relief in our last general case. That
fact alone will give the Company an opportunity to earn an estimated
$1.95 to $1.98 per share in Fiscal Year 1982, or a return on common
equity of between 10%-11%. Although this will be a significant
improvement over Fiscal Years 1981 and 1980, wherein return on equity
was below 7%, it still is a considerable shortfall from our allowed
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return of 15 3/4%. Intermountain has filed this case for two primary
reasons, namely:
1. The sales level anticipated over the next twelve months is
significantly less than the volumes upon which rates were
established in Case No. U-1034-95.
2. The loss in gross margin caused by reduced sales levels could
drive the unrestricted retained earnings to a level where the
Board of Directors would have no alternative but to pass or reduce
the common stock dividend.
I have prepared Exhibit 4 to analyze the earnings deterioration in each
of the twelve-month periods after new rates were put into effect in the
preceding five general rate cases of Intermountain Gas Company.
Careful analysis of the four schedules to this Exhibit clearly focuses
on the past negative impact on the financial health of the Company and
on the primary issue in the current case.
Q. Would you explain Exhibit 4?
A. Exhibit 4 has four Schedules. Schedule 1 is the income statement
adopted by the Idaho Public Utilities Commission as reasonable for
Intermountain Gas Company .in each of its last five general rate cases.
The date shown is the effective date of the order in each case. Lines
18, 19 and 20 show the common equity allowed in capitalization adopted,
return on equity granted and the test year adopted.
Schedule 2 of this Exhibit sets forth in the last four columns the
actual utility income statement for the twelve months immediately after
rates were put into effect.
The first column of the Exhibit is the current estimate for the twelve
months ending December 31, 1982.
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Q. Why did you pick the time period used on Schedule 2?
A. Normally, from a ratemaking perspective, you would expect that rates
adopted and put into effect would provide a reasonable opportunity to
achieve the allowed rate of return on equity for the twelve months
immediately following the effective date of the new rates. By focusing
on this time period and comparing the allowed versus actual income
statement, I felt it would more clearly demonstrate to the Commission
the areas of material deviation and provide a graphic example of the
issues in this case and their possible solutions.
Q. What is shown on Schedule 3 of Exhibit 4?
A. Schedule 3 sets forth other key financial statistics in comparing the
allowed level in rates and the actual or expected (12/31/82)
performance of the Company. Gross margin, or the difference between
total gas revenue and the cost of gas, is shown on Lines 2 and 15. The
forecasted volumes of gas sold on rates established by this Commission
are set forth on Lines 4 through 8. Actual sales volumes sold in the
twelve months after rates were set are shown on Lines 17 through 21.
Lines 24 through 26 show the average utility equity as allowed in
rates, actual equity, and as adjusted, consistent with Commission
deductions to arrive at actual adjusted utility equity.
Lines 28 through 30 demonstrate the return on equity achieved vs the
level determined reasonable by the Commission.
The final two financial indicators shown on Schedule 3, Lines 31
through 34, are the utility interes t coverage. the level allowed versus
that which was, or will be, achieved and the indenture requirement on
interest coverage before any new long-term bonds could be issued. The
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level of unrestricted retained earnings available for common dividends
is shown on Line 35.
Q. What is the purpose of Schedule 4 of Exhibit 4?
A. Schedule 4 shows the deviation or variance between the income
statements as allowed in Schedule 1 compared to the actual results
shown on Schedule 2.
Q. iniat is your analysis of the deviations between the allowed and actual
returns?
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A. Over the last five years, volumes have been impacted by the following
factors:
Residential and Commercial Classes
1. Weather
2. Price increases
3. Secondary heating sources
,...."" ')
4. Regional and local economy
5. General concern for use of energy
6. Housing market virtually dried up.
Industrial Classes
1. Price increases
2. Industrial production product declining due to general economic
conditions
3. Upgrading of plants to reduce energy consumption
4. Switching use of particular energy depending on price of
alternatives
5. Permanent reduction of load due to conversion of primary energy
source.
Some of the factors described were anticipated and included as
measurable changes in rates as they were set. However, anyone going
over this list would have to admit that predicting the result of all
these factors would have been impossible.
The gross margin in rates which will be established by this Commission
will absolutely depend on the forecast of volumes sold to customers.
The presentation by the Company anticipates that the sale to its two
largest customers will be approximately 60,000 therms per day or
220,000 therms per day less than in Case No. U-I034-95. The decreased
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gross margin resulting from that forecast has required that revenues
from all customers be increased. Determination of rates or incorrect
sales volumes guarantees that authorized revenue will not be earned.
Sales higher than anticipated would result in a windfall to the
Company. Sales at a lower level than that built into the case,
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however, makes it impossible for the Company to earn its authorized
rate of return. The dangerous result for the ratepayers is that if
sales decline, the Company will likely be forced to reduce its dividend
to its investors, which will directly increase the cost of capital for
the Company, both debt and equity, and its ability to maintain adequate
service to its customers.
I fully agree with Mr. Blickenstaff's testimony that the impact of
cutting or omitting the dividend could drive the cost of capital to a
level as high as 33%.
Q. Has the Company a proposal to reduce this exposure of dividend
reduction to the shareholders and the risk of higher future costs to
the ratepayer?
A. Yes, the Company recommends that, in addition to setting sales volumes
at a realistic and attainable level, the Commission adopt some form of
a revenue stabilization clause by banding the gross margin adopted in
this case by a minimum and maximum level. The primary reason for the
revenue stabilization clause is to allow the Company to immediately
defer recording expenses associated with service rendered if the
resulting gross margin is less than the minimum gross margin level set.
This authority to defer costs, pending recovery through a rate
adjustment at a later time, will achieve the most important result.
The reported earnings will permit the maintenance of the Company's
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credit worthiness. It will also allow the Company to finance the
deferred revenues with bank loans pending recovery during the following
Fiscal Year.
By the same mechanism, if the sales increase and the resulting gross
margin exceeds the maximum gross margin as set, the Company would
i.mmediately record the additional expenses associated with excess gross
margin and provide a deferred revenue to be returned to the ratepayers
during the following Fiscal Year.
Q. Mr. Worthan, what is the gross margin on which the revenue
stabilization clause would be based?
A. From Mr. Schultz's Exhibit 6, Schedule 1, the total gross sales
(Line 5) equals $149,135,000 less the cost of gas of $112,251,000 or
$36,884,000. This amount is reduced by the franchise revenues included
in Line 4 or $1,978,000 to arrive at the gross margin of $34,906,000
which is being requested in this Case.
Q. Why do you reduce the revenues for franchise taxes revenue?
A. This revenue is directly offset by franchise tax expense included in
general taxes because they are directly affected by variation in sales
volumes, the expense will.vary directly with the revenue and does not
affect gross margin.
Q. Would you explain the term band and its function in the stabilization
of revenue mechanism?
A. As my earlier testimony would indicate, the Company is c.cincerned with
the volitility of the sales level adopted in its rates and the
inordinate financial risk which the Company faces on one hand versus
overcollection exposure the ratepayer bears on the other. We have used
the term band to describe the minimum and maximum level of risk which
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either the Company or ratepayer should reasonably bear as a result of
the fluctuation of margin due to sales volumes. Some regulatory
jurisdictions have approved absolute margin mechanisms which adjust
base rates monthly or semi-annually. The logic in their adoption is
that sales volumes and revenue are not within the company's control.
The effect is to virtually remove the complex and speculative issue of
revenue forecasts from general rate cases.
However, the Company's concern in this case is the significant
variation in volumes and its financial impact. The Company is
recommending a minimum level be established which would prevent further
erosion of its unrestricted retained earnings. The minimum level would
provide a margin covering common dividends, preferred redemptions and
some attrition. I have shown in Exhibit 4, Schedule 5, the recommended
minimum level of $31,729,000.
Q. Mr. Worthan, do you believe the adoption of this minimum margin
mechanism would guarantee earnings and reduce incentives for efficient
operations?
A. A revenue stabilization clause would have neither of these results.
Sales volumes and resulting revenues are not effectively within the
Company's control. Management of other particular expenses are. In
order to maximize earnings, the Company must manage all other expenses
below gross margin on the income statement such as Operation and
Maintenance Expenses, Depreciation, interest charges and general taxes
at least equal to the level determined reasonable in rates as set by
this Commission. If such expenses were not contained, overruns would
not be recovered in the proposed revenue stabilization clause.
Q. How did you arrive at the maximum levels of the band?
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4. To the extent that all other expenses can be controlled, the
annual revision to base rates should minimize the need for future
general rate cases.
Q. Does the Company have any long-range financial goals which it hopes to
attain?
A. Yes. We have adopted four primary financial targets:
1. The obvious goal of at least maintaining a market to book ratio
equal to 1.
2. The attainment and maintenance of an "A" bond rating is a proper
goal from the standpoint of long-run cost minimization.
3. Pre-tax interest coverage of at least 3.0 to 4.0 times.
4. Attain a capital structure consistent with an "A" rated company,
or an equity ratio generally falling in the range of 40-45%.
These goals are the target financial criteria for gas distribution
companies as set forth by Standard and Poor's.
Q. Does this conclude your direct testimony?
A. Yes, it does.
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