UWI4222.docx

1 BOISE, IDAHO, WEDNESDAY, APRIL 22, 1998, 1:15 P. M.
2
3
4 COMMISSIONER NELSON: I guess we're ready
5 to go back on the record and we'll go to you,
6 Mr. Woodbury.
7 MR. WOODBURY: Thank you, Mr. Chairman.
8
9 JEREMIAH J. HEALY,
10 produced as a witness at the instance of United Water
11 Idaho Inc., having been previously duly sworn, resumed
12 the stand and was further examined and testified as
13 follows:
14
15 CROSS-EXAMINATION
16
17 BY MR. WOODBURY:
18 Q Good afternoon, Mr. Healy.
19 A Good afternoon.
20 Q The test year that we're using in this case
21 is 12 months ending June 30, '97; correct?
22 A Correct.
23 Q And we're making adjustments for known and
24 measurables beyond that period?
25 A Correct.
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CSB REPORTING HEALY (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 Q Okay, and when you speak on page 2 of
2 normalized and annualized adjustments were made to
3 reflect operating results at the year-end level, when you
4 say "year-end level," are you speaking of year-end
5 6/30/97, is that the reference there?
6 A Yes.
7 Q Okay. If we -- there was an exhibit, an
8 Adjustment No. 6, Amended, that you started off with?
9 A Yes.
10 Q And I had just one question by way of
11 clarification. This was your purchased power cost
12 adjustment and I didn't want to get into rebuttal now,
13 but with respect to the Micron adjustment that was made
14 in the Company's rebuttal, part of the related savings
15 that were indicated was a combination of power and
16 chemical costs?
17 A Yes.
18 Q And you applied some sort of a variable
19 expense multiplier for that?
20 A Correct.
21 Q And so an adjustment for the decreased
22 usage related to Micron would be reflected elsewhere and
23 not in this exhibit?
24 A Right.
25 Q Is that correct?
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CSB REPORTING HEALY (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 A Yeah, just let me restate for
2 clarification, but if our power cost went up --
3 Q But with the decrease in consumption with
4 respect to Micron --
5 A Right.
6 Q -- you would have some decrease in power
7 costs; correct?
8 A Right.
9 Q Okay, and should that adjustment be made
10 here or somewhere else?
11 A I guess that I wouldn't be opposed to
12 making it on the adjustment in my rebuttal. I'd have to
13 give that a little thought how to do that, but that would
14 be appropriate.
15 Q Okay. You make 29 adjustments in your
16 direct testimony and the first one was with respect to
17 payroll expense and you stated, and this is on page 4,
18 that the adjustment reflects anticipated pay increases
19 for salaried employees to be effective April 1, '98.
20 Were all of those increases put into effect?
21 A Yes, increases were put into effect on
22 April 1st.
23 Q So this adjustment is appropriate, then?
24 A I believe it is.
25 Q And your adjustment No. 5 on page 6,
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1 purchased water expense?
2 A Yes.
3 Q What was the -- I don't think you indicate
4 in your testimony, but the adjustment was an increase of
5 $20,968, but what is the pro forma total amount for
6 purchased water expense that you're utilizing now? Is
7 that Exhibit No. 5, schedule 1, page 6?
8 A Yes, it is as adjusted by --
9 Q Okay; so the pro forma purchased water
10 price would be $99,102?
11 A Actually, 97,302 less 1,800.
12 Q Okay, and who does the Company purchase
13 water from?
14 A Reflected in this exhibit our contract with
15 the City of Garden City and also our contract with the
16 Bureau of Reclamation.
17 Q Okay. With respect to the, to your
18 contract with Garden City, is the Company inclined to
19 purchase water in amounts exceeding the annual revenue
20 amount factored into rates?
21 A I'm not sure I understand the question.
22 Q You have a -- well, you have a pro forma
23 purchased water related to your rights with Garden City?
24 A Yes.
25 Q And you've included some of that within
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CSB REPORTING HEALY (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 this rate case to recover; correct?
2 A Yes.
3 Q Okay, and my question is, is the Company
4 inclined to purchase water in amounts exceeding the
5 annual revenue amount factored into the rates in this
6 case?
7 A I guess I'm still not exactly sure what you
8 mean by "exceeding the annual revenue amount."
9 Q Let's just say $100,000 is the purchased
10 power amount or purchased water amount and if you come up
11 to that amount with Garden City, would the Company be
12 inclined to purchase water above that?
13 A It's kind of an operations question. I
14 really couldn't answer that.
15 Q Better question for who? Mr. Brown?
16 A Perhaps Mr. Linam or Mr. Brown.
17 Q Okay. In your adjustment No. 7 you state,
18 which is addressed on pages 6 and 7, it's anticipated
19 that the Company employees may be offered a second
20 medical and dental option at the open enrollment period
21 in late fall of '97. As this information becomes
22 available, the cost of the medical and dental will be
23 updated. Was there any adjustment made as a result of
24 any change that might have occurred?
25 A Yes. Staff witness Smith and I discussed
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CSB REPORTING HEALY (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 that during the course of the audit and actually, the
2 adjustment shows up in his testimony and we've stipulated
3 to that adjustment.
4 Q Your adjustment 9 is the IPUC assessment?
5 A Yes.
6 Q And this was estimated on your part for
7 1998, what the assessment would be or what?
8 A I'm trying to think. It was certainly
9 estimated, yes.
10 Q Okay, and I've furnished you prior to
11 starting up again what I've labeled as Exhibit 124 and I
12 would represent that this is the 1998 annual regulatory
13 fee assessment for United Water Company that was mailed
14 yesterday and this being a copy of what was mailed. Have
15 you had time to review that?
16 A Yes, I have.
17 Q And does it reflect a regulatory fee
18 different from what you have in your No. 9 adjustment?
19 A Yes, it does.
20 Q And would it be appropriate as a known and
21 measurable to make further adjustment to that, then?
22 A Sure.
23 Q If I could refer you to your adjustment
24 No. 20, transportation and fuel expense on page 10.
25 A Okay.
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CSB REPORTING HEALY (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 Q You indicate that the Company is increasing
2 the size of its vehicle fleet by two. With the
3 elimination of the locator position and going to a
4 contract instead, will you be increasing the vehicle
5 fleet by one, then, or are you furnishing a vehicle for
6 that locator, contract locator?
7 A I'm sorry, you say that I said that we
8 increased the vehicles by two?
9 Q You said you're increasing the size of
10 vehicle fleet by two to a total of 61 vehicles, one for
11 the new locator, one for field use by engineers.
12 A Yes.
13 Q On rebuttal, the Company has made a
14 decision not to hire a new locator but to use a contract
15 position.
16 A Right.
17 Q Should that reflect also a change in the
18 size of your vehicle fleet?
19 A That adjustment was also discussed with
20 Staff witness Smith during the course of the audit. I
21 guess you could say because of our methodology in
22 adjusting the lease expense we agreed that the two leased
23 vehicles would be eliminated, but our methodology differs
24 on how to reflect that, so we're not in agreement on how
25 to reflect it, per se, so we have reduced the size of our
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1 fleet. The Company has reflected its impact and the
2 Staff has reflected their impact.
3 Q Okay. In your adjustment No. 23 on
4 page 11, O&M expense increase attributable to increased
5 number of customers and annualization of acquisitions,
6 there was some rebuttal testimony with respect to
7 projected increases in the number of customers in the
8 Eagle area, did you make any adjustments to your
9 testimony to reflect those greater numbers?
10 A No, I didn't.
11 Q Would that be appropriate?
12 A To tell you the truth, I'm not familiar
13 with the rebuttal testimony that you're referring to.
14 MR. WOODBURY: Mr. Chairman, I have no more
15 questions for Mr. Healy regarding his direct testimony.
16 COMMISSIONER NELSON: Questions from the
17 Commission. Commissioner Hansen.
18 COMMISSIONER HANSEN: I have none.
19 COMMISSIONER NELSON: Commissioner Smith.
20 COMMISSIONER SMITH: No, I don't.
21 COMMISSIONER NELSON: Well, Mr. Healy,
22 thank you for your testimony. Oh, I'm sorry, excuse me,
23 we should give Mr. Miller a chance at redirect.
24 MR. MILLER: I just had a couple,
25 Mr. Chairman. Thank you very much.
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Wilder, Idaho 83676 United Water Idaho Inc.
1 REDIRECT EXAMINATION
2
3 BY MR. MILLER:
4 Q Going back to the ad valorem taxation
5 issue --
6 A Yes.
7 Q -- just to make a couple of points clearer,
8 this isn't a sort of a circumstance where there is kind
9 of a direct pass-through of tax to the customer?
10 A I guess I'd say it's not quite a direct
11 pass-through. It's, I mean, a determination will be
12 made, for instance, in this hearing. That amount will be
13 part of our revenue requirement, so I distinguish that
14 from, say, the franchise tax that is imposed by the City
15 of Boise on the Company. That is a flat percentage that
16 the Company bills, passes through directly to the
17 customers and it is excluded from our revenue stream.
18 Q So the Company at least in the first
19 instance is at risk for payment of the ad valorem tax?
20 A Yes.
21 Q And if the allowance allowed by the
22 Commission for the payment of that tax is too low, the
23 Company will underrecover the amount that it has to pay?
24 A Yes.
25 Q So the goal here is to, to the extent
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CSB REPORTING HEALY (Di)
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1 possible, find a reasonable estimate of what the
2 allowance for that item of expense should be?
3 A Correct.
4 Q And in attempting to do that, you chose a
5 nine-year average to attempt to estimate that future
6 liability?
7 A Yes, I did.
8 Q And I just wanted to be sure that you had
9 an opportunity to explain to the Commission precisely why
10 it is you chose nine years as opposed to some other
11 number of years.
12 A Yes, and what I did is I took nine years of
13 appraisals because nine years seemed to give me a
14 reasonable blend of up years and down years. You know,
15 as I stated earlier, it could have been five, it could
16 have been eight, it could have been ten. I looked at
17 many combinations of years. Nine seemed to be a
18 compromise between up years and down years and seemed
19 reasonable to me.
20 Q So your effort was to try and find some
21 midpoint estimate that would take into account highs and
22 lows?
23 A Exactly.
24 Q I guess if a person was intent on producing
25 a low estimate, you could select another group of years?
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CSB REPORTING HEALY (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 A Yes. With regard to the appraisal, if you
2 wanted to select a two-year average that would give you
3 the lowest average, you would pick the two most current
4 years; however, as I said earlier, if you were to trend
5 those two years, you would come up with an average that
6 is higher than what I have used, so that's why I felt the
7 nine-year average was very reasonable.
8 Q Very good, and what has the Company done to
9 ensure that the amount of tax expense that is incurred in
10 this area and, of course, becomes the customers'
11 obligations is held to a minimum?
12 A The last two appraisal years the Company
13 has either used United Water M&S employees or, in the
14 case of the most recent year, we hired an expert to
15 assist us in appealing the initial appraisal of the State
16 Tax Commission and in both cases, through the hearing
17 process at the State Tax Commission, we were able to
18 significantly reduce the amount of the appraisal
19 recommended by the Tax Commission staff.
20 Q And in each circumstance am I correct that
21 the Company has reported those reductions for ratemaking
22 purposes in rate proceedings and the customers, the
23 Company's customers, have received the benefit of the
24 Company's effort in that area?
25 A Yes. In the last two United Water Idaho
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1 rate proceedings, the timing has happened to coincide
2 nicely with the two events occurring fairly
3 simultaneously, so in both cases we were able to
4 immediately pass that savings through to the customer.
5 MR. MILLER: Very good. That's all I had,
6 Mr. Chairman. Thank you very much.
7 COMMISSIONER NELSON: Thank you,
8 Mr. Miller.
9 Okay, now you may step down, Mr. Healy.
10 (The witness left the stand.)
11 MR. MILLER: The Applicant would call
12 Daniel Brown.
13
14 DANIEL BROWN,
15 produced as a witness at the instance of United Water
16 Idaho Inc., having been first duly sworn, was examined
17 and testified as follows:
18
19 DIRECT EXAMINATION
20
21 BY MR. MILLER:
22 Q Sir, would you state your name, please?
23 A Daniel Brown.
24 Q And by whom are you employed?
25 A United Water Idaho.
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CSB REPORTING BROWN (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 Q And in what capacity?
2 A As managing engineer.
3 Q What in general is the scope of your duties
4 in that position?
5 A I'm responsible for the capital expenditure
6 program as far as administering the capital expenditure
7 program and certain operations, monitoring operations for
8 efficiency and suggesting modifications as necessary in
9 those areas.
10 Q Very good. In connection with this
11 proceeding, did you have occasion to previously file
12 certain written direct testimony?
13 A Yes, I did.
14 Q And how many pages are in that testimony?
15 A It consisted of nine pages of testimony and
16 two exhibits, Nos. 10 and 11.
17 Q Turning to your Exhibit 10, could you
18 briefly explain for the Commission the purpose of that
19 exhibit and in general what it shows?
20 A The purpose of this exhibit was to indicate
21 the level of capital expenditure anticipated between
22 July 1 and February 28, 1998.
23 Q And, of course, since that time February
24 has come and gone.
25 A That's correct.
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CSB REPORTING BROWN (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 Q Have you prepared a corrected Exhibit
2 No. 10 that shows the actual expenditures during that
3 period?
4 A Yes, I have.
5 Q Do you have that with you?
6 A I believe you have it.
7 MR. MILLER: Could I approach the witness?
8 COMMISSIONER NELSON: Yes.
9 (Mr. Miller approached the witness.)
10 Q BY MR. MILLER: And what is the purpose of
11 corrected Exhibit 10?
12 A It is intended to demonstrate that the
13 anticipated expenditures forecast in the original exhibit
14 have been met or exceeded.
15 Q So the point of the exhibit is not to
16 change the amount of the Company's rate request, but
17 merely to confirm that what once were projected expenses
18 have now become actual expenses?
19 A That is correct.
20 Q Turning to your written testimony, are
21 there any additions or corrections that need to be made
22 to that direct testimony?
23 A Yes, on page 3, line 21, the project number
24 should read "C97D105."
25 Q That just corrects a clerical error?
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CSB REPORTING BROWN (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 A That's correct, and similarly, on page 6,
2 line 17, it's the same correction. It should read
3 "C97D105."
4 Q Any other additions or corrections?
5 A Not to the direct testimony.
6 Q Very good, and if I were to ask you the
7 questions that are set forth in your written direct
8 testimony, would your answers be the same?
9 A Yes, they would.
10 Q To the best of your knowledge, are they
11 true and correct?
12 A Yes, they are.
13 MR. MILLER: Mr. Chairman, we would ask
14 that the direct prefiled written testimony of witness
15 Brown be spread on the record as if read as corrected and
16 that corrected Exhibit 10 and Exhibit 11 be marked.
17 COMMISSIONER NELSON: Okay, without
18 objection, why, so ordered.
19 (The following prefiled testimony of
20 Mr. Daniel Brown is spread upon the record.)
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CSB REPORTING BROWN (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 Q Please state your name, business address,
2 position and employer.
3 A Daniel Brown. My business address is 8248
4 W. Victory Road, Boise, Idaho 83709. I am the Managing
5 Engineer, responsible for engineering at United Water
6 Idaho.
7 Q Please briefly describe your education and
8 professional background.
9 A I received a bachelor of science degree in
10 Civil Engineering from the University of Idaho in 1976.
11 I was employed by Davenport Engineers from January 1,
12 1977 through February 1978 and worked primarily on water
13 related projects for the cities of Middleton and
14 Fruitland, Idaho. On February 20, 1978 I began my
15 employment with United Water Idaho. I worked as a staff
16 engineer until 1983 when I became Managing Engineer. I
17 received my professional engineer registration in July of
18 1981.
19 Q Have you testified in any proceeding before
20 a regulatory body?
21 A Yes, before this Commission on the Garden
22 City Exchange and the Eagle acquisition cases.
23 Q In your capacity as Managing Engineer, are
24 you responsible for planning and implementing United
25 Water Idaho's capital expenditure plan?
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United Water Idaho Inc.
1 A Yes, I am.
2 Q Are you familiar with the various capital
3 projects which are planned to be placed in service
4 between July 1, 1997 and February 28, 1998?
5 A Yes, I am.
6 Q Please describe in general the categories
7 and purposes of the capital expenditure program indicated
8 on Exhibits 10 and 11.
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Brown, Di 1A
United Water Idaho Inc.
1 A The capital expenditure program indicated
2 on the above referenced Exhibits is for non-revenue
3 producing plant either placed in service or intended to
4 be placed in service prior to rates becoming effective in
5 this proceeding.
6 Non-revenue producing plant projects are service
7 enhancement projects resulting from infrastructure
8 replacement needs, quality reasons, and/or assurance of
9 continued quantity.
10 Infrastructure Replacement is primarily the result of
11 aging, non-performing plant or due to functional
12 obsolescence. The major capital expenditures which fall
13 under this sub-category are replacement services and
14 meters, replacement mains, well redrill/replacement
15 projects and replacement of information technology
16 systems.
17 Replacement services can be prompted by two
18 conditions: 1) reaching the end of physical
19 serviceable life or 2) replacement services
20 associated with replacement main projects.
21 Replacement mains are generally the result of
22 three conditions: 1) inadequate capacity, 2)
23 reaching the end of physical serviceable life and
24 3) association with street reconstruction
25 projects. The last condition will be discussed in
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Brown, Di 2
United Water Idaho Inc.
1 more detail below.
2 Well redrill/replacement projects are typically
3 the result of the deterioration of older wells
4 which, with age, are no longer providing reliable
5 production. A second reason for well
6 redrill/replacement is water quality. With newer
7 scientific technology it has been possible to
8 replace some existing poor quality wells with a
9 higher quality water.
10 Information Technology projects are intended to
11 replace hardware and software systems needed for
12 efficient company operations. The
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Brown, Di 2A
United Water Idaho Inc.
1 most significant of these are the new financial
2 systems which replace several incompatible and
3 antiquated systems which were functionally
4 obsolete and would not have survived the year 2000
5 rollover.
6 Public Agency Required Projects. These are
7 projects or increased expenditures due to local,
8 state or federal governmental agency requirements.
9 During this period, most agency required projects
10 relate to local governmental actions.
11 Q Please highlight the capital projects
12 included in Exhibit 10 under the following plant
13 designations: source of supply, treatment plant, pumping
14 plant, main lines, service lines, customer meters,
15 information technology and general plant.
16 A The following discussion provides
17 information regarding unique or significant projects
18 falling under the above plant designations.
19 Source of Supply
20 Projects C95A002 - McMillan Well and C96A003 - 27th St.
21 Well are for new sources of supply needed to meet
22 customer demands. Maximum day demands for the last three
23 years and projected for 1998 are:
24 1995-77.6 MG 1996-79.2 MG 1997-77.1 MG 1998-84.5 MG
25 The available supply in 1997 is 81.6 MGD. The combined
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United Water Idaho Inc.
1 1.6 MGD increase in supply capacity from McMillan and
2 27th St. Wells is necessary to maintain reliable service
3 capacity. These two sources, plus tying in the Floating
4 Feather/Redwood Creek Wells (2.0 MGD, see C97D105), will
5 bring the 1998 peak season capacity to approximately 85.2
6 MGD.
7 Project C96A006 - Swift Well #3. This well was
8 drilled to improve water quality from the Swift Well site
9 in northwest Boise. Swift #1, drilled in 1978, had high
10 concentrations of both iron and manganese. Customer
11 dissatisfaction and the
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Brown, Di 3A
United Water Idaho Inc.
1 high cost of available treatment/removal techniques led
2 to an exploratory test well at the Swift #1 site, which
3 yielded a higher quality aquifer with good production
4 potential. A new production well was drilled and put
5 into service during the peak demand season of 1997.
6 Customer reaction has been favorable.
7 Project C96A007 - Boise River Intake. See Witness
8 Linam's testimony for the discussion of this project.
9 Project C97A005 - Water Rights. This project reflects
10 expenditures toward the acquisition of new surface water
11 rights which are needed to insure continual raw water
12 supply for treatment and distribution to our customers.
13 This water will be produced through the Marden Water
14 Treatment Plant.
15 Project C97A006 - Auxiliary Power Generator. This
16 project is to provide additional auxiliary power
17 generation capacity for the United Water Idaho service
18 area. It will have the capacity to operate up to a 200
19 horsepower facility and will be portable for
20 transportation to any site in the system.
21 Project C97A008 - Master Meter Changeout. This project
22 is for the replacement of the original propeller type
23 flow meters which no longer provide reliable measurement
24 at our well and booster sites. Accurate flow measuring
25 devices are required by the Idaho Department of Water
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Brown, Di 4
United Water Idaho Inc.
1 Resources. The existing propeller meters do not provide
2 adequate output to the SCADA system for data acquisition
3 and control purposes. These new meters are electronic,
4 have no moving parts and do not restrict the flow of
5 water. They also provide instantaneous, compatible
6 output to the SCADA system which provides the means for
7 facility control which is not available from the
8 propeller meters.
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United Water Idaho Inc.
1 Project C97A010 - Monitoring Wells. This is part of an
2 ongoing project to construct long-term monitoring wells
3 in strategic locations throughout the service area.
4 These wells will be selectively located at both
5 non-production and production sites to more accurately
6 measure the "health" of the aquifer system. This is
7 critical as the area continues to develop and demands on
8 the groundwater system increase. Increased knowledge of
9 the aquifer will improve the reliability of service to
10 our customers.
11 Project C97A101 - C97A104 - Well Improvements.
12 These projects are for reconstruction work at two wells
13 to insure steady production. One is for the lowering of
14 a pump in one well necessary due to a lower water
15 pumping level and the other is for the replacement of a
16 pump which was struck by lightning.
17 Treatment Plant
18 Project C97B001 - Upgrade Meter Pits at the Marden Water
19 Treatment Plant. This project is for improving the
20 vaults housing the flow meters which measure the
21 flowrates from the three Ranney Collectors. High ground
22 water occurs when the river is at or near flood stage and
23 threatens these electronic meters. The vaults have been
24 upgraded to protect the meters from being submerged.
25 Project C97B002 - Chlorine Analyzer at Gowen Booster.
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Brown, Di 5
United Water Idaho Inc.
1 This project will add the equipment necessary to monitor
2 the chlorine residual of the water leaving the Gowen
3 Standpipe. This information aids in the calibration of
4 the chlorine feed systems to insure that adequate
5 disinfectant is present at all times in the water.
6 Pumping Plant
7 Project C97C002 - Boise Avenue Booster. This project is
8 for the construction of a new booster station on Boise
9 Avenue, west of Apple. This facility will allow the
10 transfer of water from the Main Service Level to the
11 Barber Service Level
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United Water Idaho Inc.
1 during periods of reduced demand. There are two major
2 objectives for this project. First, it will reduce
3 pumpage from the Southeast Boise Groundwater Management
4 Area which would be achieved by limiting production from
5 the Centennial, Bergeson and Logger Wells located in the
6 Management Area. During off-peak season operations, when
7 water is available from the Marden Water Treatment Plant,
8 the booster station would be operated in lieu of one or
9 more of these wells.
10 The second objective is added flexibility to the
11 operation of the water system. For instance, in cases of
12 emergency, available water from the Main Service Level
13 can be transferred to Barber to support fire protection
14 efforts.
15 Main Lines
16 The projects indicated under this plant category are for
17 the installation of new and replacement mains required to
18 serve customers, improve service and distribution
19 capacities, replace obsolete pipelines and to replace
20 mains impacted by roadway projects. The individual
21 projects discussed below are unique in nature or
22 significant in regard to the expenditures involved.
23 C97D105 - NW Pipeline, Hill Road to Floating Feather.
24 See Witness Linam's testimony for a discussion of this
25 project.
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United Water Idaho Inc.
1 Project 97D201 - Cloverdale Road/Wildwood St. This
2 project involves the installation of a 12-inch water main
3 in Cloverdale Road, north from our Hope Well, tying into
4 the existing 12-inch line in Fairview Avenue. The
5 Wildwood Street section entails the installation of an
6 8-inch main north from Fairview Avenue, tying into the
7 existing 8-inch line. The combination of these sections
8 of main enable the delivery of water from the Hope Well
9 into an area previously served by the Bali Hai Well.
10 Water from Bali Hai has declined in quality over the
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Brown, Di 6A
United Water Idaho Inc.
1 past few years resulting in increased customer
2 dissatisfaction regarding their water quality.
3 Project C97D603 - 8th Street Foot Bridge. This project
4 is for the installation of a new 12-inch main crossing
5 the 8th Street Foot Bridge over the Boise River to
6 replace the buried crossing which was washed out during
7 the early spring of 1997. This river crossing is one of
8 only four water lines which tie the customers in the area
9 south of the river to the storage facilities and major
10 sources of supply in the north portion of the service
11 area.
12 Project C97D604 - Boise Avenue and Juanita. This project
13 upgrades the capacity of the distribution system south of
14 Boise State University and east of Capitol Blvd. This
15 was needed to improve the capability of transferring
16 water available from the Cassia Well area to the Main
17 Service Level. It involved the installation of a 12-inch
18 main in Boise Avenue east from the Cliffside Well, tying
19 into the existing 12-inch main in Juanita.
20 Project C97D710 - Shoshone and Cassia. This project
21 upgrades the capacity of the distribution system in
22 Cassia St. west from the Cassia Well to Shoshone and
23 north on Shoshone to Rose Hill. Drilling of the new
24 Cassia Well #2 necessitated improvements in the
25 distribution system in order to carry the increased flows
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United Water Idaho Inc.
1 from this site.
2 Project C97D712 - 13th Street. This project involves the
3 installation of 8-inch water main in 13th Street from
4 State Street to Fort in conjunction with Ada County
5 Highway Districts (ACHD) overlay of 13th Street. The
6 existing main was 1 1/4 inch galvanized iron pipe
7 installed in 1923 and 1925.
8 Replacement Customer Meters
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Brown, Di 7A
United Water Idaho Inc.
1 This project is for the purchase and installation of
2 meters which replace inoperative or obsolete meters to
3 ensure accurate billing to our customers.
4 Information Technology
5 These projects are for the replacement of obsolete
6 information technology software and hardware. The most
7 significant projects falling under this designation are
8 C96J950, IT - Technical Architecture and the IFMS
9 projects, C96J952 through C96J956.
10 Project C96J950 represents the costs for linking
11 the Company's Local Area Network (LAN) to the UWR Wide
12 Area Network (WAN). The WAN permits rapid transmission
13 of information via electronic mail and file-sharing
14 between the various UWID operations as well as between
15 UWID and United Water Management and Services and other
16 subsidiaries of United Water Resources. The WAN provides
17 the framework necessary for implementation of the
18 Integrated Financial Management System (IFMS).
19 The IFMS projects C96J952 through C96J956 contain
20 various modules of a client-server based computer system.
21 The projects represent the various modules of the
22 integrated system which include:
23 General Ledger, Time Entry/Payroll, Procurement,
24 Budgeting and Project Costing/Asset Management.
25 General Plant
181
Brown, Di 8
United Water Idaho Inc.
1 The projects listed under this plant designation are for
2 the purchase of new and replacement tools and equipment,
3 building additions and modifications and a few unique
4 projects as discussed below.
5 Project C96K006 - SCADA Radio Installations. This
6 project is for the purchase and installation of new SCADA
7 radios which will enhance our
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Brown, Di 8A
United Water Idaho Inc.
1 communication reliability between the operations center
2 and the source, pumping and storage facilities in the
3 field. It will also result in significant savings in
4 telephone line communications costs which have been
5 reflected in Witness Healy's expense adjustments.
6 Project C97K012 - UW Idaho Master Plan. This project is
7 for the preparation of a master plan for United Water
8 Idaho. This plan is necessary to guide the Company's
9 efforts in providing sufficient water supply systems,
10 maintaining adequate water quality, meeting customer
11 expectations, and necessary for securing and maintaining
12 adequate water rights for the existing and future
13 customer base. The master plan forecasts where growth
14 will occur over the next twenty years and describes the
15 physical plant needed to serve this growth. The plan
16 will make recommendations as to source of supply
17 additions, transmission and distribution system
18 improvements and other plant additions and modifications.
19 Project C97K019 - Replace Roof on Office Building. This
20 project is for replacing the roof on the business office
21 building at 8248 W. Victory Road. The existing roof was
22 nearly 20 years old and leaked in numerous locations.
23 Q You stated earlier that you have prepared
24 Exhibit 11. What is the purpose of this exhibit?
25 A Exhibit 11 indicates the anticipated CIAC
183
Brown, Di 9
United Water Idaho Inc.
1 amounts during the period from July 1, 1997 through
2 February 28, 1998. Also indicated are the projects
3 against which the contributions will be applied.
4 Q Does this conclude your testimony?
5 A Yes it does.
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Brown, Di 9A
United Water Idaho Inc.
1 (The following proceedings were had in
2 open hearing.)
3 MR. MILLER: And Mr. Brown is available for
4 cross-examination.
5 COMMISSIONER NELSON: Thank you.
6 Mr. Fothergill, do you have questions of
7 Mr. Brown?
8 MR. FOTHERGILL: Yes, Mr. Chairman, I have
9 a few questions regarding the response to the Staff's
10 first production request. I have a piece of paper if I
11 could hand these out.
12 COMMISSIONER NELSON: All right.
13 (Mr. Fothergill distributing
14 documents.)
15 COMMISSIONER NELSON: Mr. Fothergill, do
16 you know what series of numbers we assigned you?
17 MR. FOTHERGILL: I don't know.
18 MR. WOODBURY: His series is 201 to 300.
19 COMMISSIONER NELSON: So this would be
20 Exhibit 201?
21 MR. FOTHERGILL: All right, thank you.
22 (Idaho Citizens Coalition Exhibit
23 No. 201 was marked for identification.)
24
25
185
CSB REPORTING BROWN
Wilder, Idaho 83676 United Water Idaho Inc.
1 CROSS-EXAMINATION
2
3 BY MR. FOTHERGILL:
4 Q Mr. Brown, have you had a chance to look
5 this over? You're familiar with this, are you not?
6 A I'm basically familiar with it, yes.
7 Q Just looking at it, I notice that there's
8 really no consistency in the way these numbers move, so
9 from 1992 through 1996, in some instances the numbers go
10 down sometimes dramatically and there's no, I mean,
11 there's no trend line that you could look at and say
12 these are the way these things are going. In addition,
13 as I see it, there's no real connection between the
14 customer growth numbers, consumption and production
15 numbers. Would you agree with those statements?
16 A I believe, if I'm understanding your
17 question correctly, that these are the result of
18 consumption characteristics of the customers. If we're
19 looking, for instance, at under the main service level,
20 the first category here --
21 Q Right.
22 A -- consumption, we've got, these would be
23 in billions of gallons, we have 5 billion, we have
24 4.4 billion, 5.1 billion, 4.6 billion, 4.8 billion and
25 essentially one has to look at what was going on those
186
CSB REPORTING BROWN (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 years as far as weather. For instance, in 1994, which is
2 the highest year here, we had, I believe, nine point,
3 speaking from memory here, 9.4 inches of rainfall and in
4 1995 and 1996, we had 14 inches of rainfall during the
5 year, so I wouldn't expect them necessarily to track
6 simply because of the variances that we have in customer
7 usage characteristics.
8 Q So a lot of this is weather related?
9 A I would say it is predominantly weather
10 related.
11 Q All right, thank you. Now, look at the
12 response that you have to Request No. 2. I looked at
13 those numbers and I tried to use a standard projection
14 method and I didn't find that they fit anything, so it
15 looked to me like the best you could say for those
16 projections is they're educated guesses; would you agree
17 with that?
18 A Well, they're our best estimates of what we
19 project will be the demands in those periods.
20 Q For example, just to look at Micron, you
21 forecast there 450,000, in thousands of gallons, 450,000
22 in each of the forecast years. That's down toward the
23 bottom of the page under Gowen service level.
24 A Yes.
25 Q All you'd need is -- I mean, looking at
187
CSB REPORTING BROWN (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 what went before, that seems like that's a pretty
2 unreasonable forecast that you're expecting that company
3 to increase its consumption by that much every year.
4 A Well, I think what we were looking at here
5 is it's not increasing by that amount every year, what we
6 looked at was the 1996 figure --
7 Q Right.
8 A -- on the previous page where it was 451,
9 this would be in millions, 451 million and, in essence,
10 for projecting purposes, we just took that number saying
11 that's the latest data we have and --
12 Q Took the highest number and projected it?
13 A Well, it's the most recent usage.
14 Q But that is an educated guess, wouldn't you
15 say?
16 A It's the best information we had available.
17 Q In fact, these numbers don't mean a lot
18 because the Company does do its planning on the basis of
19 peak days, doesn't it?
20 A Well, it depends on what the basis of your
21 question is. If we were talking about the, how we plan
22 for source of supply and storage and maximum day
23 conditions, we base our plant additions on peak day.
24 This question was basically based upon annual consumption
25 and so this data is not what we would use for planning
188
CSB REPORTING BROWN (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 our plant additions, you're correct in that regard.
2 MR. FOTHERGILL: That's all I have. Thank
3 you very much.
4 COMMISSIONER NELSON: Thank you,
5 Mr. Fothergill.
6 Ms. Ullman.
7 MS. ULLMAN: I have no questions for this
8 witness. Thank you.
9 COMMISSIONER NELSON: Thank you.
10 Mr. Woodbury.
11
12 CROSS-EXAMINATION
13
14 BY MR. WOODBURY:
15 Q Good afternoon, Mr. Brown.
16 A Good afternoon.
17 Q While you were correcting your project
18 numbers with Mr. Miller, directing your attention to
19 page 3, McMillan well, that project number as reflected
20 in the corrected Exhibit 10 is "C95A002" instead of "1,"
21 isn't it?
22 A That is correct and that should have been
23 reflected in the testimony as 95A002.
24 Q And in designating these project numbers,
25 the 95 reflects what?
189
CSB REPORTING BROWN (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 A The year.
2 Q The year that it first entered into the
3 Company's systems planning?
4 A It's the year that the project is
5 initiated.
6 Q And so if the Boise River Intake is
7 C96A007, then that would have been initiated in '96?
8 A That is correct.
9 Q On page 5, your project for monitoring
10 wells, you indicate it's to measure the health of the
11 aquifer. Is this in relation to the Treasure Valley
12 Hydrologic Study? And that's project No. C97A010.
13 A Yes. The data that is generated from the
14 monitoring wells is used and submitted to the study and
15 the data that we have used, how we have used this data in
16 the past is, was a major factor in the determination of
17 the groundwater management area as an example of how we
18 use the monitoring wells and, in fact, in 1992 and '93 we
19 generated data showing the aquifer level declining on a
20 year-by-year basis. That was the basis where we
21 understood that this aquifer area in southeast Boise was
22 certainly in trouble as far as additional wells are
23 concerned.
24 Q What year was that?
25 A 1992 to '93, so in measuring the health of
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CSB REPORTING BROWN (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 the aquifer, that resulted and the data was agreed to by
2 the Department of Water Resources.
3 Q When was southeast Boise designated a
4 groundwater management area, what year?
5 A Well, we filed the data with the department
6 in October of 1993 and it was declared a groundwater
7 management area in October of 1994.
8 Q A monitor well is different than a
9 production well?
10 A That is correct.
11 Q How many monitor wells does the Company
12 have throughout its system?
13 A I'd be speculating to some degree. We
14 monitor probably in the range of 10 to 12 scattered
15 throughout the system.
16 Q And how many of those, how many monitor
17 wells are included within the Treasure Valley Hydrologic
18 Study that are located in Boise Water's system, I mean
19 United Water?
20 A I would say that all the data that is
21 generated from those that I mentioned would be submitted
22 to the study. I believe there are a couple others that
23 the department has included that are not ours.
24 Q It was my understanding that they
25 identified just four wells for United Water that were
191
CSB REPORTING BROWN (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 included within the Treasure Valley Hydrologic Study as
2 monitor wells.
3 A The hydrologic study did that? I just know
4 that we monitor well in excess of that and any data that
5 we may generate we would share with the project. There
6 may be identified specific ones that they are
7 monitoring. Beyond that, I can't speak specifically.
8 Q Okay. Referring you to page 9 of your
9 direct, United Water Idaho master plan, project
10 No. C97K012.
11 A Yes.
12 Q This is a new plan that was initiated last
13 year and my question is, did the Company have a preceding
14 plan that it was following?
15 A The last master plan was termed a
16 projection study that was completed in 1980.
17 Q And did you do -- I mean, under this
18 particular plan, you proposed updating on a five-year
19 cycle. Did you do similar updates to the projection
20 study of 1980?
21 A Yes, but not in total. We didn't publish a
22 new study. We updated customer projections, water
23 demands, those kinds of things. As far as publishing a
24 new study we did not.
25 Q The updated projection study in 1980 was
192
CSB REPORTING BROWN (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 used as base data for the new study that's underway?
2 A There was a certain amount of information
3 that was shared from the original study to the new study;
4 however, the majority of the information is new.
5 MR. WOODBURY: Thank you, Mr. Brown. I
6 have no further questions regarding his direct testimony.
7 COMMISSIONER NELSON: Questions from the
8 Commission?
9 COMMISSIONER HANSEN: No questions.
10 COMMISSIONER SMITH: No questions.
11 COMMISSIONER NELSON: Mr. Miller, do you
12 have redirect?
13 MR. MILLER: No, Mr. Chairman. Thank you.
14 COMMISSIONER NELSON: Mr. Brown, thank you
15 for your testimony.
16 (The witness left the stand.)
17 MR. MILLER: The Applicant, Mr. Chairman,
18 would call Frank Gradilone.
19 COMMISSIONER NELSON: All right.
20
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193
CSB REPORTING BROWN (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 FRANK GRADILONE III,
2 produced as a witness at the instance of United Water
3 Idaho Inc., having been first duly sworn, was examined
4 and testified as follows:
5
6 DIRECT EXAMINATION
7
8 BY MR. MILLER:
9 Q Sir, could you state your name, please?
10 A Frank Gradilone.
11 Q And by whom are you employed?
12 A United Water Management and Services.
13 Q And what is the -- in what capacity?
14 A I am the manager of resources planning for
15 rates.
16 Q And could you describe for the Commission
17 the general nature of your duties and responsibilities in
18 that position?
19 A I've become primarily the revenue witness
20 for the company in the rate process for most of our major
21 rate filings. In that process, I analyze historical
22 data, determine what the level of consumption, the number
23 of customers that we're going to serve and then from that
24 derive the amount of revenues and basically use a test
25 year and then for the proposed revenues how much revenues
194
CSB REPORTING GRADILONE (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 we will derive from that customer base.
2 Q In connection with the proceeding that is
3 pending here today, did you previously have occasion to
4 file certain direct prefiled testimony consisting of six
5 pages?
6 A Yes, I did.
7 Q And was there an exhibit that accompanied
8 your direct testimony?
9 A Yes, it was an exhibit and it had three
10 schedules in it. One was a 28-page written document that
11 described the analytic process and then there were two
12 other schedules of supporting tables and figures, plus I
13 also provided -- that was Exhibit 8, plus I also provided
14 Exhibit 9 which was the tariff pages that were going to
15 be changed on those pages indicating what was going to be
16 changed and what the proposed tariffs were.
17 Q Very good. Could you just provide a brief
18 description of your Exhibit 8? I understand the first
19 part is a narrative and then subsequent parts are
20 numerical matters.
21 A Yes. Basically, the first 21 pages is a
22 written document that details projections for each of the
23 individual customer classes, residential, commercial and
24 public, and also analyzes the fire protection services,
25 other revenues and has a considerable detail on the
195
CSB REPORTING GRADILONE (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 additions to the system that were made during that
2 period. They were handled separately in the analysis.
3 Supporting that in the next schedule in Exhibit 8 are a
4 series of tables that are directly associated with that
5 exhibit and it essentially goes in lock step with it and
6 as you read the exhibit, the tables and figures are
7 referred to to support it and give the backup, and then,
8 finally, Schedule 3 is essentially an appendix which
9 provides considerable detail on the bill analyses that
10 were done for the basic rate year and then for what
11 revenues we would get from the proposed rates.
12 Q If I were to ask you the questions that
13 are -- before that, are there any additions or
14 corrections that need to be made either to your written
15 testimony or to any of the exhibits?
16 A Yes, there's a few minor changes. On
17 page 9 of 21 of Exhibit 8, schedule 1, which is the
18 written text, on the second line it reads "Exhibit 8,
19 Schedule 2, Page of 7 38." It should read "Page 7 of
20 38," and there are another set of changes on Schedule 2
21 of Exhibit 8, pages 35 and 36, and actually rather than
22 going through them individually, I'll just tell you what
23 they are and I can provide new copies of the tables, I
24 think that would be the most efficient way to do it, but
25 on those two tables, on the customers, these are tables
196
CSB REPORTING GRADILONE (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 that detail customers' consumption and revenue for the
2 acquired systems, Warm Springs Mesa, Eagle and Garden
3 City, on the customers' columns for each of those
4 individuals, the rate year is indicated and the numbers
5 that are in there are the sums of the number of customers
6 and it should actually be the average of the number of
7 customers. It doesn't affect the analysis in any way.
8 The average number of customers for those systems were
9 used in the analysis. It's just on this table the wrong
10 formula was put in, it was just represented as a sum, so
11 just for clarification, I'll give two new tables.
12 Randy Lobb and I have gotten together to
13 discuss how we're going to do that. Like I said, it
14 doesn't affect the analysis but just for clarity, and
15 then, finally, and this actually is on the application
16 because I also prepared the new tariff pages, there was a
17 typographical error in transcribing the proposed tariff
18 numbers from the worksheets to the final tariff page and
19 on Exhibit B, page 4 of 5, the rate per hydrant should be
20 $7.07, not the $7.08 indicated.
21 Q That's on the actual application?
22 A On the application, right. As I said,
23 basically that's just a typo.
24 Q Could you give us the number again?
25 A Of the exhibit? Exhibit B, page 4 of 5.
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CSB REPORTING GRADILONE (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 COMMISSIONER NELSON: Is that the same as
2 Exhibit 9, schedule No. 6? And there you do have 7.07.
3 THE WITNESS: Right, yes.
4 COMMISSIONER NELSON: Okay.
5 Q BY MR. MILLER: Very good. With those
6 corrections, if you were asked today the questions that
7 are set forth in your written testimony and the material
8 set forth in your exhibits, would your answers be the
9 same?
10 A Yes, they would.
11 Q To the best of your knowledge, are they
12 true and correct?
13 A Yes, they are.
14 MR. MILLER: Mr. Chairman, we would ask
15 that the direct prefiled testimony of the witness be
16 spread on the record as if read and that Exhibits 8 and 9
17 be marked.
18 COMMISSIONER NELSON: Without objection,
19 it's so ordered.
20 (The following prefiled testimony of
21 Mr. Frank Gradilone is spread upon the record.)
22
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CSB REPORTING GRADILONE (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 Q Please state your name and business
2 address.
3 A Frank Gradilone III, United Water
4 Management and Services (UWM&S), 200 Old Hook Road,
5 Harrington Park, New Jersey 07640.
6 Q Please state your educational and
7 professional background.
8 A I hold Master Degrees in Business
9 Administration, and in City and Regional Planning from
10 Rutgers, the State University of New Jersey. As an
11 undergraduate, I majored in environmental studies and
12 political science at the State University of New York at
13 Stony Brook.
14 While a graduate student in the City and Regional
15 Planning program at Rutgers University, I was a Research
16 Associate at the Center for Urban Policy Research where I
17 was involved in a number of research projects for local
18 government agencies and organizations, and for the U.S.
19 Department of Housing and Urban Development. My
20 responsibilities included survey research, computer based
21 quantitative analyses, and fiscal impact analysis. I am
22 a contributing author to the 1980, Center for Urban
23 Policy Research publication entitled, The Adaptive Reuse
24 Handbook.
25 I have been a Licensed Professional Planner in the
199
Gradilone, Di 1
United Water Idaho
1 State of New Jersey since June of 1981. I was a member
2 of the Vernon Township (NJ) Environmental Commission, and
3 served as chairperson of that body from 1993 through
4 1995.
5 My professional affiliations include memberships
6 in the American Water Works Association (where I also
7 serve as a member of the Water Conservation Division),
8 the American Marketing Association, the Water Wise
9 Council of New York, and the Regional Plan Association.
10
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Gradilone, Di 1A
United Water Idaho
1 I have authored and presented a number of
2 technical papers at national and regional conferences in
3 the field. Some of the papers with relevance to my
4 testimony here include: "A Water Conservation Program
5 for the Spring Valley Water Company", Proceedings of
6 Conserv '93, Las Vegas, NV, 1993; "Seasonal Rates-the
7 Pros and Cons: A Case Study", a paper presented at the
8 American Society of Civil Engineers, Water Resources and
9 Planning & Management '93 Conference, in Seattle,
10 Washington May 1993; Automatic Meter Reading for the
11 Water Industry, co-authored with Donald L. Schlenger,
12 American Water Works Association Research Foundation,
13 Denver, Colorado, 1992; "Some Questions on Cost and
14 Benefits of Rate Regulation," co-authored with Drs.
15 Michael Crew and Donald L. Schlenger, published in NAWC
16 Water, Summer 1986; "Water Conservation: A Case Study,"
17 a paper presented at the "Water for the 21st Century"
18 conference in Dallas, Texas, 1984; "Impact of
19 Summer/Winter Differential Rate Structure," a paper
20 presented at the ASCE, Urban Water 1984 Conference in
21 Baltimore, Maryland; and the "AWWA Survey of Remote
22 Metering Practices," a paper presented jointly with
23 Donald L. Schlenger at the 1984 AWWA Annual Conference in
24 Dallas, Texas.
25 Q Please describe your employment experience
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Gradilone, Di 2
United Water Idaho
1 with UWM&S.
2 A I have been employed by UWM&S, and its
3 predecessor companies, since August 1979. From 1979 to
4 1983, I was a Special Projects Researcher in the Research
5 and Development Division of the Hackensack Water Company
6 (now known as United Water New Jersey). My
7 responsibilities included research design and
8 quantitative analysis, system operation analysis, and
9 survey research for the
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Gradilone, Di 2A
United Water Idaho
1 Company and its subsidiary, Spring Valley Water Company
2 (now known as United Water New York).
3 From 1983 through 1987, I was Manager of Demand
4 Forecasting. My responsibilities included demographic
5 and economic forecasting, capital projects planning,
6 liaison with government agencies and regulatory bodies,
7 and management of research personnel. I also provided
8 testimony before the New York State Department of
9 Environmental Conservation on the need and timing for a
10 proposed reservoir and water filtration plant project for
11 the United Water New York system, known as the Ambrey
12 Project.
13 In 1988 I transferred to United Water
14 Resources and am currently Manager-Resources Planning,
15 Rates for UWM&S. In this capacity, I am responsible for
16 water demand, demographic and economic forecasts for
17 United Water's operating units.
18 With respect to my involvement in water demand
19 forecasting, to date, I have conducted basic research to
20 determine the appropriate forecasting methods. I have
21 created forecasting databases, and I continued to provide
22 long-range forecasts for both United Water New York and
23 United Water New Jersey. I have previously produced
24 short-run water consumption and revenue forecasts for
25 United Water New York in its last two rate cases (NYS
203
Gradilone, Di 3
United Water Idaho
1 PSC Case 92-W-0645 and Case 94-W-0486); United Water New
2 Jersey (NJ BPU Case WR-90080792J); United Water Toms
3 River (NJ BPU Case WR-95050219); United Water New
4 Rochelle (NYS PSC. Case 96-W-1168), United Water Florida
5 (FPSC Case 960451-WS), United Water Delaware (DPSC. Case
6 96-164), United Water Pennsylvania (PPUC. Docket No.
7 R-00973947), and United Water Arkansas (APSC Case
8 960451-WS).
9
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Gradilone, Di 3A
United Water Idaho
1 Q Could you describe your responsibilities in
2 connection with this rate filing?
3 A The purpose of my testimony is to present
4 an assessment of pro forma revenues for metered water
5 revenues, private fire protection service revenues, and
6 other revenues for a test year covering the twelve month
7 period ended June 30, 1997 for United Water Idaho.
8 Q How did you prepare these projections?
9 A Separate assessments of metered water
10 consumption and revenues were made for each customer
11 sector in the system; residential, commercial, and public
12 authority. Revenues for private fire protection services
13 and other revenues were also analyzed. This analysis,
14 and supporting tables and figures detailing this
15 assessment, are contained in Exhibit 8, Schedules 1, 2
16 and 3.
17 Q What was the level of pro forma metered
18 water sales for the test year in this case based on your
19 analysis of the Company's financial records?
20 A Adjusted test year metered water sales
21 revenues for the twelve month period ended June 30, 1997
22 under existing tariff schedules total $22,209,231 as
23 shown in Exhibit 8, Schedule 2, Page 30 of 39, Column 1.
24 Q What was the level of pro forma fire
25 protection services for the test year in this case?
205
Gradilone, Di 4
United Water Idaho
1 A Based on my analysis private fire
2 protection services for the test year were $349,046 on a
3 pro forma basis as shown in Exhibit 8, Schedule 2, Page
4 38 of 39, Column 8.
5 Q What other revenues did you consider in the
6 forecast?
7 A Other revenue sources include miscellaneous
8 revenues from customer fees and charges, guaranteed
9 revenue contracts, rents, and unbilled revenues. These
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Gradilone, Di 4A
United Water Idaho
1 revenues totaled $353,989 on a pro forma basis for the
2 test year, as shown in Exhibit 8, Schedule 2, Page 30 of
3 39, Column 5.
4 Q What conclusions do you draw for total pro
5 forma revenues for the test year from your analysis?
6 A Pro forma metered water sales, fire service
7 and other revenues under the existing tariff schedule for
8 the twelve month test year ended June 30, 1997 total
9 $22,135,975 (as shown in Exhibit 8, Schedule 2, Page 30
10 of 39, Column 5).
11 Q Have you prepared any other schedules for
12 this Application for Rate Increase?
13 A Yes. I also prepared Exhibit 9, which
14 shows the existing tariffs and proposed tariffs for this
15 case.
16 Q How does the Company propose to change its
17 tariffs to reflect the change in rates proposed in this
18 rate case?
19 A The Company proposes that in this phase of
20 the proceeding, that tariffs be changed on an
21 across-the-board basis (with the exception of those
22 customers currently on a phase-in rate schedule) pending
23 the completion of a detailed cost of service study, and
24 the filing of a new tariff design based on this analysis.
25 Q Are there any other changes being proposed
207
Gradilone, Di 5
United Water Idaho
1 by the Company?
2 A Yes. As detailed in Exhibit 8, Schedule 1,
3 the Company is requesting changes in its Miscellaneous
4 Service Fee schedule. Specifically, we are seeking to
5 increase the fee for insufficient checks and reconnection
6 of service for non-payment, and to implement a new fee to
7 recover the costs associated with collecting customer
8 payments in the field.
9 Q Have you developed a rate proof to show
10 that the proposed tariffs will generate the revenues
11 needed to meet the revenue requirement?
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Gradilone, Di 5A
United Water Idaho
1 A Yes. This analysis is shown in Exhibit 8,
2 Schedule 2, Page 30 of 39. The overall rate increase
3 requested is $3,424,516, or 15.47%, representing a
4 revenue requirement of $25,560,491.
5 Q Does this conclude your testimony?
6 A Yes it does.
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Gradilone, Di 6
United Water Idaho
1 (The following proceedings were had in
2 open hearing.)
3 COMMISSIONER NELSON: Mr. Gradilone is
4 available, is he?
5 MR. MILLER: He's ready for
6 cross-examination.
7 MR. FOTHERGILL: No questions.
8 COMMISSIONER NELSON: Thank you.
9 Ms. Ullman.
10 MS. ULLMAN: I have one question.
11
12 CROSS-EXAMINATION
13
14 BY MS. ULLMAN:
15 Q I'm wondering, I wanted to clarify whether
16 this is an appropriate question to ask you, the overall
17 rate of return, the percentage that the Company is asking
18 for, is actually an increase over what it currently is
19 receiving; is that correct?
20 A I'm not the witness to ask that question.
21 MS. ULLMAN: Then I'll pass. Thank you.
22 COMMISSIONER NELSON: Okay, thank you.
23 Mr. Woodbury.
24 MR. WOODBURY: Thank you.
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Wilder, Idaho 83676 United Water Idaho Inc.
1 CROSS-EXAMINATION
2
3 BY MR. WOODBURY:
4 Q Hello, Mr. Gradilone.
5 A Good afternoon.
6 Q I note on page 3 of your direct testimony
7 you state that you're responsible for water demand,
8 demographic and economic forecasts for United Water's
9 operating units. Did you do forecasts in all of those
10 areas for this particular case and for United Water
11 Idaho?
12 A Oh, okay, I think I understand the
13 question, did I do economic and demographic analyses for
14 Idaho?
15 Q Yes.
16 A For this area? I obtained some materials
17 from some of the Company personnel, from local planning
18 authorities. I also had some databases of information
19 from secondary and other sources that looked at the
20 demographics in the area and I looked at those for the
21 City of Boise and the surrounding counties. I wouldn't
22 say I did a complete, thorough analysis, but I did
23 examine what was available and did take it into account
24 in the forecasts.
25 Q And in looking at the demographics, do you
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Wilder, Idaho 83676 United Water Idaho Inc.
1 also make an assessment as to the per capita income of
2 the Boise area?
3 A I believe in the statistics that I looked
4 at from the databases, the per capita income was a part
5 of those. Did I examine them, I don't recall taking them
6 into account or examining them specifically, but they
7 were part of the information that I looked at.
8 Q So you don't recall what the numbers were,
9 then?
10 A No, I don't.
11 Q On page 5 of your testimony, you address
12 the Company is also requesting changes in this case for
13 miscellaneous service fee schedule for increased fee for
14 insufficient checks from $10.00 to $15.00 and can you
15 indicate what is the basis for that increase?
16 A It's been awhile, but if I recall in my
17 discussions with Company personnel, the fees that the
18 banks charge I believe have gone up, plus the amount of
19 time and, oh, the time that -- not the time, but the
20 amount of costs that we have internally used to process
21 an insufficient check fee have increased as well and
22 that's the basis for it.
23 Q And is this the cost related to the costs
24 incurred by the, your local United Water Idaho or are we
25 tacking on some additional costs from --
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Wilder, Idaho 83676 United Water Idaho Inc.
1 A I believe they're all for costs for United
2 Water Idaho for the bank fees and for our own customer
3 service people to process insufficient check fees.
4 Q And also proposing to increase the
5 reconnection of service for non-payment from 15 to $20.00
6 during the day and 25 to 30 for after hours and the basis
7 for that?
8 A Similar answer. I discussed it with the
9 Company personnel and they indicated that their costs of
10 providing those services had increased and I believe that
11 the after hour fee is a new fee and it reflects the fact
12 that we have to pay more to reconnect people after hours.
13 Q Did you say you were disgusted with Company
14 personnel?
15 A Discussed.
16 Q And you're proposing a new fee to recover
17 costs associated with collecting customer payments in the
18 field, $15.00 per occurrence, and all of these fees are
19 increases to customers that may be problematic to the
20 Company, but also customers that appear to have some sort
21 of cash flow problem and so, I mean, how does this help
22 the Company if they don't have money to pay you in the
23 first place, you increase the fees?
24 A I don't know if in general I would agree
25 that people that are paying in arrears necessarily have
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Wilder, Idaho 83676 United Water Idaho Inc.
1 cash flow problems. They may not be paying for other
2 reasons. That could certainly be one of them, but there
3 is also the principle that if someone is causing us, a
4 certain customer class is causing us, to incur costs, you
5 know, basic principle states that you would try to
6 recover those costs from those people rather than have
7 everyone else in the service area pick up that fee and if
8 these are identifiable costs for delivering customer
9 service, in those circumstances, I mean, granted, no
10 matter where they're coming from and what their ability
11 is, they still are causing us to incur those costs and we
12 think it's only fair to recover it from them.
13 Q And you would agree, though, based upon
14 testimony in this case that the average billing per
15 customer is somewhere just a little under $300 per year
16 and that the Company collects 70 percent of that in a
17 period of six months?
18 A Those numbers sound correct, subject to
19 check.
20 Q Also, on page 5 you talk about the tariff
21 rates increasing in this case by 15.64 percent in
22 comparison to what was originally requested of 15.47
23 percent increase, overall rate increase. Is that 15.64
24 percent an increase in the rates affected by the Micron
25 adjustment?
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Wilder, Idaho 83676 United Water Idaho Inc.
1 A It would be affected by the Micron
2 adjustment. I mean, this does not include the Micron
3 adjustment.
4 Q Did you make that calculation or do you
5 know whether that calculation was made anywhere else?
6 A Mr. Healy made that calculation.
7 Q Who?
8 A Mr. Healy.
9 Q Are the test year number of bills rendered
10 and total test year consumption for acquisitions that the
11 Company has in this particular case accurately reflected
12 in your Exhibit 8, schedule 3, pages 29 and 30?
13 A That was Exhibit 8, Schedule 3?
14 Q Pages 29 and 30.
15 A Yes, I believe so.
16 Q Okay, and are those numbers then the base
17 that you use in your Exhibit 8, schedule 2, page 24 of
18 39?
19 A That was Schedule 2?
20 Q Exhibit 8, schedule 2, page 24.
21 A Without going into the exact spreadsheet
22 and seeing the connections, the numbers in the bill
23 analysis, which are the figures in schedule 3, page 29,
24 were the figures that should have been, that would have
25 been flowed back to this table in a summary form. I
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Wilder, Idaho 83676 United Water Idaho Inc.
1 would have to go back on the spreadsheet to make sure
2 that those connections were made where that was what this
3 is supposed to represent.
4 MR. WOODBURY: Thanks you. That clarifies
5 things for us. I have no further questions for
6 Mr. Gradilone. Thank you.
7 COMMISSIONER NELSON: Thank you.
8 Questions from the Commission. None?
9 COMMISSIONER SMITH: Just one, I guess.
10
11 EXAMINATION
12
13 BY COMMISSIONER SMITH:
14 Q In your experience around the country in
15 other states, do they have the summer/winter differential
16 in the rates as we have in Idaho?
17 A One of our other operating units has a
18 summer/winter rate schedule. That's United Water New
19 York which serves actually about the same number of
20 customers, about 60,000 customers now, in an area outside
21 of New York City and I think the ratio there is
22 one-and-a-half to one, it's a little more expensive, so
23 that's the experience I directly have with it. I know
24 there are other companies that use it. My direct
25 experience would be with United Water New York and there
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Wilder, Idaho 83676 United Water Idaho Inc.
1 are some other companies that do use that rate structure.
2 Q I guess that's one of the things that I
3 think customers comment to us about, mostly unfavorably.
4 Would you be the person to express the Company policy on
5 that or would that be someone else?
6 A I probably have as much experience with
7 summer/winter rates, analyzing them and dealing with
8 them. They were implemented at United Water New York in
9 1980 and I was at the bleeding edge of that
10 implementation and I agree, most customers don't
11 particularly like the rates. They don't -- it's hard to
12 communicate that in fact they're paying less in the
13 winter than they would be paying and more in the summer
14 than they would be paying if rates were level. They just
15 see that somehow we're getting more in the summer and I
16 suppose that's a function of how well it's marketed,
17 let's say, or communicated to the customers.
18 On the other hand, summer/winter rates from
19 what I've seen in United Water New York and in Idaho,
20 they are very effective in doing what they're supposed to
21 do which is decrease the summer demand, so it's a
22 balancing of what you're trying to accomplish in terms of
23 rate design and demand management and customer relations
24 and I don't know if you want me to elaborate, but that's
25 about my take on it.
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Wilder, Idaho 83676 United Water Idaho Inc.
1 Q So in your opinion, I mean, have you
2 studied whether demand has reduced in the summer here in
3 Boise?
4 A I believe when I went through this
5 analysis, I believe demand has been affected. I think it
6 was difficult to try to ferret out that impact because
7 the implementation of the summer/winter rates also
8 happened to correspond with weather patterns that
9 essentially duplicated the results, so it was difficult
10 to draw it out of the analysis. I found that in United
11 Water New York that it has been very effective and I
12 believe that it has been effective here, although I
13 haven't yet been able to do an analysis to prove that
14 conclusively.
15 Q And what has the Company done to market
16 this rate?
17 A I don't know the details. I know they
18 announce it every year that the rates are coming and what
19 the purpose of the rates are. I also know they have an
20 active conservation program. They offer outdoor water
21 audits to help try to give people tools to deal with the
22 rates. I think one of the other Company witnesses will
23 be able to go into more detail about the full program. I
24 just know in general what's been done.
25 Q So in your opinion, is the summer/winter
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Wilder, Idaho 83676 United Water Idaho Inc.
1 rate differential something that should be preserved?
2 A Given the climate in this area and the rate
3 of growth, I would say you should think long and hard
4 before the rates, those rates are eliminated. I think
5 some, it may not necessarily have to be summer/winter
6 rates, but I think somewhere in the rate structure giving
7 a price signal that will communicate to people that water
8 is more dear in the summer would be a good thing to do in
9 this area. Whether it's summer/winter rates or something
10 else is another thing, but I think that type of a signal
11 is something that should be preserved.
12 COMMISSIONER SMITH: That's all I have.
13 Thank you.
14 COMMISSIONER NELSON: Thank you.
15 Redirect, Mr. Miller?
16 MR. MILLER: Just one or two questions.
17
18 REDIRECT EXAMINATION
19
20 BY MR. MILLER:
21 Q You were asked some questions about the
22 proposed miscellaneous fees that the Company proposes to
23 change for collection of checks and so on.
24 A Yes.
25 Q To your knowledge, has any party in any of
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Wilder, Idaho 83676 United Water Idaho Inc.
1 the testimony subsequent to your testimony opposed those
2 recommendations?
3 A No.
4 Q Have you received any word from the
5 consumer assistance Staff of the Commission that they do
6 not endorse those changes?
7 A No, I have not.
8 MR. MILLER: That's all I had,
9 Mr. Chairman.
10 COMMISSIONER NELSON: Okay, Mr. Gradilone,
11 thank you.
12 MR. MILLER: Mr. Chairman, Mr. Gradilone
13 has not sponsored rebuttal testimony, so we would not
14 anticipate seeing him back, so if no party objects, we
15 would ask if Mr. Gradilone could be excused at his
16 convenience.
17 COMMISSIONER NELSON: Well, if there's no
18 objection, why, we would excuse Mr. Gradilone. I would
19 assume he wants to go outside rather than travel away on
20 a day like this, so thank you.
21 THE WITNESS: Okay, thank you.
22 (The witness left the stand.)
23 MR. MILLER: The Applicant would call Mark
24 Gennari.
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CSB REPORTING GRADILONE (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 MARK A. GENNARI,
2 produced as a witness at the instance of United Water
3 Idaho Inc., having been first duly sworn, was examined
4 and testified as follows:
5
6 DIRECT EXAMINATION
7
8 BY MR. MILLER:
9 Q Sir, would you state your name, please?
10 A Mark A. Gennari.
11 Q Where are you employed?
12 A I'm employed by United Water Management and
13 Services Company.
14 Q And in what capacity?
15 A I am director of rates.
16 Q And as director of rates, what in general
17 is the scope and nature of your responsibilities?
18 A My duties and responsibilities include
19 preparation of data and exhibits to be filed in rate
20 proceedings and oversight and supervision of department
21 employees doing the same.
22 Q And in connection with this specific
23 proceeding, what was the general nature of your
24 assignment and obligations?
25 A In this particular proceeding, I analyzed
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CSB REPORTING GENNARI (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 information used to develop the Company's rate base in
2 this proceeding and reviewed information by other Company
3 witnesses and managed the organization of this filing.
4 Q So in addition to filing testimony with
5 respect to rate base issues, you also provided sort of a
6 coordination function between the various people involved
7 in the case?
8 A Exactly, yes.
9 Q Very good. In connection with this
10 proceeding, did you have occasion to prefile certain
11 written direct testimony?
12 A Yes, I did.
13 Q And that consists of how many pages?
14 A That consisted of seven pages of written
15 testimony, two exhibits numbered 3 and 4.
16 Q Are there any corrections or additions that
17 should be made to your written direct prefiled testimony?
18 A No.
19 Q Turning your attention to Exhibit No. 3
20 just for the purpose of clarification here, that exhibit
21 was, of course, prepared and filed at or about the time
22 the application was filed in this case; is that correct?
23 A Yes, that's correct.
24 Q Since that time through the rebuttal
25 testimony or through the testimony of the Staff and
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CSB REPORTING GENNARI (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 intervenors and then rebuttal testimony of the
2 Company, have the figures on Exhibit No. 3 been
3 superseded?
4 A Yes, they have.
5 Q Exhibit No. 3 was intended really just as
6 a very high level overview of the case; is that
7 correct?
8 A Yes, that's correct.
9 Q And now Mr. Healy's Exhibit 20 that we
10 have discussed previously really fulfills the function
11 of providing this high level view of the case?
12 A That's correct.
13 Q If I were to ask you the questions set
14 forth in your written prefiled testimony today, would
15 your answers be the same?
16 A Yes, they would.
17 Q And are they true and correct to the best
18 of your knowledge?
19 A Yes, they are.
20 MR. MILLER: Very good. Mr. Chairman, if
21 there's no objection, we would ask that the direct
22 prefiled testimony of Mr. Gennari be spread on the record
23 as if read and that Exhibits No. 3 and 4 be marked,
24 keeping in mind the clarification that we just made with
25 respect to Exhibit 3.
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CSB REPORTING GENNARI (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 COMMISSIONER NELSON: Certainly. Without
2 objection, why, that would be so ordered.
3 (The following prefiled testimony of
4 Mr. Mark Gennari is spread upon the record.)
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CSB REPORTING GENNARI (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 Q State your name and business address.
2 A Mark A. Gennari. My business address is
3 200 Old Hook Road, Harrington Park, New Jersey.
4 Q What is your position and by whom are you
5 employed?
6 A I am a Director in the Rate Department for
7 United Water Management and Services Inc.
8 Q Would you briefly state your qualifications
9 and experience.
10 A I am a graduate of Empire State College
11 with a Bachelor of Science degree in Business
12 Administration with a concentration in accounting.
13 I joined United Water Management & Services as
14 Director - Rates in January of 1997, where my duties
15 consist of the preparation and presentation of rate cases
16 before state regulatory commissions and perform related
17 analyses of regulatory issues.
18 From December 1971 until joining United Water
19 Management and Services, I was employed by NYNEX
20 Corporation. While there I held a variety of positions
21 in accounting and regulatory disciplines. More
22 specifically, from 1987 through 1996 I was responsible
23 for the preparation of accounting and financial data as
24 well as testimony used in support of rate base and
25 depreciation costs filed in rate cases with both the New
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Gennari, Di 1
United Water Idaho Inc.
1 York State Public Service Commission and the Federal
2 Communications Commission. During this time I also had
3 the responsibility for analyzing new rulemaking proposals
4 by the Commissions and preparing company recommendations
5 on those proposals. I had the further responsibility to
6 act as an audit manager coordinating regulatory audits
7 performed by the Federal Communications Commission
8 auditors. Finally, during this time I was responsible
9 for the development of rates for the company's non-
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Gennari, Di 1A
United Water Idaho Inc.
1 tariffed services and replacement costs for damage to
2 company facilities. As such I was called upon to testify
3 in litigation cases as to the composition of the rates
4 when disputes arose between the company and customers or
5 insurance companies.
6 For the five years prior to 1987 I held the
7 position of Internal Auditor for NYNEX Corporation and
8 its New York Telephone subsidiary. My responsibilities
9 included the development of audit plans, the conducting
10 of compliance and financial audits and follow up activity
11 to ensure that deficient conditions were rectified.
12 Prior to being promoted to the position of
13 Internal Auditor I held positions where I was responsible
14 for the budgeting of expense and capital projects,
15 analysis and reporting of performance results and worked
16 as a computer programmer developing and maintaining
17 company accounting and engineering programs.
18 Q In connection with the Company's present
19 application for increases in its rates and charges, what
20 is the scope of your participation and testimony?
21 A I have developed the rate base for United
22 Water Idaho (UWID, or the Company) which will be used in
23 this proceeding and is based on a test year ended June
24 30, 1997. Also incorporated are adjustments for
25 additions, including acquisitions made by UWID, and
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Gennari, Di 2
United Water Idaho Inc.
1 retirements to plant that will take place prior to the
2 time that rates will become effective in this case.
3 Q Who are the other witnesses in this case
4 and their area of responsibility?
5 A William C. Linam, Company General Manager,
6 will discuss the operations of UWID as well as certain
7 capital projects; Jeremiah J. Healy, Coordinator of
8 Planning and Rates will discuss and present accounting
9 adjustments for various
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Gennari, Di 2A
United Water Idaho Inc.
1 expense and tax issues; Frank Gradilone III,
2 Manager-Resources Planning, Rates, will discuss revenues;
3 Daniel Brown, Managing Engineer, will discuss capital
4 projects; and Frank J. Hanley, will discuss cost of
5 capital and fair rate of return.
6 Q What is the revenue requirement requested
7 by the Company?
8 A The Company is requesting revenues in the
9 amount of $25,560,491, which is an overall increase of
10 $3,424,516 or 15.47% over the adjusted test year level of
11 booked revenues. Exhibit 3 presents a summary of the
12 revenues, expenses and rate base used in the development
13 of the rate increase.
14 Q What rate of return is the Company
15 requesting in this proceeding?
16 A The Company is requesting an overall rate
17 of return of 9.76%, based on the consolidated capital
18 structure of United Waterworks Inc., the parent company
19 of UWID. Company Witness Hanley will discuss the details
20 of this request.
21 Q What is the amount of the rate base this
22 request is based upon?
23 A The rate base is $84,200,741 which includes
24 an increase in gross capital invested (net of
25 retirements) of $7,711,270 from the end of the test year.
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United Water Idaho Inc.
1 The Company has experienced significant rapid growth in
2 both customer base and its investment in plant. This
3 rate base is an accurate reflection on UWID's investment
4 in plant that has increased over a short period of time.
5 Q Please describe the acquisitions you are
6 requesting to be included in the rate base.
7 A The Company has made four Commission
8 approved acquisitions of which two, Banbury and Warm
9 Springs Mesa, have received a commission authorization
10 for inclusion in rate base. The Company is now
11 requesting rate base recognition of the Eagle and Garden
12 City acquisitions.
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United Water Idaho Inc.
1 Q Please provide more detail on the amounts
2 and the basis of the Company's request.
3 A First, in Order 26950 the Commission
4 approved a net rate base treatment of $137,600 for the
5 Banbury acquisition. Therefore I have included that
6 amount in rate base as of June 30, 1997. Second, in
7 Order 26588 the Commission decided on the inclusion of
8 $550,000 in rate base for Warm Springs Mesa; however, it
9 reserved decision on the Company's request for inclusion
10 of certain improvements needed to the system since only
11 estimates were available at the time of the request.
12 Q Has the Company made the improvements to
13 the Warm Springs Mesa System since the acquisition?
14 A Yes. UWID has incurred costs for telemetry
15 in the amount of $33,176 which is included in water plant
16 in service.
17 Q Turning now to the Garden City, or North
18 State acquisition, please describe the basis of the
19 Company's request.
20 A In the Commission's Order 26562, it
21 authorized the acquisition; however, it deferred rate
22 base treatment until the Company's next general rate
23 case.
24 Q What treatment then is the Company
25 requesting?
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Gennari, Di 4
United Water Idaho Inc.
1 A The Company is requesting that the entire
2 acquisition be included in rate base.
3 Q What treatment is the Company requesting on
4 the Eagle Area acquisition?
5 A The Company is requesting that the net
6 investment of $1,125,220 be included in rate base. This
7 amount represents the total acquisition cost excluding a
8 portion of the Island Woods area.
9 Q Please explain why the Company is only
10 requesting treatment for a portion of the investment and
11 partially excluding Island Woods.
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United Water Idaho Inc.
1 A Basically, since the acquisition was
2 comprised of source of supply and distribution plant an
3 analysis determined that the distribution system is
4 currently supporting the existing customers on the system
5 and that the source capacity is currently in excess of
6 the existing customers supplied. Therefore, the Company
7 is not seeking to include the entire cost of the source
8 of supply in rate base and UWID will include the
9 remainder in utility plant held for future use. Witness
10 Linam will discuss the specific details of this treatment
11 of the acquisition in his direct testimony.
12 Q Please explain Exhibit No. 4, page 1.
13 A Exhibit No. 4, Rate Base Summary, lists the
14 elements of the Company's rate base at June 30, 1997
15 (line 11) per the financial records of the Company.
16 Q Please explain Exhibit No. 4, page 2.
17 A Exhibit No. 4, page 2, column (a), shows
18 the rate base per the financial records of the Company at
19 June 30, 1997. The adjustments in column (b) reflect the
20 plant additions and their impact on accumulated
21 depreciation, customer advances, contributions in aid of
22 construction and accumulated deferred income taxes.
23 Finally, column (c) shows the adjusted rate base at
24 February 28, 1998.
25 Q Are there adjustments in column (b) that
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Gennari, Di 5
United Water Idaho Inc.
1 are not related to new capital projects?
2 A Yes. There are adjustments for deferred
3 charges to include relocation expenses which will be
4 discussed in witness Healy's testimony, an adjustment for
5 the removal of a portion of the Island Woods acquisition
6 as previously discussed and an adjustment for the
7 treatment of the utility plant acquisition balance.
8 Q Please explain the utility plant
9 acquisition adjustment.
10 A The Utility Plant Acquisition Adjustment
11 (UPAA) balance includes the unamortized balance for a
12 prior acquisition and the recent acquisitions in
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Gennari, Di 5A
United Water Idaho Inc.
1 Banbury, Warm Springs Mesa, Island Woods and Redwood
2 Creek. Since the Company has agreed not to seek
3 regulatory treatment of the acquisition adjustment for
4 Banbury, I am adjusting the UPAA balance to reflect its
5 removal. The details of this adjustment are shown on
6 Exhibit 4, page 3.
7 Q Please continue describing Exhibit No. 4,
8 page 2.
9 A Line 2 shows the balance of the accumulated
10 depreciation which has been adjusted for plant additions,
11 retirements and net salvage. The reserve adjustment is
12 offset by retirements of approximately $1.0 million.
13 Similarly, the advances for construction and the
14 contributions in aid of construction have been adjusted.
15 Q Please explain the remainder of Exhibit 4,
16 page 2.
17 A The remainder of Exhibit 4, page 2 is
18 explained on pages 4 through 7 of Exhibit 4.
19 Q Please explain Exhibit 4, page 4.
20 A This Exhibit shows the development of the
21 accumulated deferred income tax balance including the
22 effect of the plant changes. The balance was developed
23 using the 1997 tax schedule which incorporated a planned
24 level of plant changes. This tax schedule was adjusted
25 to include additions not in the original schedule. The
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Gennari, Di 6
United Water Idaho Inc.
1 balance considers additions through February, 1998 using
2 a half year convention of both tax and book depreciation
3 and the application of a 35% Federal Tax rate.
4 Q Please explain Exhibit 4, page 5.
5 A Exhibit 4, page 5 represents the
6 unamortized balance of pre-1971 Investment Tax Credits
7 that are deducted from rate base and amortized at a rate
8 of $1,285.00 per year.
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United Water Idaho Inc.
1 Q Please explain Exhibit 4, page 6.
2 A Exhibit 4, page 6 identifies the components
3 of deferred charges being added to the rate base. These
4 represent the unamortized balance of deferred charges for
5 which the Company has expended funds.
6 Q Please explain Exhibit 4, page 7.
7 A Exhibit 4, page 7 represents a summary of
8 the cash working capital required by the Company. The
9 method employed in the development of this amount is that
10 which was used by the Commission Staff in the last two
11 rate proceedings.
12 Q Does this conclude your testimony?
13 A Yes it does.
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Gennari, Di 7
United Water Idaho Inc.
1 (The following proceedings were had in
2 open hearing.)
3 MR. MILLER: And he's available for
4 cross-examination.
5 COMMISSIONER NELSON: Thank you.
6 Mr. Fothergill.
7 MR. FOTHERGILL: No questions.
8 COMMISSIONER NELSON: Ms. Ullman.
9 MS. ULLMAN: No questions.
10 MR. WOODBURY: Mr. Woodbury.
11
12 CROSS-EXAMINATION
13
14 BY MR. WOODBURY:
15 Q Mr. Gennari, with respect to Exhibit 3,
16 page 1 of 1, apparently, we're going to proceed with that
17 even though we know that it's been updated.
18 A Yes.
19 Q What changes should be made to this
20 exhibit?
21 A Well, as indicated, Mr. Healy has an update
22 to this in his rebuttal testimony and the changes would
23 involve --
24 Q Does he provide -- excuse me. Does
25 Mr. Healy provide an amended Exhibit No. 3?
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CSB REPORTING GENNARI (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 A Not in this specific format; however, it
2 incorporates every component here, yes.
3 Q Could you identify, then, the particular
4 areas or line numbers that would change as a result of
5 Mr. Healy's updated exhibit?
6 A Essentially, I believe, except for line
7 No. 8, the gross-up factor, basically every item would
8 change on there based on the agreed-to adjustments
9 between Mr. Healy and Mr. Smith and other updates that
10 the Company has made.
11 Q Okay. In this particular case we're using
12 an historical test year?
13 A Yes.
14 Q And that differs from a forecasted test
15 year? Some jurisdictions use forecasts?
16 A Yes.
17 Q And so using an historic test year there
18 are limited adjustments that are made, it requires known
19 and measurable?
20 A Yes, that's true.
21 Q As part of the -- you have no rebuttal
22 testimony. As part of the rebuttal testimony, we show
23 that the Company is making projections of increases in
24 customer numbers and revenue to justify acquisitions in
25 the Eagle area. Are those the type of adjustments that
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CSB REPORTING GENNARI (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 would be appropriate to make in a test year?
2 MR. MILLER: Mr. Chairman, I don't mean to
3 interrupt, but Mr. Linam's rebuttal testimony discusses
4 that issue in detail. Mr. Gennari is a rate base
5 witness, not a customer count witness, so I'd just direct
6 Mr. Woodbury to Mr. Linam for those questions.
7 MR. WOODBURY: Okay.
8 Q BY MR. WOODBURY: You're the director of
9 rates?
10 A Yes.
11 Q So you're the person that everybody here is
12 mad at for the increase?
13 A I'm not so sure I would agree with that.
14 Q Do you know what the rate increase history
15 this Company has over the last four or five years?
16 A Yes, I'm basically familiar with that.
17 Q In the 96-3 which was the Company's last
18 general rate case, do you know what kind of an increase
19 they were granted there?
20 A About three-and-a-half percent.
21 Q Oh, the last general rate case was 93-3,
22 15.47 percent?
23 A Oh, 93-3?
24 Q Yes.
25 A I believe it was in the neighborhood of
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CSB REPORTING GENNARI (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 about 20 percent.
2 Q Twenty percent, okay, and then in November
3 of '96, in the 96-3 case, that was a make whole rate
4 case?
5 A That was the three-and-a-half percent that
6 I thought you were referring to.
7 Q And the request in this case is for what,
8 15 point --
9 A 15.47 as filed which is being adjusted
10 downward.
11 Q And are you aware of what the Company's
12 plans are with respect to, do you anticipate perhaps
13 another rate filing next year when the Company completes
14 its expansion of the Marden treatment facility? Do you
15 know what the expected -- I think it's $5.6 million.
16 A I wouldn't be in a position to provide an
17 affirmative response on that right now.
18 MR. WOODBURY: Thank you, Mr. Gennari. I
19 have no further questions.
20 COMMISSIONER NELSON: Thank you,
21 Mr. Woodbury.
22 Any questions?
23 Any redirect, Mr. Miller?
24 MR. MILLER: No, thank you, Mr. Chairman.
25 COMMISSIONER NELSON: Okay, Mr. Gennari,
241
CSB REPORTING GENNARI (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 thank you for your testimony. Do you wish for
2 Mr. Gennari to be excused, also?
3 MR. MILLER: It would be nice if he could
4 be relieved from further attendance. I think as part of
5 his case coordination function he will probably stay in
6 attendance.
7 (The witness left the stand.)
8 COMMISSIONER NELSON: Okay. Well, since
9 we've gone an hour or so after lunch, why don't we take
10 10 minutes.
11 (Recess.)
12 COMMISSIONER NELSON: Okay, we'll go back
13 on the record.
14 MR. HILL: The Company calls Frank Hanley.
15 COMMISSIONER NELSON: Thank you, Mr. Hill.
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CSB REPORTING GENNARI (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 FRANK J. HANLEY,
2 produced as a witness at the instance of United Water
3 Idaho Inc., having been first duly sworn, was examined
4 and testified as follows:
5
6 DIRECT EXAMINATION
7
8 BY MR. HILL:
9 Q Would you state your name and occupation,
10 please?
11 A Frank J. Hanley. I am president of AUS
12 Consultants - Utility Services.
13 Q And your qualifications and experience are
14 set forth in your prefiled direct testimony; is that
15 correct?
16 A Yes, in detail in Appendix A accompanying
17 the direct testimony, yes.
18 Q In the course of your duties on behalf of
19 the Company in this case, did you have occasion to
20 prepare prefiled direct testimony?
21 A Yes, I did.
22 Q And could you describe that to us in terms
23 of the number of pages and exhibit numbers?
24 A Yes. My prefiled direct testimony consists
25 of 71 pages and following it is an appendix of
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CSB REPORTING HANELY (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 professional qualifications designated Appendix A and
2 that consists of eight pages. I also prepared what has
3 been designated as Exhibit No. 12 which consists of 19
4 different schedules and that accompanies the direct
5 testimony.
6 Q Do you have any additions or corrections to
7 make to your prefiled direct testimony at this time?
8 A I have just one place in the direct
9 testimony I'd like to fix a typographical error and that
10 would be at page 27, specifically at line 4. On line 4
11 of page 27, there's a reference to "pages 3 and 4." It
12 should read "pages 4 and 5." That would be the only
13 corrections that I have.
14 Q And nothing to your exhibits?
15 A No, none that I'm aware of.
16 Q And is the information contained in your
17 prefiled direct testimony and exhibits true and correct
18 to the best of your knowledge and belief?
19 A Yes.
20 Q You adopt the same as your sworn testimony
21 in this proceeding?
22 A I do.
23 MR. HILL: Mr. Chairman, I move that the
24 prefiled direct testimony of Mr. Frank Hanley be spread
25 on the record as though read and the exhibits marked for
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CSB REPORTING HANELY (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 identification in this case.
2 COMMISSIONER NELSON: That would be
3 Exhibit 12?
4 MR. HILL: Yes, sir.
5 COMMISSIONER NELSON: Okay, thank you.
6 Without objection, we would so order.
7 (The following prefiled testimony of
8 Mr. Frank Hanley is spread upon the record.)
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CSB REPORTING HANELY (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 I. INTRODUCTION AND PURPOSE
2 Q Please state your name, occupation and
3 business address.
4 A My name is Frank J. Hanley and I am
5 President of AUS Consultants - Utility Services. My
6 business address is 155 Gaither Drive, P.O. Box 1050,
7 Moorestown, New Jersey 08057.
8 Q Please summarize your educational
9 background and professional experience.
10 A I have testified as an expert witness on
11 rate of return and related financial issues before 30
12 state public utility commissions and the Federal Energy
13 Regulatory Commission. I have also testified before
14 local and county regulatory bodies, an arbitration panel,
15 a U.S. Bankruptcy Court, the U.S. Tax Court and a state
16 district court. I have appeared on behalf of
17 investor-owned companies, municipalities, and state
18 public utility commissions. The details of these
19 appearances, as well as my educational background, are
20 shown in Appendix A supplementing this testimony.
21 Q What is the purpose of your testimony?
22 A The purpose of my testimony is to provide
23 evidence on behalf of United Water Idaho (UWID or the
24 Company) as to the fair rate of return which the Company
25 should be afforded an opportunity to earn on its rate
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Hanley, Di 1
United Water Idaho, Inc.
1 base during the near-term future.
2 Q Have you prepared an exhibit which supports
3 the conclusions of your study?
4 A Yes, I have. It has been marked for
5 identification as Exhibit No. 12 which consists of 19
6 schedules.
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Hanley, Di 1A
United Water Idaho, Inc.
1 II. SUMMARY
2 Q Mr. Hanley, before you summarize your
3 overall cost of capital recommendation, please explain
4 the capital structure you employ.
5 A I employ the actual June 30, 1997
6 consolidated capital structure of United Waterworks (UWW)
7 as well as the related long-term debt and minority
8 interest cost rates. I rely upon UWW for the reasons
9 discussed in detail infra under the caption VIII. Capital
10 Structure Ratios. Briefly they are: (1) UWW provides
11 all of the external capital required by its subsidiaries;
12 (2) no equity capital has been injected into UWW by its
13 parent United Water Resources (UWR) since the April 1994
14 merger and thus UWW is not financially dependent on UWR;
15 (3) UWR provides no financial guarantees, pledges, or any
16 of its assets to any lender for the benefit of UWW; (4)
17 no capital of UWR other than UWW could be used to finance
18 UWID's rate base; (5) the UWW capital structure ratios
19 are reasonable vis-a-vis my primary proxy group of five
20 water companies generally similar in risk to UWID; and
21 (6) the UWW capital structure ratios are consistent with
22 those required by Standard & Poor's (S&P) for a water
23 utility to maintain an A bond rating with an "average"
24 business position, i.e. the business position of UWW.
25 Q Mr. Hanley, are you aware that this
248
Hanley, Di 2
United Water Idaho, Inc.
1 Commission did not adopt the capital structure of UWW in
2 Order No. 25640 resulting from Case No. BOI-W-93-3?
3 A Yes, however, I believe that the
4 uncertainties which existed in 1994 no longer exist and
5 it is now very clear that the use of UWW's capital
6 structure is entirely
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Hanley, Di 2A
United Water Idaho, Inc.
1 appropriate as discussed infra under the caption VIII.
2 Capital Structure Ratios.
3 Q Please now summarize your overall cost of
4 capital recommendation.
5 A It is 9.76% summarized as follows:
6 Capital
Structure Cost Weighted
7 Ratios Rate Return
8 Long-term debt 53.13% 8.25% 4.38%
Minority Interest 0.14 5.00 0.01
9 Common equity 46.73 11.50 5.37
Total 100.00% 9.76%
10
11 The overall cost of capital of 9.76% is based upon
12 the actual June 30, 1997 United Waterworks' consolidated
13 capital structure and related ratios and fixed capital
14 cost rates which were developed on Exhibit No. 12,
15 Schedules 7 and 8.
16 My recommended common equity cost rate is 11.50%,
17 the basis of which is summarized on Exhibit No. 12,
18 Schedule 1, page 2. As explained in more detail infra,
19 my recommendation of 11.50% reflects current capital
20 market conditions and results from the application of
21 four well-tested market-based cost of common equity
22 models, the Discounted Cash Flow Model (DCF), the Risk
23 Premium Model (RPM), and the Capital Asset Pricing Model
24 (CAPM), and the Comparable Earnings Model (CEM). It is
25 based upon a proxy group of five water companies adjusted
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Hanley, Di 3
United Water Idaho, Inc.
1 to reflect UWID's smaller size and greater business risk.
2 Also, I analyzed a second, less comparable, group of
3 water companies which I rely on only as a check on my
4 conclusion of common equity cost rate as
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Hanley, Di 3A
United Water Idaho, Inc.
1 will be discussed infra.
2 Q Please discuss the basis of the Company's
3 overall cost of capital claim of 9.76%.
4 A It is based on the weighted overall cost of
5 capital approach using the capital structure and the cost
6 rates applicable to each element of UWW's capital
7 structure. The sum of the weighted costs of each element
8 of capital (percentage times the cost rate) represents
9 the overall cost of capital. UWID's ratemaking capital
10 structure ratios are shown on Exhibit No. 12, Schedule 1,
11 page 1 and detailed on Schedule 7. The basis of UWID's
12 common equity cost rate of 11.50% is summarized on
13 Exhibit No. 12, Schedule 1, page 2. The embedded cost
14 rates of fixed capital are readily determined. However,
15 the cost rate of common equity capital is necessarily a
16 matter of informed expert judgment. Because regulation
17 is a substitute for the competition of the marketplace,
18 an analysis of marketplace transactions provides the most
19 meaningful insight into the determination of an
20 appropriate common equity cost rate.
21 UWID's common stock is wholly-owned by United
22 Waterworks, formerly General Waterworks Corporation,
23 which was merged with United Water Resources, Inc. (UWR)
24 with UWR being the surviving corporation. UWR owns 100%
25 of the common stock of United Waterworks. In light of
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Hanley, Di 4
United Water Idaho, Inc.
1 its broad geographic and regulatory diversity, UWR is not
2 an appropriate proxy for common equity cost rate. It is
3 appropriate to look to a proxy group of water companies
4 whose common stocks are actively traded for insight into
5 an appropriate common equity cost rate applicable to
6 UWID. The use of other
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Hanley, Di 4A
United Water Idaho, Inc.
1 firms of comparable risk as proxies is consistent with
2 the principles of fair rate of return established in the
3 Hope1 and Bluefield2 cases and adds reliability to the
4 exercise of informed expert judgment in arriving at a
5 recommendation of common equity cost rate. Consequently,
6 I have evaluated the market data of a proxy group of
7 comparable water companies to arrive at my recommendation
8 of common equity cost rate. I then check my
9 recommendation by using a second proxy group of larger,
10 more geographically diverse, less comparable water
11 companies. The bases of the selection are described
12 infra. The first group, which I believe is more similar
13 in risk to both UWID and UWW is comprised of five water
14 companies while the second, and less comparable group, is
15 the six Value Line companies, which includes UWR.
16 In formulating my recommended common equity cost
17 rate of 11.50%, I reviewed the results of the application
18 of four different cost of common equity models, namely,
19 the DCF, RPM, CAPM, and the CEM for my principal group of
20 five water companies. I applied each cost of common
21 equity model as a principal tool in formulating my
22 recommendation of common equity cost rate because no
23 single model is so inherently precise that it can be
24 relied upon solely, to the exclusion of other
25 theoretically sound models. All of the models are based
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Hanley, Di 5
United Water Idaho, Inc.
1 on the Efficient Market Hypothesis (EMH) and therefore
2 have application
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1Federal Power Commission v. Hope Natural Gas Co., 320
23 U.S. 591 (1944.)
24 2Bluefield Water Works Improvement Co. v. Public Serv.
Comm'n, 262 U.S. 679 (1922).
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Hanley, Di 5A
United Water Idaho, Inc.
1 problems associated with them. The prudence of using
2 more than one cost of common equity model is affirmed by
3 the financial literature. Moreover, the EMH, as will be
4 discussed infra, requires the assumption that investors
5 rely upon multiple cost of equity models. Consequently,
6 no single cost of equity model should be relied upon
7 exclusively to estimate investors' required rate of
8 return on common equity investment.
9 Although the DCF model is widely used by
10 regulatory commissions, the majority of commissions have
11 seen fit not to rely exclusively on any single model in
12 reaching a determination of common equity cost rate (see
13 Exhibit No. 12, Schedule 9). Application of the DCF
14 model usually results in an overstatement or
15 understatement of investors' required rate of return when
16 the market value of its common stock is significantly
17 less or greater than its book value, respectively.
18 Investors expect to achieve their required rate of return
19 based on dividends received and appreciation in market
20 price. My testimony shows that market prices are
21 influenced greatly by factors other than earnings per
22 share (EPS) and dividends per share (DPS). Thus, the
23 necessary use of accounting proxies for growth in the DCF
24 model, such as EPS, DPS, or their derivative, internal
25 growth, reflects only a portion of the full growth (price
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Hanley, Di 6
United Water Idaho, Inc.
1 appreciation) expected by investors. I demonstrate
2 hypothetically on Exhibit No. 12, Schedule 11 how the
3 application of a market-based DCF cost rate to a
4 substantially lower book value deprives a utility of a
5 reasonable opportunity to experience the rate of growth
6 expected by investors. This occurs because the growth
7 estimate used
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Hanley, Di 6A
United Water Idaho, Inc.
1 in the application of the DCF model is based on EPS or
2 some derivative thereof; and such proxies for growth do
3 not reflect the full rate of growth in market prices
4 anticipated by investors. This is true because market
5 prices reflect other growth factors not accounted for in
6 the standard regulatory version of the DCF model such as
7 an increase in the market value per share due to expected
8 increases in price/earnings multiples and less obvious
9 factors included in the long-range goals of investors.
10 State commissions in Iowa, Indiana, and Hawaii have
11 explicitly recognized the tendency of the DCF model to
12 understate the common equity cost rate under the bullish
13 market conditions of the recent past as well as
14 currently, as discussed more fully infra.
15 I rely upon a number of widely-used cost of common
16 equity models as principal tools in reaching my
17 recommendation because each provides useful data. None
18 is theoretically superior to the others or so precise as
19 to justify sole reliance on it.
20 The results derived from each of the four models
21 are as follows for the proxy group of five water
22 companies upon which I formulate my recommendation:
23 Single-Stage Growth DCF Model NMF%
Two-Stage Growth DCF Model 10.50
24 Risk Premium Model 11.60
Capital Asset Pricing Model 10.50
25 Comparable Earnings Model 12.60
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Hanley, Di 7
United Water Idaho, Inc.
1 After reviewing the cost rates above, I conclude
2 that a common equity cost rate of 11.30% would be
3 applicable based on my primary proxy group of five
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United Water Idaho, Inc.
1 water companies. However, when UWID's business risks and
2 small size are taken into account, a common equity cost
3 rate of 11.50% is applicable to UWID.
4 A test of pretax interest coverage confirms that
5 my recommended common equity cost rate of 11.50% and the
6 resultant overall cost of capital of 9.76% are
7 reasonable.
8 III. GENERAL PRINCIPLES
9 Q What general principles have you considered
10 in arriving at your recommended common equity cost rate
11 of 11.50%?
12 A In unregulated industries, competition in
13 the marketplace is the principal determinant in
14 establishing the price of a product or service. In the
15 case of regulated public utilities, regulation must act
16 as a substitute for the competition of the marketplace.
17 Consequently, marketplace data must be used in order to
18 assure that the utility can fulfill its obligations to
19 the public and provide adequate service at all times.
20 Fulfillment of its service obligation requires a level of
21 earnings sufficient to maintain the integrity of
22 presently invested capital and permit the attraction of
23 needed new capital at a reasonable cost in competition
24 with other comparable-risk seekers of capital. These
25 standards for a fair rate of return have been established
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United Water Idaho, Inc.
1 by the U.S. Supreme Court in the Hope and Bluefield cases
2 cited supra.
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United Water Idaho, Inc.
1 IV. BUSINESS RISK
2 Q Please define business risk and explain why
3 it is important to the determination of a fair rate of
4 return?
5 A Business risk is a collective term
6 encompassing all of the diversifiable risks of an
7 enterprise other than financial risk with financial risk
8 defined as the introduction of debt into the capital
9 structure. A few examples of business risk are the
10 quality of management, and the regulatory environment
11 which have a direct bearing on earnings.
12 Business risk is important to the determination of
13 a fair rate of return because the greater the level of
14 risk, the greater the rate of return investors demand,
15 consistent with the basic financial precept of risk and
16 return.
17 Q Please discuss the business risks facing
18 the water industry in general.
19 A Standard & Poor's (S&P)3 recently noted
20 that while most of the regulatory risk associated with
21 the Safe Drinking Water Act are behind the industry, the
22 industry still faces the risks related to replacing aging
23 transmission and distribution systems. As S&P states4:
24 Thus, there will always be a steady stream of rate
cases. Another challenge is the possible move
25 toward performance based ratemaking and whether
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Hanley, Di 9
United Water Idaho, Inc.
1 water utilities can achieve the efficiencies
necessary under this type of regulation to earn a
2 reasonable equity return.
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3Standard and Poor's, Utilities & Perspectives, September
23 22, 1997, pp. 1 and 3.
24 4Id., p. 1.
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United Water Idaho, Inc.
1 In addition, because the water industry is much more
2 capital-intensive than the electric, natural gas or
3 telephone industries, the investment required to produce
4 a dollar of revenue is greater. Thus, the challenge to
5 water utilities is significant.
6 As noted by S&P5:
7 Additional challenges, such as limited growth
prospects, regulatory lag, and low authorized
8 returns and depreciation rates (about 2% versus
around 3% for electric utilities), will continue
9 to hamper financial performance in this highly
capital-intensive business.
10
11 Lower depreciation rates, one of the principal
12 sources of internal cash flow for all utilities, means
13 that water utility depreciation as a source of
14 internally-generated cash is far less than for electric,
15 natural gas or telephone utilities. Water utilities
16 assets have longer lives and, hence, longer capital
17 recovery periods. As such, water utilities face greater
18 risk due to inflation which results in higher replacement
19 cost per dollar of net plant than do other types of
20 utilities.
21 In view of the foregoing, it is clear that,
22 although water utilities have been traditionally
23 perceived as relatively low business risk vis-a-vis other
24 utilities, their high degree of capital intensity and
25 substantial infrastructure capital spending which will be
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United Water Idaho, Inc.
1 necessary, requires regulatory support in the form of
2 adequate and timely rate relief so they will be able to
3 successfully meet the challenges they face.
4 Q In addition to the general risks facing the
5 water industry, are there any unique
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United Water Idaho, Inc.
1 risks which affect UWID?
2 A Yes, I believe there are. The Company
3 faces four major risk factors, in addition to its small
4 size which will be discussed infra, which are unique to
5 UWID. First, the Company's largest customer, Micron
6 Technology (Micron), intends to begin a re-use program
7 which could cut annual revenues to UWID from Micron by
8 $400,000, from $550,000 to $140,000. Sales to Micron
9 represent approximately 2% of UWID's total annual
10 revenues of $22,500,000.
11 Second, weather conditions have a significant
12 effect upon UWID's revenues. The Company realizes about
13 70% of its annual revenues during the six month period of
14 May to October due mainly to its dependence upon summer
15 irrigation demand. Monthly production in the peak summer
16 months is four times as large as monthly production
17 during the winter. Because the region receives only
18 approximately 12 inches of annual rainfall, UWID's
19 revenues are particularly sensitive to unusually cool or
20 wet weather in the summer months.
21 Third, surface water rights are difficult to
22 acquire and are increasingly costly both in terms of
23 acquisition and in terms of any proposed modifications to
24 existing rights. In addition, competition from
25 speculative investors is a problem in growing areas
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United Water Idaho, Inc.
1 throughout the west. Like other areas in the west where
2 water commands thousands of dollars per acre foot, Boise
3 faces competition for irrigation, anadromous fish, and
4 recreation waters which have made any acquisition
5 activity difficult and litigious. As UWID continues to
6 provide for the growing water needs of a growing
7 community, it will be necessary
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United Water Idaho, Inc.
1 to acquire these rights at market cost, which can
2 escalate dramatically and unpredictably.
3 Fourth, UWID faces the risk that deregulation of
4 the electric utility industry could raise power rates in
5 Idaho, which is served by one of the nation's lowest cost
6 producers of energy, Idaho Power Company. UWID's entire
7 infrastructure has been built around inexpensive power.
8 All system pressure must be pumped using electricity.
9 If, during the course of electric utility deregulation,
10 electrical costs in Idaho are normalized with the rest of
11 the country, UWID's costs for electricity will almost
12 double. Because this is one of the Company's biggest
13 operating costs, it will have a significant negative
14 impact on the Company's operating income if rates are not
15 adjusted to cover this increase.
16 Together, along with UWID's small size, UWID faces
17 unique business risks which increase its relative
18 business risk vis-a-vis the water utility industry, in
19 general, and the companies in both my primary proxy group
20 as well as the secondary proxy group used as a check.
21 Q How does S&P rank United Waterworks'
22 business position on its risk-adjusted matrix approach?
23 A In its latest (December 1996) credit
24 report, S&P ranked United Waterworks' (formerly GWC)
25 business position as "average". It is clear that S&P's
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1 business position assignment results from the bond rating
2 process which includes an evaluation of all elements of
3 business and financial risks. If UWID had the
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1 financial profile of its parent, United Waterworks, and
2 were of the same size, it would (theoretically speaking)
3 have long-term debt rated A3 by Moody's. Moody's rates
4 United Waterworks' long-term debt at A3 while S&P's
5 rating is A, as shown on Exhibit No. 12, Schedule 4, page
6 2. An A3/A rating is just slightly lower than the
7 average Moody's and S&P bond rating, respectively, of the
8 two proxy groups, namely A2/A3 and A+/A for the five
9 water companies and A2 and A+ for the six Value Line
10 companies as shown on Exhibit No. 12, Schedule 17, page
11 3. UWID obtains all of its external capital from its
12 parent, United Waterworks which, on a consolidated basis,
13 employed in excess of $498 million at the end of calendar
14 1996 and was, therefore, much larger than UWID whose
15 total equity (and total capital) was about $108 million
16 at the same date. It must be kept in mind that the
17 overall cost of capital which includes the weighted
18 common equity cost rate, is and must be applied to UWID's
19 rate base. Consequently, it is the risk of common equity
20 investment in UWID's rate base which is relevant. UWID
21 is smaller than its parent, UWW, as well as both my
22 primary and secondary proxy groups of water companies.
23 All else equal, size has a bearing on risk.
24 Q Please explain why size has a bearing on
25 business risk.
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United Water Idaho, Inc.
1 A Smaller companies are less able to cope
2 with significant events which affect sales, revenues and
3 earnings.
4 The loss of revenues from just a few larger
5 customers such as Micron Technologies' intention to begin
6 a re-use program, for example, would be more
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United Water Idaho, Inc.
1 devastating to a small company than a much larger company
2 with a larger customer base. Because UWID is the
3 regulated utility against whose rate base the
4 Commission's ultimately allowed overall cost of capital
5 and fair rate of return will be applied, the relevant
6 risk reflected in the cost of capital must be UWID's,
7 including the impact of its small size on common equity
8 cost rate. Size is an important factor which affects
9 common equity cost rate, and UWID is significantly
10 smaller than either its parent (on a consolidated basis)
11 or the average company in my primary and secondary proxy
12 groups of water companies based on total
13 investor-provided capital as shown below:
14
15 Times
Year-End 1996 Greater than
16 Total Capitalization UWID
($ thousands)
17 United Waterworks, Inc.
and Subsidiaries $498,813 (1) 4.4x
18 Proxy Group of Five
water companies $278,840 (2) 2.5x
19 Proxy Group of Six Value
Line water companies $929,420 (3) 8.2x
20 United Water Idaho $112,955 (4)
21 (1) From Exhibit No. 12, Schedule 4, page 1.
(2) From Exhibit No. 12, Schedule 5, page 1.
22 (3) From Exhibit No. 12, Schedule 6, page 1.
(4) Annual Report of United Water Idaho Inc. for
23 the year ended December 31, 1996.
24 The above data confirm that based on size, the most
25 relevant proxy group to use in establishing a common
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United Water Idaho, Inc.
1 equity cost rate for UWID is that comprising the five
2 water companies.
3 Q Does the financial literature affirm a
4 relationship between size and common
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1 equity cost rate?
2 A Yes. Brigham6 states:
3 A number of researchers have observed that
portfolios of small-firms have earned consistently
4 higher average returns than those of large-firms
stocks; this is called "small-firm effect." On
5 the surface, it would seem to be advantageous to
the small firm to provide average returns in a
6 stock market that are higher than those of larger
firms. In reality, it is bad news for the small
7 firm; what the small-firm effect means is that the
capital market demands higher returns on stocks of
8 small firms than on otherwise similar stocks of
the large firms. (italics added)
9
In addition, Ibbotson Associates7 states:
10
One of the most remarkable discoveries of modern
11 finance is the finding of a relationship between
firm size and return. On average, small companies
12 have higher returns than large ones. Earlier
chapters document this phenomenon for the smallest
13 stocks on the New York Stock Exchange (NYSE). The
relationship between firm size and return cuts
14 across the entire size of the spectrum; it is not
restricted to the smallest stocks. (italics added)
15
16 In view of the foregoing, UWID's business risk is
17 substantially greater than the average company in my
18 primary proxy group of five water companies upon which I
19 base my recommendation.
20 V. FINANCIAL RISK
21 Q Please define financial risk and explain
22 why it is important to the determination of a fair rate
23 of return?
24 A Financial risk is the additional
25 diversifiable risk created by the introduction of
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22 6Eugene F. Brigham, Fundamentals of Finanical Management,
Fifth Edition, The Dryden Press, 1989, p. 623.
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7Ibbotson Associates, Stocks, Bonds, Bills and Inflation
24 - 1997 Yearbook, p. 125.
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United Water Idaho, Inc.
1 debt into the capital structure.
2 Utilities formerly were considered to have much
3 less business risk vis-a-vis unregulated enterprises,
4 and, as a result, a larger percentage of debt capital was
5 acceptable to investors. In June 1994, S&P established a
6 matrix approach to the bond rating process for water
7 utilities using the June 1992 financial benchmarks but
8 refining them based on assessments of business risk (or
9 business position) categorized as "above average",
10 "average", or "below average". S&P8 stated, with regard
11 to the matrix approach:
12 For a given rating category, expected levels of
financial ratios vary with a Company's business
13 position or operating risk.
14 As shown on Exhibit No. 12, Schedule 2, page 12, United
15 Waterworks (formerly General Waterworks Corporation) has
16 been assigned an "average" business position. In
17 contrast, the average business position of the proxy
18 groups is higher, namely "high average" as shown on
19 Exhibit No. 12, Schedule 17, page 3.
20 Q How can one measure the combined,
21 diversifiable business and financial risks, i.e.,
22 investment risk?
23 A Similar bond ratings reflect similar
24 combined business and financial risks. Although the
25 specific business or financial risks may differ between
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1 companies, the same bond rating indicates that the
2 combined risks are similar as the bond rating process
3 reflects acknowledgement of all diversifiable business
4 and financial risks. For example, S&P expressly states
5 that the bond rating process
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United Water Idaho, Inc.
1 encompasses a qualitative analysis of business and
2 financial risks (see pages 3 through 9 of Exhibit No. 12,
3 Schedule 2).
4 There is no perfect single proxy, such as bond
5 rating or common stock ranking, by which one can
6 differentiate common equity risk between companies.
7 However, the bond rating provides a most useful means to
8 compare/differentiate common equity risk between
9 companies because it is the result of a thorough and
10 comprehensive analysis of all diversifiable business and
11 financial risks, i.e. investment risk.
12 VI. UWID/UNITED WATERWORKS (UWW)
13 Q Please describe UWID's operations.
14 A UWID is an investor-owned public water
15 utility that provides water service to about 56,000
16 customers. Its common stock is not traded as it is owned
17 by UWW, which is the sole source of all UWID's external
18 capital. UWW's common stock is owned by United Water
19 Resources (UWR). Exhibit No. 12, Schedule 3, page 1,
20 shows the major subsidiaries of UWR, including UWW. Each
21 of the direct subsidiaries of UWR, including UWW, does
22 its own financing of external debt capital. None relies
23 upon UWR for debt capital and UWW has not received any
24 equity infusion from UWR since the 1994 merger to date as
25 can be gleaned from Exhibit No. 12, Schedule 3, page 2.
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United Water Idaho, Inc.
1 Approximately, 87% of UWID's customers are
2 residential and highly dependent upon seasonal weather
3 conditions as the Company realizes approximately 70% of
4 annual revenues from May through October. In this
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Hanley, Di 17A
United Water Idaho, Inc.
1 regard, UWID faces above average risk attributable to
2 seasonal conditions. Combined with its small size, the
3 threat of by-pass by Micron technology, the potential
4 adverse impact of electric deregulation and the
5 uncertainty surrounding availability and costs to acquire
6 surface water rights, there exists considerable risk.
7 For informational purposes, I have shown United
8 Waterworks' capitalization and financial statistics for
9 the years 1992-1996, inclusive, on Exhibit No. 12,
10 Schedule 4. Page 1 contains the capitalization and
11 financial statistics and page 2 contains notes relevant
12 to page 1. United Waterworks' long-term debt is rated A3
13 by Moody's and A by S&P.
14 VII. PROXY GROUPS
15 Q Please explain how you chose your primary
16 proxy group of five water companies upon which you
17 formulate your recommended common equity cost rate
18 applicable to UWID.
19 A The bases of selection for the proxy group
20 of five water companies were those domestic water
21 companies that meet the following criteria: 1) they are
22 included in S&P's Compustat Services, Inc., Utility
23 Compustat II data base; 2) they are assigned an S.I.C.
24 Code of 4921 (Water Supply) by S&P's Compustat Services,
25 Inc.; 3) they have common stock which is actively traded;
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United Water Idaho, Inc.
1 4) they do not operate in California; 5) they operate in
2 no more than 2 states, and 6) they had total
3 investor-provided capital of at least $100 million at
4 year-end 1996. Five companies met all of these criteria.
5 Their financial profile is summarized in
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Hanley, Di 18A
United Water Idaho, Inc.
1 Exhibit No. 12, Schedule 5.
2 Q Explain how the second proxy group, which
3 you used only as a check, was selected.
4 A I chose to observe the market indicators of
5 common equity cost rate of a proxy group of
6 nationally-recognized water companies, namely, those
7 companies for which Value Line publishes a Ratings and
8 Report on a quarterly basis. There are six such
9 companies and their financial profile is summarized in
10 Exhibit No. 12, Schedule 6.
11 Q Please explain why the proxy group of six
12 Value Line companies is not relevant for use as a primary
13 group to establish the cost of equity applicable to UWID.
14 A The proxy group of six Value Line companies
15 is enormously larger than UWID. Based on total
16 capitalization, it is about 8.2 times larger than UWID.
17 Moreover, the group includes American Water Works Co.,
18 Inc which is even larger and more geographically diverse
19 than United Waterworks; United Water Resources, Inc.,
20 United Waterworks' parent, is even less representative
21 than United Waterworks; and California Water Service
22 Company which is affected by problems unique to
23 California. In all, this group, although published in
24 Value Line, is not a meaningful proxy from which to
25 formulate an estimate of common equity cost rate for
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United Water Idaho, Inc.
1 UWID.
2 Q Please describe Schedule 5 of Exhibit No.
3 12.
4 A Schedule 5 contains comparative
5 capitalization and financial statistics for the five
6 water companies for the years 1992 through 1996. The
7 schedule consists of three
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Hanley, Di 19A
United Water Idaho, Inc.
1 pages. Page 1 contains a summary of the comparative data
2 for the years 1992-1996. Page 2 contains notes relevant
3 to page 1, as well as the basis of selection of the
4 individual companies in the proxy group. Page 3 contains
5 the identities of the companies as well as each company's
6 most recent Moody's and S&P bond ratings.
7 During the five-year period ending 1996, the
8 achieved average earnings rate on book common equity for
9 this group ranged between 10.8% in 1996 and 11.8% in
10 1993, and averaged 11.2%. The five-year average
11 market/book ratio ending 1996 was 151.3% (see discussion
12 relative to market/book ratios and applicability of a
13 market-based common equity cost rate to book value,
14 infra). The five-year average ending 1996 total equity
15 ratio based on permanent investor-provided capital was
16 48.3%, while the five-year average dividend payout ratio
17 was 85.7%.
18 Coverage of interest charges, excluding all AFUDC
19 from income available to pay such charges, before income
20 taxes for the years 1992-1996 ranged between 2.58 and
21 3.32 times and averaged 3.08 times during the five-year
22 period.
23 Q Please describe Schedule 6 of Exhibit No.
24 12.
25 A Schedule 6 contains comparative
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Hanley, Di 20
United Water Idaho, Inc.
1 capitalization and financial statistics for the six Value
2 Line water companies for the years 1992 through 1996.
3 The schedule consists of three pages. Page 1 contains a
4 summary of the comparative data for the years 1992-1996.
5 Page 2 contains notes relevant to page 1, as well as the
6 basis of selection of the individual companies in the
7 proxy group. Page 3
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Hanley, Di 20A
United Water Idaho, Inc.
1 contains the identities of the companies as well as each
2 company's most recent Moody's and S&P bond ratings.
3 During the five-year period ending 1996, the
4 achieved average earnings rate on book common equity for
5 this group ranged between 10.0% in 1995 and 11.6% in
6 1993, and averaged 10.6%. The five-year average
7 market/book ratio ending 1996 was 146.8%. The five-year
8 average ending 1996 total equity ratio based on permanent
9 investor-provided capital was 45.1%, while the five-year
10 average dividend payout ratio was 85.0%.
11 VIII. CAPITAL STRUCTURE RATIOS
12 Q Please explain Exhibit No. 12, Schedule 7.
13 A Schedule 7 consists of three pages. Page 1
14 shows United Waterworks' actual capital structure and
15 related ratios at June 30, 1997 based on
16 investor-provided capital. Pages 2 and 3 also contain
17 similar capital structure ratios by company and year, for
18 the period 1992-1996, inclusive, for each company in the
19 two proxy groups of water companies. For the reasons
20 discussed supra, my primary proxy group of five water
21 companies is much more relevant to the risk rate of
22 equity capital to UWID than the larger, more
23 geographically diverse secondary proxy group of six Value
24 Line companies which I use only as a check.
25 Q Please explain why United Waterworks'
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Hanley, Di 21
United Water Idaho, Inc.
1 capital structure ratios are appropriate to use for UWID.
2 A The price of service should be cost-based
3 and company-specific to the greatest extent possible and
4 reflect the mix of capital financing the Company's rate
5 base.
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United Water Idaho, Inc.
1 When an operating utility issues its own senior capital
2 in the capital markets, it is proper for rate of return
3 purposes to employ the capital structure ratios and
4 related fixed capital cost rates of the regulated
5 operating utility. However, when the parent provides all
6 of the operating utility's external capital, it is
7 appropriate to employ the capital structure and fixed
8 capital cost rates of the parent and its subsidiaries on
9 a consolidated basis for rate of return purposes. The
10 per books capital structure of UWID consists of 100%
11 common equity. All external capital requirements of UWID
12 and United Waterworks' other operating subsidiaries are
13 raised by United Waterworks. Therefore, it is
14 appropriate that the consolidated capital structure
15 ratios of United Waterworks be employed when determining
16 the overall cost of capital for UWID.
17 Q Please comment on the fact that in Case No.
18 BOI-W-93-3, the Commission did not adopt the capital
19 structure of General Waterworks, the predecessor of UWW.
20 A I believe that any Commission must base its
21 decisions on the facts and circumstances which exist at
22 the time. In my view, the facts and circumstances now
23 known clearly support the use of the United Waterworks'
24 capital structure. Moreover, I believe that at the time
25 of Order No. 25062 resulting from Case No. BOI-W-93-3
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Hanley, Di 22
United Water Idaho, Inc.
1 there existed uncertainty regarding the corporate
2 relationships and resulting capital structure as
3 indicated by the Commission at page 21 of Order No. 25640
4 where it stated:
5 Because the common equity ratio of GWC is expected
to be 40%
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United Water Idaho, Inc.
1 for 1994 and because United's common equity is
expected to approximated 40% in the near term, we
2 find that to be a reasonable equity ratio.
3 Since the 1994 merger it has become
4 apparent that the capital structure ratios including the
5 common equity ratios of UWR and UWW are not similar.
6 Moreover, the reasons provided infra make it clear that
7 only the use of UWW's capital structure is appropriate in
8 the determination of the cost of capital for UWID.
9 Q Since UWW is a wholly-owned subsidiary of
10 UWR, would it be appropriate to use UWR's consolidated
11 capital structure, or a hypothetical capital structure
12 based upon UWR's consolidated ratios, and related fixed
13 capital cost rates for UWID?
14 A No. As discussed previously, all of UWID's
15 external capital requirements are provided by UWW through
16 the issuance of long-term debt and common equity. UWR
17 does not issue senior capital for the use of either UWW
18 or UWID. In fact, UWW's predecessor, General Waterworks
19 Corporation, was providing UWID's predecessor, Boise
20 Water Corporation's external capital in exactly the same
21 fashion well before the merger of GWC Corporation with
22 UWR in 1994 and General Waterworks' utility subsidiaries
23 were consistently regulated based on General Waterworks'
24 capital structure. Shown on Exhibit No. 12, Schedule 3,
25 page 3 is the corporate structure chart of GWC
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United Water Idaho, Inc.
1 Corporation before the April 1994 merger into UWR. It is
2 clear that General Waterworks' relationship to GWC
3 Corporation was exactly the same as the present
4 relationship of UWW to
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United Water Idaho, Inc.
1 UWR (Exhibit No. 12, Schedule 3, page 1). The only
2 difference is the change of name. No external equity
3 capital has been invested into UWW by its parent, United
4 Water as discussed supra and shown on Exhibit No. 12,
5 Schedule 3, page 2. In short, the only increase in UWW's
6 equity has been through the retention of earnings.
7 Furthermore, the financial integrity of UWW and its
8 operating subsidiaries, including UWID, provides the
9 wherewithal for the issuance of debt by UWW on behalf of
10 its operating subsidiaries. Only the consolidated
11 earnings of UWW can be used to meet the earnings test to
12 issue additional debt. The cost rate for UWW's long-term
13 debt is based upon investors' assessment of UWW, not of
14 UWR. UWR raises it own debt which is secured by its own
15 creditworthiness. There are no financial guarantees,
16 pledges, or assets of UWR offered to any lender and that
17 is stated explicitly in all UWW's offering materials, as
18 illustrated by the example pages shown on Exhibit No. 12,
19 Schedule 3, pages 4 and 5, which are from the recent
20 August 1997 issuance of $20 million of Water Resource
21 Development Bonds for a project of UWID. Therefore, for
22 rate of return purposes, it is not appropriate to employ
23 the consolidated capital structure ratios, or a
24 hypothetical capital structure based upon UWR's
25 consolidated capital structure ratios, and related fixed
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United Water Idaho, Inc.
1 capital cost rates. Rather, only the use of those of UWW
2 is appropriate to the determination of an overall rate of
3 return applicable to UWID.
4 Q Mr. Hanley, you have stated that UWR has
5 provided no equity capital to UWW since the April 1994
6 merger of GWC Corporation, the former parent of General
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United Water Idaho, Inc.
1 Waterworks Corporation and grandparent of the former
2 Boise Water Corporation, now known as United Water Idaho
3 Inc. Is it possible that the debt and preferred stock of
4 UWR and its subsidiaries, other than UWW, could be used
5 to finance UWID's rate base?
6 A No. Consider the following:
7 * United Water New Jersey, a direct subsidiary of
8 UWR, issues its own debt and preferred stock, both
9 of which are secured by its own assets and
10 earnings:
11 * United Water New York, a direct subsidiary of
12 United Water New Jersey, and therefore, an
13 indirect subsidiary of United Water, issues its
14 own debt and preferred stock, which are secured by
15 its own assets and earnings;
16 * United Water Idaho, a subsidiary of UWW, has a
17 de minimis amount of preferred stock outstanding
18 which, for convenience, is treated as minority
19 interest;
20 * United Properties Group, a direct subsidiary of
21 UWR, has long-term debt outstanding, all of which
22 is devoted to its non-regulated activities;
23 * United Water Services, a direct subsidiary of UWR,
24 has long-term debt outstanding, all of which is
25 devoted to its non-regulated activities and there
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United Water Idaho, Inc.
1 were no cash proceeds derived from the issuance;
2 * United Water Mid-Atlantic, a direct subsidiary of
3 UWR, has long-term debt outstanding, which is
4 devoted exclusively to its regulated subsidiaries;
5 * UWR, the parent company, has long-term debt
6 outstanding, all of which,
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1 has been committed to its non-regulated
2 activities, as well as utility activities in the
3 United Kingdom. In addition, UWR's 7.625%
4 preferred stock was issued prior to the April 1994
5 merger with GWC Corporation, while its 5.000%
6 preferred stock issue was specifically connected
7 and issued relative to the April 1994 merger with
8 GWC Corporation.
9 Consequently, in view of the foregoing, the only
10 capital available to finance any subsidiary of UWW is
11 contained in the capital structure of UWW itself.
12 Q Is it possible that UWW is financially
13 dependent on its parent, UWR, for its credit rating?
14 A No. In fact, UWR's financial health
15 depends upon its subsidiaries. United Waterworks'
16 capital structure ratios are in line with those
17 maintained by independent operating water companies
18 relatively comparable in risk to UWID such as the primary
19 proxy group of five water companies as well as S&P's
20 financial benchmark ratios for a water utility in an
21 "average" business position to maintain an A bond
22 rating. It is clear that the parent, UWR, is dependent
23 upon its subsidiaries for cash, not the other way around.
24 This is evidenced by the fact that since the April 1994
25 merger, there has been no equity infusion from UWR to UWW
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United Water Idaho, Inc.
1 as shown on Exhibit No. 12, Schedule 3, page 2. Yet, UWW
2 has paid cash dividends to UWR. Moreover, UWW has an S&P
3 bond rating of A which is higher than UWR's credit rating
4 of A-, confirming that UWR is dependent upon its
5 subsidiaries. Moreover, as noted supra, United
6 Waterworks
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1 raises its own debt which is secured by its own
2 creditworthiness. There are no financial guarantees,
3 pledges, or assets of UWR offered to any lender which is
4 explicitly stated in all UWW's offering materials, as
5 discussed supra and illustrated by pages 4 and 5 of
6 Exhibit No. 12, Schedule 3.
7 Q How does your recommended common equity
8 ratio of 46.73% compare with the common equity ratios
9 maintained by your primary proxy group of five water
10 companies?
11 A UWID's ratemaking common equity ratio of
12 46.73% based upon United Waterworks actual common equity
13 ratio at June 30, 1997, is consistent with the common
14 equity ratios maintained by the companies in the proxy
15 group of five water companies, the primary proxy group I
16 relied upon in arriving at my recommended 11.50% common
17 equity cost rate. It is also consistent with the common
18 equity ratios maintained by the companies in the larger,
19 more geographically diverse and less risky proxy group of
20 six Value Line water companies whose market data I used
21 only as a check upon my recommended common equity cost
22 rate. Since the average S&P bond rating of the proxy
23 group of five water companies is A+/ A and of the six
24 Value Line water companies is A+ (see page 3 of Schedule
25 17), it is clear that the common equity ratios maintained
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United Water Idaho, Inc.
1 by these water companies have found acceptance in the
2 marketplace. As can be determined from pages 2 and 3 of
3 Schedule 7, the five water companies and the six Value
4 Line water companies have maintained, on average, total
5 equity ratios of 47.53% and 43.98%, respectively, for the
6 year 1996. The
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1 total equity ratios of the individual water companies in
2 the two proxy groups range from 44.67% to 50.34% for the
3 five water companies and 38.52% to 52.59% for the six
4 Value Line water companies. Consequently, UWID's
5 ratemaking common equity ratio of 46.73% is reasonable,
6 if not conservative given UWID's small size and unique
7 business risks discussed supra vis-a-vis the average
8 total equity ratios maintained by the five water
9 companies upon which my recommended common equity cost
10 rate is based as well as the average total equity ratios
11 maintained by the larger, less risky and less comparable,
12 group of six Value Line water companies which I used only
13 as a check.
14 Q How do UWID's ratemaking capital structure
15 ratios based upon United Waterworks' actual capital
16 structure at June 30, 1997 compare with S&P's financial
17 benchmark criteria?
18 A They are consistent with S&P's financial
19 benchmark ratios of total debt to total capital for water
20 companies with long-term debt rated in the A category
21 (see page 3 of Schedule 17). As shown on page 11 of
22 Schedule 2, a water company in a "high average" business
23 position, like the five water companies, requires a total
24 debt to total capital ratio of 55%, or a total equity
25 ratio of 45%, in order to maintain an A bond rating.
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Hanley, Di 28
United Water Idaho, Inc.
1 However, as also shown on page 11 of Schedule 2, S&P's
2 total debt to total capital criterion for a water
3 company, in an "average" business position like United
4 Waterworks, to obtain and maintain an A bond rating is
5 52%, which implies a total equity ratio of 48%. Since
6 these primary proxy water companies maintain an
7 insignificant percentage of preferred stock
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United Water Idaho, Inc.
1 in their capital structure, UWID's 46.73% ratemaking
2 common equity ratio is reasonable.
3 UWID's ratemaking long-term/total (since there is
4 no short-term debt outstanding) debt ratio based upon
5 United Waterworks actual June 30, 1997 capital structure
6 is 53.13% as developed on page 1 of Schedule 7. A
7 long-term/total debt ratio of 53.13% is slightly higher
8 than S&P's 52% total debt criteria for an A bond rating
9 for a water company in an "average" business position.
10 Thus, it can be concluded that United Waterworks, and
11 hence UWID, should ideally maintain a total equity ratio
12 of 48%, i.e., slightly greater than the proposed
13 ratemaking equity ratio of 46.73%.
14 Clearly, in view of the foregoing and UWID's small
15 size as discussed supra., UWID's ratemaking equity ratio
16 of 46.73% is reasonable when compared with the total
17 equity ratios maintained by the proxy group of five water
18 companies and is conservative compared with the 48% total
19 equity ratio implied by S&P's total debt ratio for a
20 water company in an "average" business position to
21 maintain an A bond rating.
22 A. Long-Term Debt/Minority Interest Cost Rates
23 Q What cost rates for long-term debt and
24 minority interest are appropriate for use in determining
25 UWID's overall cost of capital?
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Hanley, Di 29
United Water Idaho, Inc.
1 A Actual long-term debt/minority interest
2 cost rates of 8.25% and 5.00%, respectively, at June 30,
3 1997 are appropriate as summarized on Exhibit No. 12,
4 Schedule 8.
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United Water Idaho, Inc.
1 IX. COMMON EQUITY COST RATE MODELS
2 A. Discounted Cash Flow Model (DCF)
3 1. Theoretical Basis
4 Q What is the theoretical basis of the DCF
5 model?
6 A DCF theory is based upon finding the
7 present value of an expected future stream of net cash
8 flows during the investment holding period discounted at
9 the cost of capital, or the capitalization rate. The
10 theory suggests that an investor buys a stock for an
11 expected total return rate which is expected to be
12 derived from cash flows in the form of dividends and
13 appreciation in market price (the expected growth rate).
14 Thus, the dividend yield on market price plus a growth
15 rate equals the capitalization rate. The capitalization
16 rate is the total return rate expected by investors.
17 Q Please comment on the applicability of the
18 DCF model in establishing a cost of common equity for
19 United Waterworks, and hence UWID.
20 A The extent to which the DCF is relied upon,
21 if at all, should depend upon the extent to which the
22 cost rate results differ from the use of other cost of
23 common equity models because the DCF model has a tendency
24 to mis-specify investors' required return rate when the
25 market value of common stock differs significantly from
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Hanley, Di 30
United Water Idaho, Inc.
1 its book value. Market values and book values of common
2 stocks are seldom, if ever, at unity. The market-based
3 DCF model will result in a total annual dollar return on
4 book common equity equal to the total annual dollar
5 return expected by investors only when market and book
6 values are equal, a rare
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Hanley, Di 30A
United Water Idaho, Inc.
1 and unlikely situation. In recent years, the market
2 values of water companies' common stocks have been well
3 in excess of their book values as shown on Exhibit No.
4 12, page 1 of Schedules 5 and 6, ranging between 141.6%
5 and 165.8% and 137.3% and 157.9% for the proxy groups of
6 five and the six Value Line water companies,
7 respectively.
8 Sole reliance on the DCF model should be avoided
9 because of its tendency to understate the common equity
10 cost rate required by investors when market value exceeds
11 book value and a market-based DCF cost rate is applied to
12 the book value of common equity. Understatement of
13 investors' required return rate by use of the DCF model
14 occurs because, in many instances, market prices reflect
15 investors' assessment of long-range growth potential
16 (consistent with the infinite investment horizon implicit
17 in the standard regulatory version of the DCF model) not
18 fully reflected in analysts' shorter range forecasts of
19 future growth. This indicates the need to better match
20 market prices with investors' longer range growth
21 expectations embedded in those prices. No single cost of
22 common equity model should ever be relied upon
23 exclusively. The problems associated with the
24 application of the market price-based DCF model to the
25 book value of common equity make it especially apparent.
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Hanley, Di 31
United Water Idaho, Inc.
1 Q Is there support in the academic literature
2 for the need to rely upon more than one cost of common
3 equity model in arriving at a recommended common equity
4 cost rate?
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United Water Idaho, Inc.
1 A Yes. For example, Phillips9 states:
2 Since regulation establishes a level of authorized
earnings which, in turn, implicitly influences
3 dividends per share, estimation of the growth rate
from such data is an inherently circular process.
4 For these reasons, the DCF model "suggests a
degree of precision which is in fact not present"
5 and leaves "wide room for controversy and argument
about the level of k". (italics added)
6
Also, Morin10 states:
7
Sole reliance on the DCF model ignores the capital
8 market evidence and financial theory formalized in
the CAPM and other risk premium methods. The DCF
9 model is one of many tools to be employed in
conjunction with other methods to estimate the
10 cost of equity. It is not a superior methodology
that supplants other financial theory and market
11 evidence. The broad usage of the DCF methodology
in regulatory proceedings does not make it
12 superior to other methods. (italics added)
(pp. 231-232)
13
Each methodology requires the exercise of
14 considerable judgment on the reasonableness of the
assumptions underlying the methodology and on the
15 reasonableness of the proxies used to validate a
theory. The failure of the traditional infinite
16 growth DCF model to account for changes in
relative market valuation, discussed above, is a
17 vivid example of the potential shortcomings of the
DCF model when applied to a given company. It
18 follows that more than one methodology should be
employed in arriving at a judgment on the cost of
19 equity and that these methodologies should be
applied across a series of comparable risk
20 companies. ...Financial literature supports the
use of multiple methods. (italics added) (p. 239)
21
Professor Eugene Brigham, a widely respected
22 scholar and finance academician asserted:
23 In practical work, it is often best to use all
three methods - CAPM,
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United Water Idaho, Inc.
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21 9Charles F. Phillips, Jr., The Regulation of Public
Utilities-Theory and Practice, 1993, Public Utility
22 Reports, Inc., Arlington, VA, p. 396.
23 10Roger A. Morin, Regulatory Finance-Utilities' Cost of
Capital, 1994, Public Utilties Reports, Inc.,
24 Arlington, VA, pp. 231-232, 239-240.
25
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Hanley, Di 32A
United Water Idaho, Inc.
1 bond yield plus risk premium, and DCF - and then
apply judgement when the methods produce different
2 results. People experienced in estimating capital
costs recognize that both careful analysis and
3 very fine judgements are required. It would be
nice to pretend that these judgements are
4 unnecessary and to specify an easy, precise way of
determining the exact cost of equity capital.
5 Unfortunately, this is not possible. (italics
added) (pp. 239-240)
6
Another prominent finance scholar, Professor
7 Stewart Myers, in his best-selling corporate
finance textbook stated:
8
The constant growth formula and the capital asset
9 pricing model are two different ways of getting a
handle on the same problem. (italics added)
10 (p. 240)
11 In an earlier article, Professor Myers explained
the point more fully:
12
Use more than one model when you can. Because
13 estimating the opportunity cost of capital is
difficult, only a fool throws away useful
14 information. That means you should not use any
one model or measure mechanically and exclusively.
15 Beta is helpful as one tool in a kit, to be used
in parallel with DCF models or other techniques
16 for interpreting capital market data. (italics
added) (p. 240)
17
2. Applicability of a Market-Based Common Equity
18 Cost Rate to a Book Value Rate Base
19 Q Is it reasonable to expect the market
20 values of utilities' common stocks to continue to sell
21 well above their book values?
22 A Yes. I believe that the common stocks of
23 utilities will continue to sell substantially above their
24 book values, because many investors, especially
25 individuals who traditionally committed less capital to
310
Hanley, Di 33
United Water Idaho, Inc.
1 the equity markets, will likely continue to commit a
2 greater percentage of their available capital to common
3 stocks in view of lower interest rate alternative
4 investment opportunities and to provide for retirement.
5 The recent past and current capital market
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Hanley, Di 33A
United Water Idaho, Inc.
1 environment is in stark contrast to the late 1970's and
2 early 1980's when very high (by historical standards)
3 yields on secured debt instruments in public utilities
4 were available. Moreover, allowed ROEs have a limited
5 effect on utilities' market/book ratios as market prices
6 of common stocks are influenced by a number of other
7 factors beyond the direct influence of the regulatory
8 process.
9 For example, Phillips11 states:
10 Many question the assumption that market price
should equal book value, believing that `the
11 earnings of utilities should be sufficiently high
to achieve market-to-book ratios which are
12 consistent with those prevailing for stocks of
unregulated companies.'
13
In addition, Bonbright12 states:
14
In the first place, commissions cannot forecast,
15 except within wide limits, the effect their rate
orders will have on the market prices of the
16 stocks of the companies they regulate. In the
second place, whatever the initial market prices
17 may be, they are sure to change not only with the
changing prospects for earnings, but with the
18 changing outlook of an inherently volatile stock
market. In short, market prices are beyond the
19 control, though not beyond the influence of rate
regulation. Moreover, even if a commission did
20 possess the power of control, any attempt to
exercise it ... would result in harmful,
21 uneconomic shifts in public utility rate levels.
(italics added)
22
23 In view of the foregoing, there is often a
24 resulting mismatch in the application of the DCF model as
25 market prices reflect long range expectations
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Hanley, Di 34
United Water Idaho, Inc.
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23 12James C. Bonbright, Albert L. Danielsen and David R.
Kamerschen, Principles of Public Utility Rates, 1988,
24 Public Utilties Reports, Inc., Arlington, VA, p. 334.
25
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Hanley, Di 34A
United Water Idaho, Inc.
1 of growth in market prices (consistent with the presumed
2 infinite investment horizon of the standard DCF model),
3 while the short range forecasts of growth do not reflect
4 the full measure of growth (market price appreciation)
5 expected in per share value.
6 Q Please describe the information shown on
7 Exhibit No. 12, Schedule 10.
8 A Schedule 10 consists of four pages. Page 1
9 contains the stock price index levels, EPS and DPS of the
10 S&P Utilities Index on a quarterly basis from the second
11 quarter of 1987 through the second quarter of 1997.
12 As can be derived from page 1 and shown in the
13 table below, the S&P Utilities Index experienced a 73.1%
14 increase in market price, while growth in EPS and DPS
15 over the period were only 41.0% and 36.1%, respectively
16 over a recent ten-year period.
17
18 Growth in Market Price and Earnings from the
Second Quarter, 1987 through the Second Quarter, 1997
19
2nd Quarter 2nd Quarter
20 1987 1997 % Change
21
S&P Utilities Index
22
Market Price $113.07 $198.39 75.5%
23 Earnings 10.12 13.75 35.9
Dividends 7.22 10.01 38.6
24
Source of Information: S&P Security Price Index Record
25 S&P Current Statistics
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Hanley, Di 35
United Water Idaho, Inc.
1 It is important to keep in mind that the growth
2 rate used in the DCF model is a proxy for growth in
3 market price, despite the fact that the accounting
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Hanley, Di 35A
United Water Idaho, Inc.
1 proxies for growth employed (such as EPS and DPS) usually
2 are unreliable predictors of growth in market price.
3 Confirmation that neither earnings nor interest rates
4 account for a substantial change in market prices is
5 found in a study published by Goldman Sachs & Co.13 which
6 concluded that during the 1980's, only 35% of the S&P
7 500's stock price growth was attributable to earnings and
8 interest rates. Pages 2 through 4 of Schedule 10 are a
9 copy of a Wall Street Journal article dated February 23
10 1996, which describes how market prices are being
11 escalated by the "Big Generation" (people now in their
12 30's and 40's) who feel compelled to provide for their
13 old age by significant investment in stock funds, etc.
14 Such methodical, compulsive, investment has little, if
15 anything, to do with company/industry specific
16 fundamentals. Such motivation to invest for the
17 long-term contributes significantly to market/book ratios
18 well above unity with no direct relationship to short
19 range forecasts (up to five years) of earnings/dividend
20 growth. In short, application of the DCF model is
21 usually incapable of fully reflecting the growth in
22 market price expected by investors. The resulting
23 mis-specification of required return rate is attributable
24 to (1) factors which are important to investors when they
25 are establishing the required rate of return on their
316
Hanley, Di 36
United Water Idaho, Inc.
1 common equity investment but are not directly related to
2 company and/or industry measures of growth and (2)
3 investors' expected rate of growth which cannot be fully
4 captured by use of the normal accounting proxies
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23 13 Goldman-Sachs & Co. - Investment Research, May 23,
1991, How Can We Explain the Growth of the S&P 500
24 in the 1980's?, by Barrie A. Wigmore.
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Hanley, Di 36A
United Water Idaho, Inc.
1 used in the DCF model for the expected growth in market
2 value.
3 Q Please explain why a DCF-derived common
4 equity cost rate mis-specifies investors' expected common
5 equity cost rate when the market/book ratio is greater or
6 less than unity (100%).
7 A Under the DCF model, the rate of return
8 investors require is related to the price paid for a
9 stock. Thus, market price is the basis upon which they
10 formulate the rate of return required. A regulated
11 utility is limited to earning on its net book value
12 (depreciated original cost) rate base. As discussed
13 supra, market values diverge from book values for many
14 reasons unrelated to ROEs. Thus, when market values are
15 grossly disparate from their book values, a market-based
16 DCF cost rate applied to the book value of common equity
17 will not reflect investors' expected common equity cost
18 rate. It will either overstate the common equity cost
19 rate (without regard to any adjustment for flotation
20 costs which may, at times, be appropriate on an ad hoc
21 basis) when market value is less than book value or
22 understate the cost rate when market value is above book
23 value.
24 Exhibit No. 12, Schedule 11 demonstrates the
25 inadequacy of a market-based DCF cost rate applied to a
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Hanley, Di 37
United Water Idaho, Inc.
1 much lower book value. As shown, there is no realistic
2 opportunity to earn the market-based rate of return on
3 book value. In this example, market price is 50% in
4 excess of book value and the investor expects a total
5 return rate of 11.50%, based on a growth rate of 5.00%
6 and a dividend yield of 6.50% on market price. In this
7 example, the 11.50% market-based cost rate implies an
8 annual return of $2.59 consisting of $1.46 in dividends
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Hanley, Di 37A
United Water Idaho, Inc.
1 and $1.13 in growth (market-price appreciation). When
2 the 11.50% return rate is applied to the book value which
3 is only two-thirds of the market value, the opportunity
4 for total annual return is just $1.73 on book value.
5 With an annual dividend of $1.46, there is an opportunity
6 to earn only $0.27 in growth which is just 1.20% on
7 market price in contrast to the 5.00% in growth expected
8 by investors. There is no way to possibly achieve the
9 expected growth of $1.13 (5.00%) related to the market
10 price of $22.50 absent a huge cut in the annual dividend,
11 an unreasonable expectation which usually indicates an
12 extremely adverse financial condition. It is clear that
13 market prices are reflective of much more than
14 short-range projections of growth in EPS and/or DPS.
15 Consequently, while application of the DCF model may
16 reflect the growth investors anticipate in market prices,
17 application of the market-based DCF model to the book
18 value of common equity understates investors' required
19 cost of common equity capital when market values exceed
20 their book values. Of course, if the converse situation
21 exists (market values substantially below their book
22 values), a market-based DCF cost rate applied to the book
23 value of common equity would overstate the cost rate.
24 Q Have any commissions explicitly stated that
25 it does not make good sense to rely solely on DCF?
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Hanley, Di 38
United Water Idaho, Inc.
1 A Yes. It can be determined from the
2 1995-1996 NARUC study (Exhibit No. 12, Schedule 9) that
3 approximately 75% of the commissions rely on no single
4 cost of common equity model. Moreover, the Iowa
5 Utilities Board (IUB) has
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United Water Idaho, Inc.
1 recognized the tendency of the DCF model to understate
2 investors' expected cost of common equity capital when
3 market values are significantly above their book values.
4 In its June 17, 1994 Final Decision and Order in Docket
5 No. RPU-93-9 re: U.S. West Communications, the IUB
6 stated:14
7 While the Board has relied in the past on the DCF
model, in Iowa Electric Light and Power Company,
8 Docket No. RPU-89-9, "Final Decision and Order"
(October 15, 1990), the Board stated: `[T]he DCF
9 model may understate the return on equity in some
circumstances. This is particularly true when the
10 market is relatively volatile and the company in
question has a market-to-book ratio in excess of
11 one." Those conditions exist in this case and the
Board will not rely on the DCF return. (Consumer
12 Advocate Ex. 367, See Tr. 2208, 2250, 2277,
2283-2284). The DCF approach underestimates the
13 cost of equity needed to assure capital attraction
during this time of market uncertainty and
14 volatility. The board will, therefore, give
preference to the risk premium approach. (italics
15 added)
16 Similarly, in 1994, the Indiana Utility Regulatory
17 Commission (IURC), for example, recognized the tendency
18 of the DCF model to understate the cost of equity when
19 market value exceeds book value15:
20 In determining a common equity cost rate, we must
again recognize the tendency of the traditional
21 DCF model, . . . to understate the cost of common
equity. As the Commission stated in Indiana-Mich.
22 Power Co. (IURC 8/24/90), Cause No. 38728, 116 PUR
4th 1, 17-18, "the unadjusted DCF result is almost
23 always well below what any informed financial
analyst would regard as defensible, and therefore,
24 requires an upward adjustment based largely on the
expert witness's judgement." (italics added)
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United Water Idaho, Inc.
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22 14 Public Utilities Reports - 152PUR4th, Re: U.S.
West Communications, Inc., Docket No. RPU-93-9,
23 p. 459.
24 15 Public Utilities Reports - 150PUR4th, Re:
Indiana-American Water Company, Inc., Cause
25 No. 39595, pp. 167-168.
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United Water Idaho, Inc.
1 * * *
2 [u]nder the traditional DCF model ... the
3 appropriate earnings level of the utility would
4 not be derived by applying the DCF result to the
5 market price of the Company's stock...it would be
6 applied to the utility's net original cost rate
7 base. If the market price of the stock exceeds
8 its book value, ... the investor will not achieve
9 the return which the model finds is necessary.
10 (italics added)
11 Also, the Hawaii Public Utilities Commission recognized
12 this phenomenon in a decision dated 6/30/92 in a case
13 regarding Hawaiian Electric Company, Inc., when it
14 stated:
15 In this docket, as in other rate proceedings,
experts disagree on the relative merits of the
16 various methods of determining the cost of common
equity. In this docket, HECO is particularly
17 critical of the use of the constant growth DCF
methodology. It asserts that method is imbued
18 with downward bias and, thus, its use will
understate common equity cost. We are cognizant
19 of the shortcomings of the DCF method. There are,
however, shortcomings to be found with the use of
20 CAPM and the RP methods as well. We reiterate
that, despite the problems with the use of any
21 methodology, all methods should be considered and
that the DCF method and the combined CAPM and RP
22 methods should be given equal weight. (italics
added)
23
24 Q Do the other cost of common equity models
25 contain unrealistic assumptions and have shortcomings?
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United Water Idaho, Inc.
1 A Yes. That is why I am recommending that
2 none of the models be exclusively relied upon. I have
3 focused on the shortcomings of the DCF model because some
4 regulatory commissions still place undue reliance on it.
5 Although the DCF model is useful, it is not a superior
6 methodology that supplants financial theory
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23 16 Public Utilities Reports - 123PUR4th, Re: Hawaiian
Electric Company, Inc., Docket No. 6998, p.479.
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United Water Idaho, Inc.
1 and market evidence based on other valid cost of common
2 equity models. For these reasons, no cost of common
3 equity model, including the DCF, should be relied upon
4 exclusively.
5 3. Application of the DCF Model
6 a. Dividend Yield
7 Q Please describe the dividend yield you used
8 in your application of the DCF model.
9 A The unadjusted dividend yields are based on
10 an average of a recent spot date (September 30, 1997) as
11 well as an average of the last three, six and twelve
12 months, ending September 30, 1997, respectively, which
13 are shown on Exhibit No. 12, Schedule 13. The average
14 unadjusted yield is 5.8% for the five water companies and
15 5.1% for the six Value Line water companies are shown on
16 Schedule 12, Line Nos. 1 and 6 and on Schedule 13 by
17 company and proxy group.
18 b. Discrete Adjustment of Dividend Yield
19 Q Please explain the adjustment for discrete
20 growth shown on Exhibit No. 12, Schedule 12, Line Nos. 2
21 and 7.
22 A Due to the fact that dividends are paid
23 quarterly, or periodically, as opposed to continuously
24 (daily), an adjustment must be made. This is often
25 referred to as the discrete, or the Gordon Periodic,
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1 version of the DCF model.
2 Since the various companies in the proxy groups
3 increase their quarterly dividend at various times of the
4 year, a reasonable assumption is to reflect one-
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1 half the annual dividend growth rate in the D1
2 expression, or D1/2. This is a conservative approach so
3 as not to overstate the dividend yield as it should be
4 representative of the next twelve-month period.
5 Therefore, the actual average dividend yields on Line
6 Nos. 1 and 6 of Schedule 12 have been adjusted upward to
7 reflect one-half the growth rates shown on Line Nos. 4
8 and 9.
9 c. Selection of Growth Rates for Use in the
Single-Stage Growth DCF Model
10
11 Q Please explain the basis of the growth
12 rates of 3.7%/3.9% and 4.5%/4.7% for the proxy groups of
13 five and six Value Line water companies, respectively,
14 which you use in your application of the single-stage
15 growth DCF model.
16 A It is shown on Exhibit No. 12, Schedule 14
17 that about 80%-83% of the common shares of both proxy
18 groups are held by individuals as opposed to
19 institutional investors. Individual investors are
20 particularly likely to place great significance on the
21 opinions expressed by financial information services such
22 as S&P and Value Line, which they can easily obtain.
23 Forecasts by analysts, including Value Line, are
24 usually limited to five years. I believe that investors
25 would have little interest in historical growth rates
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United Water Idaho, Inc.
1 beyond the most recent five years. Consequently, the use
2 of five-year historical and five-year projected growth
3 rates in earnings per share (EPS) and dividends per share
4 (DPS) as well as the sum of internal and external growth
5 in per share value (BR + SV) is appropriate to consider
6 in the determination of a growth rate for use in this
7 application of the DCF model. Also, investors realize
8 that
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Hanley, Di 42A
United Water Idaho, Inc.
1 analysts have much insight into industry dynamics and
2 individual companies' abilities to effectively deal with
3 changing laws and regulations. Consequently, I review
4 analysts' projected growth in EPS, as well as historical
5 and projected five-year compound growth rates in EPS, DPS
6 and BR + SV for each company in both proxy groups. The
7 historical growth rates are from Value Line while the
8 projected growth rates in earnings are from Value Line,
9 I/B/E/S, and S&P forecasts. I/B/E/S and S&P growth rate
10 estimates are not available for DPS and internal growth
11 nor do they include the Value Line projections. Thus,
12 Value Line's estimates are not included twice.
13 In addition to evaluating EPS and DPS growth
14 rates, it is reasonable to assume that investors also
15 assess BR + SV. The concept is based on financial theory
16 and well documented in the academic literature. Its
17 conceptual premise is that future dividend growth is a
18 function of the portion of the overall return to
19 investors which is reinvested into the firm and the sales
20 of new common stock. Consequently, the growth component
21 as proxied by internal and external growth is defined as
22 follows:
23 g = BR + SV
24 Where:
B = the fraction of earnings retained by the firm,
25 i.e., retention ratio
330
Hanley, Di 43
United Water Idaho, Inc.
1 R = the return on common equity
S = the growth in common shares outstanding
2 V = the premium/discount of a company's stock
price relative to its book value, i.e., one
3 minus the complement of the market/book ratio.
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Hanley, Di 43A
United Water Idaho, Inc.
1 Consistent with the use of five-year historical
2 and five-year projected growth rates in EPS and DPS, I
3 have derived five-year historical and five-year projected
4 BR+SV growth. Projected EPS growth rate averages are
5 shown on Line No. 9, while historical and projected
6 growth in DPS, EPS, and BR + SV is shown on Line No. 4,
7 Schedule 12. Supporting growth rate data are detailed on
8 pages 2 through 8 of Schedule 15. Pages 9 through 14 of
9 Schedule 15 contain the most current Value Line
10 Investment Survey for all of the companies in the
11 secondary and less comparable proxy group.
12 As shown on page 1 of Schedule 15, growth rates
13 for the proxy group of five water companies range from
14 1.6% to 5.3%, with a midpoint of 3.5% and an average of
15 3.7%, while projected growth rates in EPS averaged 3.9%.
16 Likewise, for the secondary proxy group of six Value Line
17 water companies, growth rates range from 3.0% to 6.3%,
18 with a midpoint of 4.2% and an average of 4.5%, while
19 projected growth rates in EPS averaged 4.7%.
20 Consequently, I conclude that growth rates of 3.7%/3.9%
21 for the proxy group of five water companies and 4.5%/4.7%
22 for the proxy group of six Value Line water companies are
23 suitable to use in the application of the DCF model.
24 Q Please summarize the single-stage growth
25 DCF model results.
332
Hanley, Di 44
United Water Idaho, Inc.
1 A As shown on Exhibit No. 12, Schedule 12,
2 Line Nos. 5 and 10, the results of the applications of
3 the single-stage DCF model are 9.6%/9.8% for the proxy
4 group of five water companies and 9.7%/9.9% for the proxy
5 group of six Value Line water companies, respectively.
6 As will be discussed infra, these cost rates
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Hanley, Di 44A
United Water Idaho, Inc.
1 derived from application of the single-stage growth DCF
2 model are so out of the range of reason when compared to
3 the cost rates indicated through application of other
4 cost of equity models that they must be considered "not
5 meaningful" in arriving at a recommended common equity
6 cost rate applicable to UWID.
7 d. Selection of Growth Rates for Use in the Two-Stage
8 Growth DCF Model
9 Q Please explain the basis for the two-stage
10 growth DCF model.
11 A The two-stage growth rate DCF model is
12 predicated upon the presumption that after a short-term
13 transition stage, a firm can be expected to reach a state
14 of maturity when its growth and return on common equity
15 would be in line with the growth of the economy or the
16 industry. As Morin17 indicates, this assumption stems
17 from the view that above or below average growth rates
18 will settle to a steady-state, long-run level consistent
19 with that of the general economy. I agree with that
20 premise as far as establishing other proxies for investor
21 expectations for longer range growth in EPS. However, as
22 demonstrated supra, market prices are affected by much
23 more than growth in EPS or DPS. Admittedly, there is no
24 basis for assuming that all companies will grow at the
25 same rate in the second stage nor that all companies will
334
Hanley, Di 45
United Water Idaho, Inc.
1 reach the mature or steady state stage of growth after
2 five years. Nonetheless, the version of the two-stage
3 growth DCF model which I employ uses the recent Federal
4 Energy Regulatory Commission (FERC) growth rate inputs,
5 i.e., I/B/E/S forecasted growth in EPS for years one
6 through
7
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24 17 Id., at p. 156.
25
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Hanley, Di 45A
United Water Idaho, Inc.
1 five and growth in GDP for years six through twenty. The
2 resulting twenty-year compound growth rates in DPS are
3 composites reflecting the two growth stages. The longer
4 stage (years six through twenty) is believed by the
5 FERC18 to be more reflective of investors' expectations
6 of long-range market price appreciation.
7 Q Please explain the stage one growth rate.
8 A The stage one growth rate is the I/B/E/S
9 five-year projected growth in EPS. Pages 4 and 5 of
10 Schedule 16 show the I/B/E/S five-year projected growth
11 in EPS for each company in both proxy groups. The FERC
12 found the use of the five-year I/B/E/S forecast growth in
13 EPS reasonable, as do I because EPS drives market prices.
14 The use of analysts' forecasts in EPS in the first stage
15 is consistent with the use of longer range forecasts of
16 growth in the second stage.
17 Q Please explain the second stage growth
18 rate.
19 A For the estimation of the second stage
20 growth rate, I utilized an average forecasted growth in
21 Gross Domestic Product (GDP) as a proxy for longer-range
22 investor growth expectations, consistent with the FERC
23 approach. The forecasted growth rates in GDP were
24 prepared by DRI-McGraw Hill, The WEFA Group, and the
25 Energy Information Administration as required by the
336
Hanley, Di 46
United Water Idaho, Inc.
1 FERC.
2 The forecasts for GDP growth by year are provided
3 on page 6 of Schedule
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9 /
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24 18 FERC, Opinion No. 356-B re Northwest Pipeline
Corporation, June 11, 1997.
25
337
Hanley, Di 46A
United Water Idaho, Inc.
1 16. They show that GDP is anticipated to grow in the
2 range of 4.9% to 5.3% annually for the period 2002 to
3 2016. GDP is the most widely used measure of the
4 nation's production. It is the market value of goods and
5 services produced by labor and property supplied by
6 residents within the country.
7 Q How were DPS for the years 1997 - 2016
8 derived?
9 A DPS in each year for each company in both
10 proxy groups were derived by applying that year's growth
11 rate to the previous years DPS, as explained in Notes 1
12 and 2 on pages 2 and 3 of Schedule 16.
13 Q Please explain the basis of the average
14 annual growth rates of 4.6% for the five water companies
15 and 4.7% for the six Value Line water companies based
16 upon I/B/E/S five-year projected growth in EPS and the
17 forecasted average longer-term growth in GDP.
18 A As explained in Note 3 on page 3 of
19 Schedule 16, those annual growth rates were derived by
20 calculating the average annual compound growth rate over
21 the entire period, 1997 - 2016, by relating each
22 company's DPS in the year 2016 to DPS at September 30,
23 1997. For example, Aquarion's 4.6% average annual growth
24 was derived as follows: 4.6% = (($3.818 / $1.620) ^
25 (1 / 19.25) -1).
338
Hanley, Di 47
United Water Idaho, Inc.
1 Q Please summarize the two-stage growth rate
2 DCF model results.
3 A As shown on Schedule 16, page 1, Line
4 No. 5, the two-stage growth DCF cost rates using I/B/E/S
5 projected five-year growth in EPS and average projected
6 annual growth in GDP are 10.5% for my primary proxy group
7 of five water companies and 9.9% for the secondary and
8 less comparable group of six Value
9
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11
12 /
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14 /
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Hanley, Di 47A
United Water Idaho, Inc.
1 Line companies used only as a check.
2 B. The Risk Premium Model (RPM)
3 1. Theoretical Basis
4 Q Please describe the theoretical basis of
5 the RPM.
6 A The RPM is based upon the theory that the
7 cost of common equity capital is greater than the
8 prospective company-specific cost rate for long-term debt
9 capital. In other words, it is the expected cost rate
10 for long-term debt capital plus a premium to compensate
11 common shareholders for the added risk of being unsecured
12 and last-in-line in any claim on the corporation's assets
13 and earnings.
14 Q Some analysts state that the RPM is another
15 form of the CAPM. Do you agree?
16 A Generally yes, but there is a very
17 significant distinction between the two models. The RPM
18 and CAPM both add a "risk premium" to an interest rate.
19 However, the beta approach to the determination of an
20 equity risk premium in the RPM should not be confused
21 with the CAPM. Beta is a measure of systematic, or
22 market, risk, a relatively small percentage of total risk
23 (i.e., the sum of both non-diversifiable systematic and
24 diversifiable unsystematic risk). Unsystematic risk is
25 fully captured in the RPM through the use of the
340
Hanley, Di 48
United Water Idaho, Inc.
1 prospective long-term bond yield. This proposition can
2 be verified by reference to pages 1 through 9 of Exhibit
3 No. 12, Schedule 2, which confirm that the bond rating
4 process involves an assessment of all business and
5 financial risks. In contrast, the use of a risk-free
6 rate of return in the CAPM does not, and by definition
7 can not, reflect a company's specific (i.e.,
8 unsystematic) risk. Consequently, a much larger portion
9
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Hanley, Di 48A
United Water Idaho, Inc.
1 of the total common equity cost rate is reflected in the
2 company-specific bond yield (a product of the bond
3 rating) than by the use of the risk-free rate in the
4 CAPM, and especially by the dividend yield in the DCF
5 model. Moreover, the financial literature recognizes the
6 RPM and CAPM as two separate and distinct cost of common
7 equity models as discussed supra.
8 Q Have you performed RPM analyses of common
9 equity cost rate?
10 A Yes. The results of my application of the
11 RPM are summarized on page 1 of Exhibit No. 12, Schedule
12 17. On Line No. 1, page 1, Schedule 17, I show the
13 average expected yield on A rated public utility bonds of
14 7.5%. On Line No. 2, I show the adjustments necessary to
15 be made to the average 7.5% expected A rated utility bond
16 yield so that the expected yield of 7.6% is reflective of
17 the average Moody's bond rating of A2/A3 for my primary
18 proxy group of five water companies while the expected
19 yield is 7.5% applicable to the secondary proxy group of
20 six Value Line companies with an average Moody's bond
21 rating of A2 as shown on page 3 of Exhibit No. 12,
22 Schedule 17. On Line No. 4 of page 1, I show my
23 conclusions of an equity risk premium applicable to each
24 proxy group while the total risk premium common equity
25 cost rates are shown on Line No. 5.
342
Hanley, Di 49
United Water Idaho, Inc.
1 2. Estimation of Expected Bond Yield
2 Q Please describe the derivation of the
3 expected bond yield.
4 A Because the cost of common equity is
5 prospective, a prospective yield on similarly-rated
6 long-term debt is appropriate. I relied on a consensus
7 forecast
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Hanley, Di 49A
United Water Idaho, Inc.
1 of about 50 economists of the expected yield on A rated
2 public utility bonds for the six calendar quarters ending
3 with the first calendar quarter of 1999 as derived from
4 the October 1, 1997 Blue Chip Financial Forecasts (page 2
5 of Exhibit No. 12, Schedule 17). The average expected
6 yield on A rated public utility bonds is 7.5%, as shown
7 on page 1 of Exhibit No. 12, Schedule 17. As discussed
8 supra, adjustments were made to reflect the average bond
9 ratings of each proxy group (see Notes 2 and 3 on
10 Schedule 17, page 1). Consequently, the average
11 prospective bond yield applicable to my primary proxy
12 group of five water companies is 7.6%, while a
13 prospective yield of 7.5% is applicable to my secondary
14 proxy group of six Value Line water companies used only
15 as a check.
16 3. Estimation of the Equity Risk Premium
17 Q Please explain the method utilized to
18 estimate the equity risk premium.
19 A I evaluated the results of two different
20 historical equity risk premium studies, as well as Value
21 Line's forecasted total annual return on the market over
22 the prospective yield on high grade corporate bonds, as
23 detailed on pages 8, 9 and 10 of Exhibit No. 12, Schedule
24 17. As shown on Line No. 3, page 8 of Schedule 17, the
25 mean equity risk premiums based on both of the studies
344
Hanley, Di 50
United Water Idaho, Inc.
1 are 4.0% and 3.9% applicable to the proxy groups of five
2 water companies and the six Value Line water companies,
3 respectively. These estimates are the result of an
4 average of beta-derived historical equity risk premiums,
5 and a forecasted total market equity risk premium as well
6 as the mean historical equity risk premium applicable to
7 public utilities with bonds rated A based on holding
8 period returns.
9
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Hanley, Di 50A
United Water Idaho, Inc.
1 The basis of the beta-derived equity risk premiums
2 applicable to the proxy groups are shown on page 9 of
3 Exhibit No. 12, Schedule 17. Beta-determined equity risk
4 premiums should receive substantial weight because betas
5 are derived from the market prices of common stocks over
6 a recent five-year period. Beta is a meaningful measure
7 of prospective relative risk to the market as a whole and
8 is a logical means by which to allocate a relative share
9 of the market's total equity risk premium.
10 The total market equity risk premium utilized was
11 5.2% and is based upon an average of both the long-term
12 historical and forecasted market risk premiums of 6.7%
13 and 3.7%, respectively, as shown on page 9 of Exhibit
14 No. 12, Schedule 17. To derive the historical market
15 equity risk premium, I used the most recent Ibbotson
16 Associates' data on holding period returns for the S&P
17 500 Composite Index and Salomon Brothers Long-term
18 High-grade Corporate Bond Index covering the period
19 1926-1996. The use of holding period returns over a very
20 long period of time is useful in the beta approach. As
21 Ibbotson Associates'19 1997 Yearbook states:
22 A long view of capital market history, exemplified
by the 71-year period (1926-1996) examined here,
23 uncovers the basic relationships between risk and
return among the different asset classes, and
24 between nominal and real (inflation-adjusted)
returns. The goal of this study of asset returns
25 is to provide a period long enough to include most
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Hanley, Di 51
United Water Idaho, Inc.
1 or all of the major types of events that investors
have experienced and may experience in the future.
2 Such events include
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24 19 Ibbotson Associates, Stocks, Bonds, Bills and
Inflation - 1997 Yearbook, pp. 27 and 153.
25
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Hanley, Di 51A
United Water Idaho, Inc.
1 war and peace, growth and decline, bull and bear
markets, inflation and deflation, as well as less
2 dramatic events that affect asset returns.
3 By studying the past, one can make inferences
about the future. While the actual events that
4 occurred in 1926-1996 will not be repeated, the
event-types (not specific events) of that period
5 can be expected to recur. It is sometimes said
that one period or another is unusual -- such as
6 the crash of 1929-1932 and World War II. This
logic is suspicious because all periods are
7 unusual. One of the most unusual events of the
century -- the stock market crash of 1987 -- took
8 place during the last decade; the equally
remarkable inflation of the 1970s and early 1980s
9 took place just over a decade ago. From the
perspective that historical event-types tend to
10 repeat themselves, a 71-year examination of past
capital market returns reveals a great deal about
11 what may be expected in the future. (italics
added)
12
* * *
13
Some analysts calculate the expected equity risk
14 premium over a shorter, more recent time period on
the basis that more recent events are more likely
15 to be repeated in the near future; furthermore,
the 1920s, 1930s and 1940s contain too many
16 unusual events. This view is suspect because all
periods contain unusual events. Some of the most
17 `unusual' events of this century took place quite
recently. These events include the inflation of
18 the late 1970s and early 1980s, the October 1987
stock market crash, the collapse of the high yield
19 bond market, the major contraction and
consolidation of the thrift industry, and the
20 collapse of the Soviet Union -- all of which
happened in the past 10 years. Without an
21 appreciation of the 1920s and 1930s, no one would
believe that such events could happen. (italics
22 added)
23 In addition to the foregoing, the use of long-term
24 data is consistent with the long-term investment horizon
25 for utilities' common stocks. Consequently, the
348
Hanley, Di 52
United Water Idaho, Inc.
1 long-term arithmetic mean total return rates on the
2 market as a whole of 12.7% and on corporate bonds of 6.0%
3 were used, as shown at Line Nos. 1 and 2 of page 9 of
4 Exhibit No. 12, Schedule 17. As shown on Line No. 3 of
5 the same
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Hanley, Di 52A
United Water Idaho, Inc.
1 page, the resultant long-term historical equity risk
2 premium on the market as a whole is 6.7%.
3 Arithmetic mean return rates were used because
4 they are appropriate for cost of capital purposes. As
5 Ibbotson Associates 20 states:
6 The expected equity risk premium should always be
calculated using the arithmetic mean. The
7 arithmetic mean is the rate of return which, when
compounded over multiple periods, gives the mean
8 of the probability distribution of ending wealth
values....Stated another way, the arithmetic mean
9 is correct because an investment with uncertain
returns will have a higher expected ending wealth
10 value than an investment which earns, with
certainty, its compound or geometric rate of
11 return every year.... Therefore, in the investment
markets, where returns are described by a
12 probability distribution, the arithmetic mean is
the measure that accounts for uncertainty, and is
13 the appropriate one for estimating discount rates
and the cost of capital. (italics added)
14
15 Ex-post (historical) total returns and equity risk
16 premium spreads differ in size and direction over time.
17 It is precisely for this reason why the arithmetic mean
18 is important. It is the arithmetic mean which provides
19 insight into the variance and standard deviation of
20 returns. It is this prospect for variance, and hence the
21 arithmetic mean, which provides the valuable insight
22 needed by investors to estimate future risk when making a
23 current investment. Absent valuable insight into the
24 potential variance of returns, there can be no meaningful
25 evaluation of prospective risk. All of the cost of
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Hanley, Di 53
United Water Idaho, Inc.
1 equity models, including the DCF, are premised upon the
2 Efficient Market Hypothesis, that all publicly available
3 information, and hence all relevant risk, is reflected in
4 the
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25 20 Id., at pp. 154-155.
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Hanley, Di 53A
United Water Idaho, Inc.
1 market prices paid. If investors relied upon the
2 geometric mean of ex-post spreads, they would have no
3 insight into the potential variance of future returns
4 because the geometric mean relates the change over many
5 periods to a constant rate of change, thereby obviating
6 the year-to-year fluctuations, or variance, critical to
7 risk analysis.
8 The basis of the forecasted market equity risk
9 premium can be found on Line Nos. 4 through 6 on page 9
10 of Exhibit No. 12, Schedule 17. It is derived from an
11 average of the most recent 12-month, 6-month, 3-month
12 (using the months of August 1996 through September 1997)
13 and a recent spot (September 29, 1997) median market
14 price appreciation potentials by Value Line as explained
15 in detail in Note 1 on page 4 of Exhibit No. 12, Schedule
16 18. The average expected price appreciation is 41% which
17 translates to 8.97% per annum and, when added to the
18 average (similarly calculated) dividend yield of 1.83%
19 equates to a forecasted annual total return rate on the
20 market as a whole of 10.80%, which rounds to 10.8%.
21 Thus, this methodology is consistent with the use of the
22 12-month, 6-month, 3-month and spot dividend yields in my
23 application of the DCF model. To derive the forecasted
24 total market equity risk premium of 3.7% shown on Exhibit
25 No. 12, Schedule 17, page 9, Line No. 6, the October 1,
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Hanley, Di 54
United Water Idaho, Inc.
1 1997 forecast of about 50 economists of the expected
2 yield on Aaa rated corporate bonds for the six calendar
3 quarters ending with the first calendar quarter 1999 of
4 7.1% from Blue Chip Financial Forecasts was deducted from
5 the Value Line total market return of 10.8%. The
6 calculation resulted in an
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Hanley, Di 54A
United Water Idaho, Inc.
1 expected market risk premium of 3.7%.
2 The average of the historical and projected market
3 equity risk premiums of 6.7% and 3.7% is 5.2%.
4 On page 11 of Exhibit No. 12, Schedule 17, the
5 most current Value Line betas for the companies in both
6 proxy groups are shown. The average betas for the proxy
7 groups of five and six Value Line water companies are
8 0.63 and 0.58, respectively. Applying these betas to the
9 average market equity risk premium of 5.2% yields equity
10 risk premiums of 3.3% for the five water companies, 3.0%
11 for the six Value Line water companies as shown on
12 Exhibit No. 12, Schedule 17, page 9, Line No. 9.
13 A mean equity risk premium of 4.7% applicable to
14 companies with A rated public utility bonds was
15 calculated based on holding period returns from a study
16 using public utilities, as shown on Line No. 2, page 8 of
17 Exhibit No. 12, Schedule 17 and detailed on page 10 of
18 the same Schedule.
19 The equity risk premiums applicable to the proxy
20 groups of five and six Value Line water companies are the
21 average of the beta derived premiums and those based upon
22 the holding period returns of public utilities with A
23 rated bonds, as summarized on Exhibit No. 12, Schedule
24 17, page 8, i.e., 4.0% and 3.9%, respectively.
25 Q What are the RPM calculated common equity
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Hanley, Di 55
United Water Idaho, Inc.
1 cost rates?
2 A They are 11.6% for the five water companies
3 and 11.4% for the six Value Line water companies as shown
4 on Exhibit No. 12, Schedule 17, page 1.
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Hanley, Di 55A
United Water Idaho, Inc.
1 Q Some critics of the RPM model claim that
2 its weakness is that it presumes a constant equity risk
3 premium. Is such a claim valid?
4 A No. The equity risk premium varies
5 inversely with interest rate changes, although not in
6 tandem with those changes. This is no different than the
7 "g", or growth component, in the DCF model. If one
8 calculates a DCF cost rate today, the absolute result
9 "k", as well as the growth component "g", would
10 invariably differ if a calculation were made again just
11 one or several months later. This implies that the "g"
12 does change, although in the application of the standard
13 DCF model, the "g" is presumed to be constant. So, there
14 is no difference between the RPM and DCF models in that
15 regard, i.e., both models assume an expectationally
16 constant equity risk premium and growth rate,
17 respectively, but in actuality, both change regularly.
18 As Morin21 states with regard to the DCF model:
19 It is not necessary that g be constant year after
year to make the model valid. The growth rate may
20 vary randomly around some average expected value.
Random variations around trend are perfectly
21 acceptable, as long as the mean expected growth is
constant. The growth rate must be `expectationally
22 constant' to use formal statistical jargon.
(italics added)
23
24 The foregoing confirms that the RPM is no different from
25 the DCF model. Both assume an "expectationally constant"
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United Water Idaho, Inc.
1 risk premium and growth rate, respectively, but in
2 reality they vary (change) randomly around the mean.
3 That mean, or arithmetic average, confirms the use of the
4 arithmetic mean, and not the
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25 21 Id., p. 111.
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Hanley, Di 56A
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1 geometric mean, in the determination of equity risk
2 premium as discussed supra.
3 C. The Capital Asset Pricing Model (CAPM)
4 1. Theoretical Basis
5 Q Please explain the theoretical basis of the
6 CAPM.
7 A The CAPM defines risk as the covariability
8 of a security's returns with the market's returns. This
9 covariability is measured by beta ("B"), an index measure
10 of an individual security's variability relative to the
11 market. A beta less than 1.0 indicates lower variability
12 while a beta greater than 1.0 indicates greater
13 variability than the market.
14 The CAPM assumes that all other risk, i.e., all
15 non-market or unsystematic risk, can be eliminated
16 through diversification. The risk that cannot be
17 eliminated through diversification is called market, or
18 systematic, risk. The model presumes that investors
19 require compensation for risks that cannot be eliminated
20 through diversification. Systematic risks are caused by
21 socioeconomic and other events that affect the returns on
22 all assets. In essence, the model is applied by adding a
23 risk-free rate of return to a market risk premium. This
24 market risk premium is adjusted proportionally to reflect
25 the systematic risk of the individual security relative
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Hanley, Di 57
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1 to the market as measured by beta. The traditional CAPM
2 model is expressed as:
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1 Rs = Rf + B (Rm-Rf)
2 Where: Rs = Return rate on the common stock
3 Rf = Risk-free rate of return
4 Rm = Return rate on the market as a
whole
5
B = Adjusted beta (volatility of the
6 security relative to the market
as a whole)
7
8 Numerous tests of the CAPM have confirmed its
9 validity. These tests have measured the extent to which
10 security returns and betas are related as predicted by
11 the CAPM. Morin observes that while the results support
12 the notion that beta is related to security returns, it
13 has been determined that the empirical Security Market
14 Line (SML) described by the CAPM is not as steeply sloped
15 as the predicted SML. Morin22 states:
16 With few exceptions, the empirical studies agree
that the implied intercept term exceeds the
17 risk-free rate and the slope term is less than
predicted by the CAPM. That is, low-beta
18 securities earn returns somewhat higher than the
CAPM would predict, and high-beta securities earn
19 less than predicted.
20 * * *
21 Therefore, the empirical evidence suggests that
the expected return on a security is related to
22 its risk by the following approximation:
23 K = RF + x (RM-RF) + (1-x) B (RM-RF)
24 where x is a fraction to be determined
empirically. ...the value of x that best explains
25 the observed relationship is between 0.25 and
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1 0.30. If x = 0.25, the equation becomes:
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1 K = RF + 0.25(RM-RF) + 0.75B(RM-RF)23
2 In view of theory and practical research, I have
3 applied both the traditional CAPM and the empirical CAPM
4 to the companies in both proxy groups and averaged the
5 results.
6 2. Risk-Free Rate of Return
7 Q Please describe your selection of a
8 risk-free rate of return.
9 A My applications of the traditional and
10 empirical CAPM are summarized on Exhibit No. 12, Schedule
11 18, page 1. As shown on Line Nos. 1 and 4, the risk-free
12 rate adopted for both applications is 6.5%. It is based
13 upon the average consensus forecast of the reporting
14 economists in the October 1, 1997 issue of Blue Chip
15 Financial Forecasts as shown in Note 2, page 4, of the
16 expected yields on 30-year U.S. Treasury bonds for the
17 six quarters ending with the first calendar quarter 1999.
18 Q Why is the prospective yield on 30-year
19 U.S. Treasury Bonds appropriate for use as the risk-free
20 rate?
21 A My analysis on page 5 of Exhibit No. 12,
22 Schedule 18 shows the yields on key indicators of
23 interest rates by month for the most recent five years,
24 September 1992 through August 1997. As shown, the
25 standard deviation of the yield on Federal funds is the
362
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United Water Idaho, Inc.
1 greatest followed closely by the 90-day T-Bill rate and
2 the Fed's discount rate. The Fed uses the Federal Funds
3 Rate to control money
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1 supply and fight inflation. Utility capital costs are
2 best reflected by the trend in the yields on Moody's A
3 rated utility bonds which had a standard deviation over
4 the period of 0.4765, very close to the standard
5 deviation of the yields on 30-year Treasury bonds of
6 0.5257. These standard deviations contrast markedly with
7 the highly volatile 1.1510 for Fed funds and 1.0216 for
8 the 90-day T-Bill as well as 0.9823 for the discount
9 rate. I believe it is clear that the yield on 30-year
10 T-Bonds is almost risk-free, closely approximates the
11 change in the long-term cost of capital to public
12 utilities measured by the yields on A rated utility
13 bonds, and is consistent with the long-term investment
14 horizon inherent in common stocks. Morin24 states:
15 Equity investors generally have an investment
horizon far in excess of ninety days. More
16 importantly, the short-term T-bill yields reflect
the impact of factors different from those
17 influencing long-term securities, such as common
stock. For example, the premium for expected
18 inflation absorbed into 90-day Treasury bills is
likely to be far different than the inflationary
19 premium absorbed into long-term securities yields.
The yields on long-term Treasury bonds match more
20 closely with common stock returns. For investors
with a long time horizon, a long-term government
21 bond is almost risk-free. (italics added)
22
23 As to the use of the highly volatile Treasury Bill
24 rate, Morin cites Brigham and Gapenski who
25 conclude25:
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United Water Idaho, Inc.
1 Treasury bill rates are subject to more random
disturbances than are Treasury bond rates. For
2 example, bills are used by the Federal Reserve
System to control the money supply, and bills are
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24 24 Id., at p. 308.
25 25 Id., at p. 308.
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United Water Idaho, Inc.
1 also used by foreign governments, firms, and
individuals as a temporary safe-house for money.
2 Thus, if the Fed decides to stimulate the economy,
it drives down the bill rate and the same thing
3 happens if trouble erupts somewhere in the world
and money flows into the United States seeking a
4 temporary haven.
5 In summary, the average expected yield on 30-year
6 Treasury Bonds is the appropriate proxy for the risk-free
7 rate in the CAPM because it is less volatile than
8 Treasury Bills, most closely matches the volatility of
9 public utility long-term debt yields, is almost risk-free
10 as noted by Morin supra and is consistent with the
11 long-term investment horizon implicit in common stocks.
12 3. Market Equity Risk Premium
13 Q Please explain the estimation of the
14 expected equity risk premium for the market.
15 A First, I estimate investors' expected total
16 return rate for the market. Then I estimate the expected
17 risk-free rate which I subtract from the expected total
18 return rate for the market. The result is an expected
19 equity risk premium for the market, some proportion of
20 which must be allocated to the companies in both proxy
21 groups. I make the allocations through the use of beta,
22 a measure of risk related to the market as a whole.
23 Thus, beta is an appropriate means by which to apportion
24 the market risk premium to a specific company or group.
25 As shown on Exhibit No. 12, Schedule 18, page 1,
366
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United Water Idaho, Inc.
1 Line No. 2, the proportional market equity risk premiums,
2 based on the traditional CAPM, are 3.7% for the proxy
3 group of five water companies and 3.4% for the proxy
4 group of six Value Line water companies. Applying the
5 empirical CAPM results in
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Hanley, Di 61A
United Water Idaho, Inc.
1 equity risk premiums of 4.3% for the five water companies
2 and 4.1% for the six Value Line water companies, as shown
3 on Line No. 5 on page 1 of Schedule 18. The total market
4 equity risk premium utilized was 5.9% and is based upon
5 an average of the long-term historical and projected
6 market risk premiums.
7 The basis of the projected median market equity
8 risk premium is explained in detail in Note 1 on page 4
9 of Exhibit No. 12, Schedule 18. As previously discussed,
10 it is derived from an average of the most recent
11 12-month, 6-month, 3-month (using the months of August
12 1996 through September 1997) and a recent spot (September
13 30, 1997) 3 - 5 year median total market price
14 appreciation projections from Value Line and the
15 long-term historical average from Ibbotson Associates.
16 The appreciation projections by Value Line and average
17 dividend yield equate to a forecasted annual total return
18 rate on the market of 10.8%. The long-term historical
19 return rate of 12.7% on the market as a whole is from
20 Ibbotson Associates' Stocks, Bonds, Bills and
21 Inflation-1997 Yearbook. In each instance, the relevant
22 risk-free rate was deducted from the total market return
23 rate. For example, from the Value Line projected total
24 market return of 10.8%, the forecasted average risk-free
25 rate of 6.5% was deducted indicating a forecasted market
368
Hanley, Di 62
United Water Idaho, Inc.
1 risk premium of 4.3%. From the Ibbotson Associates'
2 long-term historical total return rate of 12.7%, the
3 long-term historical income return rate on long-term
4 U.S. Government Securities of 5.2% was deducted
5 indicating an historical equity risk premium of 7.5%.
6 Thus, the average of the projected and historical total
7 market risk premiums of 4.3%
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United Water Idaho, Inc.
1 and 7.5%, respectively, is 5.9%.
2 Q What are the results of your applications
3 of the traditional and empirical CAPM to the companies in
4 the proxy groups?
5 A As shown on Exhibit No. 12, Schedule 18,
6 Line No. 3 of page 1, the average traditional CAPM cost
7 rates are 10.2% for the proxy group of five water
8 companies and 9.9% for the proxy group of six Value Line
9 water companies. As shown on Line No. 6 of page 1, the
10 average empirical CAPM cost rates are 10.8% for the proxy
11 group of five water companies and 10.6% for the proxy
12 group of six Value Line water companies. The traditional
13 and empirical CAPM cost rates are shown by group and by
14 company on pages 2 and 3, respectively, of Exhibit No.
15 12, Schedule 18. As shown on Line No. 7, the average
16 CAPM cost rate applicable to the more relevant proxy
17 group of five water companies is 10.5%.
18 D. Comparable Earnings Model (CEM)
19 Q Please describe your comparable earnings
20 model and how it is used to determine common equity cost
21 rate.
22 A My CEM is summarized in Exhibit No. 12,
23 Schedule 19 which consists of four pages. Page 1 relates
24 to my primary proxy group of five water companies, while
25 pages 2 and 3 relate to my secondary proxy group of six
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Hanley, Di 63
United Water Idaho, Inc.
1 Value Line companies used as a check. Page 4 contains
2 the notes related to pages 1 through 3.
3 Comparable earnings is derived from the
4 "corresponding risk" standard of the landmark cases of
5 the U.S. Supreme Court. Thus, comparable earnings is
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Hanley, Di 63A
United Water Idaho, Inc.
1 consistent with the Hope doctrine that the return to the
2 equity owner should be commensurate with returns on
3 investments in other firms having corresponding risks.
4 The CEM is based on the opportunity cost principle
5 which maintains that the true cost of an investment is
6 equal to the cost of the best available alternative use
7 of the funds to be invested. The opportunity cost
8 principle is consistent with one of the fundamental
9 principles upon which regulation rests: it is intended
10 to act as a surrogate for competition and to provide a
11 fair rate of return to investors.
12 The CEM is designed to measure the returns
13 expected to be earned on the book common equity, in this
14 case net worth, of similar risk enterprises. Thus, it
15 provides a direct measure of return, since it translates
16 into practice the competitive principle upon which
17 regulation rests. In my opinion, the use of the achieved
18 returns of regulated utilities of similar risk would be
19 an exercise in circular reasoning and inconsistent with
20 the principle of being equal in risk to non-price
21 regulated firms.
22 The difficulty in application of the CEM is to
23 select a proxy group of companies which are similar in
24 risk, but are not price regulated utilities.
25 Consequently, the first step in determining a cost of
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Hanley, Di 64
United Water Idaho, Inc.
1 common equity using the comparable earnings model is to
2 choose an appropriate proxy group of non-price regulated
3 firms. The proxy group should be broad-based in order to
4 obviate any company-specific aberrations. Utilities
5 should be eliminated to avoid circularity
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Hanley, Di 64A
United Water Idaho, Inc.
1 since the returns on book common equity of utilities are
2 substantially influenced by regulatory awards.
3 I have chosen a proxy group of domestic, non-price
4 regulated, firms to reflect both the systematic and
5 unsystematic risks of my primary proxy group of five
6 water companies. The proxy group of non-utility
7 companies is listed on page 1 of Exhibit No. 12, Schedule
8 19. The criteria used in the selection of these proxy
9 companies were that they be domestic non-utility
10 companies and have a rate of return on net worth or
11 partners' capital reported in Value Line. Value Line
12 betas were used as a measure of systematic risk. The
13 residual standard error, or the standard error of the
14 estimate from the regression equation from which each
15 company's beta was derived, was used as a measure of each
16 firm's specific, i.e., unsystematic risk. The residual
17 standard error reflects the extent to which events
18 specific to a company's operations will affect its stock
19 price. Thus, the residual standard error is a measure of
20 diversifiable, unsystematic, company-specific risk. In
21 essence, companies which have similar betas and residual
22 standard errors, have similar investment risk, i.e., the
23 sum of systematic (market) risk as reflected by beta and
24 unsystematic (business and financial) risk, as reflected
25 by the residual standard error, respectively. Those
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Hanley, Di 65
United Water Idaho, Inc.
1 statistics are derived from regression analyses using
2 market prices which, under the Efficient Market
3 Hypothesis, reflect all relevant risks. Thus, their use
4 results in proxy non-price regulated firms similar in
5 risk to the average company in my primary proxy group of
6 five water companies.
7 The non-price regulated firms were chosen based on
8 ranges of unadjusted
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Hanley, Di 65A
United Water Idaho, Inc.
1 beta and residual standard error. The ranges were based
2 upon the average standard deviations of the unadjusted
3 beta and the average residual standard error.
4 The five water companies have an average
5 unadjusted beta of 0.38 whose standard deviation is
6 0.0966 as of September 15, 1997, as shown in Note 5, page
7 4 of Exhibit No. 12, Schedule 19. The average residual
8 standard error from the regression equations which
9 derived the proxy group's average unadjusted beta is
10 2.1230 as shown on Schedule 19, page 1 with a standard
11 deviation of 0.933 as derived in Note 6, page 4 of
12 Exhibit No. 12, Schedule 19. Ranges of unadjusted betas
13 from 0.09 to 0.67 and of residual standard errors from
14 1.8431 to 2.4029 were used to select the proxy group of
15 domestic non-utility companies comparable to the average
16 profile of the proxy group of five water companies as can
17 be gleaned from page 1 and explained in Note 1 on page 4
18 of Schedule 19. These ranges are based upon the proxy
19 group's average unadjusted beta of 0.46 and average
20 residual standard error of 2.1558 plus or minus three
21 standard deviations of beta (0.0966 x 3 = 0.2898) and
22 residual standard errors (0.0933 x 3 = 0.2799).
23 I believe that this methodology for selecting
24 non-price regulated firms of similar total risk
25 (i.e., non-diversifiable systematic and diversifiable
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United Water Idaho, Inc.
1 non-systematic risk) is meaningful and effectively
2 obviates the criticisms normally associated with the
3 selection of firms presumed to be comparable in total
4 risk. This is because the selection of non-price
5 regulated companies comparable in
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Hanley, Di 66A
United Water Idaho, Inc.
1 total risk is based on regression analyses of market
2 prices which reflect investors' assessment of all risks,
3 diversifiable and non-diversifiable. Thus, my empirical
4 selection process results in companies comparable in both
5 systematic and unsystematic risks, i.e., total risk.
6 Once a proxy group of non-price regulated
7 companies is selected, it is then necessary to derive
8 returns on book common equity, net worth, or partners'
9 capital for the companies in the group. I have measured
10 these returns using the rate of return on net worth
11 reported by Value Line. It is reasonable to measure
12 these returns over both the most recent historical
13 five-year period as well as those projected over the
14 ensuing five-year period.
15 Due to the wide variation in the rates of return
16 on net worth or partners' capital for the non-price
17 regulated companies in the proxy group, the median return
18 is an appropriate indicator of the rate of return
19 applicable to my primary proxy group of five water
20 companies. The most conservative CEM result is 12.6%
21 which is the five-year historical median return as shown
22 on page 1, Schedule 19.
23 I also employed the CEM based on my less
24 comparable proxy group of six Value Line companies which
25 I used only as a check. In so doing, I employed all of
378
Hanley, Di 67
United Water Idaho, Inc.
1 the same procedures described supra with regard to my
2 primary proxy group of five water companies. The most
3 conservative CEM result based on the proxy group of six
4 Value Line companies is 12.0% as shown on page 3,
5 Schedule 19.
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Hanley, Di 67A
United Water Idaho, Inc.
1 X. CONCLUSION OF COMMON EQUITY COST RATE
2 Q What is your recommended common equity cost
3 rate applicable to UWID's ratemaking common equity ratio
4 of 46.73%?
5 A It is 11.30% unadjusted, based on the
6 following common equity cost rates resulting from
7 application of all four cost of common equity models,
8 DCF, RPM, CAPM, and CEM for the primary proxy group of
9 five water companies upon which I base my recommendation
10 as shown on Exhibit No. 12, Schedule 1, page 2 summarized
11 below.
12 Single-Stage Growth DCF Model NMF%
Two-Stage Growth DCF Model 10.5
13 Risk Premium Model 11.6
Capital Asset Pricing Model 10.5
14 Comparable Earnings Model 12.6
15 It is obvious that the single-stage growth DCF model
16 results understate the true cost of equity required by
17 investors against book value when measured against the
18 results derived from the application of the other cost of
19 common equity models. The single-stage growth DCF model
20 results in an unacceptably low implicit equity risk
21 premium due to the fact that market values of the common
22 stocks of the proxy water companies sell at substantial
23 premiums over their book values, and there is no direct
24 relationship between the rates of earnings on book equity
25 and market/book ratios as explained supra. Moreover, the
380
Hanley, Di 68
United Water Idaho, Inc.
1 average company in the group of five water companies is
2 about 2.5 times larger than UWID. Smaller companies have
3 a higher cost of capital, also discussed supra. In
4 addition, S&P's average business position for this group
5 is "high average"
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United Water Idaho, Inc.
1 compared with only an "average" business position for
2 United Waterworks. United Waterworks, i.e., the
3 consolidated entity, enjoys considerable
4 geographic/regulatory diversity and is 4.4 times larger
5 than UWID viewed alone. Surely, if UWID were to raise
6 its external capital directly, instead of through its
7 parent, its cost of debt capital would be higher due to
8 its small size and other potentially adverse
9 circumstances which increase its business risk vis-a-vis
10 the five water companies as discussed supra which would
11 probably result in either a "low average" business
12 position with an A rating or an "average" business
13 position with an A-or BBB+ bond rating. Consequently, I
14 believe the addition of 20 basis points to the 11.30%
15 unadjusted cost rate based on the proxy group of five
16 water companies is appropriate to reflect UWID's added
17 risk thereby resulting in a common equity cost rate of
18 11.50%.
19 XI. CHECKS ON THE REASONABLENESS OF THE
INDICATED COMMON EQUITY COST RATE
20
21 A. Interest Coverage
22 Q How does interest coverage affect the cost
23 rate of common equity capital?
24 A Interest coverage is defined as the number
25 of times annual interest on debt has been earned. It is
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Hanley, Di 69
United Water Idaho, Inc.
1 the relationship between the income available to pay
2 interest charges and total interest charges. Earnings
3 available for common equity provide the margin by which
4 fixed charges are covered more than once. Investors use
5 coverage as a tool to measure the relative safety of
6 their investment.
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United Water Idaho, Inc.
1 Rating agencies such as S&P place greater emphasis
2 on pretax interest coverage as it levels financial risk
3 differences between enterprises, reflects the fact that
4 interest is paid before income taxes, and more accurately
5 reflects the availability of cash from operations from
6 which interest charges can be paid. The major bond
7 rating agencies, and hence investors, review interest
8 coverage trends in conjunction with current developments.
9 Q What is the opportunity for interest
10 coverage before income taxes implicit in the requested
11 overall cost of capital of 9.76%?
12 A It is 3.05 times as shown on Exhibit
13 No. 12, Schedule 1, page 1. This opportunity to earn
14 interest coverage is very reasonable for several reasons.
15 First, it is reasonable when compared to S&P's
16 financial benchmark of pretax interest coverage for water
17 companies as shown on Exhibit No. 12, Schedule 2, page
18 11. As shown there, coverage of 3.00 times is required
19 to be earned for an A bond rating and an "average"
20 business position. As mentioned previously, I believe
21 that UWID, viewed as a stand-alone, would likely have a
22 business position of "low average" which would likely
23 require pretax interest coverage of 3.25 times for an
24 A bond rating by S&P.
25 Second, the larger and less business risky proxy
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United Water Idaho, Inc.
1 group of five water companies on average has an A bond
2 rating and "high average" business position by S&P
3 (Exhibit No. 12, Schedule 17, page 3). S&P requires 2.75
4 times pretax interest coverage for an A bond rating and
5 "high average" business position but these companies, on
6 average, actually achieved pretax interest coverage of
7 3.08
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United Water Idaho, Inc.
1 times for the five years ending 1996; 3.25 times for the
2 three years ending 1996; and 3.14 times in 1996 as shown
3 on Exhibit No. 12, Schedule 5, page 1.
4 In view of the foregoing, an opportunity for UWID
5 to earn pretax interest coverage of 3.05 times is quite
6 reasonable.
7 B. Secondary Proxy Group
8 Q Does your use of a secondary proxy group
9 used as a check substantiate your recommended common
10 equity cost rate of 11.50% applicable to UWID's
11 ratemaking common equity ratio of 46.73%?
12 A Yes. Application of all the cost of equity
13 models results in the observation that all the DCF
14 indicators of cost rate for this group are unrealistic,
15 i.e., less than 10% for both single-and two-stage growth
16 rates. Consequently, as shown on Schedule 1, page 2, I
17 conclude that an unadjusted cost rate of 11.20% is
18 applicable to this group which has a "high average"
19 business position and a solid A+ S&P bond rating.
20 Consequently, I believe conservatively, 30 basis points
21 need to be added to the unadjusted cost rate of 11.20% in
22 order to have a cost rate reflective of UWID's risk,
23 i.e., a very much smaller and more business risky company
24 vis-a-vis the average company in this group which is 8.2
25 times larger than UWID. Moreover, the average bond
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Hanley, Di 71
United Water Idaho, Inc.
1 rating of A+ and "high average" business position makes
2 this group much less risky than UWID.
3 I believe that the interest coverage and secondary
4 proxy group checks confirm my recommended 11.50% common
5 equity cost rate as reasonable.
6 Q Does this conclude your direct testimony?
7 A Yes.
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United Water Idaho, Inc.
1 (The following proceedings were had in
2 open hearing.)
3 COMMISSIONER NELSON: Mr. Hanley is
4 available for cross-examination?
5 MR. HILL: Yes, sir.
6 COMMISSIONER NELSON: Mr. Fothergill, did
7 you have questions?
8 MR. FOTHERGILL: No questions.
9 COMMISSIONER NELSON: Ms. Ullman.
10 MS. ULLMAN: Yes, thank you, Mr. Chairman,
11 I do have one question.
12
13 CROSS-EXAMINATION
14
15 BY MS. ULLMAN:
16 Q Mr. Hanley, you were here, I assume, when
17 Mr. Healy was testifying earlier today and referred to
18 making decisions based on common sense in some cases and
19 so I guess I'm going to ask from a common sense
20 perspective, the 9.76 percent rate of return requested by
21 United Water is actually higher than the rate of return
22 that they are currently entitled to; is that correct?
23 A Yes, I believe that Mr. Gennari has
24 indicated that and it's my understanding as well that the
25 revenue requirement has been revised downward to
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CSB REPORTING HANLEY (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 approximately $3.1 million principally, but not
2 exclusively, on the result of a reduced claim in the
3 overall cost of capital or fair rate of return down from
4 9.76 percent to 9.46 percent.
5 Q And in general, again from the common sense
6 perspective, if as a ratepayer observing the market right
7 now, what has been the trend in interest rates over the
8 most recent couple of years?
9 A Well, the most recent couple of years the
10 trend has been down somewhat. I wouldn't say
11 dramatically, certainly not in the last couple of years,
12 but down somewhat.
13 MS. ULLMAN: Thank you. That's all.
14 COMMISSIONER NELSON: Thank you,
15 Ms. Ullman.
16 Mr. Woodbury.
17 MR. WOODBURY: Thank you, Mr. Chairman.
18
19 CROSS-EXAMINATION
20
21 BY MR. WOODBURY:
22 Q Mr. Hanley, I just have a couple of
23 questions on your direct. Does United Waterworks issue
24 common stock that is publicly traded?
25 A No. It has common stock outstanding, but,
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CSB REPORTING HANLEY (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 of course, that's not publicly traded.
2 Q Does United Water Resources issue common
3 stock that's publicly traded?
4 A It has common stock that is traded, yes.
5 Q And that is the stock that is available
6 locally here to customers of United Water?
7 A Well, I would assume that anyone who is
8 interested in buying stock, I assume that there are a
9 proliferation of brokerage houses in Idaho as elsewhere
10 in the country and if one wants to buy the stock, one
11 merely needs to pick up the phone and call a broker, so
12 clearly, one can do it if one chooses.
13 Q Referring you to your testimony on page 68,
14 line 23, you have a statement, "Smaller companies have a
15 higher cost of capital." It sort of stands alone, but
16 isn't this all other things being equal, smaller
17 companies have a higher cost of capital?
18 A Well, I'm not sure what you mean when you
19 say "all other things being equal." Between small
20 companies --
21 Q Is this a statement, then, that bigger is
22 always better and if you are bigger, then you command a
23 better rate in the marketplace?
24 A Generally speaking, bigger tends to create
25 more dispersion, if you will, or less risk of volatility,
390
CSB REPORTING HANLEY (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 business lines, different enterprises. For example, if
2 General Motors only made Chevrolets and not a variety of
3 other products and be involved in other endeavors as
4 well, I think it would be more susceptible and more
5 risky.
6 Similarly, small companies tend to have a
7 smaller customer base and, for example, United Water
8 Idaho being here, being the Company and not looking at a
9 large holding company that owns many other companies all
10 around the country such as United Water Resources that
11 has a large geographical dispersion and so forth, to get
12 the benefits, United Water Idaho, for example, has to
13 operate here and is subject to, for example, the weather
14 conditions here and relatively little rainfall compared
15 to many other parts of the country.
16 Q Is a smaller company always more risky?
17 A Always, I couldn't answer that. In order
18 to do that, I would have to make an analysis of virtually
19 every company in the universe.
20 Q Then your statement here "Smaller companies
21 have a higher cost of capital" is not true in all
22 instances?
23 A Well, it is absolutely true as a general
24 concept in finance. That is true. Virtually every
25 textbook, everything on the subject is smaller companies
391
CSB REPORTING HANLEY (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 tend to be more risky. Smaller cap stocks, for example,
2 in the marketplace tend to have higher returns on them
3 than larger cap stocks. That's proof of the pudding.
4 Q Proof of the pudding. Do you realize that
5 United Water Idaho is the largest regulated water company
6 that we have in this state?
7 A That would not surprise me, but as I
8 pointed out, compared to other water companies, it's
9 small.
10 Q And compared to the other water companies
11 within the umbrella of United Waterworks, where does it
12 rank under the 24 water companies that are there?
13 A Well, I really --
14 Q There's a total of 300,000 customers, the
15 testimony reflects, and we have 67,000.
16 A Well, in terms of United Waterworks, that's
17 true. One could infer that that's a fairly sizable
18 portion of United Waterworks, but when you look at
19 companies whose stocks are actively traded and that are
20 not substantial holding companies, like American Water
21 Works or United Water Resources, and you look at those
22 independent operating water companies who have stocks
23 that are traded and you look at their average size,
24 United Water Idaho is relatively small.
25 MR. WOODBURY: Thank you, Mr. Hanley. No
392
CSB REPORTING HANLEY (X)
Wilder, Idaho 83676 United Water Idaho Inc.
1 further questions.
2 COMMISSIONER NELSON: Thank you,
3 Mr. Woodbury.
4 COMMISSIONER NELSON: Mr. Hill, any
5 redirect?
6 MR. HILL: Yes, Mr. Chairman, just one
7 point of clarification, if I may.
8
9 REDIRECT EXAMINATION
10
11 BY MR. HILL:
12 Q Mr. Hanley, you were questioned by
13 Mr. Woodbury regarding the availability of United Water
14 Resources' common stock in the Idaho area. Do you recall
15 that line of questioning?
16 A Yes.
17 Q Did you interpret that question to mean
18 that United Water Resources was the only water utility
19 common stock available to Idaho customers?
20 A Well, no, I answered in the context of
21 could people here buy a share of United Water Resources
22 and I think the answer is yes, they could.
23 Q And certainly, as shown in your testimony
24 and in Staff's testimony, there are many other
25 publicly-traded water companies that are available to
393
CSB REPORTING HANLEY (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 investors not only in Boise but across the country?
2 A Absolutely.
3 MR. HILL: That's all. Thank you.
4 COMMISSIONER NELSON: Thank you.
5 Mr. Hanley, thank you for your testimony.
6 (The witness left the stand.)
7 COMMISSIONER NELSON: Does that complete
8 the first round?
9 MR. MILLER: I think that concludes the
10 Applicant's direct case, Mr. Chairman. Thank you.
11 COMMISSIONER NELSON: All right, thank
12 you.
13 I believe then we'll go to Ms. Ullman, and
14 as I discussed during the break, Mr. Woodbury, would you
15 get Ms. Ullman on the record after she's sworn?
16
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394
CSB REPORTING HANLEY (Di)
Wilder, Idaho 83676 United Water Idaho Inc.
1 SHARON ULLMAN,
2 produced as a witness at the instance of the Intervenor
3 Sharon Ullman, having been first duly sworn, was examined
4 and testified as follows:
5
6 EXAMINATION
7
8 BY MR. WOODBURY:
9 Q Ms. Ullman, please state your name and
10 spell your last name for the record.
11 A My name is Sharon Ullman. My last name is
12 spelled U-l-l-m-a-n.
13 Q And are you an intervenor in this case?
14 A Yes, I am.
15 Q And in that capacity, did you have occasion
16 to prefile as direct testimony 13 pages and 16 exhibits,
17 Exhibits 401 through 416?
18 A Yes, I did.
19 Q And have you had the opportunity to review
20 that testimony prior to this hearing?
21 A Yes, I have.
22 COMMISSIONER NELSON: Mr. Woodbury, is your
23 mike on?
24 MR. WOODBURY: I'm sorry.
25 Q BY MR. WOODBURY: And is it necessary to
395
CSB REPORTING ULLMAN
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 make any changes to your prefiled testimony?
2 A Yes, it is.
3 Q And if you could walk me through that, I
4 guess.
5 A Okay. I did pass out at the break a
6 two-page document which states at the top that it is to
7 replace line 9, page 10, through line 22, page 11, of the
8 direct testimony of Sharon Ullman. This change was made
9 necessary because of new data provided by the Company
10 after the original testimony was filed.
11 In addition, I would like to retract
12 lines 15 -- let me go to page 6, line 15, through the
13 word "acceptable" on line 22 due to a misunderstanding on
14 my part and I would simply like to, as I say, retract
15 those lines.
16 Q Page 6 starting at what line?
17 A Line 15.
18 Q Okay, through?
19 A Through the word "acceptable" on line 22.
20 Q Delete that?
21 A Delete that. I would also like to
22 apologize for the improper labeling of my exhibits. I
23 did not follow the Commission's rules and hope that can
24 be corrected. On page 3, line 12, I would like to add
25 the word exempt between "UWI's" and "employees" so that
396
CSB REPORTING ULLMAN
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 it should read, "In addition, UWI noted in its response
2 to the Idaho Cross-Industry Salary and Benefits Survey
3 that 15 percent of UWI's exempt employees are eligible
4 and are actually paid an individual performance bonus
5 averaging 11 percent," and those are the changes I would
6 like to make.
7 Q All right.
8 A I have some additions as well.
9 Q Let's just take this at this point, then.
10 With those changes as to your prefiled direct testimony,
11 then, if I were to read the questions to you, would your
12 answers be as either here or as changed?
13 A Yes, they would.
14 Q And what additions do you have?
15 A I have a couple of additions. I filed a
16 response to United Water's second set of
17 interrogatories. The Company asked me to describe any
18 and all training, education, experience or specialized
19 knowledge that qualifies me to express opinions regarding
20 the reasonableness of executive compensation. They asked
21 a series of similar questions and, for the record, I
22 think that it's necessary to provide some information in
23 addition to what I provided in my direct testimony.
24 I worked as an administrative specialist in
25 human resources at ICOC Corporation then located at 830
397
CSB REPORTING ULLMAN
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 West Modd Avenue in Mountain View, California. In my
2 position as an administrative specialist in human
3 resources, I assisted the director of human resources and
4 the employment manager, served as administrator for
5 benefits, compensation and worker's compensation,
6 prepared salary key indicator reports and weekly and
7 monthly head count reports and maintained all personnel
8 files and records. I also filled out salary surveys.
9 In addition, in college after receiving a
10 grade of A in both microeconomics and macroeconomics, I
11 was offered a job by one of the economics faculty members
12 and worked as a paper grader and tutor for college level
13 economic students.
14 I would like now to refer to the exhibits
15 that I presented earlier during Mr. Linam's testimony and
16 feel that it is necessary to add to my testimony. There
17 was a dispute, as you will recall, about the availability
18 of information from the Company regarding the results of
19 a salary survey in which the Company had participated.
20 Because I was unable to obtain that information from the
21 Company and in a timely manner, I have sought replacement
22 information which I feel these exhibits are.
23 Exhibit 419 specifically refers to the
24 benefits or, excuse me, the management incentives
25 received by various United Water Idaho employees. It
398
CSB REPORTING ULLMAN
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 lists the recipients and the amounts received for 1998,
2 '97, '96 and '95, and I would simply like to point out
3 the disparity between the $28,660 received by Mr. Linam
4 in January of 1998 and all the other amounts listed on
5 this page.
6 I would then like to draw your attention to
7 Exhibit 420 which spells out Mr. Linam's salary as of
8 January 1998 as $117,650, although he testified here
9 today that it has since been increased to 124,000 and I
10 would like to compare that to the salary Mr. Booe was
11 receiving in 1996 of $93,400.
12 I would then like to draw your attention to
13 Exhibit 422. This is information that I obtained, the
14 best I was able to obtain, regarding comparisons in the
15 cost of living between Boise, Idaho, and the area in
16 New Jersey in which Mr. Linam was previously employed
17 before being transferred here. On the second page, which
18 is a cost of living index for selected metropolitan areas
19 from the third quarter of 1996, if you go down to the
20 line that reads Boise City, Idaho, metropolitan service
21 area, the composite index is 103.1. If you will recall,
22 Mr. Linam this morning testified that the area he came
23 from in New Jersey is actually in the New York
24 metropolitan service area. On the following page you
25 will find the New York metropolitan area. The composite
399
CSB REPORTING ULLMAN
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 index for the cost of living index is 234.5, more than
2 twice what it is in Boise, Idaho.
3 In addition, the next document shows just a
4 couple of additional statistics I thought were relevant.
5 The page numbered 401 which is approximately the sixth or
6 seventh page in this exhibit refers to the median monthly
7 mortgage payment for owner-occupied housing units in
8 1990. Unfortunately, it is old data and I recognize
9 that. New Jersey ranked No. 1 in the country as the
10 highest median mortgage payment. Idaho ranked No. 43 in
11 the country at approximately half the cost of New
12 Jersey.
13 The following page shows a median value of
14 a house in 1990 and shows that New Jersey ranked No. 5 in
15 the nation, Idaho ranked No. 37. The cost in New Jersey
16 was more than two-and-a-half times as much, and the last
17 set of data I am providing is in regard to perfect capita
18 personal income.
19 MR. MILLER: Mr. Chairman, I hate to object
20 and I understand there has to be some latitude in terms
21 of the requirement of filing of prefiled testimony, and
22 certainly in the area where wage surveys were in
23 question, the Commission properly ruled that the one that
24 United Water had did not have to be disclosed and so it's
25 reasonable to expect that perhaps Ms. Ullman would have
400
CSB REPORTING ULLMAN
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 to go to alternative sources; nonetheless, that aside,
2 the material we've been listening to for some time and
3 are about to go into then has nothing to do with wage and
4 salary surveys, has nothing to do with the type of
5 information that Ms. Ullman had to find from other
6 sources and could easily have been included in the
7 prefiled testimony to give other parties a fair
8 opportunity to analyze it and respond, so we have tried
9 to be accommodating here, but it has just kind of gone
10 too far, so we would object.
11 COMMISSIONER NELSON: Our process is a
12 little fouled up here when I ask the witness to respond,
13 so I don't know that I'm going to do that, but I would
14 note that Ms. Ullman's testimony was filed on
15 March 6th and while I'm not exactly sure, I think it was
16 after that date that we responded to her request to
17 include that data and so while I realize that this
18 certainly is not along the lines of a salary comparison,
19 I think that I'm going to allow this data in. It is
20 related and so I think we'll allow this exhibit in.
21 THE WITNESS: Thank you, Mr. Chairman. If
22 I might continue, then.
23 MR. MILLER: Well, if it's going to be in,
24 why don't we just put it in and skip the need for oral
25 discussion of it.
401
CSB REPORTING ULLMAN
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 COMMISSIONER NELSON: Well, I think she's
2 just pointing out which parts of this are applicable, so
3 I'm going to allow her to go ahead.
4 MR. MILLER: Very good.
5 THE WITNESS: Thank you, I'm almost done.
6 As I was saying, per capita personal income, New Jersey
7 ranked 3rd in the nation, Idaho ranked 36th in the
8 nation. On the following and last page, the number, the
9 annual household income above $50,000, again this is old
10 data, but I think the relationship between the two states
11 is relevant, New Jersey ranked 3rd, Idaho ranked 40th,
12 4-0.
13 In addition to the cost of living
14 comparison between the two states where Mr. Linam came to
15 Boise, I did go and get the information that was
16 available from this state, Exhibit 421 which I have
17 provided three pages of that information just to cite a
18 few examples. On the third page of Exhibit 421, the line
19 numbered or the job title numbered 19005, general
20 managers and top executives shows a median wage of $19.00
21 per hour, significantly less than Mr. Linam is currently
22 earning.
23 In addition, if you look at page 1 of
24 Exhibit 421, there is actually a very relevant job title
25 without having to play around with trying to get a fit
402
CSB REPORTING ULLMAN
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 between different positions, the position, the job code
2 95002, water and liquid waste treatment plant and system
3 operators shows a median wage of $11.00 per hour.
4 If you will turn to Exhibit 420 now, the
5 information provided by the Company, on the second page
6 right in the middle are four employees whose position
7 title is listed as treatment plant operator and their
8 current salary or hourly wage is listed at $19.55 for
9 three of them, 19.25 for one of the four, significantly
10 higher than the median wage in the state's salary
11 information.
12 On the second page of Exhibit 421, you will
13 find the position job code 58014, meter readers,
14 utilities, the median wage shown is $13.20. On the third
15 page of Exhibit 420, the Company is shown as having four
16 meter readers, all earning $18.29 and although I realize
17 that the information from the Company is perhaps a year
18 or two more recent than the information provided by the
19 state, I think that it does show quite a disparity
20 between what the Company is paying and what the median
21 wages are being paid in the state for these positions.
22 Although I did not personally do it, I think it would be
23 possible to go through and find other similar positions
24 and figure out which of the Company's salaries are and
25 are not reasonable.
403
CSB REPORTING ULLMAN
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 These were three examples I wanted to cite
2 just as that, examples, and recommend that before a rate
3 increase is granted in this case that the Commission
4 undertake a study to determine whether the salaries being
5 paid by this Company are reasonable in light of the fact
6 that those salaries, the payment of those salaries is
7 actually passed on to the ratepayers of the Company and
8 that would conclude my testimony.
9 Thank you.
10 MR. WOODBURY: Ms. Ullman, that concludes
11 your supplementary comments?
12 THE WITNESS: Yes.
13 MR. WOODBURY: Mr. Chairman, I'd ask that
14 her prefiled testimony be spread, that her exhibits be
15 identified and Ms. Ullman is now available for
16 cross-examination.
17 COMMISSIONER NELSON: Thank you. We would
18 order that Ms. Ullman's testimony be spread on the record
19 as if read and mark Exhibits 401 through 416.
20 MR. MILLER: Before doing that,
21 Mr. Chairman, earlier in the morning the Chair indicated
22 that at the time this testimony was offered would be, I
23 guess, the appropriate time for the Company to renew its
24 motion to strike and so we would therefore as, I guess, a
25 vehicle for getting this before the Commission object to
404
CSB REPORTING ULLMAN
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 the testimony starting really on page 7, line 18, through
2 page 8, line 2.
3 COMMISSIONER NELSON: Well, I --
4 MR. MILLER: I was going to say,
5 alternatively, I know the Commission is going to
6 obviously have to resolve this issue. We don't intend
7 obviously to cross-examine on this, so if the Commission
8 desires to discuss the question itself or some other way
9 of determining how it's going to resolve the question of
10 when these rates are going to become effective, I guess
11 we could proceed with the understanding that that is
12 subject to a motion to strike and the Commission can
13 resolve when it resolves the underlying question of when
14 the rates take effect rule on whether that should be in
15 the transcript or not and I guess I should apologize.
16 Perhaps a motion to strike wasn't really the right way to
17 get this before the Commission.
18 COMMISSIONER NELSON: Well, thank you.
19 Considering the fact that we have looked at this before,
20 we'll just note your continuing objection to this
21 testimony. I do believe we'll leave it in the record and
22 consider it. I guess I wouldn't want to say any more
23 than that, but since we have already looked at this once
24 and decided to leave it in, I think at this point we'll
25 just continue to leave it in.
405
CSB REPORTING ULLMAN
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 MR. MILLER: All right, very good.
2 (The following prefiled testimony of
3 Ms. Sharon Ullman is spread upon the record.)
4
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406
CSB REPORTING ULLMAN
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 Q Please state your name and address.
2 A My name is Sharon Ullman. My address is
3 9627 West Desert Avenue, Boise, ID 83709.
4 Q What is your interest in IPUC Case No.
5 UWI-W-97 06?
6 A I am a residential customer of United Water
7 Idaho, Inc. ("UWI") and a ratepayer.
8 Q What is your educational background?
9 A I received a BA in anthropology from the
10 University of California, Berkeley, in 1985.
11 Q What experience do you have that is
12 relevant to IPUC Case No. UWI-W-97-6?
13 A I have been an official intervenor in all
14 of UWI'S rate cases since Case No. BOI-W-93-1, back when
15 the company was known as Boise Water Corporation. In
16 addition, I have spent the past seven years working on
17 local issues such as education, sewers, taxes, solid
18 waste, planning and zoning, affordable housing, etc. I
19 currently serve as a member of the Ada County Assessor's
20 Citizens Advisory Committee as well as the Idaho
21 Statesman's Community Advisory Board.
22 Q What issues will you be addressing in this
23 prepared testimony?
24 A I will be addressing the following issues:
25 UWI's excessive expenditures on employee salaries and
407
DIRECT TESTIMONY OF SHARON ULLMAN 2
1 benefits; UWI's excessive overhead costs due to the
2 out-of-state location of its parent company; the
3 excessive projected cost of filing IPUC Case
4 No. UWI-W-97-6 and the soon-to-follow rate structure
5 case; the excessive requested rate of return on
6 investment; the timing of any authorized rate increase;
7 the high cost of water to UWI's customers compared to a
8 number of other area water providers; restrictions on
9 rates authorizing return on property not providing
10 utility service and new growth paying its own
11
12 /
13
14 /
15
16 /
17
18
19
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21
22
23
24
25
408
DIRECT TESTIMONY OF SHARON ULLMAN 2A
1 costs; the company's adjustment for ad valorem taxes; the
2 rate UWI pays its attorneys; and the presentation binders
3 that UWI utilizes to present their rate case applications
4 and testimony.
5 Q What are your concerns regarding UWI's
6 salaries and benefits.
7 A I believe that some of UWI's salaries are
8 unreasonably high and that some of the benefits the
9 company grants employees are overly generous. For
10 example, recently appointed UWI President William Linam
11 is currently being paid $117,650 per year (Exhibit 401)
12 Past President, Wayne Booe, was being paid $93,400 in
13 1996. (Exhibit 401) even taking into consideration an
14 inflationary factor of 3% per year since 1996,
15 effectively bringing Mr. Booe's effective 1998 salary to
16 $99,088, Mr. Linam is still being paid $18,562 or 18.7%
17 more. In addition, UWI noted in its response to the
18 Idaho Cross-Industry Salary and Benefits Survey that 15%
19 of UWI's exempt employees are eligible and are actually
20 paid an individual performance bonus averaging 11%.
21 (Exhibit 402) Mr. Healy has refused to verbally provide
22 the value of the most recent bonus received by Mr. Linam,
23 but assuming that Mr. Linam received a bonus equivalent
24 to the average of 11%, it would amount to $12,941,
25 bringing Mr. Linam's total annual compensation to
409
DIRECT TESTIMONY OF SHARON ULLMAN 3
1 $130,591.
2 Although Mr. Linam appears to have a higher level
3 of formal education than Mr. Booe achieved, (Exhibit
4 403), upon his retirement in mid-1997, Mr. Booe had
5 completed a 38-year career in the water utility business,
6 according to a news release written by UWI. (Exhibit
7 403) In contrast, the same news release states that
8 Mr. Linam had 27 years of experience "in engineering and
9 management of investor-owned water utilities." (Exhibit
10 403) Certainly Mr. Booe's additional ten-plus years of
11 practical experience were as valuable as Mr. Linam's
12 college degrees.
13
14 /
15
16 /
17
18 /
19
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23
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25
410
DIRECT TESTIMONY OF SHARON ULLMAN 3A
1 It is noted that Mr. Linam, who came to UWI from
2 New Jersey, allocates a small amount of time to other
3 subsidiaries; however, his high monetary compensation is
4 still unjustifiable and out-of-line in the relatively
5 low-cost-of-living environment of Boise, ID.
6 Another example of UWI's seemingly overgenerous
7 employee salaries is the $18.29 per hour wage paid to the
8 company's water meter readers. (Exhibit 404) Although
9 this work is most likely tedious, and undoubtedly comes
10 with certain on-the-job hazards such as
11 less-than-friendly canines, it simply cannot be
12 considered highly-skilled labor warranting such a wage.
13 UWI's responses to the Idaho Cross-Industry Salary
14 and Benefits Survey also point out that exempt and
15 non-union non exempt UWI employees only work a 37.5 hour
16 work week, rather than the more typical 40-hour work week
17 of other area businesses. (Exhibit 405) The company's
18 responses to the same survey indicate that UWI employees
19 receive 11 paid holidays per year (Exhibit 406) and the
20 company's discriminatory vacation policy provides exempt
21 employees 3 weeks of paid vacation per year during their
22 first five years of employment, which increases to 4
23 weeks per year after only five years with UWI, and 5
24 weeks per year after fifteen years with the
25 organization. (Exhibit 407)
411
DIRECT TESTIMONY OF SHARON ULLMAN 4
1 In examining all of the above benefits as a
2 package for Mr. Linam, we find that he is required to
3 work only 37.5 hours a week, receives 5 weeks of paid
4 vacation per year, and is compensated approximately
5 $130,591 (assuming he receives an average 11% bonus).
6 Q What are your concerns regarding UWI's
7 relationship to its parent company in New Jersey, United
8 Waterworks?
9 A The relationship between UWI and its
10 out-of-state parent company concerns
11
12 /
13
14 /
15
16 /
17
18
19
20
21
22
23
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25
412
DIRECT TESTIMONY OF SHARON ULLMAN 4A
1 me, as a ratepayer, because of the costs associated with
2 communicating long distance with United Waterworks and
3 the necessary travel between Boise and New Jersey, as
4 well as the additional overhead costs borne by UWI's
5 ratepayers in Ada County for what I believe to be the
6 unnecessary out-of-state administration of the local
7 subsidiary, UWI.
8 To cite an example, Mr. Gennari was here in Boise
9 for a pre-hearing conference in this rate case. How much
10 was paid for his travel, housing while here in Boise,
11 food, etc.? It is possible he had reasons for being in
12 Boise other than the pre-hearing conference, but I, as a
13 ratepayer, object to the fact that UWI is already paying
14 Mr. Miller $140 per hour to represent the company yet the
15 parent company, United Waterworks, then sends an
16 additional representative to a mere pre-hearing
17 conference. There are local employees who could have
18 attended this meeting in Mr. Gennari's stead, such as Ben
19 Hepler, who has been with the company for a number of
20 years and has experience with rate cases as well. It is
21 my hope that the IPUC will take into consideration this
22 type of additional costs and adjust accordingly when and
23 if any rate increase is granted UWI.
24 Q What are your concerns regarding the cost
25 of Case No. UWI-W-97-6 and the soon-to-follow rate
413
DIRECT TESTIMONY OF SHARON ULLMAN 5
1 structure case?
2 A In examining UWI's projected costs, one
3 finds that the company expects to spend in excess of
4 $300,000 for the two cases. (Exhibit 408) The available
5 intervenor funding, although double the usual limit due
6 to the bifurcation of the case, is only $50,000, a mere
7 one-sixth of the amount the company expects to spend to
8 present its position to the IPUC.
9 All of these costs, including that of any
10 intervenor funding ultimately paid, will be absorbed by
11 UWI's ratepayers, so I am not suggesting that intervenor
12 funding in any way
13
14 /
15
16 /
17
18 /
19
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414
DIRECT TESTIMONY OF SHARON ULLMAN 5A
1 be increased. It would appear, however, that the IPUC
2 should consider disallowing a portion of UWI's costs due
3 to the significant inequity.
4 Also, considering the frequency with which UWI
5 files these rate increase cases, the expense incurred by
6 the company, and therefore the ratepayers, is
7 unreasonable. Although I asked in my First Production
8 Request question No. 14 for a "detailed breakdown of all
9 the costs UWI expects to incur in this rate case as well
10 as the succeeding rate structure case, including, but not
11 limited to "attorney's fees, witness fees, travel, food,
12 lodging, intervenor funding, etc. for each case, and
13 indicate which, if any, of these expenses are included in
14 UWI's proposed rate base of $84,200,741", the response I
15 received did not provide the requested detailed
16 breakdown. For example, UWI shows expenses in Case
17 No. BOI-W-93-3 in order to project costs for Case
18 No. UWI-W-97-6 such as $181,575 81,000 "UWM&S Rate
19 Analyst". (Exhibit 408) What is this rate analyst doing
20 to incur a $181,575 cost and what is the real value to
21 UWI and to UWI's ratepayers?
22 (Testimony starting on line 15 through the word
23 acceptable on line 22 was struck by the witness.)
24 It is my recommendation that the IPUC disallow a large
25 portion of the company's rate case expense and put the
company on notice that the
415
DIRECT TESTIMONY OF SHARON ULLMAN 6
1 same will occur in every future rate case UWI chooses to
2 file.
3 Q What are your concerns with regard to the
4 company's requested rate of return on investment of
5 9.76%?
6 A Interest rates are at or near a many-year
7 low right now. UWI has a monopoly on providing water
8 service to nearly 58,000 Ada County customers. (Exhibit
9 409) Water would have to be considered the single most
10 necessarily substance we, as human beings, need.
11 Considering the company's exceedingly low risk, 9.76% is
12 an unreasonably high rate of return. My husband and I
13 can, right now, easily go out and refinance the mortgage
14 on our home for a thirty-year term at or around 7%
15 despite the possibility that interest rates will climb
16 higher in the near future. Although our credit rating is
17 excellent and my husband's job secure, it is still
18 probably far more likely than we would for some
19 unforeseen reason fail to pay off our mortgage than it is
20 that UWI would either lose its 58,000 customers or fail
21 to receive payment from the vast majority of those
22 customers. Considering UWI's low risk in providing a
23 necessary commodity to captive customers, a significantly
24 lower rate of return than 9.76% is justified.
25 Q What are your concerns with regard to the
416
DIRECT TESTIMONY OF SHARON ULLMAN 7
1 timing of any authorized rate increase?
2 A Despite the fact that UWI chose to file
3 this case in two separate parts, IPUCRP 121-01-e very
4 clearly states that the applications to change rates must
5 include "testimony and exhibits showing financial
6 statements, cost of capital and appropriate cost of
7 service studies" if the application is subject to Rule
8 122, as is UWI (Emphasis added.) UWI has failed to
9 supply appropriate cost of service studies at this time.
10 I, therefore, request that
11
12 /
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14 /
15
16 /
17
18
19
20
21
22
23
24
25
417
DIRECT TESTIMONY OF SHARON ULLMAN 7A
1 if the IPUC awards any rate increase in this case, that
2 it be inapplicable until after the second half of this
3 bifurcated case has been completed.
4 Q What are your concerns regarding UWI's
5 rates compared to those of other area water companies?
6 A UWI's rates are higher than those of nearby
7 water providers, ranging from approximately 36.4% higher
8 than Capitol Water's rate, on average, (although Capitol
9 Water allows unlimited water use to its residential
10 customers and UWI does not,) to more than 100% higher
11 than the City of Nampa's rates during the summer months.
12 I have prepared an exhibit to illustrate this point.
13 (Exhibit No. 410)
14 Although I recognize that there are some
15 differences between UWI and the other water providers
16 that would increase the cost of service for UWI
17 customers, such as the level of technology utilized by
18 the company and the absence of a profit in the case of
19 municipal water systems, there is another major
20 difference that should more than make up for these
21 differences: economy of scale. UWI is a much larger
22 operation, serving many more customers than do the other
23 water providers used in the rate comparison; however, UWI
24 seems to increase rather than decrease its rates despite
25 its larger size.
418
DIRECT TESTIMONY OF SHARON ULLMAN 8
1 Here, once again, the IPUC must consider whether
2 the expenses paid by UWI to parent company United
3 Waterworks are truly justifiable. Could UWI run as a
4 stand-alone company here in the Boise area? I believe
5 so, and at a significantly reduced cost. UWI's current
6 ratepayers are being forced to absorb the costs
7 associated with the organizational structure that has
8 been chosen by UWI and United Waterworks. UWI's
9 ratepayers did not choose this organizational structure.
10 It is unreasonable for UWI's customers to be
11 paying so much more for their water
12
13 /
14
15 /
16
17 /
18
19
20
21
22
23
24
25
419
DIRECT TESTIMONY OF SHARON ULLMAN 8A
1 than are the customers of the other water providers
2 cited. Granting UWI a rate increase at this time will
3 only serve to increase the difference between UWI's rates
4 and those of nearby water providers.
5 Q What are your concerns with regard to
6 restrictions on rates authorizing return on property not
7 providing utility service and new growth paying its own
8 costs?
9 A I am concerned about the possibility that
10 current UWI customers are helping to pay the cost of
11 growth such as in the case of the Boise River Intake, the
12 N.W. pipeline, the investment in the area west of Eagle,
13 and the Garden City acquisition. In addition, Idaho Code
14 61-502A is quite clear that "Except as authorized by this
15 section, any rates granting a return on construction work
16 in progress (except short-term construction work in
17 progress) or property held for future use are hereby
18 declared to be unjust, unreasonable, unfair, unlawful and
19 illegal." (Emphasis added.) (Exhibit 411) Yet, in his
20 testimony, Mr. Linam states: "The purpose of this intake
21 and transmission main is to supply Boise River water to a
22 future second surface water treatment plant. The plant
23 will be necessary to serve the southeast Boise area which
24 has been designated as a Groundwater Management Area due
25 to lack of adequate groundwater within that area."
420
DIRECT TESTIMONY OF SHARON ULLMAN 9
1 (Linam, Di, pg. 5, Ins. 4-8.) Mr. Linam is referring to
2 the Boise River Intake project. Obviously this
3 $1,882,531 capital project is property held for future
4 use and I would urge the Commission to carefully consider
5 whether it should be allowed under the provisions of
6 Idaho Code 61-502A.
7 Additionally, in Daniel Brown's response to my
8 First Production Request, question No. 21, Mr. Brown
9 acknowledges that the demand on the Boise River Intake
10 project's
11
12 /
13
14 /
15
16 /
17
18
19
20
21
22
23
24
25
421
DIRECT TESTIMONY OF SHARON ULLMAN 9A
1 capacity is expected to be split approximately 50% for
2 existing customers and 50% for projected customers,
3 routinely, and during peak day conditions, would only
4 utilize approximately 20% of its capacity serving its
5 existing customers and 80% serving new customers.
6 (Exhibit 412) I do not believe it is appropriate to rate
7 base the company's entire expenditure on this project
8 since much of the project is expected to serve new,
9 rather than existing, UWI customers.
10 I will leave further analysis of these projects
11 and accompanying expenses to those with the necessary
12 engineering and financial expertise to make a more
13 thorough analysis.
14 Q What are your concerns what the company's
15 adjustment for ad valorem taxes?
16 A Next, UWI uses a 7.17% figure to calculate
17 the company's new 1998 net appraised value. Mr. Healy
18 asserts that this figure represents an average annual
19 increase over the past nine years. In contrast, the
20 company's net appraised value has only increased 5.31%
21 {(65,889,778 - 59,570,000)/59,570,002/2}, on average,
22 over the most recent two-year period according to data
23 provided by Mr. Healy. Using a 5.31% projected increase
24 as opposed to Mr. Healy's 7.17% figure, the company's
25 next appraisal should come in at $69,399,056 rather than
422
DIRECT TESTIMONY OF SHARON ULLMAN 10
1 at Mr. Healy's projected figure of $70,624,792.
2 In addition, to the other half of the ad valorem
3 tax equation, Mr. Healy used an estimated levy, 1.7492%,
4 based on 1996 taxes. Mr. Healy has now provided a 1997
5 levy of 1.7224%, a reduction of 1.53% from the 1996. The
6 1995 levy was 1.79179%, according to new information
7 provided by Mr. Healy in response to a production
8 request. (Exhibit ) Due to changes in tax law as well
9 as the current political climate, particularly during
10 this election year, and in light of the recent downward
11 five-year trend, it is reasonable to assume that the 1998
12 levy will be lower than the 1997 levy. In predicting the
13 1998 levy, it makes sense to take the 1997 levy and
14 reduce it by the average levy reduction over the most
15 recent two-year period, equivalent to the process used
16 above to estimate the
17
18 /
19
20 /
21
22 /
23
24
25
423
DIRECT TESTIMONY OF SHARON ULLMAN 10A
1 increase in appraised value. From 1995 to 1997 the
2 "aggregate" levy dropped annually by approximately 1.94%
3 {(1.79179 - 1.7224)/1.79179/2}. (The levy has dropped by
4 an even larger annual percentage -- 2.76 -- when one
5 looks at the years 1993 through 1997.) By reducing the
6 1997 levy of 1.7224% by 1.94%, one gets 1.689%.
7 The effect of using the above estimates (a 1998
8 estimated appraised value of $69,399,056 and a 1998
9 estimated appraised levy of 1.689%) rather than
10 Mr. Healy's estimated 1998 appraised value and old 1996
11 levy, the adjustment for ad valorem taxes would decrease
12 by $63,253 {$1,235,403 - ($69,399,056 X 1.689% or
13 $1,172,150)}.
14 Another, less complex, possible method of
15 calculation that could be used to predict UWI's 1998
16 ad valorem tax liability would be to simply look at the
17 average percentage of increase over the most recent
18 two-year period and increase the 1997 ad valorem tax
19 liability accordingly. According to the most recent
20 figures provide by UWI, the company's tax liability for
21 1995 was $1,067,371, for 1996 was $1,084,534, and for
22 1997 was $1,135,046. (Exhibit 414) This tax
23 liability increased an average of 3.17% annually
24 {($1,135,046 - $1,067,371)/$1,067,371/2} between 1995 and
25 1997. Applying this average annual percentage increase
424
DIRECT TESTIMONY OF SHARON ULLMAN 11
1 to the 1997 ad valorem tax liability, one gets $1,171,027
2 (1.0317 X $1,135,046), which would mean a $64,376
3 reduction ($1,235,403-$1,171,027)) in the company's
4 adjustment for ad valorem taxes.
5 Q What are your concerns with regard to the
6 attorneys' fees being paid by UWI.
7
8 /
9
10 /
11
12 /
13
14
15
16
17
18
19
20
21
22
23
24
25
425
DIRECT TESTIMONY OF SHARON ULLMAN 11A
1 A UWI is paying very high rates to a number
2 of attorneys to represent the company. (Exhibit 415)
3 The $140 rate being charged by Mr. Miller to represent
4 the company in this case is excessive. (Exhibit 416)
5 Although I appreciate Mr. Miller's education and training
6 in law and his expertise on utility rate proceedings,
7 particularly in light of his previous service on the
8 IPUC, legal fees in this area vary substantially. I
9 believe that the company could have negotiated a more
10 favorable rate or found another qualified attorney to
11 represent them in this case. Unfortunately for
12 Mr. Miller, attorneys are "a dime a dozen" in this area
13 making it a "buyer's market." In light of this fact, a
14 portion of Mr. Miller's legal fees should be disallowed
15 by the IPUC.
16 Q What are your concerns with regard to the
17 presentation binders that UWI utilizes to present their
18 rate case applications and testimony?
19 A UWI's applications and testimony tend to be
20 comprised of a stack of papers several inches thick. The
21 covers or "presentation binders" the company utilizes to
22 present these documents are inadequate to hold this
23 volume of papers. I would suggest that in the future the
24 company split the documents in half and use two such
25 binders or it find a different type of inexpensive cover
426
DIRECT TESTIMONY OF SHARON ULLMAN 12
1 in which to place its applications and testimony. The
2 most difficult aspect of this case has been constantly
3 wrestling with these documents as they continuously fall
4 out of the binder provided!
5
6
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8
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10
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427
DIRECT TESTIMONY OF SHARON ULLMAN 12A
1 (The following proceedings were had in
2 open hearing.)
3 COMMISSIONER NELSON: Ms. Ullman is
4 available for cross. Mr. Fothergill, did you have
5 questions?
6 MR. FOTHERGILL: Yes, I have one question.
7
8 CROSS-EXAMINATION
9
10 BY MR. FOTHERGILL:
11 Q You've done a lot of research on salaries
12 and benefits for this Company, salaries, wages and
13 benefits, and as a result of that research, is there one
14 thing in particular that you find most unfair or
15 unreasonable about the salaries and benefits that are
16 paid to personnel in this Company?
17 MR. MILLER: To which we'd object,
18 Mr. Chairman. It's not cross-examination of any sort.
19 It's just giving this witness one more opportunity to say
20 what she's already said and at some point it becomes
21 unfair and it's not cross-examination.
22 COMMISSIONER NELSON: Well, if it went very
23 far, I'd consider it friendly cross, but I'm going to
24 allow one question.
25 THE WITNESS: Thank you, Mr. Chairman. I
428
CSB REPORTING ULLMAN (X)
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 think that the level of salaries in general at the
2 Company, particularly the salary of the new president
3 compared to the salary of the old president who was doing
4 the same job, is very much out of line for the Boise,
5 Idaho, area and that the cost of that salary and the
6 other salaries in general should not be passed along to
7 the ratepayers until they can be brought down to a
8 reasonable level.
9 MR. FOTHERGILL: Thank you.
10 COMMISSIONER NELSON: Thank you,
11 Mr. Fothergill.
12 Mr. Woodbury, did you have questions of
13 Ms. Ullman?
14 MR. WOODBURY: Mr. Chairman, no, I don't
15 have any questions.
16 COMMISSIONER NELSON: Thank you.
17 Mr. Miller, do you have any questions?
18 MR. MILLER: No questions.
19 COMMISSIONER NELSON: Any questions from
20 the Commission. Commissioner Smith.
21
22
23
24
25
429
CSB REPORTING ULLMAN (X)
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 EXAMINATION
2
3 BY COMMISSIONER SMITH:
4 Q I was just curious on Exhibits 420 and 421,
5 I couldn't tell from what I have whether these are what
6 we might call fully-loaded salaries or whether they were
7 just hourly rates, and I guess maybe clarification is
8 employees are paid a certain amount on an hourly basis
9 and then sometimes when their compensation is restated,
10 it's restated in a fully-loaded way that includes other
11 benefits they may have, so I wasn't sure when I looked at
12 these two whether they were similarly calculated; in
13 other words, am I comparing salaries that were calculated
14 in the same manner?
15 A I believe that they are. I believe that
16 these are the raw salaries without the benefits
17 included.
18 COMMISSIONER SMITH: Okay.
19 COMMISSIONER NELSON: Thank you.
20
21 EXAMINATION
22
23 BY COMMISSIONER NELSON:
24 Q I might just ask, Ms. Ullman, and I'm kind
25 of assuming that if you had had a chance to do this, we
430
CSB REPORTING ULLMAN (Com)
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 would have that information, but I'm wondering if you've
2 had a chance to compare the salaries that United Water
3 pays to the salaries that the other utilities serving
4 this service area pay such as Idaho Power, Intermountain
5 Gas and U S WEST.
6 A No, Mr. Chairman, not specifically. As I
7 said, I think that there are many positions that United
8 Water has that, comparable positions as far as
9 qualifications and skills and so on, could be found in
10 the data from the State of Idaho. I didn't attempt to do
11 even that. I did specifically pull out the positions,
12 the two positions, that related to water treatment plant
13 operators and utility meter readers because there can be,
14 you know, as far as the job title, we know what we're
15 talking about, those are directly related, we are talking
16 about comparable salaries of other similar utilities and,
17 therefore, I think that these are very legitimate
18 comparisons.
19 I admit I do not have the ability or the
20 time, the inclination personally to try to do a complete,
21 full-blown study on all of the Company's salaries. I
22 felt that by pointing out some of the examples of where
23 the salaries are unreasonable to make the point to the
24 Commission to actually study whether their salaries are
25 or are not in keeping with the positions within the
431
CSB REPORTING ULLMAN (Com)
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 Company and, again, it's difficult to operate without the
2 information of the salary survey the Company specifically
3 participates in.
4 That would have been very beneficial, so in
5 piecing together other information, of course, it's not
6 quite as easy to make direct comparisons, but in the case
7 of at least these two positions, I think these are very
8 much direct comparisons and do show quite a difference
9 between the median wage in Idaho versus what United Water
10 is paying and I don't believe the Company in this case
11 can say because they're a public utility that's different
12 from the other companies being compared. In this
13 particular case they are being directly compared with
14 utility wages.
15 I think it would also be fair to compare
16 the wages of a public utility to other potential
17 employers in the community, because, of course, the
18 employment pool, the potential employees can get jobs at
19 any number of employers, not just at public utilities and
20 so it is fair, of course, to compare what they would be
21 paid in similar positions in other companies as well.
22 Q Okay, I guess I'll accept that this is the
23 best information that was available to you. I look at
24 the meter readers and see that there was employment of
25 130 for this survey which looks pretty reasonable. I
432
CSB REPORTING ULLMAN (Com)
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 look at the general managers and top executives and see
2 that this was a pool of 14,960 people and for Idaho, that
3 seems like an awfully large number to me to be
4 determining the pay of managers and top executives.
5 A Mr. Chairman, I would agree. I think that
6 is the least valid of the three positions in this survey
7 from the information provided by the state. I think it's
8 much better as far as a comparison what Mr. Linam's
9 salary is to look at whether he actually received a
10 decrease in salary coming from a much -- an area where
11 the cost of living was significantly higher and also
12 comparing his salary to that of his predecessor who did
13 the same job that that to me is a reasonable comparison.
14 When you make those two comparisons, I think that it
15 immediately became clear to me that his salary is out of
16 line.
17 COMMISSIONER NELSON: Okay, thank you for
18 your testimony.
19 COMMISSIONER HANSEN: Mr. Chairman, I have
20 a question.
21 COMMISSIONER NELSON: Excuse me,
22 Commissioner Hansen.
23 COMMISSIONER HANSEN: Thank you.
24
25
433
CSB REPORTING ULLMAN (Com)
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 EXAMINATION
2
3 BY COMMISSIONER HANSEN:
4 Q Ms. Ullman, I guess on that survey, I'd
5 like to ask you what your impressions of the salary
6 comparison would have accomplished or given you as a
7 comparison with other Idaho industries or utilities. Was
8 it your impression or knowledge of that survey that the
9 comparison compared to other like positions right here in
10 Idaho?
11 A Yes, that is correct.
12 Q Utility companies, also?
13 A I believe so. When we're talking about
14 these specific types of positions, water and liquid waste
15 treatment plant and system operator and a meter reader
16 for utilities, then, yes, very much so.
17 Q How about top management positions, was it
18 your impression that there would have been a comparison
19 of salaries for the top management-type positions in this
20 survey?
21 A Unfortunately, as the Chairman pointed out,
22 they lumped almost 15,000 positions into one category and
23 I agree that that data therefore is not really a good
24 comparison. I included it just as additional information
25 for the top, the president of the Company, but would
434
CSB REPORTING ULLMAN (Com)
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 certainly agree that as far as a comparison, it's
2 difficult to find this type of data which is why I think
3 that we must go back and rely on such things as the
4 predecessor in the position and perhaps even comparing
5 the salary of the president to the other employees within
6 the utility itself.
7 COMMISSIONER HANSEN: That's all.
8 COMMISSIONER NELSON: Thank you.
9 Thank you, Ms. Ullman.
10 (The witness left the stand.)
11 COMMISSIONER NELSON: Let's see,
12 Mr. Fothergill, we'll be taking your witness tomorrow
13 morning; is that correct?
14 MR. FOTHERGILL: That's correct. He'll get
15 in about 11:00 in the morning.
16 COMMISSIONER NELSON: 11:00.
17 Mr. Woodbury.
18 MR. WOODBURY: Staff has three witnesses.
19 For its first witness it would call Terri Carlock.
20
21
22
23
24
25
435
CSB REPORTING ULLMAN (Com)
Wilder, Idaho 83676 Intervenor Sharon Ullman
1 TERRI CARLOCK,
2 produced as a witness at the instance of the Staff,
3 having been first duly sworn, was examined and testified
4 as follows:
5
6 DIRECT EXAMINATION
7
8 BY MR. WOODBURY:
9 Q Ms. Carlock, will you please state your
10 name, spell your last name for the record?
11 A My name is Terri Carlock, C-a-r-l-o-c-k.
12 Q And for whom do you work and in what
13 capacity?
14 A I work with the Idaho Public Utilities
15 Commission as audit section supervisor.
16 Q And in that capacity, did you have occasion
17 to prefile testimony in this case consisting of 28 pages,
18 one exhibit, Exhibit 101, consisting of 17 schedules?
19 A That is correct.
20 Q And did you have occasion to review that
21 testimony and that exhibit prior to this hearing?
22 A Yes, I did.
23 Q Is it necessary to make any changes in
24 either the testimony or the exhibit?
25 A It is not.
436
CSB REPORTING CARLOCK (Di)
Wilder, Idaho 83676 Staff
1 Q If I were to ask you the questions set
2 forth in the testimony, then, would your answers be the
3 same?
4 A They would.
5 MR. WOODBURY: Mr. Chairman, I'd ask that
6 the testimony be spread on the record, that the exhibit
7 be identified and that I would then present her for
8 cross-examination.
9 COMMISSIONER NELSON: Without objection, it
10 is so ordered.
11 (The following prefiled testimony of
12 Ms. Terri Carlock is spread upon the record.)
13
14
15
16
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24
25
437
CSB REPORTING CARLOCK (Di)
Wilder, Idaho 83676 Staff
1 Q. Please state your name and address for the
2 record.
3 A. My name is Terri Carlock. My business
4 address is 472 West Washington Street, Boise, Idaho.
5 Q. By whom are you employed and in what
6 capacity?
7 A. I am employed by the Idaho Public Utilities
8 Commission as the Accounting Section Supervisor.
9 Q. Please outline your educational background
10 and experience.
11 A. I graduated from Boise State University in
12 May 1980, with a B.B.A. Degree in Accounting and in
13 Finance. I have attended the annual regulatory studies
14 program sponsored by the National Association of
15 Regulatory Utilities Commissioners (NARUC) at Michigan
16 State University. I chaired the NARUC Staff Subcommittee
17 on Economics and Finance for over 3 years. Under this
18 subcommittee, I also chaired the Ad Hoc Committee on
19 Diversification. I have also attended various finance
20 conferences, including the Public Utilities
21 Finance/Advance Regulation Course at the University of
22 Texas at Dallas, the National Society of Rate of Return
23 Analysts' Financial Forums, the Regulatory Economics and
24 Cost of Capital Conference in Utah, and a Standard &
25 Poor's Corporation Telecommunications Ratings Seminar.
438
UWI-W-97-6 CARLOCK, T (Di) 1
03/06/98 Staff
1 Since joining the Commission Staff in May 1980, I have
2 participated in several audits, performed financial
3 analysis on various companies and have presented
4 testimony before this Commission on numerous occasions.
5 Q. What is the purpose of your testimony in
6 this proceeding?
7 A. The purpose of my testimony is to present
8 the Staff's recommendation related to the overall cost of
9 capital for United Water Idaho, Inc. (United Water Idaho
10 or UWID) to be used in the revenue requirement in this
11 case, UWI-W-97-6. I will address the appropriate capital
12 structure, cost rates and the overall rate of return.
13 Q. Please summarize your recommendations.
14 A. I am recommending a return on common equity
15 in the range of 10.25% - 11.25% with a point estimate of
16 11.00%. The recommended overall weighted cost of capital
17 is in the range of 8.56% - 8.96% with a point estimate of
18 8.86% to be applied to the rate base for the test year.
19 Q. Are you sponsoring any exhibits to
20 accompany your testimony?
21 A. Yes, I am sponsoring Exhibit No. 101
22 consisting of 17 schedules for a total of 20 pages.
23 Q. Have you reviewed the testimony and exhibits
24 of UWID witness Hanley?
25 A. Yes. I generally agree with the theoretical
439
UWI-W-97-6 CARLOCK, T (Di) 2
03/06/98 Staff
1 approach Mr. Hanley uses in his testimony and exhibits.
2 My judgement in some areas would have resulted in
3 different outcomes. I will discuss some of these
4 differences later in my testimony.
5 Q. What legal standards have been established
6 for determining a fair and reasonable rate of return?
7 A. The legal test of a fair rate of return for
8 a utility company was established in the Bluefield Water
9 Works decision of the United States Supreme Court and is
10 repeated specifically in Hope Natural Gas.
11 In Bluefield Water Works and Improvement Co.
12 v. West Virginia Public Service Commission, 262 U.S. 679,
13 692, 43 S.Ct. 675, 67 L.Ed. 1176 (1923), the Supreme
14 Court stated:
15 A public utility is entitled to such
rates as will permit it to earn a return
16 on the value of the property which it
employs for the convenience of the
17 public equal to that generally being
made at the same time and in the same
18 general part of the country on
investments in other business
19 undertakings which are attended by
corresponding risks and uncertainties;
20 but it has no constitutional right to
profits such as are realized or
21 anticipated in highly profitable
enterprises or speculative ventures.
22 The return should be reasonably
sufficient to assure confidence in the
23 financial soundness of the utility and
should be adequate, under efficient and
24 economical management, to maintain and
support its credit and enable it to
25 raise the money necessary for the proper
440
UWI-W-97-6 CARLOCK, T (Di) 3
03/06/98 Staff
1 discharge of its public duties. A rate
of return may be reasonable at one time
2 and become too high or too low by
changes affecting opportunities for
3 investment, the money market and
business conditions generally.
4
5 The Court stated in FPC v. Hope Natural Gas Company, 320
6 U.S. 591, 603, 64 S.Ct. 281, 88 L.Ed. 333 (1944):
7
8 From the investor or company point of
view it is important that there be
9 enough revenue not only for operating
expenses but also for the capital costs
10 of the business. These include service
on the debt and dividends on the stock.
11
12 ... By that standard the return to the
equity owner should be commensurate with
13 returns on investments in other
enterprises having corresponding risks.
14 That return, moreover, should be
sufficient to assure confidence in the
15 financial integrity of the enterprise,
so as to maintain its credit and to
16 attract capital. (Citations omitted.)
17 The Supreme Court decisions in Bluefield
18 Water Works and Hope Natural Gas have been affirmed in In
19 re Permian Basin Area Rate Case, 390 U.S. 747, 88 S.Ct
20 1344, 20 L.Ed 2d 312 (1968), and Duquesne Light Co. v.
21 Barasch, 488 U. S. 299, 109 S.Ct. 609, 102 L.Ed.2d. 646
22 (1989). The Idaho Supreme Court has also adopted the
23 principles established in Bluefield Water Works and Hope
24 Natural Gas. See In re Mountain States Tel. & Tel. Co.
25 76 Idaho 474, 284 P.2d 681 (1955); Hayden Pines Water
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1 Company v. IPUC, 122 ID 356, 834 P.2d 873 (1992); General
2 Telephone Co. v. IPUC, 109 Idaho 942, 712 P.2d 643
3 (1986).
4 As a result of these United States and Idaho
5 Supreme Court decisions, three standards have evolved for
6 determining a fair and reasonable rate of return:
7 (1) the Financial Integrity or Credit Maintenance
8 Standard; (2) the Capital Attraction Standard; and, (3)
9 the Comparable Earnings Standard. If the Comparable
10 Earnings Standard is met, the Financial Integrity or
11 Credit Maintenance Standard and the Capital Attraction
12 Standard will also be met, as they are an integral part
13 of the Comparable Earnings Standard.
14 Q. Have you considered these standards in your
15 recommendation?
16 A. Yes. These criteria have been seriously
17 considered in the analysis upon which my recommendations
18 are based. It is also important to recognize that the
19 fair rate of return that allows the utility company to
20 maintain its financial integrity and to attract capital
21 is established assuming efficient and economic
22 management, as specified by the Supreme Court in
23 Bluefield Water Works.
24 Q. Please summarize the parent/subsidiary
25 relationships for United Water Idaho.
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1 A. United Water Idaho's common stock is not
2 traded. It is wholly-owned by United Waterworks (UWW),
3 which is wholly-owned by United Water Resources (UWR).
4 Due to this parent/subsidiary relationship there is no
5 direct market data available on United Water Idaho. The
6 only stock market information available to utilize in
7 determining the cost of equity capital is for United
8 Water Resources.
9 Q. What approach have you used to determine
10 the cost of equity for UWID specifically?
11 A. I have presented two methods: the
12 Discounted Cash Flow (DCF) method and the Comparable
13 Earnings method for industrials and utilities. I have
14 also utilized witness Hanley's exhibits and made the
15 judgmental changes I believe are more appropriate.
16 Q. Please explain the Comparable Earnings
17 method and how the cost of equity is determined using
18 this approach.
19 A. The Comparable Earnings method for
20 determining the cost of equity is based upon the premise
21 that a given investment should earn its opportunity
22 costs. In competitive markets, if the return earned by a
23 firm is not equal to the return being earned on other
24 investments of similar risk, the flow of funds will be
25 toward those investments earning the higher returns.
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UWI-W-97-6 CARLOCK, T (Di) 6
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1 Therefore, for a utility to be competitive in the
2 financial markets, it should be allowed to earn a return
3 on equity equal to the average return earned by other
4 firms of similar risk. The Comparable Earnings approach
5 is supported by the Bluefield Water Works and Hope
6 Natural Gas decisions as a basis for determining those
7 average returns.
8 I have analyzed the returns for utilities
9 and industrials in order to determine a fair return for
10 UWID. When determining the comparable earnings rate, it
11 is important that a cross-section of various companies
12 and industries be utilized in the sample so that any
13 possible effects of unusual occurrences or monopoly
14 powers are limited. It is also important that any risk
15 differentials between the comparable earnings sample and
16 UWID be resolved.
17 In my comparable earnings analysis, the
18 rates of return on common equity historically earned by
19 industrial firms were examined. The historical returns
20 earned by electric and gas utilities were also studied.
21 Current returns for water companies, interest rates and
22 bond yields were also examined. Then, based upon current
23 economic conditions, the current cost of equity capital
24 for industrial firms on the average was estimated.
25 Taking into consideration the risk
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UWI-W-97-6 CARLOCK, T (Di) 7
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1 differentials between industrials and utilities and those
2 differentials as they specifically relate to UWID, I
3 estimated the current cost of equity range utilizing the
4 Comparable Earnings approach.
5 Q. Please explain your schedules reflecting the
6 historical rate of return earned for industrial firms.
7 A. Schedules 1 through 4 of Exhibit No. 101
8 show the returns on common equity for the Business Week
9 Corporate Scoreboard over the last ten years.
10 Industrial returns tend to fluctuate with
11 business cycles, increasing as the economy improves and
12 decreasing as the economy declines. I have utilized a
13 three-year moving average to smooth the business cycle
14 effects and yearly fluctuations in the industrial rate of
15 return. Utility returns are not as sensitive to
16 fluctuations in the business cycle because the demand for
17 utility services generally tends to be more stable and
18 predictable. Schedule 1 reflects the returns earned for
19 periods ending the First Quarter of each year; Schedule 2
20 reflects the returns for periods ending the Second
21 Quarter; Schedule 3 reflects the returns for periods
22 ending the Third Quarter; and Schedule 4 reflects the
23 returns for periods ending the Fourth Quarter of each
24 year. Slower economic conditions are reflected in the
25 yearly return fluctuations. The effects of economic
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UWI-W-97-6 CARLOCK, T (Di) 8
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1 recovery may not immediately show up in the overall
2 industry results.
3 For years ending the First Quarter
4 (Schedule 1 of Exhibit No. 101), the five-year average
5 return from 1992 through 1996 was 13.2%, and the
6 five-year average from 1993 through 1997 was 14.9%. The
7 three-year moving average for 1997 of 16.9% is greater
8 than the three-year moving average of 15.2% in 1996
9 reflecting higher Industrial Composite returns.
10 For years ending the Second Quarter
11 (Schedule 2 of Exhibit No. 101), the five-year average of
12 15.0% for 1997 is greater than the five-year average of
13 13.6% for 1996. The three-year moving average increases
14 from 15.6% in 1996 16.7% in 1997.
15 For years ending the Third Quarter
16 (Schedule 3 of Exhibit No. 101), the five-year average
17 from 1993 through 1997 was 15.3%, increasing from 13.9%
18 in 1996. The three-year moving average from 1995 through
19 1997 was 16.6%, reflecting an increase from 15.8% in
20 1996.
21 For years ending the Fourth Quarter
22 (Schedule 4 of Exhibit No. 101) the five-year average
23 return of 15.5% for 1997 is an increase from 14.2%
24 in 1996. The three-year average in 1997 of 16.5% is up
25 slightly from the 16.3% in 1996.
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UWI-W-97-6 CARLOCK, T (Di) 9
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1 These statistics show the decrease and
2 increase in average industrial returns as a result of
3 economic conditions. The fourth quarter utility
4 composite of 10.1% in 1997 is lower than the 11.4%
5 in 1996 and the 11.5% in 1995.
6 Schedule 5 of Exhibit No. 101 depicts the
7 returns for the years ending each quarter from 1988
8 through 1997 for the Corporate Scoreboard composite
9 return, the three-year moving average industrial return
10 and the utilities return as reflected in Schedules 1
11 through 4. This graph shows the increase and decrease of
12 industrial returns and the utility composite return
13 through various business cycles.
14 Q. What is your estimate of the current and
15 near-future equity returns for industrial companies?
16 A. Based upon the three-year moving average
17 trend in industrial earnings and actual earnings
18 since 1994, (Schedules 1 through 5, Exhibit No. 101)
19 along with current economic conditions, I believe
20 industrial returns will stabilize through 1999.
21 The 1997 inflation rate is 1.7% for the
22 consumer price index and -1.2% for the producer price
23 index. The change in the inflation rate can be seen by
24 looking at the consumer and producer price indexes as
25 shown in Schedule 6 of Exhibit No. 101. The change in
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UWI-W-97-6 CARLOCK, T (Di) 10
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1 bond rates is illustrated in Schedule 7 of Exhibit
2 No. 101, Moody's Average for Public Utility Bond Yields.
3 The yields are shown for "Aa", "A" and "Baa" bonds from
4 1977 through January 1998. Prime interest rates as shown
5 in Schedule 8 of Exhibit No. 101 have been at 8.25% -
6 8.50% since 1995.
7 The Dow Jones Industrial Average Index
8 (DJIA) has fluctuated widely between the August 12, 1982
9 low of 776.92 to a closing record on March 3, 1998
10 of 8584.83. The Dow Jones Utility Average (DJUA) reached
11 a record high of 272.47 on March 3, 1998.
12 I reviewed the actual earned returns on
13 equity for industrials, the decline and improvement in
14 the economy, changing inflation and stock market
15 conditions. Based upon these considerations my estimate
16 of the near future equity capital returns for industrials
17 is in the range of 16.0% - 17.0%.
18 Q. How does the trend in utility returns
19 compare with the trend in industrial returns?
20 A. Schedule 5 of Exhibit No. 101 shows in
21 graph form the more stable utility returns. Schedule 9
22 shows the returns for the Moody's Electric Utilities
23 since 1970. The returns in individual years may increase
24 or decrease from the prior year, but the three-year
25 moving averages show general movements in earned returns.
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UWI-W-97-6 CARLOCK, T (Di) 11
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1 The three-year moving average electric utility returns
2 have not been above 12.0% since 1987. The annual return
3 through September 1997 of 11.1% is consistent with each
4 of the 3-year, 5-year and 10-year average returns.
5 The return on common equity for the Moody's
6 Gas Distribution Companies is shown in Schedule 10 of
7 Exhibit No. 101. The actual return in 1996 of 15.5% is
8 higher than other years thus appearing to be an
9 aberration that may not continue. The lower 11.8% for
10 the twelve months ended September 1997 supports this
11 notion. Based on the averages, I expect the average gas
12 return will most likely be in the 12.0% to 13.0% range.
13 The return on common equity for water
14 utilities is shown on Schedule 11 of Exhibit No. 101.
15 The average return on common equity for the 12-month
16 period ending September 30, 1997 is 10.8%. The average
17 return for the group excluding United Water Resources,
18 Inc. is 11.0%.
19 A review of electric and gas utility returns
20 provides a record of actual utility returns earned in the
21 past. The water utility average provides a water
22 industry specific comparison. The required return for
23 water utilities, and United Water Idaho specifically, can
24 then be estimated by reviewing current market changes and
25 considering any risk differentials between the different
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UWI-W-97-6 CARLOCK, T (Di) 12
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1 types of utilities.
2
3 Q. Please explain the risk differentials
4 between industrials and utilities.
5 A. Risk is a degree of uncertainty relative to
6 a company. The lower risk level associated with
7 utilities is attributable to many factors. Utilities
8 continue to have limited competition for distribution of
9 utility services within the certificated area. With
10 limited competition for regulated services, there is less
11 chance of losses related to pricing practices, marketing
12 strategy and advertising policies. The competitive risks
13 for gas, electric and telecommunication utilities have
14 changed with increasing non-utility generation, open
15 transmission access, and implementing the Tele-
16 communications Act of 1996. Competitive risks are
17 limited for United Water. Smaller water companies that
18 have certificated areas near areas served by United Water
19 produce little competition for United Water. In fact,
20 United Water has evaluated the purchase of many of these
21 systems. The investments required and the costs
22 resulting from the Safe Drinking Water Act produce some
23 investment risk. Currently these investment risks for
24 United Water Idaho are fairly low since the current costs
25 are included in rates. This risk may increase again in
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UWI-W-97-6 CARLOCK, T (Di) 13
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1 the future. This investment risk is one type of risk but
2 it does not make water utilities more risky than other
3 utilities. The demand for water utility services is
4 relatively stable and certain compared to that of
5 unregulated firms and even other utility industries.
6 Under regulation, utilities are generally
7 allowed to recover, through rates, reasonable, prudent
8 and justifiable cost expenditures related to regulated
9 services. Unregulated firms have no such assurance.
10 Utilities in general are sheltered by regulation for cost
11 recovery risks, making the average utility less risky
12 than the average unregulated industrial firm.
13 Q. Have you compared United Water directly
14 with other utility companies?
15 A. United Water Idaho's common stock is
16 currently 100% owned by United Waterworks, which
17 is 100% owned by United Water Resources, Inc. In my
18 comparisons I used the market data for UWR because
19 neither UWID nor UWW have common stock outstanding in the
20 market.
21 Schedule 11 of Exhibit No. 101 shows the
22 10.8% average return for water companies and the 11.0%
23 average when UWR is excluded. On Schedule 12 of Exhibit
24 No. 101, I have compared this water company average and
25 financial statistics for UWR with other companies that
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UWI-W-97-6 CARLOCK, T (Di) 14
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1 meet the following Value Line Investment Survey criteria:
2 1. Beta of .50 - .60 where the market
3 equals 1.00 (UWR's Beta is .55);
4 2. Safety of 3 where 1 is the highest
5 rating and 3 is average (UWR's timeliness rating is 3); and
6 3. Timeliness of 3 again where 1 is the
7 highest rating and 3 is average (UWR's timeliness rating
8 is 3).
9 The companies meeting all three criteria are
10 shown on Schedule 12, pages 2 and 3 of Exhibit No. 101.
11 The group of companies have Betas of .50 through .60
12 reflecting risk similar to UWR with a Beta of .55. The
13 summary financial statistic comparisons are reflected on
14 page 1 of Exhibit No. 101, Schedule 12. The statistics
15 shown include average annual price/earnings ratio,
16 average annual dividend yield, common equity ratio,
17 percent earned on common equity, percent payout ratio and
18 market to book ratio. The sample group average earned
19 return on equity is 11.5%.
20 Q. Based upon your analysis of industrial
21 returns, utility returns, and current economic
22 conditions, what is your estimate of the cost of equity
23 capital for UWR, and ultimately United Water Idaho, based
24 upon the Comparable Earnings method?
25 A. When utilizing the Comparable Earnings
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1 method, the risk differentials between industrials and
2 utilities, particularly United Water Idaho and UWR, must
3 be considered. Utility returns, in comparison to
4 industrial returns, may be ranked by classifying the
5 utility services according to risk levels. Utility
6 groups are less risky than industrials and water
7 utilities continue to be the least risky. Because an
8 average utility company is less risky than an average
9 industrial company, its cost of equity capital range
10 would be less. Water companies, including UWR and UWID,
11 are less risky than an average utility company so the
12 cost of equity capital would be less than that of both an
13 average utility and that of an average industrial
14 company. When considering the risk differentials between
15 water utilities and other companies, capital requirements
16 to meet the standards under the Safe Drinking Water Act
17 are a concern. Under current standards, UWID has made
18 investments to meet the required standards. Therefore,
19 the investment risks to UWID due to the Safe Drinking
20 Water Act are minimized currently but additional
21 investments are expected to increase again in the future.
22 Using the Comparable Earnings approach, my
23 estimate of the current cost of equity capital for UWID
24 is in the range of 10.5% - 11.5%. This range is
25 developed by reviewing the most recent industrial returns
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UWI-W-97-6 CARLOCK, T (Di) 16
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1 and the expected industrial return range of 16% -17%
2 adjusted for the risk differential (Beta of .55 for UWR)
3 results in a risk adjusted range of 8.8% - 9.4%. The
4 utility returns as shown in the Corporate Scoreboard of
5 11.2% for the First Quarter of 1997, 10.7% for the Second
6 Quarter of 1997, 10.7% for the Third Quarter of 1997 and,
7 10.1% for the Fourth Quarter of 1997 (Ex. 101, Sch. 1-4,
8 respectively); three-year average returns of 12% ending
9 1996 and 11.1% for the twelve months ending September
10 1997 for the Moody's Electric Utilities (Ex. 101, Sch.
11 9); and three-year average returns of 13.6% ending 1996
12 and 11.8% for the twelve months ending September 1997 for
13 the Moody's Gas Distribution Utilities (Ex. 101, Sch.
14 10). These returns are then analyzed along with the 11%
15 average water utility returns shown on Ex. 101, Sch. 11,
16 the comparable earnings shown on page 1 of Schedule 12,
17 the market indicators (Schedules 6 - 8 of Ex. 101) and
18 the industrial returns (Schedules 1 - 5 of Ex. 101) to
19 predict a reasonable required return.
20 Q. You indicated that the Discounted Cash Flow
21 method is utilized in your analysis. Please explain this
22 method.
23 A. The Discounted Cash Flow (DCF) method is
24 based upon the theory that (1) stocks are bought for the
25 income they provide (i.e., both dividends and/or gains
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UWI-W-97-6 CARLOCK, T (Di) 17
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1 from the sale of the stock), and (2) the market price of
2 stocks equals the discounted value of all future incomes.
3 The discount rate, or cost of equity, equates the present
4 value of the stream of income to the current market price
5 of the stock. The formula to accomplish this goal is:
6
D1 D2 DN PN
7 Po = PV = ------- + ------- +...+ ------ + ------
(1+ks)1 (l+ks)2 (1+ks)N (1+ks)N
8
Po = Current Price
9
D = Dividend
10
ks = Capitalization Rate, Discount Rate, or Required
11 Rate of Return
12 N = Latest Year Considered
13
14 The pattern of the future income stream is
15 the key factor that must be estimated in this approach.
16 Some simplifying assumptions for ratemaking purposes can
17 be made without sacrificing the validity of the results.
18 Two such assumptions are: (1) dividends per share grow
19 at a constant rate in perpetuity; and, (2) prices track
20 earnings. These assumptions lead to the simplified DCF
21 formula, where the required return is the dividend yield
22 plus the growth rate (g):
23
D
24 ks= -- + g
Po
25
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1 Q. What is your estimate of the current cost of
2 capital for the Company using the Discounted Cash Flow
3 method?
4 A. The current cost of equity capital for UWR
5 and thus UWID, using the Discounted Cash Flow method is
6 between 8.5% - 10.7% during various time intervals over a
7 52-week range, as shown on Schedule 13, page 1 of Exhibit
8 No. 101. I believe the three-month average price
9 (November 18, 1997 - February 17, 1998) is the most
10 appropriate average time interval to use. This average
11 price reflects current investor expectations without
12 being subject to daily market fluctuations, as could be
13 the case if the price on a specific date were used. The
14 average price results in the 8.8% to 9.8% range. The
15 price of $19.125 on March 4, 1998 results in a DCF return
16 of 8.7% to 9.7%. This is not significantly different
17 from the DCF return using the average price to make it
18 unreasonable. Therefore, I have used the 8.7% to 9.7%
19 range to coincide with the growth rate that more heavily
20 reflects growth projections as the most appropriate
21 estimate under the Discounted Cash Flow method for use in
22 this case.
23 Q. How is the growth rate (g) determined?
24 A. The growth rate is the factor that requires
25 the most extensive analysis in the DCF method. It is
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UWI-W-97-6 CARLOCK, T (Di) 19
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1 important that the growth rate used in the model be
2 consistent with the dividend yield so that investor
3 expectations are accurately reflected and the growth rate
4 is not too large or too small.
5 I have used an expected growth rate
6 of 3.5% - 4.5%. This expected growth rate was derived
7 from an analysis of various historical and projected
8 growth indicators, including growth in earnings per
9 share, growth in cash dividends per share, growth in book
10 value per share and the sustainable growth for UWR
11 (Exhibit No. 101, Schedule 13, page 2).
12 A review of these growth indicators shows
13 the five-year growth rate through 1997 in earnings per
14 share of negative 2.5% and the five-year average growth
15 in cash dividends per share of .5%. These average growth
16 rates are not projected to continue. The Value-Line
17 projected growth rates for 2000-2002 are 8.0% for
18 earnings, 1.5% for dividends, and 3.5% for book value. I
19 have used a 3.5% - 4.5% growth rate to reflect the growth
20 potential over a longer term.
21 Q. You have utilized an adjusted dividend yield
22 to determine the required return with the DCF method.
23 Please explain.
24 A. The adjustments I have made to arrive at the
25 adjusted dividend yield for the DCF method recognize the
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1 quarterly compounding of dividends, growth and direct
2 issuance or flotation costs for stock issuances.
3 Although market pressure should not be reflected in the
4 flotation cost adjustment, I have used a 2% flotation
5 cost rate as a reasonable flotation cost over time to be
6 included in the DCF analysis. The adjusted formula and
7 results are shown on Exhibit No. 101, Schedule 13,
8 page 1.
9 Q. Please explain the quarterly compounding of
10 dividends.
11 A. The Commission allowed for compounding of
12 dividends in Order No. 23420, Case No. BOI-W-90-1. As in
13 BOI-W-93-1, I have adjusted the dividend yield in this
14 case to reflect the impact of quarterly dividend
15 compounding. To properly compound for the quarterly
16 payment of dividends, the adjustment is appropriately
17 made to the dividend rate. This annual dividend rate,
18 compounded for quarterly payments, is used to calculate
19 the dividend yield and required return in the DCF method.
20 Exhibit 101, Schedule 13, page 1 shows the quarterly
21 dividend payment of $.23 compounded at 3.5% - 4.5% growth
22 for four quarterly dividend payments, or $.97 annually.
23 Although it is true that dividends are paid
24 quarterly and not annually, I do not believe that the
25 quarterly adjustment is necessary for the DCF method.
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UWI-W-97-6 CARLOCK, T (Di) 21
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1 The quarterly adjustment I made increases the DCF return
2 by approximately .2%. Quarterly DCF models basically
3 compound the dividend yield for timing differences of
4 quarterly payments then add the incremental growth rate.
5 The compounded yield assumes that the company is
6 responsible for reinvestment payments the investor will
7 receive by reinvesting his/her dividends. The investor
8 has the option to reinvest the dividends in UWR stock or
9 in some other security.
10 Q. Please explain the adjustment to reflect
11 a 2.0% issuance expense or flotation cost factor to
12 calculate the dividend yield in the DCF calculation?
13 A. The 2.0% is based on the recent issuance
14 expenses incurred. Issuance costs are relevant
15 expenditures to consider in the cost of equity
16 determination for new issuances. Direct issuance or
17 flotation costs impact the actual price received by the
18 company for stock sold. The funds received amount to the
19 stock price less the issuance costs. To reflect these
20 costs, the dividend yield is adjusted in the DCF method.
21 A specific allowance for market pressure is
22 not appropriate. Investors determine the price they are
23 willing to pay for stock at the time of issuance. I do
24 not believe it is appropriate to make an allowance for
25 price fluctuations as a result of this competitive
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1 process. I have used the 2% allowance as reasonable over
2 time.
3 Q. You indicated previously that you agreed
4 with the basic theories used by UWID witness Hanley but
5 that you would make different judgement calls in some
6 areas. Please expand on the differences you would
7 utilize.
8 A. The main difference relates to Mr. Hanley's
9 judgement on what return figures are not meaningful. I
10 believe that all returns are meaningful. However, some
11 returns are discounted in importance by investors or
12 analysts. This difference may seem like semantics but I
13 believe the full range of returns identified in Mr.
14 Hanley's exhibits are relevant. Exhibit No. 101,
15 Schedule 14 is a recap of Mr. Hanley's Exhibit No. 12,
16 Schedule 1, page 2 reflecting all of the results and
17 adding a column to reflect United Water Resources. The
18 UWR column is derived from the basic information included
19 in Mr. Hanley's exhibits for each method.
20 I do not believe a business risk adjustment
21 is required as shown in Mr. Hanley's exhibit. However,
22 if a maximum adjustment of .2 is reflected this would
23 produce the upper end of a range of reasonableness. The
24 cost of equity recommendation using Exhibit No. 12,
25 Schedule 14 is in the range of 10.2% - 11.4%. This
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UWI-W-97-6 CARLOCK, T (Di) 23
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1 overlaps the ultimate 10.25% - 11.25% range of
2 reasonableness that I have recommended.
3 Q. What is the capital structure you have used
4 for United Water Idaho to determine the overall cost of
5 capital?
6 A. I have utilized a hypothetical capital
7 structure consisting of 52% debt, 8% minority interest or
8 preferred equity and 40% common equity as shown on
9 Schedule 17 of Exhibit No. 101. Company witness Hanley
10 utilizes a June 30, 1997 capital structure for United
11 Water Idaho. This capital structure consists of 53.13%
12 long-term debt, .14% minority interest and 46.73% common
13 equity.
14 Q. Please explain why the hypothetical capital
15 structure you recommend is reasonable.
16 A. The hypothetical capital structure I am
17 recommending is appropriate to use for ratemaking
18 purposes in this case. United Water Idaho does not
19 directly raise funds in the markets. The debt funds are
20 issued at the United Waterworks level and the equity
21 funds are retained through earnings or raised at the
22 United Water Resources level. Therefore, the actual
23 capital structure shown on the books of United Water
24 Idaho has been provided by and supported by one of the
25 parent entities. The UWID capital structure should be
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UWI-W-97-6 CARLOCK, T (Di) 24
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1 double leveraged to reflect this relationship. Rather
2 than double leverage the capital structure, I believe a
3 hypothetical capital structure is more appropriate.
4 The hypothetical capital structure is
5 consistent with or better than the actual and estimated
6 capital structures for United Water Resources or the
7 Value Line Water Utility Industry. The capital structure
8 for UWR is estimated for 1998 to be 52.5% long-term debt,
9 8.5% preferred stock, 38% common equity and 1% current
10 maturities. The projected capital structure through the
11 years 2000-2002 is 51% long-term debt and 40% common
12 equity. The actual and projected common equity ratios
13 show an increasing trend. The Value Line Water Utility
14 Industry shows an average 40% common equity ratio for
15 1998. The 40% common equity ratio I have utilized in the
16 hypothetical capital structure on Exhibit No. 101,
17 Schedule 17 is consistent with the UWR trend and the
18 water utility industry average. The hypothetical debt
19 ratio of 52% is less than the current debt ratio for UWR
20 of 52.5% and the water utility industry average of 56.5%.
21 The 52% debt ratio is also the same as the ratio stated
22 for an "A" rated utility as set forth in Standard &
23 Poor's Financial Benchmarks. Exhibit No. 101, Schedule
24 15 also reflects these comparisons. The 8% minority
25 interest in the hypothetical capital structure is
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UWI-W-97-6 CARLOCK, T (Di) 25
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1 consistant with the 8.5% preferred stock held by UWR.
2 Q. What are the costs related to the capital
3 structure for debt and the minority interest?
4 A. The cost of debt is 7.8% when adjusted for
5 the debt refinancings in January and February of 1998.
6 The cost of minority interest is 5.0%. I have utilized
7 the methodology used by UWID in its exhibits to calculate
8 the cost of debt as shown on Schedule 16, Exhibit
9 No. 101.
10 In BOI-W-93-1 and BOI-W-93-3, I expressed
11 concern that several long-term debt issues outstanding
12 were at rates high enough to warrant refinancings.
13 United Water has refinanced two of the high cost notes at
14 more favorable rates. The 7.8% cost of debt reflects
15 these refinancings. United Water states its policy is to
16 periodically review the feasibility of refinancing other
17 issues. However, many of the issues have call provisions
18 making these issues expensive to refinance.
19 Q. You indicated the cost of common equity
20 range for United Water Idaho is 10.5% - 11.5% under the
21 Comparable Earnings method and 8.7% - 9.7% under the
22 Discounted Cash Flow method. What is the cost of common
23 equity capital you are recommending?
24 A. The fair and reasonable cost of common
25 equity capital I am recommending for United Water Idaho
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1 is in the range of 10.25% - 11.25%. This also falls
2 within the range reflected in my recap of Mr. Hanley's
3 exhibit as shown on Exhibit No. 101, Schedule 14 with a
4 range of 10.2% - 11.4%. Although any point within the
5 range of 10.25% - 11.25% is reasonable, the return on
6 equity granted would not normally be at either extreme of
7 the fair and reasonable range. I utilized a point
8 estimate of 11%, in calculating the overall rate of
9 return for the revenue requirement.
10 Q. What is the basis for your point estimate
11 being 11% when your range is 10.25% - 11.25%?
12 A. The 11% return on equity point estimate
13 utilized is based on: (1) a review of the market data
14 and comparables shown on the schedules in Exhibit
15 No. 101; (2) UWR stock price shown on Exhibit No. 101,
16 Schedule 13, (3) average risk characteristics for UWID,
17 (4) average customer relations, and (5) the recommended
18 hypothetical capital structure. If the hypothetical
19 capital structure is not utilized, I would recommend the
20 10.75% midpoint as the reasonable return on equity point
21 within the range.
22 Q. What is the overall weighted cost of
23 capital you are recommending for United Water Idaho?
24 A. I am recommending an overall weighted cost
25 of capital in the range of 8.56% - 8.96% as shown on
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UWI-W-97-6 CARLOCK, T (Di) 27
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1 Schedule 17, Exhibit No. 101. For use in calculating the
2 revenue requirement, a point estimate consisting of a
3 return on equity of 11% and a resulting overall rate of
4 return of 8.86% was utilized.
5 Q. Does this conclude your direct testimony in
6 this proceeding?
7 A. Yes, it does.
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
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1 (The following proceedings were had in
2 open hearing.)
3 COMMISSIONER NELSON: Mr. Fothergill, did
4 you have questions?
5 MR. FOTHERGILL: We have no questions.
6 COMMISSIONER NELSON: Ms. Ullman.
7 MS. ULLMAN: Mr. Chairman, I would simply
8 ask Ms. Carlock the same question I asked Mr. Hanley
9 about interest rates. From a common sense perspective,
10 have interest rates over the last few years been going up
11 or been going down?
12 THE WITNESS: The general trend is a
13 decrease.
14 MS. ULLMAN: Thank you.
15 COMMISSIONER NELSON: Thank you.
16 Mr. Hill.
17 MR. HILL: Thank you, Mr. Chairman.
18
19 CROSS-EXAMINATION
20
21 BY MR. HILL:
22 Q Good afternoon, Ms. Carlock.
23 A Good afternoon.
24 Q Just following up a little bit on
25 Ms. Ullman's question to you regarding the direction of
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1 interests rates recently, your testimony in this case was
2 filed March 6th of this year; is that correct?
3 A That is correct.
4 Q So your recommendations would reflect the
5 direction of interest rates over the last couple of years
6 and, in effect, the level of interest rates at that time?
7 A My testimony if you're looking at direct
8 interest rates would be reflected on schedule 8 and it
9 shows from 1970 through March 1st of 1998, so the more
10 current months are not reflected on this schedule.
11 Q I guess let me ask it another way: Has
12 there been a significant change in interest rate levels
13 since you prepared your testimony?
14 A There have been some changes, but not
15 significant, no.
16 Q Thank you. Now, I note in your response to
17 the Company's interrogatory No. 7, you state, among other
18 things, that you examined various United Water cases in
19 numerous jurisdictions?
20 MR. WOODBURY: Ms. Carlock, do you have
21 that production request?
22 THE WITNESS: I do.
23 Q BY MR. HILL: Are you with me now?
24 A I have the production request responses of
25 the Staff and you're talking about interrogatory No. 7?
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1 Q Yes. And as I read some of the statements
2 in that, among other things, you've stated that you
3 examined various United Water cases in numerous
4 jurisdictions.
5 A Where are you reading that? I did look at
6 different cases, that is correct, but I don't believe I
7 said that in the response to No. 7.
8 Q Does your --
9 A Okay, I found it.
10 Q Do you see it now?
11 A Yes, and I did do that, yes, just as I
12 said.
13 Q And those cases came from PUR and the PUR
14 base and other various publications?
15 A That's correct. I also had some
16 information that was sent directly to me.
17 Q How many United Water cases did you look
18 at, if you remember?
19 A I reviewed all of the cases that Idaho has
20 had and mainly the most recent one for other entities
21 would be in the Pennsylvania case.
22 Q I think the words you use here are numerous
23 jurisdictions, so by that you mean Idaho and
24 Pennsylvania?
25 A I looked for other cases, but the more --
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1 the only ones that were recent were the Pennsylvania one
2 and Idaho that I did review. Others were not as current
3 and I did not rely on them.
4 Q In the course of your review did you find
5 any cases other than recent cases in Idaho, namely, the
6 last litigated rate case and the recent case in Delaware,
7 where the capital structure of United Waterworks, Inc.
8 was not used for regulatory purposes?
9 A Right off I cannot recall any other
10 jurisdiction that used a different capital structure. As
11 I was saying, though, I focused mainly on the more
12 current ones and what has been going on in Idaho.
13 Q Now, let me refer you to what I'll call
14 your rate of return matrix. That's set forth on
15 Exhibit 101, schedule 17.
16 A Yes.
17 Q And there you develop an overall rate of
18 return of 8.86 to be applied to the rate base of United
19 Water Idaho in this case.
20 A That is correct.
21 Q Now, you're aware that the Company has
22 provided some changes in its requested capital structure
23 due to recent refinancings?
24 A I am and those are the same refinancings
25 that I reflected in the cost of debt.
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1 Q Right, and are those set forth in
2 Mr. Hanley's most recently filed testimony? You've had
3 occasion to review his prefiled rebuttal testimony?
4 A I have.
5 Q Specifically Exhibit 13, schedule 8?
6 A I have.
7 Q And that reflects a revised capital
8 structure consisting of almost 55 percent debt and almost
9 45 percent equity?
10 A That is correct.
11 Q Contrasted to the 53 to 47 ratio in the
12 initial filing?
13 A That is correct.
14 Q Now, while I realize you may have some
15 theoretical disagreement with this kind of calculation,
16 it would be a relatively simple calculation to determine
17 the rate of return on equity implicit in your overall
18 rate of return recommendation to United Waterworks, Inc.
19 based on this revised capital structure, would it not?
20 A It would and you're correct that the
21 theoretical arguments would be the main point.
22 Q Have you done such a calculation?
23 A Mr. Hanley did a calculation, so I did not
24 feel like I needed to do a separate one.
25 Q Would you -- could I ask you to accept a
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1 result subject to your check or provide such a
2 calculation?
3 A What are you wanting to calculate?
4 Q What I'm trying to do is to take the
5 revised capital structure of United Waterworks, Inc. as
6 set forth on Mr. Hanley's rebuttal testimony on
7 Exhibit 13 which I referred you earlier and use your
8 overall recommended rate of return of 8.86 in that
9 capital structure using the same cost of debt and develop
10 an implicit rate of return on equity to United
11 Waterworks, Inc.
12 A I'm assuming you have calculated that.
13 Q I've calculated it to be 10.16.
14 A That could very well be.
15 Q Would you accept that subject to your own
16 check?
17 A I would.
18 Q Thank you, and that's outside the range of
19 reasonableness that you've stated in your testimony; is
20 that correct?
21 A It is slightly lower if you're willing to
22 accept that United Waterworks is where the equity return
23 needs to be calculated at.
24 Q Now, at several places throughout your
25 testimony, for example, at page 2, line 9, you state the
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1 Commission's purpose in this case and the purpose, your
2 own purpose in developing rate of return testimony to
3 present or to determine a fair rate of return to be
4 applied to the rate base assets of United Water Idaho,
5 would you agree with that?
6 A That is correct. My purpose is to
7 determine the fair rate of return for this case for
8 United Water Idaho.
9 Q And that ideally would reflect to as great
10 a degree as possible the risks inherent in the investment
11 in United Water Idaho's rate base?
12 A That would be true.
13 Q So, really, you agree that United
14 Waterworks is the direct owner of the equity of United
15 Water Idaho?
16 A They are the wholly-owned parent or I
17 should say that United Water Idaho is the wholly-owned
18 subsidiary of United Waterworks.
19 Q Thank you, and you've agreed, I believe,
20 that United Waterworks is the entity responsible for
21 providing senior capital or debt financing for United
22 Water Idaho?
23 A They are the party that has provided that
24 debt financing, that is correct. They would not
25 necessarily be required to do so, though.
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1 Q Do you have any reason to expect that that
2 method of financing will not continue into the future?
3 A No.
4 Q At page 6, line 6 of your testimony,
5 Ms. Carlock, you state that the only stock market
6 information available to utilize for the purposes of
7 determining the cost of capital is the market data for
8 United Water Resources. Is that a fair statement of your
9 testimony?
10 A That statement was referring to the prior
11 sentence where we were talking about United Water Idaho
12 and the parent/subsidiary relationship, so as far as any
13 United Water stock, United Water Resources is the only
14 equity stock that is traded.
15 Q But I believe, as you've recognized in your
16 testimony, there is a universe of publicly-traded water
17 companies for which market data is readily available; is
18 that correct?
19 A That is correct, but that does not mean
20 that you would ignore United Waterworks or United Water
21 Resources.
22 Q Right. In your determination of the
23 market-based return on equity developed under the DCF
24 approach, you have ignored the data from all the other
25 universe of publicly-traded water companies in favor of
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1 Resources; is that true?
2 A That is true. I have used the United Water
3 Resources stock data as the information relative to
4 United Water.
5 Q And inherent --
6 A Or most relative I should say.
7 Q Inherent in your decision not to use data
8 from other publicly-traded companies is the assumption
9 that they are not comparable to United Water Idaho?
10 A No, I believe that that is a comparable
11 analysis, not a DCF analysis.
12 Q I'm sorry, I didn't -- could you restate
13 that, please?
14 A I believe that making a comparison with
15 other water companies would be a comparable analysis and
16 not necessarily the appropriate DCF analysis.
17 Q You state you've used those water utilities
18 in your comparable earnings analysis.
19 A I looked at those utilities, yes. I also
20 looked at them in regards to the DCF calculation from
21 Mr. Hanley's exhibits and generally, the theory behind
22 what Mr. Hanley has done and what I have done is
23 basically the same.
24 Q There seems to me anyway to be one
25 significant difference in your DCF analysis related to
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1 the use of market data in that, if I understand your
2 testimony correctly, you have used only market data for
3 Resources and have not used in your DCF calculations any
4 of the market data for the other publicly-traded water
5 utilities; is that true?
6 A The application is different. Mr. Hanley
7 utilized solely the other water companies as his DCF
8 calculation and I utilized United Water Resources for my
9 calculation.
10 Q Solely United Water Resources?
11 A That's correct.
12 Q And in your comparable earnings analysis,
13 you used Resources as the benchmark or the most important
14 indicator of the indicated rate of return; is that true?
15 A I did use Resources for the published
16 benchmarks. That is not the only one that I looked at.
17 The same is true with my schedule 14 in recalculating
18 what Mr. Hanley did. Using my assumptions, I used the
19 other water entities in that calculation, also, similar
20 to what Mr. Hanley did.
21 Q Well, back to your DCF analysis again, why
22 would you ignore the market data for the universe of
23 publicly-traded water utilities?
24 A The stock price for United Water Resources
25 is the stock price that reflects the expectations, the
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1 risk analysis for the shareholders of United Water
2 Resources which is the parent of United Waterworks and
3 the parent of United Water Idaho.
4 Q Does that mean that an investor who buys a
5 share of United Water Resources has the same level of
6 investment risk that an investor who buys a share of
7 United Water Idaho, whether that investor be United
8 Waterworks or anyone else?
9 A No, that is why you do a risk comparison in
10 adjusting for those risks, reflecting the risks of what
11 are out there. There are positive risks and negative
12 risks that must be analyzed.
13 Q But your DCF analysis based solely on the
14 price and market data of Resources' stock assumes that
15 the investment risk in Resources is the same as the
16 investment risk in United Water Idaho, does it not?
17 A Overall it assumes it is basically the
18 same.
19 Q And is that assumption based on any studies
20 or empirical evidence outside your own expert opinion?
21 A I believe that the overall assumption could
22 be justified from other sources, but I do not have those
23 right in front of me. This is not a foreign assumption
24 that other analysts may have taken.
25 Q Well, let's talk about some particular
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1 risks that affect United Water Idaho. Do you agree that
2 as a general principle that size has a bearing on risk,
3 all else being equal?
4 A That is one risk factor, yes.
5 Q And do you know the -- have you compared
6 the capitalization or the total capital of United Water
7 Idaho to United Water Resources?
8 A I have looked at that information.
9 Q Do you know what the multiple is?
10 A I do not recall what that is.
11 Q Is it approximately 40 times?
12 A I can't tell you without looking back at
13 that information. In fact, I have -- I don't know if
14 this is United Water Resources, so I don't have that
15 information with me on the stand.
16 Q And we've heard a lot of testimony here
17 today about the impact of weather patterns on the
18 revenues and earnings of United Water Idaho, would you
19 agree that that has an impact on investment risk, also?
20 A It does and all of these investment risks
21 are important and must be evaluated in comparison with
22 other utilities, not just in isolation.
23 Q But Resources is a geographically diverse
24 holding company, is it not?
25 A Yes.
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1 Q Has operations in at least 13
2 jurisdictions?
3 A It is significantly more diverse than Idaho
4 is.
5 Q So it would -- you would suspect,
6 therefore, that the impact of things like weather
7 patterns would be to a certain extent diminished at the
8 Resources level as opposed to the Idaho level?
9 A That is true and it also depends on how
10 that is treated for ratemaking purposes.
11 Q And are you aware of the recommendations of
12 certain intervenors in this case that whatever rate
13 increase may be determined by the Commission at the end
14 of the suspension period in this case be deferred until
15 the conclusion of the bifurcated rate design case?
16 A I'm aware of that position.
17 Q Does that create a little bit of
18 uncertainty as to the future earnings of United Water
19 Idaho?
20 A It creates an uncertainty as to the timing,
21 that is correct.
22 Q And would that have an impact on the risk
23 of an investment in United Water Idaho?
24 A That would be one factor.
25 Q You're recommending a capital structure in
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1 this case that's composed of roughly 40 percent equity,
2 and again I'm looking at your schedule 17 where it sets
3 forth your recommended hypothetical capital structure?
4 A Yes.
5 Q As I understand your testimony, that's
6 based on the Value Line reports?
7 A That was one of the factors I utilized. It
8 was not the sole factor.
9 Q What were the other factors?
10 A The fact that that is the capital structure
11 that we have utilized for Boise Water and United Water of
12 Idaho in the last two cases, that it is comparable to the
13 industry average as presented by Value Line and is not an
14 unreasonable capital structure that should be continued,
15 particularly in light of the fact that the financing has
16 not changed as far as the structure of that financing.
17 Q And you're aware -- what companies are in
18 your Value Line group that at least in part is the basis
19 for your recommendation of this capital structure?
20 A The Value Line water utility industry
21 consists of American Water Works, Aquarion Company,
22 California Water Services, Consumers Water, Philadelphia
23 Suburban Corporation and United Water Resources.
24 Q And have you had occasion to review
25 Mr. Hanley's Exhibit 13, schedule 2 which is contained in
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1 his prefiled rebuttal testimony?
2 A Yes, I have. Let me turn to that.
3 Okay.
4 Q Would you agree with me, then, that the
5 40 percent equity capital structure which you recommend
6 is based on a weighted average as set forth by Value
7 Line, that is, weighted by capitalization and not an
8 arithmetic average of the equity ratios of the companies
9 in the group?
10 A It is a projection of the average equity
11 ratio.
12 Q That wasn't my question, Ms. Carlock. I'm
13 asking you if you would agree that that 40 percent
14 capital structure is an average weighted by
15 capitalization within the group as opposed to an average,
16 a simple arithmetic average, of the equity ratios of each
17 one of the companies within the group?
18 A It is a weighted average.
19 Q And the total capitalization of the group,
20 including those six companies, is about $5,700,000,000?
21 A According to Mr. Hanley's exhibit, that's
22 what it is.
23 Q Do you have any reason to disagree with
24 that?
25 A No, I do not.
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1 Q And American Water Works and United Water
2 Resources make up over three-quarters of that total
3 capitalization of the group; is that true?
4 A According to his exhibit, yes.
5 Q Do you have any reason to disagree?
6 A I have not recalculated them, but they
7 appear to be correct.
8 Q Do you know how many states American Water
9 Works has operating units in?
10 A Twenty-one states.
11 Q So it like Resources is a large,
12 geographically diverse holding company?
13 A It is.
14 Q And in addition, the equity ratios of both
15 American Water Works and United Water Resources are
16 significantly lower than the equity ratios of all of the
17 other companies in the group?
18 A They are lower and it depends on which
19 companies you're looking at to determine whether it's
20 significant or not.
21 Q Your recommended capital structure also
22 includes 8 percent preferred stock or minority interest?
23 A That's correct.
24 Q What's the basis for that component of your
25 recommended capital structure?
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1 A There's several bases for that. One is
2 that it reflects the minority interest as we have seen in
3 the past and have utilized for Boise Water and United
4 Water without taking into consideration the mergers. It
5 also reflects the preferred stock level that you might
6 see for other companies.
7 Q What other companies?
8 A I don't have the exact percentage for each
9 of the companies, but American Water Works has preferred
10 stock, California Water has a smaller percentage of
11 preferred stock. Consumers Water and Philadelphia
12 Suburban, their percentage is, at least for Consumers
13 Water is, a smaller percentage. Philadelphia Suburban
14 has a larger percentage, as does United Water Resources.
15 United Water Resources has approximately 8.5 percent of
16 its capital structure as being preferred stock and that
17 reflects the possibility of all of those combined what
18 United Water Idaho could finance at and what would be
19 reasonable for ratepayers to be paying for.
20 Q Well, of all the companies that you've
21 mentioned as having preferred stock, do any of them have
22 a level of preferred stock even approaching 8 percent?
23 A United Water Resources has 8.5 percent.
24 Q Yeah, other than Resources.
25 A I haven't calculated the exact percentages.
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1 Q Have you had occasion to review Exhibit 13,
2 schedule 3, pages 1 and 2, of Mr. Hanley's rebuttal
3 testimony?
4 A I did review that and he shows the
5 preferred stock levels.
6 Q Did you check -- do you agree with those
7 levels?
8 A Those are in the ball park. I didn't check
9 them, but I have no reason to recalculate them based on
10 the numbers that I have seen.
11 Q And that shows American Water Works with a
12 preferred stock component of a little over 3 percent?
13 A That's correct.
14 Q Aquarion with zero?
15 A Yes.
16 Q California Water Service with 1.2?
17 A That's correct.
18 Q Connecticut Water Service with .69 percent?
19 A Yes.
20 Q Consumers Water with 1.19?
21 A Yes.
22 Q Dominguez Services with zero?
23 A Yes.
24 Q E'town Corp. with 2.68?
25 A Yes.
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1 Q Middlesex with 4.6?
2 A Yes.
3 Q Philadelphia Suburban Corp. with 1.41?
4 A Yes.
5 Q SJW with zero?
6 A That's correct.
7 Q Southern California with .78?
8 A Yes.
9 Q And Southwest Water with .81?
10 A Those are the numbers that are reflected on
11 Schedule 3.
12 Q And I believe you've stated you have no
13 reason to disagree with these numbers?
14 A That's correct.
15 Q Finally, United Water Resources with 8.5 as
16 you stated earlier.
17 A Yes.
18 Q Now, based on those numbers, do you believe
19 the 8 percent level that you've recommended here is
20 representative of the industry?
21 A That is one factor that was taken into
22 consideration as far as what the industry showed. The
23 United Waterworks merger and that change was also part of
24 my consideration and in looking at whether it was
25 appropriate to retain the capital structure that we have
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1 used for United Water Idaho in the past and there was no
2 indication to show that it was not appropriate with the
3 combinations of preferred stock and common equity for the
4 total equity percentage and the debt percentage of 52
5 percent as it relates to the benchmarks.
6 Q I'm not sure I understood your answer, so
7 I'll try --
8 A Do you want me to try it again?
9 Q Let me try to ask the question again.
10 A Okay.
11 Q Based on the review of the preferred stock
12 percentages that we went through just a moment ago, do
13 you believe that the 8 percent preferred stock percentage
14 that you're recommending is representative of the water
15 utility industry?
16 A My answer was that for the water utility
17 industry alone, it is not the only factor that was
18 determined. The 8 percent is not the same percentage
19 used for all other water companies besides United Water
20 Resources, but that was when I looked at the overall
21 approach in looking at this and the capital structure
22 that's been used for United Water Idaho, the
23 determination was made before and I think it's still
24 appropriate that due to the uncertainties of the United
25 Waterworks and United Water Resources financings for the
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1 equity piece and the influence that they have on the
2 equity that the hypothetical capital structure is more
3 appropriate to utilize for ratemaking purposes.
4 Q Let's look at the 5 percent cost rate that
5 you've attached to that 8 percent preferred stock.
6 What's the basis of the 5 percent?
7 A The 5 percent is the actual cost rate that
8 was incurred for minority interest. I looked at that in
9 comparison to other rates that would be available for
10 other preferred stock that we have seen in other
11 utilities as well as for some of the preferred that is
12 outstanding for some of the water industries to see if
13 that 5 percent was still a reasonable number and what I
14 found was that on a weighted average percentage that is
15 still reasonable.
16 Q Is it coincidence, then, that that is the
17 cost rate of the minority interest in United Water Idaho
18 itself?
19 A No. I started out with that cost rate and
20 then looked to see if it was still reasonable because the
21 minority interest, Idaho is a smaller minority interest
22 than the 8 percent, so you have to look to see if that
23 cost rate is representative for the smaller percentage as
24 well as the 8 percent.
25 Q Ms. Carlock, would you agree that as a
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1 general financial and ratemaking principle that within
2 any given company or utility as the ratios of capital
3 employed change the cost rates will change, will change
4 based on the level of financial risk that is implicit in
5 debt financing and leverage?
6 A Generally, when you're talking about
7 blocks, that is true. It won't change for every dollar,
8 but there are ranges that will change as a result of the
9 changing in ratios.
10 Q And generally speaking, you would expect
11 that as a company issues more debt and increases its
12 financial leverage and its financial risk that the cost
13 of that debt and also the cost of the equity would
14 increase as the leverage is increased?
15 A If you're looking at the capital structure
16 at a point in time and have the costs associated with
17 those financings and then change the ratios to where
18 there is more debt, then the cost of debt would generally
19 tend to increase, again based on the block that you're
20 talking about.
21 Q And that's what's known as financial risk;
22 is that right?
23 A Yes, that is one portion, the major
24 portion, of the financial risk.
25 Q And would you also expect that the cost of
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1 equity would increase as financial risk is increased or
2 as leverage is increased, all else being equal?
3 A That is true. That's why you have
4 benchmarks that raters utilize.
5 Q And basically, again that would be because
6 the earnings to common equity would be more greatly
7 exposed to payments of interest as the level of debt in
8 the capital structure is increased; is that true?
9 A For that one particular risk factor, that
10 would be true. Again, you need to look at all of the
11 risk factors together, both the negative as you've been
12 pointing out and the positive risk factors.
13 Q Now, for your cost of debt you've accepted
14 the embedded debt cost of United Waterworks?
15 A I utilized the embedded debt cost and
16 updated it based on the refinancings, that is correct.
17 Q And certainly, as you've stated, the cost
18 rate of United Waterworks' debt is to a certain extent a
19 product of its capital structure, wouldn't you agree?
20 A That is true. Again, you're looking at the
21 blocks, the differences between certain blocks.
22 Q And you have taken that embedded cost of
23 debt which has been produced by a capital structure
24 composed roughly of 55 percent debt and used that on
25 Exhibit 101, schedule 17, within a capital structure that
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1 consists of almost 60 percent senior capital; is that
2 true?
3 A When you make the comparison for the debt,
4 you are looking at 55 percent debt versus the 52 percent
5 debt. For many analyses the preferred stock or the
6 minority interest will be treated as common equity for
7 the comparisons. As far as the level of risk for
8 recovery, you would have your debt that would be first in
9 line, then your preferred stock and then the common,
10 which is the common understanding of how the financings
11 work.
12 Q But preferred stock payments are
13 contractual in nature, are they not?
14 A They are.
15 Q And the earnings to equity are exposed not
16 only to interest payments on debt, but also to those
17 preferred stock payments?
18 A That's correct. When you're talking about
19 the earnings ratio, then the preferred stock is not
20 treated as common stock.
21 Q So it's your opinion, then, that the
22 capital structure that you've set forth here as your
23 recommendation would -- there's no inconsistency there in
24 using the embedded debt cost rate that has been produced
25 by a very different capital structure in terms of
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1 financial leverage?
2 A There could be under certain circumstances,
3 but under this particular circumstance, I do not believe
4 there is. If there were inconsistencies, then the debt
5 cost would change based on that inconsistency.
6 Q Are you aware of the bond ratings that have
7 been given to Resources and United Waterworks?
8 A I am. I would have to look those up. The
9 last I remember was that United Waterworks had an A
10 rating, United Water Resources had an A- rating.
11 Q So Resources has a lower debt rating than
12 Waterworks?
13 A Slightly lower, yes.
14 Q That would be appropriate given its higher
15 financial risk and higher degree of financial leverage?
16 A That is one reason.
17 Q Further, what would your expectation be if
18 Resources with its higher leverage and lower bond rating
19 and Waterworks sold basically the same kind of debt
20 security at the same time subject to the same market,
21 would you expect that the Resources debt would cost a
22 little bit more?
23 A That would depend on the block of financing
24 that you're talking about, but generally speaking, an A-
25 rated company would have a slightly higher debt cost than
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1 an A rated company, but that's not always the case. It
2 depends on the market and where those blocks actually
3 fall.
4 Q You've talked a little bit in your
5 testimony about the concept of double leverage.
6 A Yes, I did mention it.
7 Q And could you state what your opinion of
8 the underlying financial and ratemaking principle is to
9 double leverage?
10 A Double leveraging is appropriate when the
11 financings of a subsidiary are undertaken by a parent or
12 grandparent.
13 Q And would that be done in order to reflect
14 affiliated or parent company financings used to support
15 the jurisdictional rate base assets of the utility?
16 A Generally speaking, yes, and that's
17 different than a hypothetical capital structure.
18 Q Just so we're clear, you're not stating in
19 your testimony that any of the United Water Resources
20 senior capital financings in any way support the
21 jurisdictional assets of United Water Idaho?
22 A I am not suggesting that United Water
23 Resources' debt or preferred supports United Water Idaho,
24 no. If I was doing that, I would have a double leverage
25 capital structure that would look different than what I
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1 have here or at least the cost rates would be different.
2 Q So you've agreed or at least implicit in
3 your recommendation is the fact that United Waterworks is
4 the senior capital financing vehicle for the rate base
5 assets under consideration here?
6 A The various companies have chosen to use
7 United Waterworks as the financing vehicle for debt and
8 preferred. That could change, but I don't believe, you
9 know, there's no indication that it's going to change.
10 Q And again, the revised capital structure of
11 United Waterworks as presented in Mr. Hanley's rebuttal
12 is about 55 percent debt and 45 percent equity?
13 A That is correct.
14 Q Is it your opinion that based on the data
15 that we've seen from other publicly-traded companies that
16 that is an unreasonable capital structure for ratemaking
17 purposes?
18 A I believe that in the case of United Water
19 Idaho that the hypothetical capital structure is more
20 reasonable than the actual capital structure.
21 Q Why is that?
22 A One of the main reasons is that the
23 hypothetical capital structure does not reflect a
24 tendency that United Water Resources and United
25 Waterworks could influence the equity ratio for United
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1 Waterworks and therefore United Water Idaho. As it
2 stands right now, United Water Resources is the
3 determining factor as to what level of equity United
4 Waterworks and United Water Idaho will show on their
5 books.
6 Q But certainly the 55/45 ratio for United
7 Waterworks is within a comparable range of the other
8 water utility capital structure database or universe, if
9 you will?
10 A You could look at particular pieces of that
11 and compare that with other water utilities, yes, that's
12 correct.
13 Q Well, other than Resources and American
14 Water Works, the other 10 or 12 publicly-traded companies
15 are relatively close to that kind of capital structure,
16 aren't they?
17 A Not all of them. It depends on how you're
18 combining those.
19 COMMISSIONER NELSON: Mr. Hill, would this
20 be an appropriate time to take a break?
21 MR. HILL: I think I can finish in another
22 15 minutes if that's okay with you.
23 COMMISSIONER NELSON: If you think you have
24 15 minutes, why don't we take a break.
25 MR. HILL: Thank you.
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1 (Recess.)
2 COMMISSIONER NELSON: Okay, well go back on
3 the record and go back to you, Mr. Hill.
4 MR. HILL: Thank you, Mr. Chairman.
5 Q BY MR. HILL: Ms. Carlock, before we took a
6 break, I believe you stated that the United Waterworks
7 capital structure, even though it may be within a range
8 of reasonableness based on a comparison to other water
9 utilities, is not appropriate for use in this case
10 because it is subject to control or manipulation by
11 Resources?
12 A That's correct.
13 Q Do you have any evidence that Waterworks'
14 capital structure has been manipulated by Resources?
15 A United Water Resources impacts the common
16 equity ratio of United Waterworks primarily through the
17 retained earnings piece and that is influenced by the
18 dividend payout ratio and any parent influences the
19 common equity ratio of a subsidiary through that format.
20 Q Can you say that the rate of retention at
21 Waterworks is out of line with the rest of the water
22 utility industry?
23 A As an average it is, has been higher. It
24 depends on which particular company and which particular
25 year you're looking at.
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1 Q But is it out of line in terms of a range
2 of reasonableness by comparison to the other water
3 utility companies?
4 A If you're looking at particular companies,
5 it may not be out of line. If you're looking at what is
6 happening with the parent, it is often out of line. For
7 instance, United Water Resources may have a payout ratio
8 of 85 percent or higher. Some years it was even over
9 100 percent. You don't see that payout ratio for United
10 Waterworks.
11 Q I'm talking about the United Waterworks
12 payout ratios in comparison to other water utilities.
13 A And again it depends on the particular
14 company. Some of them may be higher, some of them may be
15 lower and you'd have to look at the other risk factors
16 and their ratings in comparison to determine how that
17 relates. My point was how the payout ratio relates to
18 that of United Water Resources and whether United Water
19 Resources is influencing the payout ratio or allowing
20 them to retain more at United Waterworks, therefore
21 influencing the common equity ratio.
22 Q You're not testifying, though, that the
23 payout ratios or the capital structure of Waterworks have
24 actually been manipulated by Resources to achieve a
25 capital structure that would increase the revenue
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1 requirement, are you?
2 A The payout ratios of United Waterworks in
3 the case of the years when they are lower than United
4 Water Resources, yes. The capital structure is
5 influenced by that decision of United Water Resources to
6 allow United Waterworks to retain that amount of
7 earnings, therefore increasing the amount of equity that
8 is on the books of United Waterworks and its
9 subsidiaries.
10 Q But again looking at the ratios that you
11 see on Mr. Hanley's Exhibit 13, the capital ratios of
12 Waterworks are not out of line with an industry average
13 or by comparison to any particular company in that group
14 other than Resources and American Water Works; isn't that
15 true?
16 A It is not out of line with some of the
17 companies. It is significantly different than what the
18 ratepayers have been charged for due to the merger and
19 that's another factor that I've taken into consideration,
20 as I mentioned before, in looking at whether the
21 hypothetical capital structure was a reasonable capital
22 structure to continue with. That is one -- you could
23 phrase that in a different manner to say that that is a
24 merger cost that is not necessarily reasonable to pass on
25 to the ratepayers.
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1 Q Did the merger have any impact on the way
2 United Water Idaho or the other utility subsidiaries of
3 Waterworks are financed?
4 A It retained the common equity type of
5 financing; therefore, United Water Resources is the
6 controlling factor for that common equity. The debt and
7 the preferred are issued still by United Waterworks
8 similar to what they were issued before.
9 MR. HILL: I have no more questions. Thank
10 you.
11 COMMISSIONER NELSON: Thank you, Mr. Hill.
12 Do we have questions from the Commission?
13 COMMISSIONER SMITH: None from me.
14
15 EXAMINATION
16
17 BY COMMISSIONER NELSON:
18 Q A question did come to my mind I wanted to
19 ask you, Ms. Carlock. Is the dividend that United Water
20 Idaho has been paying to its parent company been
21 consistent over the last several years as far as an
22 amount per share?
23 A I cannot answer that specifically. I did
24 not calculate that number and it's not a number that's on
25 their financials.
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1 Q How about a gross number, has that been
2 consistent?
3 A The gross number would depend on the number
4 of shares outstanding and without making that
5 calculation, you really can't compare it.
6 Q Well, no, the gross number if it's on the
7 financial statements, shouldn't you have earnings or
8 beginning retained earnings, operating income less
9 dividends to get your ending retained earnings?
10 A That's true.
11 Q You haven't looked at that?
12 A I looked at that a long time ago and I
13 can't recall the relationship. It has been -- in some of
14 the years I compared it was higher, but I don't have that
15 information with me. I'd have to go get it.
16 Q Higher than what?
17 A Higher than the prior year on the gross
18 level, but if you're looking at it per share, then you
19 would look at the shares outstanding and that's also
20 changed.
21 Q Well, did you see anything about the
22 dividend payout that looked unreasonable to you?
23 A It fluctuates like the payout ratio made
24 for other companies, so in that sense it's not totally
25 unreasonable. The payout ratio for other companies would
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1 be determined by the management of that entity and not
2 necessarily a parent or a grandparent, so that's what I
3 was trying to take into consideration and it depends just
4 on the particular years that you're looking at.
5 Q Well, I guess when I look at payout ratios
6 of other utilities that I'm familiar with, why, what they
7 try to do is pay out a certain amount per share, retain a
8 certain amount to grow retained earnings and increase the
9 dividend over time by the amount that retained earnings
10 gets increased.
11 A Yes, usually the utilities are maintaining
12 their dividend that they actually pay out and they want
13 to increase it, so from that sense, that is correct, if I
14 understood your question correctly.
15 Q Well, I guess what I'm hearing from you
16 this afternoon is that you've decided to use a
17 hypothetical cost of capital structure because you don't
18 think that the capital structure of United Water Idaho is
19 what it would be if it were an independent company
20 necessarily.
21 A And the capital structure that the Company
22 is using is United Waterworks, not United Water Idaho and
23 so those are the comparisons that I was making.
24 Q Excuse me just a second. On Mr. Hanley's
25 Exhibit No. 13, schedule 8, which is the last page, he
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1 has a capital structure for United Water Idaho, Inc.
2 Now, is that United Water Idaho, Inc. or is that United
3 Water Resources?
4 A It's United Waterworks.
5 Q So that consists of more than United Water
6 Idaho?
7 A That's correct.
8 Q Well, if I wanted to make a comparison,
9 where would I find the capital structure of United Water
10 Idaho?
11 A You would look at the actual trial balance
12 that we obtained when we were auditing to determine what
13 that actual capital structure is and I don't have that
14 here. I could get it from Bob through his workpapers.
15 Q Does it differ significantly from this
16 55/45?
17 A I'm not sure that it does, but your common
18 equity number is an allocated number that is going to
19 follow that. I would have to look at that trial balance
20 to see how they've done it before I could really answer
21 your question. Most of the time what you're going to
22 find is that the parent capital structure is what is
23 allocated to all the subsidiaries; therefore, the ratios
24 are going to be similar just because of that allocation.
25 Q Well, then did you look, pay any particular
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1 attention to the dividend history of United Waterworks?
2 A I had very limited information on that and
3 in a couple of years that I did have information for, it
4 was quite a bit lower than for, like, United Water
5 Resources. It may have been similar to individual other
6 water companies, but --
7 Q Lower in what regard?
8 A That the -- they did not pay out as much,
9 the payout ratio was actually lower. It may have been 59
10 percent instead of 79 percent or 79 percent instead of
11 105 percent.
12 Q You're speaking of a ratio of earnings or a
13 ratio of earnings per share?
14 A That was a number that was calculated by
15 rating agencies and I did not calculate it. It would be
16 basically a per share number if they calculated it in the
17 same manner.
18 Q Well, then let me ask you, what caused you
19 to reject use of these capital numbers and use a
20 hypothetical?
21 A I believe that I started at it more from
22 the other approach, that the hypothetical capital
23 structure was appropriate and why is it more appropriate
24 to go to a different number where you can show that it
25 can be influenced by the parent.
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1 Q So you didn't start from the prospect that
2 you would use the actual numbers unless you had some
3 reason not to?
4 A It was a joint comparison and in looking at
5 what was available in the markets and the trends for all
6 of the other companies, the hypothetical seemed more
7 appropriate, but it does not necessarily show that the
8 actual is totally unreasonable. It would be just more
9 what is more appropriate. It just depends on what
10 comparison you make. You can pick and choose comparisons
11 with other utilities that would show that yes, the actual
12 is a reasonable number. Now, not all of those utilities
13 have similar risks. That's why I went back to the
14 hypothetical that we've utilized before.
15 Q You refer to this schedule as not being
16 totally unreasonable. Let's look at it from the other
17 end. How reasonable is it just looking at it?
18 A How reasonable is the actual capital
19 structure for United Waterworks?
20 Q Uh-huh.
21 A I believe that the common equity ratio is
22 high. As part of that, the debt ratio is also higher,
23 but most companies utilize or continue to utilize a
24 little bit more preferred, not only in the water industry
25 but other industries.
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1 Q So you think that both debt and equity are
2 high?
3 A I believe that both debt and equity are
4 high, yes.
5 COMMISSIONER NELSON: Okay, redirect,
6 Mr. Woodbury?
7 MR. WOODBURY: Staff has no redirect.
8 Thank you.
9 COMMISSIONER NELSON: Ms. Carlock, thank
10 you for your testimony.
11 (The witness left the stand.)
12
13
14
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18
19
20
21
22
23
24
25
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1 COMMISSIONER NELSON: Okay, Mr. Woodbury,
2 let's see how far we can get with the next witness.
3 MR. WOODBURY: Staff would call Bob Smith.
4
5 ROBERT E. SMITH,
6 produced as a witness at the instance of the Staff,
7 having been first duly sworn, was examined and testified
8 as follows:
9
10 DIRECT EXAMINATION
11
12 BY MR. WOODBURY:
13 Q Mr. Smith, will you please state your name
14 and indicate for whom you work?
15 A My name is Robert E. Smith. I'm employed
16 by the Idaho Public Utilities Commission.
17 Q And what type of work do you do?
18 A I am an auditor in the accounting and
19 finance section.
20 Q And in that capacity, did you have occasion
21 to prefile testimony in this case consisting of 28 pages
22 and Exhibits 114 through 123?
23 A Yes.
24 Q And have you had occasion to review that
25 testimony and those exhibits prior to this hearing?
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Wilder, Idaho 83676 Staff
1 A Yes, I have.
2 Q And is it necessary to make any changes to
3 that testimony?
4 A Two minor changes on pages 23 and 24 of the
5 testimony.
6 Q On page 23, what is the correction?
7 A Yes, on page 23, on line 5, I make
8 reference to "page 2 of Exhibit 115" and that reference
9 should be to "page 1 of Exhibit 115."
10 Q And on page 24, what is the change?
11 A On line No. 18, the number "66,500"
12 appears. I somehow got a multiplier by a factor of two
13 in there. The number should be "33,250."
14 Q Was this a change that we discussed earlier
15 this morning in Mr. Healy's testimony?
16 A No, that was not part of the discussion
17 this morning. I'd point out that this number is not used
18 anywhere in the Staff case, but rather is used for
19 explanatory purposes only.
20 Q Okay, and is it necessary to make any
21 further corrections or changes to your testimony and
22 exhibits?
23 A Only to point out that I concur with the
24 changes that Mr. Healy discussed this morning regarding
25 items that we have basically agreed on. Embedded within
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Wilder, Idaho 83676 Staff
1 my exhibits two minor changes would be required. On
2 Exhibit No. 115, page No. 1, column K should be
3 eliminated from that exhibit.
4 Q Column K?
5 A That's correct. In addition to that, on
6 Exhibit No. -- find my place here. Oh, here we go.
7 Sorry, it took me a moment. On Exhibit No. 114, in
8 column F, I made an adjustment on line 1 to eliminate
9 $80,857 from rate base. Mr. Healy and I have discussed
10 that adjustment and have agreed that a substitute number
11 in that column would be $54,753. Again, it's a rate base
12 deduction in place of the 80,857 I show on that exhibit.
13 Q And are those the only changes that you'd
14 like to make at this time?
15 A Yes.
16 Q And if I were to ask you the questions set
17 forth in your testimony, with the changes that we've
18 talked about, would your answers be otherwise the same?
19 A They would.
20 COMMISSIONER NELSON: Excuse me, does that
21 adjustment go on line 1 or line 12 of that exhibit?
22 MR. WOODBURY: We're talking about
23 Exhibit 114.
24 THE WITNESS: I believe the adjustment
25 would be to line 1. I do, however, have to qualify that
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Wilder, Idaho 83676 Staff
1 I don't believe that the $54,000 adjustment substituted
2 does recognize the accumulated depreciation calculation.
3 That may be something that Mr. Healy and I will have to
4 discuss.
5 MR. WOODBURY: Mr. Chairman, with that
6 clarification, I'd ask that the testimony be spread on
7 the record and that the exhibits be identified and I'd
8 present Mr. Smith for cross-examination.
9 COMMISSIONER NELSON: Thank you. Without
10 objection, so ordered. We would mark Exhibits 114
11 through 123.
12 (The following prefiled testimony of
13 Mr. Robert Smith is spread upon the record.)
14
15
16
17
18
19
20
21
22
23
24
25
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Wilder, Idaho 83676 Staff
1 Q. Please state your name and business address?
2 A. My name is Robert E. Smith. My business
3 address is 472 West Washington Street, Boise, Idaho.
4 Q. By whom are you employed and in what
5 capacity?
6 A. I am employed by the Idaho Public Utilities
7 Commission. My title is Senior Auditor.
8 Q. Please describe your educational background
9 and professional experience.
10 A. I received my BBA degree majoring in
11 Accounting from Boise State University in 1972.
12 Following graduation I was employed in the construction
13 industry as Accountant/Office Manager until April 1975
14 when I accepted employment at the Idaho Public Utilities
15 Commission. During the course of my employment at the
16 Public Utilities Commission, I have attended numerous
17 training schools, programs and seminars in the field of
18 regulation.
19 Q. Have you previously appeared as a witness
20 in regulatory proceedings?
21 A. Yes, many times.
22 Q. What is the purpose of your testimony in
23 this case?
24 A. I will present the Commission Staff's
25 recommendations concerning the Company's Rate Base,
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UWI-W-97-6 SMITH, R. (Di) 1
03/06/98 Staff
1 Results of Operations and Revenue Requirement.
2 Q. Are you sponsoring any exhibits?
3 A. Yes. I am sponsoring Exhibit Nos. 114
4 through 123. Exhibit No. 114 presents Staff's
5 recommended rate base. Exhibit No. 115, a two page
6 exhibit, presents Staff's adjusted Results of Operations
7 which includes our recommended revenue increase of
8 $1,080,581 shown on page 2, Column "Q". This revenue
9 increase represents an increase in the Company's rates of
10 4.88%. Exhibit Nos. 116 through 123 are supporting
11 schedules for adjustments made to the Company's proforma
12 rate base and operating results.
13 Q. During the course of your analysis in this
14 case did you investigate transactions between United
15 Water Idaho and its affiliated companies?
16 A. Yes. I attempted to analyze the Company's
17 investment in the Information Technology (IT) program,
18 increased costs for services provided by United Water
19 Resources Management & Services Co. (M&S), increases in
20 the Company's vehicle leasing program, increased costs
21 for computer service and support and other transactions
22 between United Water Idaho and other affiliated
23 companies. Many of these transactions originate at
24 United Water Resources world headquarters in New Jersey
25 and I found the audit trail difficult to follow from
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UWI-W-97-6 SMITH, R. (Di) 2
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1 United Water Idaho records. Several conference calls
2 between myself, Boise employees and employees in New
3 Jersey were required to determine how various affiliated
4 costs were determined and accounted for.
5 Q. Why were you concerned with these
6 affiliated transactions?
7 A. The Company in the current case
8 (UWI-W-97-6) has included nearly two million dollars
9 ($2,000,000) in its rate base to recognize the investment
10 in the new Information Technology Program, nearly one
11 million dollars ($1,000,000) in expenses for fees paid to
12 the M&S Co. and over two hundred thousand dollars ($200,000)
13 of lease expenses arranged by the M&S Company. These
14 costs are significant and merit scrutiny in a rate case.
15 Of particular concern was the investment in the IT
16 program. This new investment is administrative only,
17 producing no new revenues to help cover its cost.
18 Q. Are you proposing any specific adjustments
19 to the Company's investment in the IT program?
20 A. Yes, I will discuss later an adjustment to
21 the Company's depreciation expense.
22 Q. Did your investigation of the IT program
23 raise any other concerns?
24 A. Yes. Embedded within the IT program is a
25 complete change in the Company's accounting and time
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UWI-W-97-6 SMITH, R. (Di) 3
03/06/98 Staff
1 reporting systems and procedures. The magnitude of this
2 change raises the question of the quality of the test
3 year data the Company is using in this case.
4 Implementation of the new program was effective on
5 January 1, 1997, midway through the test year. One would
6 expect that a change of this magnitude would initially
7 produce a decline in efficiency and productivity as
8 employees learn how the new systems function, learn new
9 reporting procedures and identify and correct problem
10 areas. The Company, in response to Staff's Production
11 Request No. 53 stated:
12 ...the Company has initiated a major
effort to completely replace its data
13 processing systems as discussed in the
testimony of Company witness Linam.
14 While these efforts have resulted in
some reductions, there were also off-
15 setting increases. The full benefit
expected to result from the new systems
16 will not occur immediately but will occur
over time. (emphasis added)
17
18 These productivity concerns are difficult
19 to quantify. I found auditing the test year using two
20 accounting systems and general ledgers challenging.
21 Q. Where does United Water Idaho fit into the
22 overall corporate structure of United Water Resources
23 Inc.?
24 A. United Water Idaho is one of approximately
25 eighty-two (82) operating units, both utility and non-
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UWI-W-97-6 SMITH, R. (Di) 4
03/06/98 Staff
1 utility, operating in fourteen U.S. states, Mexico,
2 Canada and the United Kingdom. A few of these appear to
3 be paper shells for accounting convenience and
4 consolidation purposes. Exhibit No. 116 is a flow chart
5 of the "United Water Resources Financial Reporting Rollup
6 Structure." United Water Idaho is shown in the box at
7 the bottom center of this exhibit. For convenience, I
8 have marked the location with an arrow.
9 Q. What is the magnitude of total charges made
10 to United Water Idaho by affiliated companies under the
11 United Water Resources Inc. corporate umbrella?
12 A. According to the Company's response to
13 Staff's Production Request No. 71, the magnitude of these
14 charges on the records of United Water Idaho were
15 approximately $7.2 million dollars for the twelve-month
16 period ended June 1995, $4.8 million dollars for the
17 twelve-month period ended July 1996, and $4.0 million for
18 the twelve-month period ended June 1997.
19 Q. Do you believe these charges are all
20 reasonable?
21 A. It is difficult to tell. I am sure many of
22 the charges are justified but many of the charges may
23 also be excessive for the Idaho operation. What may
24 appear to be a good corporate decision for United Water
25 Resources Inc., U.S. or worldwide operations may not
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UWI-W-97-6 SMITH, R. (Di) 5
03/06/98 Staff
1 necessarily be the most economical decision for the Idaho
2 operation in isolation. My discussion in this testimony
3 regarding the vehicle lease program is a case in point.
4 These corporate decisions may produce inter-corporate
5 subsidies among the operating units. The audit trail
6 working from United Water Idaho records in Boise is often
7 difficult to follow. Many of the source documents are
8 located in New Jersey. Entries into the accounting
9 records of United Water Idaho for affiliated transactions
10 are most often performed by the corporate personnel in
11 New Jersey. The magnitude of these corporate charges
12 would go a long way toward paying for local
13 administrative and engineering services and stimulate the
14 Boise local economy rather than the New Jersey economy.
15 Q. United Water Resources Inc. together with
16 its subsidiaries is audited regularly by external
17 accounting firms and the Internal Revenue Service is it
18 not?
19 A. Yes.
20 Q. Don't these audits provide assurance that
21 United Water Resources Inc. is correctly accounting for
22 its financial transactions?
23 A. These audits are intended to verify the
24 accuracy of the corporate accounting transactions and
25 insure that the financial statements and income tax
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UWI-W-97-6 SMITH, R. (Di) 6
03/06/98 Staff
1 returns of the corporation are presented fairly. These
2 audits do not provide the assurances a regulatory
3 commission needs to insure fair, just and equitable
4 rates. These auditors do not care whether one of the
5 consolidated subsidiaries is earning 5% or 50% return on
6 equity. Their only concern is that the total combined
7 financial and tax reports are accurately presented.
8 Q. During the course of your review did you
9 notice any other specific activities that led you to
10 question United Water Idahos relationship with its
11 affiliated companies?
12 A. Yes. The United Water Resources subsidiary
13 company operating in Rio Rancho, New Mexico was lost
14 through a municipal condemnation proceeding. The
15 corporation received approximately $67 million that must
16 be reinvested in like assets to avoid paying income taxes
17 on a $4.3 million gain realized on the sale. The $67
18 million reinvestment can be made by any one of the
19 subsidiary companies or spread out among several or all
20 of them. This fact together with the recent construction
21 and acquisition activity of United Water Idaho raised the
22 suspicion of Staff regarding not only the timing but the
23 need and the cost of construction and acquisition
24 activities. Staff witness Lobb in his testimony
25 discusses some of Staff's concern regarding timing and
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UWI-W-97-6 SMITH, R. (Di) 7
03/06/98 Staff
1 need for several of the Company's recent Idaho projects.
2 Q. Has Staff made any adjustments to the
3 Company's rate base as a result of these concerns?
4 A. Yes. Exhibit No. 114 presents Staff's rate
5 base recommendation including several adjustments for
6 both acquisitions and construction projects as well as
7 capitalized costs charged to Idaho by the M&S Company.
8 Q. Will you please explain the development of
9 this exhibit?
10 A. Column "A" of the exhibit is a restatement
11 of the proforma rate base proposed by Mr. Gennari on
12 Company Exhibit No. 4, Schedule 1, page 2. Columns "B"
13 through "G" eliminate certain construction projects and
14 acquisitions from the rate base. Column "H" corrects an
15 oversight in the Company's case to retire old computer
16 equipment. Mr. Healy and I have discussed this
17 adjustment and we agree. Column "I" makes a correction
18 for a change in the Company's plans for replacing a
19 vehicle and eliminates some capitalized costs of the
20 Company's vehicles leasing program. Column "J" reflects
21 Staff's proposed rate base for this case of $80,901,734.
22 Q. Are you sponsoring testimony to discuss all
23 of these adjustments?
24 A. No. Staff witness Lobb discusses the
25 adjustments shown in Columns "C", "D" and "E" in his
515
UWI-W-97-6 SMITH, R. (Di) 8
03/06/98 Staff
1 testimony. Both Mr. Lobb and I discuss the adjustment
2 shown in Column "B". I will discuss the remainder of the
3 adjustments.
4 Q. Why do you propose to make the elimination
5 shown in Column "B" to remove from rate base the
6 Company's acquisition of the Garden City service area?
7 A. Staff addressed its initial concern with
8 this acquisition in Case No. UWI-W-95-2 when the Company
9 first came to the Commission for approval of the exchange
10 of service areas with Garden City. Commission Staff
11 Auditor Faunce expressed Staff's concern in her testimony
12 in that case. I have reviewed that testimony and concur
13 with her recommendations. Simply put, Staff opposes
14 including United Water Idaho's acquisition cost in rate
15 base for assets that were originally contributed by
16 developers to public service. Neither Garden City nor
17 United Water contributed any capital for the construction
18 of these facilities. They were constructed with a
19 combination of developer contributed funds and customer
20 connection fees collected by Garden City.
21 Q. Did the Company provide Staff with an
22 analysis of this acquisition that indicated that it was
23 providing sufficient revenues to support the cost?
24 A. Yes. However, absent from that analysis was
25 any recognition of source of supply investment displaced
516
UWI-W-97-6 SMITH, R. (Di) 9
03/06/98 Staff
1 to provide service to those customers.
2 Q. What do you mean by the term displaced?
3 A. In order to provide service to these
4 customers, the Company had to use its existing investment
5 in wells, reservoirs and water purchase contracts. Use
6 of these existing water supply sources to serve these
7 customers hastens the need to add new water supply
8 sources at incrementally higher cost.
9 The exchange of service area with Garden
10 City was a discretionary decision made by the Company and
11 municipal authorities. The affected customers were
12 already receiving adequate service from the Garden City
13 water system. Adding the cost of the acquisition to the
14 Company's cost of service without recognition of the
15 additional burden placed on existing customers would
16 create an injustice. It would require the existing
17 customers to forfeit their claim to water supply sources
18 already embedded in the rates they pay. Were the Garden
19 City system owned by another public utility, as was Warm
20 Springs Mesa, the transfer would have been subject to the
21 accounting instructions contained in the Uniform System
22 of Accounts adopted by this Commission. Those
23 instructions require that the assets would be recorded at
24 the original cost when first devoted to public service.
25 Accumulated depreciation at the date of transfer would
517
UWI-W-97-6 SMITH, R. (Di) 10
03/06/98 Staff
1 also be recorded. Any excess cost would be recorded as
2 an Acquisition Adjustment on the books of the purchasing
3 utility. For ratemaking purposes, the Commission could
4 either include or exclude the balance in the Acquisition
5 Adjustment Account in the Company's rate base. That
6 determination is usually based upon an analysis of the
7 effect on consumers. If it is demonstrated that
8 inclusion of the adjustment does not impose additional
9 incremental cost to the consumer it may be allowed. The
10 mere fact that the selling entity is a municipality
11 rather than a regulated public utility is not sufficient
12 reason to abandon this basic principal. In essence, this
13 principal is intended to replicate circumstances that
14 would exist today had the purchasing utility been the
15 original provider of service. Had United Water been the
16 original provider, it would have exactly the same
17 investment, accumulated depreciation and contributions on
18 its books at June 30, 1997, would be in exactly the same
19 water supply position but would not have the additional
20 net investment of $577,664 requested in this case.
21 Absent this acquisition, United Water Idaho
22 today would be in a better water supply position to meet
23 future customer growth. It is obvious that the consumers
24 will be penalized should the Commission allow the Company
25 to earn a return on the Acquisition Cost Premium
518
UWI-W-97-6 SMITH, R. (Di) 11
03/06/98 Staff
1 coincident with the reduction in water supply resources
2 available for future growth.
3 Q. You indicated that Staff witness Lobb
4 addresses the adjustments shown in Columns "C", "D" and
5 "E", so, moving on to Column "F" of this exhibit, why
6 have you eliminated from rate base $78,432 that you term
7 "Equity Gross-up AFUDC"?
8 A. This is another example of decisions that
9 are made at the United Water Resources corporate level
10 that affect the local operating subsidiary companies
11 including United Water Idaho. In July of 1995 a decision
12 was made to change the way the United Water Resources
13 group of companies calculated the Allowance for Funds
14 Used During Construction (AFUDC). Prior to that date,
15 the Company used the universally accepted and Idaho
16 Commission-approved method of capitalizing its weighted
17 cost of Debt and Equity to construction projects based
18 upon the most recent allowance determined by order of the
19 regulatory commission. In July 1995 the method was
20 changed to add an additional component to the
21 calculation. The component added was an income tax
22 adder applied to the equity component of the calculation.
23 Not only was the method changed but a retroactive
24 adjustment was made for AFUDC capitalized for the first
25 six months of 1995. Exhibit No. 117 is a copy of the
519
UWI-W-97-6 SMITH, R. (Di) 12
03/06/98 Staff
1 Company's response to Staff's Production Request No. 72
2 that shows the equity gross-up component of $80,857 that
3 has been capitalized to United Water Idaho's construction
4 projects since the change occurred in 1995.
5 Q. Are you aware of any other company that
6 uses this equity gross-up method to calculate AFUDC?
7 A. No. I performed several computer query
8 searches of the "Public Utility Reports" (PUR) data base
9 files for the years 1973 to date. None of the searches
10 produced any references to this method. That does not
11 necessarily mean that there isn't a company somewhere
12 using such a method; it simply indicates that the method
13 is not discussed in any of the orders contained in the
14 PUR data base.
15 Q. Did United Water Idaho request authorization
16 from this Commission to change the AFUDC calculation
17 method?
18 A. No.
19 Q. Did the Company in any formal or informal
20 way inform either the Commission or Staff that it
21 intended to change the calculation?
22 A Not that I am aware of.
23 Q. What is the adjustment to remove $787,735
24 from rate base shown in Column "G" on Exhibit No. 114?
25 A. This adjustment removes capitalized overhead
520
UWI-W-97-6 SMITH, R. (Di) 13
03/06/98 Staff
1 costs charged to construction projects over the last
2 three years for fees and expenses charged to United Water
3 Idaho by United Water Resources and the M&S Company.
4 Exhibit No. 118 page 1, is a supporting schedule provided
5 by the Company in response to Staff's Production Request
6 No. 73 that shows the overhead costs capitalized to
7 construction for the three-year period ended June 30,
8 1997. I have annotated the Company's response to show
9 total overheads charged for the three-year period. The
10 next to the last column to the right, that I have marked
11 with an arrow, indicates the amount of M&S fees that have
12 been added to the Company's rate base over the three-year
13 period ended June 1997. Page 2 of Exhibit No. 118 shows
14 my calculation of depreciation expense and accumulated
15 depreciation at June 30, 1997.
16 As I discussed earlier, because of the
17 potential inter-affiliate subsidies, the Staff is not
18 convinced that the costs for services provided to United
19 Water Idaho by the M&S Company are justified.
20 Q. What is the adjustment you show in Column
21 "H" on Exhibit No. 114 to retire Data Point computer
22 equipment?
23 A. This adjustment is necessary to recognize
24 the retirement of equipment that was taken out of service
25 but not retired on the Company's books when the new IT
521
UWI-W-97-6 SMITH, R. (Di) 14
03/06/98 Staff
1 system was activated. Mr. Healy and I have discussed
2 this adjustment and we agree it is appropriate.
3 Q. What is the adjustment for transportation
4 equipment shown in Column "I" of this exhibit?
5 A. This adjustment removes from rate base the
6 extra costs the Company incurred through its vehicle
7 leasing program. The details of this adjustment are
8 calculated on page 1 of Exhibit No. 119. That exhibit is
9 used to develop adjustments to both rate base and
10 operating expenses.
11 Q. Has Staff ever challenged these costs?
12 A. Yes. Staff challenged the Company's
13 decision to switch from ownership of its vehicle fleet to
14 leasing in the Company's last rate case.
15 Q. Did the Commission accept Staff's
16 recommendations regarding the vehicle leasing program in
17 the last case?
18 A. Not entirely. The Commission did
19 acknowledge Staff's concern regarding the Company's
20 leasing program in its Order No. 26671 (Case No. UWI-W-
21 96-3) beginning at page 5 where it stated:
22 Based on our review of the underlying
record in this case, we are unable to
23 find that the Company has presented the
Commission with a complete picture.
24 What the Company fails to present are
the enumerated and related savings
25 attendant from the switch to leasing.
For the Company to speculate on cross-
522
UWI-W-97-6 SMITH, R. (Di) 15
03/06/98 Staff
1 examination that there may be no
articulable savings, rings hollow when
2 one examines the record and exhibits
and realizes that the Company has not
3 seriously attempted to identify any
savings. To speculate that there are
4 no actual savings, further discounts
the Company's own prefiled testimony
5 when it alludes to savings in not
having to maintain a separate purchasing
6 and selling unit thus eliminating local
administrative time in procuring bids
7 and analyzing bids on new vehicles and
disposing of old vehicles (Tr.p.39), and
8 the Company's ability under the lease
program to obtain free loaner vehicles
9 during maintenance downtime (Tr.pp.38, 39).
We acknowledge that the Company is incurring
10 increased out-of-pocket expense related to
leasing. The Company does its customers a
11 disservice however when it seeks to recover
that expense without identifying and
12 matching related and contemporaneous
savings. (emphasis added)
13
14 The Commission then attributed a level of offsetting
15 savings to the leasing program by reducing the Company's
16 requested expense adjustment from $197,170 to $175,000.
17 Q. How much control does the local management
18 of United Water Idaho have over the decisions made to
19 replace its vehicle fleet with leased vehicles and
20 replace its accounting system and computer software and
21 equipment?
22 A. From what I have observed these decisions
23 are made at the United Water Resources Inc. headquarters
24 in New Jersey.
25 Q. Did the Company, in response to the language
523
UWI-W-97-6 SMITH, R. (Di) 16
03/06/98 Staff
1 of the Commission order, provide in its exhibits and
2 testimony in this case any hard evidence that proved the
3 benefits of leasing over ownership of the vehicle fleet?
4 A. No, its prefiled case is silent on this
5 subject. It did respond to Staff's Production Request
6 No. 82 seeking such information. The Company's response
7 to that request is no more convincing than similar
8 information provided in the Company's last case. The
9 Cost/Benefit analysis is flawed and superficial.
10 Assumptions regarding vehicle residual values are
11 artificially low and adjusted to favor leasing. The
12 actual experience of United Water Idaho over the last few
13 years demonstrates unequivocally that the residual values
14 are wrong and that leasing is more costly to the Company.
15 Q. Can you provide documentation to support
16 that contention?
17 A. Yes. Page 2 of Exhibit No. 119 is a copy of
18 the Company's response to Staff's Production Request No.
19 83. The document shows all of the owned vehicles that
20 United Water Idaho has retired in the three-year period
21 ended June 1997, the original cost of each vehicle and
22 the salvage or sale price realized. I have annotated the
23 Company's response to show the age of each vehicle at the
24 date of sale and the realized percentage of original cost
25 recovered through the sale. This document shows that the
524
UWI-W-97-6 SMITH, R. (Di) 17
03/06/98 Staff
1 Company realized average residual values of 31.4% for
2 vehicles with an average age of six years. This residual
3 value for six-year old vehicles compares with an assumed
4 residual value of 32% to 35% for three-year-old vehicles
5 used by the Company in its analysis.
6 Referring back to Exhibit No. 118 where I
7 discussed overhead loading, it is obvious that the
8 Company's own internal analysis indicates that the ratio
9 of transportation expenses to direct payroll has
10 increased from 6.5% to 11.5%. The increase in this ratio
11 coincides with the Company's transition to the vehicle
12 leasing program reflecting the higher transportation
13 costs.
14 Q. Did you do any independent research into the
15 residual values of vehicles?
16 A. Yes. I accessed the Kelly Blue Book
17 Official Guide of used car prices on the Internet. There
18 I compared the trade-in values, not resale values, of
19 several very basic three-year-old vehicles in fair, not
20 excellent or even good condition in Idaho and in New
21 Jersey. I learned that the trade-in values in Idaho
22 generally exceed New Jersey values by 6% to 12%. The
23 Kelly Blue Book does not indicate what the original new
24 price of the vehicles were.
25 I also reviewed the National Association of
525
UWI-W-97-6 SMITH, R. (Di) 18
03/06/98 Staff
1 Automobile Dealers (NADA) Used Car Buyers Guide,
2 Northwest Edition, for October 1997. Using wholesale or
3 trade-in values in that publication and the original
4 retail price listed, I determined that on the average,
5 three-year-old Ford pickups and vans retain more than 60%
6 of their value. A three-year-old Ford Taurus automobile
7 retained 43% of its value. These ratios are based upon
8 the Manufacturers Suggested Retail Price (MSRP). I don't
9 believe anyone ever pays full MSRP for the purchase of a
10 new vehicle, particularly a repeat fleet customer. I
11 would expect the residual values to be much greater if
12 calculated on the actual price paid for a vehicle rather
13 than the MSRP.
14 Q. Exhibit No. 119 appears to produce two
15 adjustments, one on lines 1 through 6, and another on
16 lines 7 through 11. How do these adjustments reflect the
17 concerns you have just addressed?
18 A. The first adjustment I have discussed with
19 Mr. Healy who agrees that it is appropriate. This
20 adjustment reflects changes in the Company's budget used
21 in preparation of this case. The Company has since
22 decided not to lease two vehicles originally contained in
23 the budget and to retain one owned vehicle that it
24 assumed would be retired. This adjustment simply
25 recognizes these changes to the Company's case.
526
UWI-W-97-6 SMITH, R. (Di) 19
03/06/98 Staff
1 The second adjustment recognizes the change
2 reflected by the first adjustment and reduces the
3 remaining leasing expenses to a level comparable to the
4 costs of ownership. On lines 7 through 9 I have used the
5 transportation overhead loading factors from Exhibit
6 No. 118 to calculate the increase in the overhead loading
7 ratio. The $119,536 adjustment shown on line 11, Column
8 "B" was developed by applying the increase in the
9 overhead ratio to the adjusted level of leasing expense
10 shown on line 5. Column "C" is the ratio of
11 transportation expense Mr. Healy used to allocate the
12 leasing expenses between operating expenses and rate
13 base. I have used this same ratio to allocate the
14 adjustment. Of the total $119,536 adjustment, $14,559 is
15 related to rate base and $104,977 is related to operating
16 expenses. On lines 12 and 13, I have combined line 6 and
17 line 11 adjustments and carried the respective results to
18 Exhibit Nos. 114, Column "I" and 115, Column "F".
19 Q. Column "J" of Exhibit No. 114 then reflects
20 Staff's recommended rate base for use in this case?
21 A. Yes, Staff's recommended rate base is
22 $80,901,734.
23 Q. Would you now turn to Exhibit No. 115 and
24 briefly describe the purpose of this exhibit?
25 A. This exhibit presents Staff's recommended
527
UWI-W-97-6 SMITH, R. (Di) 20
03/06/98 Staff
1 operating results. Column "A" is the Company's proforma
2 results as presented by Mr. Healy on Exhibit No. 5,
3 Column 4. Columns "B" through "O" present Staff's
4 recommended adjustments to the Company's case to produce
5 Staff's recommended proforma operating results shown in
6 Column "P". Column "Q" represents the adjustments
7 required to recognize the revenue increase of $1,080,581
8 necessary to produce the 8.86% return recommended by
9 Staff witness Carlock. Column "R" is the proforma
10 operating results restated for Staff's recommended
11 increase in Column "Q".
12 Q. Would you please explain the adjustments
13 shown on this exhibit?
14 A. The adjustment shown in Column "B" simply
15 corrects the Company's case substituting the actual Ad
16 Valorem tax levies for the Company's estimates used
17 to prepare its case. Mr. Healy and I have discussed this
18 adjustment and agree.
19 Column "C" presents a correction to the
20 Company's case for water tests the Company anticipated
21 that will not have to be done. Mr. Healy and I have
22 discussed this adjustment and we agree.
23 Column "D" is a correction for a double
24 count of storage costs at Anderson Ranch Reservoir that
25 the Company inadvertently included in its case. Mr.
528
UWI-W-97-6 SMITH, R. (Di) 21
03/06/98 Staff
1 Healy and I agree on this adjustment.
2 Column "E" is a correction for employee
3 dental insurance coverage that the Company overlooked in
4 its case. Mr. Healy and I agree on this adjustment.
5 Column "F" is the adjustment I discussed
6 earlier regarding the Company's vehicle leasing program.
7 The details of the adjustment are shown on page 1 of
8 Exhibit No. 119.
9 Column "G" is an adjustment to correct the
10 Company's Thrift Plan adjustment to recognize the time
11 Mr. Linam spends on non-Idaho utility business. Mr.
12 Healy and I agree on this adjustment.
13 Column "H" is an adjustment to correct the
14 Company's estimated costs of its telemetry expense. The
15 adjustment simply substitutes more recent known costs for
16 the Company's estimates. Mr. Healy and I have discussed
17 the adjustment and agree.
18 Column "I" eliminates depreciation expense
19 related to the rate base adjustment I discussed earlier
20 for the equity gross-up calculation the Company began
21 using in its AFUDC calculations. The depreciation
22 expense adjustment is simply the $80,857 gross
23 capitalized AFUDC divided by the average fifty-year life
24 of the Company's plant in service.
25 Column "J" eliminates the depreciation
529
UWI-W-97-6 SMITH, R. (Di) 22
03/06/98 Staff
1 expense associated with the rate base adjustment I
2 discussed earlier regarding the capitalized corporate
3 overheads. The calculation is shown on Exhibit No. 118,
4 page 2.
5 On page 1 of Exhibit No. 115, Column "K"
6 eliminates from O&M expenses 19.72% of the proforma
7 payroll tax expenses the Company calculated on Exhibit
8 No. 5, Schedule 3, page 2. This adjustment simply
9 represents the ratio of future payroll tax expenses that
10 will be capitalized along with the associated payroll.
11 The adjustment in Column "L" to adjust PUC
12 case expenses is detailed on Exhibit No. 120. Staff has
13 considerable reservations regarding the reasonableness of
14 the fees the M&S Company is charging United Water Idaho.
15 Line 1 of Exhibit No. 120 shows the estimated cost of the
16 current case that the Company built into the case. The
17 Company has indicated through its responses to Staff's
18 Production Request Nos. 55 and 56 and Ms. Ullman's
19 Request No. 14, that its estimated rate case expenses are
20 based upon the Company's last fully litigated rate case
21 No. BOI-W-93-3. Information provided by the Company's
22 responses indicate that $228,000 of the $300,000 was
23 billed by the M&S Company. In that case Mr. Matt Jost, a
24 New Jersey employee of the M&S Company in New Jersey,
25 presented the testimony and analysis that Mr. Healy is
530
UWI-W-97-6 SMITH, R. (Di) 23
03/06/98 Staff
1 presenting in this case. As an employee of United Water
2 Idaho, not the M&S Company, Mr. Healy's wages, benefits
3 and overhead costs are already included in the Company's
4 payroll adjustments. This simply constitutes, at a
5 minimum, a double count of costs.
6 On the other hand, Mr. Healy's participation
7 supports Staff's position that many if not all of the
8 services provided by the M&S Company can be quite
9 competently handled by the local operating company.
10 Q. Is the double count you referred to the
11 sole purpose for this adjustment?
12 A. No. As I have discussed earlier, Staff is
13 skeptical of the charges imposed on United Water Idaho by
14 the M&S company as well as the motivation to invest
15 capital occasioned by the sale of the Rio Rancho, New
16 Mexico system. Billings by the M&S Company for the
17 current case indicate that the Company was billed over
18 $33,250 for one M&S employee in a four-month period of
19 time. In the month of November the Company was billed
20 over $15,000 for this employee.
21 These charges don't appear to be reasonable
22 and should not be passed on to the consumer. Staff
23 recommends disallowing at least one-half of the Company's
24 estimated charges. If the Company feels it must spend
25 this kind of money to protect the interests of both its
531
UWI-W-97-6 SMITH, R. (Di) 24
03/06/98 Staff
1 customers and its stockholders, the cost should be split
2 among them. Lines 2 through 5 of Exhibit No. 120 make
3 this elimination and accepts the two-year amortization
4 period recommended by the Company.
5 The lower half of this exhibit simply
6 adjusts the Company's proposed amortization period for
7 costs incurred for other more specialized, non-recurring
8 cases. The Company requested a two-year amortization
9 period for these costs. Given the non-recurring nature
10 of these cases, Staff believes a five-year amortization
11 period is more reasonable.
12 Line 13 accumulates the effect of the two
13 adjustments on the Company's case. The $86,044 is
14 carried to Exhibit No. 115, page 2, Column "L".
15 Q. Have you prepared an exhibit to explain the
16 adjustment shown in Column "M" on page 2 of Exhibit No.
17 115?
18 A. Yes. Exhibit No. 121 is a recalculation of
19 Mr. Healy's Exhibit No. 5, Schedule 1, pages 24 and 27.
20 The adjustments are intended to synchronize expenses with
21 the effects of customer growth and weather on the
22 Company's variable operating expenses that are sensitive
23 to these changes. The numbers in Column "A" on this
24 exhibit are taken directly from Mr. Healy's exhibits.
25 Column "B" reflects the effects of Staff's proposed
532
UWI-W-97-6 SMITH, R. (Di) 25
03/06/98 Staff
1 changes in this case and substitutes proforma adjusted
2 numbers in the case for some actual numbers used by Mr.
3 Healy. The calculations are otherwise identical. The
4 adjustments on lines 12 and 20 are simply the differences
5 between Mr. Healy's calculation and substituting Staff's
6 proforma expenses. These two adjustment are combined on
7 line 21 and carried forward to Exhibit No. 115, page 2,
8 Column "M".
9 Q. What is the adjustment you show in Column
10 "N" of Exhibit No. 115?
11 A. This adjustment simply reverses an
12 adjustment the Company included in its case to budget for
13 increases in fees paid to the M&S Company. Given the
14 discussion in this testimony regarding such fees, Staff
15 cannot support an adjustment increasing those fees to
16 even higher levels.
17 Q. What is the adjustment shown in Column "O"
18 of this exhibit?
19 A. The Company in its case used a ten-year life
20 for calculating depreciation expense on its investment in
21 the IT Program and the Master Plan. Mr. Linam, at page
22 17 of his direct testimony discussing the IT system,
23 points out that this system replaces a "20+ year old main
24 frame that was essentially obsolete." The magnitude of
25 the conversion to a new information system such as this
533
UWI-W-97-6 SMITH, R. (Di) 26
03/06/98 Staff
1 is not a normal occurrence. It isn't reasonable to think
2 that every ten years the Company will have to basically
3 scrap all of its technological equipment and software and
4 start over from scratch. Based upon the life realized on
5 the old system, Staff recommends that the depreciation on
6 the IT system investment should be based upon a twenty-
7 year period. Likewise, the Master Plan the Company is
8 completing is a long-term project that is rather unusual
9 for United Water. Staff proposes that this investment
10 also be depreciated over a twenty-year period. The
11 adjustment in Column "O" is simply a 50% reduction in the
12 Company's proforma depreciation adjustment.
13 Q. Column "P" then represents Staff's proposed
14 proforma operating results incorporating all the
15 adjustments included in Columns "B" through "O"?
16 A. Yes.
17 Q. Where do the income tax expense numbers
18 shown on Exhibit No. 115, page 2, Column "P" at lines 10
19 and 11 come from?
20 A. Exhibit No. 122 shows the calculation
21 required to restate the income taxes for the proforma
22 changes made on Exhibit No. 115, to synchronize the
23 interest expense deduction with the rate base, and
24 recognize the tax timing difference between book and tax
25 depreciation.
534
UWI-W-97-6 SMITH, R. (Di) 27
03/06/98 Staff
1 Q. What are the last two columns labeled "Q"
2 and "R"?
3 A. Column "Q" incorporates the revenue,
4 expense and tax adjustments necessary to produce the rate
5 of return proposed by Staff witness Carlock. The
6 calculations of these adjustments are shown on Exhibit
7 No. 123. Column "R" presents the proforma results of
8 operations after applying the $1,080,581 increase in
9 rates that Staff proposes.
10 Q. Does this conclude your direct testimony in
11 this proceeding?
12 A. Yes, it does.
13
14
15
16
17
18
19
20
21
22
23
24
25
535
UWI-W-97-6 SMITH, R. (Di) 28
03/06/98 Staff
1 (The following proceedings were had in
2 open hearing.)
3 MR. WOODBURY: I thought that I had
4 presented him.
5 COMMISSIONER NELSON: Excuse me, it's
6 getting late.
7 Mr. Fothergill, did you have questions?
8 MR. FOTHERGILL: No, we do not.
9 COMMISSIONER NELSON: Ms. Ullman.
10 MS. ULLMAN: Yes, I have a couple of quick
11 questions, I hope.
12
13 CROSS-EXAMINATION
14
15 BY MS. ULLMAN:
16 Q Mr. Smith, will you please briefly
17 summarize your concerns about the rate case expense for
18 the Company?
19 A Well, in a nutshell, throughout my analysis
20 in this particular case I continuously questioned some of
21 the charges that I saw appearing from the Management and
22 Service Company. I've discussed that in some detail in
23 my testimony. A good portion of the rate case expenses
24 built into this case from an estimate based upon the last
25 case were charges from the Management and Service
536
CSB REPORTING SMITH (X)
Wilder, Idaho 83676 Staff
1 Company.
2 In addition, as I've pointed out in my
3 testimony, some of the charges that I think were incurred
4 in the last case would not exist if that case were
5 repeated today given the participation by local witnesses
6 in lieu of Management and Service Company personnel.
7 Q I would also like to ask you about the
8 ad valorem tax correction. Now that you have or the
9 Company has provided and now that it is available the
10 actual 1997 Company appraisal as well as the weighted
11 levy, I'm wondering if you will -- I'll refer you to
12 Exhibit No. 115, page 1 of 2, where you have a correction
13 of only $18,974, would you agree that that number should
14 be significantly increased?
15 A I don't believe so. I believe that that
16 adjustment reflects the actual appraisal number and is
17 subject to some modification depending upon what the
18 actual mill levy charges are. That is the question that
19 you went over with Mr. Healy earlier today and I have no
20 better information than does Mr. Healy on what that mill
21 levy might do.
22 Q The correction you have included, though,
23 refers to the 1997 taxes that we already have now, the
24 specific weighted levy as well as the specific value of
25 the Company, does it not?
537
CSB REPORTING SMITH (X)
Wilder, Idaho 83676 Staff
1 A I believe that's based upon the most recent
2 data available.
3 Q Okay, and would that data be from 1996 or
4 1997 that you have used?
5 A It's based upon the assessment from the Tax
6 Commission that was provided early this year, early in
7 '98, the most recent Tax Commission assessment.
8 Q And were you aware that the Company has now
9 provided a more recent weighted levy as well?
10 A A weighted levy?
11 Q Yes, the levy -- do you by any chance have
12 Mr. Healy's testimony with you?
13 A Yes, I do here somewhere. You're referring
14 to his rebuttal testimony?
15 Q His -- no, his direct testimony, Exhibit
16 No. 5, schedule 3, page 1.
17 A Okay, I've got that before me here.
18 Q Okay. Now, your number, your adjustment of
19 $18,974, did you use on line 6 this 1.7492, the most
20 recent levy rate based on 1996 taxes?
21 A I don't appear to have my calculation here
22 with me, exactly which numbers were used in that
23 calculation.
24 Q Are you aware that in response to a
25 production request which I also can't put my hands on
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Wilder, Idaho 83676 Staff
1 right at the moment that the Company provided the actual
2 weighted 1997 levy?
3 A Was that in response to one of your
4 requests, Ms. Ullman?
5 Q Yes, it was.
6 A I don't have those here with me. I did
7 review those. I don't recall that particular question,
8 nor the response. I could get that in a matter of a few
9 moments.
10 Q Okay, I submitted it as Exhibit No. 423
11 this morning. It was in response to Request No. 27 and
12 specifically shows for the tax year 1997 an average levy
13 of 1.72238 percent.
14 A Okay, I was not privileged enough to
15 receive a copy of that exhibit. Oh, I have one now.
16 Q Okay, and again I go back to your
17 adjustment, whether you have taken the new levy provided
18 by the Company in response to my request, does your
19 adjustment reflect that new levy or the previous levy the
20 Company used, the 1996 levy?
21 A If I can answer that subject to check, I've
22 got my calculation in my office I can verify, but I
23 believe that I used the 1.7492 number.
24 Q Okay; so would you agree now that we have a
25 new number, that that should be recalculated and a
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CSB REPORTING SMITH (X)
Wilder, Idaho 83676 Staff
1 further adjustment should be made?
2 A That would be appropriate.
3 Q Okay, and as far as predicting the tax
4 burden for the tax year of 1998, you heard the testimony
5 this morning where Mr. Healy used an average annual
6 increase over the past nine years to determine the
7 appraised value of the property, do you feel that that
8 was a reasonable approach or is it just as reasonable to
9 take two years or five years or some other approach?
10 A Well, I'm not a statistician, first of all,
11 but generally speaking from the statistics I have had,
12 the more data points you have the better result would be,
13 so I don't know that any number less than nine would
14 produce a better number. It might be a more recent
15 indicator, but it may not necessarily be better.
16 Q And would your answer, would the same
17 answer, apply with regard to predicting the 1998 levy as
18 well, that if the levies are falling as has been shown
19 from 1993 to 1997, then it's a reasonable assumption to
20 assume that in 1998 the levy will again be lower than it
21 is in 1997?
22 A I believe I would agree with Mr. Healy's
23 characterization this morning that indications are it
24 would probably be lower. I, however, have no more
25 insight as to how much lower it would be than Mr. Healy
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CSB REPORTING SMITH (X)
Wilder, Idaho 83676 Staff
1 would or yourself either.
2 Q Mr. Healy discussed fairness to the Company
3 as well as fairness to the ratepayers, would it not be
4 reasonable to try to figure out some sort of accounting
5 model to predict what that levy might be rather than
6 using the 1997 levy which there is some general agreement
7 is going to be too high?
8 A If we knew what all of the taxing
9 jurisdictions were going to do with their budgets, that
10 would be somewhat simple to do. Not knowing what the
11 individual taxing districts might do with those budgets,
12 I don't know how to put together a model to forecast
13 something as elusive as that mill levy.
14 Q Do you think that it would be reasonable to
15 consider the downward trend, at least?
16 A I think that would be reasonable.
17 MS. ULLMAN: That's all I have. Thank you.
18 COMMISSIONER NELSON: Thank you,
19 Ms. Ullman.
20 Let's go off the record just a second.
21 (Off the record discussion.)
22 COMMISSIONER NELSON: Let's go back on the
23 record.
24 MR. MILLER: Commissioner Smith this
25 morning requested that the Company produce service area
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CSB REPORTING SMITH (X)
Wilder, Idaho 83676 Staff
1 maps and we have those now and we'd be happy to
2 distribute them. It was unclear to me whether the
3 Commission just wanted to see them or you had questions
4 of a witness in connection with them, but we would supply
5 those to the Commission at this time and then if you have
6 questions for any of our witnesses with respect to them,
7 you'd have a chance to look at them and we'd make a
8 witness available in the morning.
9 COMMISSIONER NELSON: Okay, thank you.
10 Well, with that, why, we'll recess until 6:30 when we
11 will convene a public hearing in this case and look
12 forward to seeing you all then. Thank you. We'll take
13 up at 9:30 in the morning.
14 (The Hearing recessed at 5:05 p.m.)
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Wilder, Idaho 83676