STATE OF FLORIDA

DIVISION OF ADMINISTRATIVE HEARINGS

LEHIGH UTILITIES, INC., )

)

Petitioner, )

)

vs. ) Case No. 80-1202

) Docket No. 790638-WS

FLORIDA PUBLIC SERVICE )

COMMISSION, )

)

Respondent. )

)

RECOMMENDED ORDER

Pursuant to notice, an administrative hearing was held before P. Michael Ruff, Hearing Officer with the Florida Public Service Commission, on March 6 and

7 and May 12 and 13, 1980, in Fort Myers, Florida, on the application of Lehigh Utilities, Inc. for an increase in rates end charges for water and sewer service to its customers in Lee County, Florida, pursuant to Section 367.081 of the Florida Statutes. On July 1, 1980, the matter was transferred to the Division of Administrative Hearings, but continues to be assigned to P. Michael Ruff as Hearing Officer for the Division, for a Recommended Order.

APPEARANCES

For Petitioner: R.M.C. Rose, Esquire

1020 East Lafayette Street Tallahassee, Florida 32301

For Respondent: William H. Harrold, Esquire

101 East Gaines Street Tallahassee, Florida 32301

On July 31, 1979, Lehigh Utilities, Inc. (hereinafter referred to as Utility or Lehigh) filed with the Public Service Commission an application to increase water and sewer rates to its customers in Lee County. The Utility is a wholly-owned subsidiary of Lehigh Corporation. Mr. Edward Shapiro is Vice President of the company. The Utility provides water services to approximately 5,000 residential customers, 129 general service customers and 14 multiple dwellings. The Utility provides sewer service to approximately 4,000 residential customers, 113 general service customers and 9 multiple dwellings.

This Petition is predicated on a test year ended March 31, 1978. By a later amendment the test year underlying the Petition was revised to include the year ended March 31, 1970. During the test period, the Utility alleges that it received operating revenues of $498,498.00 for water and $542,750.00 for sewer services. The Petitioner is requesting rates which would produce gross annual revenues of $776,897.00 for its water service, and $763,144.00 for sewer service, which would equate to an 11.76 percent rate of return on the Utility's requested rate bases of $1,872,470.00 and $1,917,931.00 for water and sewer respectively. The issues to be determined are whether the water and sewer service provided by Lehigh meets all pertinent regulatory quality standards and

determination of what amount of revenue is just, reasonable, compensatory, and not unfairly discriminatory, in accordance with Section 367.081, Florida Statutes. On August 23, 1979, in Order No. 9034, the Public Service Commission suspended the proposed rates filed by the Utility and granted an interim rate increase. Prehearing conferences were held on February 1 and 4, 1980, and public hearings were held on March 6 and 7 and May 12 and 13, 1980. The proposed rates are currently in effect subject to refund, pending a final order of the Commission. The Commission has previously considered the revenue requirements of this Utility in Commission Docket No. R-73384-WS, which culminated in Order No. 6447 and Order No. 6527, wherein the company's rates were increased.

FINDINGS OF FACT

1. Although numerous customers were present, four of them testified at the hearing. No service quality problems were described with regard to either water or sewer service. Indeed, several of the customers described water quality as being good or excellent. The primary concern of the customers was the magnitude of the proposed rate increase, although a number of then opined that some increase in rates may he necessary.

   
   

2. Expert engineering witnesses presented by both the Comission and the Petitioner established that the Utility has not been cited by any local, state or federal agency for health or environmentally related violations. No corrective orders are in force either by the Department of Environmental Regulation, the Lee County Health Department, or the Public Service Commission. The water and sewer treatment exceeds all governmental quality standards extant. In order to enhance service quality, the company has constructed a one million gallon ground storage tank and has installed an additional high-service pump. All parties agree that the cost of these improvements should be added to the Utility's rate base for purposes of this proceeding.

   
   

   Rate Base

   
   

3. The Utility propounded evidence alleging its proper water rate base to be $1,872,470.00 and the appropriate sewer rate base to be $1,917,931.00.

   
   

4. In arriving at the Utility's net investment in property used in the public service (rate base), it is necessary to calculate the amount of contributions-in-aid-of-construction, which serve to decrease the Utility's investment. Normally, where there has been a previous rate case for a utility in which the utility's net investment would have been determined by the Commission, the calculation of the utility investment in a current rate case is generally competed by adding additions to plant-in-service and subtracting additional contributions-in-aid-of construction in order to arrive at the current net "return yielding" investment.

   
   

5. In the instant proceeding, however, Lehigh has elected to take issue with the amount of contributions-in-aid-of-construction (CIAC) previously determined by the Commission in the last rate case. In that last case (Docket No. R-73384-WS), the amount of CIAC was determined by multiplying water connections by $350.00 and sewer connections by $400.00. (See Exhibits 10, 19 and 20)

   
   

6. The Utility in the prior proceeding agreed with that method of calculation and, further, two land sales contracts in evidence show that a charge of $750.00 for "sales price of water and sewer" to purchasers of houses

   in the service area has been imposed by the Utility or its predecessor, Lehigh Corporation (development company), when the Utility was merely a division of the development company. Notwithstanding that prior position, the Utility in this proceeding has elected to attempt to prove its level of CIAC ab initio and has conducted a "Special CIAC Study" in an attempt to show that the amount of contributions is now substantially less than the amount it and the Commission agreed to be applicable in the last rate proceeding and that which the Commission maintains is germane to this proceeding.

   
   

7. The Utility thus is alleging that the appropriate charge per connection for CIAC is $650.00 for a water and sewer connection as opposed to the Commission's contention that the figure should be $750.00 per connection. Although a developer's agreement with an affiliated company shows a water and sewer connection charge of $650.00, the testimony of a senior officer of the Utility establishes that there were a total of 1,308 such contracts indicating a sales price for water and sewer service of $750.00. The Utility contends that only $650.00 of the $750.00 charge in question was actually transferred to the utility company and that, therefore, the $650.00 is the appropriate amount to attribute to CIAC. There is no question, however, that with regard to these 1,308 land sales contracts, that $750.00 was actually collected from the lot purchasers involved as the sales price of water and sewer service. Thus, the actual amount of CIAC paid by those 1,308 customers was $750.00 each, for a total of $981,000.00 for water and sever service and that figure represents in its entirety contributions-in-aid-of-construction. The contracts for which the customers involved paid $750.00 for water and sewer service, were entered into in the latter 1960's and early 1970's. Prior to that time, the same type of contracts carried an amount of $650.00 for water and sewer and following the period of time when the fee was $750.00, the line item in the contract was changed so that there was no longer any separate item providing for "sales price of water and sewer." The water and sewer charge was thereafter included in the amount charged for "sales price of improvements." Thus, contrary to the position of Lehigh, because of the segregation of the items in the purchase price shown in these land sales contracts into separate figures for price and for the sales price of water and sewer service, there have been shown to be definite, proven amounts of contributions-in-aid-of-construction supported by company records. The remaining portion of the contributions attributable to the Utility and not represented by these contracts were contributed in the sum of

   $650.00 per connection, with which figure both parties agree.

   
   

8. An additional issue regarding contributions and the "Special CIAC Study" concerns contributions recorded as income from the inception of the Utility operation until November 30, 1964. As demonstrated by Exhibit 12, the amount of contributions recorded as income equals $756,656.00. The Utility's own "Special CIAC Study" refers to contributions recorded as income and Lehigh received sums of money for the availability of water and sewer service in the early 1960's which it treated as income. During the early 1960's when the Utility was regulated by Lee County, the Lee County regulatory board allowed it and other water and sewer utilities to receive and record service availability fees as revenue. This was done in order to enhance the apparent financial posture of the utilities and therefore improve their credit status as an aid to financing improvements. There is no question that those fees during this time period were paid into the Utility or its predecessor for water and sewer service availability and hence should properly be accounted for as CIAC.

   
   

9. It might be argued, as the Utility does, that if Lehigh declared the contributions it received to be revenues with the Internal Revenue Service, then the benefit of those contributions or the amount of revenue they represent to

   the Utility would be reduced by the amount of the resulting income tax, and that if they are now determined to be contributions instead of revenue that an additional detriment to the Utility would occur by the reduction by that amount of its rate base and, therefore, its dollar return. It should be pointed out, however, that because of the tax advantages of the Utility's demonstrated operating loss carry-overs and investment tax credits, as well as accelerated depreciation, all of which tax advantages this Utility has been able to employ, no actual income tax has been paid on such "revenue." Further, Lehigh is depreciating this $756,655.00 in assets in its returns to the Internal Revenue Service and is thereby recovering the costs of the assets. If the Utility is permitted to treat them for regulatory rate-making purposes as revenue instead of CIAC, then the effect would be to maintain rate base and return at a correspondingly higher level than if these amounts are determined to be CIAC, which would reduce rate base and thereby the net investment upon which a return could be earned for regulatory purposes.

   
   

10. Thus, the appropriate amount of contributions-in-aid-of-construction for the water system as of the closing date of March 31, 1979, equals

    $1,057,000.00. The amount of contributions-in-aid-of-construction attributable to the sewer system as of that date equals $1,389,977.00. (Net of amortization). The detailed calculations and adjustments supportive of the above findings with regard to rate base are attached hereto and incorporated by reference herein as Schedules I, II and II.

    
    

11. The first issue to be concerned with in calculating the operating expense basis for the revenue requirement is the cost of the above-referenced CIAC study. The Utility prepared this special CIAC study because of its fear that, in view of the Commission's decision in Tamarac Utilities, Inc. v. Hawkins, 354 So.2d 437, that it would not otherwise be able to meet its burden of proof on the issue of contributions and therefore would suffer a dismissal of the petition. In the Tamarac case, the Public Service Commission auditors encountered numerous problems resulting from a lack of primary data supporting the amount of contributions and the Commission issued an order allowing the Utility to provide clarifying evidence. When the Utility failed to satisfactorily perform this task, it ultimately suffered a dismissal of its petition and a refund of monies collected under interim rates. In this case, however, it has been demonstrated that there is no dearth of primary data or books and record supportive of the level of CIAC; nor has an order been issued requiring this Utility to provide such clarification or a "study" of its CIAC. Moreover, in the case of this utility, a previous rate case has been finalized wherein it was found by the Commission that there was a definite, specific level of contributions which were also consistent with those alleged by the petitioner in that proceeding. Thus, there is adequate primary data upon which a determination of CIAC can be computed in this proceeding without resort to a "Special CIAC Study" and the additional increment of rate case expense it represents.

    
    

12. It should be further noted that even if the instant case involved a "Tamarac situation" where financial books and records were not adequate to properly document contributions-in-aid-of-construction that, in that event, if a CIAC study were made, then the proper rate-making treatment would be to amortize tile cost of that study over several years, since it is a large, nonrecurring expense in the Utility's operation, as opposed to allowing the entire expense to be written off (and charged to the customers through rates) based upon one year.

    
    

13. The Utility has alleged that certain additional pro-forma adjustments to various expense items should be accomplished in order to arrive at the

    appropriate revenue which will support an adequate rate of return. Thus, the increased costs alleged for purchases of lime, chlorine and gasoline, depicted in the attached schedules incorporated herein, were undisputed, agreed to, are reasonable and therefore should be accepted. The alleged pro-forma cost for payroll is a mere estimate and not supported by competent, substantial evidence. Additionally, it was established by the Commission's accounting witness that certain rate case expenses arose from a prior rate case and therefore should be removed from consideration in arriving at revenue requirements for purposes of this proceeding. This adjustment was not contested, nor were similar adjustments to remove depreciation expense on construction work in progress, to remove depreciation expense on the contributed property, to remove unsupported property taxes, and to remove property tax as an expense and depreciation expense attributable to non-used and useful portions of the Utility's invested plant. None of these adjustments were disputed by the Utility. They are appropriate and reasonable and should be adopted.

    
    

14. The Utility has also requested allowance of a $55.00 annual fire hydrant charge and a $10.00 charge for the initial commencement of service. The Utility submitted evidence (Exhibits 6 and 7) supportive of the actual number of water and sewer connections made during the test years as well as the costs upon which the initial commencement of service charge requested is based. The Commission did not dispute, therefore, the requested $10.00 charge for initial commencement of service and, inasmuch as the current $25.00 annual fire hydrant charge was established in the late 1960's and was shown to be no longer sufficient to cover costs, the Commission also did not dispute the increase in the annual fire hydrant charge from $25.00 to $55.00, which accordingly should be increased.

    
    

    Cost of Capital

    
    

15. The Utility has requested a rate of return of 11.76 percent which includes an attrition allowance of .78 percent. There is no dispute as to the debt-equity ratios in the capital structure of the Utility. The common stock equity represents approximately 49.57 percent of the total capitalization.

    Long-term debt makes up 35.96 percent of capital and cost-free capital items make up 14.47 percent. The cost rate of the equity in the capital structure was established by the Commission's financial expert witness to be 14.5 percent or the midpoint in a range for companies and utility companies possessing a similar degree of risk to equity investors of 13.5 percent to 15.5 percent. The 14.5 percent cost of equity figure represents an accurate assessment of the opportunity costs of equity capital for such a company. The imbedded cost of long-term debt is 8.3 percent, which is a very advantageous rate to be enjoyed by such a company in today's money market and reflects a high degree of management efficiency on the part of the operation and management personnel of the petitioner. These two items, when combined with a zero cost factor shown to be appropriate for the cost-free capital items, results in a calculated rate of return of 10.35 percent, which does not take into account an attrition allowance due to inflation. The Utility advocated an attrition allowance equal to 10 percent of the weighted cost of equity capital to help offset the erosion in earnings caused by inflation. There can be little doubt that attrition of earnings due to significant inflation in costs of operation experienced by such companies is a very real factor. However, this record contains no substantial and competent evidence to demonstrate whether the utility wants coverage of capital attrition or attrition of its ability to cover operation and maintenance expenses nor which could justify the alleged 10 percent factor or any other quantification of attrition of earnings which may be experienced. Thus in the absence of a definitive establishment of the appropriate attrition factor, a

    cost of equity and a corresponding return on rate base in the midpoint of the range found above is appropriate. Thus, the proper return on rate base for this Utility has been shown to be 10.35 percent, which is within the range 9.85 percent to 10.84 percent. A summary of the cost of capital structure and weighted cost of capital calculation is depicted as follows:

    
    

    CALENDAR YEAR 1979

    
    

    COMMON STOCK EQUITY	RATIO 49.57	COST RATE 14.5	WEIGHTED COST 7.19
    LONG TERM DEBT	35.96	8.8	3.16
    COST FREE	14.47	-0-	-0-
    			10.35
    Floor CSE at 13.5	9.85
    Ceiling CSE at 15.5	10.34

    
    

16. In summary, the required operating revenue for the Utility's water system should be $658,451.00 which results in an operating income of

    $211,407.00. The sewer system requires an annual, gross operating revenue of

    $475,629.00 in order to obtain a return or operating income of $130,017.00. The operating expenses and adjustments supportive of these figures are depicted in more detail in Schedules IV, V and VI attached hereto and incorporated by reference herein.

    
    

17. The sewer revenue requirement found herein is less than the interim revenues authorized for sewer service, thus a refund is in order.

    
    

    CONCLUSIONS OF LAW

    
    

18. Section 367.081(2) of the Florida Statutes requires that the Public Service Commission fix rates which are just, reasonable, compensatory, and not unfairly discriminatory; and that the Commission consider the value and quality of the service rendered by a utility, the cost of providing the service including debt interest, working capital requirements, maintenance, depreciation, taxes and operating expanses incurred in the operation of all properties used and useful in the public service. In consideration of the foregoing findings of fact and these statutory criteria, it is concluded as follows:

    
    

19. The quality of the water and sewer service provided by the Utility meets all pertinent regulatory standards. On the issue of rate base, the Utility's position that, notwithstanding the language in the land sales contracts to the effect that the sales price of water and sewer was $750.00; that only $650.00 of that amount collected was transferred to the utility company by the developer company; and that $650.00 per connection therefore is an appropriate amount for CIAC, is erroneous. The correct amount of CIAC is the amount a customer actually pays for water and sewer service. The definition of the term "contributions-in-aid-of-construction" is found in Count 271, National Association of Regulatory Utility Commissioners, Uniform System of Accounts and, Rule 25-10.121(3), (4) and (16), Florida Administrative Code. A customer paying certain amounts for water and sewer service availability should be credited with the entire amount of the payment. It matters not that the amounts were originally paid to a parent and closely affiliated corporation or to a corporation under which the petitioner corporation was originally a mere division or to the petitioner corporation itself. The fact that the customer may have paid an amount for water and sewer service availability to the parent developer corporation for water and sewer service which a division of that

    developer corporation provided and which service is now provided by a different corporation but with very close origins and affiliation with the parent developer corporation (common officers and directors) is a distinction without a legal difference. The Utility cites the Supreme Court's decision in Deltona V. Mayo, 342 So.2d 510, as support for its contention that the Commission has no jurisdiction to attribute a portion of the purchase price for lots contained in the land sales contracts with the development company to the utility company herein over which the Commission does have jurisdiction. The distinguishing factor which renders the Deltona decision inapplicable to the instant situation, however, is that in the land sales contracts referred to between the lot purchaser-utility customers and the Deltona corporation-developer, no segregation of purchase price according to that portion which could be attributed to water and sewer fees was ever made, whereas in the instant situation the developer company, in its contracts with the lot purchasers (customers), did make a specific segregation or itemization of a part of the purchase price as "sales price for water and sewer service." Therefore, the Commission herein, contrary to the practice it followed and which the Court prohibited in the Deltona case is not attempting to assume the existence of some indefinite amount of CIAC. Rather, there are definite amounts of CIAC depicted on the looks and records of the utility company as well as the above-described contracts to support the figures for contribution-in-aid-of-construction found above.

    
    

20. With regard to the petitioner's contention that $756,655.00 of contributions originally recorded as income should not now be treated as CIAC, it is concluded that such a treatment would artificially inflate or enhance the Utility's rate base since the recording of those monies as revenue would reduce the amount of CIAC by corresponding amounts and therefore result in an unfair rate of return because the rate base would be larger than the Utility's true investment. No order of the Commission or the Court was cited wherein a utility under the Commission's jurisdiction has ever been allowed to treat CIAC as revenue and thereby reduce its amount of CIAC for rate-making purposes. Indeed, Exhibit 11 contains five Florida Public Service Commission orders wherein the Commission discovered such an accounting practice by a utility and reversed those entries, requiring the contributions to be treated as CIAC with corresponding reductions to rate base. Thus, it is concluded that the Utility's adjusted rate base for water is $2,042,588.00 and the rate base for sewer is

    $1,256,198.00.

    
    

21. The Utility's capital structure consists of 49.57 percent common stock equity, 35.96 percent long-term debt, and cost-free capital consists of 14.47 percent of the capital structure. The overall weighted cost of capital is 10.35 percent, equivalent to a 10.35 percent return on rate base.

    
    

22. The gross annual revenue requirement for the water system is

    $658,451.00, which provides an operating income of $211,407.00. The required annual sewer revenues is $475,629.00 for a corresponding operating income of

    $130,017.00.

    
    

23. Inasmuch as the sewer revenue requirement concluded to be appropriate herein is less than those revenues for sewer service authorized in the interim rates, the Utility should be required to refund the excess interim sewer revenues.

24 The above rate base and rate of return applicable thereto, resulting in the above gross annual revenue figures will result in rates which are just, reasonable, compensatory and not unfairly discriminatory.

RECOMMENDATIONS

In consideration of the foregoing Findings of Fact and Conclusions of Law, it is

RECOMMENDED that the application of Lehigh Utilities, Inc. be granted in part, and that the Utility be authorized to receive a gross annual water revenue of $658,451.00 and gross annual sewer revenue of $475,629.00 to be achieved by rates filed with and approved by the Public Service Commission. It is further

RECOMMENDED that the Utility be required to file revised tariff pages containing rates designed to produce annual revenues in the above amounts. It is further

RECOMMENDED that the Utility be required to refund the interim sewer revenues previously authorized in this proceeding which exceed those sewer revenues determined to be appropriate herein. It is further

RECOMMENDED that the above refunds be accomplished within ninety (90) days. This Recommended Order entered this 13th day of October, 1980, in

Tallahassee, Florida.

P. MICHAEL RUFF Hearing Officer

Division of Administrative Hearings

101 Collins Building Tallahassee, Florida 32301 (904) 488-9675

Filed with the Clerk of the Division of Administrative Hearings this 13th day of October, 1980.

COPIES FURNISHED:

R. M. C. Rose, Esquire 1020 East Lafayette Street

Tallahassee, Florida 32301

William H. Harrold, Esquire

101 East Gaines Street Tallahassee, Florida 32301

Docket for Case No: 80-001202

Orders for Case No: 80-001202