ML20003F009
| ML20003F009 | |
| Person / Time | |
|---|---|
| Site: | Comanche Peak  |
| Issue date: | 09/30/1980 |
| From: | Karney J DALLAS POWER & LIGHT CO. |
| To: | |
| Shared Package | |
| ML19240B984 | List:
|
| References | |
| NUDOCS 8104170670 | |
| Download: ML20003F009 (32) | |
Text
JDK PAGE 1
1 DIRECT TESTIMONY OF J0E D. KARNEY 2
3 Q.
PLEASE STATE YOUR NAME AND BUSINESS ADDRESS.
4 A.
My name is Joe D. Karney. My business address is 1506 Commerce Street, 5
Dallas, Texas 75201.
S Q.
BY WHOM ARE YOU EMPLOYED AND IN WHAT CAPACITY?
7 A.
I am employed by Dallas Power & Light Company, hold the position of 8
Treasurer & Assistant Secretary and have responsibility for the 9
financial, accounting, and internal audit activities of the Company.
10 Q.
PLEASE DESCRIBE YOUR EDUCATIONAL BACKGROUND AND PROFESSIONAL 11 QUALIFICATIONS.
12 A.
I graduated from Southern %thodist University in 1961 with a Bachelor 13 of Business Administration degree in accounting.
I have been employed by 14 Dcllas Power & Light Company since July,1952 and have worked in various 15 areas of the Accounting Department prior to becoming Head of the General i
16 Accounting Division in 1964.
I was elected Assistant Treasurer of the 17 Company in 1971, Assistant Treasurer and Assistant Secretary in 1975, and 18 Treasurer and Assistant Secretary in 1977.
In addition, I headed the 19 Company's Accounting Department from 1970 through 1978.
I am a Certified 20 Public Accountant in the State cf Texas and hold memberships in the 21 American 'nstitute of Certified Public Accountants, the Texas Society of l
22 Certified Public Accountants, the Financial Executives Institute, and the 23 Edison Electric Institute Financial Committee.
I have testified i
24 previously in rate proceedings before the City of Dallas and the Public 25 Utility Commission of Texas (PUC).
26 Q.
TO WHAT DEGREE D0 YOU HAVE CONTACT WITH THE INVESTMENT AND FINANCIAL 27 COMMUNITY?
28 810.417067Q
JDK PAGE 2
1 A.
I have extensive involvement in and responsibility for the financial 2
affairs of the Company. My contacts with the financial community include 3
regular meetings and discussions with representatives of commercial 4
banks, investment banking firms and rating agencies, as well as 5
consultation with individual and institutional investors and security 6
analysts.
7 Q.
WHAT IS THE PUliPOSE OF YOUR TESTIMONY IN THIS PROCEEDING?
8 A.
My testimony will discuss:
(a) the importance of the Company's ability 9
to attract capital; (b) the Company's current financial condition, 10 including fixed charge coverages, internal generation of cash, return on 11 common stock equity, and quality of earnings; (c) the basis for the 12 Company's request to include construction work in progress (CWIP) in the 13 rate base; (d) the adjusted value rate base for the Company; (e) the 14 capital structure of the Company;.and (f) the Company's composite cost of 15 capital.
16 Q.
PLEASE EXPLAIN THE SOURCES OF FUNDS AVAILABLE TO THE COMPANY AND THE 17 IMPORTANCE OF THE COMPANY'S ABILITY TO ATTRACT CAPITAL AT REASONABLE 18 COSTS.
19 A.
In addition to funds generated internally, the Company traditionally has 20 obtained permanent capital principally through the sale of long-term 21 debt, preferred stock and common stock.
In recent years, however, the 22 Company has had to resort to a higher level of short-tenn debt and the 23 sale, through private placement, of intennediate-tenn debt.
24 Electric utilities are generally conceded to be the most capital 25 intensive of all industries.
Therefore, they must enter the capital 26 market on a regular basis.
Since capital costs represent a significant 27 portion of total costs, and continue to increase in an inflationary 28
._. -~
JDK PAGE 3
1 environment such as we have experienced over the past several years, it 2
is extremely important to maintain a high credit rating in order that 3
capital may be obtainted at the lowest possible cost.
The Company's 4
ability to keep its capital costs low in the past has helped to maintain 5
reasonable electric rates for its customers.
6 As pointed out in Mr. Tanner's testimony, the Ccmpany is engaged in 7
a continuing construction program to provide facilities that will bring 8
the cost benefits resulting from the use of lignite and uranium fuels to 9
its customers. The Company's regulatory authorities have acknowledged 10 the benefits the customer receives from the conversion to lower cost 11 alternate fuels in the Company's past two rate proceedings.
Based on 12
- urrent estimates, the Company's construction expenditures will average 13 approximately $130 million per year for the next several years.
It 14 should be noted that a construction program of this size represents 15 annual expenditures equal to approximately 19 percent of the net cost of 16 all the plant currently in service.
It is therefore important, and to 17 the direct benefit of the customer, that the substantial quantities of 18 capital that will be required to provide these facilities be available at 19 the most reasonable cost.
20 Q.
CONSIDERING THE COMPANY'S NEED TO ACQUIRE CAPITAL TO FINANCE THE 21 CONSTRUCTION POGRAM, WHAT IS THE SIGNIFICANCE OF THE FIXED CHARGE 22 C0VERAGE?
23 A.
One of the most important indicators of the financial integrity of a 24 utility company is the extent to which earnings will cover its fixed 25 charges on debt. The fixed charge coverage that the Company maintains 26 over a period of years has a substantial impact on the ratings the 27 agencies assign the Company's bonds.
It is generally recognized 28
JDK PAGE 4
I throughout the financial community that for an electric utility, a fixed 2
charge coverage, including all applicable debt, of at least 4.0 times is 3
the minimum requirement to maintain a triple A bond rating.
4 Q.
WOULD YOU EXPLAIN THE TERM " SUPPLEMENTAL FIXED CHARGE C0VERAGE"?
5 A.
The computation of the supplemental ratio of earaings to fixed charges 6
is made pursuant to Securities and Exchange Commission (SEC) Accounting 7
Series Release No.122, the purpose of which is to include, for interest 8
coverage purposes, interest requirements on debt which is not on the 9
Company's balance sheet but which the Company has guaranteed or is in 10 some manner obligated to assume in case of default.
In the case of 11 Dallas Power & Light Company, the supplemental coverage calculation 12 includes the Company's proportionate obligations for senior notes issued 13 by Texas Utilities Fuel Company (TUFCO) and Texas Utilities Generating 14 Company (TUGC0).
15 Q.
MR. KARNEY, WHAT HAS BEEN THE RECOMitENDATION OF THE COMPANY'S REGULATORY 16 AUTHORITIES AS TO AN ADEQUATE FIXED CHARGE COVERAGE FOR DALLAS POWER &
17 LIGHT COMPANY?
18 A.
The staffs of the regulatory authorities exercising jurisdiction over 19 the Company have recognized the need for a 4.0 times coverage to maintain 20 a triple A bond rating.
21 Q.
WHAT HAVE BEEN THE COMPANY'S FIXED CHARGE COVERAGES AND SUPPLEMENTAL 22 FIXED CHARGE COVERAGES IN RECENT YEARS?
23 A.
They have declined substantially.
As shown in JDK Exhibit No. 1, prior 24 to 1974 the Company's fixed charge coverage was generally in excess of 25 4.0 times.
For the test year ended June 30, 1980, the fixed charge 26 coverage was 3.12 times and the supplemental fixed charge coverage was 27 2.76 times. These coverages are obviously below the minimum needed to 28
JDK PAGE 5
1 retain the triple A rating and have been for several years. Since 2
capital costs are such a major portion of the Company's expenses, 3
retention of the triple A rating is vitally important to the Company and 4
its customers.
5 Q.
HAS DALLAS POWER & LIGHT COMPANY BEEN ABLE TO ACHIEVE A 4.0 TIMES 6
SUPPLEMENTAL FIXED CHARGE C0VERAGE AS A RESULT OF RECENT RATE ORDERS?
7 A.
As shown in JDK Exhibit No. 2, the Company's supplemental fixed charge 8
coverage is substantially below the minimum 4.0 times coverage needed.
9 Although recent rate orders of the Company's regulatory authorities' have 10 addressed the need to restore the Company's financial integrity, the 11 amount of. rate increase granted in each case has been inadequate to 12 accomplish this objective.
13 Q.
MR. KARNEY, WILL DP&L'S CUSTOMERS BENEFIT IF THE COMPANY IS ABLE TO 14 MAINTAIN ITS TRIPLE A FIRST MORTGAGE BOND RATING?
15 A.
Yes.
The triple A rating allows the Company to borrow funds at the l
l 16 lowest possible cost.
This is reflected in JDK Exhibit No. 3 which shows l
17 Moody's average of yields on long-tem public utility bonds for the years 18 1969 through 1979.
For example, the spread between triple A and double A 19 was, on average, approximately 30 basis points from 1974 through 1979.
20 During periods of greatest financial strains, the spreads are 1tven 21 wider. With a difference in financing rates of 30 basis points, the 22 ovings over the 30-year life of a $75 million bond issue would be over 23 (6.7 million. The spread to lower rated bonds is even greater. With a 24 high credit rating there are additional savings in the cost of short-tem 25 debt, pollution control bonds, and preferred and common stock.
l 26 Q.
IN ADDITION TO THE SAVINGS OF INTEREST AND DIVIDENDS, ARE THERE OTHER 27 REASONS FOR MAINTAINING THE TRIPLE A B0ND RATING?
28 l
l
JDK PAGE 6
1 A.
Yes, other benefits of maintaining the triple A rating are the greater 2
availability and flexibility of capital financing. Strong credit 3
indicators lead to better financial health at a lower cost to the 4
ratepayer.
Investors will generally accept a lower return on their 5
investrant if the Company is financially strong, which results in a lower 6
cost of capital.
Th0 magnitude of the Company's construction program and 7
the required external financing necessitates that the Company have ready 8
access to the capital markets at reasonable cost.
9 Q.
IF DALLAS POWER & LIGHT COMPANY WERE TO LOSE ITS TRIPLE A RATING, WHAT 10 WOULD BE NECESSARY TO REGAIN THAT BOND RATING?
11 A.
It would take many years of sustained financial performance above the 12 established minimuin requirements before the rating agencies would 13 consider upgrading the Company's bond rating.
Therefore, retention of 14 the Company's favorable bond rating is extremely important at this time.
15 Q.
TO WHAT EXTENT ARE INTERNAL SOURCES OF FUNDS AVAILABLE TO MEET THE 16 COMPANY'S CAPITAL NEEDS?
17 A.
A portion of the Company's net earnings are reinvested in the Company in 18 support of the construction program. JDK Exhibit No. 4 shows retained 19 earnings, combined with other internally generated funds, as a percentage 20 of construction expenditures for the period January,1978 through June, 21 1980, as compared to the range of 40 to 60 percent recommended by the PUC 22 Staff in Docket 2572.
As shown in the exhibit, the percentage for the 23 Company has fluctuated during the past several years, but has averaged 24 less than 40 percent during this period.
For the test year, the level of 25 internally generated funds as a percentage of construction expenditures 26 was 32.1 percent.
JDK Exhibit No. 4 further illustrates that the rate 27 increases granted in the Company's last two rate orders have been 28
JDK PAGE 7
1 insufficient to provide the level of internal cash generation recommended 2
by the PVC staff for the maintenance of financial integrity.
3 Also, from 1969 to the end of 1979, construction expenditures have 4
increased more than four times. This means that the Company must attract
' n an inflationary 5
additional capital.
In order to obtain new capital.
i 6
and recessionary environment, internally generates cash must be 7
maintained at a level adequate to ensure investor confidence.
8 Q.
WHAT PERCENTAGE OF DALLAS POWER & LIGHT COMPANY'S CAPITAL REQUIREMENTS 9
SHOULD BE MET THROUGH INTERNALLY GENERATED FUNDS ?
10 A.
Dallas Power & Light Company should generate on a consistent basis 50 11 percent of its capital needs internally.
In view of the prevailing rate 12 of inflation and the size of our construction program, this level is the 13 minimum requirement.
14 Q.
ANOTHER TEST OF FINANCIAL PERFORMANCE IS RETURN ON COMMON STOCK EQUITY.
15 WHAT HAS BEEN DALLAS POWER & LIGHT COMPANY'S RETURN ON COMMON EQUITY 16 SINCE 1969?
17 A.
The return on equity has declined drame.tically since 1969, as shown by 18 JDK Exhibit No. 5.
This exhibit shows return on ccmmon stock equity, 19 including and excluding Allowance for Funds Used During Construction 20 (AFOC), for the period 1969 through the test year ended June 30, 1980.
21 This decline has occurred in a period which has seen the cost of high 22 quality debt issues increase from just above 6 percent to over 14 23 percent, approximately 3 percent above the Company's actual equity 24 earnings of 11.0 percent for 1978 and 1979 and 11.3% for the test year 25 ended June 30, 1980. The level of earnings for the Company has simply 26 been inadequate for several years.
Reasonable investors will not 27 continue to accept the risk of an equity security at 11 percent when they 28 can earn 13 to 14 percent on a low risk mortgage bond.
JDK PAGE 8
1 Of even greater concern is the trend in return on equity excluding 2
AFDC.
The sophisticated analyst, particularly rating agencies and 3
institutional investors, considers calculations of return on equity both 4
including and excluding AFDC.
Earnings are discounted when a significant 5
portion is attributable to AFDC.
In the case of Dallas Power & Light 6
Company, over one-third o' its test year earnings were non-cash. With 7
such a large portion of non-cash earnings, the Company's earnings are 8
subject to substantial discounting by investors. At the end of the test 9
year the cash return on equity, that is, the return excluding AFDC, was to 7.2 percent.
If allowed to continue, this condition will not permit 11 capital to be attracted at reasonable costs.
12 Q.
WHAT 00 YOU CONSIDER NECESSARY TO IMPROVE THE COMPANY'S FINANCIAL 13 INTEGRITY?
14 A.
In addition to obtaining an adequate return on common equity, the 15 inclusion of all Construction Work in Progress (CWIP) in rate base is 16 necessary.
17 Q.
IS THE COMPANY REQUESTING CONSTRUCTION WORK IN PROGRESS IN RATE BASE?
18 A.
Yes, the Company proposes to include $308,313,988 of CWIP in rate base.
19 This represents all CWIP at June 30, 1980 with the exception of a 20 noncurrent payable related to Martin Lake SES Unit 4.
21 Further, it should be understood that the amount of CWIP requested 22 to be allowed in the rate base is substantially less than will be 23 invested in CWIP before the proposed rates are in effect. At an average 24 monthly investment of $10 million, an additional $70 to $80 million will 25 be added to CWIP after the end of the test period and before these rates 26 are in effect.
27 28
JDK PAGE 9
1 Evan with 100 percent of test year CWIP in rate base the Company's 2
actual investment in CWIP will be substantially more during the period 3
when the rates are in effect.
In Docket 1526, $87.7 million of CWIP, approximately 48 percent of a requested $182.3 million, was allowed in 4
5 rate base.
By the time new rates were in effect, the amount in rate base 6
represented only 36 percent of the Company's actual investment in 7
construction and the average during the period covered by those rates was 8
only 23 percent.
In Docket 2572, the Company was allowed $194.6 million 9
of CWIP in rate base, which was approximately 80 percent of a requested 10
$243.2 million. However, after the new rates were in effect only nine 11 months, CWIP in rate base as a percent of the total CWIP for the period 12 was only 62 percent. This is estimated to decrease to 51 percent by 13 December, 1980. The Company is presently requesting that 100 percent of 14 adjusted CWIP at June 30,1980 ($308,313,988) be included in rate base.
15 As shown on JDK Exhibit No. 6, the percent of CWIP in rate base will have 16 been reduced to approximately 77 percent by the time the rates could reasonably be expected to be placed in effect and further reduced to 58 17 This percent by the end of the first year the new rates are in effect.
18 exhibit graphically reflects the capital attrition problem which exists 19 20 when rates are set on a historical test year basis and substantiates the 21 need for all CWIP at the end of the test year to be included in rate 22 base.
DP&L's ongoing construction program assures that the Company will in 23 24 the future, as it has in the past, incur substantial additional 25 investments in CWIP after the end of the test year. Since a cash return has not been allowed on this portion of the Company's investment in CWIP, 26 the Company is virtually assured that its earnings will be inadequate to 27 recover on a current basis the full carrying costs associated with the 28
_y n
JDK PAGE 10 construction program, a program which the Company undertakes for the 1
2 benefit of its customers. Thus, it is extremely important from the standpoint of the Company's financial integrity that the full requested
'3 4
amount of CWIP be allowed in rate base. Any lesser amount will only 5
result in additional non-cash earnings, further eroding the Company's 6
financial integrity.
7 Q.
ARE THERE OTHER REASONS FOR REQUESTING THAT CWIP BE INCLUDED IN RATE 8
BASE?
9 A.
In addition to enhancing the financial integrity of the Company, it is 10 the best alternative for the customer. When the construction of a facility covers an extended period of time, interest costs for the funds 11 12 necessary for the construction program are incurred. These costs must be borne by the customer whether they are capitalized and recovered over the 13 14 life of the project or recovered currently. When CWIP is included in When rate base, the rosts of construction are paid as tney are incurred.
15 these costs are capitalized, they add to the cost of the facility being 16 17 constructed and earn a return over the life of the plant.
It is better to pay the costs currently rather than to pay interest on interest.
18 IS THE COMPANY'S ABILITY TO ATTRACT CAPITAL ENHANCED BY THE INC 19 Q.
20 CONSTRUCTION WORK IN PROGRESS IN THE RATE BASE?
21 A.
Yes. The engineering and construction periods for major projects such 22 as power plants range from eight to twelve years.
During these extended periods the Company is required to obtain large amounts of capital to 23 finance the projects and, therefore, must pay for the use of these funds 24 25 in cash.
Including CWIP in rate base results in a recovery or these costs currently, providing higher quality earnings, which helps the 26 27 Company maintain its financial integrity.
Conversely, capitalizing these 28
-o
JDK PAGE 11 1
costs defers their recovery by the Company, leaves the quality of 2
earnings at an inadequate level, and increases the overall cost of 3
providing service to the customer.
4 Q.
HOW CAN COMPLETION OF A CONSTRUCTION PROJECT AFFECT THE COMPANY'S 5
ELECTRIC SERVICE RATES IF CWIP IS NOT ALLOWE0 IN RATE BASE 7 6
A.
To the extent that CWIP is excluded from rate base, completion of a 7
major project will cause revenue requirements to increase dramatically at 8
the time the project is included in rate base. This is the result of i
9 accruing AFDC which is capitalized and becomes part of the cost of a 10 project. Upon completion of a project, AFDC is discontinued, the project 11 is placed,in service, and revenue requirements must subsequently be 12 increased sufficiently to cover the return on the full amount of the 13 project, including the capitalized AFDC.
By allowing CWIP in rate base, 14 rate increases tend to be more gradual which again is in the best 15 interest of customers.
16 Q.
IF CWIP IS NOT INCLUDED IN RATE BASE, WHAT EFFECT 00 AFDC EARNINGS HAVE 17 ON THE COMPANY'S FINANCIAL INTEGRITY?
18 A.
When non-cash AFDC makes up a large part of earnings, the amount of cash 19 earnings available to pay common dividends can be inadequate to pay those 20 dividends. At the end of the test year, the dividend payout ratio, 21 excluding AFDC from earnings, was 123.3 percent.
This ratio is 22 unacceptably high and must be reduced. The inclusion of CWIP in rate 23 base will have a positive effect in reducing this ratio to more 24 acceptable levels.
25 Q.
HOW IS THE QUALITY OF THE COMPANY'S EARNINGS AFFECTED BY INCLUDING CWIP 26 IN RATE BASE?
27 28
JDK PAGE _12._
1 A.
As shown in JDK Exhibit No. 7 the construction program to convert to 2
alternative fuels has caused CWIP to increase rapidly in relation to 3
electric plant.
CWIP has increased from approximately 9 percent of 4
electric plant in 1969 to alm::st 24 percent at the end of the test year.
b l
As a result, the portion of the Company's earnings attributable to AFDC 6
has increased significantly. JDK Exhibit No. 8 shows that AFDC has 7
increased from less tiian ten percent of earnings in 1969 to a high of 8
43.2 percent in 1978 and 36.7 percent for the test year ended June 30, 0
1980.
The reduction fran the higher level in 1978 results principally 10 from the sale of portions of tne Comanche Peak Steam Electric Station.
II AFDC earnings have a negative influence on the Company's financial 12 integrity and its credit rating.
The incone statement reflects AFDC as i
I 13 income, when in fact it is a non-cash item which cannot be used in 14 ineeting the Company's capital requirements.
Actually, AFDC represents a 15 cost which cannot be fully recovered until the plant with which it is 16 associated is fully depreciated.
The Company's regulatory authorities II have recognized the impact of AFDC on the quality of earnings and the PUC 18 staff, in the Company's most recent rate case, has recommended that rates 19 be set such that AFDC not exceed 20 percent of earnings.
JDK Exhibit f6.
20 9 shows that the Staff's recommendation for AFDC ac a percent of earnings j
21 ha's never been attained during the periods of time following the 22 implementation of rates resulting froin the Company's last two rate i
23 proceedings. The amounts of CWIP allowed in rate base in those proceed-24 ings have been inadequate. As a result, the Company's AFDC as a percent 25 of earnings has not dropped below 34 percent.
Even with the requested 26
$308 million of CWIP in rate case, additions to CWIP subsequent to the 27 test year will result in additional AFDC earnings.
For all of the above 28
JDK PAGE 13 I
reasons the Company is requesting that the amount of CWIP shown in 2
Schedule B, page 3, be included in rate base.
Q.
DOES THE INCLUSION OF CWIP IN RATE BASE AFFECT THE FIXED CHARGE 3
4 C0VERAGE?
A.
Again, to the extent that AFDC is included in earnings, the quality of 5
6 those earnings is reduced.
In evaluating a company's financial condition 7
most financial analysts, the rating agencies and the sophisticated 8
investor will consider the fixed charge coverage ratio excluding earnings 9
attributable to AFDC. As shown in Schedule H-7, the Company's to supplemental fixed charge coverage, excluding AFDC, has dropped to 2.42 Il times for.the test year ended June 30, 1980. This coverage is inadequate 12 and underscores the importance and necessity of including the requested 13 amount of CWIP in the rate base.
Q.
WHAT WEIGHTINGS WERE GIVEN TO CURRENT COST AND ORIGINAL COST IN 14 15 CALCULATING THE COMPANY'S ADJUSTED VALUE RATE BASE?
16 A.
Sixty percent original cost and forty percent current cost.
Q.
WHAT FACTORS WERE CONSIDERED IN DETERMINING THESE WEIGHTINGS?
17 A.
The need to attract capital, quality of service, the growth in the 18 19 Company's service area, and inflation, as it has affected and will 20 continue to affect the Company's construction program were considered.
21 As discussed in Mr. Tanner's testimony, the Company is engaged in a 22 substantial construction program to convert from the use of scarce and l
23 costly fuels such as natural gas and oil to cheaper, more abundant fuels such as lignite and uranium.
As can be seen in MHT Exhibit No. 2, 24 25 construction expenditures have increased dramatically in the past ten 26 Our construction expenditures over the next three years are years.
27 estimated to be almost $400 million, which is approximately 58 percent of 28
JDK PAGE 14 I
the net cost of all the plant currently in service. The Company must be 2
in a position to attract large sums of money from the investJnent 3
community if it is to carry out its required construction program.
4 As to quality of service, the Company has met and is meeting the 5
needs of its customers by providing dependable electric service within 6
its service area.
In order to continue to provide quality service, the 7
construction of facilities to utilize alternate fuels must be 8
maintained. Thas, the maximum current cost weighting of 40 percent is 9
appropriate in view of the need to support this construction program and to to continue the record of high quality service.
11 Inflation continues to have a serious impact on the Company's 12 operations, as well as its construction program, since inflation 13 increases the costs of all goods and services purchased.
Also, interest 14 rates continue to be high compared to our present embedded rates.
15 Current interest rates for higher quality long-tenn debt are in the 13 percent range compared to our present embedded interest rate of 6.96 16 17 percent, as shown on Schedule H-6.
Each new dollar of long-tena debt or preferred stock increases our embedded cost of money, whether it is 18 19 issued to finance our construction program or to refund maturing bonds 20 and debentures originally issued 25 or 30 years ago.
21 In view of these factors, a 60 percent weighting for original cost 22 and a 40 percent weighting for current cost is reasonable and should be 23 allowed.
Q.
WOULO YOU BRIEFLY DESCRIBE THE CAPITAL STRUCTURE OF DALLAS POWER & LIG 24 25 COMPANY AT THE END OF THE TEST YEAR 7 26 A.
At the end of the test year the capitalization was composed of 41.6 percent long-tenn debt,12.7 percent preferred stock and 45.7 percent 27 28 common stock equity.
JDK PAGE 15 1
Q.
PLEASE DESCRIBE THE COMPANY'S LONG-TERM DEBT.
2 A.
At June 30, 1980, the Company had three basic types of long-term debt 3
outstanding. The majority of this debt is first mortgage bonds. As 4
reflected in Schedule H-6, the Company had thirteen series of first 5
mortgage bonds outstanding in the principal amount of $305 million.
6 These series range in principal amounts from $9.0 million to $50.0 7
million and have maturity dates from 1983 through 2005.
Interest rates 8
range from a low of 31/8 percent to a high of 9 3/8 percent.
9 At June 30, 1980, the Company had approximately $23.3 million of 10 sinking fund debentures outstanding. This debt is not secured by any 11 lien on the Company's property, but is issued on the basis of the 12 Company's general credit.
As reflected in Schedule H-6, there are two 13 separate issues of 25-year debentures outstanding with maturity dates of 14 1989 and 1993.
The interest rates are 4 1/2 percent and 6 3/4 percent, 15 respectively.
16 Also reflected in Schedule H-6, is other unsecured debt consisting 17 of three series of 30-year pollution control revenue bonds of i
18 approximately $16.7 million, net of fur.ds on deposit with the trustee.
l 19 These three series were sold by the Sabine River Authority, a governmental agency of the State of Texas, for the purpose of 20
(
21 constructing pollution control equipment to be installed at certain 22 jointly-owned generating stations of the Company, Texas Electric Service 23 Company and Texas Power & Light Company.
Interest on the bonds is exempt i
24 from federal income taxes to the holder.
By agreement with the 25
. Authority, the Companies contract for the repayment of the bonds sold for l
26 the purchase of the equipment installed at the generating stations. The l
27 Company is obligated for $8,590,000 of the 61/4 percent series, 28
JDK PAGE 16 1
$7,125,000 of the 5.70 percent series and $2,025,000 of the 6.60 percent 2
series. The t,.c.
cre due in 2006, 2007 and 2008, respectively. This 3
type of security it similar to the sinking fund debentures in that they 4
are bas #
the Company's general credit and are not secured by property 5
of the Company.
6 The Company's embedded interest cost on long-tenn debt has steadily 7
increased to 6.96 percent.
This represents a 63 percent increase from 8
the embedded cost of 4.26 in 1969.
9 Q.
WHAT RATINGS HAVE BEEN ASSIGNED TO THE COMPANY'S FIRST MORTGAGE BONDS, 10 SINKING FUND DEBENTURES AND POLLUTION CONTROL REVENUE BONDS?
11 A.
The Company's first mortgage bonds have been designated triple A by both 12 Moody's Investors Service, Inc. and Standard & Poor's Corporation. The sinking fund debentures and pollution control revenue bonds have been 13 14 assigned a double A rating by both agencies since they are not secured by 15 property but are based on the general credit of the Company.
16 Q.
PLEASE DESCRIBE THE NOTES PAYABLE INCLUDED IN THE COMPANY'S CAPITAL 17 STRUCTURE.
18 A.
The notes payable, amounting to an adjusted $202,821 as shown in 19 Schedule H-5, page 2, were issued as partial payment for land acquired 20 for plant sites, lignite reserves and water rights.
21 Q.
WOULD YOU DESCRIBE THE COMPANY'S PREFERRED STOCK?
22 A.
At June 30, 1980, the Company had seven preferred stock issues 23 outstanding as detailed in Schedule H-4.
The amount outstanding was 24 approximately $104.7 million with annual dividend rates ranging from 25
$4.00 per share to $7.48 per share. The preferred stock is cumulative, 26 without par value, and entitled to $100.00 per share upon liquidation.
27 The embedded annual dividend rate for all of the series is currently 6.27 28
JDK PAGE 17 1
percent, as shown in Schedule H-4.
The Company's preferred stock, like 2
the sinking fund debentures and pollution control revenue bonds, is rated 3
double A by both Moody's Investors Service, Inc. and Standard & Poor's 4
Corporation.
5 Q.
PLEASE DESCRIBE THE COMPANY'S COMMON STOCK.
6 A.
At June 30, 1980, there were 14 million shares of comon stock 7
outstanding, 99.9 percent of which were owned by Texas Utilities 8
Company.
The common stock equity on the books of the Company at this 9
date amounted to $377.9 million.
10 Q.
ARE THERE ANY OTHER ADJUSTMENTS NECESSARY TO DETERtilNING THE PROPER 11.i CAPITAL STRUCTURE OF THE COMPANY FOR THIS PROCEEDING?
12 A.
Yes. A pollution control revenue bond issue is scheduled to take place 13 in October of 1980 in which the Company will be cbligated for $6,334,000 14 of the issue.
This adjustment more accurately reflects the Company's 15 capital structure and is shown in Schedule H-6, page 1, of the rate 16 filing package.
17 Q.
HAVE YOU CALCULATED THE COMPANY'S WEIGHTED COST OF CAPITAL AT JUNE 30, 18 1980 AS ADJUSTED?
19 A.
Yes.
Schedule H, page 2, shows the outstanding capital, as adjusted, at 20 the end of the test year. The weighted cost of capital is the composite 21 cost of the various classes of capital used by the Company.
The cost of 22 long-term debt is the embedded cost of debt taken from Schedule H-6.
23 Notes payable are detailed in Schedule H-5, page 2.
The cost of 24 preferred stock capital is its annual dividend requirement as shown in 25 Schedule H-4.
The cost of common stock equity capital is the amount 26 necessary to yield a fair return as described by Dr. Charles E. Olson and 27 is reflected in Schedule H, page 2.
The cost of equity was determined 28
JDK PAGE
_18_
1 from Dr. 01 son's recommended range of return on common equity of 17.0 to 2
18.0 percent.
In view of current circumstances, I believe a 17.0 percent 3
return is appropriate.
Although the 17 percent return is the minimum of 4
the range recommended by Dr. Olson, such return together with the 5
inclusion of 100 percent of the test year balance of CWIP which the 6
Company is also requesting should be adequate to allow the Company a 7
reasonable opportunity to improve its financial integrity.
However, it 8
is apparent that with the inclusion of less than 100 percent of CWIP in 9
rate base, a higher return on common equity would be necessary and 10 appropriate.
11
-Q.
WHAT IS TfiE COMPANY'S WEIGHTED COST OF CAPITAL?
12 A.
The weighted cost of capital is derived by taking each cost element 13 expressed as a percentage rate as shown on Schedule H, page 2.
This 14 results in an 11.44 percent weighted cost of capital on a total adjusted 15 capitalization of $886,029,596.
16 Q.
MR. KARNEY, WHY D0 YOU CONSIDER 17.0 PERCENT RETURN ON COMMON EQUITY TO 17 BE REASONABLE?
18 A.
Since the equity component is the foundation of the capital structure 19 and the common shareholder bears the most risk, the return to the common 20 shareholder must be higher than the return to either the bondholders or 21 the preferred shareholders.
Currently the return on high quality 22 corporate bonds with little or no risk is approximately 13 percent. The 23 return to the risk bearing equity investor must be substantially higher.
24 With the Company's present depressed level of earn'.ngs and interest 25 coverage, the recommended return on equity is justified and necessary to 26 assure its financial integrity.
27 28
JDK PAGE 19 1
Q.
WILL YOUR PROPOSAL GUARANTEE THE COMMON EQUITY INVESTOR THAT HIS RETURN 2
WILL BE 17.0 PERCENT?
3 A.
No. Recent history shows that the allowed return on common equity has 4
not been earned. This results from the use of a historical test year to 5
detennine the Company's rate base and cost of service.
In our last 6
proceeding it was nine months after the end of the test year before the 7
Company was able to begin billing a portion of the requested rate 8
increase under bond, and it was eleven months before current rates were 9
billed under an interim rate order.
During this period, the Company's 10 costs continued to increase and the investment continued to grow, making 11 the test year out of date well before the rates went into effect.
This 12 assured that the Company would be.unlikely to earn the rate of return 13 granted based on a historical test year.
Although some adjustments have 14 been made for post-test year events, these adjustments do not fully 15 offset the effects of attrition on the Company.
Unless the Company's z.
16 regulatory authorities recognize the reality of attrition, the Company 17 will be denied the opportunity to earn the return granted.
'l 18 Q.
MR. KARNEY, WILL THE REVENUE INCREASE REQUESTED IN THIS CASE ALLOW THE 19 COMPANY A REASONABLE OPPORTUNITY TO RESTORE ITS FINANCIAL INTEGRITY?
20 A.
An analysis of the Company's projected results of operations based upon 21 rate increases resulting from various levels of return on equity and CWIP 22 in rate base clearly indicates that the Company has virtually no chance 23 of earning the 17 percent return on equity requested, unless all of the 24 CWIP requested is included in rate base.
If such amount of CWIP is 25 included in rate base, there is a reasonable opportunity to earn the 26 requested return on equity by the end of the first year the new rates 27 will be in effect; however, the return declines significantly 28
JDK PAGE 20 _
1 thereafter. Although return on equity on a twelve month basis reaches 17 2
percent at one point in time (the twelve months ended Decenber 31,1981),
3 the return for any other twelve month period it below this level.
It 4
should be noted that such results are based upon receipt of the full 5
amount of rate increase requested by the Company; anything less cannot be 6
expected to produce these results.
7 Q.
WHAT HAS BEEN DALLAS POWER & LIGHT COMPANY'S RETURN ON EQUITY SINCE 8
JANUARY 1,1978?
9 A.
JDK Exhibit No.10 clearly illustrates that the Company has not earned 10 the rate of return allowed. The Company's authorized return was 11 increased from 13.75 percent in Docket 1526 to 14.5 percent in Docket 12 2572, represented by the horizontal lines near the top of the exhibit, 13 yet the return actually earned has continued to fall below the amount 14 authorized.
Further, the deficiency between the earned and authorized 15 return is increasing. This indicates that previous rate orders have been 16 inadequate and that in determining the amount of revenue deficiency, the 17 Company's regulatory authorities must more carefully appraise the impact 18 of economic and other factors that will exist during the period the rates 19 will be in effect.
20,
Q.
DOES THIS CONCLUDE YOUR TESTIMONY?
21 A.
Yes.
i 22 l 23 24 25 i
26 27 28 h--
?
1 w
q ft 9
DALLAS POWER & LIGHT COMPANY RATIO OF EARNINGS TO FIXED CHARGES AND 6'-
SUPPLEMENTAL RATIO OF EARNINGS TO FIXED CHARGES 5.84 i
I 1969 - 1980 l
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3.97 l
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'69
'70
'71
'72
'73
'74
'75
'76
'77
'78
'79
'80*
YEARS z
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j
- TEST YEAR ENDED JUNE 30,1980 i
DALLAS POWER & LIGHT COMPANY RATIO OF EARNINGS TO FIXED CHARGES AND SUPPLEMENTAL RATIO OF EARNINGS TO FIXED CHARGES JANUARY 1978-JUNE 1980 4 i-t j
3.69 I
4 3.31 1
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Fixed Charge Coverage l
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3.36 i
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J F M A M J J A S O N D J F M A M J J A S ON D J F M A M J 3
1979 1980 H
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1978
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MONTHS
MOODY'S AVERAGE PUBLIC UTILITIES BOND YlELD BY RATING GROUP 1969 - 1979 10.96 %
11 ' -
Aaa RATING
. 10.49%
Aa RATING 10.09%
/
A RATING p*.*
10~06%
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f
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Baa RATING 10 j
, 9.86%
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9.44 %
9.54 %
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7.60 %
l 7.34%,
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'70
'71
'72
'73
'74
'75
'76
'77
'78
'79*
b
- EIGHT MONTHS ENDED AUGUST,1979 YEARS l
i
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DALLAS POWER & LIGHT COMPANY I
PERCENT OF CONSTRUCTION EXPENDITURES 45.7 '*
GENERATED INTERN ALLY i
45 J ANUARY 1978-JUNE 1980 Staff Criteria 40-60%
40 s
a.
35 32.1 %
30 25 24.8 %
20 2 E5
$m 0"
J F M A M J J A S O N D J F M A M J J ^ S O N D J FM A M J g$
1978 rje 1979 z':
1980 H
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MONTHS
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DALLAS POWER & LIGHT COMPANY RETURN ON COMMON STOCK EQUITY 204-1969 - 1980 J
RETURN ON EQUITY INCLUDING AFDC l'
-- - - RETURN ON EQUITY EXCLUDING AFDC i
16.2%
15 14.6% %
]
's 13.4 %
's
's 12.1 %
s'~-,'
11.3 %
% Q 1.0%
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7.8%
7.2%
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'70
'71
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'73
'74
'75
'76
'77
'78
'79
'80*
~
YEARS zo
- TEST YEAR ENDED JUNE 30,1980 ci
'l DALLAS POWER & LIGHT COMPANY CWIP IN RATE BASE ACTUAL VS. AMOUNT REQUESTED
$530 Total CWIP*
500 -
CWIP IN EXCESS RATES EFFECTIVE (EST.)-
f OF AMOUNT g
REQUESTED 400 TEST YEAR 6-30-80
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$308
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Amount Requested O
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50 SX 0
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"}h 1980 1981 1982 MONTHS
- ACTUAL AT JUNE 30,1980 AND ESTIMATED THEREAFTER Pe
DALLAS POWER & LIGHT COMPANY CWIP AS A PERCENT OFTOTAL ELECTRIC PLANT 1969 - 1980 30.1 %
30 23.7%
20 8
5c.
10 9.0% e.,
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t i
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'69
'70
'71
'72
'73
'74
'75
'76
'77
'78
'79
'80' oM x
YEARS
$gf
- TEST YEAR ENDED JUNE 30,1980 2
P N
DALLAS POWER & LIGHT COMPANY l
A A PE CENT OF EARNINGS f
~~1980 i
l I
9 42%
45 -
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36.7 %
35 l
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9.8%
10 y *g 5
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'69 70 7,
'73
.,4 75
,O
'77 8
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'80
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YEARS 9
J
' TEST Yegn gy9gg JUNE 30, ggg0 r
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1 DALLAS POWER & LIGHT COMPANY AFDC AS A PERCENT OF EARNINGS i
DECEMBER 1978-JUNE 1980 l
l i
l 50 t -
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43.2%
42.2%
/
1 1
40 i
36.7 %
34.2 %
30 H2m i
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20%
20 i
4 1
3_Stati C. rite, ria,, Docket 2572 15%
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gg 1979
-lc 1980 d
25 MONTHS g
1 i
I DALLAS POWER & LIGHT COMPANY RETURN ON AVERAGE COMMON EQUITY I
ACTUAL AND AUTHORIZED SEPTEMBER 1977-JUNE 1980 15 -
14.5% Authorizedin Docket 2572 14.3%
+
14 13.75% Authorized in Docket 1526
- 13.5% -!'
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13 i
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12.7 %
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11.3 %
11
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i 10.6%
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10 4
,T c,-
o S O N D J F M A M J J A S O N D J F M A M J J A S O N DJ F M A M J
- ni 1978 1:
1979 1980
,-- [
j ta-1977 -; -
MONTHS j
t i
s i
THE STATE OF TEXAS )
COUNTY OF DALLAS
)
BEFORE the undersigned authority on this day personally appeared J. D. KARNEY, who, having been placed under oath by me, did depose as follows:
"My name is J. D. Karney.
I am of legal age and a resident of the State of Texas. The foregoing testimony, and exhibits, offered by me on behalf of Dallas Power & Light Company, are true and correct, and the opinions stated therein are, to the best.of my knowledge and belief, accurate, true, and correct."
O)
J.'D. KAfiEY
- }
SUBSCRIBED AND SWORN TO BEFORE ME by the said J. D. Karney this 23rd day of September, A. D.1980.
k b
Carla F. Stroud Notary Public in and for Dallas County, Texas My commission expires 3-31-84 l
l
i
<o 5
Response to NRC Information Request No. 7.
Attached are copies provided by Dallas Power and Light Company of the following:
4 Financially related testimony of the PUC Staff in Docket 3460:
I Dale Schaefer, Accounting Division Laura J. Owen, Economic Research Di vision Christopher C. Child, Economic kesearch Division Financially related testimony of the Company in Docket 3460:
W. E. Patterson Charles E. Olson Joe D. Karney Schedules A thru Q of the rate file package in Docket 3460 Hearing Examiner's Report in Docket 3460 4
Final Order in Docket 3460 L
I 1
l
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