STATE OF VERMONT
PUBLIC SERVICE BOARD
Docket No. 7270
)
Joint Petition of Verizon New England Inc.
d/b/a Verizon Vermont, Certain Affiliates
Thereof and FairPoint Communications,
Inc. For approval of asset transfer,
acquisition of Control by merger and
associated transactions
)
)
)
)
PREFILED SURREBUTTAL TESTIMONY
OF
Ronald W. Behrns
ON BEHALF OF
VERMONT DEPARTMENT OF PUBLIC SERVICE
August 10, 2007
Summary:
Mr. Behrns’ testimony rebuts FairPoint’s contention that certain safeguards, including
dividend restrictions, are not necessary to ensure that ratepayer interests are
adequately protected in connection with this proposed transaction. Mr. Behrns
discusses the Department’s view of Vermont rate regulation and the related financial
impact such regulation may have on FairPoint and the financial and economic safe
guards that are needed to minimize risks associated with the Verizon Spin-off of Spinco
and the subsequent merger of Spinco into FairPoint.
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 2 of 28
Q:
Please state your name and business address.
A:
My name is Ronald W. Behrns. My business address is 112 State Street,
Montpelier, VT 05620. I am currently employed as Utility Finance and
Economics Director for the Vermont Department of Public Service (“DPS”
or “the Department”).
Q:
Please describe your education and work experience
A:
I hold a B.S. degree in Accounting and Management Science from
Eastern Illinois University and an M.B.A. degree with a concentration in
Finance from Illinois State University. Additionally, I hold CMA certification,
have completed numerous postgraduate courses and am a member of the
Institute of Management Accountants, the Society of Utility and Regulatory
Financial Analysts and the Tax Executives Institute. During the past four
years as Finance and Economics Director, I have been involved in
evaluating several acquisitions within Vermont along with several rate
cases, rate design cases and alternative regulation cases. Prior to that, I
have been involved in private entrepreneurial businesses and have
worked across a broad spectrum of business including Finance,
Accounting, Economics, Policy Formulation, Strategic Planning, Capital
Formation, Regulation, Marketing and Domestic and International
Consulting.
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August 10, 2007
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Q:
Have you previously testified before the Vermont Public Service
Board (“PSB”)?
A:
Yes.
Q:
What is the purpose of your testimony?
A:
I am presenting surrebuttal testimony regarding FairPoint’s apparent
assumption that Verizon’s current rates -- as established through
Verizon’s Alternative Regulation Plan (“ARP”) -- will continue into the
future beyond the expiration of Verizon’s ARP. This assumption was first
identified and highlighted in the direct testimony of Perry Wheaton.
Furthermore, on page 15, beginning at line 15 of his prefiled Rebuttal
Testimony, Mr. Leach states that “market value of its equity, based on the
company’s ability to generate and grow cash flows, is much more relevant
for our financial future than our book equity.” Mr. Balhoff testifies in that
same vein, providing further support of Mr. Leach’s view of book versus
market value of equity. Based on these comments it would not seem that
much, if any, consideration has been included in its proforma financial
statements for Vermont rate regulation and the impact this transaction
may have on FairPoint’s revenue requirement as determined in regulatory
proceedings, whether in a traditional rate making case, or in the context of
an alternative regulation docket.
My testimony that follows will cover the
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 4 of 28
financial and economic revenue implications of FairPoint’s planning
assumptions about Vermont regulation.
Q:
Can you please describe the Department’s understanding of
FairPoint’s view of the rate making implications of this transaction?
A:
FairPoint has filed proforma financial statements that indicate the
proposed transaction will result in a financially sound and viable company.
While that may be so, the Department has found nothing specific in
FairPoint’s petition or testimony that would provide any clarity as to what
FairPoint’s view of the Vermont rate making implications of this transaction
are.
This area of analysis begins and ends with FairPoint’s stated
intention of stepping into Verizon’s ARP. One of the major assumptions
FairPoint appears to have used in developing its proforma financials has
to do with the continuity of revenues.
Q:
Are FairPoint’s revenue assumptions consistent with what you know
Vermont’s rate making practice and policy to be?
A:
No.
FairPoint’s planning assumption about revenues appears to be
somewhat inconsistent with Vermont’s current rate making practices and
policy, including those associated with the renewal of alternative
regulation plans.
Admittedly, the Board’s current practices are not
Docket No. 7270
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August 10, 2007
Page 5 of 28
necessarily permanent. The Board does have the discretion to change or
adopt other policies and practices at any time.
But judging by the
proforma financials, FairPoint appears to be counting on such regulatory
change occurring. I don’t want to foreclose the possibility that FairPoint
may have other plans and proposals for any potential impact Vermont rate
regulation may have on their revenue flows beyond 2010.
Q:
Can you please describe how FairPoint’s regulatory assumptions
differ from current Board practice?
A:
In preparing their operating plans and resultant proforma financial
statements, it appears that FairPoint assumes (1) the current Verizon ARP
will be acquired “as is”; (2) that the ARP will terminate in 2010 and (3) that
the ARP will be continuously renewed with no significant changes in rates.
This assumption appears to continue through the end of the eight year
planning period (2008-2015). FairPoint evidently assumes there will be
no regulatory rate impact and that essentially existing rates will continue
indefinitely over the eight year planning period.
Q:
Can you please describe the implications of these differences?
A:
These revenue and rate making assumptions have (1) some relatively
manageable
implications
related to
FairPoint’s proforma financial
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 6 of 28
statement revenue projections; (2) a potentially modest longer term impact
on the assessment of the financial soundness of the proposed transaction;
(3) no impact on the near term financial viability of FairPoint through 2010;
and, (4) the potential to stimulate changes or accommodation in regulatory
policy related to transferring and renewing or extending Alternative
Regulation Plans.
Q:
What are the financial and economic implications of FairPoint’s
assumptions regarding their revenue projections and Vermont rate
regulation?
A:
FairPoint’s assumptions regarding Vermont rate regulation and ARP
renewal appears somewhat at odds with current Board practice and
policy. As a result the proforma financial statements for the periods
beyond 2010 may overstate projected revenues, earnings and cash flow.
This overstatement of revenues may not be material but does need to be
pointed out for future consideration by FairPoint.
The Board, too, in
reviewing this transaction, may find a need to consider the future
implications of regulatory policy and rate regulation changes that may be
needed, if any, as the telecommunications markets become more
competitive.
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August 10, 2007
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Q:
What are the specific differences between FairPoint’s planning
assumptions and Vermont rate making practices and policies?
A:
It generally has been the practice and policy of the Board to require that a
complete Cost of Service be prepared and filed for changes in base rates
when petitioning for the renewal or extension of an Alternative Regulation
Plan. See, for instance, the Board’s order issued on April 4, 2006 in the
Verizon Alternative Regulation Renewal Docket No. 6959.
This policy is based on a time tested principle that rate payers should pay
just and reasonable rates that are based on test year actual costs that are
adjusted for known and measurable changes to arrive at costs that will be
incurred during the rate year.
FairPoint’s business plan does not appear to reflect that a Cost of Service
filing may be needed or considered when renewing or extending the
Verizon Alternative Regulation Plan or if they have planned a Cost of
Service filing, that it would likely result in changes in the Verizon-FairPoint
revenue requirement.
Based on current regulatory policy, a Cost of Service filing may be
required at the end of the current Verizon ARP, whether FairPoint plans to
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Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 8 of 28
petition the Board for a renewal or extension of the existing Verizon ARP
or if they plan to opt for traditional regulation. In either case, there is some
probability the Cost of Service may indicate that a change in the overall
revenue requirement is warranted. This, in turn, may lead to changes in
rates and FairPoint’s revenue. But this kind of change does not appear to
be reflected in FairPoint’s proforma financial statements for 2011 and
beyond.
Of course, it is worth noting that rather than rate reductions, an
identified need for adjusting the revenue requirement could also lead to
alternative regulatory consequences, such as service expansion or an
increase in investment levels, as was the case in Verizon’s ARP renewal
docket.
Q:
What would be the basis for a change in the revenue requirement at
the end of the Alternative Regulation Plan?
A:
FairPoint’s business plan indicates they (1) may have synergistic savings
of approximately $60 to $75 million per year (Leach Prefiled Direct
Testimony Page 36 of 42; Lines 15 and 16); (2) will adopt a capital
structure consisting essentially of debt that they plan to maintain at a
“below investment grade” credit rating; and (3) have an annual capital
expenditure spending level that is below their current depreciation
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August 10, 2007
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expense levels. Given current regulatory rate making policies, these items
most likely would result in a decrease in the revenue requirement or where
there would be no change in rates there may be some other change in
expense levels or capital spending.
It is not apparent where these
changes have been incorporated into the business plan proforma
financials. In Mr. King’s prefiled rebuttal testimony on page 12 beginning
on line 18 and continuing thorough page 15, he describes his assumptions
regarding per line revenues as potentially conservative, i.e. “FairPoint
could reasonably be expected to outperform assumptions implicit in the
NNE Projections—improvement in revenues per average access line…
and improvements in operating cash flow margins.” Mr. King concludes by
stating that FairPoint could increase annual revenues by between 10 and
25 per cent and could increase operating cash flows by as much as 25
percent or more with new product offerings and ….”not rate increases”.
However, this analysis does not appear to consider Vermont rate
regulation and is based solely on comparisons with guideline companies1
from other jurisdictions.
1
Guideline Companies included Iowa Telecom, Consolidated Communications, Alaska
Communications
Systems,
Citizens
Communications,
CenturyTel,
Valor
Communications and Windstream Communications.
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 10 of 28
The financial impact of FairPoint’s operating plan appears to be to move
cash out of the business as the regulated rate base declines. Over time
there may be only a relatively small regulated rate base for the
provisioning of POTS or by then, POTS may be provisioned entirely
through a non-regulated IP network infrastructure that may be fully
competitive and hence, deregulation of telecommunications market
completed ending the need for any regulation or market oversight.
Before that happens near the end or beyond the eight year planning
period however, there most likely will be three important differences
between a FairPoint and a Verizon Cost of Service/Revenue Requirement
that supports Verizon’s existing rates.
Those differences include
differences in (1) operating expenses, (2) capital structure and (3) rate
base.
Some of these differences may occur at the inception of the merger while
others may materialize during the remaining years of the Alternative
Regulation Plan through 2010 and beyond, but most notably these
changes may have their greatest impact upon the renewal or extension of
the Alternative Regulation Plan beyond 2010 which may have the potential
to impact FairPoint’s financial metrics. I am assuming here, that there
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August 10, 2007
Page 11 of 28
may not be any changes in existing regulatory policy between now and
2010 that would significantly change policies and practices associated
with developing a revenue requirement, i.e. competition may not be
sufficient to warrant policy changes in developing a Cost of Service.
Q:
Can you more fully describe the revenue requirement changes that
are likely to occur at the end of the Alternative Regulation Plan?
A:
The changes may include the following, again assuming no significant
change in regulatory rate making policies:
1. Declining Rate Base-The proforma financials reflect a rate base that
may be declining over the remaining years of the Alternative
Regulation Plan and will continue to decline over the remaining 8 year
planning period. This is likely to occur because capital expenditures or
reinvestment in plant and equipment during this period will be less than
depreciation expense resulting in a lower and declining rate base.
Under traditional rate making, a declining rate base translates into a
declining basis for earning income and hence results in a lower
revenue requirement and lower operating earnings.
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August 10, 2007
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2. Declining Cost of Capital-FairPoint’s cost of capital may decrease at
the inception of the merger and may be substantially less than what is
currently included in Verizon rates.
It appears that FairPoint will
essentially have no or little book equity or stated another way their
capital structure will essentially consist of debt and traditionally when
calculating a cost of capital, the cost of debt is normally below the cost
of equity (paid in capital including retained earnings). Under traditional
rate making, this may have the impact of lowering FairPoint’s weighted
average cost of capital and their overall authorized rate of return which
in turn, may lower their revenue requirement and operating income.
Mr. Leach does acknowledge (see Prefiled Rebuttal Testimony at page
63 beginning at Line 14) that with FairPoint’s proposed capital
structure, ILECs benefit from a lower cost of capital.
However, this
lower cost of capital has not been reflected in their proforma financial
model.
3. Declining Expense Levels-FairPoint has indicated they expect
synergistic savings from the acquisition that may result in reduced
operating expenses. Again, under traditional rate of return regulation,
assuming these synergistic savings can be realized; they may justify a
reduction of FairPoint’s revenue requirement and operating income.
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August 10, 2007
Page 13 of 28
Q:
Would these changes, if incorporated into FairPoint’s business
plans, affect the overall financial soundness and financial viability of
FairPoint’s proposed business plan and the attractiveness of the
proposed transaction to the State of Vermont and to Vermont rate
payers?
A:
When considering the potential impact on rates alone, these changes
could have the effect of improving the attractiveness of the proposed
transaction to the State of Vermont and to Vermont rate payers because
they could have the potential to either lower rates or provide a
combination of lower rates, improved service quality and increased
availability of broadband service.
However, if revenues and rates are
actually decreased beginning in 2011 (based on a lower authorized rate of
return, a declining rate base, lower operating expense and decreased
cash flow from operations), there likely could be some impact on the
financial metrics and “cushion” or margin of safety in FairPoint’s financial
projections that have the potential to contribute to some degree of
regulatory uncertainty beyond 2010.
Q:
In pointing out these regulation related items and the potential
impact they may have on the overall financial soundness of the
proposed transaction, what would you like the Board to do, if it
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August 10, 2007
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concludes overall that FairPoint’s proposed transaction is still
relatively financially sound and viable?
A:
The Board should impose the safeguards recommended by the
Department, as outlined in Mr. Wheaton’s testimony previously and which
I describe in further detail below. With or without consideration for rate
regulation, and with the risks inherent in this transaction, the safe guards
should be enough to ensure that sufficient rate making options are
available so that the Board does not feel down the road that it has no
option but to maintain rates at their existing level.
Q.
In summary, what are the safe guards the Department is
recommending?
A.
The safe guards are discussed in the direct testimony of Department
witness Perry Wheaton (Page 23; Lines 1-25), and, in summary include
the following:
1. Create a Separate Legal Entity for FairPoint’s Vermont Regulated
Operations.
2. Establish Advance Notification Requirements focused on cash flows.
A. Thirty day advanced notification of planned loans, dividends and
cash transfers.
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August 10, 2007
Page 15 of 28

Suspension of the cash transfers, dividend payments and
loans if FairPoint-Vermont does was not meet commitments.
3. Establish Guidelines for Affiliate Transactions
Q.
From a policy perspective why does the Department believe these
safeguards are necessary?
A.
First, let me address it from a general policy perspective and then I will
address each individual safeguard.
To date, due to the limited amount of state specific information that was
provided, the Department’s review of the Petition and supporting
testimony has identified downside risks and a rather limited upside
potential for the State and Verizon’s retail and wholesale customers. The
Department has had the following financial concerns:
(1) The adequacy of the financial margins that may exist to absorb
changes (minor and or major) and to meet any unplanned contingencies
that may develop over the near term;
(2) Given the relatively weak balance sheet and below investment grade
credit rating of FairPoint, the extent to which FairPoint would have access
to additional capital (debt or equity) if and when additional capital may be
needed; and
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Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
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(3) Given the focus and sensitivity of cash flows, whether there would be
sufficient cash available to meet the needs of providing state-of-the-art
telecommunications
networks
and
services
throughout
FairPoint’s
Vermont serving territory after consideration for debt coverage and
dividends.
FairPoint has been responsive to formal and informal discovery requests and has
provided important and helpful rebuttal information (See summary rebuttal
testimony of Walter E. Leach, Jr. at Pages 2 through 6 of 67; and Michael Balhoff)
regarding benefits, commitments and the level of financial “cushion” that may
exist in their proforma financial statements for the planning period.
But
notwithstanding this additional very beneficial information, the fact remains that
FairPoint’s proforma financials reflect a business plan that still needs to be
executed and therein lies the uncertainty: can FairPoint successfully manage the
creation of a major telecommunications carrier almost overnight and from scratch;
the three state acquisition; the related integration challenges; systems (network
operations and back office support systems) development, implementation,
conversion and cut-over; training and process development; service quality
improvements, operations cutover and ongoing operations and still deliver on all
of its capital expenditure, broadband and service improvement promises. The
Department believes that if FairPoint is given the opportunity to do so, then it
must be with safeguards to reasonably mitigate some of the potential downside
risks to the State, customers, employees, creditors and stockholders.
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 17 of 28
The DPS believes that it is desirable to put some relatively painless safeguards
in place to protect ratepayers from any potential external financial risks that may
arise from the FairPoint holding company structure (that FairPoint Vermont
should remain structurally separate); ensure that FairPoint-Vermont remain
financially sound with adequate funds to finance their on-going Vermont
operations (notification requirements and suspension constraints related to
dividends, cash pay outs and loans); and to ensure there are no cross
subsidiaries flowing among affiliates (predetermined cost assignment and
allocation practices are in place and that all affiliate transactions are conducted
under at-arms-length written agreements).
Q:
Can you describe why the Department is recommending each of the
specific safe guards?
A:
Yes.
A separate legal entity
A separate legal entity for FairPoint’s Vermont Operations will be
beneficial in three key respects:
Mr. Leach, in his prefiled Rebuttal Testimony in response to question 42,
Page 62, does not believe a separate legal entity is necessary or that it
serves the public interest. He goes on to indicate that, “If the DPS was
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August 10, 2007
Page 18 of 28
to monitor the separate operations for the Vermont business, then
FairPoint could produce a financial report….without the need to incur the
costs to create a separate legal entity.“
He further indicates that
FairPoint has no intention to “encumber any of the Vermont assets…or
require the guarantee of parent company debt….[that] it is not necessary
to house such assets in a separate entity.” The Department disagrees.
First, the separate entity would physically separate Vermont operations
from FairPoint’s headquarters and from operations in the other states
FairPoint operates in.
At a minimum, this physical separation should
include all assets (including cash), liabilities and owner’s equity required
for the on-going Vermont regulated operations. This arrangement should
not preclude service bureaus and other support operations that FairPoint
may decide to locate in Vermont.
Physical separation of costs (assets,
liabilities, owner’s equity, revenue, and expense, net and operating
income) and cash flows among and between affiliates and the parent
should be maintained that assures the avoidance and perception of crosssubsidization. To ensure that costs associated with support operations
are equitably distributed see affiliate transactions below.
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 19 of 28
Second, a separate fully functioning legal entity covering FairPoint’s
Vermont operations may enhance the Department’s and the Board’s
ability to monitor performance, objectives and promises and compliance
with Vermont statutes, regulatory policies and practices.
Third, as evidenced with this petition 2 there has been difficulty getting
reliable and useful Vermont specific information and a separate legal
entity should be better positioned and should be required to provide
separate certified financial statements for Vermont operations.
This
may be a more effective way to facilitate effective regulatory oversight
and may be a more effective way to ensure there will be credible, reliable
operating and financial information available for FairPoint-Vermont
telecommunications operations. Without such a requirement it may be
impossible to monitor the Vermont market and FairPoint’s performance.
FairPoint-Vermont should remain structurally separate from other
operating units of FairPoint unless structural integration is approved by the
PSB and only after more Vermont specific information becomes available.
Regarding regulatory oversight –The DPS and the PSB should have
2
See the Prefiled Rebuttal Testimony of Walter E. Leach, Jr. at Page 2 of 67; Lines 2
through 4 where Mr. Leach indicates Vermont specific information “is of limited use
given the way the original three-state model was prepared.” See also his rebuttal
testimony response at page 27 to Question 21.
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 20 of 28
access to financial and operational information above the FairPointVermont operating unit level, i.e. access to financial and operational
information of FairPoint Corporate.
Verbal or written requests for
information to FairPoint-Vermont and FairPoint-Corporate should be
honored as requested.
Therefore, for all of the reasons previously stated the Department
continues to believe that a separate legal entity is necessary.
Establish Advanced Notification Requirements
The following financial safeguards that focus on advanced notification
regarding the movement of cash and the possible suspension of the
movement of cash are being recommended for adoption.
The Department recommends that the Board establish a thirty day
advanced notification requirement to the Department and to the Board for
any planned dividend payments to stockholders including parent or
holding company and cash transfers including loans of any kind from
FairPoint - Vermont to FairPoint parent and affiliates.
This notification is
simply a process that may enable the Department and the Board to
consider if such payments should be suspended for failure to comply with:

Service quality minimum standards.
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Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 21 of 28

Effectively managing its Vermont regulated retail and
wholesale operations.

Meeting the broadband build-out commitments established
under
Verizon’s
Alternative
Regulation
Plan
and
as
expanded in Mr. Nixon’s testimony.
The notification requirements are relatively modest and are reasonable
given some of the major unknowns inherent in FairPoint’s Business Plan
regarding Vermont Operations.
FairPoint’s business plan is predicated on cash flows and the stability
customers and Vermont regulation provides regarding those cash flows.
Creditors have indenture requirements and covenant provisions to ensure
repayment of any debt; unions have contracts to ensure payment of
wages and benefits; and FairPoint stockholders have been promised and
expect to receive a dividend. Customers expect and deserve high quality
state-of-the-art telecommunications services.
It only seems fitting that since most of this cash stockholders, creditors,
employees and others expect to receive comes from customers, that
customers should have some assurances that the services they have paid
for are provided and if not, payments to stockholders, loans to affiliates
and other cash transfers should be reduced or suspended until service
standards and operating commitments are met.
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 22 of 28
Since this is a notification requirement, the only risk to stockholders and
others is when FairPoint management fails to consistently deliver on
service quality and its promises and commitments that customers have
come to rely upon.
Though no such sub par results are expected or
anticipated, when and if they would occur, it seems reasonable that
stockholders should share some of that awareness through a decrease in
dividends. Likewise, it may be appropriate that planned affiliate loans and
cash transfers be suspended or reduced until commitments are met.
To accomplish this, FairPoint Vermont should provide thirty day advance
notification to the DPS and the PSB of all any planned payouts, changes
in the frequency, total quarterly amount and in the percentage of net
income and cash flow that is or will be distributed or paid out for any
reporting period in any form (including dividends, loans and transfers) from
FairPoint Vermont to others including FairPoint Corporate. The Payout
Notification should include an impact assessment on FairPoint-Vermont’s
capital spending plans and programs; identifying specific project changes
that may be required as a result of the payout and the impact such
payouts may have on service quality, commitments and promises.
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 23 of 28
These thirty day advance payout notification requirements in addition to
dividends, apply to any and all loan arrangements and cash transfers
among and between affiliates and the parent.
The notification should
state the impact such loans and cash transfers may have on the
operations and financial integrity of FairPoint-Vermont including current
and remaining credit capacity available, service quality, commitments and
promises.
Mr. Leach in his Prefiled Rebuttal Testimony beginning on page 63 in
response to question 43, indicates that “any limitation on the ability to
transfer funds to the parent in the form of loans or dividends from the
Vermont operations would not be workable…or in the best interest of the
Vermont customers”.
The consolidated “three state operations provide operational and
regulatory diversity that would cushion the Vermont operations from a
disruptive, unexpected event….[and] it provides economics of scale and
operational efficiencies….[that] would cease or materially diminish… if one
state isolates the financial resources of the operations in its state.”
Mr. Leach does acknowledge that with FairPoint’s proposed capital
structure, ILECs benefit from a lower cost of capital than what they would
otherwise enjoy if they attempted to access capital on their own.
However, this lower cost of capital has not been reflected in their proforma
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 24 of 28
financial models.
Again, under Vermont rate regulation, the Board has
discretion to impute a capital structure and it would not be unusual or
uncommon in a rate proceeding to impute a capital structure for the
subsidiary based on the capital structure of the parent or holding company.
If this were to occur, even the separate legal entity of FairPoint-Vermont
would enjoy the benefits of the lower cost of capital of the parent.
At page 64 of his Rebuttal Testimony, Mr. Leach argues that no additional
dividend restriction need to be ordered by the Board because FairPoint’s
existing Credit Agreement contains sufficient dividend restrictions that
require FairPoint to cease making dividend payment if debt exceeds a
predetermined level.
However, this argument overlooks that these
covenants are intended to protect creditor interest rather than customer
interest.
They do not take into account the Department’s regulatory
objective of ensuring FairPoint’s compliance with its service quality and
investment obligations. The Department believes it is imperative for the
Board to impose some constraint on dividends when service quality and
operating metrics and promises are not met.
Mr. Leach also suggests that the DPS has “other means” (see page 64) to
assure FairPoint complies with stated promises and commitments such as
“penalty payments” and therefore restrictions on cash are not required to
accomplish the intended objective.
Once the cash is out the door it is
gone and it would be preferable to ensure that cash provided by Vermont
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 25 of 28
customers is not disbursed outside of Vermont until services have been
rendered.
Establish Guidelines for and Monitor Results Associated with Affiliate
Transactions
Michael T. Skrivan, in his Prefiled Rebuttal Testimony beginning at page
17, argues that since FairPoint “is already subject to applicable federal
requirements which include allocations of costs between regulated and
deregulated operation pursuant to Part 64, distributions to corporate costs
pursuant to its Cost Allocation Manual (CAM) and compliance with affiliate
transaction rules in accordance with Part 32 Rules”, he did not believe any
additional affiliate transaction conditions were necessary and if imposed
would “introduce an element of confusion as to what FairPoint’s
obligations are with respect to affiliate transactions”.
He sites as an
example the confusion that may result between “arms-length” negotiations
as proposed by the Department versus the Part 32 requirement of “higher
of cost or market” when negotiating the sale of an asset.
While we recognize that Part 32 and Part 64 provide valuable guidance,
the Department continues to believe that it is in the rate payer’s interest
that compliance with those requirements be monitored. To facilitate that
monitoring, FairPoint-Vermont should be required to file copies of any
contracts and service agreements totaling $25,000 or more with the
Department and the PSB.
This requirement need not exist forever, but
Docket No. 7270
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August 10, 2007
Page 26 of 28
should be a requirement for the foreseeable future. We agree that
FairPoint must comply with Part 32 and Part 64 for FCC jurisdictional
related issues and recognize there may be occasions where state and
federal affiliated transaction rules may differ, but in the example sited, the
Department does not believe there is any inherent conflict between “atarms-length” and the “higher of cost or market”, either could be
accommodated.3
We believe the intent is the same.
The Department would recommend that the Board require that all service
agreements and contracts between FairPoint – Vermont and FairPoint
Parent and any other FairPoint affiliate be negotiated “at-arms-length” and
competitively priced. To facilitate monitoring, the Board should require
FairPoint-Vermont to file copies of all affiliate-related contracts and service
agreements over $25,000 with the DPS and the Board.
All affiliate transactions that exceed a twenty five thousand dollar per
transaction threshold should be effected through at-arms-length contracts
that can be competitively compared and evaluated.
Such contracts
include service agreements between FairPoint-Vermont and affiliates and
3
The question would become, how and by whom any dollar difference should be
absorbed, i.e. an at-arms-length sale occurring under either state or FCC jurisdiction
where the sales price was less than market but higher than cost, how would the
difference between market and sale price be accounted for and recovered, if at all.
When under FCC jurisdiction the sale would be recorded at the market price and the
difference between market and sales price would be recorded as a Plant Acquisition
Adjustment or expensed below-the-line.
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 27 of 28
the parent and would include any contractual loan documents, covenants
and agreements. Such agreements should be filed with the DPS and the
PSB thirty days prior to their effective date.
Physical separation of costs (assets, liabilities, owner’s equity, revenue,
and expense, net and operating income) and cash flows among and
between affiliates and the parent should be maintained that assures the
avoidance and perception of cross-subsidization.
Where physical
separation is not practical such as in the sharing of services and facilities
related to support and corporate parent functions, costs and revenues be
separated via predefined cost assignment and cost allocation policies and
practices that should be filed with the DPS and the PSB forty-five days
prior to execution.
FairPoint-Vermont should provide specific tracking and annual reporting
(by FCC Account) for the next seven years of the estimated savings that
FairPoint-Vermont and FairPoint-Parent anticipates and realizes from the
merger.
An annual report of savings and cost avoidance should be
provided to the PSB and the DPS within forty-five days after the close of
the calendar year.
Docket No. 7270
Prefiled Surrebuttal Testimony of Ron Behrns
August 10, 2007
Page 28 of 28
Q:
DOES THIS CONCLUDE YOUR TESTIMONY?
A:
YES.