STATE of North Carolina ex rel. UTILITIES COMMISSION, and Robert Morgan, Attorney General, Appellees.
v.
GENERAL TELEPHONE COMPANY OF the SOUTHEAST and City of Durham, Appellants.
No. 7110U668.
Court of Appeals of North Carolina.
November 17, 1971.*528 Newsom, Graham, Strayhorn, Hedrick & Murray, by A. H. Graham, Jr., Ward W. Wueste, Jr., Durham, and Power, Jones & Schneider, by John Robert Jones and William R. White, Columbus, Ohio, for General Telephone Co. of the Southeast, appellant.
City Atty. Claude V. Jones, for City of Durham, appellant.
Atty. Gen. Robert Morgan, by Asst. Atty. Gen. Jean A. Benoy, for the Using and Consuming Public, appellee.
Commission Atty. Edward B. Hipp, and Asst. Commission Atty. Maurice W. Horne, Raleigh, for North Carolina Utilities Comm.
PARKER, Judge.
The Commission having determined this to be a general rate case, the provisions of G.S. § 62-133 became applicable and controlled the further proceedings in the case. Subsection (a) of G.S. § 62-133 contains a general direction that in fixing *529 rates "the Commission shall fix such rates as shall be fair both to the public utility and to the consumer." Subsection (b) of G.S. § 62-133 contains more specific directions as follows:
§ 62-133(b) "In fixing such rates, the Commission shall:
(1) Ascertain the fair value of the public utility's property used and useful in providing the service rendered to the public within this State, considering the reasonable original cost of the property less that portion of the cost which has been consumed by previous use recovered by depreciation expense, the replacement cost of the property, and any other factors relevant to the present fair value of the property. Replacement cost may be determined by trending such reasonable depreciated cost to current cost levels, or by any other reasonable method.
(2) Estimate such public utility's revenue under the present and proposed rates.
(3) Ascertain such public utility's reasonable operating expenses, including actual investment currently consumed through reasonable actual depreciation.
(4) Fix such rate of return on the fair value of the property as will enable the public utility by sound management to produce a fair profit for its stockholders, considering changing economic conditions and other factors, as they then exist, to maintain its facilities and services in accordance with the reasonable requirements of its customers in the territory covered by its franchise, and to compete in the market for capital funds on terms which are reasonable and which are fair to its customers and to its existing investors.
(5) Fix such rates to be charged by the public utility as will earn in addition to reasonable operating expenses ascertained pursuant to paragraph (3) of this subsection the rate of return fixed pursuant to paragraph (4) on the fair value of the public utility's property ascertained pursuant to paragraph (1)."
It is apparent that the first step prescribed by G.S. § 62-133(b) (1), that of ascertaining the "fair value of the public utility's property used and useful in providing the service rendered to the public within this State," becomes of critical importance in the rate making process, for only after the determination of this "rate base" can judgment be intelligently exercised fixing the rate of return which the utility is entitled to receive on the fair value of its property and fixing rates to be charged by the utility which are "fair both to the public utility and to the consumer." It is not surprising, therefore, that the first four of the six questions argued in the brief of the appellant, General, on this appeal relate to errors which it contends were made by the Commission in the course of making its determination as to the fair value of General's property "used and useful in providing the service rendered to the public in this State." The first three of the questions presented relate to deductions made by the Commission from the original cost investment made by General in its telephone plant, and the fourth question relates to the method followed by the Commission in finally arriving at its determination of fair value after the deductions were made.
Before discussing the several deductions which the Commission made from General's cost investment in its telephone plant to which General takes exception on this appeal, it may be well to emphasize that the establishment of "the reasonable original cost of the property," as referred to in G.S. § 62-133(b) (1), is of significance only because "reasonable original cost is one of several figures and factors which the statute requires the Commission to consider in arriving at "fair value." As stated by Lake, J., speaking for our Supreme Court in State ex rel. Utilities Comm. v. Morgan, *530 Attorney General, 277 N.C. 255, 268, 177 S.E.2d 405, 414:
"There is but one rate basethe fair value of the public utility's property used and useful in providing the service rendered to the public within this State, which value the Commission must determine as of the end of the test period. G.S. § 62-133. The original cost of the properties is simply evidence to be considered in making this determination. The replacement cost, whether determined by use of trended cost indices or otherwise, is also but evidence of the fair value of the properties." (Emphasis added.)
Although original cost is simply evidence to be considered by the Commission together with other evidence in determining fair value, it was evidence of such importance and had such a major impact upon the Commission's ultimate finding as to fair value in this case that any substantial error in arriving at original cost would necessarily be of crucial significance. We therefore consider the merits of General's several assignments of error which are directed to the action of the Commission in making the deductions from original cost of its intrastate telephone plant which are brought forward in General's brief on this appeal.
General contends the Commission erred in deducting from its plant investment the sum of $978,000.00 which the Commission, in Finding of Fact No. 7, found was "in regard to the excess profits which are reasonably attributed to its major supplier, Automatic Electric Company." Automatic Electric Company (AE), as is General, is a wholly-owned subsidiary of GT&E and is the major manufacturing and supply company for GT&E affiliated companies and for other non-Bell System telephone companies. Exhibits and testimony presented by the Commission Staff showed that during the period from 1957 through 1969 annual sales from AE to GT&E affiliated companies, concluding General, increased from approximately $87 million in 1957, which was 52.6% of AE's total sales for that year, to more than $418 million in 1969, which was 74% of AE's total sales for that year. During recent years General's North Carolina division has purchased approximately 85 to 90 percent of its equipment and supplies from AE, and during the twelve-month test period which ended on 31 March 1970, General's North Carolina division purchased 94.2% of its equipment and supplies from AE. Because of the close relationship between General and AE, because of the substantial percentage of its total equipment and supplies which General purchases from AE, and because of the dominant position occupied by AE as the leading manufacturer and supplier of telephone equipment to non-Bell System companies, the Commission, in the order appealed from, concluded that it was "reasonable to deal with Automatic Electric Company and the Applicant for rate making purposes as one company subject to regulation by this Commission." The Commission further concluded that it was "reasonable to subject AE to the same rates of return on common equity as are similar-type non-regulated companies," and that prices charged by AE to General were "unreasonable and excessive to the extent they produce a return higher than 15% on common equity." On the basis of these conclusions the Commission reduced the cost of General's North Carolina telephone plant by $978,000.00, which amount it found to be "excess profits which are reasonably attributed to its dealings with its major supplier, Automatic Electric Company."
Without finding it necessary to pass on the correctness of the Commission's conclusion that AE and General should be dealt with "for rate making purposes as one company subject to regulation by this Commission," we hold that the Commission had ample authority to inquire into the reasonableness of the prices paid by General for its equipment and supplies purchased from General, and, to the extent it found such prices unreasonable, to reduce the cost basis of General's intrastate telephone plant accordingly. G.S. § 62-133(b) (1) directs the *531 Commission, in the process of ascertaining the fair value of a public utility's property, to consider, among other things, "the reasonable original cost of the property." (Emphasis added.) Where the property has been purchased from a stranger, ordinarily the price actually paid by the utility would be considered its reasonable cost, though it would not necessarily be so. Even in such a case the Commission may find that the management of the utility acted improvidently or carelessly and paid a price greater than reasonable. In cases such as the one now before us, in which a substantial portion of the utility's property was acquired by purchase from an affiliated company, it becomes obligatory upon the Commission to scrutinize the prices paid and, to the extent it finds such prices unreasonable, to make adjustments in the utility's figures accordingly. This is all the more true where, as here, the affiliated supplier so dominates the market that its pricing policies may not be sufficiently controlled by normal competition. The question, of course, is not so much whether the affiliated manufacturing company is earning "excess profits" on its overall operations, most of which involve transactions outside of North Carolina, as it is whether the prices which it charges the affiliated utility company in North Carolna are reasonable. Where such prices are the same as it charges other affiliated companies to which it makes a majority of its total sales, one method of determining the reasonableness of its prices is to compare its rate of return on common equity with the rates of return experienced by other manufacturing companies operating in similar fields. Essentially this was the method followed by the Commission in the present case, and in this we find no error.
The fact that the prices charged by AE on its sales to General's North Carolina division were the same, or in some instances lower, than prices which it charged Carolina Telephone and Telegraph Company (Carolina), an unaffiliated telephone company in North Carolina, is not, in our opinion, conclusive of the reasonableness of the prices charged to General. The Commission might reasonably find in a case involving Carolina that the prices paid by it were reasonable, since Carolina's management, dealing at arm's length with AE as the dominant supplier in the field, might have insufficient bargaining power to obtain better prices. At the same time the Commission could, in our opinion, also reasonably find these same prices, when paid by General to AE, to be unreasonable. In the one case (sales by AE to Carolina) AE's pricing may reflect some degree of exploitation of its dominant position in the market; in the other case (sales by AE to General) AE's prices are fixed in transactions between two companies, both of which are wholly owned and wholly controlled by the same parent; in neither case do normal competitive factors exert much influence. We find no error in the Commission's action in examining into the reasonableness of the prices paid by General to AE nor in the method which the Commission used in making its determination that such prices were unreasonably high to the extent requiring a reduction of $978,000.00 in the cost basis of General's North Carolina telephone plant as of the end of the test period on 31 March 1970.
The Commission also reduced General's investment in its North Carolina telephone plant in the amount of $690,340.00 for "excess margin in central office equipment in relation to the test period." In this we find error. A public utility has an obligation to furnish reasonably adequate service to the public within the limits of its franchise. It does not fulfill this obligation simply by meeting present needs; its management must attempt to anticipate future needs. This necessarily involves the exercise of judgment and discretion in forecasting future rates of growth in the demand for the utility's services and in making decisions concerning how best to meet those anticipated future demands. Difficult advance planning must be undertaken involving intricate financial, engineering, personnel, *532 and business problems. All of these problems must be solved and the solutions coordinated sufficiently in advance to permit completion of additions to the utility's facilities and plant required to meet the future growth in demand as that demand develops. And all of this must be done while conditions are continuously and rapidly changing. For engineering and financial reasons, among others, it is only prudent that some types of facilities, among them the central office equipment of a telephone company, should be so designed as to provide capacity in excess of that required when it is first put into service. It is for the management of the utility, not for the Commission or the Courts, to do the difficult advance planning and to solve the intricate problems involved in expansion of the utility's facilities. Nor do we think it proper for the Commission or the Courts, by exercising the wisdom granted them by hindsight, to second-guess the utility's management when it acted in apparent good faith. Nothing in the record before us suggests that General's management did not act in perfect good faith in planning and building the additions to its central office equipment. While that equipment might have provided at the end of the test period capacity in excess of the amount needed at that moment, no question has been raised that it was not in operation at that time, and in our opinion, it was at that time property both "used and useful" by the utility in providing services to the public within this State. This being so, the Commission had no authority to deduct any portion of its costs in arriving at the "reasonable original cost of the property" for consideration by it in making its ultimate determination of fair value.
The Commission also excluded from the cost of General's property the sum of $747,264.00 for plant under construction at the end of the test period on 31 March 1970. In this we find no error. Subsection (c) of G.S. § 62-133 is as follows:
"(c) The public utility's property and its fair value shall be determined as of the end of the test period used in the hearing and the probable future revenues and expenses shall be based on the plant and equipment in operation at that time." (Emphasis added.)
This statute is controlling. "Until it is changed by the Legislature, both the Commission and this Court must follow the statute as presently written." State ex rel. Utilities Comm. v. Morgan, Attorney General, 278 N.C. 235, 179 S.E.2d 419.
The fourth question presented by the brief of the appellant, General, on this appeal relates to the method followed by the Commission in finally arriving at its determination of the fair value of General's telephone plant after it had made the deductions discussed above from the original cost of the plant. In its order, under the heading of "Conclusions," the Commission referred to the method which it utilized in reaching its determination "in regard to Applicant's net investment in plant," referred to the deductions already discussed, and finally arrived at a figure for "Net Investment Plus w/c Adjusted" of $30,107,171.00. (This figure included an allowance for working capital, being materials, supplies, and one month's cash requirements less Federal Income Tax accruals, in the sum of $563,308.00). In its order the Commission made no finding of fact or conclusion as to the replacement cost of General's telephone plant, which is one of the matters along with `"reasonable original cost," and "any other factors relevant," which G.S. § 62-133(b) (1) directs it to consider in ascertaining fair value. It did, however, make a reference in the order to the testimony of Applicant's witness, McGrath, to the effect that during the week of 27 April 1970 he had made a visual inspection of Applicant's plant and equipment and had examined Applicant's books and records in order to arrive at what the witness believed was the replacement cost of Applicant's plant, properties and equipment. The Commission in its order simply noted that the witness, McGrath, testified that "the net trended book cost of plant of the Applicant as of the end *533 of the test period was, in his opinion, $49,409,698," and also referred to an exhibit introduced by the Applicant which showed the net trended book cost of the North Carolina intrastate portion of Applicant's plant on that date as $40,781,543.00. No further reference was made in the order to replacement cost except the passing reference in Finding of Fact No. 9, which is as follows:
"(9) The Commission finds that the fair value of the Applicant's properties used and useful in rendering intrastate telephone service to its North Carolina subscribers, considering original cost less depreciation and considering replacement cost by trending original cost by current cost levels, is $31,913,601."
The order does not reveal how the Commission arrived at the figure of $31,913,601.00 as the fair value of General's properties except the statement in Finding of Fact 9 that it was arrived at "considering original cost less depreciation and considering replacement cost by trending original cost by current cost levels." We note, however, that as pointed out in General's brief, the fair value figure of $31,913,601.00 found by the Commission is exactly 106% of $30,107,171.00, which latter figure was the Commission's conclusion, as noted above, of General's "Net Investment Plus w/c Adjusted." It is apparent, therefore, that the Commission arrived at its ultimate determination as to the fair value of General's property by first determining original cost and then increasing that figure by 6%. Nothing in G.S. § 62-133 supports this method of ascertaining fair value. Even if it did, nothing in the record supports the application of a 6% or any other percentage increment. Despite the Commission's statement in Finding of Fact 9 that it considered replacement cost, it is apparent that it did not do so, unless it assumed sub silentio that by increasing original cost exactly 6% it was adequately "considering" replacement cost. Such an assumption hardly seems justified in view of the fact that the only evidence in the record as to replacement cost yielded a figure of $40,781,543.00, which was approximately 35% higher than the Commission's determination as to original cost. We can only conclude, therefore, that the Commission's finding of fair value in this case was not supported by competent, material and substantial evidence in the record and was arrived at by a method which failed to comply with the directives contained in G.S. § 62-133(b) (1).
It was, of course, for the Commission to determine what weight to give to the evidence in the record as to replacement cost. "In these times of increased construction costs and decreased dollar value, trended cost evidence deserves weight in proportion to the accuracy of the tests and their intelligent application." State ex rel. North Carolina Utilities Commission v. Piedmont Natural Gas Co., 254 N.C. 536, 550, 119 S.E.2d 469, 479. The Commission's order in the case before us is silent as to what weight, if any, it gave to the evidence as to replacement cost, since it made no findings in this regard. It was, however, the duty of the Commission to weigh such evidence "fairly in balanced scales," State ex rel. North Carolina Utilities Commission v. Piedmont Natural Gas Co., supra, and on the present record it does not appear that this was done.
By statutory command, G.S. § 62-131(b), "[e]very public utility shall furnish adequate, efficient and reasonable service." In the present case there was extensive testimony from General's customers concerning deficiencies in its service. The Commission's Finding of Fact No. 14 contains the following:
"The Commission finds that the overall quality of service afforded by the Applicant to its subscribers is on the low side of providing reasonably adequate service. The following specific service improvements are determined to be necessarily required to be completed on or before July 1, 1972:" (There then follows a list of eleven specific types of service improvements.) *534 The language employed by the Commission is ambiguous, and we cannot clearly determine whether the Commission's finding means that it found General's service to be reasonably adequate, but just barely so, or whether it found General's service to be slightly below being reasonably adequate. If the Commission's finding means that it found the quality of General's service to fall short of the statutory requirement that it be "adequate, efficient and reasonable," then the Commission should make specific findings showing the effect of any such inadequacy upon its decision fixing rates which are "fair both to the public utility and to the consumer." Subsection (d) of G.S. § 62-133 directs that "[t]he Commission shall consider all other material facts of record that will enable it to determine what are reasonable and just rates." (Emphasis added.) Certainly the evidence of service deficiencies in the present record was such as to provide "other material facts of record" which the Commission by statutory mandate was required to consider in making its determination as to what are just and reasonable rates for the quality of service which the Applicant utility is providing its customers in the present case. As stated by Justice Lake, speaking for our Supreme Court in State ex rel. Utilities Comm. v. Morgan, Attorney General, 277 N.C. 255, 267, 177 S.E.2d 405, 413:
"The ultimate question for determination is, What is a reasonable rate to be charged by the particular utility company for the service it proposes to render in the immediate future? The determination of this question is for the Commission, in accordance with the direction of G.S. § 62-133. Serious inadequacy of such service, found by the Commission upon substantial evidence, is one of the facts which the Commission is required by that statute to take into account in making that determination."
Specific and unambiguous factual findings by the Commission are necessary to enable a reviewing court to determine whether the duty imposed by statute has been performed.
General also contends that the rate of return of 7.53% fixed by the Commission upon its finding of fair value of General's property was arbitrary and capricious and was insufficient to produce a fair profit for its stockholder. In view of the fact that the appropriate rate of return can only be determined after the fair value of the utility's property is correctly ascertained, and in view of our decision that this case should be remanded to the Commission for further consideration and fixing of fair value in accordance with the principles set forth above, we do not on this appeal pass upon the merits of General's contentions that the Commission committed error in fixing a rate of return of 7.53%.
We have examined the remaining assignments of error brought forward in the briefs of both appellants, General and the City of Durham, and find in them no prejudicial error.
The order of the Utilities Commission is reversed and this matter is remanded to the Utilities Commission for further consideration in accordance with the principles set forth in this opinion, such further consideration by the Commission to be either upon the present record or after such further hearing as the Commission shall deem proper.
Reversed and remanded.
BRITT and MORRIS, JJ., concur.