Discussion

Proposed tariff changes:

In AL. 318, Ducor is proposing the following tariff changes:

CD has reviewed Ducor's proposed tariff changes and found them reasonable. CD recommends the Commission adopt Ducor's proposed tariff changes.

Results of Operations

Appendix A compares total company results of operations for test year 2009, as estimated by the CD and Ducor at present rates.

CD calculates in test year 2009 that Ducor will earn a total company overall rate of return of 5.91% compared to Ducor's calculation of 2.22%. Since CD concludes Ducor is earning below the Commission's authorized rate of return of 10.00%, CD's estimates for Ducor reflect revisions to Ducor's estimates of revenues, expenses, and rate base as discussed below.

Total Operating Revenues

For test year 2009, CD identified the regulated components of Ducor Total Operating Revenues, Local Revenues, Access Revenues, Miscellaneous Revenues and Uncollectibles.

A comparison of CD's and Ducor's estimates of intrastate company operating revenues for test year 2009 is shown in Appendix C. Ducor's estimate of intrastate company operating revenues is $4,350,780, a difference of $297,041 from CD's estimate of $4,053,739. The reasons for the differing estimates are further described below.

CD proposes to increase Ducor's business service rates for both of its exchanges, from $29.55 to $30.00 for the Ducor exchange and from $25.55 to $30.00 for the Kennedy Meadows/Rancho Tehama exchanges. The new charges will result in an increase of $3,001 in revenue. The increased service charge will bring the charges more in line with rates charged by comparable carriers. Furthermore, CD is proposing an increase to Ducor's residential services, from $18.20 to $20.25 at the Ducor exchange and from $16.85 to $20.25 at the Kennedy Meadows/Rancho Tehama exchanges. This increase is within 150% threshold of AT&T's current rates as required for CHCF-A support. The new charges will result in an increase of $40,740 in revenue. In D.08-09-042 as corrected by D.08-10-040, Universal Regulatory Framework (URF) ILEC's (Incumbent Local Exchange Carriers) will adopt a transitional plan for increases to Basic Residential rates effective January 1, 2009. As a result, CD recommends Ducor increase its Lifeline rates, from $5.47 to $6.11, since General Order 153 ties those rates to AT&T's basic rate.

Additionally, CD proposes rate increases for the following services:

These proposed rate increases were derived from a survey of service rates charged by other California telephone companies. Factors such as the company's geographic location and the current service rates were taken into consideration. Adjustments for price elasticity were applied by CD in response to concerns raised by Ducor in its meeting with CD and in response to information provided in subsequent data requests. CD believes its proposed rate increases are reasonable and are in line with those rates charged by other comparable carriers. Furthermore, these proposed rate increases and the potential of raised revenue would lower the draw on the CHCF-A.

In its filing, Ducor has proposed the following rate increases:

Ducor also proposed Local Area Operator Assistance Service would increase from $.25 per call to $.50 per call, in addition to reducing both the business and residential call allowance from 5 to 3. However, after surveying other carriers' Local Area Operator Assistance Service, CD proposes reducing the call allowance to 1 call per month. CD believes its proposal to be reasonable and is in line with those allowed by other comparable carriers.

Uncollectibles

Uncollectibles are based on bad debts associated with local revenue and intrastate access revenues. Ducor states the estimated local debt at $1,800 and intrastate access debt at $40,694 are based on average of the historical record. CD has reviewed the annual reports and does not agree with Ducor's estimates of test year 2009 uncollectible. CD analyzed five years (2003-2007) of recorded data to arrive at an average of zero uncollectible for local revenue and 8.04% uncollectible for intrastate access revenue. CD applies these percentages to derive the 2009 uncollectible. Therefore, CD disallows $27,540 of bad debt associated with intrastate revenue and estimates intrastate uncollectibles to be $18,553 for the test year 2009.

Operating Expenses

Ducor's test year forecasts for operating expenses are calculated by annualizing seven months actual expenses from January - July, 2007. The 2008 and 2009 expenses are forecast based on an adjusted historical average growth rate for labor related and non-labor related expenses plus an adjustments for additional employees in 2008/2009 and rate case expenses in 2009 amortized over 3 years. CD used Ducor's recorded years 2005, 2006 and 2007 labor and non-labor expenses and applied the constant dollar method to estimate Ducor`s 2009 expenses.

The constant dollar method is used to measure financial statement items in dollars of the same (constant) purchasing power. Historical cost is restated in units of constant purchasing power as follows:

(Historical Expense) X (Average CPI for the Current Year/CPI at Time of Expense incurrence)

Restating all accounts in constant dollars provides greater comparability among years because all expenses appear in constant dollars regardless of when the expense was incurred. The Commission in Siskiyou's 1997-test year rate case proceeding discussed and adopted CD's use of the constant dollar methodology. In Finding of Fact 6 of Resolution T-16006, the Commission found "...CD's methodology in estimating expenses reasonable and adopt CD's recommended test year 1997 expenses contained in Appendix A." 2

Therefore, CD used Ducor' recorded expense figures for the years 2005, 2006 and 2007 and then applied the recorded inflation factors3 for labor and non-labor for each year to convert the recorded expenses to constant 2007 dollars. CD then took the average of the inflation-adjusted amounts for those three years and used it as its base estimates. It then applied the cumulative inflation factors for 2008 and 2009 to the base estimate to arrive at the test year 2009 estimate. Because rents are not subject to the same fluctuations as other types of expenses, the constant dollar method was not applicable.

The constant dollar method has been the preferred methodology and endorsed by the Commission for analyzing recorded data and has been an accepted methodology in traditional rate case.

CD reviewed Ducor's employee wages and benefits, and CD found Ducor executives' wages and employee benefits to be excessively high. CD adjusted Ducor's executive total compensation to more appropriately reflect those paid by other California small utilities by limiting the wages and benefits of the President to $250,000 per year, the Executive Vice President to $160,000, and the Vice President to $140,000. Ducor's benefit to total wages and salaries ratio has also subsequently been adjusted for ratemaking purposes. According to 2007 data provided by Ducor in response to a CD data request Ducor's benefit to salary ratio is 54%. CD applied a ratio of 42% that it deemed to be more reasonable for rate making purposes.

CD's use of the 42% benefit to salary ratio was developed through a comparison of ratios utilized by other communication carriers involved in General Rate Cases (GRC), a survey of the annual report filings and general rate cases of small water companies ranging from 2000-10,000 customers as well as U.S. Bureau of Labor Statistics (BLS) data, dated December 10, 20084 for those indicators relevant to small ILECs operating in California

CD found the average benefit to salary ratio for the water survey group to be 33%5. While the study of the latest available data from the BLS, for similarly situated companies by size, location, and operation type as well as other indicators resulted in an average benefit to salary ratio of 42%6. The BLS ratio supports CD's proposed rate of 42% therefore, CD caps the ratio of regulated benefit to salaries/wages for the test year 2009 and concludes that its proposed benefit to salary ratio of 42% for Ducor is appropriate and adequate.

Plant Specific Expenses

Plant specific expenses include expenses related to telephone plant. These include components for network support, general support, central office switching, operator systems, transmission, originations and termination, and cable and wire. Ducor estimates plant specific expenses for test year 2009 to be $1,484,760. CD's estimate for plant specific expenses for 2009 is $1,217,013. This represents a reduction of $267,747 from Ducor's estimate. This reduction is due to CD using constant dollars method (CDM) and the limitation of executives' wages and adjusted employee benefits changes.

Plant Non-Specific Expenses

Plant non-specific expenses include such expenses as those related to network administration, testing, engineering, access to the network and power. Ducor annualized seven months actual expenses for January - July, 2007 to forecast 2009 test year expenses. Ducor's plant non-specific expenses estimate for test year 2009 is $192,511. CD used recorded year 2007 amount to forecast 2009 test year expenses. CD's estimate for plant specific expenses for 2009 is $201,300. This represents a difference of $8,789 from Ducor's estimate. The difference is due to CD using constant dollars method (CDM) and the limitation of executives' wages and adjusted employee benefits changes.

Customer Operations Expense

Customer operations expenses include components for marketing and customer operations. For customer operations expenses Ducor's estimate is $330,139 for test year 2009. CD's estimate for this expense category is $272,174. This represents a reduction of $57,965 from Ducor's estimate for test year 2009 customer operations expenses. This reduction is due to CD using constant dollars method (CDM) and the limitation of executives' wages and adjusted employee benefits changes.

Corporate Operations Expense

The corporate operations expense account included components for executive and planning, general and administrative. Ducor includes $180,000 rate case expenses to amortize over 3 years in the Corporate Operation account. Ducor estimates rate case expenses for the test year 2009 to be $60,000. In Ducor's 2004 GRC, the Commission allowed $40,000 associated with rate case expense in test year. CD uses this $40,000 to apply the 2007 constant dollar inflation factors to develop 2009 rate case expense. CD includes $49,000 for rate case expense for test year 2009.

Ducor estimates its test year 2009 corporate operations expenses to be $1,248,079. CD's estimate for corporate operations expense is $1,160,445. This represents a reduction of $87,634 from Ducor's test year estimate. This reduction is due to CD using constant dollars method (CDM), the limitation of executives' wages and the adjustment to employee benefits.

Taxes

The differences in tax estimates are due to variations in Ducor's and CD's revenue and expense estimates. Ducor and CD each used a Corporate State Franchise Tax (CCFT) rate of 8.84% and a Federal Income Tax rate of 34%. CD estimates Ducor's test year 2009 intrastate taxes for CCFT and Federal Income Tax to be $56,619 and $198,517, respectively.

To calculate depreciation expenses, both Ducor and CD utilized the same methodology and depreciation rates previously adopted by the Commission for Ducor. Ducor estimates its depreciation expense to be $1,376,880 whereas CD's estimate is $1,359,772. The difference of $33,468 in depreciation expense is due to differing plant-in-service estimates. CD's depreciation expense estimate was calculated using CD's plant-in-service estimate for the test year 2009, multiplied by the depreciation rates authorized by the Commission in Ducor's 1997 general rate case, to derive its test year depreciation expense estimate.

Rate Base

CD examined Ducor's Rate Base components, which include Telephone Plant-in-Service, Telephone Plant-under-Construction, Materials & Supplies, Working Cash, Depreciation Reserve, Deferred Income Taxes and Customer Deposits.

Ducor's estimated plant in service as of December 31, 2007, was forecasted based on actual balances as of November 30, 2007, plus December 31, 2007, forecasted additions and retirements. Ducor's estimates average plant in service for test year 2009 to be $19,048,800. CD used 2007 recorded ending plant in service balance to develop 2009 plant in service. CD estimates average plant in service for test year 2009 to be $18,825,509. This difference is the result of CD adjusted additions for Vehicle purchases

for all three exchanges: Ducor, Kennedy Meadows and Rancho Tehama, Buildings from 2007 actual, Furniture for Kennedy Meadows, Circuit Subscriber projects for Ducor, Kennedy Meadows and Rancho Tehama, Cable projects for 2007 actual and Kennedy Meadows, Fiber Optic projects to a weather station in Ducor and Ducor and Rancho Tehama for redundant fiber access route project.

The adjustments to additions for the Circuit Subscriber projects for Ducor, Kennedy Meadows and Rancho Tehama exchanges were based in part on the $538,722 Ducor spent in 2007 on underground cable projects including two digital loop carriers (DLC) in the Rancho Tehama exchange. With the allowance of the two additional DLC's at a cost of $366,000 in 2009, the cost per Rancho Tehama subscriber will be over $1,000. Ducor asserts that with this investment it will have the ability to offer digital subscriber line services with the DLC's by reducing the central office distance from potential customers. However, CD has disallow one of two DLC's in the Ducor exchange as it has not been demonstrated to be a reasonable investment for ratepayers to fund.

Construction Work in Progress

Ducor estimated Construction Work in Progress for test year 2009 is $285,732. Ducor's estimate was based on an average ratio of 1.5% between construction work in progress and plant in service. CD finds Ducor's ratio to be reasonable. As compared with other California small telephone companies, CD estimates construction work in progress for test year 2009 to be $282,383. The difference is due to variations in Ducor's and CD's plant in service estimates.

Ducor estimated materials and supplies by analyzing their historical relationship to plant in service. Ducor used 1.21% of the average plant in service balance to determine its test year total company materials and supplies estimate of $229,971. As compared with other California small telephone companies, CD finds Ducor's percentage reasonable and estimates materials and supplies expense of $227,789 for the 2009 test year based on CD's average plant in service.

Ducor estimates its 2009 test year working cash requirement to be $300,397 whereas CD's estimate is $264,198. CD and Ducor both utilized the Simplified Method described in the Commission Standard Practice U-16 to calculate working cash and arrive at the above estimates. The Simplified Method was authorized by the Commission for California small telephone companies to calculate working cash allowance. The differences in the figures are the result of differing expense and revenue estimates.

Deferred Income Taxes

Ducor estimated the deferred income taxes by taking the ratio of the 2006 average deferred income taxes to the 2006 average plant in service. A negative 4.74% ratio was then applied to the forecasted 2009 plant in service to derive the 2009 deferred income taxes. CD reviewed Ducor's recorded deferred income taxes and plant in service from the years 2002 through 2006. As compared with other California small telephone companies, CD finds Ducor's estimation method to be reasonable. CD accepted Ducor's deferred income taxes' ratio. Ducor estimates its 2009 test year deferred income taxes to be $902,080, whereas CD estimates Ducor's test year 2009 DIT to be $891,506.

Separations

Ducor provides both intrastate and interstate telecommunications services, subject to regulation of the CPUC and FCC, respectively. Because Ducor's property serves both jurisdictions, the utility's expenses, taxes, investments, and reserves are allocated between interstate and intrastate services.

Separations are the process of apportioning a telephone company's property costs, related reserves, operating expenses and taxes, and revenues between the state and federal jurisdictions. It is a vehicle by which a telephone company can separately identify the amount of expenses, investments and revenues associated with the production of a given service. These apportionments are made on the basis of relative usage and direct assignment whenever possible. The costs of the classification of accounts as prescribed by the Federal Communications Commission's (FCC's) Part 32, Uniform System of Accounts (USOA) for Telecommunications Companies.

As required under FCC Part 36 jurisdictional separations' procedures, Ducor used the most recent available separation factors to allocate its expenses and investments between interstate and intrastate. CD used the separation factors provided by Ducor to separate its estimates for total company expenses and plant to derive CD's estimates for Ducor's intrastate results of operations.

Appendix B compares Ducor's and CD's total company, interstate, and intrastate results of operations for test year 2009 using these factors. Appendix C shows the difference between Ducor's and CD's 2009 intrastate results of operations.

Cost of Capital

Ducor requests an overall intrastate rate of return of 10.00%, the rate of return authorized by the Commission for Ducor in 1997 by Resolution T-16007.

The Return on Equity for all rural ILECs should be the same since the systematic and non-diversifiable risks faced by all rural ILECs are similar. In Decision D.97-04-035, the Commission authorized Ducor a 10.00% return on rate base for its 1997 test year as requested in A.95-12-076. The risks faced by rural ILECs appear similar today as in the recent past, therefore CD recommends that the Commission approve Ducor's request for an overall rate of return of 10.00% at this time.

Net-to-Gross Multiplier

The net-to-gross multiplier indicates the unit change in gross revenues required to produce a unit change in net revenue. Appendix D shows CD's computation of Ducor's net-to-gross multiplier. The net-to-gross multiplier of 1.66207 means that a change of $1,662 in gross revenue would be required to produce a change of $1,000 in net revenue. For Ducor, based on an adopted intrastate rate base of $6,507,721 and an adopted rate of return of 10.00%, the adopted intrastate revenue requirement change required is $659,103.

CHCF-A

D.01-02-018 approved Settlement Transition Agreements (STAs) between Pacific Bell and the small Local Exchange Carriers (small LECs). Funds that Pacific Bell paid the small LECs through toll and access pool settlement payments were replaced by authorized draws from the CHCF-A. The CHCF-A its elf was originally established by D.85-06-115 as a means of subsidizing reasonable basic exchange rates for the customers of small LECs that adopted Pacific Bells statewide average toll, toll private line, and access rates (settlement pools). D.01-02-018 required the small LECs' replacement funding for the STAs be subject to the same rules that apply to current draws from the CHCF-A, namely, basic residential rates shall be increased to a ceiling equal to 1.5 times urban rates as necessary, and both means test and the waterfall provisions shall apply.

Ducor calculated CHCF-A support for test year 2009 at present rates to be $1,907,971. The CHCF-A 2009 support is derived from using Ducor's 2008 draw of $1,782,058 adding the NECA estimated USF Federal support for 2008 of $942,014 and subtracting Ducor's projected 2009 USF Federal support of $816,101. On October 10, 2008, CD received the adjusted USF number from NECA. The adjusted USF for Ducor for 2009 is $922,918. CD used the adjusted USF $922,918 to derive Ducor's CHCF-A requirement.

For the test year 2009, CD's computation of Ducor's CHCF-A requirement is $2,514,516 based on CD's projected revenues, expenses, rate base and 10.00% overall intrastate rate of return.

2 At page 5 of Resolution T-16006, the Commission stated, "Generally for traditional GRCs, the Commission adopts the constant dollar method".

3 CD used the Division of Ratepayers Advocates estimates of Non-Labor and Wage Escalation Factors for 2008-2012 from the November 2008 Global Insight U.S. Economic Outlook as follows:

2005 1.0400 1.0540

2006 1.0375 1.0540

2007 1.0375 1.0300

2008 1.0290 1.0680

2009 1.0390 0.9950

4 http://www.bls.gov/news.release/ecec.nr0.htm.

5 Kenwood GRC filing Test Year 2009 at 35%, Alco Annual Report 2007 at 48%, East Pasadena Annual Report 2007 at 24%, Fruitridge Annual Report 2007 at 25%, Penngrove Annual Report 2007 at 32%.

6 Ibid, Table 8.

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