Applicants' Arguments in Favor of Settlement Agreement

SCWC contends that the settlement agreement meets the requirements of Rule 51 of the Commission's Rules of Practice and Procedure of being reasonable, lawful, and in the public interest. SCWC alleges that the current customers of Peerless will not suffer significant impact due to the merger. While SCWC's Metropolitan District rates presently are somewhat higher than those charged by Peerless, SCWC expects this difference in rates to be short-lived without the merger because of Peerless' needed infrastructure replacement and water quality improvements.

Peerless customers will also benefit from SCWC's ability to pump the full Peerless water rights from the Central Basin, whereas Peerless has been unable to operate several of its own wells due to the location of a plume of contaminants. At no time will SCWC request rates for current Peerless customers that are higher than those in effect at the same time for customers in its Metropolitan District.

SCWC believes the increases for the Peerless customers are justified because of the tangible and intangible benefits of the merger. While it is difficult to quantify the benefits of being part of a larger system, SCWC believes it is clear that there are such benefits. As a large publicly traded company, SCWC has access to more and lower cost financing, as evidenced by the different returns on rate base authorized by the Commission. This will benefit Peerless customers, not only on existing investments, but for all future capital projects as well. SCWC would anticipate replacing Peerless' purchase of high cost water from Park Water Company ($833/AF) with lower cost MWD purchases ($478/AF) at some point in the future. SCWC will provide more efficient operations and higher quality of service. By combining with SCWC, Peerless customers will enjoy the benefits of a staff of water quality experts, improved system pressure following the completion of the proposed capital improvement program, and a customer service center that operates twenty-four hours per day, seven days a week.

If Peerless remains a stand-alone water company, somehow makes the same improvements as SCWC proposes, and maintains its current rate of return on rate base, Peerless' rates will exceed the projected rate level of SCWC's ME-1 tariff in 2005, assuming ME-1 rates increase an average of 6.65% annually. Pursuant to the Settlement, SCWC will make these capital improvements at a savings to Peerless customers in comparison to what the cost would be if Peerless were to proceed on its own. Moreover, Peerless' stand-alone rates are projected to continue to be higher than SCWC's ME-1 rate into the future.

Lastly, the merger between SCWC and Peerless ensures that the current Peerless system is maintained under Commission regulation and oversight. Peerless' current customers will continue to be protected by Commission regulation from unjustified rate increases due to unnecessary capital investments or operating expenses.

SCWC also contends that its current SCWC customers will benefit from approval of the Settlement. There are approximately 98,000 customers in SCWC's Metropolitan District, so one might think the addition of 2,000 Peerless customers might have little impact. However, current SCWC customers will benefit by the acquisition of the water rights, and also in the future by the spreading of fixed costs of service over a larger customer base.

SCWC has also analyzed the tangible costs and savings of the merger under the terms of the settlement agreement. (Exh. 2-Tab J.) SCWC indicates those savings to SCWC customers which will result from the merger, those savings to Peerless customers which will result from the merger, and those costs which will be shared by both groups (that will be reflected in a Metropolitan District general rate case filed some time after the merger has been completed). This analysis is not intended to be a precise forecast of future water rates, but is an example to illustrate the relative impacts of the merger.

The tangible and identifiable benefits available due to the integration of Peerless into the Metropolitan District include:

1. Elimination of salary expense of $278,731.

2. Elimination of rent for office space of $10,000.

3. Elimination of expense for outside services and contract work of $19,065.

4. Reduced supply expense of $146,175.

5. Reduction in return on rate base and depreciation expense of $68,395. This saving is based on the lower CPUC-adopted depreciation accrual rate (2.89% vs. 3.09%) for SCWC.

6. Eliminate the cost for general liability insurance of $20,555. SCWC will add the Peerless system to its operations without any impact to SCWC's insurance expense.

7. Peerless will have a net shifting of cost recovery from SCWC's customers to Peerless customers for operation costs.

On the other hand, costs that Peerless customers will incur as a result of the integration of Peerless into SCWC's Metropolitan District include:

1. Zastrow consulting contract to pay a retainer for his services $115,000 per year, less dividends received from ASW stock (which actually are expected to exceed $115,000 each year). This cost is estimated at $0.

2. Lost water lease revenues of $86,800. Peerless currently leases out a portion of its water rights that it is unable to use for itself. SCWC will pump these rights in the future and therefore these revenues will be lost (but offset by the greater savings noted above).

3. Federal Income Tax of $9,058. Because of the small taxable income of Peerless, it is taxed at a 15% federal rate. When this system becomes a part of SCWC, the taxable income will be subject to the higher 35% federal rate. To value this cost, SCWC multiplied the 20% tax rate difference times the 1999 Commission-adopted Taxable Income for FIT ($45,290).

4. Premium paid over rate base of $441,414+$11,728+ $39,345. Because the purchase price to be recorded in rate base is at fair market value ($4,039,850 less goodwill of $190,607) while the Peerless rate base ($422,119) reflects original recorded costs, the premium paid ($3,427,124) will be reflected in SCWC's rate base. The return component reflecting a 12.88% before-tax RORB is $441,414; the annual amortization (40 years excluding non-depreciable water rights) is $11,728; and the property tax is $39,345.

SCWC identifies one other quantifiable cost of the merger, Zastrow's supplemental work agreement. In addition to his retainer, Zastrow will be compensated at the rate of $75/hour worked, plus his expenses, an amount which is currently unknown.

SCWC extended its analysis through the year 2025. SCWC applied a 3% inflation factor to most items. In general, SCWC contends the 25-year total net benefits are positive on both a nominal dollar ($13,589,833) and real dollar ($3,873,055) basis. In the first year, there is a net cost as a result of the merger, which is not passed on to ratepayers, but a net benefit in all subsequent years.

SCWC provides rate base calculations to show the impact of the merger. SCWC starts with the purchase price of $4,039,851, less goodwill of $190,607 ($3,849,244) and less the existing Peerless rate base ($422,119), to arrive at the premium paid ($3,427,125). SCWC amortized this premium (an intangible asset), less water rights ($2,958,000, a non-depreciable asset) over 40 years (Uniform System of Accounts treatment) to arrive at the net rate base addition ($3,421,261) in year 2001. This rate base addition resulting from the merger would be reflected in rates, through rate of return and depreciation, after the Commission resolves SCWC's post-merger general rate case.

SCWC made a second calculation for some of those necessary plant additions, as determined by SCWC engineers who inspected the Peerless system. The improvements for the first five years reflect the projects identified in the settlement agreement (line 32). SCWC reduced the additions to $195,500 per year thereafter to complete the remainder of the projects identified by SCWC engineers. Increasing the rates to existing Peerless customers by 10% each year from 2002 and 2005 will provide some of these funds. Depreciation expense was calculated using SCWC's adopted 2.89% accrual rate. SCWC contends these plant additions are necessary, and should be done regardless of whether Peerless remains a stand-alone utility or merges into SCWC.

Finally, if Peerless remained a stand-alone utility, it would require additional capital expenditures, such as upgrading their administrative office ($100,000); replacing two trucks, a backhoe, and an air compressor ($125,000); and replacing the computer system ($22,000). Such expenditures can be avoided by this merger.

SCWC plans to serve Peerless customers in its Central Basin East Office, located at 12013 E. Firestone Blvd. in Norwalk. The office is about seven miles from Peerless' existing administrative office and is accessible to Peerless customers for walk-in service. It can handle customer inquiries, complaints, and emergency calls both in person and, to the extent not handled by the centralized customer service center, by telephone. SCWC customer service representatives in this office will be capable of handling all customer inquiries during normal working hours, including requests for turn-on or shut-off, billing inquiries, collection activities, leak reports, meter reading, conservation and public relations, and other local matters. In addition, SCWC has customer service offices in Bell Gardens, Culver City and Carson that may be convenient for some customers to visit during their work day.