ARCHIVED -  Telecom Decision CRTC 93-18

Ottawa, 29 October 1993

Telecom Decision CRTC 93-18

AGT LIMITED - REVENUE REQUIREMENTS FOR 1993 AND 1994

Table of Contents

OVERVIEW

IINTRODUCTION

A.General Rate Increase Application
B.Public Hearing

IIACCESS TO AND QUALITY OF SERVICE

A.Subscribers' Ability to Pay Bills in Cash
B.Extended Flat Rate Calling

IIICONSTRUCTION PROGRAM

A.The 1993 CPR View
B. View-over-View Comparisons
C. Size and Scope of the Program
D.Construction of Facilities where Costs Exceed Revenue
E. Switch Items
F. Expansion Category Expenditures
G.Software and Data Processing Equipment Expenditures
H. Timing of Capital Expenditures
I. Outside Plant Items
J.Conclusions

IVINTERCORPORATE TRANSACTIONS - ISMA

A.Background
B.Issue of Affiliation
C.Payments to ISMA

VTREATMENT OF EARNINGS FROM DIRECTORY-RELATED ACTIVITIES

A.Background
B.Integrality of Directory-Related Activities
C.Integration Adjustment

VIACCOUNTING MATTERS

A.Shareholder Entitlement to Additional Tax Deductions
B.Amortization of Downsizing Costs
C.Loss on Sale of Computer Equipment
D.Individual Line Service Revenue

VIIOPERATING EXPENSES

A.Introduction
B.Workforce Reduction Program
C.Stentor Expenses
D.Depreciation
E.Conclusions

VIIIOPERATING REVENUES

A.Introduction
B.Elasticity
C.Market Share Loss
D.Customer Premises Equipment Business

IXFINANCIAL ISSUES

A.Introduction
B.Techniques for Estimating Cost of Equity
C.Risk and Capital Structure
D.Conclusions

XREGULATORY ADJUSTMENTS

XIREVENUE REQUIREMENT

A.Revenue Requirement Methodology
B.Revenue Requirements for 1993 and 1994

XIITARIFF REVISIONS

A.Network Exchange Services
B.Message Services
C.Terminal Equipment
D.Mobile Telephone Service
E.Other Matters
F.Disposition of Interim Tariffs
G.Filing of Tariffs

OVERVIEW

(Note: This overview is provided for the convenience of the reader and does not constitute part of the Decision. For details and reasons for the conclusions, the reader is referred to the various parts of the Decision.)

A. The Application and Hearing

On 16 April 1993, AGT filed an application for a general rate increase that it proposed be implemented in three stages, with the final increase to take effect on 1 January 1994.

AGT requested that the Commission set rates that would allow the company to achieve regulated returns on average common equity (ROEs) in the range of 12.25% to 13.25% for 1993 and 1994. AGT indicated that, to achieve ROEs in that range, it would require rate increases to generate additional revenues of $69 million in 1993 and $136 million in 1994.

A public hearing was held in Calgary, Alberta, from 9 August to 25 August 1993 before Commissioners Louis R. (Bud) Sherman (chairman of the hearing), Adrian Burns and Peter L. Senchuk.

B. Financial Issues

Taking into account, among other things, the fact that AGT's capital structure is more conservative than that of other Canadian telephone companies, the Commission concluded that AGT's ROE range for the test periods should be set at 11.25% to 12.25%. Further, it found that the company's proposal to gradually reduce its common equity ratio from the 60% level appears reasonable at this time.

C. Revenue Requirements

The Commission found that, in setting rates in 1993, it can legally allow the recovery of a revenue shortfall or the elimination of a surplus only for the period commencing on the date when existing rates were made interim, i.e., from 1 May 1993.

The Commission estimated that, after incorporating the various adjustments described in this Decision, and taking into account the interim rate increases made final by this Decision, AGT will earn a regulated ROE of about 11.6% for the 1993 calendar year.

In order to provide AGT with a regulated ROE of 11.75% (the midpoint of the approved range of 11.25% to 12.25%) in 1994, the Commission found that an additional revenue increase of approximately $16 million was required in that year.

D. Operating Expenses

The Commission reduced AGT's 1993 and 1994 operating expense forecasts by approximately $17.3 million and $27.5 million, respectively (see the table in Section E of Part VII).

E. Operating Revenues

The Commission increased AGT's revenue forecasts for 1993 and 1994 to reflect the company's overestimation of revenues lost as a result of its decision to exit the Customer Premises Equipment business. This was offset somewhat by a reduction in the revenue forecast to incorporate the Commission's estimates of AGT's long distance market share loss of 1.4% in 1993 and 12.1% in 1994.

F. Tariff Revisions

The Commission denied any further rate increases for residence or business exchange services over those given interim approval in Telecom Letter Decision CRTC 93-6, 28 April 1993.

Effective 1 January 1994, the Commission directed AGT to increase rates for Centrex Service by 10% and rates for Local Channels by 15%. The Commission also approved AGT's proposed restructuring of Select Route Service, and increases for directory assistance, certain terminal equipment, Rotary Hunt service, service charges and Mobile Telephone Service.

G. Other Matters

The Commission found AGT's 1993 View of the construction program reasonable, with the exception of expenditures related to adopting buried duct as a company standard, which the Commission found to require further justification.

The Commission did not consider ISM Information Systems Management Corporation to be an affiliate of AGT. A majority of the Commission likewise did not consider ISM Information Systems Management (Alberta) Corporation or the partnership known as ISM Information Systems Management (Alberta) to be affiliates of AGT.

The Commission denied AGT's request for a return on the shareholder entitlement associated with its Additional Tax Deductions commensurate with its rate of return on common equity; rather, the Commission approved a return commensurate with the company's long-term debt rate. The Commission determined that the distribution of the shareholder entitlement, including interest, should be limited to $30 million in 1994.

The Commission directed AGT to amortize its downsizing costs, as well as the loss associated with the sale of data processing equipment, over a period of five years.

The Commission also directed AGT to reduce the amortization period for the deferred revenue associated with Individual Line Service from twenty years to sixteen years.

I INTRODUCTION

A. General Rate Increase Application

On 16 April 1993, AGT Limited (AGT) filed an application for a general rate increase that it proposed be implemented in three stages. An initial interim increase of $64 million was proposed for 1 May 1993, with a second increase to take effect on a final basis 1 November 1993 and a further increase to take effect on a final basis on 1 January 1994. AGT also filed evidence with respect to its 1993 and 1994 revenue requirements.

On 28 April 1993, the Commission issued Applications for Interim Rate Increases, Interim Rates and for Use of the Rate Stabilization Reserve, Telecom Letter Decision CRTC 93-6 (Letter Decision 93-6), approving, among other things, an interim rate increase amounting to $32 million, over the period 1 May 1993 to 31 December 1993. The Commission also made interim all other rates approved prior to 1 May 1993, effective that date. The Commission stated that all interim rates were subject to final approval, following a full public proceeding and a complete examination of all issues.

In Letter Decision 93-6, the Commission invited parties to comment, at the time final argument was made in the proceeding to consider the general rate increase application, on whether the Commission can determine AGT's 1993 revenue requirement over the entire year.

On 23 July 1993, the Commission issued AGT - Issues Related to Income Taxes, Telecom Decision CRTC 93-9 (Decision 93-9). In Decision 93-9, the Commission considered that AGT's shareholder, TELUS Corporation (TELUS), was entitled to a certain portion of the Additional Tax Deductions (ATDs) flowing from the privatization of the predecessor telephone company of AGT. AGT was also directed to use an amount of the ATDs for revenue requirement purposes that is consistent with its tax returns filed or to be filed. Consequently, as a result of Decision 93-9, the Commission determined that several revisions were required to the evidence filed by AGT with respect to its 16 April 1993 application for general rate increases. Accordingly, by letter dated 23 July 1993, the Commission directed AGT to update its evidence and addressed supplementary interrogatories to the company. On 9 August 1993, the first day of the public hearing, AGT filed the requested information and responses to interrogatories.

In Decision 93-9, the Commission also concluded that it would not be appropriate to make a determination at that time with regard to two legal issues related to shareholder entitlement. The Commission stated that these issues were, for the most part, similar to the issue identified in Letter Decision 93-6 (i.e., the question of whether the Commission can determine AGT's 1993 revenue requirement over the entire year), and that they would be considered in the context of AGT's application for a general rate increase. Accordingly, the Commission placed the relevant portion of the record of the proceeding leading to Decision 93-9 on the record of the general rate increase proceeding and stated that parties would be given an opportunity to address these issues in argument.

B. Public Hearing

A public hearing was held in Calgary, Alberta, from 9 August to 25 August 1993 before Commissioners Louis R. (Bud) Sherman (chairman of the hearing), Adrian Burns and Peter L. Senchuk.

The hearing was conducted in two phases. The first phase provided interested parties with an opportunity to make submissions in an informal setting. The second and formal phase of the hearing involved the presentation of evidence, cross-examination on that evidence, and argument.

The following interveners appeared or were represented during the formal phase of the public hearing: Alberta Consumers' Coalition (ACC), Canadian Association of Petroleum Producers (CAPP), City of Calgary (Calgary) and Unitel Communications Inc. (Unitel).

II ACCESS TO AND QUALITY OF SERVICE

A. Subscribers' Ability to Pay Bills in Cash

During 1993, AGT exited the terminal equipment market and closed its phonecentres. With the closure of the phonecentres, subscribers are effectively unable to pay their bills in cash. Instead of 84 phonecentres, AGT now operates 116 pick-up centres where subscribers can deposit their payments. AGT stated that about 14% of subscribers paid their bills at phonecentres.

ACC argued that subscribers should be able to pay bills in cash in order to avoid postal fees and bank service charges. ACC also noted that the drop-off boxes do not help subscribers who do not have active chequing accounts or who may otherwise be unable to write a cheque.

AGT argued that subscribers would not be inconvenienced by the inability to pay bills in cash, since some banks provide for bill payment at reduced service charges for senior citizens and some bank accounts provide for free chequing.

In Bell Canada _ Review of Revenue Requirements for the Years 1985, 1986 and 1987, Telecom Decision CRTC 86-17, 14 October 1986 (Decision 86-17), the Commission expressed the view that the provision of teller payment facilities is part of basic telephone service. The Commission stated that it would expect Bell Canada (Bell) to continue to provide teller payment facilities at its public offices. In British Columbia Telephone Company _ Revenue Requirement for the Years 1988 and 1989 and Revised Criteria for Extended Area Service, Telecom Decision CRTC 88-21, 19 December 1988, the Commission stated that it considered that cash payment service should be provided as part of basic services wherever it is reasonable to do so.

Consistent with the above-noted Decisions, the Commission expects AGT to continue to operate pick-up centres and to permit its subscribers to pay their bills in cash at the company's public offices wherever it is reasonable to do so.

B. Extended Flat Rate Calling

Subject to the meeting of other criteria, Extended Flat Rate Calling (EFRC) is provided between communities not more than 65 kilometres apart. If the provision of an EFRC route would result in an increase in residence service rates equal to or exceeding $1.00 per month, subscribers must approve the new route by majority vote. AGT provides for the review of an existing EFRC route upon the request of an elected community official, such as a mayor, or other recognized community representative.

Unitel stated that subscribers should have the opportunity to review EFRC routes if the monthly increase resulting from this proceeding is more than a dollar.

ACC argued that compulsory EFRC charges can pose a hardship to low income subscribers, who may have voted against an EFRC route but who must nevertheless pay the EFRC charges. ACC argued, among other things, that it should be easier to review an existing EFRC route, and that a new ballot should be held if requested by at least 25 subscribers.

CAPP observed that reductions in toll rates, the introduction of toll discount plans, and the possibility of toll competition have reduced the need for EFRC. CAPP also argued that, given the significant monthly cost of EFRC charges, individual subscribers should have the ability to opt out of EFRC.

The Commission notes that EFRC targets the same market demand as the Extended Area Service (EAS) provided by Bell and BC TEL, and that neither Bell nor BC TEL subscribers can opt out of EAS. Further, as is the case with new EAS links in Bell and BC TEL territories, a new EFRC route must be accepted by a majority of subscribers prior to introduction. In addition, AGT's tariffs do make provision for the review of an EFRC route, a mechanism not available to subscribers elsewhere in the country. Accordingly, the Commission does not consider it appropriate that individual subscribers have the ability to opt out of EFRC routes.

In AGT Limited - Interconnection of Interexchange Carriers and Related Resale and Sharing Issues, Telecom Decision CRTC 93-17, 29 October 1993 (Decision 93-17), the Commission approved the interconnection of interexchange carriers (IXCs) to AGT's network and the resale and sharing of AGT's telecommunications services, under the general terms and conditions established in Competition in the Provision of Public Long Distance Voice Telephone Services and Related Resale and Sharing Issues, Telecom Decision CRTC 92-12, 12 June 1992 (Decision 92-12). With the introduction of toll competition, and the increase in alternative service options available to subscribers, the Commission considers it appropriate that AGT examine the pre-conditions for a review of existing EFRC routes with a view to determining whether they offer sufficient flexibility to subscribers. The company is to advise the Commission of its views on the matter, once that process is completed.

III CONSTRUCTION PROGRAM

A. The 1993 CPR View

AGT filed its proposed construction program (the 1993 CPR View) on 16 April 1993. AGT projected expenditures of $1.75 billion for the five years 1993 to 1997, inclusive, down from the $1.83 billion projected for the five years of the 1992 CPR View. The following table summarizes these expenditures (in millions of dollars) by category.

Year 1993 1994 1995 1996 1997

Usage Category

Sustaining (25.5%) 84.8 87.6 91.2 88.8 92.1

Expansion (60.8%) 174.5 196.0 228.5 229.3 230.8

Other Initiatives 88.2 55.8 32.8 34.5 28.4
(13.7%)

Total (100%) 347.5 339.4 352.5 352.6 351.3


Note: Percentages are compiled from five-year totals for each category.

The Sustaining category provides for the maintenance of existing levels of service, while the Expansion category is designed to meet increased customer demand. The Other Initiatives category provides for longer-term improvement of service or addition of value to customers.

B. View-over-View Comparisons

AGT expects Network Access Lines (NALs) to increase from 1.2 million in 1992 to 1.4 million in 1997, and Long Distance Messages (LDMs) to increase from 339 million to 451 million over the same period.

AGT's combined demand forecasts for 1993 and 1994 were significantly lower in the 1993 CPR View than in the 1992 CPR View (the decreases were 14% for NAL Net Gain and 43% for LDM Increase). Changes in expenditures amounted to a 6% decrease overall.

The total expenditures for the 1993 CPR View, for the common years 1993 to 1996, were $83.5 million lower than in the 1992 CPR View. AGT stated that the difference stems principally from reductions in the Expansion category.

C. Size and Scope of the Program

ACC, Calgary and CAPP found the projected construction expenditures excessive. Calgary noted that the forecast 1993 to 1997 expenditures amount to $1.7 billion, compared to AGT's 1992 net plant in service of $2.5 billion. Calgary estimated that, for 1993, the proposed expenditures of $347 million would increase the revenue requirement by approximately $49 million, offset by a revenue increase over 1992 of only $24 million, yielding a net cost to subscribers of $25 million. Calgary submitted that the company's spending was "out of control" and suggested that the total budget be cut by at least $50 million in each of 1993 and 1994.

ACC, Calgary and CAPP submitted that the company has substantially completed a highly modern and efficient platform and has not provided compelling reasons for continuing expenditures at the projected levels; further, if the plan as a whole implies significant rate increases, the cost to subscribers may well warrant reducing the capital budget.

Calgary and CAPP noted that AGT had presumed no toll competition in preparing the construction program. Calgary was concerned that AGT could be forecasting capital expenditures for 1993 and 1994 that would not be required in the long-run due to competition in long distance.

CAPP questioned the validity of AGT's marketing forecast, which it considered lacked economic justification.

AGT argued, among other things, that submissions that the construction program be cut by some arbitrary number are untenable. AGT reiterated that toll competition will have minimal impact on 1993 capital expenditures and that its long-term effects cannot yet be determined. AGT maintained that its capital spending control mechanisms are effective and appropriate.

AGT countered ACC's suggestions of "unnecessary modernization" by pointing to its wide range of basic service capabilities, such as standard touch tone. AGT also submitted that, as many of the new services are optional, it is improper to suggest, as ACC had done, that customers are captive. AGT further pointed out that modernization expenditures will provide universal benefits, such as province-wide access to emergency services and universal call trace.

AGT noted ACC's statement that it was addressing expenditures in the years 1993 and 1994. AGT submitted that this approach was in error, arguing that this CPR is for 1993, and that interested parties will have an opportunity to address other concerns in the 1994 CPR.

The Commission notes that, while it is true that 1994 capital expenditures will be re-examined in the 1994 CPR, its practice is to focus its attention equally on the first two years of the capital plan.

The Commission is of the view that Calgary, ACC, and CAPP have failed to justify their suggestions to reduce the 1993 and 1994 capital spending plan, and accordingly finds that adjustments are not required. The Commission finds Calgary's proposed reduction of $50 million arbitrary and the supporting calculations and arguments somewhat simplistic. The difference in revenues from 1992 to 1993 incorporates a number of changes due to such factors as rate changes and loss of market share; thus, that difference cannot be attributed solely to new construction. Also, Calgary failed to recognize operating expense savings flowing from technological improvements.

The Commission agrees with AGT that no project or anticipated demand was identified by Calgary or CAPP as inappropriate, and notes that a View-over-View comparison for each of the four common years indicates that expenditures will decrease by an average of 5.5% annually. The Commission has applied its usual tests in its assessment of the 1993 and 1994 expenditures and finds that the trends for local and toll growth demand-ratios are decreasing and facilities utilization is satisfactory; each new service has been economically justified; and the View-over-View, year-over-year, and actual-versus-forecast differences have been adequately explained by the company.

The Commission is concerned that, in some cases, economic studies for Other Initiatives appear to have been done after the plan was put together. Economic studies justifying such initiatives assist the Commission in an assessment of the reasonableness of the construction program, but are also intended as an input to the company's capital planning process. The Commission expects Other Initiatives to be justified prior to their inclusion in the plan and notes that the company has acknowledged this.

The Commission accepts the demand forecast for the purpose of assessing the CPR, but expects the company to amend its construction program in a timely manner in response to any significant changes. The Commission accepts AGT's statement that toll competition will have minimal impact on the CPR in 1993 and that the long-term effects cannot yet be precisely determined. However, the Commission expects AGT to respond quickly to Decision 93-17, permitting interexhange competition in its operating territory, and to include its impact in the 1994 CPR View.

D. Construction of Facilities where Costs Exceed Revenues

Calgary pointed out that AGT is modernizing switches in smaller rural areas, as well as in larger communities, on the premise that customers should enjoy the same level and quality of service throughout the province. Calgary maintained that AGT anticipates local service competition in the future and that it is inappropriate for the company to provide services in areas where the associated revenues clearly do not recover the costs.

The Commission has received demands in the past from smaller communities for modernization and has promoted upgrading service in these areas on the grounds of equity. Some specialized services (Datapac, for example) have been introduced with different access arrangements and costs in different geographical areas. While the Commission recognizes that technological development may lead to more local competition in the future, its nature and scope are as yet unclear. The Commission is of the view that, at present, features associated with basic service should be as broadly available as possible.

E. Switch Items

Calgary stated that substantially all of AGT's switches are DMS units and that almost 100% of switch purchases in the last two years have been from Northern Telecom Limited (NTL). Calgary expressed concern that AGT has locked itself into one supplier and is not taking steps to ensure that it receives the most favourable prices.

AGT replied that, by virtue of its supply agreement with NTL, it has been able to secure continuity of supply and reasonable prices. As well, continuing support for the GTD-5 technology has allowed it to defer replacement of the latter switches. AGT also noted that utilizing two suppliers has limited certain service availability due to platform incompatibility. AGT pointed out that it employs competitive tendering for other portions of the network.

The Commission notes that the major concerns with purchasing policy have arisen where the purchaser is affiliated with the supplier, and that most Canadian telephone companies have met almost all of their switching requirements in recent years using NTL equipment. Further, in this instance, there is no evidence that subscribers are paying inflated rates because the prices paid for switching equipment are too high.

Calgary questioned AGT's plan to replace 14 remote switches in 1993 and 1994. AGT stated that it must replace certain remote units that are not compatible with host switches being introduced to accommodate growth. AGT submitted that Calgary's concern stems from the company's failure to indicate the anticipated replacement dates for the host switches. The company stated that it would be prepared to file the relevant host replacement dates with the Commission.

The Commission recognizes that incompatibility would compel replacement of associated remote units. However, the Commission notes that there is a gap in the information filed by AGT. Accordingly, the Commission directs the company to file with the Commission and serve on interested parties, by 28 November 1993, the host replacement dates, indicating the affected remotes.

F. Expansion Category Expenditures

Calgary was concerned with the limited amount of information provided by AGT to support its construction program, particularly for expenditures in the Expansion category, which amount to approximately one-half of the total. Calgary noted that the Expansion category contains expenditures to meet growth in access lines and toll services, as well as those needed to provide a service on a province-wide basis once it has become a standard offering. Calgary submitted that combining such expenditures does not provide meaningful information and does not allow a proper assessment of their prudence. Calgary submitted that, in the future, AGT should be directed to provide expenditures required for growth separately from those related to new services.

The Commission understands that, prior to their introduction, new services are included in the Other Initiatives category. Once those services have been found reasonable on the basis of economic studies and have received tariff approval as standard offerings, expenditures for their roll-out are included in the Expansion category. The Commission does not consider it necessary to track separately expenditures to provide ongoing service once the related program has been found reasonable in the CPR and the service itself has received tariff approval. Accordingly, the Commission will not require AGT to break out separately the expenditures noted by Calgary.

G. Software and Data Processing Equipment Expenditures

Calgary was concerned with the magnitude of AGT's forecast expenditures on data processing equipment and administrative software in 1993 and 1994.

AGT stated that these expenditures cover its internal voice and data network and include PCs, LANs, facsimile and video conference equipment, as well as capitalized software of $25 million in each year. AGT noted that, in the 1993 CPR, unlike the 1992 CPR, activities requiring mainframe computers have been outsourced and administrative software is capitalized. AGT stated that downsizing its workforce by some two thousand employees has forced it to improve its information systems dramatically.

The Commission finds AGT's explanation for these expenditures adequate.

H. Timing of Capital Expenditures

ACC suggested that AGT may be introducing too many costly new programs and services in 1993 and 1994 to increase its depreciation and interest expense so as to justify a rate increase.

AGT Exhibit 40 indicated that, for certain identified elements in the new services program, expenditures will reduce net revenues by $7.2 million for 1993 and by $33.9 million for 1994.

The capital expenditures for 1992, 1993 and 1994 for new services are $40.1, $62.3, and $33.0 million, respectively. If the costs of Talkmail are removed, the 1993 expenditure is in the range of the 1992 and 1994 figures. Talkmail is projected to be a very profitable service with a short payback period. Accordingly, the Commission is of the view that there is no evidence to support ACC's contention.

I. Outside Plant Items

CAPP noted AGT's projected $29.7 million capital expenditure and $4.4 million expense to implement an Outside Plant Records System. CAPP noted AGT's acknowledgement that it might be possible to work with other Alberta utility companies in developing such a system. CAPP submitted that AGT should be required to investigate such possibilities before making potentially unnecessary expenditures.

AGT noted that its records system is specifically designed for a telecommunications network and that the costs are due mainly to conversion of records. Further, the system itself will cost only $7.5 million and therefore no significant savings would be achieved by requiring the company to investigate other possibilities.

The Commission accepts AGT's evidence to support the installation of the Outside Plant Records System and, accordingly, will not require the company to investigate other systems.

CAPP submitted that AGT plans to install fibre to residences to position itself for competition stemming from the convergence of cable and telephony. CAPP pointed out that AGT does not know the percentage of residential subscribers requesting service above copper's transmission limitation. CAPP submitted that the fibre expenditures should be removed from the construction program.

AGT stated that its evidence clearly justifies the placement of fibre facilities on the basis of economics, and that the CPR process ensures that no unnecessary fibre programs can be introduced. AGT submitted that CAPP's apparent focus on convergence as a driver of the company's capital program is unfounded.

The Commission remains satisfied that the company only places fibre when it is economically justified.

AGT's capital plan included expenditures for the trial and roll-out of buried duct in the distribution and drop portion of the network. CAPP noted that AGT's current standard for new provisioning or rebuilds is to direct-bury a six pair cable, while the older standard was to direct-bury two pair cable that can be expanded to the equivalent of four pair with a carrier system. AGT stated that (1) it is not able to determine the number or percentage of current residential customers requiring more than four lines into their homes, (2) it is not able to determine the number or percentage of residential customers requiring retrenching for repairs, (3) it has no idea of damage that will be avoided by the extra duct protection, and (4) it has no idea of the annual savings with the new buried duct standard.

CAPP noted AGT's acknowledgement that one of the reasons for the buried duct was to prepare for convergence. CAPP submitted that these expenses should be removed from the construction program until properly substantiated.

The Commission directs AGT to report on the results of the buried duct trial in the distribution and drop portion of the network and to provide a rationale for the introduction of buried duct before adopting it as a company standard.

J. Conclusions

The Commission finds AGT's 1993 View of the construction program reasonable, with the exception of expenditures related to adopting buried duct as a company standard. As noted above, these expenditures require further justification.

IV INTERCORPORATE TRANSACTIONS - ISMA

A. Background

On 23 April 1992, TELUS, IBM Canada Limited (IBM), and ISM Information Systems Management Corporation (ISMC), a subsidiary of IBM, agreed in principle to establish an entity to provide systems management services to companies operating in Alberta.

On 14 December 1992, TELUS Information Services Inc. (TELUS Holdings), a wholly-owned subsidiary of TELUS, ISMC and ISM Information Systems Management (Alberta) Corporation (ISMA) formed the partnership known as ISM Information Systems Management (Alberta) (the Partnership).

AGT signed the Systems Management Services Agreement (the SMS Agreement) with ISMC on 14 December 1992. ISMC, in turn, subcontracted the services required under this contract to the Partnership, via the Systems Management Services Subcontract (the Subcontract). The services provided under these agreements include central site and distributed systems operations services, distributed computer services and service capacity planning.

B. Issue of Affiliation

In Decision 86-17, the Commission determined that a 25% contribution should be calculated on an imputed cost, comprising the aggregate of the annual salary and labour-related costs of each employee temporarily transferred from Bell to its affiliate, Bell Canada International. The Commission adjusted Bell's revenue requirements for 1985, 1986 and 1987 to reflect this determination.

During its examination of AGT, the Commission pursued the issue of whether similar compensation would be appropriate with respect to the permanent transfer of 151 AGT employees to ISMA. AGT replied that such compensation would be inappropriate because, among other reasons, it did not consider ISMA an affiliate. The company based its position on, among other things, its view that TELUS did not control ISMA.

In view of the company's response, the Commission requested, in interrogatory AGT(CRTC)17Aug93-4401, that the company provide all relevant agreements detailing the exercise of control over ISMA. The Commission also sought information regarding the conduct and management of the Partnership.

In its response to that interrogatory, AGT submitted, in confidence, a copy of the Unanimous Shareholder Agreement and the Unanimous Shareholder Amending Agreement between TELUS Holdings, ISMC and ISMA, and the Articles of Incorporation and By-Law No. 1 for ISMA. The documents in question deal with matters such as the composition of the board of directors of ISMA, the nomination and removal of directors, votes required for a board resolution and for an extraordinary board resolution, the appointment of officers, the transfer of shares and the winding-up of the corporation.

In final argument, AGT maintained that ISMC, ISMA and the Partnership are not affiliates of AGT, since (1) TELUS has no ownership interest in ISMC, (2) TELUS does not control either ISMA or the Partnership, either in fact or in law, and (3) TELUS does not have control over the day-to-day operations of ISMA, which would be a requirement for a finding of control in fact.

In determining whether ISMC, ISMA or the Partnership are affiliates of AGT, the Commission has applied the following widely used definition of the term affiliate:

any person that controls or is controlled by the company or is controlled by the same person that controls the company.

The record of the proceeding reveals that TELUS has no ownership interest in ISMC. The Commission finds, for the purposes of determining whether or not ISMC is an affiliate of AGT, that TELUS clearly does not have control over ISMC. Accordingly, the Commission does not consider that ISMC is an affiliate of AGT.

TELUS Holdings and ISMC each hold an equal number of the common shares of ISMA. They also each own 49.5% of the Partnership. A majority of the Commission is not persuaded on the basis of the documents filed in response to interrogatory AGT(CRTC)17Aug93-4401 that TELUS has control over ISMA or the Partnership. Accordingly, a majority of the Commission does not consider that ISMA and the Partnership are affiliates of AGT. Commission Vice-Chairman Sherman, chairman of the hearing, dissents from this view.

During the hearing, the question of the integrality of ISMA's operations was also raised. Given its determination that ISMC is not an affiliate of AGT, and its majority determination that ISMA and the Partnership are not affiliates of AGT, the Commission does not consider it necessary to rule with respect to either the issue of compensation for transferred employees or the issue of integrality.

C. Payments to ISMA

Under the terms of the SMS Agreement and the related Subcontract, AGT estimates payments to ISMC of $37 million in 1993 and $41 million in 1994. In support of the reasonableness of the prices paid under the SMS Agreement, AGT essentially relied on the cost/benefit analysis filed in response to interrogatory AGT(CRTC)15Mar93-429 and updated in AGT Exhibit 7.

Calgary noted that AGT is forecasting total payments to ISMA of $212 million over the period 1993 to 1997, while the net benefit to the company over this period amounts to only $8.4 million. Calgary stated that it had serious concerns about the actual benefits forecast to be realized by AGT, compared with the total costs of outsourcing.

Calgary disputed many of the assumptions made in AGT's cost/benefit analysis. It noted that AGT's actual operational software expenses were $5.4 million in 1990, $4.0 million in 1991 and $3.8 million in 1992. Calgary argued that AGT did not rovide sufficient explanation for forecast savings of $5.4 million in 1993 and $6.4 million in 1994.

Similarly, Calgary noted that actual hardware maintenance costs were $2.6 million in 1990, $2.9 million in 1991 and $3.3 million in 1992. Calgary maintained that AGT did not provide sufficient explanation for forecast savings of $4.0 million in 1993 and $4.1 million in 1994.

Calgary also had concerns regarding AGT's forecast savings in depreciation expense of $10.9 million in 1993 and $11.5 million in 1994. Calgary stated that it was hampered by claims of confidentiality, but noted, along with Unitel, that AGT did not obtain direct quotes from competitive suppliers to support its forecast savings in depreciation expense.

Calgary submitted that the costs associated with the ISMA contract should be reduced in each of 1993 and 1994 to ensure, among other things, that the outsourcing of data processing results in a benefit to subscribers.

In its analysis of the reasonableness of AGT's payments pursuant to the SMS Agreement, the Commission has examined the historical costs of data processing within AGT, which are accounted for as IS & Systems Planning expense. The Commission notes that actual IS & Systems Planning expenses were $45.7 million in 1990, $40.5 million in 1991 and $37.4 million in 1992, i.e., data processing costs have been declining steadily. AGT has forecasted IS & Systems Planning expenses to be $47.3 million in 1993 and $50.0 million in 1994.

Depreciation expense is implicitly included in the 1993 and 1994 SMS Agreement costs accounted for in AGT's books as IS & Systems Planning expense. However, depreciation expense is not included in the 1990 to 1992 figures. Therefore, in comparing historical costs with the expenses forecasted for 1993 and 1994, depreciation expense must be added to the 1990 to 1992 figures. Attachment 3 to response to interrogatory AGT(CRTC)31May93-1411, filed in confidence, provides the relevant depreciation expense for 1992. On the basis of a comparison of the adjusted 1992 IS & Systems Planning expense and the expense forecast for 1993, the Commission concludes that the forecast payments to ISMA under the SMS Agreement are reasonable in 1993.

However, despite the trend of either declining or stable data processing expenses during the period of 1990 to 1993, which includes one year of the SMS Agreement, AGT has forecasted an increase in its payments to ISMA of $4 million, or 10.8%, in 1994. ISMA payments are estimated to increase by only 4.9% in 1995, 3.5% in 1996 and 4.5% in 1997.

In the Commission's view, based on both the historical trend and on the growth forecasted by AGT for the period of 1995 to 1997, a growth rate of 10.8% in 1994 has not been substantiated. In the Commission's view, a growth rate of 5.0% would be more appropriate. Accordingly, the Commission has reduced AGT's expense forecast in 1994 by $2 million.

The Commission notes in this regard that, after making adjustments to take into account the operational software expenses and hardware costs noted by Calgary, as well as salary expenses related to downsizing costs, AGT's own cost/benefit analysis would show that outsourcing these activities will result in a net cost to AGT of approximately $2 million in 1994.

V TREATMENT OF EARNINGS FROM DIRECTORY-RELATED ACTIVITIES

A. Background

Prior to 4 October 1990, all directory operations were performed by the Alberta Government Telephones Commission (AGT Commission). After the privatization and reorganization of the AGT Commission, several companies were created as wholly-owned subsidiaries of TELUS, including AGT, AGT Directory Limited (AGT Directory) and 423337 Alberta Limited (the License Company).

Through a series of agreements, the License Company holds an exclusive license from AGT to use the database from which telephone directories are produced. AGT Directory holds a non-exclusive sub-license from the License Company to use the database for the purposes of producing and marketing directories and directory information.

In a number of proceedings, the Commission has determined, based on the facts before it, that the directory-related activities of a telephone company affiliate are integral to the telephone company's business. The Commission's practice has been to treat income from those activities as income of the telephone company for the purpose of determining its revenue requirements.

B. Integrality of Directory-Related Activities

During the proceeding leading to AGT Limited - Revenue Requirement for 1992, Telecom Decision CRTC 92-9, 26 May 1992 (Decision 92-9), the Commission issued a ruling (the 19 February 1992 Ruling) regarding the integrality of the operations of AGT Directory and the License Company. In its 19 February 1992 Ruling, the Commission made the following determinations:

(1)the Commission has jurisdiction to determine that certain activities of AGT's affiliates are "integral", and to treat the income associated with those activities as the income of AGT for the purpose of determining AGT's revenue requirement in order to ensure that the company's rates are just and reasonable; and

(2)the activities of the License Company and the activities of AGT Directory, except those unrelated to directories with respect to AGT's operating territory and associated databases, are "integral", and accordingly the Commission will treat the associated income as income of AGT for the purpose of determining its revenue requirement.

Section 33 of the new Telecommunications Act sets out the Commission's authority to treat the income of an affiliate of a carrier as if it were the income of the carrier. Section 33 states as follows:

33. Where a Canadian carrier provides a basic telecommunications service and, in the opinion of the Commission,

(a) an activity of an affiliate of the carrier is integral to the provision of the service by the carrier, and

(b) the Commission's other powers under this Act are not sufficient for the purpose of ensuring that the rates charged by the carrier for telecommunications services are just and reasonable, the Commission may, for that purpose, treat some or all of the earnings of the affiliate from the activity as if they were earnings of the carrier.

With regard to whether AGT Directory's activities are integral to the provision by AGT of basic service, the Commission notes the following findings pertaining to AGT Directory set out in its Ruling of 19 February 1992: (1) AGT's approved tariffs include the requirement to provide telephone subscribers, as part of basic service, with directory listings and with white and yellow page telephone directories; (2) the provision of directories, including the directory listings and advertisements, to AGT subscribers significantly enhances the value of AGT's telephone service, in particular, by facilitating the use of the telephone network by AGT subscribers; and (3) if AGT Directory did not produce, publish, and distribute directories relating to AGT's operating territory, AGT would have to do so itself or otherwise arrange for it to be done.

During examination, Mr. J.M. Drinkwater, AGT's Assistant Vice-President and Treasurer, stated that he was not aware of any significant changes in the operations of AGT Directory and the License Company since the 19 February 1992 Ruling.

The Commission considers that the production, publishing and distribution of directories, including directory listings and advertisements, to AGT subscribers is integral to the provision of basic service, since the provision of directories forms an essential part of, and significantly enhances the value of, the company's basic telephone service. As set out below, the Commission's conclusion that the publishing of directories is integral applies equally to the Canadian Yellow Pages (CANYPS) Publishing activity.

The Commission is of the view that it is required to rely on its express power under section 33 of the Telecommunications Act in circumstances where it considers it necessary to treat the income of an affiliate as if it were the income of the carrier in order to ensure that the carrier's rates are just and reasonable.

The Commission considers it necessary to include the earnings from AGT Directory's production, publishing and distribution of directories to AGT subscribers in order to ensure that AGT's rates for telecommunications services are just and reasonable. Accordingly, the Commission has treated those earnings of AGT Directory as if they were earnings of AGT for the purpose of determining the company's revenue requirements for 1993 and 1994.

Consistent with its ruling of 19 February 1992, the Commission is of the view that the activities of the License Company are integral to the provision by AGT of basic telecommunications service. Were it not for the License Company's activity, AGT Directory could not produce and publish the directories that are required to be distributed in AGT's operating territory. However, the earnings from this activity are not material and the Commission does not consider it necessary to treat those earnings as the earnings of AGT in order to ensure that rates are just and reasonable.

In its 19 February 1992 Ruling, the Commission ordered AGT to seek to obtain from its affiliates, among other things, an estimate of the revenues and expenses associated with each activity performed by AGT Directory considered by the company to be non-integral to the operations of AGT. In Decision 92-9, the Commission noted that the company was unable to provide an estimate of the expenses associated with any of the activities deemed by the company to be non-integral and stated that this issue, as well as the determination of which activities are, in fact, unrelated to directories for AGT's operating territory and associated databases would be dealt with in a future proceeding.

In response to interrogatory AGT(CRTC)15Mar93-434, the company stated that it considered the following seven activities performed by AGT Directory to be unrelated to directories for AGT's operating territory or to associated databases:

(1)Sales of foreign directories (purchase of foreign directories for resale);

(2)CANYPS Selling (selling of services related to the placement of advertising in foreign directories);

(3)CANYPS Publishing (publishing of advertising in AGT Directory's directories received from customers outside of Alberta);

(4)Marketing Services - Non-Alberta Customers (provision of facilities to process marketing lists for Manitoba Telephone System and DirectWest for a fee);

(5)Marketing Services - Alberta Customers (selling of consumer lists, business lists and list processing services);

(6)Niche Directories (provision of information services to specialized niche markets); and

(7)Consulting Services (provision of employee expertise to other publishing companies).

AGT stated that none of the above activities (except for Marketing Services - Alberta customers) require interaction with or information from AGT in order for AGT Directory to carry them out. AGT stated that it does not have any obligation to ensure that such services are made available to telephone users and that there would be no material impact on the perceived value of telephone service offered by AGT to its customers were these services not to be provided at all. AGT stated that virtually the same observations can be made with respect to Marketing Services - Alberta customers, except that customer lists associated with the provision of these services require some information from AGT.

The Commission has reviewed the seven activities described above, and concludes that the CANYPS Publishing activity is integral to the provision of basic telephone service provided by AGT. In this respect, the Commission notes that the advertising in question is published in the same directories, provided to AGT subscribers, that are discussed above.

Furthermore, the Commission is of the opinion that, in order to ensure that AGT's rates are just and reasonable, it is necessary to treat the income of the CANYPS Publishing activity as if it were the income of AGT.

Accordingly, the Commission has included earnings from CANYPS Publishing activities in its determination of AGT's revenue requirements.

The Commission does not consider it necessary to determine, at this time, whether or not the remaining six activities listed above are integral to the provision of basic telecommunications service by AGT, since the income attributable to those activities is not material. Accordingly, that income has not been included in the determination of AGT's revenue requirements for 1993 and 1994.

C. Integration Adjustment

1. Background

In response to interrogatory AGT(CRTC)15Mar93-432, AGT provided its views regarding the appropriate regulatory adjustment resulting from the Commission's 19 February 1992 Ruling. AGT stated that, if it is ultimately determined that the Commission has the statutory authority to deem the operations of AGT Directory integral to the operations of AGT, it would also be necessary for the company to "integrate" the operations of the two entities, for regulatory purposes, to represent the conditions that would exist if AGT Directory were actually integrated with the operations of AGT. The company submitted that such an integration would alter such things as the capital structure, income tax expense and net income of AGT Directory, and would affect the rate of depletion of the ATDs available to AGT, thereby advancing AGT's income tax expense in subsequent years. This integration adjustment would result in AGT Directory having the same financial characteristics as AGT. In response to interrogatory AGT(CRTC)15Mar93-436, AGT estimated that its proposal would reduce its revenue requirement by $0.4 million in 1993 and $1.1 million in 1994.

In response to interrogatory AGT(CRTC)15Mar93-438, the company stated that its proposal does not apply to the License Company, since the amount of income to be deemed would be immaterial.

In interrogatory AGT(CRTC)31May93-1417, the company was asked to provide integrated financial statements for AGT and AGT Directory, assuming no adjustments to the capital structure of AGT Directory, and, in general, simply to add the financial results of the two companies.

2. General Method

During examination, Mr. Drinkwater also agreed that the assets used in the operations of AGT Directory were very small relative to those of AGT. Mr. Drinkwater also stated that, if the operations of AGT Directory were included within AGT, it would not make a difference in terms of the capital structure that the company would choose to employ for the entity.

The Commission notes that AGT's proposed approach is different from the Commission's current regulatory treatment, which is to deem income from directory-related activities to be income of AGT for the purposes of calculating the telephone company's revenue requirement. In the Commission's view, the purpose of the regulatory adjustment is to attempt to emulate the financial results that would arise if the operations of AGT Directory were carried on within AGT.

The Commission considers that the proposal enunciated in responses to interrogatories AGT(CRTC)15Mar93-432 and 436 would distort the financial results that would exist if the two operations were carried on within the same entity and would add unnecessary complication to the regulatory adjustment. In the Commission's view, the general approach outlined in interrogatory AGT(CRTC)31May93-1417 would better emulate the conditions that would exist if the operations of AGT Directory were included within AGT and would result in a capital structure for the combined entity that would not be significantly different from the capital structure of AGT.

3. Availability of ATDs

Mr. Drinkwater agreed that, if the operations of AGT Directory were carried on within AGT, income from these directory operations could be sheltered, if necessary, through the utilization of some of the ATDs available to AGT. The Commission considers that, in order to properly emulate the conditions that would exist if the two operations were integrated, some of the ATDs available to AGT should be used for regulatory purposes, if necessary, to shelter deemed income from AGT Directory.

Mr. Drinkwater also agreed that, if the operations of AGT Directory were carried on within AGT, the ATDs associated with those operations would accrue to AGT and would be added to AGT's other ATDs.

In response to interrogatory AGT(CRTC)23July93-2406, the company stated that, if ATDs accruing to AGT Directory are used to adjust the directory income that is deemed to be integral to AGT, the Commission should also adjust such income by a shareholder entitlement in respect of these ATDs. AGT stated that this entitlement should be based on the "premium" paid by TELUS in relation to AGT Directory, and estimated this entitlement to be $3.2 million.

In Decision 93-9, the Commission considered that shareholder entitlement to the ATDs accruing to AGT in the amount of $183 million would not be unreasonable given, among other things, their magnitude ($2.5 billion). The Commission did not find that a premium was paid by TELUS at the time of privatization. Accordingly, the Commission did not rely on the payment of a premium as a basis for allowing the shareholder an entitlement to the ATDs (see Part VI, Section A, for further discussion). Therefore, the Commission considers AGT's rationale for shareholder entitlement to ATDs related to AGT Directory to be without basis.

Further, the Commission considers that the ATDs that would be available to AGT Directory form only a very small percentage of the total ATDs that would be available to the combined entity. Thus, the recovery of any related shareholder entitlement would have a negligible impact on AGT's revenue requirement. Further, it would complicate the regulatory adjustment to an unwarranted degree.

In light of the above, the Commission considers that, in order to properly emulate the conditions that would exist if the two operations were integrated, any ATDs accruing to AGT Directory should be added to the ATDs accruing to AGT for regulatory purposes. In addition, the Commission considers that no adjustment should be made for regulatory purposes to the ATDs accruing to AGT Directory for any shareholder entitlement.

4. Notes Payable to and Receivable from Affiliated Companies

In Decision 92-9, the Commission noted that AGT provided information indicating that, as at 31 December 1992, AGT Directory estimated that the total amount due from its affiliated companies would exceed the total amount due to its affiliated companies. The Commission also noted that the terms applicable to a significant portion of the amount due to affiliated companies differed from the terms applicable to (1) the balance of the amount due to affiliated companies, and (2) the entire amount due from affiliated companies. In the Commission's view, AGT did not present sufficient evidence to demonstrate that, for regulatory purposes, certain of these transactions should be governed by different terms. Accordingly, for the purposes of Decision 92-9, the Commission adjusted the 1992 forecast net income of AGT Directory to reflect similar terms for both the amount due from and the amount due to affiliated companies.

The Commission notes that circumstances similar to those described above are forecast for 1993 and 1994. The amounts discussed above are now referred to in AGT Directory's financial statements as Notes Payable or Notes Receivable. The Commission considers that the net income to be deemed for AGT Directory should be adjusted to realize similar terms and conditions for Notes Payable to and Notes Receivable from affiliated companies, with the exception of a $20 million Note Payable. As in Decision 92-9, interest associated with this $20 million Note Payable has been included in the calculation of the company's revenue requirements.

5. Direction

Based on the above, AGT is directed to calculate the regulatory adjustment for directory income as follows:

(1)adjust AGT Directory's net income to reflect similar terms and conditions for Notes Payable to and Notes Receivable from affiliated companies (except for the $20 million Note Payable);

(2)utilize ATDs accruing to AGT Directory, if available, to reduce or eliminate any income tax expense associated with the adjustment calculated in (1) above;

(3)utilize ATDs accruing to AGT, if available, to reduce or eliminate any income tax expense for deemed AGT Directory income resulting from the adjustments made in (1) and (2) above;

(4)eliminate any intercompany revenues and expenses; and

(5)add the financial results (i.e., income statements, balance sheets and statements of retained earnings) of the two companies with no adjustment to the capital structure of AGT Directory.

The Commission notes that AGT, in calculating its revenue requirements in its current application, estimated the directory income for the purposes of the regulatory adjustment to be $1.2 million in 1993 and $1.3 million in 1994. Based on the determinations made in this Part, the Commission estimates the income from directory-related operations for the purposes of the regulatory adjustment to be $1.8 million for 1993 and $3.3 million for 1994. Therefore, the Commission has increased the directory income for regulatory purposes by $0.6 million in 1993 and $2.0 million in 1994 in calculating the company's revenue requirements.

VI ACCOUNTING MATTERS

A. Shareholder Entitlement to Additional Tax Deductions

1. Background

In its 16 April 1993 evidence, AGT made assumptions with respect to its prospective tax position that were consistent with the evidence it filed in the proceeding leading to Decision 93-9. In Decision 93-9, the Commission made several determinations regarding matters related to AGT's prospective tax position. Among those determinations were that (1) AGT was to use an amount for the ATDs for revenue requirement purposes that was consistent with its tax returns filed or to be filed, (2) the ATDs were a utility asset, and (3) a shareholder entitlement to the ATDs in the amount of $183 million would not be unreasonable.

The Commission accepted $183 million as the maximum amount of shareholder entitlement subject to the resolution of certain legal issues. In Decision 93-9, the Commission stated that it intended to rule on these issues, as well as on the final amount of the shareholder entitlement and the recovery period for that entitlement, in its decision in this proceeding.

2. Legal Issues Related to Shareholder Entitlement

In the proceeding leading to Decision 93-9, AGT proposed to calculate any shareholder entitlement as of 31 December 1992, but not to pay it out until 1 January 1994. Further, in its rebuttal evidence in that proceeding, AGT indicated that, if the ATDs were found to be a utility asset, no adjustment should be made to the shareholder entitlement for the ATDs used during the period 1990 to 1992.

The legal issues deferred to this proceeding are set out below:

(1) Can the Commission allow the shareholder any entitlement to the benefits associated with the ATDs for the period 1 January 1993 to 30 April 1993, or would this amount to retrospective rate-making?

(2) Based on the assumption that the ATDs are a utility asset, would it amount to retrospective rate-making not to adjust the shareholder entitlement for ATDs used during the period 1990 to 1992?

In final argument, AGT stated with regard to the above that the amount of ATDs (i.e., $2.5 billion) was an essential finding of Decision 93-9. Accordingly, the amount and basis for the shareholder entitlement, which is tied to the ATDs, did not crystallize until it was determined to exist by the regulator in Decision 93-9. AGT argued that the shareholder entitlement is not tied to any particular year or type of ATD, and that it merely represents a discrete portion of the total pool of ATDs equal to the "premium".

AGT also argued that, since it seeks recovery of the shareholder entitlement on a going-forward basis, recovery would not constitute retrospective rate-making.

Both ACC and Calgary argued that the inclusion in AGT's 1993 and 1994 revenue requirement of expenses, such as the shareholder entitlement, relating to a period prior to 1 May 1993, when AGT's rates were made interim, would constitute retrospective rate-making.

Unitel argued that AGT will not realize an expense in respect of the use of the ATDs until it first pays out the shareholder entitlement in 1994. Furthermore, the actual expense was not determined until the shareholder entitlement was determined in Decision 93-9. In Unitel's view, this creates considerable doubt as to whether the shareholder entitlement payout is a past expense.

The Commission agrees with AGT and Unitel that it has full jurisdiction to determine the amount of the shareholder entitlement and how it should be paid. The Commission also considers that there was no shareholder entitlement until it was established in Decision 93-9. Further, the recognition of the expense associated with a portion of the entitlement will not begin until 1 January 1994. In Decision 93-9, the Commission considered that shareholder entitlement of $183 million would not be unreasonable, given the magnitude of the ATDs ($2.5 billion) and for the other reasons stated in the Decision. While the Commission agrees that this amount relates to the total amount of the ATDs, it is not tied to any particular year or type of ATD.

The Commission disagrees with Unitel's suggestion that it abate the amount of the shareholder entitlement in proportion to the ATDs used to the date of Decision 93-9, since such an abatement would be inconsistent with the findings that there was no shareholder entitlement until the date Decision 93-9 was issued and that the entitlement is not tied to any particular year or type of ATD.

In light of the above, the Commission is of the view that full recovery of the shareholder entitlement will not lead to retrospective rate-making and that no adjustment is required for the ATDs used prior to AGT's rates being made interim (i.e., prior to 1 May 1993). Accordingly, the Commission determines that the final amount for the shareholder entitlement is $183 million.

3. Recovery of Shareholder Entitlement

In its revised evidence of 9 August 1993, filed as a result of Decision 93-9, AGT reduced its overall tax expense for 1994 by approximately $51.2 million. This reduction was attributable primarily to a reduction in income tax expenses of approximately $55.9 million and an increase of $4.5 million (from $25.5 million to $30 million) in the proposed amount of shareholder entitlement to be recovered. The company also proposed to recover the shareholder entitlement over a 10-year period, rather than over a 15-year period as originally proposed. AGT's revised recovery schedule was set out in response to interrogatory AGT(CRTC)23July93-2401.

In its revised Memorandum on Financing, the company stated that, "in view of the Commission's determination [in Decision 93-9] that the ATDs are a utility asset, the company has included in the revenue requirement for 1994 a return on the shareholder entitlement at the same rate as the proposed allowed rate of return on other equity invested in the company".

In response to interrogatory AGT(CRTC)10Aug93-3401, the company stated that, because the tax benefits obtained for the subscriber by the shareholder significantly exceed the premium paid by the shareholder, the shareholder should receive a fair return on the amount of such entitlement. The company considered a fair return to be the allowed rate of return on common equity on the basis that shareholder entitlement, as a utility asset, forms part of the asset base that existed at privatization.

In argument, AGT stated that, in recognizing a maximum shareholder entitlement in the amount of $183 million, the Commission considered, among other factors, the payment of a premium by the shareholder to acquire the telephone assets of the AGT Commission. The company submitted that the fair return on the entitlement is best provided for by treating the contributed surplus associated with the shareholder entitlement at the same rate as the allowed return on average common equity invested in the company. AGT also submitted that, if a debt rate is to be used, that rate should recognize the changed circumstances brought about by Decision 93-9, and employ the pre-tax rate of 8.8%.

AGT stated that its revised recovery period of ten years and the increase in the 1994 recovery to $30 million provide an appropriate balance of cost and benefit. The company stated that, as a result of the determinations made in Decision 93-9, subscribers over the next few years would receive the benefit of no income tax expense as part of the revenue requirement. The company considered that, since the near-term subscribers were going to receive a larger benefit relative to subscribers in later years, some rebalancing in the payment of the entitlement to the shareholder would be appropriate.

ACC stated that there is nothing in Decision 93-9 that indicates on what basis, other than the magnitude of the ATDs, the Commission determined that $183 million is the maximum amount to which the shareholder is entitled. In particular, ACC submitted that nowhere does the Commission state that it accepts AGT's arguments as to the calculation based on a premium paid at the time of privatization. Unitel submitted that it is not necessary to provide AGT a return on the shareholder entitlement simply because the ATDs have been determined to be a utility asset. Unitel submitted that the shareholder entitlement should not be included in AGT's rate base.

ACC, Calgary and Unitel all took issue with AGT's recovery schedule provided in response to interrogatory AGT(CRTC)23July93-2401.

The Commission disagrees with AGT that, in Decision 93-9, it took into account in recognizing the shareholder entitlement to a "premium" paid by the shareholder. In Decision 93-9, the Commission found that the privatization and restructuring of the AGT Commission, which ultimately resulted in the issuing of TELUS shares to the general public of Alberta, was a complex process that necessarily involved a variety of unique circumstances, and that the role of TELUS was vital in that process. The Commission further stated that it was this process that gave rise to the magnitude of the ATDs, which will result in lower rates for subscribers than would otherwise have been the case. It was on this basis that the Commission found that TELUS should receive a portion of the benefits of the ATDs.

The Commission did not find in Decision 93-9 that a premium was paid by the shareholder at the time of privatization.

In addition, although the Commission found in Decision 93-9 that the ATDs were a utility asset, the shareholder entitlement was not established until Decision 93-9 was issued. Accordingly, the shareholder entitlement could not have formed part of the asset base at the time of privatization.

The Commission notes that it normally determines a telephone company's revenue requirement on a historical (net book value) basis. The Commission considers that the inclusion of the shareholder entitlement as part of the asset base used to calculate the company's revenue requirement would not be consistent with this practice.

Based on the above, the Commission considers that the shareholder should not receive a return on the shareholder entitlement commensurate with the allowed rate of return on common equity. Therefore, the Commission has excluded the shareholder entitlement from the calculation of the company's average common equity base.

The Commission does consider, however, that the shareholder should receive a return on the outstanding balance of the unpaid entitlement commensurate with the long-term debt rate. The use of a pre-tax rate (8.8%) versus an after-tax rate (5%) will depend on when the company expects to incur an income tax expense. The Commission also considers that the methodology regarding the recovery of the shareholder entitlement as calculated in Attachment 3 to the response to interrogatory AGT(CRTC)10Aug93-3401 will not result in serious rate fluctuations over the amortization period and will ensure that the shareholder entitlement is recovered over a reasonable period of time. On that basis, the Commission has determined that the distribution of the shareholder entitlement, including interest, should be limited to $30 million in 1994.

Therefore, the Commission directs AGT to file for approval, by 28 November 1993, revised schedules regarding the proposed distribution of the shareholder entitlement in the format of Attachment 3 to the response to interrogatory AGT(CRTC)10Aug93-3401, using a rate of 8.8% in years in which the company does not expect to incur any income tax expense and a rate of 5% in years in which it does expect to incur an income tax expense. AGT is also directed to base its calculations on the assumptions that the line item "Revenue Increase (Including SSP)" will be limited to $30 million in 1994 and that rates will not be increased in future years in order to recover the shareholder entitlement.

B. Amortization of Downsizing Costs

As noted in Part VII, Section A, AGT estimated that it would incur costs of approximately $98.1 million as part of its efforts to reduce and realign its existing workforce. AGT submitted that it would be too onerous to impose these costs on subscribers in one year, and proposed to amortize these costs over three years (beginning in the month that the employee leaves the company).

In response to interrogatory AGT(CRTC)15Mar93-412, the company stated that a three-year amortization period was chosen so that the recognition of the costs would match closely the period in which the company can expect to experience a financial benefit, notably through reduced expenses for salary and benefits. AGT proposed to amortize approximately $23.5 million of these costs in 1993 and $32.6 million in 1994. In AGT Exhibit 14, based on adjustments to the scale and timing of its downsizing program, the company proposed to increase the amount to be amortized in 1993 to $24.7 million.

In argument, AGT submitted that amortization of the downsizing costs would prevent serious rate fluctuations. Further, the direct benefits associated with the cost reductions are expected to accrue for at least three years. AGT also submitted that inter-generational equity would be promoted by having the costs of those benefits borne as nearly as practical by the subscribers who receive them.

ACC, Calgary and Unitel considered that the benefits to be achieved from downsizing would be realized over a period greater than three years and that it would be inappropriate to amortize these costs over a three-year period, particularly in light of the significant rate increases proposed by the company.

Calgary also submitted that amortization of the costs should not commence until the cash is paid out to the employee (one year after the employee's lay-off date). Calgary noted that some employees have been recalled, and submitted that it is not reasonable that the revenue requirement include both wages paid to a recalled employee and the amortization of termination costs for the same employee.

With respect to Calgary's submission that the amortization of these costs should not commence until the cash is paid out to the employees, the Commission considers that AGT's policy to amortize these costs beginning in the month the employee leaves reflects appropriate conservative and matching accounting principles. The Commission notes that there is little or no certainty that recalled employees will remain with the company at the end of the recall period. In this regard, the Commission considers AGT's proposed timing of the recognition of these costs to be reasonable in the circumstances.

With respect to the amortization period, the Commission considers that the reduction of over 20% of AGT's workforce in 1993 represents a significant organizational transformation. The Commission further considers that the company would not undertake such a significant restructuring unless it planned to achieve significant longer-term benefits. In this regard, the Commission agrees with interveners that the benefits to be achieved from AGT's workforce reduction program will extend beyond the proposed three-year amortization period.

In light of the factors noted above, and in light of the impact of the proposed amortization expense on AGT's revenue requirement and the rate increases sought by the company, the Commission considers that a five-year amortization period would provide a better balance between the interests of the company and those of subscribers. Therefore, AGT is directed to amortize its downsizing costs over a period of five years. The Commission has adjusted the company's operating expense forecasts for 1993 and 1994 as noted in Part VII, below.

Should AGT wish, in the future, to shorten the amortization period for these costs, the Commission considers that such a change would be appropriate only if it could be implemented without specific local rate increases.

C. Loss on Sale of Computer Equipment

On 4 January 1993, in conjunction with its agreement with ISMC, AGT sold data processing equipment with a net book value of $18.8 million to IBM for proceeds of $10.1 million. Since the majority of this loss (i.e., $7.2 million) relates to assets for which asset classes will no longer exist, generally accepted accounting principles state that this loss should be recognized as a current loss. The company expects that the operating cost reductions available from outsourcing its data processing operations will more than offset this loss. Accordingly, AGT proposed to amortize this loss over three years, which is approximately the average remaining useful life of the assets sold.

In argument, AGT stated that these assets were sold at fair market value, which the company had verified by canvassing a number of hardware suppliers other than IBM as to the value they would assign to these assets. AGT submitted that the loss on the sale of these mainframe computer assets was unavoidable in view of the disparity between the net book value of these assets and the fair market value of mainframe computers. Further, AGT submitted that the three-year amortization period chosen provides the best match between the benefits of the sale and the costs associated with the assets.

ACC submitted that AGT should not be allowed to recover any of this loss from subscribers, arguing that the company has produced weak evidence of fair market value and that the transaction was not completely at arm's length. Unitel raised similar concerns.

With respect to the proposed amortization period, Unitel noted that, in response to an undertaking, AGT indicated that the agreement to sell this equipment to IBM was actually signed on 31 December 1992. Unitel submitted that the loss should have been written off in the year in which it was incurred (i.e., the year the agreement was signed). In the alternative, Unitel submitted that the loss should be amortized over the five-year term of the SMS Agreement with ISMC.

With respect to the recognition of the loss for regulatory purposes, the Commission notes that AGT contacted several equipment vendors to ascertain a fair and reasonable price for the data processing assets to be sold. As well, the Commission agrees with the company that this type of equipment is subject to a higher-than-average risk of obsolescence due to rapid technological advances. As such, it is likely that the fair market value of the assets would be less than the net book value. In these circumstances, the Commission considers that the loss should be recognized for revenue requirement purposes and that AGT should be permitted to recover it from subscribers.

With respect to the amortization period, the Commission notes that generally accepted accounting practices for regulated companies provide for the recognition of this loss in the year in which it is incurred or for the amortization of the loss over a period greater than one year. In this regard, the Commission considers that the benefits accruing from the sale of these assets are more closely linked to AGT's agreement with ISMC than to the estimated useful life of the assets, since the company no longer possesses these assets. Therefore, AGT is directed to amortize the $7.2 million loss associated with the sale of data processing equipment over a period of five years. The Commission has reduced AGT's operating expense forecasts by approximately $1 million in each of 1993 and 1994 as noted in Part VII, below.

D. Individual Line Service Revenue

During the years 1986 to 1990, the AGT Commission received grants from the Government of Alberta under the Individual Line Service (ILS) program. This program, which was completed in 1991, resulted in the conversion of all multi-party lines in the province to individual lines. In its 1992 Annual Report, the company stated that deferred revenue, related primarily to grants under the ILS program, is being recognized as income on a straight-line basis over twenty years, that period being the estimated useful life of the related assets. AGT estimated the amount to be recognized as income in each of 1993 and 1994 at approximately $9.8 million.

In its 16 April 1993 evidence, AGT estimated that its depreciation expense in both 1993 and 1994 would increase due, in part, to changes in the expected useful lives of some categories of plant resulting from the accelerated obsolescence of existing technology. During examination, AGT acknowledged that the average service lives for AGT plant may continue to decline in the future. In response to interrogatory AGT(CRTC)31May93-1611, the company stated that the average remaining service life of the assets related to the ILS program cannot be verified, as these assets are not separately tracked within the asset records.

In argument, AGT stated that, although the period over which the ILS grant is recognized was not chosen to match exactly the average remaining service lives of ILS plant, there is a general correspondence between the two time periods. AGT argued that there is no reasoned basis upon which to vary the amortization period, and submitted that the twenty-year amortization period provides a fair balance between the interests of subscribers and those of the shareholder.

ACC stated that, despite accelerating the depreciation schedules of a number of plant classes applicable to the ILS program, AGT did not propose to accelerate the amortization of deferred revenue associated with the ILS grant. ACC submitted that, if AGT is permitted to accelerate its depreciation schedules, the amortization schedules for the related income items should be similarly accelerated.

The Commission considers that AGT has not provided sufficient evidence to support its contention that the twenty-year amortization period for the ILS grant remains appropriate. The Commission notes that AGT is unable to determine specifically the remaining useful lives of the ILS assets and that the period over which the ILS grant is recognized does not match exactly the average remaining service lives of ILS plant. The Commission also notes that the estimated useful lives of some of the ILS plant have decreased. Given the current pace of technological change and the possible changes due to competition in the future, the Commission considers that the estimated useful lives of AGT's telephone plant and equipment (including ILS plant) will likely be further reduced in the future.

In light of the above, the Commission considers that the amortization period for the deferred revenue associated with the ILS program should be shortened in order to provide a better balance between the interests of subscribers and the interests of the shareholder. Therefore, AGT is directed to reduce the amortization period by four years (from twenty to sixteen years) for the purposes of recognizing income from the ILS grant. Based on this determination, the Commission estimates that AGT will recognize approximately $12.2 million in each of 1993 and 1994 as income associated with the ILS grant. On this basis, the Commission has increased AGT's revenue forecasts by approximately $2.4 million in each of 1993 and 1994.

VII OPERATING EXPENSES

A. Introduction

In AGT Exhibit 14, the company revised its estimates of Total Operating Expenses to $908.7 million in 1993 and $955.3 million in 1994, representing annual increases of 3.8% and 5.1%, respectively. Excluding depreciation, the updated operating expenses total $646.9 million in 1993 and $662.1 million in 1994, representing annual increases of 0.7% and 2.3%, respectively.

In 1993, AGT is undertaking a significant downsizing of its operations at a total estimated cost of $98.1 million. As noted in the previous Part, AGT proposed to amortize this cost. If the impact of this extraordinary item is removed, Total Operating Expenses are forecast to be $884.0 million in 1993 and $922.7 million in 1994, representing increases of 1.1% and 4.3%, respectively.

Excluding depreciation and the impact of downsizing, Total Operating Expenses are forecast to be $622.2 million in 1993 and $629.5 million in 1994, representing a decrease of 3.1% in 1993 and increase of 1.2% in 1994.

B. Workforce Reduction Program

In response to interrogatory AGT(CRTC)15Mar93-412, the company forecasted that, in 1994, it would incur certain downsizing costs that were not associated with its major downsizing program. These costs were not included in the $98.1 million to be amortized; rather, they were to be expensed in 1994. In response to interrogatory AGT(CRTC)31May93-1442 and during cross-examination by Calgary, AGT stated that it had changed its plans and decided to complete its downsizing program in 1993. Accordingly, the estimated expense would not be incurred in 1994. While the company made the necessary adjustment to its 1993 forecast, it did not revise its 1994 forecast to reflect the change. Based on this evidence, the Commission finds it appropriate to adjust the 1994 expense forecast downward by the costs identified in response to interrogatory AGT(CRTC)15Mar93-412.

In response to interrogatory AGT(CRTC)31May93-1442, much of which was filed in confidence, the company revised the number of employees involved in the downsizing program from 2,423 down to 2,093. However, the total cost of the downsizing program to be amortized remained at $98.1 million. In the Commission's view, AGT has failed to justify why, with a reduction in the number of employees involved, the total cost of the program should not decline. In particular, the Commission considers that AGT has not adequately justified the increases over its original estimates for termination costs and for the average cost per-employee of the separation program for one employee category. Accordingly, the Commission finds it appropriate to reduce the total cost of the downsizing program to be amortized by $4.6 million. In light of this reduction and the adjustment mentioned in the preceding paragraph, and taking into account its finding in Part VI that AGT should amortize these downsizing costs over a period of five years, the Commission has reduced the company's operating expense forecasts with respect to downsizing by $10.7 million in 1993 and $18.9 million in 1994.

C. Stentor Expenses

Based on a comparison of its share of the costs of the Stentor alliance and the benefits that the company projected it would receive from its participation in the alliance, AGT derived a "net cost" for its participation in Stentor in 1993 and 1994. Specifically, in response to interrogatory AGT(CRTC)31May93-1401, AGT forecasted that its participation would have a net cost of $5.6 million in each of 1993 and 1994. In AGT's view, while its participation in Stentor involves a net cost, AGT will derive a net benefit from the opportunity to draw on the pooled resources of the Stentor alliance.

Calgary argued that AGT has not provided sufficient information to support the net cost of its participation in the Stentor alliance. Calgary submitted that AGT's revenue requirement should be reduced by $5.6 million in each of 1993 and 1994 to ensure that there is no increase in the costs to subscribers as a result of the Stentor alliance.

Unitel noted AGT's position that the company's share of Stentor's costs is expected to be at approximately the same level as would have been incurred internally and for Telecom Canada, had Stentor not been established. Unitel noted that AGT is forecasting a cumulative increase in Total Operating Expenses of 8.1% over the test period, whereas there had been a decline of 3.0% over the two previous years. Unitel also noted that, during cross-examination, AGT stated that it had not done any economic studies to justify the $5.6 million net cost of the Stentor alliance. Unitel submitted that the Stentor costs should be reduced to a level comparable to the costs experienced by AGT in recent years.

ACC noted that AGT's forecasted research and development (R&D) budget for 1993 is double its 1992 R&D expenditures. ACC argued that AGT's expenditures should decrease, given the benefits to be gained from the pooling of resources through Stentor. ACC concluded that AGT appears to be treating Stentor as an additional cost, instead of a reallocation of costs. ACC also cited the example of AGT's payment of a portion of the expenses associated with Stentor's participation in the Review of Regulatory Framework (see Telecom Public Notice 92-78, 16 December 1992), while at the same time spending money for its own individual participation. ACC argued that the $5.6 million identified by AGT as the net cost of Stentor in 1993 should not form part of the revenue requirement.

AGT replied that ACC and Unitel failed to recognize the benefits of the Stentor alliance, specifically: "the ability to address a broader program of service development; an ability through coordination and reduction of a lot of the duplication that existed in the various owner companies." Further, AGT noted that the analysis leading to the net cost of $5.6 million does not take into account what AGT's cost would have been in 1993 without Stentor.

In the Commission's view, AGT has not adequately justified the additional cost ($5.6 million) that it will incur as a result of its participation in the Stentor alliance in each of 1993 and 1994. The Commission agrees that AGT's expenditures should decrease in the related areas, given the benefits to be gained from the pooling of resources through Stentor. The Commission notes the significant increases in the forecasted expenditures for non-labour expenses over the actual amount spent in 1992. Furthermore, while AGT may of course participate individually in any preceeding that it considers relevant to its interests, the Commission agrees with ACC's submission that AGT subscribers should not be charged, for example, for Stentor's participation in the Review of Regulatory Framework, while also paying for AGT's individual participation.

In summary, the Commission is not persuaded that AGT is gaining efficiencies from its participation in Stentor and concludes that the net cost of AGT's participation should not be borne by subscribers. Accordingly, the Commission finds it appropriate to reduce the company's operating expense forecast by $5.6 million in each of 1993 and 1994.

D. Depreciation

AGT is reducing the average service life of its transmission and switching equipment. AGT is replacing digital toll radio over the next ten years with a fibre optic transmission system. The service life of paired copper is reduced as fibre optic cable is installed in the access network. Continual upgrading of digital switching machines has increased the retirement rate and decreased the composite life of the switching machines. In general, AGT predicts a reduced service life for its plant and equipment. Depreciation expense increases of $32.6 and $28.9 million are estimated in 1993 and 1994.

The Commission finds AGT's service life estimates reasonable and approves its depreciation expense for both 1993 and 1994.

E. Conclusions

As detailed above, and in Parts IV and VI, the Commission finds it appropriate to reduce AGT's 1993 and 1994 operating expense forecasts by the amounts summarized below:

($million)

1993 1994

Stentor 5.6 5.6

Adjustments to Downsizing Costs 10.7 18.9

ISM - Disallowed Expenses
(see Part IV, Section C) 2.0

ISM - Loss on Sale of Equipment
(see Part VI _ Section C) 1.0 1.0

Totals 17.3 27.5

After adjusting for the disallowances set out above, AGT's operating expenses are forecast to be $891.4 million in 1993, an increase of 1.9% over 1992 actuals, and $927.8 million in 1994, an increase of 4.1% over the adjusted forecast for 1993.

Excluding depreciation, the revised forecast of operating expenses, after adjustments, total $629.6 million for 1993 and $634.6 million for 1994, representing a decrease of 2.0% in 1993 and an increase of 0.8% in 1994.

Excluding depreciation and the impact of the major downsizing program, operating expenses after adjustments are forecast to be $615.6 million in 1993 and $616.0 million in 1994, representing a decrease of 4.2% in 1993 and an increase of 0.1% in 1994.

VIII OPERATING REVENUES

A. Introduction

In its original submission of 16 April 1993, AGT estimated Total Operating Revenues at existing rates to be about $1.1 billion in 1993 and $1.2 billion in 1994. With proposed rates effective 1 May 1993 and 1 November 1993, the company stated that Total Operating Revenues would be about $1.2 billion in 1993 and $1.3 billion in 1994.

On 19 August 1993, AGT revised its revenue forecast at existing rates downward by about $2.9 million in 1993 and upward by about $3.7 million in 1994. In AGT Exhibit 14, the company indicated that the changes to the revenue forecast are primarily due to (1) the incorporation of year-to-date variances for certain revenue categories, (2) the implementation of the Stentor Settlement Plan, and (3) delays in the introduction of Talkmail.

B. Elasticity

In response to interrogatory AGT(CRTC)15Mar93-505, the company filed demand models for residence and business access and for several categories of toll services. The access demand models relate in-service NALs to an index of rates for basic monthly flat-rate service. AGT indicated in its response that only the model for residential access demand was used in forecasting local access revenues for 1993 and 1994. In response to interrogatory AGT(CRTC)15Mar93-716, the company stated that no price elasticity of demand was used in calculating revenues associated with local access, Centrex service, or service charges.

AGT indicated in response to interrogatory AGT(CAL)31May93-32 that use of the econometric models would not have changed its revenue forecast. During the hearing, however, AGT revised its revenue projections, taking into account price elasticity by including a reduction in revenues that would result from a reduction in in-service quantities in response to the requested higher rates. The company stated that a review of past rate changes indicates very little customer dissatisfaction or concern with the rate level. The company indicated that only a slight level of drop-off may be experienced and that most of the revenue reduction would result from a reduced demand for optional services and secondary access services, as subscribers attempt to control monthly bills.

Unitel argued that, since AGT's access models relate demand for access to monthly flat rates, there is no evidence supporting a reduction in demand for optional services in response to higher monthly flat rates. Calgary submitted that AGT's use of the price elasticity estimates had not been tested during the course of the proceeding.

The Commission is of the view that AGT's access demand models do not support its contention that revenues from optional services would decline in response to increases in monthly flat rates. The Commission also notes AGT's view that no customer drop-off has been evident due to the July 1990 rate increase, the ILS surcharge or the 1 May 1993 interim increase in basic exchange rates. The Commission therefore considers that AGT has not adequately supported the reduction in its forecast revenues for 1993 and 1994 relating to the price elasticity effect on demand. For these reasons, in this proceeding, the Commission has not recognized revenue curtailment for either basic or optional local services.

In future revenue requirement proceedings, the Commission will expect AGT to address clearly the role of demand models in developing its revenue forecast.

C. Market Share Loss

1. Background

In its evidence of 16 April 1993, AGT estimated a 0.8% market share loss in 1993 and 9.3% loss in 1994. These estimates assumed that resellers would not be granted trunk-side access in Alberta.

In the AGT Interconnection proceeding, AGT filed estimates of its market share loss based on the Choice Demand Model used in the proceeding leading to Decision 92-12. The model assumptions used by AGT in that proceeding reflect the fact that competitors would be entering AGT's market with some market experience and customer awareness and with some capacity to provide service. Based on the further assumptions that resellers and IXCs would obtain trunk-side access and would pay contribution in accordance with Decision 92-12, AGT projected market share losses of 1.6% in 1993 and 12.4% in 1994, rising to 26.8% by 1997. Further adjusting these estimates to take into account Unitel's alliance with AT&T, AGT estimated that it would lose 1.6% market share in 1993 and 15.5% in 1994, rising to 31.6% by 1997.

As indicated above, these estimates of 1.6% and 15.5% were not incorporated into AGT's original or revised forecasts in the present proceeding.

In a ruling made during the hearing, the Commission determined that it would be appropriate to add the record of the AGT Interconnection proceeding to the record of this proceeding for the purpose of its determinations with respect to market share loss. Accordingly, the Commission directed AGT to file, in this proceeding, a copy of the record of the AGT Interconnection proceeding. This determination was made in light of the fact that, when addressing the question of market share loss in the present proceeding, AGT repeatedly referenced the evidence filed in the Interconnection proceeding. Indeed, in response to interrogatory AGT(Unitel)31May93-1, AGT referred to its response to interrogatory AGT(CRTC)19Nov92-5, filed in the Interconnection proceeding. The Commission stated in its ruling that the record of the Interconnection proceeding contained adequate evidence on issues related to market share loss, but that parties could appropriately address questions that they did not have an opportunity to pursue or could not have pursued in the Interconnection proceeding.

Unitel raised the issue of market share loss at the hearing and, in argument, proposed that the Commission reduce AGT's estimates of market share loss. ACC also argued that AGT had overestimated its market share loss.

2. Conclusions

The Choice Demand Model, and most of the input parameters, were accepted in the proceeding leading to Decision 92-12 as a method of estimating long-run market share loss. However, the model results are highly sensitive to changes to the inputs that AGT has adjusted to reflect market conditions, specifically, those inputs related to supplier preference (a measure of the customer's preference for a competitor as a supplier of telecommunications services vis-à-vis the telephone company), customer awareness and the percentage savings or discount offered by competitors. The values used for supplier preference and customer awareness are judgmental, and changes to them have a particularly significant impact on market share forecasts in the early years.

The Commission considers that AGT's adjustments to the supplier preference and customer awareness factors for Unitel have not been adequately justified and result in an overestimation of market share loss to Unitel. For example, AGT stated that adjustments were made to the model from the time of the proceeding leading to Decision 92-12 in part to reflect Unitel's presence in the private line and facsimile market. However, Unitel was already participating in these markets when AGT provided estimates of Unitel's market share in the proceeding leading to Decision 92-12.

Further, the Commission notes that AGT's adjustments to non-price variables, although smaller, are similar in nature to those made by Bell in the proceeding leading to Bell Canada - Revenue Requirements for 1993 and 1994, Telecom Decision CRTC 93-12, 30 August 1993 (Decision 93-12). However, Unitel has not been able to compete in the public switched voice market in AGT's territory as it has in Bell's. In the Commission's view, some increase may be warranted to the assumptions used by AGT in the proceeding leading to Decision 92-12 in order to reflect the fact that Unitel may benefit somewhat from its experience and customer contacts in other territories. Similarly, some adjustment to supplier preference and customer awareness factors may be warranted to take into account Unitel's alliance with AT&T. However, the Commission does not accept the magnitude of the adjustments made by AGT.

On the basis of the above, the Commission considers that the expected market share for Unitel is more likely to be in the range initially estimated by AGT.

AGT also adjusted the supplier preference and customer awareness factors for resellers. While joint-use resale has been permitted in Bell's territory since 1990, such resale has not been permitted in AGT's territory. The Commission considers that some larger resellers might be able to benefit somewhat from their experience and customer contacts in other territories. However, as with Unitel, resellers will still be entering the Alberta market for the first time. In addition, since resellers will be required to enter the competitive voice market at the same time as Unitel, they will be less likely to achieve as great a market share as in Bell's territory, where joint-use resale preceded facilities-based competition. Accordingly, the Commission considers that AGT's adjustments to the model inputs for resellers result in an overestimation of resellers' market share.

As noted above, AGT also adjusted the price variables used in the Choice Demand Model, providing some analysis of the price discount that resellers could offer to small, medium and large users. For certain classes of subscribers, the Commission finds that AGT's rates for discount toll services are substantially lower than assumed, resulting in an overestimation of the price discounts that would be offered by resellers. In addition, AGT indicated that it plans to reduce toll rates further, thus further reducing resellers' ability to offer savings relative to AGT's rates.

In light of the above, the Commission considers that, as a result of its adjustments to inputs with respect to supplier preference, customer awareness and price discounts, AGT has overestimated resellers' ability to obtain market share. In the Commission's view, AGT's estimates of market share loss to resellers are approximately 15% higher than warranted. This is based on a comparison between resellers' market shares assuming supplier preference and price inputs as filed by AGT in the proceeding leading to Decision 92-12 and those filed in the AGT Interconnection proceeding in AGT's revised response to interrogatory AGT(CRTC)19Nov92-5.

In light of the above, the Commission finds that adjustments are warranted to AGT's estimates. The Commission estimates AGT's market share losses at 1.4% for 1993 and 12.1% for 1994. The Commission has incorporated these estimates into the company's revenue forecasts.

D. Customer Premises Equipment Business

AGT's revenue forecasts for 1993 and 1994 reflect the company's plans to exit the Customer Premises Equipment (CPE) business. AGT filed a breakdown of the total net revenue impact, along with supporting rationale, in confidence in response to interrogatory AGT(CRTC)23July93-2704 and in AGT Exhibit 39.

AGT stated that most of the foregone revenue in 1993 and 1994 represents gross margin lost as a result of exiting the CPE business. The Commission finds these estimates of foregone gross margin reasonable, as they are supported by comparable data for previous years.

The remaining foregone revenues represent revenue erosion in other revenue categories as a result of AGT's decision to exit the CPE business. The Commission considers that AGT has not provided adequate support for these estimated other revenue effects in 1993 and 1994.

The Commission has therefore adjusted AGT's revenue forecasts for 1993 and 1994 to remove the other revenue effects.

IX FINANCIAL ISSUES

A. Introduction

AGT proposed that its allowed ROE range be increased to 12.25% to 13.25% for 1993 and 1994. In support of its request, the company cited increased risk for the Canadian telephone industry overall and for AGT in particular. The requested ROE range was supported by the expert testimony of Dr. W.E. Avera. The company also filed capital market evidence, presented by Mr. R.D. Falconer.

AGT also argued that it would be appropriate for its capital structure to remain essentially at existing levels through 1994 (i.e., with a common equity component close to 60%).

Based on the evidence of Dr. W.R. Waters, Calgary concluded that AGT's allowed ROE should be set within the range of 10.0% to 10.5% for the test periods. In reaching this conclusion, Calgary took into account its views that AGT's business risks are extremely low in relation to any plausible benchmark and that the company's proposed common equity ratios exceed those that would result in an optimal capital structure for the company.

ACC took the position that 10.50% represented a fair ROE for the company in 1993 and 1994. ACC's recommendation was supported by the evidence of Dr. L.D. Booth and Dr. M.K. Berkowitz, who recommended an ROE range of 10.25% to 10.75% for both years. During examination, Dr. Booth stated that this recommended ROE would decline by about 25 basis points if the company's proposed capital structure were accepted.

B. Techniques for Estimating Cost of Equity

1. Discounted Cash Flow

The Commission acknowledges the concerns raised during the hearing about the difficulty of applying the discounted cash flow (DCF) approach under current market conditions. However, the Commission is of the view that the DCF approach can provide some insight into the determination of a fair ROE. The Commission makes the following comments concerning the application of this technique in this proceeding.

The most contentious issue relating to Dr. Avera's DCF analysis dealt with the appropriate growth component. In his TELUS analysis, Dr. Avera concluded that investors probably would not base their long-run growth expectations on TELUS' limited historical experience or the short-term projections of security analysts; rather, they would likely expect TELUS' growth to be modest in the near-term as it becomes established as an investor-owned utility and as the telephone industry becomes competitive. Dr. Avera also believed that investors would view TELUS' longer-term growth as likely equalling or exceeding that of the expected growth in the Alberta economy as a whole (in excess of 5% through to the end of the decade).

While recognizing that TELUS' historical growth data is limited, the Commission is of the view that investors would give such data some weight. The Commission is also of the view that some weight should be given to the projected growth rates for TELUS implicit in recent reports prepared by security analysts. Further, the Commission shares the concerns raised by interveners as to Dr. Avera's assertion that investors are more than likely expecting TELUS' longer-term growth to equal or exceed that of the Alberta economy as a whole. No historical data and no other persuasive evidence was presented that would support this proposition. The Commission is of the opinion that Dr. Avera's view of investors' longer-run expectations is somewhat overstated.

The Commission has similar concerns with Dr. Avera's DCF analysis for his group of Canadian telephone companies; in particular, his view that projections of long-term economic growth for Canada in the order of 5% to 6% per year imply a long-run expected growth rate for the Canadian telephone industry as a whole of between 5% and 6% annually. The Commission is persuaded by the evidence presented during the hearing that growth rates of this magnitude do not pass the test of reasonableness and is of the view that Dr. Avera's DCF results for Canadian telephone companies are somewhat overestimated.

The Commission has given little weight to Dr. Avera's results for non-utility companies. In this regard, the Commission agrees with certain of the concerns raised by Calgary and ACC, as well as points made by their respective witnesses. In particular, while recognizing that Dr. Avera used these results only as a check, the Commission shares Calgary's concern that this DCF analysis is suspect because of the differential in risk between AGT and these companies.

Dr. Avera viewed 25 basis points as being a modest, but reasonable, flotation cost adjustment at this time. Drs. Booth and Berkowitz did not make an explicit adjustment for flotation costs, with Dr. Booth stating that he viewed the flotation costs applicable to AGT's situation to be very small. Dr. Waters concluded that a significant case could not be made for a flotation cost allowance, given the company's specific circumstances.

Based on the record of this proceeding, the Commission is not persuaded that a departure is warranted from its position in Decision 92-9 as to an appropriate flotation cost allowance for AGT. Accordingly, the Commission is of the view that a very minimal flotation cost allowance should be made.

With respect to the DCF evidence of Drs. Booth and Berkowitz, the Commission shares certain of the concerns raised by AGT and Dr. Avera. One such concern relates to the witnesses' application of their second DCF technique. AGT argued that relying on historical data showing negative real growth for a group of six telephone companies over recent periods would lead investors to expect a real loss from investing in TELUS. AGT argued that such a proposition is not tenable and that this particular analysis does not provide meaningful information as to investors' current growth expectations. The Commission is of the view that the real growth estimate of 0.0% to 0.5% put forward by Drs. Booth and Berkowitz is not well supported by the evidence.

2. Equity Risk Premium

The Commission's comments on some of the issues raised with respect to the equity risk premium technique are set out below.

Dr. Avera used a long-term Government of Canada bond (LTC) yield of 8.24% in his risk premium analysis, which was the LTC rate as of February 1993. He noted during the hearing that LTC rates were around 7.7% at the time. Further, he estimated, based on what has happened to date in 1993 and expectations for the remainder of the year, that investors are probably expecting LTCs to average around 8% in 1993. When asked about 1994, Dr. Avera noted that, in the absence of a more detailed analysis, it was his view that investors might expect LTC rates to be slightly higher than in 1993.

Having considered the evidence concerning actual interest rate levels in 1993 and expectations for the remainder of the test period, the Commission is of the view that the LTC forecasts for the test period utilized by Mr. Falconer and Drs. Booth and Berkowitz are particularly overestimated. The Commission also notes the significant decline in interest rate projections between this proceeding and the one leading to Decision 92-9.

A major area of dispute centred on Dr. Avera's attempt to estimate an equity risk premium for AGT based on an analysis of equity risk premiums "implicit" in ROEs previously authorized by the Commission. In argument, Calgary, ACC and CAPP questioned the validity and reliability of Dr. Avera's approach, noting problems relating to circularity and the relevance and applicability of historical risk premiums in the current economic environment.

The Commission shares a number of the concerns raised by interveners on the usefulness and validity of such an approach. The Commission also notes Dr. Avera's statements as to the limitations inherent in this approach, as well as the unproven assumption that observed LTC yields during the month in which past Commission decisions were released are indicative of the levels projected for the test periods involved in each of these decisions. In light of the above, the Commission is of the view that these risk premium results should be used only as a check of reasonableness.

In establishing an appropriate market risk premium, Dr. Avera relied on the historical Hatch and White study, which indicated results of 5.93% and 6.86% (depending on the manner in which the premium was calculated), or a midpoint of about 6.4%. During cross-examination, Dr. Avera indicated that he relied solely on the results of the Hatch and White study essentially because it is much more widely referenced than other studies. He did not attempt to estimate the impact on the study results, which covered the period 1950 to 1987, if more recent data were taken into account.

Based on an analysis of the Hatch and White results and other data, Drs. Booth and Berkowitz concluded that the market risk premium is currently in the range of 3% to 3.5%. Dr. Waters used a market risk premium of 4.5% in his analysis, based in part on the historical Hatch and White results.

As in previous proceedings, the Commission has concerns about the reasonableness of the market risk premium range put forward by Drs. Booth and Berkowitz. On the other hand, the Commission is not convinced that the market risk premium is of the magnitude suggested by Dr. Avera. Further, the Commission is of the view that sole reliance should not be placed on the Hatch and White results. Taking into account the risk premium evidence presented, the Commission is of the view that the market risk premium is considerably greater than the level suggested by Drs. Booth and Berkowitz and significantly less than the level suggested by Dr. Avera.

Dr. Avera used TELUS unadjusted beta value of .70 in his analysis, as measured over the period 7 October 1992 to 26 February 1993. This contrasts with TELUS' historical beta of .43, as measured from the time TELUS stock began trading (October 1990). Dr. Avera argued that this increase is consistent with the greater risk associated with AGT as a result of the move towards a more competitive environment, and that the upward trend in beta values mirrored the experience in the U.S. when competition was introduced. Dr. Avera viewed a beta value of about .70, possibly even .80, as indicative of what investors are expecting in the future.

After an examination of a number of risk measures, including betas, Dr. Waters used a risk adjustment factor of .50 in his equity risk premium analysis. He reiterated his view that data over a number of years should be used in determining beta values, and pointed to the variability of beta values measured over relatively short time periods as support for this position.

Drs. Booth and Berkowitz viewed a beta range of .40 to .50 as reasonable for a telephone company of average risk and concluded that AGT's beta is well within that range. They were also of the view that beta values for Canadian telephone companies would not increase to the same extent as they did for American companies when competition was introduced in the U.S.

While recognizing that Dr. Avera's reliance on recent data was an attempt to estimate a forward-looking beta value that investors would consider reasonable in a competitive environment, the Commission has concerns with his sole reliance on TELUS' beta value of .70, as measured over a relatively short period of time. In the Commission's view, an examination of beta values measured over longer time periods indicates that some increase in beta values for Canadian telephone companies has taken place as a result of competition. However, the Commission remains of the view that, as stated by Drs. Booth and Berkowitz, a significant portion of the recent increase in longer-run historical beta values is caused by the removal of October 1987 data from the calculation. Taking into account the increase in the company's risk since the company's last general rate increase proceeding (discussed in more detail in Section C, below), AGT's risk relative to other Canadian telephone companies, and the possibility that beta values could increase somewhat once the impact of competition begins to take hold, the Commission is of the view that the appropriate beta value for AGT at this time is somewhat higher than the upper limit of the range suggested by Drs. Booth and Berkowitz.

In arriving at his recommended ROE, Dr. Waters relied exclusively on equity risk premium results because he found that the DCF results for a sample of low-risk industrials were not reliable. The Commission shares the concern voiced by AGT that Dr. Waters' recommendation is ultimately based on only one equity risk premium result, with no independent checks as to the reasonableness of his end result. Given its views as to the appropriate market risk premium and risk adjustment factor, the Commission finds that Dr. Waters' overall recommendation is underestimated to some degree.

Dr. Waters made a 50 basis point downward adjustment to his ROE recommendation based on capital structure considerations, and, in particular, on his view (based on his analysis of the capital structures of other utilities) that a 45% common equity component would be appropriate for AGT. AGT took issue with this adjustment. While the Commission acknowledges that, as noted by AGT, Dr. Waters' position is at odds with recent Commission decisions accepting increases in the common equity ratios of various companies, the Commission agrees with Dr. Waters that some downward adjustment is required for AGT's more conservative capital structure relative to other Canadian telephone companies. However, the Commission is not convinced that the requisite adjustment is of the magnitude suggested by Dr. Waters.

C. Risk and Capital Structure

AGT argued that investors perceive there to be greater risk in the telecommunications industry with the release of Decision 92-12, and that AGT in particular is facing significantly more risk today than at the time of Decision 92-9. While recognizing that Decision 92-12 did not deal directly with AGT, Dr. Avera viewed that Decision as having an impact on investors' risk perceptions of AGT and other Canadian telephone companies. AGT and its external witnesses also cited a number of company-specific factors that should be considered.

With respect to its capital structure proposal in this proceeding, AGT noted the Commission's acceptance in Decision 92-9 of the company's then-proposed capital structure, albeit with the caveat that a review of the capital structure may be warranted in the future when AGT incurs significant amounts of income tax. Mr. Drinkwater explained at the hearing that the company had not reduced its common equity ratio in the revisions to its evidence as a result of Decision 93-9. Given that the impact of that Decision was to postpone income tax expense for a number of years, AGT argued that it is entirely appropriate that the capital structure be maintained at existing levels through 1994, and that its common equity ratio be reduced more gradually than originally proposed.

In Mr. Falconer's view, a dramatic change in the company's common equity ratio would be unsettling to investors at this time and likely imprudent until there is greater certainty as to the impact of competition on AGT's overall operations.

On the topic of financial risk, Dr. Avera conceded that the company's common equity ratio exceeds those of other Canadian telephone companies. However, he noted that AGT is beginning to decrease its common equity ratio while the other telephone companies are increasing theirs because of changes in the risk profile of the telecommunications industry. He stated that, while this convergence will not take place in the short run, investors are looking at the long-term trend, which is for the common equity components of the telephone companies to converge.

AGT noted that the absence of tax expense has resulted in the company having the lowest pre-tax interest coverage ratio of any Canadian telephone company. AGT argued that, in order for the company to maintain its credit quality in the face of its low pre-tax interest coverage ratio and its level of business risk, it must maintain a higher common equity ratio than is necessary for any other Canadian telephone company. AGT stressed the need to maintain its bond ratings at current levels, especially given that 1993 is the first year in which it will be attempting to access debt markets.

Mr. Falconer believed that AGT's financial ratios are at the lower end of, or below, the accepted AA range, and that the company is therefore subject to a downgrade. Since the company's coverage ratios are low, he stated that it is possible that only the size of AGT and some subjective comfort factors support the company's current ratings. In addition, Mr. Falconer testified that reliable access to capital markets requires at least an A rating.

Dr. Waters concluded that AGT's business risks place it at the lower end of the scale for Canadian telephone companies. Further, Dr. Waters stated that the risks facing the Canadian telephone industry may have decreased in the last year and a half, since, with the release of Decision 92-12, both investors and telephone companies have considerably more clarity as to how events could unfold in the industry.

Both Calgary and Dr. Waters addressed the possibility that AGT is facing risks similar to those faced by companies in the U.S. at the time competition was introduced in that country. Calgary viewed AGT's position in this regard as favourable, arguing that, because of the timing of the introduction of competition, AGT has the opportunity to build upon the experience of others in developing its own strategies and forecasting.

Dr. Waters viewed AGT's financial risk as the lowest of all the Canadian telephone companies, if one were to look only at its common equity ratio. Calgary argued that the company's common equity ratio clearly indicates that AGT has the lowest financial risk exposure of any publicly-owned utility in Canada.

With respect to bond ratings, Dr. Waters noted that rating agencies have established benchmark values for a number of financial ratios, including interest coverage ratios, that serve as rough indicators as to the types of values required for a company to achieve a particular bond rating. However, he went on to state that bond rating agencies evaluate the totality of an issuer's prospective circumstances when assessing the quality of a company's debt; therefore, it is inappropriate to state categorically that an issuer's interest coverage ratios, for example, must be maintained at a certain level in order to sustain a particular bond rating.

Drs. Booth and Berkowitz believed that the company's business risk would not increase dramatically, notwithstanding the anticipated AGT interconnection decision. They viewed the increase in risk to the company from the introduction of competition as being partially offset by productivity improvements and the introduction of enhanced services. In support of their position, they pointed to factors such as the readiness of AGT for competition through the modernization of its system, the fact that, on average, AGT had higher total operating revenues per access line than any of the other Canadian telephone companies in 1991 (with this trend expected to continue through to 1994), the company's internal workforce restructuring, the formation of Stentor and the Stentor/MCI alliance, the differences between the Canadian and U.S. situations, and the movement of the stock prices of Canadian telephone companies before and after the release of Decision 92-12.

On the latter point, their analysis of TELUS' stock price movement indicated to them that while Decision 92-12 did not deal directly with AGT, investors expected the extension of long distance competition to the Alberta market and took it into account prior to the release of Decision 92-12. In a similar vein, ACC argued that the industry has been evolving towards greater competition over a period of several years, with Decision 92-12 being a logical development in a process that has been well described in analysts' reports for many years. ACC believed that it is reasonable to assume that investors have noted this evolution and have priced telephone company stocks accordingly.

On the topic of capital structure, ACC argued that the company's revenue requirement should be based on a deemed debt component of 48%, given AGT's unique tax position. Drs. Booth and Berkowitz recommended that AGT move to a 48% debt ratio over a six-year period which corresponds to the timing of a significant amount of the company's long-term debt refinancing. On the topic of debt refinancing, Dr. Booth indicated that the company is in a position to significantly lower its embedded cost of debt, particularly when compared to other Canadian telephone companies, and that this would significantly increase the company's coverage ratios. He also stated that a downgrade of the company's bond rating is unlikely. In this regard, ACC's witnesses noted that bond rating agencies are aware of the reasons for AGT's lower coverage ratios, and the fact that they are temporary, and are highly unlikely to treat AGT as they would a company whose low coverage ratios are caused by genuine economic problems.

The Commission is of the view that AGT's business risks have increased somewhat since Decision 92-9. The Commission is not persuaded by Dr. Waters' suggestion that the company's business risk may in fact have decreased as a consequence of the release of Decision 92-12.

In terms of financial risk, the Commission is of the view that AGT is at the low end of the spectrum relative to other Canadian telephone companies. The Commission notes that the company's common equity ratio will likely converge with those of other Canadian telephone companies at some point in the future; however, with the issuance of Decision 93-9, AGT revised its proposals concerning the reduction of its common equity component, deciding to decrease this ratio more gradually in light of the delay in incurring income tax expense. Consistent with its position in Decision 92-9 concerning the evolution of AGT's capital structure, the Commission accepts as reasonable the company's proposal to gradually decrease its common equity ratio.

In terms of overall risk, the Commission agrees with the evidence placing AGT at the lower end of the risk spectrum relative to other Canadian telephone companies. However, the Commission is of the view that, as submitted by Dr. Waters, the company's higher common equity ratio relative to other Canadian telephone companies should be recognized in establishing its allowed ROE range.

Further, the Commission agrees with Drs. Booth and Berkowitz that the Stentor/MCI alliance should be viewed as offsetting to some extent the increase in risk faced by the telephone companies as a result of the introduction of competition, and that it clearly indicates that Canadian telephone companies are actively positioning themselves to meet the challenges of operating in a competitive environment. In light of the various steps taken by the telephone companies in recent months (both before and after Decision 92-12), the Commission is of the view that Canadian telephone companies have learned from the U.S. experience with competition, and that there is little evidence, at this time, to support the position that the Canadian experience will necessarily mirror that of the U.S. when competition was introduced in that country.

With respect to access to capital markets, the Commission is cognizant of AGT's need to refinance a significant portion of its debt in the next few years. In addition, the Commission notes Mr. Falconer's position that reliable access to capital markets requires at least an A rating. The Commission also notes the concerns raised by the company about its projected coverage ratios. However, the Commission is of the view that the financial community has recognized, among other things, the company's somewhat higher common equity ratio relative to other Canadian telephone companies, and is well aware of the reasons why the company's pre-tax coverage ratios are lower than those of the other Canadian telephone companies.

D. Conclusions

In general, the Commission considers the techniques used by the expert witnesses to be of assistance in assessing a fair and reasonable ROE for the company, but has indicated some of the areas where it has concerns and doubts about the application of the various techniques. Further, the Commission has taken into account changes in capital market conditions since Decision 92-9 and the impact of recent events on the company's risk profile.

The Commission is of the view that the evidence presented supports an ROE range of 11.25% to 12.25%, representing no change from the range established in Decision 92-9. While recognition of the increased uncertainty facing AGT as a result of competition would normally call for an increase in the ROE range from the level approved in 1992, the Commission notes that the increase in the company's risk in the past year has effectively been offset by substantial declines in LTC projections since the proceeding leading to Decision 92-9. The Commission views the approved ROE range as fair and reasonable in light of (1) the general decline in long-term interest rates over the past few months, as well as the decline in projected rates since the last AGT revenue requirement proceeding, (2) the evolving competitive environment in telecommunications, and (3) the company's proposed capital structure.

Consistent with its position in Decision 92-9, and taking into account the increase in the company's business risk since that Decision, the Commission accepts as reasonable at this time AGT's proposal to gradually decrease its common equity ratio. However, the Commission reiterates its position that, "[i]n future, when the company incurs significant amounts of income tax expense, a review of the company's capital structure may be warranted, depending on the circumstances at that time".

X REGULATORY ADJUSTMENTS

In Decision 93-12, the Commission determined that it would be appropriate to remove from Bell's calculation of average common equity certain cumulative adjustments to regulated net income that affected the company's average common equity for regulatory purposes. Bell agreed to the elimination of these adjustments in order to simplify its financial statements for regulatory purposes.

Consistent with the above, the Commission is of the view that AGT should not carry forward any adjustments to regulated net income made in this Decision in its calculation of average common equity adjusted for regulatory purposes.

XI REVENUE REQUIREMENT

A. Revenue Requirement Methodology

1. Calculation of Revenue Shortfall or Surplus over the Entire Year or from

the Effective Date of the Interim Order

In Letter Decision 93-6, the Commission stated that, in determining the amount of interim rate increases, it had not made allowance for the recovery of any shortfall for the period 1 January to 30 April 1993. Noting that AGT, in its reply, had raised the proposition that its revenue requirement for 1993 should be determined on the basis of the entire year, the Commission invited parties to comment in final argument in the present proceeding on whether it has the jurisdiction to determine AGT's 1993 revenue requirement over the entire year.

AGT submitted, in this proceeding and in the proceeding leading to Letter Decision 93-6, that the Commission has the power and the mandate to make the company whole for the entire 1993 year. AGT based this conclusion on several propositions. First, AGT argued that the Commission has the authority under its governing legislation to make the company's rates interim effective as of 1 January 1993, since the company filed an application for interim rates on 23 December 1992. AGT stated that the Commission has not specified the information required in support of an application for interim rates. In AGT's view, providing notice to the Commission that rates may not be just and reasonable is sufficient for the Commission to exercise its powers to make rates interim. AGT also cited case law in support of its view that the Commission is empowered to make an interim order effective as of the date of the application.

Second, AGT submitted that the Commission has the duty to ensure that, so far as its powers allow, rates and tariffs are at all times just and reasonable. AGT submitted that it would be consistent with the Commission's findings in British Columbia Telephone Company - General Increase in Rates, Telecom Decision CRTC 83-8, 22 June 1983 (Decision 83-8), to review evidence concerning AGT's results in the period 1 January to 30 April 1993 in order to establish rates that are just and reasonable for the full test year 1993. AGT submitted that, if the period 1 January to 30 April were not taken into account, and the allowed rate of return were not achieved for that period, rates for that period would not be just and reasonable and the Commission would be in breach of its statutory duty to ensure that rates are at all times just and reasonable.

Third, AGT submitted that the Commission found in Letter Decision 93-6 that the rates in effect from 1 January to 30 April 1993, were not, prima facie, just and reasonable.

Finally, AGT argued that the new Telecommunications Act does not in any way limit the Commission's jurisdiction to determine AGT's revenue requirement over the entire 1993 year and, in effect, adds to the Commission's jurisdiction to provide full-year relief by virtue of sections 60 and 61.

Calgary, ACC, and Unitel argued, among other things, that the Commission does not have the power to set rates in order to recover revenue shortfalls or to eliminate surpluses incurred prior to the date that the company's rates were made interim.

The Commission reviewed the issue of revenue requirement methodology in the proceeding leading to Decision 93-12. The Commission concluded that, in setting rates, it cannot allow the recovery of a revenue shortfall or the elimination of a revenue surplus for the period prior to the date that rates were made interim.

As noted in Decision 93-12, the Supreme Court of Canada confirmed that the regulatory scheme established under the Railway Act and the National Transportation Act was a positive approval scheme. In Bell Canada v. Canada (CRTC), [1989] 1 S.C.R. 1722 at 1761 (the Bell case), the Supreme Court of Canada referred to a positive approval scheme as one which "... only gives jurisdiction to make prospective orders ..." In that decision, the Court explained that the express power of the Commission to issue interim orders provides the Commission with "added flexibility" in regulating rates by permitting the Commission, in setting final rates, to revisit the period during which rates had been made interim.

The Commission notes that, in this regard, the new Telecommunications Act does not alter the nature of the scheme governing the Commission's regulation of rates for telecommunications services. The Commission does not agree with AGT that either section 60 or section 61 of the Telecommunications Act authorizes the Commission to set rates for AGT in this proceeding for the entire 1993 test year.

In light of the above, while the Commission agrees with AGT's submissions that it can change rates through any period for which rates are established on an interim basis, it does not agree with AGT's argument that the Bell case supports the conclusion that it can make interim rates effective prior to the date of the interim order, back to the date of the application. In the Commission's view, this would amount to setting interim rates on a retroactive or retrospective basis, which it is not empowered to do pursuant to its governing legislation.

With respect to AGT's application to make rates interim effective 1 January 1993, which was filed on 23 December 1992, the Commission notes that, in order to be fair to all interested parties, its general practice is to establish a process, albeit an expedited one, affording interested parties with the opportunity to comment prior to issuing any order making rates interim. Moreover, notwithstanding the Commission's well-known practice, AGT failed to provide any financial information in support of its application, thus making it impossible for interested parties to comment on the merits of its request.

Contrary to AGT's submission, the Commission did not find in Letter Decision 93-6 that the company's rates from 1 January to 30 April 1993 were not just and reasonable. Rather, the Commission found that, in order to maintain the company's financial integrity, an interim rate increase of $32 million, over the period 1 May to 31 December 1993, was appropriate. The Commission thus concluded that certain of the company's rates should increase as of 1 May, and that all other existing rates should be made interim as of that date.

The Commission notes that it did not find in Decision 83-8, as suggested by AGT, that it could set rates to recover a revenue shortfall or eliminate a revenue surplus for the first months of a partial test year. In Decision 83-8, the Commission recognized its ability to have regard to actual results to help formulate a more accurate estimate of the company's revenue requirement.

Having considered the arguments of the parties, and consistent with its determinations in Decision 93-12, the Commission concludes that it does not have the power to set AGT's rates to recover a revenue shortfall or eliminate a surplus incurred by the company prior to 1 May 1993, the date on which the company's rates were made interim, as this would entail retrospective rate-making. The Commission also considers that, for the reasons discussed above, it did not have the authority to make the company's rates interim as of a date prior to the date of its interim order.
2. Annualization Versus Proration

In interrogatory AGT(CRTC)15Mar93-445, the Commission requested AGT's views as to whether its revenue requirement for 1993, assuming that it is determined over the period 1 May to 31 December, should be calculated using an annualization method, a proration method, or any other method suggested by the company. In response, AGT submitted that its revenue requirement for 1993 should be calculated over the entire twelve-month period and not over the eight-month period from 1 May to 31 December 1993. AGT did not express its views as to whether the annualization or the proration method was more appropriate in the event that its 1993 revenue requirement was determined for the eight-month period.

In argument, ACC and Calgary submitted that the Commission should use the proration method in determining the company's revenue requirement. Unitel submitted that the Commission could use either approach. In Decision 93-12, the Commission stated that:

... where a decision cannot be released before 1 January of a given year and an interim order is not in place effective that date, a company's revenue shortfall or surplus for that year should be determined using the proration method.

In the absence of any arguments by AGT in support of the use of any other method, the Commission adopts its conclusions in Decision 93-12, and finds that, in order to be fair and reasonable to both the company and its customers, it is appropriate to determine AGT's revenue requirement for the period 1 May to 31 December 1993 using the proration method.

B. Revenue Requirements for 1993 and 1994

In its August View, AGT estimated that it would earn an ROE of 8.0% for 1993 at existing rates. AGT estimated that a revenue increase of about $69 million would be necessary in 1993 in order for it to achieve an ROE of 12.6%.

In determining the revenue requirement for the 1993 test period, the Commission considers that, due to the timing of this Decision, it would be appropriate to allow the company to earn at the upper end of its allowed ROE range.

In light of the above, and using the proration method to calculate the 1993 revenue requirement, the Commission concludes that, after incorporating an adjustment for planned and pending tariff filings and the various other adjustments for 1993 identified in this Decision, the rates given interim approval in Letter Decision 93-6 are just and reasonable rates for the period 1 May to 31 December 1993. The Commission estimates that, with such rates, AGT will earn a regulated ROE of about 11.6% for the entire 1993 calendar year.

In its August View, the company estimated an ROE of 3.8% for 1994 at existing rates. AGT estimated that a revenue increase of about $136 million would be necessary in 1994 in order for it to achieve an ROE of 12.2%.

The Commission estimates that, after incorporating an adjustment for planned and pending tariff filings and the various other adjustments for 1994 identified in this Decision, the company would earn a regulated ROE of about 7.5% in 1994, at existing rates.

In order to provide the company with a regulated ROE of 11.75% (the midpoint of the approved range of 11.25% to 12.25%), and after taking into account the interim rate increases approved in Letter Decision 93-6, the Commission finds that additional revenue of approximately $16 million is required in 1994.

In calculating AGT's revenue requirements for 1993 and 1994, the Commission has taken into account reduced financing costs due to the fact that the Commission has granted the company increased revenues. In assessing the reduction in financing costs, the Commission has used the same underlying assumptions as those used by the company in providing its estimate of financing costs with and without its proposed rate changes.

XII TARIFF REVISIONS

A. Network Exchange Services

1. Residence and Business Exchange Services

In addition to the interim rate increases approved in Letter Decision 93-6, AGT proposed, effective 1 November 1993, a further $3.70 per month increase to residence exchange service, and increases to business exchange service ranging from $8.70 to $16.05 per month, depending on the service level and rate group.

The company also proposed to apply, in each of November and December 1993, a surcharge of $2.60 for residence exchange service and a surcharge ranging from $6.75 to $10.00 for business exchange service, depending on the subscriber's service level.

AGT stated that the proposed increases in the monthly rates recognize both the steadily increasing value of exchange service and the fact that local access rates must gradually move towards cost.

AGT indicated that it will continue to move towards simpler rate structures. The company noted that the proposed rates narrow the differences between residential rate groups, which would facilitate future rate group compression. The company further indicated that it did not propose reductions in the number of rate groups in this application due to concern over the potential impact on customers in lower rate groups.

CAPP submitted that all telephone companies across Canada should use the same tariff structure and that, in general, the tariffs need to be simplified. CAPP also expressed concern with the inconsistencies in AGT's rates for business access lines and recommended that the Commission proceed with rate group compression and that AGT be required to reduce the rates charged for basic business exchange by the current touch tone differential.

The Commission does not consider it appropriate to adopt a uniform tariff structure for all telephone companies, as proposed by CAPP. Particularly at the local service level, the Commission considers that such an approach would be overly restrictive and difficult to sustain, given that local rate levels are set to meet each company's specific revenue requirement.

With respect to rate group compression, the Commission notes its statement in Decision 92-9 that reducing the number of rate groups may have certain advantages.

However, the Commission concurs with AGT that its rate groups should not be compressed at this time.

In light of its determination with respect to the company's revenue requirements for 1993 and 1994, the Commission finds the proposed surcharges and the proposed increases effective 1 November 1993 for residence and business exchange service to be unnecessary. They are therefore denied.

2. Centrex

AGT proposed increases to Centrex rates for Service Level 1, Key and Key 100 Plus lines of $4.75 per month. The company also proposed to apply a surcharge of $6.75 to these lines in each of November and December 1993.

In light of the Commission's determination with respect to the company's revenue requirement for 1993, the proposed Centrex surcharge is denied.

The Commission's policy with respect to Centrex service is that it is a competitive alternative to PBX equipment used in conjunction with network access trunk service, and that rates for competitive services should be set to maximize contribution. Given the magnitude of the increases to business exchange service approved in Letter Decision 93-6, the Commission is of the view that Centrex rates would not maximize contribution at either existing or proposed levels. Rather, the Commission directs the company to increase Centrex service rates (Competitive Terminal Services Tariff Item 2260.4.1) at all service levels by 10% over existing levels, effective 1 January 1994.

3. Local Channels

As the Commission stated in Telecom Order CRTC 93-274, 7 April 1993, in which it approved an application by AGT for increases in its local channel rates, AGT's local channel rates are significantly below those of other telephone companies and are not compensatory. The company confirmed in response to interrogatory AGT(CRTC)31May93-1710 that it is planning to file an increase to local channel rates, although it has not established a filing date.

Given the revenue impact of the expected local channel filing, which is not included in the company's current financial view, and the fact that existing rates are not compensatory, the Commission considers it appropriate to raise local channel rates. In light of the Commission's determination with respect to the company's revenue requirement for 1994, the Commission directs the company to increase its local channel rates by 15%, effective 1 January 1994.

B. Message Services

1. Toll Service

AGT proposed to restructure its Select Route Service to provide customers with an option of either a 1-hour or 10-hour plan.

In light of its determination with respect to the company's revenue requirements for 1993 and 1994, and given that MTS/WATS competition is now permitted in Alberta by virtue of Decision 93-17, the Commission approves the restructuring of Select Route Service, effective 1 January 1994.

2. Interexchange Mileage Rates

In Letter Decision 93-6, the Commission granted interim approval to revisions to AGT's interexchange mileage rates associated with Private Line Voice and Data, Off Premises Extension, Tie Trunk and Foreign Exchange Services.

CAPP recommended that the Commission require AGT to revise its proposed tariffs for Alberta interexchange channels to make them contain the same number of mileage bands as the AltaNet tariffs and provide volume discounts equal to those offered for Trans-Canada channels.

In reply argument, AGT agreed that it would be desirable to move the Alberta interexchange mileage rates to the same level as the Trans-Canada mileage rates, including discount levels, but stated that it did not propose to do so in this proceeding in order to prevent rate shock to customers subscribing to these services.

Given AGT's view that it would be desirable to move Alberta Interexchange mileage rates towards the levels of the Trans-Canada mileage rates, the Commission would be prepared to consider an application from the company, outside of a revenue requirement proceeding, to restructure its interexchange mileage rates in this manner.
3. Directory Assistance

CAPP recommended that the Commission reject AGT's request to increase the directory assistance charge from $0.50 to $0.75 per request for a billable telephone number or address. CAPP submitted that, if AGT wishes to increase the charge for directory assistance, it should be done under a separate application and jointly with the other telephone companies with which AGT is trying to achieve parity.

The Commission notes that AGT's Directory Assistance Service was restructured in Telecom Order CRTC 93-685, 11 August 1993, to extend the current charge of $0.50 to all long distance directory assistance (LDDA) requests. The company had previously applied an LDDA charge only to calls for U.S. telephone numbers, after a free call allowance of 50 requests per month per access line.

In approving the restructuring of Directory Assistance Service, the Commission stated that the costs of providing LDDA should generally be borne by those who use it, rather than by the general body of subscribers, and that LDDA charges should generally be cost-based and rated to recover an appropriate contribution towards common costs on a per-call basis.

The Commission considers it preferable to generate the additional revenues required for 1994 through increases such as this, rather than through increases in basic exchange services or EFRC. Accordingly, the Commission approves the proposed $0.75 charge, effective 1 January 1994.

C. Terminal Equipment

1. Rental Sets

AGT proposed rate increases for certain rental telephone sets. Since the sets involved are competitive offerings and since, in the Commission's view, the proposed rates would increase contribution, the Commission finds them appropriate. The proposed rates are accordingly approved, effective 1 January 1994.

2. Rotary Hunt Service

AGT proposed to increase the monthly rate for Rotary Hunt Service from $2.50 to $3.25.

In light of the Commission's determination with respect to the company's revenue requirement for 1994, the Commission approves a rate of $2.85 for Rotary Hunt Service, effective 1 January 1994.

3. Service Charges

The company proposed increases to its service charges, noting that, at the proposed levels, the charges would recover a larger portion of the associated costs. In light of the Commission's determination with respect to the company's revenue requirement in 1994, the proposed service charges are approved, effective 1 January 1994.

D. Mobile Telephone Service

For both Alberta Manual 150 Mobile Telephone Service and Alberta Cellular 400 Mobile Telephone Service, AGT proposed to increase the access charge from $11.00 to $14.30, and to increase the airtime rates for peak period calling from $0.27 to $0.30 per minute and for off-peak period calling from $0.21 to $0.23 per minute. AGT stated that the proposed rate increases (1) reflect the value of the broad geographic coverage that these services provide, (2) maintain the existing rate relationship with business exchange service, and (3) better position these rates with Cellular airtime rates.

In light of the Commission's determination with respect to the company's revenue requirement for 1994, the Commission approves the proposed increases in rates for Mobile Telephone Service, effective 1 January 1994.

E. Other Matters

1. Rate Rebalancing

Calgary submitted that AGT's proposed rate increases to local exchange subscribers in Calgary represent a rebalancing of rates prior to the introduction of long distance competition in Alberta.

ACC submitted that the effect of granting AGT's rate application would be to rebalance local and long distance rates in a manner that was explicitly discouraged by the Commission in Decision 92-12, and that rate rebalancing should not be allowed before the Commission has had a chance, through the Regulatory Framework proceeding, to review its policy on contribution and access rate pricing.

In reply argument, AGT stated that its application does not seek rate rebalancing as an explicit policy choice. The company stated that it carefully reviewed all tariff items for revenue opportunities and distributed the proposed rate increases over a broad number of services.

The Commission notes that any AGT toll reductions to date have been made in a monopoly environment. The Commission further notes that AGT's recent toll reductions have primarily been either prescribed reductions resulting from the 1992 revenue requirement proceeding or the result of Stentor filings. Unless AGT matched the reductions proposed by the other Stentor telephone companies, its customers would have been disadvantaged vis-à-vis customers of those companies.

2. Yellow Pages Charges

CAPP recommended that the charge for a yellow page listing be unbundled from the basic exchange charge, arguing that the bundled charge makes it difficult for a business to make a rational economic decision as to the type of yellow page listing it should have.

The Commission is not persuaded, based on the record of this proceeding, that the proposed change is appropriate.

3. Calling Card Charges

CAPP was of the view that AGT's automated calling card charges are excessive and unfair. CAPP recommended that the Commission require AGT to amend its tariffs to reduce the per-call charge for automated calling card calls and to provide a subscription plan that, in return for a fixed monthly fee, would further reduce or eliminate the per-call charge.

The Commission notes that AGT has not developed causal costs for its automated calling card service and is of the view that a reduction to automated calling card surcharges would be inappropriate without cost support. Further, a reduction in these surcharges would require an increase in revenues from other services.

F. Disposition of Interim Tariffs

Effective 1 November 1993, the Commission gives final approval to the rates made interim as a result of Letter Decision 93-6, including those services for which interim rate increases were granted. The status of tariffs granted interim approval in other Commission rulings is not affected by the above determination. Such tariffs are to continue in effect on an interim basis until the Commission issues final determinations with respect to them.

G. Filing of Tariffs

AGT is to issue, by 1 November 1993, final tariff pages giving effect to the tariff revisions approved in this Decision with an effective date of 1 November 1993. Final tariff pages with respect to all other tariff revisions approved in this Decision are to be issued by, and have an effective date of, 1 January 1994.

All proposed tariff revisions not dealt with specifically in this Decision are denied.

Allan J. Darling
Secretary General