**Before the**

**Federal Communications Commission**

**Washington, D.C. 20554**

In the Matter of ) CUID Nos. CA0680 (Los Osos)

) CA0706 (Garden Farms)

Falcon Cable Systems Company ) CA0707 (Santa Margarita)

) CA0709 (Cambria)

) CA0927 (Templeton)

Appeal from a Local Rate Order of the )

County of San Luis Obispo, California ) File No. CSB-A-0589

**MEMORANDUM OPINION AND ORDER**

**Adopted: January 25, 1999** **Released: January 27, 1999**

By the Deputy Chief, Cable Services Bureau:

1\. Before the Cable Services Bureau (\"Bureau\") is an appeal of a
local rate order (\"Order\") issued August 4, 1998 by the County of San
Luis Obispo, California, the local franchising authority (\"LFA\"),
filed September 3, 1998 by Falcon Cable Systems Company (\"Operator\").
In its Order, the LFA disapproves part of the basic service tier
(\"BST\") rate increase Operator sought after upgrading its cable system
in the above-referenced communities. Operator argues in its Petition for
Review (\"Petition\") that the LFA erred in disapproving the rate
adjustment. The LFA filed an opposition to Operator\'s Petition
(\"Opposition\"). For the reasons stated below, we deny in part and
grant in part Operator\'s Petition and remand this matter to the LFA for
further proceedings consistent with this decision.

2\. In its Order, the LFA also disapproves the network upgrade for
Operator\'s cable programming services tier (\"CPST\"). Under the
Communications Act of 1934*,* as amended (\"Communications Act\"),[^1]
the Federal Communications Commission (\"Commission\") is authorized to
review the CPST rates of cable systems not subject to effective
competition to ensure that rates charged are not unreasonable. The LFA
does not have jurisdiction to review Operator\'s CPST rates[^2] and we
find that part of the LFA\'s Order to be without any effect.[^3]

3\. Pursuant to the Commission\'s rules, rate orders adopted by local
franchising authorities may be appealed to the Commission.[^4] In ruling
on appeals of local rate orders, the Commission will not conduct a *de
novo* review, but instead will sustain the franchising authority\'s
decision if a rational basis for that decision exists.[^5] The
Commission will reverse a franchising authority\'s rate decision only if
it determines that the franchising authority acted unreasonably in
applying the Commission\'s rules.[^6] If the Commission reverses a
franchising authority\'s decision, it will not substitute its own
decision but instead will remand the issue to the franchising authority
with instructions to resolve the case consistent with the Commission\'s
decision.[^7]

3\. In Implementation of Sections of the Cable Television Consumer
Protection and Competition Act of 1992: Rate Regulation and Adoption of
Uniform Accounting System for Provision of Regulated Cable Service
(\"*Cost Order*\"), the Commission concluded that cable operators making
significant upgrades should be allowed to establish the upgrade costs
through an abbreviated cost of service showing and add an upgrade
surcharge to their rates otherwise determined pursuant to the
Commission\'s benchmark and price cap methodology.[^8] The Commission
concluded that allowing abbreviated cost of service showings and
surcharges for network upgrades is an appropriate way to implement the
goals of the 1992 Cable Act. Permitting abbreviated cost of service
showings could promote the availability of diverse cable services and
facilities, encourage economically justified upgrades, and reduce
regulatory burdens, while ensuring reasonable rates for regulated
services.[^9] The FCC Form 1235 (Abbreviated Cost of Service Filing for
Cable Network Upgrades) allows cable operators to justify rate increases
related to significant capital expenditures used to improve rate
regulated services. This option is extended only in cases of significant
upgrades requiring added capital investment, such as bandwidth capacity
and conversion to fiber optics, and for system rebuilds. Cable operators
that incur increases in operating costs associated with a significant
network upgrade will be permitted to charge additional rates as
justified by their FCC Form 1235 filing.

4\. On August 4, 1998, the LFA adopted an Order which adjusted
Operator\'s FCC Form 1235 and which reduced the maximum permitted rate
(\"MPR\") Operator could charge for its network upgrade add on. The LFA
based its decision in part on a report generated by the consulting firm
Public Knowledge.[^10] Operator challenges several of the LFA\'s
adjustments regarding Operator\'s FCC Form 1235 filing.

5\. The first issue raised by Operator is the LFA\'s disallowance of
imprudent and excessive plant construction cost. Our cost of service
rules allow operators to recover \"\[p\]rudent investment . . . in
tangible plant that is used and useful in the provision of regulated
cable services . . . Cost overruns are presumed to be imprudent
investment in the absence of a showing that the overrun occurred through
no fault of the operator.\"[^11] The LFA does not dispute that the
expenditures were actually incurred by Operator or that they benefitted
subscribers. Therefore, Operator\'s investment satisfies our used and
useful criterion.[^12] The LFA does argue that Operator\'s upgrade costs
were grossly higher than its original estimates and industry norms for
construction and attributes the excess to weak construction management
practices. Accordingly, the LFA feels that Operator has failed to
demonstrate that its construction costs were reasonable. The Operator
responds that the LFA has identified no specific areas of imprudent or
excessive expenditures.[^13] Moreover, Operator claims that it is able
to account for all expenditures claimed, that its original budget was
based on a 400 MHz rebuild rather than the 750 MHz upgrade actually
completed, which explains the large variances to which LFA objects, and
that its costs are not outside the normal range. Although weak
construction management practices may be a cause of cost overruns, poor
budgeting practices could as easily explain the variance. Due to
Operator\'s continued reliance on the 400 MHz budget for a 750 MHz
upgrade, the comparison of flawed budgetary data with actual costs does
not provide a meaningful basis for demonstrating cost overruns. Neither
party has provided significant information regarding how Operator\'s
costs compare with industry norms. Consequently, we find that there is
insufficient basis to exclude costs on the basis of cost overruns.

6\. Operator\'s second issue concerns the LFA\'s allocation of headend
costs. Operator allocated all of its rebuild costs, including headend
costs, to the San Luis Obispo County franchises covered in its FCC Form
1235 filing. Operator argues that only San Luis Obispo has been rebuilt
to 750 MHz and, therefore, only those subscribers are deriving benefit
from the bandwidth expansion and attendant headend costs. The LFA argues
that the headend serves the entire system of which San Luis Obispo is a
part and, therefore, only a portion of the headend costs are assignable
to San Luis Obispo. The LFA also notes that a share of the reported
costs relate to relocation of the headend, which was undertaken by
Operator on its own initiative, and that additional costs to provide
service to system customers will not be required. Because the headend
serves the entire system and all system subscribers will ultimately
benefit from the expenditures made, it would be unreasonable to impose
all of the additional headend costs on San Luis Obispo subscribers. We
find that the LFA acted reasonably to allow only a portion of the
headend costs proposed by Operator into the rate base. This finding is
consistent with the treatment of headend costs in *Falcon Cable Systems
Company*.[^14]

7\. Third, Operator questions the LFA\'s finding that Operator is
attempting to over recover its actual upgrade investment by reporting
only its upgrade additions on FCC Form 1235 while failing to account for
assets removed from service pursuant to the upgrade. Operator argues
that its baseline rates for San Luis Obispo County were set under the
Commission\'s benchmark methodology, and that it would be inconsistent
and inappropriate to reduce benchmark based rates by cost based
retirements. Moreover, Operator believes that FCC Form 1235 is intended
to account for \"total upgrade investment\" rather than upgrade
investment net of retired assets, and that the FCC Form 1235
instructions do not prescribe an adjustment for retired assets.[^15] The
FCC Form 1235 Purpose and Filing Instructions provide, in part, that
upgrade rate increases are to include \"the actual cost of the capital
improvement, less any gains realized from the disposition of property,
plant and equipment used prior to the upgrades\"[^16] irrespective of an
operator\'s initial rate setting methodology. The benchmark rate
reflects the average cost experience of competitive systems comparable
to San Luis Obispo, including those with upgraded networks.[^17] The
benchmark system presumes that the rate charged allows recovery of
capital costs.[^18] Therefore, the subtraction of retired assets on an
actual cost basis is appropriate. In our *Cost Order*, we concluded that
\"the cost of premature abandonments should be a recoverable operating
expense rather than an element in the rate base.\"[^19] Operator is
permitted under our rules to amortize any unrecovered investment over
the remaining original life of a retired asset.[^20] Therefore, our
rules protect subscribers by \"precluding recovery of a rate of return
on abandoned plant, while preserving an opportunity for the cable
operator to invest in more advanced technology.\"[^21] Although the FCC
Form 1235 is a streamlined form, it is still based on cost of service
principles. While we do not require operators to recalculate their
initial regulated rates when using the FCC Form 1235, the LFA\'s
conclusion that cost increases must be offset by the value of retired
assets is reasonable and is consistent with *Falcon Cable Systems
Company*.[^22]

8\. The fourth issue raised by Operator concerns the LFA\'s revision of
Operator\'s allocation method. Operator allocated all of its upgrade
costs based on the channel lineup resulting from the upgrade. The LFA
argues that, in addition to providing improved quality and reliability,
the upgrade adds capacity and that more costs should be assigned to
added channels than existing channels. We find the LFA\'s adjustment to
be unreasonable because Operator allocated its costs in a manner
consistent with the Commission\'s cost of service rules.[^23] We have
previously stated that \"a straight channel ratio would be a reasonable
approach to the allocation of plant costs amongst service
baskets.\"[^24] We conclude that the Operator\'s allocation method is
reasonable.

9\. The final issue raised by Operator in its Petition is the LFA\'s
treatment of Operator\'s failure to report on the FCC Form 1235 any
additional advertising or home shopping revenues attributable to the
upgrade. The FCC Form 1235 Instructions for Worksheet A, Line 10 require
the Operator to \"\[i\]nclude the projected annual net increases or
decreases in ancillary revenues earned due to the implementation of the
upgrade, such as . . . advertising revenues\".[^25] Although the LFA
argues that advertising revenues increased significantly immediately
after the upgrade was completed, it has not demonstrated that the
increased advertising revenues are specifically attributable to the
added channels. In its Petition, Operator agreed to include the home
shopping revenues on the CPST but contends that it has not purchased or
installed any ad insertion hardware for newly added channels, and has no
plans to do so.[^26] Because Operator is not able to derive any revenue
from the ad avails on the added channels, and does not plan to derive
any revenue, we find the LFA\'s inclusion of projected advertising
revenues to be unreasonable.

10\. Accordingly, IT IS ORDERED that Falcon Cable Systems Company\'s
Petition for Review, File No. CSB-A-0589, filed September 3, 1998, IS
GRANTED IN PART and DENIED IN PART, and the matter IS REMANDED to the
County of San Luis Obispo, California for further proceedings consistent
with this decision.

11\. This action is taken pursuant to authority delegated by section
0.321 of the Commission\'s Rules.

FEDERAL COMMUNICATIONS COMMISSION

William H. Johnson

Deputy Chief, Cable Services Bureau

[^1]: Communications Act, Section 623(c), 47 U.S.C. §543(c) (1996).

[^2]: Communications Act, Section 623 (a) (1) and (2).

[^3]: On December 17, 1998, the Commission released an order resolving a
    complaint filed by the LFA against Operator\'s CPST rates. *See*
    Falcon Cable Systems Company, DA 98-2563 (released December 17,
    1998) (adjustments made to calculation of maximum permitted rate for
    network upgrade).

[^4]: Section 76.944 of the Commission\'s rules, 47 C.F.R. §76.944.

[^5]: *See* Implementation of Sections of the Cable Television Consumer
    Protection and Competition Act of 1992: Rate Regulation, Report and
    Order and Further Notice of Proposed Rulemaking, 8 FCC Rcd 5631,
    5729, ¶147 (1993) (\"*Rate Order*\"); *see also* Implementation of
    Sections of the Cable Television Consumer Protection and Competition
    Act of 1992: Rate Regulation, Buy-Through Prohibition, Third Order
    on Reconsideration, MM Docket 92-266, 9 FCC Rcd 4316, 4341, ¶67
    (1994).

[^6]: *Id*.

[^7]: *Rate Order*, 8 FCC Rcd at 5731, ¶149.

[^8]: 9 FCC Rcd 4527, 4674, ¶285, *et seq*. (1994). *See also* 47 C.F.R.
    §76.922(j)(5). Unlike the benchmark/price cap element of a cable
    operator\'s rate, the upgrade surcharge will not be adjusted for
    inflation but will be a fee charged over the useful life of the
    improvement determined in accordance with the Commission\'s cost of
    service requirements.

[^9]: *Id.* at 4674, ¶285.

[^10]: *See* Letter dated July 1, 1998 to Ellen Sturtz, Franchise
    Coordinator, County of San Luis Obispo, from Jay C. Smith,
    President, Public Knowledge.

[^11]: Section 76.922(h)(i)(6)(i) of the Commission\'s rules, 47 C.F.R.
    §76.922(h)(i)(6)(i). *See also* *Cost Order*, 9 FCC Rcd at 4593,
    ¶118.

[^12]: *Cost Order*, 9 FCC Rcd at 4545, ¶37, *et seq*.

[^13]: The Operator did remove one item of expense from the rate base in
    response to the LFA\'s concern and filed a revised FCC Form 1235
    with its Petition for Review.

[^14]: DA 98-2563 at ¶8 (released December 17, 1998).

[^15]: Petition at p. 5.

[^16]: *See* FCC Form 1235 Instructions at p. 1. *See also* *Cost
    Order*, 9 FCC Rcd at 4550, ¶45.

[^17]: *See* *Cost Order*, 9 FCC Rcd at 4675, ¶286.

[^18]: *Id.*

[^19]: *See* *Cost Order*, 9 FCC Rcd at 4593, ¶119.

[^20]: *Id.*

[^21]: *Id.*

[^22]: DA 98-2563 at ¶9 (released December 17, 1998).

[^23]: *See* Section 76.924(f)(7) of the Commission\'s rules, 47 C.F.R.
    §76.924(f)(7). *See also* Cox Communications of San Diego, Inc., 13
    FCC Rcd 17653, 17658 at ¶15 (1998).

[^24]: *See* Implementation of Sections of the Cable Television Consumer
    Protection and Competition Act of 1992: Rate Regulation and Adoption
    of Uniform Accounting System for Provision of Regulated Cable
    Service, 11 FCC Rcd. 2220, 2270, ¶123 (1996) (\"*Final Cost
    Order*\").

[^25]: FCC Form 1235 Instructions at p. 11.

[^26]: Petition at p. 7.