Notes to Unaudited Pro Forma Financial Statements
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Balance Sheet
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1. The historical financial statements of the New England
Electric System (NEES) as of June 30, 1998 have been adjusted to
give effect to the transaction between USGen New England,
Inc.(USGen), an indirect wholly owned subsidiary of PG&E
Corporation, and NEES subsidiaries New England Power Company
(NEP) and The Narragansett Electric Company (Narragansett
Electric) that occurred effective September 1, 1998. NEES first
contributed its investment in Narragansett Energy Resources
Company (NERC), which was a 20 percent owner of the Ocean State
Power generating units, to NEP. NEP and Narragansett Electric
then sold their nonnuclear generating assets, excluding NEP's
ownership interest in the Wyman 4 generating unit, as well as
NEP's newly acquired equity investment in NERC, to USGen. The pro
forma financial statement adjustments are based on NEP and
Narragansett Electric's book value of the assets being sold at
June 30, 1998. In virtually all instances, the consolidated pro
forma adjustment amount relates primarily to NEP, as NEP owned
greater than 95 percent of the net book value of the assets sold.
The substance of the transactions are detailed in the entries
shown below, but can be summarized as follows:
- - NEP, Narragansett Electric and NEES sold assets (plant assets,
materials and supplies inventory and NEES' investment in NERC)
with a book value of $1.1 billion for proceeds of
approximately $1.6 billion. The resulting gain was credited
to a regulatory liability account reflecting the obligation to
pass this gain on to ratepayers in connection with
restructuring rate settlement agreements.
- - NEP absorbed $20 million, before tax, of transaction costs in
income.
- - NEP received additional proceeds of $85 million from USGen,
which were used to offset the recognition of a liability for
employee severance and early retirement costs.
- - Approximately $24 million, before tax, of unamortized
investment tax credits associated with assets sold was
credited to income.
- - Certain capital lease assets and obligations were eliminated
as a result of these capital lease obligations being
transferred to USGen.
- - NEP retired $278 million of long-term debt and $367 million of
short-term debt, Narragansett Electric retired $39 million of
short-term debt, and NERC retired $28 million of long-term
debt.
- - NEP recorded a liability and offsetting regulatory asset
reflecting the present value of NEP's monthly fixed
contribution to USGen in connection with purchased power
contracts transferred to USGen. In addition, in connection
with the direct assignment of one of these purchased power
contracts, the Company made a lump sum payment to USGen in
lieu of ongoing monthly payments. This lump sum payment was
also reflected as a regulatory asset.
2. The cash proceeds and disposition of those proceeds reflected
in these financial statements is as follows:
Cash proceeds:
Per Asset Purchase Agreement (APA) $1,590,000,000
Reimbursement of early retirement
and severance costs 85,000,000
Materials & Supplies at book value 10,858,481
Reimbursement of purchased power
contract prepayment 5,046,250
Fuel inventory at book value 37,529,435
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Total proceeds $1,728,434,166
Use of proceeds:
Pay transaction costs 20,000,000
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Total net proceeds $1,708,434,166
NEP proceeds $1,666,525,089
Narragansett Electric proceeds $ 41,909,077
USGen has also assumed certain on-site hazardous waste
obligations for which NEP had recorded on its books an accrued
liability of $141,787 at June 30, 1998. In addition, in 1992, NEP
and Narragansett Electric entered into a 10 year tax treaty with
the City of Providence, Rhode Island which required the companies
to prepay certain property taxes prior to completion of the
Manchester Street repowering project. Upon completion of the
repowering project, NEP and Narragansett Electric were amortizing
such payments over the remainder of the term of the treaty. These
prepaid property taxes offset the gain on sale of these assets
being credited to a regulatory liability account.
3. Entries to record the effect of the sale:
Debit Credit
Entry 1: ----- ------
Cash - Increase $1,708,434,166
Utility Plant - Decrease $1,827,186,354
Accumulated Provision
for Depreciation - Decrease 811,212,756
Construction Work
in Progress - Decrease 5,087,229
Non-Utility property - Decrease 769,000
Investment in NERC - Decrease 34,483,668
Material and Supplies,
at average cost - Decrease 10,858,481
Fuel inventory - Decrease 37,591,252
Prepaid and Other
Current Assets - Decrease 19,302,250
Deferred Charges and Other
Assets - Decrease 575,330
Other Current Liabilities -
Early Retirement and
Severance Costs - Increase 85,000,000
Miscellaneous deductions -
Transaction costs - Increase 20,000,000
Other Reserves and Deferred
Credits - Increase 518,793,358
<To record the sale transaction and expense of transaction
costs.>
Entry 2:
Unamortized Investment
Tax Credits (ITC) - Decrease $23,959,059
ITC amortization - Decrease $23,959,059
Deferred income
tax expense - Increase 9,329,229
Reserve for deferred
income taxes - Increase 9,329,229
<To record ITC amortization and related taxes associated with
property sold.>
Debit Credit
Entry 3: ----- ------
Current income tax - Increase $225,537,414
Current income tax - Decrease $ 7,845,000
Accrued income
taxes payable - Increase 217,692,414
Deferred income
tax expense - Decrease 225,537,414
Reserve for deferred
income taxes - Decrease 225,537,414
<To record income taxes on the sale.>
Entry 4:
Other Reserves and
Deferred Credits - Decrease $2,335,449
Fuel, Materials, and Supplies,
at average cost - Decrease $2,335,449
<To transfer NEP's accumulated losses from its affiliate, New
England Energy Incorporated, from its fuel inventory account to
its regulatory liability account.>
Entry 5:
Other Accrued
Expenses - Decrease $ 1,305,144
Other Reserves and
Deferred Credits - Decrease 9,571,059
Utility Plant - Decrease $10,876,203
<To eliminate NEP's capital lease obligation,under the Hydro-
Quebec transmission line support agreements,which was assumed by
USGen.>
Entry 6:
Long-term debt - Decrease $303,770,000
Long-term debt due in
one year - Decrease 1,920,000
Short-term debt - Decrease 623,642,414
Cash - Decrease $929,332,414
<To record the retirement of long-term and short-term debt.>
Debit Credit
Entry 7: ----- ------
Deferred Charges
and Other Assets - Increase $1,016,641,825
Other Reserves
and Deferred Credits - Increase $867,153,867
Cash - Decrease 149,487,958
<To record the liability and offsetting regulatory asset
reflecting the present value of NEP's monthly fixed contribution
to USGen for purchased power under the Purchased Power
Agreements Transfer Agreement (PPA Transfer Agreement) discussed
below.>
Entry 8:
Accrued liabilities - Decrease $141,787
Reserve for deferred income
taxes - Increase $55,616
Retained earnings - Increase 86,171
<To record elimination of hazardous waste liability.>
4. In addition to the APA, NEP and USGen entered into several
ancillary agreements. One such agreement is the PPA Transfer
Agreement. Under the PPA Transfer Agreement, USGen will purchase
NEP's entitlements of approximately 1,100 MW of power procured by
NEP under long-term contracts with utility and non-utility
generators, which have terms expiring as late as 2019. Under the
PPA Transfer Agreement, NEP will make a monthly fixed
contribution, with USGen reimbursing NEP for the balance of the
costs. NEP's contributions will end in January 2008. The
present value of these contributions has been recorded as a
regulatory asset on NEP's books, as described in Entry 7 above.
5. In addition to the transactions portrayed herein, certain
other indirectly related transactions have taken place in
September 1998 which are not reflected in these pro forma
financial statements. NEP paid a special common dividend of
approximately $130 million, and also repurchased approximately
$30 million of its preferred stock held by NEES. Additionally,
the NEES Board of Directors authorized the purchase from time to
time of up to an additional 5 million shares over the 5 million
share buyback authorization announced in August 1997. To date,
NEES has purchased approximately 4.8 million shares.
Income Statement
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In preparing the NEES Pro Forma Statements of Consolidated
Income, the pro forma adjustments represent the compilation of
the pro forma adjustments for its subsidiaries NEP and
Narragansett Electric, net of necessary eliminations as described
below. In virtually all instances, the consolidated pro forma
adjustment amount relates primarily to NEP, as NEP owned greater
than 95 percent of the net book value of the assets sold. The pro
forma adjustments also reflect the ultimate disposition of NEES'
investment in NERC, as discussed above. The following
discussion summarizes management's process in arriving at the pro
forma adjustments for both NEP and Narragansett Electric.
NEP
The rates NEP charged its customers were not separately set
for its individual assets and, as a result, it was not possible
to determine from billing records the amount of revenues that
would be attributable to the assets sold. NEP's rates have
historically been set by regulators on a bundled basis in a
manner which attempts to reimburse NEP for the cost of operating
and maintaining its facilities plus providing it a reimbursement
for interest expense, preferred dividends and a return on its
equity investment and related income taxes. In the rate making
process, the calculation of the reimbursement for these capital
related costs is through the determination of rate base, which is
composed of the net investment in assets devoted to providing
service to customers. The principal component of rate base is
NEP's net investment in utility property, plant and equipment.
NEP's Pro Forma Statements of Income have been prepared by
first allocating net income based on the percentage breakdown of
net plant investment sold, exclusive of capital leases, versus
assets retained. This results in 54.05 percent of historical net
income removed as a pro forma adjustment.
This net plant investment calculation was similarly used,
with some modification which will be described later, for
interest expense and income taxes. For most other income
statement accounts, management utilized a more specific
identification approach. Once having allocated net income in the
manner described above and once having allocated the other income
statement accounts, it was possible to derive a revenue figure
for the assets sold versus retained following essentially a
similar process that the regulatory rate making process would use
to derive a revenue requirement.
While the above discussion is applicable to 1997, the impacts
of industry restructuring during 1998 resulted in the unbundling
of certain revenue streams for NEP for portions of 1998. A full
discussion of these changes is available in the NEP 1997 Annual
Report on Form 10-K. Due to the fact that NEP had both bundled
and unbundled revenue streams during 1998, and the associated
complexities in attempting to meld multiple methodologies,
management elected to utilize the approach described below for
the pro forma income statement for both the year ended December
31, 1997 and the six months ended June 30, 1998.
Interest Expense
The plant-based methodology utilized for net income was
similarly utilized for the calculation of pro forma adjustments
for interest expense on long-term debt, other interest and
allowance for borrowed funds used during construction. However,
once having allocated total long-term debt outstanding between
assets sold versus retained using the net plant investment
approach, it was possible to perform a more specific allocation
of lower cost pollution control debt outstanding versus higher
cost other long-term debt outstanding. This resulted in more of
the lower cost pollution control debt being associated with
assets retained and assigned more interest expense to the assets
sold.
Purchased Power
Pro forma adjustments for purchased power were derived via
specific identification of purchased power contracts subject to
the PPA Transfer Agreement between NEP and USGen, net of the
monthly fixed contributions towards purchased power, as discussed
in Item 2 above.
Fuel expense, other operation expense, maintenance expense,
depreciation and amortization expense, and taxes, other than
income taxes
Pro forma adjustments for these income statement captions
were calculated primarily by specific identification of costs.
The only significant exception in this area is for the
transmission portion of NEP's business, for which allocation
factors for the various categories, contemplated in NEP's current
transmission cost-of-service, were utilized.
Income Taxes
Income taxes were allocated primarily based on the derivation
of net income using the net plant investment allocation approach
described above. However, certain items which have the effect of
changing NEP's effective tax rate were able to be allocated on a
specific identification basis between assets sold versus
retained.
Other Income (Expense)
Since NEP's ownership interest in nuclear power companies was
not sold, the equity in income in these companies will be
retained. With respect to other costs included in other income,
these represent primarily incentive compensation costs, other
executive benefit costs and donations and lobbying costs. These
costs were allocated primarily based on either the historical
allocation of internal salaries and wages or the allocation of
net investment between assets sold versus retained.
Narragansett Electric
Historically, the entire output of Narragansett Electric's
generating capacity was made available to NEP. Narragansett
Electric was then compensated by NEP for its fuel costs and other
generation and transmission related costs, through purchased
power credits received from NEP under an approved generation and
transmission credit regulatory filing (G&T Credit Filing). These
purchased power credits are eliminated in consolidation at NEES.
Wherever possible, management utilized a specific
identification approach in the determination of pro forma income
statement adjustment amounts, which, in most cases, closely
mirrored amounts contemplated for reimbursement under the G&T
Credit Filing. The one exception relates to operation and
maintenance costs, where actual costs differed in the six months
ended June 30, 1998 due to a timing lag related to the
reimbursement of G&T Credit Filing costs as compared to actual
costs. In several cases, where specific identification of costs
related to the assets sold was not possible, management utilized
amounts and percentages contemplated in the approved G&T Credit
Filing. Specifically, the G&T Credit Filing was used in the
determination of adjustment amounts for the general and
administrative component of other operating expense and
maintenance expense, interest expense, and taxes, other than
income taxes expense.