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 Power
Company (the Company) 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 the Company and its affiliate, The Narragansett Electric
Company (Narragansett Electric), that occurred effective September
1, 1998. New England Electric System (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 the Company. The Company and Narragansett Electric then sold
their nonnuclear generating assets, excluding the Company's
ownership interest in the Wyman 4 generating unit, as well as the
Company's newly acquired equity investment in NERC, to USGen. The
pro forma financial statement adjustments are based on the
Company's and Narragansett Electric's book value of the assets
being sold at June 30, 1998.
The substance of the transactions are detailed
in the entries shown below, but can be summarized as follows:
- - The Company, 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.
- - The Company absorbed $20 million, before tax, of transaction
costs in income.
- - The Company 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 $22 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.
- - The Company retired $278 million of long-term debt and $367
million of short-term debt.
- - The Company recorded a liability and offsetting regulatory
asset reflecting the present value of the Company'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
Less: Narragansett Electric proceeds 41,909,077
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NEP net proceeds $1,666,525,089
USGen has also assumed certain on-site hazardous waste
obligations for which the Company had recorded on its books an
accrued liability of $141,787 at June 30, 1998. In addition, in
1992, the Company 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, the Company 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 $1,666,525,089
Utility Plant - Decrease $1,783,801,668
Accumulated Provision
for Depreciation - Decrease 807,674,400
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 37,529,435
Prepaid and Other
Current Assets - Decrease 17,876,650
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 $22,332,745
ITC amortization - Decrease $22,332,745
Deferred income
tax expense - Increase 8,760,019
Reserve for deferred
income taxes - Increase 8,760,019
<To record ITC amortization and related taxes associated with
property sold.>
Debit Credit
Entry 3: ----- ------
Current income tax - Increase $220,440,519
Current income tax - Decrease $ 7,845,000
Accrued income
taxes payable - Increase 212,595,519
Deferred income
tax expense - Decrease 220,440,519
Reserve for deferred
income taxes - Decrease 220,440,519
<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 the Company'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 $ 4,333,131
Other Reserves and
Deferred Credits - Decrease 60,542,199
Utility Plant - Decrease $64,875,330
<To eliminate the Company's capital lease obligation, under the
Hydro-Quebec transmission line support agreements, which was
assumed by USGen.>
Entry 6:
Long-term debt - Decrease $278,010,000
Short-term debt - Decrease 366,950,000
Accrued income
taxes payable - Decrease 212,595,519
Cash - Decrease $857,555,519
<To record the retirement of long-term and short-term debt and the
payment of taxes due on the sale.>
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 the Company's monthly fixed
contribution to USGen for purchased power under the Purchased
Power Agreements Transfer Agreement (PPA Transfer Agreement)
discussed below.>
Entry 8:
Investment in NERC - Increase $34,483,668
Other paid-in-capital - Increase $34,483,668
<To record the transfer of NEES' investment in NERC to the
Company.>
Entry 9:
Accrued liabilities - Decrease $141,787
Deferred federal and state
income tax - Increase $55,616
Retained earnings - Increase 86,171
<To record elimination of hazardous waste liability.>
4. In addition to the APA, the Company and USGen entered into
several ancillary agreements. One such agreement is the PPA
Transfer Agreement. Under the PPA Transfer Agreement, USGen will
purchase the Company's entitlements of approximately 1,100 MW of
power procured by the Company under long-term contracts with
utility and non-utility generators, which have terms expiring as
late as 2019. Under the PPA Transfer Agreement, the Company will
make a monthly fixed contribution with USGen reimbursing the
Company for the balance of the costs. The Company's contributions
will end in January 2008. The present value of these
contributions has been recorded as a regulatory asset, 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.
The Company 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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The rates the Company 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. The Company's rates
have historically been set by regulators on a bundled basis in a
manner which attempts to reimburse the Company 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 the Company's net investment in utility property, plant
and equipment.
The Company'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 the Company for portions of 1998. A
full discussion of these changes is available in the Company's
1997 Annual Report on Form 10-K. Due to the fact that the Company
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 the Company 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 the Company's business, for which allocation factors
for the various categories, contemplated in the Company'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 the Company's effective tax rate were able to be
allocated on a specific identification basis between assets sold
versus retained.
Other Income (Expense)
Since the Company'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.