HomeMy WebLinkAboutPACE991.TC.docQ. Please state your name and address for the record.
A. My name is Terri Carlock. My business address is 472 West Washington Street, Boise, Idaho.
Q. By whom are you employed and in what capacity?
A. I am employed by the Idaho Public Utilities Commission as the Accounting Section Supervisor.
Q. Please outline your educational background and experience.
A. I graduated from Boise State University in May 1980, with a B.B.A. Degree in Accounting and in Finance. I have attended the annual regulatory studies
program sponsored by the National Association of Regulatory Utilities Commissioners (NARUC) at Michigan State University. I chaired the NARUC Staff Subcommittee on Economics and Finance for over 3 years. Under this subcommittee, I also chaired the Ad Hoc Committee on Diversification. I have also attended various finance conferences, including the Public Utilities Finance/Advance Regulation Course at the University of Texas at Dallas, National Society of Rate of Return Analysts' Financial Forums, Regulatory Economics and Cost of Capital Conference, and Standard & Poor's Corporation Telecommunications Ratings Seminar. Since joining the Commission Staff in May 1980, I have participated in several audits, performed financial analysis on various companies and have presented testimony before this Commission on numerous occasions.
Q. What is the purpose of your testimony in this proceeding?
A. The purpose of my testimony is to present the Staff's recommendations related to the proposed purchase transaction/merger of PacifiCorp and ScottishPower. I will discuss issues related to the merger that I examined. Issues not directly related to the merger should be addressed in separate proceedings or regulatory reviews.
Q. Please summarize the overall Staff recommendations.
A. The Staff recommends approval of the proposed purchase transaction/merger of PacifiCorp and ScottishPower with specific conditions and reporting mechanisms to be implemented.
Q. Are you sponsoring any exhibits to accompany your testimony?
A. Yes, I am sponsoring Exhibit Nos. 101 - 103.
Q. Please explain the overall approach Staff has taken to arrive at its merger recommendations?
A. Staff reviewed the requirements necessary for the Commission to approve the merger. As Staff discovered potential issues, it was determined if the issue was created by the merger or an issue to be addressed regardless of company ownership. Issues resulting from the merger should be evaluated to determine if the merger should be approved. The other issues may be identified but they should not be considered reasons to disapprove the merger. Instead current issues should be addressed in the upcoming rate review and any new issues that may develop should be addressed in future proceedings.
Q. What standards have been established for review of this proposed merger?
A. The applicable standards of review are set forth in Idaho Code 61-328 and Idaho Code, Title 61, Chapter 9, Issuance of Securities by Public Utilities.
Idaho Code 61-328 provides as outlined in Order
No. 27939, that no electric public utility shall sell, assign or transfer, directly or indirectly, any electric property unless authorized to do so by Order of the Public Utilities Commission. More specifically, this statute requires that the Commission must find:
1. The public interest will not be adversely affected;
2. The cost of and rates for supplying service will not be increased by reason of the merger; and
3. The Applicants have the bona fide intent and financial ability to operate and maintain said electrical property in the public service.
Idaho Code, Title 61, Chapter 9, Issuance of Securities by Public Utilities specifies the requirements PacifiCorp and ScottishPower, if the merger is approved, must follow to obtain authority to issue securities. Review of all security applications with the required financial statements and subsequent reports provides an important opportunity for the Staff to monitor the stated financial objectives of the merger.
Q. Have you considered these standards in making your recommendation?
A. Yes. These standards have been seriously considered and are the basis for the analysis upon which my recommendations are based. I will discuss each standard separately.
Q. Does Staff believe the public interest will not be adversely affected?
A. Yes, in fact Staff believes the public interest of Idaho customers will be enhanced by the customer guarantees, reliability and operating standards with guaranteed efficiencies and improvements proposed by ScottishPower. Staff witnesses Barker and Sterling provide additional analysis and recommendations in these areas.
Q. Will the cost of and rates for supplying service be increased by reason of the merger?
A. No. The cost of and rates for service will not increase due to the merger itself. The merger costs incurred to transact the merger through closing will be booked below the line and customers will not pay these costs. Exhibit No. 101 contains production request responses assuring the parties that merger costs and penalties paid if standards are not met will be recorded below the line and not paid by customers.
Operating efficiencies resulting from planned changes by ScottishPower will be reflected in the actual costs. ScottishPower has guaranteed operating efficiencies of at least $10 million annually on a system basis. These assurances are continually reflected throughout the record; Green testimony p. 9, lines 21-25, MacRitchie testimony p. 13, Staff Exhibit No. 102 and Staff witness Sterlings Exhibit No. 105, pgs. 2,19 (Richardson supplemental). If the minimum $10 million annual reduction is not achieved by the end of the third year, an amount equal to the difference between the $10 million and the efficiencies actually achieved must be moved below the line to be absorbed by shareholders. Annual reporting of efficiencies achieved must be provided to the Commission Staff to verify the savings along with an annual Commission-basis earnings report. ScottishPower commits to provide these reports in a format similar to that currently used by ScottishPower in the United Kingdom (UK). The actual report format can be modified for additional information required following completion of the merger. Staff will audit the annual Commission-basis earnings report and file an audit report with the Commission. The results of the audit and recommendations can be used to determine if the efficiencies have been achieved. If the efficiencies are not achieved, the procedure and actual adjusting entries can then be determined. This guarantee and annual review will be used to assure the Commission and customers that rates will not increase by reason of the merger.
Q. Does this mean that rates will never increase?
A. It does not appear that rates will increase as a result of the merger but that doesnt necessarily mean that rates will never increase. Any requested increases will be thoroughly reviewed to assure that cost increases as a result of the merger are not included in rates to be recovered from customers. The guaranteed efficiencies to be achieved during the five-year transition period and beyond could even reduce rates.
Q. Are you proposing rates be reduced as a condition of the merger?
A. I am not proposing rate reductions at this time. PacifiCorp rates will be reviewed in a separate proceeding this summer. The resulting rates from that case should assure parties and customers that rates are currently set at a fair and reasonable level. Synergies from combining operations will be smaller with this merger compared to mergers where corporate offices and operations are combined. I believe an immediate rate reduction based on merger efficiencies would be premature. As efficiencies are achieved and costs change, the actual revenue requirement will be reviewed annually during the five-year transition period. Any recommendations related to rate reductions or the use of excess earnings should be addressed in the annual reviews.
Q. What evidence have you reviewed showing that ScottishPower can achieve efficiencies on the PacifiCorp system?
A. My review of the due diligence reports, disclosure letters, board meeting minutes, annual reports and statements of regulatory accounts, shareholder circulars, proxy statements, and the production request responses in this case reflect areas where efficiencies may be achieved. Cost reductions or elimination of duplicate functions should occur in the areas of investor relations, shareholder services, corporate finance, corporate communications, legal services, corporate strategy, human resources and information technology.
A complete analysis of the systems, controls and operations can not be completed accurately until the merger transaction is final and closed. Until this analysis can be completed ScottishPower is reluctant to state the magnitude of the savings in specific departments. This information should be required as part of the efficiency reports and the ongoing review.
Q. Do the Applicants have the bona fide intent and financial ability to operate and maintain said electrical property in the public service?
A. Yes, I believe they do based on my review of financial statements, due diligence reports, disclosure letters, board meeting minutes, numerous production requests in this case and meetings with Company representatives. Q. Order No. 27939, p. 3 asks parties to address and respond to the following issue or question: Assurances that ScottishPower will not sell electric assets, reduce the work force.... Will the merger result in sale of individual assets or reduction of manpower?
A. Asset utilization and manpower operations will be part of the review conducted by ScottishPower to determine the most efficient use of resources. Increasing efficiency in operations may result in disposing of assets and eliminating positions that are unnecessary or duplicated. These changes can reduce the overall cost of service to customers and should be in their best interest providing customer service is not impaired. Sale of electric assets in Idaho must be approved by this Commission prior to the sale. Employee reductions at PacifiCorp have already reduced the overall level of employees. There may be additional reductions or changes in job functions. Staff witness Barker discusses her impression that the Idaho service territory is operating at a bare-bones level now.
Q. ScottishPower witness Green on pages 14-15 of his prefiled direct testimony proposes conditions to facilitate the merger. Do you recommend approval of these conditions?
A. Yes, I recommend approval of these conditions as the minimum requirements in each area discussed.
Q. Condition 9 states Neither ScottishPower nor PacifiCorp will assert in any future Commission proceeding that the provisions of the Public Utility Holding Company Act of 1935 preempts the Commissions jurisdiction over affiliated interest transactions. Please discuss the involvement of the SEC, the impact that may have on regulation in the state of Idaho and if the above condition is sufficient.
A. The SEC has jurisdiction over corporate securities transactions and intra-system financial relationships such as the allocation of costs in a registered holding company. This jurisdiction does not preempt state jurisdiction over rates.
The Idaho Commission will retain jurisdiction to approve issuance of securities Idaho Code, Title 61, Chapter 9, Issuance of Securities by Public Utilities. ScottishPower provides assurance that this Commission will have the final say on allocation factors and affiliate interest transactions reflected in Idaho rates as stated in Condition 9 above and Exhibit
No. 103 consisting of various production request responses on this point.
The Commissions authority pursuant to Title 61 of the Idaho Code, along with Condition 9 should provide sufficient assurance that Idaho will retain all regulatory authority after the merger that exists before the merger.
Q. Do you have concerns related to refinancing costs, payments to shareholders due to tax impacts, payment of Stamp Duty Reserve taxes resulting from the transaction, up-front payments and cost of new financing to implement the merger?
A. Yes. These costs are directly related to the merger transaction. They should be recorded below the line and not included in future calculations to determine embedded costs of capital.
The Stamp Duty Reserve Tax is a tax payable equal to 1.5% of the issue price of new shares issued in the merger in the form of new ScottishPower American Depository Shares. PacifiCorp will pay any tax due. This tax is a merger cost and should be recorded below the line.
Q. Does the size of the premium concern you?
A. The merger will be completed with the exchange of stock. The difference in stock prices for ScottishPower and PacifiCorp on the record date will determine the actual amount of the premium paid. At the time of the merger agreement the premium was estimated to be between 20% - 25%. This premium level does not appear to concern company external auditors or rating analysts. PacifiCorps share price is currently trading in a lower price range where the premium could be approximately 30%. The market to book ratio for PacifiCorp has been lower in 1998 and currently than in the mid 1990s. This lower ratio may be attributed to the losses incurred during 1998. I am not overly concerned about this premium level after reviewing the due diligence reports, analysts reports and market price trends.
Q. How will the premium be treated for ratemaking purposes?
A. ScottishPower will book the premium as goodwill on the balance sheet of ScottishPower. The goodwill will be amortized. The revaluation adjustments and goodwill are not recovered through rates. (Exhibit No. 101, p. 7). ScottishPower does not intend to recover the acquisition adjustment from customers. (Exhibit No. 101, p. 9).
Q. Are there currency exchange risks that are a concern?
A. Yes. Changes in interest rates and the currency exchange rates create risks that may increase the cost of financings or costs allocated. PacifiCorp has hedged these financing risks with the use of interest rate swaps, interest rate collars, interest rate futures and forwards and currency swaps. These risks can be managed and ScottishPower will be required to evaluate these risks and determine if appropriate hedges are warranted. A cost/benefit analysis comparing the costs with the risks are important to determine the feasibility of a hedge.
The allocation of ScottishPower UK costs to PacifiCorp do not necessarily need to be hedged. ScottishPower records transactions in foreign currencies at the rate at the date of transaction. I believe this method is reasonable for transactions with PacifiCorp or allocations to PacifiCorp. These transactions will be audited in future reviews.
Q. Are there differences between United States Generally Accepted Accounting Principles (US GAAP) and United Kingdom Generally Accepted Accounting Principles (UK GAAP)?
A. Yes. The principles differ in the treatment of goodwill, deferred taxes, pension costs, other post retirement benefits, debt and equity costs capitalized during construction, leveraged leases and the treatment of regulatory assets. The books of PacifiCorp will continue to follow US GAAP. The consolidated books of ScottishPower will continue to follow the UK GAAP with the PacifiCorp subsidiary results restated when consolidated. The restating adjustments resulted in both increases and decreases to net income and shareholders equity. The net result of the restatements for 1996, 1997 and 1998 was an increase in net income and an increase in shareholders equity. Since these restating adjustments are at the consolidation level, they should not impact the rates of Idaho customers.
Q. Please discuss further the reporting that should be required if this merger is approved.
A. The reports committed to by ScottishPower for customer service and reliability standards may need to be supplemented to address specific issues Idaho may have. The annual Commission-basis report will show the actual results of operation for the calendar year with adjustments shown separately. Additional documentation will be filed to show the detail behind all efficiencies achieved and detail reflecting all measurements to determine if the guarantees are met in all areas(i.e. customer service, reliability, circuit improvements and the minimum $10 million dollar efficiency expense reduction).
Q. If this Commission approves the merger and ScottishPower subsequently agrees to conditions or benefits in other jurisdictions, should these conditions and benefits also apply in Idaho?
A. Any assurances, conditions or benefits agreed to by ScottishPower or PacifiCorp in other jurisdictions that would create a benefit to Idaho customers should also be received in Idaho. Without such a condition, Idaho should wait to rule on the merger until all potential benefits agreed to by the companies in other jurisdictions can be included.
Q. Does this conclude your direct testimony in this proceeding?
A. Yes, it does.
PAC-E-99-1 CARLOCK, T (Di) 1
5/18/99 Staff
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