National Grid Group plc Acquisition of
New England Electric System
Appendix C: Proposed Intrasystem Service Transactions
This Appendix describes the manner in which services will be provided to the NEES Group companies by their associates after the Merger. Capitalized terms used in the Appendix have the meanings assigned to these terms in the Order.
I. Scope of Services
After consummation of the Merger, New England Power Service Company (the "NEES Service Company") will continue to provide the NEES Group companies with a variety of administrative, management and support services. A Standard Form of Service Contract ("Standard Form"), attached to the application as Exhibit B-2, will govern the charges between the NEES Service Company and the NEES Group companies.1
In addition, National Grid System companies may provide services to the NEES Group companies; and, to a lesser extent, NEES Group companies may provide incidental services to National Grid System companies. The Merger Applicants contemplate that the majority of services will flow from the National Grid System companies to the NEES Group companies. In particular, National Grid Company will be the principal entity providing services, and the NEES Service Company will be the principal recipient of services. The charges to the NEES Group will be primarily from National Grid Company to the NEES Service Company, which will reallocate the charges as appropriate to NEES Group companies.
The services to be provided to the NEES Service Company will fall into two principal categories. The first category, central administrative services, will be provided by National Grid Company. Administrative services will include shareholder services, investor relations, group accounts, senior management, human resources, payroll and pensions.2 The second category encompasses other services that will be rendered by National Grid System companies as specifically requested by NEES Group companies. This category will include engineering, consulting, laboratory services, research and development projects, and transmission best-practices consulting.
Some services, such as corporate finance and business development, are solely concerned with events outside normal operations. The Applicants state that the NEES Group companies will not be charged with any costs relating to these departments, unless their services are specifically requested. In addition, charges for costs associated with future mergers and acquisitions may be allocated to NEES and/or to other National Grid Group companies, but not to the NEES Subsidiaries.
II. Allocation of Service Costs Among NEES Group Companies
We generally evaluate and approve the allocation methods proposed for use in section 13(b) transactions. We have assessed the methods proposed by the Merger Applicants and believe that they satisfy the requirements of section 13 and related rules.
The costs of services provided by the NEES Service Company and National Grid System companies will be directly assigned, distributed or allocated by activity, project, program, work order or other appropriate basis. The Merger Applicants expect that the majority of costs billed by companies in the National Grid System to the companies in the NEES Group will be paid initially by the NEES Service Company, which will then charge the appropriate recipient of the services. The Merger Applicants envision two types of charges.
First, for services rendered specifically for the NEES Group or its individual companies, costs will be directly attributed to specific subsidiaries when it is possible to do so accurately. The costs of engineering or laboratory services are routinely billed directly, based on an employee-hour basis. The Merger Application lists the services that are expected to be billed directly and those services that benefit the National Grid System as a whole.
Second, NEES Group companies will pay their share of the cost of services that benefit them as members of the National Grid System. Their share will be determined by a two-step process. The NEES Group's portion of these costs will be determined using measures that reflect the relevant contribution and size of the individual businesses. Allocation of group costs will follow the methodology adopted by the U.K. regulator, the Office of Gas and Electricity Markets ("OFGEM"). The OFGEM approach uses four measures (revenues, operating profit, employee numbers and net assets) and allocates the group costs equally across the four. Revenues are adjusted to exclude the income resulting from NEES' sales of purchased power and NEES' income relating to stranded assets. National Grid Company will use figures from the latest published accounts to calculate the percentage of revenues, operating profit, employee numbers and net assets on an annualized basis, and these four percentages will be averaged to calculate the group allocation.
The NEES Service Company will allocate the costs of service among the NEES Group companies using one of several methods. The NEES Service Company will choose the method that most accurately distributes the costs. The method of cost allocation variesbased on the department rendering the service.
The largest category of costs billed to the NEES Group companies will be similar to a category of costs currently being billed by the NEES Service Company: shareholder services, investor relations and group accounts. The next largest category of costs is the cost of National Grid's senior management. To the extent that these costs cannot be attributed to a specific NEES Subsidiary, the NEES Service Company currently uses a formula that allocates 25% of these costs to NEES and 75% to the NEES Subsidiaries, based on operation and maintenance expenses. The NEES Service Company proposes to use this allocation formula to allocate National Grid's senior management time and costs, to the extent that these costs cannot be attributed to a specific NEES Subsidiary.
Another major category of billings is expected to be costs incurred for human resources, payroll and pension services. The NEES Service Company proposes to allocate these costs to the NEES Subsidiaries using a formula currently in place that is based on the number of employees in each company. This formula exists specifically for use by NEES' existing human resources and payroll departments.
The remaining costs that are to be billed are comparatively minor and of a general nature. Under the NEES Service Company's accounting system, costs incurred in a department that are general in nature, such as supervision or secretarial support costs, are charged to a department overhead account. Department overhead costs are billed based on how the payroll of that department is charged to the companies for which the NEES Service Company performs services. The costs billed by the remaining National Grid Company departments will be charged to the applicable NEES Service Company department overhead account. These costs will, in turn, be billed out by the NEES Service Company based on the manner in which that NEES Service Company department charges its time.
III. Calculation of Service Costs; Currency Translation
Employees of the NEES Service Company will record transactions utilizing the data capture and accounting systems of each client company. Costs will be accumulated in accounts of the NEES Service Company and directly assigned, distributed and allocated to the appropriate client company in accordance with the guidelines set forth in Schedule II of the Standard Form.
The NEES Service Company's accounting and cost allocation methods and procedures are structured so as to comply with our standards for service companies in registered holding company systems. The NEES Service Company's billing system will use the Uniform System of Accounts for Mutual Service Companies and Subsidiary Service Companies, which we have established for service companies of registered holding company systems. Further, charges for all services provided by the NEES Service Company to associate companies will be on an at-cost basis, as determined under rules 90 and 91.
With respect to services provided to the NEES Group by National Grid Company and other National Grid System companies, appropriate policies and procedures will be used to assure that all costs are identified and attributed to particular projects, programs or work orders for purposes of direct cost allocation. Records related to services provided will be made available to our staff for review.
As required by rule 91, the costs allocated across the businesses served by National Grid Company will, to the extent possible, represent the total true cost of providing the corporate service. The costs considered in the allocation will include: (i) total payroll and associated costs; (ii) materials and consumable costs; (iii) building and facilities costs; (iv) information systems infrastructure costs; and (v) other departmental costs.
Rates for National Grid Company charges to the NEES Service Company will be calculated by dividing total cost by total time worked. This method of calculation will ensure total recovery of departmental costs on a monthly basis, with minimal fluctuation of hourly rates. Budgeted rates will be available for forecasting purposes. All charges to NEES Group from the National Grid System companies will be billed in U.S. dollars under currency exchange rates existing at the time the invoice is prepared.
National Grid Company will bill the NEES Service Company monthly in arrears. The billing format will list charges by corporate department, detailing total time applicable to NEES Group companies, multiplied by the current rate, to give the total charge for the month.
If National Grid Company provides services for the benefit of a specific NEES company, the charge applicable to that company will be specifically identified in the invoice. Otherwise, National Grid Company's charges will be allocated to individual NEES companies through the NEES' Service Company's allocation cycle, as described above.
V. Forecast of Charges to the NEES Service Company
The Merger Applicants estimate that total charges to the NEES Group will be about $8.3 million annually, representing approximately 7.5% of total NEES Group corporate costs. The Merger Applicants also forecast that the Merger will reduce the level of certain services carried out within NEES. Related savings are estimated at approximately $8.4 million annually. Accordingly, the annual cost of services provided by National Grid Company to the NEES Group will be somewhat less than the service costs savings attributable to the Merger.
VI. Restrictions on the NEES Service Company
No change in the organization of the NEES Service Company, the type and characterof the companies to be served (other than the amendment mentioned above to include services for the National Grid associate companies), the methods of allocating costs to associate companies, or the scope or character of the services to be rendered subject to section 13 of the Act or any rule or order under section 13 may be made unless the NEES Service Company gives us 60 days prior written notice of the proposed change. If we notify the NEES Service Company within the 60 day period that a question exists as to whether the proposed change is consistent with the provisions of section 13 of the Act or any related rule or order, the proposed change will not become effective. The NEES Service Company may then file with us an appropriate declaration regarding the proposed change.
VII. Reporting Requirements
The Merger Applicants also will report annually, as a supplement to the Form U-13-60 filed by NEES Service Company, service transactions among the National Grid System companies (excepting the NEES Group) and the NEES Group. The report will contain the following information:
(1) a narrative description of the services rendered by individual National Grid System companies (excepting the NEES Group) to the NEES Group and by the NEES Group to other National Grid System companies;
(2) disclosure of the dollar amount of services rendered according to category or department;
(3) identification of companies rendering services and recipient companies, including disclosure of the allocation of service costs among the companies in the NEES Group; and
(4) disclosure of the number of NEES Group employees engaged in rendering services to other National Grid System companies on an annual basis, stated as an absolute and as a percentage of total employees.
1 It is contemplated that the Standard Form will be amended to provide for services to entities that will become associate companies of NEES as a result of future mergers and acquisitions.
2 Even though NEES will no longer have public security holders, the NEES Subsidiaries will continue to have outstanding senior securities. Therefore, the NEES Subsidiaries will bear a portion of the costs of providing shareholder and investor services to security-holders of National Grid.