-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BSFVJS160+VYW4kO6WaKUOpDdTfohCSl/mfdCS8FCBDSFG1xhUBWr65tyDMaZGnW 0ys0In6PghzQw+x6Q7YXMA== 0000898080-97-000189.txt : 19970822 0000898080-97-000189.hdr.sgml : 19970822 ACCESSION NUMBER: 0000898080-97-000189 CONFORMED SUBMISSION TYPE: U-1/A PUBLIC DOCUMENT COUNT: 10 FILED AS OF DATE: 19970813 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CONECTIV INC CENTRAL INDEX KEY: 0001029590 STANDARD INDUSTRIAL CLASSIFICATION: 4931 IRS NUMBER: 510379417 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: U-1/A SEC ACT: 1935 Act SEC FILE NUMBER: 070-09069 FILM NUMBER: 97659581 BUSINESS ADDRESS: STREET 1: 800 KING STREET P O BOX 231 CITY: WILMINGTON STATE: DE ZIP: 19801 BUSINESS PHONE: 3024293017 MAIL ADDRESS: STREET 1: 800 KING ST STREET 2: P O BOX 231 CITY: WILMINGTON STATE: DE ZIP: 19801 U-1 1 FORM U-1 File No. 70-9069 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------------------------- AMENDMENT NO. 1 TO FORM U-1 APPLICATION/DECLARATION UNDER THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935 --------------------------------- Conectiv, Inc. 800 King Street Wilmington, Delaware 19899 ---------------------------------- (Name of company filing this statement and address of principal executive offices) None ---------------------------------- (Name of top registered holding company parent) Barbara S. Graham Michael J. Barron President Vice President Conectiv, Inc. Conectiv, Inc. 800 King Street 6801 Black Horse Pike Wilmington, Delaware 19899 Egg Harbor Township, New Jersey 08234 (Names and addresses of agents for service) The Commission is requested to send copies of all notices, orders and communications in connection with this Application- Declaration to: Joanne C. Rutkowski, Esq. James M. Cotter, Esq. William S. Lamb, Esq. Vincent Pagano, Jr., Esq. H. Liza Moses, Esq. Simpson Thacher & LeBoeuf, Lamb, Greene & Bartlett MacRae, L.L.P. 425 Lexington Avenue 125 West 55th Street New York, New York 10017 New York, New York 10019 Dale Stoodley, Esq. Delmarva Power & Light Company James E. Franklin II, Esq. 800 King Street Atlantic Energy, Inc. Wilmington, Delaware 19899 6801 Black Horse Pike Egg Harbor Township, New Jersey 08234 TABLE OF CONTENTS Page Item 1. Description of Proposed Mergers...................................1 A. Introduction......................................................1 1. General Request..........................................2 2. Overview of the Mergers..................................2 B. Description of the Parties to the Mergers.........................3 1. General Description......................................3 a. Delmarva........................................3 b. Atlantic........................................4 c. Conectiv and its Subsidiaries...................6 i. Conectiv (6); ii. Delmarva (7); iii. Delmarva's Subsidiaries (7); iv. ACE (7); v. AEE (7); vi. AEII (7); vii. Support Conectiv (8); viii. DS Sub (8) 2. Description of Facilities................................9 a. Delmarva........................................9 i. General (9); ii. Electric Generating Facilities and Resources (9); iii. Electric Transmission and Other Facilities (10); iv. Gas Facilities (11); v. Other (11) b. Atlantic.......................................12 i. General (12); ii. Electric Generating Facilities and Resources (12); iii. Electric Transmission and Other Facilities (13); iv. Other (13) 3. Nonutility Subsidiaries.................................14 a. Delmarva.......................................14 b. Atlantic.......................................17 C. Description of the Mergers.......................................21 1. Background and Negotiations Leading to the Proposed Mergers........................................21 2. Merger Agreement........................................26 D. Benefit Plans....................................................27 E. Management and Operations of Conectiv Following the Mergers..........................................................27 F. Industry Restructuring Initiatives...............................29 Item 2. Fees, Commissions and Expenses...................................31 Item 3. Applicable Statutory Provisions..................................32 A. Legal Analysis...................................................33 1. Section 10(b)...........................................35 a. Section 10(b)(1)...............................36 i. Interlocking Relationships (36); ii. Concentration of Control (36) b. Section 10(b)(2) -- Fairness of Consideration..39 c. Section 10(b)(2) -- Reasonableness of Fees.....40 d. Section 10(b)(3)...............................41 2. Section 10(c)...........................................48 a. Section 10(c)(1)...............................49 i. Acquisition of Gas Operations (50); ii. Direct and Indirect Nonutility Subsidiaries of Conectiv (59) b. Section 10(c)(2)...............................68 i. Efficiencies and Economies (68); ii. Integrated Public Utility System (72) 3. Section 10(f)...........................................78 4. Other Applicable Provisions -- Section 9(a)(1)..........78 B. Intra-System Provision of Services...............................79 1. Support Conectiv........................................80 2. Other Services..........................................82 Item 4. Regulatory Approvals.............................................83 A. Antitrust........................................................83 B. Federal Power Act................................................84 C. Atomic Energy Act................................................84 D. State Public Utility Regulation..................................84 Item 5. Procedure........................................................86 Item 6. Exhibits and Financial Statements................................86 A. Exhibits.........................................................86 B. Financial Statements.............................................88 Item 7. Information as to Environmental Effects..........................88 Item 1. Description of Proposed Mergers A. Introduction This Application/Declaration seeks approvals relating to the proposed combination of Delmarva Power & Light Company ("Delmarva") and Atlantic Energy, Inc. ("Atlantic"), pursuant to which Delmarva and its direct subsidiaries and the direct subsidiaries of Atlantic will become direct subsidiaries of Conectiv, Inc. ("Conectiv"), a new Delaware holding company (the "Mergers").1 Following the consummation of the Mergers, Conectiv will register with the Securities and Exchange Commission (the "SEC" or "Commission") as a holding company under the Public Utility Holding Company Act of 1935 (the "Act"). - - -------- 1 Following consummation of the Mergers, Conectiv, Inc. will change its name to Conectiv. The Mergers are expected to produce substantial benefits to the public, investors and consumers, and meet all applicable standards of the Act. Among other things, Delmarva and Atlantic believe that the Mergers will allow the shareholders of each of the companies to participate in a larger, financially stronger company that, through a combination of the equity, management, human resources and technical expertise of each company, will be able to achieve increased financial stability and strength, greater opportunities for earnings growth, reduction of operating costs, efficiencies of operation, better use of facilities for the benefit of customers, improved ability to use new technologies, greater retail and industrial sales diversity and improved capability to make wholesale power purchases and sales. In this regard, Delmarva and Atlantic believe that synergies created by the Mergers will generate substantial cost savings which would not have been available absent the Mergers. Delmarva and Atlantic have estimated the dollar value of certain synergies resulting from the Mergers to be in excess of $500 million over a ten-year period. The expected benefits of the Mergers are discussed in further detail in Item 3.A.2.b.i. below. The shareholders of Delmarva and Atlantic approved the Mergers at their respective meetings held on January 30, 1997. Delmarva and Atlantic have submitted their applications requesting approval of the Mergers and/or related matters to their various state and federal regulators. Orders approving the mergers have been received from the Maryland Public Service Commission (the "MPSC") and the Federal Energy Regulatory Commission (the "FERC"). Applications are pending before the Delaware Public Service Commission (the "DPSC"), the Virginia State Corporation Commission (the "VSCC"), the New Jersey Board of Public Utilities (the "NJBPU"), the Pennsylvania Public Utility Commission (the "PPUC"), and the Nuclear Regulatory Commission (the "NRC"). Finally, both companies have made the required filings with the Antitrust Division of the U.S. Department of Justice (the "DOJ") and the Federal Trade Commission (the "FTC") under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act"). See Item 4 below for additional detail regarding these regulatory approvals. It is anticipated that favorable responses will be received from these regulators in the near future. Conectiv seeks to consummate the Mergers by year-end. In order to permit timely consummation of the Mergers and the realization of the substantial benefits they are expected to produce, Conectiv requests that the Commission's review of this Application/Declaration commence and proceed as expeditiously as practicable, and that the Commission order be issued in no event later than November 30, 1997. To the extent that all of the state and other approvals have not been received by that time, Conectiv asks the Commission to condition the effectiveness of its order upon receipt of all necessary state and other regulatory approvals. 1. General Request Pursuant to Sections 9(a)(2) and 10 of the Act, Conectiv hereby requests authorization and approval of the Commission to acquire, by means of the Mergers described below, all of the issued and outstanding common stock of Delmarva and Atlantic. Conectiv also hereby requests that the Commission approve: (i) the designation of Support Conectiv ("Support Conectiv") as a subsidiary service company in accordance with the provisions of Rule 88 of the Act and the Service Agreement as a basis for Support Conectiv to comply with Section 13 of the Act and the Commission's rules thereunder; (ii) the acquisition by Conectiv of the gas properties of Delmarva and the continued operation of Delmarva as a combination utility; (iii) the acquisition by Conectiv of the nonutility activities, businesses and investments of Delmarva and Atlantic; and (iv) the continuation of all outstanding intrasystem financing arrangements. 2. Overview of the Mergers Pursuant to an Agreement and Plan of Merger, dated as of August 9, 1996, as amended and restated as of December 26, 1996 (the "Merger Agreement"), DS Sub, Inc., a Delaware corporation and a direct subsidiary of Conectiv ("DS Sub"), will be merged with and into Delmarva, with Delmarva continuing as the surviving corporation (the "Delmarva Merger"), and Atlantic will be merged with and into Conectiv, with Conectiv as the surviving corporation (the "Atlantic Merger"). As a result of the Delmarva Merger and the Atlantic Merger, Delmarva and its direct subsidiaries and certain direct subsidiaries of Atlantic will become direct subsidiaries of Conectiv, and Conectiv will be a holding company within the meaning of the Act. A chart of the proposed corporate structure of Conectiv following consummation of the Mergers is attached hereto as Exhibit E-4. The common shareholders of Delmarva will receive for each issued and outstanding share of common stock, par value $2.25 per share, of Delmarva (the "Delmarva Common Stock"), one share of common stock of Conectiv, par value $.01 per share ("Conectiv Common Stock"). The common shareholders of Atlantic will receive for each issued and outstanding share of common stock, no par value per share, of Atlantic (the "Atlantic Common Stock"), 0.75 shares of Conectiv Common Stock and 0.125 shares of Class A common stock of Conectiv, par value $.01 per share ("Conectiv Class A Common Stock"). Following the Mergers the common shareholders of Delmarva and Atlantic will become common shareholders of Conectiv. (See Item 1.C.2 below). The Mergers will have no effect on the shares of preferred stock of Delmarva issued and outstanding at the time of the consummation of the Mergers, each series of which and each share of which will remain unchanged. Atlantic has no shares of preferred stock outstanding. A copy of the Merger Agreement is incorporated by reference as Exhibit B-1 hereto. B. Description of the Parties to the Mergers 1. General Description a. Delmarva Delmarva was incorporated under the laws of the State of Delaware in 1909 and in Virginia in 1979 and is a public utility company engaged in providing electric service in Delaware, Maryland and Virginia and gas service in Delaware. As of December 31, 1996, Delmarva provided electric utility service to approximately 442,000 customers in an area encompassing about 6,000 square miles in Delaware (253,000 customers), Maryland (169,000 customers) and Virginia (20,000 customers), and gas utility service to approximately 100,000 customers in an area consisting of about 275 square miles in northern Delaware. A map of Delmarva's service territory is attached as Exhibit E-1. Delmarva is subject to regulation as a public utility under the Delaware Public Utilities Act as to retail electric and gas rates and other matters by the DPSC. Delmarva is also subject to regulation by the VSCC and MPSC as to retail electric rates and other matters and to regulation by the PPUC with respect to ownership of generating facilities in Pennsylvania. Delmarva is also subject to regulation by the FERC with respect to the classification of accounts, rates for any wholesale sales of electricity, the interstate transmission of electric power and energy, interconnection agreements, borrowings and issuances of securities not regulated by state commissions and acquisitions and sales of certain utility properties under the Federal Power Act. In addition, Delmarva is subject to limited regulation by the FERC under the Natural Gas Act of 1938, as amended with respect to its ownership of a 4-mile pipeline that crosses state lines and sales for resale made pursuant to FERC blanket marketing certificates. Delmarva is also currently subject to regulation by the NRC in connection with its ownership interests in the Salem Nuclear Generating Station and the Peach Bottom Nuclear Generating Station. The Delmarva Common Stock is listed on the New York Stock Exchange (the "NYSE") and the Philadelphia Stock Exchange and has unlisted trading privileges on the Cincinnati, Midwest and Pacific Stock Exchanges. As of December 31, 1996, there were 60,682,719 shares of Delmarva Common Stock and 1,253,548 shares of Delmarva preferred stock outstanding. Delmarva's principal executive office is located at 800 King Street, Wilmington, Delaware 19899. A copy of the Restated Certificate and Articles of Incorporation, as amended, of Delmarva is incorporated by reference as Exhibit A-3. Delmarva has a nonutility subsidiary trust, Delmarva Power Financing I ("DPF I"), a Delaware trust, which was formed in 1996 in connection with the issuance by Delmarva of Cumulative Quarterly Income Preferred Securities. For the year ended December 31, 1996, Delmarva's operating revenues on a consolidated basis were approximately $1,160 million, of which approximately $981 million were derived from electric operations, $114 million from gas operations and $65 million from other operations. Consolidated assets of Delmarva and its subsidiaries at December 31, 1996 were approximately $2,979 million, consisting of approximately $2,536 million in identifiable electric utility property, plant and equipment; approximately $219 million in identifiable gas utility property, plant and equipment; and approximately $224 million in other corporate assets. A more detailed summary of information concerning Delmarva and its subsidiaries is contained in Delmarva's Annual Report on Form 10-K for the year ended December 31, 1996, a copy of which is incorporated by reference as Exhibit H-1. b. Atlantic Atlantic was incorporated under the laws of the State of New Jersey in 1986 and is a public utility holding company exempt from regulation by the Commission under the Act (except for Section 9(a)(2) thereof) pursuant to Section 3(a)(1) of the Act and Rule 2 thereunder. Pursuant to Rule 2, Atlantic has filed a statement with the Commission on Form U-3A-2 for the year ended December 31, 1996, which is incorporated by reference as Exhibit H-3 hereto. The principal subsidiary of Atlantic is Atlantic City Electric Company ("ACE"). ACE is a public utility company organized under the laws of the State of New Jersey in 1924 by merger and consolidation of several utility companies. It is a holding company exempt from regulation by the Commission under the Act (except for Section 9(a)(2) thereof) pursuant to Section 3(a)(2) of the Act and Rule 2 thereunder, and is engaged in the generation, transmission, distribution and sale of electric energy. ACE serves a population of approximately 476,000 customers in a 2,700 square-mile area of Southern New Jersey. A map of ACE's service area is attached as Exhibit E-1 hereto. ACE currently has one utility subsidiary, Deepwater Operating Company ("Deepwater"), a New Jersey corporation, that operates generating facilities in New Jersey for ACE. Deepwater owns no physical assets. Prior to the closing of the Mergers, the employees of Deepwater will become employees of ACE. ACE has a nonutility subsidiary trust, Atlantic Capital I ("ACI"), a Delaware trust, which was formed in 1996 in connection with the issuance by ACE of Cumulative Quarterly Income Preferred Securities. As a public utility under the laws of the State of New Jersey, ACE is regulated by the NJBPU as to its retail rates, services, accounts, depreciation, and acquisitions and sales of utility properties, and in other respects. ACE is also subject to regulation by the FERC the classification of accounts, rates for any wholesale sales of electricity, the interstate transmission of electric power and energy, interconnection agreements, borrowings and issuances of securities not regulated by state commissions and acquisitions and sales of certain utility properties under the Federal Power Act. In addition, Atlantic is currently subject to regulation by the NRC in connection with its ownership interest in the Salem, Peach Bottom and Hope Creek Nuclear Generating Stations. The Atlantic Common Stock is listed on the New York, Philadelphia and Pacific Stock Exchanges. As of December 31, 1996, there were 52,502,479 shares of Atlantic Common Stock outstanding and no shares of preferred stock. Atlantic's principal executive office is located at 6801 Black Horse Pike, Egg Harbor Township, New Jersey 08234. A copy of the Atlantic Restated Certificate of Incorporation is incorporated by reference as Exhibit A-4. On a consolidated basis, Atlantic's operating revenues for the calendar year ended December 31, 1996 were approximately $980 million, and its total assets as of December 31, 1996 were approximately $2,671 million. More detailed information concerning Atlantic is contained in the Annual Reports of Atlantic and ACE on Form 10-K for the year ended December 31, 1996, which is incorporated by reference as Exhibit H-2. c. Conectiv and its Subsidiaries i. Conectiv Conectiv was incorporated under the laws of the State of Delaware on August 8, 1996 to become a holding company for Delmarva and its direct subsidiaries and certain direct subsidiaries of Atlantic following the Mergers and for the purpose of facilitating the Mergers. Conectiv filed a Restated Certificate of Incorporation on December 24, 1996. Conectiv has, and prior to the consummation of the Mergers will have, no operations other than those contemplated by the Merger Agreement to accomplish the Mergers. Upon consummation of the Mergers, Conectiv will be a public utility holding company and will own directly all of the issued and outstanding common stock of Delmarva, certain of Delmarva's direct subsidiaries, ACE, Atlantic Energy Enterprises, Inc. ("AEE"), Atlantic Energy International, Inc. ("AEII") and Support Conectiv. At present and until consummation of the Mergers, the common stock of Conectiv, which consists of 1,000 issued and outstanding shares, is owned by Delmarva and Atlantic, each of which owns 500 shares. A copy of the Restated Certificate of Incorporation of Conectiv is attached as Exhibit A-1. Following consummation of the Mergers, the common equity of the Company will be divided into two classes: the Conectiv Common Stock and the Conectiv Class A Common Stock. The use of two classes of common stock is designed to address the difference in Delmarva's and Atlantic's evaluations of the growth prospects of, and uncertainties associated with deregulation of, the regulated electric utility business of Atlantic. Upon the consummation of the Mergers, the Conectiv Common Stock will be issued both to the holders of the Delmarva Common Stock and to the holders of the Atlantic Common Stock while the Conectiv Class A Common Stock will be issued only to the holders of the Atlantic Common Stock, thereby giving the current holders of Atlantic Common Stock a proportionately greater opportunity to share in the growth prospects of, and a proportionately greater exposure to the uncertainties associated with deregulation of, the regulated electric utility business of Atlantic. As discussed below, upon consummation of the Mergers, and after some additional organizational changes immediately after the Mergers, it is contemplated that Conectiv will have two direct utility subsidiaries, Delmarva and ACE, whose only nonutilty subsidiaries would be DPF I and ACI, respectively. The system's other nonutility interests will be held by various direct and indirect subsidiaries of Conectiv. The precise structure of the system's nonutility operations will be determined, in part, by any consolidation, dissolution and or divestiture of the existing interests of Delmarva and ACE in nonutility businesses prior to the Mergers. ii. Delmarva Following the consummation of the Mergers, Delmarva will become a direct subsidiary of Conectiv. Delmarva's utility operations and facilities are described in Item 1.B.2.a. below and its nonutility subsidiaries and operations are described in Item 1.B.3.a. below. iii. Delmarva's Subsidiaries In conjunction with the Mergers, Delmarva's existing subsidiaries will be reorganized. Several direct subsidiaries of Delmarva, including Conectiv Services, Inc. and Conectiv Communications, Inc., are expected to become direct subsidiaries of Conectiv. Delmarva's direct subsidiaries, except DPF I, are expected to become direct subsidiaries of Conectiv. At present, these direct subsidiaries of Delmarva are Conectiv Services, Inc., Conectiv Communications, Inc., Delmarva Capital Investments, Inc. ("DCI"), Delmarva Service Company, Delmarva Energy Company, Delmarva Industries, Inc. and East Coast Natural Gas Cooperative, L.L.C. ("ECNG"). As described below, DCI is a holding company for a variety of non-utility interests. iv. ACE Following the consummation of the Mergers, ACE will become a direct subsidiary of Conectiv. ACE's utility operations and facilities are described in Item 1.B.2.b. below. ACE does not currently own any interest in any nonutility subsidiaries other than ACI. v. AEE Following the consummation of the Mergers, AEE will become a direct subsidiary of Conectiv. AEE is a holding company for Atlantic's nonutility subsidiaries, including Atlantic Generation, Inc. ("AGI"), Atlantic Southern Properties, Inc. ("ASP"), ATE Investment, Inc. ("ATE"), Atlantic Thermal Systems, Inc. ("ATS"), CoastalComm, Inc. ("CCI") and Atlantic Energy Technology, Inc. ("AET"). vi. AEII Following the consummation of the Mergers, AEII will become a direct subsidiary of Conectiv. AEII was formed in July, 1996 to provide utility consulting services and equipment sales to international markets. The business activities of AEII are being concluded with the expectation that AEII will be inactive by December 31, 1997. vii. Support Conectiv Prior to the consummation of the Mergers, Support Conectiv will be incorporated in Delaware to serve as the service company for the Conectiv system. Support Conectiv will provide Delmarva, ACE and the other companies of the Conectiv system with a variety of administrative, management, engineering, construction, environmental and support services, either directly or through agreements with associate or nonassociate companies, as needed. Support Conectiv will enter into a service agreement with most, if not all, companies in the Conectiv system (the "Service Agreement"). (A copy of the form of Service Agreement as well as an appendix entitled "Description of Services and Determination of Charges for Services" will be filed as Exhibit B-2). The authorized capital stock of Support Conectiv will consist of up to 3,000 shares of common stock, $1 par value per share. Upon consummation of the Mergers, all issued and outstanding shares of Support Conectiv common stock will be held by Conectiv. viii. DS Sub Solely for the purpose of facilitating the Mergers proposed herein, DS Sub has been incorporated under the laws of the State of Delaware as a direct transitory subsidiary of Conectiv established to effectuate the Delmarva Merger. The authorized capital stock of DS Sub consists of 1000 shares of common stock, $0.01 par value ("DS Sub Common Stock"), all of which is held by Conectiv. DS Sub has not had, and prior to the closing of the Mergers will not have, any operations other than the activities contemplated by the Merger Agreement necessary to accomplish the combination of DS Sub and Delmarva as herein described. 2. Description of Facilities a. Delmarva i. General For the year ended December 31, 1996, Delmarva sold the following amount of electric energy (retail and wholesale) and sold and transported the following amount of natural gas: Electric sales....................15,780,826 Mwh Gas sold and transported..........24,157,866 Mcf ii. Electric Generating Facilities and Resources As of December 31, 1996, Delmarva had a total net installed generating capacity of approximately 2,738 MW available from the following power plants: Edge Moor is located in Wilmington, DE. Delmarva's ownership interest results in a net installed capacity of 696 MW. The major fuel source for 251 MW is coal and the major fuel source for 445 MW is oil. Indian River is located in Millsboro, DE. Delmarva's ownership interest results in a net installed capacity of 743 MW. Its major fuel source is coal. Conemaugh is located in New Florence, PA. Delmarva's ownership interest results in a net installed capacity of 63 MW. Its major fuel source is coal. Keystone is located in Shelocta, PA. Delmarva's ownership interest results in a net installed capacity of 63 MW. Its major fuel source is coal. Vienna is located in Vienna, MD. Delmarva's ownership interest results in a net installed capacity of 151 MW. Its major fuel source is oil. Peach Bottom Nuclear Generating Station is located in Peach Bottom Township, PA. Delmarva owns 7.51 percent of Peach Bottom which results in a net installed capacity of 164 MW. Its fuel source is nuclear. Salem Nuclear Generating Station is located in Lower Alloways Creek Township, NJ. Delmarva owns 7.41 percent of Salem which results in a net installed capacity of 164 MW. Its fuel source is nuclear. Hay Road is located in Wilmington, DE. It is a combustion turbine/combined cycle power plant. Delmarva's ownership interest results in a net installed capacity of 511 MW. Its major fuel source is gas. Delmarva owns (or partially owns) fourteen peaking units, ranging in size from 0.1 MW to 26 MW. These units are located in Delaware, Maryland, Virginia, New Jersey, and Pennsylvania and are fueled with gas, oil, or diesel fuel. Delmarva's ownership interest results in a net installed capacity of 183 MW. In addition to the power plants owned or partially owned by Delmarva listed above, Delmarva purchases capacity from three utilities. At year end 1996, Delmarva's purchased capacity totaled 390 MW. Delmarva's total capacity available at year end 1996 to serve customers is 3128 MW. Delmarva's 1996 summer peak load, which occurred on July 9, 1996, was 2,569 MW and its 1996 winter peak load, which occurred on January 17, 1997, was 2,587 MW. iii. Electric Transmission and Other Facilities As of December 31, 1996, Delmarva's transmission system consisted of approximately 16 circuit miles of 500 kV lines; 326 circuit miles of 230 kV lines; 453 circuit miles of 138 kV lines; 711 circuit miles of 69 kV lines; 618 circuit miles of 34 kV lines and 5,261 circuit miles of 25 kV lines. As of December 31, 1996, Delmarva's distribution system consisted of 6,706 circuit miles of 12 kV and 4 kV lines. As of December 31, 1996, Delmarva's electric transmission and distribution system includes 1,391 transmission poleline miles of overhead lines, 5 transmission cable miles of underground cables, 6,927 distribution poleline miles of overhead lines and 5,416 distribution cable miles of underground cables. Delmarva is a member of the Pennsylvania-New Jersey- Maryland Interconnection ("PJM" or the "PJM Pool")2. The members of PJM have worked together voluntarily for almost seventy years to create the Nation's largest "tight" power pool with free-flowing ties. With the backing of their regulatory commissions, the members have built an efficient wholesale energy market based on a "split-the-savings" energy exchange, the reciprocal sharing of capacity resources, and a competitive market in transmission entitlements to import energy. Estimates of the savings realized by the PJM Pool range upwards of $1 billion per year. Delmarva's generation and bulk transmission facilities have been operated on an integrated basis with those of other PJM members. Delmarva estimates that its fuels savings associated with energy transactions within the PJM Pool amounted to $9.8 million during 1996. - - -------- 2 Atlantic is also a member of the PJM Interconnection, as described in Item b.iii below. Historically, the other members have been Baltimore Gas and Electric Company, Jersey Central Power & Light Company, Metropolitan Edison Company, Pennsylvania Electric Company, PECO Energy Company, Pennsylvania Power & Light Company, Potomac Electric Power Company and Public Service Electric and Gas Company. Recent changes in FERC policy have resulted in a restructuring of the PJM Interconnection into a limited liability corporation and expanded membership including nonutility power marketers and brokers, and utilities whose retail service territories are outside the PJM Pool geographic boundaries. Many of the rules governing the use of the nation's transmission system are changing. In FERC Order No. 888, FERC directed all transmission-owning public utilities to file tariffs that offer comparable open transmission service to others. As a member of PJM, Delmarva submitted a filing on December 31, 1996 to comply with the requirements of FERC's Order No. 888 applicable to tight power pools. This included a Transmission Owners Agreement, the pool-wide PJM Open Access Transmission Tariff, and an amended PJM Interconnection Agreement. FERC issued an order in this case on February 28, 1997. Delmarva has been, and will continue to be, involved with the restructuring of PJM and the related filings before FERC. The PJM Interconnection's installed capacity as of December 31, 1996 was 57,283 MW. The PJM Interconnection peak demand during 1996 was 44,302 MW on August 23, 1996, which resulted in a summer reserve margin of 24% (based on installed capacity of 56,865 MW on that date). iv. Gas Facilities The gas property of Delmarva as of December 31, 1996 consisted of a liquefied natural gas plant located in Wilmington, Delaware with a storage capacity of 3.045 million gallons and a maximum daily sendout capacity of 49,898 Mcf per day. This facility is used primarily as a peak-shaving facility for Delmarva's gas customers. Delmarva also owns four natural gas city gate stations at various locations in its gas service territory. These stations have a total contract sendout capacity of 125,000 Mcf per day. Delmarva has 111 miles of transmission mains (including 11 miles of joint-use gas pipelines that are used 10% for gas distribution and 90% for electricity production), 1,539 miles of distribution mains and 1,091 miles of service lines. The Delmarva gas facilities are located exclusively in New Castle County, Delaware. v. Other Delmarva and its subsidiaries own and occupy office buildings in Wilmington and Christiana, Delaware and Salisbury, Maryland and also own a number of other properties located elsewhere in its service area that are used for office, service and other purposes. In addition, Delmarva owns other property, plant and equipment supporting its electric and gas utility functions. b. Atlantic i. General For the year ended December 31, 1996, ACE sold 8.347 billion kwh of electric energy (at retail and wholesale). ii. Electric Generating Facilities and Resources As of December 31, 1996, ACE had a total net capability of approximately 1679 MW available from the following units: Deepwater is located in Penns Grove, NJ. ACE's ownership interest results in a net installed capacity of 220 MW. Its major fuel sources are oil, coal and gas. B.L. England is located in Beesley Point, NJ. ACE's ownership interest results in a net installed capacity of 439 MW. Its major fuel sources are coal and oil. Keystone is located in Shelocta, PA. ACE's ownership interest results in a net installed capacity of 42 MW. Its major fuel source is coal. Conemaugh is located in New Florence, PA. ACE's ownership interest results in a net installed capacity of 65 MW. Its major fuel source is coal. Peach Bottom Nuclear Generating Station is located in Peach Bottom Township, PA. ACE owns 7.51 percent of Peach Bottom which results in a net installed capacity of 164 MW. Its fuel source is nuclear. Salem Nuclear Generating Station is located in Lower Alloways Creek Township, NJ. ACE owns 7.41 percent of Salem which results in a net installed capacity of 164 MW. Its fuel source is nuclear. Hope Creek Nuclear Generating Station is located in Lower Alloways Creek Township, NJ. ACE's 5% ownership interest results in a net installed capacity of 52 MW. Its fuel source is nuclear. Combustion Turbine Units are located in various locations. ACE's ownership interest results in a net installed capacity of 524 MW. Their major fuel sources are oil and gas. Diesel Units are located in various locations. ACE's ownership interest results in a net installed capacity of 8.7 MW. Their major fuel source is oil. In addition, ACE had firm capacity purchases with a net total, as of December 31, 1996, of 707 MW. ACE's summer peak load for the calendar year 1996, which occurred on August 23, 1996, was 1774 MW and its 1996 winter peak load, which occurred on January 17, 1997 was 1,431 MW. iii. Electric Transmission and Other Facilities As of December 31, 1996, ACE's transmission system consisted of approximately 22 circuit miles of 500 kV lines; 127 circuit miles of 230 kV lines; 209 circuit miles of 138 kV lines; 590 circuit miles of 69 kV lines; 113 circuit miles of 34 kV lines and 197 circuit miles of 23 kV lines. As of December 31, 1996, ACE's distribution system consisted of 10,398 circuit miles of 12 kV and 4 kV lines. ACE's electric transmission and distribution system includes 1,215 transmission poleline miles of overhead lines, 46 transmission cable miles of underground cables, 9,252 distribution poleline miles of overhead lines and 1,146 distribution cable miles of underground cables. ACE is also a member of the PJM Interconnection. ACE's generation and transmission facilities are operated on an integrated basis with those of seven other utilities, including Delmarva, in Pennsylvania, New Jersey, Maryland and the District of Columbia. ACE estimates that its fuel savings associated with energy transactions within the pool amounted to $3.8 million (includes savings for Vineland Municipal Electric Utility) during 1996. iv. Other ACE owns and occupies an office building and a number of operating centers located throughout southern New Jersey. In addition, ACE owns property, plant and equipment supporting its electric utility functions. 3. Nonutility Subsidiaries Both Delmarva and Atlantic engage indirectly, through subsidiaries and affiliates, in various nonutility activities related to the systems' core utility businesses. a. Delmarva Delmarva has seven direct nonutility subsidiaries: Delmarva Industries, Inc., Delmarva Services Company, Delmarva Energy Company, Conectiv Services, Inc., Conectiv Communications, Inc., DCI and ECNG. Delmarva Industries, Inc., a Delaware corporation and a direct subsidiary of Delmarva, was formed in 1981 to be a partner in a joint venture oil and gas exploration and development program in New York, Ohio and Pennsylvania. This subsidiary is winding down its business. Delmarva Services Company, a Delaware corporation and a direct subsidiary of Delmarva, was formed in 1986 to own and finance an office building that it leases to Delmarva and/or its affiliates. Delmarva Services Company also owns approximately 2.9% of the common stock of Chesapeake Utilities Corporation, a publicly-traded gas utility company with gas utility operations in Delaware, Maryland and Florida. Delmarva Energy Company, a Delaware corporation and a direct subsidiary of Delmarva, was formed in 1975 to participate in gas and oil exploration and development opportunities. This subsidiary is currently dormant but is expected to be the vehicle for Rule 58 marketing activities. Conectiv Services, Inc., a Delaware corporation and a direct subsidiary of Delmarva, was formed in 1996 to acquire and operate service businesses primarily involving heating, ventilation and air conditioning ("HVAC") sales, installation and servicing, and other energy-related activities. Conectiv Communications, Inc., a Delaware corporation and a direct subsidiary of Delmarva, was formed in 1996 to provide a full-range of retail and wholesale telecommunications services. ECNG, a Delaware limited liability company in which Delmarva holds a 1/7 th interest, is engaged in gas related activities. Delmarva is a member of ECNG to do bulk purchasing of gas in order to improve the efficiency of its natural gas local distribution operations. Delmarva Capital Investments, Inc. ("DCI"), a Delaware corporation and a direct subsidiary of Delmarva, was formed in 1985 to be a holding company for a variety of unregulated investments. DCI's subsidiaries are: DCI I, Inc., a Delaware corporation and a wholly-owned subsidiary of DCI formed in 1985 to be involved in equity investments in leveraged leases of aircraft. DCI II, Inc., a Virgin Islands corporation and a wholly-owned foreign sales subsidiary of DCI formed in 1985 to be involved in lease investments. Delmarva Capital Technology Company ("DCTC"), a Delaware corporation and a wholly-owned subsidiary of DCI formed in 1986 to be involved in projects related to the development of new technologies and alternative energy resources. DCTC's subsidiaries are: Pine Grove, Inc., a Delaware corporation and a wholly-owned subsidiary formed in 1988 to hold interests in municipal solid waste landfill and hauling businesses. Pine Grove, Inc.'s subsidiaries are: Pine Grove Landfill, Inc., a Pennsylvania corporation and a wholly-owned subsidiary formed in 1985 that owns and operates a municipal solid waste landfill in Pine Grove, PA. Pine Grove Hauling Company, a Pennsylvania corporation and a wholly-owned subsidiary that owns and operates a waste hauling and recycling business. DCTC-Glendon, Inc., a Delaware corporation and a wholly-owned subsidiary of DCTC formed in 1987 to invest in a waste-to-energy business that was proposed to be located in Glendon, PA. The facility was never built. DCTC-Burney, Inc., a Delaware corporation and a wholly-owned subsidiary of DCTC formed in 1987 to invest in Burney Forest Products, A Joint Venture, as a general partner. DCTC-Burney, Inc.'s subsidiaries are: Pine Grove Gas Development, L.L.C., a limited liability company formed in 1995 to develop a use for methane gas produced at the municipal solid waste landfill owned and operated by Pine Grove Landfill, Inc. DCTC- Burney owns a 49% interest in the limited liability company. DelBurney Corporation, a Delaware corporation and a wholly-owned subsidiary of DCTC-Burney, Inc. formed in 1989 to act as the sole 1% general partner of Forest Products, L.P., which is a partner in Burney Forest Products, A Joint Venture. Forest Products, L.P., a Delaware limited partnership which is a general partner in Burney Forest Products, A Joint Venture. Burney Forest Products, A Joint Venture, a California general partnership which is owned by DCTC-Burney, Inc. and Forest Products, L.P. The partnership constructed and owns a power plant and sawmill in Burney, CA. DCTC-Burney, Inc.'s total direct and indirect ownership interest is 45%. DCTC is a limited partner in: Luz Solar Partners, Ltd. IV, a California limited partnership which owns a solar-powered generating station in Southern California in which DCTC owns a 4.7% limited partnership interest. UAH-Hydro Kennebec, L.P., a New York limited partnership which owns a hydro-electric project in which DCTC owns a 27.5% limited partnership interest. Delmarva Capital Realty Company ("DCRC"), a Delaware corporation and a wholly-owned subsidiary of DCI formed in 1986 to invest in real estate projects. It is a vehicle for the sale of properties not used or useful for the utility business. DCRC's Subsidiaries are: Christiana Capital Management, Inc., a Delaware corporation and a wholly-owned subsidiary formed in 1987, which owns an office building leased to affiliates. Post and Rail Farms, Inc., a Delaware corporation and a wholly-owned subsidiary formed in 1987 to develop and sell a residential housing development. Delmarva Operating Services Company, a Delaware corporation and a wholly-owned subsidiary of DCI formed in 1987, which acts as a holding company for utility operation and maintenance companies. Delmarva Operating Service Company's subsidiaries are: DelStar Operating Company, a Delaware corporation and a wholly-owned subsidiary formed in 1992 to operate and maintain the Delaware City Power Plant in Delaware City, DE, a qualifying facility, under a contract with the plant's current owner. DelWest Operating Company, a Delaware corporation and a wholly-owned subsidiary formed in 1993 to operate and maintain a power plant in Burney, CA, a qualifying facility under a contract with the plant's owner, Burney Forest Products, A Joint Venture (an investment of DCTC-Burney, Inc.). DelCal Operating Company, a Delaware corporation and a wholly-owned subsidiary formed in 1996 to operate and maintain a power plant in Sacramento, California, a qualifying facility owned by the Sacramento Power Authority under a subcontract with Siemens Power Corporation. Together, at December 31, 1996, Delmarva's nonutility subsidiaries and investments constituted approximately 4 percent of the consolidated assets of Delmarva and its subsidiaries. In connection with the Mergers, one or more of the direct and indirect subsidiaries of Delmarva may be merged with and into, or become a subsidiary of, one or more existing direct or indirect subsidiaries of Atlantic or vice versa. A corporate chart of Delmarva and its subsidiaries, showing their nonutility interests, is filed as Exhibit E-2. b. Atlantic Atlantic has two direct nonutility subsidiaries, AEII and AEE. AEII, a Delaware corporation, is a direct subsidiary of Atlantic formed in 1996 to broker used utility equipment to developing countries and to provide utility consulting services related to the design of sub-stations and other utility infrastructure. This subsidiary is winding down its business. AEE, a New Jersey corporation, is a direct subsidiary of Atlantic formed in 1995 to be a holding company for Atlantic's non-regulated subsidiaries. Through its 6 wholly-owned subsidiaries, and 50% equity interest in Enerval, L.L.C., a natural gas marketing venture, AEE has consolidated assets totaling $217 million. These 7 subsidiaries pursue growth opportunities in energy-related fields, particularly those that will complement Atlantic's existing businesses and customer relationships. AEE's active subsidiaries are: ATE, a New Jersey corporation and a wholly-owned subsidiary of AEE formed in 1986. ATE holds and manages capital resources for AEE. ATE's primary investments are equity investments in leveraged leases of three commercial aircraft and two container ships. In August, 1996, ATE joined with an unaffiliated company to create EnerTech Capital Partners, L.P., an equity limited partnership that will invest in and support a variety of energy-related technology growth companies. ATE also owns 94% of EnerTech Capital Partners L.P. At December 31, 1996, ATE had invested $7.3 million in this partnership. At December 31, 1996, ATE's total equity amounted to $11.1 million. It has outstanding financing arrangements of $10.0 million with ASP and $14.1 million with AEE. AGI, a New Jersey corporation and a wholly-owned subsidiary of AEE formed in 1986. AGI develops, owns and operates independent power production projects. AGI's investments in power projects consist of the following: Pedrick Ltd., Inc., a New Jersey corporation and a wholly-owned subsidiary of AGI, formed in 1989 to hold a 35% limited partnership interest in Pedricktown Cogeneration Limited Partnership. Pedrick Gen., Inc., a New Jersey corporation and a wholly-owned subsidiary of AGI, formed in 1989 to hold a 15% general partnership interest in Pedricktown Cogeneration Limited Partnership. Vineland Limited, Inc., a Delaware corporation and a wholly-owned subsidiary of AGI, formed in 1990 to hold a 45% limited partnership interest in Vineland Cogeneration Limited Partnership. Vineland General, Inc., a Delaware corporation and a wholly-owned subsidiary of AGI, formed in 1990 to hold a 5% general partnership interest in Vineland Cogeneration Limited Partnership. ATS, a Delaware corporation and a wholly-owned subsidiary of AEE, formed in 1994. ATS and its wholly-owned subsidiaries develop, own and operate thermal heating and cooling systems. ATS also provides other energy-related services to business and institutional energy users. ATS plans to make an investment in capital expenditures related to district heating and cooling systems to serve the business and casino district in Atlantic City, NJ. ATS is also pursuing the development of thermal projects in other regions of the U.S. ATS's subsidiaries are: Atlantic Jersey Thermal Systems, Inc., a Delaware corporation and wholly-owned subsidiary formed in 1994, that owns a 10% general partnership interest in TELP I (as defined below). ATS Operating Systems, Inc., a Delaware corporation and a wholly-owned subsidiary formed in 1995 that provides thermal energy operating services. Thermal Energy Limited Partnership I ("TELPI"), a Delaware limited partnership wholly-owned by Atlantic Thermal and Atlantic Jersey Thermal Systems, that holds an investment in the Midtown Energy Center. The Midtown Energy Center, which produces steam and chilled water, will represent the initial principal operations of ATS. It is expected to be commercial by mid-1997. Currently, TELPI is operating the heating and cooling equipment of several businesses in Atlantic City, NJ. Some of these businesses will be served by the ATS district system once it is in commercial operations and others will continue to be served independently by ATS. Atlantic Paxton Cogeneration, Inc., a wholly-owned subsidiary formed in 1977, that holds a 5% general partnership interest in ATS-EPC, L.P. ATS-EPC, L.P., a limited partnership formed in 1977 with a 5% general partnership interest held by Atlantic Paxton Cogeneration, Inc. and a 45% limited partnership interest held by ATS, owns a cogeneration qualifying facility which sells steam to Harrisburg Steam Works Limited and electric energy to Pennsylvania Power & Light Company. Harrisburg Steam Works Limited, a Pennsylvania corporation owned 50% by ATS, provides thermal energy services to the city of Harrisburg, Pennsylvania. CCI, a Delaware corporation and a wholly-owned subsidiary of AEE formed in 1995 to pursue investments and business opportunities in the telecommunications industry. ASP, a New Jersey corporation and a wholly-owned subsidiary of AEE formed in 1970 that owns and manages a 280,000 square-foot commercial office and warehouse facility in southern New Jersey. Approximately fifty percent of the space is presently leased to system companies and fifty percent is leased to nonaffiliates. AET, a Delaware corporation and a wholly-owned subsidiary of AEE formed in 1991. AET is currently winding up its sole investment which is nominal. There are no future plans for investment activity at this time by AET. Enerval, L.L.C. ("Enerval"), a Delaware limited liability company. In 1995, AEE and Cenerprise, Inc., a subsidiary of Northern States Power established Enerval, formerly known as Atlantic CNRG Services, L.L.C.. AEE and Cenerprise each own 50 percent of Enerval. Enerval provides energy management services, including natural gas procurement, transportation and marketing. At December 31, 1996, Atlantic's nonutility subsidiaries and investments constituted approximately 8.2 percent of the consolidated book value of the assets of Atlantic and its subsidiaries. A corporate chart of Atlantic and its subsidiaries, showing their nonutility interests, is filed as Exhibit E-3. In connection with the Mergers, one or more of the direct and indirect subsidiaries of Atlantic may be merged with and into, or become a subsidiary of, one or more existing direct or indirect subsidiaries of Delmarva or vice versa. C. Description of the Mergers 1. Background and Negotiations Leading to the Proposed Mergers Atlantic and Delmarva are neighboring utilities that have had a variety of working relationships on a wide range of matters over many years. These included joint minority ownership in a number of electric production facilities and membership in the PJM Interconnection. The Energy Policy Act of 1992 (the "1992 Act"), which enhanced the authority of the FERC to order electric utilities to provide transmission service, has prompted new developments in the electric utility industry. The 1992 Act also created a new class of power producers, exempt wholesale generators, which are exempt from regulation under the Act. This exemption has increased the number of entrants into the wholesale electric generation market and increased competition in the wholesale segment of the electric utility industry. Pursuant to its authority under the 1992 Act, the FERC issued a number of orders in specific cases commencing in December 1993 directing utilities to provide transmission services. The FERC's actions have increased the availability of transmission services, thus creating significant competition in the wholesale power market. Other developments have resulted from policies at the SEC, which has liberalized its interpretation and administration of the Act in ways that have made mergers between utility companies less burdensome, thereby facilitating the creation of larger industry competitors. In the fall of 1995, following a number of general discussions between Atlantic's senior management and its financial advisors and legal counsel, among others, regarding the potential strategic value of acquisitions, alliances and mergers in the restructuring utility and energy services industry, Atlantic began investigations of strategic alternatives. Atlantic's long-term advisors, corporate counsel at Simpson Thacher & Bartlett ("Simpson Thacher") and financial advisors at Morgan Stanley & Co. Incorporated ("Morgan Stanley"), were alerted to Atlantic's interest in pursuing discussions with individual target companies. During 1995, Delmarva's senior management team participated in a series of retreats focused on the future direction of the industry and its implications for the company. Over the course of the last 12-18 months Delmarva consulted with various advisors, including its long-term legal advisor, LeBoeuf, Lamb, Greene & MacRae, L.L.P. ("LeBoeuf"), regarding strategic opportunities including, among other things, alliances, joint ventures and acquisitions. Over the course of their long business relationship, Mr. Howard E. Cosgrove, Chairman, President and Chief Executive Officer of Delmarva, and Mr. Jerrold L. Jacobs, Chairman of the Board and Chief Executive Officer of Atlantic, regularly met to discuss industry issues. At one such meeting, on February 21, 1996, Mr. Cosgrove raised the possibility of a merger of the two companies. At the time, Mr. Jacobs declined to pursue the discussions, primarily because Atlantic was in the process of investigating other alternatives. Later, Atlantic decided not to continue to consider these alternatives. On March 4, 1996, Mr. Jacobs called Mr. Cosgrove to indicate his interest in commencing discussions that could lead to a merger or other business combination of the two companies. They met on March 7, 1996 to conduct exploratory discussions. At a regularly scheduled Atlantic Board meeting on March 14, 1996, Mr. Jacobs advised the Atlantic Board of the possibility of a merger or other business combination with Delmarva. At a regularly scheduled Delmarva Board meeting on March 28, 1996, Mr. Cosgrove advised the Delmarva Board of his discussions with Mr. Jacobs and interest in pursuing a possible merger or other business combination. On April 4, 1996, Messrs. Jacobs and Cosgrove met with the Delmarva and Atlantic working groups, representatives of Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") and Morgan Stanley to commence preliminary discussions of benefits at a conceptual level and the identification of issues that would need to be resolved before proceeding with a merger of the two companies. After multiple meetings between Delmarva and Atlantic and their respective advisors, including Delmarva's long-term legal advisor Potter Anderson & Corroon ("Potter Anderson"), there was a consensus that discussions of a potential business combination between Delmarva and Atlantic should continue but that there was need for further study of issues requiring resolution, including the emerging regulatory environment and general valuation issues. A joint regulatory subgroup of the Delmarva and Atlantic working groups met on May 2, 1996 to hear a presentation from The NorthBridge Group ("NorthBridge"), an economic consulting firm specializing in the utility industry, about the scope of a stranded cost review. The companies decided after the presentation to have their counsel jointly engage NorthBridge to do an evaluation of potential stranded costs arising in each of the companies. NorthBridge presented its preliminary stranded costs review to the joint working group on May 15, 1996. Following this period of intense review of the potential obstacles to a merger of Atlantic and Delmarva, representatives of the two companies met with Merrill Lynch and Morgan Stanley on May 29, 1996. Discussions were held on the status of the regulatory analysis, the analysis of general stand-alone valuation issues and the likely reaction of the capital markets to an announcement of a combination of the two companies. The companies' working groups and advisors laid out a number of options, including having as a component of the merger consideration a "second security" (i.e., a security in addition to the conventional common stock of the new company) that would be distributed to the shareholders of Atlantic to reflect the growth prospects of, and uncertainties associated with deregulation of, the regulated electric utility business of Atlantic. The parties were considering the use of such a second security as a mechanism to address the difference in Delmarva's and Atlantic's evaluations of the overall impact of these growth prospects and uncertainties on the regulated electric utility business of Atlantic. The parties considered that the second security could take the form either of a "letter stock," i.e., a common stock to be issued by the holding company that, following the Mergers, would own the businesses of both Delmarva and Atlantic, the performance of which would be tied in some manner to that of the regulated New Jersey electric utility business of Atlantic, or of a preferred stock that was in some way tied to the performance of such business. On July 3, 1996, members of both working groups and Morgan Stanley, LeBoeuf and Potter Anderson held a teleconference. Teams were formed to address a range of due diligence issues; accounting, tax and financial systems; asset evaluation and operations; communication and information systems; human resources; marketing, communications and public relations; litigation; corporate documents; and environmental and real estate. During the July 3, 1996 teleconference, a decision was made to have counsel for Delmarva and Atlantic jointly engage Deloitte & Touche Consulting Group ("D&T Consulting Group"), a nationally recognized consulting firm with experience in utility mergers and acquisitions that is a division of Deloitte & Touche LLP, to assist Delmarva and Atlantic management in identifying and quantifying the potential cost savings that could result from a business combination between the two companies. During July and in early August, intensive due diligence activities, including the exchange of documents between Delmarva and Atlantic and a series of meetings, were conducted by Delmarva and Atlantic. Through a series of conference calls held July 15 through July 18, 1996 that included representatives of Delmarva and Atlantic and representatives of Merrill Lynch, Morgan Stanley, LeBoeuf, Potter Anderson and Simpson Thacher, agreement was reached that the second security would take the form of a letter stock, i.e., a common equity security, rather than a preferred stock. During a joint meeting of the communications subgroups of the Delmarva and Atlantic teams on July 16, 1996, a decision was made that it was timely to engage Abernathy MacGregor & Associates ("Abernathy"), a communications advisor knowledgeable in merger-related communications. On July 23, 1996, Abernathy was jointly engaged to assist the communication subgroup in the development of a communication plan and in the preparation of communication materials in connection with the potential transaction. On July 25, 1996, Messrs. Jacobs and Michael J. Chesser, President and Chief Operating Officer of Atlantic were invited to a segment of the Delmarva Board meeting at which D&T Consulting Group, as a part of its assistance to the joint working group, discussed the joint analysis of potential synergies with the Delmarva Board, including the basic structure, process and content of a synergy analysis, generally described the type of synergies identified in other mergers, then explained the results to date of the joint synergies analysis. The evaluation included preliminary estimates of synergies, net of costs to achieve them, in excess of $500 million over a 10-year period that might be obtained from a business combination of the two companies. On July 26, 1996, Messrs. Jacobs and Michael J. Barron, Vice President and Chief Financial Officer, of Atlantic and Mr. Cosgrove and Mrs. Barbara S. Graham, Senior Vice President, Treasurer and Chief Financial Officer, of Delmarva met to conclude the negotiation of management structure issues and to begin to make progress on the parameters of the potential transaction, including the extent to which the merger consideration distributed to Atlantic's shareholders would include letter stock. On August 2, 1996, members of the Delmarva and Atlantic working groups met with D&T Consulting Group to review the final results of the analysis prepared by Delmarva and Atlantic with the assistance of D&T Consulting Group on potential synergies that could result in connection with a business combination of Delmarva and Atlantic. During discussions regarding the proposed merger at the August 5, 1996 Atlantic Board meeting, D&T Consulting Group, as a part of its assistance to the joint working group, discussed the joint analysis of potential synergies with the Atlantic Board. At the Atlantic Board meeting on August 8, the Atlantic Board was briefed on the status of the negotiations and considered final presentations from management on the rationale for a business combination of Delmarva and Atlantic, including the potential benefits and the similarity of vision and strategy between the two companies. Morgan Stanley made a presentation which included a description of the letter stock and the results of their valuation analysis. At the Atlantic Board meeting of August 9, 1996, detailed presentations were made by Morgan Stanley and management on the status of pricing negotiations. Simpson Thacher reviewed in detail with the Atlantic Board the terms of the Merger Agreement. The joint communication plan that would be put in place upon an approved merger was presented to the Atlantic Board by management and a representative of Abernathy. Morgan Stanley made a presentation which included a summary of the terms of the transaction, a further description of the letter stock and the results of their valuation analysis. Morgan Stanley rendered to the Atlantic Board its oral opinion, which was subsequently confirmed in writing, to the effect that as of the date of such meeting the Atlantic Conversion Ratio taking into account the Delmarva Conversion Ratio (each, as hereinafter defined), was fair from a financial point of view to the holders of Atlantic Common Stock. The Atlantic Board then approved the terms of the Merger Agreement, which was subsequently executed. At the Delmarva Board meeting on the same day, management noted that due diligence had been concluded and that no issues had been identified that would preclude management's recommending that Delmarva proceed with the proposed merger; management further noted that the synergies analysis was finalized. Representatives of Merrill Lynch reviewed various financial and other information and rendered to the Delmarva Board its opinion that, as of such date and based upon and subject to the matters discussed therein, the Delmarva Conversion Ratio was fair to Delmarva and its shareholders from a financial point of view. The Delmarva Board approved the terms of the Merger Agreement and the Merger Agreement was subsequently executed. Additional information regarding the background of the Mergers is set forth in the Conectiv Registration Statement on Form S-4 (Exhibit C-1 hereto). On January 30, 1997, at a special meeting of stockholders of Delmarva, the holders of Delmarva Common Stock voted to approve the Mergers. Out of 60,754,568 shares of Delmarva Common Stock issued and outstanding and entitled to vote, 51,621,008.553 shares (84.97%) were represented in person or by proxy at the special meeting. 49,681,023.314 shares (81.77%) of Delmarva Common Stock voted for, 1,399,949.695 shares (2.30%) of Delmarva Common Stock voted against, and 540,035.544 (.89%) shares of Delmarva Common Stock abstained from voting on the approval of the Mergers. On January 30, 1997, at a special meeting of stockholders of Atlantic, the holders of Atlantic Common Stock, voted to approve the Mergers. Out of 52,704,052 shares of Atlantic Common Stock issued and outstanding and entitled to vote, 39,648,046 shares (75.23%) were represented in person or by proxy at the special meeting. 37,843,067 shares (71.80%) of Atlantic Common Stock voted for, 1,539,886 shares (2.92%) of Atlantic Common Stock voted against, and 265,093 (0.50%) shares of Atlantic Common Stock abstained from voting on the approval of the Mergers. 2. Merger Agreement The Merger Agreement provides for Atlantic to be merged with and into Conectiv and DS Sub to be merged with and into Delmarva. The Merger Agreement is incorporated by reference as Exhibit B-1. Under the terms of the Merger Agreement, upon consummation of the Mergers: - each issued and outstanding share of Delmarva Common Stock3 shall be converted into the right to receive one share of Conectiv Common Stock (the "Delmarva Conversion Ratio"); - each issued and outstanding share of Atlantic Common Stock4 shall be converted into the right to receive 0.75 of one share of Conectiv Common Stock and 0.125 of one share of Conectiv Class A Common Stock (the "Atlantic Conversion Ratio"); and - all shares of capital stock of Conectiv issued and outstanding immediately prior to the Mergers will be cancelled without consideration and cease to exist. Based on the capitalization and the Delmarva Conversion Ratio and the Atlantic Conversion Ratio the shareholders of Delmarva and Atlantic would own approximately 60.6% and 39.4%, respectively, of the outstanding shares of the Conectiv Common Stock and the shareholders of Atlantic would own 100% of the outstanding shares of Conectiv Class A Common Stock. - - -------- 3 Other than shares owned by Delmarva as treasury stock or by Atlantic or by any direct subsidiary of Delmarva or Atlantic. Such shares will be cancelled and cease to exist and no consideration will be delivered in exchange therefor. 4 Other than shares owned by Atlantic as treasury stock or by Delmarva or by any direct subsidiary of Atlantic or Delmarva. Such shares will be cancelled and cease to exist and no consideration will be delivered in exchange therefor. The Mergers are subject to customary closing conditions, including all necessary governmental approvals, including the approval of the Commission. D. Benefit Plans Delmarva currently has a long-term incentive plan and Atlantic currently has an equity incentive plan. On January 30, 1997, the shareholders of Delmarva and Atlantic approved the Conectiv Incentive Compensation Plan, a comprehensive cash and stock compensation plan providing for the grant of annual incentive awards as well as long-term incentive awards such as restricted stock, stock options, stock appreciation rights, performance units, dividend equivalents and any other types of awards as the committee of the board of directors of Conectiv which will administer the plan deems appropriate. Upon the consummation of the Mergers, it is intended that the Conectiv Incentive Compensation Plan will replace the Delmarva long-term incentive plan and the Atlantic equity incentive plan. The maximum number of shares of Conectiv Common Stock available for issuance under the plan is five million. Conectiv will seek approval from the Commission for the issuance of shares in connection with the Conectiv Incentive Compensation Plan in another application/declaration. E. Management and Operations of Conectiv Following the Mergers Pursuant to the Merger Agreement, the Delmarva Board will be entitled to nominate ten members and the Atlantic Board will be entitled to nominate eight members to serve on the Conectiv Board upon consummation of the Mergers. The Delmarva Board and the Atlantic Board will each take all action necessary to cause each member of the Delmarva Board and each member of the Atlantic Board serving in such capacity immediately prior to the consummation of the Mergers to have the opportunity to serve as a member of the Conectiv Board. The Conectiv Board will be divided into three classes so that each class, to the extent possible, has the same proportion of directors nominated by each of the Delmarva Board and the Atlantic Board. In addition, at the consummation of the Mergers, the Conectiv Board will establish an Audit Committee consisting of an equal number of directors nominated by the Delmarva Board and the Atlantic Board. At the consummation of the Mergers, Howard E. Cosgrove will be the Chief Executive Officer of Conectiv and Chairman of the Conectiv Board, Jerrold L. Jacobs (who will retire from active employment after the consummation of the Mergers) will be Vice Chairman of the Conectiv Board and Michael J. Chesser will be the President and Chief Operating Officer of Conectiv. Jerrold L. Jacobs will serve as Vice Chairman of the Conectiv Board until the second anniversary of the consummation of the Mergers and, during his term as Vice Chairman, will be a member of the Executive Committee of the Conectiv Board. The Audit Committee of the Conectiv Board will be charged with the responsibility of advising the Conectiv Board with respect to certain intercompany transactions and other fiduciary matters that may relate to the Conectiv Class A Common Stock. Conectiv and its subsidiaries and affiliates will be subject to extensive federal and state regulation governing dealings among their utility and nonutility operations. Accordingly, any management policies adopted by the Conectiv Board must adhere to any procedural, substantive, record-keeping, accounting and other requirements imposed by such regulations. Conectiv and its subsidiaries will honor all prior contracts, agreements, collective bargaining agreements and commitments with current or former employees or current or former directors of Delmarva or Atlantic and their respective subsidiaries, in accordance with the respective terms of such contracts, agreements and commitments, subject to Conectiv's right to enforce them in accordance with their terms (including any reserved right to amend, modify, suspend, revoke or terminate them). Conectiv will provide charitable contributions and community support within the service areas of Delmarva and Atlantic and each of their respective subsidiaries at levels substantially comparable to the historical levels of charitable contribution and community support provided by Delmarva, Atlantic and their respective subsidiaries within their service areas. Both the holders of Conectiv Common Stock and the holders of Conectiv Class A Common Stock will receive the consolidated financial statements of Conectiv. Since upon consummation of the Mergers, the financial results of ACE will be substantially identical to the financial results for the Targeted Business, the notes to the consolidated financial statements of Conectiv will at such time include condensed financial information of ACE, including a reconciliation of ACE's income available to common shareholders to earnings applicable for Conectiv Class A Common Stock. Complete financial statements of ACE will continue to be filed under the Exchange Act and will be available to shareholders upon request. The Merger Agreement provides that Conectiv shall maintain (i) its corporate headquarters and principal executive offices in Wilmington, DE and (ii) a significant presence in New Jersey. Following consummation of the Mergers, the activities of Conectiv will be governed by its Restated Certificate of Incorporation and Restated Bylaws, attached hereto as Exhibits A-1 and A-2 respectively. F. Industry Restructuring Initiatives On April 30, 1997, the NJBPU issued its findings and recommendations on restructuring the electric industry in New Jersey (the "Plan"). In the Plan, the NJBPU recommended that retail customers in New Jersey should have the ability to choose their electric energy supplier beginning in October 1998 using a phase-in plan that will include all retail customers by July 2000. Customers would be able to sign an agreement with a third-party energy supplier and each electric utility, including ACE, would continue to be responsible for providing distribution service. Price and service quality for such distribution service would continue to be regulated by the NJBPU. Under the proposed Plan, beginning in October 1998, costs for electric service, which consist of power generation, transmission, distribution, metering and billing will need to be unbundled. Transmission service would be provided by an independent system operator which would be responsible for maintaining a regional power grid that would continue to be regulated by FERC. The Plan states that the NJBPU is committed to assuring that a fully competitive marketplace exists prior to the ending of its economic regulation of power supply. At a minimum, utility generating assets and functions must be separated and operate at arms length from the transmission, distribution and customer service functions of the electric utility. The NJBPU reserves final judgment on the issue of requiring divestiture of utility generating assets until detailed analyses of the potential for market power abuses by utilities have been performed. The Plan addresses the issue of "stranded" costs related to the generating capacity currently in utility rates. High costs of construction and operations incurred by the jointly-owned nuclear power plants and the long-term high cost supply contracts with independent power producers are two significant contributing factors. The report proposes recovery of stranded costs over a four to eight year period, through a specific market transition charge which will be a separate component of a customer's bill. Determination of the recoverability of costs will be on a case by case basis with no guarantee for 100% recovery of eligible stranded costs. The Plan provides that the opportunity for full recovery of such eligible costs is contingent upon and may be constrained by the utility meeting a number of conditions, including achievement of a NJBPU goal of delivering a near term rate reduction to customers of five to ten percent. The Plan states that the costs of contracts with independent power producers must be eligible for stranded cost recovery. The Plan further states that utilities are obligated to take all reasonably available measures to mitigate stranded costs caused by the introduction of retail competition. The Plan further notes that New Jersey is studying the securitization of stranded costs as a means of financing these costs at interest rates lower than the utility cost of capital, thereby helping to mitigate the rate impact of stranded cost recovery. Recovery through securitization may occur over a different period of time. The Plan also suggests that a cap may be imposed on the level of the charge as a mechanism to achieve the goal of overall rate reduction. ACE filed a restructuring plan, stranded cost estimates and unbundled rates, with the NJBPU on July 15, 1997. Exhibit D-8. Based on Delmarva's initiative, a formal process has been established in Delaware and an informal forum has been established in Maryland through which the commissions and other interested parties are addressing changes in the regulation of the electric utility industry. During 1996, Delaware and Maryland forum meetings addressed issues such as retail wheeling, stranded costs, environmental matters, social programs, rate redesign, and alternative forms of regulation. In October 1996, the MPSC issued an order instituting a proceeding to continue its review of regulatory and competitive issues affecting the electric industry in Maryland. In consultation with Maryland's electric utilities and other stakeholders, the MPSC staff has been directed to evaluate regulatory and competitive issues facing the electric utility industry, including electric retail competition, developments in federal and state regulation, and the interests of Maryland's customers and utilities. The MPSC instructed its staff to submit their recommendations by May 31, 1997. In December 1996, the forum participants issued to the DPSC and MPSC reports which discussed the issues and the positions of stakeholders, but did not reach any conclusions. While there was consensus on some issues, such as the need for unbundled costs and tariffs, there were many issues where consensus was not reached, such as the need for and benefits of retail wheeling, recovery of stranded costs, environmental and social program issues, franchise and property rights, rate design, and performance-based ratemaking. The issues mentioned above continue to be discussed by Delmarva, the DPSC Staff, and other interested parties. Delmarva expects to develop formal proposals on deregulation which are expected to be filed in mid-1997 with the DPSC. In Maryland, the participants decided in January 1997 to suspend the collaborative process until the MPSC Staff files its report. In response to a directive from the VSCC, the VSCC Staff issued in July 1996 a report on restructuring the electric industry, which included, among other recommendations, a recommendation for a "go slow" approach to restructuring. In November 1996, the VSCC issued an order indicating that more evaluation is necessary to determine what, if any, restructuring may best serve the public interest in Virginia. The VSCC established a new docket and directed its Staff to monitor and file separate studies in 1997 regarding the development of a competitive wholesale market in Virginia, service quality standards, and the results of retail wheeling experiments in other states. Also, several utilities, excluding Delmarva, were directed to file unbundled cost studies and tariffs. Item 2. Fees, Commissions and Expenses The fees, commissions and expenses to be paid or incurred, directly or indirectly, in connection with the Mergers, including the solicitation of proxies, registration of securities of Conectiv under the Securities Act of 1933, and other related matters, are estimated as follows: Commission filing fee for the Registration Statement on Form S-4................ $653,004.84 Accountants' fees................................. * Legal fees and expenses LeBoeuf, Lamb, Greene & MacRae, L.L.P................... * Potter Anderson & Corroon................ * Simpson Thacher & Bartlett............... * Other legal fees and expenses..................... * Shareholder communication and proxy solicitation ................................ * NYSE listing fee.................................. * Exchanging, printing and engraving of stock certificates................................ * Investment bankers' fees and expenses Merrill Lynch, Pierce, Fenner & Smith Incorporated............ * Morgan Stanley & Co. Incorporated........ * Consulting fees relating to the Mergers ................................ * TOTAL * To be filed by amendment. Item 3. Applicable Statutory Provisions The following sections of the Act and the Commission's rules thereunder are or may be directly or indirectly applicable to the proposed transaction: Section of the Act Transactions to which section or rule is or may be applicable 4, 5 Registration of Conectiv as a holding company following the consummation of the Mergers 9(a)(2), 10 Acquisition by Conectiv of common stock of Atlantic and by DS Sub of common stock of Delmarva 9(a)(1), 10 Acquisition by Conectiv of stock of Support Conectiv; authorization for additional investments in Conectiv Services, Inc. 8, 11(b), 21 Retention by Conectiv of gas operations and other businesses of Delmarva and Atlantic 13 Approval of the Service Agreement and services provided to affiliates thereunder by Support Conectiv; approval of the performance of certain services between other Conectiv system companies Rules 16 Exemption of certain subsidiaries 80-91 Pricing of affiliate transactions 88 Approval of Support Conectiv as a subsidiary service company 93, 94 Accounts, records and annual reports by Support Conectiv To the extent that other sections of the Act or the Commission's rules thereunder are deemed applicable to the Mergers, such sections and rules should be considered to be set forth in this Item 3. A. Legal Analysis Section 9(a)(2) makes it unlawful, without approval of the Commission under Section 10, "for any person . . . to acquire, directly or indirectly, any security of any public utility company, if such person is an affiliate . . . of such company and of any other public utility or holding company, or will by virtue of such acquisition become such an affiliate." Under the definition set forth in Section 2(a)(11)(A), an "affiliate" of a specified company means "any person that directly or indirectly owns, controls, or holds with power to vote, 5 per centum or more of the outstanding voting securities of such specified company," and "any company 5 per centum or more of whose outstanding voting securities are owned, controlled, or held with power to vote, directly or indirectly, by such specified company." Delmarva and ACE are public utility companies as defined in Section 2(a)(5) of the Act. Because Conectiv, directly or indirectly, will acquire more than five percent of the voting securities of each of Delmarva and Atlantic as a result of the Mergers, and thus will become an "affiliate" as defined in Section 2(a)(11)(A) of the Act of both Delmarva and Atlantic as a result of the Mergers, Conectiv must obtain the approval of the Commission for the Mergers under Sections 9(a)(2) and 10 of the Act. The statutory standards to be considered by the Commission in evaluating the proposed transaction are set forth in Sections 10(b), 10(c) and 10(f) of the Act. As set forth more fully below, the Mergers comply with all of the applicable provisions of Section 10 of the Act and should be approved by the Commission. Thus: - the consideration to be paid in the Mergers is fair and reasonable; - the Mergers will not create detrimental interlocking relations or concentration of control; - the Mergers will not result in an unduly complicated capital structure for the Conectiv system; - the Mergers are in the public interest and the interests of investors and consumers; - the Mergers are consistent with Sections 8 and 11 of the Act; - the Mergers tend towards the economical and efficient development of an integrated public utility system; and - the Mergers will comply with all applicable state laws. Furthermore, the Mergers provide an opportunity for the Commission to follow certain of the interpretive recommendations made by the Division of Investment Management (the "Division") in the report issued by the Division in June 1995 entitled "THE REGULATION OF PUBLIC UTILITY HOLDING COMPANIES" (the "1995 REPORT"). The Mergers and the requests contained in this Application/Declaration are well within the precedent of transactions approved by the Commission as consistent with the Act prior to the 1995 REPORT and thus could be approved without any reference to the 1995 REPORT. However, a number of the recommendations contained in the 1995 REPORT serve to strengthen the Applicants' analysis and support certain requests that would facilitate the creation of a new holding company better able to compete in the rapidly evolving utility industry. The Division's overall recommendation that the Commission "act administratively to modernize and simplify holding company regulation. . . and minimize regulatory overlap, while protecting the interests of consumers and investors,"5 should be used in reviewing this Application/Declaration since, as demonstrated below, the Mergers will benefit both consumers and shareholders of Conectiv and the other federal and state regulatory authorities with jurisdiction over the Mergers will have approved the Mergers as in the public interest. In addition, although discussed in more detail in each applicable item below, the specific recommendations of the Division with regard to utility ownership6 and diversification,7 in particular, are applicable to the Mergers. - - -------- 5 Letter of the Division of Investment Management to the Securities and Exchange Commission, 1995 REPORT. 6 The 1995 REPORT recommends that the Commission should apply a more flexible interpretation of the integration requirements under the Act; interconnection through power pools, reliability councils and wheeling arrangements can satisfy the physical interconnection requirement of section 2(a)(29); the geographic requirements of section 2(a)(29) should be interpreted flexibly, recognizing technical advances consistent with the purposes and provisions of the Act; the Commission's analysis should focus on whether the resulting system will be subject to effective regulation; the Commission should liberalize its interpretation of the "A-B-C" clauses and permit combination systems where the affected states agree, and the Commission should "watchfully defer" to the work of other regulators. 1995 REPORT at 71-7. 7 The 1995 REPORT recommended that, for example, the Commission should promulgate rules to reduce the regulatory burdens associated with energy-related diversification and the Commission should adopt a more flexible approach in considering all other requests to enter into diversified activities. 1995 REPORT at 88-90. The recommendations regarding energy-related diversification were incorporated in Rule 58. 1. Section 10(b) Section 10(b) provides that, if the requirements of Section 10(f) are satisfied, the Commission shall approve an acquisition under Section 9(a) unless: (1) such acquisition will tend towards interlocking relations or the concentration of control of public utility companies, of a kind or to an extent detrimental to the public interest or the interests of investors or consumers; (2) in case of the acquisition of securities or utility assets, the consideration, including all fees, commissions, and other remuneration, to whomsoever paid, to be given, directly or indirectly, in connection with such acquisition is not reasonable or does not bear a fair relation to the sums invested in or the earning capacity of the utility assets to be acquired or the utility assets underlying the securities to be acquired; or (3) such acquisition will unduly complicate the capital structure of the holding company system of the applicant or will be detrimental to the public interest or the interests of investors or consumers or the proper functioning of such holding company system. a. Section 10(b)(1) i. Interlocking Relationships By its nature, any merger results in new links between theretofore unrelated companies. However, these links are not the types of interlocking relationships targeted by Section 10(b)(1), which was primarily aimed at preventing business combinations unrelated to operating synergies. The Merger Agreement provides for the Board of Directors of Conectiv to be composed of members drawn from the Boards of Directors of both Delmarva and Atlantic. This is necessary to integrate Delmarva and Atlantic fully into the Conectiv system and will therefore be in the public interest and the interests of investors and consumers. Forging such relations is beneficial to the protected interests under the Act and thus are not prohibited by Section 10(b)(1). ii. Concentration of Control Section 10(b)(1) is intended to avoid "an excess of concentration and bigness" while preserving the "opportunities for economies of scale, the elimination of duplicate facilities and activities, the sharing of production capacity and reserves and generally more efficient operations" afforded by the coordination of local utilities into an integrated system. AMERICAN ELECTRIC POWER CO., 46 SEC 1299, 1309 (1978). In applying Section 10(b)(1) to utility acquisitions, the Commission must determine whether the acquisition will create "the type of structures and combinations at which the Act was specifically directed." VERMONT YANKEE NUCLEAR CORP., 43 SEC 693, 700 (1968). As discussed below, the Mergers will not create a "huge, complex, and irrational system," but rather will afford the opportunity to achieve economies of scale and efficiencies which are expected to benefit investors and consumers. AMERICAN ELECTRIC POWER CO., 46 SEC at 1307 (1978). Size: If approved, the Conectiv system will serve approximately 915,000 electric customers in four states and 100,000 gas customers in Delaware. As of and for the year ended December 31, 1996: (1) the combined assets of Delmarva and Atlantic would have totaled approximately $5.65 billion; (2) combined operating revenues of Delmarva and Atlantic would have totaled approximately $2.1 billion; and (3) combined owned generating capacity totaled would have totaled approximately 5514 MW. By comparison, the Commission has approved a number of acquisitions involving significantly larger operating utilities. SEE, E.G., CINERGY CORP., HCAR No. 26146 (Oct. 21, 1994) (combination of Cincinnati Gas & Electric Company and PSI Resources; combined assets at time of acquisition of approximately $7.9 billion); ENTERGY CORP., 55 HCAR No. 25952 (Dec. 17, 1993) (acquisition of Gulf States Utilities; combined assets at time of acquisition in excess of $21 billion); NORTHEAST UTILITIES, HCAR No. 25221 (Dec. 21, 1990) (acquisition of Public Service of New Hampshire; combined assets at time of acquisition of approximately $9 billion); CENTERIOR ENERGY CORP., HCAR No. 24073 (April 29, 1986) (combination of Cleveland Electric Illuminating Company and Toledo Edison Company; combined assets at time of acquisition of approximately $9.1 billion); AMERICAN ELECTRIC POWER CO., 46 SEC 1299 (1978) (acquisition of Columbus and Southern Ohio Electric Company combined assets at time of acquisition of close to $9 billion). As the following table demonstrates, nearly all of the registered electric, or combination gas and electric, utility holding company systems are larger than Conectiv will be following the Mergers in terms of assets, operating revenues, customers and/or sales of electricity:8 - - -------- 8 Amounts are as of December 31, 1996 or for the year ended December 31, 1996. [Bracketed numbers are 1995 figures.] The numbers for New Century Energies, Inc. are taken from the Commission's order approving its formation. NEW CENTURY ENERGIES, INC., HCAR No. 26748 (Aug. 1, 1997). Total Operating Electric Sales in System Assets Revenues Customers KWH Total ($ Millions) ($ Millions) (Thousands) (Millions) Southern 30,292 10,358 3,445 153,531 AEP 15,886 5,849 2,942 [120,653] Entergy 22,966 7,163 2,426 106,909 CSW 13,332 5,155 1,704 62,425 GPU 10,941 3,918 1,997 44,448 Northeast 10,742 3,792 [1,695] [39,618] CINergy 8,849 3,243 1,392 [54,220] NCE 7,000 3,000 1,500 7,438(1) Allegheny 6,618 1,013 1,388 59,961 NEES 5,223 2,350 [1,314] 25,194 Conectiv 5,650 2,075 920 21,272 - - -------- (1) This number is in MWH. In addition, Conectiv will be smaller than the registered holding company to be formed as a result of the merger of Union Electric Company and CIPSCO, Inc. (combined 1994 year-end assets of approximately $8,402 million and operating revenues of $2,850 million). Conectiv will be a small registered holding company, and its operations will not exceed the economies of scale of current electric generation and transmission technology or provide undue power or control to Conectiv in the region in which it will provide service. Efficiencies and economies: As noted above, the Commission has rejected a mechanical size analysis under Section 10(b)(1) in favor of assessing the size of the resulting system with reference to the efficiencies and economies that can be achieved through the integration and coordination of utility operations. More recent pronouncements of the Commission confirm that size is not determinative. Thus, in Centerior Energy Corp., HCAR No. 24073 (April 29, 1986), the Commission stated flatly that a "determination of whether to prohibit enlargement of a system by acquisition is to be made on the basis of all the circumstances, not on the basis of size alone." In addition, in the 1995 REPORT, the Division recommended that the Commission approach its analysis on merger and acquisition transactions in a flexible manner with emphasis on whether the Mergers creates an entity subject to effective regulation and is beneficial for shareholders and customers as opposed to focusing on rigid, mechanical tests.9 - - -------- 9 1995 REPORT at 73-4. By virtue of the Mergers, Conectiv will be in a position to realize the "opportunities for economies of scale, the elimination of duplicate facilities and activities, the sharing of production capacity and reserves and generally more efficient operations" described by the Commission in American Electric Power Co. 46 SEC 1299, 1309. Among other things, the Mergers are expected to yield significant capital expenditure savings through labor cost savings, facilities consolidation, corporate and administrative programs, non-fuel purchasing economies and combined fuel supply and purchased power. These expected economies and efficiencies from the combined utility operations are described in greater detail below and are projected to result in net savings of more than $500 million over the first ten years alone. Competitive Effects: In Northeast Utilities, HCAR No. 25221 (Dec. 21, 1990), the Commission stated that "antitrust ramifications of an acquisition must be considered in light of the fact that public utilities are regulated monopolies and that federal and state administrative agencies regulate the rates charged consumers." Delmarva and Atlantic have filed Notification and Report Forms with the DOJ and FTC pursuant to the HSR Act describing the effects of the Mergers on competition in the relevant market and it is a condition to the consummation of the Mergers that the applicable waiting periods under the HSR Act shall have expired or been terminated. In addition, the competitive impact of the Mergers has been fully considered by the FERC pursuant to Section 203 of the Federal Power Act in its review of the Mergers. A detailed explanation of the reasons why the Mergers will not threaten competition in even the most narrowly drawn geographic and product markets is set forth in the prepared testimony of John C. Dalton, filed with the FERC on behalf of Delmarva and Atlantic, a copy of which is filed as Exhibit D-1.2.1. As noted previously, the FERC issued an order on July 30, 1997, approving the Mergers and concluding, among other things, that the Mergers would not significantly affect competition in any relevant market. Exhibit D-1.3. For these reasons, the Mergers will not "tend toward interlocking relations or the concentration of control" of public utility companies, of a kind or to the extent detrimental to the public interest or the interests of investors or customers within the meaning of Section 10(b)(1). b. Section 10(b)(2) -- Fairness of Consideration Section 10(b)(2) requires the Commission to determine whether the consideration to be given by Conectiv to the holders of Delmarva Common Stock and Atlantic Common Stock in connection with the Mergers is reasonable and whether it bears a fair relation to investment in and earning capacity of the utility assets underlying the securities being acquired. Market prices at which securities are traded have always been strong indicators as to values. As shown in the table below, most quarterly price data, high and low, for Delmarva and Atlantic Common Stock provide support for this conversion ratio.
Delmarva Atlantic High ........ Low Dividends High Low Dividends 1994 First Quarter .............. $23 5/8 $20 1/2 $0.38 1/2 $21 3/4 $19 7/8 $0.38 1/2 Second Quarter ............. 21 16 7/8 0.38 1/2 21 1/2 16 3/8 0.38 1/2 Third Quarter .............. 20 17 3/4 0.38 1/2 19 5/8 16 1/8 0.38 1/2 Fourth Quarter ............. 19 1/4 17 5/8 0.38 1/2 18 1/4 16 0.38 1/2 1995 First Quarter .............. 20 17 7/8 0.38 1/2 19 17 3/4 0.38 1/2 Second Quarter ............. 21 1/4 19 1/8 0.38 1/2 19 5/8 17 7/8 0.38 1/2 Third Quarter .............. 23 19 1/2 0.38 1/2 19 7/8 18 1/8 0.38 1/2 Fourth Quarter ............. 23 5/8 217/8 0.38 1/2 20 1/8 19 0.38 1/2 1996 First Quarter .............. 23 5/8 21 0.38 1/2 20 16 5/8 0.38 1/2 Second Quarter ............. 21 3/8 19 1/8 0.38 1/2 18 3/4 16 0.38 1/2 Third Quarter .............. 21 1/4 20 0.38 1/2 18 1/2 17 0.38 1/2 Fourth Quarter ............. 21 1/4 19 3/4 0.38 1/2 18 1/8 17 1/8 0.38 1/2 1997 First Quarter .............. 20 1/4 18 3/8 0.38 1/2 17 1/2 16 1/2 0.38 1/2 Second Quarter(1) .......... 18 5/8 16 7/8 0.38 1/2 16 7/8 16 0.38 1/2 - - -------------------- (1) Through the close of business on June 27, 1997.
On August 9, 1996, the last full trading day before the public announcement of the execution and delivery of the Merger Agreement, the closing price per share as reported on the NYSE-- Composite Transaction of (i) Delmarva Common Stock was $205/8 and (ii) Atlantic Common Stock was $171/8, a ratio of 1 to 0.83. In addition, the conversion ratios are the product of extensive and vigorous arms-length negotiations between Delmarva and Atlantic. These negotiations were preceded by months of due diligence, analysis and evaluation of the assets, liabilities and business prospects of the respective companies. See Conectiv Registration Statement on Form S-4 (Exhibit C-1 hereto). Finally, nationally-recognized investment bankers for both Delmarva and Atlantic have reviewed extensive information concerning the companies and analyzed the conversion ratios employing a variety of valuation methodologies, and have opined that the conversion ratios are fair, from a financial point of view, to the respective holders of Delmarva Common Stock and Atlantic Common Stock. The investment bankers' analyses and opinions are attached as Annexes II and III to Conectiv's Registration Statement on Form S-4 and are described on pages 33-43 of the Form S-4 (Exhibit C-1 hereto). In light of these opinions and an analysis of all relevant factors, including the benefits that may be realized as a result of the Mergers, Conectiv believes that the conversion ratios fall within the range of reasonableness, and the consideration for the Mergers bears a fair relation to the sums invested in, and the earning capacity of, the utility assets of Delmarva and Atlantic. c. Section 10(b)(2) -- Reasonableness of Fees Conectiv believes that the overall fees, commissions and expenses incurred and to be incurred in connection with the Mergers are reasonable and fair in light of the size and complexity of the Mergers relative to other transactions and the anticipated benefits of the Mergers to the public, investors and consumers; that they are consistent with recent precedent; and that they meet the standards of Section 10(b)(2). As set forth in Item 2 of this Application/Declaration, Delmarva and Atlantic together expect to incur a combined total of approximately $18 million in fees, commissions and expenses in connection with the Mergers. By contrast, Cincinnati Gas & Electric Company and PSI Resources incurred $47.12 million in fees in connection with their reorganization as subsidiaries of CINergy. Northeast Utilities alone incurred $46.5 million in fees and expenses in connection with its acquisition of Public Service of New Hampshire and Entergy alone incurred $38 million in fees in connection with its recent acquisition of Gulf States Utilities -- which amounts all were approved as reasonable by the Commission. See CINERGY CORP., HCAR No. 26146 (Oct. 21, 1994); NORTHEAST UTILITIES, HCAR No. 25548 (June 3, 1992); ENTERGY CORP., HCAR No. 25952 (Dec. 17, 1993). With respect to financial advisory fees, Delmarva and Atlantic believe that the fees payable to their investment bankers are fair and reasonable for similar reasons. Pursuant to the terms of Merrill Lynch's engagement, Delmarva agreed to pay Merrill Lynch for its services in connection with the Mergers: (i) a financial advisory retainer fee of $150,000 and an additional fee of $1,125,000 upon the execution of the Merger Agreement. In addition, Delmarva agreed to pay Merrill Lynch a fee of $1,125,000 upon the approval of the Mergers by the stockholders of Delmarva and a fee of $2,250,000 upon consummation of the Mergers, to which the $150,000 retainer fee already paid will be credited. Delmarva also agreed to reimburse Merrill Lynch for its reasonable out-of-pocket expenses, including all reasonable fees and disbursements of its legal counsel, and to indemnify Merrill Lynch and certain related persons against certain liabilities in connection with its engagement, including certain liabilities under the federal securities laws. Pursuant to the engagement letter between Atlantic and Morgan Stanley, Morgan Stanley is entitled to the following amounts: (i) an advisory fee for its time and efforts expended in connection with the engagement which is estimated to be between $150,000 and $250,000 and which is payable in the event the transaction is not consummated, (ii) an announcement fee of $1,000,000 and (iii) a merger fee of $4,230,000 payable upon consummation of the transaction. Any amounts paid or payable to Morgan Stanley as advisory or announcement fees will be credited against the transaction fee. Atlantic agreed also to reimburse Morgan Stanley for the expenses of its counsel and to indemnify Morgan Stanley and its affiliates against certain liabilities and expenses, including liabilities under the federal securities laws. The investment banking fees of Delmarva and Atlantic reflect the competition of the marketplace, in which investment banking firms actively compete with each other to act as financial advisors to merger partners. d. Section 10(b)(3) Section 10(b)(3) requires the Commission to determine whether the Mergers will unduly complicate Conectiv's capital structure or will be detrimental to the public interest, the interests of investors or consumers or the proper functioning of Conectiv's system. The capital structure of Conectiv will not be unduly complicated nor will it be detrimental to the public interest, the interests of investors or consumers or the proper functioning of Conectiv's system. As described in Item 1.A.2., Conectiv will have two classes of common stock. Delmarva stockholders will receive one share of Conectiv Common Stock in exchange for each share of Delmarva Common Stock. Atlantic stockholders will receive 0.75 shares of Conectiv Common Stock and 0.125 shares of Conectiv Class A Common Stock in exchange for each share of Atlantic Common Stock. Although it is not common for registered holding companies to have more than one class of common stock, the use of two classes of common stock in this case is consistent with the Act because both securities will be publicly traded, will have full voting rights and will be able to be evaluated through regular periodic filings under the Securities Exchange Act of 1934. The Conectiv Class A Common Stock has been created to track the performance of a portion of Atlantic's existing businesses. The Conectiv Class A Common Stock is specifically linked to the currently regulated businesses of ACE, Atlantic's regulated electric utility company (the "Targeted Business"). In general terms, after the Initial Period, the earnings attributable to the Conectiv Class A Common Stock will be based on a 30 percent interest in the net earnings of the Targeted Business in excess of $40 million per year. The first $40 million of net earnings and the remaining 70 percent of the net earnings above $40 million will be attributable to holders of Conectiv Common Stock. Through the use of this tracking stock, the holders of Atlantic Common Stock will retain more than half the benefits and risks relating to the Targeted Business after the Mergers. The Targeted Business is described in greater detail on pages 75 to 77 of the Joint Proxy (Exhibit C-2). The Merger Agreement provides, subject to declaration by the Conectiv Board and the obligation of the Conectiv Board to react to the financial condition and regulatory environment of Conectiv and its results of operations, that the dividends declared and paid on the Conectiv Class A Common Stock will be maintained at a level of $3.20 per share per annum until the earlier of July 1, 2001, or the end of the twelfth calendar quarter in which the Mergers become effective ("Initial Period"). After the Initial Period, it is the intention of Conectiv to pay dividends to the holders of the Conectiv Class A Common Stock at a rate equal to 90% of net earnings attributable to the Targeted Business in excess of $40 million per year. The Merger Agreement further provides that if and to the extent that the annual dividends paid on the Conectiv Class A Common Stock during the Initial Period shall have exceeded 100% of Conectiv's earnings attributable to the Targeted Business in excess of $40 million per year during the Initial Period, the Conectiv Board may consider such fact in determining the appropriate annual dividend rate on the Conectiv Class A Common Stock following the Initial Period. The Company Class A Common Stock, which is a "tracking stock," was proposed during the merger negotiations as a mechanism to address the difference in Delmarva's and Atlantic's evaluations of the overall impact of the growth prospects and uncertainties of the regulated electric utility business of Atlantic. Both the Atlantic Board and the Delmarva Board determined that the Conectiv Class A Common Stock was necessary to bridge a difference in view between Delmarva and Atlantic on the appropriate conversion ratio for a business combination between the two companies. The tracking stock allocates proportionately more of the risks associated with Atlantic's regulated electric utility business to Atlantic's current stockholders and, at the same time, provides them with the opportunity to participate in proportionately more of the growth prospects of Atlantic's regulated electric utility business. Accordingly, the issuance of tracking stock in connection with the Mergers addresses the concerns of the managements of both Delmarva and Atlantic and allows the respective stockholders of Delmarva and Atlantic to gain the level of exposure to the growth prospects of, and uncertainties associated with deregulation of, the regulated electric utility business of Atlantic that the respective managements have deemed advisable. The Conectiv Class A Common Stock will be a class of common stock of the parent company, Conectiv, not of ACE. As common stockholders of Conectiv, holders of the Conectiv Class A Common Stock will not have any specific rights or claims against the businesses, assets and liabilities of the Targeted Business, including upon liquidation of Conectiv, other than as common stockholders of Conectiv, and will be subject to risks associated with an investment in Conectiv and all of its businesses, assets and liabilities. Holders of Conectiv Common Stock and holders of Conectiv Class A Common Stock will each be entitled to one vote per share on all matters submitted to a vote at any meetings of stockholders, subject to the rights, if any, of holders of any outstanding class of preferred stock. The holders of Conectiv Common Stock and the holders of Conectiv Class A Common Stock will vote as one class for all purposes, except as may otherwise be required by the laws of the State of Delaware. There are also special provisions governing the conversion and redemption of the Conectiv Class A Common Stock either at the discretion of Conectiv or in the event of a merger, tender offer or disposition of all or substantially all of the assets of the Targeted Business. For a more complete description of the Conectiv Class A Common Stock, see "Description of the Company's Capital Stock" on pages 75 to 97 of the Joint Proxy (Exhibit C-2). Risk factors associated with the dual class capital structure are also discussed extensively in the Joint Proxy on pages 14 to 22 under the heading "Risk Factors." Both the holders of Conectiv Common Stock and the holders of Conectiv Class A Common Stock will receive the consolidated financial statements of Conectiv. The notes to the consolidated financial statements of Conectiv will include condensed financial information of ACE, including a reconciliation of ACE's total income available to common stockholders to the income of the Targeted Business. In conjunction with the Mergers and the NJ Plan, ACE expects to move all of its presently non-regulated operations out of ACE, resulting in only the Targeted Business remaining in ACE. When the non-regulated businesses of ACE are transferred out of ACE, the financial results of ACE will be identical to the financial results for the Targeted Business, making any reconciliation unnecessary. Complete financial statements of ACE will continue to be filed under the Securities Exchange Act of 1934 and will be available to Conectiv stockholders upon request. The issuance of tracking stocks such as the Conectiv Class A Common Stock is not a new phenomenon. The first prominent tracking stock was issued in 1984 by General Motors Corp. when it issued shares of General Motors Class E shares in connection with its acquisition of Electronic Data Systems Corp. Since 1984, tracking stocks have been used by companies in several industries. USX Corp. has created several tracking stocks tied to separate businesses, including steel, oil and natural gas. US West Communications Group and TeleCommunications Inc. have also issued tracking stocks. In the utility area, CMS Energy issued a tracking stock in July 1995. The CMS Class G stock is tied to a 25 percent interest in its natural gas division, Consumers Power Gas Group. Although the corporate capital structure of Conectiv after the Mergers will be slightly more complex than the capital structures of existing registered holding companies because of the issuance of Conectiv Class A Common Stock to the current Atlantic stockholders in connection with the Mergers, the use of tracking stock in this case is consistent with the standards of Section 10(b)(3) and Section 11(b)(2) of the Act. The tracking stock will not unduly complicate the capital structure of Conectiv, and will not be detrimental to the public interest, the interests of investors or consumers or the proper functioning of the holding company system. In particular, the Conectiv Class A Common Stock will also not unfairly or inequitably distribute voting power among security holders. The primary objective of Section 10(b)(3) and Section 11(b)(2) is to prevent an unfair allocation of actual voting power in utility holding companies through an unduly complicated capital structure. Indeed, earlier decisions of the Commission interpreting the standards of Section 10(b)(3) and Section 11(b)(2) focused primarily on publicly-held minority stock interests.10 Conectiv does not believe that the Conectiv Class A Common Stock constitutes a minority interest for purposes of the Act. However, even if it were, the existence of the Conectiv Class A Common Stock would not constitute an undue complication of Conectiv's capital structure. In its 1992 amendments to Rule 52, the Commission eliminated its traditional limitation on the issuance of common stock to the public by public utility company subsidiaries of registered holding companies, noting that such a prohibition, "while appropriate in 1935 when minority shareholders had little ability to assess their investment, is no longer necessary to protect investors and shareholders."11 - - -------- 10 SEE UTAH POWER & LIGHT COMPANY, HCAR No. 13748 (May 6, 1958) and ILLINOIS POWER COMPANY, HCAR No. 16574 (January 2, 1970). 11 EXEMPTION OF ISSUANCE AND SALE OF CERTAIN SECURITIES BY PUBLIC-UTILITY SUBSIDIARY COMPANIES OF REGISTERED PUBLIC- UTILITY HOLDING COMPANIES, HCAR No. 25573 (July 7, 1992). The 1995 REPORT discusses the greater access to information and advances in accounting and recordkeeping requirements that have developed since the adoption of the Securities Act of 1933 and the Securities Exchange Act of 1934.12 In addition to federal law protections, under Delaware law the Conectiv Board has a duty to act with due care and in the best interests of all of Conectiv's stockholders, including the holders of Conectiv Common Stock and Conectiv Class A Common Stock. The management of Conectiv is aware that the existence of the Conectiv Common Stock and the Conectiv Class A Common Stock may give rise to occasions when the interests of the holders of Conectiv Common Stock and Conectiv Class A Common Stock may diverge or appear to diverge, just as the Commission has recognized that potential conflicts of interest exist within all registered holding company systems.13 In such instances, the Conectiv Board will be required to act on behalf of Conectiv and its stockholders taken as a whole. The existence of, and risks that may be associated with, such potential conflict have been fully disclosed. For a detailed discussion of this issue, see "The Company Following the Mergers" on page 145 of the Joint Proxy (Exhibit C-2). - - -------- 12 1995 REPORT at 34-38. 13 SEE ILLINOIS POWER COMPANY, HCAR No. 16574 (January 2, 1970). It is anticipated that the regulatory environment in which Delmarva and ACE will be conducting their respective utility operations following the consummation of the Mergers will help to ensure that dealings between ACE's regulated electric utility business and the remainder of Conectiv's businesses will be appropriate under the foregoing standard. In addition, the Audit Committee of the Conectiv Board will advise the Conectiv Board with respect to certain intercompany transactions and other fiduciary matters that may relate to the Conectiv Class A Common Stock. The Conectiv Board will exercise from time to time its judgment as to how best to obtain information regarding the divergence (or potential divergence) of interests, under what circumstances to seek the assistance of outside advisers and how to assess which available alternative is in the best interests of Conectiv and all of its stockholders. The Conectiv Class A Common Stock will have full voting rights with the Conectiv Common Stock, which will avoid the creation of an inequitable distribution of power. In addition, the Conectiv Class A Common Stock will be publicly traded on the NYSE and the information necessary to evaluate the performance of the Targeted Business will be publicly available in the quarterly filings of Conectiv and ACE under the Securities Exchange Act of 1934.14 Finally, there are safeguards in place, including regulatory protections and the involvement of the Audit Committee of the Conectiv Board, to mitigate potential conflicts of interest. - - -------- 14 As discussed above, the notes to the consolidated financial statements of Conectiv will include condensed financial information for ACE. Complete financial statements of ACE will continue to be filed under the Securities Exchange Act of 1934 and will be available to Conectiv stockholders upon request. The use of tracking stock in this instance does not create an unduly complicated capital structure making it difficult for investors to discern the value or prospects of the Targeted Business. Rather, it has been designed specifically to create a firm linkage between the performance of the Targeted Business and shareholder earnings. Thus, while the proposed issuance of tracking stock by Conectiv is, to our knowledge, a question of first impression for the Commission, there is no basis for a negative finding under Section 10(b)(3) of the Act. In the 1995 REPORT, the Staff noted that the Commission has historically "responded to change by flexible interpretation and rulemaking."15 The tracking stock is a mechanism whereby Delmarva and Atlantic addressed the difference in their evaluations of the overall impact of the growth prospects of, and uncertainties associated with deregulation of, the regulated electric utility business of Atlantic. The issuance of tracking stock in connection with the Mergers addresses the concerns of the managements of both Delmarva and Atlantic and allows the respective stockholders of Delmarva and Atlantic to gain the level of exposure to the growth prospects of, and uncertainties associated with deregulation of, the regulated utility business of Atlantic that the respective managements have deemed advisable. Given the purpose for issuing the Conectiv Class A Common Stock and its favorable attributes, especially the direct link to the performance of the Targeted Business, full voting rights and proposed NYSE listing, the Applicants hereby seek Commission approval for the inclusion of the tracking stock in the Conectiv capital structure as a flexible response to changes in the utility industry. - - ---------- 15 1995 REPORT at 46. The only voting securities of Conectiv which will be publicly held after the transaction will be Conectiv Common Stock and Conectiv Class A Common Stock. Conectiv will have the ability to issue, subject to the approval of the Commission, preferred stock, the terms of which, including any voting rights, may be set by Conectiv's Board of Directors as has been authorized by the Commission with regard to other registered holding companies. SEE, E.G., THE COLUMBIA GAS SYSTEM, INC., HCAR No. 26361 (Aug. 25, 1995) (approving restated charter, including preferred stock whose terms, including voting rights, can be established by the board of directors). In addition to common stock of Delmarva, all of which will be held by Conectiv, Delmarva will continue to have 1,253,548 shares (not including 2.8 million shares of Quarterly Income Preferred Securities) of outstanding voting preferred stock. The only class of voting securities of Conectiv's direct and indirect nonutility subsidiaries will be common stock. Set forth below are summaries of the historical capital structure of Delmarva and Atlantic as of December 31, 1996 and the pro forma consolidated capital structure of Conectiv as of December 31, 1996: Delmarva and Atlantic Historical Consolidated Capital Structures (dollars in thousands) Delmarva Atlantic Common Stock Equity $934,913 $787,394 Preferred stock not subject to 89,703 30,000 mandatory redemption Preferred stock subject to 70,000 113,950 mandatory redemption Long-term Debt 904,033 829,745 --------- --------- Total $1,998,649 $1,761,089 Conectiv Pro Forma Consolidated Capital Structure* (dollars in thousands) (unaudited) Conectiv Common Stock (incl. additional $1,449,158 paid in capital) Class A Common Stock 136,835 Retained Earnings 285,337 Preferred stock not subject to 119,703 mandatory redemption (of subsidiaries) Preferred stock subject to 183,950 mandatory redemption (of subsidiaries) Long-term Debt 1,733,778 ---------- Total $3,908,761 * The pro forma consolidated capital structure of Conectiv has been adjusted to reflect future nonrecurring charges directly related to the Mergers, which result in, among other things, the recognition of additional current liabilities and a reduction in retained earnings. Conectiv's pro forma consolidated common equity to total capitalization ratio of 48% comfortably exceeds the "traditionally acceptable 30% level." NORTHEAST UTILITIES, HCAR No. 25221 (Dec. 21, 1990), MODIFIED, HCAR No. 25273 (Mar. 15, 1991), AFF'D SUB NOM. CITY OF HOLYOKE V. SEC, 972 F.2d 358 (D.C. Cir. 1992). Protected interests: As set forth more fully in Item 3.A.2.b.i (Efficiencies and Economies), Item 3.A.2.b.ii (Integrated Public Utility System) and elsewhere in this Application/Declaration, the Mergers are expected to result in substantial cost savings and synergies, and will integrate and improve the efficiency of the Delmarva and Atlantic utility systems. The Mergers will therefore be in the public interest and the interests of investors and consumers, and will not be detrimental to the proper functioning of the resulting holding company system. 2. Section 10(c) Section 10(c) of the Act provides that, notwithstanding the provisions of Section 10(b), the Commission shall not approve: (1) an acquisition of securities or utility assets, or of any other interest, which is unlawful under the provisions of Section 8 or is detrimental to the carrying out of the provisions of Section 11/16; or (2) the acquisition of securities or utility assets of a public utility or holding company unless the Commission finds that such acquisition will serve the public interest by tending towards the economical and the efficient development of an integrated public utility system. - - -------- 16 By their terms, Sections 8 and 11 only apply to registered holding companies and are therefore inapplicable at present to Conectiv, since it is not now a registered holding company. The following discussion of Sections 8 and 11 is included only because, under the present transaction structure, Conectiv will register as a holding company after consummation of the Mergers. a. Section 10(c)(1) Section 10(c)(1) requires that an acquisition be lawful under Section 8. Section 8 prohibits registered holding companies from acquiring, owning interests in or operating both a gas and an electric utility serving substantially the same area if state law prohibits it. As discussed below, the Mergers do not raise any issue under Section 8 or, accordingly, the first clause of Section 10(c)(1). Indeed, Section 8 indicates that a registered holding company may own both gas and electric utilities where, as here, the relevant state utility commissions support such an arrangement. Section 10(c)(1) also requires that an acquisition not be detrimental to carrying out the provisions of Section 11. Section 11(a) of the Act requires the Commission to examine the corporate structure of registered holding companies to ensure that unnecessary complexities are eliminated and voting powers are fairly and equitably distributed. As described above, the Mergers will not result in unnecessary complexities or unfair voting powers. Although Section 11(b)(1) generally requires a registered holding company system to limit its operations "to a single integrated public utility system, and to such other businesses as are reasonably incidental, or economically necessary or appropriate to the operations of such integrated public utility system," a combination integrated gas and electric system within a registered holding company is permissible under Section 8. Additionally, Section 11(b)(1) provides that "one or more additional integrated public utility systems" may be retained if, as here, certain criteria are met. Section 11(b)(2) directs the Commission "to ensure that the corporate structure or continued existence of any company in the holding company system does not unduly or unnecessarily complicate the structure, or unfairly or inequitably distribute voting power among security holders, of such holding company system." As detailed below, the Mergers will not be detrimental to the carrying out of the provisions of Section 11. i. Acquisition of Gas Operations Conectiv's acquisition of the gas operations of Delmarva is lawful under Section 8 of the Act and would not be detrimental to the carrying out of Section 11 of the Act. Section 8: Section 8 of the Act provides that [w]henever a State law prohibits, or requires approval or authorization of, the ownership or operation by a single company of the utility assets of an electric utility company and a gas utility company serving substantially the same territory, it shall be unlawful for a registered holding company, or any subsidiary company thereof . . . (1) to take any step, without the express approval of the state commission of such state, which results in its having a direct or indirect interest in an electric utility company and a gas company serving substantially the same territory; or (2) if it already has any such interest, to acquire, without the express approval of the state commission, any direct or indirect interest in an electric utility company or gas utility company serving substantially the same territory as that served by such companies in which it already has an interest. (emphasis added). A fair reading of this section indicates that, with the approval of the relevant state utility commissions, registered holding company systems can include both electric and gas utility systems. In its recent order approving the formation of the New Century Energies, Inc. registered system, the Commission largely ignored the legislative intent expressed in Section 8. In its report, the Senate Committee on Interstate Commerce noted that the provision in Section 8 concerning combination companies "is concerned with competition in the field of distribution of gas and electric energy -- a field which is essentially a question of State policy, but which becomes a proper subject of Federal action where the extra-State device of a holding company is used to circumvent state policy." THE REPORT OF THE COMMITTEE ON INTERSTATE COMMERCE, S. Rep. No. 621, 74TH Cong., 1st Sess. at 31 (1935)("SENATE REPORT"). It appears that the Supreme Court's apparent rejection of a Section 8 argument in the NEES case was based on a distinction drawn by the statute between the divestiture of properties by a registered holding company in the context of a Section 11 proceeding, and the acquisition of such properties in other contexts. At issue in SEC v. NEW ENGLAND ELECTRIC SYSTEM, 384 U.S. 176 (1966) was the continued retention of gas properties that the NEES system, a registered electric system, had owned since its formation in 1926. The Commission in the NEES decision below noted correctly that Section 8, which concerns the acquisition of additional systems, "does not relate to the divestment of properties under the policy embodied in Section 11(b)(1)." NEW ENGLAND ELECTRIC SYSTEM, 41 SEC 888, 902 (1964). This matter, in contrast, involves the acquisition of a combination system by a newly-formed registered holding company. The policies and provisions of Section 8 should be considered in the Commission's determinations in this area. Conectiv believes that a reemphasis by the Commission on Section 8, which would allow registered combination companies pending state support, is consistent both with the Act and its policy objectives. Indeed, over time the Commission has in fact emphasized different aspects of Section 8 and its interplay with Section 11 -- initially allowing registered holding companies to own both gas and electric systems under Section 8, then focusing on Section 11 as controlling determinations regarding combination companies, and requiring the second system to meet a strict interpretation of the requirements set forth in clauses A, B and C of Section 11(b)(1). In its early decisions, the Commission adhered to the concept that the decision as to whether or not to allow combination companies is one that states should make (although the Commission might have to implement it in certain cases) and, where such systems were permissible, the role of the Commission was to ensure that both such systems are integrated as defined in the Act. The Commission's most notable decision in this line is AMERICAN WATER WORKS AND ELECTRIC COMPANY, INCORPORATED, 2 SEC 972 (1937). In this case, the Commission approved the applicant's voluntary reorganization plan under Section 11(e) of the Act and permitted the newly reorganized registered holding company to retain its electric and its gas operations, specifically noting that while the Act does not contain a definition of single integrated utility in the context of a combination company: We believe, however, that it is proper to regard such a combined property as a single integrated system, provided that all of the electric properties are integrated and all of the properties, both gas and electric, are in fairly close geographic proximity and are so related that substantial economies may be effectuated by their coordination under common control. The question of public policy as to the common ownership of gas and electric facilities in the same territory is apparently left by the statute to the decision of the states.17 - - -------- 17 AMERICAN WATER WORKS AND ELECTRIC COMPANY, INCORPORATED, 2 SEC at 983, n.3. Thus, since the combination company did not violate state policy, there was no need for the Commission to exercise jurisdiction to implement state policy. By the early 1940's, however, the Commission switched its focus to Section 11 and adopted a narrow interpretation of the standards contained therein as the controlling factor with regard to combination registered holding companies.18 In connection with its analysis of combination companies under Section 11, the Commission frequently noted a policy concern existing at that time which advocated separating the management of gas and electric utilities based on the belief that the gas utility business tended to be overlooked by combination company management who focused on the electric utility business. Therefore, gas utilities would benefit from having separate management focused entirely on the gas utility business.19 However, both the legislative history of the Act and recent changes in the utility industry indicate that it is a propitious time for the Commission to reemphasize the provisions of Section 8 of the Act and allow combination registered holding companies where, as in this case, they are permitted under relevant state law. - - -------- 18 SEE, E.G., COLUMBIA GAS & ELECTRIC CORPORATION, 8 SEC 443 at 463 (1941); UNITED GAS IMPROVEMENT COMPANY, HCAR No. 2692 (April 15, 1941); SECURITIES AND EXCHANGE COMMISSION v. NEW ENGLAND ELECTRIC SYSTEM, 384 U.S. 176 (1966). It should be noted that the Commission continued to give primacy to state utility commission determinations in making decisions regarding combination exempt holding companies. SEE, E.G., NORTHERN STATES POWER COMPANY, HCAR No. 12655 (Sept. 16, 1954); DELMARVA POWER & LIGHT CO., 46 SEC 710 (1976); WPL HOLDINGS, HCAR No. 24590 (Feb. 26, 1988). 19 SEE, E.G., THE PHILADELPHIA COMPANY, 28 SEC 35, 48 (1948); THE NORTH AMERICAN COMPANY, 11 SEC 169, 179-80 (195); ILLINOIS POWER COMPANY, HCAR No. 16574 (Jan. 2, 1970). A review of the legislative history of Section 8 clarifies this intent. As noted above, in its report, the Senate Committee on Interstate Commerce noted that the provision in Section 8 concerning combination companies "is concerned with competition in the field of distribution of gas and electric energy -- a field which is essentially a question of State policy, but which becomes a proper subject of Federal action where the extra-State device of a holding company is used to circumvent state policy." SENATE REPORT at 31. In addition, attached to the above-referenced committee report is the Report of the National Power Policy Committee on Public Utility Holding Companies, which sets forth a recommended policy that: "Unless approval of a State commission can be obtained the commission should not permit the use of the holding-company form to combine a gas and electric utility serving the same territory where local law prohibits their combination in a single entity." This recommendation emphasizes the importance of the state determination in this area. Much more recently, in the 1995 REPORT, the Division noted "it does not appear that the SEC's precedent concerning additional systems precludes the SEC from relaxing its interpretation of Section 11(b)(1)(A)" and "that the utility industry is evolving toward the creation of one-source energy companies that will provide their customers with whatever type of energy supply they want, whether electricity or gas," and recommended that the Commission interpret Section 11(b)(1) of the Act to allow registered holding companies to hold both gas and electric operations as long as each affected state utility regulatory commission approves of the existence of such a company.20 This change in the industry whereby, among other things, customers are increasingly seeking the most economic means of meeting their energy needs, and not simply their gas needs or their electric needs, is evidenced by the transformation of traditional utilities into energy service companies as well as the growth of new energy providers such as marketers, the increase in announced mergers between pure electric and pure gas utilities and even the treatment of energy as a commodity for arbitrage transactions. For example, Consolidated Natural Gas, Unitil Corporation, Eastern Utilities Associates, New England Electric System, Southern Company and Northeast Utilities, each a registered holding company, have been authorized to offer customers multiple fuel options and related energy services through subsidiaries.21 Furthermore, the recent merger of PanEnergy Corp., a large pipeline and electric and gas marketer with Duke Power Company, an electric utility holding company, and the acquisition of Portland General Corporation, an electric utility holding company, by Enron Corporation, a large gas pipeline and electric and gas marketer as well as the acquisition of ENSERCH Corporation, a gas utility company, by Texas Utilities Company, an electric utility holding company, and the acquisition of NorAm Energy, Inc., a gas utility company, by Houston Industries, Inc., an electric utility holding company, demonstrate that market forces are pushing for the convergence of electric and gas operations into full service utility companies. Indeed, the Commission has recently explicitly recognized that "the utility industry is evolving towards a broadly based energy-related business,22 marked by "the interchangeability of different forms of energy, particularly gas and electricity.23 - - -------- 20 1995 REPORT at 15-6. 21 CONSOLIDATED NATURAL GAS COMPANY, HCAR No. 26512 (April 30, 1994) (the "CNG Order"); UNITIL CORPORATION, HCAR No. 26527 (May 31, 1996); NORTHEAST UTILITIES, HCAR No. 26554 (Aug. 13, 1996); NEW ENGLAND ELECTRIC SYSTEM, HCAR No. 26520 (May 23, 1996); and Supplemental Order Releasing Jurisdiction For Certain Retail Electric Marketing Activities, HCAR No. 26519 (May 23, 1996); SEI HOLDINGS, HCAR No. 26581 (September 26, 1996). 22 CNG Order. 23 CNG Order at 11. The legislative history of Section 11 offers additional support for focusing on state commission determinations regarding combination companies. The SENATE REPORT makes clear that "the purpose of section 11 is simply to provide a mechanism to create conditions under which effective Federal and State regulation will be possible." SENATE REPORT at 11. This statement underscores the general policy of the Act that local regulators are in the best position to assess the needs of their communities. The Act was never intended to supplant local regulation but, rather, was intended to create conditions under which local regulation was possible. Section 21 of the Act, which further codifies this legislative intent, states: "Nothing in [the Act] shall affect . . . the jurisdiction of any other commission, board, agency, or officer of . . . any State, or political subdivision of any State, over any person, security, or contract, insofar as such jurisdiction does not conflict with any provision of [the Act] . . . ." The legislative history reveals that Section 21 of the Act was further intended "to insure the autonomy of state commissions [and] nothing in the [Act] shall exempt any public utility from obedience to the requirements of state regulatory law." The Report of the Committee on Interstate Commerce, S. Rep. No. 621 at 10 (1935). Thus, the Act should not be used as a tool to override state policy, particularly when the holding company involved is subject to both state and federal regulation and when the affected state regulatory commissions have indicated their support for the combined electric and gas operations in one holding company system. Finally, this reemphasis on Section 8 fits within the overall regulatory scheme of the Act. First, Section 11 of the Act is flexible and was designed to change as the policy concerns over the regulation of utility holding companies changed.24 As discussed below, the utility industry and the regulation of that industry has changed dramatically in recent years and it is competitive forces (the very thing that the Act was designed to promote) that are pushing holding companies to offer alternative forms of energy. Second, a registered holding company would still be required to demonstrate that any acquisition or transaction by which it would become a combination company would not be detrimental to the carrying out of the provisions of Section 11 of the Act. In other words, its electric system would have to constitute an integrated electric system and that its gas system would have to constitute an integrated gas system and both systems must be capable of being operated efficiently. Thus, the standards of Section 11 would still have to be met, but the construction of those standards should take into account the fundamental policy of the Act and allow local regulators to make the major determination with regard to combination companies. - - -------- 24 MISSISSIPPI VALLEY GENERATING CO., 36 SEC 159 (1955) (noting that Congress intended the concept of integration to be flexible); UNITIL CORPORATION, HCAR No. 25524 (April 24, 1992) (noting that section 11 contains a flexible standard designed to accommodate changes in the industry). Conectiv as a combination company is permissible pursuant to the terms of Section 8 of the Act and is in the public interest. First, the combination of electric and gas operations in Delmarva is lawful under all applicable state laws. Conectiv will not be using its holding company structure to circumvent any state regulations. Moreover, earlier concerns that a holding company such as Conectiv would be able to greatly emphasize one form of energy over the other based on its own agenda have receded because of the competitive nature of the energy market, which requires utilities to meet customer demand for energy above all else, and because state regulators will have sufficient control over, and would be unlikely to approve, a combination company that attempts to undertake such practices. Even if the Act were not interpreted as generally permitting combination gas and electric systems, Section 11 contains additional provisions that permit the retention by Delmarva of its gas system. Section 11(b)(1) of the Act permits a registered holding company to control one or more additional integrated public utility systems -- i.e., gas as well as electric -- if: (A) each of such additional systems cannot be operated as an independent system without the loss of substantial economies which can be secured by the retention of control by such holding company of such system; (B) all of such additional systems are located in one state, adjoining states, or a contiguous foreign country; and (C) the continued combination of such systems under the control of such holding company is not so large (considering the state of the art and the area or region affected) as to impair the advantages of localized management, efficient operation, or the effectiveness of regulation. In the 1995 REPORT, the Division recommended that the Commission "liberalize its interpretation of the 'A-B-C' clauses."25 Historically, as a "guide" to determining whether lost economies are "substantial" under Section 11(b)(1)(A), under its previous narrow interpretation of this section, the Commission has given consideration to four ratios, which measure the projected loss of economies as a percentage of: (1) total gas operating revenues; (2) total gas expense or "operating revenue deductions"; (3) gross gas income; and (4) net gas income or net gas utility operating income. Although the Commission has declined to draw a bright-line numerical test under Section 11(b)(1)(A), under its previous narrow interpretation of this Section it indicated that cost increases resulting in a 6.78% loss of operating revenues, a 9.72% increase in operating revenue deductions, a 25.44% loss of gross income and a 42.46% loss of net income would afford an "impressive basis for finding a loss of substantial economies." ENGINEERS PUBLIC SERVICE CO., 12 SEC 41, 59 (1942) (citation omitted). - - -------- 25 1995 REPORT at 74. Here, the lost economies that would be experienced if the gas properties of Delmarva were to be operated on a stand-alone basis exceed these numbers, without any increase in benefits to consumers. These lost economies result from the need to replicate services, the loss of economies of scale, the costs of reorganization, and other factors, and are described more fully in the Analysis of the Economic Impact of a Divestiture of the Gas Business of DPL (the "Divestiture Study") (Exhibit J-1 hereto). As set forth in the Divestiture Study, divestiture of the gas operations of Delmarva into a stand-alone company would result in lost economies of $14,728,000. These lost economies compare with Delmarva's gas operating revenues of $104,687,000, gas operating revenue deductions of $84,628,000, gas gross income of $20,059,000 and gas net income of $13,910,000. On a percentage basis, Delmarva's lost economies amount to 14.07% of gas operating revenue, 17.40% of gas operating revenue deductions, 73.42% of gross gas income and 105.88% of net gas income for Delmarva. The percent losses in net gas income alone that will be suffered by the Delmarva gas system if operated on a stand-alone basis exceed the 30% loss in the New England Electric System case that the Commission has described as the highest loss of net income in any past divestiture order.26 The percentage loss that would be suffered by Delmarva in gas operating revenue and gross gas income exceeds the percentage loss in the majority of divestiture orders issued by the Commission in the past. Delmarva's lost economies also exceed the lost economies that would have resulted if the divestiture of the gas operations of Public Service Company of Colorado and Cheyenne Light, Fuel and Power Company had been required by the Commission in connection with the approval of the formation of New Century Energies, Inc. The applicable percentages here and in past cases are summarized in Exhibit J-3. - - -------- 26 NEW ENGLAND ELECTRIC SYSTEM, 41 SEC 888 (1964), AFF'D, 384 U.S. 176 (1966) and 390 U.S. 207 (1968). In order to recover these lost economies the Delmarva gas division would need to increase its revenue from rates by $15,493,000 or 14.80%. This increase in rate revenues would have a direct and immediate negative impact on the rates charged to consumers for gas services. Moreover, it should be noted that the divestiture of Delmarva's gas business would result in rate increases of 0.79% for Delmarva electric customers. Finally, divestiture of Delmarva's gas operations would cause a significant, although difficult to quantify, amount of damage to Conectiv's customers, Conectiv's regulators and Conectiv's ability to compete in the marketplace. Such non-quantifiable costs to customers involve the additional expenses of doing business with two utilities instead of one (i.e., additional telephone calls for service and billing inquiries, and costs of providing access to meters and other facilities for two utilities) and costs associated with making the entities supply information to shareholders and publish the reports required by the 1934 Act. Similarly, regulatory costs involve additional duties for the staffs of the DPSC as a result of dealing with an additional utility. These additional duties would largely be the result of duplicating existing functions, such as separate requests for approval of financing. Conectiv's competitive position in the market would also suffer because as the utility industry moves toward a complete energy services concept, competitive companies must be able to offer customers a range of options to meet their energy needs. Divestiture of gas operations would render Conectiv unable to offer its customers a significant and important option, namely gas services, and could damage Conectiv's long-term competitive potential. Most recently in the NEW CENTURY ENERGIES order, the Commission explained: other factors operated to compound the loss of economies represented by increased costs. The Commission has previously taken notice of developments that have occurred in the electric and gas utility industry in recent years, and has interpreted the Act and analyzed proposed transactions in light of these changed and changing circumstances. In the Commission's view, these developments should be considered in determining whether PSC's and Cheyenne's gas system may be retained. The gas and electric industries are converging, and, in these circumstances, separation of gas and electric businesses may cause the separated entities to be weaker competitors than they would be together. This factor adds to the quantifiable loss of economies caused by increased costs. * * * In the 1960s, when the NEES case was decided, utilities were primarily franchised monopolies with captive ratepayers, and competition between suppliers of gas and electricity, however limited, was virtually the only source of customer choice and was thus deemed beneficial to energy consumers. The fact that other gas utilities of comparable size could operate successfully on an independent basis was evidence that a gas system could operate on its own, a desirable result, without a substantial loss of economies. The empirical basis for these assumptions, however, is rapidly eroding. Although franchised monopolies are still the rule, competition is increasing. Increased expenses of separate operations may no longer be offset, as they were in NEW ENGLAND ELECTRIC SYSTEM, by a gain of qualitative competitive benefits, but rather may be compounded by a loss of such benefits, as the Commission finds in this matter. (footnotes omitted). Accordingly, we urge the Commission to find Clause A satisfied for the reasons set forth above, consistent with its conclusions in the NEW CENTURY ENERGIES order. (B) and (C) clauses: The remaining requirements of Section 11(b)(1) are met because the gas operations of Delmarva are located in only one state (Delaware) and because the continued gas operations under Conectiv are not so large (considering the state of the art and the area or region affected) as to impair the advantages of localized management, efficient operation or the effectiveness of regulation. The gas system is confined to a small area. Finally, as detailed above, the gas operations of Delmarva enjoy substantial economies as part of the Delmarva system, and will realize additional economies as part of the Conectiv System as a result of the Mergers. Far from impairing the advantages of efficient operation, the continuation of the gas operations under Conectiv will facilitate and enhance the efficiency of gas operations. ii. Direct and Indirect Nonutility Subsidiaries of Conectiv As a result of the Mergers, the nonutility businesses and interests of Delmarva and Atlantic described in Item 1.B.3 above will become businesses and interests of Conectiv. The total assets of all nonutility investments of Delmarva and Atlantic at June 30, 1997 totaled $403 million. Corporate charts showing the nonutility subsidiaries of Delmarva and Atlantic are filed as Exhibits E-2 and E-3. A corporate chart showing the projected arrangement of these subsidiaries under Conectiv is filed immediately after consummation of the Mergers as Exhibit E-4. Standard for acquisition: Section 11(b)(1) generally limits a registered holding company to acquire "such other businesses as are reasonably incidental, or economically necessary or appropriate, to the operations of [an] integrated public utility system." Although the Commission has traditionally interpreted this provision to require an operating or "functional" relationship between the nonutility activity and the system's core nonutility business, in its recent release promulgating Rule 58,27 the Commission stated that it "has sought to respond to developments in the industry by expanding its concept of a functional relationship." The Commission added "that various considerations, including developments in the industry, the Commission's familiarity with the particular nonutility activities at issue, the absence of significant risks inherent in the particular venture, the specific protections provided for consumers and the absence of objections by the relevant state regulators, made it unnecessary to adhere rigidly to the types of administrative measures" used in the past. Furthermore, in the 1995 REPORT, the Staff recommended that the Commission replace the use of bright-line limitations with a more flexible standard that would take into account the risks inherent in the particular venture and the specific protections provided for consumers.28 As set forth more fully below, the non-utility business interests that Conectiv will hold directly or indirectly all meet the Commission's standards for retention. - - -------- 27 EXEMPTION OF ACQUISITION BY REGISTERED PUBLIC-UTILITY HOLDING COMPANIES OF SECURITIES OF NONUTILITY COMPANIES ENGAGED IN CERTAIN ENERGY-RELATED AND GAS-RELATED ACTIVITIES, HCAR No. 26667 (Feb. 14, 1997) ("RULE 58 RELEASE"). 28 1995 REPORT at 81-87, 91-92. The following is a description of the specific bases under which the nonutility investments of Delmarva and Atlantic may be retained in the Conectiv holding company system: Development and commercialization of electrotechnologies: The business activities of the following companies, either directly or through subsidiaries, are energy-related activities within the meaning of Rule 58(b)(1)(ii), involving "the development and commercialization of electrotechnologies related to energy conservation, storage and conversion, energy efficiency, waste treatment, greenhouse gas reduction, and similar innovations." SEE ALSO NEW CENTURY ENERGIES, HCAR No. 26748 (Aug. 1, 1997). Accordingly, these interests are retainable under Section 11(b)(1) of the Act:29 DCTC-Glendon, Inc. was formed to invest in a waste-to- energy business that was proposed to be located in Glendon, PA. The facility was never built. The company is dormant and will be dissolved. Pine Grove Gas Development, L.L.C. is involved in developing a use for methane gas produced at the municipal solid waste landfill owned and operated by Pine Grove Landfill, Inc. ATE is an investor in EnerTech Capital Partners, L.P., a limited partnership that will invest in and support a variety of energy technology growth companies. - - -------- 29 Rule 58 explicitly permits indirect investment in energy- related companies through project parents. Although Rule 58 was adopted pursuant to Section 9(c)(3) of the Act, businesses permissible under the rule are retainable under Section 11. See Michigan Consolidated Gas Co., 44 S.E.C. 361 (1970), aff'd, 444 F.2d 931 (D.C. Cir. 1971) (Section 9(c)(3) may not be used to circumvent Section 11). Brokering and marketing of energy commodities: The business activities of the following company are energy-related activities within the meaning of Rule 58(b)(1)(v), involving "the brokering and marketing of energy commodities, including but not limited to electricity or natural or manufactured gas or other combustible fuels." SEE ALSO NEW CENTURY ENERGIES, INC., HCAR No. 26784 (Aug. 1, 1997); SEI HOLDINGS, INC., HCAR No. 26581 (Sept 26, 1996); NORTHEAST UTILITIES, HCAR No. 26654 (Aug. 13, 1996); UNITIL CORP., HCAR No. 26257 (May 31, 1996); NEW ENGLAND ELECTRIC SYSTEM, HCAR No. 26520 (May 23, 1996); and EASTERN UTILITIES ASSOCIATES, HCAR No. 26493 (March 14, 1996). Accordingly, these interests are retainable under Section 11(b)(1) of the Act: Enerval, L.L.C. ("Enerval") provides energy management services, including natural gas procurement, transportation and marketing. Delmarva Energy Company is expected to provide marketing of energy. Delmarva Industries, Inc., previously was involved in oil and gas drilling ventures. It is dormant and will be dissolved. Thermal energy products: The business activities of the following companies (directly or through subsidiaries) are energy-related activities within the meaning of Rule 58(b)(1)(vi), involving "the production, conversion, sale and distribution of thermal energy products, such as process steam, heat, hot water, chilled water, air conditioning, compressed air and similar products; alternative fuels; and renewable energy resources; and the servicing of thermal energy facilities." SEE ALSO NEW CENTURY ENERGIES, HCAR No. 26748 (Aug. 1, 1997); CINERGY CORP., HCAR No. 26474 (Feb. 20, 1996). Accordingly, these interests are retainable under Section 11(b)(1) of the Act: ATS develops, owns and operates thermal heating and cooling systems. It is also exempt as a holding company over the following companies engaged in the same type of activities: Atlantic Jersey Thermal Systems, Inc. provides operating services for thermal heating and cooling systems. ATS Operating Systems, Inc. provides thermal energy operating services. Thermal Energy Limited Partnership I holds an investment in the Midtown Energy Center, which produces steam and chilled water ("TELPI"). Ownership and operation of QFs: The business activities of the following companies, directly or through subsidiaries, are energy-related activities within the meaning of Rule 58(b)(1)(viii), involving "the development, ownership or operation of 'qualifying facilities'..., and any integrated thermal, steam host, or other necessary facility constructed, developed or acquired primarily to enable the qualifying facility to satisfy the useful thermal output requirements under PURPA." SEE ALSO NEW CENTURY ENERGIES, INC., HCAR No. 26748 (AUG. 1, 1997); ENTERGY CORP., HCAR No. 26322 (June 30, 1995); SOUTHERN CO., HCAR No. 26212 (Dec. 30, 1994); CENTRAL AND SOUTH WEST CORP., HCAR No. 26156 (Nov. 3, 1994);CENTRAL AND SOUTH WEST CORP., HCAR No. 26155 (Nov. 2, 1994); and NORTHEAST UTILITIES, HCAR No. 25977 (Jan. 24, 1994). Accordingly, these interests are retainable under Section 11(b)(1) of the Act: DCTC has partnership interests in Luz Solar Partners, Ltd. IV and UAH-Hydro Kennebec, L.P., which own qualifying facilities located in southern California and New York state, respectively. Delmarva Operating Services Company ("DOSC") is retainable as a holding company over the following companies engaged in the operation and maintenance of qualifying facilities: DelWest Operating Company will operate and maintain a qualifying facility in Burney, CA, under a contract with the plant's owner, Burney Forest Products, Joint Venture (an investment of DCTC-Burney, Inc.). DelCal Operating Company operates and maintains a qualifying facility in Sacramento, California owned by the Sacramento Power Authority under a subcontract with Siemens Power Corporation. DelStar Operating Company operates and maintains the Delaware City Power Plant, a qualifying facility in Delaware City, Delaware under a contract with the plant's owner. DCTC-Burney, Inc. is retainable as a holding company over investments in Pine Grove Gas Development, L.L.C. (discussed above under subsection 1) and, together with the following company or companies, engaged in the operation and ownership of qualifying facilities: DelBurney Corporation is an intermediate holding company over an investment in a qualifying facility. Forest Products, L.P. is a general partner in a joint venture that owns a qualifying facility and related sawmill. Burney Forest Products, Joint Venture owns a qualifying facility and related sawmill in Burney, CA. AGI is retainable as a holding company over the following companies engaged in the operation and ownership of qualifying facilities: Pedrick Ltd., Inc. holds a limited partnership interest in Pedricktown Cogeneration Limited Partnership, a qualifying facility. Pedrick Gen., Inc. holds a general partnership interest in Pedricktown Cogeneration Limited Partnership, a qualifying facility. Vineland Limited, Inc. holds a limited partnership interest in Vineland Cogeneration Limited Partnership, a qualifying facility. Vineland General, Inc. holds a general partnership interest in Vineland Cogeneration Limited Partnership, a qualifying facility. Telecommunications facilities: Section 34 of the Act provides an exemption from the requirement of prior Commission approval the acquisition and retention by a registered holding company of interests in companies engaged in a broad range of telecommunications activities and businesses. Section 34 permits ownership of interests in telecommunications companies engaged exclusively in the business of providing telecommunications service upon application to the Federal Communications Commission for a determination of "exempt telecommunications company" status. Conectiv Communications, Inc. and CCI will file for status as exempt telecommunications companies under Section 34 of the Act prior to consummation of the Mergers. Real estate: In prior orders, the Commission has approved the purchase of real estate which is incidentally related to the operations of a registered holding company. See UNITIL Corporation et al., Holding Co. Act Release No. 25524 (Apr. 24, 1992) (Commission noted that UNITIL Realty Corporation, a subsidiary of the registered holding company, UNITIL, which acquired real estate to support utility operations, engaged in activities which were within the confines of the Act). Consequently, since the real estate held by the following companies is substantially similar to that owned by UNITIL Realty Corporation, the companies are retainable subsidiaries of a registered holding company under Section 11(b)(1) of the Act: Delmarva Services Company was formed to own and finance an office building leased to Delmarva and/or affiliates. Christiana Capital Management, Inc. was formed to own and finance an office building leased to affiliates. ASP owns and manages a commercial office and warehouse facility in southern New Jersey. Fifty percent of the space is presently leased to system companies and fifty percent is leased to a high school and a day care center. Delmarva Capital Realty Company ("DCRC") is a vehicle for the sale of properties not used or useful for the utility business. Post and Rail Farms, Inc. ("Post and Rail") is engaged in the development and sale of a residential housing development. With respect to DCRC and Post and Rail, these companies are managing real estate that was acquired for an intended utility purpose which has ceased to exist, or in order for the utility to obtain the necessary rights of way for transmission lines and other utility operations. Unlike many other states, Delaware does not provide a right of condemnation for a franchised electric utility. Rather, the utility is often forced to acquire the underlying fee simple for a larger parcel in order to obtain an easement or right of way. The development of these properties is a means of recovering the costs associated with their acquisition. Accordingly, we submit, such interests are retainable either under Section 11(b)(1) or pursuant to Section 9(c)(3) "in the ordinary course of business" of a registered system. Leveraged leases: The Commission has approved investments by registered holding companies in leveraged leases under Section 9(c)(3), which exempts from Section 9(a) and Section 10, "such commercial paper and other securities, within such limitations, as the Commission may by rules and regulations or order prescribe as appropriate in the ordinary course of business of a registered holding company or subsidiary company thereof and as not detrimental to the public interest or the interest of investors or consumers." Central and South West Corporation, HCAR 23588 (Jan. 22, 1985). As the Commission noted in Central and South West, title held by the lessor in such circumstances is insufficient to make lessor an "owner" under Section 2(a)(3)(4) of the Act. Moreover, attempting to reduce one's tax liability through leveraged lease investments is within the ordinary course of business. Consequently, since the leveraged lease investments held by the following companies and related activities of the companies are substantially similar to those discussed above, the companies are retainable subsidiaries of a registered holding company under 11(b)(1) of the Act: DCI I, Inc. makes equity investments in leveraged leases of aircraft. DCI II, Inc. is a foreign sales subsidiary formed to obtain certain tax benefits from leveraged lease investments by DCI I, Inc. ATE's primary investments are equity investments in leveraged leases of three commercial aircraft and two container ships. The other activities of ATE Investment, Inc. are (i) its investment in EnerTech Capital Partners, L.P., which, as discussed above, is retainable pursuant to Rule 58(b)(1)(ii) and (ii) certain financing arrangements with affiliates. Solid Waste Management: The Applicants also seek approval to retain certain de minimis investments in the solid waste management business. These companies were originally acquired in connection with a proposed investment in a waste-to-energy facility that was never constructed. These companies have total assets of less than $35 million. Given the de minimis size of the investment and that the Applicants are seeking only to retain, and maintain, the existing assets, the Commission should approve retention of the following two companies: Pine Grove, Inc. is a holding company over the following investments: Pine Grove Landfill, Inc. owns and operates a municipal solid waste landfill. Pine Grove Hauling Company owns and operates a waste hauling and recycling business. Gas-related Activities: Conectiv will hold an indirect ownership interest in ECNG, which is engaged in gas-related activities. Delmarva participated in the formation of ECNG in order to improve the efficiency of its natural gas local distribution operations. ECNG members provide emergency backup natural gas supplies to other members and jointly undertake the bulk purchase and storage of natural gas for use in their local distribution business. Because these activities are functionally related to the operations of the gas utility business of Delmarva, ECNG is retainable by Conectiv under Section 11(b)(1). Further, upon Commission approval of the Mergers, ECNG will be exempt from all obligations, duties or liabilities imposed upon it by the Act as a subsidiary company or as an affiliate of a registered holding company or of a subsidiary company thereof. SEE RULE 16. Nonutility Holding Companies: In addition to the companies discussed above which are engaged in a single type of business activity, Conectiv will have several other direct and indirect holding company subsidiaries, which are holding companies for subsidiaries engaged in a variety of businesses. The following holding companies are retainable because all of their investments are in companies which are retainable, as outlined above: DCI is the holding company over DCI I, Inc., DCI II, Inc., DOSC, DCRC and Delmarva Capital Technology Company. Delmarva Capital Technology Company ("DCTC") is the holding company over Pine Grove, Inc., DCTC-Glendon, Inc. and DCTC-Burney, Inc. AEE is holding company over ATE, AET, AGI, ATS, CCI, ASP and Enerval. Home Security Business: The home security business of ACE, which is located exclusively in its service territory has annual revenues of less than $10,000. It is a small operation that developed from utility operations and incurs very little cost at this point. Accordingly, Conectiv seeks to retain this business under Section 11(b)(1). Although it is currently within ACE, it may be moved to a separate subsidiary of Conectiv. Any such subsidiary will apply for exempt telecommunications company status under Section 34. Retail Services: In the NEW CENTURY ENERGIES order, the Commission authorized the new registered holding company to provide various retail services through one or more nonutility subsidiaries. The order explained: E prime provides demand side management services and proposes to provide other consulting services to commercial and industrial customers. These services and proposed services include energy analysis, project management, design and construction, energy efficient equipment installation and maintenance, facilities management services, environmental services and compliance, fuel procurement, and other similar kinds of managerial and technical services. The NEW CENTURY ENERGIES order cited a number of orders, including CENTRAL AND SOUTH WEST CORP., HCAR No. 26367 (Sept. 1, 1995) and AMERICAN ELECTRIC POWER CO., HCAR No. 26267 (Apr. 5, 1995). At present, Conectiv Services, Inc. provides heating, ventilation and air conditioning ("HVAC") sales, installation and servicing, and other energy-related services for residential, commercial and industrial customers. The HVAC services provided by Conectiv Services, Inc. are energy-related appliance sales activities that fall within the exemptive requirements of Rule 58. Because Conectiv Services, Inc. intends to engage in additional activities, however, it does not appear that Conectiv Services, Inc. would be an energy-related company for purposes of Rule 58. Nonetheless, these activities are clearly retainable under Commission precedent. Conectiv Services, Inc. also seeks approval to provide directly, or through one or more subsidiaries, a variety of energy-related services and products to residential, commercial and industrial customers ("Retail Services"). As in the NEW CENTURY ENERGIES order, these services and proposed services include energy analysis, project management, design and construction, energy efficient equipment installation and maintenance, facilities management services, environmental services and compliance, fuel procurement, and other similar kinds of managerial and technical services. While the precise list of services is still under consideration, it is anticipated that Retail Services may include: (1) service lines repair/extended warranties - repair of underground utility services lines owned by and located on the customer's property and extended service warranties covering the cost of such repairs; (2) surge protection - meter-based and plug-in equipment to protect customer household appliances and electronic equipment from power surges, including due to lightning; (3) appliance merchandising/repair/extended warranties - marketing of HVAC and other energy-related household and office appliances and equipment and, in connection therewith or separately, marketing of appliance and equipment inspection and repair services and extended service warranties covering the cost of repairing customers' appliances and equipment; (4) utility bill insurance utility bill payment protection, for a monthly fee for a specified number of months, in the event the customer becomes unemployed, disabled or dies; (5) plumbing services; and (6) incidental and reasonably necessary products and services related to the choice, purchase, provision or consumption of any such products and services. Conectiv Services, Inc. also seeks approval to furnish its own financing or to broker nonassociate third-party financing, directly or indirectly, to commercial, industrial and residential customers to support purchases by its customers of HVAC and Retail Services. Conectiv Services, Inc. may also provide financing for goods and services sold by its affiliates. Customer financing may take the form of direct loans, installment purchases, operating or finance lease arrangements (including sublet arrangements) and loan guarantees. Interest on loans and imputed interest on lease payments will be based on prevailing market rates. The obligations will have terms of one to thirty years and will be secured or unsecured. Conectiv Services, Inc. may also assign obligations acquired from customers to banks, leasing companies or other financial institutions, with or without recourse. Rule 40(a)(4) provides an exemption from Section 9(a) with respect to the acquisition: In the ordinary course of the acquiring company's business (other than the business of a holding company or investment company as such), [of] any evidence of indebtedness executed by its customers in consideration of utility or other services by such company or executed in connection with the sale of goods or real property other than utility assets. It appears that, to the extent that financing transactions support Conectiv Services, Inc.'s sales activities, they would be exempt pursuant to Rule 40(a)(4). In the alternative, we note that the Commission has previously approved customer financing activities by registered holding company systems. SEE NEW CENTURY ENERGIES, INC., HCAR No. 26748 (Aug. 1, 1997); CINERGY CORP., HCAR No. 26662 (Feb. 7, 1997); CENTRAL AND SOUTH WEST CORP., HCAR No. 26367 (Sept. 1, 1995); CONSOLIDATED NATURAL GAS CO., HCAR No. 26234 (Feb. 23 1995); and ENTERGY CORP., HCAR No. 25718 (Dec. 28, 1992). As detailed above, many of the existing nonutility activities of Delmarva and Atlantic, and their affiliates, fall within the ambit of newly adopted Rule 58. Consistent with the Commission's recent decision in NEW CENTURY ENERGIES, INC., HCAR No. 26748 (Aug. 1, 1997), investments made by Delmarva and Atlantic prior to the effective date of the Mergers, should not count in the calculation of the 15% limit for purposes of Rule 58. All additional investments made in energy-related companies subsequent to the effective date of the Mergers would, of course, be included in the 15% test. b. Section 10(c)(2) The Mergers will tend toward the economical and efficient development of an integrated public utility system, thereby serving the public interest, as required by Section 10(c)(2) of the Act. i. Efficiencies and Economies The Mergers will produce economies and efficiencies more than sufficient to satisfy the standards of Section 10(c)(2), described above. Although some of the anticipated economies and efficiencies will be fully realizable only in the longer term, they are properly considered in determining whether the standards of Section 10(c)(2) have been met. SEE AMERICAN ELECTRIC POWER CO., 46 SEC 1299, 1320-1321 (1978). Some potential benefits cannot be precisely estimated; nevertheless they too are entitled to be considered: "[S]pecific dollar forecasts of future savings are not necessarily required; a demonstrated potential for economies will suffice even when these are not precisely quantifiable." CENTERIOR ENERGY CORP., HCAR No. 24073 (April 29, 1986) (citation omitted). Delmarva and Atlantic have estimated the nominal dollar net value of synergies from the Mergers to be in excess of $500 million over the first 10-year period, from 1998 to 2007. The geographical locations of the respective service territories of Delmarva and ACE, which operate in contiguous states separated by the Delaware River and whose headquarters are within 90 miles of one another, provide an opportunity to integrate efficiently their utility operations. Delmarva's operating entities already have existing electrical interconnections with Atlantic through 500kv transmission lines. The combined system can be operated as a single, larger cohesive system, with virtually no modification needed with respect to existing generating and transmission facilities. There are five general areas where presently quantifiable savings can be realized through the combination of the companies: (1) corporate, operations and generation support labor; (2) facilities consolidation; (3) corporate and administrative programs; (4) non-fuel purchasing economies; and (5) fuel supply and purchased power. The amount of savings currently estimated in each of these categories, on a nominal dollar basis, is summarized in the table below: Category Amount (in millions) Labor $346 Facilities Consolidation 26 Corporate and Administrative Programs 125 Non-Fuel Purchasing Economies 56 Fuel Supply and Purchased Power 28 Less: Costs to Achieve 72 ---- Net Total Estimated Savings $509 These expected savings far exceed the savings claimed in a number of recent acquisitions approved by the Commission. SEE, E.G., KANSAS POWER AND LIGHT CO., HCAR No. 25465 (Feb. 5, 1992) (expected savings of $140 million over five years); IE INDUSTRIES, HCAR No. 25325 (June 3, 1991) (expected savings of $91 million over ten years); MIDWEST RESOURCES, HCAR No. 25159 (Sept. 26, 1990) (estimated savings of $25 million over five years). These savings categories are described in greater detail below. Corporate, Operations and Generation Support Labor: Savings will be realized through labor reductions related to redundant positions. Many of these reductions will be in areas where payroll costs are relatively fixed and do not vary with an increase or decrease in the number of customers served. These areas include legal services, finance, sales, support services, transmission and distribution, customer service, accounting, human resources and information services. Overall, Conectiv expects a reduction of approximately 10% (or 400 positions) in the combined company's workforce. Conectiv would also have the ability to consolidate certain customer business offices and service centers in the eastern Delaware/western New Jersey area where Delmarva and Atlantic have contiguous or geographically close service territories. Facilities Consolidation: Savings will be realized through the combination of neighboring business offices or service centers. Specifically, due to the workforce reductions, consolidation of operations at the Delmarva headquarters in Wilmington, Delaware will allow for the possible sale or lease of Atlantic's corporate headquarters in Egg Harbor Township, N.J. and other potential consolidations. Corporate and Administrative Programs: Savings will be realized through economies of scale and cost avoidance in those areas where both Delmarva and Atlantic incur many costs for items which relate to the operation of each company, but which are not directly attributable to customers. Ten such areas have been identified: administrative and general overhead; benefits administration; insurance; information services; professional services; shareholder services; advertising; association dues; credit facilities; directors' fees; and vehicles. Achieving cost savings through greater efficiencies and economies of scale will permit each of the operating utilities to offer more competitively-priced electric service and energy-related products and services than would otherwise be possible. Non-Fuel Purchasing Economies: Savings will be realized through increased order quantities and the enhanced utilization of inventory for materials and supplies. Currently, Delmarva and Atlantic independently maintain separate purchasing departments responsible for maintaining materials and supplies used by employees at various storeroom locations. In addition, both companies procure contract services independently. As a direct result of the combination, savings can be realized through the procurement of both materials and services, as well as in costs associated with the maintenance of inventory levels. Fuel Supply and Purchased Power: Savings will be realized through the bundling of commodity fuels and bulk power purchases in the form of larger quantities or volumes. Fuel supply savings were analyzed in the following areas: coal, gas, oil and rail transportation. Conectiv will be able to take advantage of commodity savings based on higher total volumes of coal and natural gas acquisition. Rail transportation costs for coal could also be renegotiated at a lower per ton cost. No savings were identified in oil procurement because both companies are purchasing through commodity markets under short term and spot contracts. This results in competitive market prices for both entities and will not result in significant savings in commodity or transportation. The total potential savings from fuel supply and purchased power are estimated to be $28 million over the ten-year period. Savings from these sources are offset by the costs that must be incurred for activities essential to achieving the savings. Costs to Achieve: Costs to achieve the identified savings are estimated at approximately $72 million for such items as relocation, retraining and system consolidation. Additional Expected Benefits: In addition to the benefits described above, there are other benefits which, while presently difficult to quantify, are nonetheless substantial. These other benefits include: o Increased Scale-- As competition intensifies within the industry, Atlantic and Delmarva believe scale will be one parameter that will contribute to overall business success. Scale has importance in many areas, including utility operations, product development, advertising and corporate services. The Mergers are expected to improve the profitability of the combined company by roughly doubling the customer base and providing increased economies of scale in all of these areas. o Competitive Prices and Services-- Sales to industrial, large commercial and wholesale customers are considered to be at greatest near-term risk as a result of increased competition in the electric utility industry. The Mergers will enable Conectiv to meet the challenges of the increased competition and will create operating efficiencies through which Conectiv will be able to provide more competitive prices to customers. o More Balanced Customer Base-- The Mergers will create a larger company with less reliance on the chemical and financial services industries, from Delmarva's perspective, and on casino gaming, tourism and recreation, from Atlantic's perspective. The combined service territories of Delmarva and Atlantic will be more diverse than their individual service territories, reducing Conectiv's exposure to adverse changes in any sector's economic and competitive conditions. o Financial Flexibility -- By roughly doubling the market capitalization of Conectiv compared with the individual companies, the Mergers should improve Conectiv's overall credit quality and liquidity of the securities and therefore improve Conectiv's ability to fund continued growth. o Regional Platform for Growth-- The combination of Atlantic and Delmarva will create a regional platform in the mid-Atlantic corridor. The corridor is experiencing economic growth that is led by the casino gaming industry in South Jersey and the expansion of the financial services industry in Delaware. Conectiv plans to expand relationships with existing customers and to develop relationships with new customers in the region. Conectiv will use its combined distribution channels to market a portfolio of energy-related products throughout the region and will follow regional relationships to other geographical areas. ii. Integrated Public Utility System I. Electric System As applied to electric utility companies, the term "integrated public utility system" is defined in Section 2(a)(29)(A) of the Act as: a system consisting of one or more units of generating plants and/or transmission lines and/or distributing facilities, whose utility assets, whether owned by one or more electric utility companies, are physically interconnected or capable of physical interconnection and which under normal conditions may be economically operated as a single interconnected and coordinated system confined in its operation to a single area or region, in one or more states, not so large as to impair (considering the state of the art and the area or region affected) the advantages of localized management, efficient operation, and the effectiveness of regulation. On the basis of this statutory definition, the Commission has established four standards that must be met before the Commission will find that an integrated public utility system will result from a proposed acquisition of securities: (1) the utility assets of the system are physically interconnected or capable of physical interconnection; (2) the utility assets, under normal conditions, may be economically operated as a single interconnected and coordinated system; (3) the system must be confined in its operations to a single area or region; and (4) the system must not be so large as to impair (considering the state of the art and the area or region affected) the advantages of localized management, efficient operation, and the effectiveness of regulation. ENVIRONMENTAL ACTION, INC. V. SECURITIES AND EXCHANGE COMMISSION, 895 F.2d 1255, 1263 (9th Cir. 1990), citing ELECTRIC ENERGY, INC., 38 SEC 658, 668 (1958). The Mergers satisfy all four of these requirements. It should be noted that in the 1995 REPORT, the Division recommended that the Commission "respond realistically to the changes in the utility industry and interpret more flexibly each piece of the integration requirement."30 - - -------- 30 1995 REPORT at 71. Conectiv satisfies each of these requirements for an integrated system. The Commission has determined that the first and second requirements are satisfied when the merging companies jointly own generation and transmission facilities and are members of the same tight power pool. UNITIL CORP., HCAR No. 25524 (April 24, 1992); NORTHEAST UTILITIES, HCAR No. 25221 (Dec. 21, 1990). In these cases, the Commission found that the utilities in the holding company systems were physically capable of supplying power to each other through wheeling or power pool arrangements. In addition, the companies are interconnected through their undivided ownership interests in and/or rights to use the same regional generation facilities and extra-high voltage transmission facilities, as well as through their contractual rights to use the transmission facilities of other members of the PJM regional power pool. Delmarva and ACE each have undivided ownership interests in two nuclear plants: Peach Bottom Nuclear Generating Station located in Pennsylvania, in which each company holds a 7.51 percent interest, and Salem Nuclear Generating Station located in New Jersey, in which each company holds a 7.41 percent interest. Both companies also hold undivided ownership interests in two coal-fired thermal units, the Keystone and Conemaugh generating stations located in Pennsylvania. These four plants together account for a substantial proportion of Conectiv's generation resources, though the plants are located outside Conectiv's traditional service areas. Delmarva and ACE both are members of the PJM Pool, which is the largest single control area and tight power pool in the country.31 In order to achieve economy and reliability in bulk power supply within the PJM region, PJM members coordinate the planning and operation of their systems, share installed and operating reserves to reduce installed generator requirements, and participate in centralized unit commitment, coordinated bilateral transactions, and instantaneous real-time dispatch of energy resources to meet customer load requirements throughout the PJM Interconnection. Most of the electricity produced by Delmarva's and ACE's generating facilities, other than generation required to support local reliability, is committed to pool dispatch. - - --------- 31 Comparable tight pools are the New York Power Pool ("NYPP") and the New England Power Pool ("NEPOOL"). Delmarva and ACE, along with other PJM members, also are owners in common or have joint rights to use certain 500 kv transmission facilities that are used to import power from the west and to deliver power from jointly owned generating plants to their owners' systems. These facilities include a transmission line which provides an aerial crossing of the Delaware River and other extra-high voltage lines that directly connect the jointly- owned power plants with lower voltage lines of the PJM Interconnection. Thus, Conectiv is able to integrate its generation resources to serve Delmarva's and ACE's customers pursuant to ownership and contractual rights to use regional transmission facilities of the PJM Interconnection.32 - - --------- 32 The fact that two facilities may be separated by other facilities that are not owned by the holding company does not change the fact that they are capable of physical connection and of supplying power to one another as needed. CITY OF NEW ORLEANS V. SEC, 969 F.2d 1163, 1165 (D.C. Cir. 1992). The Commission previously has found that the physical interconnection requirement of the Act was satisfied on the basis of contractual rights to use third-parties' transmission lines when the merging companies both were members of the same tight power pool.33 In UNITIL, the companies, Unitil's public utility subsidiary companies and Fitchburg Gas and Electric Light Company were indirectly interconnected through New England Power Pool ("NEPOOL") designated facilities and other nonaffiliate transmission facilities pursuant to the NEPOOL Agreement. While there was no particular transmission line through which transfers of power would be made among the Unitil companies, power would be delivered through a nonaffiliate system and a transmission charge would be paid to the owners of the facilities. The Commission found that the Unitil companies' contractual arrangements for transmission service established that the Unitil electric system would satisfy the physical interconnection requirement of the Act. For the same reasons, Conectiv satisfies the physical interconnection requirement of the Act. - - ---------- 33 SEE, E.G., NORTHEAST UTILITIES, HCAR No. 25221 (Dec. 21, 1990) at n. 85, MODIFIED HCAR No. 25273 (March 15, 1991), AFF'D SUB NOM. CITY OF HOLYOKE V. SEC, 972 F.2d 358 (D.C. Cir. 1992); CENTERIOR ENERGY CORP., HCAR No. 24073 (1986); CITIES SERVICES CO., 14 SEC 28, 53 n. 44. SEE ALSO YANKEE ATOMIC ELECTRIC CO., 36 SEC 552, 563 (1955); CONNECTICUT YANKEE ATOMIC POWER CO., 41 SEC 705, 710 (1963) (authorizing various New England companies to acquire interests in a commonly-owned nuclear power company and finding the interconnection requirement met because the New England transmission grid already interconnected the companies). While Delmarva and ACE now achieve integration comparable to that found in UNITIL and NORTHEAST UTILITIES under the current PJM Interconnection Agreement, PJM members are restructuring their organization in ways that will expand the available mechanisms for integrating the Conectiv system. In compliance with Order 888/34 issued by the FERC in 1996, the members of the PJM Pool filed a pool-wide open access transmission tariff ("Tariff") and certain additional agreements intended to implement a restructuring of the PJM Pool.35 Under the Tariff, Delmarva and ACE (as well as other transmission- owning members of PJM and non-members purchasing network transmission service) can obtain network integration transmission service throughout the PJM control area to deliver capacity and energy from designated generation resources to the utility's electric customers. The PJM members also filed with the FERC an amended PJM Interconnection Agreement, which, like the previous PJM Interconnection Agreement, provides for coordination of electric system loads, electric generating capacities and electric transmission facilities. The amended PJM Interconnection Agreement provides that the members will establish a bid-based wholesale energy market in which any participant may buy and sell energy, and for the PJM control center to schedule and dispatch generation on the basis of least-cost, security-constrained dispatch and the prices and operating characteristics offered by sellers in order to serve the energy purchase requirements of customers. Though there are differences of opinion among PJM members as to the appropriate rules for governing the structure of the energy market, there is substantial agreement that an energy exchange should be implemented. - - -------- 34 PROMOTING WHOLESALE COMPETITION THROUGH OPEN ACCESS NON-DISCRIMINATORY TRANSMISSION SERVICES BY PUBLIC UTILITIES AND RECOVERY OF STRANDED COSTS BY PUBLIC UTILITIES AND TRANSMITTING UTILITIES, Order No. 888, 61 Fed. Reg. 21540 (May 10, 1996), III FERC Stats. & Regs., Regulations Preambles 1991-1996 P. 31,036 (1996) ("Order 888"). 35 COMPLIANCE OF THE PENNSYLVANIA-NEW JERSEY-MARYLAND INTERCONNECTION WITH ORDER No. 888, Docket No. OA97-261-000 (filed Dec. 31, 1996). Conectiv also satisfies the second of the Commission's requirements, that utility assets, under normal conditions, may be "economically operated as a single interconnected and coordinated system."36 The Commission has interpreted this language to refer, among other things, to the physical operation of utility assets as a system in which the generation and/or flow of current within the system may be centrally controlled and allocated as need or economy directs.37 The Commission has considered advances in technology and the particular operating circumstances in applying the integration standards. In approving the acquisition of Public Service Company of New Hampshire by Northeast Utilities, the Commission noted that "the operation of generating and transmitting facilities of PSNH and the Northeast operating companies is coordinated and centrally dispatched under the NEPOOL Agreement." NORTHEAST UTILITIES CO., HCAR No. 25221 at n. 85. Similarly, in UNITIL, the Commission concluded that the combined electric utility assets of the companies may be operated as a single interconnected and coordinated system through their participation in NEPOOL. For the same reasons, Conectiv is able to operate its utility assets as a single interconnected and coordinated system. - - -------- 36 SEE CITIES SERVICES CO., 14 SEC at 55 (Congress intended that the utility properties be so connected and operated that there is coordination among all parts, and that those parts bear an integral operating relationship to each other). 37 NORTH AMERICAN CO., 11 SEC 194, 242 (1942) aff'd, 133 F.2d 148 (2d Cir. 1943), aff'd on constitutional issues, 327 U.S. 686 (1946) (evidence is necessary to show that in fact isolated territories are or can be so operated in conjunction with the remainder of the system that central control is available for the routing of power within the system). The Commission's third requirement is also satisfied. The Conectiv electric system will operate in a single area or region. The system will operate in five contiguous states in the mid-Atlantic region of the United States. It should be noted that in the 1995 REPORT, the Division has stated that the evaluation of the "single area or region" portion of the integration requirement "should be made... in light of the effect of technological advances on the ability to transmit electric energy economically over longer distance, and other developments in the industry, such as brokers and marketers, that affect the concept of geographic integration."38 The 1995 REPORT also recommends primacy be given to "demonstrated economies and efficiencies to satisfy the integration requirements."39 As set forth in Item 3.A.2.b.i, the Mergers will result in economies and efficiencies for the utilities and, in turn, their customers. - - -------- 38 1995 REPORT at 72-74. 39 1995 REPORT at 73. Finally, with respect to the Commission's fourth requirement, the Conectiv electric system will not be so large as to impair the advantages of localized management, efficient operations, and the effectiveness of regulation. After the Mergers, Conectiv will maintain system headquarters in Wilmington, Delaware. This structure will preserve all the benefits of localized management Delmarva and Atlantic presently enjoy while simultaneously allowing for the efficiencies and economies that will derive from their strategic alliance. Furthermore, as described earlier, the system will facilitate efficient operation. Additionally, the Conectiv system will not impair the effectiveness of state regulation. Delmarva and ACE will continue their separate existence as before and their utility operations will remain subject to the same regulatory authorities by which they are presently regulated, namely the DPSC, VSCC, NJBPU, PPUC, MPSC, the FERC and the NRC. Delmarva and Atlantic are working closely with the DPSC, VSCC, NJBPU, PPUC and MPSC as well as the FERC and the NRC to ensure they are well informed about these Mergers and these Mergers will not be consummated unless all required regulatory approvals are obtained. Pursuant to the recommendations contained in the 1995 REPORT, this last factor is significant as the Division stated therein "when the affected state and local regulators concur, the [Commission] should interpret the integration standard flexibly to permit non-traditional systems if the standards of the Act are otherwise met,"40 especially since these Mergers will result in a system similar to the traditional registered holding company system. - - -------- 40 1995 REPORT at 74. II. Gas Utility System Section 2(a)(29)(B) defines an "integrated public utility system" as applied to gas utility companies: [A] system consisting of one or more gas utility companies which are so located and related that substantial economies may be effectuated by being operated as a single coordinated system confined in its operation to a single area or region, in one or more States, not so large as to impair (considering the state of the art and the area or region affected) the advantages of localized management, efficient operation, and the effectiveness of regulation: Provided, that gas utility companies deriving natural gas from a common source of supply may be deemed to be included in a single area or region. The gas operations of Delmarva, which are very limited in size, currently operate as a single, integrated public utility system in New Castle County, Delaware. The Mergers will not affect that integrated operation. Thus, Conectiv gas utility system will meet the standard set forth in Section 2(a)(29)(B) and, therefore, will satisfy the requirements of Sections 10(c)(1) and (2) and should be approved by the Commission. The Conectiv gas utility system will continue to operate as a coordinated system confined in its operation to a single area or region. 3. Section 10(f) Section 10(f) provides that: The Commission shall not approve any acquisition as to which an application is made under this section unless it appears to the satisfaction of the Commission that such State laws as may apply in respect to such acquisition have been complied with, except where the Commission finds that compliance with such State laws would be detrimental to the carrying out of the provisions of section 11. As described in Item 4 of this Application/Declaration, and as evidenced by the applications before the DPSC, VSCC, NJBPU, PPUC and MPSC all relating to the Mergers, Conectiv intends to comply with all applicable state laws related to the proposed transaction. 4. Other Applicable Provisions -- Section 9(a)(1) Conectiv is also requesting authorization from the Commission under Section 9(a)(1) of the Act for the acquisition by it of the voting securities of Support Conectiv as part of the Mergers. Section 9(a)(1) of the Act requires a registered holding company or any subsidiary thereof to obtain authorization from the Commission before acquiring "any securities or utility assets or any other interest in any business." In order to approve an acquisition under Section 9(a)(1), the Commission must find that such acquisition meets the standards of Section 10 of the Act, which in turn requires compliance with Sections 8 and 11 of the Act. Although Conectiv will not become a registered holding company until consummation of the Mergers and thus Section 9(a)(1) is not applicable to it until that time, because Conectiv will become subject to Section 9(a)(1) and the exact chronology of the formation of Support Conectiv has not been determined, Conectiv is requesting the Commission's authorization for this transaction. The acquisition by Conectiv of the common stock of Support Conectiv, making it a direct subsidiary of Conectiv, will allow Conectiv to create a subsidiary service company and capture economies of scale from the centralization of administrative and general services to be provided to system companies. A portion of the benefits realized as a result of Support Conectiv are expected to be shared with Conectiv's ratepayers. Virtually every registered holding company has a subsidiary service company performing many of the same functions that Support Conectiv will perform. The acquisition of Support Conectiv is in the public interest, will not unduly complicate the capital structure of Conectiv and will not cause the Conectiv system to violate any other provision of the Act. Support Conectiv's only class of authorized stock will be its common stock, all of which will be owned by Conectiv. The operation of Support Conectiv, and the allocation of cost for its operation, is discussed in detail in Item 3.B below. B. Intra-System Provision of Services All services provided by Conectiv system companies to other Conectiv system companies will be in accordance with the requirements of Section 13 of the Act and the rules promulgated thereunder. Conectiv is aware that questions concerning the FERC's policy in this area are likely to arise with respect to affiliate transactions involving Atlantic, Delmarva and other companies which are public utilities under the Federal Power Act. The FERC, in its order authorizing the proposed mergers, noted that: in response to the [FERC's] concern under the holding of OHIO POWER CO. v. FERC, 954 F.2d 779 (D.C. Cir.), CERT. DENIED, 498 U.S. 73 (1992), Applicants commit as a condition that, for Commission ratemaking purposes, they will follow the Commission's policy regarding the treatment of costs and revenues associated with inter- company services. The FERC intra-corporate transactions policy, with respect to non-power goods and services, requires that: (1) affiliates or associates of a public utility not sell non-power goods and services to the public utility at a price above market; and (2) sales of non-power goods and services by a public utility to its affiliates or associates be at the public utility's cost for such goods and services or market value for such goods and services, whichever is higher. ATLANTIC CITY ELECTRIC COMPANY AND DELMARVA POWER & LIGHT COMPANY, FERC Docket No. EC-7-000 (slip op., July 30, 1997). Conectiv recognizes that affiliate transactions among the member companies of Conectiv will be subject of the jurisdiction of the SEC under section 13(b) of the Act and the rules and regulations thereunder. Section 13(b) of the Act generally provides that transactions between affiliates in a registered holding company system be "at cost, fairly or equitably allocated among such companies." Conectiv believes that as a practical matter there should not be any irreconcilable inconsistency between the application of the SEC's "at cost" standard and the FERC's policies with respect to intra-system transactions as applied to Conectiv. For example, Support Conectiv will provide non-power goods and services to associate companies within the Conectiv system at cost, but it is anticipated that Support Conectiv will provide only those goods and services where it can meet or better market prices for comparable quality goods and services. In other words, they are anticipating that Support Conectiv "costs" will be at or below the market. On this basis, Conectiv will be able to comply with the requirements of both the FERC and the "at cost" and fair and equitable allocation of cost requirements of Section 13, including Rules 87, 90 and 91 thereunder, for all services, sale and construction contracts between associate companies and with the holding company parent unless otherwise permitted by the Commission by rule or order. 1. Support Conectiv As described in Item 1.B.1.c.vii, Support Conectiv will provide all system companies, pursuant to the Service Agreement, with a variety of administrative, management and support services, including services relating to electric power planning, electric system operations, materials management, facilities and real estate, accounting, budgeting and financial forecasting, finance and treasury, rates and regulation, legal, internal audit, corporate communications, environmental, fuel procurement, corporate planning, investor relations, human resources, marketing and customer services, information systems and general administrative and executive management services. In accordance with the Service Agreement, Exhibit B-2, services provided by Support Conectiv will be directly assigned, distributed or allocated by activity, project, program, work order or other appropriate basis. To accomplish this, employees of Support Conectiv will record transactions utilizing the existing data capture and accounting systems of each client company. Costs of Support Conectiv will be accumulated in accounts of Support Conectiv and directly assigned, distributed and allocated to the appropriate client company in accordance with the guidelines set forth in the Service Agreement. Atlantic and Delmarva are currently developing the system and procedures necessary to implement the Service Agreement. It is anticipated that Support Conectiv will be staffed by transfer of personnel from Delmarva, Atlantic and their subsidiaries. Support Conectiv's accounting and cost allocation methods and procedures are structured so as to comply with the Commission's standards for service companies in registered holding-company systems. Support Conectiv's billing system will use the "Uniform System of Accounts for Mutual Service Companies and Subsidiary Service Companies" established by the Commission for service companies of registered holding-company systems, as may be adjusted to use the FERC uniform system of accounts. As compensation for services, the Service Agreement will provide for the client companies to: "pay to Support Conectiv all costs which reasonably can be identified and related to particular services performed by Support Conectiv for or on its behalf." Where more than one company is involved in or has received benefits from a service performed, the Service Agreement will provide that "costs will be directly assigned, distributed or allocated, between or among such companies on a basis reasonably related to the service performed to the extent reasonably practicable," in accordance with the methods set forth in Appendix A to the Service Agreement. Thus, for financial reporting purposes, charges for all services provided by Support Conectiv to affiliates will be on an "at cost" basis as determined under Rules 90 and 91 of the Act. No change in the organization of Support Conectiv, the type and character of the companies to be serviced, the methods of allocating costs to associate companies, or in the scope or character of the services to be rendered subject to Section 13 of the Act, or any rule, regulation or order thereunder, shall be made unless and until Support Conectiv shall first have given the Commission written notice of the proposed change not less than 60 days prior to the proposed effectiveness of any such change. If, upon the receipt of any such notice, the Commission shall notify Support Conectiv 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 of any rule, regulation or order thereunder, then the proposed change shall not become effective unless and until Support Conectiv shall have filed with the Commission an appropriate declaration regarding such proposed change and the Commission shall have permitted such declaration to become effective. Conectiv believes that the Service Agreement is structured so as to comply with Section 13 of the Act and the Commission's rules and regulations thereunder. Rule 88: Rule 88 provides that "[a] finding by the Commission that a subsidiary company of a registered holding company . . . is so organized and conducted, or to be conducted, as to meet the requirements of Section 13(b) of the Act with respect to reasonable assurance of efficient and economical performance of services or construction or sale of goods for the benefit of associate companies, at cost fairly and equitably allocated among them (or as permitted by Rule 90), will be made only pursuant to a declaration filed with the Commission on Form U-13-1, as specified" in the instructions for that form, by such company or the persons proposing to organize it. Notwithstanding the foregoing language, the Commission has on at least two recent occasions made findings under Section 13(b) based on information set forth in an Application/Declaration on Form U-1, without requiring the formal filing of a Form U-13-1. SEE CINERGY CORP., HCAR No. 26146 (Oct. 21, 1994); UNITIL CORP., HCAR No. 25524 (April 24, 1992). In this Application/ Declaration, Conectiv has submitted substantially the same applicable information as would have been submitted in a Form U-13-1. Accordingly, it is submitted that it is appropriate to find that Support Conectiv is so organized and its business will be so conducted as to meet the requirements of Section 13(b), and that the filing of a Form U-13-1 is unnecessary, or, alternatively, that this Application/Declaration should be deemed to constitute a filing on Form U-13-1 for purposes of Rule 88. 2. Other Services Delmarva, ACE and other associate companies of Conectiv may, from time to time, enter into leases of office or other space with other associate companies. Any such lease will be in accordance with Rules 87, 90, and 91, except as may be otherwise authorized by the Commission. To the extent necessary, Conectiv requests authority from the Commission to enter into the business of leasing such space between and among associate companies and third parties. The Commission has permitted the leasing of excess office space. SEE, E.G., CENTRAL POWER AND LIGHT COMPANY, HCAR No. 26408 (Nov. 13, 1995); NORTHEAST UTILITIES, HCAR No. 24908 (June 22, 1989). Delmarva and Atlantic may also provide to one another services incidental to their utility businesses, such as power plant maintenance overhauls, power plant and storm outage emergency repairs and services of personnel with specialized expertise related to the operation of the utility (i.e., services by an industrial lighting specialist or waste disposal specialist). These services will be provided at cost in accordance with the standards of the Act and Rules 87, 90 and 91 thereunder. In addition, it is expected that certain assets such as real property used for administrative purposes and information technology equipment and software may be transferred from Delmarva or ACE to Support Conectiv or other Conectiv companies at cost in conjunction with the integration of the two companies after consummation of the Mergers. For example, Delmarva currently owns the building that is likely to be used by Support Conectiv and so may seek to transfer this asset. These transfers may require approval by various public utility commissions. The Applicant requests authorization to transfer assets with remaining recorded value (assets less depreciation and amortization) totaling up to $100 million. Any such transfers will be in accordance with Rules 87, 90, and 91, except as may be otherwise authorized by the Commission. It is also requested that this authorization be for a period of 24 months from the effective date of the Mergers. Conectiv further requests authority to transfer at cost and/or combine real property interests and real estate related activities which benefit more than one member of the Conectiv group, and real property interests of Delmarva and Atlantic currently intended for sale to third parties, into a single legal entity through merger of subsidiaries engaged in real estate related activities and transfers of assets and business activities from Delmarva, Atlantic and their subsidiaries to such merged real estate subsidiary. Any such transfers will be in accordance with Rules 87, 90, and 91, except as may be otherwise authorized by the Commission. * * * * * Finally, pursuant to Rule 24 under the Act, Conectiv represents that the transactions proposed in this filing shall be carried out in accordance with the terms and conditions of, and for the purposes stated in, the declaration-application no later than December 31, 2000. Item 4. Regulatory Approvals Set forth below is a summary of the regulatory approvals that Conectiv has obtained or expects to obtain in connection with the Mergers. A. Antitrust The HSR Act and the rules and regulations thereunder provide that certain transactions (including the Mergers) may not be consummated until certain information has been submitted to the DOJ and FTC and specified HSR Act waiting period requirements have been satisfied. Delmarva and Atlantic have submitted Notification and Report Forms and all required information to the DOJ and FTC and the Mergers will not be consummated unless the applicable waiting period has expired or has been terminated. The expiration of the HSR Act waiting period does not preclude the DOJ or the FTC from challenging the Mergers on antitrust grounds; however, Conectiv believes that the Mergers will not violate Federal antitrust laws. If the Mergers are not consummated within twelve months after the expiration or earlier termination of the initial HSR Act waiting period, Delmarva and Atlantic would be required to submit new information to the DOJ and the FTC, and a new HSR Act waiting period would have to expire or be earlier terminated before the Mergers could be consummated. B. Federal Power Act Section 203 of the Federal Power Act as amended (the "Federal Power Act"), provides that no public utility shall sell or otherwise dispose of its jurisdictional facilities or directly or indirectly merge or consolidate such facilities with those of any other person or acquire any security of any other public utility, without first having obtained authorization from the FERC. Delmarva and Atlantic submitted a joint application for approval of the Mergers to the FERC on November 27, 1996. An order was issued approving the Mergers on July 30, 1997. Exhibit D-1.3. C. Atomic Energy Act Delmarva and Atlantic hold Nuclear Regulatory Commission ("NRC") licenses with respect to their ownership interests in certain nuclear units. Delmarva and Atlantic each own a 7.41% interest in the Salem Nuclear Generating Station, which consists of two nuclear units, and a 7.51% interest in the Peach Bottom Nuclear Generating Station, which consists of two nuclear units. In addition, Atlantic owns a 5% interest in the Hope Creek Nuclear Generating Station, which consists of one nuclear unit. The Atomic Energy Act currently provides that licenses may not be transferred or in any manner disposed of, directly or indirectly, to any person unless the NRC finds that such transfer is in accordance with the Atomic Energy Act and consents to the transfer. Pursuant to the Atomic Energy Act, Delmarva and Atlantic submitted an application for approval from the NRC on April 30, 1997. See Exhibit D-7.1. D. State Public Utility Regulation Delaware: Delmarva is incorporated in Delaware and subject to the jurisdiction of the DPSC. Pursuant to Section 215 of the Public Utilities Act, Delmarva must obtain the approval of the DPSC in order to directly or indirectly merge or consolidate with any other person or company. Section 215 also provides that no other entity shall acquire control, either directly or indirectly, of any public utility doing business within Delaware without the prior approval of the DPSC. The DPSC will approve the proposed Mergers when it finds them to be made in accordance with law, for a proper purpose and are in the public interest. Conectiv and Delmarva submitted an application with the DPSC requesting approval of the Mergers on February 24, 1997. See Exhibit D-2.1. Virginia: Delmarva is also incorporated in Virginia and subject to the jurisdiction of the VSCC. Pursuant to the Utility Transfers Act, no person, whether acting alone or in concert with others, shall, directly or indirectly, acquire control of a public utility without the prior approval of the VSCC and it is unlawful for any public utility, directly or indirectly, to dispose of any utility assets situated within Virginia unless authorized by the VSCC. The VSCC will approve a proposed transaction if satisfied that adequate service to the public at just and reasonable rates will not be impaired or jeopardized by granting an application for approval. Furthermore, except to the extent preempted by the Securities Exchange Commission, the VSCC, pursuant to statutory provisions under which the VSCC regulates relations with affiliated interests, must approve certain contracts or arrangements for certain services, purchases, sales, leases or exchanges, loans and guarantees between a public service company and affiliates. The VSCC issued an order approving the Mergers on August 8, 1997. New Jersey: As the parent company of Atlantic City Electric Company, the transfer of the ownership or control, or the merger of, Atlantic is subject to the jurisdiction of the NJBPU which, pursuant to Title 48 of the New Jersey Statutes Annotated, must give written approval before any person may acquire or seek to acquire control of a public utility directly or indirectly through the medium of an affiliated or parent corporation. In addition, the NJBPU must authorize any transfer of stock to another public utility, or a transfer that vests another corporation with a majority interest in the stock of a public utility. Furthermore, the NJBPU regulates relations between public utilities and affiliated interests, and must approve certain contracts or arrangements for certain services, purchases or loans between a public utility and affiliates. Conectiv and Atlantic submitted an application with the NJBPU requesting approval of the Mergers on February 24, 1997. See Exhibit D-4.1. Pennsylvania: Delmarva and Atlantic own fractional interests in the Keystone, Conemaugh and Peach Bottom electric generating stations and related transmission lines located in Pennsylvania. Pursuant to Pennsylvania statute, the transfer to any person or corporation of the stock, including a transfer by merger, of a public utility must be approved by the PPUC. The PPUC will approve such transfers upon a showing that the merger will affirmatively promote the service, accommodation, convenience or safety of the public in some substantial way. Delmarva and Atlantic applied for PPUC approval of the Mergers on March 24, 1997. See Exhibit D-5.1. Maryland: The MPSC has general authority to supervise and regulate public utilities with operations in Maryland. Delmarva advised the MPSC of the transactions contemplated by the Merger Agreement and that it does not believe that the approval of the MPSC of the Mergers is required. However, the MPSC ruled that it has jurisdiction over the Mergers to determine whether the Mergers will have an adverse effect on the conduct of Delmarva's Maryland franchises and any other matters that properly come before the MPSC at a hearing. The MPSC issued an order approving the Mergers on July 16, 1997. See Exhibit D-6.1. Item 5. Procedure The Commission is respectfully requested to issue and publish not later than September 1, 1997 the requisite notice under Rule 23 with respect to the filing of this Application, such notice to specify a date not later than September 26, 1997 by which comments may be entered and a date not later than September 30, 1997 as the date after which an order of the Commission granting and permitting this Application to become effective may be entered by the Commission. It is submitted that a recommended decision by a hearing or other responsible officer of the Commission is not needed for approval of the proposed Mergers. The Division of Investment Management may assist in the preparation of the Commission's decision. There should be no waiting period between the issuance of the Commission's order and the date on which it is to become effective. Item 6. Exhibits and Financial Statements A. Exhibits A-1 Restated Certificate of Incorporation of Conectiv (filed as Annex IV to the Registration Statement on Form S-4 on December 26, 1996 (Registration No. 333-18843), and incorporated herein by reference). A-2 Restated Bylaws of Conectiv (filed as Annex V to the Registration Statement on Form S-4 on December 26, 1996 (Registration No. 333-18843), and incorporated herein by reference). A-3 Restated Certificate and Articles of Incorporation of Delmarva (filed with Registration No. 33-50453 and incorporated herein by reference). A-4 Restated Certificate of Incorporation of Atlantic (filed as Exhibit 4(a) to the Atlantic Form 10-Q dated September 30, 1987) and Certificate of Amendment to the Restated Certificate of Incorporation of Atlantic (filed as Exhibit 3(ii) to the Atlantic Form S-8 dated May 6, 1994), and both incorporated herein by reference). B-1 Agreement and Plan of Merger, as amended and restated (filed as Annex I to the Registration Statement on Form S-4 on December 26, 1996 (Registration No. 333-18843), and incorporated herein by reference). B-2 Form of Service Agreement between Support Conectiv and all affiliates. C-1 Registration Statement of Conectiv on Form S-4 (filed on December 26, 1996 (Registration No 333-18843) and incorporated herein by reference). C-2 Joint Proxy Statement and Prospectus (included in Exhibit C-1). D-1.1 Joint Application of Delmarva and Atlantic before the FERC, as amended. D-1.2.1 Testimony of John C. Dalton to the FERC. D-1.3 Order of the FERC. D-2.1 Application of Delmarva to the DPSC. D-2.2 DPSC Order. (to be filed by amendment) D-3.1 Application of Delmarva to the VSCC. D-3.2 VSCC Order. (to be filed by amendment) D-4.1 Application of Atlantic to the NJBPU. D-4.2 NJBPU Order. (to be filed by amendment) D-5.1 Application of Delmarva to the PPUC. D-5.2 PPUC Order. (to be filed by amendment) D-6.1 Application of Delmarva to the MPSC. D-6.2 MPSC Order. D-7.1 Applications of Delmarva and Atlantic to the NRC. D-7.2 Order of the NRC. (to be filed by amendment) E-1 Map of service areas of Delmarva and Atlantic. (filed on Form S-E) E-2 Delmarva corporate chart. (filed on Form S-E) E-3 Atlantic corporate chart. (filed on Form S-E) E-4 Conectiv corporate chart. (filed on Form S-E) F-1 Opinion of counsel. (to be filed by amendment) F-2 Past-tense opinion of counsel. (to be filed by amendment) G-1 Opinion of Merrill Lynch, Pierce, Fenner & Smith Incorporated (filed as Annex II to the Registration Statement on Form S-4 on December 26, 1996 (Registration No. 333-18843), and incorporated herein by reference). G-2 Opinion of Morgan Stanley & Co. Incorporated (filed as Annex III to the Registration Statement on Form S-4 on December 26, 1996 (Registration No. 333-18843), and incorporated herein by reference). H-1 Quarterly Report of Delmarva on Form 10-Q for the quarter ended March 31, 1997 (filed on May 14, 1997) (File No. 1-01405) and incorporated herein by reference). H-2 Quarterly Report of Atlantic on Form 10-Q for the quarter ended March 31, 1997 (filed on May 13, 1997 (File No. 1-09760) and incorporated herein by reference). H-3 Form U-3A-2 by Atlantic (filed on February 28, 1997) (File No. 069-00337) and incorporated herein by reference). H-4 Schedule of Assets and Revenues of Nonutility Subsidiary Companies. I-1 Proposed Form of Notice. J-1 Analysis of the Economic Impact of a Divestiture of the Gas Business of DPL. J-2 (deleted) J-3 Table of Estimated Losses of Economies in Prior Decisions on Divestiture and Retention of Gas Operations. B. Financial Statements FS-1 Conectiv Unaudited Pro Forma Condensed Consolidated Balance Sheets as of March 31, 1997. FS-2 Conectiv Unaudited Pro Forma Condensed Consolidated Statements of Income for the twelve months ended March 31, 1997. FS-3 Notes to Unaudited Pro Forma Condensed Consolidated Financial Statements. FS-4 Atlantic Consolidated Balance Sheet as of March 31, 1997. FS-5 Atlantic Consolidated Statements of Income for the twelve months ended March 31, 1997. FS-6 Delmarva Consolidated Balance Sheet as of March 31, 1997. FS-7 Delmarva Consolidated Statement of Income for the twelve months ended March 31, 1997. Item 7. Information as to Environmental Effects The Mergers neither involve a "major federal action" nor "significantly affects the quality of the human environment" as those terms are used in Section 102(2)(C) of the National Environmental Policy Act, 42 U.S.C. Sec. 4321 et seq. The only federal actions related to the Mergers pertain to the Commission's declaration of the effectiveness of Conectiv's Registration Statement on Form S-4, the expiration of the applicable waiting period under the HSR Act, approval of the application filed by Conectiv with the FERC under the Federal Power Act, approval of the application filed by Conectiv with the NRC under the Atomic Energy Act, and Commission approval of this Application/Declaration. Consummation of the Mergers will not result in changes in the operations of Delmarva or Atlantic that would have any impact on the environment. No federal agency is preparing an environmental impact statement with respect to this matter. SIGNATURE Pursuant to the requirements of the Public Utility Holding Company Act of 1935, the undersigned company has duly caused this Amendment No. 1 to the Application/Declaration of Conectiv, Inc. to be signed on its behalf by the undersigned thereunto duly authorized. Date: August 12, 1997 Conectiv, Inc. By: /s/ B.S. Graham Barbara S. Graham President EX-99.1 2 EXHIBIT B-2 SERVICE AGREEMENT This Service Agreement is executed this ___ day of _______, 199__, by and between Support Conectiv, Inc., a Delaware corporation and a mutual service company formed under the terms of the Public Utility Holding Company Act of 1935 ("Service Company") and a corporation and an associate company of the Conectiv system ("Client Company", and collectively with other associate companies that have or may in the future execute this form of Service Agreement, the "Client Companies"). WITNESSETH WHEREAS, the Securities and Exchange Commission (hereinafter referred to as the "SEC") has approved and authorized as meeting the requirements of Section 13(b) of the Public Utility Holding Company Act of 1935 (hereinafter referred to as the "Act"), the organization and conduct of the business of the Service Company in accordance herewith, as a wholly owned subsidiary service company of Conectiv, Inc.; and WHEREAS, the Service Company and certain Client Companies have entered into this Service Agreement whereby the Service Company agrees to provide and the Client Companies agree to accept and pay for various services as provided herein determined in accordance with applicable rules and regulations under the Act, which require the Service Company to fairly and equitably allocate costs among all associate companies to which it renders services; and WHEREAS, economies and efficiencies benefiting the Client Companies will result from the performance by Service Company of the services as herein provided: NOW, THEREFORE, in consideration of the premises and the mutual agreements herein contained, the parties to this Service Agreement covenant and agrees as follows: ARTICLE - SERVICES Section 1.1 The Service Company shall furnish to a Client Company, as requested by a Client Company, upon the terms and conditions hereinafter set forth, such of the services described in Appendix A hereto (as such may be amended from time to time) at such times, for such periods and in such manner as the Client Company may from time to time request and which the Service Company concludes it is equipped to perform. The Service Company shall also provide a Client Company with such special services, in addition to those services described in Appendix A hereto, as may be requested by a Client Company and which the Service Company concludes it is equipped to perform. In supplying such services, the Service Company may arrange, where it deems appropriate, for the services of such experts, consultants, advisers and other persons with necessary qualifications as are required for or pertinent to the rendition of such services. Section 1.2 Each Client Company shall take from the Service Company such of the services described in Section 1.1 and such additional general or special services, whether or not now contemplated, as are required from time to time by such Client Company and which the Service Company concludes it equipped to perform. Section 1.3 The services described herein shall be directly assigned, distributed or allocated by activity, project, program, work order or other appropriate basis. A Client Company shall have the right from time to time to amend, alter or rescind any activity, project program or work order provided that (i) any such amendment or alteration which results in a material change in the scope of the services be performed or equipment to be provided is agreed to by the Service Company (ii) the cost for the services covered by the activity, project program or work order shall include any expense incurred by the Service Company as a direct result of such amendment, alteration or rescission of the activity, project, program or work order, and (iii) no amendment, alteration or rescission of an activity, project, program or work order shall release a Client Company from liability for all costs already incurred by the contracted for by the Service Company pursuant to the activity, project, program or work order, regardless of whether the services associated with such costs have been completed. ARTICLE II - COMPENSATION Section 2.1. As compensation for the services to be rendered hereunder, each Client Company shall pay to the Service Company all costs which reasonably can be identified and related to particular services performed by the Service Company for or on Client's behalf, such cost to be determined in accordance with rule 90 and other applicable rules and regulations under the Act. Where more than one Client Company is involved in or has received benefits from a service performed, costs will be directly assigned, distributed or allocated, as set forth in Appendix A hereto, between or among such companies on a basis reasonably related to the service performed. Section 2.2. It is the intent of this Service Agreement that the payment for services rendered by the Service Company to the Client Companies under this Service Agreement shall cover all the costs of its doing business (less the cost of services provided to affiliated companies not a party to this Service Agreement and other non-affiliated companies), including but not limited to, salaries and wages, office supplies and expenses, outside services employed, insurance, injuries and damages, employee benefits, miscellaneous general expenses, rents, maintenance of structures and equipment, depreciation and amortization, profit and compensation for use of capital as permitted by RULE 91 under the Act. Section 2.3. The method of assignment, distribution or allocation of costs described in Appendix A shall be subject to review annually, or more frequently if appropriate. Such method of assignment, distribution or allocation of costs may be modified or changed by the Service Company without the necessity of an amendment to this Service Agreement provided that in each instance, costs of all services rendered hereunder shall be fairly and equitable assigned distributed or allocated, all in accordance with the requirements of the Act and any orders promulgated thereunder. Section 2.4. The Service Company shall render a monthly statement to each Client Company which shall reflect the billing information necessary to identify the costs charged for that month. By the tenth (10th) calendar day following billing, each Client Company shall remit to the Service Company all charges. Monthly charges may be billed on an estimated basis, but adjustments will be made within ninety (90) days to assure that billings are in accord with paragraphs 2.1 and 2.2 above. ARTICLE III-TERM Section 3.1 This Service Agreement shall become effective as of the day of above written, and shall continue in force until terminated by either party upon no less than ninety (90) days' prior written notice to the other party. This Service Agreement shall also be subject to termination or modification at any time, without notice, if and to the extent performance under this Service Agreement may conflict with the Act or with any rule, regulation or order of the SEC adopted before or after the date of this Service Agreement or any other regulatory body. ARTICLE IV - MISCELLANEOUS Service 4.1. All accounts and records of the Service Company shall be kept in accordance with the General Rules and Regulations promulgated by the SEC pursuant to the Act, in particular, the Uniform System of Accounts for Mutual Service Companies and Subsidiary Service Companies effect from and after the date hereof, except as specifically approved by the SEC. Section 4.2. Other existing subsidiaries and new direct or indirect subsidiaries of Conectiv, which may come into existence after the effective date of this Service Agreement, may become additional client Companies (collectively, the "New Client Companies") subject to this Service Agreement by execution of this form of agreement, as it may be amended at that time. In addition, the parties hereto shall make such changes in the scope and character of the services to be rendered and the method of assignment, distributing or allocating costs of such services among the Client Companies and the New Client Companies under this Service Agreement as may become necessary. Section 4.3 The Service Company shall permit a Client Company access to its accounts and records, including the basis and computation of allocations. Section 4.4. This Service Agreement and any amendments hereto shall not be effective until any necessary regulatory approvals have been obtained. IN WITNESS WHEREOF, the parties hereto have caused this Service Agreement to be executed as of the date and year first above written. SUPPORT CONECTIV, INC. By: /s/ _____________________ [title] [Client Company] By:/s/ _______________________ [title] EX-99.2 3 EXHIBIT B-2(A) Appendix A This appendix describes Service Company services and the direct assignment and allocation of costs to the Client Companies that cannot practicably be direct charged. Definitions of the ratios are provided in Appendix B. The Service Company will provide to associate client Companies the following services: I. Information Resource Management Systems (IRMS) a. The Information Resource Management Systems function includes voice services; application systems development and support; database administration and security; computer operations; data entry; end user assistance; consulting services; distributed computing including hardware support and network operations; management and administration. b. To the extent practicable services will be directly charged using a standard rate per hour. Costs that are not direct charged will be allocated as follows: voice services - telephone ratio application systems development and support - employee ratio data administration and security - employee ratio computer operations - CPU time ratio consulting services - employee ratio distributed computing - order cost ratio management and administration - employee ratio II. Legal a. The legal function provides legal counsel related to general corporate issues. b. All costs will be direct charged to other Orders, Projects or Cost Centers at a standard rate per hour. The hourly rate will include charges for labor, occupancy, vehicle costs, training, materials and contractors. Any residual resulting from standard rates being different from actual costs will be allocated to the Client Companies based on the labor $ ratio. III. Executive Services a. The Executive Services function provides advice, counsel and other services of executive management, excluding business unit heads. b. The total actual cost of services of each executive and their direct support staff will be accumulated in Cost Centers for each executive. Each Cost Center's expenses will be allocated between client companies based on a fixed distribution. The distribution will be developed based on an analysis of how each executive's time is spent. The distributions will be reevaluated annually. IV. Administrative and Support a. The Administrative and Support function provides insurance and claims processing; insurance and claims administration, including risk management; security, including asset protection and investigative services; purchasing and storeroom management; procurement and materials management; vehicle resource management, including company vehicle maintenance; general services including mail, graphics, records management and other office services; building services including facilities management, and building maintenance; and real estate services, including right-of-way. b. To the extent practicable, services will be directly charged using a standard rate per hour. The Services that are not direct charged will be allocated based on the following ratios: insurance administration - labor $ ratio claims administration - historical claims ratio security - labor $ ratio purchasing and storeroom management and procurement and materials management- An overhead rate will be applied to all stock and non stock issuances and returns. This rate will be developed by dividing the total estimated costs of purchasing and storeroom management by estimated stock issuances and returns. Any residual amount will be allocated based on the materials stock expense ratio. vehicle resource management - A flat fee will be charged per month or per hour for pool vehicles. The fees will be calculated by dividing total estimated costs of vehicle resource management including, maintenance and insurance claims by anticipated vehicle usage. The fees will be recalculated annually. Any residual amount will be allocated based on the vehicle $ ratio. general services - employee ratio building services (facilities cost) - square footage ratio for office space and non-office space real estate - land and building ratio c. Insurance premiums and claims that are not direct charged will be allocated as follows: property insurance and miscellaneous insurance coverage - asset cost ratio general liability insurance - labor $ ratio Director's and Officers insurance - asset cost ratio nuclear insurance - installed capacity ratio V. Human Resources a. The Human Resources function provides compensation and benefit services; personnel, employment and staffing; employee/labor relations; skills training and management development; organizational development; and safety services. b. To the extent practicable, services will be directly charged using a standard rate per hour. Costs that are not direct charged will be allocated as follows: cost of benefits - Benefit costs will be directly charged based on an overhead rate as a percent added to regular labor. The residual will be allocated based on the regular wage ratio. compensation and benefits services - employee ratio personnel, employment and staffing - employee ratio employee/labor relations - employee ratio skills training and management development - Flat fees will be charged for each training class attendee. The fees will be calculated on an annual basis by dividing total estimated training costs by the estimated number of attendees. Any remainder will be allocated based on the employee ratio. safety - employee ratio VI. Finance, Accounting and Planning a. The Finance, Accounting and Planning function includes corporate planning; long range strategic planning; strategic resources consulting; internal audit; budgeting; treasury and finance including cash management, financing, trust administration; investor relations; accounting services including general ledger, corporate accounting, accounts payable and receivable, payroll, plant/property accounting; tax accounting services. b. To the extent that services are directly assignable, the services will be directly charged to a Client Company. All Finance, Accounting and Planning services that are not direct charged will be allocated based on the O&M ratio. VII. External Relations a. The External Relations function includes general corporate communications; governmental affairs; advertising services. b. To the extent practicable, services will be directly charged using a standard rate per hour. Costs that are not direct charged will be allocated based on the following ratios: communications - employee ratio governmental affairs - O&M ratio advertising - O&M ratio VIII. Customer Service, Marketing and Sales a. The Customer Service, Marketing and Sales function includes customer service centers and dispatch; sales and marketing including market product and sales planning and market and customer research, demand side management, load forecasting, and economic development; utility billing and payment, including revenue protection and customer contract services; pricing and regulatory affairs; and meter reading services. b. To the extent practicable, services will be directly charged using a standard rate per hour or per unit. Costs that are not direct charged are allocated based on the following ratios: customer service centers and dispatch- Costs of the customer service centers and dispatch are charged to the client companies as flat fee per call, a flat fee per order and a flat fee per dispatch. The flat fees are calculated by using the total estimated call costs, order costs, or dispatch costs as the numerator and dividing by the estimated number of calls, orders, or dispatches. Any residuals will be allocated based on # customer ratio. regulated sales and marketing - # utility customers ratio competitive sales and marketing - A predetermined ratio will be developed based on time studies to determine the allocation of costs between client companies. The ratio will be revised annually. utility billing & payment - Costs will be charged to client companies as a flat fee per generated bill. The flat fee will be calculated as total estimated costs of billing and payment functions divided by the estimated number of bills. Separate fees will be calculated for each type of bill. Any remainder will be allocated based on the # bills ratio. pricing and regulatory affairs - utility asset cost ratio IX. Electric Transmission and Distribution a. The Electric Transmission and Distribution function includes engineering planning, overall T&D design; and T&D management and administration. b. To the extent practicable, services will be directly charged using a standard rate per hour. All costs that are not direct charged will be allocated based on the T&D O&M ratio. X. Supply a. The Supply function includes fuel supply including fuel procurement and management; production/support staff services including engineering services for power plant design and operations, chemistry and gas turbine/diesel power supply; mechanical engineering and standards including plant engineering, facilities construction and production services; merchant functions; and management and administration. b. To the extent practicable, services will be directly charged using a standard rate per hour. Costs that are not directly charged will be allocated as follows: fuel supply - kwh generated ratio production / support staff - kwh generated ratio mechanical engineering and standards - kwh generated ratio merchant functions - merchant cost ratio management and administration - kwh generated ratio XI. Electrical System Technical Support a. The Electrical System Technical Support function includes transmission system operations, including interconnections and bulk power marketing, load management and test lab; system planning; electric systems communications; environmental affairs; and electric research and development. b. To the extent practicable, services will be directly charged using a standard rate per hour. Cost that are not direct charged will be allocated as follows: transmission systems operations - kwh output ratio system planning - kwh output ratio electric systems communications - kwh output ratio environmental affairs - O&M ratio electric research and development - O&M ratio EX-99.3 4 EXHIBIT B-2(B) Appendix B Definition of Service Company Allocation Methods Ratio Title Ratio Description Employee Ratio A ratio the numerator of which is the number of employees of a Client Company, the denominator of which is the number of employees in all the Client Companies using the service. This ratio will be calculated quarterly. Square Footage Ratio office space the denominator of which is the total number of square feet of office space occupied by all Client Companies using the service. non-office space A ratio the numerator of which is the number of square feet of non-office space occupied by a Client Company, the denominator of which is the total number of square feet of non-office space occupied by all Client Companies using the service. Telephone Ratio A ratio the numerator of which is the number of telephones used by a Client Company, the denominator of which is the number of telephones used by all Client Companies using the service. CPU Time Ratio A ratio the numerator of which is the number of hours of CPU time used for a particular system application, the denominator of which is the total number of CPU hours used by all companies. Costs are allocated to Orders based on this ratio. That cost is then either included in the cost of other Service Company services or directly routed to the appropriate Client Company. Order Cost Ratio A ratio the numerator of which is the total cost accumulated in an Order, the denominator of which is the total costs accumulated in all Orders for all Client Companies using the service. Costs are allocated to Orders based on this ratio. That cost is then either included in the cost of other Service Company services or directly routed to the appropriate Client Company. Labor $ Ratio A ratio the numerator of which is the amount of labor of a specific client company, the denominator of which is total labor for all Client Companies using the service. This ratio will be calculated monthly. Historical Claims A ratio the numerator of which is the total claims Ratio expense of a specific Client Company, the denominator of which is the total claims expense for all Client Companies using the service. Asset Cost Ratio A ratio the numerator of which is the total cost of assets in a specific Client Company, the denominator of which is the total costs of assets for all Client Companies using the service. Regular Wage Ratio A ratio the numerator of which is the total dollar cost of regular wages for a specific Client Company, the denominator of which is the total dollar cost of regular wages for all Client Companies using the service. O&M Ratio A ratio the numerator of which is the total direct (i.e., excludes charges allocated by the service company), operations and maintenance expense, excluding depreciation and fuel costs, of a specific Client Company, the denominator of which is total direct operations and maintenance expense, excluding depreciation and fuel costs, of all Client Companies using the service. # Customer Ratio A ratio the numerator of which is the number of customers served by a specific Client Company, the denominator of which is the total number of customers for all the Client Companies using the service. # Utility Customers A ratio the numerator of which is the number of Ratio utility customers served by a specific Client Company, the denominator of which is the total number of utility customers for all Client Companies using the service. Nuclear Installed A ratio the numerator of which is the nuclear Capacity Ratio facility installed capacity of a specific Client Company, the denominator of which is the total nuclear facility installed capacity of all Client Companies using the service. Materials Stock A ratio the numerator of which is the materials Expense Ratio stock expense of a specific Client Company, the denominator of which is the total materials stock expense of all Client Companies using the service. Land & Building A ratio the numerator of which is the cost of land Ratio and buildings owned by a specific Client Company, the denominator of which is the total cost of land and buildings for all Client Companies using the service. # Bills Ratio A ratio the numerator of which is the number of a certain type of bill issued for a specific Client Company cost center, the denominator of which is the number total number of the same type of bills issued for all Client Companies using the service. Utility Asset Cost A ratio the numerator of which is the total cost of Ratio utility assets in a specific Client Company, the denominator of which is the total costs of utility assets for all Client Companies using the service. # Meters Ratio A ratio the numerator of which is the number of meters for a specific Client Company, the denominator of which is the total number of meters for all Client Companies using the service. T&D O&M Ratio A ratio the numerator of which is the total direct (i.e., excludes charges allocated by the service company), operations and maintenance expense, excluding depreciation and fuel costs, of a specific Transmission and Distribution Client Company, the denominator of which is total direct operations and maintenance expense, excluding depreciation and fuel costs, of all Transmission and Distribution Client Companies. Kwh Generated Ratio A ratio the numerator of which is the number of kilowatt hours generated by a specific Client Company, the denominator of which is the total number of kilowatt hours generated by all Client Companies using the service. Kwh Output Ratio A ratio the numerator of which is the number of kilowatt hours purchased and generated by a specific Client Company, the denominator of which is the total number of kilowatt hours purchased and generated by all Client Companies using the service. Merchant Cost Ratio A ratio the numerator of which is this dollar amount of direct charges of the merchant function to a specific Client Company, the denominator of which is the total dollar amount of direct charges of the merchant function to all Client Companies using the service. Vehicle $ Ratio A ratio the numerator of which is this dollar amount of flat fees for vehicles charged to a specific Client Company, the denominator of which is the total amount of flat fees charged to all Client Companies using the service. EX-99.4 5 EXHIBIT D-1.3 DOCKET NO. EC97-7-000 UNITED STATES OF AMERICA FEDERAL ENERGY REGULATORY COMMISSION Before Commissioners: James J. Hoecker, Chairman; Vicky A. Bailey, William L. Massey, and Donald F. Santa, Jr. Atlantic City Electric Company ) Docket No. EC97-7-000 Delmarva Power & Light Company ) ORDER APPROVING MERGER (Issued July 30, 1997) I. Introduction On November 27, 1996, as supplemented on March 4, 1997, Atlantic City Electric Company (Atlantic City Electric) and Delmarva Power & Light Company (Delmarva) (jointly, Applicants) filed a joint application pursuant to section 203 of the Federal Power Act (FPA), 16 U.S.C. ss. 824b (1994), seeking authorization to consolidate their jurisdictional facilities through a merger. The merger is described as a merger of equals whereby both parties would retain their corporate existence as wholly-owned operating utility subsidiaries of a newly formed registered holding company, named Conectiv, under the Public Utility Holding Company Act of 1935, 15 U.S.C. ss. 79, et seq. (PUHCA). The projected closing date of the merger is December 31, 1997. We will approve the merger, as proposed, without a hearing. II. Background A. Description of Applicants Atlantic City Electric is incorporated in New Jersey and provides retail electric service throughout the southern one-third of the state. It has 473,000 retail customers, and provides interconnection service to the City of Vineland, New Jersey. Atlantic City Electric's annual peak load in 1995 was 2,042 MW. It owns 1,679 MW of generation and contracts for another 670 MW, which represents 4.2 percent of the generating capability of the Pennsylvania-New Jersey-Maryland Interconnection Association (PJM), of which both Atlantic City Electric and Delmarva are members.1 It also owns approximately 963 miles of transmission line facilities in New Jersey. Atlantic City Electric is a wholly-owned subsidiary of Atlantic Energy, Inc. (Atlantic Energy), an exempt holding company under PUHCA, whose stock is publicly held. Atlantic City Electric is subject to retail rate regulation by the New Jersey Board of Public Utilities.2 - - -------- 1 Other PJM members include: Public Service Electric & Gas Company, PECO Energy Company, Pennsylvania Power & Light Company, Jersey Central Power & Light Company, Metropolitan Edison Company, Pennsylvania Electric Company, Baltimore Gas & Electric Company, and Potomac Electric Power Company. 2 Application at 2-3, 29. Delmarva, incorporated in Delaware and Virginia, serves wholesale and retail electric loads in Delaware, Maryland and Virginia. Delmarva also provides natural gas sales and transportation service to approximately 100,000 natural gas customers located in New Castle County, Delaware. Delmarva has 437,000 retail electric customers, 10 wholesale customers, and provides interconnection service to two customers.3 Delmarva's annual peak load in 1995 was 2,364 MW. It owns 2,700 MW of generation and contracts for another 105 MW, which represents 5 percent of the generation of PJM. It also owns approximately 1,508 miles of transmission line facilities on the Delmarva Peninsula. Delmarva is subject to retail regulation by the Public Service Commissions of Delaware and Maryland, and the State Corporation Commission of Virginia.4 - - -------- 3 Delmarva's wholesale customers are: Old Dominion Electric Cooperative, Inc., the City of Berlin, Maryland, and the Delaware cities or towns of Clayton, Lewes, Middletown, Milford, Newark, New Castle, Seaford, and Smyrna. Delmarva's two interconnection customers are the City of Dover, Delaware and the Town of Easton, Maryland. 4 Application at 3-4, 29. The electric systems of Delmarva and Atlantic City Electric are not interconnected except to the extent that they both are interconnected to 500 kV transmission lines that are operated by PJM. B. Description of the Proposed Merger Pursuant to the Agreement and Plan of Merger (Merger Agreement) dated August 9, 1996, as amended and restated as of December 26, 1996, the merger will be achieved among four corporations: the two Applicants, Conectiv, and a new corporation, DS Sub, Inc. (DS Sub).5 At the closing, Atlantic Energy will merge into Conectiv, and DS Sub will merge into Delmarva. Applicants' preferred stock will be unchanged and will remain outstanding after the merger. After the merger, the shareholders of Atlantic Energy and Delmarva will become the common stock shareholders of Conectiv with ownership shares of approximately 40 percent and 60 percent, respectively, and Conectiv will become the shareholder of Atlantic City Electric and Delmarva. The merger will not affect any long-term or short-term debt securities of the Applicants or their affiliates.6 - - ---------- 5 DS Sub's sole purpose is to effect the merger and it will not survive the merger. 6 For accounting purposes, the merger will be treated as an acquisition of Atlantic Energy by Delmarva. According to the application, the registered holding company resulting from the merger, Conectiv, will have five subsidiaries.7 Delmarva and Atlantic City Electric will be separate, first-tier operating subsidiaries and will maintain their individual corporate existence. The two non-utility subsidiaries of Atlantic Energy will also be first-tier subsidiaries,8 and a Service Company will be created as the fifth subsidiary.9 - - -------- 7 Although the application filed with us states that the holding company will have four subsidiaries, a more recent application filed with the Maryland Commission indicates five subsidiaries. 8 Applicants indicate that Delmarva's non-utility subsidiaries would remain subsidiaries of Delmarva initially. However, at some point, all non-utility subsidiaries may be consolidated under a first-tier subsidiary of the registered holding company. 9 The Service Company will provide management, accounting, financial, legal and other support services to the Applicants, the holding company, and the non-utility subsidiaries. Applicants stated in their original filing that if a PJM- wide transmission tariff became effective prior to the merger closing, the Applicants would use that tariff for transmission services.10 On December 31, 1996, PJM filed an open access transmission tariff, which the Commission accepted for filing, suspended nominally, and made effective March 1, 1997, subject to refund and the issuance of further orders.11 - - -------- 10 Applicants submitted as an exhibit to their merger application a joint open access transmission tariff that would have been applicable to their systems as of the merger closing date if a PJM tariff were not then effective. 11 MidContinent Area Power Pool, et al., 78 FERCP. 61,203 (1997). C. Procedural Background Applicants originally filed their application on November 27, 1996. On December 18, 1996, the Commission issued its Merger Policy Statement.12 Accordingly, by letter order dated January 15, 1997, our staff requested that Applicants revise their competition analysis using the competitive screen analysis described in Appendix A of the Merger Policy Statement. On March 4, 1997, Applicants made a supplemental filing in response to this request. Applicants have also filed supplements to their Exhibit G consisting of copies of filings related to the merger made to the States of Delaware, New Jersey, Maryland, Virginia and Pennsylvania. - - -------- 12 Inquiry Concerning the Commission's Merger Policy under the Federal Power Act: Policy Statement, Order No. 592, 61 Fed. Reg. 68,595 (1996), FERC Stats. & Regs. P. 31,044 (1996), reconsideration denied, Order No. 592-A, 62 Fed. Reg. 33341, 79 FERC P. 61,321 (1997) (Merger Policy Statement). III. Notice of Filing and Responses Notice of Applicants' original filing was published in the Federal Register, 61 Fed. Reg. 65,379 (1996), with comments, protests, and motions to intervene due on or before December 26, 1996. Notice of Applicants' supplemental filing was published in the Federal Register, 62 Fed. Reg. 12,634 (1997), with comments, protests, and motions to intervene due on or before May 5, 1997. The Maryland Public Service Commission (Maryland Commission), the Delaware Public Service Commission (Delaware Commission), and the New Jersey Board of Public Utilities (New Jersey Commission) filed notices of intervention.13 - - -------- 13 The New Jersey Commission actually filed a motion to intervene believing that it missed the original deadline for state commission notices. As all interventions on or before May 5, 1997 are timely, its intervention will be considered as a timely notice of intervention. Public Service Electric and Gas Company (PSE&G), Electric Clearinghouse, Inc. (ECI), Eastern Power Distribution, Inc. and Eastern Energy Marketing, Inc. (Eastern), U.S. Generating Company (USGen), PECO Energy Company (PECO), South Jersey Gas Company (South Jersey), Delaware Office of the Public Advocate (Delaware Advocate), New Jersey Division of the Ratepayer Advocate (New Jersey Advocate), and the City of Wilmington, Delaware (Wilmington) filed motions to intervene raising no substantive issues. The Maryland Energy Administration and the Power Plant Research Program of the Maryland Department of Natural Resources (Maryland Energy Agencies) filed a joint motion to intervene. Maryland Energy Agencies state that they are concerned with the implications of the continuing concentration of ownership or control of generation assets in the PJM region, and urged the Commission to apply the Merger Policy Statement to the merger. The PJM Industrial Customer Coalition (PJM Industrials) filed a motion to intervene. PJM Industrials state that the merger will affect the development of a competitive market for electricity in the PJM control area, and that during periods of transmission congestion, the merged companies will likely be able to influence the price of electricity in the eastern portion of the PJM control area. Commonwealth Chesapeake Corporation (Commonwealth Chesapeake) filed a motion to intervene and protest, stating that there are transmission constraints that may affect generation dominance on the Delmarva Peninsula, and urging the Commission to adequately mitigate any increase in anticompetitive effects. Duke/Louis Dreyfus L.L.C. (Duke/Louis) filed a motion to intervene and provisional protest and also filed a supplemental protest. Duke/Louis states that it is an energy marketer, and that it is the exclusive agent for the City of Dover, Delaware (Dover), responsible for managing Dover's generating resources, arranging bulk power purchases and sales, procuring necessary transmission services, and ensuring Delmarva's performance under the Delmarva-Dover Interconnection Agreement. Duke/Louis asserts that it is not clear that Applicants' hold-harmless undertaking will protect Dover from merger-related harm. Duke/Louis also expresses a concern about transmission constraints for the Delmarva Peninsula and the eastern PJM interface, and urges the Commission to determine whether to impose mitigation measures to ensure that the merged company will not be able to exercise market power during constrained periods. Easton Utilities Commission (Easton) filed a motion to intervene and protest and also filed a protest of Applicants' supplemental filing. Easton states that there may be substantial concentration in eastern PJM as a result of the merger for non-firm energy and intermediate peaking capacity, and that eastern PJM is a relevant market even though the constraints on the eastern interface occur for relatively short periods. Easton also contends that the Supporting Company Group's (which includes Applicants) congestion proposal in the PJM open access transmission tariff discriminates against network transmission customers whose resources are located on the load side of the customer's PJM interconnection. Easton further asserts that Applicants' hold harmless commitment is vague, should not be treated as a supplement to existing rate schedules, and its justness and reasonableness must be decided before approving the merger. The Mayor and Council of Berlin, Maryland (Berlin) filed a motion to intervene and also filed a protest of Applicants' supplemental filing. Berlin supports Easton's contention that the Supporting Company Group's congestion proposal in the PJM open access transmission tariff discriminates against transmission dependent utilities with "behind the meter" generation. Berlin also argues that the Applicants' hold harmless commitment is vague and suffers other infirmities. Maryland People's Counsel (MPC) filed a motion to intervene, protest and request for hearing, and also filed a supplemental protest and request for hearing. MPC asserts that there exists a material issue of fact concerning the effects of the merger on competition, and also states concerns about proposed merger's impact on operating costs and rate levels. MPC believes that the relevant geographic market is narrower than used by Applicants' witness. MPC filed a letter on July 23, 1997, withdrawing its earlier request that the Commission examine the merger's effect on retail competition. The City of Vineland, New Jersey (Vineland) filed a motion to intervene, a supplemental motion to intervene, protest, and comments. Vineland states that the transmission constraints that exist into eastern PJM may not be alleviated by Applicants' planned upgrades, and that Applicants should be required to commit to upgrade or expand transmission facilities as needed to fully alleviate constraints. Vineland also asserts that Applicants have not adequately considered the effects of the merger on TDUs such as Vineland. Vineland calls Applicants' hold harmless commitment inadequate, and states that Applicants should commit not to use constrained transmission paths for off-system trades when other transmission service requests are pending. Vineland also states that the merger proceeding should be held in abeyance pending determination of discrimination issues in the PJM open access transmission tariff proceeding. Old Dominion Electric Cooperative, Inc. (Old Dominion) filed a motion to intervene, protest, and request for evidentiary hearing, and also filed a protest to Applicants' supplemental filing. Old Dominion states that Applicants' hold harmless provision is inadequate and was not negotiated with customers, and contends that the most reasonable ratepayer protection mechanism would be an open season where wholesale customers could switch suppliers. Old Dominion also expresses concern about competitive implications in the eastern PJM market due to transmission constraints over the eastern interface, and questions whether Applicants' proposed upgrade to the Red Lion substation will provide much mitigation. The Delaware Municipal Electric Corporation, Inc. (Delaware Municipal) filed a motion to intervene and protest, and also filed a supplemental motion to intervene, protest, and request for rejection of the merger application. Delaware Municipal states that Applicants' competitive screen analysis is deficient and does not satisfy the Merger Policy Statement in that it fails to analyze all relevant products, relevant markets, and generating capacity. Delaware Municipal also states that there are inconsistencies between what Applicants have stated in their Application regarding transmission constraints and what was stated in other proceedings. Delaware Municipal challenges Applicants' assumptions that all wholesale customers are reachable through open access transmission tariffs and about the amount of access to New York Power Pool suppliers, and questions Applicants' calculation of interface transfer capability. Delaware Municipal asks that the Commission evaluate issues related to retail competition. Delaware Municipal further contends that Applicants have overstated merger benefits and that Applicants' ratepayer protection commitment is inadequate. On May 22, 1997, the Electricity Consumers Resource Council (ELCON), the American Iron and Steel Institute (AISI), and the Delaware Energy Users Group (Delaware Users) filed a late motion to intervene and comments, urging the Commission to consider the effects of the merger on retail competition. On January 10, 1997, Applicants filed an answer to the motions to intervene and other relief, and on May 20, 1997, Applicants filed an answer to motions to reject and for other relief. Applicants also filed: answers opposing Vineland's request for additional time to file a protest and its supplemental motion for intervention; a letter stating that they did not oppose Berlin's motion to intervene; and an answer opposing the late motion to intervene of ELCON, AISI, and Delaware Users. IV. Discussion A. Procedural Matters Pursuant to Rule 214 of the Commission's Rules of Practice and Procedure, 18 C.F.R. ss. 385.214 (1996), the notices of intervention of the Maryland Commission, Delaware Commission, and New Jersey Commission, and the timely, unopposed motions to intervene of PSE&G, ECI, Eastern, USGen, PECO, South Jersey, Delaware Advocate, New Jersey Advocate, Wilmington, Maryland Energy Agencies, PJM Industrials, Commonwealth Chesapeake, Duke/Louis, Dover, Easton, Berlin, MPC, Vineland, Old Dominion, and Delaware Municipal serve to make them parties to the instant proceeding.14 We will grant the late motion to intervene of ELCON, AISI, and Delaware Users. - - -------- 14 Because a second notice of the filing was published after Applicants' supplemental filing, all comments, protests, and motions to intervene filed on or before May 5, 1997 are timely. B. Standard of Review Under Section 203 and the Merger Policy Statement Section 203(a) of the FPA provides, in relevant part, as follows: No public utility shall sell, lease, or otherwise dispose of the whole of its facilities subject to the jurisdiction of the Commission, or any part thereof of a value in excess of $50,000, or by any means whatsoever, directly or indirectly, merge or consolidate such facilities or any part thereof with those of any other person, or purchase, acquire, or take any security of any other public utility, without first having secured an order of the Commission authorizing it to do so. 16 U.S.C. ss. 824b(a) (1994). The Commission must approve a proposed merger if it finds that the merger "will be consistent with the public interest." Id. The Commission updated and clarified its procedures for reviewing public utility mergers in light of the changes in the electric power industry by issuing the Merger Policy Statement, in which the Commission determined to focus its review on three issues: (1) the effect of the merger on competition; (2) the effect of the merger on rates; and (3) the effect of the merger on regulation. In this case, the Commission will apply this three-factor test. C. Effect of the Merger on Competition At the outset, we find that the merger does not raise concerns regarding transmission market power. Both Applicants are members of PJM and will provide transmission service pursuant to the PJM-wide open access transmission tariff filed in compliance with Order No. 888.15 Accordingly, Applicants will not be able to exercise market power with respect to transmission. - - -------- 15 Promoting Wholesale Competition Through Open Access Nondiscriminatory Transmission Services by Public Utilities and Recovery of Stranded Costs by Public Utilities and Transmitting Utilities, Order No. 888, 61 Fed. Reg. 21,540 (May 10, 1996), FERC Stats. & Regs. P. 31,036 (1996), order on reh'g, Order No. 888-A, 62 Fed. Reg. 12,274 (March 14, 1997), FERC Stats. & Regs. P. 31,048 (1997), reh'g pending. In addition, the proposed merger raises no vertical competitive concerns. Atlantic City Electric provides no gas distribution services. Delmarva has a small gas division that provides local gas distribution service in New Castle County, Delaware. However, Delmarva's gas distribution subsidiary provides no gas service to Atlantic City Electric's gas-fired generators. Consequently, any incentives and ability of Delmarva pre-merger to disadvantage gas-fired electric generators located within its gas distribution area do not change as a result of the merger. We decline Delaware Municipal's, Elcon's, AISI's and Delaware Users' suggestion that we consider issues related to retail competition. We stated in the Merger Policy Statement that we would consider a merger's effects on retail markets if a state commission asks us to because it lacks adequate authority under state law.16 Here, no state commission has requested that we examine the merger's effect on retail competition, and we have no reason to believe that the state commissions will not consider this issue to the extent they believe it is necessary. 16 Merger Policy Statement, FERC Stats. & Regs. at 30,128. See Baltimore Gas & Electric Company and Potomac Electric Power Company, 79 FERC P. 61,027 at 61,115-116 (1997). In light of the above, we focus our attention in this case on generation market power issues relating to wholesale electric power sales. 1. The Merger Policy Statement's Competition Analysis In the Merger Policy Statement, we stated that, in analyzing the effect on competition of a proposed horizontal merger, we would adopt the Department of Justice/Federal Trade Commission Merger Guidelines (Guidelines) as our basic framework.17 The Guidelines set out five steps for a merger analysis: (1) define relevant product and geographic markets likely to be affected by the merger and measure the concentration and the increase in concentration in those markets18; (2) evaluate whether the extent of concentration and other factors that characterize the markets raise concerns about potential adverse competitive effects; (3) assess whether entry would be timely, likely, and sufficient to deter or counteract any such concern; (4) assess any efficiency gains that applicant cannot reasonably achieve by other means; and (5) assess whether either party to the merger would be likely to fail without the merger, causing its assets to exit the market.19 - - -------- 17 Merger Policy Statement, FERC Stats. & Regs. at 30,117-18. 18 The Guidelines address three ranges of market concentration in merger analysis that provide useful guidance on assessing market concentration (using the Herfindahl-Hirschman Index (HHI)): (1) unconcentrated post-merger market -- if the HHI is below 1000, regardless of the change in HHI, the merger is unlikely to have adverse competitive effects and ordinarily requires no further analysis; (2) moderately concentrated post-merger market -- if the post-merger HHI ranges from 1000 to 1800 and the change in HHI is greater than 100, the merger potentially raises significant competitive concerns; and (3) highly concentrated postmerger market -- if the post-merger HHI exceeds 1800 and the change in the HHI exceeds 50, the merger potentially raises significant competitive concerns; if the change in HHI exceeds 100, it is presumed that the merger is likely to create or enhance market power. 19 Merger Policy Statement, FERC Stats. & Regs. at 30,118. The Merger Policy Statement adopted an analytic screen, which focuses primarily on the Guidelines' first step, for applicants to submit as part of their application.20 The analytic screen requires the applicant to: (1) identify the relevant products; (2) identify the customers who may be affected by the merger (also referred to as destination markets)21; (3) identify the potential suppliers who can compete to supply each Identified customer; and (4) analyze market concentration before and after the merger.22 If an adequately supported screen analysis shows that the merger would not significantly increase concentration, and there are no interventions raising genuine issues of material fact that the Commission cannot resolve on the basis of the written record, the Commission will not set the competition issue for hearing. - - -------- 20 Id. at 30,118-20. 21 A "destination market" can be any potential wholesale customer of the merging parties. If the same suppliers can profitably serve a group of customers, it makes sense to aggregate those customers as a distinct destination market for purposes of analysis. For example, a group of customers who are served under the same transmission tariff and who are not separated by any significant transmission constraint(s) should, in theory, be able to buy power from the same group of potential suppliers. For purposes of analyzing market concentration, it is necessary to establish the relevant "geographic market" associated with each identified destination market. The relevant geographic market is defined by the set of suppliers that can physically and economically supply a relevant product to a particular destination market. 22 Merger Policy Statement at 30,119. Appendix A of the Policy Statement provides a detailed illustrative description of the analytic screen. It market concentration as shown in the screen analysis exceeds the Guideline's thresholds, then the application should present further analysis consistent with the Guidelines.23 In the Merger Policy Statement, we stated that we will set for hearing the competitive effects of merger proposals if they fail the above screen analysis, if there are problems concerning the assumptions or data used in the screen analysis, or if there are factors external to the screen which put the screen analysis in doubt. We may also set for hearing applications that have used an alternative analytic method without adequately supporting the results of the analysis.24 - - -------- 23 Id. at 30,120. 24 Id. 2. Applicants' Competition Analysis Applicants submitted a competition analysis with their original application filed on November 27, 1996, and supplemented that analysis on March 4, 1997 with an analysis modeled on the Merger Policy Statement's analytic screen. We evaluate Applicants' analysis in the context of the four-part analysis set forth in Appendix A to the Merger Policy Statement, as discussed above. a. Relevant Products The Merger Policy Statement stated that in the past, the Commission has analyzed three products, and that they remained reasonable products that merger applicants should recognize, although other product definitions may be acceptable.25 These are long-term capacity, short-term capacity, and non-firm energy. - - -------- 25 Merger Policy Statement, FERC Stats. & Regs. at 30,130. With respect to long-term capacity, Applicants provided an analysis showing that there are no barriers to entry to the long-term capacity market, and that Applicants would be unable to erect and maintain any barriers to entry.26 We agree with Applicants' analysis and find that the merger will not affect competition in the long-term capacity market. - - -------- 26 Application, Exh. No. ___ (JCD-1) at Appendix B. As stated in the Merger Policy Statement, we believe the appropriate test for entry barriers is whether there are any barriers, not whether there are barriers controlled by the merging companies. Merger Policy Statement, FERC Stats. & Regs. at 30,135. Here, Applicants' evidence supports a finding that, in this case, there are no barriers to entry into the long- term capacity market. With respect to short-term capacity, Applicants analyzed uncommitted capacity over the years 1998-2001 and found that neither company would have any uncommitted capacity during this period, and therefore, the merger could not effect competition in these markets.27 We agree with Applicants' appraisal of their capacity situation and find that the merger will not affect competition in the short-term capacity market. - - -------- 27 Application, Exh. No. ___ (JCD-1) at IV-3; Application, Exh. No. ___ (JCD-4) at 2. Applicants have performed a market concentration analysis with respect to non-firm energy. This analysis is discussed below. b. Destination Markets The Merger Policy Statement's analytic screen sets up a two-step process to determine the size of the geographic market. The first step requires identification of customers potentially affected by the merger, and must include, at a minimum, those directly interconnected to the Applicants, and additional entities should be included if historical transactions data indicates that they have been trading partners with the merging parties.28 - - -------- 28 Merger Policy Statement, FERC Stats. & Regs. at 30,130. Applicants identify local transmission dependent utilities (TDUs), PECO Energy, General Public Utilities (GPU), Baltimore Gas & Electric Company (BG&E), and Public Service Electric and Gas (PSE&G) as customers affected by the proposed merger. This was based upon an analysis of direct interconnections and historical sales.29 Additionally, Applicants claim that the inclusion of BG&E as a separate destination market reflects competitive alternatives available to other PJM utilities (i.e., Potomac Electric Power Company (PEPCO) and Pennsylvania Power & Light Company (PP&L)) located west of the eastern PJM interface. Applicants therefore conclude that all prospective customers that are located within PJM should be included in the relevant market. We believe that it is reasonable to include as destination markets all potential customers located in PJM as those who are potentially affected by the proposed merger. - - -------- 29 Application, Exh. No. ___ (JCD-4) at 3 & n.3. Although the merging companies have transacted with Allegheny Power System (APS), Consolidated Edison Company of New York, Inc. (Con Ed), and Northeast Utilities (NU) during the 1994-95 period examined, Applicants assert that the proposed merger will have no adverse effect on these utilities and exclude them from their analysis.30 In addition, sales from the merging entities to APS, Con Ed and NU were very small, relative to sales to other potentially affected customers. We agree with Applicants' reasoning that APS, Con Ed and NU do not merit inclusion as relevant destination markets. - - -------- 30 Applicants state that APS does not merit inclusion in the relevant geographic market because it has a large number of potential suppliers, its variable production costs are lower than the merging companies' and it is on the opposite side of the prevailing flow across PJM (i.e., west to east). Applicants argue that Con Ed is connected with other members of the New York Power Pool and with PJM through the PJM extra-high voltage system. In addition, the transfer capability of the tie line between eastern PJM and NYPP is limited. Finally, transfer capability on the transmission paths from the merging companies to NU is limited relative to the amount of economic capacity that is interconnected with these transmission facilities. As a result, Applicants conclude that the merging companies could not adversely affect the competitiveness of the NU market. Application, Exh. No. ___ (JCD-4) at 5. Delaware Municipal contends that the Applicants should have included PSE&G, Long Island Lighting Company (LILCO), and New York State Electric & Gas Company (NYSEG) as destination markets. We find these concerns unwarranted. First, PSE&G is included in the Applicants' analysis. With respect to LILCO and NYSEG, the Applicants made no sales to LILCO or NYSEG in 1994, 1995, and 1996. Applicants' decision not to include LILCO and NYSEG as destination markets is reasonable and consistent with the Merger Policy Statement.31 - - -------- 31 Merger Policy Statement, FERC Stats. & Regs. at 30,130. While Applicants' primary position is that the PJM system is largely unconstrained, they recognize that there are constraints on the PJM transmission system that limit power flows into eastern PJM under certain conditions for very limited periods throughout the year.32 In these circums tances, according to Applicants, the eastern PJM subregion becomes a distinct geographic market.33 Therefore, Applicants perform a separate concentration analysis for eastern PJM. This analysis will be discussed below. - - -------- 32 Applicants state that PJM, on average, is forced to dispatch generation out of economic order (i.e., run off-cost generation in eastern PJM) 4.4 percent of the hours in a year to relieve constraints. They assert that, of the f-cost generation dispatched, about one-fourth (or 1 percent of the hours in a year) was due to the constraints on the eastern PJM interface. Applicants also indicate that they will alleviate the one existing transmission constraint located on their systems. The constraint occurs at the Keeney substation where power is transferred into Delmarva's system and into eastern PJM from the 500 kV system. The constraint will be alleviated by adding a parallel 500/230 kV step-down transformer in an adjacent substation (the Red Lion substation). Applicants have stated that this transformer was energized on May 16, 1997. Applicants indicate that they have no other significant constraints that affect wholesale or transmission customers under normal operating conditions. 33 Application, Exh. No. ___ (JCD-3) at 10. c. Geographic Markets Under the Merger Policy Statement's screen analysis, the next step is to identify those suppliers that can compete to serve a given destination market and how much of a competitive presence they are in the market.34 This analysis involves determining the economic capability of a supplier to reach a market by using a delivered price test, which requires that suppliers be included in a market if they can deliver the product to a customer at no greater than 5 percent above the competitive price to that customer. This analysis also involves determining the physical capability of a supplier to reach a market by examining available transmission capacity. - - -------- 34 Merger Policy Statement, FERC Stats. & Regs. at 30,130. i. Delivered Price Test Applicants' analysis approached the delivered price test by considering as potential suppliers all generating units in PJM, and 1700 MW from the NYPP.35 Applicants listed all of these units in ascending cost order and refer to this list as the supply curve. The ordering of plants along the supply curve is based on delivered price, which includes the variable cost of each unit plus the cost of transmission, ancillary services and losses. - - -------- 35 Due to transfer limitations between the NYPP and PJM, only 1700 MW of capacity from the NYPP is included in the analysis. Applicants state that they did not consider potential suppliers within the East Central Area Reliability Coordinating Agreement (ECAR) area or the Southeastern Electric Reliability Council because these suppliers are not directly interconnected with the eastern PJM market in which the merging companies are likely to have the greatest market presence, and excluding such suppliers would, if anything, cause Applicants' analysis to overstate their market shares. Application, Exh. No. ___ (JCD-4) at 13 n.17. (a) Generation and Transmission Costs We find that Applicants' list of potential supplying plants and their delivered prices is generally reasonable, with several exceptions discussed below. Delaware Municipal argues, however, that the transfer capability from the NYPP to PJM is only 650 MW as opposed to the 1700 MW assumed by Applicants, which would reduce the amount of capacity available from New York. We disagree. A recent operating study published by several of the regional reliability councils states that the total simultaneous transfer capability from NYPP to PJM is in fact greater than what Applicants assumed.36 - - -------- 36 The study was published by the Mid Atlantic Area Council, the ECAR, and the Northeast Power Coordinating Council. It found a simultaneous transfer capability from NYPP to PJM of 2250 MW. In determining a potential suppliers' generating costs for purposes of a merger screen analysis, the Merger Policy Statement allows consideration of various measures of costs, including FERC Form No. 1 data, as long as such cost data are verifiable and supported with reasoned analysis. Applicants used operation and maintenance (O&M) expenses from FERC Form No. 1 for PJM and NYPP generating plants.37 They assigned O&M expenses to either fixed or variable costs and then divided the variable component by the annual energy output of each plant. Applicants state that in cases where variable O&M expenses were extraordinarily high, extraordinarily low, or simply not reported, they used the average variable O&M expenses for that type of plant and fuel.38 We believe Applicants' approach to developing generation costs is reasonable. Although Delaware Municipal challenges the use of average annual variable generation costs rather than marginal energy costs, we believe use of costs taken from FERC Form No. 1 is reasonable and consistent with the Merger Policy Statement. - - -------- 37 PJM imports energy from NYPP plants. As such, Applicants calculate their generation costs. 38 Applicants do not state the basis upon which they considered costs "extraordinarily" high or low. Another component of determining the delivered price for potential suppliers is determining transmission costs. Applicants calculated a rate for network integration service and ancillary services for each destination market (e.g., TDUs, PECO, PSE&G and BGE) based on the July 1996 draft PJM transmission tariff filed by the PJM Supporting Companies and tariffs filed by the individual companies.39 They also include rates for sales from utilities in NYPP to PJM. Although Applicants' approach to transmission costs for suppliers in PJM is acceptable, their assumptions about transmission costs for NYPP suppliers is not well supported. For example, they have not supported their assertion that ancillary services are included in the delivered price of power from the NYPP, nor have they supported their use of .5 cents/kWh as the transmission rate in the NYPP. However, given the relatively small amount of New York capacity included in the study, we find that Applicants' assumptions do not materially affect the outcome of the market concentration analysis.40 - - -------- 39 Rate components were calculated for scheduling, system control and dispatch; reactive supply and voltage control; regulation and frequency response service; operating reserve--spinning; and operating reserve--supplemental. The rates for the first two services are based on the PJM draft tariff and the rates for the last three services are based on an average of eastern PJM individual utility tariffs (excluding PECO, due to their use of a non-conforming methodology). Applicants note that non-firm point to point service under the proposed PJM tariff is provided at no cost to transmission customers. Therefore, it is appropriate to use network integration service transmission costs. 40 Although Applicants did not fully explain how each component of the transmission charge was determined, we note that the level of the transmission charge does not affect the end result of the Applicants' analysis. Under a worst case scenario (from the Applicants' viewpoint) where no economic capacity will be supplied from NYPP (due to extremely high transmission costs), the resulting market concentration does not exceed the threshold of concern under the Merger Policy Statement. Delaware Municipal argues that Applicants' approach fails to evaluate the effect of the merger on individual customers or types of customers. Applicants state that because a customer within a transmission zone in PJM pays a single charge for transmission service based on the zone in which it is located, transmission charges do not affect a customer's choice of suppliers. As a result, they conclude that the relative ordering of suppliers based on the delivered price will not change from one PJM customer to another, except to the degree that transmission constraints limit the ability of suppliers to access the market. Therefore, Applicants do not perform a separate analysis for each of the different destination markets identified, but evaluate an eastern PJM market (when the eastern PJM interface is constrained) and an entire PJM market (when the eastern PJM interface is not constrained). We believe that this is a reasonable approach because the effect of the merger on individual TDU customers is adequately addressed in Applicants' analyses. Another area of concern with Applicants' delivered price analysis relates to congestion pricing. The transmission tariff submitted by the PJM Supporting Companies contains locational marginal cost congestion pricing, and several intervenors have faulted Applicants' analysis for not addressing this as part of their delivered price analysis.41 We agree that, under a delivered price test where there is congestion pricing, supplies from entities transacting along a congested transmission path would become more expensive relative to supplies from entities transacting along uncongested paths. A congestion charge could conceivably alter the amount of energy that could be delivered at a price lower than 5 percent above the market-clearing price. Simply limiting supplies from all entities on the unconstrained side of the eastern PJM interface -- as Applicants have done -- does not appropriately address the effect of congestion charges in the delivered price of energy from those resources. - - -------- 41 The currently effective PJM transmission rate is based on a proposal by PECO, which does not assign congestion costs to specific transactions. However, the Commission, 78 FERC at 61,883, has indicated that it expects to implement the Supporting Companies' congestion pricing proposal. We are, however, aware that accounting for congestion prices in non-firm energy markets for the purposes of a delivered price test is complex. Given the specific facts of this case, we believe it is reasonable not to pursue the congestion pricing issue further for several reasons. First, there were competing transmission pricing proposals for PJM pending at the time Applicants filed their analysis, and the currently effective tariff allocates congestion costs evenly among all PJM participants and would not affect the delivered price from any one particular supplier. Second, the PJM Supporting Companies' proposal is complex, and until it becomes operational, it would be very difficult to estimate the cost of congestion under that proposal. Third, the amount of time that there are constraints on PJM is small, which means that the effect of congestion pricing on the delivered price analysis would likely not be significant.42 We note, however, that it is possible, in the context of other mergers, that congestion may occur in more hours of the year and at times when there are relatively few alternative economic generating resources. Under such circumstances, congestion may be an important factor in delivered energy prices and should be evaluated. - - -------- 42 Applicants' analysis indicates that generation has historically been run off-cost in eastern PJM not at times of peak demand but at times of intermediate peak demand. Therefore, regardless of the source of the binding constraint, if Applicants attempted to withhold resources and raise energy prices at intermediate peak times, the relatively larger availability of economic generating resources would likely prevent a "significant and nontransitory" price increase. (b) Competitive Market Price Our screen analysis requires determining a competitive market price for the purpose of identifying which potential supplies are economic. We recognized in the Merger Policy Statement that competitive market prices may be difficult to determine because the reporting of actual transactions prices (in many electricity markets) is still in the formative stages and electricity markets are not sufficiently mature to exhibit single market clearing prices for various products, and therefore, applicants may use surrogate measures as long as they are supported. Applicants' approach to determining the market price involved identifying fourteen points along its supply curve (in increments of at least 100 MW) where there is a generating plant owned by the merging companies. For example, the first increment of supply examined was based on the minimum PJM demand. Each subsequent point on the curve was established based on the next lowest cost Atlantic City Electric or Delmarva plant or plants that had a total capacity greater than 100 MW. Applicants refer to these points as the market conditions under which to perform a separate delivered price test, and the market price at that condition as 1.05 times the generation cost of their plant at that increment. By assuming that only the merging companies' plants will set the market-clearing price, Applicants' approach will result in the greatest change in HHIs and greatest market share for the merging company. However, by examining supply and demand conditions only at the points where Applicants' plants enter the market, Applicants' approach fails to evaluate the merger's effect on post-merger market concentration at other points on the supply curve. A better approach would evaluate both the pre-to-post merger changes in the HHIs and the post-merger market concentrations under relevant market demand conditions.43 In this case, Applicants' approach is not a problem because we have considered the pre-to-post merger change in HHIs and post-merger market concentration and find competitive concerns are not raised. The facts of other mergers could, however, result in different conclusions. Accordingly, we encourage future applicants to utilize an approach that appropriately addresses changes in market concentrations under relevant market demand conditions. - - -------- 43 A delivered price test should be performed for each relevant market demand condition. Although system lambda data may have certain limitations, see Ohio Edison Company, et al., 80 FERC P. 61,039, slip op. at 25, n.63 and accompanying text (1997), changes in system lambda data over a load cycle can provide a good indicator of when-market demand conditions change. System lambda during a distinct demand period can also be used as a proxy for market clearing prices in the relevant market to determine what capacity is economic during that period. We note that system lambda data are available for both PJM and eastern PJM, the relevant markets analyzed by Applicants. In this case, market concentration statistics based on PJM system lambda data can better reflect the effect of the merger. ii. Transmission Capability The Merger Policy Statement's screen analysis requires a determination of transmission capability to identify any restrictions on physically delivering economic supplies to a market.44 Applicants acknowledge that there are restrictions on the physical deliverability of power within PJM during "infrequent" periods.45 These constraints occur, among other points, at the eastern PJM interface which divides the eastern subregion of PJM from the central and western zones. When they occur, the constraints limit the amount of power that may be imported to eastern PJM utilities from central and western PJM, and generation in eastern PJM is dispatched "off-cost" and/or energy from the NYPP is imported to meet a limited part of the eastern PJM load. - - -------- 44 Merger Policy Statement, FERC Stats. & Regs. at 30,132. 45 Application, Exh. No.___ (JCD-3) at 10; Applicants contend that the eastern interface constraints occur about 1 percent of the time and are at intermediate load, rather than peak- load, conditions. Application, Exh. No. ___ (MM-2) at 9-10. A significant issue which intervenors and the Applicants have extensively addressed is the amount of transfer capability that exists over the eastern interface at various load levels. It is necessary to know this in order to determine the extent to which suppliers west of the interface are available to markets east of the interface during periods of constraints. Applicants submitted several sets of data to support their analysis of transfer capability. They relied primarily on a calculation using a regression analysis to estimate the transfer capability of the eastern interface at various load levels within PJM. The analysis produced two estimates for each load level - a "best estimate", which represents Applicants' best estimate of transfer capability applying a 1998 load forecast, and a "conservative estimate", which is based on a 95 percent confidence level.46 To corroborate their results, the Applicants included system operator estimates of transfer capability at various load levels. They also included actual hourly metered flows over the eastern interface for 1995. - - -------- 46 Application, Exh. No. ___ (JCD-3) at 11-15; Exh. No. ___ (JCD-4) at Appendix 1. We believe for purposes of our preliminary screen analysis that Applicants' estimate of transfer capability across the eastern PJM interface is reasonable. While we have concerns regarding the analysis Applicants used to estimate transfer capability across the eastern PJM interface, we find their results reasonable primarily because the results are corroborated by actual PJM operator data.47 We note that there are a number of approaches to estimating transfer capability. However, we caution future applicants that analyses relying on regression and other estimating techniques should be fully explained. In addition, the results of any such analyses should be corroborated with independent data, to the extent available. - - -------- 47 Applicants state that transfer capability is a function of a number of interacting factors such as load, available generation, location of generation resources and use of certain capacitor banks. However, Applicants' analysis uses only a single variable--load in eastern PJM--to explain transfer capability on the eastern PJM interface. Therefore, Applicants' assumption that load in eastern PJM adequately explains transfer capability on the eastern PJM interface is questionable. Moreover, Applicants' results do not confirm that there is a meaningful relationship between the single variable of load in eastern PJM and transfer capability on the eastern PJM interface. We note one additional point here. Applicants' analysis of transmission capability only examined eastern interface constraints. However, the evidence submitted indicates that there may be other constraints. For example, Applicants stated that eastern PJM generation was run "off-cost" in approximately four percent of annual hours, but indicate that only one percent of this was attributable to eastern interface constraints.48 Several intervenors are concerned that Applicants' analysis ignores the Importance of constraints not occurring on the eastern PJM interface, which could produce a narrower market than eastern PJM and limit TDUs' options for energy purchases. - - -------- 48 Applicants state that part of the off-cost generation not due to the eastern interface constraint was due to the Keeney constraint, which will be alleviated by the Red Lion substation upgrade, and the rest was due to local constraints not on Applicants' systems. Application, Exh. No. ___ (MM-2) at 9-10. Constraints occurring on and off the merging companies' system can potentially affect the dimensions of the relevant geographic market. As such, all constraints merit identification. However, in this case, they do not merit additional investigation. Further analysis of constraints would not alter the Applicants' results. This conclusion is based on the infrequency of the constraints and that they occur in intermediate peak periods.49 - - -------- 49 Duke/Louis and Old Dominion raised concerns that Delmarva's upgrade to the Red Lion substation will not adequately relieve constraints resulting from a more active regional energy market and a restructured PJM. These concerns are unrelated to the merger. If transmission capacity into the Delmarva peninsula becomes constrained in the future, parties are free to seek additional transmission facilities under the provisions of the PJM open access tariff. d. Concentration Analysis The final step in the Merger Policy Statement's screen analysis is to analyze the effect of the merger on market concentration and competition. This should be done using HHI measures and single firm market share statistics.50 Applicants analyzed concentration for each of the fourteen increments on their supply curve where they assumed their generating plants set the market clearing price. They performed an analysis for economic capacity, available economic capacity, and total capacity. - - -------- 50 Merger Policy Statement, FERC Stats. & Regs. at 30,133. i. Economic Capacity Applicants analyzed economic capacity under three scenarios: an eastern PJM market with the "best estimate" of eastern interface transmission capability; an eastern PJM market with a "conservative" (95 percent confidence) estimate of eastern interface capability; and a total PJM market with no eastern interface constraints. The worst case under both the "best estimate" scenario and the total PJM scenario occurs at increment 8, where the merged companies' combined market share is 8.7 percent, the post-merger HHI is 1021, and the HHI increase is 32. The worst case under the "conservative" estimate scenario occurs at increment 5, where the merged companies' combined market share is 15.7 percent, the post-merger HHI is 835, and the HHI increase is 70.51 Applicants assert that neither the HHI measures nor the market share measures, even in the worst case, raise concerns under the DOJ Merger Guidelines. - - -------- 51 Application, Exh. No. ___ (JCD-4) at Tables 7-9. We disagree with two aspects of Applicants' methodology for this analysis, but even after we have made adjustments, we agree with Applicants that the proposed merger raises no competitive concerns. The first aspect concerns the treatment of non-utility generating (NUG) capacity. Applicants treat NUG capacity as separate market shares when computing the HHIs at each load increment. However, absent evidence demonstrating that some or all of the NUG capacity is available to the market, we believe it should be considered controlled by the purchasing utility.52 As discussed below, we performed an analysis with an adjustment adding such committed NUG capacity to the purchaser's other capacity resources in determining market concentration and changes in such concentration. Although the adjustment is not significant enough to change the result of the analysis here, because the assignment of committed NUG capacity can affect market concentration, other merger applicants should account for committed NUG capacity consistent with the above discussion. - - -------- 52 NUG capacity is generally supplied under long-term contract with the purchasing utility. The second aspect concerns the way Applicants calculated concentration when an eastern interface constraint is assumed to occur. In that case, Applicants first calculated market concentration using only the capacity within eastern PJM (i.e., capacity on the other side of the constraint was excluded). The Applicants then reduced the calculated HHI statistic by a percentage equal to the ratio of the transmission transfer limit to the load. We believe that such a calculation distorts the market concentration because it effectively (1) treats all capacity on the other side of the constraint as having the same economic value and (2) ignores the relative size of sellers with economic capacity on the other side of the constraint. Using data supplied by the Applicants, we considered the units on the other side of the constraint that would be most economic to serve that portion of the load within eastern PJM up to the point that transmission transfer limitations were reached. From these data, we considered the market concentration and change in such concentration due to the merger. We believe that this approach corrects for the above-described shortcomings of Applicants' method. However, incorporating these two adjustments does not change any concentration measure so as to raise concern in either the "best estimate" scenario or the total PJM scenario. In the "conservative" scenario, the adjustments would cause post-merger HHI increases in excess of 100 in moderately concentrated markets for three load increments. Given the context in which this occurs, we do not believe it raises competition problems. The over-100 changes in HHIs occur in only three of fourteen increments examined; they only occur in the scenario which assumes a conservative estimate of eastern interface capacity; they only occur when there is a constraint in PJM, which is infrequent and, in PJM at this time, analysis of all economic capacity is less significant than an analysis of available economic capacity, which as discussed below, shows no competitive concerns. ii. Available Economic Capacity Applicants' analysis of available economic capacity assumed that the lowest-cost units are used to serve native load and firm contractual obligations, and that any remaining capacity would be available to make sales to prospective purchasers.53 Applicants compared the amount of each supplier's economic capacity with its firm native load and contractual load obligations at each point on the supply curve where the merging companies had a generating plant. The analysis also included in the suppliers' economic capacity any capacity that had a cost no greater than 5 percent above the cost of the Applicants' generating plant. If a supplier's total economic capacity at this point on the supply curve is greater than its native load and firm contract obligations, the supplier is assumed to have available economic capacity. - - -------- 53 Applicants performed two available economic capacity analyses: a market concentration analysis, and a comparative revenue/cost analysis. Both purport to show that Applicants do not possess significant amounts of available economic capacity and, consequently, that Applicants do not have market power in the non-firm energy market. We focussed on Applicants' first approach, which follows the Merger Policy Statement preference for an analysis of changes in market concentration (HHI analysis). Applicants' concentration analysis for available economic capacity shows that the post-merger HHIs do not exceed the relevant thresholds under the Guidelines. For most load increments analyzed, the Applicants had no available economic capacity, hence there is no post-merger increase in the HHI. For some increments, Delmarva had available economic capacity, but Atlantic City Electric was deficient. Therefore, for these increments, the post-merger HHI change was negative. The highest market share for the merged companies was 3.1 percent. However, Applicants did not include any of their owned capacity from western sources in the analysis for any of the constrained increments, and failure to do so biases the results in favor of the Applicants. We believe that Applicants' western capacity should be considered in the analysis up to point where the constraint occurs. However, an adjustment to Applicants' analysis that includes all purchased NUG capacity and capacity owned by the Applicants at each supply increment, regardless of its location in PJM, does not affect the end result: Applicants have virtually no available economic capacity. Hence, the concentration analysis for available economic capacity indicates that Applicants do not possess market power in the non-firm energy market. iii. Total Capacity Applicants' analysis of total capacity examined a condition at peak load for its "best estimate" scenario and its "conservative" scenario for eastern interface capability. Under the "best estimate" scenario, the post-merger HHI was 1616, the change in HHI was 68, and the merged companies' market share was 11.9 percent. Under the "conservative" scenario, the post-merger HHI was 1669, the change in HHI was 73, and the merged companies' market share was 12.4 percent. Similar to our adjustment to Applicants' economic capacity analysis, we adjusted Applicants' total capacity analysis to include committed NUG capacity in the market shares of the purchasing utility. Under both the "best estimate" scenario and the "conservative" scenario, with our adjustments, Applicants' post-merger market concentration does not exceed the thresholds established in the merger guidelines for the total capacity measure. 3. Summary of Competition Analysis While there are some flaws in Applicants' competition screen analysis, we find that the flaws are not significant enough in the context of this merger to warrant further analysis or hearing. We further find that the screen analysis adequately supports the conclusion that the merger would not significantly increase concentration in any relevant market. D. Effect of the Merger on Rates The Merger Policy Statement explains that the Commission's primary focus regarding the effects of a merger proposal on rates is ratepayer protection. The Merger Policy Statement also describes various commitments which may, in particular cases, be an acceptable means of protecting ratepayers, such as hold harmless provisions, open seasons for wholesale customers, rate freezes, and/or rate reductions.54 Thus, we must evaluate whether Applicants' wholesale requirements and transmission customers are adequately protected from any potential adverse effects of the merger on rates. - - -------- 54 Merger Policy Statement, FERC Stats. & Regs. at 30,123-24. Applicants estimate merger savings of approximately $581 million, which will be off set by approximately $72 million of merger-related costs. In their supplemental filing, Applicants included a Hold Harmless Agreement (Agreement) that is applicable to all of their resale requirements and transmission customers.55 The Agreement codifies the Applicants' commitment that they will not charge any customer merger costs in excess of merger savings. The Agreement provides details regarding: (1) the accounting treatment of merger costs and savings, and customers audit rights; (2) the amortization periods for merger-related costs; and (3) a dispute resolution procedure that the Applicants and their customers can use to resolve disputes over the recovery of merger-related costs.56 The ratepayer protection provided by the Agreement extends for the duration of the individual customer contracts, which expire between the years 2001 and 2004. Applicants maintain that the Agreement, which is a unilateral commitment by each of the Applicants, is intended to satisfy the Commission's requirement that hold harmless provisions be enforceable and administratively manageable."57 Applicants maintain that any net savings that result from the merger would remain to be reflected in the applicable rate change mechanisms and in any Section 205 filing. - - -------- 55 In response to intervenor claims that certain parties were not covered by the hold harmless provision, the Applicants clarify that the ratepayer protection applies to all the existing customers, including "Vineland, which is the only TDU in Atlantic's transmission service area, and all the TDUs, including both interconnection customers and requirements customers located in Delmarva's transmission service area." Application, Exh. No. ___ (PSG-5) at 4. 56 The Agreement provides that in the event a dispute occurs over the calculation of reasonable merger costs, the burden of proof is on the Applicants, regardless of how the dispute is raised (i.e., under the dispute resolution procedures contained in the Agreement, or in a section 206 filing made by a customer). 57 In their application, the Applicants state that they intend to hold retail customers harmless in the same manner. However, in their filing with the Maryland Commission, the Applicants propose that one-third of the allocated net merger savings be used to reduce Maryland electric rates, effective when the merger closes. Although a number of intervenors have challenged the Agreement, we believe that Applicants' proposed ratepayer protection provision is adequate to protect their wholesale and transmission customers from any merger-related cost increases. Moreover, Applicants' proposal leaves open the possibility that merger-related benefits could be passed through to customers in the future. In the Merger Policy Statement, the Commission shifted its focus from attempting to quantify merger-related benefits to insuring that ratepayers are protected from adverse effects of the merger on costs. This was done to avoid disputes over the quantification of merger-related benefits, an issue that has proven contentious in the past. While Applicants' approach relies on the quantification of merger benefits, we believe that their approach is "enforceable and administratively manageable," and that it will function to hold customers harmless from merger-related cost increases, even if the expected benefits do not materialize. We note that if a dispute over reasonable merger costs occurs, section 7.1 of the Agreement places the burden of proof in any proceeding (before the Commission or the Arbitrator) on Applicants. Moreover, Applicants are hereby advised that in the event a dispute over merger benefits arises which requires our resolution, the Commission will place a heavy burden on the Applicants to demonstrate that the disputed cost or benefit is a direct result of the merger, and that said benefit is correctly quantified. For these reasons, we will reject Delaware Municipal's and Old Dominion's suggestion that the Commission institute an open season. The hold harmless provision recommended here maintains the status quo with respect to wholesale rates found just and reasonable by this Commission, and is therefore consistent with the public interest. E. Effect of the Merger on Regulation As explained in the Merger Policy Statement, the Commission's primary concern with the effect on regulation of a proposed merger involves possible changes in the Commission's jurisdiction when a registered holding company is formed, thus invoking the jurisdiction of the Securities and Exchange Commission (SEC); and where a state does not have authority to act on a merger.58 - - -------- 58 Merger Policy Statement, FERC Stats. & Regs. at 30,124-25. Applicants assert that the merger will have no effect on state and federal regulation.59 They maintain that because each company will continue under the merger as separate utility operating companies, each of the states that currently regulate their retail rates will continue to do so. Likewise, the wholesale power sales and transmission services of each of the companies will continue to be regulated by the Commission. - - -------- 59 Application at 24-25. Applicants also note that the merger would add a new layer of regulation because the SEC Bill have jurisdiction over Conectiv. However, in response to the Commission's concern under the holding of Ohio Power Co. v. FERC, 954 F.2d 779 (D.C. Cir. 1992), cert. denied, 498 U.S. 73 (1992), Applicants commit as a condition of approval of the merger that, for Commission ratemaking purposes, they will follow the Commission's policy regarding the treatment of costs and revenues associated with intra-company services.60 - - -------- 60 Id. The Commission's intra-corporate transactions policy, with respect to non-power goods and services, requires that: (1) affiliates or associates of a public utility not sell non-power goods and services to the public utility at a price above market price; and (2) sales of non-power goods and services by a public utility to its affiliates or associates be at the public utility's cost for such goods and services or the market value for such goods and services, whichever is higher. See, e.g., Duke/Louis Dreyfus L.L.C., 73 FERC P. 61,309 at 61,868-69 (1995), order on reh'g, 75 FERC P. 61,261 (1996). We note that the state commissions that have intervened have not raised concerns regarding the merger's effect on their regulation. Applicants have represented that the merger required approval from at least three of the four states in which retail operations are conducted.61 Accordingly, we are satisfied that the proposed merger will not have an adverse impact on regulation. - - -------- 61 Application, Exh. No. ___ (PSG-5) at 2. Applicants acknowledge that approval is needed from New Jersey, Delaware, and Virginia. They state that the Maryland Commission has asserted that it has the power to review the merger agreement, and has in fact issued an order approving the merger on July 16, 1997. F. Proposed Accounting Treatment We stated in the Merger Policy Statement that proper accounting is a requirement for all mergers.62 Applicants propose use of the purchase method of accounting for the merger, since, according to Applicants, the merger fails to qualify for pooling of interests treatment under Generally Accepted Accounting Principles. Applicants state that the assets recorded by Atlantic City Electric and Delmarva will remain at the same values as before the merger and each company will continue to issue separate financial statements. Applicants propose to account for any merger acquisition premium (goodwill) on the books of Conectiv, and not "push down" any portion of it to the books of Atlantic City Electric or Delmarva.63 We have no basis to dispute Applicants' claim that this business combination qualifies for "purchase" accounting, and will therefore approve its use. Applicants proposal to account for the acquisition premium on the books of Conectiv is also acceptable and consistent with our action in Entercv Services. Inc. and Gulf States Utilities Company, 65 FERC P. 61,332 at 62,532-540 (1993). - - -------- 62 Merger Policy Statement, FERC Stats. & Regs. at 30,126. 63 Applicants reserve the right to seek rate recovery of the acquisition premium in future rate proceedings. No rate recovery is being sought in this proceeding. Applicants state that they will incur approximately $72 million of merger related costs. Delmarva is deferring the direct merger transaction costs it incurs in Account 186 (Miscellaneous Deferred Debits), and will transfer them to Conectiv (as a component of the cost to acquire Atlantic City Electric) at the time of the merger. Atlantic Energy is charging the direct merger transaction costs it incurs to expense as incurred.64 None of the direct merger transaction costs are being included in current utility operating expenses.65 Both Delmarva and Atlantic City Electric are charging the indirect merger costs to operating expense as incurred.66 We believe the proposed accounting for merger related costs is reasonable.67 - - -------- 64 Answer of Atlantic City Electric Company and Delmarva Power & Light Company to Motions for Interventions and Other Relief at 37-38. 65 Old Dominion expressed concern that Delmarva's deferral of the direct transaction costs will allow Delmarva to pass them on to Old Dominion under its rate formula. Applicants correctly note, however, that none of the direct transaction costs will be charged to ratepayers unless the Commission subsequently grants Delmarva approval to recover the merger acquisition premium. 66 Answer at 38. 67 The Applicants should submit their accounting to effect the merger to the Commission in accordance with the requirements of Account 102 (Electric Plant Purchased or Sold). 18 C.F.R. Part 101, Account 102 (1996). We note that a separate service company subsidiary of Conectiv will be established to provide common or shared services to the utility and other subsidiaries of Conectiv. The Commission will require Applicants to maintain records of service company billings in sufficient detail to ensure that such charges are classified in the proper accounts and that the amounts of such billings are fully supported and justified.68 - - -------- 68 See General Instruction No. 14, Transactions with Associated Companies, 18 C.F.R. Part 101 (1997). The Commission orders: (A) The Applicants' proposed commitments are hereby accepted. (B) The Applicants' proposed merger, disposition of jurisdictional facilities and accounting treatment are hereby approved. (C) The late motion to intervene of ELCON, AISI, and Delaware Users is hereby granted. (D) The Commission retains authority under section 203(b) of the FPA to issue supplemental orders as appropriate. (E) The foregoing authorization is without prejudice to the authority of this Commission or any other regulatory body with respect to rates, service, accounts, valuation, estimates, determinations of cost, or any other matter whatsoever now pending or which may come before this Commission. (F) Nothing in this order shall be construed to imply acquiescence in any estimate or determination of cost or any valuation of property claimed or asserted. (G) The Applicants should promptly notify the Commission when the merger is consummated. By the Commission. ( S E A L ) /s/ Lois D. Cashell, Secretary. EX-99.5 6 EXHIBIT D-6.1 BEFORE THE PUBLIC SERVICE COMMISSION OF THE STATE OF MARYLAND IN THE MATTER OF THE INQUIRY INTO THE ) MERGER OF DELMARVA POWER & LIGHT ) Case No. 8744 COMPANY AND ATLANTIC ENERGY, INC. ) (Filed APRIL 18, 1997) ) EVIDENTIARY FILING OF DELMARVA POWER & LIGHT COMPANY Delmarva Power & Light Company ("Delmarva"), pursuant to Md. Ann. Code, Art. 78 ss.24(b)(1) and the Commission's letter of December 11, 1996, hereby submits the attached testimony and schedules to provide evidentiary support for a Commission finding that the planned transaction with Atlantic Energy, Inc. ("AEI") will not have a material effect on Delmarva's Maryland retail franchises or rights thereunder. In the event that the Commission determines that the planned transaction will have such a material effect, Delmarva's filing also addresses issues regarding the computation of merger-related savings, costs to achieve the merger and a proposed sharing with Maryland-retail customers of net merger-related savings and other issues that may be relevant to a Commission determination that the planned transaction is consistent with the public convenience and necessity pursuant to Md. Ann. Code, Art. 78, ss.24(c). Delmarva requests expedited consideration of this inquiry and appropriate Commission findings on or before October 22, 1997. In support of this filing, Delmarva respectfully represents: I. PARTIES AFFECTED BY THE PLANNED TRANSACTIONS 1. Delmarva is a corporation organized under the laws of the State of Delaware and the Commonwealth of Virginia. Delmarva is engaged in the generation, transmission, distribution and sale of electric energy to approximately 437,500 residential, commercial and industrial customers in Delaware, Maryland and Virginia. Delmarva's retail electric service rates are established by the Delaware and Maryland Public Service Commissions and the Virginia State Corporation Commission. Delmarva's service territory covers all or portions of the State of Delaware, ten primarily Eastern Shore counties in Maryland, and two counties which comprise the Eastern Shore of Virginia. Delmarva also provides gas service to approximately 98,000 customers located in northern New Castle County, Delaware. Delmarva's principal business office is at 800 King Street, P. O. Box 231, Wilmington, Delaware 19899. 2. Conectiv, Inc. ("Conectiv") is a corporation organized under the laws of the State of Delaware. 50% of Conectiv's outstanding capital stock is currently owned by Delmarva, and 50% of Conectiv's outstanding capital stock is currently owned by AEI. Conectiv owns 100% of the outstanding capital stock of DS Sub, Inc. ("DS Sub"). After consummation of the transactions described herein, Conectiv will own 100% of the outstanding common stock of Delmarva and AEI's wholly-owned subsidiary, Atlantic City Electric Company ("Atlantic Electric"), and Conectiv will be a registered holding company under the Public Utility Holding Company Act of 1935 ("PUHCA"). Conectiv's principal business office is at 800 King Street, P. O. Box 231, Wilmington, Delaware 19899. 3. Atlantic Electric is a corporation organized under the laws of the State of New Jersey. Atlantic Electric is engaged in the generation, transmission, distribution and sale of electric energy to approximately 473,000 residential, commercial and industrial customers in the State of New Jersey. Atlantic Electric's retail rates are established by the New Jersey Board of Public Utilities. Atlantic Electric's service territory is principally the southern third of New Jersey and covers all or portions of eight counties in New Jersey. Atlantic Electric is a wholly-owned subsidiary of AEI. Atlantic Electric's principal business office is at 6801 Black Horse Pike, Egg Harbor Township, New Jersey 08234-4130. 4. AEI is a corporation organized under the laws of the State of New Jersey and is an exempt holding company under PUHCA. The stock of AEI is publicly held. AEI is the sole common shareholder of Atlantic Electric. AEI's principal business office is at 6801 Black Horse Pike, Egg Harbor Township, New Jersey 08234-4130. 5. DS Sub is a corporation organized under the laws of the State of Delaware. DS Sub was formed solely for the purpose of facilitating the planned transactions. DS Sub will merge into Delmarva, with Delmarva as the surviving corporation. II. DESCRIPTION OF THE PLANNED TRANSACTIONS 6. AEI, Delmarva, Conectiv and DS Sub are parties to an Agreement and Plan of Merger, dated August 9, 1996, as amended and restated as of December 26, 1996 (the "Merger Agreement" or the "Agreement"). The Merger Agreement is attached hereto as Annex 1 to the Joint Proxy Statement of Delmarva Power & Light Company and AEI, Inc., dated December 26, 1996, (the "Proxy Statement") (Exhibit A). The Proxy Statement and the attached testimony of Barbara S. Graham provide a more detailed description of the transactions summarized below. 7. The planned transactions are: (i) AEI will merge with Conectiv, with Conectiv as the surviving corporation; (ii) DS Sub will merge with Delmarva, with Delmarva as the surviving corporation; and (iii) Together, these transactions result in Conectiv becoming the parent company of Atlantic Electric and Delmarva. (Collectively, the above transactions, are referred to herein and in testimony as the "Merger".) Exhibit B compares the pre-and post-Merger corporate structures of the entities involved in these transactions. 8. Upon consummation of the Merger, except for fractional, treasury, and affiliate-owned shares (if any), each share of the common stock of Delmarva will be converted into the right to receive one share of Conectiv common stock, and each share of the common stock of AEI will be converted into the right to receive 0.75 shares of Conectiv common stock and 0.125 shares of Conectiv Class A common stock. 9. As a result of these share exchanges, the holders of Delmarva and AEI common stock will hold approximately 60.6% and 39.4%, respectively, of Conectiv's common stock (based on the capitalization of each company as of September 30, 1996). Holders of AEI common stock will hold 100% of Conectiv Class A common stock. Shares of Conectiv common stock will represent approximately 94% of the voting power of the common stock, and shares of Conectiv Class A common stock will represent approximately 6% of that voting power. 10. The Merger will not affect the debt securities or preferred stock of either Delmarva or Atlantic Electric. 11. The Merger Agreement required the approval of the holders of shares of common stock in both Delmarva and AEI. The shareholders of Delmarva and AEI approved the Merger Agreement on January 30, 1997. 12. Upon consummation of the Merger, Conectiv will have five first-tier subsidiaries consisting of: two operating utilities (Delmarva and Atlantic Electric); a service company that will provide services (including, for example, accounting, financial, and legal services) to the operating utilities and other affiliates; and two existing non-utility subsidiaries of AEI. 13. Delmarva and Conectiv request that the Commission make all necessary findings and issue appropriate orders on or before October 22, 1997. The target date for receiving all necessary regulatory approvals, fulfilling all other conditions of the Merger Agreement, and closing on the Merger is December 31, 1997. Delays beyond that time would likely increase the total transaction and transition costs, while delaying the realization of Merger-related benefits. III. THE PLANNED MERGER WILL NOT HAVE A MATERIAL EFFECT ON DELMARVA'S MARYLAND-RETAIL FRANCHISES OR RIGHTS THEREUNDER. 14. None of the corporate entities in the Merger are Maryland corporations. Consequently, statutory power to approve or reject the Merger Agreement arises only if there is a determination made under Md. Ann. Code, Art. 78, ss.24(b)(1) that the Merger Agreement will have "a material effect on the franchise or rights thereunder." The requested finding of no material effect on the franchise or rights thereunder is supported by the attached testimony and schedules, which, among other matters discussed, explain and demonstrate that: o The Merger will not result in the transfer or impairment of any Delmarva's franchises, property rights, or rights to serve. After closing, Delmarva will continue to exist as the utility operating company providing retail electric utility service in Maryland. o The Merger will not have a material effect on Delmarva's ability to exercise its franchise to provide electric service safely and reliably to Delmarva's Maryland customers. Both companies are committed to maintaining and potentially improving their existing high standards of safety, reliability and customer service. o Because Delmarva will remain the Maryland operating utility, the Merger will not affect the statutory and regulatory requirements applicable to corporations providing utility services in Maryland. In particular, the Maryland Commission's requirements regarding demand-side management programs, integrated resource planning and low income programs would continue to apply to Delmarva to the same extent such requirements are currently applied. This Commission has experience as to how its regulatory policies are applicable to Columbia Gas of Maryland and Potomac Edison Company, both of which are Maryland operating utilities and are subsidiaries of holding companies. o The combined companies will continue to maintain a significant local workforce in each of the States in which they operate. Currently, Delmarva has approximately 480 Maryland employees. Decisions have not yet been made as to the particular levels, post-merger, of employment within each state, but, overall, Conectiv expects a reduction of approximately 10% (or 400 positions) in the combined utilities' workforce. 15. As explained in the attached testimony of Mr. Howard E. Cosgrove, the primary purpose of the Merger is to create a regional company from two companies that share a common vision of the strategic path necessary to succeed in the increasingly competitive utility and energy services marketplace. As further explained by Mr. Cosgrove, the combined companies recognize that a local workforce is necessary to maintain excellent customer service levels and to respond to the particular needs within each of the States that the operating utilities will serve. While cost savings are an expected result of the Merger, cost savings were not a material factor driving the decision to merge. IV. THE MERGER AGREEMENT IS CONSISTENT WITH THE PUBLIC CONVENIENCE AND NECESSITY. 16. It is Delmarva's sincere belief that, because the Merger Agreement will not have a material effect on Delmarva's franchises and rights thereunder, the Commission need not examine rate-related matters and other issues that may be relevant in determining whether a proposed transaction is consistent with the public convenience and necessity. Nevertheless, in a good-faith effort to address any such issues that may be raised by other participants in this proceeding, Delmarva hereby submits testimony and schedules describing in detail matters including: how costs will be allocated from a service company to Delmarva's Maryland-retail jurisdiction; how Merger-related savings were estimated; and how costs to achieve the Merger were calculated. Delmarva also has submitted a proposed sharing of expected net Merger-related savings allocable to Maryland-retail customers. In filing such information, Delmarva specifically reserves, and does not waive, any rights it may have to assert its legal position before the Commission or a court as to the proper scope of ss.24(b)(1) in the event that the Commission determines that the Merger will have a material effect on the franchise or rights thereunder. The Merger is expected to save approximately $500 million (net of transaction and transition costs) over the first ten years after the Merger is consummated. In a combined company that will generate approximately $2 billion in revenue each year, a $50 million annual average net savings does not materially affect cash flow or the ability of the combined companies to provide utility service. To the extent there may be any effect, the effect will be positive i.e., utility services could be provided at slightly lower cost. The estimated cost savings are supported by Mr. Thomas Flaherty of Deloitte & Touche Consulting Group in his attached testimony and related exhibits. The methodology for determining how merger-related costs and savings are assigned to the Maryland-retail jurisdiction is supported by the testimony of Messrs. David G. Dougher and William R. Moore, Jr. 17. Delmarva and Atlantic Electric are proposing in their applications before their respective retail regulatory commissions that one-third of each State's allocable share of estimated average annual net merger savings over the first 10 years after consummation of the Merger be available for sharing with customers. The precise method to implement this sharing should be established by each regulatory agency, consistent with the goals and objectives of the particular State. Delmarva further recognizes that it may be appropriate to reopen the savings mechanism at a later date, if the Commission establishes retail electric competition, in order to retain an equivalent customer benefit. 18. As described in more detail in the testimony of Mr. Paul S. Gerritsen, Delmarva specifically proposes that one-third of the allocated net merger savings be used to reduce Maryland retail electric rates, effective when the Merger closes. Other alternative uses, instead of a rate decrease, that would also be acceptable to Delmarva include: (i) using this amount to reduce Delmarva's stranded costs; (ii) using this amount to fund societal programs, such as demand-side management programs or low income weatherization programs, or to fund economic development activities; or (iii) any combination of any of the above or other uses that the Commission determines to be appropriate. 19. Delmarva would be at risk to achieve the level of projected savings, while customers would benefit as proposed even if the achieved savings are less than the amounts projected. If, on the other hand, actually achieved savings are greater than projected, with the result that Delmarva's actual earnings rise above authorized levels, the Commission retains the authority to adjust base rates accordingly, consistent with traditional statutory and regulatory practices. 20. Delmarva commits that the transaction and transition costs of the Merger, including the acquisition premium, will not be reflected in retail rates except to the extent that those items are at least offset by Merger-related savings. 21. Delmarva submits that the holding company structure is appropriate in that it avoids further multiple incorporation in New Jersey, Delaware and Virginia, simplifies contract and franchise issues, and facilitates the process of maintaining separate utility base and fuel rates between Delmarva and Atlantic Electric. 22. Within the holding company structure will be a Conectiv service company subsidiary (the "Service Company"), which will include many employees who are currently employed by Delmarva or Atlantic Electric. The Securities and Exchange Commission ("SEC") has oversight over the arrangements by which Service Company costs are charged and assigned to the related utilities and affiliates for financial accounting and reporting purposes. When the Service Company arrangements are finalized for filing with the SEC, copies will be provided to this Commission. Mr. Gerritsen's testimony describes in greater detail how service company costs will be allocated among jurisdictions. Delmarva commits to submit to this Commission's jurisdiction any issues regarding the ratemaking treatment of any Service Company costs assigned or allocated to Delmarva's Maryland utility business. Because a significant portion of the expected cost savings are in administrative-type functions that will be performed by the Service Company, it is expected that these cost assignment issues will involve how best to allocate a lower overall cost structure. 23. Attached hereto are testimony and reports prepared by John C. Dalton and filed with the Federal Energy Regulatory Commission ("FERC"). Mr. Dalton's testimony and reports were prepared to address wholesale market power issues that are of particular interest to the FERC. Delmarva submits that any issues that may be raised in this proceeding regarding the potential effects of the Merger in a retail-wheeling environment would be premature until the Commission establishes a definite policy on retail wheeling. The attached testimony and reports are submitted, however, to further understanding as to the size of the combined companies relative to regional competitors and as to the lack of market power that Conectiv will have in wholesale electric markets. 24. Attached hereto are the following Exhibits: Exhibit A Proxy Statement of December 26, 1996, including: (1) at pages 114 - 140 detailed financial statements of Delmarva, AEI, and Conectiv; (2) as Annex I, the Agreement and Plan of Merger, dated August 9, 1996, as amended and restated as of December 26, 1996; and (3) as Annex IV and Annex V, the Conectiv Certificate of Incorporation and Bylaws. Exhibit B Corporate Structures Prior to and After Transaction. Exhibit C Maps. Exhibit D Maryland Franchises of Delmarva. Exhibit E FERC Direct Testimony and Report of John C. Dalton regarding market power in wholesale markets. Exhibit F FERC Supplemental Testimony and Report of John C. Dalton regarding market power in wholesale markets. 25. Attached hereto in support of this filing are the testimony and exhibits of the following: Howard E. Cosgrove Barbara S. Graham Thomas J. Flaherty David G. Dougher Paul S. Gerritsen William R. Moore, Jr. 26. Communications and correspondence relating to the proceedings herein should be sent to: Paul S. Gerritsen Delmarva Power & Light Company 800 King Street, P. O. Box 231 Wilmington, Delaware 19899 Randall V. Griffin, Esq. Delmarva Power & Light Company 800 King Street, P. O. Box 231 Wilmington, Delaware 19899 James E. Franklin, II, Esq. Atlantic City Electric Company 6801 Black Horse Pike Egg Harbor Township, New Jersey 08234 VII. REQUESTED APPROVALS WHEREFORE, Delmarva Power & Light Company requests that the Commission: A. Find that the planned transaction does not materially affect Delmarva's franchise or rights thereto; or, alternatively, B. Find that the planned transaction is consistent with the public convenience and necessity; and C. Expedite review procedures so that a final Commission decision may occur on or before October 22, 1997. Respectfully submitted, By: /s/______________________________ Delmarva Power & Light Company Counsel for Delmarva: Randall V. Griffin, Esq. Delmarva Power & Light Company P. O. Box 231 Wilmington, DE 19899 302/429-3757 Dated: April 18, 1997 EX-99.6 7 EXHIBIT D-6.2 STATE OF MARYLAND PUBLIC SERVICE COMMISSION ORDER NO. 73620 IN THE MATTER OF THE INQUIRY * BEFORE THE INTO THE MERGER OF DELMARVA * PUBLIC SERVICE COMMISSION POWER & LIGHT COMPANY AND * OF MARYLAND ATLANTIC ENERGY, INC. * _____________ CASE NO. 8744 - - ---------------------------- ------------- Appearances: Randall V. Griffin and Thomas P. Perkins, III, for Delmarva Power & Light Company. Kathryn L. Simpson, for the Staff of the Public Service Commission of Maryland. Michael J. Travieso, Sandra M. Guthorn, and John D. Sayles, for the Maryland Office of People's Counsel. M. Brent Hare, for the Maryland Department of Natural Resources and the Maryland Energy Administration. On October 25, 1996, Delmarva Power & Light Company ("Delmarva," "DPL," or "Company") filed a letter requesting the Commission's concurrence with DPL's position that it need not obtain the Commission's approval prior to Delmarva's merger with Atlantic Energy, Inc. ("Atlantic" or "AEI"). After considering responses filed by the Commission's Staff and the Office of People's Counsel ("OPC" or "People's Counsel"), at the December 11, 1996 Administrative Meeting we decided to initiate this proceeding to determine whether the merger will materially affect the Company's franchise or right.1 Notice of the proceeding was given to Delmarva's customers by way of newspaper advertisements. A prehearing conference was held on April 1, 1997, and a procedural schedule was established. Then, on April 18, 1997, DPL filed direct testimony and exhibits on the issue of whether the proposed merger would materially affect the Company's retail franchises or rights thereunder. To plan for the contingency of a Commission finding that the merger would materially affect DPL's franchise or right, the filing also addressed issues relevant to a determination of whether the transaction is consistent with the public convenience and necessity pursuant to Md. Ann. Code art. 78, ss. 24(c). After discovery, a hearing was held on May 27, 1997 for cross-examination of Delmarva's witnesses. Following the hearing, the parties engaged in discussions to determine if they could reach a negotiated settlement of the issues presented in the proceeding. - - -------- 1 In this regard, Md. Ann. Code art. 78, ss. 24(b)(1) prohibits a public service company such as Delmarva from entering into any agreement or contract materially affecting its franchise or any right thereunder without prior authorization of the Commission. On July 1, 1997, the parties to the proceeding2 filed a Settlement Agreement ("Agreement") with the Commission. We have attached the Agreement to this Order as Appendix A. The parties request approval of the merger and the Agreement, and specific findings with respect to the merger.3 As seen in the Agreement, the parties ask us to find that it is consistent with the public convenience and necessity for DPL to merge with AEI in accordance with the terms and conditions contained in the Merger Agreement, and for a holding company4 to be established which will own 100 percent of Delmarva's and Atlantic City Electric Company's ("Atlantic Electric")5 common stock. The parties also request a finding that it is consistent with the public convenience and necessity for a service company to be established that will be an affiliate of Delmarva and provide various services to DPL.6 - - -------- 2 In addition to DPL, Staff, and OPC, the parties are the Maryland Energy Administration and the Maryland Department of Natural Resources. 3 Additionally, on July 8, 1997, Staff filed Comments supporting the Agreement. 4 The holding company will be called Conectiv, Inc. 5 Atlantic Electric is a wholly-owned subsidiary of AEI. 6 The services are generally described in the Company's evidentiary filing, and include such items as accounting, legal and financial services. As part of the settlement, DPL agrees that it will not assert that "any authority preempts this Commission's power to determine the Maryland-retail ratemaking treatment for Delmarva's regulated utility operations of charges, asset transfers, or benefits provided from such service company or other affiliate . . . to Delmarva or . . . from Delmarva to the service company or any affiliate." The Agreement further provides that upon merger closing, DPL will provide a benefits package to its Maryland retail jurisdiction of $3.84 million. Of this amount, $3.5 million will be applied to a base rate reduction for Maryland retail customers, and $340,000 will fund annual contributions to certain programs to be agreed upon by the parties. Such programs may include low-income assistance, economic development, or low-income energy efficiency programs. Program funding proposals will be submitted to the Commission for approval. Program funding will continue for three years from the time the funding begins. The base rate reductions will take effect with service rendered on and after the date of the closing of the merger. Additionally, the Agreement proposes treatments for merger-related out-of-pocket costs, amortization of the acquisition premium associated with DPL's purchase of Conowingo Power Company, depreciation of the Company's assets, and the sale or auction of Clean Air Act SO2 allowances. The Agreement also contains several "hold harmless" provisions aimed at protecting retail customers from higher rates in the future, and agreements insuring Delmarva's cooperation with and concurrence in the Commission's authority over aspects of the provision of retail electric service in the State. Included among these covenants are Delmarva's agreements to prepare and file a Code of Conduct and Cost Allocation Manual applicable to Conectiv, Inc. and its affiliates, and a retail market power study to be filed in Case No. 8738 7 or other case as determined by the Commission. - - -------- 7 Case No. 8739 is a Commission inquiry into the provision and regulation of electric service in Maryland. The parties agree that the provisions of their Agreement are not severable, and that the Agreement represents a compromise for the purposes of settlement and shall not be regarded as precedent. The Agreement provides that no party necessarily agrees or disagrees with any particular item in the Agreement, but that the parties do agree that the resolution of the issues in the Agreement, when taken as a whole, produce a result that is consistent with the public convenience and necessity. After considering the evidentiary record in this proceeding and the Agreement of the parties, we find that the proposed merger as described in the Agreement is consistent with the public convenience and necessity. Accordingly, we adopt the Agreement in its entirety, without modification. We also make the specific findings requested in Section A of the Agreement. Thus, we find that: (1) It is consistent with the public convenience and necessity for Delmarva Power & Light Company to merge with Atlantic Energy, Inc., in accordance with the terms and conditions set forth in the Merger Agreement; (2) It is consistent with the public convenience and necessity for a holding company to be established which will own 100 percent of Delmarva Power & Light Company's and Atlantic City Electric Company's common stock; and (3) It is consistent with the public convenience and necessity for a service company to be established that will be an affiliate of Delmarva Power & Light Company and will provide various services to Delmarva Power & Light Company as described generally in the evidentiary filing, according to the terms expressed by the parties on Page 2 of their Agreement. IT IS, THEREFORE, this 16th day of July, in the year Nineteen Hundred and Ninety-Seven, by the Public Service Commission of Maryland, ORDERED: (1) That the Commission adopts the Settlement Agreement filed by the parties on July 1, 1997 in its entirety, without modification. (2) That Delmarva Power & Light Company is authorized to proceed with the merger according to the terms set forth in the Merger Agreement and the Settlement Agreement. (3) That Delmarva Power & Light Company shall conduct its Maryland retail electric operations in accordance with the terms adopted in this Order. (4) That all motions not previously granted are hereby denied. /s/----------------------------- /s/----------------------------- /s/----------------------------- /s/----------------------------- /s/----------------------------- Commissioners APPENDIX A IN THE MATTER OF THE INQUIRY * BEFORE THE INTO THE MERGER OF DELMARVA * PUBLIC SERVICE COMMISSION POWER & LIGHT COMPANY AND * OF MARYLAND ATLANTIC ENERGY, INC. * _____________ CASE NO. 8744 ------------- SETTLEMENT AGREEMENT WHEREAS, the undersigned Parties (Delmarva Power & Light Company ("Delmarva"), Maryland Public Service Commission Staff ("Staff"), Office of People's Counsel ("OPC"), Maryland Energy Administration and the Maryland Department of Natural Resources (collectively referred to as "MEA/DNR")), have reached a settlement under which they believe the proposed merger will be consistent with the public convenience and necessity, and the Parties further agree that the Public Service Commission of Maryland ("Commission") should grant prompt regulatory approval of the merger as described in this settlement; NOW THEREFORE, on this 1st day of July, 1997, the undersigned Parties agree to recommend that the Commission approve this settlement and make the findings specified herein. A. Approval of the Merger Agreement and Specific Findings. The Parties to this settlement agreement recommend that the Commission make the following findings with respect to the merger as it will be implemented in conjunction with this settlement agreement: 1. It is consistent with the public convenience and necessity for Delmarva to merge with Atlantic Energy, Inc. ("AEI") in accordance with the terms and conditions set forth in the Merger Agreement; 2. It is consistent with the public convenience and necessity for a holding company to be established which will own 100% of Delmarva's and Atlantic City Electric Company's ("Atlantic Electric") common stock; and 3. It is consistent with the public convenience and necessity for a service company to be established that will be an affiliate of Delmarva and will provide various services to Delmarva as described generally in Delmarva's evidentiary filing. Delmarva agrees that it will not assert that any authority preempts this Commission's power to determine the Maryland-retail ratemaking treatment for Delmarva's regulated utility operations of charges, asset transfers, or benefits provided from such service company or other affiliates to Delmarva or the ratemaking treatment of any charges, asset transfers, or benefits provided from Delmarva to the service company or any affiliate. Delmarva further agrees that it will be subject to the Commission's jurisdiction regarding the ratemaking treatment of costs allocated to Delmarva's Maryland-retail jurisdiction from the service company. B. Rate Reductions and Additional Funding of Programs by Delmarva. 1. (a) Upon merger closing, Delmarva agrees to provide a benefits package to its Maryland retail jurisdiction of $3.84 million. $3,500,000 of this amount will be used to provide a base rate reduction for Maryland retail customers. Annually, 340,000 of the total will be used for Delmarva's funding of annual contributions to certain programs in Delmarva's Maryland service territory, to be agreed upon by the Parties. Such programs may include low-income assistance, economic development, low income energy efficiency or other programs. $170,000 of the $340,000 shall be used for economic development programs identified by the MEA/DNR. $170,000 of the $340,000 shall be used for low-income qualifying programs identified by OPC. The Parties shall make good faith efforts to identify such programs by October 1, 1997, for funding and will submit them for Commission review and approval. Such program funding shall continue for three years from the time funding begins. (b) Such base rate decrease shall be reflected in a compliance filing made within 30 days after approval of this settlement. Such rate decrease shall become effective for service rendered on and after the date of Closing of the merger. To the extent mathematically feasible, the base rate decrease shall be designed so that the base revenues of each rate class will be decreased by the product of the ratio that each rate class' base revenues (excluding fuel related expenses) bears to the total Delmarva Maryland-retail base revenues (excluding fuel related expenses) multiplied by $3,500,000. For purposes of this calculation, calendar year 1996 shall be used to determine Maryland retail total and class base rate revenues. Nothing herein is intended to cause a change in the Deferred Purchase Power Rate currently applicable to rates in the Conowingo, District. C. Amortization of Merger-Related "Out-of-Pocket" Costs. The Parties agree that for purposes of Delmarva's quarterly rate of return reports and future base rate cases, severance costs associated with the merger shall be amortized over 5 years and other "out-of-pocket" costs to achieve the merger shall be amortized over 10 years, commencing with the date of Closing of the merger, with the unamortized balance reflected in rate base. Delmarva shall file a report delineating final actual "out-of-pocket" costs with the Commission, including the annual amortization amount based on the actual costs. D. Stipulated Treatment of Other Costs. 1. In Case No. 8583, Order No. 71719, January 18, 1995, the Commission authorized Delmarva to defer for future recovery in rates the amortization of the acquisition premium associated with the purchase of Conowingo Power Company. Effective on the first day of the month following Closing of the merger with AEI, Delmarva shall, for Maryland-retail ratemaking purposes, start to amortize that acquisition premium in accordance with the procedure's approved in Order No. 71719. 2. In Case No. 8718, Order No. 726999 June 18, 1996, the Commission approved a settlement agreement which established two sets of depreciation rates, the first of which are currently in effect and the second of which were to become effective at a later time. Effective on the first day of the month following Closing of the merger with AEI, Delmarva shall, for Maryland retail-ratemaking purposes, begin to depreciate its assets consistent with the second set of depreciation rates approved in Order No. 72699. 3. For Maryland-retail ratemaking purposes, Delmarva shall reflect revenues received from the sale or auctioning of Clean Air Act SO2 Allowances as a credit to fuel expense; shall reflect the costs of acquiring Clean Air Act SO2 Allowances in fuel expense for the period during which such SO2 Allowances are expensed; and shall, for purposes of future Maryland-retail base rate cases and rate of return reports, adjust rate base for the cash cost of any such SO2 Allowances purchased for future use. The ratemaking treatment of any such SO2 Allowance transaction between Atlantic Electric and Delmarva shall be subject to Commission review. E. "Hold Harmless" Provisions. 1. Delmarva agrees not to seek to include in Maryland retail rates any merger costs in excess of merger savings. In establishing compliance with this commitment, Delmarva shall be obligated: a) to quantify in accordance with Generally Accepted Accounting Principles the direct, indirect and internal merger costs that are properly attributable to the relevant period used to establish rates, and b) to demonstrate that merger-related savings for the same time period exceed such merger costs. 2. Delmarva agrees not to seek to include in Maryland-retail rates any costs attributable to AEI's above-market power supply costs and/or regulatory assets, unless Delmarva can demonstrate in a rate or fuel proceeding that doing so is beneficial to its Maryland customers. 3. Delmarva does not plan in the foreseeable future to blend or levelize Delmarva's and Atlantic Electric's fuel rates. However, if Delmarva decides to do so in the future, Delmarva agrees to seek specific Commission authorization prior to any proposed blending or levelizing Delmarva's fuel rate with Atlantic Electric's fuel rate. Delmarva further agrees that records will be maintained of the costs and revenues associated with any joint purchases or sales of power or fuel sufficient to permit an audit to verify that the appropriate level of costs and revenues are assigned to the Maryland-retail jurisdiction. Upon a proper evidentiary showing, the Commission has the authority to disallow such costs found to be improper or to redetermine such sales revenues. The intent is to avoid inappropriate power supply cost shifting to the Maryland retail jurisdiction. 4. Delmarva agrees that in future base rate proceedings its allowed rate of return (including cost of equity, debt and capital structure) should not reflect any risk premium or increased capital costs resulting from the merger. This determination of any risk premium or increased capital cost must be based on an appropriate evidentiary record. F. Agreements Regarding Future Proceedings. 1. Delmarva agrees that, to the extent the Commission currently has such power and exercises such power based on an appropriate evidentiary record, Delmarva will not assert that the Commission lacks authority for Maryland-retail ratemaking purposes to disallow costs associated with purchase power contracts between Delmarva and an affiliate or to review and disallow costs associated with Federal Energy Regulatory Commission ("FERC") jurisdictional joint dispatch, capacity equalization or other interconnection or power supply agreements that are either solely between Delmarva and its affiliates or, in the event such FERC jurisdictional agreement(s) involves parties in addition to Delmarva and an affiliate, where a majority of the revenues involved are likely to be paid by or to Delmarva. 2. Delmarva agrees that it will prepare and file a retail market power study in Case No. 8738 (or other case as determined by the Commission). The undersigned Parties agree to discuss in good faith and to develop jointly the appropriate scope and parameters for such a retail market power study. Nothing herein is intended to limit the Commission's authority to order appropriate and lawful mitigation measures if the Commission finds in Case No. 8738 (or other case as determined by the Commission), based on an appropriate evidentiary record, that Delmarva and/or Conectiv would have retail market power and that mitigation measures should be ordered prior to permitting retail customer competition in Maryland. 3. Delmarva agrees that it will prepare and file a Code of Conduct and Cost Allocation Manual that would be applicable to Conectiv and its affiliates. Such filing shall be made the later of 6 months after Closing or 90 days after the conclusion of Case No. 8747. Nothing herein is intended to limit the Commission's authority to address affiliate-related issues involving Delmarva and/or Conectiv in Case No. 8747. 4. The undersigned Parties agree that the earliest test period that shall be used in adjusting or resetting Delmarva's base rates in a future base rate proceeding shall be calendar year 1998. 5. The undersigned Parties agree that issues relating to the proper ratemaking treatment of transmission revenues received and costs incurred by Delmarva can be addressed in Case No. 8738 or such other case as the Commission may find appropriate. G. Other Commitments. 1. Delmarva agrees that it will not assert that the merger affects Delmarva's obligation to comply with lawful Commission requirements regarding demand-side management programs. 2. The OPC agrees that, within 10 days of the adoption of this settlement by the Commission, it will make a filing with the FERC to withdraw its request for a hearing on retail market power issues in FERC Docket No. EC97-7-000. 3. Commission Staff agrees that it will recommend to the Commission that, within 10 days of the adoption of this settlement by the Commission, the Commission should file a letter with FERC in FERC Docket No. EC97-7-000 stating that the Commission has the authority to address retail market power issues, will be addressing such issues in connection with Case No. 8738 and requesting that the FERC not set for hearing any issue regarding Delmarva's, Atlantic Electric's, or Conectiv's retail market power. 4. Subsequent to Closing the merger, Delmarva shall make good faith efforts to obtain as expeditiously as practicable all necessary approvals, if any, to adjust the Conectiv corporate structure to move Delmarva's current non-utility subsidiaries into one or more affiliates that would not be subsidiaries of the Delmarva utility operating company. H. Miscellaneous. 1. The provisions of this settlement are not severable. 2. This settlement represents a compromise for the purposes of settlement and shall not be regarded as a precedent with respect to any ratemaking or any other principle in any future case. No Party to this settlement necessarily agrees or disagrees with the treatment of any particular item, any procedure followed, or the resolution of any particular issue in agreeing to this settlement other than as specified herein, except that the Parties agree that the resolution of the issues herein, taken as a whole, produce a result that is consistent with the public convenience and necessity. WHEREFORE, the undersigned Parties respectfully request that the Commission: 1) Make the specific findings set forth in section A above; 2) Approve this settlement agreement without modification; 3) Make any additional findings and all other approvals that the Commission may deem to be necessary to effectuate the proposed merger and to implement this settlement. IN WITNESS WHEREOF, intending to bind themselves and their successors and assigns, the undersigned Parties have caused this Settlement to be signed by their duly-authorized representatives. DELMARVA POWER & LIGHT COMPANY MARYLAND PUBLIC SERVICE COMMISSION STAFF By: /s/______________________ By: /s/______________________ MARYLAND OFFICE OF MARYLAND ENERGY ADMINISTRATION PEOPLE'S COUNSEL By: /s/______________________ By: /s/______________________ MARYLAND DEPARTMENT OF NATURAL RESOURCES By: /s/______________________ EX-99.7 8 EXHIBIT H-4 EXHIBIT H-4 PAGE 1 OF 2 I. DELMARVA POWER & LIGHT NONUTILITY SUBSIDIARIES TOTAL ASSETS IN $ MILLIONS AS OF JUNE 30, 1997 AND REVENUES IN $ MILLIONS FOR THE TWELVE MONTHS ENDED JUNE 30, 1997 TOTAL TOTAL COMPANY ASSETS (1) REVENUES (1) ------- ---------- ------------ EAST COAST NATURAL GAS COOPERATIVE L.L.C. (2) - - DELMARVA POWER FINANCING I - - DELMARVA CAPITAL INVESTMENTS, INC. 2.8 4.0 DELMARVA ENERGY COMPANY 1.0 - CONECTIV COMMUNICATIONS, INC. - 0.3 CONECTIV SERVICES, INC. 41.3 36.9 DELMARVA SERVICES COMPANY 15.0 - DCI I, INC. 46.3 0.4 DCI II, INC. - - DELMARVA CAPITAL TECHNOLOGY COMPANY 3.8 0.5 DELMARVA CAPITAL REALTY COMPANY 2.8 7.9 DELMARVA OPERATING SERVICES COMPANY 0.2 - CHESAPEAKE UTILITIES CORPORATION (2) - - PINE GROVE, INC. 3.7 - DCTC-BURNEY, INC. 0.3 - LUZ SOLAR PARTNERS, LTD. IV (2) - - UAH-HYDRO KENNEBEC, L.P. (2) - - CHRISTIANA CAPITAL MANAGEMENT, INC. 5.7 1.2 POST AND RAIL FARMS, INC. 0.5 0.2 DELSTAR OPERATING COMPANY 2.0 18.1 DELWEST OPERATING COMPANY 0.7 3.4 DELCAL OPERATING COMPANY 0.3 0.4 PINE GROVE LANDFILL, INC. 23.5 6.1 PINE GROVE HAULING COMPANY 5.8 8.5 DELBURNEY CORPORATION - - PINE GROVE GAS DEVELOPMENT L.L.C. (2) - - FORREST PRODUCTS, L.P. (2) - - BURNEY FOREST PRODUCTS, A JOINT VENTURE (2) - - --------------------- ------------------------- TOTAL 155.7 87.9
(1) INTERCOMPANY ASSETS AND REVENUES HAVE BEEN ELIMINATED. (2) UNCONSOLIDATED SUBSIDIARIES (LESS THAN 51% OWNED). SHOWN AS INVESTMENTS IN THEIR PARENT OPERATIONS. EXHIBIT H-4 PAGE 2 OF 2 I. ATLANTIC ENERGY, INC. NONUTILITY SUBSIDIARIES TOTAL ASSETS IN $ MILLIONS AS OF JUNE 30, 1997 AND REVENUES IN $ MILLIONS FOR THE TWELVE MONTHS ENDED JUNE 30, 1997 TOTAL TOTAL COMPANY ASSETS (1) REVENUES (1) ------- ---------- ------------ ATLANTIC ENERGY INTERNATIONAL, INC. 0.3 0.3 ATLANTIC CAPITAL I - - ATLANTIC ENERGY ENTERPRISES, INC. 7.2 0.1 ENERVAL, L.L.C. 2.6 - ATLANTIC SOUTHERN PROPERTIES, INC. 8.9 0.8 ATE INVESTMENTS, INC. 85.1 0.7 ENERTECH, LP. 9.0 - COASTALCOMM, INC. 0.7 0.1 ATLANTIC THERMAL SYSTEMS, INC. 6.9 - ATLANTIC JERSEY THERMAL SYSTEMS, INC. 0.2 - ATS OPERATING SERVICES, INC. - - THERMAL ENERGY LIMITED PARTNERSHIP I 99.4 12.7 ATLANTIC GENERATION, INC. 7.5 1.7 BINGHAMPTON LIMITED, INC. - - BINGHAMPTON GENERAL, INC. - - BINGHAMPTON COGENERATION LIMITED PARTNERSHIP 1.2 - PEDRICKTOWN LIMITED, INC. - - PEDRICKTOWN GENERAL, INC. - - PEDRICKTOWN COGENERATION LIMITED PARTNERSHIP 11.8 - VINELAND LIMITED, INC. - - VINELAND GENERAL, INC. - - VINELAND COGENERATION LIMITED PARTNERSHIP 6.3 - ATLANTIC ENERGY TECHNOLOGY, INC. 0.1 - THE EARTH EXCHANGE, INC. - - --------------------- ------------------------- TOTAL 247.2 16.4
EX-99.8 9 EXHIBIT J-1 DELMARVA POWER & LIGHT COMPANY ANALYSIS OF THE ECONOMIC IMPACT OF A DIVESTITURE OF THE GAS BUSINESS OF DPL The management and staff of DELMARVA POWER & LIGHT COMPANY (DPL) conducted this study. The objective of this study is to identify and quantify the economic effects on shareholders and customers of divesting DPL of its natural gas assets and business. MAY 6, 1997 TABLE OF CONTENTS PAGE SECTION I. EXECUTIVE SUMMARY AND CONCLUSIONS 1 SECTION II. GENERAL STUDY ASSUMPTIONS 3 SECTION III.A. NEWGAS-CO. OVERVIEW 6 SECTION III.B. NEWGAS-CO. ANALYSIS 7 SECTION III.C. DPL-ELECTRIC OVERVIEW 11 SECTION IV NEWGAS-CO. SCHEDULE OF EXHIBITS 12 EXHIBIT 1 - INCOME STATEMENT 13 EXHIBIT 2 - ESTIMATED ADDITIONAL OPERATING EXPENSES 14 EXHIBIT 2a - ESTIMATED EXTERNAL AUDIT FEES 15 EXHIBIT 2b - ESTIMATED INFORMATION TECHNOLOGY COSTS 16 EXHIBIT 2c - ESTIMATED INCREASED COST OF INSURANCE COVERAGE 17 EXHIBIT 2d - ESTIMATED NET LABOR INCREASE, INCLUDING BENEFITS 18 EXHIBIT 2e - ESTIMATED OPERATING LEASE FACILITIES & FURN. COSTS 19 EXHIBIT 2f - ESTIMATED TRANSITION COSTS 20 EXHIBIT 2g - ESTIMATED NET INCREASE IN TRANSPORTATION & MOTORIZED EQUIPMENT EXPENSE 21 EXHIBIT 2h - ESTIMATED SHAREHOLDER COSTS 22 EXHIBIT 2i - ESTIMATED POSTAGE & GENERAL SERVICES 23 EXHIBIT 2j - ESTIMATED GAS TRANSMISSION PIPELINE IMPACT 24 EXHIBIT 3 - RATE BASE 25 EXHIBIT 4 - STAND-ALONE COST OF CAPITAL 26 EXHIBIT 5 - ORGANIZATION CHART 27 EXHIBIT 6 - SALARIES & WAGES SUMMARY 28 EXHIBIT 7 - COMPARABLE LOCAL DISTRIBUTION COMPANIES 29 EXHIBIT 8 - ESTIMATED SALARIES 30 EXHIBIT 9 - DPL-ELECTRIC RATE BASE & RATE OF RETURN 31 EXHIBIT 10 - DPL-ELECTRIC ESTIMATED ADDITIONAL OPERATING EXPENSES 32 SECTION I. EXECUTIVE SUMMARY AND CONCLUSIONS The management and staff of DELMARVA POWER & LIGHT COMPANY (DPL) have conducted this "Analysis of the Economic Impact of a Divestiture of the Gas Business of DPL" (Study) to determine the effects of spinning off the Company's natural gas assets and business into a separate and distinct entity. The Study analyzes the additional costs (from lost economies) that would be necessary to operate an independent gas company (called NEWGAS-CO. for the purpose of this Study), as well as any potential benefits that would accrue. All estimates for NEWGAS-CO. are based on DPL's operating experience. Where possible, estimates of the operating costs were compared to similar investor-owned gas distribution companies in the region. The study evaluates the increased costs or "lost economies" associated with divestiture of this business from two perspectives--shareholders and customers. The effects on shareholders were calculated using the increased costs caused by divestiture assuming no regulatory rate relief. The effects on customers were calculated assuming recovery of additional costs through rate increases. SHAREHOLDERS The projected effects on the shareholders of the lost economies resulting from the spin-off of DPL's gas business into NEWGAS-CO. are shown in Table I-1. TABLE I-1 ANNUAL EFFECT OF LOST ECONOMIES ON SHAREHOLDERS ($000's) NEWGAS-CO. LOST ECONOMIES $14,728 LOST ECONOMIES AS A PERCENT OF: TOTAL GAS OPERATING REVENUE 14.07% TOTAL GAS OPERATING REVENUE DEDUCTIONS 17.40% GROSS GAS INCOME 73.42% NET GAS INCOME 105.88% IN THE ABSENCE OF RATE RELIEF: ESTIMATED RETURN ON RATE BASE 3.35% ESTIMATED RETURN ON NET PLANT 3.39% In Table I-1, Lost Economies represents the increased costs, excluding income taxes, to operate as a stand-alone company. Total Gas Operating Revenue is the sum of all gas revenues for the 12 months ended September 30, 1996. Total Gas Operating Revenue Deductions include all purchased gas and gas withdrawn from storage, operation and maintenance expenses, depreciation and taxes other than income taxes. Gross Gas Income is the difference between Total Gas Operating Revenue and Total Gas Operating Revenue Deductions. Net Gas Income is Gross Gas Income minus Income Taxes. (See SECTION IV. NEWGAS-CO. Exhibit 1 for detailed information). GAS CUSTOMERS The projected effect on gas customers, assuming NEWGAS-CO. is allowed rate increases to recover lost economies and applicable income taxes, is shown in Table I-2. TABLE I-2 ANNUAL EFFECT OF LOST ECONOMIES ON GAS CUSTOMERS ($000's) RATE REVENUE NEW GAS CO. PRE SPIN-OFF $104,687 POST SPIN-OFF $120,180 DOLLAR INCREASE $ 15,493 PERCENT INCREASE 14.80% (See Section IV. NEWGAS-CO. Exhibit 1 for detailed information.) ELECTRIC CUSTOMERS In addition to the forgoing impacts on gas business, divesting the gas business would result in a rate increase of 0.79% for DPL electric customers. This impact is primarily due to the company transferring all common property into the electric rate base, requiring a rate increase to maintain the existing rate of return (see Section III.C.). CONCLUSIONS The economies that DPL realizes from combined electric and gas operations provide significant benefits to customers and shareholders. This Study demonstrates that spinning off the gas business into a separate entity would be inefficient due to lost economies, which would be passed on to gas customers, electric customers and/or to shareholders. Without increased rates, the immediate negative effect on shareholders' earnings would be substantial, making ownership of shares in NEWGAS-CO. unattractive. The pass-through of increased costs to gas customers would cause significant increases in gas rates, with no increase in the level or quality of service. The rate increase required to operate NEWGAS-CO. is estimated at $15.5M (Table I-2). Such an increase would make NEWGAS-CO. less competitive at a time when competition in the energy industry is rapidly increasing due to Federal Energy Regulatory Commission (FERC) Order No.636 and other FERC and state regulatory initiatives. In addition, NEWGAS-CO. would receive none of the $16.3M in benefits expected to accrue to the existing gas business over a ten year period from the proposed merger of DPL and Atlantic Energy. It is estimated there would also be increased costs for electric customers from the divestiture of the gas business. The transfer of common property to electric offsets minimal savings from personal reductions. Reallocation of fixed operating expenses for data processing and facility costs would outweigh variable cost reductions if a spin-off occurred. These increased costs to electric customers would cause increases in electric rates with no increase in the level or quality of service. SECTION II. GENERAL STUDY ASSUMPTIONS The assumptions, information and data utilized for this Study are based on the industry expertise and experience of the management and staff of DPL. Below are the major assumptions employed for this Study. 1. ORGANIZATION: The NEWGAS-CO. would operate as an independent, stand-alone, publicly held, regulated company. It would have all the necessary management personnel, along with facilities, equipment, materials, supplies, etc., required to operate as a stand-alone company. 2. SYSTEM OPERATION & MAINTENANCE: The gas and electric systems would continue to be operated and administered in the existing manner to insure safe and reliable service. In addition, current system renewal programs would be continued. 3. STAFFING: A sufficient number of employees would be included within each spun-off company to ensure that customers receive the present level and quality of service. 4. LABOR COSTS: Labor cost estimates were based upon assessments of work assignments, using DPL wage structure. Executive salary estimates were based on industry averages and DPL wage structure. 5. NON-LABOR COSTS: These costs were estimated based upon actual costs incurred by DPL for the gas business assuming the customers of NEWGAS-CO. would receive existing levels and quality of service. 6. COST PASS-THROUGH: Full pass-through to gas and electric customers of increased costs due to lost economies would be allowed in formal rate proceedings. 7. SPECIFIC LABOR ASSUMPTIONS: a) Organization size and spans of control were estimated using existing DPL structure, adjusted downward to recognize the broader functional responsibilities that would exist in smaller companies. b) Pensions and benefits were estimated as a percent of direct labor cost. The net costs include a credit from the actual return on the pension plan's assets. A negotiated allocation of the pension assets, including overfunding, would occur as part of the spin-off. While it is not expected that net overfunding would continue in NEWGAS-CO. and, thus, new pension costs could rise, no attempt was made to estimate an increase. c) Employee benefits would be similar to the existing combined utility. d) Negotiation of new union contracts are included in transition costs. 8. CAPITAL EXPENDITURE AND COST ASSUMPTIONS: a) The accounting for direct and indirect capital expenditures would remain the same as that currently used in the combined utility. b) The actual capital costs for the divested company and DPL may be considerably higher than those of the combined utility. Since gas purchases are highly seasonal, the stand-alone gas company would experience greater volatility in cash positions. At the same time, the book values of the assets of this stand alone gas company would be much smaller than those of the combined utility predecessor. As a result, the new company would be perceived as riskier and would be subject to higher borrowing rates. Because of the constraints of the mortgage indentures, the debt associated with the spun-off facilities would have to be refinanced at today's rates. 9. TRANSITION COST ASSUMPTIONS: Costs such as the legal, investment banking, filing and printing fees associated with the public spin-off of stock, costs associated with new indenture agreements, negotiation of new service and union contracts, and costs to establish business facilities and processes would be incurred and amortized appropriately. Costs were based on an average of actual corporate spin-offs. 10. TRANSACTIONS BETWEEN COMPANIES: All transactions and transfers between NEWGAS-CO. and DPL would be arms-length transactions based upon fair market values. Expected transactions include joint trench utility installation contracts and joint venture pipeline operation, maintenance and capacity agreements. 11. OTHER ASSUMPTIONS: a) Facility costs would include separate headquarters, storerooms, and office space for employees currently using facilities shared by the electric and gas business. b) To facilitate the assessment of financial effects, it was assumed that the costs for outsourcing and performing work in-house would be comparable. c) Information Technology costs were estimated based on an industry survey. d) Additional equipment (e.g., vehicles) would be leased under an operating lease. e) External auditing costs were estimated based on an industry survey and DPL's budgeted costs. f) Insurance costs were estimates based on protecting a gas utility against losses and damages to leased properties used in its operations, as well as injuries and damage claims. Estimates from similar gas divestiture studies were reviewed. g) Regulatory commission expenses would be similar to those currently incurred in connection with formal cases before regulatory commissions involving gas business. h) Estimated costs for the probable clean-up of environmental sites (coal gasification plants) have been accrued and would be the same whether or not the gas business is spun off. For this reason, such costs were not considered in this Study. i) Current growth projections for both gas and electric business were assumed to be unaffected by the divestiture. NOTE:TAX EXEMPT BONDS: The combined utility, DPL, has traditionally used tax exempt financing for gas projects. Currently, $159 million of tax exempt bonds issued to finance gas projects are outstanding and $93M of the bonds are non-callable. In the event that DPL was to spin off its gas business, DPL may be required to defease $93M of non-callable bonds. The defeased bonds would represent 61% of gas rate base. DPL believes the Financing Agreements of the $93M non-callable bonds would require that the impact of the defeasance be borne by DPL electric.The remaining $66M tax-exempt bonds would be immediately called. The impact of these additional costs have not been quantified in this study. SECTION III.A. NEWGAS-CO. OVERVIEW Spinning off DPL's gas business into a separate stand-alone company (NEWGAS-CO.) would result in the following: o NEWGAS-CO. would need to establish service functions duplicating those at DPL, such as treasury, financial planning, accounting, tax planning and compliance, rates, risk management, employee benefits, marketing, legal, customer service, regulatory, public affairs, communications, . information technology, building services, and human resources. o Annual operating revenue deductions, exclusive of income taxes, for NEWGAS-CO. would be about 17.40% ($14.7M ) greater than DPL's gas operating revenue deductions. (SECTION IV., NEWGAS-CO.,Exhibit 1). o NEWGAS-CO.'s customers would experience a rate increase of about 14.80% ($15.5M) in order to provide a 9.36% rate of return for stockholders (SECTION IV., NEWGAS-CO., Exhibit 1). o NEWGAS-CO. would be at a competitive disadvantage because of higher operating expenses. o There would be no substantial benefits for gas or electric customers or stockholders. SECTION III.B. NEWGAS-CO. ANALYSIS The DPL gas distribution system serves approximately 100,000 customers (as of September 30, 1996) over a 275 square mile area in Northern Delaware. There are 1,550 miles of mains and 101,094 service lines in the system. Natural gas revenue for 12 months ended September 30, 1996, was $105.7M on system throughput of 22.4 billion cubic feet of gas. DPL operates as a tightly integrated company with many employees supporting both gas and electric operations. Of DPL's 2,521 employees (as of September 30, 1996), only 153 devote 100% of their time to gas operations. Shared operations include customer service personnel who deal with service requests for gas and electric customers, and meter readers who read both the electric and gas meters. Additionally, DPL provides the gas business' required services in the areas of treasury, financial planning, accounting, tax planning and compliance, rates, risk management, employee benefits, marketing, legal, regulatory, public affairs, communications, information technology, building services, and human resources. Through approved accounting mechanisms, these costs are shared by gas and electric operations. The shared gas/electric responsibilities of many of the DPL employees have enabled DPL to provide quality service at a low cost. ORGANIZATION STRUCTURE AND STAFFING IMPACT The DPL organization as of September 30, 1996, was used as a pattern for developing the NEWGAS-CO. organization structure. See SECTION IV., NEWGAS-CO., Exhibit 5 for the proposed organization. Divesting the gas business would eliminate the effective use of shared staff to the detriment of both the gas and electric business. To support a stand-alone corporate structure, 248 full-time employees would be required to perform the previously shared duties. DPL could expect minimal reductions in labor-related expenses as a result of a gas divestiture. SECTION IV., NEWGAS-CO., Exhibit 6 shows the proposed staffing, salaries, and wages summary, while Exhibit 2d shows that NEWGAS-CO. would incur an estimated net annual labor increase, including benefits, of $5.2M or about a 30% increase. Exhibit 7 shows that with this proposed staffing, NEWGAS-CO. compares favorably with other gas utilities in the number of customers per employee. The following comments demonstrate some of the rationale behind additional staffing. Most DPL gas customers receive one bill for both gas and electric service and pay with one check. When Customer Accounting and district office personnel process the checks, automated equipment posts both electric and gas payments to customers' accounts. NEWGAS-CO. would have to hire staff to handle gas billing and payments that are now handled at essentially no additional cost by DPL. Spinning off the gas business would only minimally reduce the workload on DPL's cash processing personnel since most gas customers, except those in the City of Newark and the Town of New Castle, also have electric service and would still send a check monthly. DPL's meter readers read gas and electric meters in the same routes. NEWGAS-CO. would have to hire meter readers to follow similar routes to read the gas meters. Spinning off the gas business would not substantially reduce the number of meter readers needed by DPL since electric routes would remain essentially the same. DPL's Finance, Accounting, and Corporate Services personnel maintain the books of the Company and arrange for insurance. They arrange for long-term financing and borrow short-term funds for operations. They oversee the maintenance of stockholder records and perform various investor services. NEWGAS-CO. would require personnel to provide the same services. Spinning off the gas business would not provide any measurable savings for DPL in the finance and accounting area, since all the existing books and records of the Company would remain essentially unchanged, insurance needs would be similar, and staff time devoted to financing activities would not be significantly reduced. DPL's Human Resources Department administers benefit and salary plans. NEWGAS-CO. would need to hire personnel to perform the same duties. Spinning off the gas business would not provide substantial savings to DPL because each of DPL's existing benefit and salary plans, and the associated reporting requirements, would remain. DPL's Procurement & Materials Management and Vehicle Resource Management Departments provide materials, supplies, transportation equipment, etc. to operating divisions. NEWGAS-CO. would need to hire personnel to perform the same duties. Spinning off the gas business would reduce the number of purchase orders handled by DPL as well as the amount of material handled and storage costs. However, the quantities involved are a small percentage of the total; so few, if any, staffing reductions could be effected and no facilities could be eliminated, making the actual savings for DPL minimal. DPL's Legal, Pricing and Regulation, and Claims Departments provide legal, regulatory, and claims services for DPL operating divisions. NEWGAS-CO. would need to hire personnel to perform the same duties. Since many legal issues are not divided into gas and electric considerations, the amount of work performed by DPL's legal department would not decrease significantly, and there would be no staffing reductions. INDEPENDENT ACCOUNTANT IMPACT DPL hires independent accountants to audit the financial statements of the Company. NEWGAS-CO. would need to hire independent accountants to perform the same duties. DPL would not achieve any savings, since the existing level of work for the independent accountants would remain the same. INFORMATION TECHNOLOGY IMPACT DPL provides extensive information technology resources for its day-to-day operations. These resources include acquiring, developing, managing, and maintaining all PC and mainframe-based systems. To maintain the level of service needed for hardware, software, and telecommunications, NEWGAS-CO. costs are based on outsourcing to a third party the information technology function. NEWGAS-CO. will maintain a staff of five employees to oversee various outstanding contracts. See Section IV., NEWGAS-CO., Exhibit 2b, which identifies a net increase in actual costs for information technology of $6.4M. Transition costs include $2M for data conversion. These costs were based on a 1996 group survey. Divesting the gas business would eliminate opportunities for sharing information technology resources to the detriment of both the gas and electric operations. INSURANCE COSTS DPL obtains property, liability, directors and officers, workers compensation, and other insurance. NEWGAS-CO. would require similar policies, at similar costs. See SECTION IV., NEW GAS-CO., Exhibit 2c, which shows an estimated increase in insurance costs of $118K to NEWGAS-CO.. Since all coverage would remain in effect, DPL would experience an increase of $122K for insurance,representing the portion of premiums currently allocated to gas operating expenses. OFFICE AND CREW FACILITIES COSTS DPL maintains combined electric and gas office and crew facilities at several locations. NEWGAS-CO. would need facilities for office, crew, and service personnel. See Section IV., NEW GAS-CO., Exhibit 2e, which identifies $621K in additional office and crew facilities costs. Since DPL would still operate the electric system, the existing office, crew, and service facilities would still remain at each location, but the costs would no longer be shared by NEWGAS-CO. Transition costs include $1.2M for the initial fit-out and moving costs associated with providing equivalent facilities for NEWGAS-CO. TRANSPORTATION AND MOTORIZED EQUIPMENT COSTS DPL maintains transportation and motorized equipment used by both gas and electric crew and support personnel. NEWGAS-CO. would need to obtain similar equipment for gas operations. NEWGAS-CO.'s additional transportation cost would be about $140K as identified in SECTION IV., NEWGAS-CO., Exhibit 2g. Since vehicle needs correlate closely with personnel needs, it is estimated that the reduction in equipment to be achieved by DPL would equal the additional equipment required by NEWGAS-CO., except for vehicles used by meter readers to read both electric and gas meters. DPL would still need about the same number of meter reader vehicles currently used in the combination gas and electric districts, but the costs currently allocated to the gas business would be absorbed by the electric customers, resulting in increased annual meter reading vehicle costs to DPL of about $14K. TRANSITION COSTS The divestiture of the gas business of DPL and the creation of a stand-alone gas company would be a complex legal and financial transaction that would involve substantial transition costs. These costs would include legal and financial advisory fees, and the services of independent accountants, actuaries and other consultants. Real estate services would be needed to procure facilities. Several hundred personnel would have to be hired and trained. New services and union contracts would need to be negotiated. Benefit plans would need to be established. The estimated transition costs of $11M for NEWGAS-Co. were developed by calculating the average of such costs incurred in several other publicly reported business spin-offs. These costs would be amortized over a period of ten years. See SECTION IV., NEWGAS-CO., Exhibit 2f. COST OF CAPITAL The effective cost of capital for the stand-alone gas business was based upon capitalization ratios of DPL's capital structure as of September 30, 1996, and estimated current costs of debt and equity, which average about 9.36%. The annual increase in costs due to capitalizing NEWGAS-CO. at current market rates is $477K. See SECTION IV., NEWGAS-CO., Exhibit 4 for detailed information. SHAREHOLDER COSTS DPL incurs costs to hold annual Shareholders' Meeting, compensate the transfer agent for common and preferred stock, and provide shareholder services. NEWGAS-CO. would have to incur similar costs. See Section IV., NEWGAS-CO., Exhibit 2h for detailed information. POSTAGE AND GENERAL SERVICES DPL allocates costs for postage and general services (including copier costs) to the gas business. The postage costs are shared for joint bills in which the customer is both a gas and electric customer. Both NEWGAS-CO. and DPL-Electric would have to bear the entire cost. NEWGAS-CO. would incur costs for general services and copier leases. Only the variable costs related to the copiers would be eliminated for DPL-Electric. The shared general services costs are mostly fixed and would remain with DPL-Electric. See SECTION IV., NEWGAS-CO., Exhibit 2i for detailed information. GAS TRANSMISSION PIPELINE IMPACT Currently, DPL Gas and Electric production own and operate a seven mile natural gas transmission pipeline in Delaware. The costs would continue to be shared, but a formal joint venture agreement would be put in place to replace the current operating and accounting procedures. DPL Electric production also currently owns a four mile natural gas transmission pipeline in Pennsylvania from which DPL Gas purchases annual capacity. Since this pipeline is under FERC jurisdiction, the existing approvals would require updating and modification. The total cost of legal agreements and FERC filings to accomplish these two changes are estimated at $100K and are included in the transition cost estimate. If the Pennsylvania pipeline was also set up as a joint venture, then NEWGAS-CO. could expect to incur capital costs of approximately $656K. This would reduce annual gas transportation and GCR costs by $150K (See Exhibit 2j). CONCLUSION The Study concludes that a separate gas distribution company would require 401 full-time employees, an increase of approximately 30% in salary expense. Based upon the assumptions set forth in SECTION II and the staffing requirements of the organization structure, increased estimated annual costs (excluding Federal and State income taxes) for NEWGAS-CO. are projected to be $14.7M. The exhibits (SECTION IV.) that follow show the economic effects of operation of DPL's gas business as a separate entity. SECTION III.C. DPL-ELECTRIC OVERVIEW Spinning off DPL's gas business into a separate stand-alone company (NEWGAS-CO.) would have the following effect on DPL-Electric. o All common property would be transferred into the electric rate base. o Annual operating revenue deductions, exclusive of income taxes, for DPL-ELECTRIC would be about .033% ($2.4M) greater than DPL's electric operating revenue deductions when a combined utility (SECTION IV., NEWGAS-CO., Exhibit 1). o The DPL-Electric customers would experience a total rate increase of about 0.79% ($7.5M) in order to provide a 9.35% rate of return for stockholders (SECTION IV., NEWGAS-CO., Exhibit 1). o Estimated additional operating expenses for fixed costs related to information technology, facility costs, and postage would remain with DPL-Electric following the spin-off of the gas business (SECTION IV., NEWGAS-CO., Exhibit 10). o The impact to DPL-Electric of the number of shared employees who perform duties for gas and electric was diminimus and is not reflected in this Study. o There would be no substantial benefits for gas or electric customers or stockholders. CONCLUSION The Study concludes that separating the combined electric and gas utility would increase the electric customer rates and provide no net benefit to shareholders. This impact is primarily due to the transfer of all common property to the electric rate base. Other operating expenses of approximately $2.4M (See SECTION IV., NEWGAS-CO., Exhibit 10) are fixed expenses that would remain with DPL-Electric following the spin-off of the gas business. By divesting the gas business, a rate increase of 0.79% would occur for electric customers. SECTION IV. NEWGAS-CO. SCHEDULE OF EXHIBITS EXHIBIT NO. EXHIBIT TITLE 1 Income Statement, Proforma Adjustments & Revenue Requirement 2 Estimated Additional Operating Expenses 2a Estimated External Audit Fees Based on Survey Data 2b Estimated Information Technology Costs 2c Estimated Increased Cost of Insurance Coverage 2d Estimated Net Labor Increase, Including Benefits 2e Estimated Operating Lease Facilities and Furniture Costs 2f Estimated Transition Costs 2g Estimated Net Increase in Transportation & Motorized Equipment Expense 2h Estimated Shareholder Costs 2i Postage and General Services 2j Estimated Gas Transmission Pipeline Impact 3 Rate Base 4 Cost of Capital 5 Corporate Structure 6 Salaries and Wages Summary 7 Comparable Local Distribution Companies (Customers Per Employee Ratios) 8 Estimated Executive Salaries 9 DPL's Electric Rate Base & Rate of Return 10 DPL-Electric's Estimated Additional Operating Expenses NEWGAS-CO. Exhibit 1 NEWGAS-CO. INCOME STATEMENT PROFORMA ADJUSTMENTS & REVENUE REQUIREMENT (In Thousands of Dollars) Existing DPL Gas Company Revenue Year Ending Proforma Proformed Requirement 9/30/96 Adjustments (1) NEWGAS-CO. Increase (2) Operating Revenue: Sales Revenue $ 98,434 $ 98,434 $ 113,927 Other Revenue $ 6,253 $ 6,253 $ 6,253 Total Operating Revenue $ 104,687 $ 104,687 $ 120,180 Operating Revenue Deductions: Gas Supply $ 56,524 $ 56,524 $ 56,524 O&M $ 18,153 $ 14,705 $ 32,858 $ 32,858 Depreciation $ 7,752 $ 23 $ 7,775 $ 7,775 Other Income & Deductions ($201) ($201) ($201) Taxes Other Than Income $ 2,400 $ 2,400 $ 2,400 Total Operating Revenue Deductions $ 84,628 $ 14,728 $ 99,356 $ 99,356 Gross Gas Income $ 20,059 $ (14,728) $ 5,331 $ 20,824 Federal & State Income Taxes (3) $ 6,149 $ (5,988) $ 161 $ 6,364 Net Gas Income $ 13,910 $ (8,740) $ 5,170 $ 14,460 Rate Base (4) $ 161,209 $ (6,717) $ 154,492 $ 154,492(5) Indicated Rate of Return 8.63% 3.35% 9.36%
(1) See Exhibit 2 for a detailed summary of proforma adjustments (2) An increase of $15.5M or 14.80% in Sales Revenue is required to achieve a rate of return of 9.36%. For the purposes of this Study, gross receipts taxes were not considered since both the resulting revenue and taxes (revenue deduction) would nullify any impact from this calculation. (3) DPL's composite Federal & State Income Taxes is 40.66%. This composite tax rate was used to calculate taxes for the adjustments and to develop the Proformed NEWGAS-CO. and Revenue Requirement increase columns. (4) See Exhibit 3. (5) The effective rate of return is assumed to be the weighted costs of capital per Exhibit 4. NEWGAS-CO. Exhibit 2 NEWGAS-CO. ESTIMATED ADDITIONAL OPERATING EXPENSES PROFORMA ADJUSTMENTS (In Thousands of Dollars) Exhibit Reference Number Amount External Auditing Costs 2a $ 78 Information Technology Costs (Outsourced) 2b $ 6,399 Insurance Premiums 2c $ 118 Labor & Benefits 2d $ 5,162 Leased Facilities/Furniture 2e $ 621 Transition Costs (Amortized) 2f $ 1,103 Transportation & Work Equipment 2g $ 141 Shareholder Costs 2h $ 533 Postage and General Services 2i $ 223 Gas Transmission Pipeline Impact 2j $ (127) Cost of Capital 4 $ 477 TOTAL ADDITIONAL OPERATING EXPENSES $14,728 NEWGAS-CO. Exhibit 2a NEWGAS-CO. ESTIMATED EXTERNAL AUDIT FEES PROFORMA ADJUSTMENT Amount NEWGAS-CO.: Total Estimated Annual Audit Fees for External Audit $63,303 Total Estimated Annual Audit Fees for Pension Plans $32,000 ------- Total External Audit Fees $95,303 Less: External Audit Fees Allocated to Gas Operations in 1996 $16,896 Net Estimated Annual Audit Fees Increase for NEWGAS-CO. $78,407 ======= SOURCE: American Gas Association/Edison Electric Institute External Audit Fees - October, 1995 and DPL Audit Fees NEWGAS-CO. Exhibit 2b NEWGAS-CO. ESTIMATED INFORMATION TECHNOLOGY COSTS PROFORMA ADJUSTMENT (In Thousands of Dollars) Estimated Information Technology Outsource Costs $8,000 These costs include the following software and hardware: General Ledger/Capital Projects/Asset Management/Accounts Payable Payroll Distribution Investor Services Customer Information System (CIS) Computer Telephone Integration System (CTI) Procurement and Materials Management System ICES/Work Management System AM/FM (GRIDS and gas facilities database) Pension Manager Payroll/Human Resources Time Reporting Damage Tracking Resource Management/Dispatch System Local Area Network and Personal Computers Vehicle Resource Management System Less: Information Technology Expenses Allocated to Gas Operation - 1996 $1,601 Net Increase in NEWGAS-CO. Cost for Information Technology $6,399 SOURCE 1995/1996 Gartner Group IT Budgets and Practices Survey and DPL Accounting and Information Technology Departments NEWGAS-CO. Exhibit 2c NEWGAS-CO. ESTIMATED INCREASED COST OF INSURANCE COVERAGE PROFORMA ADJUSTMENT Estimated Net Increase Limits Stand Alone to Coverage (Millions) Deductible Premium Cost NEWGAS-CO. Property $ 5 $250,000 $ 21,000 General Liability $60 $250,000 $213,000 Auto Liability $ 1 - $ 50,000 Directors & Officers Liability $10 $250,000 $ 75,000 Workers Compensation Statutory $350,000 $ 61,000 Fiduciary Liability $ 5 $ 5,000 $ 10,000 Crime (Fidelity) $ 5 $ 5,000 $ 10,000 ---------- Total NEWGAS-CO. Premium $440,000 Less: Insurance Cost Allocated to NEWGAS-CO. $322,100 ---------- Net Increase in Insurance Costs for NEWGAS-CO. $117,900 ========
Source: DPL's Insurance Department and Insurance Broker reviewed estimated insurance costs for two gas retention studies. One in particular, NEWGAS-UE (Union Electric) represents the limits, deductibles, and premiums most similar to NEWGAS-CO. NEWGAS-CO. Exhibit 2d NEWGAS-CO. ESTIMATED NET LABOR INCREASE, INCLUDING BENEFITS PROFORMA ADJUSTMENT (In Thousands of Dollars) Total Estimated Salaries and Wages for NEWGAS-CO. (Exhibit 6) $20,503 Less: Amount Capitalized (average 21.7%) - (1) $ 4,446 Total Estimated NEWGAS-CO. Salaries & Wages Charged to O&M $16,057 Less: Year ending 9/30/96 DPL Gas Salaries & Wages Charged to O&M $12,388 Increase in NEWGAS-CO. Salaries & Wages Charged to O&M $3,669 Benefits 40.69% - (2) $1,493 NEWGAS-CO. Net Labor Increase, Including Benefits $5,162 ======
(1) Amount of labor allocated to capital based on 1995 DPL Percentage of Wages & Salaries Capitalized Study. Field capitalized salaries - 26.88% and Administrative capitalized salaries - 17.07%. (2) Benefit costs were estimated based upon the 1995 actual cost (as a percentage of payroll). Benefits include: Pension, Post Employment Benefits, Life Insurance, Medical, Dental, Savings & Thrift, Workers Compensation, FICA, Unemployment Taxes, and other. NEWGAS-CO. Exhibit 2e NEWGAS-CO. ESTIMATED OPERATING LEASE FACILITIES AND FURNITURE COSTS PROFORMA ADJUSTMENT Office Space Calculation Management Office Space & Staff Needs in Cost Per Total Employee Square Feet Square Foot Office Space Count (1) (2) Lease General Office 274 68,500 $16.83 $1,152,855 Shop and Stores Area 127 34,870 $4.30 $ 149,941 Total 401 $1,302,796 Less: Current allocated costs for gas facilities $ 681,431 Net NEWGAS-CO. Facilities Cost: $ 621,365
Source: Estimated costs provided by DPL Building Services Department (1) An average of 250 square feet per employee was used based on Company experience. (2) Cost per square foot was provided by Jackson Cross International Realtors. NEWGAS-CO. Exhibit 2f NEWGAS-CO. ESTIMATED TRANSITION COSTS PROFORMA ADJUSTMENT Transition costs required to establish a new corporation would include the following: Legal fees Financial advisory fees Consulting services of independent accountants, actuaries, and others Real estate services for acquisitions Hiring and training costs to staff newly created positions Benefit plans established Data conversion Transition costs for NEWGAS-CO. were established based upon an average of the following published transition costs for other corporate spin-offs. Transition Original Corporation Spin-Off Company Costs (000) Baxter International Caremark $13,300 Adolph Coors ACX Technologies $ 7,200 Dial Corporation GFC Financial $13,000 Union Carbide Praxair $11,000 Ryder Avial $ 9,000 Price Costco Price Enterprises $15,250 Humana Galen $15,000 Honeywell Aliant $ 4,500 Average Transition Costs of the Above Companies $11,031 Annual amortization of Transition Costs for NEWGAS-CO.(10%) $ 1,103 Source: Transition costs reported in SEC Form 10-K filings NEWGAS-CO. Exhibit 2g NEWGAS-CO. ESTIMATED NET INCREASE IN TRANSPORTATION & MOTORIZED EQUIPMENT EXPENSE PROFORMA ADJUSTMENT EST. NO. OF EST. ANNUAL VEHICLE SUMMARY VEHICLES COST Executive 1 $ 5,500 VP Distribution, Operations, & Construction 1 $ 5,500 Construction & Maintenance 92 $1,154,268 Operations, Planning & Procurement 11 $ 60,204 Gas Engineering 18 $ 91,368 Gas Meter 3 $ 14,544 VP Marketing & Customer Service 1 $ 5,500 Gas Meter Reading 9 $ 37,368 Customer Relations 1 $ 1,245 Media Relations/Comm. Relations/Public Affairs 1 $ 1,245 Marketing 1 $ 4,152 Field Customer Service 51 $ 305,172 VP Business Support Services 1 $ 5,500 VP Human Resources 1 $ 5,500 Safety 2 $ 8,304 Training 3 $ 3,735 Benefits & Employee Relations 1 $ 1,245 VP/CFO 1 $ 5,500 Claims 2 $ 2,490 Controller 1 $ 5,500 VP Legal, Regulatory, Environmental Affairs, & Corp. Plng. 1 $ 5,500 Environmental Affairs 2 $ 2,490 Corporate Secretary 1 $ 5,500 Security 2 $ 8,304 -------------------------- NEWGAS-CO. 208 $1,745,634 Less: Amount charged to Gas Business for 12 months ended 9/30/96 $1,418,619 Net increase in transportation & equipment expenses for NEWGAS-CO. $ 327,015 Less amount Capitalized (56.71%) $ (186,399) NEWGAS-CO. Increase to O&M Costs $ 140,616
Source: Estimated costs based on DPL Vehicle Resource Management's assessment of transportation & equipment needs and operating & maintenance experience. NEWGAS-CO. Exhibit 2h NEWGAS-CO. ESTIMATED SHAREHOLDER COSTS PROFORMA ADJUSTMENT Annual Meeting $225,000 Transfer Agent $317,000 Shareholders' Services $ 37,000 -------- TOTAL NEWGAS-CO. $579,000 Less Amount Allocated to Gas Business $ 46,320 Net Increase to NEWGAS-CO. $532,680 ======== SOURCE Estimated costs provided by DPL Financial Services Department NEWGAS-CO. Exhibit 2j NEWGAS-CO. ESTIMATED GAS TRANSMISSION PIPELINE IMPACT Net Operating Expenses Gas Transportation/GR Costs $(150,000) Depreciation Expense $ 23,430 Net decrease to Operating Expenses $(126,570) NEWGAS-CO. would also have a capital expenditure of approximatey $656,000. SOURCE Estimated information provided by DPL Plant Accounting Department and Gas Division NEWGAS-CO. Exhibit 2i NEWGAS-CO. ESTIMATED POSTAGE & GENERAL SERVICES PROFORMA ADJUSTMENT Postage $281,642 General Services (1) $176,899 -------- TOTAL NEWGAS-CO. $458,541 Less Amount Allocated to Gas Business $235,189 New Increase to NEWGAS-CO. $223,352 ======== SOURCE Estimated costs provided by DPL General Services Department (1) Costs include expenses such as reproduction, printing, internal mail distribution, and external non-billing mail. NEWGAS-CO. Exhibit 3 NEWGAS-CO. RATE BASE (In Thousands of Dollars) Existing DPL Gas Company Eliminations Year Ending for Common Proforma Description 9/30/96 Plant (1) NEWGAS - DPL Gas Plant In Service $220,855 $ (8,501) $ 212,354 Depreciation Reserve $ 68,467 $ (3,636) $ 64,831 Net Plant $152,388 $ (4,865) $ 147,523 Construction Work In Progress $ 8,381 $ (1,828) $ 6,553 Fuel Inventory And Materials & Supplies $ 6,781 $ 6,781 Working Funds $ 24 $ (24) $ - Prepayments $ 4,544 $ 4,544 Deferred Income Tax $ (7,488) $ (7,488) Investment Tax Credit $ (1,908) $ (1,908) Customer Advances & Deposits $ (1,513) $ (1,513) Net Rate Base $161,209 $ (6,717) $ 154,492 (1) Common Plant consists mainly of Buildings, Office Furniture, Communications Equipment, and Land. Under a divestiture, all common properties would go with the Electric Division. SOURCE Information provided by DPL Pricing & Regulation Department NEWGAS-CO. Exhibit 4 NEWGAS-CO. STAND-ALONE COST OF CAPITAL The provisions of the indentures of DPL would require the recapitalization of NEWGAS-CO. at the prevailing market rates at the time of the spin-off. This study assumes that NEWGAS-CO. would have access to capital at the same cost as DPL.1 In addition, the capital structure of DPL was used to approximate the capital structure of NEWGAS-CO. As of September 30,1996, DPL was capitalized as follows. Ratio Cost Weighted Cost of Capital Long Term Debt 45.28% 7.37% 3.34% Preferred Stock 8.67% 5.85% 0.51% Common Equity 46.05% 11.50% 5.30% ------- Total 100.00% 9.15% DPL's long term debt consists of first mortgage bonds, medium term notes, and tax exempt facilities bonds.2 It is assumed that NEWGAS-CO. will issue medium term notes for the long term portion of its capitalization. The current market rate for thirty year medium term notes is 7.500%.3 The effective cost of medium term notes, including issuance costs of approximately 1% of proceeds, is 7.58%. The current market rate for utility perpetual preferred stock is 7.125%.3 The effective cost of preferred stock, including issuance costs of approximately 1.5% of proceeds, is 7.23%. The cost of common equity is 11.50% which was established by the Delaware Public Service Commission on October 18, 1994, in Docket Number 94-22. It is assumed that NEWGAS-CO. will issue the common equity to the existing shareholders of DPL; therefore, the sale of common equity securities will not be required. Based on the rates stated above, the resulting cost of capital is as follows. Ratio Cost Weighted Cost of Capital Long Term Debt 45.28% 7.58% 3.43% Preferred Stock 8.67% 7.23% 0.63% Common Equity 46.05% 11.50% 5.30% ------- Total 100.00% 9.36% Applying the increase in the cost of capital to the $159 million of net plant in service results in an estimated pre-tax increase in annual capital costs of $477,000 and an after-tax increase in annual capital costs of $270,300. 1 NEWGAS-CO. may actually incur higher capital market costs than DPL due to a higher level of investor risk resulting from a smaller asset base, concern of liquidity of the investment, and greater volatility in the cash position due to the seasonal nature of gas purchases. 2 Approximately $93 million of tax exempt bonds issued by DPL to finance gas projects are outstanding and not callable as of 12/31/96. In the event that DPL was required to spin-off its gas assets, DPL may be required to defease such bonds. 3 Rates were provided by Merrill Lynch and are based on the market conditions of February 20, 1997. The actual rates in effect at the time of the issuance of securities may be substantially different than those stated in this study. NEWGAS-CO. Exhibit 5 NEWGAS-CO. ORGANIZATION CHART President & CEO Vice President - Distribution, Operations & Construction Manager - Construction & Maintenance Manager - Gas Operations, Planning & Procurement Manager - Gas Engineering Vice President - Marketing & Customer Service General Manager - Customer Service Manager - Customer Service Manager - Field Customer Service Manager - Marketing Vice President - Business Support Services Manager - Procurement & Materials Management, Vehicle Resource Management, and Real Estate Manager - Information Resource Management Services, General Services and Records Vice President - Human Resources Manager - Benefits & Employee Relations Vice President - CFO Treasurer Controller Manager - Financial Planning/Budgets Manager - General Accounting & Tax Compliance Manager - Accounts Payable, Plant Accounting & Payroll Vice President - Legal, Pricing & Regulation, Environmental Affairs, & Corporate Planning General Counsel Manager - Pricing & Regulation Corporate Secretary NEWGAS-CO. Exhibit 6 NEW GAS-DPL SALARIES AND WAGES SUMMARY (In Thousands of Dollars) Salaries/ Totals Employees Wages Employees Salaries/Wages Executive Staff & Administrative Support 20 $ 1,960 Distribution, Operations & Construction: Construction & Maintenance 80 $ 3,628 Gas Operations, Planning & Procurement 41 $ 1,961 Gas Engineering 35 $ 1,702 Gas Meters 7 $ 322 Dist., Oper. & Const. Total 163 $ 7,612 Marketing & Customer Service: Customer Service 45 $ 2,084 Field Customer Service 51 $ 2,333 Marketing 12 $ 647 Customer Relations 1 $ 54 Media & Community Relations & Public Affairs 3 $ 162 Marketing & Cust. Svc. Total 112 $ 5,279 Business Support Services: Procurement & Materials Management 6 $ 305 Vehicle Resource Management 5 $ 270 Real Estate 3 $ 162 Information Resource Management Services 6 $ 324 General Services 4 $ 216 Records 2 $ 108 Business Support Servcs. Total 26 $ 1,384 Human Resources: Safety 2 $ 108 Training 4 $ 216 Benefits 7 $ 377 Employee Relations 2 $ 108 Human Resources Total 15 $ 809 Treasury: Treasury Operations 4 $ 216 Investor Relations 2 $ 108 Risk Management - Claims & Insurance 5 $ 270 Treasury Total 11 $ 593 Controller: Financial Planning/Budgets 7 $ 377 General Accounting, Reporting & Tax Compliance 12 $ 647 Accounts Payable, Plant Accounting, & Payroll 11 $ 547 Controller Total 30 $ 1,571 Legal, Pricing & Regulation, Environmental Affairs, & Corporate Planning Legal 4 $ 216 Pricing & Regulation 8 $ 431 Environmental Affairs 3 $ 162 Corporate Planning 4 $ 216 Legal, Pricing & Reg., Env. Affrs., & Corp. Plng. Total 19 $ 1,025 Corporate Secretary: Security 2 $ 108 Internal Auditing 3 $ 162 Corporate Secretary Total 5 $ 270 GRAND TOTAL 401 $20,503
NEWGAS-CO. Exhibit 7 NEWGAS-CO. COMPARABLE LOCAL DISTRIBUTION COMPANIES CUSTOMERS PER EMPLOYEE RATIOS CUSTOMERS COMPANIES CUSTOMERS EMPLOYEES PER EMPLOYEE NEWGAS-CO. 100,000 40 249 Baltimore Gas & Electric Co. 530,036 1,536 345 Chesapeake Utilities Co. 33,514 140 239 Philadelphia Gas Works 532,302 2,000 266 South Jersey Gas Company 248,022 690 359 Washington Gas Light Co. 725,960 2,484 292 Public Service Co. of North Carolina 276,763 1,128 245 Virginia Natural Gas 193,929 550 353 Providence Gas Co. 164,582 553 298 Source: 1997 Brown's Directory of North American and International Gas Companies NEWGAS-DPL Exhibit 8 NEWGAS-CO. ESTIMATED SALARIES An American Gas Association 1996 survey for companies with revenues less than $200 million was used to establish a reasonable range for the NEWGAS-DPL top executive salary. This survey, in conjunction with DPL's average salary was used for the NEWGAS-DPL executives. For remaining management and bargaining unit positions that would become part of the spin-off company, existing DPL average salaries were used. NEWGAS-DPL SALARY POSITION LEVELS President & CEO $170,000 Vice President/Executive Level $130,499 Management $ 53,928 Bargaining Unit $ 44,652 Source: 1996 American Gas Association Executive Compensation Survey and DPL Human Resources Average Salaries NEWGAS-CO. Exhibit 9 DPL ELECTRIC RATE BASE & RATE OF RETURN TWELVE MONTHS ENDED 9/30/96 (In Thousands of Dollars) Existing Eliminations DPL Electric For Common Proforma Description Company Plant (1) NewElectric - DPL Plant In Service $3,011,733 $ 8,501 $3,020,234 Depreciation Reserve $1,143,390 $ 1,487 $1,147,026 Net Plant $1,868,343 $ 7,014 $1,873,208 Construction Work In Progress $ 88,630 $ 1,828 $ 90,458 Fuel Inventory and Materials & Supplies $ 58,912 $ - $ 58,912 Working Funds $ 7,520 $ 24 $ 7,544 Prepayments $ 36,132 $ - $ 36,132 Deferred Income Tax $ (305,482) $ - $ (305,482) Investment Tax Credit $ (42,475) $ - $ (42,475) Customer Advances & Deposits $ (7,662) $ - $ (7,662) Net Rate Base $1,703,918 $ 6,717 $1,710,635 Net Income $ 156,382 $ 156,382 Rate of Return 9.18% 9.14%
(1) Common Plant consists mainly of Buildings, Office Furniture, Communications Equipment, and Land. Under a divestiture, all common properties would go with the Electric Division. Source: Information provided by DPL Pricing & Regulation Department NEWGAS-CO. Exhibit 10 DPL ELECTRIC ESTIMATED ADDITIONAL OPERATING EXPENSES PROFORMA ADJUSTMENTS (In Thousands of Dollars) Facility Costs $ 507 Transportation & Work Equipment Costs $ 14 Information Technology Costs $1,373 External Auditing Costs $ 17 Insurance Premiums $ 122 Shareholder Costs $ 46 Postage & General Services $ 193 Gas Transmission Pipeline Impact $ 127 Total Additional Operating Expenses $2,399 EX-99.9 10 EXHIBIT J-3 Exhibit J-3 SUMMARY OF LOST ECONOMY RATIOS NEW CENTURY ENERGIES, INC.
NewGasco-Colorado NewGasco-Wyoming Percent of Percent of estimated estimated loss of loss of economies economies Amount to: Amount to: Operating Revenues $677,326,418 6.44% $15,630,080 10.77% Operating Revenue 607,599,384 7.18% 13,681,672 12.30% Deductions Gross Income 69,727,034 62.54% 1,948,408 88.36% Net Income 51,266,520 85.06% 1,530,526 109.94% Estimated Loss of 43,605,187 1,682,723 Economies
GULF STATES UTILITIES GSU Gas Division 1991 Percent of estimated Amount loss of economies to: Operating Revenues $31,858,000 16.13% Operating Revenues Deductions 30,770,000 16.70% Gross Income 1,088,000 472.24% Net Income n/a n/a Estimated Loss of Economies 5,138,000 FITCHBURG GAS & ELECTRIC Fitchburg Gas Division - 1990 Percent of estimated Amount loss of economies to: Operating Revenues $17,324,993 13.94% Operating Revenues Deductions 15,755,267 15.33% Gross Income 1,569,726 153.87% Net Income n/a n/a Estimated Loss of Economies 2,415,391 ENGINEER PUBLIC SERVICE COMPANY Gas Properties of Gulf States Utilities Co. - 1940 Percent of estimated Amount loss of economies to: Operating Revenues $638,711 6.58% Operating Revenues Deductions 444,006 9.46% Gross Income 201,594 20.85% Net Income 166,402 25.25% Estimated Loss of Economies 42,024 Gas Properties of Virginia Electric and Power Co. - 1940 Percent of estimated Amount loss of economies to: Operating Revenues $1,057,000 3.38% Operating Revenues Deductions 735,294 4.86% Gross Income 317,890 11.25% Net Income 168,412 21.23% Estimated Loss of Economies 35,750 THE NORTH AMERICAN COMPANY Gas Properties of the St. Louis County Gas Co. - 1942 Percent of estimated Amount loss of economies to: Operating Revenues $2,748,770 5.85% Operating Revenues Deductions 2,009,757 8.01% Gross Income 742,027 21.68% Net Income 661,110 24.34% Estimated Loss of Economies 160,900 PHILADELPHIA COMPANY Gas Group - 1946 Percent of estimated Amount loss of economies to: Operating Revenues $16,656,560 3.00% Operating Revenues Deductions 13,197,846 3.79% Gross Income 3,565,357 14.03% Net Income n/a n/a Estimated Loss of Economies 500,328 GENERAL PUBLIC UTILITIES CORP. Gas Properties of Jersey Central Power & Light Co. - 1949 Percent of estimated Amount loss of economies to: Operating Revenues $4,714,958 4.87% Operating Revenues Deductions 4,235,661 5.42% Gross Income 479,477 47.84% Net Income 202,582 113.24% Estimated Loss of Economies 229,398 MIDDLE SOUTH UTILITIES, INC. Gas Properties of Louisiana Power & Light Co. - 1954 Percent of estimated Amount loss of economies to: Operating Revenues $5,264,186 5.18% Operating Revenues Deductions 4,112,285 6.63% Gross Income 1,151,901 23.68% Net Income n/a n/a Estimated Loss of Economies 272,816 NEES Gas Properties of 8 Subsidiaries Combined - 1958 Percent of estimated Amount loss of economies to: Operating Revenues $22,752,270 4.83% Operating Revenues Deductions 18,207,191 6.03% Gross Income 4,718,864 23.28% Net Income 3,669,931 29.93% Estimated Loss of Economies 1,098,500 - - --------------------- Excludes federal income taxes. Before deducting federal income taxes. * Based on estimated cost increases rejected by the SEC as "overstated" and "doubtful." -----END PRIVACY-ENHANCED MESSAGE-----