File No. 070-09477
As filed with the Securities and Exchange Commission
on August 11, 1999
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM U-1 APPLICATION-DECLARATION
--------------------------------
AMENDMENT NO. 3
TO
APPLICATION
UNDER
THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
----------------------------------------------
Dominion Resources, Inc. Consolidated Natural Gas
120 Tredegar Street Company
Richmond, VA 23219 CNG Tower, 625 Liberty Avenue
Pittsburgh, PA 15222
(Name of company filing this statement and
address of principal executive offices)
----------------------------------------------
None Consolidated Natural Gas
Company
(Name of top registered holding company
parent of each applicant or declarant)
---------------------------------------
James F. Stutts Stephen E. Williams
Vice President and Senior Vice President and
General Counsel General Counsel
Dominion Resources, Inc. Consolidated Natural Gas
120 Tredegar Street Company
Richmond, VA 23219 CNG Tower, 625 Liberty Avenue
Pittsburgh, PA 15222
(Name and address of agent for service)
---------------------------------------
<PAGE>
The Commission is also requested to send copies
of any communications in connection with this matter to:
Gary W. Wolf, Esq.
Kevin J. Burke, Esq.
Cahill Gordon & Reindel
80 Pine Street
New York, NY 10005
-2-
<PAGE>
APPLICATION
UNDER
SECTIONS 9(a)(2) and 10
OF
THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
FOR APPROVAL OF
ACQUISITION OF REGISTERED HOLDING COMPANY
AND
RELATED MATTERS
Dominion Resources, Inc. and Consolidated Natural Gas Company hereby amend
and restate Item 6. Exhibits and Financial Statements to their Application in
File No. 070-09477 as follows:
Item 6. Exhibits and Financial Statements
A. Exhibits
A-1 Articles of Incorporation of DRI as in effect on April 16, 1999.
(Filed as Exhibit 3(i) to DRI's Form 10-Q for the quarter ended
March 31, 1999, File No. 1-8489 and incorporated by reference
herein)
A-2 By-Laws of DRI as in effect on April 16, 1999. (Filed as Exhibit
3(ii) to DRI's Form 10-Q for the quarter ended March 31, 1999 and
incorporated by reference herein)
A-3 Restated Certificate of Incorporation of CNG. (Filed as Exhibit
A-1 to Form U-1, File No. 70-7811 and incorporated by reference
herein)
A-3.1 Amendment, dated May 31, 1996, to Exhibit A-1. (Filed as Exhibit
4(B) to the Registration Statement on Form S-3, File No.
333-10869 and incorporated by reference herein)
A-4 By-laws of CNG, last amended May 19, 1996. (Filed as Exhibit 3B
to Form 2158 for the year ended December 31, 1998, File No.
1-3196 and incorporated by reference herein)
B-1 Amended and Restated Agreement and Plan of Merger, dated as of
May 11, 1999 by and between DRI and CNG. (Included in Exhibit C-1
hereto)
C-1 Registration Statement on Form S-4 of DRI for the shareholders
meeting to be held in connection with the Merger (Filed with the
Commission on
-3-
<PAGE>
May 20, 1999, File No. 333-75669 and incorporated by reference
herein)
C-2 Joint Proxy Statement/Prospectus of DRI and CNG for the special
meeting of shareholders to be held in connection with the Merger.
(Included in Exhibit C-1)
D-1.1 Application to the FERC under the FPA. (Filed in paper format in
Form SE)
D-1.2 Order of the FERC. (To be filed by amendment)
D-2.1 Submission to the Virginia Commission. (Filed in paper format in
Form SE)
D-2.2 Order of the Virginia Commission. (To be filed by amendment)
D-3.1 Submission to the North Carolina Commission. (Filed in paper
format in Form SE)
D-3.2 Order of the North Carolina Commission. (To be filed by
amendment)
D-4.1 Submission to the West Virginia Commission. (Filed in paper
format in Form SE)
D-4.2 Order of the West Virginia Commission. (Filed in paper format in
Form SE)
D-5.1 Submission to the Pennsylvania Commission. (Filed in paper
format in Form SE)
D-5.2 Order of the Pennsylvania Commission. (Filed in paper format in
Form SE)
E-1 Map of service territory of DRI. (Filed in paper format in Form
SE)
E-2 Map of service territory of CNG. (Filed in paper format on Form
SE)
E-3 Statistical Analysis of companies in the DRI-CNG region. (To be
filed by amendment)
E-4 DRI Corporate Organization Chart. (Filed in paper format in Form
SE)
E-5 CNG Corporate Organization Chart. (Filed in paper format in Form
SE)
-4-
<PAGE>
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 Lehman Brothers, Inc. (Included in Exhibit C-1)
G-2 Opinion of Merrill Lynch, Pierce, Fenner & Smith Incorporated.
(Included in Exhibit C-1)
H-1 Annual Report of DRI on Form 10-K for the year ended December 31,
1998. (Filed with the Commission on March 1, 1999, File No.
1-8489 and incorporated by reference herein)
H-2 Annual Report of CNG on Form 10-K for the year ended December 31,
1998. (Filed with the Commission on March 15, 1999, File No.
1-3196 and incorporated by reference herein)
H-3 Quarterly Report on Form 10-Q of DRI for the quarter ended March
31, 1999 (filed with the Commission on May 17, 1999, File No.
1-8489 and incorporated by reference herein)
H-4 Quarterly Report on Form 10-Q of CNG for the quarter ended March
31, 1999 (filed with the Commission on May 14, 1999, File No.
1-3196 and incorporated by reference herein)
H-5 Form U-3A-2 of DRI for the year ended December 31, 1998 (filed
with the Commission on February 26, 1999, File No. 69-278 and
incorporated by reference herein)
I-1 Proposed Form of Notice
J-1 Lost Economies Study.
B. Financial Statements
FS-1 DRI Unaudited Pro Forma Condensed Consolidated Balance Sheet.
(Included in Exhibit C-1)
FS-2 DRI Unaudited Pro Forma Condensed Consolidated Statement of
Income. (Included in Exhibit C-1)
FS-3 Notes to DRI Unaudited Pro Forma Condensed Consolidated Financial
Statements. (Included in Exhibit C-1)
-5-
<PAGE>
FS-4 DRI Consolidated Balance Sheet as of December 31, 1998. (Included
in Exhibit H-1)
FS-5 DRI Consolidated Statement of Income for the twelve months ended
December 31, 1998. (Included in Exhibit H-1)
FS-6 CNG Consolidated Balance Sheet as of December 31, 1998. (Included
in Exhibit H-2)
FS-7 CNG Consolidated Statement of Income for the twelve months ended
December 31, 1998. (Included in Exhibit H-2)
-6-
<PAGE>
SIGNATURE
Pursuant to the Public Utility Holding Company Act of 1935, each of the
undersigned companies has caused this Application-Declaration to be signed on
its behalf by the undersigned thereunto duly authorized.
DOMINION RESOURCES, INC. CONSOLIDATED NATURAL GAS COMPANY
By: /s/ James F. Stutts By: /s/ Stephen E. Williams
------------------------------ ------------------------------
Name: James F. Stutts Name: Stephen E. Williams
Title: Vice President and Title: Senior Vice President and
General Counsel General Counsel
Date: August 11, 1999 Date: August 11, 1999
-7-
Analysis of the Economic Impact of a Divestiture
of the Retail Natural Gas Operations of
Consolidated Natural Gas Company
I. Executive Summary
Reed Consulting Group (REED) was retained by Dominion Resources Inc. (DRI) and
Consolidated Natural Gas Company (CNG) to quantify the economic impact on
shareholders and customers of a spin-off of the retail gas distribution
subsidiaries of CNG into separate and distinct entities. CNG's retail gas
operations currently consist of four natural gas local distribution companies,
The East Ohio Gas Company (East Ohio Gas or EOG), which operates exclusively in
Ohio, The Peoples Natural Gas Company (Peoples Natural Gas or PNG), which
operates exclusively in Pennsylvania, Virginia Natural Gas, Inc. (Virginia
Natural Gas or VNG), which operates exclusively in Virginia, and Hope Gas, Inc
(Hope Gas or HGI) which operates exclusively in West Virginia, (collectively,
the "LDCs"). This study analyzes the additional costs that would be incurred in
operating each of these businesses independently from the other CNG businesses
and each other. This assessment was based on REED's understanding of the
operating structure of CNG and its LDC subsidiaries and our knowledge of other
stand-alone gas distribution utility companies.
This study evaluates the increased costs or lost economies associated with the
divestiture of these businesses from two perspectives: shareholders and
customers. The effects on shareholders were calculated based on the increased
costs from divestiture, and assuming no regulatory rate relief to recover these
additional costs. The effects on customers were calculated assuming recovery of
additional costs through rate increases. This study attempts to quantify many of
the direct increases in the costs of labor, facilities, information technology
resources, and capital financing that would be experienced in the event of a
spin-off. In addition to such direct costs, CNG provides the LDCs with a number
of indirect benefits that are difficult to quantify and that would be lost in
the event of divestiture. These indirect lost economies are discussed in the
body of this report.
Shareholder Perspective
Our analysis indicates that a divestiture of the four LDCs of CNG into four
separate stand-alone companies would result in increased operating expenses
primarily due to higher labor and overhead costs for the four stand-alone
companies. The total annual impact of lost economies for all four companies is
$61.3 million. Cumulative incremental staffing requirements include 700
full-time management and staff positions. While some of this staff could be
drawn from the existing Service Company, the estimated total incremental labor
costs are still expected to be $31.7 million annually. The estimated effects on
each company are shown in Table I-1 below.
In Table I-1, lost economies represent the additional costs, excluding income
taxes, for each subsidiary to operate as a stand-alone company. Total revenues
reflect the gas operating revenues for each LDC as reported in CNG's Form U5S
Annual Report for the 12 months ended December 31, 1998. Net Revenues refer to
total revenues less purchased gas expenses. Total expenses include all purchased
gas and gas withdrawn from storage, operation and maintenance expenses,
depreciation, and taxes other than income taxes. Non-gas expenses refer to total
expenses less purchased gas expenses. Gross Income is the difference between
Total Revenues and Total Expenses; it excludes income taxes. Net Income is equal
to Gross Income less Income Taxes. Rate base refers to the market capitalization
at December 31, 1998.
Page 1 of 37
<PAGE>
<TABLE>
<CAPTION>
Table I-1
Annual Effects of Lost Economies on Shareholders
($000's)
----------------------- -------------------- ------------------- ------------------- -------------------
East Ohio Gas Peoples Natural Virginia Natural Hope Gas Inc.
Gas Gas
----------------------- -------------------- ------------------- ------------------- -------------------
<S> <C> <C> <C> <C>
Total Lost Economies $20,908,144 $15,715,120 $13,176,747 $11,540,096
----------------------- -------------------- ------------------- ------------------- -------------------
Lost Economies as a
percent of
----------------------- -------------------- ------------------- ------------------- -------------------
Total Revenues 2.052% 5.190% 6.942% 11.509%
----------------------- -------------------- ------------------- ------------------- -------------------
Net Revenues 4.737% 8.500% 13.669% 21.384%
----------------------- -------------------- ------------------- ------------------- -------------------
Total Expenses 2.290% 6.579% 8.190% 12.721%
----------------------- -------------------- ------------------- ------------------- -------------------
Non-Gas Expenses 6.231% 12.994% 19.525% 25.984%
----------------------- -------------------- ------------------- ------------------- -------------------
Gross Income 19.76% 24.58% 45.58% 120.80%
----------------------- -------------------- ------------------- ------------------- -------------------
Net Income 36.61% 43.37% 105.30% 252.52%
----------------------- -------------------- ------------------- ------------------- -------------------
In absence of rate
relief
----------------------- -------------------- ------------------- ------------------- -------------------
Estimated return on 5.1977% 7.1758% 1.7230% -2.9188%
rate base
----------------------- -------------------- ------------------- ------------------- -------------------
Estimated return on 4.8723% 6.0761% 1.0591% -2.5556%
net plant
----------------------- -------------------- ------------------- ------------------- -------------------
</TABLE>
Customer Perspective
It is a reasonable expectation that each company would be allowed to recover the
increased costs of stand-alone operations, including related income taxes
through a rate increase. In this case, the projected effect on the gas customers
of each subsidiary is as follows:
Table I-2
Annual Effects of Lost Economies on Customers
($000's)
<TABLE>
<CAPTION>
- ---------------------- -------------------- --------------------- --------------------- --------------------
East Ohio Gas Peoples Natural Gas Virginia Natural Gas Hope Gas Inc.
- --------------------- -------------------- --------------------- --------------------- --------------------
<S> <C> <C> <C> <C>
Rate Revenue
- ---------------------- -------------------- --------------------- --------------------- --------------------
Pre-Spin-Off $1,018,979 $302,806 $189,803 $100,271
- ---------------------- -------------------- --------------------- --------------------- --------------------
Post-Spin-Off $1,080,697 $326,957 $221,631 $121,370
- ---------------------- -------------------- --------------------- --------------------- --------------------
Dollar Increase $61,718 $24,151 $31,828 $21,099
- ---------------------- -------------------- --------------------- --------------------- --------------------
Percent Increase 6.057% 7.976% 16.769% 21.042%
- ---------------------- -------------------- --------------------- --------------------- --------------------
</TABLE>
Conclusion
The economies that CNG realizes from consolidated administration and management
of its gas operations provide significant benefits to customers and
shareholders. The centralized management provided by CNG allows the CNG LDCs to
realize economies of scale in the procurement of equipment, gas supplies
Page 2 of 37
<PAGE>
and various technical and administrative services. Spinning off CNG's gas
distribution subsidiaries into stand-alone companies would likely result in
substantial cost increases and significant earnings decreases absent regulatory
rate relief. Without rate adjustments, the spin-off would have significant
negative impacts on shareholders and make ownership of shares in the stand-alone
LDCs unattractive.
The pass-through of the increased costs from divestiture would likely lead to
significant rate increases with no corresponding increase in the level and
quality of services received by the LDC customers. The estimated rate increases
for each company range from 6 to 21 percent. These increases would make each
stand-alone company less competitive at a time when competition in the energy
industry is rapidly increasing due to state and federal restructuring efforts in
both the electric and gas industries.
The potential by-pass of local distribution systems by interstate pipelines or
alternate fuels is a threat faced by the CNG LDCs. Peoples Natural Gas faces
direct competition from other LDCs to provide distribution service in certain
portions of its service territory in western Pennsylvania. Pennsylvania has also
become one of the first states in the nation to deregulate electric generation
and to allow retail customers to select their choice of electricity supplier.
Unnecessarily higher costs will make it difficult for these stand-alone
companies to compete against other fuels, pipeline bypass, and, in certain
cases, other LDCs.
As a result of federal restructuring and refocus on competition in the gas
industry, there is an increased interest in the unbundling of LDC services and
allowing more customers to select alternative natural gas suppliers. Peoples
Natural Gas and East Ohio Gas have already expanded their natural gas
transportation services available to retail customers. Pennsylvania passed
legislation in June 1999 requiring all natural gas customers to have a choice in
their natural gas supplier. The increases discussed here may make both bundled
and unbundled services less competitive.
Finally, in an era of rapid consolidation of electric and gas providers into
large energy service companies, a regulated utility which either offers only one
energy product or has a narrow geographic focus, faces a competitive
disadvantage to larger companies which offer a variety of products and services
over a larger service area. In fact, for this reason, many smaller retail gas
companies have been merged into larger, more diverse energy service companies
during the last few years/1/. Such mergers allow LDCs to enhance revenues
through cross selling opportunities and market expansion and to take advantage
of operating synergies created by corporate consolidation. Thus, in the case of
an LDC spin off, the CNG LDCs would likely be highly sought after merger
partners. The LDCs separation from CNG would arguably result in a need to be
acquired by a larger or more diversified energy company in order to remain
financially stable and competitive in the long-run. Thus, any mandated spin off
of the CNG LDCs would, in the short run, result in increased costs and, in the
long run, likely result in the reacquisition of the CNG LDCs by a larger company
in order to recapture the synergies lost in the original spin off.
Based on the foregoing, REED believes that spinning off the CNG gas distribution
subsidiaries into four stand-alone companies would adversely affect both the CNG
shareholders and natural gas customers.
- ----------
/1/ In the last six months, there have been a number of gas LDC mergers that
demonstrate this pattern:
o Wisconsin Energy Corp.'s acquisition of WICOR Inc., announced June 28,
1999.
o Eastern Enterprises' acquisition of Colonial Gas, announced October
19, 1998, and Energy North, announced July 15, 1999.
o Energy East's acquisitions of Connecticut Energy Corp, announced April
23, 1999, CMP Group, announced June 15, 1999, and CTG Resources,
announced June 30, 1999,
o Northeast Utilities reacquisition of Yankee Energy System, announced
June 15, 1999.
o Indiana Energy Inc. and Sigcorp Inc.'s merger to form Vectren Corp,
announced June 14, 1999.
- ----------
Page 3 of 37
<PAGE>
REED believes, therefore, that it is in the best interest of CNG to retain its
existing gas distribution assets and businesses.
II. Analytical Approach and Study Assumptions
Overview
To estimate the increased costs from divestiture of CNG gas distribution
subsidiaries, REED undertook an organizational assessment of each LDC as it
exists today first on its own, and then as part of the larger CNG organization.
To assess where additional costs would be incurred as a result of a divestiture,
REED examined the areas and functions which are currently being provided fully
or partially by the Consolidated Natural Gas Service Company (Service Company)
to the LDCs. Given that each company would be operating on a stand-alone basis
and would need to either perform these functions on its own or outsource these
responsibilities, REED estimated the additional costs that would be incurred
from transferring the functions provided by the Service Company to each LDC
organization.
In performing this assessment, each area, department, or function was
incorporated into the stand-alone LDCs to ensure the current levels of service
provided to end-use customers are maintained. The increased costs were then
estimated by comparing the incremental costs of stand-alone operations with the
allocated charges from the Service Company. While divestiture would likely
impact the costs of many departments and business units within the LDC, the
study does not assume additional cost increases in areas outside of the
functional and administrative department covered by the Service Company. The
study does, however, attempt to quantify the increased shareholder-related costs
associated with independent corporate existence.
The Base Case for each LDC analysis reflects the actual sales, revenues, costs,
and rates of return for the 12 months ended December 31, 1998. Although CNG is
undertaking continued restructuring of its operations, including the operations
of its LDC subsidiaries and the Service Company, the analysis of lost economies
is based on the organizational structure that existed at year-end 1998. In the
last few years, the Service Company has consolidated many functions previously
performed individually by the LDCs and its transmission company. This
consolidation has enabled CNG LDCs to achieve economies of scale in functions
such as marketing, gas supply and engineering. Current restructuring efforts are
focusing on areas such as the human resource and legal departments in an attempt
to extract savings from streamlining and consolidating these functions across
the CNG companies.
In each Base Case analysis, REED focused on the major cost components likely to
be impacted by divestiture of the LDCs based on reviews of corporate information
and discussions with CNG personnel. A more exhaustive analysis would likely
produce additional costs from lost economies from divestiture of the LDC
operations. For example, the Service Company is a party to various long-term
contracts which would be impacted by a divestiture. The Service Company would
incur significant costs to buyout or buy down these contracts after a spin off.
Furthermore, given the latest restructuring actions by the Service Company and
the expected increased operational efficiencies and savings from these efforts,
the estimated lost economies in this study may well be understated.
In evaluating the impact of divestiture of CNG's four natural gas distribution
subsidiaries, REED made a number of assumptions based on its understanding of
the operational structure and relationships between CNG and each of its
subsidiaries, REED's expertise in natural gas distribution operations, and the
impacts of changes in the natural gas industry on those operations. REED
consulted with CNG management and staff in developing the assumptions for
stand-alone operations of the LDC subsidiaries. A discussion of the key
assumptions used to estimate the lost economies is provided below.
Page 4 of 37
<PAGE>
Spin-Off Assumptions
The study assumes that CNG's four regulated natural gas distribution businesses,
East Ohio Gas, Peoples Natural Gas, Hope Gas, and Virginia Natural Gas will be
divested as separate stand-alone LDCs. Once divested, these entities would
operate as independent, publicly held, regulated companies. They would have all
necessary management personnel, along with facilities, equipment, materials and
supplies, etc. required to operate as stand-alone utilities.
REED assumed the spin-off of each subsidiary into a single stand-alone company
rather than one combined company for the following reasons:
o Each LDC is presently a separate wholly-owned subsidiary of CNG. The four
corporations would need to be merged to form a single combined gas company.
o Each does business under its own name and has its own identity with
customers.
o Each LDC's revenue requirements, rate design, and natural gas tariff is
regulated by a different state and state regulatory commission: East Ohio
Gas, by the Ohio Public Utility Commission; Peoples Natural Gas, by the
Pennsylvania Public Utility Commission; Hope Gas, by the West Virginia
Public Service Commission; and, Virginia Natural Gas by the Virginia State
Corporation Commission.
o Each LDC's gas system can be operated independently.
o A significant number of personnel who operate and maintain the four gas
systems are employees of one of the respective gas companies only.
It might be argued that it would be more appropriate to analyze the impact of a
divestiture of CNG's four LDCs as an entirety, either under a common holding
company or as a single multi-state operating utility. However, neither of such
approaches gives effect to two critical considerations. First, divestiture of
the LDCs under a common holding company would require that such holding company
register as a holding company under the Public Utility Holding Company Act of
1935 (the 1935 Act). It cannot be assumed that any potential buyer would be
willing to register as a holding company under the 1935 Act, and accept the
regulation of the SEC thereunder in connection with the acquisition of these
LDCs. Second, the creation of a new multi-state operating utility would result
in jurisdictional issues among the four states in which the LDCs operate. As
they are presently organized, each LDC is subject to full regulation only in the
state in which it operates. Under a multi-state utility structure, the
regulatory burden of the company would increase as the full operations of the
company would be regulated by four different sets of state regulators. Moreover,
separation of CNG four LDCs from the much larger unregulated CNG businesses
would itself entail lost economies, as the four LDCs would need to bear the
entire costs of services that are now shared by the entire CNG system.
1. Staffing and Labor Costs
For the purpose of determining the staffing requirements for each LDC, REED
included a sufficient number of employees in each stand-alone company to ensure
that customers continue to receive the present level and quality of service, and
that employees continue to utilize many of the same systems and processes in
daily operations. The labor cost estimates for additional staff are based upon
assessments of straight-time, over-time, incentive compensation, and pension and
benefit costs for each employee of the stand-alone organizations. The
incremental labor expenses are based on current Service Company salary expense,
industry benchmarking data, and REED's experience. Given the continuing
tightness in the labor markets, the levels of incentive compensation for
executive staff included in this study may not be reflective of the current
compensation packages required to retain quality management in executive
positions.
Although the CNG LDCs benefit from the centralized procurement provided by the
Service Company, for purposes of this study REED assumed that benefit levels and
costs are expected to remain unchanged in the stand-alone organization. In
addition, the study assumes that labor costs for direct employees of the
Page 5 of 37
<PAGE>
LDC subsidiaries are not expected to change. The companies would not be required
to renegotiate any collective bargaining agreements as few, if any, employees
under these agreements would be affected by divestiture. In addition, all
collective bargaining agreements are unique to each LDC.
The specific cost figures for increased labor costs are based on average salary
figures from the Service Company, utility compensation benchmarking data, and
REED's experience in LDC management. A utility-specific benefits-cost adder was
developed based on 1998 benefit costs as a share of total wages and salary for
each LDC.
Estimates of the portion of increased labor expenses that are likely to be
capitalized are based on the level of capitalized labor expenses to total labor
expenses for each LDC subsidiary based on 1998 costs.
2. Non-Labor and Facilities Costs
Unless otherwise stated, the non-labor costs are expected to remain essentially
unchanged from the costs allocated to the organizations to be spun off or
incurred directly by that organization. The primary categories of non-labor cost
increases are in the information technology resources and in the cost of
additional facilities, including office lease expenses.
3. Gas Supply Administration/Engineering Expenses
Cost differentials related to the acquisition and administration of gas supply
arrangements by four separate entities rather than by a central department were
estimated based on CNG's historical experience prior to centralizing its gas
supply administration in the Service Company. Incremental labor-related
engineering costs likewise were estimated based on staffing levels prior to the
centralization of this function in the Service Company.
4. Capital Expenditures
REED estimated additional capital expenditures resulting from divestiture of the
LDCs. Given that each LDC already operates its distribution system on a
stand-alone basis, there would be minimal increased expenditures for gas assets.
The majority of increased capital expenditures are most likely to arise from
increased capitalized labor expenses, higher procurement costs due to losses in
purchasing efficiencies, and the need to separate, duplicate, and replace
various information systems previously provided on a centralized basis. These
incremental information systems costs include computer hardware, software, and
systems applications for centralized functions within the Service Company (e.g.,
financial, human resource, gas supply) which must be performed independently in
each stand-alone company.
5. Transition/Transaction Costs
The analysis of lost economies includes costs associated with establishing the
new departments and functional areas within each LDC and/or outsourcing the
functions provided by the Service Company. These costs include organizational
restructuring costs, hiring and training costs, costs for any transitional
services provided by CNG, capital expenditures for office equipment, and any
costs incurred in outsourcing or evaluating the outsourcing of certain
functions. Estimates of the hiring and training costs were based on REED's
experience in corporate reorganization. In particular, REED estimated the costs
of hiring for executives at 1/3 the salary costs for those positions. Training
costs for new employees were assumed to be $1,000/position. In addition, the
companies would incur significant legal and financial costs associated with a
spin-off from CNG. REED estimated the legal and financial transaction costs
based on recent experience in utility merger and asset divestiture transactions.
6. Other Shareholder Costs
The divestiture of the LDCs would create four new independent, publicly traded
companies. As a result, each LDC would be responsible for shareholder-related
costs including the issuance of annual reports and proxy statements, external
reporting to the SEC, annual shareholder meeting, and other investor-relations
Page 6 of 37
<PAGE>
expenses. After comparing the costs incurred by both CNG and Dominion in these
areas, REED assumed the lower of the two as an estimate of the costs that would
be incurred by the new stand-alone LDCs.
7. Cost of Capital
Given the change in overall company size and the risk profiles of the LDC
subsidiaries as a result of a divestiture from CNG, REED expects the cost of
capital on a stand-alone basis to increase, especially for the smaller LDCs.
Estimates of the impact on debt costs of divestiture were provided by CNG. The
costs of issuing new securities for four independent companies were included in
the calculation of total transition and transaction costs for each LDC spin off.
8. Cost Pass Through
In estimating the impacts of additional costs on customers of each LDC, REED
assumed that full pass through of increased costs would be allowed in formal
rate proceedings.
9. Third-Party Contracts
Any contracts with third parties are assumed to continue in the spun-off
organizations.
III. Functions of the Service Company
While each company currently exists as a wholly-owned subsidiary within the CNG
organization, certain business functions are provided on a consolidated basis to
each subsidiary through the Service Company. The Service Company has been an
integral part of CNG since 1962,/2/ when it was formed to centralize certain
administrative and operational functions in an effort to achieve better
organizational efficiencies. In addition, through this centralized structure,
CNG is responsible for meeting the financing needs of each of its subsidiaries.
In this regard, CNG is able to obtain financing at a lower cost than if each
company were to finance itself independently.
Currently, the Service Company consists of three main areas: the Executive
Offices and Central Administrative departments, the System Services Group, and
the Regulated Business Support Group. This first area includes CNG's Executive
Offices, the Controller, Internal Auditing, Treasury, Secretary, Tax, Risk
Management, Strategic Planning, Corporate Planning, Human Resources, Employee
Benefits, Investor Relations, Asset Management, Corporate Communications, and
Legal, as well as other related central administrative departments. The second
area, the System Service Group, is responsible for centralized information
technology, telecommunications, purchasing, customer payments, payroll,
processing services, and cash management among its subsidiaries. The third area,
the Regulated Business Support Group, provides consolidated services to CNG's
regulated businesses in the areas of management, marketing, gas supply,
engineering, and materials management.
The Service Company has agreements with each of CNG's regulated subsidiaries for
the performance of the administrative and operational functions and the
allocation of costs for these services. Through this centralized administration,
the costs of such functions are shared among the CNG companies through direct
and indirect cost allocation. Due to economies of scale, each company benefits
from receiving these services at a lower cost than it if provided them on its
own.
Over the last few years, the Service Company and CNG as a whole have
restructured their operations and responsibilities to continue to take advantage
of increased operational and organizational efficiencies in light of the
changing natural gas industry. From 1994 to 1998, the combined staff of the CNG
LDC
- ----------
/2/ The original Service Company was known as Con-Gas Service Corporation
from January 1962 to January 1966.
- ----------
Page 7 of 37
<PAGE>
subsidiaries and the Service Company has been reduced from 5,240 to 4,487. The
Service Company continues to examine ways by which it can operate more
efficiently through centralized administration and operation of its system.
Page 8 of 37
<PAGE>
IV. Analysis of Lost Economies from Divestiture on East Ohio Gas
Overview
East Ohio Gas provides service to approximately 1.2 million customers in 400
eastern and western counties in Ohio. East Ohio Gas' system consists of more
than 20,000 miles of main line. Natural gas revenue in 1998 was approximately $1
billion on system throughput of 281.5 billion cubic feet of gas.
As a subsidiary of CNG, many administrative and operational functions are
performed for East Ohio Gas by the Service Company. Thus, the majority of
increased costs from divestiture result from the need to replace Service Company
personnel and resources with staff directly employed by East Ohio Gas.
Organizational and Staffing Impact
As a result of a divestiture from the CNG system, East Ohio Gas would need to
expand its organizational structure to add the executive, administrative, and
operational staff to perform the functions it currently receives from the
Service Company.
The East Ohio Gas organizational structure as of December 31, 1998 was used as a
pattern for developing the new stand-alone LDC organization. To support a
stand-alone corporate structure, an additional 289 management and staff would be
required to perform the Service Company functions. Table IV-1 provides a
breakdown of the incremental additions by executive. The new areas and their
relationship to the December 31, 1998 East Ohio Gas organizational structure are
summarized below.
Table IV-1
Summary of Incremental Staffing Requirements
at East Ohio Gas
------------------------------------------------------
Executive Position Incremental Staff
------------------------------------------------------
President 2
------------------------------------------------------
Chief Operating Officer
------------------------------------------------------
VP of Operations 35.3
------------------------------------------------------
VP of Sales and Rates 19.3
------------------------------------------------------
VP of Gas Supply 21
------------------------------------------------------
------------------------------------------------------
Chief Information Officer 111
------------------------------------------------------
------------------------------------------------------
Chief Financial Officer 2
------------------------------------------------------
VP of Finance and Treasurer 16.3
------------------------------------------------------
Controller 55
------------------------------------------------------
Director of Investor Relations 1
------------------------------------------------------
VP of Corporate Planning 1
------------------------------------------------------
------------------------------------------------------
General Counsel 8.3
------------------------------------------------------
VP of Human Resources 17
------------------------------------------------------
Total Incremental Staff 289.2
------------------------------------------------------
Page 9 of 37
<PAGE>
Board of Directors The Board of Directors is assumed to consist of 12 directors
based on the size and scope of East Ohio Gas.
Chief Executive Officer (CEO): The CEO/President position would report to the
East Ohio Gas Board of Directors rather than the Executives at the Service
Company. The CEO/President would be the highest position within the stand-alone
corporate organization. The CEO/President would be responsible for representing
the corporation to customers, the financial community, regulators and the
public. This position would carry significantly more responsibilities than the
current position of President at East Ohio Gas. This position would have new
reporting relationships with the new executives and staff added as a result of
the divestiture.
Chief Operating Officer (COO) - The COO would report directly to the CEO and
would be responsible for the overall operating activities of the company. The
COO position would be equivalent to the existing President/CEO position at East
Ohio Gas at December 31, 1998, and would oversee the work of three vice
presidents: the VP of Operations, the VP of Gas Supply, and the VP of Sales and
Rates.
The VP of Operations would be similar to the current VP of Operations
position at East Ohio Gas. However, the Engineering Services department
under the VP of Operations would be expanded to accommodate the additional
staff responsible for design standards, operating procedures, planning,
audits and compliance, and general technical support. These functions are
currently performed by the Engineering department under the Regulated
Business Support Group of the Service Company. In the event of divestiture,
East Ohio Gas would require an additional 19 engineering staff for
stand-alone operations. The VP of Operations would also oversee the
purchasing and materials management functions and the additional 16 staff
required to perform these activities.
The VP of Sales and Rates would be similar to the current VP of Sales and
Rates position at East Ohio Gas. However, the Marketing department under
this executive would be expanded and modified to accommodate the additional
staff currently under the Regulated Business Support Group of the Service
Company. While the marketing group within the Service Company operates out
of East Ohio Gas' offices, the group would be downsized at East Ohio Gas
and staff transferred to meet the marketing requirements of other LDCs in
the event of divestiture. Approximately 19 staff would be needed to support
the East Ohio Gas marketing function.
The VP of Gas Supply would be a new position responsible for all gas supply
planning, procurement, and contract administration. In the event of
divestiture, East Ohio Gas would require an additional 20 gas supply staff
reporting to the VP of Gas Supply for stand-alone operations. Gas Supply is
currently managed centrally by the Service Company. Under the current
structure, the CNG LDCs have submitted joint comments in response to
actions by the Federal Energy Regulatory Commission and have jointly
intervened in interstate pipeline regulatory proceedings where they have
common interests. In the event of a spin-off, East Ohio Gas would have to
independently participate in these regulatory filings. These increased
costs associated with the increased responsibilities for federal regulatory
filings have been included in the labor costs increases in the gas supply
area, as this department is responsible for dealing with these issues.
Chief Information Officer (CIO) would be a new position responsible for the
information technology needs of East Ohio Gas. These functions are currently
provided centrally by the Service Company. This position would oversee the
entire information systems, communication systems, data processing, application
development, software and hardware procurement within the East Ohio Gas
organization.
Page 10 of 37
<PAGE>
Approximately, 111 staff would be added to support the information technology
needs of East Ohio Gas as a stand-alone LDC.
Chief Financial Officer (CFO) - The Chief Financial Officer would report
directly to the CEO and would be responsible for corporate finance, corporate
planning, treasury, accounting, risk management, and investor relations. The CFO
would oversee the work of two vice presidents and two directors, the VP of
Finance and Treasurer, the VP of Corporate Planning, the Controller, and the
Director of Investor Relations. As part of this reorganization, the current
responsibilities of East Ohio Gas' VP of Finance and VP of Corporate Planning
positions would be modified. Certain responsibilities under East Ohio Gas' VP of
Finance position would be moved under the Controller function, while others such
as risk management, cash processing, and strategic financial planning would be
moved under the new VP of Finance and Treasurer position. These new functional
areas are described in detail below.
The VP of Finance and Treasurer would be a new position similar to the
existing VP of Finance at East Ohio Gas. This position would incorporate
the role of Treasurer and the corporate financial functions currently
provided by the Service Company, including Risk Management, Financial
Systems, Strategic Financial Planning, Purchasing and Facilities
Management. This position would be in charge of all financing, both debt
and equity for the new corporate entity of East Ohio Gas. Approximately 16
new staff would be added in the departments reporting to this position.
The Controller would assume the accounting-related functions currently
directed by East Ohio Gas' VP of Finance. The Controller would oversee all
accounting, cash management, transaction processing, customer billing,
internal auditing, external reporting, and tax functions of East Ohio Gas.
An additional 55 management and staff positions would be required to
support these accounting and processing services currently provided by the
Service Company.
The Director of Investor Relations would handle all financial corporate
communications and would be in charge of producing the Annual Report and
organizing the annual stockholders meetings.
The VP of Corporate Planning would be similar to the current position at
East Ohio Gas. The role of corporate strategic planning would be expanded
as East Ohio Gas would exist as its own entity. One additional analyst
would be required to support the increased role of strategic planning in
the new stand-alone organization.
General Counsel - The General Counsel reports directly to the CEO and would be
responsible for overseeing legal affairs, government affairs, and corporate
communications. The existing General Counsel position within East Ohio Gas would
be expanded to assume responsibilities over all corporate legal matters,
environmental compliance, SEC compliance, litigation, state and federal
regulatory matters, labor and benefit legal matters, contracts and corporate
governance. A new executive position under the General Counsel would be created
to consolidate the external communications and policy work of East Ohio Gas. The
General Counsel would oversee all legal services procured through outside
attorneys. The new position of Corporate Secretary would report to the General
Counsel.
The Director of External Affairs and Policy Development would report to the
General Counsel. The existing Community Affairs, Government Affairs, and
Corporate Communications departments within East Ohio Gas would report to
this position. The existing manager of Corporate Communications/Media
Relations under East Ohio Gas' current VP of Sales and Rates would transfer
reporting functions to this Director.
Page 11 of 37
<PAGE>
In addition to the transfer of current positions and departmental reporting to
the General Counsel, approximately 8 incremental positions would be added within
this area.
Human Resources - The VP of Human Resources would report directly to the CEO and
would be responsible for employee staffing, compensation, training, benefits,
health services, employee services, and security. All positions currently
reporting to East Ohio Gas' Director of Human Resources would report to the new
VP of Human Resources. In addition, reporting departments would be expanded to
include additional staff responsible for employee benefits servicing, which is
currently provided by a third-party vendor through an outsource arrangement by
the Service Company. The spin-off of East Ohio Gas would require an additional
staff of 17 within the Human Resources and Benefits Administration function.
Facilities Impact
As a result of the addition of 289 full-time equivalent staff, East Ohio Gas
would be required to lease additional office space. REED estimates that
approximately 92,500 square feet of additional space would be required. The
estimated costs for this space are $1.89 million per year. However, when
compared with the current allocation of lease expenses in the charges from the
Service Company, the net effect for East Ohio Gas is an annual savings of
$377,000 in lease expenses.
Information Technology - Non-labor/Outside Services
East Ohio Gas would experience significant non-labor cost increases from the
need to assume full responsibility for the information technology functions
provided by the Service Company. The additional labor-related costs have already
been incorporated into the labor cost figures above. Many of these non-labor
costs would be one-time transition costs for the replacement and duplication of
central systems currently operated and maintained by the Service Company. These
systems, which would be separated and/or duplicated for East Ohio Gas, include
the following:
East Ohio Gas would require its own employee, human resources, and payroll
information system. The current People Soft program would need to be
duplicated and customized for East Ohio Gas as a stand-alone company.
CNG's Oracle-based financial applications (purchasing, inventory, project
accounting, general ledger, accounts payable, accounts receivable,
budgeting, fixed assets) would need to be duplicated and customized for
East Ohio Gas.
The ALTRA Gas Management System would need to be purchased and customized
by East Ohio Gas. This program is used for transaction processing, contract
administration, and gas accounting. A separate Oracle-based system would be
required for the administration and management of contracts with local
producers directly connected to the East Ohio Gas system.
The SAMS engineering system already in place within the East Ohio Gas
engineering department would need ongoing support and maintenance from East
Ohio Gas.
The new customer information system developed by the Service Company, CAMP
(Customer Activities and Marketing Project), consists of three tiers: 1) a
central database and the batch billing process run on an IBM mainframe; 2)
UNIX Servers and a relational database from Sybase; 3) the client tier
which is customized using Power Builder. The current centralized CAMP
system would need to be separated and redesigned for stand alone
operations. In addition, East Ohio Gas would
Page 12 of 37
<PAGE>
require its own independent server/mainframe to serve as the first tier of
the stand alone CAMP system.
East Ohio Gas would need its own version of ACCLAIM, a system used to
automate dispatching and communicate service orders.
East Ohio Gas would also need its own version of the ITRON hardware used
for the Meter Reading System.
REED estimates the costs to separate, replace and duplicate these systems to be
approximately $38.4 million. Assuming the systems are depreciated on the same
basis as that used by the Service Company, the annual depreciation costs would
be $3.9 million. While the majority of these IT-related costs would be one-time
transition costs, annual maintenance and lease costs are expected to be higher
for the stand-alone company. Currently, the Service Company outsources the help
desk function. Its uncertain whether East Ohio Gas would be able to continue
this arrangement on a stand-alone basis at its current cost. In addition, East
Ohio Gas would loose the opportunity to jointly develop new applications and
share the cost of those applications with other corporate entities.
Loss of Purchasing Efficiencies
Currently, the Service Company centrally manages purchasing across all CNG
subsidiaries. East Ohio Gas would have to assume responsibility for acquisition
planning, purchase order placement, supplier negotiations, contract formation,
contract administration, expediting, supplier payment problem resolution,
purchasing systems support, and supplier source development. In addition to the
administrative and labor cost increases for this function, East Ohio Gas would
experience reduced purchasing economies on a stand-alone basis. Based on CNG's
experience to date in savings achieved from centralized procurement, East Ohio
Gas is estimated to lose approximately $6 million in annual savings. The $3.1
million annual impact of this lost savings assumes 50% of the total procurement
savings applies to capitalized expenditures. The primary categories for
procurement savings include purchases of gas line materials, such as plastic
pipe, valves, and meter sets; purchases of gas line services such as
environmental services, construction services, and line locating; and purchases
of administrative support equipment and services, including long distance,
office supplies, computer support, and personal computers.
Cost of Capital
The divestiture of East Ohio Gas from the CNG family of companies would require
the recapitalization of the debt at prevailing market rates and an issuance of
equity for the new corporation at the time of the spin-off. This study assumes
that the existing East Ohio Gas capital structure would be maintained in the
stand-alone organization. However, East Ohio Gas would be required to replace
approximately $150 million of short-term debt with long-term financing. Assuming
no change in the existing cost of equity, based on the market capitalization at
year-end 1998, East Ohio Gas would experience a pre-tax capital cost increase of
$6 million, or an after-tax capital cost increase of $3.9 million.
Transition/Transaction Costs
The divestiture of East Ohio Gas from CNG and the creation of a stand-alone
utility would be a complex legal and financial transaction that would incur
significant transition costs. The costs for issuance of new debt and equity
securities are based on standard fees for similar transactions by other
utilities. Other transaction costs include legal and financial advisory fees,
fees for independent accountants, actuaries, and other management consultants.
As discussed above, East Ohio Gas would incur significant costs to
Page 13 of 37
<PAGE>
either purchase, duplicate, or replace many of the information systems provided
by the Service Company. Real estate services would be required to obtain
additional office space for increased staff at the LDC. The company would
experience significant costs for hiring and training the 289 additional staff
required for stand-alone operations. The hiring costs for senior executives are
estimated at 1/3 the first year's salary. REED estimated hiring and training
costs for incremental staff at $1000/employee. The following transition costs
would be applicable in a spin-off of East Ohio Gas:
Table IV-2
Summary of Transition/Transaction Costs for East Ohio Gas
------------------------------------- ------------------------------------
Category Total Fees
------------------------------------- ------------------------------------
Transaction Costs (debt and equity $4,879,000
issuance)
------------------------------------- ------------------------------------
Legal, accounting, other advisory $3,000,000
fees
------------------------------------- ------------------------------------
Hiring/Training $1,452,210
------------------------------------- ------------------------------------
Total Costs $9,331,210
------------------------------------- ------------------------------------
Annual Amortization (10 years) $933,121
------------------------------------- ------------------------------------
Other Indirect Lost Economies
Although East Ohio Gas has its own contracts for gas supply, storage, and
transportation services, the procurement and administration of gas
supply-related resources are managed by the gas supply area of the Service
Company. In addition to the increased labor costs from assuming responsibility
for supply planning, procurement, and day-to-day administration, East Ohio Gas
will lose the purchasing economies enjoyed by the centralized management of this
function by CNG. Given the continuing change and evolution of the gas market, it
is difficult to quantify the degree of cost savings provided by central
management beyond the administrative labor cost savings. However, the experience
of the Service Company suggests that CNG has been able to obtain lower-cost
supplies through bulk purchasing for the LDC group and enhance capacity release
credits through its centralized administration and purchasing.
Summary of Impacts for East Ohio Gas Spin-Off
The study illustrates that a spin-off of East Ohio Gas into a stand-alone LDC
would require an additional 289 full-time management and staff positions. Based
on the assumptions set forth in Section II and the staffing requirements
outlined above, the annual cost increase is estimated to be $20.9 million. The
categories of cost increases are set forth below.
Table IV-3
Summary of Lost Economies for East Ohio Gas
-----------------------------------------------------------------
Cost Category Annual Increase
-----------------------------------------------------------------
Board of Directors' Fees $300,000
-----------------------------------------------------------------
Labor O&M $5,980,291
-----------------------------------------------------------------
Facilities Expense ($377,925)
-----------------------------------------------------------------
Lost OM&A Procurement Savings $3,000,000
-----------------------------------------------------------------
Depreciation and Return on Capitalized $145,411
Labor Costs
-----------------------------------------------------------------
Depreciation and Return on Lost $111,720
Capital Procurement Savings
-----------------------------------------------------------------
Page 14 of 37
<PAGE>
-----------------------------------------------------------------
Cost Category Annual Increase
-----------------------------------------------------------------
Cost of Capital Impact (Pre-Tax) $6,063,132
-----------------------------------------------------------------
Amortization of IS/IT Replacement $3,940,660
-----------------------------------------------------------------
Amortization of Transition Costs $933,121
-----------------------------------------------------------------
Other Shareholder-Related Costs $811,734
-----------------------------------------------------------------
TOTAL $20,908,144
-----------------------------------------------------------------
Table IV-4
Analysis of Lost Economies for East Ohio Gas
------------------------------------- --------------------
Total Lost Economies $20,908,144
------------------------------------- --------------------
Lost Economies as a percent of
------------------------------------- --------------------
Total Revenues 2.052%
------------------------------------- --------------------
Net Revenues 4.737%
------------------------------------- --------------------
Total Expenses 2.290%
------------------------------------- --------------------
Non-Gas Expenses 6.231%
------------------------------------- --------------------
Gross Income 19.76%
------------------------------------- --------------------
Net Income 36.61%
------------------------------------- --------------------
In absence of rate relief
------------------------------------- --------------------
Estimated return on rate base 5.1977%
------------------------------------- --------------------
Estimated return on net plant 4.8723%
------------------------------------- --------------------
Table IV-5
Analysis of Customer Impacts of
Lost Economies for East Ohio Gas
--------------------------------- ---------------------
Rate Revenue
--------------------------------- ---------------------
Pre-Spin-Off $1,018,979
--------------------------------- ---------------------
Post-Spin-Off $1,080,697
--------------------------------- ---------------------
Dollar Increase $61,718
--------------------------------- ---------------------
Percent Increase 6.057%
--------------------------------- ---------------------
Page 15 of 37
<PAGE>
V. Analysis of Lost Economies from Divestiture on Peoples Natural Gas
Overview
Peoples Natural Gas provides service to approximately 350,000 customers in
western Pennsylvania. Peoples Natural Gas' system consists of approximately
6,600 miles of transmission and distribution lines. Natural gas revenue in 1998
was approximately $300 million on system throughput of 77.1 billion cubic feet
of gas.
As a subsidiary of CNG, many administrative and operational functions are
performed for Peoples Natural Gas by the Service Company. Thus, the majority of
increased costs from divestiture result from the need to replace Service Company
personnel and resources with staff directly employed by Peoples Natural Gas.
Organizational and Staffing Impact
As a result of a divestiture from the CNG system, Peoples Natural Gas would need
to expand its organizational structure to add the executive, administrative, and
operational staff to perform the functions it currently receives from the
Service Company.
The Peoples Natural Gas organizational structure as of December 31, 1998 was
used as a pattern for developing the new stand-alone LDC organization. To
support a stand-alone corporate structure, an additional 179 management and
staff positions would be required to perform the Service Company functions. The
new areas and their relationship to the December 31, 1998 Peoples Natural Gas
organizational structure are summarized below.
Table V-1
Summary of Incremental Staffing Requirements
at Peoples Natural Gas
------------------------------------------------------
Executive Position Incremental Staff
------------------------------------------------------
President 2
------------------------------------------------------
Chief Operating Officer 2
------------------------------------------------------
VP of Operations 25.3
------------------------------------------------------
Director of Sales 8
------------------------------------------------------
VP of Gas Supply 10
------------------------------------------------------
------------------------------------------------------
Chief Information Officer 55
------------------------------------------------------
------------------------------------------------------
Chief Financial Officer 2
------------------------------------------------------
VP of Finance and Treasurer 14
------------------------------------------------------
Controller 39.3
------------------------------------------------------
Director of Investor Relations 1
------------------------------------------------------
Director of Corporate Planning 1
------------------------------------------------------
------------------------------------------------------
General Counsel 6.8
------------------------------------------------------
VP of Human Resources 13
------------------------------------------------------
Total Incremental Staff 179.4
------------------------------------------------------
Page 16 of 37
<PAGE>
Board of Directors The Board of Directors is assumed to consist of 12 directors
based on the size and scope of Peoples Natural Gas.
Chief Executive Officer (CEO): The CEO/President position would report to the
Peoples Natural Gas Board of Directors rather than the Executives at the Service
Company. The CEO/President would be the highest position within the stand-alone
corporate organization. The CEO/President would be responsible for representing
the corporation to customers, the financial community, regulators and the
public. This position would carry significantly more responsibilities than the
current position of President at Peoples Natural Gas. This position would have
new reporting relationships with new executives and staff added as a result of
the divestiture.
Chief Operating Officer (COO) - The COO would report directly to the CEO and
would be responsible for the overall operating activities of the Company. The
COO would oversee the work of three vice presidents and two directors: the VP of
Operations, the VP of Gas Supply, the VP of Rates and Regulatory Affairs, the
Director of Customer Service, and the Director of Sales. With the exception of
the VP of Gas Supply, all positions currently exist within the Peoples Natural
Gas Organization.
The VP of Operations would be similar to the current VP of Operations
position at Peoples Natural Gas. However, the Engineering Services
department under the VP of Operations would be expanded to accommodate the
additional staff responsible for design standards, operating procedures,
planning, audits and compliance, and general technical support. These
functions are currently performed by the Engineering department under the
Regulated Business Support Group of the Service Company. In the event of
divestiture, Peoples Natural Gas would require an additional 12 engineering
staff for stand-alone operations. The VP of Operations would also oversee
the purchasing and materials management functions and the additional 13
staff required to perform these activities.
The Director of Sales position would continue in the new organization.
However, the Marketing department under this executive would be expanded to
accommodate the additional staff currently under the Regulated Business
Support Group of the Service Company. Approximately 8 staff from the
existing marketing group would be transferred to support the Peoples
Natural Gas marketing function.
The VP of Gas Supply would be a new position responsible for all gas supply
planning, procurement, and contract administration. In the event of
divestiture, Peoples Natural Gas would require an additional 9 gas supply
staff reporting to the VP of Gas Supply for stand-alone operations. Gas
Supply is currently managed centrally by the Service Company. Under the
current structure, the CNG LDCs have submitted joint comments in response
to actions by the Federal Energy Regulatory Commission and have jointly
intervened in interstate pipeline regulatory proceedings where they have
common interests. In the event of a spin-off, Peoples Natural Gas would
have to independently participate in these regulatory filings. These
increased costs associated with the increased responsibilities for federal
regulatory filings have been included in the labor costs increases in the
gas supply area, as this department is responsible for dealing with these
issues.
Chief Information Officer (CIO) would be a new position responsible for the
information technology needs of Peoples Natural Gas. Currently, these functions
are provided centrally by the Service Company. This position would oversee the
entire information systems, communication systems, data processing, application
development, software and hardware procurement within the Peoples Natural Gas
Page 17 of 37
<PAGE>
organization. Approximately, 55 managers and staff would be added to support the
information technology needs of Peoples Natural Gas as a stand-alone LDC.
Chief Financial Officer (CFO) - The Chief Financial Officer would report
directly to the CEO and would be responsible for corporate finance, corporate
planning, treasury, accounting, risk management, and investor relations. As part
of this reorganization, the current responsibilities of Peoples Natural Gas'
Director of Finance and Budget would be split between three new senior
management positions: VP of Finance and Treasurer, Director of Corporate
Planning, and Controller. The Director of Investor Relations would also report
to the CFO. These new functional areas are described in detail below.
The VP of Finance and Treasurer would be a new position responsible for
Treasury and the corporate financial functions currently provided by the
Service Company, including Risk Management, Financial Systems, Strategic
Financial Planning, Purchasing and Facilities Management. This position
would be in charge of all financing, both debt and equity for the new
corporate entity of Peoples Natural Gas. Approximately 14 new staff would
be added in the departments reporting to this position.
The Controller would assume the accounting-related functions currently
directed by Peoples Natural's Director of Finance and Budgets. The
Controller would oversee all accounting, cash management, transaction
processing, customer billing, internal auditing, external reporting and tax
functions of Peoples Natural Gas. An additional 39 management and staff
would be required to support these accounting and processing services
currently provided by the Service Company.
The Director of Investor Relations would handle all financial corporate
communications and would be in charge of producing the Annual Report and
organizing the annual stockholders meetings.
The Director of Corporate Planning would be added to expand the corporate
strategic planning function within the stand-alone LDC. This position would
support part of the existing Finance and Budget department within Peoples
Natural Gas.
General Counsel - The General Counsel would report directly to the CEO and would
be responsible for overseeing the legal affairs, government affairs, and
corporate communications. The existing General Counsel position within Peoples
Natural Gas would be expanded to assume responsibilities over all corporate
legal matters, environmental compliance, SEC compliance, litigation, state and
federal regulatory matters, labor and benefit legal matters, contracts and
corporate governance. A new executive position under the General Counsel would
be created to consolidate the external communications and policy work of Peoples
Natural Gas. The General Counsel would oversee all legal services procured
through outside attorneys. The new position of Corporate Secretary would report
to the General Counsel.
The Director of External Affairs and Policy Development would report to the
General Counsel. This position would be an expansion of the current General
Manager of Public Affairs within the Peoples Natural Gas organization. The
existing Community Affairs, Government Affairs, and Corporate
Communications departments within Peoples Natural Gas would continue to
report to this position.
In addition to the transfer of current positions and departmental reporting to
the General Counsel, approximately 7 incremental positions would be added under
this position.
Human Resources - The VP of Human Resources would report directly to the CEO and
would be responsible for employee staffing, compensation, training, benefits,
health services, employee services,
Page 18 of 37
<PAGE>
and security. All positions currently reporting to Peoples Natural Gas' Director
of Human Resources would report to the new VP of Human Resources. In addition,
reporting departments would be expanded to include additional staff responsible
for employee benefits servicing, which is currently provided by a third-party
vendor through an outsource arrangement by the Service Company. The spin-off of
Peoples Natural Gas would require an additional staff of 13 within the Human
Resources and Benefits Administration function.
Facilities Impact
As a result of the addition of 179 full-time equivalent staff, Peoples Natural
Gas would be required to lease additional office space for these new employees.
REED estimates that approximately, 56,600 square feet of additional space would
be required. The estimated costs for this space are $1.2 million per year. When
compared with the allocation of lease expenses from the Service Company, the
annual incremental lease cost is estimated to be $310,000.
Information Technology - Non-labor/Outside Services
Peoples Natural Gas would experience significant non-labor cost increases from
the need to assume full responsibility for the information technology functions
provided by the Service Company. The additional labor-related costs have already
been incorporated into the labor cost figures above. Many of these non-labor
costs would be one-time transition costs for the replacement and duplication of
central systems currently operated and maintained by the Service Company. These
systems, which would be duplicated by Peoples Natural Gas, include the
following:
Peoples Natural Gas would require its own employee, human resources, and
payroll information system. The current People Soft program would need to
be duplicated and customized for Peoples Natural Gas as a stand-alone
company.
CNG's Oracle-based financial applications (purchasing, inventory, project
accounting, general ledger, accounts payable, accounts receivable,
budgeting, fixed assets) would need to be duplicated and customized for
Peoples Natural Gas.
The ALTRA Gas Management System would need to be purchased and customized
by Peoples Natural Gas. This program is used for transaction processing,
contract administration, and gas accounting. A separate Oracle-based system
would be required for the administration and management of contracts with
local producers directly connected to the Peoples Natural Gas system.
The new customer information system developed by the Service Company, CAMP
(Customer Activities and Marketing Project), consists of three tiers: 1) a
central database and the batch billing process run on an IBM mainframe; 2)
UNIX Servers and a relational database from Sybase; 3) the client tier,
which is customized using Power Builder. The current centralized CAMP
system would need to be separated and redesigned for stand alone
operations. In addition, Peoples Natural Gas would require its own
independent server/mainframe to serve as the first tier of the stand alone
CAMP system.
Peoples Natural Gas would need its own version of ACCLAIM, a system used to
automate dispatching and communicate service orders.
Peoples Natural Gas would also need its own version of the ITRON hardware
used for the Meter Reading System.
Page 19 of 37
<PAGE>
REED estimates the costs to separate, replace and duplicate these systems to be
approximately $23.1 million. Assuming the systems are depreciated on the same
basis as that used by the Service Company, the annual depreciation costs would
be $2.4 million. While many of these IT-related costs would be one-time
transition costs, annual maintenance and lease costs are expected to be higher
for the stand-alone company. The Service Company currently outsources the help
desk function. It's uncertain whether Peoples Natural Gas would be able to
continue this arrangement on a stand-alone basis at its current cost. In
addition, Peoples Natural Gas would lose the opportunity to jointly develop new
applications and share the cost of those applications with other corporate
entities.
Loss in Purchasing Efficiencies
As mentioned earlier, the Service Company centrally manages purchasing across
all CNG subsidiaries. Peoples Natural Gas would have to assume responsibility
for acquisition planning, purchase order placement, supplier negotiations,
contract formation, contract administration, expediting, supplier payment
problem resolution, purchasing systems support, and supplier source development.
In addition to the administrative and labor cost increases for this function,
Peoples Natural Gas would experience reduced purchasing economies on a
stand-alone basis. Based on CNG's experience to date in savings achieved from
centralized procurement, Peoples Natural Gas is estimated to lose approximately
$2 million a year in savings. The $1.04 million annual impact of this lost
savings assumes 50% of the total procurement savings applies to capitalized
expenditures. The primary categories for procurement savings include purchases
of gas line materials, such as plastic pipe, valves, and meter sets; purchases
of gas line services such as environmental services, construction services, and
line locating; and purchases of administrative support equipment and services,
including long distance, office supplies, computer support, and personal
computers.
Cost of Capital
The divestiture of Peoples Natural Gas from the CNG family of companies would
require the recapitalization of the debt at prevailing market rates at the time
of the spin-off. This study assumes that the existing Peoples Natural Gas
capital structure would be maintained in the stand-alone organization. Assuming
no change in the existing cost of equity, based on the market capitalization at
year-end 1998, Peoples Natural Gas would experience a pre-tax capital cost
increase of $2.1 million or an after-tax capital cost increase of $1.2 million.
Transition/Transaction Costs
The divestiture of Peoples Natural Gas from CNG and the creation of a
stand-alone utility would be a complex legal and financial transaction that
would incur significant transition costs. The costs for issuance of new debt and
equity securities are based on standard fees for similar transactions by other
utilities. These costs include the legal and financial advisory fees, fees for
independent accountants, actuaries, and other management consultants. As
discussed above, Peoples Natural Gas would incur significant costs to either
purchase, duplicate, or replace many of the information systems provided by the
Service Company. Real estate services would be required to obtain additional
office space for increased staff at the LDC. The company would experience
significant costs for hiring and training the more than 179 additional staff
required for stand-alone operations. The hiring costs for senior executives are
estimated at 1/3 the first year's salary. REED estimated hiring and training
costs for incremental staff at $1000/employee. The following transition costs
would be applicable in a spin-off of Peoples Natural Gas:
Page 20 of 37
<PAGE>
Table V-2
Summary of Transition/Transaction Costs for Peoples Natural Gas
------------------------------------- --------------------------------
Category Total Fees
------------------------------------- --------------------------------
Transaction Costs (debt and equity $2,415,000
issuance)
------------------------------------- --------------------------------
Legal, accounting, other advisory $3,000,000
fees
------------------------------------- --------------------------------
Hiring/Training $1,262,700
------------------------------------- --------------------------------
Total Costs $6,677,700
------------------------------------- --------------------------------
Annual Amortization (10 years) $667,770
------------------------------------- --------------------------------
Other Indirect Lost Economies
Although Peoples Natural Gas has its own contracts for gas supply, storage, and
transportation services, the procurement and administration of gas
supply-related resources is managed by the gas supply area of the Service
Company. In addition to the increased labor costs from assuming responsibility
for supply planning, procurement, and day-to-day administration, Peoples Natural
Gas would lose the purchasing economies enjoyed by the centralized management of
this function by CNG. Given the continuing change and evolution of the gas
market, it is difficult to quantify the degree of cost savings provided by
central management beyond the administrative labor cost savings. However, the
experience of the Service Company suggests that CNG has been able to obtain
lower-cost supplies through bulk purchasing for the LDC group and enhance
capacity release credits through its centralized administration and purchasing.
Summary of Impacts for Peoples Natural Gas Spin-Off
The study illustrates that a spin-off of Peoples Natural Gas into a stand-alone
LDC would require an additional 179 full-time management and staff positions.
Based on the assumptions set forth in Section II and the staffing requirements
outlined above, the annual cost increase is estimated to be $15.7 million. The
categories of cost increases are set forth below.
Table V-3
Summary of Lost Economies for Peoples Natural Gas
-----------------------------------------------------------------
Cost Category Annual Increase
-----------------------------------------------------------------
Board of Directors' Fees $300,000
-----------------------------------------------------------------
Labor O&M $7,879,208
-----------------------------------------------------------------
Facilities Expense $309,575
-----------------------------------------------------------------
Lost OM&A Procurement Savings $1,000,000
-----------------------------------------------------------------
Depreciation and Return on Capitalized $192,883
Labor Costs
-----------------------------------------------------------------
Depreciation and Return on Lost $35,599
Capital Procurement Savings
-----------------------------------------------------------------
Cost of Capital Impact (Pre-Tax) $2,103,797
-----------------------------------------------------------------
Amortization of IS/IT Replacement $2,414,555
-----------------------------------------------------------------
Amortization of Transition Costs $667,770
-----------------------------------------------------------------
Other Shareholder-Related Costs $811,734
-----------------------------------------------------------------
TOTAL $15,715,120
-----------------------------------------------------------------
Page 21 of 37
<PAGE>
Table V-4
Analysis of Lost Economies for Peoples Natural Gas
-------------------------------------- --------------------
Total Lost Economies $15,715,120
-------------------------------------- --------------------
Lost Economies as a percent of
-------------------------------------- --------------------
Total Revenues 5.190%
-------------------------------------- --------------------
Net Revenues 8.500%
-------------------------------------- --------------------
Total Expenses 6.579%
-------------------------------------- --------------------
Net Expenses 12.994%
-------------------------------------- --------------------
Gross Income 24.58%
-------------------------------------- --------------------
Net Income 43.37%
-------------------------------------- --------------------
In absence of rate relief
-------------------------------------- --------------------
Estimated return on rate base 7.1758%
-------------------------------------- --------------------
Estimated return on net plant 6.0761%
-------------------------------------- --------------------
Table V-5
Analysis of Customer Impacts of
Lost Economies for Peoples Natural Gas
--------------------------------- ---------------------
Rate Revenue
--------------------------------- ---------------------
Pre-Spin-Off $302,806
--------------------------------- ---------------------
Post-Spin-Off $326,957
--------------------------------- ---------------------
Dollar Increase $24,151
--------------------------------- ---------------------
Percent Increase 7.976%
--------------------------------- ---------------------
Page 22 of 37
<PAGE>
VI. Analysis of Lost Economies from Divestiture on Virginia Natural Gas
Overview
Virginia Natural Gas provides service to approximately 201,900 customers in
Virginia. Virginia Natural Gas' system consists of 3,856 miles of transmission
and distribution main lines. Natural gas revenue in 1998 was $189 million on
system throughput of 50.9 billion cubic feet of gas.
Organizational and Staffing Impact
As a result of a divestiture from the CNG system, Virginia Natural Gas would
need to expand its organizational structure to add the executive,
administrative, and operational staff to perform the functions it currently
receives from the Service Company.
The Virginia Natural Gas organizational structure as of December 31, 1998 was
used as a pattern for developing the new stand-alone LDC organization. To
support a stand-alone corporate structure, an additional 131 management and
staff would be required to perform the Service Company functions. The new areas
and their relationship to the December 31, 1998 Virginia Natural Gas
organizational structure are summarized below.
Table VI-1
Summary of Incremental Staffing Requirements
at Virginia Natural Gas
- ------------------------------------------------------
Executive Position Incremental Staff
- ------------------------------------------------------
President 2
- ------------------------------------------------------
Chief Operating Officer
- ------------------------------------------------------
VP of Operations 19.3
- ------------------------------------------------------
VP of Marketing and Rates 5
- ------------------------------------------------------
VP of Gas Supply 8.5
- ------------------------------------------------------
- ------------------------------------------------------
Chief Information Officer 35
- ------------------------------------------------------
- ------------------------------------------------------
Chief Financial Officer 2
- ------------------------------------------------------
VP of Finance and Treasurer 11
- ------------------------------------------------------
Controller 29.3
- ------------------------------------------------------
Director of Investor Relations 1
- ------------------------------------------------------
Director of Corporate Planning 1
- ------------------------------------------------------
- ------------------------------------------------------
General Counsel 9.3
- ------------------------------------------------------
VP of Human Resources 8
- ------------------------------------------------------
Total Incremental Staff 131.4
- ------------------------------------------------------
Board of Directors The Board of Directors is assumed to consist of 9 directors
based on the size and scope of Virginia Natural Gas.
Chief Executive Officer (CEO): The CEO/President position would report to the
Virginia Natural Gas Board of Directors rather than the Executives at the
Service Company. The CEO/President would be the highest position within the
stand-alone corporate organization. The CEO/President would be responsible
Page 23 of 37
<PAGE>
for representing the corporation to customers, the financial community,
regulators and the public. This position would carry significantly more
responsibilities than the current position of President at Virginia Natural Gas.
This position would have new reporting relationships with new executives and
staff added as a result of the divestiture.
Chief Operating Officer (COO) - The COO would report directly to the CEO and
would be responsible for the overall operating activities of the Company. The
COO would oversee the work of three vice presidents: the VP of Operations, the
VP of Gas Supply, and the VP of Marketing and Rates. With the exception of the
VP of Gas Supply, all positions currently exist within the Virginia Natural Gas
Organization.
The VP of Operations would be similar to the current VP of Operations
position at Virginia Natural Gas. However, the Engineering Services
department under the VP of Operations would be expanded to accommodate the
additional staff responsible for design standards, operating procedures,
planning, audits and compliance, and general technical support. These
functions are currently performed by the Engineering department under the
Regulated Business Support Group of the Service Company. In the event of
divestiture, Virginia Natural Gas would require an additional 10
engineering staff for stand-alone operations. The VP of Operations would
also oversee the purchasing and materials management functions and the
additional 9 staff required to perform these activities.
The VP of Marketing and Rates position would continue in the new
organization. However, the Marketing department under this executive would
be expanded to accommodate the additional staff currently under the
Regulated Business Support Group of the Service Company. Approximately 5
staff from the existing marketing group would be transferred to support the
Virginia Natural Gas marketing function.
The VP of Gas Supply would be a new position responsible for all gas supply
planning, procurement, and contract administration. In the event of
divestiture, Virginia Natural Gas would require an additional 7.5 gas
supply staff reporting to the VP of Gas Supply for stand-alone operations.
Gas Supply is currently managed centrally by the Service Company. Under the
current structure, the CNG LDCs have submitted joint comments in response
to actions by the Federal Energy Regulatory Commission and have jointly
intervened in interstate pipeline regulatory proceedings where they have
common interests. In the event of a spin-off, Virginia Natural Gas would
have to independently participate in these regulatory filings. These
increased costs associated with the increased responsibilities for federal
regulatory filings have been included in the labor costs increases in the
gas supply area, as this department is responsible for dealing with these
issues.
Chief Information Officer (CIO) would be a new position responsible for the
information technology needs of Virginia Natural Gas. Currently, these functions
are provided centrally by the Service Company. This position would oversee the
entire information systems, communication systems, data processing, application
development, software and hardware procurement within the Virginia Natural Gas
organization. Approximately, 35 staff would be added to support the information
technology needs of Virginia Natural Gas as a stand-alone LDC.
Chief Financial Officer (CFO) - The Chief Financial Officer would report
directly to the CEO and be responsible for corporate finance, corporate
planning, treasury, accounting, risk management, and investor relations. As part
of this reorganization, the current responsibilities of Virginia Natural Gas'
Treasurer/Controller/Director of Finance would be split between three new senior
management positions:
Page 24 of 37
<PAGE>
the VP of Finance and Treasurer, the Director of Corporate Planning, and the
Controller. The Director of Investor Relations would also report to the CFO.
These new functional areas are described in detail below.
The VP of Finance and Treasurer would be a new position responsible for
Treasury and the corporate financial functions currently provided by the
Service Company, including Risk Management, Financial Systems, Strategic
Financial Planning, Purchasing and Facilities Management. This position
would be in charge of all financing, both debt and equity for the new
corporate entity of Virginia Natural Gas. Approximately 11 new staff would
be added in the departments reporting to this position.
The Controller would assume the accounting-related functions currently
directed by Virginia Natural Gas' Treasurer/Controller/Director of Finance.
The Controller would oversee all accounting, cash management, transaction
processing, customer billing, internal auditing, external reporting and tax
functions of Virginia Natural Gas. An additional 29 management and staff
would be required to support these accounting and processing services
currently provided by the Service Company.
The Director of Investor Relations would handle all financial corporate
communications and would be in charge of producing the Annual Report and
organizing the annual stockholders meetings.
The Director of Corporate Planning would be added to expand the corporate
strategic planning function within the stand-alone LDC. This position would
support part of the existing Planning and Budget department within Virginia
Natural Gas.
General Counsel - The General Counsel reports directly to the CEO and would be
responsible for overseeing the legal affairs, government affairs, and corporate
communications. The existing General Counsel position within Virginia Natural
Gas would be expanded to assume responsibilities over all corporate legal
matters, environmental compliance, SEC compliance, litigation, state and federal
regulatory matters, labor and benefit legal matters, contracts and corporate
governance. A new executive position under the General Counsel would be created
to consolidate the external communications and policy work of Virginia Natural
Gas. The General Counsel would oversee all legal services procured through
outside attorneys. The new position of Corporate Secretary would report to the
General Counsel.
The Director of External Affairs and Policy Development would report to the
General Counsel. The existing Public Affairs and Communications departments
within Virginia Natural Gas would report to this position.
In addition to the transfer of current positions and departmental reporting to
the General Counsel, approximately 9 incremental positions would be added under
this position.
Human Resources - The VP of Human Resources would report directly to the CEO and
would be responsible for employee staffing, compensation, training, benefits,
health services, employee services and security. All positions currently
reporting to Virginia Natural Gas' Director of Human Resource would report to
the new VP of Human Resources. In addition, reporting departments would be
expanded to include additional staff responsible for employee benefits
servicing, which is currently provided by a third-party vendor through an
outsource arrangement by the Service Company. The spin-off of Virginia Natural
Gas would require an additional staff of 8 within the Human Resources and
Benefits Administration function.
Page 25 of 37
<PAGE>
Facilities Impact
As a result of the addition of 131 full-time equivalent staff, Virginia Natural
Gas would be required to lease additional office space for these new employees.
REED estimates that approximately 42,000 square feet of additional space would
be required. The estimated costs for this space are $0.75 million per year. When
compared with the allocation of lease expenses from the Service Company, the
annual incremental lease cost is estimated to be $300,000.
Information Technology - Non-labor/Outside Services
Virginia Natural Gas would experience significant non-labor cost increases from
the need to assume full responsibility for the information technology functions
provided by the Service Company. The additional labor-related costs have already
been incorporated into the labor cost figures above. Many of these non-labor
costs would be one-time transition costs for the replacement and duplication of
central systems currently operated and maintained by the Service Company. These
systems, which would be duplicated by Virginia Natural Gas, include the
following:
Virginia Natural Gas would require its own employee, human resources, and
payroll information system. The current People Soft program would need to
be duplicated and customized for Virginia Natural Gas as a stand-alone
company.
CNG's Oracle-based financial applications (purchasing, inventory, project
accounting, general ledger, accounts payable, accounts receivable,
budgeting, fixed assets) would need to be duplicated and customized for
Virginia Natural Gas.
The ALTRA Gas Management System would need to be purchased and customized
by Virginia Natural Gas. This program is used for transaction processing,
contract administration, and gas accounting. A separate Oracle-based system
would be required for the administration and management of contracts with
local producers directly connected to the Virginia Natural Gas system.
The SAMS engineering system already in place at CNG would need ongoing
support and maintenance from Virginia Natural Gas.
Virginia Natural Gas would need its own version of ACCLAIM, a system used
to automate dispatching and communicate services orders.
Virginia Natural Gas would also need its own version of the ITRON hardware
used for the Meter Reading System.
REED estimates the costs to separate, replace and duplicate these systems to be
approximately $8.5 million. Assuming the systems are depreciated on the same
basis as that used by the Service Company, the annual depreciation costs would
be approximately $1 million. While many of these IT-related costs would be
one-time transition costs, annual maintenance and lease costs are expected to be
higher for the stand-alone company. Currently, the Service Company outsources
the help desk function. Its uncertain whether Virginia Natural Gas would be able
to continue this arrangement on a stand-alone basis at its current cost. In
addition, Virginia Natural Gas would lose the opportunity to jointly develop new
applications and share the cost of those applications with other corporate
entities.
Loss in Purchasing Efficiencies
Currently, the Service Company centrally manages purchasing across all CNG
subsidiaries. Virginia Natural Gas would have to assume responsibility for
acquisition planning, purchase order placement, supplier negotiations, contract
formation, contract administration, expediting, supplier payment problem
resolution, purchasing systems support, and supplier source development. In
addition to the
Page 26 of 37
<PAGE>
administrative and labor cost increases for this function, Virginia Natural Gas
would experience reduced purchasing economies on a stand-alone basis. Based on
CNG's experience to date in savings achieved from centralized procurement,
Virginia Natural Gas is estimated to lose approximately $2 million annually in
savings. The $1.04 million annual impact of this lost savings assumes 50% of the
total procurement savings applies to capitalized expenditures. The primary
categories for procurement savings include purchases of gas line materials, such
as plastic pipe, valves, and meter sets; purchases of gas line services such as
environmental services, construction services and line locating; and purchases
of administrative support equipment and services, including long distance,
office supplies, computer support, and personal computers.
Cost of Capital
The divestiture of Virginia Natural Gas from the CNG family of companies would
require the recapitalization of the debt at prevailing market rates at the time
of the spin-off. This study assumes that the existing Virginia Natural Gas
capital structure would be maintained in the stand-alone organization. Assuming
no change in the existing cost of equity, based on the market capitalization at
year-end 1998, Virginia Natural Gas would experience a pre-tax capital cost
increase of $2.1 million, or an after-tax capital cost increase of $1.4 million.
Transition/Transaction Costs
The divestiture of Virginia Natural Gas from CNG and the creation of a
stand-alone utility would be a complex legal and financial transaction that
would incur significant transition costs. The costs for issuance of new debt and
equity securities are based on standard fees for similar transactions by other
utilities. These costs include the legal and financial advisory fees, fees for
independent accountants, actuaries, and other management consultants. As
discussed above, Virginia Natural Gas would incur significant costs to either
purchase, duplicate or replace many of the information systems provided by the
Service Company. Real estate services would be required to obtain additional
office space for increased staff at the LDC. The company would experience
significant costs for hiring and training the more than 131 additional staff
required for stand-alone operations. The hiring costs for senior executives are
estimated at 1/3 the first year's salary. REED estimated hiring and training
costs for incremental staff at $1000/employee. The following transition costs
would be applicable in a spin-off of Virginia Natural Gas:
Table VI-2
Summary of Transition/Transaction Costs for Virginia Natural Gas
----------------------------------- ----------------------------------
Category Total Fees
----------------------------------- ----------------------------------
Transaction Costs (debt and $2,089,000
equity issuance)
----------------------------------- ----------------------------------
Legal, accounting, other advisory $2,500,000
fees
----------------------------------- ----------------------------------
Hiring/Training $1,116,500
----------------------------------- ----------------------------------
Total Costs $5,705,500
----------------------------------- ----------------------------------
Annual Amortization $570,550
----------------------------------- ----------------------------------
Other Indirect Lost Economies
Although Virginia Natural Gas has its own contracts for gas supply, storage, and
transportation services, the procurement and administration of gas
supply-related resources is managed by the gas supply area of the Service
Company. In addition to the increased labor costs from assuming responsibility
for supply planning, procurement, and day-to-day administration, Virginia
Natural Gas will lose the purchasing economies enjoyed by the centralized
management of this function by CNG. Given the continuing change
Page 27 of 37
<PAGE>
and evolution of the gas market, it is difficult to quantify the degree of cost
savings provided by central management beyond the administrative labor cost
savings. However, the experience of the Service Company suggests that CNG has
been able to obtain lower-cost supplies through bulk purchasing for the LDC
group and enhance capacity release credits through its centralized
administration and purchasing.
Summary of Impacts for Virginia Natural Gas Spin-Off
The study illustrates that a spin-off of Virginia Natural Gas into a stand-alone
LDC would require an additional 131 full-time employees. Based on the
assumptions set forth in Section II and the staffing requirements outlined
above, the annual cost increase is estimated to be $13.2 million. The categories
of cost increases are set forth below.
Table VI-3
Summary of Lost Economies for Virginia Natural Gas
-----------------------------------------------------------------
Cost Category Annual Increase
-----------------------------------------------------------------
Board of Directors' Fees $225,000
-----------------------------------------------------------------
Labor O&M $6,993,603
-----------------------------------------------------------------
Facilities Expense $302,125
-----------------------------------------------------------------
Lost OM&A Procurement Savings $1,000,000
-----------------------------------------------------------------
Depreciation and Return on Capitalized $168,193
Labor Costs
-----------------------------------------------------------------
Depreciation and Return on Lost $37,458
Capital Procurement Savings
-----------------------------------------------------------------
Cost of Capital Impact (Pre-Tax) $2,109,185
-----------------------------------------------------------------
Amortization of IS/IT Replacement $958,900
-----------------------------------------------------------------
Amortization of Transition Costs $570,550
-----------------------------------------------------------------
Other Shareholder-Related Costs $811,734
-----------------------------------------------------------------
TOTAL $13,176,747
-----------------------------------------------------------------
Table VI-4
Analysis of Lost Economies for Virginia Natural Gas
------------------------------------- --------------------
Total Lost Economies $13,176,747
------------------------------------- --------------------
Lost Economies as a percent of
------------------------------------- --------------------
Total Revenues 6.942%
------------------------------------- --------------------
Net Revenues 13.669%
------------------------------------- --------------------
Total Expenses 8.190%
------------------------------------- --------------------
Net Expenses 19.525%
------------------------------------- --------------------
Gross Income 45.58%
------------------------------------- --------------------
Net Income 105.30%
------------------------------------- --------------------
In absence of rate relief
------------------------------------- --------------------
Estimated return on rate base 1.7230%
------------------------------------- --------------------
Estimated return on net plant 1.0591%
------------------------------------- --------------------
Page 28 of 37
<PAGE>
Table VI-5
Analysis of Customer Impacts of
Lost Economies for Virginia Natural Gas
--------------------------------- ---------------------
Rate Revenue
--------------------------------- ---------------------
Pre-Spin-Off $189,803
--------------------------------- ---------------------
Post-Spin-Off $221,631
--------------------------------- ---------------------
Dollar Increase $31,828
--------------------------------- ---------------------
Percent Increase 16.769%
--------------------------------- ---------------------
Page 29 of 37
<PAGE>
VII. Analysis of Lost Economies from Divestiture on Hope Gas
Overview
Hope Gas provides service to approximately 115,000 customers in West Virginia.
Hope Gas' system consists of approximately 3,000 miles of distribution lines.
Natural gas revenue in 1998 was $100 million on system throughput of 27.1
billion cubic feet of gas.
Organizational and Staffing Impact
As a result of a divestiture from the CNG system, Hope Gas would need to expand
its organizational structure to add the executive, administrative, and
operational staff to perform the functions it currently receives from the
Service Company.
The Hope Gas organizational structure as of December 31, 1998 was used as a
pattern for developing the new stand-alone LDC organization. To support a
stand-alone corporate structure, an additional 100 management and staff
positions would be required to perform the Service Company functions. The new
areas and their relationship to the December 31, 1998 Hope Gas organizational
structure are summarized below.
Table VI-1
Summary of Incremental Staffing Requirements
at Hope Gas
------------------------------------------------------
Executive Position Incremental Staff
------------------------------------------------------
President 2
------------------------------------------------------
Chief Operating Officer
------------------------------------------------------
Director of Operations 11
------------------------------------------------------
Director of Sales 3
------------------------------------------------------
Director of Gas Supply 6
------------------------------------------------------
------------------------------------------------------
Chief Information Officer 20
------------------------------------------------------
------------------------------------------------------
Chief Financial Officer 2
------------------------------------------------------
VP of Finance and Treasurer 10
------------------------------------------------------
Controller 25.3
------------------------------------------------------
Director of Investor Relations 1
------------------------------------------------------
------------------------------------------------------
General Counsel 10
------------------------------------------------------
VP of Human Resources 10
------------------------------------------------------
Total Incremental Staff 100.3
------------------------------------------------------
Board of Directors The Board of Directors is assumed to consist of 9 directors
based on the size and scope of Hope Gas.
Chief Executive Officer (CEO): The CEO/President position would report to the
Hope Gas Board of Directors rather than the Executives at the Service Company.
The CEO/President would be the highest position within the stand-alone corporate
organization. The CEO/President would be responsible for
Page 30 of 37
<PAGE>
representing the corporation to customers, the financial community, regulators
and the public. This position would carry significantly more responsibilities
than the current position of President at Hope Gas. This position would have new
reporting relationships with the new executives and staff added as a result of
the divestiture.
Chief Operating Officer (COO) - The COO would report directly to the CEO and
would be responsible for the overall operating activities of the company. The
COO would oversee the work of three senior managers: the Director of Operations,
the Director of Gas Supply, and the Director of Sales. The Director of Gas
Supply and the Director of Operations are new positions described below.
The Director of Operations would oversee all of the existing Managers of
Operations and the Supervisor of Engineering. The Engineering Services
department under this Director would be expanded to accommodate the
additional staff responsible for design standards, operating procedures,
planning, audits and compliance, and general technical support. These
functions are currently performed by the Engineering department under the
Regulated Business Support Group of the Service Company. In the event of
divestiture, Hope Gas would require an additional 8 engineering staff for
stand-alone operations. The Director of Operations would also oversee the
purchasing and materials management functions and the additional 3 staff
required to perform these activities.
The Director of Sales position would continue in the new organization.
However, the Marketing department under this executive would be expanded to
accommodate the additional staff currently under the Regulated Business
Support Group of the Service Company. Approximately 3 staff from the
existing marketing group would be transferred to support the Hope Gas
marketing function.
The Director of Gas Supply would be a new position responsible for all gas
supply planning, procurement, and contract administration. In the event of
divestiture, Hope Gas would require an additional 5 gas supply staff
reporting to the Director for stand-alone operations. Gas Supply is
currently managed centrally by the Service Company. Under the current
structure, the CNG LDCs have submitted joint comments in response to
actions by the Federal Energy Regulatory Commission and have jointly
intervened in interstate pipeline regulatory proceedings where they have
common interests. In the event of a spin-off, Hope Gas would have to
independently participate in these regulatory filings. These increased
costs associated with the increased responsibilities for federal regulatory
filings have been included in the labor costs increases in the gas supply
area, as this department is responsible for dealing with these issues.
Chief Information Officer (CIO) would be a new position responsible for the
information technology needs of Hope Gas. Currently, these functions are
provided centrally by the Service Company. This position would oversee the
entire information systems, communication systems, data processing, application
development, software and hardware procurement within the Hope Gas organization.
Approximately, 20 staff would be added to support the information technology
needs of Hope Gas as a stand-alone LDC.
Chief Financial Officer (CFO) - The Chief Financial Officer would report
directly to the CEO and would be responsible for corporate finance, corporate
planning, treasury, accounting, risk management, and investor relations. As part
of this reorganization, the current responsibilities of Hope Gas's Director of
Finance and Customer Activities would be split between two new senior management
positions: the VP of Finance and Treasury, and the Controller. The Director of
Investor Relations would also report to the CFO. These new functional areas are
described in detail below.
Page 31 of 37
<PAGE>
The VP of Finance and Treasurer would be a new position responsible for
Treasury and the corporate financial functions currently provided by the
Service Company, including Risk Management, Financial Systems, Strategic
Financial Planning, Corporate Planning, Purchasing, and Facilities
Management. This position would be in charge of all financing, both debt
and equity, for the new corporate entity of Hope Gas. Approximately 10 new
staff would be added in the departments reporting to this position.
The Controller would assume the accounting-related functions currently
directed by Hope Gas's Director of Finance and Customer Activities. The
Controller would oversee all accounting, cash management, transaction
processing, customer billing, internal auditing, external reporting, and
tax functions of Hope Gas. An additional 25 management and staff would be
required to support these accounting and processing services currently
provided by the Service Company.
The Director of Investor Relations would handle all financial corporate
communications and would be in charge of producing the Annual Report and
organizing the annual stockholders meetings.
General Counsel - The General Counsel reports directly to the CEO and would be
responsible for overseeing the legal affairs, government affairs, and corporate
communications. The existing General Counsel position within Hope Gas would be
expanded to assume responsibilities over all corporate legal matters,
environmental compliance, SEC compliance, litigation, state and federal
regulatory matters, labor and benefit legal matters, contracts, and corporate
governance. A new executive position under the General Counsel would be created
to consolidate the external communications and policy work of Hope Gas. The
General Counsel would oversee all legal services procured through outside
attorneys. The new position of Corporate Secretary would report to the General
Counsel.
The Director of External Affairs and Policy Development would report to the
General Counsel. The existing Public Affairs departments within Hope Gas
would report to this position. New staff would be added to support the
Corporate Communications and Government Affairs functions of the new stand
alone organization.
In addition to the transfer of current positions and departmental reporting to
the General Counsel, approximately 10 incremental positions would be added under
the General Counsel position.
Human Resources - The VP of Human Resources would report directly to the CEO and
would be responsible for employee staffing, compensation, training, benefits,
health services, employee services, and security. All positions currently
reporting to Hope Gas' Director of Human Resource would report to the new VP of
Human Resources. In addition, reporting departments would be expanded to include
additional staff responsible for employee benefits servicing, which is currently
provided by a third-party vendor through an outsource arrangement by the Service
Company. The spin-off of Hope Gas would require an additional staff of 10 within
the Human Resources and Benefits Administration function.
Facilities Impact
As a result of the addition of 100 full-time equivalent staff, Hope Gas would be
required to lease additional office space for these new employees. REED
estimates that approximately 33,000 square feet of additional space would be
required. The estimated costs for this space are $0.5 million per year. When
compared with the allocation of lease expenses from the Service Company, Hope
would face an incremental expense of $177,000.
Page 32 of 37
<PAGE>
Information Technology - Non-labor/Outside Services
Hope Gas would experience significant non-labor cost increases from the need to
assume full responsibility for the information technology functions provided by
the Service Company. The additional labor-related costs have already been
incorporated into the labor cost figures above. Many of these non-labor costs
would be one-time transition costs for the replacement and duplication of
central systems currently operated and maintained by the Service Company. These
systems, which would be duplicated by Hope Gas, include the following:
Hope Gas would require its own employee, human resources, and payroll
information system. The current People Soft program would need to be
duplicated and customized for Hope Gas as a stand-alone company.
CNG's Oracle-based financial applications (purchasing, inventory, project
accounting, general ledger, accounts payable, accounts receivable,
budgeting, fixed assets) would need to be duplicated and customized for
Hope Gas.
The ALTRA Gas Management System would need to be purchased and customized
by Hope Gas. This program is used for transaction processing, contract
administration, and gas accounting. A separate Oracle-based system would be
required for the administration and management of contracts with local
producers directly connected to the Hope Gas system.
The SAMS engineering system already in place at CNG would need ongoing
support and maintenance from Hope Gas.
The new customer information system developed by the Service Company, CAMP
(Customer Activities and Marketing Project), consists of three tiers: 1) a
central database and the batch billing process run on an IBM mainframe; 2)
UNIX Servers and a relational database from Sybase; 3) the client tier,
which is customized using Power Builder. The current centralized CAMP
system would need to be separated and redesigned for stand alone
operations. In addition, Hope Gas would require its own independent
server/mainframe to serve as the first tier of the stand alone CAMP system.
Hope Gas would need its own version of ACCLAIM, a system used to automate
dispatching and communicate services orders.
Hope Gas would also need its own version of the ITRON hardware used for the
Meter Reading System.
REED estimates the costs to separate, replace and duplicate these systems to be
approximately $19.9 million. Assuming the systems are depreciated on the same
basis as that used by the Service Company, the annual depreciation costs would
be approximately $2.1 million. While many of these IT-related costs would be
one-time transition costs, annual maintenance and lease costs are expected to be
higher for the stand-alone company. Currently, the Service Company outsources
the help desk function. Its uncertain whether Hope Gas would be able to continue
this arrangement on a stand-alone basis at its current cost. In addition, Hope
Gas would lose the opportunity to jointly develop new applications and share the
cost of those applications with other corporate entities.
Loss in Purchasing Efficiencies
Currently, the Service Company centrally manages purchasing across all CNG
subsidiaries. Hope Gas would have to assume responsibility for acquisition
planning, purchase order placement, supplier negotiations, contract formation,
contract administration, expediting, supplier payment problem
Page 33 of 37
<PAGE>
resolution, purchasing systems support, and supplier source development. In
addition to the administrative and labor cost increases for this function, Hope
Gas would experience reduced purchasing economies on a stand-alone basis. Based
on CNG's experience to date in savings achieved from centralized procurement,
Hope Gas is estimated to lose approximately $1 million annually in cost savings.
The $0.520 million annual impact of this lost savings assumes 50% of the total
procurement savings applies to capitalized expenditures. The primary categories
for procurement savings include purchases of gas line materials, such as plastic
pipe, valves, and meter sets; purchases of gas line services such as
environmental services, construction services and line locating; and purchases
of administrative support equipment and services, including long distance,
office supplies, computer support, and personal computers.
Cost of Capital
The divestiture of Hope Gas from the CNG family of companies would require the
recapitalization of the debt at prevailing market rates at the time of the
spin-off. This study assumes that the existing Hope Gas capital structure would
be maintained in the stand-alone organization. Assuming no change in the
existing cost of equity, based on the market capitalization at year-end 1998,
Hope Gas would experience a pre-tax capital cost increase of approximately $1
million, or an after-tax capital cost increase of $0.6 million.
Transition/Transaction Costs
The divestiture of Hope Gas from CNG and the creation of a stand-alone utility
would be a complex legal and financial transaction that would incur significant
transition costs. The costs for issuance of new debt and equity securities are
based on standard fees for similar transactions by other utilities. These costs
include the legal and financial advisory fees, fees for independent accountants,
actuaries, and other management consultants. As discussed above, Hope Gas would
incur significant costs to either purchase, duplicate, or replace many of the
information systems provided by the Service Company. Real estate services would
be required to obtain additional office space for increased staff at the LDC.
The company would experience significant costs for hiring and training the 100
additional staff required for stand-alone operations. The hiring costs for
senior executives are estimated at 1/3 the first year's salary. REED estimated
hiring and training costs for incremental staff at $1000/employee. The following
transition costs would be applicable in a spin-off of Hope Gas:
Table VI-2
Summary of Transition/Transaction Costs for Hope Gas
---------------------------------- ----------------------------------
Category Total Fees
---------------------------------- ----------------------------------
Transaction Costs (debt and $627,000
equity issuance)
---------------------------------- ----------------------------------
Legal, accounting, other $2,000,000
advisory fees
---------------------------------- ----------------------------------
Hiring/Training $923,120
---------------------------------- ----------------------------------
Total Costs $3,550,120
---------------------------------- ----------------------------------
Annual Amortization $355,012
---------------------------------- ----------------------------------
Other Indirect Lost Economies
Although Hope Gas has its own contracts for gas supply, storage, and
transportation services, the procurement and administration of gas
supply-related resources is managed by the gas supply area of the Service
Company. In addition to the increased labor costs from assuming responsibility
for supply
Page 34 of 37
<PAGE>
planning, procurement, and day-to-day administration, Hope Gas will lose the
purchasing economies enjoyed by the centralized management of this function by
CNG. Given the continuing change and evolution of the gas market, it is
difficult to quantify the degree of cost savings provided by central management
beyond the administrative labor cost savings. However, the experience of the
Service Company suggests that CNG has been able to obtain lower-cost supplies
through bulk purchasing for the LDC group and enhance capacity release credits
through its centralized administration and purchasing.
Summary of Impacts for Hope Gas Spin-Off
The study illustrates that a spin-off of Hope Gas into a stand-alone LDC would
require an additional 100 full-time employees. Based on the assumptions set
forth in Section II and the staffing requirements outlined above, the annual
cost increase is estimated to be $11.5 million. The categories of cost increases
are set forth below.
Table VI-3
Summary of Lost Economies for Hope Gas
- -----------------------------------------------------------------
Cost Category Total Annual Increase
- -----------------------------------------------------------------
Board of Directors' Fees $225,000
- -----------------------------------------------------------------
Labor O&M $6,271,329
- -----------------------------------------------------------------
Facilities Expense $177,188
- -----------------------------------------------------------------
Lost OM&A Procurement Savings $500,000
- -----------------------------------------------------------------
Depreciation and Return on Capitalized $99,407
Labor Costs
- -----------------------------------------------------------------
Depreciation and Return on Lost $19,943
Capital Procurement Savings
- -----------------------------------------------------------------
Cost of Capital Impact (Pre-Tax) $992,666
- -----------------------------------------------------------------
Amortization of IS/IT Replacement $2,087,818
- -----------------------------------------------------------------
Amortization of Transition Costs $355,012
- -----------------------------------------------------------------
Other Shareholder-Related Costs $811,734
- -----------------------------------------------------------------
TOTAL $11,540,096
- -----------------------------------------------------------------
Table VI-4
Analysis of Lost Economies for Hope Gas
-------------------------------------- --------------------
Total Lost Economies $11,540,096
-------------------------------------- --------------------
Lost Economies as a percent of
-------------------------------------- --------------------
Total Revenues 11.509%
-------------------------------------- --------------------
Net Revenues 21.384%
-------------------------------------- --------------------
Total Expenses 12.721%
-------------------------------------- --------------------
Non-Gas Expenses 25.984%
-------------------------------------- --------------------
Gross Income 120.80%
-------------------------------------- --------------------
Net Income 252.52%
-------------------------------------- --------------------
In absence of rate relief
-------------------------------------- --------------------
Estimated return on rate base -2.9188%
-------------------------------------- --------------------
Estimated return on net plant -2.5556%
-------------------------------------- --------------------
Page 35 of 37
<PAGE>
Table VI-5
Analysis of Customer Impacts of
Lost Economies for Hope Gas
- --------------------------------- ---------------------
Rate Revenue
- --------------------------------- ---------------------
Pre-Spin-Off $100,271
- --------------------------------- ---------------------
Post-Spin-Off $121,370
- --------------------------------- ---------------------
Dollar Increase $21,099
- --------------------------------- ---------------------
Percent Increase 21.042%
- --------------------------------- ---------------------
Page 36 of 37
<PAGE>
VIII. Conclusion
The results of this study demonstrate that the spin-off of the CNG LDCs into
separate stand-alone distribution companies will require an additional 700
full-time management and staff positions. While some of this staff could be
drawn from the existing Service Company, the estimated total incremental labor
costs are still expected to be $31.7 million annually. In addition to higher
labor costs, the LDCs would face various transition costs associated with the
divestiture transaction, increased purchasing costs due to a loss in purchasing
economies realized through central procurement carried out by the Service
Company, and additional shareholder related costs associated with the formation
of four independent LDCs. The increases in each LDC's cost of capital on a
stand-alone basis range from 56 to 100 basis points. The total cumulative cost
impact of lost economies resulting from LDC divestiture is estimated to be $61.3
million annually.
Page 37 of 37
