BEFORE THE WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION In the Matter of the Filing of ) ) PUGET SOUND ENERGY, INC. ) DOCKET UE-980866 ) For Approval of Property Transfers ) and Related Transactions with ) ConnexT, Inc. ) ORDER APPROVING APPLICATION . . . . . . . . . . . . . . . . . . . . . . . . . . ) BACKGROUND On June 22, 1998, Puget Sound Energy (PSE or Company) filed with the Commission an application for Commission approval of several agreements entered into between PSE (or its predecessor companies, Puget Sound Power & Light Company and Washington Natural Gas Company) and ConnexT, Inc. (ConnexT), a wholly owned subsidiary of PSE. These agreements were executed subject to regulatory review, and certain aspects of these agreements required regulatory approval. In accordance with RCW 80.12.020, WAC 480-100-036, and WAC 480-143-010, PSE seeks an Order of the Commission which: (1) authorizes the Company to transfer certain equipment and to assign its rights under certain leases, licenses and agreements to ConnexT; (2) authorizes the Company to assign its rights under certain licenses and agreements to ConnexT in exchange for which the Company receives certain royalty payments; and (3) approves proposed accounting treatment with respect to transactions between the Company and ConnexT. The Company included as appendices to its Application the following agreements between the Company and ConnexT: Appendix Agreement 1 The Master Services Agreement between Puget Sound Power & Light Company and ConnexT, Inc. dated as of April 2, 1996, including (a) the Assignment and Assumption Agreement, (b) the Equipment Transfer Agreement, and (c) the Software License Agreement (as amended by Amendment No.1 dated January 20, 1998), which are included as Exhibits G, I, and K, respectively, to the Master Services Agreement; DOCKET UE-980866 PAGE 1 2 Assignment and Assumption Agreement between Puget Sound Energy, Inc., and ConnexT, Inc., dated January 20, 1998; 3 Equipment Transfer Agreement between Puget Sound Energy, Inc., and ConnexT, Inc., dated January 20, 1998; 4 Initial Service Contract for Basic Services between Puget Sound Power & Light Company and ConnexT, Inc., dated July 1, 1996; 5 Agreement between Puget Sound Power & Light Company and TELLUS, Inc., dated October 1, 1996; and 6 Service Contract No.153 for Special Projects between Puget Sound Energy, Inc., and ConnexT, Inc., dated December 23, 1996 (the "ConsumerLink Development Agreement"), including the CL3 Software License Agreement. The Company also included with its Application a copy of its most recent Annual Report to Shareholders in satisfaction of the requirements of WAC 480-143-010. MEMORANDUM I. Overview According to the Application, the agreements will allow the Company to outsource certain billing and customer information technology functions currently performed by the Company. These services will be performed by ConnexT, a wholly owned subsidiary devoted to providing metering, customer information systems and billing functions, and distribution software for utilities. The Application identifies the following benefits for customers arising from the outsourcing enabled by the agreements: Spreading the Costs of Developing the Customer Information System ("CIS"): The costs of developing the customer information and billing systems will be spread over a larger customer base, through marketing of these services to other utilities. Under the accounting proposed by PSE, receipt of the royalty payments from marketing by ConnexT -- activities that PSE would not undertake on its own -- will result in monies that will be recorded as revenues by the Company in Accounts 456 and 495. As a result, these revenues will reduce the revenue requirement necessary to fund the cost of the new CIS system. The Application asserts that customers are thus better off than under the alternative; in the absence of this arrangement, customers would bear the entire costs that are associated with developing the CIS software. According to the Application, the arrangement of using a subsidiary is appropriate given the risks involved, and the difficulty for a regulated utility to achieve success in marketing and maintaining this type of product. Priced Competitively: According to the Application, the price for ConnexT's services under the Initial Service Contract for Basic Services was established at the outset at a level lower than Puget's and WNG's then-existing costs and is expected to continue to be a cost-effective method of obtaining these services. Advantageous Contract Terms: The Master Services Agreement includes a "Most Favored Pricing" provision which will allow PSE to obtain the best terms that any other client of ConnexT negotiates. Benefits from Marketing and Development of Software: PSE receives royalty payments from ConnexT's marketing of software, and free use of derivative software products developed by ConnexT for a specified period. More Choices: ConnexT is a separate organization devoted exclusively to metering, customer information systems, billing functions, and distribution software. According to the Application, this specialization will facilitate the implementation of new technology and result in the development of new products and services to provide customers with better information and increased options regarding their use of energy. Attraction and Retention of Quality Workforce: Formation of a subsidiary allowed ConnexT to attract and retain high-tech computer programmers in an increasingly competitive and specialized labor market. ConnexT has more flexibility to offer an attractive compensation package and career options. Risk of Developing a New Customer Information System Shifted: The ConsumerLink Development agreement requires ConnexT to develop a new CIS at a fixed cost, thereby protecting PSE from the cost overruns and unsuccessful projects experienced by other utilities. The new CIS system is being developed to meet Year 2000 concerns and to provide operating efficiencies. The Application included a description of the inadequacies of the Company's current CIS and the advantages which ConsumerLink will deliver to customers. Cost Avoidance: Customers avoid the capital expenditures associated with modernizing a mainframe data center for a period of ten years and providing on-site backup electric generation. These costs are borne by ConnexT under the agreements. Increased Reliability: Customers are provided a more secure, modern, and reliable mainframe data center with enhanced electric back-up generation capability currently not in place at the Company's mainframe data center. II. Description of Transactions Under the transactions, ConnexT will assume complete responsibility for support of customer information systems. ConnexT will own and operate mainframe data center operating system software and hardware, and will assume responsibility for maintenance of mainframe jobs that are primarily production control and mainframe operating system support. ConnexT will also own and operate bill print/mail equipment. PSE will retain support of systems related to administration; finance; accounting; purchasing; material inventory; engineering construction and maintenance; gas and electric purchase and supply; conservation; local, state, and national regulation; and long-term and business planning. Because ConnexT assumes responsibility under the transactions to perform a number of activities formerly performed by the Company, certain equipment and software rights formerly used by the Company to perform those operations will no longer be necessary. Under the transactions, the Company transfers to ConnexT the equipment and software no longer needed by the PSE. This is one aspect of the transactions for which the Company seeks regulatory approval. The agreements further provide that ConnexT will assume the Company's obligations under the associated equipment leases and software licensing arrangements. ConnexT is also authorized under the transactions to market and further develop the software licensed by the Company to ConnexT. To the extent ConnexT realizes software license fees from the sale of such software to third parties, ConnexT will pay the Company a royalty for such revenues as set forth in the Software License Agreement. As compensation for the services which ConnexT provides to the Company, ConnexT receives fixed monthly payments. Under the Initial Service Contract for Basic Services, the monthly payment is determined by the monthly average number of customer accounts which are being managed and administered by ConnexT. Where ConnexT performs certain special projects for the Company, ConnexT is paid in accordance with hourly rates and reimbursable expenses as determined between the parties, as set forth in the Master Services Agreement. Other agreements included in the application provide for the development and implementation of Customer Information System, or CIS, software to be known as ConsumerLink, as well as ConnexT's license to market and sell ConsumerLink to other entities. Under the development agreement, the Company pays to ConnexT a fixed price for the design and development of a system for the collection, processing, and management of customer information. The accompanying software license agreement authorizes ConnexT to use, market, and sell ConsumerLink and derivatives that ConnexT makes from it. ConnexT will pay the Company five percent of any revenues it receives from the sale or use of ConsumerLink. That percentage increases to 20% of revenues in the case of distributor revenues, which are revenues recognized by ConnexT from a distribution sublicense. The arrangement is exclusive with ConnexT through 2003, at which time ConnexT may renew the exclusive license for an additional five years but only if royalties paid during the first five years equal or exceed $5 million. Under the accounting treatment proposed by the Company, the proceeds PSE receives from ConnexT from these royalties will be recorded as revenues, thereby reducing the revenue requirement needed to fund the cost of the new CIS. The Application states that the services performed by ConnexT for the Company are completely transparent to the Company's customers, and that the existing relationship between the Company and its customers is unaffected. According to the Application, the Company is merely outsourcing the services to an entity devoted exclusively to billing, metering, and customer information services and distribution software. III. Requested Approvals PSE states in its Application that because ConnexT is a wholly owned subsidiary of PSE, it is not an "affiliated interest" within the definition of this term in RCW 80.16.010. This reading of Chapter 80.16 RCW is consistent with our historical interpretation of those statutory provisions. See, Waste Management, Inc. v. WUTC, 123 Wn.2d 621, 636 (1994). PSE seeks approval for the property transfers involved in the transactions. PSE requests authorization to: (1) Transfer to ConnexT the equipment, components, parts, and other items of tangible personal property described in Exhibit J to the Master Services Agreement. This property, which has a fair market value of $673,200, will be treated as an equity investment by PSE in ConnexT; (2) Assign to ConnexT all of PSE's right, title, and interest in the leases, licenses, agreements, and other contracts set forth in Exhibit H to the Master Services Agreement; (3) Assign to ConnexT all of PSE's right, title, and interest in the leases, licenses, agreements, and other contracts set forth in Appendix 2 to the Application; (4) Transfer to ConnexT the equipment, components, parts, and other items of tangible personal property described in Appendix 3 to the Application. This property, which has a fair market value of $14,900, will be treated as an equity investment by PSE in ConnexT; and (5) Receive, in exchange for the transfers and assignments above, the various royalty payments which ConnexT is obligated to make under the Software License Agreement, the CL3 Software License Agreement, and the TELLUS Agreement. The Company submits that granting these requested authorizations would be in the public interest. PSE states in its Application that the transactions produce significant benefits for the Company and its customers. Under the transactions, the Company will receive royalty payments from marketing of the products developed by ConnexT. These are benefits which arise from outsourcing this activity and spreading the development costs over a larger customer base; these revenues would not have been available had the Company developed its CIS internally. Under the Company's proposed accounting treatment, these royalty payments would be included in utility income and thus benefit customers through the rate making process. With regard to the accounting issues included in PSE's application, PSE submits that our regulatory oversight can be facilitated if the accounting treatment for the transactions with ConnexT are clarified at the outset. Another aspect of regulatory oversight to be clarified, according to the Company, is the access Commission Staff will have to the books and records of ConnexT in connection with the regulatory review of PSE's transactions with ConnexT. PSE also notes that due to competitive concerns, it may be necessary to impose confidentiality restrictions in making such information available. PSE requests review and approval of its proposed accounting treatment for the payments to and from ConnexT under the agreements, and the proposed discovery procedures associated therewith. PSE proposes the following accounting treatment for payments to and from ConnexT under the agreements: 1. The fair market value of the equipment transferred to ConnexT under the Equipment Transfer Agreements (Exhibit G to the Master Services Agreement and Appendix 3 to the Application) would be recorded as an equity investment by PSE in its wholly owned subsidiary, ConnexT, and salvage related to the retirement of electric utility plant. This fair market value, $688,100, would be recorded in Account 123.1, Investment in Subsidiary Companies. 2. Amounts paid to ConnexT under the Initial Service Contract for Basic Services shall be recorded in PSE's books of account and treated for accounting purposes as if such costs were paid by PSE to third-party providers. 3. Amounts paid to ConnexT under the ConsumerLink agreements shall be recorded in PSE's books of account and treated for accounting purposes as if such costs were paid by PSE to third-party providers. 4. Royalty payments from ConnexT to PSE under the Software License Agreement and the TELLUS Agreement would be credited to Operating Revenue Account 456, "Other Electric Revenues", and Account 495, "Other Gas Revenues". 5. Royalty payments from ConnexT to PSE under the CL3 Software license Agreement would be credited to Operating Revenue Account 456, "Other Electric Revenues", and Account 495, "Other Gas Revenues". 6. So long as ConnexT remains a wholly owned subsidiary of PSE, Commission Staff shall have access to those books and records of ConnexT pursuant to authority the Commission may have under its general rate making authority to review transactions between parent and subsidiary companies. In the event ConnexT becomes an affiliate of PSE, the Commission is authorized, pursuant to RCW 80.16.030, to require satisfactory proof in proceedings of the reasonableness of payment or compensation by PSE to ConnexT. Due to competitive concerns, any information made available to Commission Staff under these provisions may be on a confidential basis in accordance with WAC 480-09-015. 7. Amounts to be paid to ConnexT each year by PSE would be reported to the Commission as "Contemplated Payments to Subsidiary Companies" in PSE's filing Annual Budget of Expenditures filing of with the Commission pursuant to WAC 480-140-040. It appears from the Application that a basis exists for granting the requested authorization for the transfers. The transactions potentially could produce significant benefits for the Company and its customers. Under the transactions, the Company will receive royalty payments from marketing of the products developed by ConnexT. Had the Company developed its CIS internally and not spread the development costs by marketing to a larger customer base, these royalty revenues would not have been available. At this juncture, the level of these royalty payments -- 5% of the revenues derived by ConnexT -- appears reasonable, and will benefit the Company's customers through the Company's proposed accounting to include these royalty payments in utility income. Accordingly, granting these requested authorizations appears to be in the public interest. As to the subsequent rate making treatment of the transactions, the Commission has authority under the general rate making statutes, in subsequent PSE general rate case proceedings, to evaluate the reasonableness of PSE's expenditures under the contracts with ConnexT. We agree with PSE that our regulatory oversight can be facilitated if the accounting treatment for the transactions with ConnexT are clarified at the outset. It is helpful to clarify as well the access Commission Staff will have to the books and records of ConnexT in connection with our regulatory oversight of PSE's transactions with ConnexT. The accounting treatment proposed by PSE for the payments to and from ConnexT under the agreements is a reasonable measure to facilitate Staff's examination of the rate making implications of these transactions. The proposed accounting treatment requires modification in one respect, however. Recording the equipment transferred to ConnexT under the Equipment Transfer Agreements at fair market value will result in some of the book value of this equipment remaining on the books of the Company which, in turn, may affect future depreciation charges imposed on the Company's customers. To address this concern, we will require the Company to credit accumulated depreciation reserve and to debit miscellaneous deferred debit for the difference between the net book value of the equipment and the fair market value. (This difference is estimated by Commission Staff to be approximately $613,000.) The Company has agreed to this modification, and will amortize this difference over the remaining portion of the rate stability period, or prior to December 31, 2001. With this modification, approval of the Company's proposal is appropriate. The Company's proposal regarding discovery procedures in connection with its transactions with ConnexT is also reasonable, as it comports with our authority under law and our existing practice with respect to transactions between utilities and their affiliated companies. FINDINGS OF FACT 1. Puget Sound Energy, Inc., is a public service company furnishing electric and gas service primarily in the Puget Sound region of the State of Washington and is subject to the regulatory authority of the Commission as to its rates, service, facilities, and practices. 2. On June 22, 1998, PSE filed with the Commission its application for approval of several agreements entered into between PSE (or its predecessor companies, Puget Sound Power & Light Company and Washington Natural Gas Company) and ConnexT, Inc., a wholly owned subsidiary of PSE. By its application, PSE seeks Commission authorization to transfer certain equipment, and to assign its right under certain leases, licenses, and agreements, to ConnexT. PSE also seeks approval of proposed accounting treatment with respect to transactions between the Company and ConnexT. 3. The application provides a basis for granting the requested authorization for the transfer and assignment. The transactions potentially could produce significant benefits for PSE and its customers. Granting the requested authorizations is in the public interest. 4. The accounting treatment proposed by PSE for the payments to and from ConnexT under the agreements is reasonable, as modified in the manner described above. The royalty provided under the agreements provides reasonable compensation to the Company's customers for the transfer of equipment and assignment of contract rights. Including these payments as part of utility income is an appropriate method to allow customers to gain benefit from ConnexT's ability to market ConsumerLink and other software developed by ConnexT. 5. The discovery procedures proposed by the Company are reasonable measures to facilitate the Commission's regulatory review of the transactions in subsequent PSE general rate proceedings. CONCLUSIONS OF LAW 1. The Washington Utilities and Transportation Commission has jurisdiction over the parties and the subject matter of this application. 2. The application, as modified by this Order, is in the public interest. ORDER THE COMMISSION ORDERS: 1. PSE is authorized to (a) transfer to ConnexT the equipment, components, parts, and other items of tangible personal property described in Exhibit J to the Master Services Agreement, and (b) assign to ConnexT all of PSE's right, title, and interest in the leases, licenses, agreements, and other contracts set forth in Exhibit H to the Master Services Agreement. 2. The following accounting treatment for the payments to and from ConnexT under the agreements is adopted: a. The fair market value of the equipment transferred to ConnexT under the Equipment Transfer Agreements (Exhibit G to the Master Services Agreement and Appendix 3 to the Application) shall be recorded as an equity investment by the Company PSE in its wholly owned subsidiary, ConnexT, and salvage related to the retirement of electric utility plant. The fair market value, $688,100, shall be recorded in Account 123.1, Investment in Subsidiary Companies. The Company shall credit accumulated depreciation reserve and debit miscellaneous deferred debit (Account 186) for the difference between this fair market value of the equipment and the net book value of the equipment, and amortize such amount prior to the end of the rate stability period (December 31, 2001). This cost item shall be adjusted out from any test year used in rate making; b. Amounts paid to ConnexT under the Initial Service Contract for Basic Services shall be recorded in PSE's books of account as if such costs were paid by PSE to third-party providers; c. Amounts paid to ConnexT under the ConsumerLink agreement shall be recorded in PSE's books of account as if such costs were paid by PSE to third-party providers; d. Royalty payments from ConnexT to PSE under the Software License Agreement and the TELLUS Agreement shall be credited to Operating Revenue Account 456, "Other Electric Revenues", and Account 495, "Other Gas Revenues"; e. Royalty payments from ConnexT to PSE under the CL3 Software License Agreement shall be credited to Operating Revenue Account 456, "Other Electric Revenues", and Account 495, "Other Gas Revenues"; and f. Amounts to be paid to ConnexT each year by PSE shall be reported to the Commission as "Contemplated Payments to Subsidiary Companies" in PSE's filing of Annual Budget of Expenditures with the Commission pursuant to WAC 480-140-040. 3. So long as ConnexT remains a wholly owned subsidiary of PSE, Commission Staff shall have access to those books and records of ConnexT pursuant to authority the Commission may have under its general rate making authority to review transactions between parent and subsidiary companies. In the event ConnexT becomes an affiliate of PSE, the Commission is authorized under RCW 80.16.030 to require satisfactory proof in proceedings of the reasonableness of payment or compensation by PSE to ConnexT. Due to competitive concerns, any information made available to Staff under these provisions may be on a confidential basis in accordance with WAC 480-09-015. 4. Nothing in PSE’s application or this Order shall be construed to waive or otherwise impair the jurisdiction of the Commission over the rates, services, accounts, and practices of the Company. 5. The Commission retains jurisdiction over the parties to effectuate the provisions of this Order. DATED at Olympia, Washington, and effective this day of September 1998. WASHINGTON UTILITIES AND TRANSPORTATION COMMISSION ANNE LEVINSON, Chair RICHARD HEMSTAD, Commissioner WILLIAM R. GILLIS, Commissioner