---

SHARYLAND UTILITIES, L.P.

 

Consolidated Balance Sheets

(In thousands)

(Unaudited)

 

 

See accompanying notes to the consolidated financial statements.

 

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SHARYLAND UTILITIES, L.P.

 

Consolidated Statements of Operations

(In thousands)

(Unaudited)

 

 

See accompanying notes to the consolidated financial statements.

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SHARYLAND UTILITIES, L.P.

 

Consolidated Statements of Comprehensive Income

(In thousands)

(Unaudited)

 

 

See accompanying notes to the consolidated financial statements.

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SHARYLAND UTILITIES, L.P.

 

Consolidated Statements of Partners’ Capital

Nine Months Ended September 30, 2017

(In thousands)

(Unaudited)

 

 

See accompanying notes to the consolidated financial statements.

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SHARYLAND UTILITIES, L.P.

 

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

See accompanying notes to the consolidated financial statements.

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SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

Sharyland Utilities, L.P. (the Partnership or SULP) is a partnership engaged in providing regulated electric transmission and distribution delivery services to retail electric providers (REPs) serving over 54,000 electric delivery points in 29 counties with approximately 35,800 circuit miles of overhead and 4,700 circuit miles of underground distribution lines throughout Texas. The Partnership’s customers currently are principally residential, commercial and irrigation customers located in the cities of Mission and McAllen, Texas, in the outlying areas of Hidalgo County in south Texas, in the Midland-Stanton area of west Texas, in the central Texas area around Brady, and in northeast Texas in Hunt, Collin and Fannin Counties.

The Partnership is also engaged in the transmission of electricity throughout Texas. Those transmission activities include: a 138 Kilovolt (kV) looped system of approximately 323 circuit miles in length near Stanton; approximately 45 circuit miles of 345 kV transmission line located near Stanton; a 138 kV direct current transmission interconnection between Texas and Mexico (Railroad DC Tie); approximately 16 circuit miles of 138 kV transmission line located in the cities of Mission and McAllen; approximately 430 circuit miles of 345 kV transmission loop in the Texas Panhandle and South Plains near Amarillo, Texas; approximately 55 circuit miles 345 kV transmission line between Golden Spread Electric Co-op and the White River Station in the Texas Panhandle; and approximately 48 circuit miles of 345 kV transmission line from the eastern half of the North Edinburg substation to the Palmito substation in the southern region of Texas near Brownsville.

The Partnership was organized as a Texas limited partnership on November 3, 1998, as an electrical distribution utility located in Hidalgo County, Texas. On March 24, 2016, the Partnership transferred its ownership in SU FERC, L.L.C., a subsidiary of the Partnership, to its General Partner.

On March 18, 2016, Hunt Power, L.P. (HP), an affiliate of the Partnership, contributed GS Project Entity, L.L.C. (GSPE) to the partners of the Partnership (Partners). The Partners contributed their interests in GSPE to the Partnership. GSPE became a wholly owned subsidiary of the Partnership. On May 6, 2016, HP also contributed CV Project Entity, L.L.C. (CVPE) to the Partners. The Partners contributed their interests in CVPE to the Partnership. CVPE became a wholly owned subsidiary of the Partnership. See Note 2.

The Partnership leases most of its transmission and distribution assets from a related party, Sharyland Distribution & Transmission Services, L.L.C. (SDTS) under Master Lease Agreements. See Note 4.

All significant intercompany balances and transactions have been eliminated. The Partnership maintains accounting records in accordance with the uniform system of accounts, as prescribed by the Federal Energy Regulatory Commission (FERC). The Partnership’s consolidated financial statements reflect the effects of the different rate making principles mandated by FERC and the Public Utility Counsel of Texas (PUCT) regulating its operations.

(Continued)

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2

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

The Partnership accounted for the contributions of GSPE and CVPE as common control transactions whereby the net assets acquired are combined with the Partnership at their carrying value.

The preparation of the Partnership’s consolidated financial statements in accordance with accounting principles generally accepted in the United States (GAAP) requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Clarification of Certain Cash Receipts and Cash Payments. The objective of ASU 2016-15 is to eliminate the diversity in practice related to the classification of certain cash receipts and payments in the statement of cash flows, by adding or clarifying guidance on eight specific cash flow issues. ASU 2016-15 is effective for periods beginning after December 15, 2017 with early adoption permitted. The new standard requires a modified retrospective transition approach for all periods presented, unless deemed impracticable, in which case, prospective application is permitted. The Partnership is currently evaluating the new guidance and has not determined the impact this standard may have on our cash flows.

In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 amended the existing accounting standard for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. ASU 2016-02 is effective for periods beginning after December 15, 2019 with early adoption permitted. The new standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. The Partnership is currently evaluating the new guidance and the extent of the impact this standard may have on its financial position, results of operations or cash flows.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 requires revenue to be recognized when promised goods or services are transferred to customers in an amount that reflects the expected consideration for theses goods and services. The guidance supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. ASU 2014-09 is effective for periods beginning after December 15, 2018. The Partnership is currently evaluating the new guidance and the extent of the impact this standard may have on its financial position, results of operations or cash flows.

On July 21, 2017, the Partnership and SDTS signed a definitive agreement (Definitive Agreement) with Oncor Electric Delivery Company LLC (Oncor) to exchange SDTS’s retail distribution assets and the Partnership’s general plant used in distribution operations for a group of Oncor’s transmission assets located in West and Central Texas and cash.

(Continued)

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3

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

Under the Definitive Agreement with Oncor, the Partnership will transfer general and regulatory assets used for the retail distribution business net of liabilities at a carrying value of approximately $6.5 million to Oncor for approximately $6.5 million in cash, subject to customary adjustments to be made at and following closing. SDTS will exchange approximately $400.0 million of distribution assets for approximately $380.0 million of transmission assets located in West and Central Texas and approximately $20.0 million in cash from Oncor, subject to customary adjustments to be made at and following closing.

Upon closing, the Partnership will lease these transmission assets from SDTS and operate them under an amended certificate of convenience and necessity (CCN). The Partnership will no longer lease the distribution assets transferred to Oncor. Thereafter, SDTS will continue to own and lease certain substations related to its distribution assets, but the Partnership will exit the retail distribution business. In accordance with the Definitive Agreement, the Partnership, SDTS and Oncor filed a joint Sale-Transfer-Merger application (STM) with the PUCT on August 4, 2017 under Docket No. 47469 requesting PUCT approval of the asset exchange transaction. See Note 19, Subsequent Events for additional information regarding the approval of the STM.

Concurrently with the execution of the Definitive Agreement, the Partnership and SDTS entered into an agreement (Rate Case Dismissal Agreement) with certain parties to their pending rate case under Docket No 45414 (Rate Case), which would result in the dismissal of the rate case upon the completion of the asset exchange transaction with Oncor. On September 29, 2017, the PUCT issued an order dismissing the Rate Case contingent on PUCT approval of the STM and the closing of the asset exchange transaction. For further information related to the Rate Case and the pending dismissal, see Note 17, Commitments and Contingencies - regulatory proceedings.

The closing of the asset exchange transaction with Oncor and the effectiveness of the Rate Case dismissal are dependent upon each other and subject to a number of closing conditions, including the PUCT approvals discussed above as well as PUCT approval of Oncor’s rate case settlement. The closing of the asset exchange transaction is also contingent upon Oncor’s parent company obtaining consent of the U.S. Bankruptcy Court for the District of Delaware (Bankruptcy Court) and SDTS obtaining certain consents from its lenders, as well as other customary closing conditions.

On August 18, 2017, SDTS received early termination of the Hart-Scott-Rodino Act waiting period regarding the asset exchange transaction. On September 15, 2017, the Bankruptcy Court provided consent for Oncor to enter into the asset exchange transaction. See Note 19, Subsequent Events for additional information regarding the satisfaction of the other key closing conditions, including the PUCT’s approval of the STM.

On March 18, 2016, Hunt Power, L.P. (HP), an affiliate of the Partnership, contributed all of its ownership interest in GS Project Entity, L.L.C. (GSPE) to the Partners. The Partners contributed their interests in GSPE to the Partnership. GSPE became a wholly owned subsidiary of the Partnership. The Partnership accounted for the contributions of GSPE as common control transactions whereby the net assets acquired are combined with the Partnership at their carrying value. GSPE was formed on January 6, 2015 for the purpose of financing and owning the Golden Spread 345 kV-Transmission Line Project (GS Project). The approximately 55 circuit miles transmission line connects Golden Spread Electric Co-op (GSEC) gas-fired generation facilities to the White River Station in the Texas Panhandle which is owned by SDTS.

(Continued)

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4

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

On May 6, 2016, HP also contributed all of its ownership interest in CV Project Entity, L.L.C. (CVPE) to the Partners. The Partners contributed their interests in CVPE to the Partnership. CVPE became a wholly owned subsidiary of the Partnership. The Partnership accounted for the contributions of CVPE as common control transactions whereby the net assets acquired are combined with the Partnership at their carrying value. CVPE was formed on November 14, 2014 for the purpose of financing and owning the Cross Valley 345 kV-Transmission Line Project (CV Project). The approximately 48 circuit miles of transmission line connects the eastern half of the North Edinburg substation owned by American Electric Power (AEP) to the Palmito Station in south Texas which is owned by the Partnership. The Partnership’s financial statements have been adjusted to reflect CVPE’s activities from the formation date. The CV Project was acquired by CVPE on January 15, 2015.

The Partnership leases most of its Transmission and all of its Distribution (T&D) assets from SDTS, a related party, under five Master Lease Agreements (MLA). See Note 17, Regulatory Proceedings. Also under these same MLAs, SDTS is responsible for funding all prudently incurred electric plant capital expenditures deemed necessary to serve customers by the Partnership. In accordance with the MLAs, the Partnership is responsible for the maintenance and the operation of the T&D assets and for compliance with all regulatory requirements of the PUCT, FERC, and any other regulatory entity with jurisdiction over the T&D assets. The MLAs obligate the Partnership to pay all property-related expenses, including maintenance, repairs, taxes on equipment in service, insurance, and to comply with the terms of the secured credit facilities and secured-term loan, if any, affecting the leased assets. The MLAs are subject to failed sale-leaseback accounting. See Note 5.

The MLAs, as amended, expire at various dates from December 31, 2017 through December 31, 2022. Each agreement includes annual base payments while all but one agreement includes additional payments, based on an agreed upon percentage of revenue earned by the Partnership, as defined in the MLAs, in excess of annual specified breakpoints. The rate used to calculate additional payments varies by lease and ranges from a high of 37% to a low of 23% over the term of the agreements.

The Partnership made fixed lease payments during the periods presented as follows:

 

 

The Partnership’s MLAs include a rent validation mechanism after year end to true up lease payments for the difference between actual and estimated incremental capital expenditures placed in service. As a result of the rent validation, the Partnership made additional fixed payments of approximately $334,000 and $858,000 on March 22, 2017 and April 12, 2016, respectively, associated with the years ended December 31, 2016 and 2015, respectively.

The Partnership is also subject to certain restrictive covenants, including indebtedness limits, contained in the MLAs. The Partnership was in compliance with all such covenants as of September 30, 2017 and December 31, 2016.

(Continued)

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5

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

Future minimum lease payments in accordance with these MLAs are as follows:

 

 

The Partnership leases most of its T&D assets from SDTS, a related party. SDTS has legal title to such T&D assets under lease. The Partnership, as a managing member of SDTS, has the exclusive power and authority on behalf of SDTS to manage, control, administer, and operate the T&D assets and business affairs of SDTS in accordance with the limited liability company agreement governing SDTS. These rights and obligations constitute continuing involvement, which results in failed sale-leaseback (financing) accounting. Under failed sale-leaseback accounting, the Partnership is deemed owner of the assets under all MLAs, including assets currently under construction. Consequently, the T&D assets, including assets currently under construction and corresponding financial obligations, are included in the Partnership’s Consolidated Balance Sheets. The leases are considered a failed sale-leaseback (financing) due to the Partnership’s continuing involvement in SDTS and due to the ongoing involvement in the construction of the T&D assets as defined by ASC Topic 840, Accounting for Leases.

Approximately $1.6 billion are included in long-term financing obligation liabilities related to the failed sale-leaseback (financing), as of September 30, 2017 and December 31, 2016. Approximately $26.4 million and $39.0 million of the failed sale-leaseback (financing) obligation are included in current liabilities as of September 30, 2017 and December 31, 2016, respectively.

The Partnership recorded interest on failed sale-leaseback (financing) in interest expense, net as follows:

 

 

(Continued)

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6

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

As a result of the failed sale-leaseback (financing) transaction, the Partnership accounted for lease payments to the lessor as a reduction of its financing obligation. Payments made on the long-term financing obligation were as follows:

 

 

Future payments of the financing obligation as of September 30, 2017 are as follows:

 

 

The Partnership recorded depreciation expense related to the assets accounted for in accordance with failed sale-leaseback as follows:

 

 

Prepaids and other current assets at September 30, 2017 and December 31, 2016 are as follows:

 

 

(Continued)

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7

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

The major classes of property, plant and equipment at September 30, 2017 and December 31, 2016 are as follows:

 

 

See Note 3 in regards to the acquisition of transmission plant in 2016.

See Note 5 in regards to leased system and leased system under construction.

General plant consists of a warehouse, furniture, fixtures, equipment, computer hardware, software, and vehicles.

Deferred Charges – Regulatory Assets, Net

Regulatory assets represent probable future recovery of costs from customers through the regulatory ratemaking process.  The table below provides detail of deferred charges that are included on the Partnership’s Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016.

(Continued)

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8

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

Net deferred costs recoverable in future years as of September 30, 2017 and December 31, 2016 are as follows:

 

 

Deferred financing costs included in net deferred charges – regulatory assets consist of debt issuance costs incurred in connection with the construction credit agreements associated with GSPE and CVPE. These assets are classified as regulatory assets and amortized over the length of the related loan. These costs will be included in the costs to be recovered in connection with a future rate case.

The inception operating costs of approximately $23.8 million at September 30, 2017 and December 31, 2016 represent operating costs incurred from inception through December 31, 2007. The 2013 rate case settlement established that the Partnership may seek recovery in a future rate case, pursuant to the mechanism established in Docket Nos. 21591 and 27556, of the inception operating costs plus related return on rate base. The right to benefit from the inception operating costs was transferred to SDTS. Consequently, due to the failed sale-leaseback accounting treatment, the Partnership has recorded a corresponding liability in financing obligation.

See Note 17, Commitments and Contingencies – Regulatory proceedings for information regarding the proposed dismissal of the rate case.

Regulatory Liabilities

Regulatory liabilities represent probable future reduction in rates due to the over-recovery of costs from customers through the regulatory ratemaking process.

(Continued)

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9

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

The carrying amount of the regulatory liabilities as of September 30, 2017 and December 31, 2016 are as follows:

 

 

The Partnership made payments associated with the lease of some of its T&D assets to SDTS as follows:

 

 

The Partnership received payments throughout the period related to the acquisition of gross property plant and equipment, contracted services, direct labor, materials and supervision associated with its existing asset build out on the T&D assets from SDTS as follows:

 

 

Asset build out costs are included on the Consolidated Balance Sheets under property, plant and equipment - net.

On February 12, 2015, the Partnership entered into a subordinated and unsecured loan agreement of $10.0 million with Loyal Trust No. 1 (LT1), a related party, as amended on, February 16, 2017. The promissory note matures on December 31, 2018. The revolving promissory note accrues interest at the floating JP Morgan Chase Prime Rate with all interest compounded semiannually. As of September 30, 2017 and December 31, 2016, the Partnership had no amount outstanding on the subordinated note. The interest expense and fees on the subordinated note as follows:

 

 

(Continued)

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10

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

The Partnership leases office space for its Dallas location from an affiliate through a contractually agreed upon lease amounts.  Charges for the lease are included in general and administrative expense in the accompanying Consolidated Statements of Operations as follows:

 

 

An affiliate of the Partnership provides services to the Partnership at contractually agreed upon hourly rates and set amounts for infrastructure support. Charges for such services are included in general and administrative expense in the accompanying Consolidated Statements of Operations as follows:

 

 

Accrued fees are included in due to affiliates on the Partnership’s Consolidated Balance Sheets related to these charges were approximately $405,000 and $1.1 million as of September 30, 2017 and 2016, respectively.

Revenues, income, gains, losses, expenditures, deductions, credits and distributions, as defined in the partnership agreement, are allocated 1 percent to the general partner and 99 percent to the limited partner.

On May 15, 2014, the Partnership entered into an unsecured revolving credit facility of $5.0 million with Amegy Bank, as amended on, December 10, 2014. On August 11, 2017, the credit facility was amended and extended to increase the commitment to $10.0 million. The credit facility accrues interest on the outstanding balance at the Prime Rate. At September 30, 2017, the Prime Rate was at 4.25%. In addition to the interest on the outstanding balance, commitment fees accrue at 0.35% for the unused portion of the credit facility. The revolving credit facility expires on August 11, 2019.

As of September 30, 2017 and December 31, 2016, the Partnership had no amount outstanding on the revolving credit facility. The interest expense and fees for the revolving credit facility were approximately $18,000 and $105,000 during the three and nine months ended September 30, 2017, respectively. The interest expense and fees for the revolving credit facility were approximately $44,000 and $115,000 during the three and nine months ended September 30, 2016, respectively.

The agreement requires maintenance of certain financial ratios and imposes certain restricted covenants. The Partnership was in compliance with all covenants as of September 30, 2017 and December 31, 2016, respectively.

(Continued)

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11

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

 

 

Senior Secured Credit Facilities – On January 15, 2015, in conjunction with the acquisition, CVPE entered into a construction-term loan agreement consisting of a $106.5 million construction term loan syndicated to five banks and a $23.5 million senior secured note issued to Prudential Insurance Company of America and affiliates (Fixed Rate Notes). The senior secured credit facilities and Fixed Rate Notes are collateralized by the CV Project assets.

The CV Project was placed in service June 10, 2016 and the new transmission cost of service (TCOS) rate that included the CV Project assets was approved on September 22, 2016 by the PUCT. On November 30, 2016, the amount outstanding on the construction-term loan was converted into a term loan with a balance of $82.5 million. After this conversion, interest accrues at LIBOR plus 1.75%. Interest is payable the last day of the selected interest period for interest periods of three months or less, and every three months for interest periods greater than three months. Amortized principal amounts of the term loan are payable quarterly after the conversion. The outstanding borrowing under the term loan at September 30, 2017 and December 31, 2016 was $80.4 million and $82.0 million, respectively.

As of September 30, 2017 and December 31, 2016, the Fixed Rate Notes had a principal balance of $23.5 million, respectively. Interest is payable quarterly at a rate of 3.58% per annum. The Fixed Rate Notes and the term loan mature on January 15, 2020 and do not provide for any principal payments.

The construction-term loan agreement and senior secured notes contain certain default triggers, including without limitation: failure to maintain compliance with financial and other covenants contained in the agreement, limitation on liens, investments and the incurrence of additional indebtedness. CVPE was in compliance with all debt covenants for the construction-term loan agreement at September 30, 2017 and December 31, 2016.

On March 31, 2015, GSPE entered into a construction-term loan agreement of $84.0 million syndicated to three banks. The senior secured credit facilities are collateralized by GSPE’s assets.

(Continued)

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12

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

The GS Project was placed in service in March 29, 2016 and the new TCOS rate that included the GS Project assets was approved on June 13, 2016 by the PUCT. On October 31, 2016, the amount outstanding on the construction-term loan was converted into a term loan with a balance of $57.2 million. After this conversion, interest accrues at LIBOR plus 1.75%. Interest is payable the last day of the selected interest period for interest periods of three months or less, and every three months for interest periods greater than three months. Amortized principal amounts of the term loan are payable quarterly after the conversion. The term loan will mature on October 31, 2019. The outstanding borrowing under the term loan at September 30, 2017 and December 31, 2016 was $55.8 million and $56.8 million, respectively.

The construction-term loan agreement contains certain default triggers, including without limitation: failure to maintain compliance with financial and other covenants contained in the agreement, limitation on liens, investments and the incurrence of additional indebtedness. GSPE was in compliance with all debt covenants for the construction-term loan agreement at September 30, 2017 and December 31, 2016.

Future maturities of the total long-term debt as of September 30, 2017 are as follows:

 

 

Interest – During 2015, each of CVPE and GSPE entered into an interest swap agreement designated as a cash flow hedge against variable interest rate exposure on a portion of their construction-term loans that established a fixed rate on the LIBOR interest rates specified in the construction-term loans at 0.7185% and 0.760%, respectively, per annum until December 31, 2016. Notional amounts reset on a monthly basis and did not exceed $35.4 million and $38.1 million, respectively, at any given time. There were no notional amounts as of September 30, 2017 as these swap agreements terminated on December 31, 2016.

These cash flow hedging instruments were recorded as a liability in the Consolidated Balance Sheets at fair value, with an offset to accumulated other comprehensive income to the extent the cash flow hedging instruments were effective. The cash flow hedging instrument gains and losses included in other comprehensive income were reclassified into earnings as the underlying transaction occurred. There was no cash flow hedging instrument ineffectiveness recorded for these swap agreements.

The Partnership reclassified approximately $5,000 included in other comprehensive income, during the nine months ended September 30, 2016 to interest expense, net on the Consolidated Statement of Operations.

(Continued)

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13

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

All Transmission Service Providers (TSPs) within Electric Reliability Council of Texas (ERCOT) provide open access transmission service and the costs are ultimately passed through to end-use customers. The PUCT regulates the transmission rates that are charged by the ERCOT TSPs. The Partnership is billed based on the Partnership’s pro rata share, during the prior year, of the average of ERCOT coincident peak demand for the months of June, July, August, and September (ERCOT 4CP), excluding the portion of coincident peak demand attributable to wholesale storage load. Each TSP files a tariff for transmission service to establish its rates, calculated as the TSP’s commission-approved transmission cost of service, or revenue requirement, divided by the aggregate ERCOT 4CP during the prior year. Therefore, the monthly transmission service charge to be paid by the Partnership is the product of each TSP’s monthly rate as specified in its tariff and the Partnership’s previous year’s share of the aggregate ERCOT 4CP.

Taking power over the ERCOT network requires the Partnership to pay fees regulated by the PUCT. The annual charges to use the ERCOT transmission network cover the period from January 1 through December 31 of each year. Because the use of the network is governed by ERCOT and falls under the jurisdiction of the PUCT, a contract is not required with each ERCOT TSP.

The Partnership provides continued major medical coverage to retired employees and their dependents meeting certain eligibility requirements. The Partnership’s postretirement health care benefit plan provides prescription drug coverage. The Medicare Prescription Drug Improvement and Modernization Act of 2003 includes a federal subsidy for plans that offer prescription drug benefits that are actuarially equivalent to Medicare Part D. The Partnership and the actuarial advisors have determined that the prescription drug coverage provided by the Partnership’s postretirement health care benefit plan is actuarially equivalent to Medicare Part D, and accordingly, the subsidy provides some relief for ongoing retiree prescription costs.

The Partnership is required to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability on its balance sheet. FASB guidance requires an entity to include items that have not yet been recognized as net periodic postretirement benefit cost as a component of accumulated other comprehensive income. However, for a regulated utility this information is allowed to be recorded as a regulatory asset if: (i) the utility has historically recovered and currently recovers postretirement benefit plan expenses in its electric rates; and (ii) there is no negative evidence that the existing regulatory treatment will change. The Partnership has recorded the unrecognized components of net periodic postretirement benefit cost as a regulatory asset (liability) as these expenses are probable of future recovery.

In accordance with ASC Topic 820, Fair Value Measurements and Disclosures, the Partnership is required to assess the fair value of its financial instruments and disclose the level of inputs used for that estimate set forth in ASC 820.

The carrying amounts of the Partnership’s cash and cash equivalents, due to and from affiliates, and accounts payable approximate fair value due to the short-term nature of these assets and liabilities.

As of September 30, 2017 and December 31, 2016, the Partnership had approximately $136.2 million and $138.8 million, respectively, of borrowings under the construction-term loans which accrued interest under a floating rate structure. Accordingly, the carrying value of such indebtedness approximated the fair value for the amounts outstanding.

(Continued)

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14

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

The Partnership also had borrowings totaling $23.5 million under senior secured notes with a rate of 3.58% per annum as of September 30, 2017 and December 31, 2016. The fair value of these borrowings is estimated using discounted cash flow analysis based on current market rates.

Financial instruments, measured at fair value as defined by ASC 820, by level within the fair value hierarchy were as follows:

 

 

Leases

The Partnership has various obligations under operating leases pertaining to equipment, facilities and office space. Charges for the operating leases included in general and administrative expense in the accompanying Consolidated Statements of Operations amounted to approximately $186,000 and $555,000 during the three and nine months ended September 30, 2017, respectively.

The following is a schedule of future minimum lease payments required under operating leases with a term of greater than 12 months at inception as of September 30, 2017:

 

 

Regulatory proceedings

On April 29, 2016, the Partnership filed a system-wide rate proceeding with the PUCT to update its rates (April Rate Case Filing). Pursuant to a restructuring order issued by the PUCT in 2008 allowing the Partnership and SDTS to utilize a REIT structure, the April Rate Case Filing was prepared using the audited books and records of both Sharyland and SDTS and proposed rates to be set on a combined basis. However, as a result of a preliminary order issued by the PUCT in October 2016, Sharyland and SDTS filed an amended rate case application and rate filing packages (December Rate Case Filing) on December 30, 2016 with the PUCT, which superseded the April Rate Case Filing. On September 29, 2017, the PUCT issued an order dismissing the December Rate Case filing contingent on PUCT approval of the STM and the closing of the asset exchange transaction. See Note 2, Asset Exchange Transaction and Note 19, Subsequent Events for additional information regarding the pending asset exchange transaction and the status of the key closing conditions.

(Continued)

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15

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

Once the Rate Case dismissal becomes effective, the Partnership and SDTS will continue operating under their existing regulatory structure, and the current regulatory parameters will remain in place until the next rate case, including an allowed return on equity of 9.7%, a capital structure of 55% debt and 45% equity and a cost of debt of 6.73%. The Partnership and SDTS will be required to file a new rate case in the calendar year 2020 with a test year ending December 31, 2019.

In the interim, the Partnership reduced its base distribution rates by approximately 10% for its residential customers in its Stanton, Brady, and Celeste (SBC) service territories in accordance with the regulatory order issued on July 27, 2017 in Docket No. 45414. This interim rate relief for residential customers will reflect an approximately $3.0 million decrease in the Partnership’s retail distribution revenue requirement on an annualized basis.

On July 14, 2016, the Partnership received formal notification from the Oversight and Enforcement (O&E) Division of the PUCT that an investigation was being opened to determine whether the Partnership’s policy and procedures related to the transitioning of approximately 1,500 customers from the Small Secondary to the Large Secondary rate schedule were consistent with the Partnership’s tariff for delivery service, the Public Utilities Regulatory Authority (PURA), and the PUCT’s rules. After the O&E staff analyzed the data obtained from the Partnership, O&E staff concluded that over 1,000 customers were impacted by this transition from Small Secondary to the Large Secondary rate schedule. On February 17, 2017, the Partnership and O&E (the Parties) executed and filed in Docket No 46873, a settlement resolving O&E staff’s investigation of the Partnership for alleged violations of PURA, the PUCT’s rules, and the Partnership’s tariff. On March 30, 2017, the order for the settlement agreement was approved by the PUCT. The settlement order required the Partnership to pay an administrative penalty of approximately $425,000 and to refund the impacted customers approximately $990,000 including interest. On April 25, 2017, the Partnership paid the administrative penalty of $425,000 to the PUCT.

Supplemental cash flow information and non-cash investment and financing activities for the nine months ended September 30 are as follows:

 

 

(Continued)

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16

SHARYLAND UTILITIES, L.P.

Notes to the Consolidated Financial Statements
September 30, 2017
(Unaudited)

 

On October 13, 2017, the PUCT issued an order approving the STM for the asset exchange transaction and granting SDTS a CCN authorizing SDTS to continue to own and lease its assets to the Partnership. Also on October 13, 2017, the PUCT issued an order approving the settlement of Oncor’s rate case in Docket No. 46957 contingent on the closing of the asset exchange transaction. The PUCT’s approval of the STM and Oncor’s rate case settlement are both conditions to the closing of the asset exchange transaction.

The Partnership has evaluated subsequent events from the Balance Sheet date through October 25, 2017, the date at which the Financial Statements were made available to be issued, and determined there are no other items to disclose.

 

 

(Continued)

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