(2) To reimburse the declarant for the purchase and cancelation or the redemption on or before February 1, 1940, of $4,142,500 principal amount of first and refunding mortgage gold bonds, 5% series, due 2/1/52, of Lexington Utilities Company (including the payment, at the time of delivery of the proposed securities, of short-term notes issued to provide money for the redemption or purchase of bonds of said issue), requiring for principal and premium of 3% a_ (3) To the redemption (or reimbursement therefor) on or prior to 6/1/44, through the operation of the sinking fund applicable thereto, of $373,000 principal amount of first mortgage 5% gold bonds, due 6/1/49, of Lexington Railway Company, requiring for principal and premium of 10% . Total $4, 266, 775 410, 300 31, 680, 900 In order to achieve certain income-tax savings for the taxable year 1939 and also to avoid approximately 6 months' duplicate interest on the bonds of Lexington Utilities Company (which are callable only on February 1 and August 1 of each year upon 30 days' notice), declarant and its subsidiary, Lexington Utilities Company, anticipated the present refunding program by arranging a temporary loan in December 1939 with which to purchase on or before December 31, 1939, $2,417,500 of the Lexington bonds (at a cost of $2,490,025) and deposit sufficient funds on January 2, 1940, for the redemption of the balance outstanding (requiring $1,776,750 for principal and premium of 3%). $4,000,000 was borrowed by Lexington from The Chase National Bank of New York upon the issuance of a like amount of 3% % notes, guaranteed by declarant, presently secured by the pledge of $4,000,000 of Lexington bonds due 1951 and $989,400 of declarant's first mortgage bonds due in various amounts between 1948 and 1969. See In the matter of Lexington Utilities Company, et al., 6 8. E. C. 409 (1939). All of the Lexington first and refunding mortgage bonds, 5% series due 1952, have accordingly been retired and proceeds from the proposed financing will be used to pay the $4,000,000 note and reimburse declarant to the extent of $266,775 for additional funds expended as above (exclusive of expenses). The bonds of Lexington Railway Company constitute a lien on substantial portions of the properties acquired from Lexington Utilities Company and are callable only by means of the sinking fund applicable thereto. To secure a release of such lien and thereby eliminate all mortgage liens which would be prior to the proposed new bonds, declarant proposes to deposit with the trustee of the Lexington Railway bonds $473,475 in cash, being an amount equal to the sum of the principal of the $321,000 of bonds presently outstanding ($52,000 of the bonds having been retired since September 30, 1939), and interest of $152,475 on all of such bonds to maturity. By the operation of the sinking fund, however, it is estimated that the bonds will be retired by June 1, 1944, requiring $321,000 for principal, $43,875 for interest, and $32,100 for redemption premiums, an aggregate of $396,975. The difference of $76,500 between the amount to be deposited and the amount which it is estimated will be actually required to redeem the bonds in accordance with the sinking fund will be returned to declarant upon the final retirement of the bonds. The balance of $631,100 of net proceeds to be received will be applied in the manner hereinbefore discussed. SECURITY STRUCTURE Declarant's capitalization (including surplus) after its merger with Lexington Utilities Company, and its pro forma capitalization after giving effect to the proposed financing, is shown in the following table (as at September 30, 1939): • After giving effect to the merger of Lexington Utilities Co. and Kentucky Utilities Co. as authorized in In the matter of Kentucky Utilities Company et al., 6 8. E. C. 247 (1939). All bonds of Lexington Utilities Company were retired by February 1, 1940, by means of treasury funds and proceeds of a bank loan for $4,000,000 evidenced by a 3% note for $4,000,000, maturing on 12/20/41, secured by certain bonds of Lexington Utilities Company and declarant. See note of table on p. 944. As is apparent from the above schedule, the proposed financing will increase declarant's funded debt as of September 30, 1939, by $1,398,000, the increase being principally due to securities issued to acquire funds with which to pay redemption premiums of $1,078,900 in connection therewith. Substantial improvement will be effected, however, by the retirement of the serial notes at the rate of $825,000 a year, beginning in 1940, and by the retirement of sinking-fund mortgage bonds by their maturity in 1955, both of which it is anticipated can be taken care of by means of funds generated by declarant out of earnings and without the need of additional borrowings. ACCOUNTING ENTRIES Unamortized discount and expense applicable to the bonds to be refunded, and the call premiums to be paid upon their redemption, will be allocated to the proposed three new issues of securities on a dollar-year basis. The amounts so allocated will then be amortized over the lives of the new or old issues, whichever is shorter. The expenses of the new issues, and the discount applicable to the sinkingfund mortgage bonds, will be amortized over the lives of the respective issues. PROPERTY ACCOUNT Giving effect to the acquisition of the assets of Lexington Ice Company and Lexington Utilities Company, declarant's utility plant was stated as of September 30, 1939, as follows: Tangible property. Intangibles Plant acquired from Lexington Utilities Company, not segregated between tangible property and intangibles_ Total--- $37, 145, 385 5, 309, 415 6, 013, 322 48, 468, 122 The company represents that tangible property is stated at cost of construction except for that portion of properties acquired as entireties, for which construction cost records are not available (estimated at $5,400,000), which portion is stated on the basis of cost to the company or at reproduction cost new less observed depreciation as determined by independent engineers as of or substantially at dates of acquisition, less retirements. The adjusted cost to the company, in cash and securities, of properties acquired as entireties was approximately $22,484,000. Of this cost, $17,200,000 was assigned to tangible property, the balance of $5,264,000, plus subsequent net expenditures for organization, etc., having been assigned to intangibles. Plant purchased (the item of $6,013,322) represents the utility assets acquired from Lexington Utilities Company on January 3, 1940, of which $3,047,790 represents additions at cost, less retirements, by that company, the balance representing cash paid and the par value of securities issued or assumed for properties acquired as entireties by that company. In conformity with the uniform system of accounts prescribed by the Public Service Commission of Kentucky, declarant is engaged in a joint study with engineers of that Commission of all plant accounts to determine original cost when first devoted to public service. De •Declarant represents that all upward revaluations and intersystem profits have been eliminated from its property account. It appears, however, that the property account of declarant's subsidiary, Old Dominion Power Company, reflects an aggregate of $1,008,302 in upward revaluations effected prior to 1922. 6 S. E. C. clarant represents that the extent to which such studies, when completed, may affect future financial statements is not presently known although it estimates that the aggregate amounts of utility plant, including intangibles, will exceed such original cost by approximately $1,500,000 with respect to the property acquired from Lexington Utilities Company and by approximately $4,800,000 with respect to the balance. As of September 30, 1939, total long-term debt constituted 63 percent of gross utility plant and 68.7 percent of depreciated plant. Giving effect to the proposed financing and the subsequent application of $500,000 to be donated by The Middle West Corporation toward the reduction of the outstanding serial notes, these ratios would have been 65 and 71 percent, respectively. The retirement of the serial notes as they mature in the next few years will materially improve these ratios. MAINTENANCE AND DEPRECIATION Giving effect to the acquisition of the assets of Lexington Ice Company and Lexington Utilities Company, declarant's reserve for depreciation as of September 30, 1939, amounted to $4,104,375, equal to approximately 8.5 percent of gross utility plant. Prior to 1937, under the retirement method of accounting declarant and Lexington Utilities Company provided amounts which in their judgment were sufficient to provide for property retirement losses currently realized and also provide reserves for future retirements. This method did not contemplate a full provision for accrued depreciation as determined by the age and estimated service lives of the properties. In 1937 the depreciation principle of accounting was adopted, and declarant believes that the provisions for depreciation for the 2 years and 9 months ended September 30, 1939, are sufficient to cover the loss in service value not restored by current maintenance, incurred in connection with the consumption or prospective retirement of utility plant in the course of service from causes known to be in current operation and against which the utilities are not protected by insurance. The following table shows (a) the ratios of maintenance and depreciation (or retirements for the year 1936) to gross operating revenues and (b) the ratio of depreciation appropriation (or retirement appropriation for the year 1936) to total utility plant at the end of each year for the consolidated accounts of Kentucky Utilities Company 6 S. E. C. and Lexington Utilities Company: MAINTENANCE EXPENSE AND DEPRECIATION (OR RETIREMENT) PROVISION The indentures securing the proposed first mortgage bonds and the sinking-fund mortgage bonds provide that beginning with the calendar year 1940, declarant will expend or accrue on its books for maintenance and/or credit on its books to a reserve for depreciation or amortization of property, not less than 15 percent of gross operating revenues (as defined in the indenture) provided that any of such credits or expenditures made after December 31, 1939, and not applied toward the satisfaction of this requirement during the particular year may be applied toward its satisfaction in any ensuing year or years. EARNINGS Giving effect to the acquisition of the assets and assumption of the liabilities of Lexington Ice Company and Lexington Utilities Company, for the 12 months ended September 30, 1939, declarant had gross income of $3,590,959 available for interest of $1,652,828 on funded debt and $1,801,916 of total fixed charges, coverages of approximately 2.17 and 1.99 times, respectively. Giving effect to the financing, pro forma gross income of $3,496,819 would have been available for interest of $1,287,500 on the new bonds and notes, and for total fixed charges of $1,491,587, coverage of 2.72 and 2.34 times, respectively. Total fixed charges and preferred stock dividend requirements would be covered 1.50 times on a pro forma basis. The $500,000 reduction in outstanding serial notes to be effected through application of the donation to be received from Middle West will correspondingly increase these coverages through the elimination of interest thereon. COMPLIANCE WITH THE ACT Since the first mortgage bonds to be issued will be secured, in the opinion of counsel for declarant, by a first lien on physical property of the issuer, and since both issues of bonds and the serial notes are to be issued and sold solely for the purpose of refunding or discharging outstanding securities of declarant, as hereinabove stated, |