5. PE Power purposes to use the proceeds of the issue and sale of the bonds, notes and common stock to redeem its outstanding first mortgage gold bonds, 52 percent Series, due 1972, in the principal amount of $29,731,000 at the redemption price of 1052 percent of the principal amount thereof plus accrued interest and to redeem its outstanding 480,000 shares of 8 percent cumulative preferred stock having a par value of $25 per share at the redemption price of $28 per share plus accrued dividends.

BALANCE SHEETS OF PE POWER

Condensed consolidated balance sheets of PE Power at March 31, 1946, per books and pro forma reflecting the proposed transactions are attached hereto as Appendix A. The financial data contained in these findings are based on the assumptions made by the company that the new bonds will be sold at 102 percent of the principal amount thereof and will bear interest at the rate of 234 percent per annum and that PE will purchase from PE Power $2,400,000 par value of common stock.

PROPERTY ACCOUNT AND DEPRECIATION RESERVE

The consolidated plant and property account of PE Power as at March 31, 1946 aggregated $55,534,675. In August of 1945, the Federal Power Commission, after proceedings relating to the actual legitimate original cost of the Initial Conowingo Project at December 31, 1932, issued an order allowing $49,047,700 of $54,866,626 claimed project cost as of that date and disallowing $5,818,926. Of the amount disallowed the order required that $530,096 be transferred to other balance sheet accounts and that $5,288,830 be charged to earned surplus accounts, with the proviso that $4,058,152 of the $5,288,830 could be charged to capital surplus properly created for that purpose.

In October, 1945, a petition for review was filed by PE Power and Susquehanna with the United States Circuit Court of Appeals for the Third Circuit with respect to $4,389,819 of the $5,818,926 disallowed. Pending final determination, the court granted a stay of the Federal Power Commission order and ordered that the companies remove from their earned surplus accounts and transfer to and reserve in special earned surplus accounts the aggregate sum of $5,288,830 earmarked for compliance with the Federal Power Commission's orders if such orders are not modified or set aside by the Court.

The company has estimated that of the $55,534,675 book amount of property, about $17,000,000 represents non-depreciable land and land rights, and $38,000,000 represents depreciable property. Of the last amount, $18,000,000 represents machinery and equipment and the remaining $20,000,000 represents dams, reservoirs and waterways. The

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reserve for depreciation as at March 31, 1946, amounted to $5,153,783 or 9.28 percent of the $55,534,675 plant and property recorded on the books of PE Power and Susquehanna and 13 percent of the $38,000,000 of depreciable property.

CAPITALIZATION AND PERTINENT PROPERTY RATIOS

The consolidated capitalization and surplus of PE Power as at March 31, 1946, actual and pro forma, reflecting the proposed transactions are shown in Table I below:

While, initially, the ratio of long-term debt to total capitalization and surplus will be increased from 63.57 percent to 73.17 percent, the semi-annual maturities of the serial notes and the subsequent operation of the sinking fund for the proposed new bonds which provides for the complete retirement of the bonds by maturity will result in a rapid decrease in the amount of long-term debt outstanding. More

The company follows the sinking fund method of providing depreciation, maintaining a special depreciation fund consisting of cash and securities equivalent in amount to the balance in the depreciation reserve. An amount of $216,000 has been credited annually to the reserve through charges to income since commencement of operations in 1928 and the reserve has been further augmented by the earnings on the investments in the fund. The indenture for the presently outstanding bonds also provides for complete retirement of the bonds over their life. However, the new bonds provide for equal semi-annual sinking fund payments as against the provision in the indenture for the presently outstanding bonds which provide for graduated semi-annual sinking fund payments with the greatest amounts provided for in the later years.

over, the substitution, in effect, of serial notes for the preferred stock will result in the eventual elimination of $12,000,000 of senior securities which might otherwise remain outstanding at the expiration of the license.

On the other hand, as indicated in the above table, the common stock equity will be increased from 15.11 percent to 26.83 percent of total capitalization and surplus. It should be noted, however, that the above table gives no effect to the impact upon the common stock equity of any adjustments which may be required as a result of orders by the Federal Power Commission. If the entire amount of special earned surplus is eliminated, the common stock equity would amount to 8.11 percent per books and 19.40 percent on a pro forma basis.

The ratios of PE Power's senior securities, actual and pro forma giving effect to the proposed transactions, to its assets per books and as adjusted to reflect the adjustments ordered by the Federal Power Commission are shown in Table II below.

In connection with the above ratios, it is to be noted that, as previously indicated, the notes will be repaid in ten years by equal semi-annual payments and the bonds will be completely retired by their maturity date by equal semi-annual sinking fund payments beginning after the payment of the notes. In addition, the record indicates that the life expectancy of the largest portion of the property is substantially greater than the period during which the bonds will be outstanding.

EARNINGS

Attached hereto as Appendix B are condensed consolidated statements of income of PE Power for the twelve months ended March 31, 1946, per books and pro forma reflecting the first year effect of the refinancing.

Pursuant to the provisions of the agreements governing the operation of the project, P. E. is obligated to pay during the term of the license or any renewal thereof, seven percent per annum on the actual legitimate investment in the Conowingo Project' plus all operating expenses, taxes and depreciation charges. This obligation remains constant regardless of the amount of electric energy produced and transmitted, and accordingly any changes in the project companies' operating expenses, depreciation or taxes will have no effect upon their income, but will instead affect the amount of reimbursement from the parent.

As a result of the proposed transactions, the coverage on long-term debt and fixed charges of 1.93 and 1.82 times, respectively, on a per books basis will become, on a pro forma basis, 3.82 and 2.36, respectively, and the preferred dividend requirements will be eliminated. These ratios of coverage will improve each year, since the decrease in the total amount of bonds and notes outstanding will result in smaller interest charges while the amount of gross income in view of the contractual arrangements heretofore mentioned will tend to remain substantially the same. In this connection, however, it should be noted that the Federal license requires the project companies, commencing in 1948, and estimated by the companies to continue until 1966, to set aside in a special amortization fund excess earnings over and above a specified rate of return. The company has estimated that the excess earnings to be placed in the special amortization fund will amount to $11,051,000 for the period and that as a rosult of the investment of this amount such fund will be increased to $19,022,000 by the maturity of the proposed new bonds in 1975.8

ACCOUNTING TREATMENT

The accounting treatment to be accorded the debt discount and expense and call premiums with respect to the 52 percent first mortgage bonds to be refunded, is subject to the jurisdiction of the Federal

7 This rental is subject to change by the various regulatory authorities having jurisdiction. See Fn. 2, supra.

If the Conowingo Project is recaptured by the government in 1976, the net investment, for which the government would pay, may be reduced by the amount of the amortization reserve; but in this event the companies would retain the fund investments of like amount, so that there would be no capital impairment at that time.

Power Commission and the Pennsylvania Public Utility Commission. Both of the commissions have approved PE Power's proposal to amortize, over a period of four years, commencing July 1, 1946, by equal annual charges to income, the $2,561,258 of unamortized premium, discount and expense, call premium and duplicate interest relating to the bonds proposed to be retired.

The premium of $1,440,000 to be paid in connection with the redemption of the preferred stock will be charged to earned surplus.

THE BOND INDENTURE

The $30,000,000 principal amount of first mortgage bonds to be issued and sold will be dated July 1, 1946, and will mature July 1, 1975. The bonds will be a new series and will be issued under an existing mortgage between PE Power, Susquehanna (as joint mortgagor) and Fidelity Trust Company (now Fidelity Philadelphia Trust Company) as Trustee, as amended and supplemented by a supplemental indenture to be dated July 1, 1946. In the opinion of counsel for the company, the new bonds will constitute at the time of issuance a first lien on all of the properties now owned by PE Power and Susquehanna except certain stocks, bonds and other securities not specifically pledged. In addition, the bonds are secured by the pledge of all of the capital stock of Susquehanna and all of PE Power's and Susquehanna's rights, titles and interests in the Federal license and other agreements governing the operation of the Conowingo Project.

The Indenture provides that additional bonds may be issued to the extent of 60 percent of the cost or fair value (whichever is less) of unfunded property, provided that such property is subject to the same leases and rentals existing on the present property.

The Indenture contains a sinking fund provision requiring the company to make semi-annual payments to the Trustee in an amount sufficient to retire $800,000 principal amount of bonds on each interest payment date from January 1, 1957 to January 1, 1975, inclusive, and $400,000 on July 1, 1975. Such payments may be made in cash or by the delivery of bonds and will result in the retirement of all of the bonds by their maturity.

The Indenture also provides that until January 1, 1957, by which date the serial notes will be completely retired, the company will not pay any dividends on its common stock except out of net income available for dividends earned subsequent to June 30, 1946, unless prior to January 1, 1957 all of the new bonds are retired.

The Indenture will be qualified under the provisions of the Trust Indenture Act of 1939.