-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OPN1j3eMbWd5Zcn6PWdxZaji1R5F9M8mHJu5KuwuMqKoHLi07/Fcd06QBRWiMtsY 2u6vExE2kKvPOPCWz1ie0g== 0000835715-98-000001.txt : 19980327 0000835715-98-000001.hdr.sgml : 19980327 ACCESSION NUMBER: 0000835715-98-000001 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980326 SROS: NYSE SROS: PHLX FILER: COMPANY DATA: COMPANY CONFORMED NAME: KENTUCKY UTILITIES CO CENTRAL INDEX KEY: 0000055387 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 610247570 STATE OF INCORPORATION: KY FISCAL YEAR END: 1229 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-03464 FILM NUMBER: 98574241 BUSINESS ADDRESS: STREET 1: ONE QUALITY ST CITY: LEXINGTON STATE: KY ZIP: 40507 BUSINESS PHONE: 6062552100 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KU ENERGY CORP CENTRAL INDEX KEY: 0000835715 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 611141273 STATE OF INCORPORATION: KY FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-10944 FILM NUMBER: 98574242 BUSINESS ADDRESS: STREET 1: ONE QUALITY ST CITY: LEXINGTON STATE: KY ZIP: 40507 BUSINESS PHONE: 6062552100 FORMER COMPANY: FORMER CONFORMED NAME: HOLDINGS INC DATE OF NAME CHANGE: 19600201 10-K405 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K X ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission Registrant; State of Incorporation; IRS Employer File Number Address; and Telephone Number Identification No. 1-10944 KU Energy Corporation 61-1141273 (A Kentucky Corporation) One Quality Street Lexington, Kentucky 40507-1428 (606) 255-2100 1-3464 Kentucky Utilities Company 61-0247570 (A Kentucky and Virginia Corporation) One Quality Street Lexington, Kentucky 40507-1428 (606) 255-2100 Indicate by check mark whether the Registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ( X ) Securities registered pursuant to Section 12(b) of the Act: KU Energy Corporation Name of Each Exchange Title of Each Class on Which Registered Common Stock, without par value New York Stock Exchange Pacific Stock Exchange Kentucky Utilities Company Name of Each Exchange Title of Each Class on Which Registered Preferred Stock, 4 3/4% cumulative, Philadelphia Stock Exchange stated value $100 Per Share -1- Securities registered pursuant to Section 12(g) of the Act: KU Energy Corporation None Kentucky Utilities Company Preferred Stock, cumulative, stated value $100 per share (Title of Class) KU Energy Corporation Aggregate market value at March 25, 1998 of the voting stock held by nonaffiliates of KU Energy Corporation (KU Energy): $1,602,517,283. Number of shares of Common Stock outstanding at March 25, 1998: 37,817,517 shares. Kentucky Utilities Company Aggregate market value of the voting stock held by nonaffiliates of Kentucky Utilities Company (KU): None Number of shares of Common Stock outstanding at March 25, 1998: 37,817,878 shares (owned by the parent - KU Energy). Documents Incorporated by Reference: A portion of KU Energy's 1997 Annual Report to Shareholders is incorporated by reference in Parts I, II and IV. A portion of KU Energy's Proxy Statement relating to the 1998 Annual Shareholders Meeting is incorporated by reference in Part III. Exhibit Index appears on page 42. -2- KU ENERGY CORPORATION AND KENTUCKY UTILITIES COMPANY Form 10-K Annual Report to the Securities and Exchange Commission For the Year Ended December 31, 1997* TABLE OF CONTENTS Item Page PART I 1.Business . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.Properties . . . . . . . . . . . . . . . . . . . . . . . . . . 12 3.Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . 13 4.Submission of Matters to a Vote of Security Holders . . . . . . 13 Executive Officers of the Registrants . . . . . . . . . . . . . 14 PART II 5.Market for Registrants Common Equity and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . 17 6.Selected Financial Data . . . . . . . . . . . . . . . . . . . . 18 7.Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . 22 7A.Quantitative and Qualitative Disclosures About Market Risk . . 22 8.Financial Statements and Supplementary Data . . . . . . . . . . 22 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . . . . . . . . . . . . . . . . 40 PART III 10.Directors and Executive Officers of the Registrants . . . . . . 40 11.Executive Compensation . . . . . . . . . . . . . . . . . . . . 40 12.Security Ownership of Certain Beneficial Owners and Management 40 13.Certain Relationships and Related Transactions . . . . . . . . 40 PART IV 14.Exhibits, Financial Statement Schedules, and Reports on Form 8-K 41 Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . . . 42 Pro Forma Financial Statements . . . . . . . . . . . . . . . . 50 Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . 58 *Information included herein which relates solely to KU Energy Corporation is provided solely by KU Energy Corporation and not by Kentucky Utilities Company and shall be deemed not included in the Annual Report on Form 10-K of Kentucky Utilities Company. -3- PART I Item 1. Business KU ENERGY CORPORATION KU Energy Corporation (KU Energy or the Company), an exempt utility holding company, was incorporated in the state of Kentucky on June 23, 1988. On December 1, 1991, KU Energy became the holder of all common stock of Kentucky Utilities Company (KU). KU Energy has two wholly owned subsidiaries, KU, an electric utility, and KU Capital Corporation (KU Capital), a nonutility subsidiary. KU is KU Energy's principal subsidiary. The Company is a public utility holding company as defined in the Public Utility Holding Company Act of 1935 (the Holding Company Act). On November 13, 1991, the Company obtained an order from the Securities and Exchange Commission which granted an exemption from all provisions of the Holding Company Act, except Section 9(a)(2) thereof which relates to the acquisition of securities of public utility companies. The ability of the Company to pay dividends on its common stock is dependent upon distributions made to it by KU and KU Capital and on amounts that may be earned by the Company on investments. Merger On May 20, 1997, KU Energy and LG&E Energy Corp. (LG&E Energy) entered into an Agreement and Plan of Merger (Merger) providing for a tax-free, stock for stock merger of KU Energy and LG&E Energy. As a result of the Merger, LG&E Energy, the surviving corporation, will become the parent company of KU and will continue as parent of Louisville Gas and Electric Company. When the Merger is completed, shareholders of KU Energy common stock will receive 1.67 shares of LG&E Energy common stock for each share of KU Energy common stock held. The Merger has been approved by shareholders of KU Energy and LG&E Energy, by the Kentucky Public Service Commission (PSC) and the Virginia State Corporation Commission (SCC). The Merger was approved by the Federal Energy Regulatory Commission (FERC) on March 25, 1998. The Merger must still be approved by the the Securities and Exchange Commission and reviewed by the Federal Trade Commission. Following receipt of the remaining regulatory approvals, the Merger is expected to be effective as early as the first half of 1998. See Management's Discussion and Analysis of Financial Condition and Results of Operations - The Merger in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13), which is incorporated herein by reference for further information related to the Merger. LG&E Energy serves about 351,000 electric customers and 277,000 gas customers in Louisville and adjacent areas in Kentucky through its utility subsidiary, Louisville Gas and Electric Company. At December 31, 1997, LG&E Energy had assets of $3.4 billion. For 1997, LG&E Energy had electric revenues of $615 million, gas revenues of $231 million and net income of $97.8 million. Further information concerning LG&E Energy is contained in LG&E Energy's Annual Report on Form 10-K for the year ended December 31, 1997. See Unaudited Pro Forma Combined Condensed Financial Information of KU Energy and LG&E Energy contained under Item 14 of this report for selected historical and unaudited pro forma combined condensed financial information of KU Energy and LG&E Energy. -4- KU CAPITAL CORPORATION KU Capital continues to pursue a core energy strategy for its nonutility business activities. Under this strategy, targeted opportunities are energy-related activities that build on the Company's knowledge and expertise and have the appropriate risk/reward profile. KENTUCKY UTILITIES COMPANY General KU is a wholly owned subsidiary of KU Energy. KU was incorporated in Kentucky in 1912 and incorporated in Virginia in 1991. KU is a public utility engaged in producing, transmitting and selling electric energy. KU provides electric service to about 441,200 customers in over 600 communities and adjacent suburban and rural areas in 77 counties in central, southeastern and western Kentucky, and to about 29,000 customers in 5 counties in southwestern Virginia. In Virginia, KU operates under the name Old Dominion Power Company. KU operates under appropriate franchises in substantially all of the 160 Kentucky incorporated municipalities served. No franchises are required in unincorporated Kentucky communities. Service has been provided in Virginia without franchises for a number of years. The lack of franchises is not expected to have a material adverse effect on KU's operations. KU also sells electric energy at wholesale for resale in 12 municipalities. The territory served by KU has an aggregate population estimated at about 1,000,000. The largest city served is Lexington, Kentucky. The population of the metropolitan Lexington area is estimated at about 225,000. The populations of the next 10 largest cities served at retail range from about 21,000 to 9,000. The territory served includes most of the Bluegrass Region of central Kentucky and parts of the coal mining areas in southeastern and western Kentucky and southwestern Virginia. Lexington is the center of the Bluegrass Region, in which thoroughbred horse, burley tobacco and bourbon whiskey distilling industries are located. Among the principal industries in the territory served are automotive and related industries, coal mining, the manufacture of paper and paper products, rubber and miscellaneous plastic products and electrical and other machinery. Revenues KU's sources of electric revenues and the respective percentages of total revenues for the three years 1995-1997 were as follows: Year Ended December 31, 1997 1996 1995 Amount % Amount % Amount %
(dollars in thousands) Residential $ 231,824 32 $ 236,229 33 $ 232,760 34 Commercial 150,794 21 150,640 21 151,778 22 Industrial 146,801 21 136,856 19 130,066 19 Mine Power 34,541 5 34,014 5 36,076 5 Public Authorities 56,243 8 56,023 8 54,161 8 Sales for Resale 87,330 12 89,208 13 75,940 11 Miscellaneous Revenues 8,904 1 8,741 1 5,649 1 Total $ 716,437 100 $ 711,711 100 $ 686,430 100
-5- The electric utility business is affected by seasonal weather patterns. As a result, operating revenues (and associated operating expenses) are not generated evenly throughout the year. See Management's Discussion and Analysis of Financial Condition and Results of Operations - Sales and Revenues in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) which is incorporated herein by reference for information related to revenues. Operations KU's net generating capability was 3,718 megawatts at December 31, 1997. The net generating capability available for operation at any time may be lower because of periodic outages of generating units due to inspection, maintenance, fuel restrictions, or modifications required by regulatory agencies. KU obtains power from other utilities under bulk power purchase and interchange contracts. At December 31, 1997, KU's system capability, including purchases from others, was 4,274 megawatts. On July 28, 1997, an all-time system peak demand, on a one-hour integrated basis, was set at 3,510 megawatts. See Item 2, Properties-Construction for a discussion of KU's plans to add additional peaking capacity. The percentage of KU's system output which was internally generated and purchased for the periods indicated was as follows: 1997 1996 1995 Internally Generated 81% 84% 82% Purchased 19% 16% 18% KU is one of 18 full members of the East Central Area Reliability Coordination Agreement, the purpose of which is to augment the reliability of the members' bulk power supply through coordination of planning and operation of generation and transmission facilities. The members are engaged in the generation, transmission and sale of electric power and energy in the east central area of the United States, which covers all or portions of Michigan, Indiana, Ohio, Kentucky, Pennsylvania, Virginia, West Virginia and Maryland. KU also has interconnections and contractually established operating arrangements with neighboring utilities and cooperatives. Under a contract expiring 2020 with Owensboro Municipal Utilities (OMU), KU has agreed to purchase from OMU the surplus output of the 150-megawatt and 250-megawatt generating units at OMU's Elmer Smith station. Purchases under the contract are made under a contractual formula which has resulted in costs which were and are expected to be comparable to the cost of other power purchased or generated by KU. Such power constituted about 10% of KU's net system output during 1997. See Note 4 of the Notes to Financial Statements, Commitments and Contingencies under Item 8. KU owns 20% of the common stock of Electric Energy, Inc. (EEI), which owns and operates a 1,000-megawatt generating station in southern Illinois. KU's entitlement is 20% of the available capacity of the station. Purchases from EEI are made under a contractual formula which has resulted in costs which were and are expected to be comparable to the cost of other power purchased or generated by KU. Such power constituted about 8% of KU's net system output in 1997. See Note 4 of the Notes to Financial Statements, Commitments and Contingencies, under Item 8. KU had approximately 2,060 employees at December 31, 1997, of which about 300 are covered by union contracts expiring August 1, 1998. -6- Fuel Matters Coal-fired generating units provided more than 99% of KU's net kilowatt- hour generation for 1997. The remainder of KU's net generation for 1997 was provided by oil and/or natural gas burning units and hydroelectric plants. The average delivered cost of coal purchased per million BTU (MBTU) and the percentage of spot coal purchases for the periods indicated were as follows: 1997 1996 1995 Per MBTU - all sources $ 1.15 $ 1.14 $ 1.16 Per MBTU - spot purchases only $ 1.12 $ 1.08 $ 1.10 Spot purchases as % of all sources 34% 33% 30% KU maintains its fuel inventory at levels estimated to be necessary to avoid operational disruptions at its coal-fired generating units. Reliability of coal deliveries can be affected from time to time by a number of factors, including fluctuations in demand, coal mine labor issues and other supplier or transporter operating difficulties. KU believes there are adequate reserves available to supply its existing base-load generating units with the quantity and quality of coal required for those units throughout their useful lives. KU intends to meet a substantial portion of its coal requirements with 3-year or shorter contracts. KU anticipates that coal supplied under such contracts will represent about one-half to two-thirds of the requirements over the next several years. As part of this strategy, KU will continue to negotiate replacement contracts as contracts expire. KU does not anticipate any problems negotiating new contracts for future coal needs. The balance of coal requirements will be met through spot purchases. See Note 4 of the Notes to Financial Statements, Commitments and Contingencies, under Item 8 for the estimated obligations under existing fuel contracts for each of the years 1998 through 2002. KU has no long-term contracts in place for the purchase of natural gas for its combustion turbine peaking units. KU has met its gas requirements through spot purchases. KU does not anticipate encountering any significant problems acquiring an adequate supply of fuel necessary to operate its peaking units. See Item 2, Properties-Construction, for a discussion of KU's plans to add additional peaking capacity. Environmental Matters Federal and state agencies have adopted environmental protection standards which apply to the electric operations of KU. Capital expenditures to comply with environmental requirements amounted to about $182 million during the 1993-1997 time period. KU's generating units are operated in compliance with the Kentucky Natural Resources and Environmental Protection Cabinet's (Cabinet) State Implementation Plan (KYSIP) and New Source Performance Standards developed under the Clean Air Act. The KYSIP is a federally approved plan for the attainment of the national ambient air quality standards. The KYSIP contains standards relating to the emissions of various pollutants (sulfur dioxide, particulates and nitrogen oxides) from KU's fossil-fuel fired steam electric generating units. These emission standards are of varying -7- stringencies and compliance with these standards is attained through a variety of air pollution control technologies (scrubbers, electrostatic precipitators, and low nitrogen oxide burners) and the use of low-sulfur coal. KU's operations are in substantial compliance with current emission standards. The operating permit program under the 1990 Clean Air Act Amendments required KU to make application to the Cabinet for new operating permits for its six generating stations. KU's existing permits to operate air contaminant sources continue in effect until new permits are issued. The acid rain control provisions of the 1990 Clean Air Act Amendments, which are effective in two phases, require KU to further decrease the emissions of sulfur dioxide and nitrogen oxides from its fossil-fuel fired steam electric generating units. Ghent Unit 1, E. W. Brown Units 1, 2 and 3, and Green River Unit 4 were designated as Phase I affected units which were required to comply with sulfur dioxide emission reduction obligations beginning January 1, 1995. In order to comply with these sulfur dioxide emission limitations, KU installed a scrubber and related facilities on Ghent Unit 1 and switched to lower sulfur coal on some other Phase I affected units. In addition, these units were retrofitted with low nitrogen oxide burners in order to comply with applicable nitrogen oxide limitations under United States Environmental Protection Agency (EPA) regulations. The EPA issued final acid rain permits for each of KU's Phase I affected units. The EPA's approval of KU's acid rain compliance plan was accompanied by bonus allowances awarded for the installation of the scrubber on Ghent Unit 1. KU's current emission allowance strategy, in part, includes the accumulation of unused sulfur dioxide emission allowances. These unused allowances result from the bonus allowances received from the EPA and the expected reduced sulfur dioxide emissions from the installation of the Ghent Unit 1 scrubber. The accumulated allowances are expected to allow KU to delay capital expenditures associated with KU's Phase II acid rain compliance obligations, which are effective January 1, 2000. KU's Phase II compliance strategy, in addition to utilizing accumulated allowances, may include additional fuel switching or the installation of additional scrubbers. However, KU will continue to reassess its options for complying with Phase II emission reduction requirements to determine an overall least cost strategy. See Management's Discussion and Analysis of Financial Condition and Results of Operations - Environmental Matters in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) incorporated herein by reference for additional discussion. The Environmental Protection Agency (EPA) issued final rules on July 18, 1997 revising the National Ambient Air Quality Standards for ozone and particulate matter. The revised standards would require significant reductions in sulfur dioxide and nitrogen oxide emissions from coal-fired boilers (including those at KU's generating stations) beginning in 2004. Certain implementation proposals, which are not yet finalized, would target coal-fired utilities in the Midwest and South, including Kentucky, for more substantial reductions than other areas and other sources of emissions. Implementation methods will be determined by the EPA as well as state regulatory authorities. KU believes that the costs relating to compliance with the new standards, including capital costs, as well as associated increases in operating costs, are likely to be substantial and are dependent on the ultimate control program agreed to by the targeted states and the EPA. KU further believes that such capital and operating costs are the type of costs that are eligible for recovery from customers under its environmental surcharge mechanism. However, approval from the PSC is required. See Note 9 of the Notes to Financial Statements, Environmental Cost Recovery under Item 8. KU will continue to closely monitor -8- developments in this area and anticipates that the exact nature of the impact of the new standards on its operations will not be known for some time. During 1996, each of KU's five fossil-fuel fired steam electric generating stations was re-issued a wastewater discharge permit by the Cabinet under the Clean Water Act's National Pollutant Discharge Elimination System. These 5-year permits place water quality-based effluent limitations (i.e., thermal and chemical limits) on each of the power plant's discharges. KU's operations are in substantial compliance with the conditions in the permits. Pursuant to the Resource Conservation and Recovery Act, utility wastes (fly ash, bottom ash and scrubber sludge) have been categorized as special wastes (i.e., wastes of large volume, but low environmental hazard). The EPA has concluded that the disposal of coal combustion byproducts by practices common to the utility industry is adequate for the protection of human health and the environment. The Cabinet also regulates utility wastes as special wastes under its waste management program. Under the Toxic Substances Control Act, the EPA regulates the use, servicing, repair, storage and disposal of electrical equipment containing polychlorinated biphenyls (PCB). KU is in substantial compliance with applicable PCB regulations. Regulation KU is subject to the jurisdiction of the PSC and the SCC as to retail rates and service, accounts, issuance of securities and in other respects. The FERC has jurisdiction under the Federal Power Act (FPA) over certain of the electric utility facilities and operations, wholesale sale of power and related transactions and accounting practices of KU, and in certain other respects as provided in the FPA. The FERC has classified KU as a "public utility" as defined in the FPA. By reason of owning and operating a small amount of electric utility property in one county in Tennessee (having a gross book value of about $225,000), KU may also be subject to the jurisdiction of the Tennessee Regulatory Authority as to retail rates, accounts, issuance of securities and in other respects. Since 1992, utilities in Kentucky have had the option to use either a historical test period or a forward-looking test period in base rate filings. KU's fuel adjustment clause for Kentucky customers operates to reflect changes in the cost of fuel in billings to customers, and is designed to conform with a PSC regulation providing for a uniform monthly fuel adjustment clause for all electric utilities in Kentucky subject to the jurisdiction of the PSC. The PSC regulation is based on a formula approved by the FERC but with certain modifications, including the exclusion of excess fuel expense attributable to certain forced outages, the filing of fuel procurement documentation, a procedure for billing over- and under- recoveries of fuel cost fluctuations from the base rate level and provision for periodic public hearings to review past adjustments, to make allowance for any past adjustments found not justified, to disallow any improper expenses and to re-index base rates to include current fuel costs. The fuel adjustment clause mechanism for Virginia customers uses an average fuel cost factor based primarily on projected fuel costs. The fuel cost factor may be adjusted annually for over- or under- collections of fuel costs from the previous year. -9- Rate regulation in Kentucky allows each electric utility, with a PSC- approved environmental compliance plan and environmental surcharge, to recover on a current basis the cost of complying with federal, state or local environmental requirements, including the Federal Clean Air Act as amended, applicable to coal combustion wastes and byproducts from facilities utilized for the production of energy from coal. In 1994, the PSC approved KU's environmental surcharge, which is designed to allow KU to recover compliance related operating expenses and to earn a return on those compliance-related capital expenditures not already included in existing rates through the application of the surcharge each month to customers' bills. Surcharge billings are subject to periodic PSC review of the level of environmental expenditures and reconciliation of previous surcharge billings with actual costs. For additional information regarding the environmental surcharge, including information concerning pending legal proceedings, see Management's Discussion and Analysis of Financial Condition and Results of Operations - Environmental Cost Recovery in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) incorporated herein by reference and Note 9 of the Notes to Financial Statements, Environmental Cost Recovery, under Item 8. Integrated resource planning regulations in Kentucky require KU and the other major utilities to make triennial filings with the PSC, of various historical and forecasted information relating to forecasted load, capacity margins and demand-side management techniques. Pursuant to Kentucky law, the PSC has established the boundaries of the service territory or area of each retail electric supplier in Kentucky (including KU), other than municipal corporations, within which each such supplier has the exclusive right to render retail electric service. The SCC requires each Virginia utility to make annual filings of either a base rate change or an Annual Informational Filing consisting of a set of standard financial schedules. These filings are subject to review by the SCC Staff (Staff). The Staff issues a Staff Report, which includes any findings or recommendations to the SCC relating to the individual utility's financial performance during the historic 12-month period, including previously accepted adjustments. The Staff Report may lead to an adjustment in rates. KU is presently exempt from all the provisions of the Public Utility Holding Company Act of 1935, except Section 9(a)(2) thereof (which relates to the acquisition of securities of public utility companies), by virtue of the exemption granted by an order of the Securities and Exchange Commission dated April 19, 1949 and, absent further action by the Commission, by virtue of annual exemption statements filed by KU with the Commission pursuant to Rule 2 prescribed under the Act. For information regarding regulatory matters related to the Merger, see Management's Discussion and Analysis of Financial Condition and Results of Operations - The Merger in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) incorporated herein by reference. Competition The electric utility industry has been rapidly moving to a less regulated and more competitive environment since the passage of the National Energy Policy Act of 1992 (NEPA). NEPA gave the FERC the authority to order electric utilities to provide wholesale transmission access to independent power producers and other utilities. It also reduced restrictions on the ownership and operation of independent power producers. See Management's -10- Discussion and Analysis of Financial Condition and Results of Operation - Utility Issues - Competition in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) incorporated herein by reference for further discussion of competition. In April 1996, the FERC issued two final rules and a new Notice of Proposed Rulemaking (NOPR) to promote competition and deregulation in the wholesale electric market. FERC Order No. 888 (Order 888) addressed both open access transmission service and stranded cost issues. FERC Order No. 889 (Order 889) required utilities to establish an electronic Open Access Same-Time Information System (OASIS) to share information about available transmission capacity and also required the establishment by each utility of standards of conduct for its transmission system operation. The 1996 NOPR proposes to establish a new system for utilities to use in reserving capacity on their own and other s transmission lines. See Management's Discussion and Analysis of Financial Condition and Results of Operation - Competition - Wholesale in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) incorporated herein by reference for further discussion of the FERC orders. In 1998, KU announced that it will join the Midwest Independent System Operator (MISO). KU is among nine transmission system owners, including Louisville Gas and Electric Company, which filed a proposal with the FERC in January 1998 seeking approval to form the MISO. The MISO is a regional entity that would manage and operate the transmission owners collective transmission systems in an eight-state region. The primary objectives of the MISO are to advance wholesale competition by ensuring nondiscriminatory open transmission access to all wholesale customers and to enhance transmission reliability. Cautionary Factors See Management's Discussion and Analysis for information concerning forward looking statements. Forward looking statements have been and will be made in written documents and oral presentations of the Company and KU. All statements made herein which are not based on historical facts are forward looking and, accordingly, involve risks and uncertainties that could cause actual results to differ materially from those discussed. In addition to those forward looking statements and cautionary factors referred to in Management's Discussion and Analysis, forward looking statements in this Form 10-K include those relating to: 1. The need for franchise agreements. 2. The future comparability of OMU and EEI power costs to generation and other available power. 3. The percent of future total kWh requirements provided by OMU and EEI. 4. Maintaining necessary levels of fuel inventory and adequate supplies of coal and gas to avoid operational disruptions. 5. Availability of coal reserves to supply baseload generating units over their useful lives. 6. The amount of coal supplied by contract versus spot purchase. 7. Negotiations of new coal contracts for future coal needs. 8. The impact of revisions to the National Ambient Air Quality Standards. 9. The availability of an adequate supply of natural gas. 10. Estimates of future construction expenditures discussed under Item 2 - Properties--Construction. 11. The expected timing of regulatory approvals of the Merger. -11- All such statements are and will be based on management's belief, judgment and analysis as well as assumptions made by and information available to management at the time the statements are made. When used in the Company's or KU's documents or oral presentations, the words anticipate, estimate, expect, believe and similar expressions are intended to identify forward looking statements. In addition to any assumptions and other factors referred to specifically in connection with such forward looking statements, factors that could cause the Company's or KU's actual results to differ materially from those contemplated in any forward looking statements include, among others, those identified in Exhibit 99.04 hereto, which is incorporated herein by reference. Item 2. Properties Currently, KU Energy and KU Capital have no significant physical property. KU owns and operates the following electric generating stations:
Nameplate Effective Rating (KW) Capability (KW) Steam: Ghent Ghent, Ky 2,226,060 1,997,000 Green River South Carrollton, Ky 263,636 239,000 E. W. Brown Burgin, Ky 739,534 717,000 Tyrone Tyrone, Ky 137,500 136,000 Pineville Four Mile, Ky 37,500 34,000 Hydro: Dix Dam & Lock #7 Burgin, Ky 30,297 24,000 Gas/Oil Peaking: Haefling Lexington, Ky 62,100 59,000 E.W. Brown Burgin, Ky 504,000 512,000 4,000,627 3,718,000
Substantially all properties are subject to the lien of KU's Mortgage Indenture. Construction Four 126-MW combustion turbine peaking units have been installed over the past four years. The first peaking unit was placed into commercial operation in late 1994. The second and third units were placed into commercial operation in February 1995 and December 1995, respectively. The fourth unit was placed into commercial operation in May 1996. Total construction expenditures for the years 1998 through 2002 are estimated at $549 million. Such expenditures include an estimated $183 million for generating facilities, $76 million for transmission facilities and $290 million for distribution and general facilities. Included in total construction expenditures for the 1998-2002 period are $105 million for 480 MW of peak generating capacity to be added during 1998-2002. KU has no plans to install baseload generating capacity before 2010. Construction expenditures for the years 1993 through 1997 aggregated about $695 million. See Note 4 of the Notes to Financial Statements, Commitments and Contingencies, under Item 8, for the estimated amounts of construction expenditures for each of the years 1998 through 2002. KU frequently reviews its construction program and construction expenditures, which may be affected by numerous factors, including competition and deregulation, the rate of load growth, changes in construction costs, changes in environmental regulations, least cost planning, the adequacy of rate relief and KU's ability to raise necessary -12- capital. See Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity & Capital Resources - Capital Requirements in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) incorporated herein by reference. KU's planned additions to its electric generating capacity are based on future load projections using estimated load growth rates. Consideration is also given to projections by neighboring utilities of their future loads and capacity. However, forecasts of future loads are subject to numerous uncertainties, including economic conditions and effectiveness of energy conservation measures. Following consumation of the Merger, the Company and LG&E Energy will each re-examine the timing of potential additional electric generation resources. See Management's Discussion and Analysis of Financial Condition and Results of Operations - The Merger in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) incorporated herein by reference. Item 3. Legal Proceedings KU Energy and KU Capital are involved in no material legal proceedings. See Management's Discussion and Analysis - Environmental Matters - Environmental Cost Recovery in KU Energy's 1997 Annual Report to Shareholders Exhibit 13) incorporated herein by reference and Note 9 of the Notes to Financial Statements, "Environmental Cost Recovery," under Item 8 for a discussion of KU's environmental surcharge legal proceedings. Item 4. Submission of Matters to a Vote of Security Holders At the October 14, 1997 Special Meeting of Shareholders, the following proposal was acted on and approved by the holders of KU Energy Common Stock. (a) To consider and vote upon the adoption and approval of the Agreement and Plan of Merger, dated as of May 20, 1997 between LG&E Energy and KU Energy. Affirming Negative Broker Votes Votes Abstentions Non-Votes 29,113,099 441,062 943,712 0 The Merger was approved by 77% of the outstanding common shares and by 95% of those shares represented at the meeting. -13- Executive Officers of KU Energy Current Positions Held During at Name and Age Positions Held Least the Last 5 Years Michael R. Whitley Chairman and Chairman of the Board of KU Energy Age 54 President* since August 1995 and President of KU Energy since November 1994. Director of KU Energy since March 1992. Senior Vice President from 1988 to November 1994. O. M. Goodlett Senior Vice- Senior Vice-President of KU Energy Age 50 President* since November 1994. James W. Tipton Senior Vice- Senior Vice-President of KU Energy Age 54 President since November 1994. Senior Vice- President of Kentucky Utilities from November 1986 to November 1994. George S. Brooks II General Corporate Secretary of KU Energy Age 47 Counsel and since November 1992, and General Corporate Counsel since 1988. Secretary* William N. English Treasurer* Treasurer of KU Energy since 1988. Age 47 Michael D. Robinson Controller* Controller of KU Energy since June Age 42 1990. Note: Officers are elected annually by the Board of Directors. There is no family relationship between any executive officer and any other executive officer or any director. Certain executive officers of KU may be considered "executive officers" of KU Energy for certain purposes. Refer to KU's listing of executive officers for information concerning positions held during the last five years and information concerning KU executive officers. * Identified persons hold positions with the same titles at KU. -14- Executive Officers of KU Current Positions Held During at Name and Age Positions Held Least the Last 5 Years Michael R. Whitley Chairman and Chairman of the Board of KU Age 54 President and since August 1995 and Chief Executive President from November 1994. Officer* Director of KU since March 1992. Senior Vice-President of KU from March 1987 to November 1994. O. M. Goodlett Senior Vice- Senior Vice-President of KU Age 50 President since November 1992. Finance and Administration and Chief Financial Officer* Robert M. Hewett Senior Vice- Senior Vice-President of KU Age 50 President since May 1997. Vice- Customer Service President of KU since January and Marketing 1982. Wayne T. Lucas Senior Vice- Senior Vice-President of KU Age 50 President since November 1994. Vice Energy Supply President of KU from November 1986 to November 1994. George S. Brooks II General Counsel Corporate Secretary of KU Age 47 and Corporate since November 1992, and Secretary* General Counsel since January 1988. Gary E. Blake Vice-President Vice-President of KU since Age 44 Retail Marketing November 1992. William E. Casebier Vice-President Vice-President of KU since Age 55 Information May 1988. Technology and Administrative Services Linda M. DiMascio Vice-President Vice-President of KU since Age 43 Human Resources February 1995. Director of Human Resources of Tucker Housewares from September 1994 to February 1995. Senior Area Coordinator for U.S. Manufacturing Department of Mobil Oil Corporation from April 1992 to September 1994. -15- Current Positions Held During at Name and Age Positions Held Least the Last 5 Years Gary L. Hawley Vice-President Vice President of KU since Age 49 Bulk Power January 1996. Director of Engineering Bulk Power Planning from November 1986 to January 1996. Henry C. A. List Vice-President Vice-President of KU since Age 48 Governmental May 1997. Director of Affairs Governmental Affairs from July 1979 to May 1997. Ronald L. Willhite Vice-President Vice-President of KU since Age 50 Regulation and May 1997. Director of Economic Planning Regulation from December 1992 to May 1997. William N. English Treasurer* Treasurer of KU since April Age 47 1982. Michael D. Robinson Controller* Controller of KU since August Age 42 1990. John J. Maloy, Jr. Assistant Assistant Treasurer of KU Age 43 Treasurer since August 1984. (Not an Executive Officer) Note: Officers are elected annually by the Board of Directors. There is no family relationship between any executive officer and any other executive officer or any director. Certain executive officers of KU may be considered "executive officers" of KU Energy for certain purposes. * Identified persons hold positions with the same titles at KU Energy. -16- PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters KU Energy KU Energy's common stock is listed on the New York and Pacific stock exchanges under the ticker symbol "KU." Quotes in daily newspapers can be found under the listing KU Engy. The table below sets forth the high and low sales prices and the dividends paid for the Company's common stock for the periods shown. 1997 1996 Dividend Price Dividend Price Quarter Paid High Low Paid High Low First $.44 31-1/8 29-3/8 $.43 30-5/8 28-5/8 Second $.44 35-5/8 29-3/4 $.43 30 28-3/8 Third $.44 36-1/8 32-9/16 $.43 30 27 Fourth $.44 39-13/16 32-7/8 $.43 30-1/2 28-1/8 KU Energy's Board has declared a common stock dividend of $.45 per share payable March 13, 1998, to shareholders of record on February 25, 1998. As of December 31, 1997, KU Energy had approximately 29,300 common shareholders of record. The Company (or its predecessor, KU) has paid cash dividends since 1939. Future dividends are dependent on future earnings, capital requirements and financial conditions. Future dividend policy will also be dependent on the Company's pending Merger with LG&E Energy. See Management's Discussion and Analysis of Finacial Condition and Results of Operations - The Merger in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) incorporated herein by reference. The dividend payout ratio (cash dividends as a percentage of net income) was 78% for 1997 and 79% for 1996. See Note 5 of the Notes to Consolidated Financial Statements, Common Stock, in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) incorporated herein by reference for information regarding dividend restrictions. KU All of the outstanding common stock of KU is held by KU Energy. The following table sets forth the cash distributions (in thousands of dollars) on common stock paid by KU for the periods indicated: 1997 1996 First Quarter $16,639 $16,261 Second Quarter $16,640 $16,262 Third Quarter $16,640 $16,262 Fourth Quarter $16,640 $16,262 See Note 5 of the Notes to Financial Statements, Common Stock, under Item 8 for information regarding dividend restrictions. -17- Item 6. Selected Financial Data - KU Energy
Year ended December 31, 1997 1996 1995 1994 1993 (dollars in thousands) Operating Revenues: Residential $ 231,824 $ 236,229 $ 232,760 $ 213,574 $ 210,759 Commercial 150,794 150,640 151,778 142,207 138,271 Industrial 146,801 136,856 130,066 120,043 111,857 Mine power 34,541 34,014 36,076 36,498 34,977 Public authorities 56,243 56,023 54,161 49,869 48,142 Total retail revenues 620,203 613,762 604,841 562,191 544,006 Sales for resale 87,330 89,208 75,940 89,665 62,463 Miscellaneous revenues and other 8,877 8,716 5,619 4,157 3,448 Provision for refund - litigation settlement - - - (19,385) (3,309) Total operating revenues 716,410 711,686 686,400 636,628 606,608 Operating Expenses: Fuel used in generation (1) 188,439 198,198 189,845 170,654 178,910 Electric power purchased 72,542 62,490 69,579 61,442 34,711 Other operating expenses 123,537 125,351 124,044 114,551 106,124 Maintenance 65,004 64,170 62,599 66,141 59,458 Depreciation 84,297 80,612 75,268 65,441 60,811 Federal and state income taxes 50,501 50,247 43,426 43,904 47,752 Other taxes 15,459 15,049 15,038 14,789 14,357 Total operating expenses 599,779 596,117 579,799 536,922 502,123 Net Operating Income 116,631 115,569 106,601 99,706 104,485 Other Income and Deductions 10,458 8,203 11,655 11,530 10,362 Income Before Interest and Other Charges and AFUDC 127,089 123,772 118,256 111,236 114,847 Interest and Other Charges: Interest on long-term debt 37,405 37,584 36,095 32,147 31,650 Preferred stock dividend requirements of Subsidiary 2,256 2,256 2,256 2,384 2,558 Other interest 2,329 2,120 4,031 2,414 1,249 Total interest and other charges 41,990 41,960 42,382 36,945 35,457 AFUDC 80 137 179 1,585 593 Net Income $ 85,179 $ 81,949 $ 76,053 $ 75,876 $ 79,983 Basic Earnings per Average Common Share $ 2.25 $ 2.17 $ 2.01 $ 2.01 $ 2.11 Common Stock Data: Shares Outstanding - average and year-end 37,818 37,818 37,818 37,818 37,818 Dividends per Share of Common Stock $ 1.76 $ 1.72 $ 1.68 $ 1.64 $ 1.60 (1) Amounts for 1994 and 1993 reflect reductions of $23 million and $4 million, respectively, associated with refunds to customers related to a litigation settlement with a former coal supplier.
-18- Item 6. Selected Financial Data - KU Energy (continued)
1997 1996 1995 1994 1993 Assets (in thousands) $1,737,262 $1,726,948 $1,714,974 $1,669,294 $1,573,194 Capitalization: (in thousands) Bonds $ 546,330 $ 546,330 $ 545,830 $ 495,830 $ 441,830 Notes 21 43 64 86 107 Unamortized premium on long-term debt - - 86 96 108 Preferred stock 40,000 40,000 40,000 40,000 40,000 Common stock equity 664,122 645,513 628,611 616,092 602,503 Total capitalization $1,250,473 $1,231,886 $1,214,591 $1,152,104 $1,084,548 % Total Capitalization Represented by: Long-term debt 43.7 44.4 44.9 43.0 40.8 Preferred stock 3.2 3.2 3.3 3.5 3.7 Common stock equity 53.1 52.4 51.8 53.5 55.5 Kilowatt-hours Generated, Purchased and Sold: (in thousands) Power generated 15,845,089 16,510,347 15,223,851 15,524,844 14,934,839 Power purchased 3,767,458 3,165,589 3,254,861 3,066,917 1,926,299 Power interchanged - net (831) 12,450 (6,569) 2,638 1,556 Total 19,611,716 19,688,386 18,472,143 18,594,399 16,862,694 Less - losses and company use 986,347 1,057,808 1,054,589 998,010 1,066,251 Kilowatt-hours sold 18,625,369 18,630,578 17,417,554 17,596,389 15,796,443 Sales classified: Residential 5,060,935 5,148,364 5,016,012 4,706,058 4,702,697 Commercial 3,422,167 3,410,710 3,403,054 3,272,370 3,217,504 Industrial 4,464,332 4,107,537 3,850,647 3,641,469 3,409,213 Mine power 925,882 893,650 926,873 974,233 933,317 Public authorities 1,354,630 1,349,948 1,297,913 1,225,668 1,199,893 Total retail sales 15,227,946 14,910,209 14,494,499 13,819,798 13,462,624 Sales for resale 3,397,423 3,720,369 2,923,055 3,776,591 2,333,819 Total 18,625,369 18,630,578 17,417,554 17,596,389 15,796,443 Average Number of Customers 464,165 456,167 449,144 440,590 432,636 Residential Sales (per customer): Average kilowatt-hours 13,083 13,531 13,377 12,781 12,995 Average revenue $ 599.30 $ 620.87 $ 620.75 $ 580.05 $ 582.41 System Capability - Megawatts: KU's plants 3,718 3,639 3,509 3,265 3,164 Purchased contracts 556 393 394 540 365 Total system capability 4,274 4,032 3,903 3,805 3,529 Net System Maximum Demand - Megawatts 3,510 3,391 3,341 3,127 3,176 Load Factor (%) 58.2 59.3 58.7 59.8 57.7 Heat Rate (BTU per KWH) (1) 10,335 10,351 10,377 10,306 10,367 Fuel - Average Cost per Ton (1) $ 27.96 $ 27.68 $ 28.49 $ 28.84 $ 28.31 Average Cost per Million BTU (1) $ 1.14 $ 1.14 $ 1.18 $ 1.19 $ 1.17 (1) Based on coal consumed
-19- Item 6. Selected Financial Data - KU
Year ended December 31, 1997 1996 1995 1994 1993 (in thousands) Operating Revenues: Residential $ 231,824 $ 236,229 $ 232,760 $ 213,574 $ 210,759 Commercial 150,794 150,640 151,778 142,207 138,271 Industrial 146,801 136,856 130,066 120,043 111,857 Mine power 34,541 34,014 36,076 36,498 34,977 Public authorities 56,243 56,023 54,161 49,869 48,142 Total retail revenues 620,203 613,762 604,841 562,191 544,006 Sales for resale 87,330 89,208 75,940 89,665 62,463 Miscellaneous revenues and other 8,904 8,741 5,649 4,181 3,428 Provision for refund - litigation settlement - - - (19,385) (3,309) Total operating revenues 716,437 711,711 686,430 636,652 606,588 Operating Expenses: Fuel used in generation (1) 188,439 198,198 189,845 170,654 178,910 Electric power purchased 72,542 62,490 69,579 61,442 34,711 Other operating expenses 120,951 122,872 121,426 112,712 104,930 Maintenance 64,990 64,161 62,592 66,134 59,451 Depreciation 84,111 80,424 75,080 65,259 60,800 Federal and state income taxes 51,690 51,452 44,670 44,683 48,178 Other taxes 15,306 14,777 14,694 14,582 14,347 Total operating expenses 598,029 594,374 577,886 535,466 501,327 Net Operating Income 118,408 117,337 108,544 101,186 105,261 Other Income and Deductions 6,954 8,377 8,235 9,299 8,331 Income Before Interest Charges and AFUDC 125,362 125,714 116,779 110,485 113,592 Interest Charges: Interest on long-term debt 37,405 37,584 36,095 32,147 31,650 Other interest 2,324 2,104 4,021 2,411 1,249 Total interest charges 39,729 39,688 40,116 34,558 32,899 AFUDC 80 137 179 1,585 593 Net Income $ 85,713 $ 86,163 $ 76,842 $ 77,512 $ 81,286 Preferred Stock Dividend Requirements 2,256 2,256 2,256 2,384 2,558 Net Income Applicable to Common Stock $ 83,457 $ 83,907 $ 74,586 $ 75,128 $ 78,728 Common Dividends $ 66,559 $ 65,047 $ 63,250 $ 61,644 $ 60,509 (1) Amounts for 1994 and 1993 reflect reductions of $23 million and $4 million, respectively, associated with refunds to customers related to a litigation settlement with a former coal supplier.
-20- Item 6. Selected Financial Data - KU (continued)
1997 1996 1995 1994 1993 Assets (in thousands) $1,679,880 $1,673,055 $1,659,988 $1,618,100 $1,523,274 Capitalization: (in thousands) Bonds $ 546,330 $ 546,330 $ 545,830 $ 495,830 $ 441,830 Notes 21 43 64 86 107 Unamortized premium on long-term debt - - 86 96 108 Preferred stock 40,000 40,000 40,000 40,000 40,000 Common stock equity 612,295 595,397 576,537 565,201 552,106 Total capitalization $1,198,646 $1,181,770 $1,162,517 $1,101,213 $1,034,151 % Total Capitalization Represented by: Long-term debt 45.6 46.2 47.0 45.1 42.7 Preferred stock 3.3 3.4 3.4 3.6 3.9 Common stock equity 51.1 50.4 49.6 51.3 53.4 Kilowatt-hours Generated, Purchased and Sold: (in thousands) Power generated 15,845,089 16,510,347 15,223,851 15,524,844 14,934,839 Power purchased 3,767,458 3,165,589 3,254,861 3,066,917 1,926,299 Power interchanged - net (831) 12,450 (6,569) 2,638 1,556 Total 19,611,716 19,688,386 18,472,143 18,594,399 16,862,694 Less - losses and company use 986,347 1,057,808 1,054,589 998,010 1,066,251 Kilowatt-hours sold 18,625,369 18,630,578 17,417,554 17,596,389 15,796,443 Sales classified: Residential 5,060,935 5,148,364 5,016,012 4,706,058 4,702,697 Commercial 3,422,167 3,410,710 3,403,054 3,272,370 3,217,504 Industrial 4,464,332 4,107,537 3,850,647 3,641,469 3,409,213 Mine power 925,882 893,650 926,873 974,233 933,317 Public authorities 1,354,630 1,349,948 1,297,913 1,225,668 1,199,893 Total retail sales 15,227,946 14,910,209 14,494,499 13,819,798 13,462,624 Sales for resale 3,397,423 3,720,369 2,923,055 3,776,591 2,333,819 Total 18,625,369 18,630,578 17,417,554 17,596,389 15,796,443 Average Number of Customers 464,165 456,167 449,144 440,590 432,636 Residential Sales (per customer): Average kilowatt-hours 13,083 13,531 13,377 12,781 12,995 Average revenue $ 599.30 $ 620.87 $ 620.75 $ 580.05 $ 582.41 System Capability - Megawatts: KU's plants 3,718 3,639 3,509 3,265 3,164 Purchased contracts 556 393 394 540 365 Total system capability 4,274 4,032 3,903 3,805 3,529 Net System Maximum Demand - Megawatts 3,510 3,391 3,341 3,127 3,176 Load Factor (%) 58.2 59.3 58.7 59.8 57.7 Heat Rate (BTU per KWH) (1) 10,335 10,351 10,377 10,306 10,367 Fuel - Average Cost per Ton(1) $ 27.96 $ 27.68 $ 28.49 $ 28.84 $ 28.31 Average Cost per Million BTU(1) $ 1.14 $ 1.14 $ 1.18 $ 1.19 $ 1.17 (1) Based on coal consumed
-21- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information under the heading Management's Discussion and Analysis of Financial Condition and Results of Operation is combined for KU Energy and KU on pages 16 through 21 of KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) and is incorporated herein by reference. Item 7A. Quantitative and Qualitative Disclosures About Market Risk The information required by this item is not applicable to KU Energy or KU. Item 8. Financial Statements and Supplementary Data KU ENERGY The financial statements and supplementary data on pages 22 through 35 of KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) are incorporated herein by reference. KU Page(s) Index to Financial Statements and Supplementary Data: Report of Independent Public Accountants 23 Statements of Income and Retained Earnings 24 Statements of Cash Flows 25 Balance Sheets 26 Statements of Capitalization 27 Notes to Financial Statements 28-38 Supplemental Quarterly Financial Information 39 -22- REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Kentucky Utilities Company: We have audited the accompanying balance sheets and statements of capitalization of Kentucky Utilities Company (a Kentucky and Virginia corporation) as of December 31, 1997 and 1996, and the related statements of income and retained earnings, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the management of Kentucky Utilities Company. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Kentucky Utilities Company as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/Arthur Andersen LLP Arthur Andersen LLP Chicago, Illinois January 26, 1998 -23- Statements of Income and Retained Earnings
Kentucky Utilities Company Year Ended December 31, (in thousands of dollars) 1997 1996 1995 Operating Revenues $ 716,437 $ 711,711 $ 686,430 Operating Expenses: Fuel, principally coal, used in generation 188,439 198,198 189,845 Electric power purchased 72,542 62,490 69,579 Other operating expenses 120,951 122,872 121,426 Maintenance 64,990 64,161 62,592 Depreciation 84,111 80,424 75,080 Federal and state income taxes 51,690 51,452 44,670 Other taxes 15,306 14,777 14,694 Total Operating Expenses 598,029 594,374 577,886 Net Operating Income 118,408 117,337 108,544 Other Income and Deductions: Interest and dividend income 1,673 1,733 2,838 Other income and deductions - net 5,330 6,710 5,467 Total Other Income and Deductions 7,003 8,443 8,305 Income Before Interest Charges 125,411 125,780 116,849 Interest Charges: Interest on long-term debt 37,405 37,584 36,095 Other interest charges 2,293 2,033 3,912 Total Interest Charges 39,698 39,617 40,007 Net Income 85,713 86,163 76,842 Preferred Stock Dividend Requirements 2,256 2,256 2,256 Net Income Applicable to Common Stock $ 83,457 $ 83,907 $ 74,586 Retained Earnings Beginning of Year $ 287,852 $ 268,992 $ 257,656 Add Net Income 85,713 86,163 76,842 373,565 355,155 334,498 Deduct: Dividends on preferred stock 2,256 2,256 2,256 Dividends on common stock 66,559 65,047 63,250 68,815 67,303 65,506 Retained Earnings End of Year $ 304,750 $ 287,852 $ 268,992 The accompanying Notes to Financial Statements are an integral part of these statements.
-24- Statements of Cash Flows
Kentucky Utilities Company Year Ended December 31, (in thousands of dollars) 1997 1996 1995 Cash Flows from Operating Activities: Net income $ 85,713 $ 86,163 $ 76,842 Items not requiring (providing) cash currently: Depreciation 84,111 80,424 75,080 Deferred income taxes 4,606 3,750 15,502 Investment tax credit deferred (4,036) (4,013) (4,095) Deferred merger-related costs (4,062) - - Changes in current assets and liabilities: Change in accounts receivable 5,726 (1,111) (7,759) Change in accounts payable 4,426 (9,040) (11,517) Change in other current assets and liabilities 1,785 6,923 (509) Other - net 637 8,701 5,515 Net Cash Provided by Operating Activities 178,906 171,797 149,059 Cash Flows from Investing Activities: Construction expenditures - utility (94,006) (106,503) (124,515) Proceeds from insurance reimbursements 4,270 257 152 Other - (79) (271) Net Cash Used by Investing Activities (89,736) (106,325) (124,634) Cash Flows from Financing Activities: Short-term borrowings - net (20,600) (1,400) (20,700) Issuance of long-term debt - 35,666 49,288 Funds deposited with trustee - net - 3,779 15,100 Retirement of long-term debt, including premiums (21) (36,192) (21) Payment of dividends (68,815) (67,303) (65,506) Net Cash Used by Financing Activities (89,436) (65,450) (21,839) Net Increase (Decrease) in Cash and Cash Equivalents (266) 22 2,586 Cash and Cash Equivalents Beginning of Year 5,719 5,697 3,111 Cash and Cash Equivalents End of Year $ 5,453 $ 5,719 $ 5,697 Supplemental Disclosures Cash paid for: Interest $ 37,053 $ 36,729 $ 37,961 Income Taxes $ 44,857 $ 47,539 $ 31,974 The accompanying Notes to Financial Statements are an integral part of these statements.
-25- Balance Sheets
Kentucky Utilities Company As of December 31, (in thousands of dollars) 1997 1996 Assets Utility Plant: Plant in service, at cost $ 2,552,695 $ 2,482,812 Less: Accumulated depreciation 1,128,282 1,067,911 1,424,413 1,414,901 Construction work in progress 58,939 63,435 Total Utility Plant 1,483,352 1,478,336 Current Assets: Cash and cash equivalents 5,453 5,719 Accounts receivable, net of allowance for doubtful accounts 44,856 50,582 Accrued utility revenues 29,668 24,239 Fuel, principally coal, at average cost 27,799 30,895 Plant materials and operating supplies, at average cost 23,648 21,656 Other 5,769 7,486 Total Current Assets 137,193 140,577 Other Assets: Regulatory assets 14,773 11,531 Other 44,562 42,611 Total Other Assets 59,335 54,142 Total Assets $ 1,679,880 $ 1,673,055 Capitalization and Liabilities Capitalization: (See Statements of Capitalization) Common stock equity $ 612,295 $ 595,397 Preferred stock 40,000 40,000 Long-term debt 546,351 546,373 Total Capitalization 1,198,646 1,181,770 Current Liabilities: Long-term debt due within one year 21 21 Short-term borrowings 33,600 54,200 Accounts payable 33,386 28,960 Accrued interest 8,283 8,048 Accrued taxes 7,473 5,383 Customer deposits 9,841 8,746 Accrued payroll and vacations 10,348 9,862 Other 6,215 5,728 Total Current Liabilities 109,167 120,948 Other Liabilities: Accumulated deferred income taxes 245,150 238,542 Accumulated deferred investment tax credits 26,131 30,167 Regulatory tax liability - net 50,904 54,388 Other 49,882 47,240 Total Other Liabilities 372,067 370,337 Total Capitalization and Liabilities $ 1,679,880 $ 1,673,055 The accompanying Notes to Financial Statements are an integral part of these statements.
-26- Statements of Capitalization
Kentucky Utilities Company As of December 31, (in thousands of dollars) 1997 1996 Common Stock Equity: Common stock, without par value, outstanding 37,817,878 shares and 37,817,878 shares, respectively $ 308,140 $ 308,140 Capital stock expense and other (595) (595) Retained earnings 304,750 287,852 Total Common Stock Equity 612,295 595,397 Preferred Stock, cumulative, without par value, $100 stated value 4 3/4%, outstanding 200,000 shares 20,000 20,000 6.53%, outstanding 200,000 shares 20,000 20,000 Total Preferred Stock 40,000 40,000 Long-Term Debt: First Mortgage Bonds: 5.95% Series Q, due June 15, 2000 61,500 61,500 6.32% Series Q, due June 15, 2003 62,000 62,000 5.99% Series S, due January 15, 2006 36,000 36,000 7.92% Series P, due May 15, 2007 53,000 53,000 7.55% Series R, due June 1, 2025 50,000 50,000 8.55% Series P, due May 15, 2027 33,000 33,000 295,500 295,500 First Mortgage Bonds, Pollution Control Series: 7 3/8% Pollution Control Series 7, due May 1, 2010 4,000 4,000 7.45% Pollution Control Series 8, due September 15, 2016 96,000 96,000 6 1/4% Pollution Control Series 1B, due February 1, 2018 20,930 20,930 6 1/4% Pollution Control Series 2B, due February 1, 2018 2,400 2,400 6 1/4% Pollution Control Series 3B, due February 1, 2018 7,200 7,200 6 1/4% Pollution Control Series 4B, due February 1, 2018 7,400 7,400 7.60% Pollution Control Series 7, due May 1, 2020 8,900 8,900 5 3/4% Pollution Control Series 9, due December 1, 2023 50,000 50,000 Variable Rate Pollution Control Series 10, due November 1, 2024 54,000 54,000 250,830 250,830 Total First Mortgage Bonds 546,330 546,330 8% secured note, due January 5, 1999 (net of current maturity) 21 43 Total Long-Term Debt 546,351 546,373 Total Capitalization $ 1,198,646 $1,181,770 The accompanying Notes to Financial Statements are an integral part of these statements.
-27- Notes to Financial Statements Kentucky Utilities Company 1. Summary of Significant Accounting Policies General Kentucky Utilities Company (KU) is the principal subsidiary of KU Energy Corporation (KU Energy). The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts from prior periods have been reclassified to conform with the current year presentation. KU is a public utility engaged in producing, transmitting and selling electric energy. KU provides electric service to about 441,200 customers in over 600 communities and adjacent suburban and rural areas in 77 counties in central, southeastern and western Kentucky and to about 29,000 customers in 5 counties in southwestern Virginia. Regulation KU is exempt from regulation as a registered holding company under the Public Utility Holding Company Act of 1935. KU is subject to regulation by the Kentucky Public Service Commission (PSC), the Virginia State Corporation Commission (SCC) and the Federal Energy Regulatory Commission (FERC). With respect to accounting matters, KU maintains its accounts in accordance with the Uniform System of Accounts as defined by these agencies. KU's accounting policies conform to generally accepted accounting principles applicable to rate regulated enterprises and reflect the effects of the ratemaking process. The following is a summary of the components of regulatory assets: As of December 31, (in thousands of dollars) 1997 1996 Unamortized loss on reacquired debt $ 9,756 $ 10,838 Merger costs 4,062 - Other 955 693 Regulatory Assets $ 14,773 $ 11,531 KU is currently not earning a return on these regulatory assets. Utility Plant Utility plant is stated at the original cost of construction. The cost of repairs of property units and replacements of minor items is charged to maintenance expense as incurred. Property unit replacements are capitalized and the depreciation reserve is charged with the cost, less net salvage, of units retired. -28- Notes to Financial Statements Kentucky Utilities Company Depreciation Provision for depreciation of utility plant is based on straight-line composite rates applied to the cost of depreciable property. The rates approximated 3.5% in 1997, 1996 and 1995. Cash and Cash Equivalents For purposes of reporting cash flows, KU considers highly liquid investments with a maturity of three months or less from the date of purchase to be cash equivalents. Unamortized Loss on Reacquired Debt KU defers costs (primarily call premiums) arising from the reacquisition or retirement of long-term debt. Costs related to refinanced debt are amortized over the lives of the new debt issues. Costs related to retired debt not refinanced are amortized over the period to the scheduled maturity of the retired debt. Operating Revenues and Fuel Costs Revenues are recorded based on services rendered to customers. KU accrues an estimate of revenues for electric service furnished from the meter reading dates to the end of each accounting period. Cost of fuel used in electric generation is charged to expense as the fuel is consumed. Fuel adjustment clauses adjust operating revenues for changes in the level of fuel costs charged to expense. An environmental surcharge for Kentucky retail customers, implemented in August 1994, permits the utility to recover certain ongoing operating and capital costs of compliance with federal, state or local environmental requirements associated with the production of energy from coal, including the Federal Clean Air Act as amended. See Note 9 of the Notes to Financial Statements, "Environmental Cost Recovery," for information about environmental surcharge legal proceedings. Income Taxes KU establishes deferred tax assets and liabilities, as appropriate, for all temporary differences, and adjusts deferred tax balances to reflect changes in tax rates expected to be in effect during the periods the temporary differences reverse. Investment tax credits resulted from provisions of the tax law which permitted a reduction of KU's tax liability based on certain construction expenditures. Such credits have been deferred in the accounts and are being amortized as reductions in income tax expense over the life of the related property. Because of rate regulation, changes in tax rates are deferred and amortized as the temporary differences reverse. New Accounting Pronouncements In June 1997, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards No. 130, Reporting -29- Notes to Financial Statements Kentucky Utilities Company Comprehensive Income, and No. 131, Disclosures about Segments of an Enterprise and Related Information, effective for periods beginning after December 15, 1997. These statements do not affect the accounting recognition or measurement of transactions, but rather require expanded disclosures regarding financial results. KU will adopt these standards in 1998 as required by the FASB. Stock-Based Compensation KU adopted Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, in 1996 by continuing to account for stock compensation in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. If KU had recognized compensation expense for awards under its stock-based compensation plan according to the new standard, net income and net income applicable to common stock for the years ended 1997, 1996 and 1995 would not have been materially different from amounts recorded. 2. Income Taxes KU is included in the consolidated federal tax return of its parent company, KU Energy. Income taxes are allocated to the individual companies, including KU, based on their respective taxable income or loss. The accumulated deferred income taxes as set forth in the Balance Sheet arise from the following temporary differences:
As of December 31, (in thousands of dollars) 1997 1996 Deferred Tax Assets: Unamortized investment tax credit and other property related differences $ 48,364 $ 50,629 Other 20,577 20,583 Less: Amounts included in current assets 3,242 4,723 65,699 66,489 Deferred Tax Liabilities: Accelerated depreciation and other property related differences 305,461 299,371 Other 5,388 5,660 310,849 305,031 Net Accumulated Deferred Income Tax Liability $245,150 $238,542
-30- Notes to Financial Statements Kentucky Utilities Company The components of income tax expense are as follows:
Year Ended December 31, (in thousands of dollars) 1997 1996 1995 Income Taxes Charged to Operating Income: Current - federal $ 39,353 $ 35,656 $ 23,597 - state 8,964 7,387 5,134 48,317 43,043 28,731 Deferred - federal 1,996 5,510 12,165 - state 1,377 2,899 3,845 3,373 8,409 16,010 Deferred investment tax credit - - (71) 51,690 51,452 44,670 Income Taxes Charged to Other Income and Deductions: Current - federal (853) 3,565 854 - state (246) 861 190 (1,099) 4,426 1,044 Deferred - federal 975 (3,665) (406) - state 258 (994) (102) 1,233 (4,659) (508) Amortization of deferred investment tax credit (4,036) (4,013) (4,024) (3,902) (4,246) (3,488) Total Income Tax Expense $ 47,788 $ 47,206 $ 41,182
KU's effective income tax rate, determined by dividing income taxes by the sum of such taxes and net income, was 35.8% in 1997, 35.4% in 1996 and 34.9% in 1995. The difference between the effective rate and the statutory federal income tax rate is attributable to the following factors:
Year Ended December 31, (in thousands of dollars) 1997 1996 1995 Federal Income Tax Computed at 35% $ 46,726 $ 46,679 $ 41,308 Add (Deduct): State income taxes, net of federal income tax benefit 6,729 6,599 5,894 Amortization of deferred investment tax credit (4,036) (4,013) (4,095) Other, net (1,631) (2,059) (1,925) Total Income Tax Expense $ 47,788 $ 47,206 $ 41,182 3. Retirement Benefits Pensions KU has a noncontributory defined benefit pension plan covering substantially all of its employees. Benefits under this plan are based on years of service, final average base pay and age at retirement. KU's funding policy is to make such contributions as are necessary to finance the benefits provided under the plan. KU's contributions meet the funding standards set forth in the Employee Retirement Income Security Act of 1974. The plan assets consist primarily of common stocks, corporate bonds and U.S. Government Securities. -31- Notes to Financial Statements Kentucky Utilities Company KU also has a Supplemental Security Plan for certain management personnel. Retirement benefits under this plan are based on years of service, earnings and age at retirement. The plan has no advance funding. Benefit payments are made to retired employees or their beneficiaries from the general assets of KU. On May 20, 1997, KU Energy and LG&E Energy Corp. (LG&E Energy) entered into a Merger Agreement. For information concerning the agreement, see Management's Discussion and Analysis - The Merger in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) incorporated herein by reference. Under the provisions of the Supplemental Security Plan, the Merger Agreement constituted a change-in-control which required that a lump sum present value payment be made to retired employees entitled to retirement benefits on the date of the Merger Agreement. On May 30, 1997, lump sum payments totalling $4.7 million were made to retired employees. The reconciliation of the funded status of the retirement plans and the pension liability recorded by KU is as follows: As of December 31, (in thousands of dollars) 1997 1996 Fair value of plan assets $ 217,424 $ 191,778 Projected benefit obligation (214,657) (194,874) Plan assets more (less) than projected benefit obligation 2,767 (3,096) Unrecognized net (gain)/loss from past experience different than that assumed (19,775) (12,448) Unrecognized prior service cost 3,635 3,990 Unrecognized net asset (1,350) (1,500) Regulatory effect recorded 462 201 Pension liability $ (14,261) $ (12,853) Accumulated benefit obligation (including vested benefits of $164,498 and $147,103, respectively) $ 168,810 $ 149,814 Components of Net Pension Cost: Year Ended December 31, (in thousands of dollars) 1997 1996 1995 Service cost (benefits earned during the period) $ 6,728 $ 6,399 $ 6,060 Interest cost on projected benefit obligation 14,680 13,856 13,560 Actual return on plan assets (34,211) (20,798) (27,064) Net amortization and deferral 19,320 6,568 14,608 Regulatory effect recorded (261) (1,835) (1,595) Net pension cost $ 6,256 $ 4,190 $ 5,569 -32- Notes to Financial Statements Kentucky Utilities Company
Assumptions Used in Determining Actuarial Valuations: 1997 1996 1995 Weighted average discount rate used to determine the projected benefit obligation 7.00% 7.75% 7.75% Rate of increase for compensation levels 4.00% 4.75% 4.75% Weighted average expected long-term rate of return on assets 8.25% 8.25% 8.25%
Other Postretirement Benefits KU provides certain health care and life insurance benefits to eligible retired employees and their dependents. KU accrues, during the years that employees render service, the expected cost of providing these benefits upon retirement to such employees, their beneficiaries and covered dependents. The postretirement health care plan is contributory for employees who retired after December 31, 1992, with retiree contributions indexed annually based upon the experience of retiree medical expenses for the preceding year. Pre-1993 retirees are not required to contribute to the plan. KU's employees become eligible for retiree medical benefits after 15 years of service and attainment of age 55. The life insurance plan is noncontributory and is based on compensation levels prior to retirement. In 1993, KU began funding, in addition to current requirements for benefit payments, the maximum tax-favored amount allowed through certain tax deductible funding vehicles. KU anticipates making similar funding decisions in future years, but will consider and make such funding decisions on the basis of tax, regulatory and other relevant conditions in effect at such times. The plan assets consist primarily of equity investments. The reconciliation of the funded status of the plans and the postretirement benefit liability recorded by KU is as follows:
As of December 31, (in thousands of dollars) 1997 1996 Accumulated postretirement benefit obligation: Retirees $ (30,777) $ (29,313) Fully eligible active plan participants (9,777) (8,678) Other active plan participants (31,585) (28,528) (72,139) (66,519) Plan assets at fair value 17,763 13,322 Accumulated postretirement benefit obligation in excess of plan assets (54,376) (53,197) Unrecognized net (gain)/loss from past experience different from that assumed (19,697) (20,029) Unrecognized transition obligation 50,118 53,460 Accrued postretirement benefit liability $ (23,955) $ (19,766)
-33- Notes to Financial Statements Kentucky Utilities Company Components of the net periodic postretirement benefit cost are as follows:
Year Ended December 31, (in thousands of dollars) 1997 1996 1995 Service cost (benefits attributed to service during the period) $ 1,853 $ 1,859 $ 1,918 Interest cost on accumulated postretirement benefit obligation 4,895 4,751 4,926 Actual return on plan assets (3,569) (1,633) (1,722) Net amortization and deferral 1,706 103 792 Amortization of transition obligation 3,341 3,341 3,341 Net periodic postretirement benefit cost $ 8,226 $ 8,421 $ 9,255 Assumptions Used in Determining Actuarial Valuations: 1997 1996 1995 Weighted average discount rate used to determine the projected benefit obligation 7.00% 7.75% 7.75% Rate of increase for compensation levels 4.00% 4.75% 4.75% Weighted average expected long-term rate of return on assets 7.90% 8.00% 8.00%
For measurement purposes, a 7.0% annual rate of increase in the per capita cost of covered health care benefits is assumed for 1998. The health care cost trend rate is assumed to decrease gradually to 4.25% through 2004 and remain at that level thereafter over the projected payout period of the benefits. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1997, by $11.5 million (16%) and the aggregate of the service and interest cost components of the net periodic postretirement benefit cost for the year by $1.2 million (18%). 4. Commitments and Contingencies
The effects of certain commitments made by KU are estimated below: (in thousands of dollars) 1998 1999 2000 2001 2002 1998-2002 Estimated Construction Expenditures $ 97,200 $103,200 $ 120,000 $ 115,600 $112,700 $ 548,700 Estimated Contract Obligations: Fuel 157,800 50,400 9,000 - - 217,200 Purchased power 31,300 30,200 29,500 32,300 32,300 155,600 Operating leases 2,900 2,800 2,800 2,800 2,700 14,000 First Mortgage Bond Maturities: Series Q $ - $ - $ 61,500 $ - $ - $ 61,500
Construction Program KU frequently reviews its construction program and may revise its projections of related expenditures based on revisions to its estimated -34- Notes to Financial Statements Kentucky Utilities Company load growth and projections of its future load. See Management's Discussion and Analysis - Capital Requirements in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) incorporated herein by reference for a discussion of future construction expenditures including those relating to construction of peaking units. Coal Supply Obligations under KU's coal purchase contracts are stated at prices effective January 1, 1998, and are subject to changes as defined by the terms of the contracts. Purchased Power KU has purchase power arrangements with Owensboro Municipal Utilities (OMU), Electric Energy, Inc. (EEI), and other parties. Under the OMU agreement, which expires on January 1, 2020, KU purchases all of the output of a 400-MW generating station not required by OMU. The amount of purchased power available to KU during 1998-2002, which is expected to be approximately 8% of KU's total kWh requirements, is dependent upon a number of factors including the units' availability, maintenance schedules, fuel costs and OMU requirements. Payments are based on the total costs of the station allocated per terms of the OMU agreement, which generally follows delivered kWh. Included in the total costs is KU's proportionate share of debt service requirements on $186.6 million of OMU bonds outstanding at December 31, 1997. The debt service is allocated to KU based on its annual allocated share of capacity, which averaged approximately 50% in 1997. KU has a 20% equity ownership in EEI, which is accounted for on the equity method of accounting. KU's entitlement is 20% of the available capacity of a 1,000-MW station. Payments are based on the total costs of the station allocated per terms of an agreement among the owners, which generally follows delivered kWh. KU has several other contracts for purchased power during 1998-2002 of various MW capacities and for varying periods with a maximum entitlement at any time of 282 MW. Credit Arrangements KU has aggregate bank lines of credit of $60 million, all of which remained unused at December 31, 1997. All of these credit lines expire in December 1999. In support of these lines of credit, KU compensates the banks by paying a commitment fee. 5. Common Stock KU is subject to restrictions applicable to all corporations under Kentucky and Virginia law on the use of retained earnings for cash dividends on common stock, as well as those contained in its Mortgage Indenture and Articles of Incorporation. At December 31, 1997, there -35- Notes to Financial Statements Kentucky Utilities Company were no restricted retained earnings. 6. Preferred and Preference Stock Each series of preferred stock is redeemable at the option of KU upon 30 days' written notice as follows: Redemption Price per Share Series (plus accrued and unpaid dividends, if any) 4 3/4% $101.00 6.53% (Not redeemable prior to December 1, 2003.) $103.265 through November 30, 2004, decreasing approximately $.33 each twelve months thereafter to $100 on or after December 1, 2013. As of December 31, 1997, there were 5.3 million shares of KU preferred stock, having a maximum aggregate stated value of $200 million, authorized for issuance, of which 400,000 shares were outstanding. As of December 31, 1997, there were 2 million shares of KU preference stock, without par value, authorized for issuance. 7. Short-Term and Long-Term Debt KU's short-term financing requirements are satisfied through the sale of commercial paper. The weighted average interest rate on the year-end balance was 6.79% for 1997 and 6.17% for 1996. Under the provisions for the variable rate Pollution Control Series 10 Bonds, KU can choose between various interest rate options. Currently, the daily interest rate option is being utilized. The average annual interest rate on the bonds during 1997 and 1996 was 3.77% and 3.53%, respectively. The variable rate bonds are subject to tender for purchase at the option of the holder and to mandatory tender for purchase upon the occurrence of certain events. If tendered bonds are not remarketed, KU has available lines of credit which may be used to repurchase the bonds. In January 1996, KU issued $36 million of Series S First Mortgage Bonds which bear interest at 5.99% and will mature January 15, 2006. The proceeds were used to redeem $35.5 million of Series K First Mortgage Bonds which carried a rate of 7-3/8%. Substantially all of KU's utility plant is pledged as security for the first mortgage bonds. -36- Notes to Financial Statements Kentucky Utilities Company 8. Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: The carrying values of cash and cash equivalents, escrow funds, short- term borrowings, commercial paper and customer deposits approximate fair value because of the short maturity of these amounts. KU's temporary cash investments are classified as held-to-maturity and are reported under the caption Cash and Cash Equivalents on the Balance Sheet. Long-term debt fair values are based on quoted market prices for KU's first mortgage bonds and on current rates available to KU for debt of the same remaining maturities for KU's pollution control bonds and promissory note. The carrying value of long-term debt on December 31, 1997 and 1996 was $546 million, and the estimated fair value was $579 million and $587 million, respectively. If the difference between fair value and carrying value of KU's long-term debt were settled at amounts approximating those above, the anticipated regulatory treatment (based on the current regulatory environment) would allow recovery of these amounts in rates over a prescribed amortization period. Accordingly, any settlement would not have a material impact on KU's financial position or results of operations. 9. Environmental Cost Recovery Since August 1994, KU has been collecting an environmental surcharge from its Kentucky retail customers under a Kentucky statute which authorizes electric utilities (including KU) to implement, beginning January 1, 1993, an environmental surcharge. The surcharge is designed to recover certain operating and capital costs of compliance with federal, state or local environmental requirements associated with the production of energy from coal, including the Federal Clean Air Act as amended. KU's environmental surcharge was approved by the Kentucky Public Service Commission (PSC) in July 1994 and was implemented in August 1994. The total surcharge collections from August 1, 1994 through December 31, 1997 were approximately $60 million. The PSC's order approving the surcharge and the constitutionality of the surcharge statute were challenged in the Franklin County (Kentucky) Circuit Court (Circuit Court) in an action brought against KU and the PSC by the Attorney General of Kentucky and joined by representatives of consumer groups. In July 1995, the Circuit Court entered a judgment upholding the constitutionality of the surcharge statute, but vacating that part of the PSC's July 1994 order which the Circuit Court's judgment described as retroactively applying the surcharge statute. The Circuit Court further ordered the case remanded to the PSC for a determination in accordance with the judgment. KU and the PSC argued that the PSC's July 1994 order did not retroactively apply the statute. -37- Notes to Financial Statements Kentucky Utilities Company The Kentucky Attorney General and other consumer representatives appealed to the Kentucky Court of Appeals (Court of Appeals) that part of the Circuit Court judgment upholding the constitutionality of the surcharge statute. The PSC and KU appealed that part of the judgment concerning the retroactive application of the surcharge statute. The PSC has ordered all surcharge revenues collected by KU from February 1, 1995, subject to refund pending final determination of all appeals. The total surcharge collections from February 1, 1995 through December 31, 1997 were approximately $56 million. In December 1997, the Court of Appeals rendered an opinion upholding the portion of the Circuit Court's judgment regarding the constitutionality of the surcharge statute but reversing that portion of the Circuit Court's judgment concerning the claim of retroactive application of the statute. The Kentucky Attorney General and other consumer representatives have filed motions for discretionary review with the Kentucky Supreme Court (Supreme Court). The Supreme Court has the discretion to grant or deny the motions. KU and the PSC have asked the Supreme Court to deny the motions. KU cannot predict whether the Supreme Court will grant review of the case or when it will act on the matter. KU continues to believe that the constitutionality of the surcharge statute will be upheld. Although KU cannot predict the outcome of the claim of retroactive application of the statute, it is the position of KU and the PSC that the July 1994 PSC order did not retroactively apply the statute. If the Court of Appeals opinion reversing the Circuit Court's judgment on the claim of retroactivity is overturned and the Circuit Court's judgment, as entered, is upheld, KU estimates that the amount it could be required to refund for surcharge collections through December 31, 1997, from the implementation of the surcharge would be approximately $15 million and from February 1, 1995, would be approximately $13 million. At this time, KU has not recorded any reserve for refund. 10. Merger Agreement With LG&E Energy KU Energy and LG&E Energy entered into a Merger Agreement dated May 20, 1997. For information concerning the agreement, see Management's Discussion and Analysis of Financial Condition and Results of Operations - The Merger in KU Energy's 1997 Annual Report to Shareholders (Exhibit 13) incorporated herein by reference. -38- Supplementary Quarterly Financial Information (Unaudited) Kentucky Utilities Company Quarterly financial results for 1997 and 1996 are summarized below. Generally, quarterly results may fluctuate due to seasonal variations, changes in fuel costs and other factors.
Quarter 4th 3rd 2nd 1st (in thousands of dollars) 1997 Operating Revenues $ 182,553 $ 192,102 $ 162,868 $ 178,914 Net Operating Income 29,899 35,343 19,742 33,424 Net Income 21,740 26,924 12,088 24,961 Net Income Applicable to Common Stock 21,176 26,360 11,524 24,397 1996 Operating Revenues $ 174,924 $ 178,275 $ 167,516 $ 190,996 Net Operating Income 28,029 30,457 23,863 34,988 Net Income 19,746 22,724 16,190 27,503 Net Income Applicable to Common Stock 19,182 22,160 15,626 26,939
These quarterly amounts reflect, in KU's opinion, all adjustments (including only normal recurring adjustments) necessary for a fair presentation. -39- Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None for KU Energy or KU. PART III Item 10. Directors and Executive Officers of the Registrants The information required by Item 10 for the Company and KU relating to each director and each nominee for election as a director at the Company's and KU's 1998 Annual Shareholders Meetings is set forth in the Company's definitive proxy statement (the Proxy Statement) filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 in connection with the Company's 1998 Annual Shareholders Meeting. Such information is incorporated herein by reference to the material appearing in the Proxy Statement under the caption "Election of Directors--General" and is also filed herewith as Exhibit 99.03. Information required by this item relating to executive officers of the Company and KU is set forth under a separate caption in Part I hereof. Item 11. Executive Compensation The information required by Item 11 for the Company and KU is incorporated herein by reference to the material appearing in the Proxy Statement under the caption "Election of Directors -- Directors' Compensation, and -- Executive Compensation" and is also filed herewith as Exhibit 99.03 (but excluding any information contained under the subheadings -- "Report of Compensation Committee on Executive Compensation," -- "Performance Graph"). Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by Item 12 for the Company and KU is incorporated herein by reference to the material appearing in the Proxy Statement under the caption "Election of Directors--Voting Securities Beneficially Owned by Directors, Nominees and Executive Officers" and is also filed herewith as Exhibit 99.03. Item 13. Certain Relationships and Related Transactions None for KU Energy or KU. -40- PART IV KU ENERGY AND KU Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K Page of this Report on Form 10-K KU Energy KU Pro Forma (a) (1) Financial Statements** Report of Independent Public Accountants * 23 N/A Statements of Income and Retained Earnings for the years ended December 31, 1997, 1996 and 1995 * 24 N/A Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 * 25 N/A Balance Sheets as of December 31, 1997 and 1996 * 26 N/A Statements of Capitalization as of December 31, 1997, and 1996 * 27 N/A Notes to Financial Statements * 28-38 N/A (a) (2) All financial statement schedules for KU Energy and KU are omitted as not applicable or not required under Regulation S-X. N/A N/A N/A (a) (3) Unaudited Pro Forma Combined Condensed Financial Information of KU Energy and LG&E Energy. Balance Sheet - December 31, 1997 N/A N/A 51-52 Statements of Income for the years ended December 31, 1997, 1996 and 1995 N/A N/A 53-55 Notes to Unaudited Pro Forma Combined Condensed Financial Statements N/A N/A 56-57 * Incorporated by reference from KU Energy's 1997 Annual Report to Shareholders which is Exhibit 13. ** The KU Energy consolidated financial statements, including notes, and the Unaudited Pro Forma Information are not included in the KU Annual Report on Form 10-K. -41- (a) (4) Exhibits - KU Energy and KU Applicable to Form 10-K of KU No. Description Energy KU Page(s) 2.01 Agreement and Plan of Merger, dated as of May 20, 1997, by and between KU Energy and LG&E Energy (Exhibit 2 to Form 8-K Current Report of KU Energy and Kentucky Utilities dated May 30, 1997). Incorporated by reference. x x 3.01 Amended and Restated Articles of Incorporation of KU Energy Corporation (Exhibit 3A to Form 10-K Annual Report of KU Energy for the year ended December 31, 1992). Incorporated by reference. x 3.02 Amended and Restated Articles of Incorporation of Kentucky Utilities Company (Exhibits 4.03 and 4.04 to Form 8-K Current Report of KU, dated December 10, 1993). Incorporated by reference. x 3.03 By-laws of KU Energy Corporation dated July 29, 1996 (Exhibit 4.01 to Form 10-Q Quarterly Report for the quarter ended June 30, 1996 of KU Energy and KU). Incorporated by reference. x 3.04 By-laws of Kentucky Utilities Company dated July 29, 1996 (Exhibit 4.02 to Form 10-Q Quarterly Report for the quarter ended June 30, 1996 of KU Energy and KU). Incorporated by reference. x 4.01 Rights Agreement, dated as of January 27, 1992, by and between KU Energy Corporation and Illinois Stock Transfer Company (Exhibit 4.1 to Form 8-K Current Report of KU Energy dated January 27, 1992). Incorporated by reference. x 4.02 Indenture of Mortgage or Deed of Trust dated May 1, 1947, between Kentucky Utilities Company and First Trust National Association (successor Trustee) and a successor individual co-trustee, as Trustees (the Trustees) (Amended Exhibit 7(a) in File No. 2-7061), and Supplemental Indentures thereto dated, respectively, January 1, 1949 (Second Amended Exhibit 7.02 in File No. 2-7802), July 1, 1950 (Amended Exhibit 7.02 in File No. 2-8499), June 15, 1951 (Exhibit 7.02(a) -42- Applicable to Form 10-K of KU No. Description Energy KU Page(s) 4.02 in File No. 2-8499), June 1, 1952 (Amended Cont. Exhibit 4.02 in File No. 2-9658), April 1, 1953 (Amended Exhibit 4.02 in File No. 2-10120), April 1, 1955 (Amended Exhibit 4.02 in File No. 2-11476), April 1, 1956 (Amended Exhibit 2.02 in File No. 2-12322), May 1, 1969 (Amended Exhibit 2.02 in File No. 2-32602), April 1, 1970 (Amended Exhibit 2.02 in File No. 2-36410), September 1, 1971 (Amended Exhibit 2.02 in File No. 2-41467), December 1, 1972 (Amended Exhibit 2.02 in File No. 2-46161), April 1, 1974 (Amended Exhibit 2.02 in File No. 2-50344), September 1, 1974 (Exhibit 2.04 in File No. 2-59328), July 1, 1975 (Exhibit 2.05 in File No. 2-59328), May 15, 1976 (Amended Exhibit 2.02 in File No. 2-56126), April 15, 1977 (Exhibit 2.06 in File No. 2-59328), August 1, 1979 (Exhibit 2.04 in File No. 2-64969), May 1, 1980 (Exhibit 2 to Form 10-Q Quarterly Report of KU for the quarter ended June 30, 1980), September 15, 1982 (Exhibit 4.04 in File No. 2-79891), August 1, 1984 (Exhibit 4B to Form 10-K Annual Report of KU for the year ended December 31, 1984), June 1, 1985 (Exhibit 4 to Form 10-Q Quarterly Report of KU for the quarter ended June 30, 1985), May 1, 1990 (Exhibit 4 to Form 10-Q Quarterly Report of KU for the quarter ended June 30, 1990), May 1, 1991 (Exhibit 4 to Form 10-Q Quarterly Report of KU for the quarter ended June 30, 1991), May 15, 1992 (Exhibit 4.02 to Form 8-K of KU dated May 14, 1992), August 1, 1992 (Exhibit 4 to Form 10-Q Quarterly Report of KU for the quarter ended September 30, 1992), June 15, 1993 (Exhibit 4.02 to Form 8-K of KU dated June 15, 1993) and December 1, 1993 (Exhibit 4.01 to Form 8-K of KU dated December 10, 1993), November 1, 1994 (Exhibit 4.C to Form 10-K Annual Report of KU for the year ended December 31, 1994), June 1, 1995 (Exhibit 4 to Form 10-Q Quarterly Report of KU for the quarter ended June 30, 1995) and January 15, 1996 (Exhibit 4.E to Form 10-K Annual Report of KU for the year ended December 31, 1995). Incorporated by reference. x x -43- Applicable to Form 10-K of KU No. Description Energy KU Page(s) 4.03 Supplemental Indenture dated March 1, 1992 between Kentucky Utilities Company and the Trustees, providing for the conveyance of properties formerly held by Old Dominion Power Company (Exhibit 4B to Form 10-K Annual Report of KU for the year ended December 31, 1992). Incorporated by reference. x x 4.04 Amendment No. 1, dated as of May 20, 1997, to the Rights Agreement, dated as of January 27, 1992, between KU Energy Corporation and Illinois Stock Transfer Company (Exhibit 99.1 to Form 8-A/A dated May 21, 1997). Incorporated by reference. x 10.01 KU's Amended and Restated Performance Share Plan (Exhibit 10.A to Form 10-Q Quarterly Report of KU for the quarter ended June 30, 1993). Incorporated by reference. x x 10.02 KU's Annual Performance Incentive Plan (Exhibit 10B to Form 10-K Annual Report of KU for the year ended December 31, 1990). Incorporated by reference. x x 10.03 Amendment No. 1 to KU's Performance Share Plan (Exhibit 10.03 to Form 10-K Annual Report for KU for the year ended December 31, 1996). Incorporated by reference. x x 10.04 Amendment No. 1 to KU's Annual Performance Incentive Plan (Exhibit 10D to Form 10-K Annual Report of KU for the year ended December 31, 1991). Incorporated by reference. x x 10.05 Amendment No. 2 to KU's Annual Performance Incentive Plan (Exhibit 10.H to Form 10-K Annual Report of KU for the year ended December 31, 1993). Incorporated by reference. x x 10.06 Amendment No. 3 to KU's Annual Performance Incentive Plan (Exhibit 10.I to Form 10-K Annual Report of KU for the year ended December 31, 1993). Incorporated by reference. x x 10.07 Amendment No. 4 to KU's Annual Performance Incentive Plan (Exhibit 10.07 to Form 10-K Annual Report for KU for the year ended December 31, 1996). Incorporated by reference. x x -44- Applicable to Form 10-K of KU No. Description Energy KU Page(s) 10.08 KU's Executive Optional Deferred Compensation Plan (Exhibit 10.08 to Form 10-K Annual Report for KU for the year ended December 31, 1996). Incorporated by reference. x x 10.09 KU's Director Retirement Retainer Program, and Amendment No. 1 (Exhibit 10G to Form 10-K Annual Report of KU for the year ended December 31, 1991). Incorporated by reference. x x 10.10 Amendment No. 2 to KU's Director Retirement Retainer Program (Exhibit 10.10 to Form 10-K Annual Report for KU for the year ended December 31, 1996). Incorporated by reference. x x 10.11 Amendment No. 3 to KU's Director Retirement Retainer Program (Exhibit 10.11 to Form 10-K Annual Report for KU for the year ended December 31, 1996). Incorporated by reference. x x 10.12 KU's Supplemental Security Plan (Exhibit 10I to Form 10-K Annual Report of KU for the year ended December 31, 1991). Incorporated by reference. x x 10.13 Amendment No. 1 to KU's Supplemental Security Plan (Exhibit 10.J to Form 10-K Annual Report of KU for the year ended December 31, 1994). Incorporated by reference. x x 10.14 Amendment No. 2 to KU's Supplemental Security Plan (Exhibit 10.K to Form 10-K Annual Report of KU for the year ended December 31, 1994). Incorporated by reference. x x 10.15 Amendment No. 3 to KU's Supplemental Security Plan (Exhibit 10.15 to Form 10-K Annual Report for KU for the year ended December 31, 1996). Incorporated by reference. x x 10.16 KU's Amended and Restated Director Deferred Compensation Plan (Exhibit 10.16 to Form 10-K Annual Report for KU for the year ended December 31, 1996). Incorporated by reference. x x -45- Applicable to Form 10-K of KU No. Description Energy KU Page(s) 10.17 KU Energy's Performance Share Plan (Exhibit 10A to Form 10-Q Quarterly Report of KU Energy for the quarter ended June 30, 1993). Incorporated by reference. x 10.18 Amendment No. 1 to KU Energy's Performance Share Plan (Exhibit 10.18 to Form 10-K Annual Report of KU Energy for the year ended December 31, 1996). Incorporated by reference. x 10.19 KU Energy's Annual Performance Incentive Plan of January 1993 (Exhibit 10.J to Form 10-K Annual Report of KU Energy for the year ended December 31, 1993). Incorporated by reference. x 10.20 Amendment No. 1 to KU Energy's Annual Performance Incentive Plan (Exhibit 10.K to Form 10-K Annual Report of KU Energy for the year ended December 31, 1993). Incorporated by reference. x 10.21 Amendment No. 2 to KU Energy's Annual Performance Incentive Plan of January 1993 (Exhibit 10.21 to Form 10-K Annual Report of KU Energy for the year ended December 31, 1996). Incorporated by reference. x 10.22 KU Energy's Annual Performance Incentive Plan as amended and restated effective as of January 28, 1997 (Exhibit 10.22 to Form 10-K Annual Report of KU Energy for the year ended December 31, 1996). Incorporated by reference. x 10.23 KU Energy's Executive Optional Deferred Compensation Plan (Exhibit 10.23 to Form 10-K Annual Report of KU Energy for the year ended December 31, 1996). Incorporated by reference. x 10.24 KU Energy's Director Retirement Retainer Program (Exhibit 10J to Form 10-K Annual Report of KU Energy for the year ended December 31, 1992). Incorporated by reference. x 10.25 Amendment No. 1 to KU Energy's Director Retirement Retainer Program (Exhibit 10.25 to Form 10-K Annual Report of KU Energy for the year ended December 31, 1996). Incorporated by reference. x -46- Applicable to Form 10-K of KU No. Description Energy KU Page(s) 10.26 KU Energy's Amended and Restated Director Deferred Compensation Plan (Exhibit 10.26 to Form 10-K Annual Report of KU Energy for the year ended December 31, 1996). Incorporated by reference. x 10.27 KU Energy's Long-Term Incentive Plan (Exhibit 10.27 to Form 10-K Annual Report of KU Energy for the year ended December 31, 1996). Incorporated by reference. x 10.28 Employment Agreement by and between KU Energy Corporation and Michael R. Whitley (Exhibit (2)-5 to S-4 Registration Statement File No. 333-34219; Annex E to Form DEFM14A Joint Proxy Statement of LG&E Energy Corp. and KU Energy Corporation dated August 22, 1997). Incorporated by reference x x 10.29 KU Energy Stock Option Agreement, dated as of May 20, 1997, by and between KU Energy and LG&E Energy Corp. (Exhibit 99.1 to Form 8-K Current Report dated May 30, 1997). Incorporated by reference. x 10.30 LG&E Energy Corp. Stock Option Agreement, dated as of May 20, 1997, by and between LG&E Energy Corp. and KU Energy (Exhibit 99.2 to Form 8-K Current Report dated May 30, 1997). Incorporated by x reference. 12 Computation of Ratio of Earnings to Fixed Charges x 60 13 Portions of 1997 KU Energy Annual Report to Shareholders x x* 61-88 21 List of Subsidiaries x x 89 23 Consent of Independent Public Accountants - KU Energy and KU x x 90 27.01 Financial Data Schedule of KU Energy x ** 27.02 Financial Data Schedule of KU x ** 99.01 Description of Common Stock - KU Energy x 91-93 99.02 Description of Common Stock - KU x 94-95 99.03 Director and Officer Information x 96-107 -47- Applicable to Form 10-K of KU No. Description Energy KU Page(s) 99.04 Cautionary Statements - KU Energy and KU x x 108-109 Note - Exhibit numbers 10.01 through 10.28 are management contracts or compensatory plans or arrangements required to be filed as exhibits to this Form 10-K. * Only the Management's Discussion and Analysis of Financial Condition and Results of Operations is included or incorporated in the Annual Report on Form 10-K of Kentucky Utilities. ** Included in electronic filing only. -48- The following instruments defining the rights of holders of certain long- term debt of KU have not been filed with the Securities and Exchange Commission but will be furnished to the Commission upon request. 1. Loan Agreement dated as of May 1, 1990 between KU and the County of Mercer, Kentucky, in connection with $12,900,000 County of Mercer, Kentucky, Collateralized Solid Waste Disposal Facility Revenue Bonds (KU Project) 1990 Series A, due May 1, 2010 and May 1, 2020. 2. Loan Agreement dated as of May 1, 1991 between KU and the County of Carroll, Kentucky, in connection with $96,000,000 County of Carroll, Kentucky, Collateralized Pollution Control Revenue Bonds (KU Project) 1992 Series A, due September 15, 2016. 3. Loan Agreement dated as of August 1, 1992 between KU and the County of Carroll, Kentucky, in connection with $2,400,000 County of Carroll, Kentucky, Collateralized Pollution Control Revenue Bonds (KU Project) 1992 Series C, due February 1, 2018. 4. Loan Agreement dated as of August 1, 1992 between KU and the County of Muhlenberg, Kentucky, in connection with $7,200,000 County of Muhlenberg, Kentucky, Collateralized Pollution Control Revenue Bonds (KU Project) 1992 Series A, due February 1, 2018. 5. Loan Agreement dated as of August 1, 1992 between KU and the County of Mercer, Kentucky, in connection with $7,400,000 County of Mercer, Kentucky, Collateralized Pollution Control Revenue Bonds (KU Project) 1992 Series A, due February 1, 2018. 6. Loan Agreement dated as of August 1, 1992 between KU and the County of Carroll, Kentucky, in connection with $20,930,000 County of Carroll, Kentucky, Collateralized Pollution Control Revenue Bonds (KU Project) 1992 Series B, due February 1, 2018. 7. Loan Agreement dated as of December 1, 1993, between KU and the County of Carroll, Kentucky, in connection with $50,000,000 County of Carroll, Kentucky, Collateralized Solid Waste Disposal Facilities Revenue Bonds (KU Project) 1993 Series A, due December 1, 2023. 8. Loan Agreement dated as of November 1, 1994, between KU and the County of Carroll, Kentucky, in connection with $54,000,000 County of Carroll, Kentucky, Collateralized Solid Waste Disposal Facilities Revenue Bonds (KU Project) 1994 Series A, due November 1, 2024. (B) No reports on Form 8-K were filed by KU Energy or KU during the last quarter of 1997. -49- UNAUDITED PRO FORMA COMBINED CONDENSED CONSOLIDATED FINANCIAL INFORMATION The following unaudited pro forma financial information combines the historical balance sheets and statements of income of LG&E Energy and KU Energy, including their respective subsidiaries, after giving effect to the Merger. The unaudited pro forma combined condensed balance sheet at December 31, 1997 gives effect to the Merger as if it had occurred at December 31, 1997. The unaudited pro forma combined condensed statements of income for all periods give effect to the Merger as if it had occurred at the beginning of the periods presented. These statements are prepared on the basis of accounting for the Merger as a pooling of interests and are based on the assumptions set forth in the notes thereto. The pro forma financial information does not give effect to the expected synergies of the transaction. The following pro forma financial information has been prepared from, and should be read in conjunction with, the historical financial statements and related notes thereto of LG&E Energy and KU Energy. The following information is not necessarily indicative of the financial position or operating results that would have occurred had the Merger been consummated on the date as of which, or at the beginning of the periods for which, the Merger is being given effect, nor is it necessarily indicative of future operating results or financial position. -50- LG&E ENERGY CORP. UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET At December 31,1997 (Thousands of Dollars)
LG&E Energy KU Energy Pro Forma Pro Forma (As Reported) (As Reported) Adjustment Combined (Note 1) (Note 2) (Note 3) ASSETS Current assets: Cash and temporary cash investments $ 104,366 $ 21,726 $ - $ 126,092 Marketable securities 22,300 - - 22,300 Accounts receivable - less reserve 521,166 74,937 (156) 595,947 Materials and supplies - primarily at average cost: Fuel (predominately coal) 17,651 27,799 - 45,450 Gas stored underground 49,396 - - 49,396 Other 31,866 23,648 - 55,514 Price risk management assets 120,341 - - 120,341 Prepayments and other 10,599 5,769 - 16,368 Total current assets 877,685 153,879 (156) 1,031,408 Utility plant: At original cost 2,779,234 2,611,634 - 5,390,868 Less: reserve for depreciation 1,072,842 1,128,282 - 2,201,124 Net utility plant 1,706,392 1,483,352 - 3,189,744 Other property and investments - less reserve: Investments in affiliates 168,276 2,157 - 170,433 Non-utility property and plant, net 421,486 2,666 - 424,152 Price risk management assets 44,240 - - 44,240 Other 24,743 42,409 - 67,152 Total other property and investments 658,745 47,232 - 705,977 Deferred debits and other assets 123,569 52,799 (5,012) 171,356 Total assets $ 3,366,391 $ 1,737,262 $ (5,168) $ 5,098,485 See accompanying Notes to Unaudited Pro Forma Combined Condensed Financial Statements.
-51- LG&E ENERGY CORP. UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET At December 31, 1997 (Thousands of Dollars)
LG&E Energy KU Energy Pro Forma Pro Forma (As Reported) (As Reported) Adjustment Combined (Note 1) (Note 2) (Note 3) CAPITAL AND LIABILITIES Current liabilities: Long-term debt due within one year $ 20,000 $ 21 $ - $ 20,021 Notes payable 360,184 33,600 - 393,784 Accounts payable 449,230 29,561 3,082 481,873 Trimble County settlement 13,248 - - 13,248 Price risk management liabilities 131,107 - - 131,107 Other 84,966 42,733 (3,330) 124,369 Total current liabilities 1,058,735 105,915 (248) 1,164,402 Long-term debt 664,339 546,351 - 1,210,690 Deferred credits and other liabilities: Accumulated deferred income taxes 327,343 252,492 - 579,835 Investment tax credit, in process of amortization 75,800 26,131 - 101,931 Accumulated provision for pensions and related benefits 43,883 35,664 - 79,547 Regulatory liability 65,502 51,577 - 117,079 Price risk management liabilities 23,803 - - 23,803 Other 67,576 15,010 - 82,586 Total deferred credits and other liabilities 603,907 380,874 - 984,781 Minority interests 105,985 - - 105,985 Cumulative preferred stock 98,353 40,000 - 138,353 Common equity 835,072 664,122 (4,920) 1,494,274 Total capital and liabilities $ 3,366,391 $ 1,737,262 $ (5,168) $ 5,098,485 See accompanying Notes to Unaudited Pro Forma Combined Condensed Financial Statements.
-52- LG&E ENERGY CORP. UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME Year Ended December 31, 1997 (Thousands of Dollars Except Per Share Data)
LG&E Energy KU Energy Pro Forma Pro Forma (As Reported) (As Reported) Adjustment Combined (Note 1) (Note 2) (Note 3) REVENUES Energy marketing and trading $ 3,266,811 $ - $ (4) $ 3,266,807 Electric utility 615,159 716,410 (305) 1,331,264 Gas utility 231,011 - - 231,011 Argentine gas distribution and other 150,839 5,899 - 156,738 Total revenues 4,263,820 722,309 (309) 4,985,820 COST OF REVENUES Energy marketing and trading 3,245,234 - (14) 3,245,220 Fuel and power purchased 166,692 260,981 (295) 427,378 Gas supply expenses 158,929 - - 158,929 Argentine gas distribution and other 84,873 - - 84,873 Total cost of revenues 3,655,728 260,981 (309) 3,916,400 Gross profit 608,092 461,328 - 1,069,420 OPERATING EXPENSES Operation and maintenance: Energy marketing and trading 40,012 - - 40,012 Utility 214,635 201,247 - 415,882 Argentine gas distribution and other 49,562 3,661 - 53,223 Depreciation and amortization 115,736 84,297 - 200,033 Non-recurring charges (1,342) - - (1,342) Total operating expenses 418,603 289,205 - 707,808 Equity in earnings of joint ventures 21,014 - - 21,014 OPERATING INCOME 210,503 172,123 - 382,626 Other income and (deductions) 15,476 3,960 - 19,436 Interest charges and preferred dividends 63,865 41,959 - 105,824 Minority interest 9,035 - - 9,035 Income before income taxes 153,079 134,124 - 287,203 Income taxes 55,262 48,945 - 104,207 NET INCOME (Note 5) $ 97,817 $ 85,179 $ - $ 182,996 Average common shares outstanding (Note 4) 66,471 37,818 25,338 129,627 Earnings per share of common stock - basic and diluted $ 1.47 $ 2.25 $ - $ 1.41 See accompanying Notes to Unaudited Pro Forma Combined Condensed Financial Statements.
-53- LG&E ENERGY CORP. UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME Year Ended December 31, 1996 (Thousands of Dollars Except Per Share Data)
LG&E Energy KU Energy Pro Forma Pro Forma (As Reported) (As Reported) Adjustment Combined (Note 1) (Note 2) (Note 3) REVENUES Energy marketing and trading (Note 6) $ 2,748,873 $ - $ - $ 2,748,873 Electric utility 607,160 711,686 (760) 1,318,086 Gas utility 214,419 - - 214,419 Argentine gas distribution and other 19,013 4,522 - 23,535 Total revenues 3,589,465 716,208 (760) 4,304,913 COST OF REVENUES Energy marketing and trading 2,664,399 - (257) 2,664,142 Fuel and power purchased 166,323 260,688 (503) 426,508 Gas supply expenses 140,482 - - 140,482 Argentine gas distribution and other 13,059 - - 13,059 Total cost of revenues 2,984,263 260,688 (760) 3,244,191 Gross profit 605,202 455,520 - 1,060,722 OPERATING EXPENSES Operation and maintenance: Energy marketing and trading 41,916 - - 41,916 Utility 214,786 201,811 - 416,597 Argentine gas distribution and other 25,991 2,759 - 28,750 Depreciation and amortization 103,556 80,612 - 184,168 Non-recurring charges (Notes 7 and 8) 26,330 5,493 - 31,823 Total operating expenses 412,579 290,675 - 703,254 Equity in earnings of joint ventures 18,818 - - 18,818 OPERATING INCOME 211,441 164,845 - 376,286 Other income and (deductions) 3,808 5,327 - 9,135 Interest charges and preferred dividends 53,887 41,889 - 95,776 Income before income taxes 161,362 128,283 - 289,645 Income taxes 57,359 46,334 - 103,693 NET INCOME $ 104,003 $ 81,949 $ - $ 185,952 Average common shares outstanding (Note 4) 66,294 37,818 25,338 129,450 Earnings per share of common stock - basic and diluted $ 1.57 $ 2.17 $ - $ 1.44 See accompanying Notes to Unaudited Pro Forma Combined Condensed Financial Statements.
-54- LG&E ENERGY CORP. UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENTS OF INCOME Year Ended December 31, 1995 (Thousands of Dollars Except Per Share Data)
LG&E Energy KU Energy Pro Forma Pro Forma (As Reported) (As Reported) Adjustment Combined (Note 1) (Note 2) (Note 3) REVENUES Energy marketing and trading $ 630,249 $ - $ (1,616) $ 628,633 Electric utility 571,086 686,400 (2,212) 1,255,274 Refund - Trimble County settlement (Note 9) (28,300) - - (28,300) Gas utility 181,126 - - 181,126 Argentine gas distribution and other 20,519 4,028 - 24,547 Total revenues 1,374,680 690,428 (3,828) 2,061,280 COST OF REVENUES Energy marketing and trading 604,302 - - 604,302 Fuel and power purchased 154,832 259,424 (3,828) 410,428 Gas supply expenses 110,738 - - 110,738 Argentine gas distribution and other 19,858 - - 19,858 Total cost of revenues 889,730 259,424 (3,828) 1,145,326 Gross profit 484,950 431,004 - 915,954 OPERATING EXPENSES Operation and maintenance: Energy marketing and trading 18,177 - - 18,177 Utility 203,284 198,712 - 401,996 Argentine gas distribution and other 21,697 2,969 - 24,666 Depreciation and amortization 94,393 75,268 - 169,661 Total operating expenses 337,551 276,949 - 614,500 Equity in earnings of joint ventures 28,158 - - 28,158 OPERATING INCOME 175,557 154,055 - 329,612 Other income and (deductions) 5,389 6,092 - 11,481 Interest charges and preferred dividends 53,822 42,273 - 96,095 Income before income taxes 127,124 117,874 - 244,998 Income taxes 44,294 41,821 - 86,115 NET INCOME $ 82,830 $ 76,053 $ - $ 158,883 Average common shares outstanding (Note 4) 66,105 37,818 25,338 129,261 Earnings per share of common stock - basic and diluted $ 1.25 $ 2.01 $ - $ 1.23 See accompanying Notes to Unaudited Pro Forma Combined Condensed Financial Statements.
-55- LG&E ENERGY CORP. NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS 1. Reclassifications have been made to certain as reported account balances reflected in KU Energy's financial statements to conform to this reporting presentation. All other financial statement presentation and accounting policy differences are immaterial and have not been adjusted in the pro forma combined condensed financial statements. 2. Intercompany transactions (power purchased and power sales transactions) between LG&E Energy and KU Energy during the periods presented were eliminated through pro forma adjustments. 3. Merger-related transaction costs are currently estimated to be approximately $16.5 million (including fees for financial advisors, attorneys, accountants, consultants, filings and printing). LG&E Energy and KU Energy have incurred transaction costs of $13.3 million through December 31, 1997, which are included in deferred debits and other assets in the pro forma combined condensed balance sheet. None of the estimated cost savings resulting from the Merger or costs to achieve such savings have been reflected in the pro forma combined condensed statements of income. A charge of $4.92 million ($8.25 million, net of income taxes of $3.33 million) as a pro forma adjustment to retained earnings and a credit of $5.0 million ($8.25 million less $13.3 million actual charges incurred through December 31, 1997) as a pro forma adjustment to deferred debits and other assets have been made in the pro forma combined condensed balance sheet to recognize such estimated transaction costs and the proposed treatment following the consummation of the Merger. 4. The pro forma combined condensed financial statements reflect the conversion of each share of KU Energy Common Stock (no par value) outstanding into 1.67 shares of LG&E Energy Common Stock (no par value) as provided in the Merger Agreement. The pro forma combined condensed financial statements are presented as if the companies were combined during all periods included therein. 5. LG&E Energy's non-recurring charges for the year ended December 31, 1997, included a net insurance settlement of $7.6 million related to losses incurred in its Canadian office during 1996, partially offset by a charge of $6.3 million to reflect the costs of consolidating the trading, risk management and administrative operations of its power and gas marketing divisions into a single energy marketing unit, located in its Louisville headquarters. 6. LG&E Energy adopted the mark-to-market method of accounting for its energy trading and price risk management activities during 1996. This resulted in an increase in Energy Marketing and Trading revenues and income from operations of $26.2 million for 1996. The impact on prior period financial results was immaterial. 7. LG&E Energy's net income for the year ended December 31, 1996, includes a non-recurring after-tax charge of $17.1 million for losses in its natural gas marketing business resulting from unauthorized transactions entered into by a marketer in its Calgary, Alberta, office. This charge is reflected in non-recurring charges on the -56- respective statements of income. 8. KU Energy's net income for the year ended December 31, 1996, includes a non-recurring write-off of nonutility investments of $5.5 million which is reflected in non-recurring charges. 9. LG&E Energy's 1995 operating revenues were reduced by $28.3 million related to a settlement agreement approved by the Kentucky Commission on December 8, 1995, which resolved numerous legal and regulatory proceedings to determine the appropriate ratemaking treatment to implement the Kentucky Commission's 1988 decision that LG&E should not be allowed to recover 25 percent of the cost of Trimble County Unit 1 (Trimble County) from ratepayers. -57- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, KU Energy Corporation and Kentucky Utilities Company have each duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 25, 1998. KU ENERGY CORPORATION AND KENTUCKY UTILITIES COMPANY (Registrants) /s/Michael R. Whitley Michael R. Whitley Chairman and President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrants in the capacities and on the date indicated. Signature Title /s/Michael R. Whitley Michael R. Whitley Chairman and President (Principal Executive Officer) and Director of KU Energy and KU /s/O.M. Goodlett O. M. Goodlett Senior Vice-President (Principal Financial Officer) of KU Energy and KU /s/Michael D. Robinson Michael D. Robinson Controller (Principal Accounting Officer) of KU Energy and KU /s/Mira S. Ball Mira S. Ball Director of KU Energy and KU /s/Carol M. Gatton Carol M. Gatton Director of KU Energy and KU /s/Harry M. Hoe Harry M. Hoe Director of KU Energy and KU /s/Milton W. Hudson Milton W. Hudson Director of KU Energy and KU /s/John T. Newton John T. Newton Director of KU Energy and KU -58- Signature Title /s/Frank V. Ramsey, Jr. Frank V. Ramsey, Jr. Director of KU Energy and KU /s/William L. Rouse, Jr. William L. Rouse, Jr. Director of KU Energy and KU /s/Charles L. Shearer Charles L. Shearer Director of KU Energy and KU /s/Lee T. Todd, Jr. Lee T. Todd, Jr. Director of KU Energy and KU March 25, 1998 -59- EX-12 2 EXHIBIT 12 EXHIBIT 12 KENTUCKY UTILITIES COMPANY COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
Year Ended December 31, 1997 1996 1995 1994 1993 (in thousands except ratios) Earnings Net Income $ 85,713 $ 86,163 $ 76,842 $ 77,512 $ 81,286 Adjustments Fixed charges 39,729 39,688 40,116 34,558 32,899 Income taxes Current Federal 39,353 35,656 23,597 37,058 35,893 Current State 8,964 7,387 5,134 8,812 9,484 Deferred Federal--Net 1,996 5,510 12,165 (1,114) 2,837 Deferred State--Net 1,377 2,899 3,845 13 71 Deferred investment tax credit--Net - - (71) (86) (107) Income taxes included in Other Income and Deductions Current Fed and State (1,099) 4,426 1,044 1,881 (2,616) Deferred Fed and State 1,233 (4,659) (508) (458) 2,817 Amortization of investment credit (4,036) (4,013) (4,024) (4,024) (4,024) Undistributed income of Electric Energy, Inc. (37) 24 99 (39) (38) Total Earnings $ 173,193 $ 173,081 $ 158,239 $ 154,113 $ 158,502 Fixed Charges Int. on long-term debt $ 37,405 $ 37,584 $ 36,095 $ 32,147 $ 31,650 Other interest charges 2,324 2,104 4,021 2,411 1,249 Total Fixed Charges $ 39,729 $ 39,688 $ 40,116 $ 34,558 $ 32,899 Ratio of Earnings to Fixed Charges 4.36 4.36 3.94 4.46 4.82
____________ Note--Rentals are not material and have not been included in fixed charges. -60- EX-13 3 EXHIBIT 13 EXHIBIT 13 Management's Discussion and Analysis of Financial Condition and Results of Operation COMPANY DESCRIPTION KU Energy Corporation (KU Energy or the Company) is an investor-owned utility holding company with two wholly owned subsidiaries. Kentucky Utilities Company (KU), the principal subsidiary of KU Energy, is an electric utility, and KU Capital Corporation (KU Capital) is a nonutility subsidiary. Material changes in the consolidated financial condition and results of operations of the Company are primarily attributable to the operations of KU. THE MERGER On May 20, 1997, KU Energy and LG&E Energy Corp. (LG&E Energy) entered into an Agreement and Plan of Merger (Merger) providing for a tax-free, stock for stock merger of KU Energy and LG&E Energy. As a result of the Merger, LG&E Energy, the surviving corporation, will become the parent company of KU and will continue as parent of Louisville Gas & Electric Company (LG&E). When the Merger is completed, shareholders of KU Energy common stock will receive 1.67 shares of LG&E Energy common stock for each share of KU Energy common stock held. Shareholders of both companies approved the Merger on October 14, 1997. The Merger also has been approved by the Virginia State Corporation Commission (SCC) and the Kentucky Public Service Commission (PSC). The PSC order approves a surcredit mechanism which passes one-half of the potential non-fuel merger savings (net of costs to achieve) to customers over the first five years following the consummation of the Merger. The credit will be nearly 2% of customers bills in the five-year period and will amount to approximately $63 million in net non-fuel savings to KU customers. Similar methods for passing net non-fuel merger savings have been approved for Virginia customers by the SCC and agreed to by KU's municipal wholesale customers. The PSC order also approves recovery from ratepayers of one-half of merger- related expenses (not to exceed $77 million) over a five-year period. The remaining merger-related expenses will be expensed as incurred after the effective date of the Merger. The Company's share of merger-related expenses is expected to be approximately $38 million. Through December 31, 1997, the Company has deferred approximately $7.9 million pending consummation of the Merger. Of that amount, $4.1 million is included in regulatory assets to be recovered following the consummation of the Merger as described above. Refer to Note 1 of the Notes to Consolidated Financial Statements, Summary of Significant Accounting Policies. As part of their application, KU and LG&E have proposed a base rate cap for five years after consummation of the Merger, except in the event of extraordinary circumstances such as a significant increase in the federal corporate tax rate. The PSC order notes that the PSC has the statutory jurisdiction to regulate utility rates including the authority to investigate and review KU's and LG&E's earnings at any time. The PSC order also requires KU and LG&E to file by September 14, 1998, or -61- the consummation of the Merger, whichever is later, detailed plans to address any future rate regulation that may be adopted in the state. The PSC order further provides that the PSC will at that time determine on the basis of the described filings and other information whether changes should be made to the existing regulation of KU and LG&E. The Merger must still be approved by the Federal Energy Regulatory Commission and the Securities and Exchange Commission and reviewed by the Federal Trade Commission. Following receipt of the remaining regulatory approvals, the Merger is expected to be effective as early as the first half of 1998. RESULTS OF OPERATIONS Earnings and Dividends The Company's 1997 earnings were $2.25 per share compared to $2.17 per share earned in 1996, an increase of 4%. Earnings in 1997 were positively impacted by increased kilowatt-hour (kWh) sales to industrial customers and higher market prices on sales for resale offset somewhat by overall milder weather in 1997. Earnings per share for 1996 of $2.17 were 8% above earnings of $2.01 per share for 1995. The increase in 1996 earnings was largely due to kWh sales growth which was attributable to increased sales to neighboring utilities, continued economic growth in KU's service area and the impact of KU's successful marketing efforts. Common stock dividends were increased 2.3% to $1.76 per share in 1997. In January 1998, KU Energy's Board increased the common dividend again to an indicated annual rate of $1.80 per share. This marked the 17th consecutive year in which dividends have increased. 1997 kWh Sales by Classification Year Ended December 31, 1997 Residential 27% Commercial 19% Industrial 24% Mine Power 5% Public Authorities 7% Sales for Resale 18% Total 100% Sales and Revenues 1997 1996 kWh Revenue kWh Revenue Change Variance Change Variance (%) (000's) (%) (000's) Residential (2) $(4,405) 3 $ 3,469 Commercial - 154 - (1,138) Industrial 9 9,945 7 6,790 Mine Power 4 527 (4) (2,062) Public Authorities - 220 4 1,862 Total Retail Sales 2 6,441 3 8,921 Sales for Resale (9) (1,878) 27 13,268 Miscellaneous Revenues and Other - 161 - 3,097 Total - $ 4,724 7 $25,286 -62- Total sales for 1997 were flat as compared to 1996. Residential sales decreased 2% for the year due to milder weather in 1997 compared to 1996. Industrial sales increased 9% reflecting continued growth in the manufacturing sector of the service area economy. Sales for resale, which include wholesale and opportunity sales, declined 9% in 1997; however, revenues did not decline by a comparable amount due to higher market prices per megawatt-hour on opportunity sales. Operating revenues of $716.4 million for 1997 were fairly flat, increasing $4.7 million (1%) from 1996 due primarily to kWh sales remaining almost unchanged as discussed above. Sales for 1996 were 7% above 1995. Sales for resale rose 27% in 1996. Industrial sales increased 7% while residential sales increased 3%. These increases were the result of the Company's successful marketing efforts and continued economic growth in KU s service area. Operating revenues for 1996 were $711.7 million, up 4% from 1995. The increase in 1996 revenues was largely due to the growth in kWh sales as described above. Operating Expenses Fuel expense totaled $188.4 million in 1997, a $9.8 million (5%) decrease from 1996. The decline was primarily due to a 4% decrease in MBTU (million British thermal units) consumed which resulted from an increase in kWh purchases. Purchased power expense increased $10.1 million (16%) in 1997 due to a 19% increase in kWh purchases associated with increased availability of surplus power on favorable pricing terms and to a one-time reduction in demand costs in 1996 of about $4 million under a contract with a neighboring utility. Fuel expense for 1996 was $198.2 million, an $8.4 million (4%) increase from 1995. This increase was due to increased generation for kWh sales, partially offset by a 3% decrease in the cost per MBTU of coal consumed. Purchased power expense decreased $7.1 million (10%) in 1996. The decline was due to a reduction in kWh purchases and to a one-time reduction in demand costs as discussed above. Depreciation expense increased $3.7 million (5%) and $5.3 million (7%) in 1997 and 1996, respectively. The increases were primarily due to increased utility plant in service including a combustion turbine peaking unit placed into service in May 1996. Federal and state income taxes increased $.3 million (1%) in 1997 primarily due to the increase in pre-tax income. Federal and state income taxes increased $6.8 million (16%) in 1996. The increase was primarily due to the increase in pre-tax income. Other Income and Deductions Other income and deductions of $10.5 million in 1997 were up $2.2 million -63- (27%) compared to 1996. Other income and deductions for 1996 include a $5.5 million pre-tax write-off associated with nonutility investments. Other income and deductions of $8.3 million in 1996 were down 29% from 1995 primarily due to the $5.5 million pre-tax write-off mentioned above. (For additional information, refer to page 21 Nonutility Activities. ) COMPETITION Wholesale The electric utility industry's move to competition formally began with passage of The National Energy Policy Act of 1992 (NEPA). NEPA gave the Federal Energy Regulatory Commission (FERC) authority to order electric utilities to provide wholesale transmission services to independent power producers and other utilities. NEPA also increased competition in the wholesale generation market by reducing restrictions on the ownership and operation of independent power producers. In 1996, under authority granted by NEPA, the FERC issued rules (FERC Order 888 and Order 889) requiring electric utilities to open their transmission systems to other wholesale buyers and sellers. In addition, the rules require electric utilities to separate their merchant and transmission functions. These rules create greater competition in the industry by increasing the availability of transmission services. In March 1997, FERC issued its Final Rule (Order 888-A) affirming Orders 888 and 889. In July 1997, KU filed a conforming open access transmission tariff (TS) with the FERC. The Company's TS has been accepted by the FERC. Retail Proposals to bring competition to the retail level of the electric utility industry are being considered in numerous states and at the federal level. In Kentucky, the PSC has held a series of informal meetings with electric utilities and other interested parties to discuss the potential impact of industry restructuring. Based upon these meetings, the PSC issued in December 1997 a set of principles and guidelines on the restructuring of the electric utility industry. The principles and guidelines focus on the fundamental issues relating to consumer protection and benefits, system reliability, environmental responsibility and other related matters. The Company continues to advocate nationwide competition in the electric utility industry and believes customer choice should be extended to the retail level. With low-cost generation and rates that are among the lowest in the nation, the Company is well-positioned for the challenges and opportunities of a competitive marketplace. The Company believes its merger with LG&E Energy will strengthen its competitive position. The larger size of the combined company will provide greater opportunities for growth while expected cost savings will help ensure that KU's rates remain among the lowest in the nation. Stranded Costs KU believes that it will have very little, if any, stranded costs as a result of wholesale or retail competition. -64- Midwest Independent System Operator In 1998, KU announced that it will join the Midwest Independent System Operator (MISO). KU is among nine transmission system owners, including LG&E, which filed a proposal with the FERC in January 1998 seeking approval to form the MISO. The MISO is a regional entity that would manage and operate the transmission owners collective transmission systems in an eight-state region. The primary objectives of the MISO are to advance wholesale competition by ensuring nondiscriminatory open transmission access to all wholesale customers and to enhance transmission reliability. ENVIRONMENTAL MATTERS Clean Air Act KU met Phase I requirements of the Clean Air Act Amendments of 1990 (which were effective January 1, 1995) primarily through the addition of a flue gas desulfurization system (scrubber) on Unit 1 of the KU's Ghent Generating Station. The scrubber began commercial operation in December 1994. The Company's current strategy for Phase II requirements (which will be effective January 1, 2000) is to use accumulated emission allowances to delay additional capital expenditures and may also include fuel switching or the installation of additional scrubbers. The Company's future compliance plans are contingent upon many factors, including developments in the emission allowance market and fuel markets as well as regulatory and legislative actions and advances in clean air technology. The Company will continue to review and revise its compliance plans accordingly to ensure that its environmental obligations are met in the most efficient and cost-effective manner. Environmental Cost Recovery In August 1994, KU implemented an environmental cost recovery mechanism (surcharge) in Kentucky. Authorized by a 1992 state statute and approved by the PSC in July 1994, the surcharge is designed to recover certain environmental compliance costs, including costs to comply with the 1990 Clean Air Act Amendments, through a surcharge on customers bills. The PSC's order approving the surcharge and the constitutionality of the surcharge were challenged in a Franklin County (Kentucky) Circuit Court (Circuit Court) action brought against KU and the PSC by the Attorney General of Kentucky and representatives of consumer groups. In July 1995, the Circuit Court entered a judgment upholding the constitutionality of the surcharge statute but vacating that part of the PSC's order which the Circuit Court's judgment described as retroactively applying the surcharge statute. All parties (including KU and the PSC) appealed the Circuit Court's judgment to the Kentucky Court of Appeals (Court of Appeals). The PSC has ordered surcharge revenues collected by KU from February 1, 1995 subject to refund pending final determination of all appeals. The total surcharge collections from February 1, 1995 through December 31, 1997 were approximately $56 million. In December 1997, the Court of Appeals rendered an opinion upholding the portion of the Circuit Court's judgment regarding the constitutionality of the surcharge statute but reversing that portion of the Circuit Court's judgment concerning the claim of retroactive application of the statute. The Kentucky Attorney General and other consumer representatives have filed motions for discretionary review with the Kentucky Supreme Court (Supreme -65- Court). The Supreme Court has the discretion to grant or deny the motions. KU and the PSC have asked the Supreme Court to deny the motions. KU cannot predict whether the Supreme Court will grant review of the case or when it will act on the matter. KU continues to believe that the constitutionality of the surcharge statute will be upheld. Although KU cannot predict the outcome of the claim of retroactive application of the statute, it is the position of KU and the PSC that the July 1994 PSC order did not retroactively apply the statute. If the Court of Appeals opinion reversing the Circuit Court's judgment on the claim of retroactivity is overturned and the Circuit Court's judgment, as entered, is upheld, KU estimates that the amount it could be required to refund for surcharge collections through December 31, 1997, from the implementation of the surcharge would be approximately $15 million, and from February 1, 1995, would be approximately $13 million. At this time, KU has not recorded any reserve for refund. Refer to Note 9 of the Notes to Consolidated Financial Statements, Environmental Cost Recovery. Nitrogen Oxide Emissions Reductions The Environmental Protection Agency (EPA) issued final rules revising the National Ambient Air Quality Standards for ozone and particulate matter in July 1997. The revised standards would require significant reductions in sulfur dioxide and nitrogen oxide emissions from coal-fired boilers (including those at KU's generating stations) beginning in 2004. Certain implementation proposals, which are not yet final, would target coal-fired utilities in the Midwest and South, including Kentucky, for more substantial reductions than other areas and other sources of emissions. Final implementation methods will be set by the EPA as well as state regulatory authorities. KU believes that the costs relating to compliance with the new standards, including capital costs as well as associated increases in operating costs, are likely to be substantial and are dependent upon the ultimate control program agreed to by the targeted states and EPA. Such costs are expected to be incurred in the 2004-2007 time period. KU further believes that such capital and operating costs are the type of costs that are eligible for recovery from customers under its environmental surcharge mechanism. However, approval from the PSC is required. Refer to Note 9 of the Notes to Consolidated Financial Statements, Environmental Cost Recovery. The exact nature of the impact of the new standards on KU's operations will not likely be known for some time. INFLATION KU's rates are designed to recover operating and historical plant investment costs. Financial statements, which are prepared in accordance with generally accepted accounting principles, report operating results in terms of historic costs and do not evaluate the impact of inflation. Inflation affects KU's construction costs, operating expenses and interest charges. Inflation can also impact KU's financial performance if rate relief is not granted on a timely basis for increased operating costs. (Refer to page 16, The Merger, regarding a proposed rate cap.) LIQUIDITY AND CAPITAL RESOURCES The Company's financial position remained strong in 1997. At the end of the year, common stock equity represented 53% of total capitalization while -66- long-term debt was 44%, and preferred stock was 3%. Current ratings on KU's senior debt securities are as follows: Duff & Phelps AA, Moody's Aa2 and Standard & Poor's AA.
As of December 31, 1997 1996 1995 1994 1993 Capitalization (in millions) $1,250 $1,232 $1,215 $1,152 $1,085 Long-Term Debt 43.7% 44.4% 44.9% 43.0% 40.8% Preferred Stock 3.2% 3.2% 3.3% 3.5% 3.7% Common Stock Equity 53.1% 52.4% 51.8% 53.5% 55.5%
Cash from operations accounted for 106% of cash requirements in 1997 as compared to 99% in 1996 and 78% in 1995. For calculation purposes, cash requirements exclude optional debt refinancings and redemptions and optional preferred stock redemptions. At the end of 1997, KU's short-term borrowings were $34 million compared to $54 million at December 31, 1996. The Company has used short-term borrowings to temporarily finance ongoing construction expenditures and general corporate requirements. The decrease is due primarily to cash provided by operations exceeding cash required for investing and financing activities (exclusive of short-term borrowings). Taking advantage of lower interest rates, KU issued $36 million of Series S First Mortgage Bonds, maturing 2006, at a rate of 5.99% in January 1996 and used the proceeds to redeem $35.5 million of Series K First Mortgage Bonds which carried a rate of 7 3/8%. In June 1995, KU issued $50 million of Series R First Mortgage Bonds which will mature in 2025 and bear interest at 7.55%. The proceeds were used primarily to pay short-term indebtedness incurred to finance ongoing construction expenditures and general corporate requirements. The Company's financial strength is enhanced by its low cost of capital. Shown below are the Company's embedded costs of long-term debt and preferred stock at year-end: Embedded Costs 1997 1996 1995 Long-Term Debt 6.98% 6.98% 7.15% Preferred Stock 5.64% 5.64% 5.64% Capital Requirements Construction Expenditures - 1997 Actual, 1998-2002 Estimated Actual Estimated (In millions of dollars) 1997 1998 1999 2000 2001 2002 Construction Expenditures $94 $ 97 $ 103 $120 $116 $113 During 1997, construction expenditures were $94 million. Construction expenditures are expected to be approximately $97 million in 1998. For the five-year period 1998-2002, construction expenditures are projected to be $549 million. Included in the projection is $105 million for additional peaking units. Construction expenditures for the five-year period ending -67- in 1997 were $695 million. In addition to construction expenditures, projected capital requirements for 1998-2002 include $61.5 million for scheduled debt retirements. Capital requirements for the five-year period 1998-2002 are expected to be met primarily through internal sources of funds. External financing to fund scheduled debt retirements will be required. KU forecasts annual growth in sales and peak demand of 2.5% and 2.7%, respectively, over the next 5 years. KU plans to provide for the future power needs of its customers primarily through purchased power and the addition of combustion turbine peaking units. There are no plans for additional baseload capacity before 2010. YEAR 2000 SOFTWARE MODIFICATIONS The Company, like most owners of computer software, is required to modify significant portions of its software so that it will function properly in the year 2000. The Company has developed a plan to be year 2000 compliant no later than the second quarter of 1999. Maintenance or modification costs will be expensed as incurred. The Company does not expect that the amounts required to be expensed over the next two years will have a material effect on its financial position or results of operations. The amount expensed through 1997 was immaterial. If the Company's year 2000 plans are not successful, there could be significant disruption of the Company's ability to bill customers and pay suppliers, as well as a possible slowdown of certain computer-dependent processes. NONUTILITY ACTIVITIES KU Capital, KU Energy's nonutility subsidiary, has an investment of about $28 million in equity interests in eight combustion turbine generating units (all of which are leased to investment grade utility companies). In addition, KU Capital has an investment of $8.7 million in limited partnership interests in three operating independent power projects through agreements with Tenaska, Inc. (Tenaska), a developer of domestic gas-fired cogeneration and independent power generation projects, and its affiliates. KU Capital also has a limited partnership interest in a gas-fired generation project which is the subject of a breach of contract claim filed by Tenaska against the Bonneville Power Administration (BPA). Construction of the project was suspended in 1995 after BPA notified Tenaska of its intent to cancel a power purchase agreement under which BPA committed to buy electricity to be produced by the project. Tenaska has a $650 million claim for damages against BPA in the United States Court of Federal Claims (Court of Claims). Arbitration ordered by the Court of Claims began in February 1997. An initial decision is expected in the second half of 1998. Although it is not possible at this time to determine the outcome of such arbitration, the Company believes the possibility of any material adverse impact on the results of operations or the financial position of the Company as a result of this matter is remote. Under its agreements with Tenaska, KU Capital has been funding a portion of the costs associated with identifying and pursuing potential independent power projects in North America. Such funding, which was expensed as incurred, totaled about $1 million in 1997. In 1996, KU Capital wrote-off -68- $5.5 million of costs funded during 1994-1996 that was associated with unsuccessful projects. KU Capital's remaining funding commitment over the next several years totals $3.6 million. FORWARD LOOKING STATEMENTS This report includes forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements made herein which are not based on historical facts are forward looking and, accordingly, involve risks and uncertainties that could cause actual results to differ materially from those discussed. Such forward looking statements include those under Management's Discussion and Analysis relating to (i) amounts of future construction expenditures, sources of funds to meet capital requirements and financing requirements, (ii) forecasts of annual growth in sales and peak demand and anticipated sources of additional power supply to meet customer demand, (iii) the anticipated level of stranded costs, (iv) the anticipated strategy to comply with the Clean Air Act Amendments of 1990, (v) the anticipated results of proceedings related to the environmental surcharge, (vi) the anticipated results of the arbitration relating to the Tenaska claim against BPA, (vii) the impact of the revisions to the National Ambient Air Quality Standards and recovery of related costs, (viii) with respect to the Merger, the expected timing of consummation, the Company's share of merger- related expenses, the anticipated amount of customer savings and the anticipated strengthened competitive position and (ix) the expected costs associated with year 2000 software modifications. Such statements are based on management's belief, judgment and analysis as well as assumptions made by and information available to management at the date hereof. In addition to any assumptions and cautionary factors referred to specifically in this report in connection with such forward looking statements, factors that could cause actual results to differ materially from those contemplated by the forward looking statements include (i) the speed and nature of increased competition and deregulation in the electric and gas utility industry, (ii) economic or weather conditions affecting future sales and margins, (iii) changing energy prices, (iv) legislative and regulatory changes including revised environmental requirements, (v) availability and cost of capital, (vi) unanticipated or adverse decisions in regulatory proceedings or litigation and (vii) other matters detailed from time to time in the Company's or KU's reports filed with the Securities and Exchange Commission. -69- Consolidated Statements of Income and Retained Earnings
KU Energy Corporation & Subsidiaries Year Ended December 31, 1997 1996 1995 (in thousands, except for per share amounts) OPERATING REVENUES $ 716,410 $ 711,686 $686,400 OPERATING EXPENSES: Fuel, principally coal, used in generation 188,439 198,198 189,845 Electric power purchased 72,542 62,490 69,579 Other operating expenses 123,537 125,351 124,044 Maintenance 65,004 64,170 62,599 Depreciation 84,297 80,612 75,268 Federal and state income taxes 50,501 50,247 43,426 Other taxes 15,459 15,049 15,038 Total Operating Expenses 599,779 596,117 579,799 NET OPERATING INCOME 116,631 115,569 106,601 OTHER INCOME AND DEDUCTIONS: Interest and dividend income 2,507 2,800 4,115 Other income and deductions - net 8,000 5,469 7,610 Total Other Income and Deductions 10,507 8,269 11,725 INCOME BEFORE INTEREST AND OTHER CHARGES 127,138 123,838 118,326 INTEREST AND OTHER CHARGES: Interest on long-term debt 37,405 37,584 36,095 Preferred stock dividend requirements of Subsidiary 2,256 2,256 2,256 Other interest charges 2,298 2,049 3,922 Total Interest and Other Charges 41,959 41,889 42,273 NET INCOME $ 85,179 $ 81,949 $ 76,053 BASIC EARNINGS PER AVERAGE COMMON SHARE, based on average shares outstanding of 37,818 $ 2.25 $ 2.17 $ 2.01 RETAINED EARNINGS BEGINNING OF YEAR $ 337,968 $ 321,066 $308,547 ADD NET INCOME 85,179 81,949 76,053 423,147 403,015 384,600 DEDUCT: Dividends on common stock, $1.76, $1.72 and $1.68 per share during 1997, 1996 and 1995, respectively 66,559 65,047 63,534 Other 8 - - RETAINED EARNINGS END OF YEAR $ 356,580 $337,968 $321,066 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
-70- Consolidated Statements of Cash Flows KU Energy Corporation & Subsidiaries
Year Ended December 31, (in thousands of dollars) 1997 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 85,179 $ 81,949 $ 76,053 Items not requiring (providing) cash currently: Depreciation 84,297 80,612 75,268 Deferred income taxes 7,815 5,891 16,919 Investment tax credit deferred (4,036) (4,013) (4,095) Deferred merger-related costs (7,851) - - Changes in current assets and liabilities: Change in accounts receivable 5,229 (969) (7,945) Change in accounts payable 1,308 (9,682) (10,774) Change in other current assets and liabilities 3,451 5,778 (431) Other - net (5,254) 10,181 1,868 Net Cash Provided by Operating Activities 170,138 169,747 146,863 CASH FLOWS FROM INVESTING ACTIVITIES: Construction expenditures - utility (94,006) (106,503) (124,515) Investment in independent power projects (4,805) (1,310) (3,204) Proceeds from insurance reimbursements 4,270 257 152 Proceeds from independent power projects 2,567 1,388 943 Other 472 393 193 Net Cash Used by Investing Activities (91,502) (105,775) (126,431) CASH FLOWS FROM FINANCING ACTIVITIES: Short-term borrowings - net (20,600) (1,400) (20,700) Issuance of long-term debt - 35,666 49,288 Funds deposited with trustee - net - 3,779 15,100 Retirement of long-term debt, including premiums (21) (36,192) (21) Payment of common stock dividends (66,559) (65,047) (63,534) Net Cash Used by Financing Activities (87,180) (63,194) (19,867) NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (8,544) 778 565 Cash and Cash Equivalents Beginning of Year 30,270 29,492 28,927 Cash and Cash Equivalents End of Year $ 21,726 $ 30,270 $ 29,492 SUPPLEMENTAL DISCLOSURES Cash paid for: Interest $ 37,053 $ 36,729 $ 37,961 Income Taxes $ 41,398 $ 45,775 $ 31,507 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
-71- Consolidated Balance Sheets KU Energy Corporation & Subsidiaries
As of December 31, (in thousands of dollars) 1997 1996 ASSETS UTILITY PLANT: Plant in service, at cost $2,552,695 $2,482,812 Less: Accumulated depreciation 1,128,282 1,067,911 1,424,413 1,414,901 Construction work in progress 58,939 63,435 Total Utility Plant 1,483,352 1,478,336 CURRENT ASSETS: Cash and cash equivalents 21,726 30,270 Accounts receivable, net of allowance for doubtful accounts 45,269 50,498 Accrued utility revenues 29,668 24,239 Fuel, principally coal, at average cost 27,799 30,895 Plant materials and operating supplies, at average cost 23,648 21,656 Other 5,769 7,486 Total Current Assets 153,879 165,044 OTHER ASSETS: Investment in leveraged leases 28,152 24,650 Investment in independent power projects 8,730 4,745 Regulatory assets 14,773 11,531 Other 48,376 42,642 Total Other Assets 100,031 83,568 Total Assets $1,737,262 $1,726,948 CAPITALIZATION AND LIABILITIES CAPITALIZATION: (SEE CONSOLIDATED STATEMENTS OF CAPITALIZATION) Common stock equity $ 664,122 $ 645,513 Preferred stock 40,000 40,000 Long-term debt 546,351 546,373 Total Capitalization 1,250,473 1,231,886 CURRENT LIABILITIES: Long-term debt due within one year 21 21 Short-term borrowings 33,600 54,200 Accounts payable 29,561 28,253 Accrued interest 8,283 8,048 Accrued taxes 7,710 4,005 Customer deposits 9,841 8,746 Accrued payroll and vacations 10,407 9,921 Other 6,492 5,954 Total Current Liabilities 105,915 119,148 OTHER LIABILITIES: Accumulated deferred income taxes 252,492 242,674 Accumulated deferred investment tax credits 26,131 30,167 Regulatory tax liability - net 50,904 54,388 Other 51,347 48,685 Total Other Liabilities 380,874 375,914 Total Capitalization and Liabilities $1,737,262 $1,726,948 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
-72- Consolidated Statements of Capitalization KU Energy Corporation & Subsidiaries
As of December 31, (in thousands of dollars) 1997 1996 COMMON STOCK EQUITY: Common stock, without par value, authorized 160,000,000 shares, outstanding 37,817,517 shares in 1997 and 37,817,878 shares in 1996 $ 308,137 $ 308,140 Capital stock expense and other (595) (595) Retained earnings 356,580 337,968 Total Common Stock Equity 664,122 645,513 PREFERRED STOCK: Kentucky Utilities cumulative, without par value, $100 stated value 4 3/4%, outstanding 200,000 shares 20,000 20,000 6.53%, outstanding 200,000 shares 20,000 20,000 Total Preferred Stock 40,000 40,000 LONG-TERM DEBT: First Mortgage Bonds: 5.95% Series Q, due June 15, 2000 61,500 61,500 6.32% Series Q, due June 15, 2003 62,000 62,000 5.99% Series S, due January 15, 2006 36,000 36,000 7.92% Series P, due May 15, 2007 53,000 53,000 7.55% Series R, due June 1, 2025 50,000 50,000 8.55% Series P, due May 15, 2027 33,000 33,000 295,500 295,500 First Mortgage Bonds, Pollution Control Series: 7 3/8% Pollution Control Series 7, due May 1, 2010 4,000 4,000 7.45% Pollution Control Series 8, due September 15, 2016 96,000 96,000 6 1/4% Pollution Control Series 1B, due February 1, 2018 20,930 20,930 6 1/4% Pollution Control Series 2B, due February 1, 2018 2,400 2,400 6 1/4% Pollution Control Series 3B, due February 1, 2018 7,200 7,200 6 1/4% Pollution Control Series 4B, due February 1, 2018 7,400 7,400 7.60% Pollution Control Series 7, due May 1, 2020 8,900 8,900 5 3/4% Pollution Control Series 9, due December 1, 2023 50,000 50,000 Variable Rate Pollution Control Series 10, due November 1, 2024 54,000 54,000 250,830 250,830 Total First Mortgage Bonds 546,330 546,330 8% secured note, due January 5, 1999 (net of current maturity) 21 43 Total Long-Term Debt 546,351 546,373 Total Capitalization $1,250,473 $1,231,886 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
-73- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES General The consolidated financial statements include the accounts of KU Energy Corporation (KU Energy or the Company), a holding company, and its wholly owned subsidiaries, Kentucky Utilities Company (KU) and KU Capital Corporation (KU Capital). The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. All significant intercompany balances and transactions have been eliminated from the consolidated financial statements. Certain amounts from prior periods have been reclassified to conform with the current year presentation. KU is a public utility engaged in producing, transmitting and selling electric energy. KU provides electric service to about 441,200 customers in over 600 communities and adjacent suburban and rural areas in 77 counties in central, southeastern and western Kentucky and to about 29,000 customers in 5 counties in southwestern Virginia. KU Capital continues to pursue a core energy strategy for its nonutility business activities. Under this strategy, targeted opportunities are energy-related activities that build on the Company's knowledge and expertise and have the appropriate risk/reward profile. Regulation The Company is exempt from regulation as a registered holding company under the Public Utility Holding Company Act of 1935. KU is subject to regulation by the Kentucky Public Service Commission (PSC), the Virginia State Corporation Commission (SCC) and the Federal Energy Regulatory Commission (FERC). With respect to accounting matters, KU maintains its accounts in accordance with the Uniform System of Accounts as defined by these agencies. KU's accounting policies conform to generally accepted accounting principles applicable to rate regulated enterprises and reflect the effects of the ratemaking process. The following is a summary of the components of regulatory assets: As of December 31, (in thousands of dollars) 1997 1996 Unamortized loss on reacquired debt $ 9,756 $ 10,838 Merger costs 4,062 - Other 955 693 Regulatory Assets $ 14,773 $ 11,531 KU is currently not earning a return on these regulatory assets. -74- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries Utility Plant Utility plant is stated at the original cost of construction. The cost of repairs of property units and replacements of minor items is charged to maintenance expense as incurred. Property unit replacements are capitalized and the depreciation reserve is charged with the cost, less net salvage, of units retired. Depreciation Provision for depreciation of utility plant is based on straight-line composite rates applied to the cost of depreciable property. The rates approximated 3.5% in 1997, 1996 and 1995. Cash and Cash Equivalents For purposes of reporting cash flows, the Company considers highly liquid investments with a maturity of three months or less from the date of purchase to be cash equivalents. Unamortized Loss on Reacquired Debt KU defers costs (primarily call premiums) arising from the reacquisition or retirement of long-term debt. Costs related to refinanced debt are amortized over the lives of the new debt issues. Costs related to retired debt not refinanced are amortized over the period to the scheduled maturity of the retired debt. Operating Revenues and Fuel Costs Revenues are recorded based on services rendered to customers. KU accrues an estimate of revenues for electric service furnished from the meter reading dates to the end of each accounting period. Cost of fuel used in electric generation is charged to expense as the fuel is consumed. Fuel adjustment clauses adjust operating revenues for changes in the level of fuel costs charged to expense. An environmental surcharge for Kentucky retail customers, implemented in August 1994, permits the utility to recover certain ongoing operating and capital costs of compliance with federal, state or local environmental requirements associated with the production of energy from coal, including the Federal Clean Air Act as amended. See Note 9 of the Notes to Consolidated Financial Statements, "Environmental Cost Recovery," for information about environmental surcharge legal proceedings. Income Taxes The Company establishes deferred tax assets and liabilities, as appropriate, for all temporary differences, and adjusts deferred tax balances to reflect changes in tax rates expected to be in effect during the periods the temporary differences reverse. Investment tax credits resulted from provisions of the tax law which permitted a reduction of the Company's tax liability based on certain construction expenditures. -75- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries Such credits have been deferred in the accounts and are being amortized as reductions in income tax expense over the life of the related property. Because of rate regulation, changes in tax rates are deferred and amortized as the temporary differences reverse. New Accounting Pronouncements In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128), and Statement of Financial Accounting Standards No. 129, Disclosure of Information about Capital Structure (SFAS 129). SFAS 128 specifies the computation, presentation, and disclosure requirements for earnings per share for entities with publicly held common stock. SFAS 129 was issued in conjunction with the FASB's earnings per share project and incorporated related disclosure requirements from APB Opinion No. 10, Disclosure of Long-Term Obligations, and Statement of Financial Accounting Standards No. 47, Disclosure of Long-Term Obligations. The Company adopted the statements for year-end 1997 and adoption of the statements did not have any dilutive impact on the basic current earnings per share calculation or disclosures. In June 1997, FASB issued Statements of Financial Accounting Standards No. 130, Reporting Comprehensive Income, and No. 131, Disclosures about Segments of an Enterprise and Related Information, effective for periods beginning after December 15, 1997. These statements do not affect the accounting recognition or measurement of transactions, but rather require expanded disclosures regarding financial results. The Company will adopt these standards in 1998 as required by the FASB. Stock-Based Compensation The Company adopted Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, in 1996 by continuing to account for stock compensation in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. If the Company had recognized compensation expense for awards under its stock- based compensation plan according to the new standard, net income and basic earnings per share for the years ended 1997, 1996 and 1995 would not have been materially different from amounts recorded. -76- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries 2. INCOME TAXES The accumulated deferred income taxes as set forth in the Consolidated Balance Sheets arise from the following temporary differences:
As of December 31, (in thousands of dollars) 1997 1996 DEFERRED TAX ASSETS: Unamortized investment tax credit and other property related differences $ 48,364 $ 50,629 Other 21,691 21,627 Less: Amounts included in current assets 3,242 4,723 66,813 67,533 DEFERRED TAX LIABILITIES: Accelerated depreciation and other property related differences 305,468 299,379 Other 13,837 10,828 319,305 310,207 NET ACCUMULATED DEFERRED INCOME TAX LIABILITY $ 252,492 $ 242,674 The components of income tax expense are as follows: Year Ended December 31, (in thousands of dollars) 1997 1996 1995 INCOME TAXES CHARGED TO OPERATING INCOME: Current - federal $ 38,472 $ 34,255 $ 22,011 - state 8,757 6,585 4,734 47,229 40,840 26,745 Deferred - federal 1,917 5,949 12,809 - state 1,355 3,458 3,943 3,272 9,407 16,752 Deferred investment tax credit - - (71) 50,501 50,247 43,426 INCOME TAXES CHARGED TO OTHER INCOME AND DEDUCTIONS: Current - federal (1,609) 2,716 1,868 - state (454) 900 384 (2,063) 3,616 2,252 Deferred - federal 3,426 (3,138) 176 - state 1,117 (378) (9) 4,543 (3,516) 167 Amortization of deferred investment tax credit (4,036) (4,013) (4,024) (1,556) (3,913) (1,605) TOTAL INCOME TAX EXPENSE $ 48,945 $ 46,334 $ 41,821
-77- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries The Company's effective income tax rate, determined by dividing income taxes by the sum of such taxes and net income, was 36.5% in 1997, 36.1% in 1996 and 35.5% in 1995. The difference between the effective rate and the statutory federal income tax rate is attributable to the following factors:
Year Ended December 31, (in thousands of dollars) 1997 1996 1995 FEDERAL INCOME TAX COMPUTED AT 35% $ 46,943 $ 44,899 $ 41,256 Add (Deduct): State income taxes, net of federal income tax benefit 7,004 6,867 5,884 Amortization of deferred investment tax credit (4,036) (4,013) (4,095) Other, net (966) (1,419) (1,224) TOTAL INCOME TAX EXPENSE $ 48,945 $ 46,334 $ 41,821
3. RETIREMENT BENEFITS Pensions The Company has a noncontributory defined benefit pension plan covering substantially all of its employees. Benefits under this plan are based on years of service, final average base pay and age at retirement. The Company's funding policy is to make such contributions as are necessary to finance the benefits provided under the plan. The Company's contributions meet the funding standards set forth in the Employee Retirement Income Security Act of 1974. The plan assets consist primarily of common stocks, corporate bonds and U.S. Government Securities. The Company also has a Supplemental Security Plan for certain management personnel. Retirement benefits under this plan are based on years of service, earnings and age at retirement. The plan has no advance funding. Benefit payments are made to retired employees or their beneficiaries from the general assets of the Company. On May 20, 1997, KU Energy and LG&E Energy Corp. (LG&E Energy) entered into a Merger Agreement. For information concerning the agreement, see Management's Discussion and Analysis - The Merger. Under the provisions of the Supplemental Security Plan, the Merger Agreement constituted a change-in-control which required that a lump sum present value payment be made to retired employees entitled to retirement benefits on the date of the Merger Agreement. On May 30, 1997, lump sum payments totalling $4.7 million were made to retired employees. -78- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries The reconciliation of the funded status of the retirement plans and the pension liability recorded by the Company is as follows:
As of December 31, (in thousands of dollars) 1997 1996 Fair value of plan assets $ 217,424 $ 191,778 Projected benefit obligation (214,657) (194,874) Plan assets more (less) than projected benefit obligation 2,767 (3,096) Unrecognized net (gain)/loss from past experience different than that assumed (19,775) (12,448) Unrecognized prior service cost 3,635 3,990 Unrecognized net asset (1,350) (1,500) Regulatory effect recorded 462 201 Pension liability $ (14,261) $ (12,853) Accumulated benefit obligation (including vested benefits of $164,498 and $147,103, respectively) $ 168,810 $ 149,814 Components of Net Pension Cost: Year Ended December 31, (in thousands of dollars) 1997 1996 1995 Service cost (benefits earned during the period) $ 6,728 $ 6,399 $ 6,060 Interest cost on projected benefit obligation 14,680 13,856 13,560 Actual return on plan assets (34,211) (20,798) (27,064) Net amortization and deferral 19,320 6,568 14,608 Regulatory effect recorded (261) (1,835) (1,595) Net pension cost $ 6,256 $ 4,190 $ 5,569 Assumptions Used in Determining Actuarial Valuations: 1997 1996 1995 Weighted average discount rate used to determine the projected benefit obligation 7.00% 7.75% 7.75% Rate of increase for compensation levels 4.00% 4.75% 4.75% Weighted average expected long-term rate of return on assets 8.25% 8.25% 8.25%
Other Postretirement Benefits The Company provides certain health care and life insurance benefits to eligible retired employees and their dependents. The Company accrues, during the years that employees render service, the expected cost of providing these benefits upon retirement to such employees, their beneficiaries and covered dependents. The postretirement health care plan is contributory for employees who retired after December 31, 1992, with retiree contributions indexed annually based upon the experience of retiree medical expenses for the preceding year. Pre-1993 retirees are not required to contribute to the plan. The Company's employees become eligible for retiree medical benefits after 15 years of service and -79- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries attainment of age 55. The life insurance plan is noncontributory and is based on compensation levels prior to retirement. In 1993, the Company began funding, in addition to current requirements for benefit payments, the maximum tax-favored amount allowed through certain tax deductible funding vehicles. The Company anticipates making similar funding decisions in future years, but will consider and make such funding decisions on the basis of tax, regulatory and other relevant conditions in effect at such times. The plan assets consist primarily of equity investments. The reconciliation of the funded status of the plans and the postretirement benefit liability recorded by the Company is as follows:
As of December 31, (in thousands of dollars) 1997 1996 Accumulated postretirement benefit obligation: Retirees $ (30,777) $(29,313) Fully eligible active plan participants (9,777) (8,678) Other active plan participants (31,585) (28,528) (72,139) (66,519) Plan assets at fair value 17,763 13,322 Accumulated postretirement benefit obligation in excess of plan assets (54,376) (53,197) Unrecognized net (gain)/loss from past experience different from that assumed (19,697) (20,029) Unrecognized transition obligation 50,118 53,460 Accrued postretirement benefit liability $ (23,955) $(19,766) Components of the net periodic postretirement benefit cost are as follows: Year Ended December 31, (in thousands of dollars) 1997 1996 1995 Service cost (benefits attributed to service during the period) $ 1,853 $ 1,859 $ 1,918 Interest cost on accumulated postretirement benefit obligation 4,895 4,751 4,926 Actual return on plan assets (3,569) (1,633) (1,722) Net amortization and deferral 1,706 103 792 Amortization of transition obligation 3,341 3,341 3,341 Net periodic postretirement benefit cost $ 8,226 $ 8,421 $ 9,255
-80- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries
Assumptions Used in Determining Actuarial Valuations: 1997 1996 1995 Weighted average discount rate used to determine the projected benefit obligation 7.00% 7.75% 7.75% Rate of increase for compensation levels 4.00% 4.75% 4.75% Weighted average expected long-term rate of return on assets 7.90% 8.00% 8.00%
For measurement purposes, a 7.0% annual rate of increase in the per capita cost of covered health care benefits is assumed for 1998. The health care cost trend rate is assumed to decrease gradually to 4.25% through 2004 and remain at that level thereafter over the projected payout period of the benefits. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1997, by $11.5 million (16%) and the aggregate of the service and interest cost components of the net periodic postretirement benefit cost for the year by $1.2 million (18%). 4. COMMITMENTS AND CONTINGENCIES The effects of certain commitments made by the Company are estimated below:
(in thousands of dollars) 1998 1999 2000 2001 2002 1998-2002 ESTIMATED CONSTRUCTION EXPENDITURES $ 97,200 $ 103,200 $ 120,000 $ 115,600 $ 112,700 $ 548,700 ESTIMATED CONTRACT OBLIGATIONS: Fuel 157,800 50,400 9,000 - - 217,200 Purchased power 31,300 30,200 29,500 32,300 32,300 155,600 Operating leases 2,900 2,800 2,800 2,800 2,700 14,000 INDEPENDENT POWER PROJECT COMMITMENTS 1,000 1,000 1,000 600 - 3,600 FIRST MORTGAGE BOND MATURITIES: Series Q $ - $ - $ 61,500 $ - $ - $ 61,500
Construction Program KU frequently reviews its construction program and may revise its projections of related expenditures based on revisions to its estimated load growth and projections of its future load. See Management's Discussion and Analysis - Capital Requirements for a discussion of future construction expenditures including those relating to construction of peaking units. Coal Supply Obligations under KU's coal purchase contracts are stated at prices -81- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries effective January 1, 1998, and are subject to changes as defined by the terms of the contracts. Purchased Power KU has purchase power arrangements with Owensboro Municipal Utilities (OMU), Electric Energy, Inc. (EEI), and other parties. Under the OMU agreement, which expires on January 1, 2020, KU purchases all of the output of a 400-MW generating station not required by OMU. The amount of purchased power available to KU during 1998-2002, which is expected to be approximately 8% of KU's total kWh requirements, is dependent upon a number of factors including the units' availability, maintenance schedules, fuel costs and OMU requirements. Payments are based on the total costs of the station allocated per terms of the OMU agreement, which generally follows delivered kWh. Included in the total costs is KU's proportionate share of debt service requirements on $186.6 million of OMU bonds outstanding at December 31, 1997. The debt service is allocated to KU based on its annual allocated share of capacity, which averaged approximately 50% in 1997. KU has a 20% equity ownership in EEI, which is accounted for on the equity method of accounting. KU's entitlement is 20% of the available capacity of a 1,000-MW station. Payments are based on the total costs of the station allocated per terms of an agreement among the owners, which generally follows delivered kWh. KU has several other contracts for purchased power during 1998-2002 of various MW capacities and for varying periods with a maximum entitlement at any time of 282 MW. Independent Power Projects The Company has agreements with Tenaska, Inc. (a developer of gas-fired cogeneration and independent power generation projects), and its affiliates to purchase limited partnership interests in the identification, development and ownership of certain independent power projects in North America. Under the agreements, the Company (through its wholly owned subsidiaries) is a limited partner in three operating cogeneration projects. The Company also has agreed to participate in funding the costs associated with identifying and pursuing potential independent power projects in North America. The remaining funding commitment over the next several years totals $3.6 million. Credit Arrangements KU has aggregate bank lines of credit of $60 million, all of which remained unused at December 31, 1997. All of these credit lines expire in December 1999. In support of these lines of credit, KU compensates the banks by paying a commitment fee. 5. COMMON STOCK KU Energy is subject to restrictions applicable to all corporations under -82- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries Kentucky law on the use of retained earnings for cash dividends on common stock. KU is subject to the same restrictions as well as those contained in Virginia law, its Mortgage Indenture and Articles of Incorporation. At December 31, 1997, there were no restricted retained earnings. The Company has a shareholder rights plan designed to provide protection to shareholders in the event of an unsolicited attempt to acquire the Company. Under the shareholder rights plan, in certain circumstances, KU Energy shareholders will receive as a dividend one right for each share of KU Energy common stock. Should certain events occur (for instance, an acquirer becomes the beneficial owner of 20 percent or more of the Company's outstanding voting stock without approval by the Company, or certain transactions occur following an acquirer becoming the beneficial owner of 10 percent or more of such voting stock without Company approval), each right would entitle the holder, other than the acquirer, to purchase common shares of KU Energy or shares of any company that acquires KU Energy at a discount from the market value. In certain circumstances, the Company may redeem the rights at a price of $.01 per right. The rights expire in February 2002. The rights have been amended to provide that the Merger will not result in the rights becoming exercisable. 6. PREFERRED AND PREFERENCE STOCK KU Energy As of December 31, 1997, there were 20 million shares of KU Energy preferred stock, without par value, authorized for issuance. Kentucky Utilities Each series of preferred stock is redeemable at the option of KU upon 30 days' written notice as follows: Redemption Price per Share Series (plus accrued and unpaid dividends, if any) 4 3/4% $101.00 6.53% (Not redeemable prior to December 1, 2003.) $103.265 through November 30, 2004, decreasing approximately $.33 each twelve months thereafter to $100 on or after December 1, 2013. As of December 31, 1997, there were 5.3 million shares of KU preferred stock, having a maximum aggregate stated value of $200 million, authorized for issuance, of which 400,000 shares were outstanding. As of December 31, 1997, there were 2 million shares of KU preference stock, without par value, authorized for issuance. -83- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries 7. SHORT-TERM AND LONG-TERM DEBT KU's short-term financing requirements are satisfied through the sale of commercial paper. The weighted average interest rate on the year-end balance was 6.79% for 1997 and 6.17% for 1996. Under the provisions for the variable rate Pollution Control Series 10 Bonds, KU can choose between various interest rate options. Currently, the daily interest rate option is being utilized. The average annual interest rate on the bonds during 1997 and 1996 was 3.77% and 3.53%, respectively. The variable rate bonds are subject to tender for purchase at the option of the holder and to mandatory tender for purchase upon the occurrence of certain events. If tendered bonds are not remarketed, the Company has available lines of credit which may be used to repurchase the bonds. In January 1996, KU issued $36 million of Series S First Mortgage Bonds which bear interest at 5.99% and will mature January 15, 2006. The proceeds were used to redeem $35.5 million of Series K First Mortgage Bonds which carried a rate of 7 3/8%. Substantially all of KU's utility plant is pledged as security for the first mortgage bonds. 8. FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: The carrying values of cash and cash equivalents, escrow funds, short- term borrowings, commercial paper and customer deposits approximate fair value because of the short maturity of these amounts. The Company's temporary cash investments are classified as held-to-maturity and are reported under the caption Cash and Cash Equivalents on the Consolidated Balance Sheet. Long-term debt fair values are based on quoted market prices for KU's first mortgage bonds and on current rates available to KU for debt of the same remaining maturities for KU's pollution control bonds and promissory note. The carrying value of long-term debt on December 31, 1997 and 1996 was $546 million, and the estimated fair value was $579 million and $587 million, respectively. If the difference between fair value and carrying value of KU's long-term debt were settled at amounts approximating those above, the anticipated regulatory treatment (based on the current regulatory environment) would allow recovery of these amounts in rates over a prescribed amortization period. Accordingly, any settlement would not have a material impact on the Company's financial position or results of operations. -84- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries 9. ENVIRONMENTAL COST RECOVERY Since August 1994, KU has been collecting an environmental surcharge from its Kentucky retail customers under a Kentucky statute which authorizes electric utilities (including KU) to implement, beginning January 1, 1993, an environmental surcharge. The surcharge is designed to recover certain operating and capital costs of compliance with federal, state or local environmental requirements associated with the production of energy from coal, including the Federal Clean Air Act as amended. KU's environmental surcharge was approved by the Kentucky Public Service Commission (PSC) in July 1994 and was implemented in August 1994. The total surcharge collections from August 1, 1994 through December 31, 1997 were approximately $60 million. The PSC's order approving the surcharge and the constitutionality of the surcharge statute were challenged in the Franklin County (Kentucky) Circuit Court (Circuit Court) in an action brought against KU and the PSC by the Attorney General of Kentucky and joined by representatives of consumer groups. In July 1995, the Circuit Court entered a judgment upholding the constitutionality of the surcharge statute, but vacating that part of the PSC's July 1994 order which the Circuit Court's judgment described as retroactively applying the surcharge statute. The Circuit Court further ordered the case remanded to the PSC for a determination in accordance with the judgment. KU and the PSC argued that the PSC's July 1994 order did not retroactively apply the statute. The Kentucky Attorney General and other consumer representatives appealed to the Kentucky Court of Appeals (Court of Appeals) that part of the Circuit Court judgment upholding the constitutionality of the surcharge statute. The PSC and KU appealed that part of the judgment concerning the retroactive application of the surcharge statute. The PSC has ordered all surcharge revenues collected by KU from February 1, 1995, subject to refund pending final determination of all appeals. The total surcharge collections from February 1, 1995 through December 31, 1997 were approximately $56 million. In December 1997, the Court of Appeals rendered an opinion upholding the portion of the Circuit Court's judgment regarding the constitutionality of the surcharge statute but reversing that portion of the Circuit Court's judgment concerning the claim of retroactive application of the statute. The Kentucky Attorney General and other consumer representatives have filed motions for discretionary review with the Kentucky Supreme Court (Supreme Court). The Supreme Court has the discretion to grant or deny the motions. KU and the PSC have asked the Supreme Court to deny the motions. KU cannot predict whether the Supreme Court will grant review of the case or when it will act on the matter. KU continues to believe that the constitutionality of the surcharge statute will be upheld. Although KU cannot predict the outcome of the claim of retroactive application of the statute, it is the position of KU and the PSC that the July 1994 PSC order did not retroactively apply the statute. If the Court of Appeals opinion reversing the Circuit Court's -85- Notes to Consolidated Financial Statements KU Energy Corporation & Subsidiaries judgment on the claim of retroactivity is overturned and the Circuit Court's judgment, as entered, is upheld, KU estimates that the amount it could be required to refund for surcharge collections through December 31, 1997, from the implementation of the surcharge would be approximately $15 million, and from February 1, 1995, would be approximately $13 million. At this time, KU has not recorded any reserve for refund. 10. MERGER AGREEMENT WITH LG&E ENERGY KU Energy and LG&E Energy entered into a Merger Agreement dated May 20, 1997. For information concerning the agreement, see Management's Discussion and Analysis - The Merger. 11. LEVERAGED LEASES KU Capital owns equity interests in several leveraged leases for combustion turbine units leased to utility companies. The leases expire in 1999. KU Capital's equity investment represents 75% of the aggregate purchase price of the leases. The remaining 25% represents the nonrecourse debt provided by lenders at the inception of the leases in 1974. The lenders have been granted, as their sole remedy in the event of default by the lessees, an assignment of rentals due under the leases and a security interest in the leased properties.
The following is a summary of the components of KU Capital's net investment in leveraged leases: As of December 31, (in thousands of dollars) 1997 1996 Rentals receivable (net of nonrecourse debt) $ 3,039 $ 3,511 Estimated residual value of leased property 32,707 32,707 Less: Unearned and deferred income 7,594 11,568 Investment in leveraged leases 28,152 24,650 Less: Accumulated deferred income taxes 5,750 4,219 Net investment in leveraged leases $ 22,402 $ 20,431 The following is a summary of the components of income from leveraged leases: Year Ended December 31, (in thousands of dollars) 1997 1996 1995 Income before income taxes $ 3,974 $ 3,613 $ 3,306 Income tax expense 1,751 1,890 1,286 Income from leveraged leases $ 2,223 $ 1,723 $ 2,020
-86- Financial Information (Unaudited) KU Energy Corporation & Subsidiaries Quarterly financial results for 1997 and 1996 are summarized below. Generally, quarterly results may fluctuate due to seasonal variations, changes in fuel costs and other factors. Net Income and Earnings per Average Common Share for the fourth quarter of 1996 were reduced by $2.4 million and $.06, respectively, for the write-off associated with nonutility investments. (For additional information refer to Management's Discussion and Analysis - Nonutility Activities.)
Quarter 4th 3rd 2nd 1st (in thousands of dollars, except for per share amounts) 1997 Operating Revenues $ 182,546 $ 192,095 $ 162,861 $ 178,908 Net Operating Income 29,543 34,630 19,322 33,136 Net Income 21,713 26,553 12,050 24,863 Earnings per Average Common Share .57 .70 .32 .66 1996 Operating Revenues $ 174,917 $ 178,269 $ 167,510 $ 190,990 Net Operating Income 27,796 29,820 22,825 35,128 Net Income 17,064 22,493 16,073 26,319 Earnings per Average Common Share .45 .60 .42 .70
These quarterly amounts reflect, in the Company's opinion, all adjustments (including only normal recurring adjustments) necessary for a fair presentation. -87- Report of Independent Public Accountants KU Energy Corporation & Subsidiaries To the Shareholders of KU Energy Corporation: We have audited the accompanying consolidated balance sheets and statements of capitalization of KU Energy Corporation (a Kentucky corporation) and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income and retained earnings, and cash flows for each of the three years in the period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of KU Energy Corporation and Subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/Arthur Andersen LLP Arthur Andersen LLP Chicago, Illinois January 26, 1998 -88- EX-21 4 EXHIBIT 21 EXHIBIT 21 SUBSIDIARIES OF KU ENERGY AND KU State or Jurisdiction Name of Incorporation KU Energy Corporation Kentucky KU Capital Corporation* Kentucky Kentucky Utilities Company* Kentucky and Virginia Electric Energy, Inc.** Illinois * KU Energy Corporation owns 100% of the common stock of KU Capital Corporation and Kentucky Utilities Company. ** Kentucky Utilities Company owns 20% of the Common Stock of Electric Energy, Inc. -89- EX-23 5 EXHIBIT 23 EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference of our report dated January 26, 1998, on the financial statements of KU Energy Corporation incorporated in this Form 10-K and our report dated January 26, 1998, on the financial statements of Kentucky Utilities Company included in this Form 10-K into the previously filed Form S-8 Registration Statement of KU Energy Corporation and Kentucky Utilities Company (File No. 33-57087). /s/Arthur Andersen LLP Arthur Andersen LLP Chicago, Illinois March 25, 1998 -90- EX-27 6 EXHIBIT 27.01
UT THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE SHEET AS OF DECEMBER 31, 1997 AND THE STATEMENTS OF INCOME AND CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-K ANNUAL REPORT. 0000835715 KU ENERGY CORPORATION 1,000 YEAR DEC-31-1997 DEC-31-1997 PER-BOOK 1,483,352 49,713 153,879 50,318 0 1,737,262 308,137 (595) 356,580 664,122 0 40,000 546,351 33,600 0 0 21 0 0 0 453,168 1,737,262 716,410 50,501 549,278 599,779 116,631 10,507 127,138 41,959 85,179 0 85,179 66,559 37,405 170,138 2.25 2.25
EX-27 7 EXHIBIT 27.02
UT THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE SHEET AS OF DECEMER 31, 1997 AND THE STATEMENTS OF INCOME AND CASH FLOWS FOR THE PERIOD ENDED DECEMBER 31,1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-K ANNUAL REPORT. 0000055387 KENTUCKY UTILITIES COMPANY 1,000 YEAR DEC-31-1997 DEC-31-1997 PER-BOOK 1,483,352 12,807 137,193 46,528 0 1,679,880 308,140 (595) 304,750 612,295 0 40,000 546,351 33,600 0 0 21 0 0 0 447,613 1,679,880 716,437 51,690 546,339 598,029 118,408 7,003 125,411 39,698 85,713 2,256 83,457 66,559 37,405 178,906 0 0 ALL OUTSTANDING COMMON STOCK OF KENTUCKY UTILITIES COMPANY IS HELD BY ITS PARENT COMPANY, KU ENERGY CORPORATION. THEREFORE, EARNINGS PER SHARE IS NOT APPLICABLE.
EX-99.01 8 EXHIBIT 99.01 EXHIBIT 99.01 DESCRIPTION OF COMMON STOCK - KU ENERGY General. The authorized capital stock of KU Energy consists of 20,000,000 shares of preferred stock, without par value, issuable in series of which none is outstanding, and 160,000,000 shares of common stock, without par value, of which 37,817,517 were outstanding at December 31, 1997. Kentucky Utilities, KU Energy's subsidiary, has authorized capital stock of 5,300,000 shares of Cumulative Preferred Stock, without par value, issuable in series, of which 400,000 shares, $100 per share stated value, were outstanding at December 31, 1997; 2,000,000 shares of Preference Stock, without par value, issuable in series, of which no shares are outstanding; and 80,000,000 shares of common stock, of which 37,817,878 shares, all owned by KU Energy, were outstanding at December 31, 1997. Kentucky Utilities has issued and outstanding $546,330,000 in aggregate principal amount of First Mortgage Bonds of various series under its First Mortgage Indenture (Kentucky Utilities' Mortgage Indenture). The following statements, unless the context otherwise indicates, are brief summaries of the substance or general effect of certain provisions of KU Energy's Amended and Restated Articles of Incorporation, as amended, (KU Energy's Articles) or the Amended and Restated Articles of Incorporation, as amended, of Kentucky Utilities' and the resolutions or amendments establishing series of Kentucky Utilities Preferred Stock and Preference Stock (collectively, Kentucky Utilities' Articles), and of Kentucky Utilities' Mortgage Indenture securing its outstanding First Mortgage Bonds. Such statements make use of defined terms and are not complete; they are subject to all the provisions of KU Energy's Articles, Kentucky Utilities' Articles or Kentucky Utilities' Mortgage Indenture, as the case may be. Dividend Rights. Dividends on Common Stock of KU Energy will depend in the foreseeable future primarily upon the earnings, financial condition and capital requirements of Kentucky Utilities. The ability of KU Energy to pay dividends on its Common Stock would be limited to the extent Kentucky Utilities is limited in its right to pay dividends on or acquire Kentucky Utilities Common Stock. Whenever dividends on all outstanding shares of Kentucky Utilities Preferred and Preference Stock of all series for all previous quarter-yearly dividend periods and the current quarter-yearly dividend period shall have been paid or declared and set apart for payment, and whenever all amounts required to be set aside for any sinking fund for the redemption or purchase of shares of the Kentucky Utilities Preferred or Preference Stock for all previous periods or dates shall have been paid or set aside, and subject to the limitations summarized below, the Kentucky Utilities Board of Directors may declare dividends on Kentucky Utilities Common Stock out of any surplus or net profits of Kentucky Utilities legally available for that purpose. Kentucky Utilities' Mortgage Indenture provides, in effect, that, so long as certain currently outstanding series of First Mortgage Bonds are outstanding, Kentucky Utilities will not declare or pay any dividends (other than in stock) on Kentucky Utilities Common Stock, or make any other distribution on or purchase any Kentucky Utilities Common Stock, unless the total amount charged or provided for maintenance, repairs and depreciation of the mortgaged properties subsequent to May 1, 1947, plus the surplus earned during the period and remaining after any such dividend, distribution or purchase, shall equal at least 15% of Kentucky Utilities' total utility operating revenues for the period, after deducting from such revenues the cost of electricity purchased for resale. Kentucky Utilities' Articles -91- provide in effect that, so long as any Kentucky Utilities Preferred Stock is outstanding, the total amount of all dividends or other distributions on Kentucky Utilities Common Stock (other than in stock) that may be paid, and purchases of Kentucky Utilities Common Stock that may be made, during any 12-month period shall not exceed (a) 5% of Kentucky Utilities' net income (as defined) for the 12-month period next preceding each such dividend, distribution or purchase, if the ratio of "common stock equity" to "total capital" (as defined) is 20% to 25%, or (b) 50% of such net income if such ratio is less than 20%. If such ratio is in excess of 25%, no such dividends may be paid or distributions or purchases made that would reduce such ratio to less than 25% except to the extent permitted by clauses (a) and (b). At December 31, 1997, no amount of retained earnings was restricted as to the payment of dividends on Kentucky Utilities Common Stock under the foregoing provisions of Kentucky Utilities' Mortgage Indenture or Kentucky Utilities' Articles. Voting Rights. The shares of KU Energy's Common Stock entitle the holders thereof to one vote for each share upon all matters upon which shareholders have the right to vote, subject to any special voting rights, if any, which may vest in the holders of KU Energy's preferred stock. KU Energy's preferred stock may be issued in series, each of which will be identical except for such relative rights and preferences with respect to the matters listed in the next sentence as may be determined by the Board of Directors of KU Energy. The Board of Directors of KU Energy may determine, for each series of preferred stock, the number of shares and the rate of dividend (or method of determining dividends) to be borne by the shares of each such series, the voting rights, if any, the stated value, if any, and the preferences with respect to distributions including dividends and distributions upon dissolution of shares of such series, the price or prices at which, and other terms and conditions on which, shares of each series may be redeemed, and the sinking fund provisions, if any, for the redemption or purchase of shares of each such series, the conversion privileges, if any, and may change redeemed or re-acquired shares of any such series into shares of another series, subject, however, to such restrictions and limitations as are or may be, from time to time provided by law or contained in KU Energy's Articles. If a quorum consisting of a majority of the shares outstanding and entitled to vote on the matter is present (either in person or by proxy) at a shareholders' meeting, action on a matter (other than the election of directors) by a voting group shall be approved if the votes cast within the voting group favoring the action exceed the votes cast opposing the action, (i) except as described under "Board of Directors" below, (ii) except that directors are elected by cumulative voting and (iii) unless a greater vote is required by law. Shareholder Rights. KU Energy has a shareholder rights plan designed to provide protection to shareholders in the event of an unsolicited attempt to acquire KU Energy. Under the shareholder rights plan, in certain circumstances, KU Energy shareholders will receive as a dividend one right for each share of KU Energy common stock. Should certain events occur (for instance, an acquirer becomes the beneficial owner of 20 percent or more of KU Energy's outstanding voting stock without approval by KU Energy or certain transactions occur following an acquirer becoming the beneficial owner of 10 percent or more of such voting stock without KU Energy approval), each right would entitle the holder, other than the acquirer, to purchase common shares of KU Energy or shares of any company that acquires KU Energy at a discount from the market value. In certain circumstances, KU Energy may redeem the rights at a price of $.01 per right. The rights expire in February 2002. The rights have been amended to provide that the Merger will not result in the rights becoming exercisable. -92- Preemptive Rights. Holders of KU Energy's securities have no preemptive subscription rights. Liquidation Rights. In the event of any liquidation or dissolution of KU Energy, holders of Common Stock are entitled to receive the net assets of KU Energy except to the extent of the preferential rights, if any, of the holders of KU Energy's preferred stock as may be established from time to time in accordance with KU Energy's Articles. Board of Directors. KU Energy's Bylaws provide for a Board of Directors comprised of from nine to eleven members as determined from time to time by the Board. The Board currently has ten members. KU Energy's Articles provide for the classification of the Board of Directors into groups with directors being elected for three-year terms. Under KU Energy's Articles, the article providing for the classification of the Board of Directors may not be altered, amended or repealed and no provision inconsistent with such article may be adopted without the vote of 80 percent of the shares entitled to vote generally, voting as a class. Cumulative Voting. KU Energy's Articles provide for the election of directors by cumulative voting. Amendments to the Registrant's Articles. Except as set forth under "Board of Directors" above, KU Energy's Articles may be amended or repealed, if the number of shares voted in favor of such amendment exceeded the number of shares voted against such amendment by each voting group or, if such amendment would give rise to dissenters' rights, by the affirmative vote of the holders of a majority of the outstanding shares of KU Energy entitled to vote on such amendment (which would include the Common Stock and any series of preferred stock which, by its terms or applicable law, was so entitled to vote), unless any class or series of shares is entitled to vote as a class in respect thereof, in which event the proposed amendment must be approved in addition by the required vote of each class or series of shares entitled to vote as a class in respect thereof. Call of Special Meetings. KU Energy's Articles provide that no meeting of shareholders may be called by shareholders unless called by the holders of at least 51 percent of all the votes entitled to be cast on each issue proposed to be considered at the special meeting. Miscellaneous. The Transfer Agents for the Common Stock are Illinois Stock Transfer Company, Chicago, Illinois, and Harris Trust and Savings Bank, Chicago, Illinois; and the Registrar is Harris Trust and Savings Bank, Chicago, Illinois. The outstanding shares of Common Stock of KU Energy are fully paid and nonassessable. KU Energy reserves the right to increase, decrease or reclassify its authorized capital stock or any class or series thereof, and to amend or repeal any provisions of KU Energy's Articles, in the manner prescribed by law, subject to the limitations described in KU Energy's Articles; and all rights conferred on shareholders in KU Energy's Articles are subject to this reservation. -93- EX-99.02 9 EXHIBIT 99.02 EXHIBIT 99.02 DESCRIPTION OF COMMON STOCK - KU General. The authorized capital stock of KU consists of 5,300,000 shares of Preferred Stock, cumulative, without par value, issuable in series, of which 400,000 shares were outstanding at December 31, 1997, 2,000,000 shares of Preference Stock, cumulative, without par value, issuable in series, and 80,000,000 shares of Common Stock, without par value of which 37,817,878 shares were outstanding (all of which were held by KU Energy) at December 31, 1997. No shares of Preference Stock are issued or outstanding. The following statements, unless the context otherwise indicates, are brief summaries of the substance or general effect of certain provisions of KU's Amended and Restated Articles of Incorporation and resolutions and amendments establishing series of Preferred Stock (collectively, the Articles) and of KU's Mortgage Indenture, as amended, securing its first mortgage bonds (Indenture). The statements make use of defined terms, are not complete and do not give effect to statutory or common law. Dividend Rights. The Board of Directors of KU may declare dividends on the Common Stock out of any surplus or net profits of KU legally available for the purpose, provided full cumulative dividends on the Preferred Stock and the Preference Stock for the current and all past quarterly dividend periods shall have been paid or declared and set apart for payment and KU is not in arrears in its sinking fund obligations in respect of any shares of Preferred Stock or Preference Stock. Limitations on Dividends on Common Stock. The Indenture provides that, so long as certain currently outstanding series of First Mortgage Bonds are outstanding, KU will not declare or pay any dividends on its Common Stock or make any other distribution on or purchase any of its Common Stock unless the amounts expended by KU for maintenance and repairs and provided for depreciation subsequent to April 30, 1947, plus KU's earned surplus (retained earnings) for such period and remaining after any such payment, distribution or purchase, shall aggregate not less than 15% of the gross operating revenues of KU for the period. The Articles provide, in effect, that, so long as any of the Preferred Stock is outstanding, the total amount of all dividends or other distributions on Common Stock and purchases of such stock that may be paid or made during any 12-month period shall not exceed (a) 75% of the "net income available for dividends on common stock" if the ratio of "common stock equity" to "total capital" (each as defined) of KU shall be 20% to 25%, or (b) 50% of such net income if such ratio shall be less than 20%. When such ratio is 25% or more, no such dividends, distributions or purchases may be paid or made which would reduce such ratio to less than 25% except to the extent permitted by clauses (a) and (b) above. As of December 31, 1997, no amount of retained earnings was restricted under the Indenture or Articles. Voting Rights. Each share of Common Stock is entitled to one vote on each matter voted on at stockholders' meetings, except as otherwise provided in the Articles, and to cumulative voting rights in the election of directors. Shares of Preferred Stock and Preference Stock are not entitled to vote for the election of directors or in respect of any other matters, except as expressly provided in the Articles or as may be required by law. The Articles give to holders of Preferred Stock and Preference Stock certain special voting rights designed to protect their interest with respect to specified corporate action. In addition, in certain events relating to dividends in default on Preferred Stock, holders of Preferred Stock as a class are entitled to elect a majority of the full Board of Directors; and -94- in certain events relating to dividends in default on the Preference Stock, holders of Preference Stock as a class are entitled to elect two directors. Liquidation Rights. Upon the liquidation or dissolution of KU, the holders of Preferred Stock and the Preference Stock are entitled to be paid designated amounts out of the net assets of KU in preference to the Common Stock. After such payment to holders of Preferred Stock and Preference Stock, the remaining assets and profits shall be distributed to the holders of Common Stock. Board of Directors. KU's Bylaws provide for a Board of Directors comprised of from nine to eleven members as determined from time to time by the Board. The Board currently has ten members. KU's Articles provide for the classification of the Board of Directors into groups with directors being elected for three-year terms subject to certain rights of holders of Preferred Stock and Preference Stock to elect directors. Preemptive Rights. Holders of KU's Stock have no preemptive right to subscribe for stock or securities of KU. Call of Special Meetings. KU's Articles provide that no meeting of shareholders (except for certain meetings called by holders of Preferred Stock or Preference Stock) may be called by shareholders unless called by the holders of at least 51 percent of all the votes entitled to be cast on each issue proposed to be considered at the special meeting. Miscellaneous. The outstanding shares of Common Stock of KU are fully paid and non-assessable. Under Kentucky and Virginia law, KU may amend the Articles to increase, decrease or adjust its capital stock or any class thereof or otherwise amend any provision of the Articles or any amendment thereto, in the manner permitted by law, subject, however, to the limitations prescribed in the Articles; and all rights conferred on stockholders in the Articles or any amendment thereto are subject to the foregoing. The Transfer Agents of the Common Stock are Illinois Stock Transfer Company, Chicago, Illinois, and Harris Trust and Savings Bank, Chicago, Illinois; and the Registrar is Harris Trust and Savings Bank, Chicago, Illinois. -95- EX-99.03 10 EXHIBIT 99.03 EXHIBIT 99.03 instructions have been received (i.e., a ''broker non-vote''), will be counted to determine the presence of a quorum but will not be present for other purposes and will not be the equivalent of a ''no'' vote on a proposition. Shares represented by a proxy with instructions to abstain on a matter will be counted in determining whether a quorum is in attendance. An abstention is not the equivalent of a ''no'' vote on a proposition. Shareholders may vote either in person or by duly authorized proxy. The giving of a proxy will not prevent a shareholder from voting in person at the meeting. A proxy may be revoked by a shareholder at any time prior to the voting thereof by giving written notice to the Secretary of the Company prior to such voting. All shares entitled to vote and represented by effective proxies on the enclosed form, received by the Company, will be voted at the meeting (or any adjourned session thereof) in accordance with the terms of such proxies. Each Participant in the Company's Automatic Dividend Reinvestment and Stock Purchase Plan (the ''Reinvestment Plan''), Kentucky Utilities' Employee Stock Ownership Plan (the ''ESOP'') or the Kentucky Utilities Employee Savings Plan (the ''Savings Plan'') will receive a form of proxy by which such Participant may direct the agent or trustee under such Plans as to the manner of voting shares credited to the Participant's accounts under such Plans. Shareholders of record who are participants in the Reinvestment Plan will receive only one form of proxy for their certificated shares and those shares which they may have acquired through reinvested dividends. A Participant of any of such Plans wishing to vote in person at the meeting may obtain a proxy for shares credited to his account under such Plans by making a written request therefor by April 23, 1998, as follows: for the Reinvestment Plan, to George S. Brooks II, Secretary of the Company, at the address stated on page 1; for the ESOP, to Banc One Kentucky, PO Box 32500, Louisville, Kentucky 40232, Attention: Barbara J. Steele, Trust Investment Division; and for the Savings Plan, to CG Trust Company, c/o Cigna Retirement and Investment Services, Routing Code M- 122, 350 Church Street, Hartford, Connecticut 06103, Attention: Bruce Beckmann. ELECTION OF DIRECTORS General In light of the pending Merger, which will result in the Company merging into LG&E Energy, the Board of Directors has elected to temporarily waive its retirement policy with respect to two directors. Mr. Harry M. Hoe, who was to have retired from the Board in 1998, will stand for reelection. Mr. Milton W. Hudson, who had planned to retire from the Board in 1998, will continue to serve. It is anticipated that Mr. Hoe and Mr. Hudson will each resign from the Board of Directors at the earlier of the consummation of the Merger or the 1999 Annual Meeting of Shareholders. Three directors are to be elected at the meeting. Barring unforeseen circumstances and in the absence of contrary directions, the proxies solicited herewith will be voted for the election of Carol M. Gatton, Harry M. Hoe and Michael R. Whitley, as directors of the Company. Except as noted above, the nominees will hold office until the 2001 Annual Meeting of Shareholders of the Company or until their respective successors shall have been duly elected and qualified. The proxies may also be voted for a substitute nominee or nominees in the event any one or more of said persons shall be unable to serve for any reason or be withdrawn from nomination, an occurrence not now anticipated. Except as otherwise indicated, each nominee has been engaged in his present principal occupation for at least the past five years. All information regarding share ownership is as of January 31, 1998. -96- The following information is given with respect to the nominees for election as directors: LOGO Carol M. Gatton, 65, is Chairman of Area Bancshares, Inc., a bank holding company in Owensboro, Kentucky. He is also involved in real estate ventures and automobile dealerships. Mr. Gatton beneficially owns 1,000 shares of Common Stock of the Company. LOGO Harry M. Hoe, 72, is President and a director of J. R. Hoe & Sons, Inc., Middlesboro, Kentucky, a foundry and casting company. He has been a director of the Company since 1991 and a director of Kentucky Utilities since 1979. Mr. Hoe beneficially owns 17,623 shares of Common Stock of the Company, which include 5,677 shares held solely by his wife. LOGO Michael R. Whitley, 55, has been Chairman, President and Chief Executive Officer of the Company and Kentucky Utilities since August 1, 1995. He was President and Chief Operating Officer of the Company and Kentucky Utilities from November 1, 1994 to August 1, 1995. He was Executive Vice President of these companies from August 1, 1994 to November 1, 1994. Before this period, he had been a Senior Vice President of the Company since 1988 and of Kentucky Utilities since 1987. Mr. Whitley was Secretary of the Company from 1988 until 1992 and of Kentucky Utilities from 1978 until 1992. He is a director of PNC Bank Kentucky, Inc., a wholly owned subsidiary of PNC Bank Corp., Inc. Mr. Whitley has been a director of the Company and Kentucky Utilities since 1992. He beneficially owns 34,748 shares of Common Stock of the Company, which include 6,300 shares held jointly with his wife and 964 shares held solely by his wife. Information with respect to those directors whose terms are not expiring is as follows: LOGO Mira S. Ball, 63, is Secretary-Treasurer and Chief Financial Officer of Ball Homes, Inc., a single-family residential developer and property management company. She has been a director of the Company and Kentucky Utilities since 1992. Ms. Ball beneficially owns 6,123 shares of Common Stock of the Company. Her term expires in 1999. -97- LOGO Milton W. Hudson, 70, has been an economic consultant (Washington, DC) since 1991. He was Managing Director and Senior Economic Advisor of Morgan Guaranty Trust Company of New York from January 1990 until his retirement in June 1991. He has been a director of the Company since 1991 and a director of Kentucky Utilities since 1990. Mr. Hudson beneficially owns 1,274 shares of Common Stock of the Company. His term expires in 2000. LOGO John T. Newton, 67, retired in 1995 as Chairman of the Board and Chief Executive Officer of the Company and Kentucky Utilities, positions he had held since 1987. He had also been President of these companies from 1987 to November 1, 1994. Mr. Newton has been a director of the Company since 1988 and a director of Kentucky Utilities since 1974. He beneficially owns 32,653 shares of Common Stock of the Company, which include 7,668 shares held jointly with his wife and 5,000 shares held solely by his wife. His term expires in 2000. LOGO Frank V. Ramsey, Jr., 66, is President and Director of Dixon Bank, Dixon, Kentucky, and a farm owner and operator. He has been a director of the Company since 1991 and a director of Kentucky Utilities since 1986. Mr. Ramsey beneficially owns 1,400 shares of Common Stock of the Company. His term expires in 1999. LOGO William L. Rouse, Jr., 65, was Chairman of the Board and Chief Executive Officer and a director of First Security Corporation of Kentucky, a multi-bank holding company, prior to his retirement in 1992. Mr. Rouse is a director of Ashland, Incorporated. He has been a director of the Company since 1991 and a director of Kentucky Utilities since 1989. Mr. Rouse beneficially owns 1,000 shares of Common Stock of the Company. In addition, Mr. Rouse's account under the Directors Deferred Compensation Plan described below has the equivalent of 7,004 shares of Common Stock. His term expires in 2000. LOGO Charles L. Shearer, Ph.D., 55, is President of Transylvania University, Lexington, Kentucky. He has been a director of the Company since 1991 and a director of Kentucky Utilities since 1987. Dr. Shearer beneficially owns 1,527 shares of Common Stock of the Company, which include 200 shares held solely by his wife and 16 shares held by his children. His term expires in 1999. -98- LOGO Lee T. Todd, Jr., Ph.D., 51, is President and Chief Executive Officer of DataBeam Corporation, a Kentucky-based, high-technology firm. He was elected a director of the Company and Kentucky Utilities in 1995. Dr. Todd beneficially owns 500 shares of Common Stock of the Company. His term expires in 1999. Voting Securities Beneficially Owned by Directors, Nominees and Executive Officers The directors, nominees and executive officers of the Company and Kentucky Utilities owned beneficially at January 31, 1998 an aggregate of 219,869 shares of Common Stock of the Company, representing in the aggregate 0.6% of such stock. Meetings and Committees of the Board of Directors All members of the Company's Board of Directors are currently members of Kentucky Utilities' Board of Directors. The Board of Directors of the Company and the Board of Directors of Kentucky Utilities have each established the following six committees: the Executive Committee, the Audit Committee, the Compensation Committee, the Finance Committee, the Long-Range Planning Committee and the Nominating and Corporate Governance Committee. Committee members are the same for committees of the Company and committees of Kentucky Utilities. During 1997, the Board of Directors of the Company held 20 meetings (including Committee meetings), and the Board of Directors of Kentucky Utilities held 21 meetings (including Committee meetings). During 1997, each current director attended 100% of the meetings of the Company's and Kentucky Utilities' Board of Directors and applicable Committee meetings. The members of the Executive Committee are Messrs. Hoe, Ramsey, Rouse, Shearer and Whitley. Neither the Company's nor Kentucky Utilities' Executive Committee met during 1997. The Executive Committee has the full power of the Board between meetings of the Board, except as provided by law. The members of the Audit Committee are Ms. Ball and Messrs. Gatton, Hoe, Shearer and Todd. The Company's Audit Committee met two times in 1997, as did Kentucky Utilities' Audit Committee. The Audit Committee selects and engages (and may discharge) the Company's independent auditors; approves or disapproves each professional service or type of service to be provided by the auditors; meets with the auditors regarding the scope and results of the annual audit and of internal accounting procedures and practices; reviews any recommendations which may be made by the independent auditors; and generally exercises supervision over all matters relating to audit functions, making periodic reports to the Board. The members of the Compensation Committee are Messrs. Gatton, Hudson, Ramsey, and Rouse. The Company's Compensation Committee met four times in 1997, and Kentucky Utilities' Compensation Committee met five times. The Compensation Committee reviews compensation for all officers, directors' fees and fees paid to directors for membership on the various committees of the Board; makes recommendations to the Board at least annually with respect to appropriate levels of compensation and fees; and administers certain benefit plans. -99- Equity Ownership Guidelines Effective January 1, 1998, under the Company's Equity Ownership Guidelines adopted by the Board of Directors of the Company, directors and executives of the Company and Kentucky Utilities are encouraged to make a minimum personal investment in Company Common Stock. The minimum guidelines may be satisfied in various ways including through plans maintained by the Company or a subsidiary. A director's or executive's compliance with the guidelines will be taken into account by the Compensation Committee in the grant or payment of awards to the director or executive under incentive or other plans maintained by the Company. The Board of Directors of the Company may amend or terminate the Equity Ownership Guidelines at any time or from time to time. Directors' Compensation Each director of the Company is also a director of its principal subsidiary, Kentucky Utilities. Each director who is not an employee of the Company or Kentucky Utilities is paid an annual retainer of $20,000. This retainer is reduced by any retainer paid from a Company subsidiary. Kentucky Utilities pays non-employee directors an annual retainer of $15,000. Thus, the net annual Company retainer paid to such directors is $5,000 but the aggregate paid for serving on both Boards is $20,000. An additional annual retainer of $1,200 is paid to each non-employee director who is a chairperson of a committee of either Board. However, if a non-employee director is a chairperson of the same Board committee of the Company and Kentucky Utilities, only one such additional annual retainer is paid. In addition to an annual retainer, the Company and Kentucky Utilities pay each non-employee director a $1,000 fee for each meeting of a Board or a particular committee attended; provided that if the Boards of the Company and Kentucky Utilities meet on the same day, only one $1,000 fee is paid for both meetings. Similarly, if the same committee of the Boards of the Company and Kentucky Utilities meets on the same day, only one $1,000 fee is paid for both meetings. Out-of-pocket travel expenses are paid to directors for all meetings attended. The Compensation Committees have recommended that the total compensation to Directors for service on the Board of the Company and Kentucky Utilities be revised, effective March 1, 1998, to be as follows: the annual retainer, $28,000 (of which $21,000 would relate to Kentucky Utilities as described above); the committee chairperson fee, $2,000; the Board meeting fee, $1,100; and the committee meeting fee, unchanged. The Boards may not act on such proposal or may modify the proposal upon adoption. All eligible directors of the Company and Kentucky Utilities are entitled to participate in the Director Retirement Retainer Programs (the ''Director Retirement Plans'') of the Company and Kentucky Utilities. Directors who are not, and have not previously been, an officer of Kentucky Utilities, the Company, or their affiliated companies (''outside directors'') are eligible to participate. An outside director who is 65 years of age or older and has completed at least five consecutive years of service on the Company's and/or Kentucky Utilities' Board will receive, upon termination of service from a Board for any reason other than death, an annual retirement benefit equal to the annual retainer paid to such Board's directors in effect as of such termination, payable monthly over a period of years equal to the number of full years such director served on the Board, but not in excess of 10 years. Such payments cease, however, if the director dies before all such payments are made. The annual retainer in effect upon the director's termination from a Board will generally be calculated as described in the first paragraph under this caption (excluding the additional annual retainer for chairpersons). In -100- the event of a change in control of the Company or Kentucky Utilities, any person then receiving a retirement benefit would be paid, within 30 days of the change in control, a lump-sum payment equal to the discounted present value of all then unpaid installments of the director's retirement benefit. In the event of a change in control, each outside director in office immediately prior to such change in control will be eligible to receive an accelerated retirement benefit if the director terminates service from a Board for any reason other than death within three years of the date of the change in control. Such accelerated retirement benefit would be paid in a lump sum within 30 days of such termination and would be equal to the discounted present value of the retirement benefit which such director would have received if the director had retired from the Board at age 70 (or for certain directors, 72) and lived to collect the full benefit otherwise payable under the applicable Director Retirement Plan. Such benefit would be based on the higher of the annual retainer in effect immediately prior to the change in control or immediately prior to such director's termination of service. Change in control has the meaning set out under ''Change In Control Arrangements'' below. The consummation of the Merger will constitute a ''change in control'' under the Director Retirement Plans. Directors may elect to have all or a specified portion of their directors' fees deferred under the Director Deferred Compensation Plans (the ''Director Deferred Compensation Plans'') of the Company and Kentucky Utilities, such elections to be made in accordance with and subject to the terms of the Director Deferred Compensation Plans. Amounts deferred will be maintained in unfunded accounts for each participant, which, based on a choice made by the director, either: (1) bear interest at a floating rate based upon the average prime rate charged by banks as reported in the Federal Reserve Bulletin; or ( 2 ) experience appreciation (depreciation) and earnings based on a hypothetical investment in the Company's Common Stock. Amounts deferred under the Director Deferred Compensation Plans will be paid to the participant upon termination as a director for any reason other than death based on a choice made by the Director as permitted by the Director Deferred Compensation Plans in a single payment or, with interest, quarterly over a period of not to exceed 40 calendar quarters, or, with interest, annually over a period of not to exceed 10 years. In the event of a participant's death, payment of any remaining balance of credited amounts will be made in a single payment to a designated beneficiary. In certain cases, directors may receive a distribution of deferred amounts in the event of substantial financial hardship. In the event of a change in control of the Company or Kentucky Utilities, any director who terminated prior to the change in control whose deferred amounts have not been distributed would receive, within 15 days of the change in control, a lump sum payment of the undistributed amounts. In the event of a change in control, each director who terminates thereafter within three years of the date of the change in control would be paid, within 15 days after termination, a lump sum payment of the director's deferred amounts. The consummation of the Merger will also constitute a ''change in control'' under the Director Deferred Compensation Plans. The Compensation Committees have recommended a proposal to eliminate the Director Retirement Plans for current and future directors. Under this proposal, current participating directors would be entitled to a lump sum benefit based on the present value of the Director's retirement benefits calculated as if a ''change in control'' had occurred and the Director had terminated service immediately thereafter. Such lump sum amount would be credited to the Director Deferred Compensation Plans in the hypothetical Company Common Stock account (except for certain retiring directors who may make the election described in the preceding paragraph). The Boards may not act on such proposal or may modify the proposal upon adoption. -101- Executive Compensation General. The following table contains information with respect to the compensation paid by (or earned from) the Company and Kentucky Utilities, for all services rendered during 1995 through 1997 in all capacities, to the Chief Executive Officer and the other four most highly compensated executive officers of the Company and Kentucky Utilities: SUMMARY COMPENSATION TABLE
Annual Compensation Long-Term Other Annual Compensation All Other Salary Bonus Compensation Payouts Compensation Name and Principal Position Year ($) ($)(1) ($)(2) ($)(3) ($)(4) Michael R. Whitley; 1997 444,427 186,173 2,477 50,967 4,750 Chairman of the Board, President 1996 387,737 99,741 2,164 79,798 6,242 & Chief Executive Officer & 1995 318,467 73,476 116 0 4,686 Director of the Company & Kentucky Utilities O. M. Goodlett; 1997 239,153 69,828 1,738 58,406 4,750 Senior Vice President of the 1996 231,840 51,994 0 52,560 5,181 Company & Kentucky Utilities 1995 210,195 44,550 0 0 4,500 James W. Tipton; 1997 237,340 83,166 2,854 64,829 4,750 Senior Vice President 1996 230,750 38,304 2,004 77,882 5,670 of the Company 1995 227,591 39,942 1,445 0 4,667 Wayne T. Lucas; 1997 215,792 69,555 1,271 29,576 4,750 Senior Vice President 1996 208,137 49,043 749 33,124 6,361 of Kentucky Utilities 1995 194,553 42,160 711 0 4,692 Robert M. Hewett; 1997 183,727 45,033 1,768 29,576 4,750 Senior Vice President 1996 164,681 32,052 363 33,124 4,500 of Kentucky Utilities 1995 157,396 28,054 15 0 4,500
(1) Bonuses are paid under the Incentive Plans. Any bonus earned but deferred under the Executive Deferred Compensation Plans is included in the Table. (2) Other annual compensation consists of amounts for group term life insurance and related taxes and above-market-rate interest earned on deferred compensation during 1997 and paid in 1997. (3) Reflects payouts under the Performance Share Plans described under "Report of Compensation Committee on Executive Compensation" above. Performance goals were not met, and thus no payouts were made for the Performance Cycle that relates to 1995 in the table above. Amounts shown for 1996 and 1997 reflect a payout, in the form of restricted shares of the Company's Common Stock, of a percentage of the contingent grant for the applicable Performance Cycle as follows: 1996, 100%; 1997, 100% for the Kentucky Utilities Performance Share Plan and 75% for the KUE Performance Share Plan. Such restricted stock was subject to forfeiture if the officer terminated employment prior to January 2, 2003 (for amounts shown for 1996) and January 2, 2000 (for amounts shown for 1997) for any reason other than retirement, disability or death. In the event of a change in control, however, the restrictions lapse immediately. The execution of the Merger -102- Agreement constituted a "change in control" for this purpose and all restrictions on these shares lapsed in 1997. (4) All other compensation for 1995 and 1996 includes: (a) above- market-rate interest earned on deferred compensation; and (b) the employer matching contribution made to the officer's account in the 401(k) Employee Savings Plan. Such amounts for 1997 relate only to employer matching contributions to 401(k) Employee Savings Plan. Long-Term Incentive Awards. Performance Shares contingently awarded under the Long-Term Incentive Plan in 1997 are reported in the Long-Term Incentive Plan awards table below. A description of how awards are determined is presented under "Report of Compensation Committee on Executive Compensation." A description of the scale by which performance targets are set follows the table. LONG-TERM INCENTIVE PLAN-AWARDS IN LAST FISCAL YEAR
Number of Performance of Shares, Other Period Units or Until Estimated Future Payouts Under Other Rights Maturation Non-Stock Price-Based Plans(2) Name (#) or Payout(1) Threshold($) Target ($) Maximum ($) Michael R. Whitley 6,835 3 0 214,619-268,274 321,929 James W. Tipton . . 2,350 3 0 73,790-92,238 110,685 O.M. Goodlett . . . 2,270 3 0 71,278-89,098 106,917 Wayne T. Lucas 2,030 3 0 63,742-79,678 95,613 Robert M. Hewett . 1,075 3 0 33,755-42,194 50,633 (1)Number of years in Performance Cycle. (2)See description below for the scale that determines which amount may be applicable. Amounts are calculated based on the price of the Company's Common Stock on December 31, 1997.
For the Performance Cycle commencing in 1997, payouts of contingent grants shown in the table above will be determined by calculating the average total shareholder return of the Company for the Performance Cycle and comparing it to the average total shareholder return of the EEI Index for the Performance Cycle, with adjustment to payouts in certain cases based on the Company's average total shareholder return relative to the S&P 500 Index. For the 1997-1999 Performance Cycle, the scale that determines if contingent grants are earned is as follows: if the Company's average total shareholder return is at or above 75th percentile of the EEI Index, 100% of the contingent grant will be earned (the second figure shown as Target in the table); if it is at the 50th percentile level, 60% will be earned (the first figure shown as Target in the table); and if the average is between the 50th and 75th percentile levels, the earned grants will be between 60% and 100% determined by straight line interpolation. If the average is below the 50th percentile, no shares contingently granted will be earned (shown as the Threshold in the table) for that Performance Cycle. Any performance shares earned under the foregoing scale will be increased by 20% if the Company's average total shareholder return for the Performance Cycle is at or above the 75th percentile of the S&P 500 Index for the Performance Cycle (the Maximum shown in the table) and reduced by 20% if the average is below the 25th percentile. Retirement Plan. Each of the officers of the Company and Kentucky Utilities is entitled to participate in the Kentucky Utilities employee retirement plans described below. Executive officers, like other employees, are -103- eligible to participate in Kentucky Utilities' Retirement Plan, and all eligible persons whose compensation is reported in the Summary Compensation Table participated in the Retirement Plan. Contributions to the Retirement Plan are determined actuarially and cannot be readily calculated as applied to any individual participant or small group of participants. Generally, compensation for Retirement Plan purposes means base compensation while a participant, excluding overtime pay, commissions, performance incentive compensation or other extraordinary compensation. The compensation for Retirement Plan purposes of the individuals named in the foregoing table is substantially equivalent to the base salary reported in the Summary Compensation Table. The credited years of service under the Retirement Plan for such persons were as follows: Mr. Whitley, 33 years; Mr. Tipton, 30 years; Mr. Goodlett, 27 years; Mr. Lucas, 28 years; and Mr. Hewett, 29 years. All of the credited years of service were computed as of December 31, 1997. Retirement Plan benefits depend upon length of service, age at retirement and amount of compensation (determined in accordance with the Retirement Plan). Although higher amounts are determined under the Retirement Plan and shown in the table below, in most cases, pension benefits under the Retirement Plan or compensation used to measure such benefits will be reduced to comply with maximum limitations imposed by the Internal Revenue Code. Under such limitations, no base compensation above $150,000 ($160,000 effective for compensation in 1997) may be used to calculate a benefit, except in the case of certain executive officers to preserve benefits accrued under previously applicable rules. In addition, in 1997 no annual benefit derived from employer contributions may exceed $125,000. Assuming retirement at age 65, a Retirement Plan participant would be eligible at retirement for a maximum annual pension benefit (without taking into account the Internal Revenue Code limitations referred to above) set forth in the following table. However, assuming retirement at age 65, assuming 1997 base compensation and taking into account the Internal Revenue Code limitations, the annual pension benefit under the Retirement Plan for the executive officers named in the Summary Compensation Table would be as follows: Mr. Whitley, $103,607; Mr. Tipton, $95,146; Mr. Goodlett, $90,493; Mr. Lucas, $93,011; and Mr. Hewett, $93,246.
Annual Benefit After Specified Years of Service(2) Final Average Base Pay(1) 15 20 25 30 35 40 45 $150,000 $ 29,999 $ 39,999 $ 49,999 $ 59,999 $ 69,998 $ 79,998 $ 89,998 $200,000 $ 39,999 $ 53,332 $ 66,665 $ 79,998 $ 93,331 $106,664 $119,997 $250,000 $ 49,999 $ 66,665 $ 83,331 $ 99,998 $116,664 $133,330 $149,996 $300,000 $ 59,999 $ 79,998 $ 99,998 $119,997 $139,997 $159,996 $179,996 $350,000 $ 69,998 $ 93,331 $116,664 $139,997 $163,329 $186,662 $209,995 $400,000 $ 79,998 $106,664 $133,330 $159,996 $186,662 $213,328 $239,994 $450,000 $ 89,998 $119,997 $149,996 $179,996 $209,995 $239,994 $269,993 $500,000 $ 99,998 $133,330 $166,663 $199,995 $233,328 $266,660 $299,993 $550,000 $109,997 $146,663 $183,329 $219,995 $256,660 $293,326 $329,992 $600,000 $119,997 $159,996 $199,995 $239,994 $279,993 $319,992 $359,991 (1) "Final average base pay" generally means the average annual compensation during the 60 consecutive months of highest pay during the period of employment. (2) Annual benefits shown are on a straight life annuity basis. Amounts shown are not subject to any deduction for Social Security benefits or other offset amounts. Benefits may be reduced by Internal Revenue Code limitations described above.
Supplemental Security Plan. Executive officers and certain other employees of the Company and Kentucky Utilities are eligible to be members in Kentucky Utilities' Supplemental Security Plan which provides retirement, -104- disability and death benefits as well as a change in control retirement benefit and a change in control severance benefit. Change in control has the meaning set out under "Change in Control Arrangements" below. As to executive officers, upon retirement at age 65, an eligible member will receive 15 annual payments of an amount equal to 75% of basic compensation, offset by benefits payable from any defined benefit plan of the Company or an affiliate (such as Kentucky Utilities' Retirement Plan) and Social Security benefits. Basic compensation is the annualized base monthly salary of the member, exclusive of performance incentive compensation or other extraordinary compensation, in effect at termination of employment by retirement, disability or death. Upon termination of employment by death of an eligible executive officer prior to age 65, the member's beneficiary will receive an annual benefit equal to 50% of basic compensation until the later of the date such member would have attained age 65 or completion of 15 annual payments. Upon termination of employment by disability prior to age 65, the member will receive the "retirement benefit" if the member lives to retirement age and remains disabled or the "death benefit" if the member dies prior to retirement age and is disabled at death. Benefits will be paid from the general funds of the employer. The estimated annual benefits from Kentucky Utilities' Supplemental Security Plan that would be payable upon retirement at normal retirement age (age 65) for the individuals named in the Summary Compensation Table (assuming 1997 base salary) are as follows: Mr. Whitley, $216,937; Mr. Tipton, $68,654; Mr. Goodlett, $68,279; Mr. Lucas, $47,761; and Mr. Hewett, $30,273. To assist in providing funds to pay such benefits when they become payable, insurance is purchased on the lives of the members of the Supplemental Security Plan. Change In Control Arrangements. Under the Supplemental Security Plan, members are entitled to change in control severance benefits in the following circumstances: (i) involuntary termination of the individual's employment within two years following a change in control (or, if later, prior to the consummation of the change in control transaction or its earlier abandonment) for reasons other than cause (as defined in the plan), death or permanent disability; (ii) resignation within two years of a change in control (or, if later, prior to the consummation of the change in control transaction or its earlier abandonment) for good reason (as defined in the plan); and (iii) in respect of the Chairman of the Board, the President, the Chief Financial Officer (or, if such positions are filled by less than three persons, the Executive Vice President), the Senior Vice Presidents and the Corporate Secretary, in each case of Kentucky Utilities, termination of employment for any reason during the 30-day period commencing on the first anniversary of the consummation of a change in control. In such circumstances, the employee will be entitled to a change in control severance payment equal to a certain percentage (300% in the case of executive officers of the Company or Kentucky Utilities) of the sum of (i) the employee's basic compensation and (ii) the employee's target annual performance incentive compensation. In addition, the employee will be entitled to continuation of certain employee welfare benefits for up to three years following termination of employment, subject to an offset for comparable benefits. Under the Supplemental Security Plan, the employee is entitled to receive additional payments, if necessary, to reimburse the employee for certain excise tax liabilities payable under federal, state or local law as a result of the payment and any other compensation being contingent on a change in control. The Supplemental Security Plan's change in control retirement benefit provides that, upon termination of employment, other than for cause (as defined in the Supplemental Security Plan) following a change in control, an eligible member will receive a lump-sum amount equal to the present value of the retirement benefit (described in the preceding paragraph and assuming the member is then 65 but prorated if the member then has less than 15 years of service, including an assumed three additional years of service in the case of executive officers); provided that, if the termination is more than two years from the change in control, the calculation of years of service will not include the assumed additional three years and the compensation upon which the benefit is calculated will be the actual compensation in effect at termination (rather than the compensation in effect at the change in control which, if higher, would be used if -105- termination occurred within two years of the change in control). The change in control severance benefits and change in control retirement benefits are effective for a minimum of five years, which is automatically extended from year to year unless Kentucky Utilities gives notice that it does not wish to extend the period of effectiveness. The Incentive Plans, Performance Share Plans, Executive Deferred Compensation Plans and Long-Term Incentive Plan contain provisions relating to a change in control. Under the Performance Share Plans and Long-Term Incentive Plan, or the awards granted thereunder, if a participant's employment is terminated voluntarily or involuntarily after a change in control, such participant will have the right to an immediate payment in shares of Company Common Stock for all Performance Cycles in which the participant is currently participating. The amount payable to a participant in the event of termination following a change in control will be determined in accordance with the formula specified in the plans. In addition, the restriction on any restricted shares then held by the participant under these plans will lapse on the occurrence of a change in control, whether or not the participant is terminated. Under the Executive Deferred Compensation Plans, all amounts held under such plans will be paid to the participant after a change in control, whether or not the participant is terminated. Such payments were made to participants following execution of the Merger Agreement, which constituted a change in control. Under the Incentive Plans, after a change in control, whether or not a participant is terminated, a participant, including a participant who had terminated prior to the change in control by reason of retirement, disability or death, will have a right to an immediate cash payment based on actual base salary earned prior to the change in control and on the assumption that established targets for the year had been met. For purposes of all the executive and director plans, "change in control" includes any merger, consolidation, reorganization or sale of substantially all of the assets of the Company or Kentucky Utilities which results in less than 60% of the voting power of the resulting entity being owned by the holders of the Common Stock of the Company prior to the transaction; a change in the majority of the Board of Directors of the Company or Kentucky Utilities over a two-year period which is not approved by two-thirds of the incumbent directors; and the acquisition by any person or group of persons of beneficial ownership of 10% or more of the Common Stock of the Company or Kentucky Utilities. The execution of the Merger Agreement constituted, and the consummation of the Merger will also constitute, a "change in control" under all of the executive and director plans, or awards granted thereunder, described above, other than the Incentive Plans, the Director Retirement Plans and the Director Deferred Compensation Plans under which only the consummation of the Merger will constitute a "change in control". Employment Agreement. In connection with the Merger Agreement, the Company entered into an Employment Agreement with Mr. Whitley which will become effective only upon consummation of the Merger. The Employment Agreement will have an initial term of five years commencing at the effective date of the Merger with automatic renewal for additional one-year terms at the end of the initial term or any renewal term unless Mr. Whitley or LG&E Energy (as successor to the Company) gives at least 3 months prior notice of an intention not to renew. Under the Employment Agreement Mr. Whitley will serve as Vice Chairman, President and Chief Operating Officer of LG&E Energy and Vice Chairman and Chief Operating Officer of Louisville Gas and Electric Company and Kentucky Utilities. Under the Employment Agreement, Mr. Whitley will receive an annual base salary of not less than $575,000 and will participate in the annual bonus plan and long-term incentive plan of LG&E Energy, with an annual bonus target award of not less than 55% of his base salary and long-term incentive grants with a present value of not less than 70% of his base salary, to be delivered 60% in the form of performance units/shares and 40% in the form of non-qualified stock options. He is also entitled to life insurance -106- coverage in an amount of not less than $2,000,000 and certain other welfare, retirement and fringe benefits similar to other LG&E Energy executive officers and benefits currently offered by the Company. If LG&E Energy terminates Mr. Whitley's employment without cause (as defined in the Employment Agreement) or if Mr. Whitley terminates his employment for good reason (which, as defined in the Employment Agreement includes for any reason during the 30-day period commencing on the first anniversary of the effective date of the Merger), Mr. Whitley will receive, in addition to all compensation earned through the date of termination and coverage and benefits under all benefit and incentive compensation plans, a severance payment equal to the discounted present value of his base salary and target bonus for the greater of (i) two years, or (ii) the remainder of the employment term then in effect (the "Continuation Period"). In addition, in such event Mr. Whitley will receive his outstanding target bonus award, pro-rated through the date of his termination. Further, he will continue to receive welfare benefits during the Continuation Period and all stock options will become exercisable and all restricted stock and other equity awards will vest. In addition, any long term incentive awards (other than stock options) will be cashed out at the discounted present value of the target payout pro-rated for Mr. Whitley's actual period of service plus the Continuation Period. Payments to Mr. Whitley upon termination after a change in control under the Employment Agreement will be grossed up for any applicable excise taxes. GENERAL Independent Public Accountants The Audit Committee of the Board has selected the firm of Arthur Andersen LLP as independent public accountants to examine the financial statements of the Company and Kentucky Utilities for 1998. The firm has served as the independent public accountants for the Company and Kentucky Utilities for many years. Representatives of the firm are not expected to be present at the annual meeting. If the Merger is consummated prior to the end of 1998, it may be deemed desirable at that time for the current auditors of LG&E Energy Corp. or another auditing firm to audit the annual financial statements for all affiliated corporations for 1998, in which case Arthur Andersen LLP would no longer serve. Proposals of Shareholders Under the rules of the Securities and Exchange Commission, any shareholder proposal intended to be presented at the 1999 Annual Meeting of Shareholders must be received by the Company at its principal executive offices no later than November 18, 1998 in order to be eligible to be considered for inclusion in the Company's proxy materials relating to that meeting. A shareholder submitting a proposal or nominating a person to serve as director must comply with procedures set forth in the Company's By-laws. In general, the By-laws provide that for business to be considered at an annual meeting of shareholders, a shareholder must give timely and proper notice of the matter to the Secretary of the Company. The notice must specify in reasonable detail the business desired to be brought before the meeting and contain other information required by the By-laws. Nominations for director may be made by shareholders only if the shareholder has given timely and proper notice thereof to the Secretary of the Company. The notice must contain the name of the person or persons nominated, certain information about the nominee and other information required by the By-laws. Shareholder proposals or nominations must be received no fewer than 60 days prior to the meeting (or, if the date of the meeting has not been made public, within 10 days after the publication of the date of the meeting). -107- EX-99.04 11 EXHIBIT 99.04 EXHIBIT 99.04 CAUTIONARY STATEMENTS - KU ENERGY AND KU The following are cautionary statements, assumptions and other factors that could cause the Company's or KU's actual results to differ materially from those contemplated in any forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 1. Increased competition in the utility industry including effects of: decreasing margins as a result of competitive pressures; industry restructuring initiatives; inability to recover in rates a return on investments made under regulation; legislation or regulatory initiatives (such as retail wheeling, open access or customer choice) designed to increase competition and the presence of new competitors entering KU's service territory, including other traditional utilities, nonutility generators, power marketers, power brokers and others. These factors could result in lower revenues and earnings. 2. Economic conditions affecting customers businesses producing changes in demand for their products or services or changes in their cost structures causing fluctuations in the amount of energy purchased from KU. These factors could have a significant impact on the economic health of KU s service territory, which (in turn) could have an adverse impact on revenues and earnings. 3. Increased capital and other costs of providing for increased customer demand (through addition of peaking capacity or purchased power). Increased costs not recovered from customers because of competitive pressure on prices, lack of rate relief or other reasons could result in lower earnings. 4. Financial or regulatory accounting principles or policies imposed by the Financial Accounting Standards Board, the Securities and Exchange Commission, the Federal Energy Regulatory Commission and applicable state utility regulatory bodies. These could adversely affect reported results. 5. Availability or cost of capital, which may be affected by, or may affect, interest rates, market perceptions of the utility and energy- related industries, the Company or any of its subsidiaries or changes in security ratings of the Company or KU. Increases in capital costs, without corresponding increases in revenues, would adversely affect earnings. 6. Unusual weather conditions; catastrophic weather-related events; unscheduled generation outages; unanticipated changes in the cost or availability of fuel or gas supply due to higher demand, shortages or transportation problems; or electric transmission system or gas pipeline constraints. The foregoing could adversely affect operating results. 7. Economic conditions including significant fluctuations in the rate of inflation. Increased costs caused by inflation, without corresponding increases in revenues would adversely affect earnings. -108- 8. Changes in monetary, fiscal, tax or environmental policies of governments or governmental agencies, which may significantly affect costs of capital, expense levels or costs of compliance with existing or future environmental requirements. Such increases in costs, without corresponding increases in revenues, would adversely affect earnings. 9. Employee workforce factors including changes in collective bargaining agreements with union employees, or work stoppages, which may increase costs or reduce revenues. 10. Significant changes in policies of regulatory agencies with jurisdiction over KU's rates, which may adversely affect revenues and earnings. 11. Costs and other effects of legal and administrative proceedings, settlements, investigations and claims, including but not limited to those described in Notes 4 and 9 of the Notes to Consolidated Financial Statements in the Company's and KU's Annual Report on Form 10-K for the year ended December 31, 1997. 12. Development of new technology such as distributed generation provided by others which would result in lower sales. This could result in lower revenues and earnings. Neither the Company nor KU undertakes any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. -109- -----END PRIVACY-ENHANCED MESSAGE-----