SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
Registrant; I.R.S. Employer
Commission State of Incorporation; Identification
File Number Address; and Telephone Number Number
1-267 ALLEGHENY ENERGY, INC. 13-5531602
(A Maryland Corporation)
10435 Downsville Pike
Hagerstown, Maryland 21740-1766
Telephone (301) 790-3400
1-5164 MONONGAHELA POWER COMPANY 13-5229392
(An Ohio Corporation)
1310 Fairmont Avenue
Fairmont, West Virginia 26554
Telephone (304) 366-3000
1-3376-2 THE POTOMAC EDISON COMPANY 13-5323955
(A Maryland and Virginia
Corporation)
10435 Downsville Pike
Hagerstown, Maryland 21740-1766
Telephone (301) 790-3400
1-255-2 WEST PENN POWER COMPANY 13-5480882
(A Pennsylvania Corporation)
800 Cabin Hill Drive
Greensburg, Pennsylvania 15601
Telephone (412) 837-3000
0-14688 ALLEGHENY GENERATING COMPANY 13-3079675
(A Virginia Corporation)
10435 Downsville Pike
Hagerstown, Maryland 21740-1766
Telephone (301) 790-3400
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 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:
Name of each exchange
Registrant Title of each class on which registered
Allegheny Energy, Common Stock, New York Stock Exchange
Inc. $1.25 par value Chicago Stock Exchange
Pacific Stock Exchange
Amsterdam Stock Exchange
Monongahela Power
Company Cumulative Preferred
Stock,
$100 par value;
4.40% American Stock Exchange
4.50%, Series C American Stock Exchange
8% Quarterly Income
Debt Securities,
Junior Subordinated
Deferrable Interest
Debentures,
Series A New York Stock Exchange
The Potomac Edison
Company Cumulative Preferred
Stock,
$100 par value:
3.60% Philadelphia Stock
Exchange Inc.
$5.88, Series C Philadelphia Stock
Exchange Inc.
8% Quarterly Income
Debt Securities,
Junior Subordinated
Deferrable Interest
Debentures,
Series A New York Stock Exchange
West Penn Power Cumulative Preferred
Company Stock,
$100 par value:
4-1/2% New York Stock Exchange
8% Quarterly Income
Debt Securities,
Junior Subordinated
Deferrable Interest
Debentures,
Series A New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Allegheny Generating
Company Common Stock
$1.00 par value None
Aggregate market value Number of shares
of voting stock (common stock) of common stock
held by nonaffiliates of of the registrants
the registrants at outstanding at
March 5, 1998 March 5, 1998
Allegheny Energy,Inc. $3,764,916,748 122,436,317
($1.25 par value)
Monongahela Power None. (a) 5,891,000
Company ($50 par value)
The Potomac Edison None. (a) 22,385,000
Company (no par value)
West Penn Power None. (a) 24,361,586
Company (no par value)
Allegheny Generating
Company None. (b) 1,000
($1.00 par value)
(a) All such common stock is held by Allegheny Energy, Inc., the
parent company.
(b) All such common stock is held by its parents, Monongahela
Power Company, The Potomac Edison Company, and West Penn
Power Company.
CONTENTS
PART I: Page
ITEM 1. Business 1
Proposed Merger with DQE, Inc. 3
Competition 4
Restructuring 7
Regulated Sales 8
Unregulated Sales 11
Electric Facilities 12
Allegheny Map 15
Research and Development 16
Capital Requirements and Financing 18
Fuel Supply 21
Rate Matters 22
Environmental Matters 24
Climate Change Negotiations 24
Air Standards 24
Water Standards 27
Hazardous and Solid Wastes 28
Toxic Release Inventory 29
Regulation 29
ITEM 2. Properties 29
ITEM 3. Legal Proceedings 30
ITEM 4. Submission of Matters to a Vote of
Security Holders 33
Executive Officers of the Registrants 34
PART II:
ITEM 5. Market for the Registrants' Common Equity
and Related Shareholder Matters 36
ITEM 6. Selected Financial Data 37
ITEM 7. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 38
ITEM 8. Financial Statements and Supplementary
Data 39
ITEM 9. Changes in and Disagreements with
Accountants on Accounting and Financial
Disclosure 46
CONTENTS (Cont'd)
Page
PART III:
ITEM 10. Directors and Executive Officers of
the Registrants 46
ITEM 11. Executive Compensation 47
ITEM 12. Security Ownership of Certain Beneficial
Owners and Management 53
ITEM 13. Certain Relationships and Related
Transactions 54
PART IV:
ITEM 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K 54
THIS COMBINED FORM 10-K IS SEPARATELY FILED BY
ALLEGHENY ENERGY, INC., MONONGAHELA POWER COMPANY, THE
POTOMAC EDISON COMPANY, WEST PENN POWER COMPANY, AND
ALLEGHENY GENERATING COMPANY.
INFORMATION CONTAINED HEREIN RELATING TO ANY
INDIVIDUAL REGISTRANT IS FILED BY SUCH REGISTRANT ON
ITS OWN BEHALF. EACH REGISTRANT MAKES NO
REPRESENTATION AS TO INFORMATION RELATING TO THE OTHER
REGISTRANTS.
PART I
ITEM 1. BUSINESS
Allegheny Energy, Inc. (AE) is the new name of
Allegheny Power System, Inc., an electric utility holding
company, incorporated in Maryland in 1925, which owns
directly and indirectly various regulated and non-
regulated subsidiaries (collectively and generically,
Allegheny). AE changed its name in September of 1997
to better describe its diversified interests in energy
and related services and its plan to form a new
company by merging with DQE, Inc. AE derives
substantially all of its income from the electric
utility operations of its direct and indirect
regulated subsidiaries Monongahela Power Company
(Monongahela), The Potomac Edison Company (Potomac
Edison), West Penn Power Company (West Penn), and
Allegheny Generating Company (AGC) (collectively, the
Regulated Subsidiaries). The properties of the
Regulated Subsidiaries are located in Maryland, Ohio,
Pennsylvania, Virginia, and West Virginia, are
interconnected, and are operated as a single
integrated electric utility system
(System), which is interconnected with all neighboring
utility systems. The three electric utility operating
subsidiaries are Monongahela, Potomac Edison, and West
Penn (collectively, the Operating Subsidiaries). AE
has no employees. Its officers are employed by
Allegheny Power Service Corporation (APSC), a wholly
owned subsidiary of AE. On December 31, 1997,
Allegheny had approximately 4,892 employees.
Monongahela, incorporated in Ohio in 1924,
operates in northern West Virginia and an adjacent
portion of Ohio. It also owns generating capacity in
Pennsylvania. Monongahela serves about 353,300
customers in a service area of about 11,900 square
miles with a population of about 710,000. The seven
largest communities served have populations ranging
from 10,900 to 33,900. On December 31, 1997,
Monongahela had no employees. Its employees were
transferred to APSC as part of the final phase of a
restructuring of operations which began in 1996.
Monongahela reimburses APSC for services provided by
APSC's employees. Monongahela's service area has
navigable waterways and substantial deposits of
bituminous coal, glass sand, natural gas, rock salt,
and other natural resources. Its service area's
principal industries produce coal, chemicals, iron and
steel, fabricated products, wood products, and glass.
There are two municipal electric distribution systems
and two rural electric cooperative associations in its
service area. Except for one of the cooperatives,
they purchase all of their power from Monongahela.
Potomac Edison, incorporated in Maryland in 1923
and in Virginia in 1974, operates in portions of
Maryland, Virginia, and West Virginia. It also owns
generating capacity in Pennsylvania. Potomac Edison
serves about 382,600 customers in a service area of
about 7,300 square miles with a population of about
782,000. The six largest communities served have
populations ranging from 11,900 to 40,100. On
December 31, 1997, Potomac Edison had 31 employees.
The remainder of its employees were transferred to
APSC as part of the final phase of a restructuring of
operations which began in 1996. Potomac Edison
reimburses APSC for services provided by APSC's
employees. Potomac Edison's service area's principal
industries produce aluminum, cement, fabricated
products, rubber products, sand, stone, and gravel.
There are four municipal electric distribution systems
in its service area, all of which purchase power from
Potomac Edison, and six rural electric cooperatives,
one of which purchases power from Potomac Edison.
2
West Penn, incorporated in Pennsylvania in 1916,
operates in southwestern and north and south central
Pennsylvania. It also owns generating capacity in
West Virginia. West Penn serves about 667,100
customers in a service area of about 9,900 square
miles with a population of about 1,399,000. The 10
largest communities served have populations ranging
from 11,200 to 38,900. On December 31, 1997, West
Penn had no employees. Its employees were transferred
to APSC as part of the final phase of a restructuring
of operations, which began in 1996. West Penn
reimburses APSC for services provided by APSC's
employees. West Penn's service area has navigable
waterways and substantial deposits of bituminous coal,
limestone, and other natural resources. Its service
area's principal industries produce steel, coal,
fabricated products, and glass. There are three
municipal electric distribution systems in its service
area, all of which purchase their power requirements
from West Penn, and five rural electric cooperative
associations, located partly within the area, all of
which purchase virtually all their power through a
pool supplied by West Penn and other nonaffiliated
utilities.
AGC, organized in 1981 under the laws of Virginia, is
jointly owned by the Operating Subsidiaries as
follows: Monongahela, 27%; Potomac Edison, 28%; and
West Penn, 45%. AGC has no employees, and its only
asset is a 40% undivided interest in the Bath County
(Virginia) pumped-storage hydroelectric station, which
was placed in commercial operation in December 1985,
and its connecting transmission facilities. AGC's 840
megawatt (MW) share of capacity of the station is sold
to its three parents. The remaining 60% interest in
the Bath County Station is owned by Virginia Electric
and Power Company (Virginia Power).
APSC, incorporated in Maryland in 1963, is a wholly
owned subsidiary of AE which employs substantially all
Allegheny employees and provides all necessary
services to Allegheny at cost. On December 31, 1997,
APSC had 4,861 employees. This number increased
significantly in the past year, as employees formerly
employed by the Operating Subsidiaries were
transferred to APSC as part of a restructuring of
operations.
AYP Capital, Inc. (AYP Capital), incorporated in
Delaware in 1994, is a wholly owned nonutility
subsidiary of AE. AYP Capital has three wholly owned
subsidiaries, AYP Energy, Inc. (AYP Energy), Allegheny
Communications Connect, Inc., (ACC) and Allegheny
Energy Solutions, Inc. (Allegheny Energy Solutions),
all Delaware corporations. AYP Capital is also part
owner of APS Cogenex, a limited liability company
formed with EUA Cogenex. APS Cogenex ceased
its marketing activities in 1996
and is concluding existing projects. (See ITEM 1.
BUSINESS Competition and ITEM 7. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Significant Events in 1997,
1996 and 1995 for a further description of AYP Capital
and its subsidiaries' activities.) AYP Capital and
its subsidiaries have no employees. However, as of
December 31, 1997, 30 APSC employees were dedicated to
AYP Capital and its subsidiaries' activities on a full-
time basis. Other APSC employees provide services to
AYP Capital as required. AYP Capital reimburses APSC
for services provided by APSC's employees. AE's total
investment in AYP Capital as of December 31, 1997, was
$26.1 million. AE is currently committed to invest up
to an additional $5.2 million in AYP Capital to fund
AYP Capital's investment in two limited partnerships.
In addition to the historical information
contained herein, this report contains a number of
"forward-looking statements", within the meaning of
the Securities and Exchange Act of 1934. Such
statements address future events and conditions
concerning capital expenditures, earnings on assets,
resolution and impact of litigation, regulatory
matters, liquidity and capital resources, and
accounting matters. Actual results in each case could
differ materially
3
from those projected in such
statements, by reason of factors including, without
limitation, the effect on Allegheny of: electric
utility restructuring, including the ongoing state and
federal activities; enactment of legislation
permitting retail competition; future economic
conditions; earnings retention and dividend payout
policies; developments in the legislative, regulatory
and competitive markets in which Allegheny operates;
the potential adverse effect of increased competition
on revenues and earnings; learning experiences and
start-up costs of new and newly unregulated
businesses; difficulty in obtaining adequate and
timely rate relief (particularly as ratemaking
methodologies change as the industry moves toward
increased competition and exposure to market forces);
and other circumstances that could affect anticipated
revenues and costs, such as increases in operating and
other expenses due to unscheduled maintenance or repair
requirements of generating and other facilities and
compliance with laws and regulations. Further
concerns of the electric generation business include
restrictions on construction and operation of
facilities due to regulatory requirements and
environmental considerations; possible restrictions on
carbon dioxide and NOx and other emissions; and
uncertainties in demand due to economic conditions,
energy conservation, market competition, weather, and
interruptions in fuel supply.
The move to a more competitive environment will
present a new set of opportunities and problems,
including determining the appropriate industry
structure, determining recovery of stranded costs
(those costs imposed or incurred under a regulatory
structure that would not be recoverable in a
competitive environment), retaining existing customers
and acquiring new customers, and, in general, changing
the way electric utilities do business.
PROPOSED MERGER WITH DQE, INC.
On April 7, 1997, AE and DQE, Inc. (DQE)
announced that they had entered into an Agreement and
Plan of Merger dated April 5, 1997 (Merger Agreement),
and that the combined company would be called
Allegheny Energy, Inc. The Merger Agreement provides
for the business combination of AE and DQE in which an
AE subsidiary corporation, to be formed under the laws
of Pennsylvania (Merger Sub), will be merged with and
into DQE. DQE will be the surviving corporation and
will become a wholly owned subsidiary of AE. The
merger is contingent, among other things, upon the
approval of each company's shareholders, the
Pennsylvania Public Utility Commission (Pennsylvania
PUC), the Federal Energy Regulatory Commission (FERC),
the Securities and Exchange Commission (SEC), the
Nuclear Regulatory Commission and the Federal Trade
Commission/Department of Justice. AE has also
requested that the Maryland Public Service Commission
(Maryland PSC) approve the issuance of additional AE
common stock to accomplish the transactions. At
separate meetings held on August 7, 1997, the
shareholders of AE and DQE approved the merger. All of
the other above filings have been made and are
pending. The effective time of the merger is
dependent upon all conditions in the Merger Agreement,
including all necessary regulatory approvals, being
met or waived. See ITEM 7. MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - Significant Continuing Issues - Proposed
Merger with DQE and ITEM 3. LEGAL PROCEEDINGS for a
discussion of the lawsuit filed by the City of
Pittsburgh and other merger opposition. In addition,
the Maryland PSC and the Public Utilities Commission
of Ohio (Ohio PUC) have instituted proceedings to
investigate the effect of the merger on Potomac Edison
and Monongahela, respectively.
Under the terms of the Merger Agreement, upon the
merger becoming effective, each share of DQE common
stock (other than shares owned by AE, Merger Sub or
any other direct or indirect subsidiary of AE and
shares owned by DQE or any direct or indirect
subsidiary of DQE, in each case not held on
4
behalf of third parties) issued and outstanding will be
converted into the right to receive 1.12 shares of AE
common stock. Upon consummation of the merger,
holders of DQE common stock will own approximately 42%
of the outstanding shares of AE common stock.
After the merger, AE's utility and nonutility
subsidiaries will remain subsidiaries of AE and DQE's
utility and nonutility subsidiaries will become
indirect subsidiaries of AE. The merger
will have no effect on the issued and outstanding
preferred stock of DQE, nor will it have any effect on
the issued and outstanding common stock, public debt
securities, preferred stock nor preference stock of
the respective subsidiaries of AE and DQE.
As part of its merger applications in
Pennsylvania and with the FERC, AE agreed to form or
join an independent system operator (ISO). For more
information on AE's examination of an ISO, see ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Significant
Continuing Issues - Independent Transmission Sytem
Operation Study. A more complete description of the
merger transaction may be found in the Form U-1
requesting SEC approval of the merger, filed at File
No. 70-9147. See also ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA - Note B - Proposed Merger.
COMPETITION
The electric utility industry in the United
States is in the process of evolving from an
historically regulated monopolistic market to a
competitive integrated marketplace. The Energy Policy
Act of 1992 (EPACT) began the process of deregulation
of the electric industry by permitting the FERC to
compel electric utilities to allow third parties to
sell electricity to wholesale customers over their
transmission systems. Since 1992, the wholesale
electric market has become increasingly competitive as
companies began to engage in nationwide power
brokering. In addition, some states have taken active
steps toward allowing retail customers the right to
choose their electric power supplier. Competition in
electric generation is no longer just a theoretical
possibility for Allegheny. Two of the five state
jurisdictions the Operating Subsidiaries serve have
now taken action to begin implementation of retail
access to alternate generation suppliers. Allegheny
has been an advocate of Federal legislation to create
competition in the retail electricity markets to avoid
regional dislocations and ensure level playing fields.
In the absence of Federal legislation, state-by-state
implementation has begun.
In December 1996, the Commonwealth of
Pennsylvania enacted the Electricity Generation
Customer Choice and Competition Act (Customer Choice
Act) to restructure the electric industry in
Pennsylvania to create retail access to a competitive
electric energy generation market. Pursuant to the
Customer Choice Act, all electric utilities in
Pennsylvania are required to establish and administer
retail access pilot programs to 5% of the load of each
class of their customers. In order to assure
participation in the pilot program, a credit was
established by the Pennsylvania PUC. The credit for
West Penn's customers participating in the pilot is
high, with the result that West Penn has
estimated it could suffer a loss of revenues of up to
about $10 million for the pilot period which ends
December 31, 1998. In order to mitigate this loss,
West Penn took action to become a licensed energy
supplier to the pilot customers of the other electric
utilities in Pennsylvania. However, sales prices are
low and margins are thin. West Penn believes it is
unlikely that it will completely offset its pilot
losses with new revenues. In 1997, Allegheny formed
Allegheny Energy Solutions, which is also
participating as a licensed energy supplier in the
Pennsylvania pilot program. Subsequently, Allegheny
Energy Solutions and DQ Energy Partners, Inc.
5
(DEP), an unregulated subsidiary of DQE, formed a joint
venture named Allegheny Energy Solutions, L.L.C.
(Allegheny Energy Solutions LLC), which will take over
Allegheny Energy Solutions' participation in the
Pennsylvania pilot program and continue
thereafter.
Beginning January 1, 1999, immediately after the
pilot program ends, pursuant to the Customer Choice
Act, one third of West Penn's retail customers will
have the ability to choose another energy supplier,
but will not be required to do so. The next year
another third, and beginning January 1, 2001, all of
its customers will have retail access to alternative
generation. West Penn will continue to provide
transmission and distribution service and, depending
upon the outcome of its restructuring filing, may bill
a Competitive Transition Charge (CTC) to native load
customers. For a discussion of this legislation and
the potential for West Penn to suffer a severe loss of
revenues and earnings in 1999 and thereafter if it is
not permitted to bill a reasonable CTC, see ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Review of
Operations - Sales and Revenues, and Significant
Continuing Issues - Electric Energy Competition, as
well as Note C to the Consolidated Financial
Statements in ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA. Both West Penn and Allegheny
Energy Solutions, LLC are planning to compete as
energy suppliers in Pennsylvania.
The Maryland PSC in December 1997 issued an Order
to implement retail competition in that state. A
special task force of the Maryland General Assembly,
which had been working on the same subject, had not
yet issued its report. The Maryland PSC's Order and
its revised second Order, call for a deregulation
process including a three-year phase-in beginning July
1, 2000, with recovery of prudent stranded costs,
after mitigation. The Order recognizes that many
details are yet to be decided and calls for roundtable
discussions and adjudicatory proceedings for that
purpose.
For information on competition, including a discussion
of the Pennsylvania legislation, West Penn's and
Allegheny Energy Solutions LLC's participation,
stranded cost issues and the Maryland PSC's Orders to
implement retail competition, see ITEM 7. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Significant Continuing Issues
Electric Energy Competition and Note C to the
Consolidated Financial Statements in ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
In February 1997, the Virginia General Assembly
passed Senate Joint Resolution 259, which continued
the Joint Committee Examining the Restructuring of the
Electric Utility Industry. In addition, a separate Tax
Task Force in Virginia has been examining tax issues
arising as a result of proposed restructuring. SJR
259 directed the Virginia State Corporation Commission
(Virginia SCC) to provide a report to the Committee on
how customer choice should be implemented in Virginia.
On November 7, the Virginia SCC Staff issued its
report, which recommended that utilities undergo a
thorough rate examination, experiment with small-scale
retail pilot programs, and form or join independent
system operators and regional power exchanges. After
this phase is under way, a decision would be made
whether Virginia should go to the next step of retail
choice. In the 1998 legislative session, several
bills have been introduced, one of which would, among
other things, phase in retail competition in the 2002-
2004 period.
On December 12, 1996, the Public Service
Commission of West Virginia (West Virginia PSC) issued
an order initiating a general investigation regarding
the restructuring of the regulated electric utility
industry. A public hearing was held on May 1,
1997, which resulted in the establishment of a Task
Force to further investigate restructuring issues.
The Task Force issued a report in mid-October,
concluding that West Virginia would likely benefit
from competition and retail choice, although there was
no consensus on
6
a model for restructuring. In December
1997, the Task Force approved legislative language
that would give the West Virginia PSC broad authority
to implement retail choice. The legislation was
introduced in February 1998. It is anticipated that
the West Virginia PSC and the Task Force will work to
develop a detailed restructuring plan in 1998.
The Ohio PUC has continued informal roundtable
discussions on issues concerning competition in the
electric utility industry. The meetings have resulted
in sets of guidelines on interruptible rates and
conjunctive service pilot programs which have been
adopted by the Ohio PUC. The Governor established a
legislative committee from members of both the Senate
and House to further review issues regarding
deregulation.
Allegheny continues to participate in the
Partnership for Customer Choice whose purpose is to
seek enactment of federal legislation to bring choice
to electric customers no later than the year 2000.
The legislation sought would deregulate the generation
and sale of electricity, creating a free market for
electric power.
Fully meeting challenges in the emerging
competitive environment will be difficult for
Allegheny unless certain outmoded and anti-competitive
laws, specifically the Public Utility Holding Company
Act of 1935 (PUHCA) and Section 210 of the Public
Utility Regulatory Policies Act of 1978 (PURPA), are
repealed or significantly revised. Allegheny
continues to advocate the repeal of PUCHA and PURPA,
and, in 1997, worked with other utilities seeking the
repeal of PUHCA and PURPA or reform of Section 210 of
PURPA on the grounds that they are obsolete,
anticompetitive, and that PURPA, in particular,
results in utility customers paying above-market
prices for power. (See ITEM 3. LEGAL PROCEEDINGS for
information concerning PURPArelated litigation.)
In 1996, AYP Capital, AE's nonutility subsidiary,
expanded its operations by forming AYP Energy and ACC.
In 1997, it formed Allegheny Energy Solutions. AYP
Energy is an exempt wholesale generator and a bulk
power marketer. In October 1996, AYP Energy purchased
for about $170 million, a 50% interest (276 MW) in
Unit No. 1 of the Fort Martin coal-fired power station
in West Virginia. AYP Energy is marketing the output
of its 50% interest in Unit No. 1 of Fort Martin, as
well as engaging in other power marketing activities.
The increase in losses in 1997 from nonutility
operations resulted primarily from low selling prices
in competitive markets. For a discussion of the
losses, see ITEM 7. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - Earnings Summary. The operation of a
merchant plant and power marketing in the wholesale
market is essentially participation in a commodity
market, which creates certain risk exposures. AYP
Energy uses exchange-traded and overthe-counter futures,
options, and swap contracts both to hedge
its exposure to changes in electric power prices and
for trading purposes. The risks to which AYP Energy
is exposed include underlying price volatility,
credit risk, and variation in cash flows, among
others. To manage these risks and other risks to
which the Operating Subsidiaries are exposed,
Allegheny has implemented risk management policies
and procedures, consistent with industry practice and
its goals. See also discussion in ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Significant
Continuing Issues - Risk Management.
During 1997, AYP Capital made several
investments in funds which were established in 1995.
They include an investment in EnviroTech Investment
Fund I, L.P. (EnviroTech), a limited partnership
formed to invest in emerging electrotechnologies that
promote the efficient use of electricity and improve
the environment. AYP Capital committed to invest up
to $5 million in EnviroTech over 10 years, beginning
in 1995. They also include an investment in the
Latin American Energy and Electricity Fund I, L.P.
(FONDELEC), a
7
limited partnership formed to invest in
and develop electric energy opportunities in Latin
America. AYP Capital committed to invest up to
$5 million in FONDELEC over eight years, beginning in
1995. Through FONDELEC, AYP Capital has invested in
electric distribution companies in Peru and
Argentina. Both EnviroTech and FONDELEC may offer
AYP Capital opportunities to identify investments in
which AYP Capital may coinvest, in excess of its
capital commitment in each limited partnership.
AYP Capital is also developing other energy-
related service businesses. AYP Capital offers
engineering consulting services and project
management for transmission and distribution
facilities.
ACC was formed in 1996 as an exempt
telecommunications company to develop opportunities
in the deregulated communications market. ACC and Hyperion
Telecommunications of Pennsylvania, Inc., a Delaware
corporation, entered into an Operating Agreement and
agreed to form a limited liability company known as
Allegheny Hyperion Telecommunications, L.L.C. to
engage in telecommunications services.
Allegheny Energy Solutions was formed in 1997 to
market electric energy to retail customers in
deregulated markets. As previously mentioned, in
1997, Allegheny Energy Solutions and DEP, a
subsidiary of DQE, agreed to form Allegheny Energy
Solutions LLC, a limited liability joint venture, to
participate in the Pennsylvania pilot program and to
market electricity and related energy services.
Allegheny Energy Solutions and DEP each plan to
maintain a 50% interest in Allegheny Energy Solutions
LLC. For a discussion of the activities undertaken
by Allegheny Energy Solutions in 1997 and related
nonutility losses, see ITEM 7. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Earnings Summary and Note C to
Consolidated Financial Statements in ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
RESTRUCTURING
In 1995, Allegheny announced its intention to
undertake a restructuring designed to consolidate and
reengineer its operations to better meet the competitive
challenges of the changing electric utility industry
and remain the energy supplier of choice in the
future for its customers. In 1996, Allegheny
essentially completed restructuring of its
operations. The benefits Allegheny has realized from
restructuring include increased efficiencies and
synergies due to the elimination of layers of
management and the combination of previously
duplicated functions. For a discussion of
Allegheny's restructuring see Note D to Consolidated
Financial Statements in ITEM 8. FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA.
In general, the restructuring of Allegheny
consolidated in APSC certain functions which previously
were either performed separately by employees of each of the
three Operating Subsidiaries or by employees of the
three Operating Subsidiaries along with employees of
APSC. Also, virtually all employees of the Operating
Subsidiaries were transferred to APSC. The Operating
Subsidiaries and APSC were restructured into the
following revenue-generating business units:
Operating Business Unit; Retail Marketing Business
Unit; Generation Business Unit; and Transmission
Business Unit. Support business units which provide
services to these revenue-generating business units
have also been formed. The restructuring did not
involve the formation of any new legal entities, the
dissolution of any existing business, nor did it
require the writedown of any rate base assets.
Moreover, no capital assets were transferred within
Allegheny in connection with the restructuring.
8
Most of the functions which were performed
exclusively by the Operating Subsidiaries have been
restructured into the Operating Business Unit and
Retail Marketing Business Units. Most of the functions
performed by the Bulk Power Supply section of APSC were
restructured into the distinct generating, transmission,
and planning and compliance business units. The support
functions were restructured in order to supply services
to the above with greater efficiency.
REGULATED SALES
In 1997, consolidated regulated kWh sales to
regular customers (retail and wholesale power)
decreased .6% from those of 1996 as a net result of a
decrease of 3.9% in residential sales and increases
of .3% and 1.6% in commercial and industrial sales,
respectively. Consolidated regulated revenues from
residential, commercial, and industrial sales
decreased 4.2%, .5% and .7%, respectively. (See ITEM
1. RATE MATTERS and ITEM 7. MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.)
Utility bulk power transaction revenues,
primarily with nonaffiliated utilities and power
marketers, increased 8.6%. For the most part, these
revenues have had little effect on net income as most
profit therefrom was passed through to retail
customers. (See ITEM 1. RATE MATTERS for a
discussion of why this no longer applies to West
Penn.)
Allegheny's all-time peak load of 7500 MW
occurred on February 5, 1996. The peak load in 1997
of 7423 MW occurred on January 17, 1997.
Consolidated regulated electric operating
revenues for 1997 were derived as follows:
Pennsylvania, 45.6%; West Virginia, 27.4%; Maryland,
19.0%; Virginia, 5.8%; Ohio, 2.2% (residential,
39.1%; commercial, 21.5%; industrial, 32.7%; bulk
power transactions, 3.6%; and other, 3.1%). The
following percentages of such revenues were derived
from these industries: iron and steel, 6.5%; aluminum
and other nonferrous metals, 3.4%; chemicals, 3.3%;
coal mines, 3.3%; cement, 2.5%; fabricated products,
1.8%; and all other industries, 10.8%.
During 1997, Monongahela's kWh sales to retail
customers increased 1.3%. Residential and commercial
sales decreased 1.8% and 1.0%, respectively, but
industrial sales increased 4.0%.
Revenues from residential, commercial and industrial
customers decreased 3.0%, 2.3%, and 2.1%,
respectively, primarily due to a reduction in the
fuel and energy cost component. Revenues from bulk
power transactions and sales to affiliates increased
9.4%. Monongahela's revenues represented 23.9% of
Allegheny's total regulated sales to regular
customers. Monongahela's all-time peak load of 1825
MW occurred on August 17, 1995. The peak load in
1997 of 1746 MW occurred on July 15, 1997.
Monongahela's electric operating revenues were
derived as follows: West Virginia, 92.1%, and Ohio,
7.9% (residential, 31.8%; commercial, 18.9%;
industrial, 31.3%; bulk power transactions, 2.7%; and
other, 15.3%).
During 1997, Potomac Edison's kWh sales to
retail customers decreased 1.9%. Residential sales
decreased 6.7%, but commercial and industrial sales
increased 1.9% and .5%, respectively. Revenues from
residential customers decreased 7.5% due to lower
usage. Revenues from commercial and industrial
customers increased 1.3% and .7%, respectively.
Revenues from bulk power transactions and sales to
affiliates increased 23.7%. Potomac Edison's
revenues represented 30.8% of Allegheny's total
regulated sales to regular customers. Potomac
Edison's all-time peak load of 2614 MW occurred on
January 17, 1997.
9
Potomac Edison's electric operating revenues
were derived as follows: Maryland, 62.5%; West
Virginia 18.6%, and Virginia, 18.9%; (residential,
42.3%; commercial, 20.9%; industrial, 28.0%; bulk
power transactions, 3.3%; and other, 5.5%). Revenues
from one industrial customer, the Eastalco aluminum
reduction plant near Frederick, Maryland, amounted to
$64.1 million (9.0% of total electric operating
revenues). Minimum annual charges to Eastalco under
an electric service agreement which continues through
March 31, 2000, with automatic extensions thereafter
unless terminated on notice by either party, were
$20.3 million in 1997. This agreement may be canceled
before the year 2000 upon 90 days' notice in the
event of a governmental decision resulting in a
material modification of the agreement.
During 1997, West Penn's kWh sales to retail
customers decreased .5% as a result of decreases of
2.7% and .1% in residential and commercial sales,
respectively. Industrial sales increased .9%.
Revenues from residential, commercial and industrial
customers decreased 2.2%, .6%, and .7%, respectively,
due to a reduction in the fuel and energy cost
component. Revenues from bulk power transactions and
sales to affiliates increased 3.2%. West Penn's
regulated revenues represented 45.3% of Allegheny's
total regulated sales to regular customers. West
Penn's all-time peak load of 3251 MW occurred on July 15, 1997.
West Penn's electric operating revenues were derived
as follows: Pennsylvania, 100% (residential, 36.3%;
commercial, 20.6%; industrial, 32.6%; bulk power
transactions, 3.8%; and other, 6.7%).
In 1997, the Operating Subsidiaries provided
approximately 1.7 billion kWh of energy to
nonaffiliated companies and marketers from generation
facilities operated by the Operating Subsidiaries.
Revenues from those sales of generation from the
Operating Subsidiaries were approximately
$39.6 million.
The Operating Subsidiaries transmitted approximately
12.4 billion kWh to others located outside their service
territories under various forms of transmission
service agreements. Revenues from those sales of
service approximated $41.6 million.
Sales of generation and transmission services to
others vary with the needs of those customers for
capacity and/or economic replacement power; the availability of
generating facilities and excess power, fuel, and regional
transmission facilities; and the availability and
price of competitive sources of power. Sales of
transmission services to others by the Operating
Subsidiaries decreased slightly in 1997 relative to
1996 due primarily to mild weather and the increased
willingness of neighboring utilities to sell
transmission service at competitive prices. Sales of
power generated by the Operating Subsidiaries
increased in 1997 relative to 1996 primarily from
increased sales to brokers and power marketers. From
January through April of 1997, substantially all of
the benefits of power and transmission service sales
to nonaffiliates by the Operating Subsidiaries were
passed on to retail customers and as a result had
little effect on net income during those months.
However, effective May 1, 1997, West Penn received
approval from the Pennsylvania PUC to freeze the
level of benefits passed on to retail customers. See
ITEM 1. RATE MATTERS for a discussion of West Penn's
request to zero its energy cost rate.
Pursuant to a peak diversity exchange
arrangement with Virginia Power, the Operating
Subsidiaries annually supply Virginia Power with 200
MW during each June, July, and August and, in return,
Virginia Power supplies the Operating Subsidiaries
with 200 MW during each December, January, and
February, at least through February 2000.
Thereafter, specific amounts of
annual diversity exchanges beyond those currently
established are to be mutually determined prior to
each year for which an exchange is to take place.
Negotiations are expected in 1998 to reach an agreement
on an amount of diversity exchange beyond March 2000.
The total number of megawatt-hours (MWh) to be delivered
by each utility to the other over the term of the
arrangement is expected to be the same.
Pursuant to an exchange arrangement with
Duquesne Light Company (Duquesne) which will continue
through February 2000 and may be extended beyond that
date, the Operating Subsidiaries supply Duquesne with
up to 200 MW for a specified number of weeks,
generally during each March, April, May, September,
October, and November. In return, Duquesne supplies
the Operating Subsidiaries with up to 100 MW,
generally during each December, January, and
February. The total number of MWh to be delivered by
each utility to the other over the term of the
arrangement is expected to be the same. This
arrangement will be terminated upon consummation of
the merger and will be replaced by a Joint Dispatch
Agreement, which was filed at the FERC with the
merger approval. See ITEM 1. PROPOSED MERGER WITH
DQE, INC. and ITEM 7. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - Significant Continuing Issues - Proposed
Merger with DQE.
The Energy Policy Act of 1992 (EPACT) initiated
the restructuring of the electric utility industry by
permitting competition in the wholesale generation
market. In order to facilitate the efficient use of
generation facilities, on April 24, 1996, the FERC
issued Orders 888 and 889. On March 4, 1997, the FERC
issued Orders 888A and 889A reaffirming and
clarifying the legal and policy issues as originally
presented in the previous Orders. In response to
requests for rehearing, the FERC issued Orders 888B
and 889B on November 25, 1997. The Commission again
supported its original intentions and presented
explanations and minor revisions to specific sections
of the Orders.
The FERC Orders require all transmission
providers to offer service to entities selling
generation services in a manner that is comparable to
their own use of the transmission system. The
Orders required each transmission provider to file
standardized open access transmission service
tariffs; therefore, the Operating Subsidiaries have
on file a pro forma open access tariff under which
they sell transmission services to all eligible
customers. The Operating Subsidiaries also arrange
for transmission services for their own sales
pursuant to the rates, terms and conditions of the
open access tariff. A preliminary order was issued
on December 16, 1996 on the Operating Subsidiaries'
tariff. The Operating Subsidiaries still await a
final order by the Commission concurring with the
administrative law judge's decision that the tariff
rates, if in conformity with the conclusions in the
Initial Decision, are just and reasonable.
To meet the objective of providing comparable or
nondiscriminatory transmission services, the FERC
Orders further require that utilities functionally
unbundle transmission operations and reliability
functions from wholesale merchant functions within
the Operating Subsidiaries. Accordingly, discrete
business units have been formed including a
transmission business unit and a generation business
unit. Each unit has its own management, staff,
objectives, and facilities. The Operating
Subsidiaries conduct their business in a manner that
is consistent with FERC's Standards of Conduct.
The Orders require that all transmission
requests for service be made over the Open Access
Same Time Information System (OASIS). The OASIS, an
internet-based nationwide electronic network, became
operational on January 3, 1997. The Operating
Subsidiaries, in conjunction with a consortium of
transmission providers, continue to work to upgrade
the OASIS by improving its efficiency and adding new
functions that are intended to promote the purchases
and sales of transmission services under the open
access tariff.
11
The FERC established its jurisdiction over
unbundled retail as well as wholesale transmission
services in Order 888. Although states retain the
authority to determine if retail wheeling should be adopted,
retail transmission service under the jurisdiction of the
FERC is available once these historically franchised
customers have access to alternate generation
sources. Pennsylvania enacted legislation authorizing
retail choice for selected customers as of November
1, 1997 (Customer Choice Act). Prior to the
implementation of the Customer Choice Act, the
Operating Subsidiaries added to their open access
tariff a retail access supplement authorizing the
sale of open access transmission services to retail
customers who have chosen a new electric supplier
during the course of the Pennsylvania pilot program
under the Customer Choice Act.
In compliance with Pennsylvania's restructuring
requirements and in conjunction with the merger
plans, in August 1997 AE and DQE filed jointly with
the FERC an Allegheny Energy open access tariff.
The Operating Subsidiaries also have on file
with the FERC a Standard Generation Service Rate
Schedule for the sale of wholesale power at cost-
based rates. In October 1997, the Operating
Subsidiaries submitted a new wholesale tariff to the
FERC asking for authority to sell power at market-
based rates. The Operating Subsidiaries will begin
selling power at marketbased rates once the filing
has been accepted by the FERC.
The Operating Subsidiaries are founding members of
the General Agreement on Parallel Paths (GAPP). Six GAPP
participants joined together to implement the GAPP
experiment which commenced on April 2, 1997. The
primary purpose of the Experiment is to develop a mutually
acceptable method of resolving the inequities imposed on
transmission network owners by parallel power flows. Using data
collected during the experiment, the participants
reallocate filed open access tariff rates to match
compensation for transmission services with actual
use of the interconnected grid. At the FERC's
request, in November 1997 the participants submitted
a status report detailing the results of the first
six months of operation and will conduct a technical
conference at the FERC sometime in 1998.
Under PURPA, certain municipalities, businesses
and private developers have installed, are installing
or are proposing to install generating facilities at
various locations in or near the Operating
Subsidiaries' service areas with the intent of
selling some or all of the electric capacity and
energy to the Operating Subsidiaries at rates
consistent with PURPA and ordered by appropriate
state commissions. As a result of PURPA, the
Operating Subsidiaries are committed to purchase 299
MW of online PURPA capacity. Payments for PURPA
capacity and energy in 1997 totaled approximately
$134.8 million at an average cost to the Operating
Subsidiaries of 5.6 cents/kWh, as compared to the Operating
Subsidiaries' own generating cost of about 3
cents/kWh. The Operating Subsidiaries project an
additional 180 MW of PURPA capacity (Warrior Run) to
come on-line in 1999. It is expected that the
Warrior Run project will result in substantial rate
increases for Potomac Edison's Maryland customers.
(See ITEM 3. LEGAL PROCEEDINGS for a description of
litigation and regulatory proceedings in Pennsylvania
and West Virginia concerning other proposed PURPA
projects.)
UNREGULATED SALES
In 1997, AYP Energy provided 3.7 billion kWh of
energy to nonaffiliated customers, including generation from
the Fort Martin Unit No. 1 acquisition amounting to
1.9 billion kWh. Revenues from those sales of
generation were
12
approximately $80.7 million. Total unregulated
operating revenues in 1997 amounted to $85.8 million.
For a discussion of increases in nonutility losses in
1997, See ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -
Earnings Summary.
ELECTRIC FACILITIES
The following table shows Allegheny's December
31, 1997, generating capacity based on the maximum
monthly normal seasonal operating capacity of each
unit. The Regulated Subsidiaries' owned capacity
totaled 8071 MW, of which 7091 MW (88%) are coal
fired, 840 MW (10%) are pumped-storage, 82 MW (1%)
are oil-fired, and 58 MW (1%) are hydroelectric. AYP
Energy, an exempt wholesale generator, also owns 276
MW of coal-fired generation. The term "pumped-
storage" refers to the Bath County station which
stores energy for use principally during peak load
hours by pumping water from a lower to an upper
reservoir, using the most economic available
electricity, generally during off-peak hours. During
the generating cycle, power is produced by water
falling from the upper to the lower reservoir through
turbine generators.
The weighted average age of the Regulated
Subsidiaries' owned steam stations shown on the
following page is about 27.6 years. In 1997,
their book value was $1.8 billion,
average heat rate was 9,936 Btu's/kWh, and their
availability factor was 87.2%. The age of AYP
Energy's owned generation is 31.0 years. In 1997,
the book value of AYP Energy's owned generation was
$168.0 million, average heat rate was 9,594
Btu's/kWh, and the availability factor was 93.4%.
13
Allegheny Stations
Maximum Generating Capacity
(Megawatts) (a)
AYP Dates When
Station Monon- Potomac West Energy Service
Station Units Total gahela Edison Penn (b) Commenced (c)
Coal-fired (steam):
Albright 3 292 216 76 1952-4
Armstrong 2 352 352 1958-9
Fort Martin 2 1,107 249 304 278 276 1967-8
Harrison 3 1,920 480 629 811 1972-4
Hatfield's Ferry 3 1,660 456 332 872 1969-71
Mitchell 1 284 284 1963
Pleasants 2 1,252 313 376 563 1979-80
Rivesville 2 142 142 1943-51
R. Paul Smith 2 115 115 1947-58
Willow Island 2 243 243 1949-60
Oil-fired (steam): (a)
Mitchell 1 82 82 1948
Pumped-storage and Hydro:
Bath County 6 840 227(d) 235(d) 378(d) 1985
Lake Lynn(e) 4 52 52 1926
Potomac Edison 21 6 6 Various
Total Allegheny Owned
Capacity 54 8,347 2,326 2,073 3,672 276
Other Generation
Maximum Generating Capacity
(Megawatts) (f)
AYP Contract
Project Monon- Potomac West Energy Commencement
Project Total gahela Edison Penn (b) Date
Coal-fired: (steam)
AES Beaver Valley 125 125 1987
Grant Town 80 80 1993
West Virginia University 50 50 1992
Hydro:
Allegheny Lock and Dam 5 6 6 1988
Allegheny Lock and Dam 6 7 7 1989
Hannibal Lock and Dam 31 31 1988
Total Other Capacity 299 161 0(g) 138 0
Total Allegheny Owned and
PURPA Committed 8,646 2,487 2,073 3,810 276
Generating Capacity (a)
14
(a) Winter rating. Excludes 207 MW of West Penn oil-
fired capacity at Springdale Power Station and 77 MW of the
total MW at Mitchell Power Station, which were placed on cold
reserve status as of June 1, 1983. Current plans call for the
reactivation/repowering of these units in about five years. On
December 31, 1994, 82 MW of the total MW at Mitchell Power
Station were reactivated.
(b) AYP Energy owns 50% of Unit No. 1 at Fort Martin as an
exempt wholesale generator.
(c) Where more than one year is listed as a commencement date
for a particular source, the dates refer to the years in which
operations commenced for the different units at that source.
(d) Capacity entitlement through ownership of AGC, 27%,
28% and 45% by Monongahela, Potomac Edison and West Penn, respectively.
(e) West Penn has a 30-year license for Lake Lynn, effective
December 1994. Potomac Edison's license for hydroelectric
facilities Dam No. 4 and Dam No. 5 will expire in 2003.
Potomac Edison has received 30-year licenses, effective
January 1994, for the Shenandoah, Warren, Luray and Newport
projects. The FERC accepted Potomac Edison's surrender of
the license for the Harper's Ferry Dam No. 3 and issued
an order effective October 1994.
(f) Other generating capacity available through state utility
commission approved arrangements pursuant to PURPA.
(g) The 180-MW Warrior Run project is under construction and is
planned to begin providing capacity and energy to Potomac
Edison in 1999.
15
ALLEGHENY MAP
The Allegheny Map (Map), which has been omitted,
provides a broad illustration of the names and approximate
locations of Allegheny's major generation and transmission
facilities, both existing and under construction, in a five
state region which includes portions of Pennsylvania, Ohio,
West Virginia, Maryland and Virginia. Additionally, Extra
High Voltage substations are displayed. By use of shading,
the Map also provides a general representation of the service
areas of Monongahela (portions of West Virginia and Ohio),
Potomac Edison (portions of Maryland, Virginia and West
Virginia), and West Penn (portions of Pennsylvania).
Power Stations shown on the Map which appear within the
Monongahela service area are Willow Island, Pleasants, Harrison,
Rivesville, Albright, and Fort Martin. The single Power Station
appearing within the Potomac Edison service area is R. Paul
Smith. The Bath County Power Station appears on the map just
south of the westernmost portion of Potomac Edison's service area
formed by the borders of Virginia and West Virginia. Power
Stations appearing within the West Penn service area are
Armstrong, Mitchell, Hatfield's Ferry, Springdale and Lake Lynn.
The Map also depicts transmission facilities which are (i)
owned solely by the Operating Subsidiaries; (ii) owned by the
Operating Subsidiaries in conjunction with other utilities; or
(iii) owned solely by other utilities. The transmission
facilities portrayed range in capcity from 138kV to 765kV.
Additionally, interconnections with other utilities are
displayed.
16
The following table sets forth the existing miles of
tower and pole transmission and distribution lines and
the number of substations of the Regulated Subsidiaries as
of December 31, 1997:
Above Ground Transmission and
Distribution Lines (a) and Substations
Portion of Total Transmission and
Representing Distribution
Total 500-Kilovolt (kV) Lines Substations(b)
Monongahela 20,952 283 350
Potomac Edison 17,988 202 262
West Penn 23,998 273 711
AGC(c) 85 85 1
Total 63,023 843 1,324
(a) The Operating Subsidiaries have a total of 6,379
miles of underground distribution lines.
(b) The substations have an aggregate transformer
capacity of 55,375,620 kilovoltamperes.
(c) Total Bath County transmission lines, of which
AGC owns an undivided 40% interest and Virginia Power owns
the remainder.
The Operating Subsidiaries have 12 extra-high-voltage (345-
kV and above) (EHV) and 31 lower-voltage interconnections
with neighboring utility systems. The interregional EHV
transmission system, including System facilities, continued to
operate near reliability limits during periods of heavy power
flows that are predominantly in a west-to-east orientation.
In early 1997, the North American Electric Reliability Council (NERC)
implemented the development of a national security process. The
Operating Subsidiaries serve as one of the 22 national Security
Coordinators. This process includes a Transmission Loading Relief
procedure that reduces loading on the transmission system when
necessary and effectively addresses parallel path flows.
Wholesale generators and other wholesale customers may now
seek from owners of bulk power transmission facilities a commitment
to supply transmission services. (See discussion under ITEM 1. SALES.)
Such demand on the Operating Subsidiaries' transmission facilities
may add to heavy power flows on the Operating Subsidiaries' facilities
and may, eventually, require construction of additional transmission
facilities.
The Operating Subsidiaries have, since the early 1980's, provided
contractual access to their transmission facilities under various
tariffs. As described earlier, for new agreements starting in 1996,
access is also governed by the provisions of the Operating Subsidiaries'
open access tariffs filed with the FERC.
RESEARCH AND DEVELOPMENT
The Operating Subsidiaries spent $7.4 million, $7.7 million, and
$9.0 million, in 1997, 1996, and 1995, respectively, for research programs.
Of these amounts, $5.7 million, $5.5 million, and $6.2 million were for
Electric Power Research Institute (EPRI) dues in 1997, 1996, and 1995,
respectively. EPRI is an industry-sponsored research and development
institution. The Operating Subsidiaries plan to spend approximately $7.8
17
million for research in 1998, with EPRI dues representing $5.9 million of
that total.
In addition to EPRI support, in-house research
conducted by Allegheny concentrated on
environmental protection, generating unit
performance and future generation technologies,
transmission system performance, delivery systems,
customer-related research, clean power technology
focused on power quality and load management
devices, and techniques for customer, delivery
equipment and marketing. All Allegheny-funded
research is related to adapting both competitive
and leading edge technology to Allegheny's
operations.
Research is also being directed to help
address major issues facing our industry, including
electric and magnetic field (EMF) assessment of
employee exposure within the work environment,
waste disposal and discharges, greenhouse gases,
renewable resources, fuel cells, new combustion
turbines, cogeneration technologies, and transmission loading
mitigation using Flexible AC Transmission System
(FACTS) devices. A constructed wetlands project at
the Springdale Power Station significantly improved
the water quality of the effluent from a closed ash
management facility. The project received the 1996
Industrial Excellence Award from the Pennsylvania
Water Environment Association and the 1997 Governor
of Pennsylvania's Environmental Excellence Award.
During 1997, the Operating Subsidiaries supported
the federal government's National EMF Research and
Public Information Dissemination Program, a project
on biomechanisms with the Massachusetts Institute
of Technology, and an Edison Electric Institute
(EEI) program to study employee and public health
effects, if any, of EMF. An investigation of the
value of biodiversity of lands owned by Allegheny
is being done. The financial effect of these
issues on Allegheny, if any, cannot be determined
at this time. In addition, there is continuing
evaluation of technical proposals from outside
sources and monitoring of developments in industry-
related literature, law and litigation, general
business and environmental standards (ISO 9000 AND
ISO 14000), and intellectual property rights. The
World Health Organization over the next two to
three years will issue a report on EMF affecting
future R&D funding.
Because of the NOx control requirements of the
Clean Air Act Amendments of 1990 (CAAA), Allegheny
is participating in a collaborative effort
coordinated by EPRI to gain a greater understanding
of the formation of ground level ozone and how
measures to control NOx and volatile organic
compounds affect ozone formation. The North
American Research Strategy for Tropospheric Ozone-
Northeast is focused on this effort. Other
research is directed at NOx control technologies
for power station compliance, including optimizing
existing low NOx burners to improve performance.
The Operating Subsidiaries continue to monitor
and demonstrate technical solutions to greenhouse
gas reduction, sequestration, capture, and control.
As part of their response to EPACT and President
Clinton's subsequent Climate Action Plan, the Operating
Subsidiaries, as part of an EEI program, have agreed to
participate in research initiatives which are designed
to reduce, sequester or control greenhouse gases. This
program is consistent with filings made with the
Department of Energy (DOE) in voluntary compliance
with Section 1605(b) of EPACT.
Electric vehicle (EV) research through 1997
included participation in the EV America and the Electric
Transportation Coalition, as well as the
development of appropriate wiring and building code
standards to accommodate electric vehicles. As a
result, Allegheny is positioned to support
commercial manufacturers when they move forward
with EV development.
18
In 1997 research was also directed into
communication systems to develop and demonstrate a
high speed advanced power line communication system
using existing utility wires to service information
and automation needs of Allegheny's customers and
to support system requirements in retail wheeling
and marketing.
Allegheny continues to pursue beneficial uses
of coal combustion by-products. In cooperation
with the West Virginia Division of Environmental
Protection, a project is under way to investigate
the feasibility and cost-effectiveness of injecting
fly ash from Allegheny-owned power stations into
abandoned underground mine sites in West Virginia
to reduce acid mine drainage and mine surface
subsidence. The project cost is being shared with
EPRI as part of a Tailored Collaboration Agreement.
Also being investigated is the use of fly ash as a
construction material for a residential home
demonstration and consideration of flue-gas
desulfurization byproducts for road building.
As part of customer research, a model home
program is underway and adjustable speed drives for
customer motor loads are being used at a steel
company and at an extrusion process plant. An
effort in which West Penn participated in 1997 is
the Pennsylvania Electric Energy Research Council
(PEERC). PEERC was formed in 1987 as a partnership
of Pennsylvaniabased electric utilities to promote
technological advancements related to the electric
utility industry.
In 1997 the Operating Subsidiaries made research
grants to regional colleges and universities to encourage
the development of technical resources related to
current and future utility problems.
CAPITAL REQUIREMENTS AND FINANCING
Construction expenditures by the Regulated
Subsidiaries in 1997 amounted to $284.7 million.
Construction expenditures for 1998 and 1999 are
expected to aggregate $274.5 million and $305.5 million,
respectively. Construction expenditures by AYP
Capital, the wholly-owned nonutility (unregulated)
subsidiary of AE, in 1997 amounted to $1.4 million
and for 1998 and 1999 are expected to aggregate
$32.6 million and $8.5 million, respectively. In
1997, regulated expenditures included $2.6 million
for compliance with the CAAA. The 1998 and 1999
estimated regulated expenditures include $1.6
million and $13.9 million, respectively, to cover
the costs of compliance with the CAAA.
Expenditures to cover the costs of compliance with
the CAAA were much more significant in prior years
and may be again in future years if required for
Phase II compliance. Additionally, new environmental
initiatives (see ITEM 1. ENVIRONMENTAL MATTERS)
may substantially increase Allegheny's
construction requirements as early as 2000.
19
Construction Expenditures
1997 1998 1999
Millions of Dollars
(Actual) (Estimated)
Monongahela
Generation Business Unit $ 22.5 $ 31.2 $29.5
Transmission Business Unit 7.0 4.5 5.3
Distribution Business Unit 47.6 41.4 39.7
Retail Business Unit 0.0 0.7 0.4
Other 1.0
Total* $ 78.1 $ 77.8 $74.9
Potomac Edison
Generation Business Unit $ 19.5 $ 16.3 $27.0
Transmission Business Unit 3.8 1.0 9.2
Distribution Business Unit 53.6 65.5 75.3
Retail Business Unit 0.0 1.2 0.8
Other 1.4
Total* $ 78.3 $ 84.0 $112.3
West Penn
Generation Business Unit $ 40.9 $ 40.6 $ 55.4
Transmission Business Unit 13.8 5.6 2.1
Distribution Business Unit 66.3 58.6 57.4
Retail Business Unit 0.0 0.8 0.5
Other 7.1 6.7 0.8
Total* $ 128.1 $ 112.3 $116.2
AGC & APSC $ .2 $ .4 $ 2.1
Total Construction Expenditures, $ 284.7 $ 274.5 $305.5
Regulated
AYP Capital, Unregulated $ 1.4 $ 32.6 $ 8.5
Total Capital Expenditures $ 286.1** $ 307.1** $ 314.0**
* Includes allowance for funds used during construction (AFUDC)
for 1997, 1998 and 1999 of: Monongahela $1.4, $1.7
and $2.3; Potomac Edison $2.8, $2.2 and $2.8; and
West Penn $4.1, $2.8 and $3.6.
** Includes amounts for projects connected with
Allegheny's restructuring of $28.9, $17.2 and $0.3
for 1997, 1998 and 1999, respectively.
These Capital Expenditures include major
projects at existing generating stations,
upgrading distribution lines and substations, and
the strengthening of the transmission and
subtransmission systems.
On a collective basis for the Regulated
Subsidiaries, expenditures for 1997, 1998 and
1999 include $30.8 million, $19.7 million, and
$52.5 million, respectively, for construction
of currently mandated environmental control
20
technology. Outages for construction, CAAA compliance
work, and other environmental work is, and will continue
to be, coordinated with planned outages where possible.
Allegheny continues to study ways to reduce and
meet existing customer demand and future increases in
customer demand, including demand-side management
programs, new and efficient electric technologies,
construction of various types and sizes of generating
units, increasing the efficiency and availability of
Allegheny generating facilities, reducing internal
electrical use and transmission and distribution
losses, and, acquisition of energy and capacity from
third-party suppliers. The advent of retail
competition is expected to have a significant effect
on load growth and the Operating Subsidiaries'
obligation to meet such load growth.
Potomac Edison is engaged in implementing state
commission ordered demand-side management programs.
(See ITEM 1. REGULATION for a further discussion of
these programs.)
Current forecasts, which reflect demand-side
management efforts and other considerations and
assume normal weather conditions, project average
annual winter and summer peak load growth rates of
1.4% and 1.6%, respectively, in the period 19982008.
Competition for existing loads can have a substantial
impact on those projections. It is anticipated that
existing resources, purchased power arrangements,
reactivation of existing capacity, and/or the
acquisition of capacity will be sufficient for
Allegheny's future needs.
In connection with its construction and demand-side
management programs, Allegheny must make estimates of
the availability and cost of capital as well as the
future demands of its customers that are necessarily
subject to regional, national, and international
developments, changing business conditions, and other
factors. The construction of facilities and their
cost are affected by laws and regulations, lead times
in manufacturing, availability of labor, materials
and supplies, inflation, interest rates, and
licensing, rate, environmental, and other proceedings
before regulatory authorities. Decisions regarding
construction of facilities must now also take into
account retail competition. As a result, future
plans of Allegheny are subject to continuing review
and substantial change.
The Regulated Subsidiaries have financed their
construction programs through internally generated
funds, first mortgage bonds, debentures, medium-term
notes, subordinated debt and preferred stock issues,
pollution control and solid waste disposal notes,
installment loans, long-term lease arrangements,
equity investments by AE (or, in the case of AGC, by
the Operating Subsidiaries), and, where necessary,
interim short-term debt. The future ability of the
Regulated Subsidiaries to finance their construction
programs by these means depends on many factors,
including creditworthiness, and adequate revenues to
produce satisfactory internally-generated funds and
return on the common equity portion of the
Subsidiaries' capital structures and to support their
issuance of senior and other securities. AE obtains
funds for equity investments in the Regulated
Subsidiaries through retained earnings and the
issuance and sale of its common stock publicly.
In 1997, AE issued 595,990 shares of its common stock
for $16.7 million through its Dividend Reinvestment and
Stock Purchase Plan (DRISP), its Employee Stock Ownership
and Savings Plan (ESOSP), and its Performance Share
Plan. Beginning in the third quarter of 1997, AE
began buying shares in the open market for the DRISP
and ESOSP plans.
During 1997, the rate for West Penn's 400,000
shares of market auction preferred stock, par value
$100 per share, reset approximately every 90 days
21
at 4.008%, 4.2%, 4.29% and 4.1%. The rate set at
auction for payment on January 14, 1998 was 3.95%.
At December 31, 1997, short-term debt was
outstanding in the following amounts: AE $206.4
million, Monongahela $58.3 million, and West Penn
$52.0 million. At December 31, 1997, AGC had $5.3
million invested and Potomac Edison had $1.5 million
invested.
The Regulated Subsidiaries' ratios of earnings
to fixed charges for the year ended December 31,
1997, were as follows: Monongahela, 4.14; Potomac
Edison, 3.76; West Penn, 3.92; and AGC, 4.14.
Allegheny's consolidated capitalization ratios
as of December 31, 1997, were: common equity, 48.8%;
preferred stock, 3.7%; and long-term debt, 47.5%,
including Quarterly Income Debt Securities (QUIDS)
(3.4%). Allegheny Energy's long-term objective is to
maintain the common equity portion above 46%.
During 1998, Monongahela, Potomac Edison and West
Penn anticipate meeting their capital requirements through
a combination of internally generated funds, cash on
hand, shortterm borrowing as necessary, and refunding
a portion of maturing long-term debt.
FUEL SUPPLY
Allegheny stations burned approximately 17.2
million tons of coal in 1997. Of that amount, 84%
was either cleaned (5.4 million tons) or used in
stations equipped with scrubbers (9.1 million tons).
The use of desulfurization equipment and the cleaning
and blending of coal make burning local higher-sulfur
coal practical. In 1997, almost 100% of the coal
received at Allegheny-operated stations came from
mines in West Virginia, Pennsylvania, Maryland, and
Ohio. Allegheny does not mine or clean any coal.
All raw, clean, or washed coal is purchased from
various suppliers as necessary to meet station
requirements.
Long-term arrangements, subject to price change,
are in effect to provide for approximately 15.0
million tons of coal in 1998. The Operating
Subsidiaries will depend on short-term arrangements
and spot purchases for their remaining requirements.
Through the year 1999, the total coal requirements of
present Allegheny-operated stations are expected to
be met with coal acquired under existing contracts or
from known suppliers.
For each of the years 1993 through 1996, the average
cost per ton of coal burned was $36.19, $35.88, $32.68,
and $32.25, respectively. For the year 1997, the
cost per ton increased to $32.66.
Long-term arrangements, subject to price change,
are in effect and will provide for the lime
requirements of scrubbers at Allegheny's scrubbed
stations.
In addition to using ash in various power plant
applications such as scrubber by-product
stabilization at Harrison and Mitchell Power
Stations, the Operating Subsidiaries continue
their efforts to market coal combustion by-products
for beneficial uses and thereby reduce landfill
requirements. (See ITEM 1. RESEARCH AND
DEVELOPMENT.) In 1997, the Operating Subsidiaries
received approximately $656,000 from the sale of
178,000 tons of fly ash and 127,000 tons of bottom
ash for various uses, including cement replacement,
mine grouting, oil well grouting, soil extenders, and
anti-skid material.
The Operating Subsidiaries own coal reserves
estimated to contain about 125 million tons of higher
sulfur coal recoverable by deep mining. There are
22
no present plans to mine these reserves and, in view of
economic conditions now prevailing in the coal
market, the Operating Subsidiaries plan to hold the
reserves as a long-term resource.
RATE MATTERS
On August 1, 1997, West Penn filed its Restructuring
Plan with the Pennsylvania PUC. The Customer Choice Act
required every utility in the State to file a
restructuring plan. These filings address a number
of regulatory issues including unbundling of rates,
implementation of customer choice and recovery of
stranded costs. In its August 1 filing, West Penn
identified $2.0 billion (a January 1, 1999 present
value amount) of stranded costs. This amount was
revised to $1.6 billion (including $55.4 million of
buy-out and associated legal costs) to reflect
subsequent settlements for a PURPA related power
supply contract relating to Burgettstown.
Evidentiary hearings were held in December 1997 and
January 1998 on West Penn's restructuring filing.
Intervenors include the Office of Consumer Advocate,
the Pennsylvania PUC Office of Trial Staff, ARMCO
Steel, Allegheny Teledyne, the Office of Small
Business Advocate, West Penn Industrial Intervenors,
Enron and the City of Pittsburgh. Intervenors in the
proceeding have recommended a significantly lower
amount of stranded cost recovery, or in some cases
recommended no stranded cost recovery. A Commission
order is expected by June 1998. West Penn cannot
predict the outcome of this proceeding. For a
discussion of West Penn's restructuring plan, see
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Significant Continuing Issues - Electric Energy
Competition and Note C to the Consolidated Financial
Statements in ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA.
The West Virginia PSC, the Ohio PUC, and
Virginia SCC began or continued investigations during
1997 regarding the restructuring of and competition
in the electric utility industry. (See ITEM 1.
BUSINESS - Competition for a description of these
proceedings).
On August 26, 1997, West Penn entered
into an agreement with Milesburg Energy Inc., subject
to Pennsylvania PUC approval, to buy out and settle a
disputed obligation with the developers of the
proposed Milesburg Power Plant. On October 24, 1997,
the Pennsylvania PUC approved the agreement. See
ITEM 3. LEGAL PROCEEDINGS for a description of the
Milesburg buyout.
On December 1, 1997, West Penn reached agreement with
the developer of the proposed Burgettstown facility,
Washington Power, to buy out and terminate all
obligations to purchase power from the proposed 80
megawatt Burgettstown project. See ITEM 3. - LEGAL
PROCEEDINGS for a description of the Burgettstown buyout.
In Maryland, Potomac Edison filed its annual
update to the Energy Conservation Surcharge (ECS) in
July 1997. The Maryland PSC, in September, accepted
the filing, which increased the annual recovery by
$3.4 million to $12.3 million. Also in September,
the Maryland PSC accepted revisions to Potomac
Edison's line extension program (with undergrounding
of distribution facilities mandated by Maryland),
which transferred the responsibility for trenching
and backfilling to residential customers and either
eliminates or significantly reduces cost to serve
these new customers. During 1997, Potomac Edison
discontinued two minor surcharges; one recovering
costs associated with start up payments to a PURPA
project and the second which refunded to customers a
credit associated with a special contract.
23
In 1997, the Maryland PSC instituted a proceeding to
investigate the effect of the proposed AE and DQE
merger on Potomac Edison's Maryland customers and
operations. On March 6, 1998, a settlement agreement was
filed with the PSC. In the settlement, as a sharing of
merger synergy benefits, Potomac Edison agreed to reduce
annual retail base rates by $4.4 million upon merger
consummation. Additionally, the parties to the settlement
recommended that the Maryland PSC find it is in the public
interest for AE to issue additional common stock to exchange
for DQE, Inc. stock, as provided in the Merger Agreement.
Potomac Edison expects that the Maryland PSC will act on the
settlement by May 1, 1998.
On March 11, 1998, the Maryland PSC docketed a proceeding
to consider a petition by the People's Counsel in Maryland to
reduce Potomac Edison's rates by at least $15 million. Potomac
Edison responded by opposing the petition. The Maryland PSC
staff filed in support of the People's Counsel's petition.
Potomac Edison cannot predict the outcome of this proceeding.
Potomac Edison submitted its Annual Informational Filing
to the Virginia SCC on June 30, 1997. After review by the SCC
Staff, the Virginia SCC, on October 6, 1997 ordered that rates for
customers in Virginia remain unchanged.
Currently, all state regulatory jurisdictions
except Pennsylvania and the FERC utilize fuel clause
procedures to recognize changes in fuel and other
energy costs in rates. These procedures utilize an
expedited proceeding which permits energy costs to be
adjusted on a more timely basis than other costs.
Differences between revenues received for energy
costs and actual energy costs are deferred until the
next proceeding when energy rates are adjusted to
return or recover previous overrecoveries or
underrecoveries, respectively. This procedure
minimizes the effect on net income associated with
changes in energy costs. With the move toward
competition, fuel clause procedures may be altered or
discontinued as experienced in Pennsylvania.
In preparation for retail competition in
Pennsylvania, West Penn filed a petition on February
28, 1997 with the Pennsylvania PUC asking for
permission to zero its Energy Cost Rate (ECR) and
state tax surcharge tariffs and to roll energy costs
and state tax adjustments into base rates, effective
May 1,1997. On April 24, 1997, the Pennsylvania PUC
approved West Penn's request.
West Penn's petition was necessitated by the passage
of the Customer Choice Act, which capped electric
rates in Pennsylvania as of January 1, 1997. Prior
to May 1, 1997, changes in West Penn's costs of
fuel, purchased power, and certain other costs, and
changes in revenues from sales to other utilities,
including transmission services, were passed on to
customers by adjustment to customer bills through
the ECR with the result that such changes had no
effect on net income. Effective May 1, 1997, West
Penn began assuming the risks and benefits of
changes in these costs and revenues.
On June 30, 1997, the West Virginia PSC issued
an order in the annual Expanded Net Energy Cost
proceedings under which Monongahela and Potomac
Edison received annual increases of $1.4 million and
$2.4 million, respectively. The increases were
primarily due to the removal of a credit, which had
been refunding to customers a prior overrecovery of
fuel costs. The new rates became effective July 1,
1997.
Fuel proceedings before the Ohio PUC require a
mid-term filing, financial audit, management
performance audit, and an annual filing. The Ohio PUC
approved a stipulated agreement for Monongahela on
January 28, 1998, which granted an increase of $1 million
due primarily to the removal of a credit, which had been
refunding to customers a prior overrecovery of fuel costs.
The new rate was effective February 1, 1998.
Existing energy rates in Maryland and Virginia
did not change in 1997. On January 15, 1998, Potomac
Edison filed with the Virginia SCC for an annual
increase in fuel rates of $2.1 million to become
effective March 9, 1998. The increase was primarily
due to an increase to collect from customers a prior
underrecovery of fuel costs and a small increase in
fuel costs. On February 25, 1998, the Virginia SCC
approved the increase, to become effective March 7,
1998.
AGC's rates are set by a formula filed with and
previously accepted by the FERC. The only component
that changes is the return on equity (ROE). Pursuant
to a settlement agreement filed April 4, 1996, with the
FERC, AGC's ROE was set at 11% for 1996 and will continue
until the time any affected party seeks renegotiation of
the ROE. Notice of such intent to seek a
24
revision in ROE must be filed during a notice
period each year between November 1 and November 15.
No requests for change were filed during the 1997
notice period. Therefore, AGC's ROE will remain at
11% for 1998.
ENVIRONMENTAL MATTERS
The operations of the Allegheny-operated
generating stations are subject to regulation as to
air and water quality, hazardous and solid waste
disposal, and other environmental matters by various
federal, state, and local authorities. That portion
of Fort Martin Unit 1 (50%) owned by AYP Capital is
subject to the same environmental regulations as other
units owned by the Operating Subsidiaries. Compliance
strategies, compliance assurance, permitting,
compliance costs, allowance allocation, etc. for this
unit are closely coordinated with AYP Capital.
Meeting known environmental standards is
estimated to cost the Operating Subsidiaries about
$103 million in construction expenditures over the
next three years. Additional legislation or
regulatory control requirements have been proposed
and, if enacted, will require modifying,
supplementing, or replacing equipment at existing
stations at substantial additional cost.
Climate Change Negotiations
Climate change is alleged to be the result of the
atmospheric accumulation of certain gases collectively
referred to as greenhouse gases (GHG), the most
significant of which is carbon dioxide (CO2). Human
activities, particularly combustion of fossil fuels,
are alleged to be responsible for this accumulation of
GHG. The third Conference of the Parties to the
United Nations Framework Convention on Climate Change
(COP-3) took place in Kyoto, Japan from December 1-11,
1997. COP-3 resulted in the adoption of the Kyoto
Protocol, which specifies individual targets for
industrialized countries to reduce emissions of GHG in
the 2008-2012 time period. The Kyoto Protocol will
enter into force when ratified by 55 Parties to the
Convention including enough of the industrialized
countries that will be governed by it to represent 55%
of their collective 1990 CO2 emissions. It is
uncertain whether the Kyoto Protocol will
be ratified by the U.S. Senate. Ratification could
require reduction of CO2 emissions in the U.S. by
approximately 35% from projected levels in the 2008-
2012 time period and substantially increase the cost
of operating coal-fired power plants. Allegheny will
be assessing what actions it may need to take as the
implications of the Kyoto Protocol for the U.S. become
clearer.
Air Standards
Allegheny currently meets applicable standards as
to particulate and opacity at the power stations
through highefficiency electrostatic precipitators,
cleaned coal, flue-gas conditioning, and, at times,
reduction of output. From time to time minor
excursions of opacity, normal to fossil fuel
operations, are experienced and are accommodated by
the regulatory process.
Allegheny meets current emission standards as to
SO2 by the use of scrubbers, the burning of low-sulfur
coal, the purchase of cleaned coal to lower the sulfur
content, and the blending of lowsulfur with higher sulfur coal.
The CAAA, among other things, require an annual
reduction in total utility emissions within the United
States of 10 million tons of SO2 and two
million tons
25
of NOx from 1980 emission
levels, to be completed in two phases, Phase I and
Phase II. Five coal-fired Allegheny plants are
affected in Phase I and the remaining plants and
units reactivated in the future will be affected in
Phase II. Installation of scrubbers at the Harrison
Power Station was the strategy undertaken by
Allegheny to meet the required SO2 emission
reductions for Phase I (1995-1999). Allegheny
estimates that its banked emission allowances will
allow it to comply with Phase II SO2 limits through
2005. Studies to evaluate cost-effective options to
comply with Phase II SO2 limits beyond 2005,
including those available in connection with the
emission allowance trading market, are continuing.
It is expected that burner modifications at most of
the Allegheny-operated stations will satisfy the NOx
emission reduction requirements for the acid rain (Title IV)
provisions of the CAAA. Additional post-combustion
controls may be mandated in Maryland, Pennsylvania,
and West Virginia for ozone nonattainment (Title I)
reasons. Continuous emission monitoring equipment
has been installed on all Phase I and Phase II units.
In an effort to introduce market forces into
pollution control, the CAAA created SO2 emission
allowances. An allowance is defined as an
authorization to emit one ton of SO2 into the
atmosphere. Subject to regulatory limitations,
allowances (including bonus and extension allowances)
may be sold or banked for future use or sale.
Allegheny received, through an industry allowance
pooling agreement, a total of approximately 554,000
bonus and extension allowances during Phase I. These
allowances are in addition to the CAAA Table A
allowances that the Operating Subsidiaries receive of
approximately 356,000 per year during the Phase I
years. Ownership of these allowances permits
Allegheny to operate in compliance with Phase I, and,
as noted above, is expected to facilitate compliance
during the early years of Phase II. As part of its
compliance strategy, Allegheny continues to study the
allowance market to determine whether sales or
purchases of allowances or participation in certain
derivative or hedging allowance transactions are
appropriate.
Pursuant to an option in the CAAA, Allegheny
chose to treat eight Phase II boilers as Phase-I-
affected units (Substitution Units) for calendar year
1997. The status of all Substitution Units is
evaluated on an annual basis to ascertain the
financial benefits of retaining these units as
Phase-I-affected units. As a result of being
Phase-I-affected, these Substitution Units are
required to comply with the Phase I SO2 limits
for each year that they are accorded substitution
status by Allegheny.
Title I of the CAAA established an Ozone
Transport Region (OTR) consisting of the District of
Columbia, the northern part of Virginia and 11
northeastern states including Maryland and
Pennsylvania. Sources within the OTR will be required
to reduce NOx emissions, a precursor of ozone, to a
level conducive to attainment of the ozone National
Ambient Air Quality Standard (NAAQS). The installation
of Reasonably Available Control Technology (RACT)
(overfire air equipment and/or low NOx burners) at
all Pennsylvania and Maryland stations has been
completed. The installation of RACT satisfies both
Title I and Title IV NOx reduction requirements.
Title I of the CAAA also established an Ozone
Transport Commission (OTC), which has determined that
utilities within the OTR will be required to make
additional NOx reductions beyond RACT in order for
the OTR to meet the ozone NAAQS. Under terms of a
Memorandum of Understanding (MOU) among the OTR
states, Allegheny-operated stations located in
Maryland and Pennsylvania will be required to reduce
NOx emissions by approximately 55% from the 1990
baseline emissions, with a compliance date of May
1999. RACT controls installed in Allegheny's
Maryland and Pennsylvania generating plants are
expected to meet the 55% reduction requirement, at
least for several years. Further reductions of 75%
from the 1990 baseline may be required by May 2003
26
under Phase III of the MOU, unless the results of
modeling studies, due to be completed by the end of
1998, indicate otherwise. If Allegheny has to make
reductions of 75%, it could be very expensive and
would require the installation of postcombustion
control technologies. Pennsylvania promulgated
regulations to implement Phase II of the MOU in
November 1997. Maryland is scheduled to propose Phase
II regulations in early 1998.
During 1995, the Environmental Council of States
(ECOS) and the U.S. Environmental Protection Agency
(EPA) established the Ozone Transport Assessment
Group (OTAG) to develop recommendations for the
regional control of NOx and Volatile Organic
Compounds (VOCs) in 37 states east of and bordering
the west bank of the Mississippi River plus Texas.
OTAG issued its final report in June 1997 that
recommended EPA consider a range of utility NOx
controls between existing Clean Air Act (Title IV)
controls and the less stringent of 85% reduction from
the 1990 emission rate or 0.15 lb/mmBtu. According
to OTAG recommendations, the states would have the
opportunity to conduct additional local and
subregional modeling in order to develop and propose
appropriate levels and timing of controls. The EPA
initiated the regulatory process to adopt the OTAG
recommendations with a proposed State Implementation
Plan (SIP) call issued November 1997. The EPA
proposal would require the equivalent of a uniform
0.15 lb/mmBtu emission rate throughout a 22 state
region, including Maryland, Pennsylvania, and West
Virginia without the benefit of the OTAG recommended
additional subregional modeling evaluation.
Implementation of controls could be required by
summer 2003. EPA intends to finalize the SIP call by
September 1998. Allegheny's compliance with such
stringent regulations would require the installation
of very expensive post-combustion control
technologies on most, if not all, of its power
stations.
In August 1997, eight northeastern states filed
Section 126 petitions with the EPA requesting the
immediate imposition of up to an 85% NOx reduction
from utilities located in the Midwest and Southeast
(West Virginia included). The petitions claim NOx
emissions from these upwind sources are preventing
their attainment with the ozone standard. In December
1997, the petitioning states and EPA signed a Memorandum
of Agreement to address these petitions in conjunction
with the OTAG-related SIP call mentioned above.
The EPA is required by law to regularly review
the NAAQS for criteria pollutants. Recent court
orders in litigation by the American Lung Association
have expedited these reviews. The EPA in 1996
decided not to revise the SO2 and NOx standards.
Revisions to particulate matter and ozone standards
were proposed by the EPA in 1996 and finalized in
July 1997. State attainment plans to meet the revised
standards will not be developed for several years.
Also, in July 1997, EPA proposed regional haze
regulations to improve visibility in Class I federal
areas (natural parks and wilderness areas). If
finalized, subsequent state regulations could require
additional reduction of SO2 and/or NOx emissions from
Allegheny facilities. The impact on Allegheny of
revision to any of these standards or regulations is
unknown at this time but could be substantial.
The final outcome of the revised ambient standards,
Phase III of the MOU, SIP calls and Section 126 petitions
cannot be determined at this time. All are being
challenged via rulemaking, petition and/or litigation
process. NOx controls for the extreme scenarios, 85%
from 1990 levels, could be substantial. Implementation
dates are also uncertain at this time but could be as
early as year 2003, which would require the beginning of
substantial capital expenditures in 2000.
In 1989, the West Virginia Air Pollution Control
Commission approved the construction of a third-party
cogeneration facility in the vicinity of Rivesville,
West Virginia. Emissions impact modeling for that
facility raised
27
concerns about the compliance of Monongahela's
Rivesville Station with ambient standards for SO2.
Pursuant to a consent order, Monongahela agreed
to collect on-site meteorological data and conduct
additional dispersion modeling in order to demonstrate
compliance. The modeling study and a compliance
strategy recommending construction of a new "good
engineering practices" (GEP) stack were submitted
to the West Virginia Department of Environmental
Protection (WVDEP) in June 1993. Costs associated
with the GEP stack are approximately $20 million.
Monongahela is awaiting action by the WVDEP.
Under an EPA-approved consent order with
Pennsylvania, West Penn completed construction of a
GEP stack at the Armstrong Power Station in 1982 at a
cost of over $13 million with the expectation that
EPA's reclassification of Armstrong County to
"attainment status" under NAAQS for SO2 would follow.
As a result of the 1985 revision of its stack height
rules, EPA refused to reclassify the area to
attainment status. Subsequently, West Penn filed an
appeal with the U.S. Court of Appeals for the Third
Circuit for review of that decision as well as a
petition for reconsideration with EPA. In 1988, the
Court dismissed West Penn's appeal, stating it could
not decide the case while West Penn's request for
reconsideration before EPA was pending. West Penn
cannot predict the outcome of this proceeding.
Water Standards
Under the National Pollutant Discharge Elimination
System (NPDES), permits for all of Allegheny's stations and
disposal sites are in place. However, NPDES permit renewals
for several West Virginia and Pennsylvania disposal
sites contain what Allegheny believes are overly
stringent discharge limitations. Allegheny in
cooperation with the states and EPA has developed
alternate water quality criteria which if approved by
the agencies will result in less stringent permit
limits. If their criteria are not approved,
installation of wastewater treatment facilities may
become necessary. The cost of such facilities, if
required, cannot be predicted at this time.
As the result of a lawsuit by environmental
groups, the EPA and WVDEP, on October 27, 1997,
proposed total maximum daily loads (TMDLs) for the
Blackwater River and South Fork of the Potomac River
and five of its tributaries. This is the first of
forty-four court ordered waste load allocations for
West Virginia to be issued over six years which will,
when implemented, reduce the amount of pollutants
that can be discharged into rivers that do not meet
water quality standards. The proposed Blackwater
TMDL would reduce the amount of existing sewage
discharge to the river by fifty percent and eliminate
unused waste load allocations, including those owned
by Allegheny, thereby precluding further development
in the area. Lawsuits have also been filed in a
number of other states including Pennsylvania and
Maryland which will, when settled, force these states
and the EPA to develop and implement wastewater
discharge restrictions. The direct result of these
actions will be further reductions in the amount of
pollutants that can be discharged by certain company
owned power stations which are located on rivers
whose water quality does not meet standards.
Indirectly, the TMDL process can adversely impact the
region's economy and therefore the financial
performance of Allegheny by limiting economic
development and curtailing the wastewater discharges
of existing industrial customers in certain areas.
The total implications of the pending waste load
allocations will not be known until the agencies
develop and implement TMDLs in specific watersheds.
The Pennsylvania Land Recycling Act, adopted in 1996,
and the West Virginia Voluntary Cleanup Act, adopted in
1997, allow for the development and application of site-
specific, risk-based groundwater cleanup standards to both
abandoned and active industrial sites. The intent is to
encourage the reuse of abandoned but contaminated industrial
sites and to allow for continual
28
operation of industrial sites whose operation began
before groundwater protection statutes were in place --
as long as it can be demonstrated by the owner/operator
that there is little or no risk to human health or the
environment. The implementing regulations provide for
reasonable and costeffective groundwater cleanup of
Allegheny facilities should it become necessary and will
encourage economic development in Allegheny's service
territories in Pennsylvania and West Virginia.
Hazardous and Solid Wastes
Pursuant to the Resource Conservation and Recovery
Act of 1976 (RCRA) and the Hazardous and Solid Waste
Management Amendments of 1984, the EPA regulates the
disposal of hazardous and solid waste materials.
Maryland, Ohio, Pennsylvania, Virginia, and West
Virginia have also enacted hazardous and solid waste
management regulations that are as stringent as or
more stringent than the corresponding EPA regulations.
Allegheny is in a continual process of either
permitting new or re-permitting existing disposal
capacity to meet future disposal needs. All disposal
areas are currently operating in compliance with their permits.
Significant costs were incurred during 1995 and
1996 for expansion of existing coal combustion by-
products disposal sites due to requirements for
installation of liners on new sites and assessment of
groundwater effects through routine groundwater
monitoring and specific hydrogeological studies.
Existing sites may not meet the current regulatory
criteria and groundwater remediation may be required
at some of Allegheny's facilities.
Allegheny continues to actively pursue, with
PADEP and WVDEP encouragement, ash utilization
projects such as deep mine injection for subsidence
and water quality improvement, structural fills for
highway and building construction, and soil
enhancement for surface mine reclamation.
Potomac Edison received a notice from the
Maryland Department of the Environment (MDE) in 1990
regarding a remediation ordered under Maryland law at
a facility previously owned by Potomac Edison. The
MDE has identified Potomac Edison as a potentially
responsible party under Maryland law. Remediation is
being implemented by the current owner of the
facility which is located in Frederick. It is not
anticipated that Potomac Edison's share of
remediation costs, if any, will be substantial.
The Operating Subsidiaries are also among a group of
potentially responsible parties under the
Comprehensive Environmental Response, Compensation
and Liability Act of 1980, as amended (CERCLA), for
the Jack's Creek/Sitkin Smelting Superfund Site and
the Butler Tunnel Superfund Site in Pennsylvania.
(See ITEM 3. LEGAL PROCEEDINGS for a description of
these Superfund cases.)
Toxic Release Inventory (TRI)
On Earth Day 1997, President Clinton announced
the expansion of TRI to include electric utilities,
limited to facilities that combust coal and/or oil
for the purpose of generating power for distribution
in commerce. The purpose of TRI is to provide site
specific information on chemical releases to the air,
land, and water. The first TRI report is due on July
1, 1999, for calendar year 1998. The reports will be
filed with EPA and made available through publication
of the reported information and posting on the
Internet. Allegheny is actively working on a
communications plan to proactively educate
29
employees and the community on the TRI program and the
amounts of reportable chemicals released by Allegheny.
REGULATION
Allegheny is subject to the broad jurisdiction
of the SEC under PUHCA. AE, in the past, has
requested the approval of the Maryland PSC as to
certain capital stock issuance matters. The
Regulated Subsidiaries are regulated as to
substantially all of their operations by regulatory
commissions in the states in which they operate. The
Regulated Subsidiaries and AYP Energy are also
regulated by the FERC. In addition, they are subject
to numerous other local, state, and federal laws,
regulations, and rules.
In June 1995, the SEC published its report which
recommended changes to PUHCA, including a
recommendation to Congress to repeal the entire act.
Bills were introduced in the last Congress to repeal
PUHCA, but did not pass. A similar bill is
currently before the U.S. Senate. However, Allegheny
cannot predict what changes, if any, will be made to
PUHCA as a result of these activities.
During 1997, Potomac Edison continued its
participation in the Collaborative Process for demand-
side management in Maryland. Rebates paid in the
various programs totaled $654,259 and the savings in
future generation requirements was 2,527 kW.
In 1997, the Operating Subsidiaries continued to
take part in and fund various programs to assist low
income customers, customers with special needs,
and/or customers experiencing temporary financial
hardship.
ITEM 2. PROPERTIES
Substantially all of the properties of the
Operating Subsidiaries are held subject to the lien
of the indenture securing each Operating Subsidiary's
first mortgage bonds and, in many cases, subject to
certain reservations, minor encumbrances, and title
defects which do not materially interfere with their
use. Some properties are also subject to a second
lien securing certain solid waste disposal and
pollution control notes. The indenture under which
AGC's unsecured debentures and medium-term notes are
issued prohibits AGC, with certain limited
exceptions, from incurring or permitting liens to
exist on any of its properties or assets unless the
debentures and medium-term notes are
contemporaneously secured equally and ratably with
all other indebtedness secured by such lien.
Transmission and distribution lines, in substantial
part, some substations and switching stations, and
some ancillary facilities at power stations are on
lands of others, in some cases by sufferance, but in
most instances pursuant to leases, easements, rights-
of-way, permits or other arrangements, many of which
have not been recorded and some of which are not
evidenced by formal grants. In some cases no
examination of titles has been made as to lands on
which transmission and distribution lines and
substations are located. Each of the Operating
Subsidiaries possesses the power of eminent domain
with respect to its public utility operations. (See
also ITEM 1. BUSINESS and ALLEGHENY MAP.)
ITEM 3. LEGAL PROCEEDINGS
On September 29, 1997, the City of Pittsburgh
filed an antitrust and conspiracy lawsuit in the
Federal District Court for the Western District
30
of Pennsylvania against AE, West Penn, DQE and Duquesne.
The complaint alleged eight counts, two of which were
claimed violations of the antitrust statutes and six
were state law claims. The relief sought included a
request that the proposed merger between AE and DQE
be stopped. The complaint also, requested unspecified monetary
damages relating to alleged collusion between the two
companies in their actions dealing with proposals to
provide electric service to redevelopment zones in
the city. On October 27, 1997, all defendants filed
motions to dismiss the complaint. On January 6,
1998, the District Court issued an order which
granted the motions to dismiss. On January 14, 1998,
the City appealed the order to the United States
Court of Appeals for the Third Circuit. AE and West
Penn cannot predict the outcome of this appeal.
Pursuant to PURPA, in 1987, West Penn entered
into separate Electric Energy Purchase Agreements
(EEPAs) with developers of three PURPA projects:
Milesburg (43 MW), Burgettstown (80 MW), and Shannopin
(80 MW). The EEPAs provided for the purchase of each project's
power over 30 years or more at rates generally
approximating West Penn's estimated avoided cost at
the time the EEPAs were negotiated. Each EEPA was
subject to prior Pennsylvania PUC approval. In 1987
and 1988, West Penn filed a separate petition with
the Pennsylvania PUC for approval of each EEPA.
Thereafter the Pennsylvania PUC issued orders that
significantly modified the EEPAs. Since that time,
all three EEPAs, as modified, have been, in varying
degrees, the subject of complex and continuing
regulatory and judicial proceedings.
West Penn and the developers of the Shannopin
project reached an agreement on January 25, 1996,
which provided that West Penn would buy out the
Shannopin EEPA and terminate the project and all
pending litigation associated with the Shannopin
project for a price of $31 million. The buyout
agreement which was approved by the Pennsylvania PUC
on May 28, 1996, provided for full pass-through of
the buyout price to West Penn's customers through the
energy cost rate by no later than March 31, 1999.
However, a Secretary's letter issued by the
Pennsylvania PUC on August 25, 1997 impacted this
recovery. This letter ruling effectively eliminated
the ECR as a mechanism for future recovery of costs,
including non-utility generator (NUG) and purchased
power costs, but allowed these costs to be rolled
into base rates subject to final review and
resolution by the Pennsylvania PUC in West Penn's
Restructuring proceeding. Passthrough of the
outstanding and unsecured amount of $7 million of the
buyout price will be reviewed by the Pennsylvania PUC
as a component of West Penn's restructuring
proceedings.
On August 26, 1997, West Penn and the developers
of the Milesburg project entered into a Buyout
Agreement for a price of $15 Million. West Penn
assumed ownership of the project property as a
condition of the buyout. The Buyout Agreement was
conditioned on Pennsylvania PUC approval of the
buyout agreement, approval of collection of the
buyout costs and approval of the settlement as a
whole. By order entered October 24, 1997, the
Pennsylvania PUC approved the Buyout Agreement,
approved of collection of the buyout costs and
approved of the settlement as a whole. The
Pennsylvania PUC ordered the pass through of the cash
portion of the termination consideration of $15
million plus interest and ordered that it be
accomplished by applying the residual of over-
collected amounts in the ECR. In West Penn's
restructuring case in Pennsylvania, West Penn also
requested recovery of $5 million associated with
environmental remediation of the site.
On May 2, 1995, Washington Power, the developer
of the Burgettstown project, filed a complaint against
West Penn, AE and APSC in the United States District Court
for the Western District of Pennsylvania asserting claims
of treble damages for monopolization and attempts to
monopolize in violation of the federal antitrust laws,
unfair competition, breach of contract, intentional
interference with contract and interference with prospective
31
business relations. This complaint was
later amended to add a count alleging wrongful use of
civil proceedings. On April 1, 1996, Champion
Processing, Inc., North Branch Energy, Inc., and Air
Products and Chemicals, Inc., claiming involvement or
potential involvement in the Burgettstown project,
filed a similar complaint alleging anti-trust
violations, unfair competition and intentional
interference with a contract. The complaints were
consolidated. As of December 1, 1997, AE, West Penn
and the developers of the Washington Power Project
reached an agreement to buy out and terminate an
arrangement to purchase power from the proposed 80-megawatt
cogenerating facility near Burgettstown in Washington County,
Pennsylvania, and to settle associated litigation
including the above-referenced two antitrust
lawsuits. Under the agreement, West Penn agreed to
buy out and settle the disputed obligation with the
project developers for a cash amount of $48 million.
Initially, the West Penn restructuring filing
reflected $330.8 million, present value, of stranded
costs for the Washington Power obligation.
Thereafter, these stranded costs were reduced from
$330.8 million to $55.4 million to reflect the
savings from the buyout and the continuing claim for
the buyout amount and the associated legal costs.
In October 1993, South River Power Partners,
L.P. (South River) filed a complaint against West
Penn with the Pennsylvania PUC. The complaint sought
to require West Penn to purchase 240 MW of power from
a proposed coal-fired PURPA project to be built in
Fayette County, Pennsylvania. West Penn opposed this
complaint. On October 7, 1996, the Pennsylvania PUC
dismissed the complaint on the basis that the
developers had failed to demonstrate that they had a
"defined and viable" Qualifying Facility (QF)
project. On July 9, 1997, the Pennsylvania
Commonwealth Court upheld the Pennsylvania PUC's
dismissal of the South River complaint. On December
2, 1997, the Pennsylvania Supreme Court dismissed the
developer's appeal.
On September 7, 1995, MidAtlantic Energy
(MidAtlantic) sued Monongahela, Potomac Edison, and
AE in state court in Marshall County, West Virginia
for failure to comply with PURPA regulations in
refusing to purchase capacity and energy from a
proposed PURPA project and interference with
MidAtlantic's contract with the Babcock and Wilcox
Company (B and W), among other things. This suit
followed an unsuccessful complaint proceeding by
MidAtlantic requesting the West Virginia PSC to order
Monongahela and Potomac Edison to purchase capacity
and energy from the project. The MidAtlantic suit
also named B and W as a defendant. MidAtlantic seeks
compensatory and punitive damages. Monongahela,
Potomac Edison and AE filed an answer and B and W
filed an answer and counterclaim. The parties are
proceeding with discovery. Monongahela, Potomac
Edison and AE cannot predict the outcome of this
litigation.
On August 13, 1996, American Bituminous
Partners, L.P., (AmBit), filed a request for
arbitration alleging that the energy rate payable
under its purchase power contract with Monongahela
had been improperly calculated. The arbitration
proceeding was bifurcated into a liability phase and,
if necessary, a damages phase. A hearing in the
liability phase of the arbitration proceeding has
been completed and briefed. On February 18, 1998,
the arbitration panel made a determination in the
liability phase. They determined that certain lime
handling costs should have been a component of the
energy rate and therefore were improperly accounted
for in 1995 and 1996. The damages phase of the
arbitration on this issue will be limited to
determination of the extent of these costs and any
related lime handling costs that AmBit can show
should have been included in the calculation of the
energy rate. Monongahela cannot predict the outcome
of this proceeding.
32
As of January 13, 1998, Monongahela has been named as
a defendant along with multiple other defendants in a
total of 7,021 pending asbestos cases involving one
or more plaintiffs. Potomac Edison and West Penn have
been named as defendants along with multiple other
defendants in approximately one-half of those
cases. Because these cases are filed in a "shot-gun"
format whereby multiple plaintiffs file claims
against multiple defendants in the same case, it is
presently impossible to determine the actual number
of cases in which plaintiffs make claims against the
Operating Subsidiaries. However, based upon past
experience and available data, it is estimated that
about one-third of the total number of cases filed
actually involve claims against any or all of the
Operating Subsidiaries. All complaints allege that
the plaintiffs sustained unspecified injuries
resulting from claimed exposure to asbestos in
various generating plants and other industrial
facilities operated by the various defendants,
although all plaintiffs do not claim exposure at
facilities operated by all defendants. With very few
exceptions, plaintiffs claiming exposure at stations
operated by the Operating Subsidiaries were employed
by third-party contractors, not the Operating
Subsidiaries. Three plaintiffs are known to be
either present or former employees of Monongahela.
Each plaintiff generally seeks compensatory and
punitive damages against all defendants in amounts of
up to $1 million and $3 million, respectively; in
those cases which include a spousal claim for loss of
consortium, damages are generally sought against all
defendants in an amount of up to an additional $1
million. A total of 94 cases have been previously
settled and/or dismissed as against Monongahela for
an amount substantially less than the anticipated
cost of defense. While the Operating Subsidiaries
believe that all of the cases are without merit, they
cannot predict the outcome nor are they able to
determine whether additional cases will be filed.
On January 27, 1995, Allegheny filed a
declaratory judgment action in the Court of Common
Pleas of Westmoreland County, Pennsylvania against
its historic comprehensive general liability (CGL)
insurers. This suit seeks a declaration that the CGL
insurers have a duty to defend and indemnify the
Operating Subsidiaries in the asbestos cases, as well
as in certain environmental actions. To date, two
insurers have settled. However, the final outcome of
this proceeding cannot be predicted.
On March 4, 1994, the Operating Subsidiaries
received notice that the EPA had identified them as
potentially responsible parties (PRPs) under the
Comprehensive Environmental Response, Compensation
and Liability Act of 1980, as amended, with respect
to the Jack's Creek/Sitkin Smelting Superfund Site
(Site). There are approximately 875 other PRPs
involved. A Remedial Investigation/Feasibility Study
(RI/FS) prepared by the EPA originally indicated
remedial alternatives which ranged as high as $113
million, to be shared by all responsible parties. A
PRP Group consisting of approximately forty (40)
members, and to which the Operating Subsidiaries
belong, has been formed and has submitted an addendum
to the RI/FS which proposes a substantially less
expensive cleanup remedy. In January 1998, this PRP
Group has made a good-faith offer to the EPA to
settle this matter. A final determination has not
been made for the Operating Subsidiaries' share of
the remediation costs based on the amount of
materials sent to the site. However, at this time it
is estimated that the impact to the Operating
Subsidiaries will not be material.
Potomac Edison received a questionnaire on
October 1, 1996 from the EPA concerning a release or
threat of release of hazardous substances,
pollutants, or contaminants into the environment at
the Butler Tunnel Site located in Luzerne County,
Pennsylvania. Potomac Edison notified the EPA that
it has no records or recollection of any business
relations with the site or any of the companies
identified in the questionnaire. It is
not possible to determine at this time what impact,
if any, this matter may have on Potomac Edison.
33
After protracted litigation concerning the
Operating Subsidiaries' application for a license to
build a 1,000-MW energy-storage facility near Davis,
West Virginia, in 1988 the U.S. District Court
reversed the U.S. Army Corps of Engineers' (Corps)
denial of a dredge and fill permit on the grounds
that, among other things, the Operating Subsidiaries
were denied an opportunity to review and comment upon
written materials and other communications used by
the Corps in reaching its decision. As a result, the
Court remanded the matter to the Corps for further
proceedings. This remand order has been appealed.
The Operating Subsidiaries cannot predict the outcome
of this proceeding.
In 1979, National Steel Corporation (National
Steel) filed suit against AE and certain subsidiaries
in the Circuit Court of Hancock County, West
Virginia, alleging damages of approximately $7.9
million as a result of an order issued by the West
Virginia PSC requiring curtailment of National
Steel's use of electric power during the United Mine
Workers' strike of 1977-8. A jury verdict in favor
of AE and the subsidiaries was rendered in June 1991.
National Steel has filed a motion for a new trial,
which is still pending before the Circuit Court of
Hancock County. AE and the subsidiaries believe the
motion is without merit; however, they cannot predict
the outcome of this case.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
AE, Monongahela, Potomac Edison, West Penn and
AGC did not submit any matters to a vote ofshareholders
during the fourth quarter of 1997.
34
Executive Officers of the Registrants
The names of the executive officers of each company,
their ages as of December 31, 1997, the positions they
hold, or held during 1997, and their business
experience during the past five years appears below:
Position (a) and Period of Service
Name Age AE MP PE WP AGC
Charles S. Ault 59 V.P.
(1990- )
Eileen M. Beck 56 Secretary Secretary Secretary Secretary Secretary
(1988- ) (1995- ) (1996-) (1996- ) (1982- )
Previously, Previously, Previously, Previously,
Asst. Treas. Asst. Treas. Asst. Sec. Asst. Sec.
(1979-95) (1981-95) (1988-95) (1988-95)
Asst. Sec.
(1988-94)
Nancy L. Campbell 58 V.P. Treasurer Treasurer Treasurer Treasurer
(1994- ) (1995- ) (1996- ) (1996- ) (1988- )
& Treas. Previously, Previously
(1988- ) Asst. Sec. Asst. Sec.
(1988-96) (1988-96)
Asst. Treas.
(1988-95)
C. Vernon Estel, Jr. 42 V.P.
(1996- )
Richard J. Gagliardi 47 V.P. Asst. Sec. Asst. Treas.
(1991- ) (1990-96) (1982-96)
Thomas K. Henderson 57 V.P. V.P. V.P. V.P. Dir. & V.P.
(1997- ) (1995- ) (1995- ) (1985- ) (1996- )
Kenneth M. Jones 60 V.P. & Dir. & V.P.
Controller (1991- )
(1991- )
Thomas J. Kloc 45 Controller Controller Controller Controller
(1996- ) (1988- ) (1995- ) (1988- )
James D. Latimer 59 V.P. V.P. V.P.
(1995- ) (1995- ) (1995- )
Previously,
Executive V.P.
(1994-95)
V.P.
(1988-94)
Michael P. Morrell(b) 49 Sr. V.P. Dir. & V.P. Dir. & V.P. Dir. & V.P. Dir. & V.P.
(1996- ) (1996- ) (1996- ) (1996- ) (1996- )
Alan J. Noia(c) 50 Chairman Chairman Chairman Chairman Chairman,
& CEO & CEO & CEO &CEO Pres. & CEO
(1996- ) (1996- ) (1996- ) (1996- ) (1996- )
Pres.& Dir. Dir. Dir. Dir. Previously,
(1994- ) (1994- ) (1990- ) (1994- ) Dir. & V.P.
Previously Previously, (1994-96)
COO Pres.
(1994-96) (1990-94)
Karl V. Pfirrmann 49 V.P. V.P. V.P.
(1996- ) (1996- ) (1996- )
35
Executive Officers of the Registrants, cont'd.
The names of the executive officers of each company, their ages as of
December 31, 1997, the positions they hold, or held during
1997, and their business experience during the past five
years appears below:
Position (a) and Period of Service
Name Age AE MP PE WP AGC
Jay S. Pifer 60 Senior V.P. Pres. & Dir. Pres. & Dir. Pres.
(1996- ) (1995- ) (1995- ) (1990- )
& Dir.
(1992- )
Victoria V. Schaff 53 V.P.
(d) (1997- )
Peter J. Skrgic 56 Senior V.P. V.P. V.P. & Dir. V.P. V.P. & Dir.
(1994- ) (1996- ) (1990- ) (1996- ) (1989- )
Previously, & Dir. & Dir.
V.P. (1990- ) (1990- )
(1989-94)
Robert R. Winter 54 V.P. V.P. V.P.
(1987- ) (1995- ) (1995- )
(a) All officers and directors are elected annually.
(b) Prior to joining Allegheny, Mr. Morrell
was V.P. - Regulatory and Public Affairs, Jersey Central
Power & Light Company (JCP&L) (8/94-4/96); V.P.
Materials, Services and Regulatory Affairs, JCP&L, (1/93-8/94);
and V.P. and Treasurer, GPU, Inc. and Subsidiaries (2/86-1/93).
(c) Chairman AE (formerly Allegheny Power System, Inc.), effective
June 1, 1997.
(d) Prior to joining Allegheny, Ms. Schaff was a Federal Affairs
Representative with the Union Electric Company (4/88-12/95).
36
PART II
ITEM 5. MARKET FOR THE REGISTRANTS' COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
AE
AYE is the trading symbol of the common stock of
AE on the New York, Chicago, and Pacific Stock
Exchanges. The stock is also traded on the Amsterdam
(Netherlands) and other stock exchanges. As of
December 31, 1997, there were 53,389 holders of
record of AE's common stock.
The tables below show the dividends paid and the high
and low sale prices of the common stock for the periods
indicated:
1997 1996
Dividend High Low Dividend High Low
1st Quarter 43 cents $31-5/8 $29-1/8 42 cents $30-7/8 $28
2nd Quarter 43 cents $30-1/8 $25-1/2 42 cents $31-1/16 $28-1/2
3rd Quarter 43 cents $30-3/8 $26-5/8 42 cents $31 $29
4th Quarter 43 cents $32-19/32 $27-1/4 43 cents $31-1/8 $28-7/8
The high and low prices through March 5, 1998 were $32-7/16 and
$30-1/8. The last reported sale on that date was at $30-3/4.
Monongahela, Potomac Edison, and West Penn. The information
required by this Item is not applicable as all the common stock of
the Operating Subsidiaries is held by AE.
AGC. The information required by this Item is not
applicable as all the common stock of AGC is held by
Monongahela, Potomac Edison, and West Penn.
37
ITEM 6. SELECTED FINANCIAL DATA
Page No.
AE D-1
Monongahela D-4
Potomac Edison D-6
West Penn D-8
AGC D-10
D-1
Allegheny Energy, Inc.
Consolidated Statistics
Year ended December 31 1997 1996 1995 1994 1993 1992 1987
Summary of Operations
(Millions of Dollars)
Operating revenues $2,369.5 $2,327.6 $2,315.2 $2,184.6 $2,050.6 $1,962.6 $1,820.5
Operation expense 1,065.9 1,013.0 1,024.9 1,017.8 927.5 907.9 865.8
Maintenance 230.6 243.3 249.5 241.9 231.2 210.9 180.8
Restructuring charges 103.9 23.4 9.2
and asset write-offs
Depreciation 265.7 263.2 256.3 223.9 210.4 197.8 158.8
Taxes other than income 187.0 185.4 184.7 183.1 178.8 174.6 125.9
Taxes on income 168.1 128.0 154.2 125.9 128.1 115.4 134.6
Allowance for funds
used during construction -8.3 -5.9 -8.2 -19.6 -21.5 -17.5 -5.1
Interest charges and
preferred dividends 197.2 191.1 196.9 184.1 180.3 171.3 153.0
Other income and -18.0 -4.4 -6.2 -1.5 -1.3 -.3
deductions
Consolidated income before
cumulative effect of
accounting change 281.3 210.0 239.7 219.8 215.8 203.5 207.0
Cumulative effect of
accounting change, net (a) 43.4
Consolidated net income $281.3 $210.0 $239.7 $263.2 $215.8 $203.5 $207.0
Common Stock Data(b)
Shares outstanding (Thousands) 122,436. 121,840. 120,701. 119,293. 117,664. 113,899. 102,982.
Average shares outstanding 122,208. 121,141. 119,864. 118,272. 114,937. 111,226. 102,184.
(Thousands)
Earnings per average share:c
Consolidated income before
cumulative effect of
accounting change $2.30 $1.73 $2.00 $1.86 $1.88 $1.83 $2.02
Cumulative effect of
accounting change $.37
Consolidated net income $2.30 $1.73 $2.00 $2.23 $1.88 $1.83 $2.02
Dividends paid per share $1.72 $1.69 $1.65 $1.64 $1.63 $1.605 $1.47
Dividend payout ratiod 74.7% 97.5% 82.5% 88.3% 86.9% 88.3% 72.6%
Shareholders 53,389 58,677 63,280 66,818 63,396 63,918 71,985
Market price range per share:
High 32 19/32 31 1/8 29 1/4 26 1/2 28 7/16 24 3/8 24 1/2
Low 25 1/2 28 21 1/2 19 3/4 23 7/16 20 3/4 15 11/16
Book value per share $18.43 $17.80 $17.65 $17.26 $16.62 $16.05 $14.09
Return on average(d)
common equity 12.63% 9.69% 11.35% 10.96% 11.40% 11.45% 14.51%
Capitalization Data
(Millions of Dollars)
Common stock $2,256.9 $2,169.1 $2,129.9 $2,059.3 $1,955.8 $1,827.8 $1,451.6
Preferred stock: Not
subject to mandatory
redemption 170.1 170.1 170.1 300.1 250.1 250.1 235.1
Subject to mandatory redemption 25.2 26.4 28.0 30.8
Long-term debt and QUIDS 2,193.1 2,397.1 2,273.2 2,178.5 2,008.1 1,951.6 1,604.3
D-2
Allegheny Energy, Inc.
Consolidated Statistics (continued)
Total capitalization $4,620.1 $4,736.3 $4,573.2 $4,563.1 $4,240.4 $4,057.5 $3,321.8
Capitalization ratios:
Common stock 48.8% 45.8% 46.6% 45.1% 46.1 45.0% 43.7%
Preferred stock:
Not subject to
mandatory redemption 3.7 3.6 3.7 6.6 5.9 6.2 7.1
Subject to mandatory redemption .6 .6 .7 .9
Long-term debt and QUIDS 47.5 50.6 49.7 47.7 47.4 48.1 48.3
Total Assets (Millions of
Dollars $6,654.1 $6,618.5 $6,447.3 $6,362.2 $5,949.2 $5,039.3 $4,304.3
Property Data (Millions of Dollars)
Gross property $8,451.4 $8,206.2 $7,812.7 $7,586.8 $7,176.9 $6,679.9 $5,320.2
Accumulated depreciation (3,155.2) (2,910.0) (2,700.1) (2,529.4) (2,388.8) (2,240.0) (1,539.2)
Net property $5,296.2 $5,296.2 $5,112.6 $5,057.4 $4,788.1 $4,439.9 $3,781.0
Gross additions during year
-utility $284.7 $289.5 $319.1 $508.3 $574.0 $487.6 $218.9
-nonutility $1.4 $178.5
Ratio of provisions for
depreciation to depreciable
property 3.34% 3.47% 3.50% 3.32% 3.37% 3.31% 3.21%
Year ended December 31 1997 1996 1995 1994 1993 1992 1987
Revenues (Millions of Dollars)
Residential $893.3 $932.2 $927.0 $863.7 $818.4 $734.9 $633.7
Commercial 491.0 492.7 493.7 459.3 430.2 391.9 331.6
Industrial 747.9 752.9 770.2 728.0 673.4 637.7 593.1
Wholesale and other 75.2 74.3 66.1 65.8 60.3 60.0 49.7
Bulk power 120.5 23.1 13.0 29.0 28.5 91.7 190.4
Transmission services 41.6 52.4 45.2 38.8 39.8 46.4 22.0
Total revenues 2,369.5 2,327.6 2,315.2 2,184.6 2,050.6 1,962.6 1,820.5
Sales Volumes-gWh
Residential 12,825 13,328 13,003 12,630 12,514 11,746 10,271
Commercial 8,173 8,132 7,963 7,607 7,440 7,071 5,965
Industrial 18,875 18,568 18,457 17,708 16,967 16,910 15,557
Wholesale and other 1,421 1,456 1,304 1,275 1,240 1,186 1,039
Bulk power 5,355 1,075 507 1,086 1,145 3,164 8,608
Transmission services 12,444 17,402 14,586 9,405 11,864 15,426 6,576
Total sales 59,093 59,961 55,820 49,711 51,170 55,503 48,016
Output and Delivery-GWh
Steam generation 43,463 40,067 39,174 38,959 38,247 40,373 41,905
Hydro and pumped-storage 1,171 1,348 1,234 1,390 1,233 1,204 1,294
generation
Pumped-storage input (1,298) (1,405) (1,390) (1,564) (1,385) (1,340) (1,440)
Purchased power 6,485 5,518 5,021 4,136 4,002 2,690 2,289
Transmission services 12,444 17,402 14,586 9,405 11,864 15,426 6,576
Losses and system uses (3,172) (2,969) (2,805) (2,615) (2,791) (2,850) (2,608)
Total sales as above 59,093 59,961 55,820 49,711 51,170 55,503 48,016
Utility Statistics
Year ended December 31 1997 1996 1995 1994 1993 1992 1987
Energy Supply
Generating capability-MW
Utility-owned 8,071 8,070 8,070 8,070 7,991 7,991 7,991
Nonutility contracts(e) 299 299 299 299 292 212 118
Maximum hour peak-MW 7,423 7,500 7,280 7,153 6,678 6,530 5,653
Load factor 68.3% 67.5% 68.3% 66.8% 70.0% 69.3% 71.7%
D-3
Allegheny Energy, Inc.
Heat rate-Btu's per kWh 9,936 9,910 9,970 9,927 10,020 9,910 9,903
Fuel costs-cents per million
btu's 130.05 129.22 130.2 141.5 142.12 141.93 139.69
Customers (Thousands)
Residential 1,224.9 1,213.7 1,204.4 1,189.7 1,176.6 1,161.5 1,083.3
Commercial 151.5 148.5 146 143 140.1 137.4 121.9
Industrial 25.2 25.0 24.6 24.2 23.8 23.6 21.5
Other 1.3 1.3 1.3 1.3 1.2 1.2 1.2
Total customers 1,402.9 1,388.5 1,376.3 1,358.2 1,341.7 1,323.7 1,227.9
Average Annual Use-
kWh per customer
Residential-Allegheny
Energy 10,521 11,042 10,865 10,682 10,715 10,181 9,560
Residential-National 9,531f 9,713 9,583 9,378 9,394 8,949 8,861
All retail service- 28,647 29,085 28,908 28,205 27,800 27,259 26,204
Allegheny Energy
Average Rate-cents per kWh
Residential-Allegheny
Energy 6.96 6.99 7.13 6.84 6.54 6.26 6.17
Residential-National 8.95f 8.86 8.87 8.83 8.73 8.63 7.75
All retail service-
Allegheny Energy 5.36 5.46 5.58 5.43 5.23 4.96 4.92
a To record unbilled revenues, net of income taxes.
b Reflects a two-for-one common stock split effective November 4, 1993.
c Basic and diluted earnings per average share.
d Excludes the cumulative effect of the accounting change in 1994 and includes
the effect of restructuring in 1995 and 1996.
e Capability available through contractual arrangements with nonutility
generators.
f Preliminary.
D-4
Monongahela Power Company
SUMMARY OF OPERATIONS
Year ended December 31
(Thousands of Dollars)
1997 1996 1995 1994 1993 1992
Electric operating revenues:
Residential............... $199,931 $206,033 $209,065 $190,861 $185,141 $169,589
Commercial.................. 118,825 121,631 124,457 116,201 110,762 102,709
Industrial................. 196,716 200,970 212,427 202,181 187,669 186,442
Wholesale and other, including
affiliates................ 95,579 86,474 84,193 90,351 71,573 49,403
Bulk power................. 7,299 4,772 2,749 7,681 8,382 26,748
Transmission services..... 9,961 12,591 10,589 9,172 9,754 11,571
Total................... 628,311 632,471 643,480 616,447 573,281 546,462
Operation expense .......... 305,487 310,480 330,740 330,909 295,464 286,501
Maintenance................... 70,561 74,735 73,041 69,389 67,770 62,909
Restructuring charges and asset
write-off.................... 24,299 5,493
Depreciation.................... 56,593 55,490 57,864 57,952 56,056 53,865
Taxes other than income......... 38,776 40,418 38,551 40,404 34,076 33,207
Taxes on income............. 47,519 34,496 41,834 30,650 33,612 27,919
Allowance for funds used
during construction....... (1,386) (672) (1,393) (2,946) (5,780) (3,908)
Interest charges............ 38,730 38,604 39,872 38,156 37,588 36,013
Other income, net.. ........ (8,498) (6,831) (9,235) (8,003) (7,203) (8,388)
Income before cumulative effect
of accounting change...... 80,529 61,452 66,713 59,936 61,698 58,344
Cumulative effect of accounting
change, net (a)........... 7,945
Net income.................. $ 80,529 $ 61,452 $ 66,713 $ 67,881 $ 61,698 $ 58,344
Return on average common
equity (b) 13.99% 11.00% 11.92% 10.66% 11.83% 11.96%
(a) To record unbilled revenues, net of income taxes.
(b) Excludes the cumulative effect of the accounting change in 1994 and
includes the effect of restructuring in 1995 and 1996.
D-5
Monongahela Power Company
FINANCIAL AND OPERATING STATISTICS
1997 1996 1995 1994 1993 1992
PROPERTY, PLANT, AND EQUIPMENT
at Dec. 31 (Thousands):
Gross................ $1,950,478 $1,879,622 $1,821,613 $1,763,533 $1,684,322 $1,567,252
Accumulated depreciation (840,525) (790,649) (747,013) (701,271) (664,947) (628,595)
Net................ $1,109,953 $1,088,973 $1,074,600 $1,062,262 $1,019,375 $ 938,657
GROSS ADDITIONS TO PROPERTY
(Thousands):.... ..... $ 78,139 $ 72,577 $ 75,458 $ 103,975 $ 140,748 $ 126,422
TOTAL ASSETS at Dec. 31
(Thousands)............ $1,493,254 $1,486,755 $1,480,591 $1,476,483 $1,407,453 $1,166,410
CAPITALIZATION at Dec. 31
(Thousands):
Common stock ........ $ 540,930 $ 512,212 $ 505,752 $ 495,693 $ 483,030 $ 475,628
Preferred stock...... 74,000 74,000 74,000 114,000 64,000 64,000
Long-term debt and QUIDS 455,088 474,841 489,995 470,131 460,129 444,506
$1,070,018 $1,061,053 $1,069,747 $1,079,824 $1,007,159 $ 984,134
Ratios:
Common stock........ 50.6% 48.3% 47.3% 45.9% 48.0% 48.3%
Preferred stock..... 6.9 7.0 6.9 10.6 6.3 6.5
Long-term debt and QUIDS 42.5 44.7 45.8 43.5 45.7 45.2
100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
GENERATING CAPABILITY--
kW at Dec. 31:
Company-owned......... 2,326,300 2,326,300 2,326,300 2,326,300 2,325,300 2,325,300
Nonutility contracts (a) 161,000 161,000 161,000 161,000 159,000 79,000
KILOWATT-HOURS (Thousands):
Sales Volumes:
Residential............ 2,764,630 2,815,414 2,807,135 2,674,664 2,689,830 2,527,247
Commercial............. 1,987,147 2,007,116 1,967,473 1,846,791 1,825,127 1,742,469
Industrial............. 5,224,364 5,024,257 5,114,126 4,942,388 4,656,921 4,872,126
Wholesale and other,
including affiliates. 2,223,369 1,836,920 1,734,537 1,925,450 1,565,561 824,393
Bulk power............. 249,505 196,843 105,126 285,048 338,476 953,048
Transmission services 3,007,439 4,218,150 3,497,216 2,278,111 2,938,187 3,873,200
Total sales.......... 15,456,454 16,098,700 15,225,613 13,952,452 14,014,102 14,792,483
Output and Delivery:
Steam generation....... 10,936,469 10,678,491 10,620,003 10,743,934 10,194,794 10,593,059
Pumped-storage generation
241,958 263,640 257,284 290,586 263,329 260,155
Pumped-storage input... (310,565) (337,451) (330,915) (373,116) (337,737) (332,989)
Purchased power........ 2,294,059 2,040,136 1,903,644 1,685,938 1,637,677 1,080,279
Transmission services 3,007,439 4,218,150 3,497,216 2,278,111 2,938,187 3,873,200
Losses and system uses (712,906) (764,266) (721,619) (673,001) (682,148) (681,221)
Total sales as above 15,456,454 16,098,700 15,225,613 13,952,452 14,014,102 14,792,483
CUSTOMERS at Dec. 31:
Residential............. 307,920 305,579 303,568 300,465 297,865 294,595
Commercial.............. 37,168 36,323 35,793 35,268 34,626 34,005
Industrial.............. 7,996 8,019 8,085 8,029 8,014 8,005
Other................... 199 182 170 171 170 172
Total customers....... 353,283 350,103 347,616 343,933 340,675 336,777
RESIDENTIAL SERVICE:
Average use-
kWh per customer..... 9,023 9,256 9,306 8,957 9,093 8,636
Average revenue-
dollars per customer. 652.53 677.37 693.11 639.16 625.87 579.51
Average rate-
cents per kWh........ 7.23 7.32 7.45 7.14 6.88 6.71
(a) Capability available through contractual arrangements with nonutility
generators.
D-6
The Potomac Edison Company
SUMMARY OF OPERATIONS
Year ended December 31 (Thousands of Dollars)
1997 1996 1995 1994 1993 1992
Electric operating revenues:
Residential................. $299,876 $324,120 $316,714 $296,090 $274,358 $243,413
Commercial.................. 148,287 146,432 145,096 135,937 124,667 111,506
Industrial.............. ... 198,174 196,813 200,890 195,089 175,902 157,304
Wholesale and other, including
affiliates................ 38,857 34,901 28,592 24,178 28,744 29,480
Bulk power.................. 10,035 7,577 4,566 8,932 8,585 27,488
Transmission services....... 13,552 16,917 14,811 12,675 12,423 14,092
Total..................... 708,781 726,760 710,669 672,901 624,679 583,283
Operation expense............. 359,350 373,133 374,731 362,167 325,239 310,335
Maintenance................... 56,815 62,248 60,052 58,624 64,376 53,141
Restructuring charges and asset
write-off................... 26,094 6,847
Depreciation.................. 71,763 71,254 68,826 59,989 56,449 53,446
Taxes other than income....... 47,585 45,809 47,629 46,740 46,813 45,791
Taxes on income............... 44,496 34,132 36,936 33,126 30,086 28,422
Allowance for funds used
during construction......... (2,830) (2,491) (1,752) (5,874) (7,134) (5,368)
Interest charges.............. 49,823 50,197 51,179 46,456 43,802 39,392
Other income, net............. (13,976) (11,791) (12,044) (10,310) (8,419) (9,352)
Income before cumulative effect
of accounting change........ 95,755 78,175 78,265 81,983 73,467 67,476
Cumulative effect of accounting
change, net (a)............. 16,471
Net income.................... $ 95,755 $ 78,175 $ 78,265 $ 98,454 $ 73,467 $ 67,476
Return on average common equity 13.44% 11.42% 11.34% 11.86% 11.63% 11.85%
(b)
(a) To record unbilled revenues, net of income taxes.
(b) Excludes the cumulative effect of the accounting change in 1994 and
includes the effect of restructuring in 1995 and 1996.
D-7
The Potomac Edison Company
FINANCIAL AND OPERATING STATISTICS
1997 1996 1995 1994 1993 1992
PROPERTY, PLANT, AND EQUIPMENT
at Dec. 31 (Thousands):
Gross................... $2,196,262 $2,124,956 $2,050,835 $1,978,396 $1,857,961 $1,698,711
Accumulated depreciation (859,076) (791,257) (729,653) (673,853) (632,269) (591,378)
Net................... $1,337,186 $1,333,699 $1,321,182 $1,304,543 $1,225,692 $1,107,333
GROSS ADDITIONS TO PROPERTY
(Thousands)............... $ 78,298 $ 86,256 $ 92,240 $ 142,826 $ 179,433 $ 153,485
TOTAL ASSETS at Dec. 31
(Thousands)............... $1,660,647 $1,677,886 $1,654,444 $1,629,535 $1,519,763 $1,355,385
CAPITALIZATION at Dec. 31:
(Thousands):
Common stock............ $ 689,781 $ 678,116 $ 667,242 $ 658,146 $ 626,467 $ 567,826
Preferred stock:
Not subject to
mandatory redemption.. 16,378 16,378 16,378 36,378 36,378 36,378
Subject to mandatory
redemption............ 25,200 26,400 28,005
Long-term debt and QUIDS 627,012 628,431 628,854 604,749 517,910 511,801
$1,333,171 $1,322,925 $1,312,474 $1,324,473 $1,207,155 $1,144,010
Ratios:
Common stock............ 51.8% 51.3% 50.8% 49.7% 51.9% 49.6%
Preferred stock:
Not subject to mandatory
redemption............ 1.2 1.2 1.3 2.7 3.0 3.2
Subject to mandatory
redemption............ 1.9 2.2 2.5
Long-term debt and QUIDS 47.0 47.5 47.9 45.7 42.9 44.7
100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
GENERATING CAPABILITY--
kW at Dec. 31 2,073,292 2,072,292 2,072,292 2,072,292 2,076,592 2,076,592
KILOWATT-HOURS (Thousands):
Sales Volumes:
Residential............. 4,290,117 4,599,758 4,377,416 4,214,997 4,144,958 3,822,387
Commercial.............. 2,331,789 2,288,229 2,213,052 2,136,081 2,091,930 1,954,025
Industrial.............. 5,593,722 5,567,088 5,485,220 5,339,737 5,194,909 4,979,219
Wholesale and other, including
affiliates............ 1,258,259 771,792 656,539 653,614 649,636 616,711
Bulk power.............. 369,732 315,808 173,110 331,832 343,837 958,702
Transmission services... 4,044,837 5,617,912 4,740,010 3,031,339 3,693,330 4,673,518
Total sales........... 17,888,456 19,160,587 17,645,347 15,707,600 16,118,600 17,004,562
Output and Delivery:
Steam generation........ 11,002,533 10,762,678 10,410,118 10,464,607 10,103,411 10,713,987
Hydro and pumped-storage
generation.... 370,026 401,998 395,315 426,550 368,834 351,035
Pumped-storage input.... (426,087) (455,142) (452,151) (506,213) (433,885) (407,393)
Purchased power......... 3,934,815 3,639,519 3,318,302 3,033,744 3,174,838 2,501,733
Transmission services... 4,044,837 5,617,912 4,740,010 3,031,339 3,693,330 4,673,518
Losses and system uses.. (1,037,668) (806,378) (766,247) (742,427) (787,928) (828,318)
Total sales as above.. 17,888,456 19,160,587 17,645,347 15,707,600 16,118,600 17,004,562
CUSTOMERS at Dec. 31:
Residential............... 333,224 327,344 321,813 315,309 309,096 302,559
Commercial................ 43,794 42,670 41,759 40,927 40,173 39,236
Industrial................ 5,010 4,887 4,733 4,595 4,509 4,435
Other..................... 598 571 543 524 510 510
Total customers......... 382,626 375,472 368,848 361,355 354,288 346,740
RESIDENTIAL SERVICE:
Average use-
kWh per customer........ 13,003 14,179 13,729 13,506 13,562 12,766
Average revenue-
dollars per customer.... 908.87 999.10 993.35 948.76 897.70 812.96
Average rate-
cents per kWh........... 6.99 7.05 7.24 7.02 6.62 6.37
D-8
West Penn Power Company
and Subsidiaries
SUMMARY OF OPERATIONS
Year ended December 31
(Thousands of Dollars)
1997 1996 1995 1994 1993 1992
Electric operating revenues:
Residential............ $ 393,036 $ 402,083 $ 401,186 $ 376,776 $ 358,900 $321,871
Commercial............. 223,347 224,663 224,144 207,165 194,773 177,697
Industrial............. 352,730 355,120 356,937 330,739 309,847 293,910
Wholesale and other, including
affiliates........... 72,459 74,328 73,388 67,320 67,806 71,168
Bulk power............. 22,188 10,012 5,687 12,339 11,547 37,490
Transmission services.. 18,402 22,918 19,751 16,998 17,625 20,741
Total................ 1,082,162 1,089,124 1,081,093 1,011,337 960,498 922,877
Operation expense........ 524,051 531,522 523,279 531,059 500,790 494,025
Maintenance.............. 98,252 104,211 114,489 111,841 96,706 93,067
Restructuring charges and asset
write-offs............. 53,343 11,099 8,919
Depreciation............. 113,793 119,066 112,334 88,935 80,872 73,469
Taxes other than income.. 90,140 90,132 89,694 87,224 89,249 87,300
Taxes on income.......... 73,279 47,455 61,745 46,645 51,529 44,078
Allowance for funds used
during construction.... (4,085) (2,723) (5,041) (10,777) (8,566) (8,276)
Interest charges......... 69,629 71,072 67,902 60,274 60,585 55,592
Other income, net........ (17,562) (13,439) (12,287) (13,798) (12,728) (14,534)
Consolidated income before cumulative
effect of accounting change... 134,665 88,485 117,879 101,015 102,061 98,156
Cumulative effect of accounting
change, net (a)........ 19,031
Consolidated net income.. 134,665 $ 88,485 $ 117,879 $ 120,046 $ 102,061 $98,156
Return on average common equity 13.70% 8.72% 11.46% 9.94% 11.49% 11.53%
(b)
(a) To record unbilled revenues, net of income taxes.
(b) Excludes the cumulative effect of the accounting change in 1994 and
includes the effect of restructuring in 1995 and 1996.
D-9
West Penn Power Company
and Subsidiaries
FINANCIAL AND OPERATING STATISTICS
1997 1996 1995 1994 1993 1992
PROPERTY, PLANT, AND EQUIPMENT
at Dec. 31 (Thousands):
Gross..................... $3,293,039 $3,182,208 $3,097,522 $3,013,777 $2,803,811 $2,581,641
Accumulated depreciation.. (1,254,900) (1,152,383) (1,063,399) (1,009,565) (962,623) (904,906)
Net..................... $2,038,139 $2,029,825 $2,034,123 $2,004,212 $1,841,188 $1,676,735
GROSS ADDITIONS TO PROPERTY
(Thousands)................... $ 128,054 $ 130,606 $ 149,122 $ 260,366 $ 251,017 $ 204,409
TOTAL ASSETS at Dec. 31
(Thousands)................... $2,747,159 $2,699,737 $2,771,164 $2,731,858 $2,544,763 $2,083,127
CAPITALIZATION at Dec. 31:
(Thousands):
Common stock............... $ 997,027 $ 962,752 $ 973,188 $ 955,482 $ 893,969 $ 782,341
Preferred stock........... 79,708 79,708 79,708 149,708 149,708 149,708
Long-term debt and QUIDS.. 802,319 905,243 904,669 836,426 782,369 759,005
$1,879,054 $1,947,703 $1,957,565 $1,941,616 $1,826,046 $1,691,054
Ratios:
Common stock.............. 53.1% 49.4% 49.7% 49.2% 49.0% 46.3%
Preferred stock........... 4.2 4.1 4.1 7.7 8.2 8.8
Long-term debt and QUIDS.. 42.7 46.5 46.2 43.1 42.8 44.9
100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
GENERATING CAPABILITY--
kW at Dec. 31:
Company-owned............. 3,671,408 3,671,408 3,671,408 3,671,408 3,589,408 3,589,408
Nonutility contracts (a).. 138,000 138,000 138,000 138,000 133,000 133,000
KILOWATT-HOURS (Thousands):
Sales Volumes:
Residential............... 5,756,594 5,913,412 5,818,838 5,740,028 5,679,746 5,396,533
Commercial................ 3,833,178 3,835,831 3,782,250 3,624,117 3,522,566 3,374,355
Industrial................ 8,046,166 7,974,265 7,857,689 7,426,267 7,114,765 7,058,895
Wholesale and other, including
affiliates.............. 2,400,581 1,659,834 1,621,745 1,530,853 1,821,189 2,247,844
Bulk power................ 1,046,905 453,028 227,893 471,050 462,286 1,253,251
Transmission services..... 5,392,916 7,567,153 6,348,926 4,093,693 5,233,229 6,878,017
Total sales............. 26,476,340 27,403,523 25,657,341 22,886,008 23,833,781 26,208,895
Output and Delivery:
Steam generation.......... 19,523,537 18,578,677 18,143,822 17,750,267 17,949,335 19,066,445
Hydro and pumped-storage
generation.............. 559,241 682,747 581,353 673,195 600,497 592,895
Pumped-storage input...... (561,135) (612,877) (606,953) (684,715) (613,290) (599,729)
Purchased power........... 2,968,258 2,583,166 2,507,196 2,253,701 1,985,240 1,612,093
Transmission services..... 5,392,916 7,567,153 6,348,926 4,093,693 5,233,229 6,878,017
Losses and system uses.... (1,406,477) (1,395,343) (1,317,003) (1,200,133) (1,321,230) (1,340,826)
Total sales as above.... 26,476,340 27,403,523 25,657,341 22,886,008 23,833,781 26,208,895
CUSTOMERS at Dec. 31:
Residential................. 583,745 580,816 578,983 573,963 569,601 564,300
Commercial.................. 70,559 69,457 68,500 66,842 65,337 64,212
Industrial.................. 12,142 12,051 11,801 11,563 11,218 11,138
Other....................... 629 607 598 586 576 569
Total customers........... 667,075 662,931 659,882 652,954 646,732 640,219
RESIDENTIAL SERVICE:
Average use-
kWh per customer.......... 9,903 10,223 10,096 10,041 10,025 9,608
Average revenue-
dollars per customer...... 674.73 695.08 696.06 659.07 633.48 573.07
Average rate-
cents per kWh............. 6.81 6.80 6.89 6.56 6.32 5.96
(a) Capability available through contractual arrangements with nonutility
generators.
D-10
Allegheny Generating Company
STATISTICS
SUMMARY OF OPERATIONS Year ended December 31
(Thousands of Dollars)
1997 1996 1995 1994 1993 1992
Electric operating revenues..... $ 76,458 $ 83,402 $ 86,970 $ 91,022 $ 90,606 $ 96,147
Operation and maintenance
expense....................... 4,877 5,165 5,740 6,695 6,609 6,094
Depreciation.................... 17,000 17,160 17,018 16,852 16,899 16,827
Taxes other than income taxes... 4,835 4,801 5,091 5,223 5,347 5,236
Federal income taxes.. ......... 11,213 13,297 13,552 14,737 13,262 14,702
Interest charges................ 15,391 16,193 18,361 17,809 21,635 22,585
Other income, net............... (9,126) (3) (16) (11) (328) (21)
Net Income.................... $ 32,268 $ 26,789 $ 27,224 $ 29,717 $ 27,182 $ 30,724
Return on average common equity. 15.98% 12.58% 12.46% 13.14% 11.72% 12.79%
PROPERTY, PLANT, AND EQUIPMENT
at Dec. 31 (Thousands):
Gross....................... $828,658* $837,050 $836,894* $824,714 $824,904 $825,493
Accumulated depreciation.... (193,173) (176,178) (159,037) (143,965) (128,375) (114,684)
Net....................... $635,485 $660,872 $677,857 $680,749 $696,529 $710,809
GROSS ADDITIONS TO PROPERTY
(Thousands)................... $ 444 $ 178 $ 14,165* $ 1,065 $ 2,729 $ 3,251
TOTAL ASSETS
at Dec. 31 (Thousands)........ $663,920 $692,408 $710,287 $714,236 $735,929 $727,820
CAPITALIZATION at Dec. 31:
Amount (in thousands):
Common stock................ $199,523 $202,955 $214,153 $222,729 $228,512 $235,530
Long-term debt.............. 148,735 228,634 249,709 267,165 277,196 287,139
$348,258 $431,589 $463,862 $489,894 $505,708 $522,669
Ratios:
Common stock................ 57.3% 47.0% 46.2% 45.5% 45.2% 45.1%
Long-term debt.............. 42.7 53.0 53.8 54.5 54.8 54.9
100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
KILOWATT-HOURS (Thousands):
Pumping energy supplied by
Parents....................... 1,297,787 1,405,470 1,390,019 1,564,044 1,384,912 1,340,111
Pumped-storage generation..... 1,011,366 1,098,278 1,081,112 1,218,446 1,079,985 1,047,015
*Reflects a balance sheet reclassification in 1995 of $12 million from deferred
charges to plant for a prior tax payment, and a related settlement of $8.8
million in 1997 that was recorded as a reduction to plant.
38
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Page No.
AE M-1
Monongahela M-15
Potomac Edison M-27
West Penn M-39
AGC M-53
M-1
Allegheny Energy, Inc.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Factors That May Affect Future Results
This management's discussion and analysis of financial
condition and results of operations contains
forecast information items that are "forward-
looking statements" as defined in the Private
Securities Litigation Reform Act of 1995. All
such forward-looking information is necessarily
only estimated. There can be no assurance that
actual results will not materially differ from
expectations. Actual results have varied
materially and unpredictably from past
expectations.
Factors that could cause actual results to
differ materially include, among other matters,
electric utility restructuring, including the
ongoing state and federal activities; future
economic conditions; earnings retention and
dividend payout policies; developments in the
legislative, regulatory, and competitive
environments in which the Company operates;
environmental legislative and regulatory
changes; and other circumstances that could
affect anticipated revenues and costs, such as
unscheduled maintenance or repair requirements
and compliance with laws and regulations.
Significant Events in 1997, 1996, and 1995
On April 7, 1997, the Company and DQE, Inc.
(DQE), parent company of Duquesne Light Company
in Pittsburgh, Pennsylvania, announced that they
had agreed to merge and that the combined
Company would be called Allegheny Energy, Inc.
Each company held separate shareholder meetings
on August 7 at which the merger was decisively
approved. At the Company's meeting, the
shareholders also approved the change in the
Company's name to Allegheny Energy, Inc. The
merger is contingent upon approval by various
regulatory authorities. See Note B to the
consolidated financial statements and "Proposed
Merger with DQE" on page 33 for additional
information. All of the Company's incremental
costs of the merger process ($11.2 million
through December 31, 1997) are being deferred
and will be written off by the combined Company
when the merger occurs or by the Company if the
merger does not occur.
In December 1996, the Commonwealth of
Pennsylvania enacted the Electricity Generation Customer
Choice and Competition Act (Customer Choice Act)
to restructure the electric industry in
Pennsylvania to create retail access to a
competitive electric energy generation market.
In December 1997, the Maryland Public Service
Commission (PSC) ordered an electric competition
transition plan (Maryland Transition Plan). See
Note C to the consolidated financial statements
for major provisions of the Pennsylvania and
Maryland plans, and "Electric Energy
Competition" on page 33 for additional
information.
In 1996, the Company's nonutility subsidiary,
AYP Capital, Inc. (AYP Capital), expanded its
nonutility operations by forming AYP Energy,
Inc. (AYP Energy) and Allegheny Communications
Connect, Inc. (ACC). In 1997, it formed
Allegheny Energy Solutions, Inc. (Allegheny
Energy Solutions). AYP Energy is an exempt
wholesale generator and bulk power marketer. ACC
was formed to develop opportunities in the
deregulated communications market. Allegheny
Energy Solutions was formed to market electric
energy to retail customers in deregulated
markets and other energy-related services. AYP
Capital, in its own name, also markets various
services related to the electric industry and
has investments in two limited energy
partnerships. In October 1996, AYP Energy
purchased for about $170 million a 50% interest,
276 megawatts (MW), in Unit No. 1 of the
M-2
Allegheny Energy, Inc.
Fort Martin coal-fired power station in West
Virginia. Two of the Company's utility
subsidiaries own the other 50%. In January 1998,
Allegheny Energy Solutions and DQEnergy
Partners, Inc. (DEP), a subsidiary of DQE,
formed Allegheny Energy Solutions, L.L.C., a
limited liability joint venture, to market
electricity and energy-related services.
Allegheny Energy Solutions and DEP each plan to
maintain a 50% interest in Allegheny Energy
Solutions, L.L.C.
In 1994, the Company and its subsidiaries
initiated a restructuring process to consolidate and
reengineer their utility operations to meet the
competitive challenges of the changing electric
utility industry. As a result of this process,
the subsidiaries reduced employment by about
1,000 employees through a voluntary separation
plan, attrition, and layoffs and changed
processes to obtain efficiencies to reduce the
rate of growth in operating and maintenance
costs. This process resulted in restructuring
charges and asset write-offs in 1996 and 1995,
and asset write-offs in 1994.
On August 26, 1997, and December 3, 1997, West
Penn Power Company (West Penn) announced that it had
negotiated agreements to buy out and settle
disputes with developers of proposed nonutility
generation plants (the Milesburg and Washington
Power projects) for $15 million and $48 million,
respectively, reducing costs over the proposed
30- and 33-year lives of the projects by an
estimated $1.4 billion. The disputed projects
under the Public Utility Regulatory Policies Act
of 1978 (PURPA) would have required West Penn to
buy 43 and 80 MW, respectively, of capacity and
energy over the lives of the projects at prices
well above market price estimates. Recovery of
the Milesburg buyout payment, by offset against
a residual balance of deferred fuel liabilities,
was approved by the Pennsylvania Public Utility
Commission (PUC). The Washington Power payment
has been included in amounts for which West Penn
has requested recovery as part of its stranded
cost recovery request in its restructuring
filing required under the Customer Choice Act
and is the subject of a separate request to the
PUC for recovery from customers. In 1996, West
Penn and the developers of a proposed Shannopin
PURPA project reached an agreement to terminate
that project at a buyout price of $31 million.
Recovery of the buyout price was authorized by
the PUC. The Shannopin buyout will reduce West
Penn's costs approximately $665 million over 30
years by eliminating the need to buy the
uneconomic power.
Review of Operations
Earnings Summary
Earnings Earnings
Per Share
(Millions of Dollars Except for Per Share Data)
1997 1996 1995 1997 1996 1995
Utility Operations:
Operations $295.7 $275.5 $254.4 $2.42 $ 2.27 $2.12
Expenses related to restructuring activities (62.6) (14.1) (0.52) (0.12)
295.7 212.9 240.3 2.42 1.75 2.00
Nonutility Operations (14.4) (2.9) (0.6) (0.12) (0.02)
Consolidated Net Income $281.3 $210.0 $239.7 $2.30 $1.73 $2.00
The increase in 1997 earnings from utility operations
resulted primarily from reductions in operation
and maintenance (O&M) expenses from the restructuring
process and additional actions taken during the year to
achieve further O&M reductions in response to significant
decreases in kilowatt-hour (kWh) sales to residential
customers caused primarily by mild weather. Also contributing
to the increase was an $8.3 million (after tax)
M-3
Allegheny Energy, Inc.
interest refund on a tax-related
contract settlement. The increase in 1996
earnings from utility operations was due
primarily to increases in kWh sales and, to a
lesser extent, to increased revenues from retail
rate increases.
The year 1997 was the first full year of
operations of AYP Energy after its purchase in
October 1996 of a 50% ownership interest in Unit
No. 1 of the Fort Martin power station. The
increase in losses from nonutility operations
resulted primarily from low selling prices of
electricity in competitive markets. This
condition is likely to continue until further
deregulation activities expand market
opportunities and competing excess capacity is
absorbed by demand growth. Another item
contributing to the nonutility losses in 1997
was Allegheny Energy Solutions' 50% share of net
losses ($1.4 million) incurred to market energy
to newly deregulated retail customers
participating in a Pennsylvania pilot program
(see Note C to the consolidated financial
statements for more information about the pilot
and DQE's agreement to a 50/50 sharing of
Allegheny Energy Solutions' revenues and
expenses until Allegheny Energy Solutions,
L.L.C. becomes licensed to conduct pilot
business in Pennsylvania). While sales to the
pilot customers did not begin until November
1997, virtually all of the competing energy
suppliers, including Allegheny Energy Solutions,
began their advertising well in advance to
establish brand recognition. Since the total
market demand was limited to 5% of the load of
each rate class of Pennsylvania customers, and
excess capacity is available from many suppliers
(both in-state and out-of-state), the selling
prices are low. For this reason Allegheny Energy
Solutions, L.L.C. does not expect its revenues
during the 1998 pilot to be sufficient to cover
all of its continuing operating expenses.
Allegheny Energy Solutions, L.L.C. will be using
the pilot process to develop its marketing
infrastructure, sales expertise, and brand name
recognition. By beginning early, Allegheny
Energy Solutions, L.L.C. expects to be a strong
and experienced competitor when complete
deregulation arrives. Allegheny Energy Solutions
does not own generating capacity. It purchases
its energy from AYP Energy, which AYP Energy
obtains from its share of the Fort Martin power
station or by purchase from other suppliers.
Sales and Revenues
Percentage changes in revenues and kWh sales in 1997
and 1996 by major retail customer classes were:
1997 vs. 1996 1996 vs. 1995
Revenues kWh Revenues kWh
Residential (4.2%) (3.8%) 0.6% 2.5%
Commercial (0.3) 0.5 (0.2) 2.1
Industrial (0.7) 1.7 (2.3) 0.6
Total (2.1%) (0.4%) (0.6%) 1.5%
The changes in residential kWh sales, which are more weather
sensitive than the other classes, were due primarily to
changes in customer usage because of weather conditions.
The growth in the number of residential customers was .9%
and .8% in 1997 and 1996, respectively. The weather in
1997 was mild in both the early and late winter and in
the summer, causing the 3.8% decrease in residential kWh
sales. In 1996, the early winter (January through April)
was about 10% colder than in 1995. While this cold early
winter was somewhat offset by milder weather the remainder
of the year, the overall average for the year plus the
increase in the number of customers resulted in an increase
in 1996 residential kWh sales of 2.5%.
M-4
Allegheny Energy, Inc.
Commercial kWh sales are also affected by
weather, but to a lesser extent than
residential. The 2.1% increase in 1996 reflects
growth in the number of customers and the
increased heating requirements that year.
The increase in industrial kWh sales in
1997 and 1996 reflects a trend of continued
economic growth in the service territory and, in
1997, to two new customers with particularly
large electricity requirements.
Changes in revenues from retail customers
resulted from the following:
Changes from Prior Year
(Millions of Dollars) 1997 vs. 1996 1996 vs. 1995
Fuel clauses ($28.4) ($40.3)
General tariff rate change (Ohio) 5.6
All other (17.3) 21.7
Net change in retail revenues ($45.7) ($13.0)
Revenues reflect not only the changes in kWh sales,
but also any changes in revenues from fuel and energy cost
adjustment clauses (fuel clauses) which have no
effect on consolidated net income because
increases and decreases in fuel and purchased
power costs and sales of transmission services
and bulk power are passed on to customers by
adjustment of customer bills through fuel
clauses. Effective May 1, 1997, as a result of
the Customer Choice Act, which placed a cap on
electric rates, West Penn filed for and obtained
PUC authorization to set its fuel clause to zero
and to roll its then applicable fuel clause
rates into base rates. Thereafter, West Penn
assumed the risks and benefits of changes in
fuel and purchased power costs and sales of
transmission services and bulk power.
All other is the net effect of kWh sales
changes due to changes in customer usage
(primarily weather for residential customers),
growth in the number of customers, and changes
in pricing other than changes in general tariff
and fuel clause rates. The decrease in 1997 all
other retail revenues is primarily the result of
mild weather in 1997. The increase in 1996 all
other retail revenues was the combined result of
increased customer usage (primarily due to cold
weather in the early 1996 winter) and growth in
the number of customers.
See Note C to the consolidated financial
statements for information about a potential
loss of revenues by West Penn of up to $10
million in 1998 pursuant to a pilot program
under the Customer Choice Act and the potential
for a much greater loss of revenues during the transition
period to complete deregulation (estimated to be
from 1999 to about 2005).
Wholesale customers are cooperatives and
municipalities that own their own distribution
systems and buy all or part of their bulk power
needs from the subsidiaries under regulation by
the Federal Energy Regulatory Commission (FERC).
Other revenues include nonutility revenues from
various energy-related services. The increase in
wholesale and other revenues in 1996 resulted
primarily from load additions to the wholesale
customers' systems. Competition in the wholesale
market for electricity was initiated by the
National Energy Policy Act of 1992 (EPACT),
which permits wholesale generators, utility-
owned and otherwise, and wholesale customers to
request from owners of bulk power transmission
facilities a commitment
M-5
Allegheny Energy, Inc.
to supply transmission services.
Revenues from bulk power transactions consist of
the following items:
(Millions of Dollars) 1997 1996 1995
Revenues:
Utility operations:
Transmission services $ 41.6 $52.4 $45.2
Bulk power 39.6 22.4 13.0
81.2 74.8 58.2
Nonutility operations-bulk power 80.9 0.7
Total bulk power transactions, $162.1 $75.5 $58.2
net
The final rules on open transmission access,
issued by the FERC in early 1996, require utilities to offer
to others transmission service that is comparable
to service they provide to themselves. Revenues
from utility operations' transmission services in
1997 decreased due to reduced
demand, primarily because of mild weather.
Increased transmission services in 1996 resulted
primarily from increased activity from power
marketers who agreed to take service under the
new open access tariffs filed by the
subsidiaries in accordance with the new 1996
rules. The increases in utility operations' bulk
power revenues resulted primarily from increased
sales to power marketers and other utilities
from the subsidiaries' generating plants.
Revenues from nonutility operations were the
result of sales by the Company's nonutility
exempt wholesale generator and power marketer,
AYP Energy, which began operations in late 1996,
and include sales from its share of the Fort
Martin power station as well as from purchased
power.
Operating Expenses
Fuel expenses for 1997, 1996, and 1995 were as
follows:
(Millions of Dollars) 1997 1996 1995
Utility operations $535.7 $512.5 $508.5
Nonutility operations 24.2 0.7
Total fuel expenses $559.9 $513.2 $508.5
Fuel expenses for utility operations
increased 4.5% in 1997 because of a 3.6%
increase in kWh's generated, a .6% increase in
average fuel prices, and a .3% increase in the
average heat rate of the generating stations.
The increase in kWh's generated for utility
operations was primarily the result of increased
utility operations' bulk power sales to
power marketers and other utilities. The 1%
increase in 1996 fuel expenses was due to a 2%
increase in kWh's generated, offset by lower
average coal prices. Fuel expenses for
nonutility operations reflect the kWh's
generated by the 50% of Unit No. 1 of the Fort
Martin power station purchased by AYP Energy in
late 1996.
M-6
Allegheny Energy, Inc.
Purchased power and exchanges, net
represents power purchases from and exchanges
with other companies and purchases from
qualified facilities under PURPA, and consists
of the following items:
(Millions of Dollars) 1997 1996 1995
Purchased power:
Utility operations:
From PURPA generation* $134.8 $132.7 $129.3
Other 41.2 47.3 49.0
Total purchased power for
utility operations 176.0 180.0 178.3
Power exchanges, net .3 3.3 (.2)
Nonutility operations 43.5 1.1
Purchased power and exchanges, net 219.8 184.4 178.1
*PURPA cost (cents per kWh) 5.6 5.5 5.5
Other purchased power for utility operations
in 1997 decreased because of decreased demand due to
decreased sales to retail customers related to
mild 1997 weather, as well as increased availability
of the subsidiaries' power stations. Nonutility
operations' purchases were the result of power replacement
requirements and transaction opportunities by AYP Energy,
which began operations in late 1996.
A PURPA power station project in Potomac Edison
Company's (Potomac Edison) Maryland jurisdiction
is scheduled to commence generation in 1999.
Because of the high cost of this energy, Potomac
Edison unsuccessfully sought a buyout or
restructuring of the existing contract to reduce
the cost to customers. This project will
significantly increase the cost of power
purchases ($60 million or more annually) and
Potomac Edison's rates in Maryland.
None of the subsidiaries' purchased power
contracts is capitalized since there are no
minimum payment requirements absent associated
kWh generation.
Other operation expenses were as follows:
(Millions of Dollars) 1997 1996 1995
Utility operations $292.3 $298.5 $290.5
Nonutility operations 16.7 1.3
Total other operation expenses $309.0 $299.8 $290.5
Utility other operation expenses in 1997
include $3.3 million for increased allowances for
uncollectible accounts and $4.4 million of legal
expenses incurred by West Penn to defend itself
against an antitrust lawsuit filed by the
developers of the proposed Washington Power PURPA
project. The dispute was settled in December
1997. Nevertheless, utility other operation
expense decreased in 1997 because of a reduction in
embedded expenses achieved through the 1996
restructuring process. The increase in utility
other operation expense in 1996 resulted
primarily from increased allowances for
uncollectible accounts ($4 million) and the write-
off of deferred Clean Air Act Amendments of 1990
compliance costs ($4 million).
M-7
Allegheny Energy, Inc.
The increase in nonutility other operation
expenses was due primarily to expenses associated
with AYP Energy, which began operations in late 1996.
A contributing factor to the increase in 1997 was
$3.6 million of operating expenditures representing
Allegheny Energy Solutions' expenses incurred in
marketing energy to retail customers in the
Pennsylvania pilot, of which 50% was billed to DEP
and is recorded as other income. Both West Penn and
Allegheny Energy Solutions expect to incur increased
advertising and other sales related expenditures to
enhance sales and to build brand name recognition.
Maintenance expenses decreased $12.7 million in 1997
due primarily to reduced expenses achieved through
restructuring efforts and other cost controls. AYP
Energy's maintenance expenses were $3.5 million and
$.8 million in 1997 and 1996, respectively.
Maintenance expense represents costs incurred to
maintain the power stations, the transmission and
distribution (T&D) system, and general plant, and
reflects routine maintenance of equipment and rights-
of-way as well as planned major repairs and unplanned
expenditures, primarily from forced outages at the
power stations and periodic storm damage on the T&D
system. Variations in
M-8
Allegheny Energy, Inc.
maintenance expense result primarily from unplanned
events and planned major projects, which vary in timing
and magnitude depending upon the length of time equipment
has been in service without a major overhaul and the
amount of work found necessary when the equipment is
dismantled.
Restructuring charges and asset write-offs in
1996 and 1995 resulted from restructuring activities,
which have been completed, and the write-offs of
previously accumulated costs related to a proposed
transmission line and obsolete and slow-moving
materials.
Depreciation expense in 1997 increased $2.5
million, the net result of a $4.1 million decrease
for utility operations and $6.6 million of annual
depreciation incurred by AYP Energy in 1997 because
of its purchase in October 1996 of a 50% ownership in
Unit No. 1 of the Fort Martin power station. The
utility decrease reflects a reduction in West Penn's
annual depreciation expense determined to be
necessary as part of its comprehensive restructuring
filing required by the Customer Choice Act.
Taxes other than income taxes increased $1.6
million in 1997 due to increased West Virginia
Business and Occupation taxes (B&O) and property
taxes resulting from AYP Energy's purchase of an
ownership interest in the Fort Martin power station.
The B&O tax is based on generating capacity. Taxes
other than income taxes for utility operations
decreased $4.0 million because of decreases in gross
receipts taxes resulting from lower revenues from
retail customers and lower FICA taxes due to the
Company's recent restructuring. The increase in 1996
was due to higher property taxes on utility
operations.
The 1997 increase in federal and state income
taxes was primarily due to increased income in 1997
compared with 1996. The decrease in federal and state
income taxes in 1996 resulted primarily from a
decrease in income before taxes ($23 million),
primarily because of the restructuring charges
recorded in 1996. Note E to the consolidated
financial statements provides a further analysis of
income tax expenses.
The increase in allowance for other than
borrowed funds used during construction (AOFDC) in
1997 resulted primarily from application of the FERC
AOFDC formula under which in 1997 a larger percentage
of construction was financed by more expensive equity
funds rather than by less expensive short-term debt funds.
The decrease in 1996 reflects decreases in capital expenditures.
The increase in other income, net, in 1997 was
due primarily to an interest refund on a tax-related
contract settlement ($8.3 million, net of taxes) and
to a sale of land ($2.8 million, net of taxes). The
decrease in 1996 was due primarily to a write-off of
a deferred return on West Virginia Clean Air Act
expenditures and increased interest income in 1995
associated with 1995 refinancings.
Interest on long-term debt in 1997 increased due
to October 1996 bank borrowings of $160 million by
AYP Energy related to its purchase of an ownership
interest in the Fort Martin power station. Other
interest expense reflects changes in the levels of
short-term debt maintained by the companies
throughout the year, as well as the associated
interest rates.
Dividends on preferred stock decreased $6
million in 1996 due primarily to the redemption of
preferred stock issues.
Financial Condition, Requirements, and Resources
M-9
Allegheny Energy, Inc.
Liquidity and Capital Requirements
To meet the subsidiaries' need for cash for operating
expenses, the payment of interest and dividends,
retirement of debt and certain preferred stocks, and
for their construction programs, the companies have
used internally generated funds and external
financings, such as the sale of common and preferred
stock, debt instruments, installment loans, and lease
arrangements. The timing and amount of external
financings depend primarily upon economic and
financial market conditions, the companies' cash
needs, and capitalization ratio objectives. The
availability and cost of external financings depend
upon the financial health of the companies seeking
those funds and market conditions.
Construction expenditures of all the
subsidiaries in 1997 were $286 million and, for 1998
and 1999, are estimated at $307 million and $314 million,
respectively. The 1998 and 1999 estimated
expenditures include $20 million and $52 million,
respectively, for construction of currently mandated
environmental control technology. It is the Company's
goal to constrain future base construction spending,
with the exception of mandated environmental
expenditures, to the approximate level of
depreciation currently in rates. The subsidiaries
also have additional capital requirements for debt
maturities (see Note K to the consolidated financial
statements).
Internal Cash Flow
Internal generation of cash, consisting of cash flows
from operations reduced by dividends, was $268
million in 1997 compared with $386 million in 1996.
The decrease in 1997 was primarily the result of the
$48 million buyout of the Washington Power PURPA
project and payment of restructuring liabilities.
Current rate levels and reduced levels of
construction expenditures permitted the subsidiaries
to finance nearly all of their construction
expenditures in 1997 and 1996 with internal cash
flow. As described under "Electric Energy
Competition" on page 33, the Company's largest
subsidiary, West Penn, is facing a serious potential
for income erosion. As described under "Environmental
Issues" on page 34, the subsidiaries could
potentially face significant mandated increases in
construction expenditures and operating costs related
to environmental issues. Whether the regulated subsidiaries
can continue to meet the majority of their construction
needs with internally generated cash is largely dependent
upon the outcome of these issues. Dividends paid on common
stock in 1997 increased to $1.72 per share compared with $1.69
in 1996. The dividend payout ratio decreased in 1997 as it did
in 1996, excluding the restructuring charges and asset write-off in 1996.
Financing
During 1997, the Company issued 595,990 shares of
common stock under its Dividend Reinvestment and
Stock Purchase Plan (DRISP), Employee Stock Ownership
and Savings Plan (ESOSP), and Performance Share Plan
(PSP) for $16.7 million. Beginning in the third
quarter of 1997, the Company began buying shares in
the open market for the DRISP and ESOSP plans. Short-
term debt is used to meet temporary cash needs until
the timing is considered appropriate to issue long
term securities. Short-term debt increased $50.0
million to $206.4 million in 1997. At December 31,
1997, unused lines of credit with banks were $260
million. The subsidiaries will meet their 1998 cash
needs through internal cash generation, cash on hand,
short-term borrowing as necessary, and refunding of a
portion of maturing long-term debt.
M-10
Allegheny Energy, Inc.
Significant Continuing Issues
Proposed Merger with DQE
Following the negotiations and announcement of the
merger, the Company and DQE obtained their respective
shareholders' approval, made regulatory filings for
approval, and started the merger planning process by
naming certain employees of both companies, including
management personnel, to merger planning teams. All
of the regulatory approvals are expected by June 30,
1998.
Merger opposition has arisen in two forms:
The City of Pittsburgh filed an antitrust
lawsuit, which was dismissed by the United
States District Court for the Western District of
Pennsylvania in December 1997. The City has since
filed an appeal with the United States Court of
Appeals for the Third Circuit.
Various intervenors in the PUC and the FERC
merger proceedings allege that the combined
company may have the ability to exercise market
power.
An additional risk to the merger is the
possibility that the regulatory approvals might
contain such onerous conditions
that the merger would no longer be beneficial
to shareholders. The companies' proposals for
the sharing of merger synergy savings between
customers and shareholders are described in
Note B to the consolidated financial
statements.
While the Company cannot predict the
outcome of the merger hearings or the City of
Pittsburgh's appeal process, it believes that
the opposition's arguments are without merit
and that the approvals should be received in a
manner which will allow the merger to proceed.
Electric Energy Competition
Competition in the wholesale market for
electricity was initiated by EPACT in 1992 and
Orders 888 and 889 by the FERC in April 1996,
which together mandated that the owners
of transmission facilities provide
nondiscriminatory open access of transmission
services to wholesale customers and electricity
generators, utility-owned and otherwise. With
these actions, wholesale customers obtained the
ability to seek their electricity requirements
from competing generators. The Company has been
an advocate of federal legislation to create
competition in the retail electricity markets to
avoid regional dislocations and ensure level
playing fields. Various bills have been
introduced and debated in the United States
Congress, but none has passed.
In the absence of federal legislation, state-
by-state implementation has begun. Two of the five state
jurisdictions the utility subsidiaries serve,
Pennsylvania and Maryland, have taken action to
begin implementation of access by retail
customers to alternate generation suppliers. The
Pennsylvania process, which began with the
Customer Choice Act in December 1996, is well
under way. Hearings have been completed on West
Penn's restructuring filing required by the
Customer Choice Act. As described in Note C to
the consolidated financial statements,
intervenors in the proceeding have recommended
that West Penn should be allowed to recover
little or none of its stranded costs, i.e., costs
recoverable under regulation, but which will not
be supported in a competitive market. While
M-11
Allegheny Energy, Inc.
they generally agree that low market prices during the
transition period (1999-2005) will cause a
significant reduction of West Penn's revenues and
earnings (perhaps as much as reducing its net
income by half in the earlier years), they allege
that market prices will rise sharply thereafter
and, therefore, West Penn has little or no
stranded costs over the life of its generating
assets.
Nearly all of the parties to the filing
agree that market prices of energy in the
transition period will be well below West Penn's
embedded costs. A significant reason for this
circumstance is a considerable amount of excess
capacity in several states available for the
limited demand of one state, a result of state-by-
state implementation of retail competition. Many
of the out-of-state sellers have the embedded
fixed costs of their excess capacity included in
their rate base with the result that they are
recovering such costs from their regulated
captive retail customers. It is expected that the
other utilities in Pennsylvania will also have
some payment of their embedded costs by their
captive customers through collection of a
Competitive Transition Charge (CTC) to recover
some portion of their stranded costs. The Company
is continuing to advocate federal legislation
through its membership in the Partnership for
Customer Choice, along with six other electric
utilities. The purpose is to seek enactment of
federal legislation to bring choice to electric
customers no later than the year 2000.
West Penn included in its restructuring
filing alternative recommendations for the PUC to
consider to avoid the potential significant
reduction of its revenues and earnings. The
intervenors in the filing have recommended that
West Penn sell all or most of its generation
assets and use the proceeds to cover the stranded
costs. They allege that customers would then not
have to pay any CTC and West Penn would not incur
any losses. The Customer Choice Act specifically
prohibits the PUC from ordering generation
divestiture.
West Penn is making substantial efforts to settle
the case by negotiation with the intervenors. PECO
Energy (PECO), in mid-1997, reached a settlement
with most of its intervenors in its restructuring
proceeding, which the PUC rejected. PECO has
appealed the PUC Order to the Courts.
Portions of the language of the PUC Order in the
PECO proceeding are not supportive of an
acceptable settlement for West Penn if the same
language is applied to West Penn. If a settlement
cannot be reached, the issue will fall to the PUC
in its final Order. In its filing and in
subsequent testimony, West Penn has amply
supported its primary case, which the Commission
could accept. While the Company and West Penn
believe that the worst-case scenario described is
not the intent of the Customer Choice Act, the
decision may ultimately lie with the PUC. The
Company and West Penn cannot predict the outcome.
The Maryland PSC in December 1997 issued an Order
to implement retail competition in that state. A
special task force of the Maryland General
Assembly, which had been working on the same
subject, had not yet issued its report. The PSC's
Order and its revised second Order call for a
deregulation process including a three-year phase-
in beginning July 1, 2000, with recovery of
prudent stranded costs after mitigation. The
Order recognizes that many details are yet to be
decided and calls for roundtable discussions and
adjudicatory proceedings for that purpose, which
should give Potomac Edison the opportunity to
address the uncertainties and problems created.
Among the issues for Potomac Edison is recovery
of the substantially greater-than market costs it
will be required to pay for the PURPA project
scheduled to begin producing energy in 1999.
The regulated utility subsidiaries also
have franchised
<PAGE
M-12
Allegheny Energy, Inc.
regulated customers in Ohio, Virginia, and West
Virginia where the subjects of competition and
deregulation are being debated. We are actively
involved in the debates, with personnel on virtually
all of the various committees and proceedings.
The Company is also advocating federal
legislation to repeal Section 210 of PURPA and the Public
Utility Holding Company Act of 1935 (PUHCA).
Both of these laws severely impede our ability
to compete on equal terms with utility and
nonutility electric providers who are not
subject to their requirements.
With efficient operations, a reputation for
quality service and reliability, and electric
rates among the lowest in the areas they serve,
the Company believes its subsidiaries are well-
positioned for fair and open competition in the
marketplace. But, as West Penn's experience
demonstrates, there is substantial risk inherent
in the transition process of moving toward
retail competition.
Environmental Issues
In the normal course of business, the
subsidiaries are subject to various
contingencies and uncertainties relating to
their operations and construction programs,
including legal actions and regulations and
uncertainties related to environmental matters.
The significant costs of complying with
Phase I of the Clean Air Act Amendments of 1990
(CAAA) have been incurred and are being
recovered currently from customers in rates.
Studies to evaluate cost-effective options to
comply with Phase II SO2 limits, including those
which may be available from the use of the
Company's banked emission allowances and from
the emission allowance trading market, are
continuing.
Title I of the CAAA established an Ozone
Transport Commission to ascertain additional NOx
reductions to allow the Ozone Transport Region
(OTR) to meet the ozone National Ambient Air
Quality Standards (NAAQS). Under terms of a
Memorandum of Understanding (MOU) among the OTR
states, the Company's operating stations located
in Maryland and Pennsylvania will be required to
reduce NOx emissions by approximately 55% from the 1990
baseline emissions, with a compliance date of
May 1999. Further reductions of 75% from the
1990 baseline may be required by May 2003,
depending on the results of modeling studies to
be completed by 1998. If reductions of 75% are
required, installation of post-combustion control
technologies would be very expensive.
Pennsylvania promulgated regulations to
implement Phase II of the MOU in November 1997.
Maryland is scheduled to propose regulations in
early 1998.
Several other significant regulatory
actions initiated in 1997 could require
significant expenditures for further control of
air emissions. In November 1997, the Environ
mental Protection Agency (EPA) issued a proposed
State Implementation Plan (SIP) call which would
require further controls of NOx emissions to the
less stringent of an 85% reduction from 1990
emission rates or an emission rate of 0.15
lb/mmBtu. The EPA intends to finalize the SIP
call by September 1998. Implementation of
controls, which could be required by mid-2003,
would require very expensive post-combustion
control technologies on most, if not all, of the
subsidiaries' power stations.
In August 1997, eight northeastern states
filed Section 126 petitions with the EPA
requesting the immediate imposition of up to an
85% NOx reduction from utilities located in the
Midwest and Southeast (West Virginia included).
The petitions claim NOx emissions from these
upwind
M-13
Allegheny Energy, Inc.
sources are preventing their attainment
of the ozone standard. The EPA will probably
address these petitions in conjunction with the
SIP call mentioned above.
The EPA is required by law to regularly review
the NAAQS for criteria pollutants. Revisions to
particulate matter and ozone standards were
proposed by the EPA in 1996 and finalized in
July 1997. The effect on the subsidiaries of any
revisions to these standards is unknown at this
time but could be substantial. State attainment
plans to meet the revised standards will not be
developed for several years. Also, in July 1997,
the EPA proposed regional haze regulations to
improve visibility in Class I Federal areas
(national parks and wilderness areas). If
finalized, subsequent state regulations could
require additional reductions of SO2 and/or NOx
emissions from the subsidiaries' facilities.
The final outcome of the revised ambient
standards, Phase III of the MOU, SIP calls, and
Section 126 petitions cannot be determined at
this time. All are being challenged by
rulemaking, petition, and/or litigation
proceedings. Implementation dates, if required,
are uncertain at this time, but could be as
early as 2003.
In December 1997, the Clinton Administration, at
a conference in Kyoto, Japan, agreed to a protocol
for greenhouse gas reductions to 7% below 1990
levels as early as 2008. The protocol will not
go into effect unless ratified by the United
States Senate. If implemented, the protocol
would require dramatic reductions in emissions
of carbon dioxide, a major so-called greenhouse
gas emitted during combustion of fossil fuels,
particularly coal. Significant reduction
requirements could force the subsidiaries to
make major changes in electricity production to
reduce or eliminate the use of coal. The Company
is actively opposing implementation of the
protocol in the United States Congress and
through alliances with other affected companies.
The subsidiaries previously reported that the
EPA had identified them and approximately 875 others as
potentially responsible parties in a Superfund site subject
to cleanup. A final determination has not been
made for the subsidiaries' share of the
remediation costs based on the amount of
materials sent to the site. The subsidiaries
have also been named as defendants along with
multiple other defendants in pending asbestos
cases involving one or more plaintiffs. The
subsidiaries believe that provisions for
liability and insurance recoveries are such that
final resolution of these claims will not have a
material effect on their financial position.
Independent Transmission System Operation Study
On December 7, 1997, the Company's utility
subsidiaries announced that they and eight other
investor-owned electric utilities had signed an
MOU to explore the creation of an independent,
regional transmission entity. Many industry
participants, including customers and regulatory
authorities, believe that an entity independent
of the utilities who own the transmission
systems is needed to operate the systems to
ensure nondiscriminatory access to the
transmission systems by all users. As part of
its merger application in Pennsylvania and with
the FERC, the Company agreed to join or form an
independent system operator.
The group will explore arrangements to achieve
non-discriminatory access to all while maintaining
other key goals, such as reliability, security,
efficient use, etc.
M-14
Allegheny Energy, Inc.
Risk Management
Certain of the Company's subsidiaries use
derivative instruments to manage the risk
exposure associated with contracts they write
for the purchase and/or sale of electricity for
receipt or delivery at future dates. Such
instruments are used in accordance with a risk
management policy adopted by the Board of
Directors and monitored by an Exposure
Management Committee of senior management. The
policy requires continuous monitoring,
reporting, and stress testing of all open
positions for conformity to policies which limit
value at risk and market risk associated with
the credit standing of trading counterparties.
Such credit standings must be investment grade
or better, or be guaranteed by a parent company
with such a credit standing for all over-the-
counter instruments.
At December 31, 1997, the trading books of
the Company's subsidiaries consisted primarily
of physical contracts with fixed pricing. Most
contracts were fixed-priced, forward purchase
and/or sale contracts which required settlement
by physical delivery of electricity. During
1997, the subsidiaries also entered into option
contracts which, if exercised, were settled with
physical delivery of electricity.
These transactions result in market risk which
occurs when the market price of a particular obligation
or entitlement varies from the contract price.
As the Company continues to develop its power
marketing and trading business, its exposure to
volatility in the price of electricity and other
energy commodities may increase within approved
policy limits.
Year 2000 Computer Systems Issue
The Company's subsidiaries have spent
considerable time and effort over the past
several years on the issue of the year 2000
software compliance, and the effort is
continuing. Certain software has already been
made year 2000 compliant by upgrades and replacement,
and analysis is continuing on others, in accordance
with a schedule planned to permit the subsidiaries to
process information in the year 2000 and beyond
without significant problems. Expenditures for
year 2000 compliance are not expected to have a
material effect on the Company's results of
operations or financial position.
M-15
Monongahela Power Company
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FACTORS THAT MAY AFFECT FUTURE RESULTS
This management's discussion and analysis of
financial condition and results of operations
contains forecast information items that are
"forward-looking statements" as defined in the
Private Securities Litigation Reform Act of 1995.
All such forward-looking information is necessarily
only estimated. There can be no assurance that
actual results will not materially differ from
expectations. Actual results have varied
materially and unpredictably from past
expectations.
Factors that could cause actual results to differ
materially include, among other matters, electric
utility restructuring, including the ongoing state
and federal activities; future economic conditions;
earnings retention; developments in the
legislative, regulatory, and competitive
environments in which the Company operates;
environmental legislative and regulatory changes;
and other circumstances that could affect
anticipated revenues and costs, such as unscheduled
maintenance or repair requirements and compliance
with laws and regulations.
SIGNIFICANT EVENTS IN 1997, 1996, AND 1995
On April 7, 1997, Allegheny Power System, Inc.
(Allegheny Power), parent of the Company, and DQE,
Inc. (DQE), parent company of Duquesne Light
Company in Pittsburgh, Pennsylvania, announced that
they had agreed to merge and that the combined
company would be called Allegheny Energy, Inc.
Each company held separate shareholder meetings on
August 7 at which the merger was decisively
approved. At Allegheny Power's meeting, the
shareholders also approved the change in the
company's name to Allegheny Energy, Inc. (Allegheny
Energy). The merger is contingent upon approval by
various regulatory authorities. See Note B to the
financial statements and "Proposed Merger with DQE"
on page 7 for additional information. All of the
Company's incremental costs of the merger process
($2.8 million through December 31, 1997) are being
deferred, and will be written off by the Company
when the merger occurs or when it is determined
that the merger will not occur.
In 1994, the Allegheny Energy integrated electric
utility system (the System), including the Company,
initiated a restructuring process to consolidate
and reengineer their utility operations to meet the
competitive challenges of the changing electric
utility industry. As a result of this process, the
System reduced employment by about 1,000 employees
through a voluntary separation plan, attrition, and
layoffs, changed processes to obtain efficiencies
to reduce the rate of growth in operating and
maintenance costs, and began doing business under
the trade name of Allegheny Power. See Note D to
the financial statements for
M-16
Monongahela Power Company
additional information. This process resulted in
restructuring charges in 1996 and 1995 and an asset
write-off in 1995.
REVIEW OF OPERATIONS
Earnings Summary
Earnings
(Millions of Dollars)
1997 1996 1995
Operations................................. $80.5 $76.1 $70.0
Expenses related to restructuring
activities............................... (14.6) (3.3)
Net Income................................. $80.5 $61.5 $66.7
The increase in 1997 earnings from operations
resulted primarily from reductions in operation and
maintenance (O&M) expenses from the restructuring
process and additional actions taken during the
year to achieve further O&M reductions in response
to significant decreases in kilowatt-hour (kWh)
sales to residential customers caused primarily by
mild weather. Also contributing to the increase was
additional revenues due to a change in allocation
of affiliated transmission services, increased
generating capacity sales to an affiliate, and an
interest refund on a tax-related contract
settlement by the Company's 27% owned subsidiary,
Allegheny Generating Company (AGC), recorded in
other income as increased equity in earnings of
AGC. The increase in 1996 earnings from operations
was due primarily to increased revenues from
previously reported retail rate increases.
Sales and Revenues
Percentage changes in revenues and kWh sales in
1997 and 1996 by major retail customer classes
were:
1997 vs. 1996 1996 vs. 1995
Revenues kWh Revenues kWh
Residential.............. (3.0)% (1.8)% (1.5)% .3 %
Commercial............... (2.3) (1.0) (2.3) 2.0
Industrial............... (2.1) 4.0 (5.4) (1.8)
Total.................. (2.5)% 1.3 % (3.2)% (.4)%
The changes in residential kWh sales, which are
more weather sensitive than the other classes, were
due primarily to changes in customer usage because
of weather conditions. The growth in the number of
residential customers was .8% and .7% in 1997 and 1996,
respectively. The weather in 1997 was mild in both the
early and late winter and in the summer, causing the 1.8%
decrease in residential kWh sales. In 1996, the early
winter
M-17
Monongahela Power Company
(January through April) was about 8% colder than in
1995. While this cold early winter was mostly
offset by milder weather the remainder of the year,
the overall average for the year plus the increase
in the number of customers resulted in an increase
in 1996 residential kWh sales of .3%.
Commercial kWh sales are also affected by weather,
but to a lesser extent than residential. The 2.0%
increase in 1996 reflects growth in the number of
customers and increased heating requirements that
year. The increase in industrial kWh sales in 1997
reflects a new customer with particularly large
electricity requirements.
Changes in revenues from retail customers resulted
from the following:
Changes from Prior Year
(Millions of Dollars)
1997 vs. 1996 1996 vs. 1995
Fuel clauses.............................. $(10.2) $(22.0)
General tariff rate change (Ohio)......... 5.6
All other................................. (3.0) (.9)
Net change in retail revenues........... $(13.2) $(17.3)
Revenues reflect not only the changes in kWh sales,
but also any changes in revenues from fuel and
energy cost adjustment clauses (fuel clauses) which
have little effect on net income because increases
and decreases in fuel and purchased power costs and
sales of transmission services and bulk power are
passed on to customers by adjustment of customer
bills through fuel clauses.
All other is the net effect of kWh sales changes
due to changes in customer usage (primarily weather
for residential customers), growth in the number of
customers, and changes in pricing other than
changes in general tariff and fuel clause rates.
The decrease in 1997 all other retail revenues is
primarily the result of mild weather in 1997. In
1996, residential usage decreased because of mild
weather in comparison to the extremely hot summer
and cooler-than-normal winter weather in 1995.
Wholesale and other revenues were as follows:
(Millions of Dollars) 1997 1996 1995
Wholesale customers.................... $ 4.9 $ 5.0 $ 4.5
Affiliated companies................... 84.0 74.9 73.2
Street lighting and other.............. 6.7 6.6 6.5
Total wholesale and other revenues... $95.6 86.5 $84.2
Wholesale customers are cooperatives and
municipalities that own their own distribution
systems and buy all or part of their bulk power
needs from the Company under regulation by the
Federal Energy Regulatory Commission
M-18
Monongahela Power Company
(FERC). Competition in the wholesale market for
electricity was initiated by the National Energy
Policy Act of 1992 (EPACT), which permits wholesale
generators, utility-owned and otherwise, and
wholesale customers to request from owners of bulk
power transmission facilities a commitment to
supply transmission services. All of the Company's
wholesale customers have signed contracts to remain
as customers until December 1, 2000.
Revenues from affiliated companies represent sales
of energy and intercompany allocations of
generating capacity, generation spinning reserves
and transmission services pursuant to a power
supply agreement among the Company and the other
regulated utility subsidiaries of Allegheny Energy.
The increase in such revenues in 1997 resulted
primarily from an increase in the allocation of
transmission services revenues and increased
generating capacity sales ($6.5 million).
Revenues from bulk power transactions consist of
the following items:
(Millions of Dollars) 1997 1996 1995
Revenues:
Transmission services to
nonaffiliated companies.............. $10.0 $12.6 $10.6
Bulk power............................. 7.3 4.8 2.7
Total bulk power transactions, net... $17.3 $17.4 $13.3
The final rules on open transmission access, issued
by the FERC in early 1996, require utilities to
offer to others transmission service that is
comparable to service they provide to themselves.
Revenues from transmission services to
nonaffiliated companies in 1997 decreased due to
reduced demand, primarily because of mild weather.
Increased transmission services to nonaffiliated
companies in 1996 resulted primarily from increased
activity from power marketers who agreed to take
service under the new open access tariffs filed by
the Company in accordance with the new 1996 rules.
The increases in bulk power revenues resulted
primarily from increased sales to power marketers
and other utilities from the Company's generating
plants.
Operating Expenses
Fuel expenses increased 4.1% in 1997 because of a
2.4% increase in kWh's generated, a 1.4% increase
in average fuel prices, and a .3% increase in the
average heat rate of the generating stations. The
increase in kWh's generated was
primarily the result of increased bulk power sales
to power marketers and other utilities. The 1%
decrease in 1996 fuel expenses was due to lower
average coal prices.
Purchased power and exchanges, net represents power
purchases from and exchanges with nonaffiliated
utilities and purchases from qualified facilities
under the Public Utility Regulatory Policies Act of
1978 (PURPA), capacity charges paid to AGC, and
other transactions with
M-19
Monongahela Power Company
affiliates made pursuant to the power supply
agreement whereby each company uses the most
economical generation available in the System at
any given time, and consists of the following
items:
(Millions of Dollars) 1997 1996 1995
Nonaffiliated transactions:
Purchased power:
From PURPA generation*............... $69.8 $ 69.1 $64.6
Other................................ 9.6 11.3 11.7
Power exchanges, net................... .1 .9 .1
Affiliated transactions:
AGC capacity charges................... 18.5 20.2 20.6
Energy and spinning reserve charges.... .3 .1 .4
Purchased power and exchanges, net... $98.3 $101.6 $97.4
*PURPA cost (cents per kWh) 5.3 5.3 5.3
Other purchased power in 1997 decreased because of
decreased demand due to decreased sales to retail
customers related to mild 1997 weather.
None of the Company's purchased power contracts is
capitalized since there are no minimum payment
requirements absent associated kWh generation.
Other operation expenses in 1997 include $1.7
million for increased allowances for uncollectible
accounts. Nevertheless, other operation expense
decreased in 1997 because of a reduction in embedded
expenses achieved through the 1996 restructuring process.
The decrease in other operation expense in 1996
resulted primarily from decreases in salaries and
wages and employee benefits.
Maintenance expenses decreased $4.2 million in 1997
due primarily to reduced expenses achieved through
restructuring efforts and other cost controls.
Maintenance expense represents costs incurred to
maintain the power stations, the transmission and
distribution (T&D) system, and general plant, and
reflects routine maintenance of equipment and
rights-ofway as well as planned major repairs and
unplanned expenditures, primarily from forced
outages at the power stations and periodic storm
damage on the T&D system. Variations in maintenance
expense result primarily from unplanned events and
planned major projects, which vary in
timing and magnitude depending upon the length of
time equipment has been in service without a major
overhaul and the amount of work found necessary
when the equipment is dismantled.
Restructuring charges in 1996 and 1995 and the
write-off in 1995 of obsolete and slow-moving
materials resulted from restructuring activities,
which have been completed.
Depreciation expense in 1997 increased $1.1 million
due to additions to electric plant. The
depreciation expense decrease in 1996 was the net
M-20
Monongahela Power Company
result of a reduction in depreciation rates of $5.3
million, effective in January 1996, offset by
additions to electric plant of $3 million.
Taxes other than income taxes decreased $1.6
million because of decreases in gross receipts
taxes resulting from lower revenues from retail
customers and lower FICA taxes due to the Company's
recent restructuring. The increase in 1996 was due
to higher property taxes and a prior period
adjustment in West Virginia Business and Occupation
Taxes.
The 1997 increase in federal and state income taxes
was primarily due to increased income in 1997
compared with 1996. The decrease in federal and
state income taxes in 1996 resulted primarily from
a decrease in income before taxes ($4 million),
primarily because of the restructuring charges
recorded in 1996 and changes in the provisions for
prior years ($2 million). Note E to the financial
statements provides a further analysis of income
tax expenses.
The increase in other income, net, in 1997 was due
primarily to an interest refund on a tax-related
contract settlement ($2.2 million, net of taxes)
received by the Company's subsidiary, AGC. The
decrease in 1996 was due primarily to a write-off
of a deferred return on West Virginia Clean Air Act
expenditures and increased interest income in 1995
associated with 1995 refinancings.
Interest on long-term debt decreased $.6 million in
1997 due primarily to the redemption of $15 million
of first mortgage bonds in 1997. The decrease in
interest on long-term debt in 1996 was due to
decreased interest on first mortgage bonds due
primarily to refinancings to lower rate securities
in 1995. Other interest expense reflects changes in the
levels of shortterm debt maintained by the Company
throughout the year, as well as the associated
interest rates.
FINANCIAL CONDITION, REQUIREMENTS, AND RESOURCES
Liquidity and Capital Requirements
To meet the Company's need for cash for operating
expenses, the payment of interest and dividends, retirement
of debt and certain preferred stocks, and for its
construction program, the Company has used
internally generated funds and external
financings, such as the sale of common and
preferred stock, debt instruments, installment
loans, and lease arrangements. The timing and
amount of external financings depend primarily
upon economic and financial market conditions, the
Company's cash needs, and capitalization ratio
objectives. The availability and cost of external
financings depend upon the financial health of the
companies seeking those funds and market conditions.
Construction expenditures in 1997 were $78 million
and, for 1998 and 1999, are estimated at $78
million and $75 million, respectively. The 1998
and 1999 estimated expenditures include $4 million
and $12 million, respectively, for construction of
currently mandated environmental control
M-21
Monongahela Power Company
technology. The Company also has additional
capital requirements for debt maturities (see Note
K to the financial statements).
Internal Cash Flow
Internal generation of cash, consisting of cash
flows from operations reduced by dividends, was
$65 million in 1997 compared with $92 million in
1996. The decrease in 1997 was primarily the
result of the payment of restructuring
liabilities. Current rate levels and reduced
levels of construction expenditures permitted the
Company to finance nearly all of its construction
expenditures in 1997 and 1996 with internal cash
flow. As described under "Environmental Issues"
on page 9, the Company could potentially face
significant mandated increases in construction
expenditures and operating costs related to
environmental issues. Whether the Company can
continue to meet the majority of its construction
needs with internally generated cash is largely
dependent upon the outcome of these issues.
Financing
Short-term debt is used to meet temporary cash
needs until the timing is considered appropriate
to issue long-term securities. Short-term debt,
including notes payable to affiliates under the
money pool, increased $27.1 million to $58.3 million
in 1997. At December 31, 1997, the Company had
Securities and Exchange Commission authorization
to issue up to $106 million of short-term debt.
The Company and its regulated affiliates use an
internal money pool as a facility to accommodate
intercompany short-term borrowing needs, to the
extent that certain of the companies have funds
available. The Company will meet its 1998 cash
needs through internal cash generation, cash on
hand, short-term borrowing as necessary, and
refunding of a portion of maturing long-term debt.
SIGNIFICANT CONTINUING ISSUES
Proposed Merger with DQE
Following the negotiations and announcement of the
merger, Allegheny Power and DQE obtained their
respective shareholders' approval, made regulatory
filings for approval, and started the merger
planning process by naming certain employees of
both companies, including management personnel, to
merger planning teams. All of the regulatory
approvals are expected by June 30, 1998.
Merger opposition has arisen in two forms:
The City of Pittsburgh filed an antitrust
lawsuit, which was dismissed by the United
States District Court for the Western District
of Pennsylvania in December 1997. The City
has since filed an appeal with the United States
Court of Appeals for the Third Circuit.
M-22
Monongahela Power Company
Various intervenors in the Pennsylvania Public
Utility Commission (PUC) and the FERC merger
proceedings allege that the combined company may
have the ability to exercise market power.
An additional risk to the merger is the possibility
that the regulatory approvals might contain such
onerous conditions that the merger would no longer
be beneficial to shareholders.
While Allegheny Energy cannot predict the outcome
of the merger hearings or the City of Pittsburgh's
appeal process, it believes that the opposition's
arguments are without merit and that the approvals
should be received in a manner which will allow the
merger to proceed.
Electric Energy Competition
Competition in the wholesale market for electricity
was initiated by EPACT in 1992 and Orders 888 and
889 by the FERC in April 1996, which together
mandated that the owners of transmission facilities
provide nondiscriminatory open access of
transmission services to wholesale customers and
electricity generators, utility-owned and
otherwise. With these actions, wholesale customers
obtained the ability to seek their electricity
requirements from competing generators. The
Company has been an advocate of federal legislation
to create competition in the retail electricity
markets to avoid regional dislocations and ensure
level playing fields. Various bills have been
introduced and debated in the United States
Congress, but none has passed.
The Company has franchised regulated customers in
Ohio and West Virginia where the subjects of
competition and deregulation are being debated.
The Company is actively involved in the debates,
with personnel on virtually all of the various
committees and proceedings.
In the absence of federal legislation, state-by-
state implementation has begun. Two of the state
jurisdictions in which affiliates of the Company
serve, Pennsylvania and Maryland, have taken action
to begin implementation of access by retail
customers to alternate generation suppliers.
Allegheny Energy is continuing to advocate federal
legislation through its membership
in the Partnership for Customer Choice, along with
six other electric utilities. The purpose is to
seek enactment of federal legislation to bring
choice to electric customers no later than the year
2000.
In December 1996, Pennsylvania enacted the
Electricity Generation Customer Choice and
Competition Act (Customer Choice Act) to
restructure the electric industry in Pennsylvania
to create retail access to a competitive electric
energy generation market.
M-23
Monongahela Power Company
On August 1, 1997, concurrent with Allegheny
Energy's merger approval filing, the Company's
Pennsylvania affiliate, West
Penn, filed with the PUC a comprehensive stand-
alone restructuring plan to implement full customer
choice of electric generation suppliers as required
by the Customer Choice Act. The filing included an
unbundling of West Penn's electric service rates
into generation, transmission, and distribution
components; a plan to revise how West Penn and its
affiliates, including the Company, share capacity,
energy, capacity reserves, transmission
resources, and costs; and a plan for recovery of
stranded costs through a Competitive Transition
Charge (CTC).
The PUC has established a schedule of proceedings
for the restructuring plan, concurrent with the
merger proceedings, under which it would issue an
order on the filing by the end of May 1998. This
order will include a determination of West Penn's
rates for transmission and distribution services
beginning January 1, 1999; generation rates for
customers who take regulated generation service
during the transition period (potentially 1999
through 2005 if customers so choose); and the CTC
West Penn will be allowed to charge through the
transition period.
Allegheny Energy is also advocating federal
legislation to repeal Section 210 of PURPA and the
Public Utility Holding Company Act of 1935 (PUHCA).
Both of these laws severely impede the Company's
ability to compete on equal terms with utility and
nonutility electric providers who are not subject
to their requirements.
With efficient operations, a reputation for quality
service and reliability, and electric rates among
the lowest in the areas it serves, the Company
believes it is well-positioned for fair and open
competition in the marketplace.
Environmental Issues
In the normal course of business, the Company is
subject to various contingencies and uncertainties
relating to its operations and construction
programs, including legal actions and regulations
and uncertainties related to environmental matters.
The significant costs of complying with Phase I of
the Clean Air Act Amendments of 1990 (CAAA) have
been incurred and are being recovered currently
from customers in rates. Studies to evaluate cost-
effective options to comply with Phase II SO2
limits, including those which may be available from
the use of the Company's banked emission allowances
and from the emission allowance trading market, are
continuing.
Title I of the CAAA established an Ozone Transport
Commission to ascertain additional NOx reductions
to allow the Ozone Transport Region (OTR) to meet
the ozone National Ambient Air Quality Standards
(NAAQS). Under terms of a Memorandum of
Understanding (MOU) among the OTR states, the
Company's operating station located in Pennsylvania
will be required to reduce NOx emissions by
approximately 55% from the 1990 baseline
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Monongahela Power Company
emissions, with a compliance date of May 1999.
Further reductions of 75% from the 1990 baseline
may be required by May 2003, depending on the
results of modeling studies to be completed by
1998. If reductions of 75% are required,
installation of post-combustion control
technologies would be very expensive. Pennsylvania
promulgated regulations to implement Phase II of the
MOU in November 1997.
Several other significant regulatory actions
initiated in 1997 could require significant
expenditures for further control of air emissions.
In November 1997, the Environmental Protection
Agency (EPA) issued a proposed State Implementation
Plan (SIP) call which would require further
controls of NOx emissions to the less stringent of an 85%
reduction from 1990 emission rates or an emission
rate of 0.15 lb/mmBtu. The EPA intends to finalize
the SIP call by September 1998. Implementation of
controls, which could be required by mid2003, would
require very expensive post-combustion control
technologies on most, if not all, of the Company's
power stations.
In August 1997, eight northeastern states filed
Section 126 petitions with the EPA requesting the
immediate imposition of up to an 85% NOx reduction
from utilities located in the Midwest and Southeast
(West Virginia included). The petitions claim NOx
emissions from these upwind sources are preventing
their attainment of the ozone standard. The EPA
will probably address these petitions in
conjunction with the SIP call mentioned above.
The EPA is required by law to regularly review the
NAAQS for criteria pollutants. Revisions to
particulate matter and ozone standards were
proposed by the EPA in 1996 and finalized in July
1997. The effect on the Company of any revisions
to these standards is unknown at this time but
could be substantial. State attainment plans to
meet the revised standards will not be developed
for several years. Also, in July 1997, the EPA
proposed regional haze regulations to improve
visibility in Class I Federal areas (national parks
and wilderness areas). If finalized, subsequent state
regulations could require additional reduction of SO2
and/or NOx emissions from the Company's facilities.
The final outcome of the revised ambient standards,
Phase III of the MOU, SIP calls, and Section 126
petitions cannot be determined at this time. All
are being challenged by rulemaking, petition,
and/or litigation proceedings. Implementation
dates, if required, are uncertain at this time, but
could be as early as 2003.
In December 1997, the Clinton Administration, at a
conference in Kyoto, Japan, agreed to a protocol
for greenhouse gas reductions to 7% below 1990
levels as early as 2008. The protocol will not go
into effect unless ratified by the United States
Senate. If implemented, the protocol would require
dramatic reductions in emissions of carbon dioxide,
a major socalled greenhouse gas emitted during
combustion of fossil fuels, particularly coal.
Significant reduction requirements could force the
Company to make major changes in electricity
production to reduce or
M-25
Monongahela Power Company
eliminate the use of coal. Allegheny Energy is
actively opposing implementation of the protocol in
the United States Congress and through alliances
with other affected companies.
The Company previously reported that the EPA had
identified the Company and its regulated affiliates
and approximately 875 others as potentially
responsible parties in a Superfund site subject to
cleanup. A final determination has not been made
for the Company's share of the remediation costs
based on the amount of materials sent to the site.
The Company has also been named as a defendant
along with multiple other affiliated and
nonaffiliated defendants in pending asbestos cases
involving one or more plaintiffs. The Company
believes that provisions for liability and
insurance recoveries are such that final resolution
of these claims will not have a material effect on
its financial position.
Independent Transmission System Operation Study
On December 7, 1997, the Company and its two
regulated affiliates announced that they and eight
other investor-owned electric utilities had signed
an MOU to explore the creation of an independent,
regional transmission entity. Many industry
participants, including customers and regulatory
authorities, believe that an entity independent of
the utilities who own the transmission systems is
needed to operate the systems to ensure
nondiscriminatory access to the transmission
systems by all users. As part of its merger
application in Pennsylvania and with the FERC,
Allegheny Energy agreed to join or form an
independent system operator.
The group will explore arrangements to achieve
nondiscriminatory access to all while maintaining
other key goals, such as reliability, security,
efficient use, etc.
Risk Management
The Company and its affiliates use derivative
instruments to manage the risk exposure associated
with contracts it writes for the purchase and/or
sale of electricity for receipt or delivery at
future dates. Such instruments are used in
accordance with a risk management policy adopted by
the Board of Directors and monitored by an Exposure
Management Committee of senior management. The
policy requires continuous monitoring, reporting,
and stress testing of all open positions for
conformity to policies which limit value at risk
and market risk associated with the credit standing
of trading counterparties. Such credit standings
must be investment grade or better, or be
guaranteed by a parent company with such a credit
standing, for all over-the-counter instruments.
At December 31, 1997, the trading books of the
Company and its affiliates consisted primarily of
physical contracts with fixed pricing. Most
contracts were fixed-priced, forward purchase
and/or sale contracts which required settlement by
physical delivery of electricity. During 1997, the
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Monongahela Power Company
Company and its affiliates also entered into option
contracts which, if exercised, were settled with
physical delivery of electricity.
These transactions result in market risk which
occurs when the market price of a particular
obligation or entitlement varies from the contract
price. As the Company continues to develop its
power marketing and trading business, its exposure
to volatility in the price of electricity and other
energy commodities may increase within approved
policy limits.
Year 2000 Computer Systems Issue
The Company and its affiliates have spent
considerable time and effort over the past several
years on the issue of the year 2000 software
compliance, and the effort is continuing.
Certain software has already been made year 2000
compliant by upgrades and replacement, and analysis
is continuing on others, in accordance with a
schedule planned to permit the Company and its
affiliates to process information in the year 2000
and beyond without significant problems.
Expenditures for year 2000 compliance are not
expected to have a material effect on the Company's
results of operations or financial position.
M-27
The Potomac Edison Company
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FACTORS THAT MAY AFFECT FUTURE RESULTS
This management's discussion and analysis of
financial condition and results of operations
contains forecast information items that are "forward-
looking statements" as defined in the Private
Securities Litigation Reform Act of 1995. All such
forward-looking information is necessarily only estimated.
There can be no assurance that actual results will
not materially differ from expectations. Actual
results have varied materially and unpredictably from
past expectations.
Factors that could cause actual results to differ
materially include, among other matters, electric
utility restructuring, including the ongoing state
and federal activities; future economic conditions;
earnings retention; developments in the legislative,
regulatory, and competitive environments in which the
Company operates; environmental legislative and
regulatory changes; and other circumstances that
could affect anticipated revenues and costs, such as
unscheduled maintenance or repair requirements and
compliance with laws and regulations.
SIGNIFICANT EVENTS IN 1997, 1996, AND 1995
On April 7, 1997, Allegheny Power System, Inc.
(Allegheny Power), parent of the Company, and DQE,
Inc. (DQE), parent company of Duquesne Light Company
in Pittsburgh, Pennsylvania, announced that they had
agreed to merge and that the combined company would
be called Allegheny Energy, Inc. Each company held
separate shareholder meetings on August 7 at which
the merger was decisively approved. At Allegheny
Power's meeting, the shareholders also approved the
change in the company's name to Allegheny Energy,
Inc. (Allegheny Energy). The merger is contingent
upon approval by various regulatory authorities. See
Note B to the financial statements and "Proposed
Merger with DQE" on page 7 for additional
information. All of the Company's incremental costs
of the merger process ($3.3 million through December
31, 1997) are being deferred, and will be written off
by the Company when the merger occurs or when it is
determined that the merger will not occur.
In December 1997, the Maryland Public Service
Commission (PSC) ordered an electric competition
transition plan (Maryland Transition Plan). See
Note C to the financial statements for major
provisions of the Maryland plan and "Electric Energy
Competition" on page 7 for additional information.
In 1994, the Allegheny Energy integrated electric
utility system (the System), including the Company,
initiated a restructuring process to consolidate and
reengineer their utility operations to meet the
competitive challenges of the changing electric
utility industry. As a
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The Potomac Edison Company
result of this process, the System reduced employment
by about 1,000 employees through a voluntary
separation plan, attrition, and layoffs, changed
processes to obtain efficiencies to reduce the rate
of growth in operating and maintenance costs, and
began doing business under the trade name of
Allegheny Power. See Note D to the financial
statements for additional information. This
process resulted in restructuring charges in 1996 and
1995 and an asset write-off in 1995.
REVIEW OF OPERATIONS
Earnings Summary
Earnings
(Millions of Dollars) 1997 1996 1995
Operations................................. $95.8 $94.7 $82.6
Expenses related to restructuring
activities............................... 16.5 4.3
Net Income................................. $95.8 $78.2 $78.3
The increase in 1997 earnings from operations
resulted primarily from reductions in operation and
maintenance (O&M) expenses from the restructuring
process and additional actions taken during the year
to achieve further O&M reductions in response to
significant decreases in kilowatt-hour (kWh) sales to
residential customers caused primarily by mild
weather. Also contributing to the increase was
additional revenues due to a change in allocation of
affiliated transmission services and an interest
refund on a tax-related contract settlement by the
Company's 28% owned subsidiary, Allegheny Generating
Company (AGC), recorded in other income as increased
equity in earnings of AGC. The increase in 1996
earnings from operations was due primarily to
increases in kWh sales.
Sales and Revenues
Percentage changes in revenues and kWh sales in 1997
and 1996 by major retail customer classes were:
1997 vs. 1996 1996 vs. 1995
Revenues kWh Revenues kWh
Residential.............. (7.5)% (6.7)% 2.3% 5.1%
Commercial............... 1.3 1.9 .9 3.4
Industrial............... .7 .5 (2.0) 1.5
Total.................. (3.2)% (1.9)% .7% 3.1%
The changes in residential kWh sales, which are more
weather sensitive than the other classes, were due
primarily to changes in customer usage because of
weather conditions. The growth in the number of
residential customers was 1.8% and 1.7% in 1997 and
1996, respectively. The weather
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The Potomac E dison Company
in 1997 was mild in both the early and late winter
and in the summer, causing the 6.7% decrease in
residential kWh sales. In 1996, the early winter
(January through April) was about 12% colder than in
1995. While this cold early winter was somewhat
offset by milder weather the remainder of the year,
the overall average for the year plus the increase in
the number of customers resulted in an increase in
1996 residential kWh sales of 5.1%.
Commercial kWh sales are also affected by weather,
but to a lesser extent than residential. The 1.9%
and 3.4% increases in 1997 and 1996, respectively,
reflect growth in the number of customers and in 1996
from increased heating requirements.
The increase in industrial kWh sales in 1997 and 1996
reflects a trend of continued economic growth in the
service territory.
Changes in revenues from retail customers resulted
from the following:
Changes from Prior Year
(Millions of Dollars) 1997 vs. 1996 1996 vs. 1995
Fuel clauses............................ $ (9.6) $(10.5)
All other............................... (11.4) 15.2
Net change in retail revenues......... $(21.0) $ 4.7
Revenues reflect not only the changes in kWh sales,
but also any changes in revenues from fuel and energy
cost adjustment clauses (fuel clauses) which have
little effect on net income because increases and
decreases in fuel and purchased power costs and sales
of transmission services and bulk power are passed on
to customers by adjustment of customer bills through
fuel clauses.
All other is the net effect of kWh sales changes due
to changes in customer usage (primarily weather for
residential customers), growth in the number of
customers, and changes in pricing other than changes
in general tariff and fuel clause rates. The
decrease in 1997 all other retail revenues is
primarily the result of mild weather in 1997. The
increase in 1996 all other retail revenues was the
combined result of increased customer usage
(primarily due to cold weather in the early 1996
winter) and growth in the number of customers.
Wholesale and other revenues were as follows:
(Millions of Dollars) 1997 1996 1995
Wholesale customers....................... $26.6 $29.1 $23.4
Affiliated companies...................... 10.3 2.5 2.5
Street lighting and other................. 2.0 3.3 2.7
Total wholesale and other revenues...... $38.9 $34.9 $28.6
M-30
The Potomac Edison Company
Wholesale customers are cooperatives and
municipalities that own their own distribution
systems and buy all or part of their bulk power needs
from the Company under regulation by the Federal
Energy Regulatory Commission (FERC). Competition in
the wholesale market for electricity was initiated by
the National Energy Policy Act of 1992 (EPACT), which
permits wholesale generators, utility-owned and
otherwise, and wholesale customers to request from
owners of bulk power transmission facilities a
commitment to supply transmission services. A five-
year contract with estimated annual revenues totaling
about $3 million was signed in 1997 with one of the
Company's wholesale customers. The existing contracts
with four Maryland wholesale customers expire in 1998.
The Company is bidding to continue as their wholesale
supplier. The decrease in wholesale revenues in 1997,
as well as the increase in 1996, was primarily due to
fluctuations in the electricity requirements of one
wholesale customer caused by the start-up in late 1995
and shut-down in early 1997 of a large fiber plant on the
wholesale customer's system.
Revenues from affiliated companies represent sales of
energy and intercompany allocations of generation
spinning reserves and transmission services pursuant
to a power supply agreement among the Company and the
other regulated utility subsidiaries of Allegheny
Energy. The increase in such revenues in 1997
resulted primarily from an increase in the allocation
of transmission services revenues ($5.3 million) to
the Company.
Revenues from bulk power transactions consist of the
following items:
(Millions of Dollars) 1997 1996 1995
Revenues:
Transmission services to
nonaffiliated companies.............. $13.6 $16.9 $14.8
Bulk power............................. 10.0 7.6 4.6
Total bulk power transactions, net... $23.6 $24.5 $19.4
The final rules on open transmission access, issued
by the FERC in early 1996, require utilities to offer
to others transmission service that is comparable to
service they provide to themselves. Revenues from
transmission services to nonaffiliated companies in
1997 decreased due to reduced demand, primarily
because of mild weather. Increased transmission
services to nonaffiliated companies in 1996 resulted
primarily from increased activity from power
marketers who agreed to take service under the new
open access tariffs filed by the Company in
accordance with the new 1996 rules. The increases in
bulk power revenues resulted primarily from increased
sales to power marketers and other utilities from the
Company's generating plants.
Operating Expenses
Fuel expenses increased 2.1% in 1997 due to an
increase in kWh's generated. The increase in kWh's
generated was primarily the result of increased bulk
power sales to power marketers and other utilities.
The 2% increase in 1996
M-31
The Potomac Edison Company
fuel expenses was due to a 3% increase in kWh's
generated, offset by lower average coal prices.
Purchased power and exchanges, net represents power
purchases from and exchanges with nonaffiliated
utilities, capacity charges paid to AGC, and
other transactions with affiliates made pursuant to
the power supply agreement whereby each company uses
the most economical generation available in the
System at any given time, and consists of the
following items:
(Millions of Dollars) 1997 1996 1995
Nonaffiliated transactions:
Purchased power......................... $ 13.2 $ 14.8 $ 15.6
Power exchanges, net.................... 1.7 (.2)
Affiliated transactions:
AGC capacity charges.................... 25.5 26.9 28.1
Other affiliated capacity charges....... 50.8 47.7 44.0
Energy and spinning reserve charges..... 50.7 49.9 49.8
Purchased power and exchanges, net.... $140.2 $141.0 $137.3
Purchased power in 1997 decreased because of
decreased demand due to decreased sales to retail
customers related to mild 1997 weather.
A Public Utility Regulatory Policies Act of 1978
(PURPA) power station project in the Company's Maryland
jurisdiction is scheduled to commence generation in
1999. Because of the high cost of this energy, the
Company unsuccessfully sought a buyout or
restructuring of the existing contract to reduce the
cost to customers. This project will significantly
increase the cost of power purchases ($60 million or
more annually) and the Company's rates in Maryland.
Other operation expenses in 1997 include $1.2 million
for increased allowances for uncollectible accounts.
Nevertheless, other operation expense decreased in
1997 because of a reduction in embedded expenses
achieved through the 1996 restructuring process.
Maintenance expenses decreased $5.4 million in 1997
due primarily to reduced expenses achieved through
restructuring efforts and other cost controls.
Maintenance expense represents costs incurred to
maintain the power stations, the transmission and
distribution (T&D) system, and general plant, and
reflects routine maintenance of equipment and rights-
of-way as well as planned major repairs and unplanned
expenditures, primarily from forced outages at the
power stations and periodic storm damage on the T&D
system. Variations in maintenance expense result
primarily from unplanned events and planned major
projects, which vary in timing and magnitude
depending upon the length of time
equipment has been in service without a major
overhaul and the amount of work found necessary when
the equipment is dismantled.
M-32
The Potomac Edison Company
Restructuring charges in 1996 and 1995 and the write-
off in 1995 of obsolete and slow-moving materials
resulted from restructuring activities, which have
been completed.
Depreciation expense increases resulted primarily
from additions to electric plant.
Taxes other than income taxes increased $1.8 million
in 1997 due to increased property taxes and capital
stock and franchise taxes related to an increase in
the assessment of property in Maryland.
The 1997 increase in federal and state income taxes
was primarily due to increased income in 1997
compared with 1996. The decrease in federal and
state income taxes in 1996 resulted primarily from a
decrease in income before taxes primarily because of
the restructuring charges recorded in 1996, changes
in the provisions for prior years, and plant removal
tax deductions for which deferred taxes were not
provided. Note E to the financial statements
provides a further analysis of income tax expenses.
The increase in other income, net, in 1997 was due
primarily to an interest refund on a tax-related
contract settlement ($2.5 million, net of taxes)
received by the Company's subsidiary, AGC.
The decrease in interest on long-term debt in 1996
was due to decreased interest on first mortgage bonds
due primarily to refinancings to lower rate
securities in 1995. Other interest expense reflects
changes in the levels of short-term debt maintained
by the Company throughout the year, as well as the
associated interest rates.
FINANCIAL CONDITION, REQUIREMENTS, AND RESOURCES
Liquidity and Capital Requirements
To meet the Company's need for cash for operating
expenses, the payment of interest and dividends,
retirement of debt and certain preferred stocks, and
for its construction program, the Company has used
internally generated funds and external financings,
such as the sale of common and preferred stock, debt
instruments, installment loans, and lease
arrangements. The timing and amount of external
financings depend primarily upon economic and
financial market conditions, the Company's cash
needs, and capitalization ratio objectives. The
availability and cost of external financings depend
upon the financial health of the companies seeking
those funds and market conditions.
Construction expenditures in 1997 were $78 million
and, for 1998 and 1999, are estimated at $84 million
and $112 million, respectively. The 1998 and 1999
estimated expenditures include $4 million and $13
million, respectively, for construction of currently
mandated environmental control technology. It is the
Company's goal to constrain future base construction
spending, with the exception of mandated
environmental expenditures, to the approximate level
of depreciation currently in rates. The Company also
has additional
M-33
The Potomac Edison Company
capital requirements for debt maturities (see Note J
to the financial statements).
Internal Cash Flow
Internal generation of cash, consisting of cash flows
from operations reduced by dividends, was $87 million
in 1997 compared with $116 million in 1996. The
decrease in 1997 was primarily the result of the
payment of restructuring liabilities. Current rate
levels and reduced levels of construction
expenditures permitted the Company to finance its
entire construction expenditure program in 1997 and
1996 through internal cash generation. As described
under "Environmental Issues" on page 9, the Company
could potentially face significant mandated increases
in construction expenditures and operating costs
related to environmental issues. Whether the Company
can continue to meet the majority of its construction
needs with internally generated cash is largely
dependent upon the outcome of these issues.
Financing
Short-term debt is used to meet temporary cash needs
until the timing is considered appropriate to issue
long-term securities. Short-term debt decreased $7
million in 1997, and none was outstanding at December
31, 1997. At December 31, 1997, the Company had
Securities and Exchange Commission authorization to
issue up to $130 million of short-term debt. The
Company and its regulated affiliates use an internal
money pool as a facility to accommodate intercompany
short-term borrowing needs to the extent that certain
of the companies have funds available. The Company
will meet its 1998 cash needs through internal cash
generation, cash on hand, short-term borrowing as
necessary, and refunding of a portion of maturing
long-term debt.
SIGNIFICANT CONTINUING ISSUES
Proposed Merger with DQE
Following the negotiations and announcement of the
merger, Allegheny Power and DQE obtained their
respective shareholders' approval, made regulatory
filings for approval, and started the merger planning
process by naming certain employees of both
companies, including management personnel, to merger
planning teams. All of the regulatory approvals are
expected by June 30, 1998.
Merger opposition has arisen in two forms:
The City of Pittsburgh filed an antitrust
lawsuit, which was dismissed by the United States
District Court for the Western District of
Pennsylvania in December 1997. The City has since
filed an appeal with the United States Court of
Appeals for the Third Circuit.
M-34
The Potomac Edison Company
Various intervenors in the Pennsylvania Public
Utility Commission (PUC) and the FERC merger
proceedings allege that the combined company may
have the ability to exercise market power.
An additional risk to the merger is the possibility
that the regulatory approvals might contain such
onerous conditions that the merger would no longer be
beneficial to shareholders.
While Allegheny Energy cannot predict the outcome of
the merger hearings or the City of Pittsburgh's
appeal process, it believes that the opposition's
arguments are without merit and that the approvals
should be received in a manner which will allow the
merger to proceed.
Electric Energy Competition
Competition in the wholesale market for electricity
was initiated by EPACT in 1992 and Orders 888 and
889 by the FERC in April 1996, which together
mandated that the owners of transmission facilities
provide nondiscriminatory open access of
transmission services to wholesale customers and
electricity generators, utility-owned and otherwise.
With these actions, wholesale customers obtained the
ability to seek their electricity requirements from
competing generators. The Company has been an
advocate of federal legislation to create
competition in the retail electricity markets to
avoid regional dislocations and ensure level playing
fields. Various bills have been introduced and
debated in the United States Congress, but none has
passed.
In the absence of federal legislation, state-by-
state implementation has begun. Maryland has taken
action to begin implementation of access by retail
customers to alternate generation suppliers.
Allegheny Energy is continuing to advocate federal
legislation through its membership in the
Partnership for Customer Choice, along with six
other electric utilities. The purpose is to seek
enactment of federal legislation to bring choice to
electric customers no later than the year 2000.
The Maryland PSC in December 1997 issued an Order to
implement retail competition in that state. A
special task force of the Maryland General Assembly,
which had been working on the same subject, had not
yet issued its report. The PSC's Order and its
revised second Order call for a deregulation process
including a three-year phase-in beginning July 1,
2000, with recovery of prudent stranded costs after
mitigation. The Order recognizes that many details
are yet to be decided and calls for roundtable
discussions and adjudicatory proceedings for that
purpose, which should give the Company the
opportunity to address the uncertainties and
problems created. Among the issues for the Company
is recovery of the substantially greater-than-market
costs it will be required to pay for the PURPA project
scheduled to begin producing energy in 1999.
The Company also has franchised, regulated customers
in Virginia and West Virginia where the subjects of
competition and deregulation are being
M-35
The Potomac Edison Company
debated. The Company is actively involved in the
debates, with personnel on virtually all of the
various committees and proceedings.
In December 1996, Pennsylvania enacted the
Electricity Generation Customer Choice and
Competition Act (Customer Choice Act) to
restructure the electric industry in Pennsylvania
to create retail access to a competitive electric
energy generation market.
On August 1, 1997, concurrent with Allegheny
Energy's merger approval filing, the Company's
Pennsylvania affiliate, West Penn, filed with the
PUC a comprehensive stand-alone restructuring plan
to implement full customer choice of electric
generation suppliers as required by the Customer
Choice Act. The filing included an unbundling of
West Penn's electric service rates into generation,
transmission, and distribution components; a plan
to revise how West Penn and its affiliates,
including the Company, share capacity, energy,
capacity reserves, transmission resources, and
costs; and a plan for recovery of stranded costs
through a Competitive Transition Charge (CTC).
The PUC has established a schedule of proceedings
for the restructuring plan, concurrent with the
merger proceedings, under which it would issue an
order on the filing by the end of May 1998. This
order will include a determination of West Penn's
rates for transmission and distribution services
beginning January 1, 1999; generation rates for
customers who take regulated generation service
during the transition period (potentially 1999
through 2005 if customers so choose); and the CTC
West Penn will be allowed to charge through the
transition period.
Allegheny Energy is also advocating federal
legislation to repeal Section 210 of PURPA and the
Public Utility Holding Company Act of 1935 (PUHCA).
Both of these laws severely impede the Company's
ability to compete on equal terms with utility and
nonutility electric providers who are not subject
to their requirements.
With efficient operations, a reputation for quality
service and reliability, and electric rates among
the lowest in the areas it serves, the Company
believes it is well-positioned for fair and open
competition in the marketplace.
Environmental Issues
In the normal course of business, the Company is
subject to various contingencies and uncertainties
relating to its operations and construction
programs, including legal actions and regulations
and uncertainties related to environmental matters.
The significant costs of complying with Phase I of
the Clean Air Act Amendments of 1990 (CAAA) have
been incurred and are being recovered currently
from customers in rates. Studies to evaluate cost-
effective options to comply with Phase II SO2
limits, including those which may be available from
the use of the Company's banked emission allowances
and from the emission allowance trading market, are
continuing.
M-36
The Potomac Edison Company
Title I of the CAAA established an Ozone Transport
Commission to ascertain additional NOx reductions
to allow the Ozone Transport Region (OTR) to meet
the ozone National Ambient Air Quality Standards
(NAAQS). Under terms of a Memorandum of
Understanding (MOU) among the OTR states, the
Company's operating stations located in Maryland
and Pennsylvania will be required to reduce NOx
emissions by approximately 55% from the 1990
baseline emissions, with a compliance date of May
1999. Further reductions of 75% from the 1990
baseline may be required by May 2003, depending on
the results of modeling studies to be completed by
1998. If reductions of 75% are required,
installation of post-combustion control
technologies would be very expensive. Pennsylvania
promulgated regulations to implement Phase II of
the MOU in November 1997. Maryland is scheduled to
propose regulations in early 1998.
Several other significant regulatory actions
initiated in 1997 could require significant
expenditures for further control of air emissions.
In November 1997, the Environmental Protection Agency
(EPA) issued a proposed State Implementation Plan
(SIP) call which would require further controls of
NOx emissions to the less stringent of an 85% reduction
from 1990 emission rates or an emission rate of 0.15
lb/mmBtu. The EPA intends to finalize the SIP call
by September 1998. Implementation of controls,
which could be required by mid-2003, would require
very expensive post-combustion control technologies
on most, if not all, of the Company's power
stations.
In August 1997, eight northeastern states filed
Section 126 petitions with the EPA requesting the
immediate imposition of up to an 85% NOx reduction
from utilities located in the Midwest and Southeast
(West Virginia included). The petitions claim NOx
emissions from these upwind sources are preventing
their attainment of the ozone standard. The EPA
will probably address these petitions in
conjunction with the SIP call mentioned above.
The EPA is required by law to regularly review the
NAAQS for criteria pollutants. Revisions to
particulate matter and ozone standards were
proposed by the EPA in 1996 and finalized in July
1997. The effect on the Company of any revisions
to these standards is unknown at this time but
could be substantial. State attainment plans to
meet the revised standards
will not be developed for several years. Also, in
July 1997, the EPA proposed regional haze
regulations to improve visibility in Class I
Federal areas (national parks and wilderness
areas). If finalized, subsequent state regulations
could require additional reduction of SO2 and/or
NOx emissions from the Company's facilities.
The final outcome of the revised ambient standards,
Phase III of the MOU, SIP calls, and Section 126
petitions cannot be determined at this time. All
are being challenged by rulemaking, petition,
and/or litigation proceedings. Implementation
dates, if required, are uncertain at this time, but
could be as early as 2003.
In December 1997, the Clinton Administration, at a
conference in Kyoto, Japan, agreed to a protocol
for greenhouse gas reductions to 7% below 1990
levels as early as 2008. The protocol will not go
into effect unless ratified by the United States
Senate. If implemented, the protocol would
M-37
The Potomac Edison Company
require dramatic reductions in emissions of carbon
dioxide, a major so-called greenhouse gas emitted
during combustion of fossil fuels, particularly
coal. Significant reduction requirements could
force the Company to make major changes in
electricity production to reduce or eliminate the
use of coal. Allegheny Energy is actively opposing
implementation of the protocol in the United States
Congress and through alliances with other affected
companies.
The Company previously reported that the EPA had
identified the Company and its regulated affiliates
and approximately 875 others as potentially
responsible parties in a Superfund site subject to
cleanup. A final determination has not been made
for the Company's share of the remediation costs
based on the amount of materials sent to the site.
The Company has also been named as a defendant
along with multiple other affiliated and
nonaffiliated defendants in pending asbestos cases
involving one or more plaintiffs. The Company
believes that provisions for liability and insurance
recoveries are such that final resolution of these
claims will not have a material effect on its
financial position.
Independent Transmission System Operation Study
On December 7, 1997, the Company and its two
regulated affiliates announced that they and eight
other investor-owned electric utilities had signed
an MOU to explore the creation of an independent,
regional transmission entity. Many industry
participants, including customers and regulatory
authorities, believe that an entity independent of
the utilities who own the transmission systems is
needed to operate the systems to ensure nondiscriminatory
access to the transmission systems by all users. As part
of its merger application in Pennsylvania and with the
FERC, Allegheny Energy agreed to join or form an
independent system operator.
The group will explore arrangements to achieve
nondiscriminatory access to all while maintaining
other key goals, such as reliability, security,
efficient use, etc.
Risk Management
The Company and its affiliates use derivative
instruments to manage the risk exposure associated
with contracts it writes for the purchase and/or
sale of electricity for receipt or delivery at
future dates. Such instruments are used in
accordance with a risk management policy adopted by
the Board of Directors and monitored by an Exposure
Management Committee of senior management. The
policy requires continuous monitoring, reporting,
and stress testing of all open positions for
conformity to policies which limit value at risk
and market risk associated with the credit standing
of trading counterparties. Such credit standings
must be investment grade or better, or be
guaranteed by a parent company with such a credit
standing for all over-the-counter instruments.
M-38
The Potomac Edison Company
At December 31, 1997, the trading books of the
Company and its affiliates consisted primarily of
physical contracts with fixed pricing. Most
contracts were fixed-priced, forward purchase
and/or sales contracts which required settlement by
physical delivery of electricity. During 1997, the
Company and its affiliates also entered into option
contracts which, if exercised, were settled with
physical delivery of electricity.
These transactions result in market risk which
occurs when the market price of a particular
obligation or entitlement varies from the contract
price. As the Company continues to develop its
power marketing and trading business, its exposure
to volatility in the price of electricity and other
energy commodities may increase within approved
policy limits.
Year 2000 Computer Systems Issue
The Company and its affiliates have spent
considerable time and effort over the past several
years on the issue of the year 2000 software
compliance, and the effort is continuing.
Certain software has already been made year 2000
compliant by upgrades and replacement, and analysis
is continuing on others, in accordance with a
schedule planned to permit the Company and its
affiliates to process information in the year 2000
and beyond without significant problems.
Expenditures for year 2000 compliance are not
expected to have a material effect on
the Company's results of operations or financial
position.
M-39
West Penn Power Company
and Subsidiaries
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FACTORS THAT MAY AFFECT FUTURE RESULTS
This management's discussion and analysis of
financial condition and results of operations
contains forecast information items that are
"forward-looking statements" as defined in the
Private Securities Litigation Reform Act of 1995.
All such forward-looking information is necessarily
only estimated. There can be no assurance that
actual results will not materially differ from
expectations. Actual results have varied
materially and unpredictably from past
expectations.
Factors that could cause actual results to differ
materially include, among other matters, electric
utility restructuring, including the ongoing state
and federal activities; future economic conditions;
earnings retention; developments in the
legislative, regulatory, and competitive
environments in which the Company operates;
environmental legislative and regulatory changes;
and other circumstances that could affect
anticipated revenues and costs, such as unscheduled
maintenance or repair requirements and compliance
with laws and regulations.
SIGNIFICANT EVENTS IN 1997, 1996, AND 1995
On April 7, 1997, Allegheny Power System, Inc.
(Allegheny Power), parent of the Company, and DQE,
Inc. (DQE), parent company of Duquesne Light
Company in Pittsburgh, Pennsylvania, announced that
they had agreed to merge and that the combined
company would be called Allegheny Energy, Inc.
Each company held separate shareholder meetings on
August 7 at which the merger was decisively
approved. At Allegheny Power's meeting, the
shareholders also approved the change in the
company's name to Allegheny Energy, Inc. (Allegheny
Energy). The merger is contingent upon approval by
various regulatory authorities. See Note B to the
consolidated financial statements and "Proposed Merger
with DQE" on page 8 for additional information. All
of the Company's incremental costs of the merger process
($5.1 million through December 31, 1997) are being
deferred, and will be written off by the Company
when the merger occurs or when it is determined
that the merger will not occur.
In December 1996, the Commonwealth of Pennsylvania
enacted the Electricity Generation Customer Choice
and Competition Act (Customer Choice Act) to
restructure the electric industry in Pennsylvania
to create retail access to a competitive electric
energy generation market. See Note C to the
consolidated financial statements for major
provisions of the Pennsylvania Plan and "Electric
Energy Competition" on page 8 for additional
information.
M-40
West Penn Power Company
and Subsidiaries
In 1994, the Allegheny Energy integrated electric
utility system (the System), including the Company,
initiated a restructuring process to consolidate and
reengineer their utility operations to meet the competitive
challenges of the changing electric utility
industry. As a result of this process, the System
reduced employment by about 1,000 employees through
a voluntary separation plan, attrition, and
layoffs, changed processes to obtain efficiencies
to reduce the rate of growth in operating and
maintenance costs, and began doing business under
the trade name of Allegheny Power. See Note D to
the consolidated financial statements for
additional information. This process resulted in
restructuring charges and asset write-offs in 1996
and 1995.
On August 26, 1997, and December 3, 1997, the
Company announced that it had negotiated agreements
to buy out and settle disputes with developers of
proposed nonutility generation plants (the
Milesburg and Washington Power projects) for $15
million and $48 million, respectively, reducing
costs over the proposed 30- and 33-year lives of
the projects by an estimated $1.4 billion. The
disputed projects under the Public Utility
Regulatory Policies Act of 1978 (PURPA) would have
required the Company to buy 43 and 80 megawatts,
respectively, of capacity and energy over the lives
of the projects at prices well above market price
estimates. Recovery of the Milesburg buyout
payment, by offset against a residual balance of
deferred fuel liabilities, was approved by the
Pennsylvania Public Utility Commission (PUC). The
Washington Power payment has been included in
amounts for which the Company has requested
recovery as part of its stranded cost recovery
request in its restructuring filing required under
the Customer Choice Act and is the subject of a
separate request to the PUC for recovery from
customers. In 1996, the Company and the developers
of a proposed Shannopin PURPA project reached an
agreement to terminate that project at a buyout
price of $31 million. Recovery of the buyout price
was authorized by the PUC. In 1996, $24 million of
the $31 million was recovered by reducing the
Company's over-recovered fuel balance, and the
remaining $7 million was included in amounts for
which the Company has requested recovery as part of
its stranded cost recovery request in its
restructuring filing required under the Customer
Choice Act. The Shannopin buyout will reduce the
Company's costs approximately $665 million over 30
years by eliminating the need to buy the uneconomic
power.
REVIEW OF OPERATIONS
Earnings Summary
Earnings
(Millions of Dollars) 1997 1996 1995
Operations................................. $134.7 $119.9 $124.5
Expenses related to restructuring
activities............................... 31.4 6.6
Consolidated Net Income.................... $134.7 $ 88.5 $117.9
M-41
West Penn Power Company
and Subsidiaries
The increase in 1997 earnings from operations
resulted primarily from reductions in operation and
maintenance (O&M) expenses from the restructuring
process, and additional actions taken during the
year to achieve further O&M reductions in
response to significant decreases in kilowatt-hour
(kWh) sales to residential customers caused
primarily by mild weather. The reductions from the
restructuring process were offset in part by a
change in allocation of affiliated transmission
services which resulted in higher charges to the
Company. Also contributing to the increase was a
$3.6 million (after tax) interest refund on a tax-
related contract settlement by the Company's 45%
owned subsidiary, Allegheny Generating Company
(AGC), recorded in other income as increased equity
in earnings of AGC, a gain on a sale of land by a
subsidiary ($2.8 million (after tax), and decreased
depreciation expense. The decrease in 1996
earnings from operations was due primarily to
higher depreciation expense, increased charge-offs
for uncollectible accounts, and the write-off of
deferred Clean Air Act Amendments of 1990 (CAAA)
compliance costs.
Sales and Revenues
Percentage changes in revenues and kWh sales in
1997 and 1996 by major retail customer classes
were:
1997 vs. 1996 1996 vs. 1995
Revenues kWh Revenues kWh
Residential................. (2.3)% (2.7)% .2 % 1.6%
Commercial.................. (.6) (.1) .2 1.4
Industrial.................. (.7) .9 (.5) 1.5
Total..................... (1.3)% (.5)% .0 % 1.5%
The changes in residential kWh sales, which are
more weather sensitive than the other classes, were
due primarily to changes in customer usage because
of weather conditions. The growth in the number of
residential customers was .5% and .3% in 1997 and
1996, respectively. The weather in 1997 was mild
in both the early and late winter and in the
summer, causing the 2.7% decrease in residential
kWh sales. In 1996, the early winter (January
through April) was about 8% colder than in 1995.
While this cold early winter was somewhat offset
by milder weather the remainder of the year, the
overall average for the year plus the increase in
the number of customers resulted in an increase in
1996 residential kWh sales of 1.6%.
Commercial kWh sales are also affected by weather,
but to a lesser extent than residential. The 1.4%
increase in 1996 reflects growth in the number of
customers and the increased heating requirements
that year.
The increase in industrial kWh sales in 1997 and
1996 reflects a trend of continued economic growth
in the service territory.
M-42
West Penn Power Company
and Subsidiaries
Changes in revenues from retail customers resulted
from the following:
Changes from Prior Year
(Millions of Dollars) 1997 vs. 1996 1996 vs. 1995
Fuel clauses...................... $ (8.6) $(7.7)
All other......................... (4.2) 7.3
Net change in retail revenues... $(12.8) $ (.4)
Revenues reflect not only the changes in kWh sales,
but also any changes in revenues from fuel and
energy cost adjustment clauses (fuel clauses) which
have no effect on consolidated net income because
increases and decreases in fuel and purchased power
costs and sales of transmission services and bulk
power are passed on to customers by adjustment of
customer bills through fuel clauses. Effective May
1, 1997, as a result of the Customer Choice Act,
which placed a cap on electric rates, the Company
filed for and obtained PUC authorization to set its
fuel clause to zero and to roll its then applicable
fuel clause rates into base rates. Thereafter, the Company
assumed the risks and benefits of changes in fuel
and purchased power costs and sales of transmission
services and bulk power.
All other is the net effect of kWh sales changes
due to changes in customer usage (primarily weather
for residential customers), growth in the number of
customers, and changes in pricing other than
changes in general tariff and fuel clause rates.
The decrease in 1997 all other retail revenues is
primarily the result of mild weather in 1997. The
increase in 1996 all other retail revenues was the
combined result of increased customer usage
(primarily due to cold weather in the early 1996
winter) and growth in the number of customers.
See Note C to the consolidated financial statements
for information about a potential loss of revenues
by the Company of up to $10 million in 1998
pursuant to a pilot program under the Customer
Choice Act and the potential for a much greater
loss of revenues during the transition period to
complete deregulation (estimated to be from 1999 to
about 2005).
Wholesale and other revenues were as follows:
(Millions of Dollars) 1997 1996 1995
Wholesale customers...................... $20.0 $19.1 $18.3
Affiliated companies..................... 41.0 44.3 44.3
Street lighting and other................ 11.5 10.9 10.8
Total wholesale and other revenues..... $72.5 $74.3 $73.4
Wholesale customers are cooperatives and municipalities
that own their own distribution systems and buy all or
part of their bulk power needs from the Company under
regulation by the Federal Energy Regulatory Commission (FERC).
Competition in the wholesale market for electricity was initiated
M-43
West Penn Power Company
and Subsidiaries
by the National Energy Policy Act of 1992 (EPACT),
which permits wholesale generators, utility-owned
and otherwise, and wholesale customers to request
from owners of bulk power transmission facilities
a commitment to supply transmission services. All
of the Company's wholesale customers have signed
contracts to remain as customers through at least
November 2001. The increase in wholesale revenues
in 1997, as well as the increase in 1996, was primarily
due to a new wholesale customer in April 1996 (formerly
a retail customer).
Revenues from affiliated companies represent sales
of energy and intercompany allocations of
generating capacity, generation spinning reserves
and transmission services pursuant to a power
supply agreement among the Company and the other
regulated utility subsidiaries of Allegheny Energy.
Revenues from bulk power transactions consist of
the following items:
(Millions of Dollars) 1997 1996 1995
Revenues:
Transmission services to
nonaffiliated companies.............. $18.4 $22.9 $19.7
Bulk power............................. 22.2 10.0 5.7
Total bulk power transactions, net... $40.6 $32.9 $25.4
The final rules on open transmission access, issued
by the FERC in early 1996, require utilities to
offer to others transmission service that is
comparable to service they provide to themselves.
Revenues from transmission services to
nonaffiliated companies in 1997 decreased due to
reduced demand, primarily because of mild weather.
Increased transmission services to nonaffiliated
companies in 1996 resulted primarily from increased
activity from power marketers who agreed to take
service under the new open access tariffs filed by
the Company in accordance with the new 1996 rules.
The increases in bulk power revenues resulted
primarily from increased sales to power marketers
and other utilities from the Company's generating
plants.
Operating Expenses
Fuel expenses increased 6.2% in 1997 because of a
5.1% increase in kWh's generated, a .8% increase
in average fuel prices, and a .3% increase in the
average heat rate of the generating stations. The
increase in kWh's generated was primarily the result
of increased bulk power sales to power marketers and
other utilities. The 1% increase in 1996 fuel expenses
was due to a 2% increase in kWh's generated, offset by
lower average coal prices.
M-44
West Penn Power Company
and Subsidiaries
Purchased power and exchanges, net represents power
purchases from and exchanges with nonaffiliated
utilities and purchases from qualified facilities
under PURPA, capacity charges paid to AGC, and
other transactions with affiliates made pursuant to
the power supply agreement whereby each company
uses the most economical generation available in
the System at any given time, and consists of the
following items:
(Millions of Dollars) 1997 1996 1995
Nonaffiliated transactions:
Purchased power:
From PURPA generation*............... $ 65.1 $ 63.6 $ 64.7
Other................................ 18.4 22.3 21.8
Power exchanges, net................... .2 .7 (.1)
Affiliated transactions:
AGC capacity charges................... 32.4 36.3 37.8
Energy and spinning reserve charges.... 3.9 4.0 5.3
Purchased power and exchanges, net... $120.0 $126.9 $129.5
*PURPA cost (cents per kWh) 6.0 5.8 5.8
Other purchased power in 1997 decreased because of
decreased demand due to decreased sales to retail
customers related to mild 1997 weather.
None of the Company's purchased power contracts is
capitalized since there are no minimum payment
requirements absent associated kWh generation.
The increase in other operation expenses in 1997
was primarily due to increased transmission
services cost allocations from affiliated companies
under the power supply agreement ($10.1 million)
and Pennsylvania pilot-related expenses. Other
operation expense also includes $4.4 million of
legal expenses incurred by the Company to defend
itself against an antitrust lawsuit filed by the
developers of the proposed Washington Power
PURPA project. The dispute was settled in December
1997. These expenses more than offset the reduction
in embedded expenses achieved through the 1996
restructuring process. The increase in other
operation expense in 1996 resulted primarily from
increased allowances for uncollectible accounts ($3
million) and the write-off of deferred CAAA
compliance costs ($2 million).
Maintenance expenses decreased $6.0 million in 1997
due primarily to reduced expenses achieved through
restructuring efforts and other cost controls.
Maintenance expense represents costs incurred to
maintain the power stations, the transmission and
distribution (T&D) system, and general plant,
and reflects routine maintenance of equipment and
rights-of-way as well as planned major repairs and
unplanned expenditures, primarily from forced
outages at the power stations and periodic storm
damage on the T&D system. Variations in maintenance
expense result primarily from unplanned events and
planned major projects, which vary in timing and
magnitude depending upon the
M-45
West Penn Power Company
and Subsidiaries
length of time equipment has been in service
without a major overhaul and the amount of work
found necessary when the equipment is dismantled.
Restructuring charges and asset write-offs in 1996
and 1995 resulted from restructuring activities, which have
been completed, and the write-offs of previously
accumulated costs related to a proposed transmission
line and obsolete and slow-moving materials.
The depreciation expense decrease of $5.3 million
in 1997 reflects a reduction in the Company's
annual depreciation expense determined to be
necessary as part of its comprehensive
restructuring filing required by the Customer
Choice Act. The depreciation expense increase in
1996 resulted primarily from additions to electric
plant.
The increase in taxes other than income in 1996 was
due to higher property taxes. The 1997 increase in
federal and state income taxes was primarily due to
increased income in 1997 compared with 1996. The
decrease in federal and state income taxes in 1996
resulted primarily from a decrease in income before
taxes ($18 million), primarily because of the
restructuring charges recorded in 1996. Note E to
the consolidated financial statements provides a
further analysis of income tax expenses.
The increase in allowance for other than borrowed
funds used during construction (AOFDC) in 1997
resulted from application of the FERC AOFDC formula
under which in 1997 a larger percentage of
construction was financed by more expensive equity
funds rather than by less expensive short-term debt
funds and an increase in the base amount on which
AOFDC is calculated. The decrease in 1996 reflects
decreases in capital expenditures.
The increase in other income, net, in 1997 was due
primarily to an interest refund on a tax-related
contract settlement ($3.6 million, net of taxes)
received by the Company's subsidiary, AGC, and to a
sale of land ($2.8 million, net of taxes) by the
Company's subsidiary, West Virginia Power and
Transmission Company.
Other interest expense reflects changes in the
levels of short-term debt maintained by the Company
throughout the year, as well as the associated
interest rates. The decrease in other interest
expense in 1997 resulted primarily from decreased
interest due to reduced overcollections of the fuel
cost portion of customer billings. The increase in
other interest expense in 1996 resulted primarily
from interest on overcollections of the fuel cost
portion of customer billings.
FINANCIAL CONDITION, REQUIREMENTS, AND RESOURCES
Liquidity and Capital Requirements
To meet the Company's need for cash for operating
expenses, the payment of interest and dividends,
retirement of debt and certain preferred stocks,
and for its construction program, the Company has
used internally generated funds
M-46
West Penn Power Company
and Subsidiaries
and external financings, such as the sale of common
and preferred stock, debt instruments, installment
loans, and lease arrangements. The timing and
amount of external financings depend primarily upon
economic and financial market conditions, the
Company's cash needs, and capitalization ratio
objectives. The availability and cost of external
financings depend upon the financial health of the
companies seeking those funds and market conditions.
Construction expenditures in 1997 were $128 million
and, for 1998 and 1999, are estimated at $112
million and $116 million, respectively. The 1998
and 1999 estimated expenditures include $12 million
and $27 million, respectively, for construction of
currently mandated environmental control
technology. It is the Company's goal to constrain
future base construction spending, with the
exception of mandated environmental expenditures,
to the approximate level of depreciation currently
in rates. The Company also has additional capital
requirements for debt maturities (see Note K to the
consolidated financial statements).
Internal Cash Flow
Internal generation of cash, consisting of cash
flows from operations reduced by dividends, was
$103 million in 1997 compared with $173 million in
1996. The decrease in 1997 was primarily the
result of the $48 million buyout of the Washington
Power PURPA project and payment of restructuring
liabilities. Current rate levels and reduced
levels of construction expenditures permitted the
Company to finance nearly all of its construction
expenditures in 1997 and 1996 with internal cash
flow. As described under "Electric Energy Competition" on
page 8, the Company is facing a serious potential
for income erosion. As described under
"Environmental Issues" on page 10, the Company
could potentially face significant mandated
increases in construction expenditures and
operating costs related to environmental issues.
Whether the Company can continue to meet the
majority of its construction needs with internally
generated cash is largely dependent upon the
outcome of these issues.
Financing
Short-term debt is used to meet temporary cash
needs until the timing is considered appropriate to
issue long-term securities. Short-term debt
increased $19 million to $52 million in 1997. At
December 31, 1997, the Company had Securities and
Exchange Commission authorization to issue up to
$182 million of short-term debt. The Company and
its regulated affiliates use an internal money pool
as a facility to accommodate intercompany short-term
borrowing needs, to the extent that certain of the
companies have funds available. The Company will
meet its 1998 cash needs through internal cash
generation, cash on hand, short-term borrowings as
necessary, and refunding of a portion of maturing
long-term debt.
M-47
West Penn Power Company
and Subsidiaries
SIGNIFICANT CONTINUING ISSUES
Proposed Merger with DQE
Following the negotiations and announcement of the
merger, Allegheny Power and DQE obtained their
respective shareholders' approval, made regulatory
filings for approval, and started the merger
planning process by naming certain employees of
both companies, including management personnel, to
merger planning teams. All of the regulatory
approvals are expected by June 30, 1998.
Merger opposition has arisen in two forms:
The City of Pittsburgh filed an antitrust
lawsuit, which was dismissed by the United States
District Court for the Western District of
Pennsylvania in December 1997. The City has
since filed an appeal with the United States
Court of Appeals for the Third Circuit.
Various intervenors in the PUC and the FERC
merger proceedings allege that the combined
company may have the ability to exercise market
power.
An additional risk to the merger is the possibility
that the regulatory approvals might contain such
onerous conditions that the merger would no longer
be beneficial to shareholders. The companies'
proposals for the sharing of merger synergy savings
between customers and shareholders are described in
Note B to the consolidated financial statements.
While Allegheny Energy cannot predict the outcome
of the merger hearings or the City of Pittsburgh's
appeal process, it believes that the opposition's
arguments are without merit and that the approvals
should be received in a manner which will allow the
merger to proceed.
Electric Energy Competition
Competition in the wholesale market for electricity
was initiated by EPACT in 1992 and Orders 888 and
889 by the FERC in April 1996, which together
mandated that the owners of transmission facilities
provide nondiscriminatory open access of
transmission services to wholesale customers and
electricity generators, utility-owned and
otherwise. With these actions, wholesale customers
obtained the ability to seek their electricity
requirements from competing generators. The Company
has been an advocate of federal legislation to create
competition in the retail electricity markets to
avoid regional dislocations and ensure level
playing fields. Various bills have been introduced
and debated in the United States Congress, but none
has passed.
In the absence of federal legislation, state-by-state
implementation has begun. Pennsylvania has taken action
to begin implementation of access by retail customers to
alternate generation suppliers. The Pennsylvania
M-48
West Penn Power Company
and Subsidiaries
process, which began with the Customer Choice Act
in December 1996, is well under way. Hearings have
been completed on the Company's restructuring
filing required by the Customer Choice Act. As
described in Note C to the consolidated financial
statements, intervenors in the proceeding have
recommended that the Company should be allowed to
recover little or none of its stranded costs, i.e.,
costs recoverable under regulation, but which will
not be supported in a competitive market. While
they generally agree that low market prices during
the transition period (1999-2005) will cause a
significant reduction of the Company's revenues and
earnings (perhaps as much as reducing its net
income by half in the earlier years), they allege
that market prices will rise sharply thereafter
and, therefore, the Company has little or no
stranded costs over the life of its generating
assets.
Nearly all of the parties to the filing agree that
market prices of energy in the transition period
will be well below the Company's embedded costs.
A significant reason for this circumstance is a
considerable amount of excess capacity in several
states available for the limited demand of one state,
a result of state-by-state implementation of retail
competition. Many of the out-of-state sellers have
the embedded fixed costs of their excess capacity
included in their rate base with the result that they
are recovering such costs from their regulated captive
retail customers. It is expected that the other utilities
in Pennsylvania will also have some payment of
their embedded costs by their captive customers
through collection of a Competitive Transition
Charge (CTC) to recover some portion of their
stranded costs. Allegheny Energy is continuing to
advocate federal legislation through its membership
in the Partnership for Customer Choice, along with
six other electric utilities. The purpose is to
seek enactment of federal legislation to bring
choice to electric customers no later than the year
2000.
The Company included in its restructuring filing
alternative recommendations for the PUC to consider
to avoid the potential significant reduction of its
revenues and earnings. The intervenors in the
filing have recommended that the Company sell all
or most of its generation assets and use the
proceeds to cover the stranded costs. They allege
that customers would then not have to pay any CTC
and the Company would not incur any losses. The
Customer Choice Act specifically prohibits the PUC
from ordering generation divestiture.
The Company is making substantial efforts to settle
the case by negotiation with the intervenors. PECO
Energy (PECO), in mid-1997, reached a settlement
with most of its intervenors in its restructuring
proceeding, which the PUC rejected. PECO has
appealed the PUC Order to the Courts. Portions of
the language of the PUC Order in the PECO
proceeding are not supportive of an acceptable
settlement for the Company if the same language is
applied to the Company. If a settlement cannot be
reached, the issue will fall to the PUC in its
final Order. In its filing and in subsequent
testimony, the Company has amply supported its
primary case, which the Commission could accept.
While Allegheny Energy and the Company believe that
the worst-case scenario described is not the intent
of the Customer Choice Act, the decision may
ultimately lie with the PUC. Allegheny Energy and
the Company cannot predict the outcome.
M-49
West Penn Power Company
and Subsidiaries
Allegheny Energy is also advocating federal
legislation to repeal Section 210 of PURPA and the
Public Utility Holding Company Act of 1935 (PUHCA).
Both of these laws severely impede the Company's
ability to compete on equal terms with utility and
nonutility electric providers who are not subject
to their requirements.
With efficient operations, a reputation for quality
service and reliability, and electric rates among
the lowest in the areas it serves, the Company
believes it is well-positioned for fair and open
competition in the marketplace. But, as the
Company's experience demonstrates, there is
substantial risk inherent in the transition process
of moving toward retail competition.
Environmental Issues
In the normal course of business, the Company is
subject to various contingencies and uncertainties
relating to its operations and construction programs,
including legal actions and regulations and uncertainties
related to environmental matters.
The significant costs of complying with Phase I of
the Clean Air Act Amendments of 1990 (CAAA) have
been incurred and are being recovered currently
from customers in rates. Studies to evaluate cost-
effective options to comply with Phase II SO2
limits, including those which may be available from
the use of the Company's banked emission allowances
and from the emission allowance trading market, are
continuing.
Title I of the CAAA established an Ozone Transport
Commission to ascertain additional NOx reductions
to allow the Ozone Transport Region (OTR) to meet
the ozone National Ambient Air Quality Standards
(NAAQS). Under terms of a Memorandum of
Understanding (MOU) among the OTR states, the
Company's operating stations located in
Pennsylvania will be required to reduce NOx
emissions by approximately 55% from the 1990
baseline emissions, with a compliance date of May
1999. Further reductions of 75% from the 1990
baseline may be required by May 2003, depending on
the results of modeling studies to be completed by
1998. If reductions of 75% are required,
installation of post-combustion control
technologies would be very expensive. Pennsylvania
promulgated regulations to implement Phase II of
the MOU in November 1997.
Several other significant regulatory actions
initiated in 1997 could require significant
expenditures for further control of air emissions.
In November 1997, the Environmental Protection
Agency (EPA) issued a proposed State Implementation
Plan (SIP) call which would require further
controls of NOx emissions to the less stringent of
an 85% reduction from 1990 emission rates or an
emission rate of 0.15 lb/mmBtu. The EPA intends to
finalize the SIP call by September 1998.
Implementation of controls, which could be required
by mid-2003, would require very expensive post-combustion
control technologies on most, if not all, of the Company's
power stations.
M-50
West Penn Power Company
and Subsidiaries
In August 1997, eight northeastern states filed
Section 126 petitions with the EPA requesting the
immediate imposition of up to an 85% NOx reduction
from utilities located in the Midwest and Southeast
(West Virginia included). The petitions claim NOx
emissions from these upwind sources are preventing
their attainment of the ozone standard. The EPA
will probably address these petitions in
conjunction with the SIP call mentioned above.
The EPA is required by law to regularly review the
NAAQS for criteria pollutants. Revisions to
particulate matter and ozone standards were
proposed by the EPA in 1996 and finalized in July
1997. The effect on the Company of any revisions
to these standards is unknown at this time but
could be substantial. State attainment plans to
meet the revised standards will not be developed
for several years. Also, in July 1997, the EPA
proposed regional haze regulations to improve
visibility in Class I Federal areas (national parks
and wilderness areas). If finalized, subsequent
state regulations could require additional
reduction of SO2 and/or NOx emissions from the
Company's facilities.
The final outcome of the revised ambient standards,
Phase III of the MOU, SIP calls, and Section 126
petitions cannot be determined at this time. All
are being challenged by rulemaking, petition,
and/or litigation proceedings. Implementation
dates, if required, are uncertain at this time, but
could be as early as 2003.
In December 1997, the Clinton Administration, at a
conference in Kyoto, Japan, agreed to a protocol
for greenhouse gas reductions to 7% below 1990
levels as early as 2008. The protocol will not go
into effect unless ratified by the United States
Senate. If implemented, the protocol would require
dramatic reductions in emissions of carbon dioxide,
a major so-called greenhouse gas emitted during
combustion of fossil fuels, particularly coal.
Significant reduction requirements could force the
Company to make major changes in electricity
production to reduce or eliminate the use of coal.
Allegheny Energy is actively opposing implementation
of the protocol in the United States Congress and
through alliances with other affected companies.
The Company previously reported that the EPA had
identified the Company and its regulated affiliates
and approximately 875 others as potentially
responsible parties in a Superfund site subject to
cleanup. A final determination has not been made
for the Company's share of the remediation costs
based on the amount of materials sent to the site.
The Company has also been named as a defendant
along with multiple other affiliated and
nonaffiliated defendants in pending asbestos cases
involving one or more plaintiffs. The Company
believes that provisions for liability and
insurance recoveries are such that final resolution
of these claims will not have a material effect on
its financial position.
M-51
West Penn Power Company
and Subsidiaries
Independent Transmission System Operation Study
On December 7, 1997, the Company and its two
regulated affiliates announced that they and eight
other investor-owned electric utilities had signed
an MOU to explore the creation of an independent,
regional transmission entity. Many industry
participants, including customers and regulatory
authorities, believe that an entity independent of
the utilities who own the transmission systems is
needed to operate the systems to ensure
nondiscriminatory access to the transmission
systems by all users. As part of its merger
application in Pennsylvania and with the FERC,
Allegheny Energy agreed to join or form an
independent system operator.
The group will explore arrangements to achieve
nondiscriminatory access to all while maintaining
other key goals, such as reliability, security,
efficient use, etc.
Risk Management
The Company and its affiliates use derivative
instruments to manage the risk exposure associated
with contracts it writes for the purchase and/or
sale of electricity for receipt or delivery at
future dates. Such instruments are used in
accordance with a risk management policy adopted by
the Board of Directors and monitored by an Exposure
Management Committee of senior management. The
policy requires continuous monitoring, reporting,
and stress testing of all open positions for conformity
to policies which limit value at risk and market risk
associated with the credit standing of trading counterparties.
Such credit standings must be investment grade or
better, or be guaranteed by a parent company with
such a credit standing for all over-the-counter
instruments.
At December 31, 1997, the trading books of the
Company and its affiliates consisted primarily of
physical contracts with fixed pricing. Most
contracts were fixed-priced, forward purchase
and/or sale contracts which required settlement by
physical delivery of electricity. During 1997, the
Company and its affiliates also entered into option
contracts which, if exercised, were settled with
physical delivery of electricty.
These transactions result in market risk which
occurs when the market price of a particular
obligation or entitlement varies from the contract
price. As the Company continues to develop its
power marketing and trading business, its exposure
to volatility in the price of electricity and other
energy commodities may increase within approved
policy limits.
M-52
West Penn Power Company
and Subsidiaries
Year 2000 Computer Systems Issue
The Company and its affiliates have spent
considerable time and effort over the past several
years on the issue of the year 2000 software
compliance, and the effort is continuing.
Certain software has already been made year 2000
compliant by upgrades and replacement, and analysis
is continuing on others, in accordance with a
schedule planned to permit the Company and its
affiliates to process information in the year 2000
and beyond without significant problems.
Expenditures for year 2000 compliance are not
expected to have a material effect on the Company's
results of operations or financial position.
M-53
Allegheny Generating Company
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FACTORS THAT MAY AFFECT FUTURE RESULTS
This management's discussion and analysis of
financial condition and results of operations
contains forecast information items that are
"forward-looking statements" as defined in the
Private Securities Litigation Reform Act of 1995.
All such forward-looking information is necessarily
only estimated. There can be no assurance that
actual results will not materially differ from
expectations. Actual results have varied
materially and unpredictably from past
expectations.
Factors that could cause actual results to differ
materially include, among other matters, electric
utility restructuring, including the ongoing state
and federal activities; future economic conditions;
earnings retention; developments in the
legislative, regulatory, and competitive
environments in which the Company operates;
environmental legislative and regulatory changes;
and other circumstances that could affect
anticipated revenues and costs, such as unscheduled
maintenance or repair requirements and compliance
with laws and regulations.
SIGNIFICANT EVENT IN 1997
On April 7, 1997, Allegheny Power System, Inc.
(Allegheny Power), parent of the Company's Parents
(Monongahela Power Company, The Potomac Edison
Company, and West Penn Power Company), and DQE,
Inc. (DQE), parent company of Duquesne Light
Company in Pittsburgh, Pennsylvania, announced that
they had agreed to merge and that the combined
company would be called Allegheny Energy, Inc. Each
company held separate shareholder meetings on
August 7 at which the merger was decisively
approved. At Allegheny Power's meeting, the
shareholders also approved the change in the
company's name to Allegheny Energy, Inc. The
merger is contingent upon approval by various
regulatory authorities. See Note B to the
financial statements for additional information.
REVIEW OF OPERATIONS
As described under Liquidity and Capital
Requirements, revenues are determined under a cost
of service formula rate schedule. Therefore, if all
other factors remain equal, revenues are expected
to decrease each year due to a normal continuing
reduction in the Company's net investment in the
Bath County station and its connecting transmission
facilities upon which the return on investment is
determined. The net investment (primarily net
plant less deferred income taxes) decreases to the
extent that provisions for depreciation and
deferred income taxes exceed net plant additions.
Revenues for 1997 and 1996 decreased due to a
reduction in net investment and reduced operating
expenses and, additionally for 1996, due to the
decrease in the Company's return on equity (ROE)
from 11.2% to 11% described below.
M-54
Allegheny Generating Company
The decrease in operating expenses in 1997 resulted
from a decrease in federal income taxes due to a
decrease in operating income before taxes.
Effective June 1, 1995, the Federal Energy
Regulatory Commission (FERC) gave approval for the
Company to add a prior tax payment of approximately
$12 million to rate base. In September 1997, the
Company received a tax-related contract settlement
of $8.8 million of taxes related to the
$12 million added to rate base in 1995. The 1997
settlement amount was recorded as a reduction to
plant and was removed from rate base.
The increase in other income, net was due to
interest on the refund on the tax-related contract
settlement (see above).
The decrease in interest on long-term debt in 1997
and 1996 was primarily the result of a decrease in
the average amount of long-term debt outstanding.
LIQUIDITY AND CAPITAL REQUIREMENTS
The Company's only operating assets are an
undivided 40% interest in the Bath County
(Virginia) pumped-storage hydroelectric station and
its connecting transmission facilities. The
Company has no plans for construction of any other
major facilities.
Pursuant to an agreement, the Parents buy all of
the Company's capacity in the station priced under
a "cost of service formula" wholesale rate schedule
approved by the FERC. Under this arrangement, the Company
recovers in revenues all of its operation and
maintenance expenses, depreciation, taxes, and a
return on its investment.
The Company's rates are set by a formula filed with
and previously accepted by the FERC. The only
component which changes is the ROE. The ROE
authorized for the Company was 11.2% in 1995.
Pursuant to a settlement agreement filed with and
approved by the FERC, the Company's ROE was set at
11% for 1996 and will continue at that rate until
the time any affected party seeks renegotiation of
the ROE. Notice of such intent to seek a revision
in ROE must be filed during a notice period each
year between November 1 and November 15. No
requests for change were filed during the 1997
notice period. Therefore, the Company's ROE will
remain at 11% for 1998.
In July 1996, the Company filed a request with the
Securities and Exchange Commission (SEC) for
authority to pay common dividends from time to time
through December 31, 2001, out of capital to the
extent permitted under applicable corporation law
and any applicable financing agreements which
restrict distributions to shareholders. Due to the
nature of being a single asset company with
declining capital needs, the Company systematically
reduces capitalization each year as its asset
depreciates. This has resulted in the payment of
dividends in excess of current earnings and the
reduction of retained earnings. The Company's goal
is to retire debt and pay dividends in amounts
necessary to maintain a common equity position of
about 45%. The payment of dividends out of capital
surplus will not be detrimental to the
M-55
Allegheny Generating Company
financial integrity or working capital of either
the Company or its Parents, nor will it adversely
affect the protections due debt security holders.
On September 19, 1996, the SEC approved the
Company's request to pay common dividends out of
capital.
An internal money pool accommodates intercompany
short-term borrowing needs to the extent that
certain of the Company's regulated affiliates have
funds available.
YEAR 2000 COMPUTER SYSTEMS ISSUE
The Company and its Parents have spent considerable
time and effort over the past several years on the
issue of the year 2000 software compliance, and the
effort is continuing. Certain software has already
been made year 2000 compliant by upgrades and
replacement, and analysis is continuing on others,
in accordance with a schedule planned to permit the
Company and its Parents to process information in the
year 2000 and beyond without significant problems.
Expenditures for year 2000 compliance are not expected
to have a material effect on the Company's results of
operations or financial position.
39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA Financial Statements
Index
Monon- Potomac West
AE gahela Edison Penn AGC
Report of Independent Accountants F-1 F-22 F-39 F-56 F-76
Statement of Income for
the three years ended
December 31, 1997 F-2 F-23 F-40 F-57 F-77
Statement of Retained Earnings
for the three years ended
December 31, 1997 - F-23 F-40 F-57 F-77
Statement of Cash Flows for
the three years ended
December 31, 1997 F-3 F-24 F-41 F-58 F-78
Balance Sheet at December 31,
1997 and 1996 F-4 F-25 F-42 F-59 F-79
Statement of Capitalization at
December 31, 1997 and 1996 F-6 F-26 F-43 F-60 F-79
Statement of Common Equity for
the three years ended
December 31, 1997 F-7 - - - -
Notes to financial statements F-8 F-27 F-44 F-61 F-80
Financial Statement Schedules -
Schedules - for the three years 40 40 40 40 40
ended December 31, 1997
II Valuation and qualifying
accounts S-1 S-2 S-3 S-4 -
All other schedules are omitted because they are not applicable or the required
information is shown in the Financial Statements or Notes thereto.
F-1
Allegheny Energy, Inc.
Report Of Independent Accountants
To the Board of Directors and the Shareholders
of Allegheny Energy, Inc.
In our opinion, the accompanying consolidated balance
sheet, consolidated statements of capitalization and of
common equity and the related consolidated statements of
income and of cash flows present fairly, in all
material respects, the financial position of
Allegheny Energy, Inc. and its subsidiaries at
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. These 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 of these statements in
accordance with generally accepted auditing
standards which 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,
assessing the accounting principles used and
significant estimates made by management, and
evaluating the overall financial statement
presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
Price Waterhouse LLP
Pittsburgh, Pennsylvania
February 4, 1998
F-2
Allegheny Energy, Inc.
Consolidated Statement of Income
Year ended December 31 1997 1996 1995
(Thousands of Dollars Except for
Per Share Data)
Electric Operating Revenues:
Residential $893,264 $932,235 $926,966
Commercial 491,007 492,726 493,696
Industrial 747,863 752,905 770,251
Wholesale and other 75,263 74,260 66,147
Bulk power transactions, net 162,094 75,523 58,151
Total Operating Revenues 2,369,491 2,327,649 2,315,211
Operating Expenses:
Operation:
Fuel 559,939 513,210 508,533
Purchased power and exchanges, net 219,837 184,357 178,103
Deferred power costs, net (22,916) 15,621 47,796
Other 308,991 299,817 290,501
Maintenance 230,602 243,314 249,477
Restructuring charges and asset write-offs 103,865 23,440
Depreciation 265,750 263,246 256,316
Taxes other than income taxes 186,978 185,373 184,729
Federal and state income taxes 168,073 127,992 154,203
Total Operating Expenses 1,917,254 1,936,795 1,893,098
Operating Income 452,237 390,854 422,113
Other Income and Deductions:
Allowance for other than borrowed
funds used during construction 4,393 3,157 4,473
Other income, net 18,016 4,370 6,224
Total Other Income and Deductions 22,409 7,527 10,697
Income Before Interest Charges and
Preferred Dividends 474,646 398,381 432,810
Interest Charges and Preferred Dividends:
Interest on long-term debt 173,568 166,387 167,199
Other interest 14,409 15,398 14,417
Allowance for borrowed funds used
during construction (3,907) (2,731) (3,713)
Dividends on preferred stock of subsidiaries 9,280 9,280 15,215
Total Interest Charges and
Preferred Dividends 193,350 188,334 193,118
Consolidated Net Income $281,296 $210,047 $239,692
Common Stock Shares Outstanding
(average) 122,208,465 121,141,446 119,863,753
Basic and Diluted Earnings
Per Average Share $2.30 $1.73 $2.00
See accompanying notes to consolidated financial statements.
F-3
Allegheny Energy, Inc.
Consolidated Statement of Cash Flows
Year ended December 31 1997 1996 1995
(Thousands of Dollars)
Cash Flows from Operations:
Consolidated net income $281,296 $210,047 $239,692
Depreciation 265,750 263,246 256,316
Deferred investment credit and
income taxes, net 66,362 20,887 27,019
Deferred power costs, net (22,916) 15,621 47,796
Allowance for other than borrowed funds
used during construction (4,393) (3,157) (4,473)
Restructuring liability (50,597) 55,544 14,435
PURPA project buyout (48,000)
Changes in certain current assets
and liabilities:
Accounts receivable, net (6,052) 19,570 (63,370)
Materials and supplies (1,385) 15,507 20,358
Accounts payable (17,172) 1,739 (45,387)
Other, net 15,733 (8,083) (13,951)
478,626 590,921 478,435
Cash Flows from Investing:
Utility construction expenditures
(less allowance for equity funds
used during construction) (280,255) (286,297) (314,577)
Nonutility investments (829) (180,245) (1,076)
(281,084) (466,542) (315,653)
Cash Flows from Financing:
Sale of common stock 16,706 33,847 34,514
Retirement of preferred stock (162,171)
Issuance of long-term debt and QUIDS 160,000 482,856
Retirement of long-term debt (46,892) (54,143) (392,715)
Short-term debt, net 49,971 (43,988) 73,600
Cash dividends on common stock (210,195) (204,720) (197,764)
(190,410) (109,004) (161,680)
Net Change in Cash and
Temporary Cash Investments 7,132 15,375 1,102
Cash and Temporary Cash Investments
at January 1 19,242 3,867 2,765
Cash and Temporary Cash Investments
at December 31 $26,374 $19,242 $3,867
Supplemental Cash Flow Information
Cash paid during the year for:
Interest (net of amount capitalized) $178,121 $169,200 $178,239
Income taxes 108,519 132,037 126,386
See accompanying notes to consolidated financial statements.
F-4
Allegheny Energy, Inc.
Consolidated Balance Sheet
As of December 31 1997 1996
(Thousands of Dollars)
Assets
Property, Plant, and Equipment:
At original cost, including $229,785,000 and $202,259,000
under construction $8,451,424 $8,206,213
Accumulated depreciation (3,155,210) (2,910,022)
5,296,214 5,296,191
Investments and Other Assets:
Subsidiaries consolidated-excess of cost over book equity at
acquisition 15,077 15,077
Benefit plans' investments 79,474 63,197
Other 6,551 4,359
101,102 82,633
Current Assets:
Cash and temporary cash investments 26,374 19,242
Accounts receivable:
Electric service, net of $17,191,000 and $15,052,000
uncollectible allowance 296,082 280,154
Other 12,312 22,188
Materials and supplies-at average cost:
Operating and construction 80,836 82,057
Fuel 63,361 60,755
Prepaid taxes 51,724 62,110
Deferred income taxes 12,357 39,428
Other 11,648 16,324
554,694 582,258
Deferred Charges:
Regulatory assets 586,125 565,185
Unamortized loss on reacquired debt 49,550 53,403
Other 66,406 38,840
702,081 657,428
Total $6,654,091 $6,618,510
Capitalization and Liabilities
Capitalization:
Common stock, other paid-in capital, and retained earnings $2,256,898 $2,169,091
Preferred stock 170,086 170,086
Long-term debt and QUIDS 2,193,153 2,397,149
4,620,137 4,736,326
Current Liabilities:
Short-term debt 206,401 156,430
Long-term debt due within one year 185,400 26,900
Accounts payable 129,989 147,161
Taxes accrued:
Federal and state income 10,453 7,173
Other 55,428 62,361
Interest accrued 40,000 40,630
Restructuring liability 5,504 56,101
Other 68,666 80,281
701,841 577,037
F-5
Allegheny Energy, Inc.
Deferred Credits and Other Liabilities
Unamortized investment credit 133,316 141,519
Deferred income taxes 1,031,236 1,000,023
Regulatory liabilities 91,178 93,216
Other 76,383 70,389
1,332,113 1,305,147
Commitments and Contingencies (Note M)
Total $6,654,091 $6,618,510
See accompanying notes to consolidated financial statements.
F-6
Allegheny Energy, Inc.
Consolidated Statement of Capitalization
(Thousands of Dollars) (Capitalization Ratios)
As of December 31 1997 1996 1997 1996
Common Stock:
Common stock of Allegheny Energy, Inc.
$1.25 par value per share, 260,000,000 shares
authorized, outstanding 122,436,317 and
121,840,327 shares $153,045 $152,300
Other paid-in capital 1,044,085 1,028,124
Retained earnings 1,059,768 988,667
Total 2,256,898 2,169,091 48.8% 45.8%
Preferred Stock of Subsidiaries-cumulative, par value
$100 per share, authorized 9,975,688 shares:
December 31, 1997
Shares Regular Call Price
Series Outstanding Per Share
3.60%-4.80% 650,861 $103.75 to $110.00 65,086 65,086
$5.88-$7.73 650,000 $102.85 to $102.86 65,000 65,000
Auction 4.008%-4.29% 400,000 $100.00 40,000 40,000
Total (annual dividend requirements $9,246,469) 170,086 170,086 3.7% 3.6%
Long-Term Debt and QUIDS of Subsidiaries:
First mortgage bonds: December 31, 1997
Maturity Interest Rate-%
1997-2000 5 1/2-6 1/2 242,000 257,000
2002-2004 6 3/8-7 7/8 175,000 175,000
2006-2007 7 1/4-8 120,000 120,000
2021-2025 7 5/8-8 7/8 925,000 925,000
Debentures due 2003-2023 5 5/8-6 7/8 150,000 150,000
Quarterly Income Debt
Securities due 2025 8.00 155,457 155,457
Secured notes due 1998-2024 4.95-6.875 368,300 368,300
Unsecured notes due 1997-2012 6.10-6.40 24,995 26,295
Installment purchase obligations
due 1998 6.875 19,100 19,100
Commercial paper 19,992
Medium-term debt due 1997-2001 5.75-7.93 220,000 230,600
Unamortized debt discount and premium, net (21,299) (22,695)
Total (annual interest requirements $172,193,732) 2,378,553 2,424,049
Less current maturities (185,400) (26,900)
Total 2,193,153 2,397,149 47.5% 50.6%
Total Capitalization $4,620,137 $4,736,326 100.0% 100.0%
See accompanying notes to consolidated financial statements.
F-7
Allegheny Energy, Inc.
Consolidated Statement of Common Equity (Thousands of Dollars)
Year ended December 31 Other Retained Total
Shares Common Paid-In Earnings Common
Outstanding Stock Capital (Note F) Equity
Balance at January 1, 1995 119,292,954 $149,116 $963,269 $946,919 $2,059,304
Add:
Sale of common stock, net of expenses:
Dividend Reinvestment and Stock
Purchase Plan and Employee Stock
Ownership and Savings Plan 1,407,855 1,760 32,754 34,514
Consolidated net income 239,692 239,692
Deduct:
Dividends on common stock of the
Company (cash) 197,764 197,764
Expenses related to subsidiary companies'
preferred stock transactions 322 5,507 5,829
Balance at December 31, 1995 120,700,809 $150,876 $995,701 $ 983,340 $2,129,917
Add:
Sale of common stock, net of expenses:
Dividend Reinvestment and Stock
Purchase Plan and Employee Stock
Ownership and Savings Plan 1,139,518 1,424 32,423 33,847
Consolidated net income 210,047 210,047
Deduct:
Dividends on common stock of the
Company (cash) 204,720 204,720
Balance at December 31, 1996 121,840,327 152,300 1,028,124 988,667 2,169,091
Add:
Sale of common stock, net of expenses:
Dividend Reinvestment and Stock
Purchase Plan, Employee Stock
Ownership and Savings Plan,
and Performance Share Plan 595,990 745 15,961 16,706
Consolidated net income 281,296 281,296
Deduct:
Dividends on common stock of the
Company (cash) 210,195 210,195
Balance at December 31, 1997 122,436,317 $153,045 $1,044,085 $1,059,768 $2,256,898
See accompanying notes to consolidated financial statements.
F-8
Allegheny Energy, Inc.
Notes To Consolidated Financial Statements
(These notes are an integral part of the consolidated financial statements.)
NOTE A: Summary of Significant Accounting
Policies
Allegheny Energy, Inc. (the Company) is an
electric utility holding company that derives
substantially all of its income
from the electric utility operations of its
regulated subsidiaries, Monongahela Power Company
(Monongahela Power), The Potomac Edison Company
(Potomac Edison), and West Penn Power Company
(West Penn). These subsidiaries jointly own
Allegheny Generating Company (AGC), which owns
and sells to its parents 840 megawatts (MW) of
pumped-storage generating capacity. The markets
for the subsidiaries' regulated electric retail
sales are in the states of Pennsylvania, West
Virginia, Maryland, Virginia, and Ohio. In 1997,
revenues from 50 of their largest electric
utility customers provided approximately 18% of
consolidated retail revenues. The Company also
has a wholly owned nonutility subsidiary, AYP
Capital, Inc. (AYP Capital), formed in 1994,
which, along with its subsidiaries, is involved
primarily in energy-related services, development
of wholesale nonutility power generation, retail
electricity sales to deregulated markets, and
other energy-related businesses.
The Company and its subsidiaries are subject
to regulation by the Securities and Exchange
Commission (SEC), including the Public Utility
Holding Company Act of 1935 (PUHCA). The
regulated subsidiaries are subject to
regulation by various state bodies having
jurisdiction and by the Federal Energy
Regulatory Commission (FERC). Significant
accounting policies of the Company and its
subsidiaries are summarized below.
Consolidation
The Company owns all of the outstanding common
stock of its subsidiaries. The consolidated
financial statements include the accounts of the
Company and all subsidiary companies after
elimination of intercompany transactions.
Use of Estimates
The preparation of financial statements in
conformity with generally accepted accounting
principles requires management to make estimates
that affect the reported amounts of assets,
liabilities, revenues, expenses, and disclosures
of contingencies during the reporting period,
which in the normal course of business are
subsequently adjusted to actual results.
Revenues
Revenues, including amounts resulting from the
application of fuel and energy cost adjustment
clauses, are recognized in the same period in
which the related electric services are provided
to customers by recording an estimate for
unbilled revenues for services provided from the
meter reading date to the end of the accounting
period. Revenues from nonregulated activities
are recorded in the period earned.
Deferred Power Costs, Net
The costs of fuel, purchased power, and certain
other costs, and revenues from sales to other
utilities, including transmission services, are
deferred until they are either recovered from or
credited to customers under fuel and energy cost
recovery procedures in West Virginia, Maryland,
Virginia, and Ohio. West Penn discontinued this
practice in Pennsylvania effective May 1, 1997.
F-9
Allegheny Energy, Inc.
Property, Plant, and Equipment
Utility property, plant, and equipment are
stated at original cost, less contributions
in aid of construction, except for capital
leases, which are recorded at present value.
Cost includes direct labor and material,
allowance for funds used during construction
(AFUDC) on utility property for which
construction work in progress is not included
in rate base, and such indirect costs as
administration, maintenance, and depreciation
of transportation and construction equipment,
and postretirement benefits, taxes, and other
fringe benefits related to employees engaged
in construction.
The cost of depreciable utility property
units retired, plus removal costs less salvage,
are charged to accumulated depreciation.
Allowance for Funds Used During Construction
AFUDC, an item that does not represent current
cash income, is defined in applicable regulatory
systems of accounts as including "the net cost
for the period of construction of borrowed funds
used for construction purposes and a reasonable
rate on other funds when so used." AFUDC is
recognized by the regulated subsidiaries as a
cost of utility property, plant, and equipment
with offsetting credits to other income and
interest charges. Rates used by the subsidiaries
for computing AFUDC in 1997, 1996, and 1995
averaged 8.59%, 8.41%, and 8.73%, respectively.
AFUDC is not included in the cost of
construction by the nonutility businesses or by
the utility businesses when the cost of
financing the construction is being recovered
through rates.
Depreciation and Maintenance
Provisions for depreciation are determined
generally on a straight-line method based on
estimated service lives of depreciable
properties and amounted to approximately 3.3% of
average depreciable property in 1997 and 3.5% in
1996 and 1995. The cost of maintenance and of
certain replacements of property, plant, and
equipment is charged principally to operating
expenses.
Nonutility Property
Nonutility property is stated at original cost
and is depreciated by the straight-line method
over its estimated useful life.
Investments
The investment in subsidiaries consolidated
represents the excess of acquisition cost over
book equity (goodwill) prior to 1966. Goodwill
is not being amortized because, in management's
opinion, there has been no reduction in its
value.
Benefit plans' investments primarily
represent the estimated cash surrender values of
purchased life insurance on qualifying
management employees under executive life
insurance and supplemental executive retirement
plans. Payment of future premiums will fully
fund these benefits.
Temporary Cash Investments
For purposes of the consolidated statement of
cash flows, temporary cash investments with
original maturities of three months or less, generally
in the form of commercial paper, certificates of deposit,
and repurchase agreements, are considered to be the
equivalent of cash.
Regulatory Assets and Liabilities
In accordance with the Financial Accounting
Standards Board's Statement of Financial
Accounting Standards (SFAS) No. 71, "Accounting
for the Effects of Certain Types of Regulation,"
the Company's consolidated financial statements
reflect assets and liabilities based on cost-
based ratemaking regulation.
F-10
Allegheny Energy, Inc.
Income Taxes
Financial accounting income before income taxes
differs from taxable income principally because
certain income and deductions for tax purposes
are recorded in the financial income statement
in another period. For the regulated
subsidiaries, differences between income tax
expense computed on the basis of financial
accounting income and taxes payable based on
taxable income are accounted for substantially
in accordance with the accounting procedures
followed for ratemaking purposes. Deferred tax
assets and liabilities represent the tax effect
of temporary differences between the financial
statement and tax basis of assets and
liabilities computed utilizing the most current
tax rates.
Provisions for federal income tax were
reduced in previous years by investment credits,
and amounts equivalent to such credits were
charged to income with concurrent credits to a
deferred account. These balances are being
amortized over the estimated service lives of
the related properties.
Postretirement Benefits
The subsidiaries have a noncontributory, defined
benefit pension plan covering substantially all
employees, including officers. Benefits are
based on the employee's years of service and
compensation. The funding policy is to
contribute annually at least the minimum amount
required under the Employee Retirement Income
Security Act and not more than can be deducted
for federal income tax purposes.
The subsidiaries also provide partially contributory
medical and life insurance plans for eligible
retirees and dependents. Medical benefits, which
comprise the largest component of the plans, are
based upon an age and years-ofservice vesting
schedule and other plan provisions. The funding
plan for these costs is to contribute the
maximum amount that can be deducted for federal
income tax purposes. Funding of these benefits
is made primarily into Voluntary Employee
Beneficiary Association trust funds. Medical
benefits are self-insured. The life insurance
plan is paid through insurance premiums.
Risk Management
Certain of the Company's subsidiaries use
derivative instruments to manage risk exposure
associated with energy contracts. Such
instruments are used in accordance with a risk
management policy adopted by the Board of
Directors. The fair value of such instruments at
December 31, 1997, is not materially different
from book value.
NOTE B: Proposed Merger
On April 7, 1997, the Company and DQE, Inc.
(DQE), parent company of Duquesne Light Company
in Pittsburgh, Pennsylvania, announced that they
had agreed to merge in a tax-free, stock-for-
stock transaction. The combined company will be
called Allegheny Energy, Inc. (Allegheny
Energy). It is expected that Allegheny Energy
will continue to be operated as an integrated
electric utility holding company and that the
regulated electric utility companies will
continue to exist as separate legal entities,
including Duquesne Light Company. The companies
stated in their announcement that the merger is
expected to produce synergy savings of about $1
billion.
The merger is conditioned, among other
things, upon the approval of each company's
shareholders, the Pennsylvania Public Utility
Commission (PUC), the SEC, the FERC, the Nuclear
Regulatory Commission (NRC), and the Department
of Justice/Federal Trade Commission (DOJ/FTC)
under the Hart, Scott, Rodino Antitrust
Improvements Act (HSR). Additionally, the Company
F-11
Allegheny Energy, Inc.
requested that the Maryland Public
Service Commission (PSC) approve the issuance of
additional Company stock to accomplish the
transaction. The companies have established a
schedule to obtain all regulatory approvals by
June 30, 1998. On May 2, 1997, the Company filed
a registration statement with the SEC on Form S-
4 containing a joint proxy statement/prospectus
with DQE concerning the merger and the
transactions contemplated thereby. In late June,
the S-4 became effective, allowing the Company
and DQE to pursue shareholder approval. The
Company and DQE each held separate shareholder
meetings on August 7, 1997, at which the
combination of the two companies was approved by
the shareholders of both companies. At the
Company's meeting, the shareholders also
approved the change in the Company's name to
Allegheny Energy, Inc.
On August 1, 1997, the Company and DQE jointly
filed requests for merger approval with the PUC and
the FERC, DQE filed the necessary approval
requests with the NRC, and the Company filed its
request with the PSC for approval to issue the
Company stock. Subsequently, the Company filed
for approval from the SEC under the PUHCA, and
both companies filed with the DOJ/FTC under the
HSR. The PUC has established a schedule of
proceedings which is expected to result in an
approval order by the end of May 1998. The FERC
has not scheduled hearings. Absent such
hearings, the Company expects a FERC order
before the end of May 1998. The PSC instituted a
proceeding involving Potomac Edison, the
Company's Maryland public utility subsidiary, to
examine the effect of the merger on Maryland
customers, for which a final determination is
expected by May 1, 1998. In their Pennsylvania
filings, the companies proposed the following:
Duquesne Light will use the generation-related
portion of its share of net operating synergy
savings to shorten its stranded cost recovery
period under the Pennsylvania Customer Choice
Act and committed to a minimum increase in its
stranded cost amortization of $160
million. It also agreed to use any earnings
achieved above its allowed return on equity to
further write down stranded cost and to reduce
its distribution rates by $25
million in 2001 and freeze distribution
rates at that level until the end of the
transition period to full customer
choice. (See Note C for information on
the Customer Choice Act and stranded
costs.)
West Penn agreed to share synergy savings
achieved equitably between customers and
shareholders after it earns its approved
return on equity and agreed to freeze
distribution rates until the end of the
transition period to full customer choice.
On September 16, 1997, the Company officially changed
its name to Allegheny Energy, Inc., by filing the
appropriate papers in Maryland. The Company
began trading on the New York Stock Exchange
under its new symbol, AYE, on October 1, 1997.
All of the Company's incremental costs of
the merger process ($11.2 million through
December 31, 1997) are being deferred. The
accumulated merger costs will be written off by
the combined company when the merger occurs, or
by the Company if the merger does not occur.
NOTE C: Competition and Customer Choice
In December 1996, Pennsylvania enacted the
Electricity Generation Customer Choice and
Competition Act (Customer Choice Act) to
restructure the electric industry in
Pennsylvania to create retail access to a
competitive electric energy generation market.
Approximately 45% of the Company's retail
revenues are from Pennsylvania customers. Major
provisions of the legislation are:
Customer choice for electric energy supply to be
phased in beginning with one-third of
customers on January 1, 1999; two-thirds the
next year; and all customers beginning January
1, 2001.
F-12
Allegheny Energy, Inc.
Transmission and distribution rates remain regulated
and are capped until July 1, 2001. Generation
rates are capped until all customers receive
market-based energy service.
Pennsylvania utilities will be permitted to
recover the amount of stranded costs approved by
the PUC.
On August 1, 1997, concurrent with the
Company's merger approval filing, the Company's
Pennsylvania subsidiary, West Penn, filed with
the PUC a comprehensive stand-alone
restructuring plan to implement full customer
choice of electric generation suppliers as
required by the Customer Choice Act. The filing
included an unbundling of West Penn's electric
service rates into generation, transmission, and
distribution components; a plan to revise how
the Company's three utility subsidiaries share
capacity, energy, capacity reserves,
transmission resources, and costs; and a plan
for recovery of stranded costs through a
Competitive Transition Charge (CTC).
Recovery of stranded costs is a key issue.
West Penn has listed its stranded cost exposure
at about $1.6 billion (a January 1, 1999,
present value amount before taxes), composed
approximately of $1.1 billion for generation
plant investment in excess of estimated market
prices, $300 million of nonutility generation
(NUG) contracts in excess of market prices, and
$200 million of regulatory assets and transition
costs. In accordance with West Penn's
interpretation of the legislation, the $1.6
billion estimate is based, among other things,
on a forecast of future revenue requirements,
market prices, and assumptions about future
costs to be incurred. The embedded cost of West
Penn's generation assets are low in relation to
other utilities in the state and the nation.
Because of this and intervenor testimony
predicting sharply rising future market
prices of electricity, virtually all intervenors
in West Penn's restructuring filing have
recommended that West Penn receive little or no
CTC for stranded cost recovery. Their allegation
is that, over the life of the assets, their
forecasted market prices exceed West Penn's
costs, and, under those circumstances, little or
no CTC is allowable pursuant to their
interpretation of the Customer Choice Act. Most
intervenors generally agree with West Penn that
market prices in the early years of the
transition period will be significantly lower
than West Penn's embedded costs, and, without a
CTC, West Penn's earnings for a number of years
will be severely eroded. To avoid the risks
associated with estimating future market prices,
West Penn included as part of its restructuring
plan a proposal to reset the CTC on a year-to-
year basis based on actual market prices of
electricity sales in its area, followed by a
final stranded cost valuation in 3 to 5 years
and, if necessary, to definitively determine the
market value of its generation assets, in the
final valuation in about 2003, to auction up to
5% (up to 330 MW) of the generation of West Penn
and Duquesne Light combined. Even if a CTC is
allowed, West Penn's stranded cost recovery,
absent further action by the PUC, is restricted
to about $1.2 billion because of the
restrictions imposed by the capped rates. Based
on the estimates and projections supporting the
stranded cost exposure of about $1.6 billion,
the difference would be reflected as lower cash
flow to West Penn after the year 2005 than would
have occurred with continued regulated rates.
The PUC has established a schedule of
proceedings for the restructuring plan, concurrent
with the merger proceedings, under which it would issue
an order on the filing by the end of May 1998.
This order will include a determination of West
Penn's rates for transmission and distribution
services beginning January 1, 1999; generation
rates for customers who take regulated
generation service during the transition period
(potentially 1999 through 2005 if customers so
choose); and the CTC West Penn will be allowed
to charge through the transition period. West
Penn cannot predict the outcome of the
restructuring proceedings and the transition
process. It believes that, as the lowest cost
utility in the state, recovery of stranded costs
should be allowed, at least during an interim
period of low market prices, to maintain its
financial strength.
Nevertheless, depending upon the outcome of
the proceedings, West
F-13
Allegheny Energy, Inc.
Penn's future earnings beginning in 1999 could be
severely adversely affected during the transition
to deregulation of electricity generation.
Also pursuant to the Customer Choice Act,
all electric utilities in Pennsylvania were
required to establish and administer retail
access pilot programs under which customers
representing 5% of the load of each rate class
must choose a generation supplier other than
their local franchise utility. The pilot
programs began on November 1, 1997, and will
continue through December 31, 1998. To
accomplish the 5% pilot requirement, West Penn
solicited customers to sign up for the program
and then, through a lottery, selected about
33,000 participants from those who responded.
As ordered by the PUC, pilot participants
will receive an energy credit to their bills
from their local utility (for example, 3.45 cents per
kWh for residential customers in West Penn's
case) and will reach agreement with an alternate
supplier as to their price for energy. The
savings to West Penn's customers will be the
difference between the alternate supplier's
price and West Penn's credit. To assure
participation in the pilot program, the credit
established by the PUC is artificially high
(greater than West Penn's generation costs),
with the result that West Penn has estimated it
could suffer a revenue loss of up to $10 million
in 1998 for the pilot. West Penn is attempting
to mitigate the loss by competing for sales to
pilot participants of other utilities as an
alternate supplier. The PUC has approved West
Penn's pilot compliance filing and thus has
indicated its intent to treat the revenue losses
as a regulatory asset subject to review and
potential rate recovery. Accordingly, West Penn
is deferring the net revenue losses as a
regulatory asset. The credit only applies to the
pilot program through December 31, 1998.
Beginning January 1, 1999, customers with choice
will pay the generation charges they negotiate
with the energy supplier they choose as well as
the transmission and distribution charges and
the CTC charge from their franchise utility.
Under the PUC's pilot program procedures,
all companies who wish to compete as alternate
electricity suppliers are required to be
approved by the PUC as licensed suppliers
through a filing and registration process. West
Penn filed for and obtained PUC approval as an
alternate supplier (under the brand name of
Allegheny Power) to sell to the pilot
participating customers of all electric
utilities in the state other than its own.
Accordingly, West Penn is incurring marketing
and pilot program expenditures to compete for
electricity sales to the 5% of Pennsylvania
customers of other utilities who have the right
to choose their supplier under the pilot
program.
Separately and independent of West Penn's
sales efforts, the Company's nonutility
subsidiary, AYP Capital, Inc., has formed
Allegheny Energy Solutions, Inc. (Allegheny
Energy Solutions), a new unregulated company
that is also licensed with the PUC as an
alternate supplier in Pennsylvania's pilot
program. Subsequently, Allegheny Energy
Solutions and DQEnergy Partners, Inc. (DEP), a
subsidiary of DQE, formed Allegheny Energy
Solutions, L.L.C., a limited liability joint
venture, to market electricity and related
energy services. Allegheny Energy Solutions and
DEP each plan to maintain a 50% interest in
Allegheny Energy Solutions, L.L.C. Allegheny
Energy Solutions is an independent and
separately staffed entity and is a competitor of
West Penn. Because it is an independent,
unregulated company, Allegheny Energy Solutions
is permitted to sell to all Pennsylvania
customers participating in the pilot, including
West Penn's participating customers. Allegheny
Energy Solutions is in the process of
transferring its license to Allegheny Energy
Solutions, L.L.C. Allegheny Energy Solutions and
DEP have agreed to a 50/50 sharing of all
Allegheny Energy Solutions' revenues and costs
until the license is transferred. After
transfer, Allegheny Energy Solutions, L.L.C.
will absorb Allegheny Energy Solutions' staff to
conduct the Company's nonutility retail sales
businesses, including the pilot.
In preparation for retail competition in
Pennsylvania, West Penn filed a petition on
February 28, 1997, with the PUC asking for
permission to zero its Energy Cost Rate (ECR)
and state tax surcharge tariffs and to roll
energy costs and state tax adjustments into base
rates, effective May 1, 1997.
F-14
Allegheny Energy, Inc.
On April 24, 1997, the PUC approved West Penn's
request. West Penn's petition was necessitated by
the passage of the Customer Choice Act, which capped
electric rates in Pennsylvania as of January 1,
1997. Prior to May 1, 1997, changes in West
Penn's costs of fuel, purchased power, and
certain other costs, and changes in revenues
from sales to other utilities, including transmission
services, were passed on to customers by
adjustment to customer bills through the ECR
with the result that such changes had no effect
on net income. Effective May 1, 1997, West Penn
began assuming the risks and benefits of changes
in these costs and revenues.
In December 1997, in an initial Order followed
by a second Order revising certain implementation
dates, the Maryland PSC ordered an electric
competition transition plan requiring full
retail customer choice by July 1, 2002, in
yearly one-third increments beginning July 1,
2000; a price cap mechanism; recovery of
verifiable and prudent stranded costs (after
mitigation); and roundtable and adjudicatory
proceedings to address issues such as universal
service, demand-side management programs,
customer education, etc. In its Order, the PSC
stated its belief that it had the authority
under existing law to implement the Order, but
requested the legislature to enact certain
"technical amendments" to facilitate the
transition.
In addition to Maryland and Pennsylvania,
the Company's subsidiaries serve customers in
Ohio, Virginia, and West Virginia. These states
are also in the process of exploring the move
toward competition and deregulation, but have
not yet taken definitive action. The
subsidiaries' wholesale customers have had the
right to choose their generation supplier since
passage of the National Energy Policy Act of
1992.
In July 1997, the Emerging Issues Task
Force (EITF) of the Financial Accounting
Standards Board (FASB) released Issue Number 97-
4, Deregulation of the Pricing of Electricity-
Issues Related to the Application of FASB
Statement Numbers 71 and 101, which concluded
that utilities should discontinue application of
Statement of Financial Accounting Standards
(SFAS) No. 71 for the generation portion of
their business when a deregulation plan is in
place and its terms are known. Since the
Customer Choice Act in Pennsylvania and the
Maryland PSC Order establish such processes,
West Penn and Potomac Edison have determined
that they will be required to discontinue use of
SFAS No. 71 for the generation portion of their
business (the Maryland portion only for Potomac
Edison) on or before the end of May 1998 for
West Penn, the date by which the PUC must issue
its order on West Penn's comprehensive
restructuring plan, and an uncertain future date
for Potomac Edison. One of the conclusions of
the EITF is that, after discontinuing SFAS No.
71, utilities should continue to carry on their
books the assets and liabilities recorded under
SFAS No. 71 if the regulatory cash flows to
settle them will be derived from the continuing
regulated transmission and distribution
business. Additionally, continuing costs and
obligations of the deregulated generation
business which are similarly covered by the cash
flows from the continuing regulated business
will meet the criteria as regulatory assets and
liabilities. The Customer Choice Act and the
Maryland Order establish definitive processes
for transition to deregulation and market-based
pricing for electric generation, which include
continuing cost-of-service based ratemaking for
transmission and distribution services, subject
to rate caps, and provide for a nonbypassable
CTC to give utilities the opportunity to recover
their stranded costs over the transition period.
Until relevant regulatory proceedings are
complete and final orders are received, West
Penn and Potomac Edison are unable to predict
the effect of discontinuing SFAS No. 71.
NOTE D: Restructuring Charges and Asset Write-
offs
In 1996, the Company and its subsidiaries
essentially completed their restructuring
activities initiated in 1994, simplifying the
management structure and streamlining
operations. During 1996, restructuring
activities included consolidating operating
divisions, customer services, and other
functions. By reorganizing and eliminating
certain processes and consolidating
F-15
Allegheny Energy, Inc.
common decentralized functions, the Company and its
subsidiaries have reduced employment by about
1,000 employees since October 1994. These
reductions were accomplished through a
voluntary separation plan, attrition, and
layoffs.
In 1996 and 1995, the subsidiaries
recorded restructuring charges of $93.1 million
($56.2 million after tax) and $16.0 million
($9.6 million after tax), respectively, in
operating expenses, including all restructuring
charges associated with the reorganization.
These charges reflect liabilities and payments
for severance, employee termination costs, and
other restructuring costs.
The current portion of the restructuring
liability excluding benefit plans' curtailment
adjustments to postretirement
liabilities (which are primarily recorded in
other deferred credits) consists of:
Thousands of Dollars) 1997 1996
Restructuring liability:
Balance at beginning of period $56,101 $14,435
Accruals 79,225
Less payments (50,597) (37,559)
Balance at end of period $ 5,504 $56,101
In 1996, the regulated subsidiaries wrote off
$10.8 million ($6.3 million after tax) of previously
accumulated costs related to a proposed
transmission line. In the industry's more
competitive environment, it was no longer
reasonable to assume future recovery of these
costs in rates.
In connection with changes in inventory
management objectives, the regulated
subsidiaries in 1995 recorded $7.4 million ($4.5
million after tax) for the write-off of obsolete
and slow-moving materials.
NOTE E: Income Taxes
Details of federal and state income tax
provisions are:
(Thousands of Dollars) 1997 1996 1995
Income taxes-current:
Federal $87,394 $83,456 $112,482
State 23,960 26,004 17,375
Total 111,354 109,460 129,857
Income taxes-deferred, net of amortization 74,565 29,129 35,279
Amortization of deferred investment credit (8,203) (8,242) (8,260)
Total income taxes 177,716 130,347 156,876
Income taxes-charged to other income
and deductions (9,643) (2,355) (2,673)
Income taxes-charged to operating income $168,073 $127,992 $154,203
The total provision for income taxes is different from
the amount produced by applying the federal income statutory
tax rate of 35% to financial accounting income, as set forth
below:
F-16
Allegheny Energy, Inc.
(Thousands of Dollars) 1997 1996 1995
Financial accounting income before
preferred dividends and income taxes $458,649 $347,319 $409,110
Amount so produced $160,500 $121,600 $143,200
Increased (decreased) for:
Tax deductions for which deferred tax
was not provided:
Lower tax depreciation 14,200 12,600 13,500
Plant removal costs (1,700) (1,900) (3,500)
State income tax, net of federal income
tax benefit 11,700 14,100 16,300
Amortization of deferred investment credit (8,203) (8,242) (8,260)
Other, net (8,424) (10,166) (7,037)
Total $168,073 $127,992 $154,203
Federal income tax returns through 1993 have been
examined and substantially settled through 1991. At
December 31, the deferred tax assets and liabilities consist
of the following:
(Thousands of Dollars) 1997 1996
Deferred tax assets:
Unamortized investment tax credit $ 83,818 $ 88,371
Tax interest capitalized 35,954 35,286
Contributions in aid of construction 22,980 22,136
Restructuring 4,001 19,870
Postretirement benefits other than
pensions 21,986 13,599
Deferred power costs, net 10,598 6,053
Unbilled revenue 13,657 1,110
Other 34,577 51,460
227,571 237,885
Deferred tax liabilities:
Book vs. tax plant basis differences,net 1,142,035 1,125,936
Other 104,415 72,544
1,246,450 1,198,480
Total net deferred tax liabilities 1,018,879 960,595
Add portion above included in
current assets 12,357 39,428
Total long-term net deferred
tax liabilities $1,031,236 $1,000,023
NOTE F: Dividend Restriction
Supplemental indentures relating to certain
outstanding bonds of Monongahela Power and West Penn
contain dividend restrictions under the most
restrictive of which $121,015,000 of
consolidated retained earnings at December 31,
1997, is not available for cash dividends on
their common stocks, except that a portion
thereof may be paid as cash dividends where
concurrently an equivalent amount of cash is
received by a subsidiary as a capital contribution
or as the proceeds of the issue and sale of shares
of such subsidiary's common stock.
NOTE G: Pension Benefits
Net pension (credits) costs, a portion of which
(about 25% to 30%)
F-17
Allegheny Energy, Inc.
was (credited) charged to plant construction,
included the following components:
(Thousands of Dollars) 1997 1996 1995
Service cost-benefits earned $12,435 $14,881 $13,695
Interest cost on projected
benefit obligation 43,060 41,500 39,901
Actual return on plan assets (134,503) (56,939) (107,972)
Net amortization and deferral 75,394 665 56,451
Pension (credit) cost (3,614) 107 2,075
Reversal of previous deferrals 760 760 760
Net pension (credit) cost ($2,854) $867 $2,835
The benefits earned to date and funded status at December 31
using a measurement date of September 30 were as follows:
(Thousands of Dollars) 1997 1996
Actuarial present value of accumulated benefit obligation
earned to date (including vested benefit
of $535,805,000 and $467,126,000) $569,642 $495,703
Funded status:
Actuarial present value of projected benefit obligation $664,695 $586,473
Plan assets at market value, primarily common stocks and
fixed income securities 786,159 691,063
Plan assets in excess of projected benefit obligation (121,464) (104,590)
Unrecognized cumulative net gain from past experience
different from that assumed 129,129 95,189
Unamortized transition asset, being amortized over 14 years
beginning January 1, 1987 9,444 12,590
Unrecognized prior service cost due to plan amendments (24,814) (7,280)
Pension cost prepaid at December 31 ($7,705) ($4,091)
In determining the actuarial present value of the
projected benefit obligation at September 30,
1997, 1996, and 1995, the discount rates used
were 7.25%, 7.5%, and 7.5%, respectively, and
the rates of increase in future compensation
levels were 4.25%, 4.5%, and 4.5%, respectively.
The expected long-term rate of return on assets was
9% in each of the years 1997, 1996, and 1995.
NOTE H: Postretirement Benefits Other Than
Pensions
The cost of postretirement benefits other than
pensions (principally health care and life
insurance) for employees and covered
dependents, a portion of which (about 25% to
30%) was charged to plant construction,
included the following components:
(Thousands of Dollars) 1997 1996 1995
Service cost-benefits earned $2,619 $2,930 $2,919
Interest cost on accumulated postretirement
benefit obligation 15,244 14,251 14,736
Actual return on plan assets (12,230) (4,518) (6,378)
Amortization of unrecognized transition
obligation 6,433 7,272 7,272
Other net amortization and deferral 7,525 852 5,163
Postretirement cost 19,591 20,787 23,712
Regulatory reversal 1,975 492
Total postretirement cost $19,591 $22,762 $24,204
F-18
Allegheny Energy, Inc.
The benefits earned to date and funded status at December 31
using a measurement date of September 30 were as follows:
(Thousands of Dollars) 1997 1996
Accumulated postretirement benefit obligation:
Retirees $138,760 $148,008
Fully eligible employees 14,795 11,838
Other employees 48,719 46,383
Total obligation 202,274 206,229
Plan assets at market value, in common stocks, fixed income
securities, and short-term investments 73,363 55,802
Accumulated postretirement benefit obligation in excess of
plan assets 128,911 150,427
Unrecognized cumulative net gain (loss) from past experience
different from that assumed 12,355 (10,412)
Unrecognized transition obligation, being amortized over
20 years beginning January 1, 1993 (96,493) (102,926)
Postretirement benefit liability at September 30 44,773 37,089
Fourth quarter contributions and benefit payments (4,025) (4,200)
Postretirement benefit liability at December 31 $40,748 $32,889
In determining the accumulated postretirement benefit
obligation (APBO) at September 30, 1997, 1996, and 1995, the
discount rates used were 7.25%, 7.5%, and 7.5%,
and the rates of increase in future compensation
levels were 4.25%, 4.5%, and 4.5%, respectively.
The expected long-term rate of return on assets
was 8.25% in each of the years 1997, 1996, and
1995. For measurement purposes, an ultimate
health care cost trend rate of 6.25% for 1998
and beyond, and plan provisions which limit
future medical and life insurance benefits, were
assumed. Increasing the assumed health care
trend rate by 1% in each year would increase the
APBO at December 31, 1997, by $8.4 million and
the aggregate of the service and interest cost
components of net periodic postretirement
benefit cost for 1997 by $.8 million.
NOTE I: Regulatory Assets and Liabilities
The Company's utility operations are subject to
the provisions of SFAS No. 71, "Accounting for
the Effects of Certain Types of Regulation."
Regulatory assets represent probable future
revenues associated with deferred costs that are
expected to be recovered from customers through
the ratemaking process. Regulatory liabilities
represent probable future reductions in revenues
associated with amounts that are to be credited
to customers through the ratemaking process.
Regulatory assets, net of regulatory
liabilities,
F-19
Allegheny Energy, Inc.
reflected in the Consolidated Balance Sheet at December 31 relate to:
(Thousands of Dollars) 1997 1996
Long-Term Assets (Liabilities), Net:
Income taxes, net $417,382 $434,592
PURPA project buyout 48,000
Demand-side management 14,204 15,748
Postretirement benefits 7,053 7,750
Storm damage 3,537 4,973
Deferred power costs, net (reported
in other deferred charges/credits 4,051 4,024
Other, net 4,771 8,906
Subtotal 498,998 475,993
Current Assets (Liabilities), Net:
Income taxes, net (reported in other current
assets/liabilities) 1,847 926
Deferred power costs, net (reported in other
current assets/liabilities) 2,198 (22,845)
Subtotal 4,045 (21,919)
Net Regulatory Assets $503,043 $454,074
NOTE J: Fair Value of Financial Instruments
The carrying amounts and estimated fair value of financial
instruments at December 31 were as follows:
1997 1996
Carrying Fair Carrying Fair
(Thousands of Dollars) Amount Value Amount Value
Assets:
Temporary cash investments $5,863 $5,863 $4,000 $4,000
Life insurance contracts 79,474 79,474 63,197 63,197
Liabilities:
Short-term debt 206,401 206,401 156,430 156,430
Long-term debt and QUIDS 2,399,852 2,517,863 2,446,744 2,455,705
The carrying amount of temporary cash investments, as
well as short-term debt, approximates the fair value because
of the short maturity of those instruments. The fair value of
the life insurance contracts was estimated based on cash
surrender value. The fair value of long-term debt and QUIDS was
estimated based on actual market prices or market prices of
similar issues. The Company has no financial instruments
held or issued for trading purposes.
NOTE K: Capitalization
Preferred Stock
All of the preferred stock is entitled on
voluntary liquidation to its then current call
price and on involuntary liquidation to $100 a
share. The holders of West Penn's market auction
preferred stock are entitled to dividends at a
rate determined by an auction held the business
day preceding each quarterly dividend payment
date.
Long-Term Debt and QUIDS
Maturities for long-term debt for the next five
years are: 1998, $185,400,000; 1999, $4,300,000;
2000, $145,300,000; 2001, $165,300,000; and
2002, $30,860,000. Substantially all of the
properties of the subsidiaries are
F-20
Allegheny Energy, Inc.
held subject to the lien securing each subsidiary's first
mortgage bonds. Some properties are also subject
to a second lien securing certain pollution
control and solid waste disposal notes.
In October 1996, AYP Energy borrowed $160
million for five years from a syndicate of eight banks
priced at the London Interbank Offering Rate
(LIBOR) plus a spread. AYP Energy also entered
into a floating-to-fixed interest rate swap to
hedge against fluctuations in interest rates.
The swap plus the spread on the underlying
financing fixed the interest rate to AYP Energy
at 6.78%. In January 1998, the swap was
refinanced in exchange for the counterparty's
right to exercise an option to extend the swap
until 2006. The new swap plus the spread on the
underlying financing lowered the interest rate
to AYP Energy to 6.18%. The extension option
will be marked-to-market quarterly and will
determine the magnitude of the buyout, if any,
should AYP Energy choose to terminate the
arrangement.
NOTE L: Short-Term Debt
To provide interim financing and support for
outstanding commercial paper, lines of credit
have been established with several banks. The
Company and its regulated subsidiaries have fee
arrangements on all of their lines of credit and
no compensating balance requirements. At
December 31, 1997, unused lines of credit with
banks were $260,000,000. In addition to bank
lines of credit, an internal money pool
accommodates intercompany short-term borrowing
needs, to the extent that certain of the
regulated companies have funds available. Short-
term debt outstanding for 1997 and 1996
consisted of:
(Thousands of Dollars) 1997 1996
Balance and interest rate at end of year:
Commercial Paper $166,401-6.14% $156,430-6.22%
Notes Payable to Banks 40,000-6.75%
Average amount outstanding and interest rate
during the year:
Commercial Paper 100,572-5.62% 90,722-5.47%
Notes Payable to Banks 13,022-5.60% 13,862-5.51%
NOTE M: Commitments and Contingencies
Construction Program
The subsidiaries have entered into commitments for their
construction programs, for which expenditures
are estimated to be $307 million for 1998 and
$314 million for 1999. Construction expenditure
levels in 2000 and beyond will depend upon the
strategy eventually selected for complying with
Phase II of the Clean Air Act Amendments of 1990
(CAAA) and the extent to which environmental
initiatives currently being considered become
mandated.
Environmental Matters and Litigation
The companies are subject to various laws,
regulations, and uncertainties as to
environmental matters. Compliance may require
them to incur substantial additional costs to
modify or replace existing and proposed
equipment and facilities and may affect
adversely the cost of future operations.
The more significant additional environmental
initiatives currently being considered (in terms
of their potential adverse financial effect on
the companies) are:
NOx reductions of 75% from a 1990 baseline
by mid-year 2003, depending upon modeling
studies required by the Ozone Transport Commission
F-21
Allegheny Energy, Inc.
established under Title I of the CAAA. A 55% reduction
is currently mandated.
NOx reductions of 85% from a 1990 baseline
by mid-year 2003 under a State Implementation Plan (SIP)
call proposed by the Environmental Protection Agency
(EPA) in November 1997, as well as by petitions
filed with the EPA in August 1997 by eight
northeastern states proposing an 85% reduction.
CO2 reductions of 7% below 1990 levels agreed to by
the Clinton administration in a protocol for
greenhouse gas reductions at a conference in Kyoto,
Japan, in December 1997. The protocol requires approval
of the United States Senate to become effective.
The NOx reduction proposals beyond 55% are being
vigorously opposed by the companies and other
coal-burning utilities and by other affected
constituencies in coal producing states. In
January 1998, the Chambers of Commerce in
Virginia and West Virginia announced that they
had joined in the first court challenge,
accusing the EPA of failing to assess the impact
of the 75% and 85% reduction proposals on small
businesses. The EPA contends that the Small
Business Regulatory Enforcement Fairness Act of
1996 does not apply. The United States Senate
has indicated that it will not approve the Kyoto
protocol because of its failure to include CO2
reduction requirements on developing nations.
The companies cannot predict the outcome of
these issues.
In the normal course of business, the
companies become involved in various legal
proceedings. The companies do not believe that
the ultimate outcome of these proceedings will
have a material effect on their financial
position.
The regulated subsidiaries previously
reported that the EPA had identified them and
approximately 875 others as potentially
responsible parties in a Superfund site subject
to cleanup. The regulated subsidiaries have also
been named as defendants along with multiple
other defendants in pending asbestos cases
involving one or more plaintiffs. The
subsidiaries believe that provisions for
liabilities and insurance recoveries are such
that final resolution of these claims will not
have a material effect on their financial
position.
F-22
Monongahela Power Company
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Monongahela Power Company
In our opinion, the accompanying balance sheet and
statement of capitalization and the related
statements of income, of retained earnings and of
cash flows present fairly, in all material
respects, the financial position of Monongahela
Power Company (a subsidiary of Allegheny Energy,
Inc.) at 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. These 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 of these
statements in accordance with generally accepted
auditing standards which 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, assessing the accounting principles
used and significant estimates made by management,
and evaluating the overall financial statement
presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Pittsburgh, Pennsylvania
February 4, 1998
F-23
Monongahela Power Company
STATEMENT OF INCOME
YEAR ENDED DECEMBER 31
1997 1996 1995
(Thousands of Dollars)
Electric Operating Revenues:
Residential...................................... $199,931 $206,033 $209,065
Commercial....................................... 118,825 121,631 124,457
Industrial....................................... 196,716 200,970 212,427
Wholesale and other,including affiliates......... 95,579 86,474 84,193
Bulk power transactions,net...................... 17,260 17,363 13,338
Total Operating Revenues....................... 628,311 632,471 643,480
Operating Expenses:
Operation:
Fuel........................................... 141,340 135,833 136,695
Purchased power and exchanges,net.............. 98,266 101,593 97,378
Deferred power costs, net...................... (10,027) (3,051) 19,647
Other.......................................... 75,908 76,105 77,020
Maintenance........................................ 70,561 74,735 73,041
Restructuring charges and asset write-off........ 24,299 5,493
Depreciation..................................... 56,593 55,490 57,864
Taxes other than income taxes.................... 38,776 40,418 38,551
Federal and state income taxes................... 47,519 34,496 41,834
Total Operating Expenses....................... 518,936 539,918 547,523
Operating Income............................... 109,375 92,553 95,957
Other Income and Deductions:
Allowance for other than borrowed funds used
during construction............................ 570 313 446
Other income, net................................ 8,498 6,831 9,235
Total Other Income and Deductions.............. 9,068 7,144 9,681
Income Before Interest Charges................. 118,443 99,697 105,638
Interest Charges:
Interest on long-term debt....................... 36,076 36,654 37,244
Other interest................................... 2,654 1,950 2,628
Allowance for borrowed funds used during
construction................................. (816) (359) (947)
Total Interest Charges......................... 37,914 38,245 38,925
Net Income......................................... $80,529 $61,452 $66,713
STATEMENT OF RETAINED EARNINGS
Balance at January 1............................... $215,221 $208,761 $198,626
Add:
Net income....................................... 80,529 61,452 66,713
295,750 270,213 265,339
Deduct:
Dividends on capital stock:
Preferred stock................................ 5,037 5,037 6,555
Common stock................................... 46,774 49,955 48,660
Charge on redemption of preferred stock.......... 1,363
Total Deductions............................. 51,811 54,992 56,578
Balance at December 31............................. $243,939 $215,221 $208,761
See accompanying notes to financial statements.
F-24
Monongahela Power Company
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31
1997 1996 1995
(Thousands of Dollars)
Cash Flows from Operations:
Net income.............................. $ 80,529 $ 61,452 $ 66,713
Depreciation............................ 56,593 55,490 57,864
Deferred investment credit and income
taxes, net............................ 18,139 7,739 3,519
Deferred power costs, net............... (10,027) (3,051) 19,647
Unconsolidated subsidiaries' dividends
in excess of earnings................. 988 3,100 2,403
Allowance for other than borrowed funds
used during construction.............. (570) (313) (446)
Restructuring liability................. (13,761) 13,734 3,693
Changes in certain current assets and
liabilities:
Accounts receivable, net............ (80) 4,356 (11,222)
Materials and supplies.............. 1,878 5,123 6,639
Accounts payable.................... (11,453) (9,970) (3,373)
Other, net.............................. (5,100) 8,998 3,049
117,136 146,658 148,486
Cash Flows from Investing:
Construction expenditures (less allowance
for equity funds used during
construction).......................... (77,569) (72,264) (75,012)
Cash Flows from Financing:
Retirement of preferred stock............. (41,406)
Issuance of long-term debt and QUIDS...... 132,137
Retirement of long-term debt.............. (15,500) (18,500) (99,403)
Short-term debt, net...................... 28,590 1,271 (6,702)
Notes payable to affiliates............... (1,450) (2,900)
Dividends on capital stock:
Preferred stock......................... (5,037) (5,037) (6,555)
Common stock............................ (46,774) (49,955) (48,660)
(40,171) (72,221) (73,489)
Net Change in Cash and Temporary
Cash Investments.......................... (604) 2,173 (15)
Cash and Temporary Cash Investments
at January 1.............................. 2,290 117 132
Cash and Temporary Cash Investments at
December 31............................... $ 1,686 $ 2,290 $ 117
Supplemental Cash Flow Information:
Cash paid during the year for:
Interest (net of amount capitalized)..... $ 36,776 $ 37,190 $ 42,394
Income taxes............................. 28,282 31,064 30,696
See accompanying notes to financial statements.
F-25
Monongahela Power Company
BALANCE SHEET
DECEMBER 31
ASSETS 1997 1996
(Thousands of Dollars)
Property, Plant, and Equipment:
At original cost, including $55,588,000 and
$33,366,000 under construction........... $1,950,478 $1,879,622
Accumulated depreciation................... (840,525) (790,649)
1,109,953 1,088,973
Investments:
Allegheny Generating Company--common stock
at equity................................ 53,888 54,798
Other...................................... 268 346
54,156 55,144
Current Assets:
Cash....................................... 1,686 2,290
Accounts receivable:
Electric service, net of $2,176,000 and
$1,949,000 uncollectible allowance..... 68,143 65,615
Affiliated and other..................... 10,917 13,365
Materials and supplies--at average cost:
Operating and construction............... 18,716 19,785
Fuel..................................... 15,885 16,694
Prepaid taxes.............................. 17,287 18,331
Other...................................... 3,559 10,693
136,193 146,773
Deferred Charges:
Regulatory assets.......................... 164,260 171,692
Unamortized loss on reacquired debt........ 14,338 15,256
Other...................................... 14,354 8,917
192,952 195,865
Total........................................ $1,493,254 $1,486,755
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock, other paid-in capital, and
retained earnings........................ $ 540,930 $ 512,212
Preferred stock............................ 74,000 74,000
Long-term debt and QUIDS................... 455,088 474,841
1,070,018 1,061,053
Current Liabilities:
Short-term debt............................. 56,829 28,239
Long-term debt due within one year.......... 20,100 15,500
Notes payable to affiliates................. 1,450 2,900
Accounts payable............................ 5,910 12,997
Accounts payable to affiliates.............. 5,804 10,170
Taxes accrued:
Federal and state income.................. 5,046 3,788
Other..................................... 18,935 21,464
Interest accrued............................ 7,877 8,234
Deferred power costs........................ 484 12,419
Restructuring liability..................... 236 13,997
Other....................................... 12,750 13,613
135,421 143,321
Deferred Credits and Other Liabilities:
Unamortized investment credit............... 18,297 20,445
Deferred income taxes....................... 235,291 225,841
Regulatory liabilities...................... 16,973 18,554
Other....................................... 17,254 17,541
287,815 282,381
Commitments and Contingencies (Note M)
Total.......................................... $1,493,254 $1,486,755
See accompanying notes to financial statements.
F-26
Monongahela Power Company
STATEMENT OF CAPITALIZATION
DECEMBER 31
1997 1996 1997 1996
(Thousands of Dollars) (Capitalization Ratios)
Common Stock:
Common stock--par value $50 per share,
authorized 8,000,000 shares,
outstanding 5,891,000 shares........ $ 294,550 $ 294,550
Other paid-in capital................. 2,441 2,441
Retained earnings..................... 243,939 215,221
Total.............................. 540,930 512,212 50.6% 48.3%
Preferred Stock:
Cumulative preferred stock--par value $100
per share, authorized 1,500,000 shares,
outstanding as follows:
December 31, 1997
Regular
Shares Call Price Date of
Series Outstanding Per Share Issue
4.40% .... 90,000 $106.50 1945 9,000 9,000
4.80% B... 40,000 105.25 1947 4,000 4,000
4.50% C... 60,000 103.50 1950 6,000 6,000
$6.28 D... 50,000 102.86 1967 5,000 5,000
$7.73 L.. 500,000 100.00 1994 50,000 50,000
Total (annual dividend requirements
$5,037,000) 74,000 74,000 6.9 7.0
Long-Term Debt and QUIDS:
First mortgage Date of Date Date
bonds: Issue Redeemable Due
6-1/2% ... 1967 1997 1997 15,000
5-5/8% ... 1993 2000 2000 65,000 65,000
7-3/8% ... 1992 2002 2002 25,000 25,000
7-1/4% ... 1992 2002 2007 25,000 25,000
8-5/8% ... 1991 2001 2021 50,000 50,000
8-1/2% ... 1992 1997 2022 65,000 65,000
8-3/8% ... 1992 2002 2022 40,000 40,000
7-5/8% ... 1995 2005 2025 70,000 70,000
December 31, 1997
Interest Rate
Quarterly Income Debt Securities
due 2025.................. 8.0% 40,000 40,000
Secured notes due 1998-2024...5.95%-6.875% 74,050 74,050
Unsecured notes due
1997-2012... 6.30%-6.40% 6,560 7,060
Installment purchase
obligations due 1998........ 6.875% 19,100 19,100
Unamortized debt discount
and premium, net............ (4,522) (4,869)
Total (annual interest
requirements $35,447,131) 475,188 490,341
Less current maturities....... (20,100) (15,500)
Total.................. 455,088 474,841 42.5 44.7
Total Capitalization......... $1,070,018 $1,061,053 100.0% 100.0%
See accompanying notes to financial statements.
F-27
Monongahela Power Company
NOTES TO FINANCIAL STATEMENTS
(These notes are an integral part of the financial statements.)
NOTE A: SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
The Company is a wholly owned subsidiary of
Allegheny Energy, Inc. and is a part of the
Allegheny Energy integrated electric utility system
(the System).
The Company is subject to regulation by the
Securities and Exchange Commission (SEC), by
various state bodies having jurisdiction, and by
the Federal Energy Regulatory Commission (FERC).
Significant accounting policies of the Company are
summarized below.
Use of Estimates
The preparation of financial statements in
conformity with generally accepted accounting
principles requires management to make estimates
that affect the reported amounts of assets,
liabilities, revenues, expenses, and disclosures of
contingencies during the reporting period, which in
the normal course of business are subsequently
adjusted to actual results.
Revenues
Revenues, including amounts resulting from the
application of fuel and energy cost adjustment
clauses, are recognized in the same period in which
the related electric services are provided to
customers by recording an estimate for unbilled
revenues for services provided from the meter
reading date to the end of the accounting period.
Deferred Power Costs, Net
The costs of fuel, purchased power, and certain
other costs, and revenues from sales to other
companies, including transmission services, are
deferred until they are either recovered from or
credited to customers under fuel and energy cost
recovery procedures.
Property, Plant, and Equipment
Property, plant, and equipment, including
facilities owned with regulated affiliates in the
System, are stated at original cost, less
contributions in aid of construction, except for
capital leases, which are recorded at present
value. Cost includes direct labor and material,
allowance for funds used during construction
(AFUDC) on property for which construction work in
progress is not included in rate base, and such
indirect costs as administration, maintenance, and
depreciation of transportation and construction
equipment, and postretirement benefits, taxes, and
other fringe benefits related to employees engaged
in construction.
The cost of depreciable property units retired,
plus removal costs less salvage, are charged to
accumulated depreciation.
F-28
Monongahela Power Company
Allowance for Funds Used During Construction
AFUDC, an item that does not represent current cash
income, is defined in applicable regulatory systems
of accounts as including "the net cost for the
period of construction of borrowed funds used for
construction purposes and a reasonable rate on
other funds when so used." AFUDC is recognized as
a cost of property, plant, and equipment with
offsetting credits to other income and interest charges.
Rates used for computing AFUDC in 1997, 1996, and 1995
were 7.55%, 7.90%, and 7.29%, respectively. AFUDC is not
included in the cost of the construction when the cost of
financing the construction is being recovered through rates.
Depreciation and Maintenance
Provisions for depreciation are determined
generally on a straight-line method based on
estimated service lives of depreciable properties
and amounted to approximately 3.1% of average
depreciable property in 1997 and 1996 and 3.4% in
1995. The cost of maintenance and of certain
replacements of property, plant, and equipment is
charged principally to operating expenses.
Temporary Cash Investments
For purposes of the statement of cash flows,
temporary cash investments with original maturities
of three months or less, generally in the form of
commercial paper, certificates of deposit, and
repurchase agreements, are considered to be the
equivalent of cash.
Regulatory Assets and Liabilities
In accordance with the Financial Accounting
Standards Board's Statement of Financial Accounting
Standards (SFAS) No. 71, "Accounting for the
Effects of Certain Types of Regulation," the
Company's financial statements reflect assets and
liabilities based on cost-based ratemaking
regulation.
Income Taxes
The Company joins with its parent and affiliates in
filing a consolidated federal income tax return.
The consolidated tax liability is allocated among
the participants generally in proportion to the
taxable income of each participant, except that no
subsidiary pays tax in excess of its separate
return tax liability.
Financial accounting income before income taxes
differs from taxable income principally because
certain income and deductions for tax purposes are
recorded in the financial income statement in
another period. Differences between income tax
expense computed on the basis of financial
accounting income and taxes payable based on
taxable income are accounted for substantially in
accordance with the accounting procedures followed
for ratemaking purposes. Deferred tax assets and
liabilities represent the tax effect of temporary
differences between the financial statement and tax
basis of assets and liabilities computed utilizing
the most current tax rates.
F-28
Monongahela Power Company
Provisions for federal income tax were reduced in
previous years by investment credits, and amounts equivalent
to such credits were charged to income with
concurrent credits to a deferred account. These
balances are being amortized over the estimated
service lives of the related properties.
Postretirement Benefits
The Company participates with affiliated companies
of Allegheny Energy, Inc. in a noncontributory,
defined benefit pension plan covering substantially
all employees, including officers. Benefits are
based on the employee's years of service and
compensation. The funding policy is to contribute
annually at least the minimum amount required under
the Employee Retirement Income Security Act and not
more than can be deducted for federal income tax
purposes.
The Company and its affiliates also provide
partially contributory medical and life insurance
plans for eligible retirees and dependents. Medical
benefits, which comprise the largest component of
the plans, are based upon an age and years-of-service
vesting schedule and other plan provisions. The
funding plan for these costs is to contribute the
maximum amount that can be deducted for federal income tax
purposes. Funding of these benefits is made
primarily into Voluntary Employee Beneficiary
Association trust funds. Medical benefits are self-
insured. The life insurance plan is paid through
insurance premiums.
Risk Management
The Company uses derivative instruments to manage
risk exposure associated with energy contracts.
Such instruments are used in accordance with a risk
management policy adopted by the Board of
Directors. The fair value of such instruments at
December 31, 1997, is not materially different from
book value.
NOTE B: PROPOSED MERGER
On April 7, 1997, Allegheny Power System, Inc.
(Allegheny Power) and DQE, Inc. (DQE), parent
company of Duquesne Light Company in Pittsburgh,
Pennsylvania, announced that they had agreed to
merge in a tax-free, stock-for-stock transaction.
The combined company will be called Allegheny
Energy, Inc. (Allegheny Energy). It is expected
that Allegheny Energy will continue to be operated
as an integrated electric utility holding company
and that the regulated electric utility companies
will continue to exist as separate legal entities,
including the Company, its regulated affiliates,
and Duquesne Light Company. The companies stated
in their announcement that the merger is expected
to produce synergy savings of about $1 billion.
The merger is conditioned, among other things, upon
the approval of each company's shareholders, the
Pennsylvania Public Utility Commission (PUC), the SEC,
the FERC, the Nuclear Regulatory Commission (NRC), and
the Department of Justice/Federal Trade Commission
(DOJ/FTC) under the Hart, Scott, Rodino Antitrust
Improvements Act (HSR). Additionally, Allegheny Power
requested that the Maryland Public Service Commission
(PSC) approve the issuance of additional Allegheny Power
stock to accomplish the transaction. The
F-30
Monongahela Power Company
companies have established a schedule to obtain all
regulatory approvals by June 30, 1998. On May 2,
1997, Allegheny Power filed a registration
statement with the SEC on Form S-4 containing a
joint proxy statement/prospectus with DQE
concerning the merger and the transactions
contemplated thereby. In late June, the S-4 became
effective, allowing Allegheny Power and DQE to pursue
shareholder approval. Allegheny Power and DQE each
held separate shareholder meetings on August 7,
1997, at which the combination of the two companies
was approved by the shareholders of both companies.
At Allegheny Power's meeting, the shareholders also
approved the change in Allegheny Power's name to
Allegheny Energy, Inc.
On August 1, 1997, Allegheny Power and DQE jointly
filed requests for merger approval with the PUC and
the FERC, DQE filed the necessary approval requests
with the NRC, and Allegheny Power filed its request
with the PSC for approval to issue Allegheny Power
stock. Subsequently, Allegheny Power filed for
approval from the SEC under the Public Utility
Holding Company Act of 1935 (PUHCA) and both
companies filed with the DOJ/FTC under the HSR.
The PUC has established a schedule of proceedings
which is expected to result in an approval order by
the end of May 1998. The FERC has not scheduled
hearings. Absent such hearings, Allegheny Energy
expects a FERC order before the end of May 1998.
The PSC instituted a proceeding involving The
Potomac Edison Company, the Company's Maryland
public utility affiliate, to examine the effect of
the merger on Maryland customers for which a final
determination is expected by May 1, 1998.
On September 16, 1997, Allegheny Power officially
changed its name to Allegheny Energy, Inc., by
filing the appropriate papers in Maryland.
Allegheny Energy began trading on the New York
Stock Exchange under its new symbol, AYE, on
October 1, 1997.
All of the Company's incremental costs of the
merger process ($2.8 million through December 31,
1997) are being deferred. The accumulated merger
costs will be written off by the Company when the
merger occurs or when it is determined that the
merger will not occur.
NOTE C: COMPETITION AND CUSTOMER CHOICE
The Company serves customers in Ohio and West
Virginia. These states are also in the process of
exploring the move toward competition and
deregulation, but have not yet taken definitive
action. The Company's wholesale customers have had
the right to choose their generation supplier since
passage of the National Energy Policy Act of 1992.
In December 1996, Pennsylvania enacted the
Electricity Generation Customer Choice and
Competition Act (Customer Choice Act) to
restructure the electric industry in Pennsylvania
to create retail access to a competitive electric
energy generation market. On August 1, 1997,
concurrent with Allegheny Power's merger approval
filing, the Company's Pennsylvania utility
affiliate, West Penn Power Company (West Penn),
filed with the PUC a comprehensive stand-alone
restructuring plan to implement full customer
choice of electric generation suppliers as required
by the Customer Choice Act. The filing
F-31
Monongahela Power Company
included an unbundling of West Penn's electric
service rates into generation, transmission, and
distribution components; a plan to revise how West
Penn and its affiliates, including the Company,
share capacity, energy, capacity reserves,
transmission resources, and costs; and a plan for
recovery of stranded costs through a Competitive
Transition Charge (CTC).
The PUC has established a schedule of proceedings
for the restructuring plan, concurrent with the
merger proceedings, under which it would issue an
order on the filing by the end of May 1998. This
order will include a determination of West Penn's
rates for transmission and distribution services
beginning January 1, 1999; generation rates for
customers who take regulated generation service
during the transition period (potentially 1999
through 2005 if customers so choose); and the CTC
West Penn will be allowed to charge through the
transition period.
In December 1997, the Maryland Public Service
Commission ordered an electric competition
transition plan for Maryland utilities, including
the Company's affiliate, The Potomac Edison
Company, as to its operations in Maryland. The
Maryland plan requires, among other things, full
retail customer choice by July 1, 2002, in yearly
one-third increments beginning July 1, 2000, a
price cap mechanism and recovery of verifiable and
prudent stranded costs.
NOTE D: RESTRUCTURING CHARGES AND ASSET WRITE-OFF
In 1996, the System, including the Company,
essentially completed its restructuring activities
initiated in 1994, simplifying the management
structure, streamlining operations, and began doing
business under the trade name of Allegheny Power.
During 1996, restructuring activities included
consolidating operating divisions, customer
services, and other functions. By reorganizing and
eliminating certain processes and
consolidating common decentralized functions, the
System reduced employment by about 1,000 employees
since October 1994. These reductions were
accomplished through a voluntary separation plan,
attrition, and layoffs.
In 1996 and 1995, the Company recorded
restructuring charges of $24.3 million ($14.6
million after tax) and $4.1 million ($2.5 million
after tax), respectively, in operating expenses,
including its share of all restructuring charges
associated with the reorganization. These charges
reflect liabilities and payments for severance,
employee termination costs, and other restructuring
costs. The current portion of the restructuring
liability excluding benefit plans' curtailment
adjustments to postretirement liabilities (which
are primarily recorded in other deferred credits)
consists of:
(Thousands of Dollars) 1997 1996
Restructuring Liability:
Balance at the beginning of period............. $13,997 $ 3,693
Accruals..................................... 20,869
Less payments............................... (13,761) (10,565)
Balance at end of period....................... $ 236 $13,997
F-32
Monongahela Power Company
In connection with changes in inventory management
objectives, the Company in 1995 recorded $1.4
million ($.8 million after tax) for the write-off
of obsolete and slow-moving materials.
As part of the reorganization, the Company and its
utility affiliates in 1996 expanded the
intercompany use of each other's employees to optimize
the use of their skills. In 1997 virtually all the
employees in the System, including all of the Company's
employees, were transferred to Allegheny Power Service
Corporation (APSC) to facilitate the intercompany use of
personnel. APSC was formed in 1963 pursuant to the PUHCA
to perform certain functions common to all companies in the
System. APSC bills each company at its cost (without profit)
based on the work performed and services provided to each company.
NOTE E: INCOME TAXES
Details of federal and state income tax provisions
are:
(Thousands of Dollars) 1997 1996 1995
Income taxes--current:
Federal............................. $21,812 $19,412 $30,236
State............................... 7,455 7,317 8,707
Total............................. 29,267 26,729 38,943
Income taxes--deferred, net of
amortization........................ 20,287 9,883 5,664
Amortization of deferred
investment credit................... (2,148) (2,145) (2,145)
Total income taxes................ 47,406 34,467 42,462
Income taxes--credited (charged)
to other income and deductions...... 113 29 (628)
Income taxes--charged to operating
income.............................. $47,519 $34,496 $41,834
F-33
Monongahela Power Company
The total provision for income taxes is different
from the amount produced by applying the federal
income statutory tax rate of 35% to financial
accounting income, as set forth below:
(Thousands of Dollars) 1997 1996 1995
Financial accounting income before
income taxes........................ $128,048 $ 95,948 $108,547
Amount so produced.................... $ 44,800 $ 33,600 $ 38,000
Increased (decreased) for:
Tax deductions for which deferred
tax was not provided:
Lower tax depreciation.......... 5,000 4,300 4,300
Plant removal costs............. (2,400) (2,200) (1,500)
State income tax, net of federal
income tax benefit................ 3,600 4,000 4,800
Amortization of deferred
investment credit................. (2,148) (2,145) (2,145)
Equity in earnings of subsidiaries.. (3,000) (2,500) (2,500)
Adjustments of provisions for
prior years....................... (40) 2,431
Other, net.......................... 1,667 (519) (1,552)
Total............................. $ 47,519 $ 34,496 $ 41,834
Federal income tax returns through 1993 have been
examined and substantially settled through 1991.
At December 31, the deferred tax assets and
liabilities consist of the following:
(Thousands of Dollars) 1997 1996
Deferred tax assets:
Unamortized investment tax credit.............. $ 12,275 $ 13,744
Tax interest capitalized........................ 4,500 4,300
Contributions in aid of construction............ 2,619 2,483
Advances for construction....................... 2,087 1,939
Deferred power costs, net....................... 1,266 5,297
Restructuring................................... 53 4,968
Other........................................... 12,090 10,153
34,890 42,884
Deferred tax liabilities:
Book vs. tax plant basis differences, net....... 236,962 230,738
Other........................................... 33,865 31,545
270,827 262,283
Total net deferred tax liabilities................ 235,937 219,399
Portion above included in current
(liabilities)/assets............................ (646) 6,442
Total long-term net deferred tax liabilities.. $235,291 $225,841
F-34
Monongahela Power Company
NOTE F: DIVIDEND RESTRICTION
Supplemental indentures relating to certain
outstanding bonds of the Company contain dividend
restrictions under the most restrictive of which
$76,384,000 of retained earnings at December 31,
1997, is not available for cash dividends on common
stock, except that a portion thereof may be paid as
cash dividends where concurrently an equivalent
amount of cash is received by the Company as a
capital contribution or as the proceeds of the
issue and sale of shares of its common stock.
NOTE G: ALLEGHENY GENERATING COMPANY
The Company owns 27% of the common stock of
Allegheny Generating Company (AGC), and affiliates
of the Company own the remainder. AGC owns an
undivided 40% interest, 840 MW, in the 2,100-MW
pumped-storage hydroelectric station in Bath
County, Virginia, operated by the 60% owner,
Virginia Electric and Power Company, a
nonaffiliated utility.
AGC recovers from the Company and its affiliates
all of its operation and maintenance expenses,
depreciation, taxes, and a return on its investment
under a wholesale rate schedule approved by the
FERC. AGC's rates are set by a formula filed with
and previously accepted by the FERC. The only
component which changes is the return on equity
(ROE). Pursuant to a settlement agreement filed
April 4, 1996, with the FERC, AGC's ROE was set at
11% for 1996 and will continue until the time any
affected party seeks renegotiation of the ROE.
Notice of such intent to seek a revision in ROE
must be filed during a notice period each year
between November 1 and November 15. No requests
for change were filed during the 1997 notice
period. Therefore, AGC's ROE will remain at 11% for
1998.
Following is a summary of financial information for
AGC:
December 31
(Thousands of Dollars) 1997 1996
Balance sheet information:
Property, plant, and equipment............... $635,485 $660,872
Current assets............................... 11,876 7,659
Deferred charges............................. 16,559 23,877
Total assets............................... $663,920 $692,408
Total capitalization......................... $348,258 $431,589
Current liabilities.......................... 70,540 15,531
Deferred credits............................. 245,122 245,288
Total capitalization and liabilities....... $663,920 $692,408
F-34
Monongahela Power Company
Year Ended December 31
(Thousands of Dollars) 1997 1996 1995
Income statement information:
Electric operating revenues......... $76,458 $83,402 $86,970
Operation and maintenance expense... 4,877 5,165 5,740
Depreciation........................ 17,000 17,160 17,018
Taxes other than income taxes....... 4,835 4,801 5,091
Federal income taxes................ 11,213 13,297 13,552
Interest charges.................... 15,391 16,193 18,361
Other income, net................... (9,126) (3) (16)
Net income........................ $32,268 $26,789 $27,224
The Company's share of the equity in earnings was
$8.7 million, $7.2 million, and $7.4 million for
1997, 1996, and 1995, respectively, and is included
in other income, net, on the Company's Statement of
Income.
NOTE H: POSTRETIREMENT BENEFITS
As described in Note A, the Company and its
affiliates participate in a pension plan and
medical and life insurance plans for eligible
employees and dependents. The Company is
responsible for its proportional share of the costs
(credits) and liabilities of the plans. As
described in Note D, in 1997 the Company
transferred all of its employees to APSC. The
Company's share of the costs (credits) of these
plans, a portion of which (about 25% to 30%) was
charged to plant construction, is as follows:
(Thousands of Dollars) 1997 1996 1995
Pension.............................. $(1,754) $ 78 $ 629
Medical and life insurance........... $ 3,706 $5,461 $6,482
NOTE I: REGULATORY ASSETS AND LIABILITIES
The Company's operations are subject to the
provisions of SFAS No. 71, "Accounting for the
Effects of Certain Types of Regulation."
Regulatory assets represent probable future
revenues associated with deferred costs that are
expected to be recovered from customers through the
ratemaking process. Regulatory liabilities
represent probable future reductions in revenues
associated with amounts that are to be credited to
customers through the ratemaking process.
Regulatory assets, net of regulatory liabilities,
reflected in the Balance Sheet at December 31
relate to:
F-36
Monongahela Power Company
(Thousands of Dollars) 1997 1996
Long-Term Assets (Liabilities), Net:
Income taxes, net.......................... $137,056 $140,804
Postretirement benefits.................... 4,937 4,937
Storm damage............................... 2,211 3,375
Other, net................................. 3,083 4,022
Subtotal................................. 147,287 153,138
Current Assets (Liabilities), Net:
Income taxes, net (reported in other
current assets).......................... 1,847 1,847
Deferred power costs....................... (484) (12,419)
Subtotal................................. 1,363 (10,572)
Net Regulatory Assets.................. $148,650 $142,566
NOTE J: FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair value of financial instruments at
December 31 were as follows:
1997 1996
Carrying Fair Carrying Fair
(Thousands of Dollars) Amount Value Amount Value
Liabilities:
Short-term debt..... $ 58,279 $ 58,279 $ 31,139 $ 31,139
Long-term debt and
QUIDS............. 479,710 528,155 495,210 505,922
The carrying amount of short-term debt approximates
the fair value because of the short maturity of
those instruments. The fair value of long-term
debt and QUIDS was estimated based on actual market
prices or market prices of similar issues. The
Company has no financial instruments held or issued
for trading purposes.
NOTE K: CAPITALIZATION
Preferred Stock
All of the preferred stock is entitled on voluntary
liquidation to its then current call price and on
involuntary liquidation to $100 a share.
Long-Term Debt and QUIDS
Maturities for long-term debt for the next five
years are: 1998, $20,100,000; 1999, $1,000,000;
2000, $66,000,000; 2001, $1,000,000; and 2002,
$26,060,000. Substantially all of the properties
of the Company are held subject to the lien
securing its first mortgage bonds. Some properties
are also subject to a second lien securing
certain pollution control and solid waste disposal
notes. Certain first mortgage bonds series are not
redeemable
F-37
Monongahela Power Company
by certain refunding until dates established in the
respective supplemental indentures.
NOTE L: SHORT-TERM DEBT
To provide interim financing and support for
outstanding commercial paper, the System companies
have established lines of credit with several
banks. The Company has SEC authorization for total
short-term borrowings of $106 million, including
money pool borrowings described below. The Company
has fee arrangements on all of its lines of credit
and no compensating balance requirements. In
addition to bank lines of credit, an internal money
pool accommodates intercompany short-term borrowing
needs, to the extent that certain of the regulated
companies have funds available. Short-term debt
outstanding for 1997 and 1996 consisted of:
(Thousands of Dollars) 1997 1996
Balance and interest rate at end of year:
Commercial Paper.................. $56,829-6.50% $28,239-7.00%
Money Pool........................ 1,450-5.96% 2,900-5.53%
Average amount outstanding and
interest rate during the year:
Commercial Paper.................. 1,651-5.76% 3,176-5.64%
Notes Payable to Banks............ 7,307-5.56% 2,266-5.46%
Money Pool........................ 9,300-5.44% 1,058-5.29%
NOTE M: COMMITMENTS AND CONTINGENCIES
Construction Program
The Company has entered into commitments for its
construction program, for which expenditures are
estimated to be $78 million for 1998 and $75 million
for 1999. Construction expenditure levels in 2000
and beyond will depend upon the strategy eventually
selected for complying with Phase II of the Clean Air
Act Amendments of 1990 (CAAA) and the extent to which
environmental initiatives currently being considered
become mandated.
Environmental Matters and Litigation
System companies are subject to various laws,
regulations, and uncertainties as to environmental
matters. Compliance may require them to
incur substantial additional costs to modify or
replace existing and proposed equipment and
facilities and may affect adversely the cost of
future operations. The more significant additional
environmental initiatives currently being considered
(in terms of their potential adverse financial effect
on the companies) are:
NOx reductions of 75% from a 1990 baseline by
mid-year 2003, depending upon modeling studies
required by the Ozone Transport Commission
established under Title I of the CAAA. A 55%
reduction is currently mandated.
F-38
Monongahela Power Company
NOx reductions of 85% from a 1990 baseline by
mid-year 2003 under a State Implementation Plan
(SIP) call proposed by the Environmental Protection
Agency (EPA) in November 1997, as well as by petitions
filed with the EPA in August 1997 by eight northeastern
states proposing an 85% reduction.
CO2 reductions of 7% below 1990 levels agreed to
by the Clinton Administration in a protocol for
greenhouse gas reductions at a conference in Kyoto,
Japan, in December 1997. The protocol requires
approval of the United States Senate to become
effective.
The NOx reduction proposals beyond 55% are being
vigorously opposed by the companies and other coal-
burning utilities and by other affected constituencies
in coal producing states. In January 1998, the Chambers
of Commerce in Virginia and West Virginia announced that
they had joined in the first court challenge, accusing
the EPA of failing to assess the impact of the 75%
and 85% reduction proposals on small businesses.
The EPA contends that the Small Business Regulatory
Enforcement Fairness Act of 1996 does not apply.
The United States Senate has indicated that it will
not approve the Kyoto protocol because of its
failure to include CO2 reduction requirements on
developing nations. The Company cannot predict the
outcome of these issues.
In the normal course of business, the Company
becomes involved in various legal proceedings. The
Company does not believe that the ultimate outcome
of these proceedings will have a material effect on
its financial position.
The Company previously reported that the EPA had
identified it and its affiliates and approximately
875 others as potentially responsible parties in a
Superfund site subject to cleanup.
The Company has also been named as a defendant
along with multiple other defendants in pending
asbestos cases involving one or more plaintiffs.
The Company believes that provisions for
liabilities and insurance recoveries are such that
final resolution of these claims will not have a
material effect on their financial position.
F-39
The Potomac Edison Company
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
The Potomac Edison Company
In our opinion, the accompanying balance sheet and
statement of capitalization and the related
statements of income, of retained earnings and of
cash flows present fairly, in all material
respects, the financial position of The Potomac
Edison Company (a subsidiary of Allegheny Energy,
Inc.) at 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. These 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 of these
statements in accordance with generally accepted
auditing standards which 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, assessing the accounting principles
used and significant estimates made by management,
and evaluating the overall financial statement
presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Pittsburgh, Pennsylvania
February 4, 1998
F-40
The Potomac Edison Company
STATEMENT OF INCOME
YEAR ENDED DECEMBER 31
1997 1996 1995
(Thousands of Dollars)
Electric Operating Revenues:
Residential........................ $299,876 $324,120 $316,714
Commercial......................... 148,287 146,432 145,096
Industrial......................... 198,174 196,813 200,890
Wholesale and other, including
affiliates......................... 38,857 34,901 28,592
Bulk power transactions, net....... 23,587 24,494 19,377
Total Operating Revenues......... 708,781 726,760 710,669
Operating Expenses:
Operation:
Fuel............................. 140,206 137,310 134,459
Purchased power and
exchanges, net................... 140,183 141,027 137,280
Deferred power costs, net........ (4,944) 5,040 13,056
Other............................ 83,905 89,756 89,936
Maintenance........................ 56,815 62,248 60,052
Restructuring charges and asset write
off.............................. 26,094 6,847
Depreciation....................... 71,763 71,254 68,826
Taxes other than income taxes...... 47,585 45,809 47,629
Federal and state income taxes..... 44,496 34,132 36,936
Total Operating Expenses......... 580,009 612,670 595,021
Operating Income................. 128,772 114,090 115,648
Other Income and Deductions:
Allowance for other than borrowed
funds used during construction..... 1,716 1,409 1,054
Other income, net.................. 13,976 11,791 12,044
Total Other Income and Deductions. 15,692 13,200 13,098
Income Before Interest Charges.... 144,464 127,290 128,746
Interest Charges:
Interest on long-term debt......... 47,659 47,982 49,113
Other interest..................... 2,164 2,215 2,066
Allowance for borrowed funds used
during construction............... (1,114) (1,082) (698)
Total Interest Charges........... 48,709 49,115 50,481
Net Income........................... $ 95,755 $ 78,175 $ 78,265
STATEMENT OF RETAINED EARNINGS
Balance at January 1................. $227,726 $216,852 $207,722
Add:
Net income......................... 95,755 78,175 78,265
323,481 295,027 285,987
Deduct:
Dividends on capital stock:
Preferred stock................... 818 818 2,455
Common stock...................... 83,272 66,483 64,693
Charge on redemption of preferred
stock.............................. 1,987
Total Deductions.................. 84,090 67,301 69,135
Balance at December 31................ $239,391 $227,726 $216,852
See accompanying notes to financial statements.
F-41
The Potomac Edison Company
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31
1997 1996 1995
(Thousands of Dollars)
Cash Flows from Operations:
Net income......................... $ 95,755 $ 78,175 $ 78,265
Depreciation....................... 71,763 71,254 68,826
Deferred investment credit and
income taxes, net................. 5,984 5,157 14,279
Deferred power costs, net.......... (4,944) 5,040 13,056
Unconsolidated subsidiaries' dividends
in excess of earnings............. 1,058 3,211 2,489
Allowance for other than borrowed funds
used during construction........... (1,716) (1,409) (1,054)
Restructuring liability............. (13,783) 15,801 4,251
Changes in certain current assets and
liabilities:
Accounts and notes receivable, net 9,450 (2,016) (25,050)
Materials and supplies........... (764) 6,768 4,554
Accounts payable................. (1,994) 4,184 885
Other, net........................... 10,485 (2,686) (8,322)
171,294 183,479 152,179
Cash Flows from Investing:
Construction expenditures (less
allowance for equity funds used
during construction)................. (76,582) (84,847) (91,186)
Cash Flows from Financing:
Retirement of preferred stock......... (48,396)
Issuance of long-term debt and QUIDS.. 207,019
Retirement of long-term debt.......... (800) (18,700) (175,248)
Short-term debt, net.................. (7,497) (14,140) 21,637
Notes receivable from affiliates...... (1,450) 1,900
Dividends on capital stock:
Preferred stock..................... (818) (818) (2,455)
Common stock........................ (83,272) (66,483) (64,693)
(93,837) (100,141) (60,236)
Net Change in Cash and Temporary Cash
Investments........................... 875 (1,509) 757
Cash and Temporary Cash Investments
at January 1.......................... 1,444 2,953 2,196
Cash and Temporary Cash Investments at
December 31........................... $ 2,319 $ 1,444 $ 2,953
Supplemental Cash Flow Information:
Cash paid during the year for:
Interest (net of amount capitalized). $ 47,642 $ 47,580 $ 49,399
Income taxes......................... 36,705 37,694 25,679
See accompanying notes to financial statements.
F-42
The Potomac Edison Company
BALANCE SHEET
DECEMBER 31
ASSETS 1997 1996
(Thousands of Dollars)
Property, Plant, and Equipment:
At original cost, including $55,702,000
and $60,082,000 under construction..... $2,196,262 $2,124,956
Accumulated depreciation................. (859,076) (791,257)
1,337,186 1,333,699
Investments and Other Assets:
Allegheny Generating Company--common stock
at equity............................... 55,847 56,827
Other..................................... 529 642
56,376 57,469
Current Assets:
Cash....................................... 2,319 1,444
Accounts receivable:
Electric service, net of $1,683,000
and $1,580,000 uncollectible allowance. 83,431 95,215
Affiliated and other..................... 5,302 2,968
Notes receivable from affiliate............ 1,450
Materials and supplies--at average cost:
Operating and construction............... 23,715 23,775
Fuel..................................... 15,843 15,019
Prepaid taxes.............................. 15,052 17,648
Other...................................... 4,716 7,764
151,828 163,833
Deferred Charges:
Regulatory assets........................... 80,651 94,919
Unamortized loss on reacquired debt......... 17,094 18,010
Other....................................... 17,512 9,956
115,257 122,885
Total..................................... $1,660,647 $1,677,886
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock, other paid-in capital,
and retained earnings.................. $ 689,781 $ 678,116
Preferred stock.......................... 16,378 16,378
Long-term debt and QUIDS................. 627,012 628,431
1,333,171 1,322,925
Current Liabilities:
Short-term debt.......................... 7,497
Long-term debt due within one year....... 1,800 800
Accounts payable......................... 29,125 33,152
Accounts payable to affiliates........... 19,929 17,896
Taxes accrued:
Federal and state income............... 2,106 123
Other.................................. 11,461 11,542
Interest accrued......................... 9,487 9,412
Payrolls accrued......................... 6,353 3,886
Customer deposits........................ 4,200 6,121
Restructuring liability.................. 1,187 14,970
Other.................................... 5,166 3,717
90,814 109,116
Deferred Credits and Other Liabilities:
Unamortized investment credit............. 21,470 23,622
Deferred income taxes..................... 178,529 183,727
Regulatory liabilities.................... 12,424 13,907
Other..................................... 24,239 24,589
236,662 245,845
Commitments and Contingencies (Note L)
Total........................................ $1,660,647 $1,677,886
See accompanying notes to financial statements.
F-43
The Potomac Edison Company
STATEMENT OF CAPITALIZATION
DECEMBER 31
1997 1996 1997 1996
(Thousands of Dollars) (Capitalization Ratios)
Common Stock:
Common stock--no par value, authorized
23,000,000 shares, outstanding
22,385,000 shares................... $ 447,700 $ 447,700
Other paid-in capital................. 2,690 2,690
Retained earnings..................... 239,391 227,726
Total............................. 689,781 678,116 51.8% 51.3
Preferred Stock:
Cumulative preferred stock--par value
$100 per share, authorized 5,378,611
shares, outstanding as follows:
December 31, 1997
Regular
Shares Call Price Date of
Series Outstanding Per Share Issue
3.60% 63,784 $103.75 1946 6,378 6,378
$5.88 C 100,000 102.85 1967 10,000 10,000
Total (annual dividend requirements
$817,622) 16,378 16,378 1.2 1.2
Long-Term Debt and QUIDS:
First mortgage Date of Date Date
bonds: Issue Redeemable Due
5-7/8%.... 1993 2000 2000 75,000 75,000
8 %.... 1991 2001 2006 50,000 50,000
8-7/8%.... 1991 2001 2021 50,000 50,000
8 %.... 1992 2002 2022 55,000 55,000
7-3/4%.... 1993 2003 2023 45,000 45,000
8 %.... 1994 2004 2024 75,000 75,000
7-5/8%.... 1995 2005 2025 80,000 80,000
7-3/4%.... 1995 2005 2025 65,000 65,000
December 31, 1997
Interest Rate
Quarterly Income Debt
Securities due 2025.......... 8.00% 45,457 45,457
Secured notes due 1998-2024... 5.95%-6.875% 91,700 91,700
Unsecured note due 1997-2002... 6.30% 4,000 4,800
Unamortized debt discount...... (7,345) (7,726)
Total (annual interest
requirements $47,555,458) 628,812 629,231
Less current maturities........ (1,800) (800)
Total........................ 627,012 628,431 47.0 47.5
Total Capitalization........... $1,333,171 $1,322,925 100.0% 100.0%
See accompanying notes to financial statements.
F-44
The Potomac Edison Company
NOTES TO FINANCIAL STATEMENTS
(These notes are an integral part of the financial
statements.)
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company is a wholly owned subsidiary of
Allegheny Energy, Inc. and is a part of the
Allegheny Energy integrated electric utility system
(the System).
The Company is subject to regulation by the
Securities and Exchange Commission (SEC), by
various state bodies having jurisdiction, and by
the Federal Energy Regulatory Commission (FERC).
Significant accounting policies of the Company are
summarized below.
Use of Estimates
The preparation of financial statements in
conformity with generally accepted accounting
principles requires management to make estimates
that affect the reported amounts of assets,
liabilities, revenues, expenses, and disclosures of
contingencies during the reporting period, which in
the normal course of business are subsequently
adjusted to actual results.
Revenues
Revenues, including amounts resulting from the
application of fuel and energy cost adjustment
clauses, are recognized in the same period in which
the related electric services are provided to
customers by recording an estimate for unbilled
revenues for services provided from the meter
reading date to the end of the accounting period.
Revenues of $65 million from one industrial
customer were 9% of total electric operating
revenues in 1997.
Deferred Power Costs, Net
The costs of fuel, purchased power, and certain
other costs, and revenues from sales to other
companies, including transmission services, are
deferred until they are either recovered from or
credited to customers under fuel and energy cost
recovery procedures.
Property, Plant, and Equipment
Property, plant, and equipment, including
facilities owned with regulated affiliates in the
System, are stated at original cost, less
contributions in aid of construction. Cost
includes direct labor and material, allowance for
funds used during construction (AFUDC) on property
for which construction work in progress is not
included in rate base, and such indirect costs as
administration, maintenance, and depreciation of
transportation and construction equipment, and
postretirement benefits, taxes, and other fringe
benefits related to employees engaged in
construction.
The cost of depreciable property units retired,
plus removal costs less salvage, are charged to
accumulated depreciation.
Allowance for Funds Used During Construction
AFUDC, an item that does not represent current cash
income, is defined in applicable regulatory systems
of accounts as including "the net cost for the
period of construction of borrowed funds used for
construction purposes and a reasonable rate on
other funds when so used." AFUDC is recognized as
a cost of property, plant, and equipment with
offsetting credits to other
F-45
The Potomac Edison Company
income and interest charges. Rates used for
computing AFUDC in 1997, 1996, and 1995 were 9.75%,
9.32%, and 9.71%, respectively. AFUDC is not
included in the cost of construction when the cost of
financing the construction is being recovered
through rates. AFUDC is not recorded for
construction applicable to the state of Virginia,
where construction work in progress is included in
rate base.
Depreciation and Maintenance
Provisions for depreciation are determined
generally on a straight-line method based on
estimated service lives of depreciable properties
and amounted to approximately 3.5% of average
depreciable property in 1997 and 3.6% in 1996 and
1995. The cost of maintenance and of certain
replacements of property, plant, and equipment is
charged principally to operating expenses.
Temporary Cash Investments
For purposes of the statement of cash flows,
temporary cash investments with original maturities
of three months or less, generally in the form of
commercial paper, certificates of deposit, and
repurchase agreements, are considered to be the
equivalent of cash.
Regulatory Assets and Liabilities
In accordance with the Financial Accounting
Standards Board's Statement of Financial Accounting
Standards (SFAS) No. 71, "Accounting for the
Effects of Certain Types of Regulation," the
Company's financial statements reflect assets and
liabilities based on cost-based ratemaking
regulation.
Income Taxes
The Company joins with its parent and affiliates in
filing a consolidated federal income tax return.
The consolidated tax liability is allocated among
the participants generally in proportion to the
taxable income of each participant, except that no
subsidiary pays tax in excess of its separate
return tax liability.
Financial accounting income before income taxes
differs from taxable income principally because
certain income and deductions for tax purposes are
recorded in the financial income statement in
another period. Differences between income tax
expense computed on the basis of financial
accounting income and taxes payable based on
taxable income are accounted for substantially in
accordance with the accounting procedures followed
for ratemaking purposes. Deferred tax assets and
liabilities represent the tax effect of temporary
differences between the financial statement and tax
basis of assets and liabilities computed utilizing
the most current tax rates.
Provisions for federal income tax were reduced in
previous years by investment credits, and amounts
equivalent to such credits were charged to income
with concurrent credits to a deferred account.
These balances are being amortized over the
estimated service lives of the related properties.
F-46
The Potomac Edison Company
Postretirement Benefits
The Company participates with affiliated companies
of Allegheny Energy, Inc. in a noncontributory,
defined benefit pension plan covering substantially
all employees, including officers. Benefits are
based on the employee's years of service and
compensation. The funding policy is to contribute
annually at least the minimum amount required under
the Employee Retirement Income Security Act and not
more than can be deducted for federal income tax purposes.
The Company and its affiliates also provide
partially contributory medical and life insurance
plans for eligible retirees and dependents. Medical
benefits, which comprise the largest component of
the plans, are based upon an age and years-of-service
vesting schedule and other plan provisions. The
funding plan for these costs is to contribute the
maximum amount that can be deducted for federal income
tax purposes. Funding of these benefits is made
primarily into Voluntary Employee Beneficiary
Association trust funds. Medical benefits are self-
insured. The life insurance plan is paid through
insurance premiums.
Risk Management
The Company uses derivative instruments to manage
risk exposure associated with energy contracts.
Such instruments are used in accordance with a risk
management policy adopted by the Board of Directors.
The fair value of such instruments at December 31,
1997, is not materially different from book value.
NOTE B: PROPOSED MERGER
On April 7, 1997, Allegheny Power System, Inc.
(Allegheny Power) and DQE, Inc. (DQE), parent
company of Duquesne Light Company in Pittsburgh,
Pennsylvania, announced that they had agreed to
merge in a tax-free, stock-for-stock transaction.
The combined company will be called Allegheny
Energy, Inc. (Allegheny Energy). It is expected
that Allegheny Energy will continue to be operated
as an integrated electric utility holding company
and that the regulated electric utility companies
will continue to exist as separate legal entities,
including the Company, its regulated affiliates, and
Duquesne Light Company. The companies stated in
their announcement that the merger is expected to
produce synergy savings of about $1 billion.
The merger is conditioned, among other things, upon
the approval of each company's shareholders, the
Pennsylvania Public Utility Commission (PUC), the
SEC, the FERC, the Nuclear Regulatory Commission
(NRC), and the Department of Justice/Federal Trade
Commission (DOJ/FTC) under the Hart, Scott, Rodino
Antitrust Improvements Act (HSR). Additionally,
Allegheny Power requested that the Maryland Public
Service Commission (PSC) approve the issuance of
additional Allegheny Power stock to accomplish the
transaction. The companies have established a
schedule to obtain all regulatory approvals by June
30, 1998. On May 2, 1997, Allegheny Power filed a
registration statement with the SEC on Form S-4
containing a joint proxy statement/prospectus with
DQE concerning the merger and the transactions
contemplated thereby. In late June, the S-4 became
effective, allowing Allegheny Power and DQE to pursue
shareholder approval. Allegheny Power and DQE each
held separate shareholder meetings on August 7, 1997,
at which the combination of the two companies was
approved by the shareholders of both companies.
At Allegheny Power's
F-47
The Potomac Edison Company
meeting, the shareholders also approved the change
in Allegheny Power's name to Allegheny Energy, Inc.
On August 1, 1997, Allegheny Power and DQE jointly
filed requests for merger approval with the PUC and
the FERC, DQE filed the necessary approval requests
with the NRC, and Allegheny Power filed its request
with the PSC for approval to issue Allegheny Power stock.
Subsequently, Allegheny Power filed for approval
from the SEC under the Public Utility Holding
Company Act of 1935 (PUHCA) and both companies
filed with the DOJ/FTC under the HSR. The PUC has
established a schedule of proceedings which is
expected to result in an approval order by the end
of May 1998. The FERC has not scheduled hearings.
Absent such hearings, Allegheny Energy expects a FERC
order before the end of May 1998. The PSC instituted
a proceeding involving the Company to examine the effect
of the merger on Maryland customers for which a final
determination is expected by May 1, 1998.
On September 16, 1997, Allegheny Power officially
changed its name to Allegheny Energy, Inc., by
filing the appropriate papers in Maryland.
Allegheny Energy began trading on the New York
Stock Exchange under its new symbol, AYE, on
October 1, 1997.
All of the Company's incremental costs of the
merger process ($3.3 million through December 31,
1997) are being deferred. The accumulated merger
costs will be written off by the Company when the
merger occurs or when it is determined that the
merger will not occur.
NOTE C: COMPETITION AND CUSTOMER CHOICE
In December 1997, in an initial Order followed by a
second Order revising certain implementation dates,
the Maryland PSC ordered an electric competition
transition plan requiring full retail customer
choice by July 1, 2002, in yearly one-third
increments beginning July 1, 2000; a price cap
mechanism; recovery of verifiable and prudent
stranded costs (after mitigation); and roundtable
and adjudicatory proceedings to address issues such
as universal service, demand-side management
programs, customer education, etc. In its Order,
the PSC stated its belief that it had the authority
under existing law to implement the Order, but
requested the legislature to enact certain
"technical amendments" to facilitate the
transition.
In addition to Maryland, the Company serves
customers in Virginia and West Virginia. These
states are also in the process of exploring the
move toward competition and deregulation, but have
not yet taken definitive action. The Company's
wholesale customers have had the right to choose
their generation supplier since passage of the
National Energy Policy Act of 1992.
In July 1997, the Emerging Issues Task Force (EITF)
of the Financial Accounting Standards Board (FASB)
released Issue Number 97-4, Deregulation of the
Pricing of Electricity-Issues Related to the
Application of FASB Statement Numbers 71 and 101,
which concluded that utilities should discontinue
application of Statement of Financial Accounting
Standards (SFAS) No. 71 for the generation portion
of their business when a deregulation plan is in
place and its terms are known. Since the Maryland
PSC Order establishes such processes, the Company
has determined that it will be required to discontinue
use of SFAS No. 71 for the generation portion of
F-48
The Potomac Edison Company
its business (the Maryland portion only) on an
uncertain future date. One of the conclusions of
the EITF is that, after discontinuing SFAS No. 71,
utilities should continue to carry on
their books the assets and liabilities recorded
under SFAS No. 71 if the regulatory cash flows to
settle them will be derived from the continuing
regulated transmission and distribution business.
Additionally, continuing costs and obligations of
the deregulated generation business which are
similarly covered by the cash flows from the
continuing regulated business will meet the
criteria as regulatory assets and liabilities.
The Maryland Order establishes definitive
processes for transition to deregulation and
market-based pricing for electric generation,
which include continuing cost-of-service based
ratemaking for transmission and distribution
services, subject to rate caps, and provide for a
non-bypassable Competitive Transition Charge (CTC)
to give utilities the opportunity to recover their
stranded costs over the transition period. Until
relevant regulatory proceedings are complete and
final orders are received, the Company is unable
to predict the effect of discontinuing SFAS No. 71.
In December 1996, Pennsylvania enacted the
Electricity Generation Customer Choice and
Competition Act (Customer Choice Act) to
restructure the electric industry in Pennsylvania
to create retail access to a competitive electric
energy generation market. On August 1, 1997,
concurrent with Allegheny Power's merger approval
filing, the Company's Pennsylvania utility
affiliate, West Penn Power Company (West Penn),
filed with the PUC a comprehensive stand-alone
restructuring plan to implement full customer
choice of electric generation suppliers as
required by the Customer Choice Act. The filing
included an unbundling of West Penn's electric
service rates into generation, transmission, and
distribution components; a plan to revise how West
Penn and its affiliates, including the Company,
share capacity, energy, capacity reserves,
transmission resources, and costs; and a plan for
recovery of stranded costs through a CTC.
The PUC has established a schedule of
proceedings for the restructuring plan, concurrent
with the merger proceedings, under which it would
issue an order on the filing by the end of May
1998. This order will include a determination of
West Penn's rates for transmission and
distribution services beginning January 1, 1999;
generation rates for customers who take regulated
generation service during the transition period
(potentially 1999 through 2005 if customers so
choose); and the CTC West Penn will be allowed to
charge through the transition period.
NOTE D: RESTRUCTURING CHARGES AND ASSET WRITE-OFF
In 1996, the System, including the Company,
essentially completed its restructuring activities
initiated in 1994, simplifying the management
structure, streamlining operations, and began
doing business under the trade name of Allegheny
Power. During 1996, restructuring activities
included consolidating operating divisions,
customer services, and other functions. By
reorganizing and eliminating certain processes
and consolidating common decentralized functions,
the System reduced employment by about 1,000
employees since October 1994. These reductions
were accomplished through a voluntary separation
plan, attrition, and layoffs.
F-49
The Potomac Edison Company
In 1996 and 1995, the Company recorded
restructuring charges of $26.1 million
($16.5 million after tax) and $4.6 million
($2.9 million after tax), respectively, in
operating expenses, including its share of all
restructuring charges associated with the
reorganization. These charges reflect liabilities
and payments for severance, employee termination
costs, and other restructuring costs. The current
portion of the restructuring liability excluding
benefit plans' curtailment adjustments to
postretirement liabilities (which are primarily
recorded in other deferred credits) consists of:
(Thousands of Dollars) 1997 1996
Restructuring liability:
Balance at beginning of period............... $14,970 $ 4,251
Accruals................................... 21,012
Less payments.............................. (13,783) (10,293)
Balance at end of period..................... $ 1,187 $14,970
In connection with changes in inventory management
objectives, the Company in 1995 recorded $2.2
million ($1.4 million after tax) for the write-off
of obsolete and slow-moving materials.
As part of the reorganization, the Company and its
utility affiliates in 1996 expanded the
intercompany use of each other's employees to
optimize the use of their skills. In 1997
virtually all the employees in the System,
including virtually all of the Company's employees,
were transferred to Allegheny Power Service
Corporation (APSC) to facilitate the intercompany
use of personnel. APSC was formed in 1963 pursuant
to the PUHCA to perform certain functions common to
all companies in the System. APSC bills each
company at its cost (without profit) based on the
work performed and services provided to each
company.
NOTE E: INCOME TAXES
Details of federal and state income tax provisions are:
(Thousands of Dollars) 1997 1996 1995
Income taxes--current:
Federal............................. $36,126 $26,651 $25,949
State............................... 5,264 4,833 (640)
Total............................. 41,390 31,484 25,309
Income taxes--deferred, net of
amortization........................ 8,136 7,351 16,504
Amortization of deferred
investment credit................... (2,152) (2,194) (2,225)
Total income taxes................ 47,374 36,641 39,588
Income taxes--charged to other
income and deductions............... (2,878) (2,509) (2,652)
Income taxes--charged to operating
income.............................. $44,496 $34,132 $36,936
F-50
The Potomac Edison Company
The total provision for income taxes is different
from the amount produced by applying the federal
income statutory tax rate of 35% to financial
accounting income, as set forth below:
(Thousands of Dollars) 1997 1996 1995
Financial accounting income before
income taxes....................... $140,251 $112,305 $115,201
Amount so produced................... $ 49,100 $ 39,300 $ 40,300
Increased (decreased) for:
Tax deductions for which deferred
tax was not provided:
Lower tax depreciation......... 2,900 4,300 4,200
Plant removal costs............ (700) (1,800) (1,200)
State income tax, net of federal
income tax benefit............... 4,400 1,300 2,200
Amortization of deferred
investment credit................ (2,152) (2,194) (2,225)
Equity in earnings of subsidiaries. (3,100) (2,600) (2,600)
Other, net......................... (5,952) (4,174) (3,739)
Total.......................... $ 44,496 $ 34,132 $ 36,936
Federal income tax returns through 1993 have been
examined and substantially settled through 1991.
At December 31, the deferred tax assets and
liabilities consist of the following:
(Thousands of Dollars) 1997 1996
Deferred tax assets:
Contributions in aid of construction......... $ 13,841 $ 13,414
Unamortized investment tax credit............ 12,518 13,929
Tax interest capitalized..................... 12,234 12,124
Postretirement benefits other than pensions.. 3,998 2,560
Unbilled revenue............................. 3,492
Restructuring................................ 1,239 4,844
Advances for construction.................... 1,194 1,327
Other........................................ 3,436 3,002
51,952 51,200
Deferred tax liabilities:
Book vs. tax plant basis differences, net.... 211,837 215,884
Other........................................ 17,600 15,060
229,437 230,944
Total net deferred tax liabilities............. 177,485 179,744
Add portion above included in current assets... 1,044 3,983
Total long-term net deferred tax liabilities. $178,529 $183,727
F-51
The Potomac Edison Company
NOTE F: ALLEGHENY GENERATING COMPANY
The Company owns 28% of the common stock of
Allegheny Generating Company (AGC), and affiliates
of the Company own the remainder. AGC owns an
undivided 40% interest, 840 MW, in the 2,100-MW
pumped-storage hydroelectric station in Bath
County, Virginia, operated by the 60% owner,
Virginia Electric and Power Company, a
nonaffiliated utility.
AGC recovers from the Company and its affiliates
all of its operation and maintenance expenses,
depreciation, taxes, and a return on its investment
under a wholesale rate schedule approved by the
FERC. AGC's rates are set by a formula filed with
and previously accepted by the FERC. The only
component which changes is the return on equity
(ROE). Pursuant to a settlement agreement filed
April 4, 1996, with the FERC, AGC's ROE was set at
11% for 1996 and will continue until the time any
affected party seeks renegotiation of the ROE.
Notice of such intent to seek a revision in ROE
must be filed during a notice period each year
between November 1 and November 15. No requests
for change were filed during the 1997 notice
period. Therefore, AGC's ROE will remain at 11% for
1998.
Following is a summary of financial information for
AGC:
December 31
(Thousands of Dollars) 1997 1996
Balance sheet information:
Property, plant, and equipment............... $635,485 $660,872
Current assets............................... 11,876 7,659
Deferred charges............................. 16,559 23,877
Total assets............................... $663,920 $692,408
Total capitalization......................... $348,258 $431,589
Current liabilities.......................... 70,540 15,531
Deferred credits............................. 245,122 245,288
Total capitalization and liabilities....... 663,920 $692,408
Year Ended December 31
(Thousands of Dollars) 1997 1996 1995
Income statement information:
Electric operating revenues......... $76,458 $83,402 $86,970
Operation and maintenance expense... 4,877 5,165 5,740
Depreciation........................ 17,000 17,160 17,018
Taxes other than income taxes....... 4,835 4,801 5,091
Federal income taxes................ 11,213 13,297 13,552
Interest charges.................... 15,391 16,193 18,361
Other income, net................... (9,126) (3) (16)
Net income........................ $32,268 $26,789 $27,224
The Company's share of the equity in earnings was
$9.0 million, $7.5 million, and $7.6 million for
1997, 1996, and 1995, respectively, and is included
in other income, net, on the Company's Statement of
Income.
F-52
The Potomac Edison Company
NOTE G: POSTRETIREMENT BENEFITS
As described in Note A, the Company and its
affiliates participate in a pension plan and
medical and life insurance plans for eligible
employees and dependents. The Company is
responsible for its proportional share of the costs
(credits) and liabilities of the plans. As
described in Note D, in 1997 the Company
transferred virtually all of its employees to APSC.
The Company's share of the costs (credits) of these
plans, a portion of which (about 25% to 30%) was
charged to plant construction, is as follows:
(Thousands of Dollars) 1997 1996 1995
Pension.............................. $(1,745) $ (201) $ 360
Medical and life insurance........... $ 4,007 $5,831 $6,813
NOTE H: REGULATORY ASSETS AND LIABILITIES
The Company's operations are subject to the
provisions of SFAS No. 71, "Accounting for the
Effects of Certain Types of Regulation."
Regulatory assets represent probable future
revenues associated with deferred costs that are
expected to be recovered from customers through the
ratemaking process. Regulatory liabilities
represent probable future reductions in revenues
associated with amounts that are to be credited to
customers through the ratemaking process.
Regulatory assets, net of regulatory liabilities,
reflected in the Balance Sheet at December 31
relate to:
(Thousands of Dollars) 1997 1996
Long-Term Assets (Liabilities), Net:
Income taxes, net.......................... $52,231 $62,625
Demand-side management..................... 14,204 15,748
Postretirement benefits.................... 1,292 1,292
Deferred power costs (reported in other
deferred credits)........................ (2,949) (3,187)
Other, net................................. 500 1,347
Subtotal................................. 65,278 77,825
Current Assets (Liabilities), Net:
Deferred power costs (reported in
other current assets/liabilities)........ 2,682 (319)
Net Regulatory Assets.................. $67,960 $77,506
F-53
The Potomac Edison Company
NOTE I: FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair value of
financial instruments at December 31 were as
follows:
1997 1996
Carrying Fair Carrying Fair
(Thousands of Dollars) Amount Value Amount Value
Liabilities:
Short-term debt...... $7,497 $7,497
Long-term debt and
QUIDS.............. $636,157 $672,198 $636,957 $648,586
The carrying amount of short-term debt approximates
the fair value because of the short maturity of
those instruments. The fair value of long-term
debt and QUIDS was estimated based on actual market
prices or market prices of similar issues. The
Company has no financial instruments held or issued
for trading purposes.
NOTE J: CAPITALIZATION
Preferred Stock
All of the preferred stock is entitled on voluntary
liquidation to its then current call price and on
involuntary liquidation to $100 a share.
Long-Term Debt and QUIDS
Maturities for long-term debt for the next five
years are: 1998, $1,800,000; 1999, $1,800,000;
2000, $76,800,000; 2001, $1,800,000; and 2002,
$1,800,000. Substantially all of the properties of
the Company are held subject to the lien securing
its first mortgage bonds. Some properties are also
subject to a second lien securing certain pollution
control and solid waste disposal notes. Certain first
mortgage bond series are not redeemable by certain
refunding until dates established in the respective
supplemental indentures.
NOTE K: SHORT-TERM DEBT
To provide interim financing and support for
outstanding commercial paper, the System companies
have established lines of credit with several
banks. The Company has SEC authorization for total
short-term borrowings of $130 million, including
money pool borrowings described below. The Company
has fee arrangements on all of its lines of credit
and no compensating balance requirements. In
addition to bank lines of credit, an internal money
pool accommodates intercompany short-term borrowing
needs, to the extent that certain of the regulated
companies have funds available.
F-54
The Potomac Edison Company
Short-term debt outstanding for 1997 and 1996
consisted of:
(Thousands of Dollars) 1997 1996
Balance and interest rate
at end of year:
Commercial Paper................ $7,497-7.00%
Average amount outstanding and
interest rate during the year:
Commercial Paper................ $137-5.63% $1,116-5.70%
Notes Payable to Banks.......... $189-5.37% $ 793-5.60%
NOTE L: COMMITMENTS AND CONTINGENCIES
Construction Program
The Company has entered into commitments for its
construction program, for which expenditures are
estimated to be $84 million for 1998 and $112 million
for 1999. Construction expenditure levels in 2000
and beyond will depend upon the strategy eventually
selected for complying with Phase II of the Clean Air
Act Amendments of 1990 (CAAA) and the extent to which
environmental initiatives currently being considered
become mandated.
Environmental Matters and Litigation
System companies are subject to various laws,
regulations, and uncertainties as to environmental
matters. Compliance may require them to incur
substantial additional costs to modify or replace
existing and proposed equipment and facilities and
may affect adversely the cost of
future operations. The more significant additional
environmental initiatives currently being considered
(in terms of their potential adverse financial effect
on the companies) are:
NOx reductions of 75% from a 1990 baseline by
mid-year 2003, depending upon modeling studies
required by the Ozone Transport Commission
established under Title I of the CAAA. A 55%
reduction is currently mandated.
NOx reductions of 85% from a 1990 baseline by
mid-year 2003 under a State Implementation Plan
(SIP) call proposed by the Environmental Protection
Agency (EPA) in November 1997, as well as by
petitions filed with the EPA in August 1997 by eight
northeastern states proposing an 85% reduction.
CO2 reductions of 7% below 1990 levels agreed to
by the Clinton Administration in a protocol for
greenhouse gas reductions at a conference in Kyoto,
Japan, in December 1997. The protocol requires
approval of the United States Senate to
become effective.
The NOx reduction proposals beyond 55% are being
vigorously opposed by the companies and other coal-
burning utilities and by other affected
constituencies in coal producing states. In
January 1998, the Chambers of Commerce in Virginia
and West Virginia announced that they had joined in
the first court challenge, accusing the EPA of
failing to assess the impact of the 75% and 85%
reduction proposals on small businesses. The EPA
contends that the Small Business Regulatory
Enforcement Fairness Act of 1996 does not
F-55
The Potomac Edison Company
apply. The United States Senate has indicated that
it will not approve the Kyoto protocol because of
its failure to include CO2 reduction requirements
on developing nations. The Company cannot predict
the outcome of these issues.
In the normal course of business, the Company
becomes involved in various legal proceedings. The
Company does not believe that the ultimate outcome
of these proceedings will have a material effect on
its financial position.
The Company previously reported that the EPA had
identified it and its affiliates and approximately
875 others as potentially responsible parties in a
Superfund site subject to cleanup.
The Company has also been named as a defendant
along with multiple other defendants in pending
asbestos cases involving one or more plaintiffs.
The Company believes that provisions for
liabilities and insurance recoveries are such that
final resolution of these claims will not have a
material effect on its financial position.
F-56
West Penn Power Company
and Subsidiaries
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Directors of
West Penn Power Company
In our opinion, the accompanying consolidated
balance sheet and consolidated statement of
capitalization and the related consolidated
statements of income, of retained earnings and of
cash flows present fairly, in all material
respects, the financial position of West Penn Power
Company (a subsidiary of Allegheny Energy, Inc.)
and its subsidiaries at 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. These
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 of these statements in accordance with
generally accepted auditing standards which 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, assessing
the accounting principles used and significant
estimates made by management, and evaluating the
overall financial statement presentation. We believe
that our audits provide a reasonable basis for the
opinion expressed above.
PRICE WATERHOUSE LLP
Pittsburgh, Pennsylvania
February 4, 1998
F-57
West Penn Power Company
and Subsidiaries
CONSOLIDATED STATEMENT OF INCOME
YEAR ENDED DECEMBER 31
1997 1996 1995
(Thousands of Dollars)
Electric Operating Revenues:
Residential......................... $ 393,036 $ 402,083 $ 401,186
Commercial.......................... 223,347 224,663 224,144
Industrial.......................... 352,730 355,120 356,937
Wholesale and other, including
affiliates....................... 72,459 74,328 73,388
Bulk power transactions, net........ 40,590 32,930 25,438
Total Operating Revenues.......... 1,082,162 1,089,124 1,081,093
Operating Expenses:
Operation:
Fuel.............................. 254,210 239,337 237,376
Purchased power and exchanges,net. 120,005 126,908 129,457
Deferred power costs, net......... (7,944) 13,635 15,091
Other............................. 157,780 151,642 141,355
Maintenance......................... 98,252 104,211 114,489
Restructuring charges and asset
write-offs......................... 53,343 11,099
Depreciation........................ 113,793 119,066 112,334
Taxes other than income taxes....... 90,140 90,132 89,694
Federal and state income taxes...... 73,279 47,455 61,745
Total Operating Expenses.......... 899,515 945,729 912,640
Operating Income.................. 182,647 143,395 168,453
Other Income and Deductions:
Allowance for other than borrowed
funds used during construction....... 2,107 1,434 2,974
Other income, net..................... 17,562 13,439 12,287
Total Other Income and Deductions... 19,669 14,873 15,261
Income Before Interest Charges...... 202,316 158,268 183,714
Interest Charges:
Interest on long-term debt.......... 64,990 64,988 64,571
Other interest...................... 4,639 6,084 3,331
Allowance for borrowed funds
used during construction........... (1,978) (1,289) (2,067)
Total Interest Charges........... 67,651 69,783 65,835
Consolidated Net Income.............$ 134,665 $ 88,485 $ 117,879
CONSOLIDATED STATEMENT OF RETAINED EARNINGS
Balance at January .....................$ 441,283 $ 451,719 $ 433,801
Add:
Consolidated net income............... 134,665 88,485 117,879
575,948 540,204 551,680
Deduct:
Dividends on capital stock of the Company:
Preferred stock..................... 3,430 3,423 6,204
Common stock........................ 96,960 95,498 91,600
Charge on redemption of
preferred stock......................... 2,157
Total Deductions.....................100,390 98,921 99,961
Balance at December 31....................$475,558 $ 441,283 $ 451,719
See accompanying notes to consolidated financial statements.
F-58
West Penn Power Company
and Subsidiaries
CONSOLIDATED STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31
1997 1996 1995
(Thousands of Dollars)
Cash Flows from Operations:
Consolidated net income.......... $ 134,665 $ 88,485 $117,879
Depreciation..................... 113,793 119,066 112,334
Deferred investment credit and
income taxes, net............... 31,381 2,022 2,364
Deferred power costs, net........ (7,944) 13,635 15,091
Unconsolidated subsidiaries'
dividends in excess of earnings.. 1,702 5,191 4,034
Allowance for other than borrowed
funds used during construction... (2,107) (1,434) (2,974)
Restructuring liability........... (23,052) 25,879 6,492
PURPA project buyout.............. (48,000)
Changes in certain current assets
and liabilities:
Accounts receivable, net........ (12,382) 23,671 (30,280)
Materials and supplies.......... (3,421) 8,847 9,022
Accounts payable................ 7,507 (14,809) (15,041)
Other, net...................... 11,532 1,714 (11,258)
203,674 272,267 207,663
Cash Flows from Investing:
Construction expenditures (less
allowance for equity funds used
during construction)............... (125,947) (129,172) (146,148)
Cash Flows from Financing:
Retirement of preferred stock....... (72,369)
Issuance of long-term debt and
QUIDS.............................. 143,700
Retirement of long-term debt........ (105,888)
Short-term debt, net................ 18,659 (36,831) 70,218
Notes receivable from affiliates.... 2,900 (2,900) 1,000
Dividends on capital stock:
Preferred stock................... (3,430) (3,423) (6,204)
Common stock...................... (96,960) (95,498) (91,600)
(78,831) (138,652) (61,143)
Net Change in Cash and Temporary
Cash Investments..................... (1,104) 4,443 372
Cash and Temporary Cash Investments
at January 1.......................... 5,160 717 345
Cash and Temporary Cash Investments
at December 31................ $ 4,056 $ 5,160 $ 717
Supplemental Cash Flow Information:
Cash paid during the year for:
Interest (net of amount
capitalized)..........................$ 64,594 $ 65,149 $ 64,374
Income taxes............................ 43,297 57,126 64,330
See accompanying notes to consolidated financial statements.
F-59
West Penn Power Company
and Subsidiaries
CONSOLIDATED BALANCE SHEET
DECEMBER 31
ASSETS 1997 1996
(Thousands of Dollars)
Property, Plant, and Equipment:
At original cost, including
$117,588,000 and $102,003,000
under construction....................... $3,293,039 $3,182,208
Accumulated depreciation.................. (1,254,900) (1,152,383)
2,038,139 2,029,825
Investments and Other Assets:
Allegheny Generating Company--common stock
at equity............................... 89,783 91,330
Other..................................... 721 881
90,504 92,211
Current Assets:
Cash and temporary cash investments....... 4,056 5,160
Accounts receivable:
Electric service, net of $13,326,000
and $11,524,000 uncollectible
allowance............................. 128,348 117,240
Affiliated and other.................... 21,525 20,251
Notes receivable from affiliate........... 2,900
Materials and supplies--at average cost:
Operating and construction.............. 34,212 34,011
Fuel.................................... 29,467 26,247
Deferred income taxes..................... 11,959 29,003
Prepaid taxes............................. 11,738 20,688
Other..................................... 2,252 7,492
243,557 262,992
Deferred Charges:
Regulatory assets......................... 333,235 284,099
Unamortized loss on reacquired debt....... 9,725 10,990
Other..................................... 31,999 19,620
374,959 314,709
Total....................................... $2,747,159 $2,699,737
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock, other paid-in capital,
and retained earnings..................... $ 997,027 $ 962,752
Preferred stock............................ 79,708 79,708
Long-term debt and QUIDS................... 802,319 905,243
1,879,054 1,947,703
Current Liabilities:
Short-term debt............................ 52,046 33,387
Long-term debt due within one year......... 103,500
Accounts payable........................... 73,584 74,229
Accounts payable to affiliates............. 16,137 7,985
Taxes accrued:
Federal and state income................. 1,605 250
Other...................................... 22,728 28,649
Interest accrued........................... 15,817 15,741
Deferred power costs....................... 10,107
Restructuring liability.................... 4,082 27,134
Other...................................... 24,375 21,341
313,874 218,823
Deferred Credits and Other Liabilities:
Unamortized investment credit............... 45,206 47,786
Deferred income taxes....................... 450,390 429,122
Regulatory liabilities...................... 34,326 33,302
Other....................................... 24,309 23,001
554,231 533,211
Commitments and Contingencies (Note M)
Total......................................... $2,747,159 $2,699,737
See accompanying notes to consolidated financial statements.
F-60
West Penn Power Company
and Subsidiaries
CONSOLIDATED STATEMENT OF CAPITALIZATION
DECEMBER 31
1997 1996 1997 1996
(Thousands of Dollars) (Capitalization Ratios)
Common Stock of the Company:
Common stock--no par value, authorized
28,902,923 shares, outstanding
24,361,586 shares...................... $ 465,994 $ 465,994
Other paid-in capital................... 55,475 55,475
Retained earnings....................... 475,558 441,283
Total............................... 997,027 962,752 53.1% 49.4%
Preferred Stock of the Company:
Cumulative preferred stock--par value
$100 per share, authorized 3,097,077
shares, outstanding as follows:
December 31, 1997
Regular
Shares Call Price Date of
Series Outstanding Per Share Issue
4-1/2% 297,077 $110.00 1939 29,708 29,708
4.20% B 50,000 102.205 1948 5,000 5,000
4.10% C 50,000 103.50 1949 5,000 5,000
Auction
4.008%-4.29% 400,000 100.00 1992 40,000 40,000
Total (annual dividend requirements
$3,391,847) 79,708 79,708 4.2 4.1
Long-Term Debt and QUIDS:
First mortgage
bonds: Date of Date Date
Issue Redeemable Due
5-1/2% JJ 1993 1998 1998 102,000 102,000
6-3/8% KK 1993 2003 2003 80,000 80,000
7-7/8% GG 1991 2001 2004 70,000 70,000
7-3/8% HH 1992 2002 2007 45,000 45,000
8-7/8% FF 1991 2001 2021 100,000 100,000
7-7/8% II 1992 2002 2022 135,000 135,000
8-1/8% LL 1994 2004 2024 65,000 65,000
7-3/4% MM 1995 2005 2025 30,000 30,000
December 31, 1997
Interest Rate
Quarterly Income Debt Securities
due 2025...................... 8.00% 70,000 70,000
Secured notes due 1998-2024.....4.95%-6.875% 202,550 202,550
Unsecured notes due 2000-2007... 6.10% 14,435 14,435
Unamortized debt discount....... (8,166) (8,742)
Total (annual interest
requirements $64,988,743) 905,819 905,243
Less current maturities......... (103,500)
Total...................... 802,319 905,243 42.7 46.5
Total Capitalization............ $1,879,054 $1,947,703 100.0% 100.0%
See accompanying notes to consolidated financial statements.
F-61
West Penn Power Company
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(These notes are an integral part of the consolidated
financial statements.)
NOTE A: SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
The Company is a wholly owned subsidiary of Allegheny
Energy, Inc. and is a part of the Allegheny Energy
integrated electric utility system (the System).
The Company is subject to regulation by the
Securities and Exchange Commission (SEC), by
various state bodies having jurisdiction, and by
the Federal Energy Regulatory Commission (FERC).
Significant accounting policies of the Company are
summarized below.
Consolidation
The consolidated financial statements include the
accounts of the Company and its wholly owned
subsidiaries (the companies).
Use Of Estimates
The preparation of financial statements in
conformity with generally accepted accounting
principles requires management to make estimates
that affect the reported amounts of assets,
liabilities, revenues, expenses, and disclosures of
contingencies during the reporting period, which in
the normal course of business are subsequently
adjusted to actual results.
Revenues
Revenues are recognized in the same period in which
the related electric services are provided to
customers by recording an estimate for unbilled
revenues for services provided from the meter
reading date to the end of the accounting period.
Deferred Power Costs, Net
Prior to May 1, 1997, the costs of fuel, purchased
power, and certain other costs, and revenues from
sales to other companies, including transmission
services, were deferred until they were either
recovered from or credited to customers under fuel
and energy cost recovery procedures. The Company
discontinued this practice effective May 1, 1997.
Property, Plant, and Equipment
Property, plant, and equipment, including facilities
owned with regulated affiliates in the System, are
stated at original cost, less contributions in aid
of construction, except for capital leases, which
are recorded at present value. Cost includes direct
labor and material, allowance for funds used during
construction (AFUDC) on property for which
construction work in progress is not included in
rate base, and such indirect costs as
administration, maintenance, and depreciation of
transportation and construction equipment, and
postretirement benefits, taxes, and other fringe
benefits related to employees engaged in
construction.
The cost of depreciable property units retired, plus
removal costs less salvage, are charged to
accumulated depreciation.
F-62
West Penn Power Company
and Subsidiaries
Allowance for Funds Used During Construction
AFUDC, an item that does not represent current cash
income, is defined in applicable regulatory systems
of accounts as including "the net cost for the
period of construction of borrowed funds used for
construction purposes and a reasonable rate on other
funds when so used." AFUDC is recognized as
a cost of property, plant, and equipment with
offsetting credits to other income and interest
charges. Rates used for computing AFUDC in 1997,
1996, and 1995 were 8.30%, 7.83%, and 8.90%,
respectively. AFUDC is not included
in the cost of construction when the cost of
financing the construction is being recovered
through rates.
Depreciation and Maintenance
Provisions for depreciation are determined generally
on a straight-line method based on estimated service
lives of depreciable properties and amounted to
approximately 3.7%, 4.0%, and 3.9%, of average
depreciable property in 1997, 1996, and 1995,
respectively. The cost of maintenance and of
certain replacements of property, plant, and
equipment is charged principally to operating expenses.
Temporary Cash Investments
For purposes of the consolidated statement of cash
flows, temporary cash investments with original
maturities of three months or less, generally in the
form of commercial paper, certificates of deposit,
and repurchase agreements, are considered to be the
equivalent of cash.
Regulatory Assets and Liabilities
In accordance with the Financial Accounting
Standards Board's Statement of Financial Accounting
Standards (SFAS) No. 71, "Accounting for the Effects
of Certain Types of Regulation," the Company's
consolidated financial statements reflect assets and
liabilities based on cost-based ratemaking
regulation.
Income Taxes
The companies join with their parent and affiliates
in filing a consolidated federal income tax return.
The consolidated tax liability is allocated among
the participants generally in proportion to the
taxable income of each participant, except that no
subsidiary pays tax in excess of its separate return
tax liability.
Financial accounting income before income taxes
differs from taxable income principally because
certain income and deductions for tax purposes are
recorded in the financial income statement in
another period. Differences between income tax
expense computed on the basis of financial
accounting income and taxes payable based on taxable
income are accounted for substantially in accordance
with the accounting procedures followed for
ratemaking purposes. Deferred tax assets and
liabilities represent the tax effect of temporary
differences between the financial statement and tax
basis of assets and liabilities computed utilizing
the most current tax rates.
Provisions for federal income tax were reduced in
previous years by investment credits, and amounts
equivalent to such credits were charged to income
with concurrent credits to a deferred account.
These balances are being amortized over the
estimated service lives of the related properties.
F-63
West Penn Power Company
and Subsidiaries
Postretirement Benefits
The Company participates with affiliated companies
of Allegheny Energy, Inc. in a noncontributory,
defined benefit pension plan covering substantially
all employees, including officers. Benefits are
based on the employee's years of service and
compensation. The funding policy is to contribute
annually at least the minimum amount required under
the Employee Retirement Income Security Act and not
more than can be deducted for federal income tax
purposes.
The Company and its affiliates also provide
partially contributory medical and life insurance
plans for eligible retirees and dependents. Medical
benefits, which comprise the largest component of the
plans, are based upon an age and years-of-service
vesting schedule and other plan provisions. The
funding plan for these costs is to contribute the
maximum amount that can be deducted for federal
income tax purposes. Funding of these benefits is
made primarily into Voluntary Employee Beneficiary
Association trust funds. Medical benefits are self-
insured. The life insurance plan is paid through
insurance premiums.
Risk Management
The Company uses derivative instruments to manage
risk exposure associated with energy contracts.
Such instruments are used in accordance with a risk
management policy adopted by the Board of Directors.
The fair value of such instruments at December 31,
1997, is not materially different from book value.
NOTE B: PROPOSED MERGER
On April 7, 1997, Allegheny Power System, Inc.
(Allegheny Power) and DQE, Inc. (DQE), parent
company of Duquesne Light Company in Pittsburgh,
Pennsylvania, announced that they had agreed to
merge in a tax-free, stock-for-stock transaction.
The combined company will be called Allegheny
Energy, Inc. (Allegheny Energy). It is expected
that Allegheny Energy will continue to be operated
as an integrated electric utility holding company
and that the regulated electric utility companies
will continue to exist as separate legal entities,
including the Company, its regulated affiliates, and
Duquesne Light Company. The companies stated in
their announcement that the merger is expected to
produce synergy savings of about $1 billion.
The merger is conditioned, among other things, upon
the approval of each company's shareholders, the
Pennsylvania Public Utility Commission (PUC), the
SEC, the FERC, the Nuclear Regulatory Commission
(NRC), and the Department of Justice/Federal Trade
Commission (DOJ/FTC) under the Hart, Scott, Rodino
Antitrust Improvements Act (HSR). Additionally,
Allegheny Power requested that the Maryland Public
Service Commission (PSC) approve the issuance of
additional Allegheny Power stock to accomplish the
transaction. The companies have established a schedule
to obtain all regulatory approvals by June 30, 1998.
On May 2, 1997, Allegheny Power filed a registration
statement with the SEC on Form S-4 containing a joint
proxy statement/prospectus with DQE concerning the merger
and the transactions contemplated thereby. In late June,
the S-4 became effective, allowing Allegheny Power and DQE
to pursue shareholder approval. Allegheny Power and DQE
each held separate shareholder meetings on August 7, 1997,
at which the combination of the two companies was approved
by the shareholders of both companies. At Allegheny Power's
F-64
West Penn Power Company
and Subsidiaries
meeting, the shareholders also approved the change
in Allegheny Power's name to Allegheny Energy, Inc.
On August 1, 1997, Allegheny Power and DQE jointly
filed requests for merger approval with the PUC and
the FERC, DQE filed the necessary approval requests
with the NRC, and Allegheny Power filed its request
with the PSC for approval to issue Allegheny Power
stock. Subsequently, Allegheny Power filed for
approval from the SEC under the Public Utility
Holding Company Act of 1935 (PUHCA) and both
companies filed with the DOJ/FTC under the HSR.
The PUC has established a schedule of proceedings
which is expected to result in an approval order by
the end of May 1998. The FERC has not scheduled
hearings. Absent such hearings, Allegheny Energy
expects a FERC order before the end of May 1998.
The PSC instituted a proceeding involving The
Potomac Edison Company, the Company's Maryland
public utility affiliate, to examine the effect of
the merger on Maryland customers for which a final
determination is expected by May 1, 1998. In their
Pennsylvania filings, the companies proposed the
following:
Duquesne Light will use the generation-related
portion of its share of net operating synergy
savings to shorten its stranded cost recovery
period under the Pennsylvania Customer Choice Act
and committed to a minimum increase in its stranded
cost amortization of $160 million. It also agreed
to use any earnings achieved above its allowed
return on equity to further write down stranded
cost and to reduce its distribution rates by $25
million in 2001 and freeze distribution rates at
that level until the end of the transition period
to full customer choice. (See Note C for
information on the Customer Choice Act and stranded
costs.)
The Company agreed to share synergy savings
achieved equitably between customers and
shareholders after it earns its approved return on
equity and agreed to freeze distribution rates
until the end of the transition period to full
customer choice.
On September 16, 1997, Allegheny Power officially
changed its name to Allegheny Energy, Inc., by filing
the appropriate papers in Maryland. Allegheny Energy
began trading on the New York Stock Exchange under its
new symbol, AYE, on October 1, 1997.
All of the Company's incremental costs of the merger
process ($5.1 million through December 31, 1997) are
being deferred. The accumulated merger costs will be
written off by the Company when the merger occurs or
when it is determined that the merger will not
occur.
NOTE C: COMPETITION AND CUSTOMER CHOICE
In December 1996, Pennsylvania enacted the
Electricity Generation Customer Choice and
Competition Act (Customer Choice Act) to restructure
the electric industry in Pennsylvania to create
retail access to a competitive electric energy
generation market. Major provisions of the
legislation are:
Customer choice for electric energy supply to
be phased in beginning with one-third of customers
on January 1, 1999; two-thirds the next year; and
all customers beginning January 1, 2001.
F-65
West Penn Power Company
and Subsidiaries
Transmission and distribution rates remain
regulated and are capped until July 1, 2001.
Generation rates are capped until all customers
receive market-based energy service.
Pennsylvania utilities will be permitted to
recover the amount of stranded costs approved by
the PUC.
On August 1, 1997, concurrent with Allegheny Power's
merger approval filing, the Company filed with the
PUC a comprehensive stand-alone restructuring plan
to implement full customer choice of electric generation
suppliers as required by the Customer Choice Act. The
filing included an unbundling of the Company's electric
service rates into generation, transmission, and distribution
components; a plan to revise how the Company and
its two utility affiliates share capacity, energy,
capacity reserves, transmission resources, and
costs; and a plan for recovery of stranded costs
through a Competitive Transition Charge (CTC).
Recovery of stranded costs is a key issue. The
Company has listed its stranded cost exposure at
about $1.6 billion (a January 1, 1999, present
value amount before taxes), composed approximately
of $1.1 billion for generation plant investment in
excess of estimated market prices, $300 million of
nonutility generation (NUG) contracts in excess of
market prices, and $200 million of regulatory
assets and transition costs. In accordance with
the Company's interpretation of the legislation,
the $1.6 billion estimate is based, among other
things, on a forecast of future revenue
requirements, market prices, and assumptions about
future costs to be incurred. The embedded cost of
the Company's generation assets are low in relation
to other utilities in the state and the nation.
Because of this and intervenor testimony predicting
sharply rising future market prices of electricity,
virtually all intervenors in the Company's
restructuring filing have recommended that the
Company receive little or no CTC for stranded cost
recovery. Their allegation is that, over the life
of the assets, their forecasted market prices
exceed the Company's costs, and, under those
circumstances, little or no CTC is allowable
pursuant to their interpretation of the Customer
Choice Act. Most intervenors generally agree with
the Company that market prices in the early years
of the transition period will be significantly
lower than the Company's embedded costs, and,
without a CTC, the Company's earnings for a number
of years, will be severely eroded. To avoid the
risks associated with estimating future market
prices, the Company included as part of its
restructuring plan a proposal to reset the CTC on a
year-to-year basis based on actual market prices of
electricity sales in its area, followed by a final
stranded cost valuation in 3 to 5 years and, if
necessary, to definitively determine the market
value of its generation assets, in the final
valuation in about 2003, to auction up to 5% (up to
330 MW) of the generation of the Company and
Duquesne Light combined. Even if a CTC is allowed,
the Company's stranded cost recovery, absent
further action by the PUC, is restricted to about
$1.2 billion because of the restrictions imposed by
the capped rates. Based on the estimates and
projections supporting the stranded cost exposure
of about $1.6 billion, the difference would be
reflected as lower cash flow to the Company after
the year 2005 than would have occurred with
continued regulated rates.
F-66
West Penn Power Company
and Subsidiaries
The PUC has established a schedule of proceedings
for the restructuring plan, concurrent with the
merger proceedings, under which it would issue an
order on the filing by the end of May 1998. This
order will include a determination of the Company's
rates for transmission and distribution services
beginning January 1, 1999; generation rates for
customers who take regulated generation service during the
transition period (potentially 1999 through 2005 if
customers so choose); and the CTC the Company will
be allowed to charge through the transition period.
The Company cannot predict the outcome of the
restructuring proceedings and the transition
process. It believes that, as the lowest cost
utility in the state, recovery of stranded costs
should be allowed, at least during an interim
period of low market prices, to maintain its
financial strength.
Nevertheless, depending upon the outcome of the
proceedings, the Company's future earnings
beginning in 1999 could be severely adversely
affected during the transition to deregulation of
electricity generation.
Also pursuant to the Customer Choice Act, all
electric utilities in Pennsylvania were required to
establish and administer retail access pilot
programs under which customers representing 5% of
the load of each rate class must choose a
generation supplier other than their local
franchise utility. The pilot programs began on
November 1, 1997, and will continue through
December 31, 1998. To accomplish the 5% pilot
requirement, the Company solicited customers to
sign up for the program and then, through a
lottery, selected about 33,000 participants from
those who responded.
As ordered by the PUC, pilot participants will
receive an energy credit to their bills from their
local utility (for example, 3.45 cents per kWh for
residential customers in the Company's case), and
will reach agreement with an alternate supplier as
to their price for energy. The savings to the
Company's customers will be the difference between
the alternate supplier's price and the Company's
credit. To assure participation in the pilot
program, the credit established by the PUC is
artificially high (greater than the Company's
generation costs), with the result that the Company
has estimated it could suffer a revenue loss of up
to $10 million in 1998 for the pilot. The Company
is attempting to mitigate the loss by competing for
sales to pilot participants of other utilities as
an alternate supplier. The PUC has approved the
Company's pilot compliance filing and thus has
indicated its intent to treat the revenue losses as
a regulatory asset subject to review and potential
rate recovery. Accordingly, the Company is
deferring the net revenue losses as a regulatory
asset. The credit only applies to the pilot
program through December 31, 1998. Beginning
January 1, 1999, customers with choice will pay the
generation charges they negotiate with the energy
supplier they choose as well as the transmission
and distribution charges and the CTC charge from
their franchise utility.
Under the PUC's pilot program procedures, all
companies who wish to compete as alternate
electricity suppliers are required to be approved
by the PUC as licensed suppliers through a filing
and registration process. The Company filed for
and obtained PUC approval as an alternate supplier
(under the brand name of Allegheny Power) to sell
to the pilot participating customers of all
electric utilities in the state other than its own.
Accordingly, the Company is incurring marketing and
pilot program expenditures to compete for
F-67
West Penn Power Company
and Subsidiaries
electricity sales to the 5% of Pennsylvania
customers of other utilities who have the right to
choose their supplier under the pilot program.
In preparation for retail competition in
Pennsylvania, the Company filed a petition on
February 28, 1997, with the PUC asking for
permission to zero its Energy Cost Rate (ECR) and
state tax surcharge tariffs and to roll energy
costs and state tax adjustments into base rates,
effective May 1, 1997. On April 24, 1997, the PUC
approved the Company's request. The Company's petition was
necessitated by the passage of the Customer Choice
Act, which capped electric rates in Pennsylvania as
of January 1, 1997. Prior to May 1, 1997, changes
in the Company's costs of fuel, purchased power,
and certain other costs, and changes in revenues
from sales to other utilities, including
transmission services, were passed on to customers
by adjustment to customer bills through the ECR
with the result that such changes had no effect on
net income. Effective May 1, 1997, the Company began
assuming the risks and benefits of changes in these costs
and revenues.
In July 1997, the Emerging Issues Task Force (EITF)
of the Financial Accounting Standards Board (FASB)
released Issue Number 97-4, Deregulation of the
Pricing of Electricity-Issues Related to the
Application of FASB Statement Numbers 71 and 101,
which concluded that utilities should discontinue
application of Statement of Financial Accounting
Standards (SFAS) No. 71 for the generation portion
of their business when a deregulation plan is in
place and its terms are known. Since the Customer
Choice Act in Pennsylvania establishes such
processes, the Company has determined that it will
be required to discontinue use of SFAS No. 71 for
the generation portion of its business on or before
the end of May 1998, the date by which the PUC must
issue its order on the Company's comprehensive
restructuring plan. One of the conclusions of the
EITF is that, after discontinuing SFAS No. 71,
utilities should continue to carry on their books
the assets and liabilities recorded under SFAS No.
71 if the regulatory cash flows to settle them will
be derived from the continuing regulated
transmission and distribution business.
Additionally, continuing costs and obligations of
the deregulated generation business which are
similarly covered by the cash flows from the
continuing regulated business will meet the
criteria as regulatory assets and liabilities. The
Customer Choice Act establishes definitive
processes for transition to deregulation and market-
based pricing for electric generation, which
include continuing cost-of-service based ratemaking
for transmission and distribution services, subject
to rate caps, and provide for a nonbypassable CTC
to give utilities the opportunity to recover their
stranded costs over the transition period. Until
relevant regulatory proceedings are complete and
final orders are received, the Company is unable to
predict the effect of discontinuing SFAS No. 71.
In December 1997, the Maryland Public Service
Commission ordered an electric competition
transition plan for Maryland utilities, including
the Company's affiliate, The Potomac Edison
Company, as to its operations in Maryland. The
Maryland plan requires, among other things, full
retail customer choice by July 1, 2002, in yearly
one-third increments beginning July 1, 2000, a
price cap mechanism and recovery of verifiable and
prudent stranded costs.
F-68
West Penn Power Company
and Subsidiaries
NOTE D: RESTRUCTURING CHARGES AND ASSET WRITE-OFFS
In 1996, the System, including the Company,
essentially completed its restructuring activities
initiated in 1994, simplifying the management
structure, streamlining operations, and began doing
business under the trade name of Allegheny Power.
During 1996, restructuring activities included
consolidating operating divisions, customer
services, and other functions. By reorganizing and
eliminating certain processes and consolidating
common decentralized functions, the System reduced
employment by about 1,000 employees since October
1994. These reductions were accomplished through a
voluntary separation plan, attrition, and layoffs.
In 1996 and 1995, the Company recorded
restructuring charges of $42.6 million ($25.1
million after tax) and $7.3 million ($4.3 million
after tax), respectively, in operating expenses,
including its share of all restructuring charges
associated with the reorganization. These charges reflect
liabilities and payments for severance, employee
termination costs, and other restructuring costs.
The current portion of the restructuring liability
excluding benefit plans' curtailment adjustments to
postretirement liabilities (which are primarily
recorded in other deferred credits) consists of:
(Thousands of Dollars) 1997 1996
Restructuring liability:
Balance at beginning of period............. $27,134 $ 6,492
Accruals................................. 37,343
Less payments............................ (23,052) (16,701)
Balance at end of period.................. $ 4,082 $27,134
In 1996, the Company wrote off $10.8 million ($6.3
million after tax) of previously accumulated costs
related to a proposed transmission line. In the
industry's more competitive environment, it was no
longer reasonable to assume future recovery of
these costs in rates.
In connection with changes in inventory management
objectives, the Company in 1995 recorded $3.8
million ($2.3 million after tax) for the write-off
of obsolete and slow-moving materials.
As part of the reorganization, the Company and its
utility affiliates in 1996 expanded the
intercompany use of each other's employees to
optimize the use of their skills. In 1997
virtually all the employees in the System,
including all of the Company's employees, were
transferred to Allegheny Power Service Corporation
(APSC) to facilitate the intercompany use of
personnel. APSC was formed in 1963 pursuant to the
PUHCA to perform certain functions common to all
companies in the System. APSC bills each company
at its cost (without profit) based on the work
performed and services provided to each company.
F-69
West Penn Power Company
and Subsidiaries
NOTE E: INCOME TAXES
Details of federal and state income tax provisions
are:
(Thousands of Dollars) 1997 1996 1995
Income taxes--current:
Federal............................. $29,426 $32,778 $49,928
State............................... 12,357 12,975 9,344
Total.............................. 41,783 45,753 59,272
Income taxes--deferred, net of
amortization........................ 33,961 4,602 4,944
Amortization of deferred
investment credit................... (2,580) (2,580) (2,580)
Total income taxes................ 73,164 47,775 61,636
Income taxes--credited (charged)
to other income and deductions...... 115 (320) 109
Income taxes--charged to operating
income.............................. $73,279 $47,455 $61,745
The total provision for income taxes is different
from the amount produced by applying the federal
income statutory tax rate of 35% to financial
accounting income, as set forth below:
(Thousands of Dollars) 1997 1996 1995
Financial accounting income before
income taxes....................... $207,944 $135,900 $179,600
Amount so produced................... $ 72,800 $ 47,600 $ 62,900
Increased (decreased) for:
Tax deductions for which deferred
tax was not provided:
Lower tax depreciation......... 5,700 3,300 4,300
Plant removal costs............ 1,400 2,100 (900)
State income tax, net of federal
income tax benefit............... 4,900 8,900 9,300
Amortization of deferred
investment credit................ (2,580) (2,580) (2,580)
Equity in earnings of subsidiaries. (6,300) (4,600) (4,300)
Other, net......................... (2,641) (7,265) (6,975)
Total............................ $ 73,279 $ 47,455 $ 61,745
Federal income tax returns through 1993 have been
examined and substantially settled through 1991.
F-70
West Penn Power Company
and Subsidiaries
At December 31, the deferred tax assets and
liabilities consist of the following:
(Thousands of Dollars) 1997 1996
Deferred tax assets:
Unamortized investment tax credit............ $ 31,570 $ 33,243
Tax interest capitalized..................... 19,220 18,862
Postretirement benefits other than pensions. . 12,857 11,039
Unbilled revenue............................. 9,226 631
Contributions in aid of construction......... 6,520 6,239
Restructuring................................ 2,709 10,058
Other........................................ 25,777 28,177
107,879 108,249
Deferred tax liabilities:
Book vs. tax plant basis differences, net.... 493,361 483,042
Other........................................ 52,949 25,326
546,310 508,368
Total net deferred tax liabilities............. 438,431 400,119
Add portion above included in current assets... 11,959 29,003
Total long-term net deferred tax liabilities. $450,390 $429,122
NOTE F: DIVIDEND RESTRICTION
Supplemental indentures relating to certain
outstanding bonds of the Company contain dividend
restrictions under the most restrictive of which
$70,576,000 of consolidated retained earnings at
December 31, 1997, is not available for cash
dividends on common stock, except that a portion
thereof may be paid as cash dividends where
concurrently an equivalent amount of cash is
received by the Company as a capital contribution
or as the proceeds of the issue and sale of shares
of its common stock.
NOTE G: ALLEGHENY GENERATING COMPANY
The Company owns 45% of the common stock of
Allegheny Generating Company (AGC), and affiliates
of the Company own the remainder. AGC owns an
undivided 40% interest, 840 MW, in the 2,100-MW
pumped-storage hydroelectric station in Bath County,
Virginia, operated by the 60% owner, Virginia
Electric and Power Company, a nonaffiliated utility.
AGC recovers from the Company and its affiliates
all of its operation and maintenance expenses,
depreciation, taxes, and a return on its investment
under a wholesale rate schedule approved by the
FERC. AGC's rates are set by a formula filed with
and previously accepted by the FERC. The only
component which changes is the return on equity
(ROE). Pursuant to a settlement agreement filed
April 4, 1996, with the FERC, AGC's ROE was set at
11% for 1996 and will continue until the time any
affected party seeks renegotiation of the ROE.
Notice of such intent to seek a revision in ROE
must be filed during a notice period each year
between November 1 and November 15. No requests
for change were filed during the 1997 notice
period. Therefore, AGC's ROE will remain at 11% for
1998.
F-71
West Penn Power Company
and Subsidiaries
Following is a summary of financial information for AGC:
December 31
(Thousands of Dollars) 1997 1996
Balance sheet information:
Property, plant, and equipment............... $635,485 $660,872
Current assets............................... 11,876 7,659
Deferred charges............................. 16,559 23,877
Total assets............................... $663,920 $692,408
Total capitalization......................... $348,258 $431,589
Current liabilities.......................... 70,540 15,531
Deferred credits............................. 245,122 245,288
Total capitalization and liabilities....... $663,920 $692,408
Year Ended December 31
(Thousands of Dollars) 1997 1996 1995
Income statement information:
Electric operating revenues......... $76,458 $83,402 $86,970
Operation and maintenance expense... 4,877 5,165 5,740
Depreciation........................ 17,000 17,160 17,018
Taxes other than income taxes....... 4,835 4,801 5,091
Federal income taxes................ 11,213 13,297 13,552
Interest charges.................... 15,391 16,193 18,361
Other income, net................... (9,126) (3) (16)
Net income........................ $32,268 $26,789 $27,224
The Company's share of the equity in earnings was
$14.5 million, $12.1 million, and $12.3 million
for 1997, 1996, and 1995, respectively, and is
included in other income, net, on the Company's
Consolidated Statement of Income.
NOTE H: POSTRETIREMENT BENEFITS
As described in Note A, the Company and its
affiliates participate in a pension plan and
medical and life insurance plans for eligible
employees and dependents. The Company is
responsible for its proportional share of the
costs (credits) and liabilities of the plans. As
described in Note D, in 1997 the Company
transferred all of its employees to APSC. The
Company's share of the costs (credits) of these
plans, a portion of which (about 25% to 30%) was
charged to plant construction, is as follows:
(Thousands of Dollars) 1997 1996 1995
Pension.............................. $(3,037) $ 564 $1,217
Medical and life insurance........... $ 4,551 $9,039 $8,237
F-72
West Penn Power Company
and Subsidiaries
NOTE I: REGULATORY ASSETS AND LIABILITIES
The Company's operations are subject to the
provisions of SFAS No. 71, "Accounting for the
Effects of Certain Types of Regulation."
Regulatory assets represent probable future
revenues associated with deferred costs that are
expected to be recovered from customers through the
ratemaking process. Regulatory liabilities
represent probable future reductions in revenues
associated with amounts that are to be credited to
customers through the ratemaking process.
Regulatory assets, net of regulatory liabilities,
reflected in the Consolidated Balance Sheet at
December 31 relate to:
(Thousands of Dollars) 1997 1996
Long-Term Assets (Liabilities), Net:
Income taxes, net......................... $247,574 $244,142
PURPA project buyout........................ 48,000
Storm damage................................ 1,326 1,598
Postretirement benefits..................... 823 1,520
Deferred power costs, (reported in
other deferred charges)................... 7,000 7,211
Other, net.................................. 1,186 3,537
Subtotal.................................. 305,909 258,008
Current Liabilities:
Income taxes (reported in other current
liabilities).............................. (921)
Deferred power costs........................ (10,107)
Subtotal.................................. (11,028)
Net Regulatory Assets................... $305,909 $246,980
NOTE J: FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair value of
financial instruments at December 31 were as
follows:
1997 1996
Carrying Fair Carrying Fair
(Thousands of Dollars) Amount Value Amount Value
Assets:
Temporary cash
investments........ $ 573 $ 573
Liabilities:
Short-term debt...... 52,046 52,046 $ 33,387 $ 33,387
Long-term debt
and QUIDS.......... 913,985 953,700 913,985 931,725
F-73
West Penn Power Company
and Subsidiaries
The carrying amount of temporary cash investments,
as well as short-term debt, approximates the fair
value because of the short maturity of those
instruments. The fair value of long-term debt and
QUIDS was estimated based on actual market prices
or market prices of similar issues. The Company
has no financial instruments held or issued for
trading purposes.
NOTE K: CAPITALIZATION
Preferred Stock
All of the preferred stock is entitled on voluntary
liquidation to its then current call price and on
involuntary liquidation to $100 a share. The
holders of the Company's market auction preferred
stock are entitled to dividends at a rate
determined by an auction held the business day
preceding each quarterly dividend payment date.
Long-Term Debt and QUIDS
Maturities for long-term debt for the next five
years are: 1998, $103,500,000; 1999, $1,500,000;
2000, $2,500,000; 2001, $2,500,000; and 2002,
$3,000,000. Substantially all of the properties of
the Company are held subject to the lien securing
its first mortgage bonds. Some properties are also
subject to a second lien securing certain pollution
control and solid waste disposal notes. Certain
first mortgage bond series are not redeemable by
certain refunding until dates established in the
respective supplemental indentures.
NOTE L: SHORT-TERM DEBT
To provide interim financing and support for
outstanding commercial paper, the System companies
have established lines of credit with several
banks. The Company has SEC authorization for total
short-term borrowings of $182 million, including
money pool borrowings described below. The Company
has fee arrangements on all of its lines of credit
and no compensating balance requirements. In addition
to bank lines of credit, an internal money pool
accommodates intercompany short-term borrowing needs,
to the extent that certain of the regulated companies
have funds available.
Short-term debt outstanding for 1997 and 1996
consisted of:
(Thousands of Dollars) 1997 1996
Balance and interest rate
at end of year:
Commercial Paper..................$12,046-6.50% $33,387-7.00%
Notes Payable to Banks............ 40,000-6.75%
Average amount outstanding and
interest rate during the year:
Commercial Paper.................. 3,376-5.73% $ 9,245-5.51%
Notes Payable to Banks............ 5,526-5.67% 10,200-5.51%
Money Pool........................ 17,628-5.48% 3,229-5.25%
F-74
West Penn Power Company
and Subsidiaries
NOTE M: COMMITMENTS AND CONTINGENCIES
Construction Program
The Company has entered into commitments for its
construction program, for which expenditures are
estimated to be $112 million for 1998 and
$116 million for 1999. Construction expenditure
levels in 2000 and beyond will depend upon the
strategy eventually selected for complying with Phase
II of the Clean Air Act Amendments of 1990 (CAAA) and
the extent to which environmental initiatives
currently being considered become mandated.
Environmental Matters and Litigation
System companies are subject to various laws,
regulations, and uncertainties as to environmental
matters. Compliance may require them to incur
substantial additional costs to modify or replace
existing and proposed equipment and facilities and
may affect adversely the cost of future operations.
The more significant additional environmental
initiatives currently being considered (in terms of
their potential adverse financial effect on the
companies) are:
NOx reductions of 75% from a 1990 baseline by
mid-year 2003, depending upon modeling studies
required by the Ozone Transport Commission
established under Title I of the CAAA. A 55%
reduction is currently mandated.
NOx reductions of 85% from a 1990 baseline by
mid-year 2003 under a State Implementation Plan
(SIP) call proposed by the Environmental Protection
Agency (EPA) in November 1997, as well as by petitions
filed with the EPA in August 1997 by eight
northeastern states proposing an 85% reduction.
CO2 reductions of 7% below 1990 levels agreed to
by the Clinton Administration in a protocol for
greenhouse gas reductions at a conference in Kyoto,
Japan, in December 1997. The protocol requires
approval of the United States Senate to become
effective.
The NOx reduction proposals beyond 55% are being
vigorously opposed by the companies and other coal-
burning utilities and by other affected constituencies
in coal producing states. In January 1998, the Chambers
of Commerce in Virginia and West Virginia announced that
they had joined in the first court challenge, accusing
the EPA of failing to assess the impact of the 75%
and 85% reduction proposals on small businesses.
The EPA contends that the Small Business Regulatory
Enforcement Fairness Act of 1996 does not apply.
The United States Senate has indicated that it will
not approve the Kyoto protocol because of its
failure to include CO2 reduction requirements on
developing nations. The Company cannot predict the
outcome of these issues.
In the normal course of business, the Company
becomes involved in various legal proceedings. The
Company does not believe that the ultimate outcome
of these proceedings will have a material effect on
its financial position.
The Company previously reported that the EPA had
identified it and its affiliates and approximately
875 others as potentially responsible parties in a
Superfund site subject to cleanup. The Company has
also been named as a defendant along with multiple
other defendants in pending asbestos cases
F-75
West Penn Power Company
and Subsidiaries
involving one or more plaintiffs. The Company
believes that provisions for liabilities and
insurance recoveries are such that final resolution
of these claims will not have a material effect on
its financial position.
F-76
Allegheny Generating Company
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Directors of
Allegheny Generating Company
In our opinion, the accompanying balance sheet and the
related statements of income, of retained earnings and
of cash flows present fairly, in all material respects,
the financial position of Allegheny Generating Company
(a subsidiary of Allegheny Energy, Inc.) at 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. These
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 of these statements in
accordance with generally accepted auditing standards
which 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, assessing the accounting principles used
and significant estimates made by management, and
evaluating the overall financial statement
presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Pittsburgh, Pennsylvania
February 4, 1998
F-77
Allegheny Generating Company
STATEMENT OF INCOME
YEAR ENDED DECEMBER 31
1997 1996 1995
(Thousands of Dollars)
Electric Operating
Revenues.................................. $76,458 $83,402 $86,970
Operating Expenses:
Operation and maintenance expense......... 4,877 5,165 5,740
Depreciation.............................. 17,000 17,160 17,018
Taxes other than income taxes............. 4,835 4,801 5,091
Federal income taxes...................... 11,213 13,297 13,552
Total Operating Expenses................ 37,925 40,423 41,401
Operating Income........................ 38,533 42,979 45,569
Other Income, net........................... 9,126 3 16
Income Before Interest Charges............ 47,659 42,982 45,585
Interest Charges:
Interest on long-term debt................ 14,431 15,235 16,859
Other interest............................ 960 958 1,502
Total Interest Charges.................. 15,391 16,193 18,361
Net Income.................................. $32,268 $26,789 $27,224
STATEMENT OF RETAINED EARNINGS
Balance at January 1........................ $ 0 $ 4,153 $12,729
Add:
Net income................................ 32,268 26,789 27,224
32,268 30,942 39,953
Deduct:
Dividends on common stock................. 32,268* 30,942* 35,800
Balance at December 31...................... $ 0 $ 0 $ 4,153
*Excludes cash dividends paid from other paid-in capital.
See accompanying notes to financial statements.
F-78
Allegheny Generating Company
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31
1997 1996 1995
(Thousands of Dollars)
Cash Flows from Operations:
Net income......................... $ 32,268 $ 26,789 $ 27,224
Depreciation....................... 17,000 17,160 17,018
Tax-related contract settlement.... 8,835
Deferred investment credit and
income taxes, net................. 6,329 10,898 6,508
Changes in certain current assets
and liabilities:
Accounts receivable............. 1,331 3,937 (3,758)
Materials and supplies.......... 260 (43) 144
Accounts payable................ 5,913 206 (32)
Other, net...................... 28 (3,739) 3,034
71,964 55,208 50,138
Cash Flows from Investing:
Construction expenditures........... (444) (178) (2,177)
Cash Flows from Financing:
Retirement of long-term debt........ (30,592) (16,943) (12,175)
Cash dividends on common stock...... (35,700) (37,987) (35,800)
(66,292) (54,930) (47,975)
Net Change in Cash and Temporary Cash
Investments.......... 5,228 100 (14)
Cash at January 1...................... 131 31 45
Cash and Temporary Cash Investments
at December 31................ $ 5,359 $ 131 31
Supplemental Cash Flow Information
Cash paid during the year for:
Interest........................... $ 14,770 $ 15,703 $ 17,165
Income taxes....................... 10,313 6,256 5,274
See accompanying notes to financial statements.
F-79
Allegheny Generating Company
BALANCE SHEET
DECEMBER 31
ASSETS 1997 1996
(Thousands of Dollars)
Property, Plant, and Equipment:
At original cost, including $906,000
and $508,000 under construction....... $ 828,658 $ 837,050
Accumulated depreciation................ (193,173) (176,178)
635,485 660,872
Current Assets:
Cash and temporary cash investments..... 5,359 131
Accounts receivable from Parents........ 6 1,337
Materials and supplies--at average
cost................................... 1,832 2,092
Prepaid taxes........................... 4,442 3,860
Other................................... 237 239
11,876 7,659
Deferred Charges:
Regulatory assets........................ 7,979 14,475
Unamortized loss on reacquired debt...... 8,393 9,147
Other.................................... 187 255
16,559 23,877
Total...................................... $ 663,920 $ 692,408
CAPITALIZATION AND LIABILITIES
Capitalization :
Common stock - $1.00 par value per share,
authorized 5,000 shares, outstanding
1,000 shares............................ $ 1 $ 1
Other paid-in capital..................... 199,522 202,954
199,523 202,955
Long-term debt............................. 148,735 228,634
348,258 431,589
Current Liabilities:
Long-term debt due within one year......... 60,000 10,600
Accounts payable to affiliates............. 6,135 222
Interest accrued........................... 4,404 4,709
Other...................................... 1
70,540 15,531
Deferred Credits:
Unamortized investment credit............... 48,342 49,665
Deferred income taxes....................... 169,325 168,168
Regulatory liabilities...................... 27,455 27,455
245,122 245,288
Total......................................... $ 663,920 $ 692,408
See accompanying notes to financial statements.
F-80
Allegheny Generating Company
NOTES TO FINANCIAL STATEMENTS
(These notes are an integral part of the financial
statements.)
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company was incorporated in Virginia in 1981. Its
common stock is owned by Monongahela Power Company -
27%, The Potomac Edison Company - 28%, and West Penn
Power Company - 45% (the Parents).
The Parents are wholly-owned subsidiaries of Allegheny
Energy, Inc. and are a part of the Allegheny Energy
integrated electric utility system. The Company is
subject to regulation by the Securities and Exchange
Commission (SEC) and by the Federal Energy Regulatory
Commission (FERC). Significant accounting policies of
the Company are summarized below.
Use of Estimates
The preparation of financial statements in conformity
with generally accepted accounting principles requires
management to make estimates that affect the reported
amounts of assets, liabilities, revenues, expenses, and
disclosures of contingencies during the reporting
period, which in the normal course of business are
subsequently adjusted to actual results.
Property, Plant, and Equipment
Property, plant, and equipment are stated at original
cost, and consist of a 40% undivided interest in the
Bath County pumpedstorage hydroelectric station and its
connecting transmission facilities. The cost of
depreciable property units retired, plus removal costs
less salvage, are charged to accumulated depreciation.
Depreciation and Maintenance
Provisions for depreciation are determined on a straight-
line method based on estimated service lives of depreciable
properties and amounted to approximately 2.1% of average
depreciable property in each of the years 1997, 1996, and
1995. The cost of maintenance and of certain replacements
of property, plant, and equipment is charged to operating
expenses.
Temporary Cash Investments
For purposes of the statement of cash flows, temporary
cash investments with original maturities of three
months or less, generally in the form of commercial
paper, certificates of deposit, and repurchase
agreements, are considered to be the equivalent of
cash.
Income Taxes
The Company joins with its Parents and affiliates in
filing a consolidated federal income tax return. The
consolidated tax liability is allocated among the
participants generally in proportion to the taxable
income of each participant, except that no subsidiary
pays tax in excess of its separate return tax
liability.
Financial accounting income before income taxes differs
from taxable income principally because certain income
and deductions for tax purposes are recorded in the
financial income statement in another period.
Differences between income tax expense computed on the
basis of financial accounting income and taxes payable
based on taxable income are deferred. Deferred
F-81
Allegheny Generating Company
tax assets and liabilities represent the tax effect of
temporary differences between the financial statement
and tax basis of assets and liabilities computed
utilizing the most current tax rates.
Prior to 1987, provisions for federal income tax were
reduced by investment credits, and amounts equivalent
to such credits were charged to income with concurrent
credits to a deferred account. These balances are being
amortized over the estimated service lives of the
related properties.
NOTE B: PROPOSED MERGER
On April 7, 1997, Allegheny Power System, Inc.
(Allegheny Power) and DQE, Inc. (DQE), parent company
of Duquesne Light Company in Pittsburgh, Pennsylvania,
announced that they had agreed to merge in a tax-free,
stock-for-stock transaction. The combined company will
be called Allegheny Energy, Inc. (Allegheny Energy).
It is expected that Allegheny Energy will continue to
be operated as an integrated electric utility holding
company and that the regulated electric utility
companies will continue to exist as separate legal
entities, including the Company, its Parents, and
Duquesne Light Company. The companies stated in their
announcement that the merger is expected to produce
synergy savings of about $1 billion.
The merger is conditioned, among other things, upon the
approval of each company's shareholders, the
Pennsylvania Public Utility Commission (PUC), the SEC,
the FERC, the Nuclear Regulatory Commission (NRC), and
the Department of Justice/Federal Trade
Commission (DOJ/FTC) under the Hart, Scott, Rodino
Antitrust Improvements Act (HSR). Additionally,
Allegheny Power requested that the Maryland Public
Service Commission (PSC) approve the issuance of
additional Allegheny Power stock to accomplish the
transaction. The companies have established a schedule
to obtain all regulatory approvals by June 30, 1998.
On May 2, 1997, Allegheny Power filed a registration
statement with the SEC on Form S-4 containing a joint
proxy statement/prospectus with DQE concerning the
merger and the transactions contemplated thereby.
In late June, the S-4 became effective allowing
Allegheny Power and DQE to pursue shareholder approval.
Allegheny Power and DQE each held separate shareholder
meetings on August 7, 1997, at which the combination of
the two companies was decisively approved by the
shareholders of both companies. At Allegheny Power's
meeting, the shareholders also approved the change in
Allegheny Power's name to Allegheny Energy, Inc.
On August 1, 1997, Allegheny Power and DQE jointly
filed requests for merger approval with the PUC and the
FERC, DQE filed the necessary approval requests with
the NRC, and Allegheny Power filed its request with the
PSC for approval to issue Allegheny Power stock.
Subsequently, Allegheny Power filed for approval from
the SEC under the Public Utility Holding Company Act of
1935 and both companies filed with the DOJ/FTC under
HSR. The PUC has established a schedule of proceedings
which is expected to result in an approval order by the
end of May 1998. The FERC has not scheduled hearings.
Absent such hearings, Allegheny Energy expects a FERC
order before the end of May 1998. The PSC instituted a
proceeding involving The Potomac Edison Company, the
Company's Maryland public utility parent, to examine
the effect of the merger on Maryland customers for
which a final determination is expected by May 1, 1998.
F-82
Allegheny Generating Company
On September 16, 1997, Allegheny Power officially
changed its name to Allegheny Energy, Inc., by filing
the appropriate papers in Maryland. Allegheny Energy
began trading on the New York Stock Exchange under its
new symbol, AYE, on October 1, 1997.
NOTE C: INCOME TAXES
Details of federal income tax provisions are:
(Thousands of Dollars) 1997 1996 1995
Current income taxes payable.......... $ 9,799 $2,401 $ 7,053
Deferred income taxes--
accelerated depreciation............ 7,652 12,220 7,818
Amortization of deferred
investment credit................... (1,323) (1,322) (1,310)
Total income taxes................ 16,128 13,299 13,561
Income taxes--charged to
other income....................... (4,915) (2) (9)
Income taxes--charged to
operating income.................. $11,213 $13,297 $13,552
In 1997, the total provision for income taxes
($11,213,000) was less than the amount produced by
applying the federal income tax
statutory rate of 35% to financial accounting income
before income taxes ($15,218,000), primarily due to
income taxes charged to other income related to
interest earned on a tax-related contract settlement.
Federal income tax returns through 1993 have been
examined and substantially settled through 1991. At
December 31, the deferred tax assets and liabilities
consist of the following:
(Thousands of Dollars) 1997 1996
Deferred tax assets:
Unamortized investment tax credit............ $ 27,455 $ 27,455
Deferred tax liabilities:
Book vs. tax plant basis differences, net.... 196,780 195,623
Total long-term net deferred tax liabilities... $169,325 $168,168
F-83
Allegheny Generating Company
NOTE D: FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair value of
financial instruments at December 31 were as follows:
1997 1996
Carrying Fair Carrying Fair
(Thousands of Dollars) Amount Value Amount Value
Liabilities:
Long-term debt:
Debentures......... $150,000 $144,410 $150,000 $138,872
Medium-term notes.. 60,000 60,000 70,600 70,600
Commercial paper... 19,992 19,992
The fair value of debentures and medium-term notes was
estimated based on actual market prices or market
prices of similar issues. The carrying amount of
commercial paper approximates the fair value because of
the short maturity of those instruments. The Company
has no financial instruments held or issued for trading
purposes.
NOTE E: CAPITALIZATION
The Company systematically reduces capitalization each
year as its asset depreciates, resulting in the payment
of dividends in excess of current earnings. The SEC
has approved the Company's request to pay common
dividends out of capital. In 1997 common dividends of
$32,268,000 were paid from retained earnings, reducing
the account balance to zero, and common dividends of
$3,432,000 were paid from other paid-in capital. In
1996 common dividends of $30,942,000 and $7,045,000
were paid from retained earnings and other paid-in
capital, respectively.
NOTE F: LONG-TERM DEBT
The Company had long-term debt outstanding as follows:
12-31-97
Interest December 31
(Thousands of Dollars) Rate 1997 1996
Debentures due:
September 1, 2003............... 5.625% $50,000 $ 50,000
September 1, 2023............... 6.875% 100,000 100,000
Commercial paper.................. 19,992
Medium term notes due 1998........ 6.11%(1) 60,000 70,600
Unamortized debt discount......... (1,265) (1,358)
Total......................... 208,735 239,234
Less current maturities........... 60,000 10,600
Total......................... $148,735 $228,634
(1) Weighted average interest rate at December 31, 1997.
F-84
Allegheny Generating Company
To provide interim financing and support for
outstanding commercial paper, the System companies have
established lines of credit with several banks. The
Company has SEC authorization for total short-term
borrowings of $100 million, including money pool
borrowings described below. The Company has fee
arrangements on all of its lines of credit and no
compensating balance requirements. In addition to bank
lines of credit, an internal money pool accommodates
intercompany short-term borrowing needs, to the extent
that certain of the Company's regulated affiliates have
funds available.
Maturities for long-term debt for the next five years
are $60,000,000 in 1998.
S-1
SCHEDULE II
ALLEGHENY ENERGY, INC. AND SUBSIDIARY COMPANIES
Valuation and Qualifying Accounts
For Years Ended December 31, 1997, 1996, and 1995
Col. A Col. B Col.C Col. D Col. E
Additions
Balance at Charged to Charged to Balance at
beginning costs and other end of
Description of period expenses accounts Deductions period
Allowance for uncollectible
accounts:
Year ended December 31, 1997 $15 052 494 $16 300 002 $ 3 869 153 $18 036 419 $17 185 230
Year ended December 31, 1996 $13 046 900 $12 970 000 $ 3 243 945 $14 208 351 $15 052 494
Year ended December 31, 1995 $11 352 674 $ 9 206 000 $ 3 130 418 $10 642 192 $13 046 900
(A) Recoveries.
(B) Uncollectible accounts charged off.
S-2
SCHEDULE II
MONONGAHELA POWER COMPANY
Valuation and Qualifying Accounts
For Years Ended December 31, 1997, 1996, and 1995
Col. A Col. B Col. C Col.D Col. E
Additions
Balance at Charged to Charged to Balance at
beginning costs and other end of
Description of period expenses accounts Deductions period
(A) (B)
Allowance for uncollectible
accounts:
Year ended December 31, 1997 $ 1 949 219 $ 3 699 997 $ 1 005 246 $ 4 478 456 $ 2 176 006
Year ended December 31, 1996 $ 2 266 808 $ 1 970 000 $ 666 816 $ 2 954 405 $ 1 949 219
Year ended December 31, 1995 $ 1 910 605 $ 2 266 000 $ 700 288 $ 2 610 085 $ 2 266 808
(A) Recoveries.
(B) Uncollectible accounts charged off.
S-3
SCHEDULE II
THE POTOMAC EDISON COMPANY
Valuation and Qualifying Accounts
For Years Ended December 31, 1997, 1996, and 1995
Col. A Col. B Col. C Col.D Col. E
Additions
Balance at Charged to Charged to Balance at
beginning costs and other end of
Description of period expenses accounts Deductions period
(A) (B)
Allowance for uncollectible
accounts:
Year ended December 31, 1997 $ 1 579 503 $ 3 700 000 $ 1 312 074 $ 4 908 092 $ 1 683 485
Year ended December 31, 1996 $ 1 344 077 $ 2 514 000 $ 957 372 $ 3 235 946 $ 1 579 503
Year ended December 31, 1995 $ 1 175 437 $ 1 630 000 $ 983 776 $ 2 445 136 $ 1 344 077
(A) Recoveries.
(B) Uncollectible accounts charged off.
S-4
SCHEDULE II
WEST PENN POWER COMPANY AND SUBSIDIARY COMPANIES
Valuation and Qualifying Accounts
For Years Ended December 31, 1997, 1996, and 1995
Col. A Col. B Col. C Col. D Col. E
Additions
Balance at Charged to Charged to Balance at
beginning costs and other end of
Description of period expenses accounts Deductions period
(A) (B)
Allowance for uncollectible
accounts:
Year ended December 31, 1997 $11 523 772 $ 8 900 005 $ 1 551 833 $ 8 649 871 $13 325 739
Year ended December 31, 1996 $ 9 436 015 $ 8 486 000 $ 1 619 757 $ 8 018 000 $11 523 772
Year ended December 31, 1995 $ 8 266 632 $ 5 310 000 $ 1 446 354 $ 5 586 971 $ 9 436 015
(A) Recoveries.
(B) Uncollectible accounts charged off.
40
Supplementary Data
Quarterly Financial Data (Unaudited)
(Dollar Amounts in Thousands Except for Per Share Data)
Electric
Operating Operating Net Earnings
Revenues Income* Income* Per Share*
Quarter ended
AE
March 1997 $614 980 $124 094 $77 591 $ .64
June 1997 542 750 95 473 51 683 .42
September 1997 595 125 110 635 74 808 .61
December 1997 616 636 122 035 77 214 .63
March 1996 648 018 97 592 51 418 .43
June 1996 550 945 100 891 53 786 .44
September 1996 553 990 99 918 56 227 .46
December 1996 574 696 92 453 48 616 .40
Monongahela
March 1997 162 803 30 480 22 556
June 1997 144 078 23 701 16 174
September 1997 158 240 28 493 23 457
December 1997 163 190 26 701 18 342
March 1996 175 617 20 900 12 989
June 1996 152 126 24 735 16 712
September 1996 152 167 24 428 16 917
December 1996 152 561 22 490 14 834
Potomac Edison
March 1997 192 228 37 062 27 723
June 1997 164 867 26 894 18 376
September 1997 175 464 30 388 25 296
December 1997 176 222 34 428 24 360
March 1996 208 928 31 665 22 154
June 1996 167 991 30 234 21 080
September 1996 167 327 25 027 16 381
December 1996 182 514 27 164 18 560
West Penn
March 1997 282 530 47 271 36 901
June 1997 252 731 35 661 21 963
September 1997 266 746 43 865 34 333
December 1997 280 155 55 850 41 468
March 1996 296 445 34 368 20 382
June 1996 258 431 34 939 19 459
September 1996 263 682 39 912 26 330
December 1996 270 566 34 176 22 314
AGC
March 1997 20 216 10 328 6 368
June 1997 20 408 10 311 6 395
September 1997 19 664 10 230 15 396
December 1997 16 170 7 664 4 109
March 1996 20 909 10 946 6 721
June 1996 21 023 10 958 6 777
September 1996 20 825 10 766 6 686
December 1996 20 645 10 309 6 605
*Except for AGC, results for the 1996 quarters include
restructuring charges, and the 1996 second quarter
also includes an asset write-off.
41
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and the Shareholders of
Allegheny Energy, Inc.
In our opinion, the consolidated
financial statements listed in the accompanying
index present fairly, in all material respects,
the financial position of Allegheny Energy, Inc.
and its subsidiaries at 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. These 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 of these statements in
accordance with generally accepted auditing
standards which 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,
assessing the accounting principles used and
significant estimates made by management, and
evaluating the overall financial statement
presentation. We believe that our audits
provide a reasonable basis for the opinion
expressed above.
PRICE WATERHOUSE LLP
Pittsburgh, Pennsylvania
February 4, 1998
42
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Monongahela Power Company
In our opinion, the financial statements
listed in the accompanying index present fairly,
in all material respects, the financial position
of Monongahela Power Company (a subsidiary of
Allegheny Energy, Inc.) at 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.
These 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 of these statements in
accordance with generally accepted auditing
standards which 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, assessing the accounting principles
used and significant estimates made by
management, and evaluating the overall financial
statement presentation. We believe that our
audits provide a reasonable basis for the
opinion expressed above.
PRICE WATERHOUSE LLP
Pittsburgh, Pennsylvania
February 4, 1998
43
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
The Potomac Edison Company
In our opinion, the financial statements
listed in the accompanying index present fairly,
in all material respects, the financial position
of The Potomac Edison Company (a subsidiary of
Allegheny Energy, Inc.) at 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.
These 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 of these statements in
accordance with generally accepted auditing
standards which 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, assessing the accounting principles
used and significant estimates made by
management, and evaluating the overall financial
statement presentation. We believe that our
audits provide a reasonable basis for the
opinion expressed above.
PRICE WATERHOUSE LLP
Pittsburgh, Pennsylvania
February 4, 1998
44
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
West Penn Power Company
In our opinion, the consolidated
financial statements listed in the accompanying
index present fairly, in all material respects,
the financial position of West Penn Power
Company (a subsidiary of Allegheny Energy, Inc.)
and its subsidiaries at 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. These 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 of these statements in accordance with generally
accepted auditing standards which 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, assessing the accounting principles
used and significant estimates made by management, and
evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for
the opinion expressed above.
PRICE WATERHOUSE LLP
Pittsburgh, Pennsylvania
February 4, 1998
45
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Allegheny Generating Company
In our opinion, the financial statements
listed in the accompanying index present fairly,
in all material respects, the financial position
of Allegheny Generating Company (a subsidiary of
Allegheny Energy, Inc.) at 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.
These 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 of these statements in
accordance with generally accepted auditing
standards which 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, assessing the accounting principles
used and significant estimates made by
management, and evaluating the overall financial
statement presentation. We believe that our
audits provide a reasonable basis for the
opinion expressed above.
PRICE WATERHOUSE LLP
Pittsburgh, Pennsylvania
February 4, 1998
46
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
For AE and its subsidiaries, none.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANTS
AE, Monongahela, Potomac Edison, West Penn, and
AGC. Reference is made to the Executive Officers of
the Registrants in Part I of this report. The names,
ages as of December 31, 1997, and the business
experience during the past five years of the
directors of the System companies are set forth below:
Business Experience during Director since date shown of
Name the Past Five Years Age AE MP PE WP AGC
Eleanor Baum See below (a) 57 1988 1988 1988 1988
William L. Bennett See below (b) 48 1991 1991 1991 1991
Thomas K. Henderson Company employee (1) 57 1996
Wendell F. Holland See below (c) 45 1994 1994 1994 1994
Kenneth M. Jones Company employee (1) 60 1991
Phillip E. Lint See below (d) 68 1989 1989 1989 1989
Frank A. Metz, Jr. See below (e) 63 1984 1984 1984 1984
Michael P. Morrell Company employee (1) 49 1996 1996 1996 1996
Alan J. Noia Company employee (1) 50 1994 1994 1987 1994 1994
Jay S. Pifer Company employee (1) 60 1995 1995 1992
Steven H. Rice See below (f) 54 1986 1986 1986 1986
Gunnar E. Sarsten See below (g) 60 1992 1992 1992 1992
Peter J. Skrgic Company employee (1) 56 1990 1990 1990 1989
(1) See Executive Officers of the Registrants in Part I of
this report for further details.
(a) Eleanor Baum. Dean of The Albert Nerken
School of Engineering of The Cooper Union for the
Advancement of Science and Art. Director of Avnet,
Inc. and United States Trust Company, Commissioner
of the Engineering Manpower Commission, a fellow of
the Institute of Electrical and Electronic
Engineers, member of Board of Governors, New
York Academy of Sciences and President of
Accreditation Board for Engineering and
Technology. Formerly, President, American
Society of Engineering Education.
(b) William L. Bennett. Co-Chairman and
Director of HealthPlan Services Corporation, and
Director of Sylvan, Inc. Formerly, Chairman,
Director and Chief Executive Officer of Noel
Group, Inc. and Director of Belding Heminway
Company, Inc.
(c) Wendell F. Holland. Vice President,
American Water Works Service Company, Inc. and
Director of Bryn Mawr Trust Company. Formerly,
Of Counsel, Law Firm of Reed, Smith, Shaw &
McClay; Partner, Law Firm of LeBoeuf, Lamb,
Greene & MacRae; and Commissioner of the
Pennsylvania Public Utility Commission.
(d) Phillip E. Lint. Retired. Formerly,
Partner, Price Waterhouse.
(e) Frank A. Metz, Jr. Retired. Director of
Solutia, Inc. and Norrell Corporation.
Formerly, Senior Vice President, Finance and
Planning, and Director of International Business
Machines Corporation and Director of Monsanto
Company.
(f) Steven H. Rice. President, Chief Executive
Officer, Vice Chairman and Director of Stamford
Federal Savings Bank. Formerly, bank consultant,
President and Director of The Seamen's Bank for
Savings and Director of Royal Group, Inc.
(g) Gunnar E. Sarsten. Chairman and Chief
Executive Officer of MK International. Formerly,
President and Chief Operating Officer of
Morrison Knudsen Corporation, President and
Chief Executive Officer of United Engineers &
Constructors International, Inc. (now Raytheon
Engineers & Constructors), and Deputy Chairman
of the Third District Federal Reserve Bank in
Philadelphia.
47
ITEM 11. EXECUTIVE COMPENSATION
During 1997, and for 1996 and 1995, the annual
compensation paid by AE, Monongahela, Potomac Edison,
West Penn and AGC directly or indirectly for services
in all capacities to such companies to their Chief
Executive Officer and each of the four most highly
paid executive officers of the System whose cash
compensation exceeded $100,000 was as follows:
Summary Compensation Tables (a)
AE(b), Monongahela(c), Potomac Edison, West Penn(c) and AGC(c)
Annual Compensation
All
e Other
and Annual Long-Term Compen-
Principal Incentive Performance sation
Position(d) Year Salary($) ($)(e) Plan($)(f) ($)(g)
Alan J. Noia, 1997 460,000 460,000 250,657 124,495
Chief Executive Officer 1996 360,000 253,750 131,071 92,769
1995 305,000 120,000 48,983
Peter J. Skrgic, 1997 265,000 265,000 150,394 91,409
Senior Vice President 1996 245,000 176,300 96,119 24,830
1995 238,000 73,800 37,830
Jay S. Pifer, 1997 240,000 240,000 150,394 67,810
Senior Vice President 1996 230,000 112,000 87,381 30,949
1995 220,000 72,600 34,098
Michael P. Morrell 1997 240,000 240,000 (h) 26,068
Senior Vice President 1996 183,336 72,500 (h) (h)
1995
Richard J. Gagliardi 1997 190,000 190,000 100,263 25,340
Vice President 1996 175,000 100,800 52,429 17,898
1995 160,000 48,400 18,769
(a) The individuals appearing in this chart perform policy-
making functions for each of the Registrants. The
compensation shown is for all services in all
capacities to AE and its subsidiaries. All
salaries and bonuses of these executives are paid
by APSC.
(b) AE has no paid employees.
(c) Monongahela, West Penn and AGC have no paid employees.
(d) See Executive Officers of the Registrants for all positions held.
(e) Incentive awards are based upon performance in the year in which the
figure appears but are paid in the following year. The incentive
award plan will be continued for 1998.
(f) In 1994, the Boards of Directors of AE, APSC and the Operating
Subsidiaries implemented a Performance Share Plan (the "Plan") for
senior officers which was approved by the shareholders of APS at the
annual meeting in May 1994. The first Plan cycle began on January 1,
1994 and ended on December 31, 1996. The second Plan cycle began on
January 1, 1995 and ended on December 31, 1997. The figure shown for
1996 represents the dollar value paid in 1997 to each of the named
executive officers who participated in Cycle I. The figure shown for
1997 represents the dollar value to be paid in 1998 to each of the
named executive officers who participated in Cycle II. A third cycle
began on January 1, 1996 and will end on December 31, 1998. A fourth
cycle began on January 1, 1997 and will end on December 31, 1999.
After completion of each cycle, AE stock or cash may be paid if
performance criteria have been met.
(g) Effective January 1, 1992, the basic group life insurance provided
employees was reduced from two times salary during employment, which
reduced to one times salary after 5 years in retirement, to a new plan
which provides one times salary until retirement and $25,000 thereafter.
48
Some executive officers and other senior managers remain under the prior
plan. In order to pay for this insurance for these executives, during
1992 insurance was purchased on the lives of each of them. Effective
January 1, 1993, AE started to provide funds to pay for the future
benefits due under the supplemental retirement plan (Secured Benefit
Plan) as described in note (d) on p. 49. To do this, AE purchased,
during 1993, life insurance on the lives of the covered executives.
The premium costs of both the 1992 and 1993 policies plus a factor for
the use of the money are returned to AE at the earlier of (a) death of
the insured or (b) the later of age 65 or 10 years from the date of the
policy's inception. The figures in this column include the present
value of the executives' cash value at retirement attributable to the
current year's premium payment (based upon the premium, future valued
to retirement, using the policy internal rate of return minus the
corporation's premium payment), as well as the premium paid for
the basic group life insurance program plan and the contribution
for the 401(k) plan. For 1997, the figure shown includes amounts
representing (a) the aggregate of life insurance premiums and
dollar value of the benefit to the executive officer of the remainder
of the premium paid on the Group Life Insurance program and the
Executive Life Insurance and Secured Benefit Plans, and (b) 401(k)
contributions as follows: Mr. Noia $119,883 and $4,612; Mr. Skrgic
$87,313 and $4,096; Mr. Pifer $63,060 and $4,750; Mr. Morrell $21,964
and $4,104; and Mr. Gagliardi $20,590 and $4,750.
(h) Michael P. Morrell joined Allegheny on May 1, 1996. He did not
receive a payment from the Long-Term Performance Plan for the first
or second Plan cycles.
ALLEGHENY POWER SYSTEM PERFORMANCE SHARE PLAN
SHARES AWARDED IN LAST FISCAL YEAR (CYCLE IV)
Estimated Future Payout
Performance Threshold Target Maximum
Number of Period Until Number of Number of Number of
Name Shares Payout Shares Shares Shares
Alan J. Noia
Chief Executive Officer 7,570 1997-99 4,542 7,570 15,140
Peter J. Skrgic
Senior Vice President 4,610 1997-99 2,766 4,610 9,220
Jay S. Pifer
Senior Vice President 2,800 1997-99 1,680 2,800 5,600
Michael P. Morrell
Senior Vice President 2,800 1997-99 1,680 2,800 5,600
Richard J. Gagliardi
Vice President 2,300 1997-99 1,380 2,300 4,600
49
The named executives were awarded the above number of
shares for Cycle IV. Such number of shares are only
targets. As described below, no payouts will be
made unless certain criteria are met. Each
executive's 1997-1999 target long-term incentive
opportunity was converted into performance shares
equal to an equivalent number of shares of AE
common stock based on the price of such stock on
December 31, 1996. At the end of this three-year
performance period, the performance shares
attributed to the calculated award will be valued
based on the price of AE common stock on December
31, 1999 and will reflect dividends that would
have been paid on such stock during the
performance period as if they were reinvested on
the date paid. If an executive retires, dies or
otherwise leaves the employment of Allegheny
prior to the end of the three-year period, the
executive may still receive an award based on the
number of months worked during the period.
However, an executive must work at least eighteen
months during the three-year period to be
eligible for an award payout. The final value of
an executive's account, if any, will be paid to
the executive in stock or cash in early 2000.
The actual payout of an executive's award may
range from 0 to 200% of the target amount, before
dividend reinvestment. The payout is based upon
customer and stockholder performance factors and
AE's rankings versus the peer group. The
combined customer and stockholder rating is then
compared to a pre-established percentile ranking
chart to determine the payout percentage of
target. A ranking below 30% results in a 0%
payout. The minimum payout begins at the 30%
ranking, which results in a payout of 60% of
target, ranging up to a payout of 200% of target
if there is a 90% or higher ranking.
DEFINED BENEFIT OR ACTUARIAL PLAN DISCLOSURE (a)
AE(b), Monongahela(c), Potomac Edison, West Penn(c) and AGC (c)
Estimated
Name and Capacities Annual Benefits
In Which Served on Retirement (d)
Alan J. Noia, $315,000
Chief Executive Officer (e)(f)
Peter J. Skrgic, $168,005
Senior Vice President (e)(f)
Jay S. Pifer, $146,671
Senior Vice President(e)(f)
Richard J. Gagliardi $116,926
Vice President(e)(f)
Michael P. Morrell, $128,775
Senior Vice President(e)(f)(g)
(a) The individuals appearing in this chart perform policy-making functions
for each of the Registrants.
(b) AE has no paid employees.
(c) Monongahela, West Penn and AGC have no paid employees.
(d) Assumes present insured benefit plan and salary continue and retirement
at age 65 with single life annuity. Under plan provisions, the annual
rate of benefits payable at the normal retirement age of 65 are computed
by adding (i) 1% of final average
50
pay up to covered compensation times years of service up to 35 years,
plus (ii) 1.5% of final average pay in excess of covered compensation
times years of service up to 35 years, plus (iii) 1.3% of final average
pay times years of service in excess of 35 years. Covered compensation
is the average of the maximum taxable Social Security wage cases during
the 35 years preceding the member's retirement. The final average pay
benefit is based on the member's average total earnings during the
highestpaid 60 consecutive calendar months or, if smaller, the member's
highest rate of pay as of any July 1st. Effective July 1, 1994 the
maximum amount of any employee's compensation that may be used in these
computations is $160,000. Benefits for employees retiring
between 55 and 62 differ from the foregoing.
Pursuant to a supplemental plan (Secured Benefit Plan), senior executives
of Allegheny who retire at age 60 or over with 40 or more years of
service are entitled to a supplemental retirement benefit in an
amount that, together with the benefits under the basic plan and from
other employment, will equal 60% of the executive's highest average
monthly earnings for any 36 consecutive months. The earnings include
50% of the actual annual bonus paid effective February 1, 1997. The
figures shown do not give any effect to bonus payments. The supplemental
benefit is reduced for less than 40 years service and for retirement age
from 60 to 55. It is included in the amounts shown where applicable.
In order to provide funds to pay such benefits, effective January 1, 1993
the Company purchased insurance on the lives of the plan participants.
The Secured Benefit Plan has been designed so that if the assumptions
made as to mortality experience, policy dividends, and other factors
are realized, the Company will recover all premium payments, plus a
factor for the use of the Company's money. The amount of the premiums
for this insurance required to be deemed "compensation" by the SEC is
described and included in the "All Other Compensation" column on page
47. All executive officers are participants in the Secured Benefit Plan.
The figures shown do not include benefits from an Employee Stock
Ownership and Savings Plan (ESOSP) established as a non-contributory
stock ownership plan for all eligible employees effective January 1,
1976, and amended in 1984 to include a savings program. Under the ESOSP,
all eligible employees may elect to have from 2% to 7% of their
compensation contributed to the Plan as pre-tax contributions and an
additional 1% to 6% as post-tax contributions. Employees direct
the investment of these contributions into one or more available funds.
Each System company matches 50% of the pre-tax contributions up to 6% of
compensation with common stock of AE. Effective January 1, 1997 the
maximum amount of any employee's compensation that may be used in these
computations was increased to $160,000. Employees' interests in the
ESOSP vest immediately. Their pre-tax contributions may be withdrawn
only upon meeting certain financial hardship requirements or upon
termination of employment.
(e) See Executive Officers of the Registrants for all positions held.
(f) The total estimated annual benefits on retirement payable to Messrs.
Noia, Skrgic, Pifer, Morrell and Gagliardi for services in all
capacities to AE and its subsidiaries is set forth in the table.
(g) Michael P. Morrell joined AE on May 1, 1996. The figure shown for
Mr. Morrell reflects a provision of his agreement with AE which grants
him an additional eight years of service after he has been with AE
for ten years.
51
Change In Control Contracts
In March 1996, AE entered into
Change in Control contracts with certain
Allegheny executive officers
(Agreements). Each Agreement sets forth
(i) the severance benefits that will be
provided to the employee in the event
the employee is terminated subsequent to
a Change in Control of AE (as defined in
the Agreements), and (ii) the employee's
obligation to continue his or her
employment after the occurrence of
certain circumstances that could lead to
a Change in Control. The Agreements
provide generally that if there is a
Change in Control, unless employment is
terminated by AE for Cause, Disability
or Retirement or by the employee for
Good Reason (each as defined in the
Agreements), severance benefits payable
to the employee will consist of a cash
payment equal to 2.99 times the five-
year average of the employee's annual
compensation and AE will maintain
existing benefits for the employee and
the employee's dependents for a period
of three years. Each Agreement expired
on December 31, 1997, but is
automatically extended for one year
periods thereafter unless either AE or
the employee gives notice otherwise.
Notwithstanding the delivery of such
notice, the Agreements will continue in
effect for thirty-six months after a
Change in Control.
A Senior Officer Separation Plan has
been approved for senior officers offered
a position in the combined
company resulting from AE's merger with DQE
(Merger), as that merger does not qualify as
a Change in Control. The Plan is
available only to those who have signed
Change in Control Contracts and will be offered
only upon consummation of the Merger.
The Plan offers benefits substantially similar to the
Change in Control Contracts, except that
the cash payment is computed on the
basis of 1997 base salary and short-term
incentive and long-term incentive target
amounts. The Chief Executive Officer
will determine the date of departure,
which will be within a twelve-month
period following closure of the merger. In
addition, if a senior officer is eligible to
retire, the officer will be credited with
three additional years of service and will
receive a payment of $400 per month until age
62 or for 12 months, whichever is greater.
Benefits will not be reduced for early retirement.
An Other Executive Separation Plan has been
approved for certain management personnel
offered a position with Allegheny after the
Merger that warrants a reduction in compensation.
The Plan is available only to Business Unit Heads
and certain other management employees of Allegheny
who do not have Change in Control contracts and will
be offered only upon consummation of the Merger.
The Plan provides benefits in the event the employee is
offered a position that warrants a reduction in
compensation. The employee's departure date will
be determined by the Chief Executive Officer, but
will be within a twelve-month period following
closure of the Merger. The Plan provides generally
one year's base salary, plus management out-placement
services and 12-month continuance of medical and dental
coverage. In addition, if an employee is eligible
to retire, the employee will be credited with
three additional years of service and will receive
a payment of $400 per month until age 62 or for
12 months, whichever is greater. Benefits will
not be reduced for early retirement.
Compensation of Directors
In 1997, AE directors who were not
officers or employees of System
companies received for all services to
System companies (a) $16,000 in retainer
fees, (b) $800 for each committee
meeting attended, except Executive
Committee meetings, for which fees are
$200, (c) $250 for each Board
meeting of each company attended, and
(d) 200 shares of AE common stock pursuant
to the Restricted Stock Plan for Outside
Directors. Under an unfunded deferred
compensation plan, a director may elect
to defer receipt of all or part of his
or her director's fees for succeeding
calendar years to be payable with
accumulated interest when the director
ceases to be such, in equal annual
installments, or, upon authorization by
the Board of Directors, in a lump sum.
In addition to the fees mentioned above,
the Chairperson of each of the Audit,
Finance, Management Review and Director
Affairs, New Business, and Strategic
Affairs Committees receives a
further fee of $4,000 per year. For the first five
months of 1997, Klaus Bergman received a fixed fee of
$8,333 per month for services as
52
Chairman of the Board of AE. Mr. Bergman
also received a onetime payment of
$250,000 at the time he retired as Chairman.
In March 1997, the Board of Directors Retirement
Plan was replaced with a Deferred Stock Unit Plan for
Outside Directors. The present value of the accrued
benefits under the Directors Retirement Plan was
credited to each director's opening account balance
under the new plan in the form of deferred stock units.
In addition, each year the Company will credit each
outside director's account with 275 deferred stock
units. The value of each director's account will
correspondingly rise or decline with the value of AE
stock.
53
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The table below shows the number of shares of AE
common stock that are beneficially owned, directly or
indirectly, by each director and named executive
officer of AE, Monongahela, Potomac Edison, West Penn,
and AGC and by all directors and executive officers of
each such company as a group as of December 31, 1997.
To the best of the knowledge of AE, there is no person
who is a beneficial owner of more than 5% of the voting
securities of AE other than the one shareholder shown
in the chart below.
Executive Shares of
Officer or APS Percent
Name Director of Common Stock of Class
Eleanor Baum AE,MP,PE,WP 2,800* .02% or less
William L. Bennett AE,MP,PE,WP 3,571* "
Richard J. Gagliardi AE 10,147 "
Thomas K. Henderson AE,MP,PE,WP,AGC 5,349 "
Wendell F. Holland AE,MP,PE,WP 1,010* "
Kenneth M. Jones AE,AGC 10,802 "
Phillip E. Lint AE,MP,PE,WP 1,470* "
Frank A. Metz, Jr. AE,MP,PE,WP 3,184* "
Michael P. Morrell AE,MP,PE,WP,AGC 140 "
Alan J. Noia AE,MP,PE,WP,AGC 26,421 "
Jay S. Pifer AE,MP,PE,WP 14,380 "
Steven H. Rice AE,MP,PE,WP 3,451* "
Gunnar E. Sarsten AE,MP,PE,WP 6,800* "
Peter J. Skrgic AE,MP,PE,WP,AGC 15,127 "
Sanford C. Bernstein & Co., Inc. 11,397,135 9.3%
767 Fifth Avenue
New York, NY 10153
All directors and executive officers
of AE as a group (17 persons) 115,695 Less than .10%
All directors and executive officers
of MP as a group (19 persons) 116,637 "
All directors and executive officers
of PE as a group (19 persons) 114,736 "
All directors and executive officers
of WP as a group (19 persons) 120,673 "
All directors and executive officers
of AGC as a group (8 persons) 73,011 Less than .06%
*Excludes the outside directors' accounts in the Deferred
Stock Unit Plan which, at March 1, 1998, were valued at
the number of shares shown: Baum, 3009; Bennett, 1358;
Holland 1223; Lint 4545; Metz, 3263; Rice, 1879; and
Sarsten, 2721.
All of the shares of common stock of Monongahela
(5,891,000), Potomac Edison (22,385,000), and West Penn
(24,361,586) are owned by AE. All of the common stock
of AGC is owned by Monongahela (270 shares), Potomac
Edison (280 shares), and West Penn (450 shares).
54
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K
(a)(1)(2) The financial statements and financial
statement schedules filed as part of this Report are
set forth under ITEM 8. and reference is made to the
index on page 39.
(b) The following companies filed reports on
Form 8-K during the quarter ended December 31,
1997: (i)Monongahela November 19, 1997; (ii)
Potomac Edison - November 19, 1997; (iii) West
Penn - November 19, 1997; (iv) AE - December 10,
1997; and (v) West Penn - December 10, 1997.
(c) Exhibits for AE, Monongahela, Potomac
Edison, West Penn, and AGC are listed in the
Exhibit Index beginning on page E-1 and are
incorporated herein by reference.
55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
ALLEGHENY ENERGY, INC.
By: /s/ ALAN J. NOIA
(Alan J. Noia) Chairman, President
and Chief Executive Officer
Date: March 5, 1998
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 registrant and in the capacities and on the dates indicated.
Signature Title Date
(i) Principal Executive Officer:
Chairman, President, Chief 3/5/98
/s/ ALAN J. NOIA Executive Officer and Director
(Alan J. Noia)
(ii) Principal Financial Officer:
/s/ MICHAEL P. MORRELL Senior Vice President, 3/5/98
(Michael P. Morrell) Finance
(iii) Principal Accounting Officer:
/s/ KENNETH M. JONES Vice President and 3/5/98
(Kenneth M. Jones) Controller
(iv) A Majority of the Directors:
*Eleanor Baum *Frank A. Metz, Jr.
*William L. Bennett *Alan J. Noia
*Wendell F. Holland *Steven H. Rice
*Phillip E. Lint *Gunnar E. Sarsten
*By: /s/ THOMAS K. HENDERSON 3/5/98
(Thomas K. Henderson)
56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized. The signature
of the undersigned company shall be deemed to relate only to matters having
reference to such company and any subsidiaries thereof.
MONONGAHELA POWER COMPANY
By: /s/ JAY S. PIFER
(Jay S. Pifer) President
and Director
Date: March 5, 1998
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 registrant and in the capacities and on the dates indicated. The
signature of each of the undersigned shall be deemed to relate only to matters
having reference to the above-named company and any subsidiaries thereof.
Signature Title Date
(i) Principal Executive Officer:
Chairman of the Board, 3/5/98
/s/ ALAN J. NOIA Chief Executive Officer,
(Alan J. Noia) and Director
(ii) Principal Financial Officer:
/s/ MICHAEL P. MORRELL Vice President, 3/5/98
(Michael P. Morrell) Finance
(iii) Principal Accounting Officer:
/s/ THOMAS J. KLOC Controller 3/5/98
(Thomas J. Kloc)
(iv) A Majority of the Directors:
*Eleanor Baum *Alan J. Noia
*William L. Bennett *Jay S. Pifer
*Wendell F. Holland *Steven H. Rice
*Phillip E. Lint *Gunnar E. Sarsten
*Frank A. Metz, Jr. *Peter J. Skrgic
*Michael P. Morrell
*By: /s/ THOMAS K. HENDERSON 3/5/98
(Thomas K. Henderson)
57
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized. The signature of
the undersigned company shall be deemed to relate only to matters having
reference to such company and any subsidiaries thereof.
THE POTOMAC EDISON COMPANY
By: /s/ JAY S. PIFER
(Jay S. Pifer) President
and Director
Date: March 5, 1998
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 registrant and in the capacities and on the dates indicated. The
signature of each of the undersigned shall be deemed to relate only to matters
having reference to the above-named company and any subsidiaries thereof.
Signature Title Date
(i) Principal Executive Officer:
Chairman of the Board, 3/5/98
/s/ ALAN J. NOIA Chief Executive Officer,
(Alan J. Noia) and Director
(ii) Principal Financial Officer:
/s/ MICHAEL P. MORRELL Vice President, 3/5/98
(Michael P. Morrell) Finance
(iii) Principal Accounting Officer:
/s/ THOMAS J. KLOC Controller 3/5/98
(Thomas J. Kloc)
(iv) A Majority of the Directors:
*Eleanor Baum *Alan J. Noia
*William L. Bennett *Jay S. Pifer
*Wendell F. Holland *Steven H. Rice
*Phillip E. Lint *Gunnar E. Sarsten
*Frank A. Metz, Jr. *Peter J. Skrgic
*Michael P. Morrell
*By: /s/ THOMAS K. HENDERSON 3/5/98
(Thomas K. Henderson)
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized. The signature
of the undersigned company shall be deemed to relate only to matters having
reference to such company and any subsidiaries thereof.
WEST PENN POWER COMPANY
By: /s/ JAY S. PIFER
(Jay S. Pifer) President
and Director
Date: March 5, 1998
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized. The signature
of the undersigned company shall be deemed to relate only to matters having
reference to such company and any subsidiaries thereof.
Signature Title Date
(i) Principal Executive Officer:
Chairman of the Board, 3/5/98
/s/ ALAN J. NOIA Chief Executive Officer,
(Alan J. Noia) and Director
(ii) Principal Financial Officer:
/s/ MICHAEL P. MORRELL Vice President, 3/5/98
(Michael P. Morrell) Finance
(iii) Principal Accounting Officer:
/s/ THOMAS J. KLOC Controller 3/5/98
(Thomas J. Kloc)
(iv) A Majority of the Directors:
*Eleanor Baum *Alan J. Noia
*William L. Bennett *Jay S. Pifer
*Wendell F. Holland *Steven H. Rice
*Phillip E. Lint *Gunnar E. Sarsten
*Frank A. Metz, Jr. *Peter J. Skrgic
*Michael P. Morrell
*By: /s/ THOMAS K. HENDERSON 3/5/98
(Thomas K. Henderson)
59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized. The signature of
the undersigned company shall be deemed to relate only to matters having
reference to such company and any subsidiaries thereof.
ALLEGHENY GENERATING COMPANY
By: /s/ ALAN J. NOIA
(Alan J. Noia)
Chief Executive Officer
Date: March 5, 1998
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 registrant and in the capacities and on the dates indicated. The
signature of each of the undersigned shall be deemed to relate only to matters
having reference to the above-named company and any subsidiaries thereof.
Signature Title Date
(i) Principal Executive Officer:
/s/ ALAN J. NOIA President, Chief Executive 3/5/98
(Alan J. Noia) Officer and Director
(ii) Principal Financial Officer:
/s/ MICHAEL P. MORRELL Vice President, 3/5/98
(Michael P. Morrell) Finance
(iii) Principal Accounting Officer:
/s/ THOMAS J. KLOC Controller 3/5/98
(Thomas J. Kloc)
(iv) A Majority of the Directors:
*Thomas K. Henderson
*Kenneth M. Jones
*Michael P. Morrell
*Alan J. Noia
*Peter J. Skrgic
*By: /s/ THOMAS K. HENDERSON 3/5/98
(Thomas K. Henderson)
60
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Prospectus
constituting part of Allegheny Power System Inc.'s (now Allegheny Energy, Inc.)
Registration Statements on Form S-3 (Nos. 33-36716 and 33-57027) relating to
the Dividend Reinvestment and Stock Purchase Plan of Allegheny Energy, Inc.;
in the Prospectus constituting part of Allegheny Power System, Inc.'s (now
Allegheny Energy, Inc.) Registration Statement on Form S-3 (No. 33-49791)
relating to the common stock shelf registration; in the Prospectus constituting
part of Monongahela Power Company's Registration Statements on Form S-3 (Nos.
333-31493, 3351301, 33-56262 and 33-59131); in the Prospectus constituting
part of The Potomac Edison Company's Registration Statements on Form S-3 (Nos.
333-33413, 3351305 and 33-59493); and in the Prospectus constituting part of
West Penn Power Company's Registration Statements on Form S-3 (Nos. 333-34511,
33-51303, 33-56997, 33-52862, 33-56260 and 33-59133); of our reports dated
February 4, 1998 included in ITEM 8 of this Form 10-K. We also consent to the
references to us under the heading "Experts" in such Prospectuses.
PRICE WATERHOUSE LLP
Pittsburgh, Pennsylvania
March 23, 1998
61
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS THAT the undersigned
directors of Allegheny Energy, Inc., a Maryland corporation,
Monongahela Power Company, an Ohio corporation, The Potomac
Edison Company, a Maryland and Virginia corporation, and West
Penn Power Company, a Pennsylvania corporation, do hereby
constitute and appoint THOMAS K. HENDERSON and EILEEN M.
BECK, and each of them, a true and lawful attorney in his or
her name, place and stead, in any and all capacities, to sign
his or her name to Annual Reports on Form 10-K for the year
ended December 31, 1997 under the Securities Exchange Act of
1934, as amended, and to any and all amendments, of said
Companies, and to cause the same to be filed with the SEC,
granting unto said attorneys and each of them full power and
authority to do and perform any act and thing necessary and
proper to be done in the premises, as fully and to all
intents and purposes as the undersigned could do if
personally present, and the undersigned hereby ratifies and
confirms all that said attorneys or any one of them shall
lawfully do or cause to be done by virtue hereof.
Dated: March 5, 1998
/s/ ELEANOR BAUM /s/ FRANK A. METZ, JR.
(Eleanor Baum) (Frank A. Metz, Jr.)
/s/ WILLIAM L. BENNETT /s/ ALAN J. NOIA
(William L. Bennett) (Alan J. Noia)
/s/ WENDELL F. HOLLAND /s/ STEVEN H. RICE
(Wendell F. Holland) (Steven H. Rice)
/s/ PHILLIP E. LINT /s/ GUNNAR E. SARSTEN
(Phillip E. Lint) (Gunnar E. Sarsten)
62
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS THAT the undersigned
directors of Monongahela Power Company, an Ohio corporation,
The Potomac Edison Company, a Maryland and Virginia
corporation, and West Penn Power Company, a Pennsylvania
corporation, do hereby constitute and appoint THOMAS K.
HENDERSON and EILEEN M. BECK, and each of them, a true and
lawful attorney in his name, place and stead, in any and all
capacities, to sign his or her name to the Annual Report on
Form 10-K for the year ended December 31, 1997 under the
Securities Exchange Act of 1934, as amended, and to any and
all amendments, of said Company, and to cause the same to be
filed with the SEC, granting unto said attorneys and each of
them full power and authority to do and perform any act and
thing necessary and proper to be done in the premises, as
fully and to all intents and purposes as the undersigned
could do if personally present, and the undersigned hereby
ratify and confirm all that said attorneys or any one of them
shall lawfully do or cause to be done by virtue hereof.
Dated: March 5, 1998
/s/ MICHAEL P. MORRELL
(Michael P. Morrell)
/s/ JAY S. PIFER
(Jay S. Pifer)
/s/ PETER J. SKRGIC
(Peter J. Skrgic)
63
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS THAT the undersigned
directors of Allegheny Generating Company, a Virginia
corporation, do hereby constitute and appoint THOMAS K.
HENDERSON and EILEEN M. BECK, and each of them, a true and
lawful attorney in his name, place and stead, in any and all
capacities, to sign his or her name to the Annual Report on
Form 10-K for the year ended December 31, 1997 under the
Securities Exchange Act of 1934, as amended, and to any and
all amendments, of said Company, and to cause the same to be
filed with the SEC, granting unto said attorneys and each of
them full power and authority to do and perform any act and
thing necessary and proper to be done in the premises, as
fully and to all intents and purposes as the undersigned
could do if personally present, and the undersigned hereby
ratify and confirm all that said attorneys or any one of
them shall lawfully do or cause to be done by virtue hereof.
Dated: March 5, 1998
/s/ THOMAS K. HENDERSON
(Thomas K. Henderson)
/s/ KENNETH M. JONES
(Kenneth M. Jones)
/s/ MICHAEL P. MORRELL
(Michael P. Morrell)
/s/ ALAN J. NOIA
(Alan J. Noia)
/s/ PETER J. SKRGIC
(Peter J. Skrgic)
E-1
EXHIBIT INDEX
(Rule 601(a))
Allegheny Energy, Inc.
Incorporation
Documents by Reference
3.1 Charter of the Company,
as amended, September 16, 1997
3.2 By-laws of the Company,
as amended September 16, 1997
4 Subsidiaries' Indentures
described below
10.1 Directors' Deferred Form 10-K of the Company
Compensation Plan (1-267), December 31, 1994,
exh. 10.1
10.2 Executive Compensation Plan Form 10-K of the Company
(1-267), December 31, 1996
exh. 10.2
10.3 Allegheny Power System Incentive Form 10-K of the Company
Compensation Plan (1-267), December 31, 1996
exh. 10.3
10.4 Allegheny Power System Form 10-K of the Company
Supplemental Executive (1-267), December 31, 1996
Retirement Plan exh. 10.4
10.5 Executive Life Insurance Form 10-K of the Company
Program and Collateral (1-267), December 31, 1994,
Assignment Agreement exh. 10.5
10.6 Secured Benefit Plan Form 10-K of the Company
and Collateral Assignment (1-267), December 31, 1994,
Agreement exh. 10.6
10.7 Restricted Stock Plan Form 10-K of the Company
for Outside Directors (1-267), December 31, 1994,
exh. 10.7
10.8 Deferred Stock Unit Plan
for Outside Directors
10.9 Allegheny Power System Form 10-K of the Company
Performance Share Plan (1-267), December 31, 1994,
exh. 10.9
10.10 Form of Change in Control Form 8-K of the Company(1-267),
Contract dated April 11, 1996, Exhibits
10.1 and 10.2
E-1 (Cont'd)
EXHIBIT INDEX
(Rule 601(a))
Allegheny Energy, Inc.
Incorporation
Documents by Reference
10.11 Allegheny Energy Senior Form 8K of the Company (1-267)
Officer Separation Plan dated December 4, 1997,
Statement of Enhancements Exhibit 10.1
12 Statement re computation of
per share earnings: Clearly
determinable from the financial
statements contained in Item 8.
21 Subsidiaries of AE:
Name of Company State of Organization
Allegheny Generating Company (a) Virginia
Allegheny Power Service Corporation Maryland
AYP Capital, Inc. Delaware
Monongahela Power Company Ohio
The Potomac Edison Company Maryland and Virginia
West Penn Power Company Pennsylvania
(a) Owned directly by Monongahela,
Potomac Edison, and West Penn.
23 Consent of Independent Accountants See page 60 herein.
24 Powers of Attorney See pages 61-63 herein.
27 Financial Data Schedule
E-2
Monongahela Power Company
Incorporation
Documents by Reference
3.1 Charter of the Company, Form 10-Q of the Company
as amended (1-5164), September 1995,
exh. (a)(3)(i)
3.2 Code of Regulations, Form 10-Q of the Company
as amended (1-5164), September 1995,
exh.(a)(3)(ii)
4 Indenture, dated as of S 2-5819, exh. 7(f)
August 1, 1945, and S 2-8782, exh.7(f)(1)
certain Supplemental S 2-8881, exh. 7(b)
Indentures of the S 2-9355, exh. 4(h)(1)
Company defining rights S 2-9979, exh.4(h)(1)
of security holders.* S 2-10548, exh. 4(b)
S 2-14763, exh. 2(b)(i)
S 2-24404, exh. 2(c);
S 2-26806, exh. 4(d);
Forms 8-K of the Company
(1-268-2) dated November 21,
1991, June 4, 1992, July 15,
1992, September 1, 1992, April
29, 1993 and May 23, 1995
* There are omitted the Supplemental Indentures
which do no more than subject property to the
lien of the above Indentures since they are not
considered constituent instruments defining the
rights of the holders of the securities. The
Company agrees to furnish the Commission on its
request with copies of such Supplemental Indentures.
10.1 Form of Employment Contract Form 8-K of the Company
with Certain Executive Officers (1-5164) dated April 11,
Under Age 55 1996, exh. 10.1
10.2 Form of Employment Contract Form 8-K of the Company
with Certain Executive Officers (1-5164) dated April 11,
Over Age 55 1996, exh 10.2
10.3 Other Executive Separation Plan Form 8-K of the Company
Statement of Enhancements (1-5164) dated December 4,
1997, exh. 10.1
12 Computation of ratio of earnings
to fixed charges
21 Subsidiaries: Monongahela Power Company has a 27% equity
ownership in Allegheny Generating Company, incorporated in
Virginia; and a 25% equity ownership in Allegheny Pittsburgh
Coal Company, incorporated in Pennsylvania.
23 Consent of Independent Accountants See page 60 herein.
24 Powers of Attorney See pages 61-63 herein.
27 Financial Data Schedule
E-3
The Potomac Edison Company
Incorporation
Documents by Reference
3.1 Charter of the Company, Form 10-Q of the Company
as amended (1-3376-2), September 1995,
exh. (a)(3)(i)
3.2 By-laws of the Company, Form 10-Q of the Company
as amended (1-3376-2), September 1995,
exh. (a)(3)(ii)
4 Indenture, dated as of S 2-5473, exh. 7(b); Form
October 1, 1944, and S-3, 33-51305, exh. 4(d)
certain Supplemental Forms 8-K of the Company
Indentures of the (1-3376-2) dated August 21,
Company defining rights 1991, December 11, 1991,
of security holders* December 15, 1992,
February 17, 1993, March 30,
1993, June 22, 1994, May 12,
1995 and May 17, 1995
* There are omitted the Supplemental Indentures which do no more
than subject property to the lien of the above Indentures since
they are not considered constituent instruments defining the
rights of the holders of the securities. The Company agrees to
furnish the Commission on its request with copies of such
Supplemental Indentures.
10.1 Form of Employment Contract Form 8-K of the Company
with Certain Executive Officers (1-3376-2) dated April 11,
Under Age 55 1996, exh. 10.1
10.2 Form of Employment Contract Form 8-K of the Company
with Certain Executive Officers (1-3376-2) dated April 11,
Over Age 55 1996, exh. 10.2
10.3 Other Executive Separation Plan Form 8-K of the Company
Statement of Enhancements (1-3376-2) dated December 4,
1997, exh. 10.1
12 Computation of ratio of earnings
to fixed charges
21 Subsidiaries: The Potomac Edison Company has a 28% equity
ownership in Allegheny Generating Company, incorporated in
Virginia and a 25% equity ownership in Allegheny Pittsburgh
Coal Company, incorporated in Pennsylvania.
23 Consent of Independent See page 60 herein.
Accountants
24 Powers of Attorney See pages 61-63 herein.
27 Financial Data Schedule
E-4
West Penn Power Company
Incorporation
Documents by Reference
3.1 Charter of the Company, Form 10-Q of the Company
as amended (1-255-2), September 1995,
exh. (a)(3)(i)
3.2 By-laws of the Company, Form 10-Q of the Company
as amended (1-255-2), September 1995,
exh. (a)(3)(ii)
4 Indenture, dated as of S-3, 33-51303, exh. 4(d)
March 1, 1916, and certain S 2-1835, exh. B(1), B(6)
Supplemental Indentures of S 2-4099, exh. B(6), B(7)
the Company defining rights S 2-4322, exh. B(5)
of security holders.* S 2-5362, exh. B(2), B(5)
S 2-7422, exh. 7(c), 7(i)
S 2-7840, exh. 7(d), 7(k)
S 2-8782, exh. 7(e) (1)
S 2-9477, exh. 4(c),(d)
S 2-10802, exh.4(b),4(c)
S 2-13400, exh. 2(c), 2(d)
Form 10-Q of the Company
(1-255-2), June 1980, exh. D
Forms 8-K of the Company
(1-255-2) dated February 1991,
December 1991, August 13,
1993, September 15, 1992,
June 9,1993, August 2,
September 15, 1992, June 1994
and May 19, 1995
* There are omitted the Supplemental Indentures which do no more
than subject property to the lien of the above Indentures since
they are not considered constituent instruments defining the rights
of the holders of the securities. The Company agrees to furnish the
Commission on its request with copies of such Supplemental Indentures.
10.1 Form of Employment Contract Form 8-K of the Company
with Certain Executive Officers (1-255-2) dated April 11,
Under Age 55 1996, exh. 10.1
10.2 Form of Employment Contract Form 8-K of the Company
with Certain Executive Officers (1-255-2) dated April 11,
Over Age 55 1996, exh. 10.2
10.3 Other Executive Separation Plan Form 8-K of the Company
Statement of Enhancements (1-255-2) dated December 4,
1997, exh. 10.1
12 Computation of ratio of earnings
to fixed charges
E-4, (Cont'd)
West Penn Power Company
Incorporation
Documents by Reference
21 Subsidiaries: West Penn Power Company
has a 45% equity ownership in Allegheny
Generating Company, incorporated in
Virginia; a 50% equity ownership in
Allegheny Pittsburgh Coal Company,
incorporated in Pennsylvania; and a 100%
equity ownership in West Virginia Power
and Transmission Company, incorporated in
West Virginia, which owns a 100% equity
ownership in West Penn West Virginia
Water Power Company, incorporated in
Pennsylvania.
23 Consent of Independent See page 60 herein.
Accountants
24 Powers of Attorney See pages 61-63 herein.
27 Financial Data Schedule
E-5
Allegheny Generating Company
Documents
3.1(a) Charter of the Company, as amended*
3.1(b) Certificate of Amendment to Charter, effective July 14, 1989**
3.2 By-laws of the Company, as amended, effective December 23, 1996.
4 Indenture, dated as of December 1, 1986, and Supplemental
Indenture, dated as of December 15, 1988, of the Company
defining rights of security holders.***
10.1 APS Power Agreement-Bath County Pumped Storage Project, as
amended, dated as of August 14, 1981, among Monongahela Power Company,
West Penn Power Company, and The Potomac Edison Company and
Allegheny Generating Company.****
10.2 Operating Agreement, dated as of June 17, 1981, among Virginia
Electric and Power Company, Allegheny Generating Company,
Monongahela Power Company, West Penn Power Company and The
Potomac Edison Company.****
10.3 Equity Agreement, dated June 17, 1981, between and among
Allegheny Generating Company, Monongahela Power Company, West
Penn Power Company and The Potomac Edison Company.****
10.4 United States of America Before The Federal Energy
Regulatory Commission, Allegheny Generating Company, Docket No.
ER84-504-000, Settlement Agreement effective October 1, 1985.****
12 Computation of ratio of earnings to fixed charges
23 Consent of Independent
Accountants See page 60 herein.
24 Powers of Attorney See pages 61-63 herein.
27 Financial Data Schedule
* Incorporated by reference to the designated exhibit to AGC's
registration statement on Form 10, File No. 0-14688.
** Incorporated by reference to Form 10-Q of the Company (0-14688)
for June 1989, exh. (a).
*** Incorporated by reference to Forms 8-K of the Company (0-14688)
for December 1986, exh. 4(A), and December 1988, exh. 4.1.
**** Incorporated by reference to Form 10-Q of the Company (0-14688)
for June 1989, exh. (a).