<PAGE>
Page 1 of 21
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended June 30, 1998
Commission File Number 1-255-2
WEST PENN POWER COMPANY
(Exact name of registrant as specified in its charter)
Pennsylvania 13-5480882
(State of Incorporation) (I.R.S. Employer Identification No.)
800 Cabin Hill Drive, Greensburg, Pennsylvania 15601
Telephone Number - 724-837-3000
The registrant (1) has 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) has been subject to such
filing requirements for the past 90 days.
At August 14, 1998, 24,361,586 shares of the Common Stock (no
par value) of the registrant were outstanding, all of which are
held by Allegheny Energy, Inc., the Company's parent.
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WEST PENN POWER COMPANY AND SUBSIDIARIES
Form 10-Q for Quarter Ended June 30, 1998
Index
Page
No.
PART I--FINANCIAL INFORMATION:
Consolidated statement of income -
Three and six months ended June 30, 1998 and 1997 3
Consolidated balance sheet - June 30, 1998
and December 31, 1997 4
Consolidated statement of cash flows -
Six months ended June 30, 1998 and 1997 5
Notes to consolidated financial statements 6-10
Management's discussion and analysis of financial
condition and results of operations 11-19
PART II--OTHER INFORMATION 20-21
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WEST PENN POWER COMPANY AND SUBSIDIARIES
Consolidated Statement of Income
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
1998 1997 1998 1997
(Thousands of Dollars)
ELECTRIC OPERATING REVENUES:
<S> <C> <C> <C> <C>
Residential $ 82,563 $ 86,022 $ 185,273 $ 196,333
Commercial 53,727 52,178 108,619 108,315
Industrial 86,619 88,242 173,733 175,983
Wholesale and other, including affiliates 18,169 17,525 40,482 37,313
Bulk power transactions, net 21,945 8,764 35,619 17,317
Total Operating Revenues 263,023 252,731 543,726 535,261
OPERATING EXPENSES:
Operation:
Fuel 64,295 61,185 128,608 125,331
Purchased power and exchanges, net 27,714 29,651 58,431 61,566
Deferred power costs, net - 874 - 2,922
Other 41,466 36,907 76,705 72,799
Maintenance 23,229 25,460 46,171 52,553
Depreciation 29,425 30,448 58,765 60,902
Taxes other than income taxes 21,740 21,765 44,865 45,287
Federal and state income taxes 14,527 10,780 36,935 30,969
Total Operating Expenses 222,396 217,070 450,480 452,329
Operating Income 40,627 35,661 93,246 82,932
OTHER INCOME AND DEDUCTIONS:
Allowance for other than borrowed funds
used during construction 127 654 745 1,263
Other income, net 2,894 3,133 5,560 8,730
Total Other Income and Deductions 3,021 3,787 6,305 9,993
Income Before Interest Charges 43,648 39,448 99,551 92,925
INTEREST CHARGES:
Interest on long-term debt 15,571 16,247 31,936 32,494
Other interest 1,968 1,767 2,846 2,587
Allowance for borrowed funds used during
construction (199) (529) (540) (1,020)
Total Interest Charges 17,340 17,485 34,242 34,061
Consolidated Income Before
Extraordinary Charge 26,308 21,963 65,309 58,864
Extraordinary Charge, net (1) (265,446) - (265,446) -
CONSOLIDATED NET (LOSS) INCOME $ (239,138) $ 21,963 $ (200,137) $ 58,864
</TABLE>
See accompanying notes to consolidated financial statements.
(1) See Note 6 in the notes to the consolidated financial statements.
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WEST PENN POWER COMPANY AND SUBSIDIARIES
Consolidated Balance Sheet
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
ASSETS: (Thousands of Dollars)
<S> <C> <C>
Property, Plant, and Equipment:
At original cost, including $99,595,000
and $117,588,000 under construction $ 3,279,546 $ 3,293,039
Accumulated depreciation (1,280,896) (1,254,900)
1,998,650 2,038,139
Investments and Other Assets:
Allegheny Generating Company - common stock at equity 73,537 89,783
Other 660 721
74,197 90,504
Current Assets:
Cash and temporary cash investments 3,978 4,056
Accounts receivable:
Electric service, net of $15,556,000 and $13,326,000
uncollectible allowance 125,740 128,348
Affiliated and other 21,729 21,525
Materials and supplies - at average cost:
Operating and construction 33,663 34,212
Fuel 34,736 29,467
Prepaid taxes 30,178 11,738
Other 8,539 14,211
258,563 243,557
Deferred Charges:
Regulatory assets 495,733 333,235
Unamortized loss on reacquired debt 4,603 9,725
Other 25,924 31,999
526,260 374,959
Total Assets $ 2,857,670 $ 2,747,159
CAPITALIZATION AND LIABILITIES:
Capitalization:
Common stock $ 465,994 $ 465,994
Other paid-in capital 55,475 55,475
Retained earnings 216,975 475,558
738,444 997,027
Preferred stock 79,708 79,708
Long-term debt and QUIDS 804,095 802,319
1,622,247 1,879,054
Current Liabilities:
Short-term debt 140,852 52,046
Long-term debt due within one year - 103,500
Accounts payable 65,031 73,584
Accounts payable to affiliates 33,690 16,137
Taxes accrued:
Federal and state income 263 1,605
Other 9,577 22,728
Interest accrued 15,310 15,817
Other 19,962 28,457
284,685 313,874
Deferred Credits and Other Liabilities:
Unamortized investment credit 43,916 45,206
Deferred income taxes 265,597 450,390
Regulatory liabilities 30,670 34,326
Adverse power purchase commitments 585,918 -
Other 24,637 24,309
950,738 554,231
Total Capitalization and Liabilities $ 2,857,670 $ 2,747,159
</TABLE>
See accompanying notes to consolidated financial statements.
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WEST PENN POWER COMPANY AND SUBSIDIARIES
Consolidated Statement of Cash Flows
<TABLE>
<CAPTION>
Six Months Ended
June 30
1998 1997
(Thousands of Dollars)
CASH FLOWS FROM OPERATIONS:
<S> <C> <C>
Consolidated net (loss) income $ (200,137) $ 58,864
Extraordinary charge, net of taxes 265,446 -
Consolidated income before extraordinary charge 65,309 58,864
Depreciation 58,765 60,902
Deferred investment credit and income taxes, net 3,171 5,506
Deferred power costs, net - 2,922
Unconsolidated subsidiaries' dividends in excess of earnings 16,307 2,357
Allowance for other than borrowed funds used
during construction (745) (1,263)
Restructuring liability (4,082) (10,084)
Changes in certain current assets and
liabilities:
Accounts receivable, net 2,404 14,240
Materials and supplies (4,720) (10,459)
Prepaid taxes (18,440) (3,076)
Accounts payable 9,000 (1,344)
Taxes accrued (14,493) (18,552)
Other, net (4,460) (5,089)
108,016 94,924
CASH FLOWS FROM INVESTING:
Construction expenditures (less allowance for
equity funds used during construction) (36,455) (46,614)
CASH FLOWS FROM FINANCING:
Issuance of long-term debt 15,935 -
Retirement of long-term debt (117,935) -
Short-term debt, net 88,806 49,852
Notes receivable from affiliates - 2,900
Dividends on capital stock:
Preferred stock (1,683) (1,701)
Common stock (56,762) (96,959)
(71,639) (45,908)
NET CHANGE IN CASH AND TEMPORARY CASH INVESTMENTS (78) 2,402
Cash and Temporary Cash Investments at January 1 4,056 5,160
Cash and Temporary Cash Investments at June 30 $ 3,978 $ 7,562
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) $32,622 $32,212
Income taxes 40,551 29,538
</TABLE>
See accompanying notes to consolidated financial statements.
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WEST PENN POWER COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. The Company's Notes to Consolidated Financial Statements in
its Annual Report on Form 10-K for the year ended December
31, 1997 should be read with the accompanying consolidated
financial statements and the following notes. With the
exception of the December 31, 1997 consolidated balance sheet
in the aforementioned Annual Report on Form 10-K, the
accompanying consolidated financial statements appearing on
pages 3 through 5 and these notes to consolidated financial
statements are unaudited. In the opinion of the Company,
such consolidated financial statements together with these
notes contain all adjustments necessary to present fairly the
Company's financial position as of June 30, 1998, the results
of operations for the three and six months ended June 30,
1998 and 1997, and cash flows for the six months ended June
30, 1998 and 1997.
2. The Consolidated Statement of Income reflects the results of
past operations and is not intended as any representation as
to future results. For purposes of the Consolidated Balance
Sheet and 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.
3. 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
megawatts (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.
Following is a summary of income statement information for
AGC:
Three Months Ended Six Months Ended
June 30 June 30
1998 1997 1998 1997
(Thousands of Dollars)
Electric operating revenues $19,126 $20,408 $37,730 $40,624
Operation and maintenance
expense 1,542 1,471 2,495 2,756
Depreciation 4,242 4,284 8,468 8,568
Taxes other than income taxes 1,177 1,201 2,337 2,396
Federal income taxes 2,907 3,141 5,772 6,265
Interest charges 3,298 3,917 6,811 7,877
Other income, net (1) (1) (51) (1)
Net income $ 5,961 $ 6,395 $11,898 $12,763
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The Company's share of the equity in earnings above was $2.7
million and $2.9 million for the three months ended June 30,
1998 and 1997, respectively, and $5.4 million and $5.7
million for the six months ended June 30, 1998 and 1997,
respectively, and was included in other income, net, on the
Consolidated Statement of Income.
4. On April 7, 1997, the Company's parent, Allegheny Power
System, Inc. (now renamed Allegheny Energy, Inc.) 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.
On March 25, 1998, the Maryland Public Service Commission
(PSC) approved a settlement agreement between Allegheny
Energy, Inc. (Allegheny Energy) and various parties, in which
the PSC indicated its approval of the merger. This action
was requested in connection with the proposed issuance of
Allegheny Energy stock to exchange for DQE stock to complete
the merger.
On July 8, 1998, the City of Pittsburgh reached a settlement
agreement with Allegheny Energy and agreed to support the
merger.
On July 16, 1998, the Public Utilities Commission of Ohio
(PUCO) found that the proposed merger would be in the public
interest. The PUCO also stated that the Midwest ISO is the
regional transmission entity that will best serve the
interests of the Ohio customers of Monongahela Power Company,
the Company's utility affiliate, and will best mitigate the
market power issue.
The Nuclear Regulatory Commission has approved the transfer
of control of the operating licenses for DQE's nuclear
plants. While Duquesne Light Company (Duquesne), principal
subsidiary of DQE, will continue to be the licensee, this
approval was necessary since control of Duquesne will pass
from DQE to Allegheny Energy after the merger.
On July 23, 1998, the Pennsylvania Public Utility Commission
(PUC) approved the Allegheny Energy-DQE merger with
conditions acceptable to Allegheny Energy in response to a
Petition for Reconsideration filed by Allegheny Energy on
June 12, 1998. In its Petition for Reconsideration of a
previous PUC Order, Allegheny Energy reiterated its
commitment to staying in and supporting the Midwest ISO, and
also offered to relinquish some generation in order to
mitigate market power concerns. Allegheny Energy committed
to relinquishing control of the 570 MW Cheswick,
Pennsylvania, generating station through at least June 30,
2000 and, in the event that the Midwest ISO has not
eliminated pancaked transmission rates by June 30, 2000,
Allegheny Energy may be required to divest up to 2,500 MW of
generation, subject to a PUC Order.
In a letter dated July 28, 1998 to Allegheny Energy, DQE
stated that its Board of Directors determined that DQE was
not required to proceed with the merger under present
circumstances, referring to the PUC's Orders of July 23, 1998
(regarding the PUC's approval of the merger described above),
and May 29, 1998 (regarding the restructuring plan of the
Company described in Note 5 below). DQE took the position
that the findings of both Orders constitute a material
adverse effect under the Agreement and Plan of Merger and
invited Allegheny Energy to agree promptly to terminate the
merger agreement by mutual consent. DQE asserted that the
findings in
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the PUC Orders will result in a failure of the conditions to
DQE's obligation to consummate the merger. DQE indicated
that if Allegheny Energy was not amenable to a consensual
termination, DQE would terminate the agreement unilaterally
not later than October 5, 1998 if circumstances did not
change sufficiently to remedy the adverse effects DQE stated
were associated with the PUC Orders. In a letter dated July
30, 1998, Allegheny Energy informed DQE that DQE's
allegations were incorrect, that the Orders do not constitute
a material adverse effect, that Allegheny Energy remains
committed to the merger, and that if DQE prevents completion
of the merger, Allegheny Energy will pursue all remedies
available to protect the legal and financial interests of
Allegheny Energy and its shareholders. Allegheny Energy has
also notified DQE that its letter and other actions
constitute a material breach of the merger agreement by DQE.
All of the Company's incremental costs of the merger process
($6.5 million through June 30, 1998) 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.
5. 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, the
Company filed with the PUC a comprehensive restructuring plan
to implement full customer choice of electric generation
suppliers as required by the Customer Choice Act. The filing
included a plan for recovery of stranded costs through a
Competitive Transition Charge (CTC).
On May 29, 1998, the Company received a final Order from the
PUC denying full recovery of its stranded cost claim. The
Order authorized recovery of $524 million in stranded costs,
with return, over the 1999 through 2005 period, of the
approximately $1.2 billion available for recovery under the
capped rates mandated by the Customer Choice Act.
On June 26, 1998, the PUC denied a request by the Company for
reconsideration of the May 29, 1998 PUC Order on the
Company's restructuring plan. In denying the request for
reconsideration, the PUC let stand the earlier Order under
which the Company would provide customers who shop for their
electricity a shopping credit of about 3.12 cents per
kilowatt-hour (kWh) beginning in January 1999, and about 3.23
cents per kWh beginning in January 2000. Shopping credits
vary from one rate class to another and increase over a seven-
year transition period. Under the reconsideration Order, the
Company would be allowed to collect $525 million ($.5 million
more than the previous Order) in stranded costs, with a
return, over seven years, starting in January 1999, through
the CTC. Although in its restructuring application, the
Company had listed $1.6 billion in stranded costs, because of
capped rates, the Company would be limited to $1.2 billion in
stranded cost recovery under the Customer Choice Act.
Stranded costs are costs incurred under a regulated
environment, which are not expected to be recoverable in a
competitive market. Actual recovery of such costs will
depend upon the market prices for electricity in future
periods and the number of the Company's customers who choose
other generation suppliers. The PUC Order on the Company's
restructuring plan assumed significantly higher electricity
prices in future years than Allegheny Energy and the Company
believed were appropriate.
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One-third of the Company's customers will be able to buy
power from the supplier of their choice on January 1, 1999,
another one-third on the following day, January 2, 1999, and
the remainder on January 2, 2000. In a separate action, the
PUC directed that open enrollment for Pennsylvania customers
to choose their electric generation suppliers will begin on
July 1, 1998. Starting in 1999, the Company would unbundle
its rates to reflect separate prices for the generation
charge, the CTC, and transmission and distribution charges.
While generation would be open to competition, the Company
would continue to provide transmission and distribution
services to its customers at PUC and Federal Energy
Regulatory Commission (FERC) regulated rates.
Allegheny Energy and the Company believe that the $525
million of stranded costs recommended for recovery is
contrary to legal requirements and does not adequately
reflect the potential effects of competition on the Company.
On June 26, 1998, the Company filed a formal appeal in state
court and an action in federal court challenging the PUC's
restructuring Order. On July 23, 1998, the Company also
filed in the Commonwealth Court of Pennsylvania a petition
for a stay of the two-thirds, one-third phase-in schedule
ordered by the PUC. On August 5, 1998, the Company withdrew
its petition for stay without prejudice based on a PUC
agreement to offer settlement discussions on issues related
to the PUC's restructuring Order.
6. As a result of the PUC Order described in Note 5 above, the
Company has determined that it is required to discontinue the
application of Statement of Financial Accounting Standards
(SFAS) No. 71 for electric generation operations and to adopt
SFAS No. 101, "Accounting for the Discontinuation of
Application of SFAS No. 71". In doing so, the Company has
also determined that under the provisions of SFAS No. 101 an
extraordinary charge of $450.6 million ($265.4 million after
taxes) is required to reflect a write-off of disallowances in
the PUC's Order. The write-off, recorded in June 1998,
reflects adverse power purchase commitments and deferred
costs that are not recoverable from customers under the PUC's
Order as follows:
(In Millions)
AES Beaver Valley nonutility generation contract $201.4
Allegheny Generating Company (AGC) pumped storage
capacity contract 177.2
Other 72.0
Total $450.6
In 1985, the Company entered into a contract with AES
Corporation for the purchase of energy from AES's Beaver
Valley generating plant in Pennsylvania pursuant to the
requirements of the Public Utility Regulatory Policies Act of
1978 (PURPA) at prices then determined under the Act.
The Company owns 45% of AGC, which owns an undivided 40%
interest in the 2,100 MW pumped storage hydroelectric station
in Bath County, Virginia. The Company buys AGC's capacity in
the station priced under a cost of service formula wholesale
rate schedule approved by the FERC.
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Under both of these contracts, the Company has purchase
commitments at costs in excess of the market value of energy
from the plants. Because of utility restructuring under the
Customer Choice Act, these commitments have been determined
to be adverse purchase commitments requiring accrual as loss
contingencies pursuant to SFAS No. 5, "Accounting for
Contingencies". The extraordinary charge for these contracts
is the net result of such excess cost accruals (recorded in
June as adverse power purchase commitments) less estimated
revenue recoveries authorized in the PUC Order (recorded in
June 1998 as regulatory assets) as follows:
AES AGC
Beaver Valley Bath County
(In Millions)
Projected costs in excess of market value
of energy $351.5 $234.4
Estimated recovery 150.1 57.2
Net unrecoverable extraordinary charge $201.4 $177.2
The other $72.0 million of extraordinary charges represents
$55.0 million of deferred unrecovered expenditures for
previous PURPA buyouts, $15.4 million for an abandoned
generating plant, and $1.6 million of other generation-
related regulatory assets.
Allegheny Energy continues to review the financial impact of
the PUC's Order. Ultimately, future financial effects depend
on the number of Company customers who choose other
generation suppliers and the market price of electricity
during the transition period.
7. In June 1998, the Financial Accounting Standards Board issued
SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," to establish accounting and reporting
standards for derivatives. The new standard requires
recognizing all derivatives as either assets or liabilities
on the balance sheet at their fair value and specifies the
accounting for changes in fair value depending upon the
intended use of the derivative. The new standard is
effective for fiscal years beginning after June 15, 1999.
The Company expects to adopt SFAS No. 133 in the first
quarter of 2000. The Company is in the process of evaluating
the impact of SFAS No. 133.
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WEST PENN POWER COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
COMPARISON OF SECOND QUARTER AND SIX MONTHS ENDED JUNE 30, 1998
WITH SECOND QUARTER AND SIX MONTHS ENDED JUNE 30, 1997
The Notes to Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and
Results of Operations in the Company's Annual Report on Form 10-K
for the year ended December 31, 1997 should be read in
conjunction with the following Management's Discussion and
Analysis information.
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. These include
statements with respect to deregulation activities and movements
toward competition in Pennsylvania and the DQE, Inc. (DQE) merger
as well as results of operations. 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; potential Year 2000 operation problems; developments
in the legislative, regulatory, and competitive environments in
which the Company operates, including regulatory proceedings
affecting rates charged by the Company; environmental legislative
and regulatory changes; future economic conditions; developments
relating to the proposed merger with DQE, including expenses that
may be incurred in litigation if DQE seeks to terminate the
merger agreement; and other circumstances that could affect
anticipated revenues and costs such as significant volatility in
the market price of wholesale power, unscheduled maintenance or
repair requirements, weather, and compliance with laws and
regulations.
Significant Events in the First Six Months of 1998
* Merger with DQE
In a letter dated July 28, 1998 to Allegheny Energy, DQE
stated that its Board of Directors determined that DQE was not
required to proceed with the merger under present circumstances,
referring to the Pennsylvania Public Utility Commission (PUC)
Orders of July 23, 1998 and May 29, 1998. See Notes 4 and 5 to
the Consolidated Financial Statements for more information about
these Orders. DQE took the position that the findings of both
Orders constitute a material adverse effect under the Agreement
and Plan of Merger, and invited Allegheny Energy to agree
promptly to terminate the merger
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agreement by mutual consent. DQE asserted that the findings in
the PUC Orders will result in a failure of the conditions to
DQE's obligation to consummate the merger. DQE indicated that if
Allegheny Energy was not amenable to a consensual termination,
DQE would terminate the agreement unilaterally not later than
October 5, 1998 if circumstances did not change sufficiently to
remedy the adverse effects DQE stated were associated with the
PUC Orders. In a letter dated July 30, 1998, Allegheny Energy
informed DQE that DQE's allegations were incorrect, that the
Orders do not constitute a material adverse effect, that
Allegheny Energy remains committed to the merger, and that if DQE
prevents completion of the merger, Allegheny Energy will pursue
all remedies available to protect the legal and financial
interests of Allegheny Energy and its shareholders. Allegheny
Energy has also notified DQE that its letter and other actions
constitute a material breach of the merger agreement by DQE.
Allegheny Energy believes that DQE's basis for seeking to
terminate the merger is without merit. Accordingly, Allegheny
Energy is continuing to seek the remaining regulatory approvals
from the Federal Energy Regulatory Commission (FERC), the
Department of Justice, and the Securities and Exchange
Commission. The Company cannot predict the outcome of the
requested approvals or of the differences between Allegheny
Energy and DQE.
* Pennsylvania Deregulation
On May 29, 1998, the Company received a final Order from
the PUC denying full recovery of its stranded cost claim. The
Order authorized recovery of $524 million in stranded costs, with
return, over the 1999 through 2005 period, of the approximately
$1.2 billion available for recovery under the capped rates
mandated by the Customer Choice Act.
On June 26, 1998, the PUC denied a request by the Company
for reconsideration of the May 29, 1998 PUC Order on the
Company's restructuring plan. In denying the request for
reconsideration, the PUC let stand the earlier Order under which
the Company would provide customers who shop for their
electricity a shopping credit of about 3.12 cents per kilowatt-
hour (kWh) beginning in January 1999, and about 3.23 cents per
kWh beginning in January 2000. Shopping credits vary from one
rate class to another and increase over a seven-year transition
period. Under the reconsideration Order, the Company would be
allowed to collect $525 million ($.5 million more than the
previous Order) in stranded costs, with a return over seven
years, starting in January 1999, through the Competitive
Transition Charge (CTC). Although in its restructuring
application, the Company had listed $1.6 billion in stranded
costs, because of capped rates, the Company would be limited to
$1.2 billion in stranded cost recovery under the Customer Choice
Act. Stranded costs are costs incurred under a regulated
environment which are not expected to be recoverable in a
competitive market. Actual recovery of such costs will depend
upon the market prices for electricity in future periods and the
number of the Company's customers who choose other generation
suppliers. The PUC Order on the Company's restructuring plan
assumed significantly higher electricity prices in future years
than Allegheny Energy and the Company believed were appropriate.
One-third of the Company's customers will be able to buy
power from the supplier of their choice on January 1, 1999,
another one-third on the following day, January 2, 1999, and the
remainder on January 2, 2000. In a separate action, the PUC
directed that open enrollment for Pennsylvania customers to
choose their electric generation suppliers will begin on July 1,
1998. Starting in 1999, the Company would unbundle its rates to
reflect
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separate prices for the generation charge, the CTC, and
transmission and distribution charges. While generation would be
open to competition, the Company would continue to provide
transmission and distribution services to its customers at PUC
and FERC regulated rates.
Allegheny Energy and the Company believe that the $525
million of stranded costs recommended for recovery is contrary to
legal requirements and does not adequately reflect the potential
effects of competition on the Company. On June 26, 1998, The
Company filed a formal appeal in state court and an action in
federal court challenging the PUC's restructuring Order. On July
23, 1998, the Company also filed in the Commonwealth Court of
Pennsylvania a petition for a stay of the two-thirds, one-third
phase-in schedule ordered by the PUC. On August 5, 1998, the
Company withdrew its petition for stay without prejudice based on
a PUC agreement to offer settlement discussions on issues related
to the PUC's restructuring Order. Allegheny Energy cannot
predict the outcome of settlement discussions or the related
legal proceedings.
* Trading Activities
In June and July 1998, certain events combined to produce
very significant volatility in the spot prices for electricity at
the wholesale level. These events included extremely hot weather
and Midwest generation unit outages and transmission constraints.
Wholesale prices for electricity rose from a normal range of from
$25-$40 per megawatt-hour (mWh) to as high as $3,500-$7,000 per
mWh. The potential exists for such volatility to significantly
affect the Company's operating results. The impact on such
results, either positively or negatively, depends on whether the
Company is a net buyer or seller of electricity during such
periods. The impact of such price volatility in June 1998 was
insignificant to the Company.
Review of Operations
EARNINGS SUMMARY
Consolidated net income for the second quarter and first
six months of 1998 includes an extraordinary charge of $450.6
million ($265.4 million, net of taxes) to reflect a write-off by
the Company of prudently incurred costs determined to be
unrecoverable as a result of the May 29, 1998 Order by the
Pennsylvania PUC in connection with the deregulation proceedings
in Pennsylvania. See Note 6 to the Consolidated Financial
Statements for more information on the extraordinary charge.
Consolidated income before the extraordinary charge for
the second quarter of 1998 was $26.3 million compared with $22.0
million in the corresponding 1997 period, and for the first six
months of 1998, consolidated income before the extraordinary
charge was $65.3 million compared with $58.9 million for the
corresponding 1997 period. The increases in consolidated income
before extraordinary charge in the second quarter and first six
months were due to significant bulk power transactions, a
reduction in the Company's depreciation expense determined to be
necessary as part of its comprehensive restructuring filing
required by the Customer Choice Act, and in the first six months
also due to continuing efforts to reduce operations and
maintenance (O&M) expense.
<PAGE>
- 14 -
SALES AND REVENUES
Total operating revenues for the second quarter and first
six months of 1998 and 1997 were as follows:
Three Months Ended Six Months Ended
June 30 June 30
1998 1997 1998 1997
(Millions of Dollars)
Operating revenues:
Bundled retail sales $222.3 $228.1 $465.4 $484.2
Unbundled retail sales 2.3 - 5.9 -
Wholesale and other* 16.5 15.8 36.8 33.8
Bulk power, including
transmission services 21.9 8.8 35.6 17.3
Total operating revenues $263.0 $252.7 $543.7 $535.3
*Excludes street lighting sales
which are included in bundled
retail sales $1.7 $1.7 $3.7 $3.5
The decrease in bundled retail sales (full service sales
to retail customers) for the six months ended June 30, 1998 is
due in part to reduced residential kWh sales to retail customers
due to the mild first quarter winter weather. The 1998 first
quarter winter weather was 15% warmer than 1997 and 22% warmer
than normal as measured by heating degree days. The decrease in
bundled retail sales revenues in both periods was also due in
part to the Customer Choice Act in Pennsylvania. As part of the
Customer Choice Act, all utilities in Pennsylvania were required
to administer retail access pilot programs under which customers
representing 5% of the load of each rate class would choose a
generation supplier other than their own local franchise utility.
As a result, up to 5% of previously fully bundled customers chose
to participate in the Pennsylvania pilot program and were
required to buy energy from another supplier of their choice.
The pilot program began on November 1, 1997 and will continue
through December 31, 1998. Unbundled retail sales revenues
represent transmission and distribution revenues for Pennsylvania
pilot customers who chose another supplier to provide their
energy needs.
To assure participation in the pilot program, pilot
participants are receiving an energy credit from their local
utility and a price for energy pursuant to an agreement with an
alternate supplier. The credit established by the PUC is
artificially high, with the result that the Company could suffer
a revenue loss of up to $10 million in 1998 for the pilot. 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. Wholesale and other revenues include an
accrual of such revenue losses, as well as sales to wholesale
customers (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 FERC) and non-kWh
revenues. The increase in wholesale and other revenues was due
primarily to $1.4 million and $3.3 million for the three and six
months ended June 30, 1998, respectively, of deferred net revenue
losses recorded as a regulatory asset to offset revenue losses
suffered as a result of the pilot.
<PAGE>
- 15 -
The increase in revenues from bulk power, including
transmission services, in the 1998 periods are due primarily to
increased sales of energy which occurred primarily in June as a
result of a heat wave which increased the demand and prices for
energy. The increases are also due to pilot-related sales of
energy.
OPERATING EXPENSES
Fuel expenses for the three and six months ended June 30,
1998, increased 5.1% and 2.6%, respectively, due primarily to an
increase in kWh's generated. Prior to May 1, 1997, the
Company's fuel expenses were primarily subject to deferred power
cost accounting procedures to match fuel and energy cost
adjustment clause revenues, with the result that changes in fuel
expenses until then had little effect on consolidated net income.
After May 1, 1997, the Company assumed the risks and benefits of
changes in fuel and purchased power costs and sales of
transmission and bulk power.
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
Allegheny Generating Company (AGC), an affiliate partially owned
by the Company, and other transactions with affiliates made
pursuant to a power supply agreement whereby each company uses
the most economical generation available in the Allegheny Energy
System at any given time, and consists of the following items:
Three Months Ended Six Months Ended
June 30 June 30
1998 1997 1998 1997
(Millions of Dollars)
Nonaffiliated transactions:
Purchased power:
From PURPA generation* $16.3 $17.2 $32.8 $33.9
Other 2.9 3.4 7.0 7.2
Power exchanges, net (.7) (.5) .7 1.3
Affiliated transactions:
AGC capacity charges 8.3 8.8 16.2 17.6
Energy and spinning reserve
charges .9 .8 1.7 1.6
Purchased power and
exchanges, net $27.7 $29.7 $58.4 $61.6
*PURPA cost (cents per kWh) 5.7 6.0 5.8 6.0
The increases in other operation expense for the second
quarter and six months ended periods were primarily due to
increases in the provision for uninsured claims ($1.6 and $1.3
million, respectively), increases in the allowance for
uncollectible accounts ($.4 and $.6 million, respectively), and
increased expenses related to the Pennsylvania pilot and
competition ($.4 and $1.9 million, respectively).
<PAGE>
- 16 -
Maintenance expenses decreased $2.2 million and $6.4
million for the second quarter and year-to-date periods ended
June 30, 1998, respectively. Both 1998 periods include $1.7
million of incremental transmission and distribution (T&D) storm
damage expenses incurred in June for two unusually strong
thunderstorms in the Company's territory. The maintenance
expense decreases were achieved through restructuring efforts and
other cost controls. Maintenance expenses represent costs
incurred to maintain the power stations, the T&D system, and
general plant, and reflect 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.
Depreciation expense decreased $1.0 million and $2.1
million in the second quarter and first six months of 1998,
respectively, due to 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 increases in federal and state income taxes resulted
primarily from increases in income before taxes.
Other income, net, decreased $3.2 million in the six
months ended June 30, 1998, primarily due to a gain on a sale of
land in the 1997 period by the Company's subsidiary, West
Virginia Power & Transmission Company.
Financial Condition
The Company's discussion on Financial Condition,
Requirements, and Resources and Significant Continuing Issues in
its Annual Report on Form 10-K for the year ended December 31,
1997 should be read in conjunction with the following
information.
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.
See Notes 4, 5, and 6 to the Consolidated Financial Statements
for information about merger activities and the Pennsylvania
Customer Choice Act.
* Risk Management
The Company and its affiliates 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
management is done in accordance with a formal 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.
<PAGE>
- 17 -
At June 30, 1998, 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 require settlement by
physical delivery of electricity. During 1998, 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 Readiness
As the Year 2000 approaches, most organizations, including
the Company, could experience serious problems related to
software and various equipment with embedded chips which may not
properly recognize calendar dates. To minimize such problems,
the Company and its affiliates in the Allegheny Energy System
(the System) are proceeding with a comprehensive effort to
continue operations without significant problems in the Year 2000
(Y2K) and beyond. An Executive Task Force is coordinating the
efforts of 21 separate Y2K Teams, representing all business and
support units in the System.
The System has segmented the Y2K problem into the
following components:
* Computer software
* Embedded chips in various equipment
* Vendors and other organizations on which the System relies
for critical materials and services.
The System's effort for each of these three components
includes assessment of the problem areas, remediation, testing
and contingency plans for critical functions for which
remediation and testing are not possible or which do not provide
reasonable assurance.
The Company has expended significant time and money over
the past several years on upgrading and replacing its large and
complex computer systems and software to achieve greater
efficiency as well as Y2K readiness. As a result, the Company
expects these systems to achieve a state of Y2K readiness on or
about March 31, 1999, subject to continuing review and testing.
Various equipment used by the System includes thousands of
embedded chips. Most are not date sensitive, but identifying
those which are, and which are critical to operations, is a labor
intensive task. Identification, remediation, and testing in many
cases require the assistance of the original equipment
manufacturers. Even they frequently cannot state with certainty
if the chips they used are date sensitive. The System's review
calls for the inventory and assessment of suspect embedded chips
in critical systems to be completed by December 31, 1998,
remediation initiated as needs are identified, with 1999 to
complete remediation and testing.
<PAGE>
- 18 -
Integrated electric utilities are uniquely reliant on each
other to avoid, in a worst case situation, cascading failure of
the entire electrical system. The System is working with the
Edison Electric Institute (EEI), the Electric Power Research
Institute (EPRI), the North American Electric Reliability Council
(NERC), and the East Central Area Reliability Agreement group
(ECAR) to capitalize on industry-wide experiences and to
participate in industry-wide testing and contingency planning.
The effort with regard to vendors and other organizations is to
obtain reasonable assurance of their readiness to conduct
operations at the Year 2000 and beyond and, where reasonable
assurance is questionable, to develop contingency plans. Of
particular concern are telecommunications systems which are
integral to the System's electricity production and distribution
operations. While the System will develop contingency plans for
critical telecommunication needs, there can be no assurance that
the contingency plans could cope with a significant failure of
major telecommunication systems.
The Company is aware of the importance of electricity to
its service territory and its customers and is using its best
efforts to avoid any serious Y2K problems. Despite the System's
best efforts, including working with internal resources, external
vendors, and industry associations, the Company cannot guarantee
that it will be able to conduct all of its operations without Y2K
interruptions. To the extent that any Y2K problem may be
encountered, the Company is committed to resolution as
expeditiously as possible to minimize the effect.
Expenditures for Y2K readiness are not expected to have a
material effect on the Company's results of operations or
financial position primarily because of the significant time and
money expended over the past several years on upgrading and
replacing its large mainframe computer systems and software.
While the remaining Y2K work is significant, it primarily
represents an internal labor intensive effort of assessment,
remediation, and component testing for noncompliant embedded
chips in equipment, and a substantial labor intensive effort of
multiple systems testing, documentation, and working with other
parties. While outside contractors and equipment vendors will be
employed for some of the work, the Company believes it must rely
on System employees for most of the effort because of their
experience with systems and equipment. The Company currently
estimates that its incremental expenditures for the remaining Y2K
effort will not exceed $7 million.
The descriptions herein of the elements of the Company's
Y2K effort are forward-looking statements as defined in the
Private Securities Litigation Reform Act of 1995. Of necessity,
this effort is based on estimates of assessment, remediation,
testing and contingency planning activities and dates for
perceived problems not yet identified. There can be no assurance
that actual results will not materially differ from expectations.
* Environmental Issues
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
<PAGE>
- 19 -
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.
* Electric Energy Competition
Allegheny Energy is working actively within its states to
advance customer choice. However, Allegheny Energy believes that
federal legislation is necessary to ensure that electric
restructuring is implemented consistently across state and
regional boundaries so that all electric customers have an equal
opportunity to benefit from competition and customer choice by a
date certain. Federal legislation is also needed to remove
barriers to competition, including the repeal of both the Public
Utility Holding Company Act of 1935 and PURPA. Although several
restructuring bills were introduced in the House and Senate in
1998, Congress is not expected to move legislation on
restructuring this year.
<PAGE>
-20-
WEST PENN POWER COMPANY AND SUBSIDIARIES
Part II - Other Information to Form 10-Q
for Quarter Ended June 30, 1998
ITEM 1. LEGAL PROCEEDINGS
On September 29, 1997, the City of Pittsburgh filed an
antitrust and breach of contract lawsuit in the United States
District Court for the Western District of Pennsylvania against
Allegheny Power System, Inc. (now renamed Allegheny Energy,
Inc.), the Company, DQE, Inc. and Duquesne Light Company. 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 for an injunction
preventing the proposed merger between Allegheny Power System,
Inc. and DQE, Inc. 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 the federal claims for failure to
state a claim, and dismissed the state claims for lack of subject
matter jurisdiction. On January 14, 1998, the City appealed the
Order to the United States Court of Appeals for the Third
Circuit. On June 12, 1998, the United States Third Circuit Court
of Appeals affirmed the District Court's decision of January 1998
to dismiss the City of Pittsburgh's lawsuit against the Company,
Allegheny Energy, Inc., DQE, Inc., and Duquesne Light Company.
The City filed a motion for reconsideration en banc with the
Third Circuit. On July 8, 1998, the City of Pittsburgh reached a
settlement with Allegheny Energy, Inc. in the City's pursuit of
lower electric utility costs for the consumers. Under the terms
of the settlement, the City agrees to withdraw all opposition to
the proposed merger, to dismiss its motion for reconsideration in
federal court, and not to re-file any claims in state court.
Allegheny Energy, Inc. agreed to pay the City's legal fees and to
support the City's efforts to obtain favorable redevelopment zone
rates from the Pennsylvania Public Utility Commission (PUC). In
addition, if the merger is consummated, Allegheny Energy, Inc.
agreed to make a contribution of $4,000,000 to the Pittsburgh
Development Fund of the Urban Redevelopment Authority and to
maintain annual charitable giving in the City. Allegheny Energy,
Inc. also repeated in the settlement the same commitments it had
made to the PUC regarding participation in an independent system
operator and relinquishment of control of 570 MW of capacity.
On June 26, 1998, the Company filed a complaint in the
United States District Court for the Western District of
Pennsylvania challenging the PUC's interpretation and application
of the Competition Act in Pennsylvania. The Complaint alleges
various violations of federal law and the constitutional rights
of the Company. The Complaint seeks monetary relief, a
declaration that the Competition Act violates federal law and the
United States Constitution, and a permanent injunction
prohibiting the PUC from acting on its Order. Also, on June 26,
1998, the Company filed a petition for review of the PUC Order in
the Commonwealth Court of Pennsylvania, alleging numerous errors
of law and abuse of discretion by the PUC. Various other parties
have cross-appealed or intervened in the Company's case. The
Company filed a
<PAGE>
- 21 -
motion for stay with the Commonwealth Court on July 23, 1998
specifically seeking to stay the PUC's accelerated implementation
schedule for competition. On August 5, 1998, the Company
withdrew its petition for stay without prejudice based on a PUC
agreement to offer settlement discussions on issues related to
the PUC's restructuring Order.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
(27) Financial Data Schedule
(b) On April 2, 1998, the Company filed a Form 8-K concerning
the March 25, 1998, recommendations of the Pennsylvania
Administrative Law Judges (ALJs) in the Company's restructuring
case. A copy of the press release issued by Allegheny Energy,
Inc, on March 26, 1998, concerning the ALJs decision in both the
merger case and the restructuring case was filed as an exhibit.
On June 12, 1998, the Company filed a Form 8-K and a Form
8-K/A concerning the Pennsylvania Public Utility
Commission's final orders on the Company's restructuring
plan and on Allegheny Energy, Inc.'s application for
approval to merge.
On July 27, 1998, the Company filed a Form 8-K
concerning the Pennsylvania Public Utility Commission's
May 29, 1998 Order on the Company's stand-alone
restructuring plan which was denied in part and accepted
in part as to the Company's claim to stranded cost
recovery. As determined under SFAS No. 101, a write-off
of the disallowances in the PUC's Order was required.
Signature
Pursuant to the requirements 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.
WEST PENN POWER COMPANY
/s/ T. J. KLOC
T. J. Kloc, Controller
(Chief Accounting Officer)
August 14, 1998
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<PERIOD-START> JAN-01-1998
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79,708
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