<PAGE>
Page 1 of 18
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 March 31, 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 May 15, 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 March 31, 1998
Index
Page
No.
PART I--FINANCIAL INFORMATION:
Consolidated statement of income -
Three months ended March 31, 1998 and 1997 3
Consolidated balance sheet - March 31, 1998
and December 31, 1997 4
Consolidated statement of cash flows -
Three months ended March 31, 1998 and 1997 5
Notes to consolidated financial statements 6-9
Management's discussion and analysis of financial
condition and results of operations 10-16
PART II--OTHER INFORMATION 17-18
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WEST PENN POWER COMPANY AND SUBSIDIARIES
Consolidated Statement of Income
Three Months Ended
March 31
1998 1997
(Thousands of Dollars)
ELECTRIC OPERATING REVENUES:
Residential $ 102,710 $ 110,311
Commercial 54,892 56,137
Industrial 87,114 87,741
Wholesale and other, including affiliates 22,313 19,788
Bulk power transactions, net 13,674 8,553
Total Operating Revenues 280,703 282,530
OPERATING EXPENSES:
Operation:
Fuel 64,313 64,146
Purchased power and exchanges, net 30,717 31,915
Deferred power costs, net - 2,048
Other 35,239 35,892
Maintenance 22,942 27,093
Depreciation 29,340 30,454
Taxes other than income taxes 23,125 23,522
Federal and state income taxes 22,408 20,189
Total Operating Expenses 228,084 235,259
Operating Income 52,619 47,271
OTHER INCOME AND DEDUCTIONS:
Allowance for other than borrowed funds
used during construction 618 609
Other income, net 2,666 5,597
Total Other Income and Deductions 3,284 6,206
Income Before Interest Charges 55,903 53,477
INTEREST CHARGES:
Interest on long-term debt 16,365 16,247
Other interest 878 820
Allowance for borrowed funds used during
construction (341) (491)
Total Interest Charges 16,902 16,576
CONSOLIDATED NET INCOME $ 39,001 $ 36,901
See accompanying notes to consolidated financial statements.
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WEST PENN POWER COMPANY AND SUBSIDIARIES
Consolidated Balance Sheet
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
ASSETS: (Thousands of Dollars)
Property, Plant, and Equipment:
<S> <C><C> <C> <C>
At original cost, including $117,895,000
and $117,588,000 under construction $ 3,309,090 $ 3,293,039
Accumulated depreciation (1,283,036) (1,254,900)
2,026,054 2,038,139
Investments and Other Assets:
Allegheny Generating Company - common stock at equity 88,855 89,783
Other 699 721
89,554 90,504
Current Assets:
Cash and temporary cash investments 2,863 4,056
Deposit with trustee for redemption
of long-term debt 14,601 -
Accounts receivable:
Electric service, net of $13,850,000 and $13,326,000
uncollectible allowance 121,753 128,348
Affiliated and other 17,495 21,525
Materials and supplies - at average cost:
Operating and construction 34,133 34,212
Fuel 32,682 29,467
Prepaid taxes 35,383 11,738
Other 981 14,211
259,891 243,557
Deferred Charges:
Regulatory assets 341,914 333,235
Unamortized loss on reacquired debt 9,672 9,725
Other 24,577 31,999
376,163 374,959
Total Assets $ 2,751,662 $ 2,747,159
CAPITALIZATION AND LIABILITIES:
Capitalization:
Common stock $ 465,994 $ 465,994
Other paid-in capital 55,475 55,475
Retained earnings 457,934 475,558
979,403 997,027
Preferred stock 79,708 79,708
Long-term debt and QUIDS 803,962 802,319
1,863,073 1,879,054
Current Liabilities:
Short-term debt 71,388 52,046
Long-term debt due within one year 116,435 103,500
Notes payable to affiliates 600 -
Accounts payable 68,433 73,584
Accounts payable to affiliates 26,524 16,137
Taxes accrued:
Federal and state income 18,735 1,605
Other 9,220 22,728
Interest accrued 13,408 15,817
Other 27,082 28,457
351,825 313,874
Deferred Credits and Other Liabilities:
Unamortized investment credit 44,561 45,206
Deferred income taxes 433,538 450,390
Regulatory liabilities 33,964 34,326
Other 24,701 24,309
536,764 554,231
Total Capitalization and Liabilities $ 2,751,662 $ 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>
Three Months Ended
March 31
1998 1997
(Thousands of Dollars)
CASH FLOWS FROM OPERATIONS:
<S> <C> <C>
Consolidated net income $ 39,001 $ 36,901
Depreciation 29,340 30,454
Deferred investment credit and income taxes, net 1,691 2,539
Deferred power costs, net - 2,048
Unconsolidated subsidiaries' dividends in excess of earnings 950 1,183
Allowance for other than borrowed funds used
during construction (618) (609)
Restructuring liability (3,547) (6,302)
Changes in certain current assets and
liabilities:
Accounts receivable, net 10,625 (1,510)
Prepaid taxes (23,645) (10,111)
Materials and supplies (3,136) (7,239)
Accounts payable 5,236 (1,675)
Taxes accrued 3,622 (7,371)
Interest accrued (2,409) (1,669)
Other, net (3,628) 11,863
53,482 48,502
CASH FLOWS FROM INVESTING:
Construction expenditures (less allowance for
equity funds used during construction) (17,825) (18,881)
CASH FLOWS FROM FINANCING:
Issuance of long-term debt 15,935 -
Retirement of long-term debt (1,500) -
Deposit with trustee for redemption
of long-term debt (14,601) -
Short-term debt, net 19,342 28,313
Notes payable to affiliates 600 -
Notes receivable from affiliates - 2,900
Dividends on capital stock:
Preferred stock (838) (839)
Common stock (55,788) (58,711)
(36,850) (28,337)
NET CHANGE IN CASH AND TEMPORARY CASH INVESTMENTS (1,193) 1,284
Cash and Temporary Cash Investments at January 1 4,056 5,160
Cash and Temporary Cash Investments at March 31 $ 2,863 $ 6,444
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) $17,842 $17,579
Income taxes 3,802 -
</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 (which consist only of normal
recurring adjustments) necessary to present fairly the
Company's financial position as of March 31, 1998, and the
results of operations and cash flows for the three months
ended March 31, 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 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
March 31
1998 1997
(Thousands of Dollars)
Electric operating revenues $18,604 $20,216
Operation and maintenance expense 953 1,285
Depreciation 4,226 4,284
Taxes other than income taxes 1,160 1,195
Federal income taxes 2,865 3,124
Interest charges 3,513 3,960
Other income, net (50) -
Net income $ 5,937 $ 6,368
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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 March 31,
1998 and 1997, respectively, and was included in other
income, net, on the Consolidated Statement of Income.
4. 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).
On March 25, 1998, the Maryland Public Service Commission
(PSC) approved a settlement agreement between 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 April 30, 1998, the Pennsylvania Public Utility Commission
(PUC) adopted a motion (the "Order") approving the merger
subject to a condition precedent that the merged entity joins
a Federal Energy Regulatory Commission (FERC) approved, fully
functioning Independent System Operator (ISO). The Order
specifically approved the Midwest ISO as satisfying the
condition precedent provided it was FERC approved and fully
functioning. Allegheny Energy has joined the Midwest ISO,
contingent only on merger consummation, but it is not
projected to be FERC approved and fully functioning until on
or after January 1, 2000. The Order also noted that the
Pennsylvania, New Jersey, Maryland, L.L.C. ISO (PJM ISO)
might also satisfy the pre-condition but that it would
require an updated study and analysis be submitted to the
PUC. The PJM ISO is FERC approved and fully functioning.
The PUC Order noted that the merger would produce substantial
savings and further noted that an 18-month delay recommended
by two Administrative Law Judges (ALJs) in their recommended
decision of March 25, 1998, was not in the public interest.
Allegheny Energy is dismayed that the PUC nevertheless
imposed a condition precedent that could impose a delay
likely to be as long or longer than recommended by the ALJs.
Upon official entry of the PUC's Order, Allegheny Energy is
likely to file a motion for reconsideration to allow the
merger to go forward immediately as it has already joined the
Midwest ISO and has already pledged sufficient interim
mitigation measures until the Midwest ISO is functioning,
including temporary relinquishment of control of 570
megawatts of generation to mitigate market power concerns.
Allegheny Energy may also propose additional interim
mitigation measures. Allegheny Energy is also exploring
further the PJM ISO. Allegheny Energy believes the merger is
unlikely to be completed if the pre-condition in the Order
actually imposes significant delay.
The Nuclear Regulatory Commission (NRC) 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.
Merger-related decisions are expected by the end of the
second quarter from the FERC, the Department of
Justice/Federal Trade Commission, and the Securities and
Exchange Commission. Allegheny Energy is also filing for
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review of certain merger-related activities with the Public
Service Commission of West Virginia and the Virginia State
Corporate Commission.
All of the Company's incremental costs of the merger process
($5.8 million through March 31, 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,
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 utility affiliates share capacity,
energy, capacity reserves, and 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.
On April 30, 1998, the PUC, in a non-binding polling,
outlined a restructuring plan for the Company. Under the non-
binding polling, the Company would provide residential
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 will vary from one rate class to another and
will increase over the transition period. According to the
polling, the Company is allowed to collect $524 million in
stranded costs over seven years, starting in January 1999,
through a CTC. In its restructuring application, the Company
had requested $1.6 billion in stranded costs. Stranded costs
are costs incurred under a regulated environment which are
not recoverable in a competitive market. The PUC polling
indicated that 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 FERC regulated rates. Allegheny Energy and the
Company believe that the $524 million of stranded costs
recommended for recovery is inadequate and financially
harmful to the Company. The non-binding polling of the PUC
is a preliminary step leading up to a final order on the
Company's restructuring plan expected May 21, 1998. If the
PUC's final order remains as financially harmful as the
polling, the Company plans to seek redress through
reconsideration by the PUC and/or full judicial review and/or
legislative revision of the Customer Choice Act.
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6. 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 establishes such a process, the
Company has determined that it will be required to
discontinue use of SFAS No. 71 for the generation portion of
its business on May 21, 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, but it may be required to write off significant
unrecoverable regulatory assets, impaired assets, and
uneconomic commitments.
7. For the most part, regulatory assets and liabilities are not
included in rate base. Income tax regulatory
assets/(liabilities), net of $248 million at March 31, 1998,
are primarily related to investments in electric facilities.
The portion related to transmission and distribution
facilities will be recovered over periods of from 20 to 40
years under the expected continuing regulated transmission
and distribution business. The portion related to generation
business in Pennsylvania has been included in the Company's
stranded costs for CTC recovery. The remaining recovery
period for items other than income taxes is from three to
seven years in businesses that remain subject to regulation.
The final decision by the PUC related to recovery of the
Company's stranded costs, as filed in its restructuring
application, is expected May 21, 1998.
8. 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 March 31, 1998, is not materially different
from book value.
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WEST PENN POWER COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
COMPARISON OF FIRST QUARTER OF 1998 WITH FIRST QUARTER OF 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 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. 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 the First Quarter of 1998
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 issuance of stock for the merger
with DQE, Inc. (DQE). This action was requested in connection
with the proposed issuance of Allegheny Energy stock to exchange
for DQE stock to complete the merger. Thereafter, the Nuclear
Regulatory Commission approved the transfer of control of the
operating licenses for Duquesne Light Company's (Duquesne) Beaver
Valley Unit No.'s 1 and 2 and Perry Unit No. 1 nuclear plants as
required for the proposed merger between Allegheny Power System,
Inc. and DQE, parent company of Duquesne. Duquesne will still be
the licensee, but the approval was necessary since control of
Duquesne after the merger will pass from DQE to Allegheny Energy.
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On April 30, 1998, the Pennsylvania Public Utility
Commission (PUC) adopted a motion (the "Order") approving the
merger subject to a condition precedent that the merged entity
joins a Federal Energy Regulatory Commission (FERC) approved,
fully functioning Independent System Operator (ISO). The Order
specifically approved the Midwest ISO as satisfying the condition
precedent provided it was FERC approved and fully functioning.
Allegheny Energy has joined the Midwest ISO, contingent only on
merger consummation, but it is not projected to be FERC approved
and fully functioning until on or after January 1, 2000. The
Order also noted that the Pennsylvania, New Jersey, Maryland,
L.L.C. ISO (PJM ISO) might also satisfy the pre-condition but
that it would require an updated study and analysis be submitted
to the PUC. The PJM ISO is FERC approved and fully functioning.
The PUC Order noted that the merger would produce substantial
savings and further noted that an 18-month delay recommended by
two Administrative Law Judges (ALJs) in their recommended
decision of March 25, 1998, was not in the public interest.
Allegheny Energy is dismayed that the PUC nevertheless imposed a
condition precedent that could impose a delay likely to be as
long or longer than recommended by the ALJs. Upon official entry
of the PUC's Order, Allegheny Energy is likely to file a motion
for reconsideration to allow the merger to go forward immediately
as it has already joined the Midwest ISO and has already pledged
sufficient interim mitigation measures until the Midwest ISO is
functioning, including temporary relinquishment of control of 570
megawatts of generation to mitigate market power concerns.
Allegheny Energy may also propose additional interim mitigation
measures. Allegheny Energy is also exploring further the PJM
ISO. Allegheny Energy believes the merger is unlikely to be
completed if the pre-condition in the Order actually imposes
significant delay.
On April 30, 1998, the PUC, in a non-binding polling,
outlined a restructuring plan for the Company. Under the non-
binding polling, the Company would provide residential 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 will vary from one rate class to another and will
increase over the transition period. According to the polling,
the Company is allowed to collect $524 million in stranded costs
over seven years, starting in January 1999, through a Competitive
Transition Charge (CTC). In its restructuring application, the
Company had requested $1.6 billion in stranded costs. Stranded
costs are costs incurred under a regulated environment, which are
not recoverable in a competitive market. The PUC polling
indicated that 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 FERC regulated rates. Allegheny Energy and the Company
believe that the $524 million of stranded costs recommended for
recovery is inadequate and financially harmful to the Company.
The non-binding polling of the PUC is a preliminary step leading
up to a final order on the Company's restructuring plan expected
May 21, 1998. If the PUC's final order remains as financially
harmful as the polling, the Company plans to seek redress through
reconsideration by the PUC and/or full judicial review and/or
legislative revision of the Customer Choice Act.
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Review of Operations
EARNINGS SUMMARY
Consolidated net income for the first quarter of 1998 was
$39.0 million compared with $36.9 million for the corresponding
1997 period. The increase in consolidated net income for the
first quarter of 1998 was achieved by continuing efforts to
reduce operations and maintenance (O&M) expense and also due to 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. Consolidated net income
increased despite the 1998 first quarter weather which was 15%
warmer than 1997 and 22% warmer than normal as measured by
heating degree days and was the warmest in more than 100 years.
SALES AND REVENUES
Total operating revenues for the first quarter of 1998
and 1997 were as follows:
Three Months Ended
March 31
1998 1997
(Millions of Dollars)
Operating revenues:
Bundled retail sales $243.1 $255.9
Unbundled retail sales 3.6 -
Wholesale and other, excluding bundled
street lighting sales 20.3 18.0
Utility bulk power, including transmission
services 13.7 8.6
Total operating revenues $280.7 $282.5
The decrease in bundled retail sales (full service sales
to retail customers) 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 revenue 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
must choose a generation supplier other than their own local
franchise utility. As a result, up to 5% of previously fully
bundled customers were able to participate in the Pennsylvania
pilot program and were allowed to buy energy from a supplier of
their choice. The pilot programs began on November 1, 1997, and
will continue through December 31, 1998. Unbundled retail sales
revenues represents 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 will reach agreement with an alternate supplier as to
the price for energy. The credit established by the PUC is
artificially high (greater than the Company's generation costs),
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
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compliance filing and thus has indicated its intent to treat the
revenue losses as a regulatory asset. Wholesale and other
includes an accrual of such revenue losses, 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 was due primarily
to $1.9 million of deferred net revenue losses recorded as a
regulatory asset to offset revenue losses suffered as a result of
the pilot.
The increase in utility bulk power, including
transmission services, is due primarily to pilot-related sales of
energy to Pennsylvania pilot customers of other utilities and
marketers.
OPERATING EXPENSES
Fuel expenses for the first quarter remained relatively
unchanged from the previous quarter. 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
March 31
1998 1997
(Millions of Dollars)
Nonaffiliated transactions:
Purchased power:
From PURPA generation* $16.5 $16.7
Other 4.1 3.8
Power exchanges, net 1.4 1.8
Affiliated transactions:
AGC capacity charges 7.9 8.8
Energy and spinning reserve charges .8 .8
Purchased power and exchanges, net $30.7 $31.9
*PURPA cost (cents per kWh) 5.8 6.1
None of the Company's purchased power contracts are
capitalized since there are no minimum payment requirements
absent associated kWh generation and under a regulated
environment recovery of the costs are reasonably assured.
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The $.7 million decrease in other operation expense
resulted primarily from a $2 million decrease to expense related
to a reversal of a portion of the remaining restructuring
liability. This decrease was offset in part by $1.6 million of
increased expenses related to the Pennsylvania pilot and
competition.
Maintenance expenses decreased $4.2 million for the first
quarter due primarily to reduced expenses achieved through
restructuring efforts and other cost controls. Maintenance
expenses represent costs incurred to maintain the power stations,
the transmission and distribution (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 in the first quarter decreased $1.1
million 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 net increase in federal and state income taxes
resulted primarily from an increase in income before taxes.
Other income, net, decreased $2.9 million primarily due
to the gain on a sale of land by the Company's subsidiary, West
Virginia Power & Transmission Company in the first quarter of
1997.
Financial Condition and Requirements
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 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 and 5 to the Consolidated Financial Statements for
information about merger activities and the Pennsylvania Customer
Choice Act.
The Financial Accounting Standards Board's Statement of
Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of", establishes standards for impairment of long-lived
assets and certain identifiable intangibles and requires
companies to recognize an impairment loss if the expected future
undiscounted cash flows are less than the carrying value of an
asset. Due in part to the evolving process of the electric
utility industry in the United States changing from a
historically regulated monopolistic market to a competitive
marketplace, the competitive market price of energy and the
resultant undiscounted cash flows could be less than the carrying
value of
<PAGE>
- 15 -
power stations. If that were to occur, an impairment loss would
be required to be recognized in an amount by which the book value
of the power stations exceeded their market value. As part of
the final PUC Order expected on May 21, 1998, the PUC will make a
final decision as to the amount of stranded costs allowed to be
recovered by the Company through a CTC. At its non-binding
polling on April 30, 1998, the PUC indicated a plan for the
Company to recover $524 million of the $1.6 billion of stranded
costs requested by the Company in its restructuring filing. In
its final order, if the PUC does not increase the proposed $524
million of stranded costs that the Company would be allowed to
recover, the resultant decrease in future undiscounted cash flows
related to energy recovery associated with the power stations may
become less than the book value of the Company's power stations.
In that event, an asset impairment loss would be required to be
recognized. Dependent upon the May 21, 1998, final PUC order
associated with the amount of the Company's stranded costs
approved for future recovery, the Company may need to record an
impairment loss in the second quarter of 1998 to write-down the
book value of its power stations. The Company and its parent,
Allegheny Energy, are currently evaluating the Company's power
station assets for potential impairment, contingent upon the
expected May 21, 1998, final PUC Order. Allegheny Energy and the
Company are also evaluating the possibility that a write-off may
also be required for unrecoverable regulatory assets and the
excess costs of a PURPA project if the May 21 Order remains
substantially similar to the polling.
The Company uses 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 March 31, 1998, the trading books of the Company
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 1998, the Company 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.
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.
<PAGE>
- 16 -
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 liabilities and insurance recoveries are such that
final resolution of these claims will not have a material effect
on its financial position.
Allegheny Energy is working actively within its states to
advance customer choice. However, it 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 Public Utility Holding Company Act of 1935 and
PURPA.
In late March, on the federal level, the Clinton
Administration outlined its electricity deregulation proposal in
a set of "principles" for Congress. The proposal sets January 1,
2003, as the start date for customer choice. States that have
already deregulated would be allowed to maintain the structures
they have created, and low-cost states could opt out if they
believe their consumers would not benefit from competition.
<PAGE>
- 17 -
WEST PENN POWER COMPANY AND SUBSIDIARIES
Part II - Other Information to Form 10-Q
for Quarter Ended March 31, 1998
ITEM 1. 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 of Pennsylvania against Allegheny Power
System, 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 that the proposed
merger between Allegheny Power System, Inc. and DQE, Inc. 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. Allegheny Energy and the Company cannot predict the
outcome of this appeal.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDER
1. (a) Date and Kind of Meeting:
The annual meeting of shareholders was held at
Greensburg, Pennsylvania, on April 15, 1998. No
proxies were solicited.
(b) Election of Directors:
The holder of all 24,361,586 shares of common stock
voted to elect the following Directors at the annual
meeting to hold office until the next annual meeting
of shareholders and until their successors are duly
chosen and qualified:
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
<PAGE>
- 18 -
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
(27) Financial Data Schedule
(b) On March 23, 1998, the Company filed a Form 8-K
concerning the Senior Officer Separation Plan which may
be offered to certain of its officers after consummation
of the merger between Allegheny Energy, Inc. and DQE,
Inc. At the Company's December 4, 1997, Board of
Directors Meeting, the Board approved the Separation
Plan.
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)
May 15, 1998
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