<PAGE>
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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 September 30, 1997
Commission File Number 1-267
ALLEGHENY ENERGY, INC.
(Exact name of registrant as specified in its charter)
Maryland 13-5531602
(State of Incorporation) (I.R.S. Employer Identification No.)
10435 Downsville Pike, Hagerstown, Maryland 21740-1766
Telephone Number - 301-790-3400
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 November 13, 1997, 122,436,317 shares of the Common Stock
($1.25 par value) of the registrant were outstanding.
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ALLEGHENY ENERGY, INC.
Form 10-Q for Quarter Ended September 30, 1997
Index
Page
No.
PART I--FINANCIAL INFORMATION:
Consolidated statement of income -
Three and nine months ended September 30, 1997 and 1996 3
Consolidated balance sheet - September 30, 1997
and December 31, 1996 4
Consolidated statement of cash flows -
Nine months ended September 30, 1997 and 1996 5
Notes to consolidated financial statements 6-12
Management's discussion and analysis of financial
condition and results of operations 13-19
PART II--OTHER INFORMATION 20-21
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ALLEGHENY ENERGY, INC.
Consolidated Statement of Income
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1997 1996 1997 1996
(Thousands of Dollars)
ELECTRIC OPERATING REVENUES:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Residential $ 208,938 $ 211,160 $ 663,052 $ 704,824
Commercial 128,259 125,416 366,395 370,417
Industrial 186,996 182,874 555,113 563,201
Wholesale and other 18,223 17,900 55,300 56,017
Bulk power transactions, net 52,709 16,640 112,995 58,494
Total Operating Revenues 595,125 553,990 1,752,855 1,752,953
OPERATING EXPENSES:
Operation:
Fuel 143,901 126,109 417,643 388,857
Purchased power and exchanges, net 52,950 39,525 147,299 134,198
Deferred power costs, net 587 (2,223) (6,366) 19,995
Other 78,872 76,793 223,560 219,531
Maintenance 51,679 59,193 172,966 178,530
Restructuring charges and asset write-off - 7,981 - 72,162
Depreciation 69,224 66,231 206,760 198,774
Taxes other than income taxes 45,867 46,115 141,715 140,885
Federal and state income taxes 41,410 34,348 119,076 101,620
Total Operating Expenses 484,490 454,072 1,422,653 1,454,552
Operating Income 110,635 99,918 330,202 298,401
OTHER INCOME AND DEDUCTIONS:
Allowance for other than borrowed funds
used during construction 1,033 604 3,309 1,262
Other income, net 11,125 1,688 15,705 2,175
Total Other Income and Deductions 12,158 2,292 19,014 3,437
Income Before Interest Charges and
Preferred Dividends 122,793 102,210 349,216 301,838
INTEREST CHARGES AND PREFERRED DIVIDENDS:
Interest on long-term debt 43,428 40,928 130,362 123,691
Other interest 3,233 3,743 10,852 11,929
Allowance for borrowed funds used during
construction (1,010) (1,025) (3,040) (2,180)
Dividends on preferred stock of subsidiaries 2,334 2,337 6,960 6,967
Total Interest Charges and
Preferred Dividends 47,985 45,983 145,134 140,407
CONSOLIDATED NET INCOME $ 74,808 $ 56,227 $ 204,082 $ 161,431
COMMON STOCK SHARES OUTSTANDING (average) 122,430,327 121,283,162 122,131,679 120,998,676
EARNINGS PER AVERAGE SHARE $0.61 $0.46 $1.67 $1.33
</TABLE>
See accompanying notes to consolidated financial statements.
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ALLEGHENY ENERGY, INC.
Consolidated Balance Sheet
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
(Thousands of Dollars)
ASSETS:
Property, Plant, and Equipment:
<S> <C> <C>
At original cost, including $198,547,000
and $202,259,000 under construction $ 8,349,440 $ 8,206,213
Accumulated depreciation (3,114,171) (2,910,022)
5,235,269 5,296,191
Investments and Other Assets:
Subsidiaries consolidated--excess of cost
over book equity at acquisition 15,077 15,077
Benefit plan's investments 65,752 63,197
Nonutility investments 6,403 2,791
Other 1,554 1,568
88,786 82,633
Current assets:
Cash and temporary cash investments 42,219 19,242
Accounts receivable:
Electric service, net of $12,455,000 and
$15,052,000 uncollectible allowance 252,299 280,154
Other 9,896 22,188
Materials and supplies--at average cost:
Operating and construction 83,284 82,057
Fuel 71,040 60,755
Prepaid taxes 57,885 62,110
Deferred income taxes 6,486 39,428
Other 28,652 16,324
551,761 582,258
Deferred Charges:
Regulatory assets 547,773 565,185
Unamortized loss on reacquired debt 50,513 53,403
Other 62,000 38,840
660,286 657,428
Total Assets $ 6,536,102 $ 6,618,510
CAPITALIZATION AND LIABILITIES:
Capitalization:
Common stock $ 153,045 $ 152,300
Other paid-in capital 1,044,085 1,028,124
Retained earnings 1,035,202 988,667
2,232,332 2,169,091
Preferred stock 170,086 170,086
Long-term debt and QUIDS 2,205,804 2,397,149
4,608,222 4,736,326
Current Liabilities:
Short-term debt 111,040 156,430
Long-term debt due within one year 182,400 26,900
Accounts payable 122,160 147,161
Taxes accrued:
Federal and state income 2,028 7,173
Other 53,141 62,361
Interest accrued 43,092 40,630
Restructuring liability 8,622 56,101
Other 74,185 80,281
596 668 577 037
Deferred Credits and Other Liabilities:
Unamortized investment credit 135,367 141,519
Deferred income taxes 1,010,623 1,000,023
Regulatory liabilities 107,565 93,216
Other 77,657 70,389
1,331,212 1,305,147
Total Capitalization and Liabilities $ 6,536,102 $ 6,618,510
</TABLE>
See accompanying notes to consolidated financial statements.
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ALLEGHENY ENERGY, INC.
Consolidated Statement of Cash Flows
<TABLE>
<CAPTION>
Nine Months Ended
September 30
1997 1996
(Thousands of Dollars)
CASH FLOWS FROM OPERATIONS:
<S> <C> <C>
Consolidated net income $ 204,082 $ 161,431
Depreciation 206,760 198,774
Deferred investment credit and income taxes, net 46,698 (16,830)
Deferred power costs, net (6,366) 19,995
Allowance for other than borrowed funds used
during construction (3,309) (1,262)
Restructuring liability (47,479) 40,154
Asset write-off - 10,762
Changes in certain current assets and
liabilities:
Accounts receivable, net 40,147 50,762
Materials and supplies (11,512) 17,317
Accounts payable (25,001) (29,921)
Taxes accrued (14,365) 7,146
Interest accrued 2,462 1,549
Other current assets/liabilities 6,260 19,588
Other, net 12,562 1,540
410,939 481,005
CASH FLOWS FROM INVESTING:
Utility construction expenditures (less allowance
for equity funds used during construction) (161,226) (168,890)
Nonutility investment (3,613) (1,667)
(164,839) (170,557)
CASH FLOWS FROM FINANCING:
Sale of common stock 16,706 25,517
Retirement of long-term debt (36,892) (66,686)
Short-term debt, net (45,390) (102,357)
Cash dividends on common stock (157,547) (152,448)
(223,123) (295,974)
NET CHANGE IN CASH AND TEMPORARY CASH INVESTMENTS 22,977 14,474
Cash and Temporary Cash Investments at January 1 19,242 3,867
Cash and Temporary Cash Investments at September 30 $ 42,219 $ 18,341
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) $135,324 $124,835
Income taxes 87,071 97,631
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See accompanying notes to consolidated financial statements.
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ALLEGHENY ENERGY, INC.
Notes to Consolidated Financial Statements
1. The Company's Notes to Consolidated Financial Statements in
the Allegheny Power System companies' combined Annual Report
on Form 10-K for the year ended December 31, 1996, should be
read with the accompanying financial statements and the
following notes. With the exception of the December 31,
1996, 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 September 30, 1997, the results of operations for the
three and nine months ended September 30, 1997 and 1996, and
cash flows for the nine months ended September 30, 1997 and
1996.
2. The Company owns all of the outstanding common stock of its
subsidiaries. The consolidated financial statements include
the accounts of the Company and all subsidiary companies
after elimination of intercompany transactions. Allegheny
Generating Company is jointly (100%) owned by the Company's
operating subsidiaries and thus is among the subsidiaries
fully consolidated into the financial statements of Allegheny
Energy, Inc.
3. 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.
4. On April 7, 1997, the Company and DQE, Inc. (DQE), parent
company of Duquesne Light Company in Pittsburgh,
Pennsylvania, announced that they have agreed to merge in a
tax-free, stock-for-stock transaction. The combined company
will be called Allegheny Energy, Inc. (Allegheny Energy). It
is expected that Allegheny Energy will continue to be
operated as an integrated electric utility holding company
and that the regulated electric utility companies will
continue to exist as separate legal entities, including
Duquesne Light Company.
The merger is conditioned, among other things, upon the
approval of each company's shareholders, the Pennsylvania
Public Utility Commission (PUC), the Securities and Exchange
Commission (SEC), the Federal Energy Regulatory Commission
(FERC), the Nuclear Regulatory Commission (NRC), and the
Department of Justice/Federal Trade Commission under the
Hart, Scott, Rudino legislation. Additionally, the Company
has requested the Maryland Public Service Commission (PSC) to
indicate its approval of the issuance of additional Company
stock to accomplish the transaction. The companies have
established a schedule to obtain all regulatory approvals by
June 1, 1998. On May 2, 1997, the Company filed a
registration statement with the
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SEC on Form S-4 containing a joint proxy statement/prospectus
with DQE concerning the merger and the transactions
contemplated thereby. In late June, the S-4 became effective
allowing the Company and DQE to pursue shareholder approval
for the proposed merger that would create Allegheny Energy.
The Company and DQE each held a separate shareholder meeting
on August 7, 1997, at which the combination of the two
companies was decisively approved by the shareholders of both
companies. At the Company's meeting, the shareholders also
decisively approved the change in the Company's name to
Allegheny Energy, Inc.
On August 1, 1997, the Company and DQE jointly filed requests
for merger approval with the PUC and FERC, DQE filed the
necessary approval requests with the NRC, and the Company
filed its request with the PSC for approval to issue the
Company stock. The PUC has established a schedule of
proceedings which is expected to result in an approval order
by the end of May 1998. The FERC has not scheduled hearings.
Absent such hearings, the Company expects a FERC order on or
before the end of May 1998. The PSC instituted a proceeding
against The Potomac Edison Company, the Company's Maryland
public utility subsidiary, to examine the effect of the
merger on Maryland customers for which a final determination
is expected by May 1, 1998.
On September 16, 1997, the Company officially changed its
name to Allegheny Energy, Inc. by filing the appropriate
papers in Maryland. The Company began trading on the New
York Stock Exchange under its new symbol, AYE, on October 1,
1997.
On September 29, 1997, the City of Pittsburgh filed an
antitrust and conspiracy lawsuit in Federal District Court
for the Western District of Pennsylvania against the Company,
West Penn, DQE, and Duquesne Light Company. The verified
complaint alleges eight counts, two of which are claimed
violations of the federal antitrust statutes and six are
state law claims. The relief sought includes a request that
the proposed merger between the Company and DQE be stopped,
and a request for unspecified monetary damages relating to
alleged collusion by the two companies in their actions
dealing with proposals to provide electric service to the
city's redevelopment zones. On October 27, 1997, the
Company, West Penn, DQE, and Duquesne Light Company filed
motions to dismiss the complaint. While the Company cannot
predict the outcome of this action, it believes the suit is
without merit.
5. In December 1996, Pennsylvania enacted the Electric
Generation Customer Choice and Competition Act (Customer
Choice Act) to restructure the electric industry in
Pennsylvania in order to create retail access to a
competitive electric energy market. Major provisions of the
legislation are:
- Customer choice for electric energy supply to be phased in
beginning with one-third of customers on January 1, 1999, two-
thirds the next year, and all customers beginning January 1,
2001.
- Transmission and distribution rates remain regulated and are
capped until July 1, 2001. Generation rates are capped until the
customer receives market-based energy service.
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- Pennsylvania utilities will be permitted to recover the
amount of stranded costs approved by the PUC.
On August 1, 1997, in combination with the Company's merger
approval filing, the Company's Pennsylvania subsidiary, West
Penn Power Company (West Penn), filed with the PUC a
comprehensive stand-alone restructuring plan to implement
full customer choice of electric generation suppliers as
required by the Customer Choice Act. The filing included an
unbundling of West Penn's electric service rates into their
generation, transmission and distribution components, a plan
for eventual replacement of the existing Power Supply
Agreement (PSA) under which the Company's existing three
utility subsidiaries share capacity, energy, capacity
reserves and transmission resources with a more efficient
structure, and a plan for recovery of stranded costs through
a Competitive Transition Charge (CTC).
Recovery of stranded costs is a key issue. West Penn listed
its stranded costs exposure as about $2 billion (a January 1,
1999 present value amount), composed of $1.1 billion for
generation plant investment in excess of estimated market
prices, $760 million of existing and potential nonutility
generation (NUG) contracts in excess of market prices, and
$170 million of regulatory assets and transition costs. In
accordance with West Penn's interpretation of the
legislation, the $2 billion estimate is based on a forecast
of future revenue requirements, market prices, and
assumptions about future costs to be incurred. To avoid the
problems associated with estimating future market prices,
West Penn included as part of its restructuring plan a
proposal to reset the CTC on a year-to-year basis based on
actual market prices of electricity sales in its area.
Because of the restrictions imposed by the capped rates, West
Penn's stranded cost recovery could be restricted to about
$1.2 billion (in January 1, 1999 present value dollars),
absent further action by the PUC as allowed by the Customer
Choice Act. Based on the estimates and projections
supporting the stranded cost exposure of about $2 billion,
the remaining $800 million would be reflected as lower cash
flow to West Penn after the year 2005 than would have
occurred with continued regulated rates.
The PUC has established a schedule of proceedings for the
restructuring plan concurrent with the merger proceedings,
under which it would issue an order on the filing by the end
of May 1998. This order will include a determination of West
Penn's rates for transmission and distribution services
beginning January 1, 1999, generation rates for customers who
take regulated generation service during the transition
period (potentially 1999 through 2005 if customers so
choose), and the CTC West Penn will be allowed to charge
through the transition period. While West Penn cannot
predict the outcome of the restructuring proceedings and the
transition process, it believes that, as the lowest cost
utility in the state, recovery of stranded costs should be
allowed to maintain its financial viability as provided by
the Customer Choice Act.
Nevertheless, depending upon the outcome of the proceedings
and future events affecting stranded costs and mitigation,
West Penn's future earnings could be adversely affected.
Such adverse effects could be avoided through future action
of the PUC as allowed by the Customer Choice Act, or by
mitigation of future costs.
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6. Pursuant to the Customer Choice Act, all electric utilities
in Pennsylvania are required to establish and administer
retail access pilot programs, under which customers
representing 5% of the load of each rate class must choose a
generation supplier other than their local franchise utility.
The pilot programs will begin on November 1, 1997 and will
continue until January 1, 1999. To accomplish the 5% pilot
requirement, West Penn solicited customers to sign up for the
program and then, through a lottery, selected about 33,000
participants from those who responded.
As ordered by the PUC, participants will receive an energy
credit to their bills from their local utility (for example,
3.45 cents per kWh for residential customers in West Penn's case),
and will reach agreement with an alternate supplier as to
their price for energy. The savings to West Penn's customers
will be the difference between the alternate supplier's price
and West Penn's credit. In order to assure participation in
the pilot program, the credit established by the PUC is
artificially high (greater than West Penn's energy costs)
with the result that West Penn has estimated it could suffer
a loss of up to about $30 million for the 14-month pilot
period. West Penn will attempt to mitigate the loss by
competing for sales to pilot participants of other utilities
as an alternate supplier. Because of the potential loss,
West Penn petitioned the PUC to reconsider the amount of the
credit and to modify its pilot program order to include more
specific language to make clearer its intent to permit
deferral of such net losses for recovery through distribution
rates at the end of the rate cap period. Although the
Commission has not ruled on this petition, the Commission has
approved the Company's pilot compliance filing and thus has
indicated its intent to treat the losses, offset by sales of
energy freed up by customers choosing another supplier, as a
regulatory asset subject to review and potential rate
recovery. It should be noted that the credit only applies to
the pilot program through December 31, 1998. Beginning
January 1, 1999, customers will no longer receive a credit.
Rather, as they move to competition, they will pay the
generation billing they negotiate with the energy supplier
they choose as well as the transmission and distribution
charges and the CTC charge from their franchise utility.
Under the PUC's pilot program procedures, all companies who
wish to compete as alternate electricity suppliers are
required to be approved by the PUC as licensed suppliers
through a filing and registration process. West Penn filed
for and obtained PUC approval under the brand name of
Allegheny Power as an alternate supplier to the pilot
participating customers of all electric utilities in the
state other than its own. Under the pilot rules, West Penn
is not permitted to sell energy to its own 33,000 customers
who chose to participate in the pilot. Accordingly, West
Penn has created a sales force and is incurring advertising
and other expenditures in order to compete for electricity
sales in Pennsylvania to the 5% of Pennsylvania customers of
other utilities who have the right to choose their supplier
under the pilot program.
Separately and independent of West Penn's sales efforts, the
Company has formed Allegheny Energy Solutions, Inc., a new
unregulated company that is also licensed with the PUC as an
alternate supplier in Pennsylvania's pilot program.
Allegheny Energy Solutions, Inc. has its own independent
sales staff and its own advertising program, and is a
competitor of West Penn. Because it is an independent,
unregulated company, Allegheny Energy
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Solutions, Inc. is permitted to sell to all Pennsylvania
customers participating in the pilot, including West Penn's
33,000 customers.
7. 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) 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, West Penn
has determined that it will be required to discontinue use of
SFAS 71 for the generation portion of its business on or
before the end of May 1998, the date by which the PUC must
issue its order on West Penn's comprehensive restructuring
plan. One of the conclusions of the EITF is that after
discontinuing SFAS 71, utilities should continue to carry on
their books the assets and liabilities recorded under SFAS 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 a definitive process for
transition to deregulation and market-based pricing for
electric generation in Pennsylvania, which includes
continuing cost-of-service based ratemaking for transmission
and distribution services, subject to a rate cap. The Act
provides for a non-bypassable CTC to give utilities the
opportunity to recover their stranded costs over the
transition period.
Because of these circumstances, West Penn believes that
discontinuance of the application of SFAS 71 to the
generation portion of its business will not have a material
adverse effect on its financial condition and that it will
not be required to write-off any material assets.
8. In preparation for retail competition in Pennsylvania, West
Penn filed a petition on February 28, 1997 with the PUC
asking for permission to zero its Energy Cost Rate (ECR) and
state tax surcharge tariffs and to roll energy costs and
state tax adjustments into base rates, effective May 1, 1997.
On April 24, 1997, the PUC approved West Penn's request.
West Penn's petition was necessitated by the passage of the
Customer Choice Act, which capped electric rates in
Pennsylvania as of January 1, 1997. Prior to May 1, 1997,
changes in West Penn's costs of fuel, purchased power, and
certain other costs, and changes in revenues from sales to
other utilities, including transmission services, were passed
on to customers by adjustment to customer bills through the
ECR with the result that such changes had no effect on net
income. Effective May 1, 1997, such changes in costs and
revenues will affect West Penn's earnings.
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9. On August 26, 1997, West Penn announced that it had agreed to
buy-out and settle a disputed obligation with the developers
of a proposed power plant to be built in Milesburg,
Pennsylvania, reducing costs to customers over the proposed
30-year life of the project by an estimated $500 million.
The disputed obligation under the Public Utility Regulatory
Policies Act (PURPA) would have required West Penn to buy 43
megawatts of capacity and energy over a 30-year period at
prices well above market price estimates. Under the terms of
the agreement, West Penn agreed to a one-time buy-out payment
of $15 million, plus approximately $.3 million of interest,
subject to approval by the PUC to allow the payment to be
offset against a residual balance of deferred fuel
liabilities. In addition, West Penn would take possession of
the proposed plant site. The PUC approved the transaction in
its opinion and order entered October 24, 1997. As a result,
West Penn will remove the $185 million, present value,
estimated excess cost of capacity and energy of the Milesburg
plant from its PURPA-related stranded cost request.
10.The Company's subsidiaries have spent considerable time and
effort over the past several years on the issue of the year
2000 software compliance, and the effort is continuing.
Certain software has already been made year 2000 compliant by
upgrades and replacement, and analysis is continuing on
others, in accordance with a schedule planned to permit the
subsidiaries to process information in the year 2000 and
beyond without significant problems. Expenditures for the
software modifications and upgrades are not expected to have
a material impact on the Company's results of operations or
financial position.
11.Other paid-in capital increased $15,961,000 in the nine
months ended September 30, 1997, representing the excess of
amounts received over par value, less related expenses, from
the issuance of 595,990 shares of common stock pursuant to
the Company's Dividend Reinvestment and Stock Purchase Plan,
Employee Stock Ownership and Savings Plan, and Performance
Share Plan.
12.Common stock dividends per share declared during the periods
for which income statements are included are as follows:
1997 1996
Number Amount Number Amount
of Shares Per Share of Shares Per Share
First Quarter 121,840,327 $.43 120,700,809 $.42
Second Quarter 122,111,567 $.43 120,989,831 $.42
Third Quarter 122,436,317 $.43 121,280,080 $.42
13.Restructuring charges and an asset write-off in the first
nine months of 1996 ($43.5 million, net of tax) include
expenses associated with a reorganization, which is
essentially complete.
14.For the most part, regulatory assets and liabilities are not
included in rate base. Income tax regulatory
assets/(liabilities), net of $426 million at September 30,
1997, are primarily related to investments in
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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
West Penn's stranded cost for CTC recovery. Similar
treatment is expected in the other states when they require
the generation business to be deregulated, which is expected.
The remaining recovery period for items other than income
taxes, is from three to seven years in businesses that remain
subject to regulation.
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ALLEGHENY ENERGY, INC.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
COMPARISON OF THIRD QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 1997
WITH THIRD QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 1996
Review of Operations
EARNINGS
Earnings for the third quarter and first nine months of
1997 and 1996, and the after-tax restructuring charges and asset
write-off included in the 1996 periods are shown below.
Consolidated Net Income
Three Months Ended Nine Months Ended
September 30 September 30
1997 1996 1997 1996
(Millions of Dollars)
Consolidated Net
Income as Reported $74.8 $56.2 $204.1 $161.4
Restructuring Charges and
Asset Write-Off - 4.8 - 43.5
Consolidated Net
Income Adjusted $74.8 $61.0 $204.1 $204.9
Cents Per Share
Three Months Ended Nine Months Ended
September 30 September 30
1997 1996 1997 1996
Cents per Share
as Reported $.61 $.46 $1.67 $1.33
Restructuring Charges and
Asset Write-Off - .04 - .36
Cents per Share
Adjusted $.61 $.50 $1.67 $1.69
The increase in third quarter consolidated net income,
before restructuring charges, was primarily due to a $12.1
million interest refund on a tax-related contract settlement and
a reduction of expenses achieved through restructuring efforts
and other cost controls. Total retail kilowatt-hour (kWh) sales
were up for the quarter.
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The decrease in year-to-date consolidated net income,
before restructuring charges and asset write-off, was primarily
due to decreased kWh sales to residential customers and
anticipated start-up losses of $8.2 million of an unregulated
subsidiary, AYP Energy, Inc. (AYP Energy), which commenced
operations in late 1996. Residential kWh sales decreased 5% due
to the mild first quarter winter weather (heating degree days 9%
below normal and 15% below the first quarter of 1996) and the
mild summer weather. Commercial kWh sales were about the same as
the previous period. Industrial kWh sales increased 1%.
SALES AND REVENUES
Retail kWh sales in the third quarter to residential
customers decreased 1%, and to commercial and industrial
customers increased 3% and 4%, respectively, for a net increase
of 2%. In the first nine months, kWh sales to residential
customers decreased 5%, to commercial customers remained about
the same, and to industrial customers increased 1%, for a net
decrease of 1%. As discussed above, residential kWh sales, which
are more weather sensitive than the commercial and industrial
classes, decreased due to the mild weather. The increase in
third quarter kWh sales to commercial customers was due primarily
to growth in the number of customers. Industrial kWh sales
increased for the third quarter due primarily to increased sales
to the iron and steel and chemical customer groups. The year-to-
date increase in kWh sales to industrial customers was due
primarily to increased sales to the lumber products, glass, and
concrete customer groups. The 1% decrease in year-to-date
industrial revenues was due to a decrease in the fuel and energy
cost component of industrial sales.
The changes in revenues from sales to residential,
commercial, and industrial customers resulted from the following:
Change from Prior Periods
Quarter Nine Months
(Millions of Dollars)
Fuel and energy cost adjustment clauses* $ .7 $(32.2)
Increased (decreased) kWh sales 3.4 (22.6)
Other .6 .9
Change in retail revenues $4.7 $(53.9)
* Changes in revenues from fuel and energy cost adjustment
clauses have little effect on consolidated net income.
Changes in the costs of fuel, purchased power, and certain
other costs, and changes in revenues from sales to other
utilities, including transmission services, have had little
effect on consolidated net income because such changes have
been passed on to customers by adjustment of customer bills
through fuel and energy cost adjustment clauses. However,
effective May 1, 1997, one of the Company's subsidiaries,
West Penn Power Company (West Penn), as a result of
legislation in Pennsylvania to begin deregulation of electric
generation, rolled its fuel and energy costs into base rates
and set to zero its fuel and energy cost adjustment clause.
Thereafter, West Penn assumes the risks of increases in the
costs of fuel and purchased power and any declines in bulk
power transaction sales and retains the benefits of decreases
in such costs and increases in such sales. West Penn fuel
and energy cost revenues are approximately 50% of total
Allegheny Energy fuel and energy cost revenues.
<PAGE>
- 15 -
The year-to-date decrease in wholesale and other revenues
was due primarily to The Potomac Edison Company's (Potomac
Edison) decreased sales to a wholesale customer. In the second
quarter of 1997, the largest customer of that particular
wholesale customer suspended production and shut down its paper
recycling plant. All of the Company's wholesale customers have
signed contracts to remain as customers for periods ranging from
about one year to four years.
Revenues from bulk power transactions consist of the
following items:
Three Months Ended Nine Months Ended
September 30 September 30
1997 1996 1997 1996
(Millions of Dollars)
Revenues:
Utility operations:
From transmission services $10.0 $12.7 $ 31.6 $41.0
From sale of subsidiaries'
generation 15.1 3.9 30.3 17.5
Nonutility operations 27.6 - 51.1 -
Total $52.7 $16.6 $113.0 $58.5
Revenues from nonutility operations were the result of
sales by the Company's nonutility exempt wholesale generator and
power marketer, AYP Energy, Inc., which began operations in late
1996. Revenues from utility operations transmission services
decreased primarily due to reduced demand, primarily because of
mild weather. The increases in sales of subsidiaries' generation
resulted primarily from increased sales to brokers and power
marketers. The aggregate benefits from utility bulk power
transactions are primarily passed on to retail customers through
fuel and energy adjustment clauses (described above) and have had
little effect on consolidated net income. Beginning on May 1,
1997, due to the elimination of West Penn's fuel and energy
adjustment clause (referred to by West Penn as ECR for Energy
Cost Rate), changes in these revenues for West Penn, which are
approximately 50% of total Allegheny Energy fuel and energy cost
revenues, have a direct effect on consolidated net income. The
effect on consolidated net income from sales of subsidiaries'
generation is offset by the cost of producing the sales,
primarily fuel, and the profit margins in this competitive
business are thin.
Pursuant to the Customer Choice Act, all electric
utilities in Pennsylvania are required to establish and
administer retail access pilot programs. In order to assure
participation in the pilot program, a credit established by the
PUC to West Penn's customers participating in the pilot is
artificially high, with the result that West Penn has estimated
it could suffer a loss of up to about $30 million for the 14-
month pilot period which ends December 31, 1998. In order to
mitigate this loss, West Penn took action to become a licensed
energy supplier to the pilot customers of the other electric
utilities in Pennsylvania. Sales prices are low and margins are
thin. West Penn believes it is unlikely that it will completely
offset its pilot losses with new revenues. Based upon the PUC's
approval of West Penn's pilot compliance filing, West Penn plans
to defer its net pilot revenue losses for later potential
recovery. The Company's new unregulated subsidiary, Allegheny
Energy Solutions, Inc., also became licensed as an energy
supplier in Pennsylvania. It will retain its profits on energy
sales.
<PAGE>
- 16 -
See Notes 5 and 6 to the Consolidated Financial Statements for
additional information on the Customer Choice Act.
Beginning January 1, 1999, one-third of West Penn's
retail customers will have the ability to choose another energy
supplier, but will not be required to do so. The next year
another third, and beginning January 1, 2001, all of its
customers will have retail access to alternative generation.
West Penn will continue to provide transmission and distribution
service, energy to those who choose West Penn as their supplier,
and will bill a Competitive Transition Charge, which the PUC has
yet to approve, to those customers who choose another supplier.
West Penn and Allegheny Energy Solutions, Inc. are both planning
to compete as energy suppliers in Pennsylvania. See Note 5 to
the Consolidated Financial Statements for additional information
concerning Pennsylvania deregulation of electric generation.
OPERATING EXPENSES
Fuel expenses for the third quarter and first nine months
of 1997 increased 14% and 7%, respectively. The increases in
fuel expenses in both periods resulted from increases in kWh's
generated due primarily to the operation of 50% of Unit No. 1 of
the Fort Martin Power Station which was purchased by the
Company's nonutility subsidiary (AYP Energy, Inc.) in late 1996
and increased bulk power sales from subsidiaries' generation to
brokers and power marketers. Fuel expenses for the regulated
subsidiaries, except for West Penn beginning May 1, 1997, are
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, other than fuel expenses of
West Penn, have little effect on consolidated net income. West
Penn's fuel expenses were 46% of consolidated fuel expenses in
both the quarter and nine months ended September 30, 1997.
"Purchased power and exchanges, net" represents power
purchases from and exchanges with other companies and purchases
from qualified facilities under the Public Utility Regulatory
Policies Act of 1978 (PURPA), and consists of the following
items:
Three Months Ended Nine Months Ended
September 30 September 30
1997 1996 1997 1996
(Millions of Dollars)
Purchased power:
Utility operations:
From PURPA generation* $30.4 $31.7 $100.2 $ 97.2
Other 8.2 7.7 24.4 33.6
Total purchased power 38.6 39.4 124.6 130.8
Power exchanges, net (2.7) .1 .1 3.4
Nonutility operations 17.1 - 22.6 -
Purchased power and
exchanges, net $53.0 $39.5 $147.3 $134.2
* PURPA cost per kWh $.053 $.055 $.056 $.055
<PAGE>
- 17 -
Nonutility operations purchases were the result of power
replacement requirements and transaction opportunities by AYP
Energy, which began operations in late 1996. Other purchased
power for the nine months ended September 1997 decreased because
of decreased demand due to decreased sales to retail customers.
The cost of utility purchased power and exchanges, including
power from PURPA generation, except for West Penn, is mostly
recovered from customers currently through the regular fuel and
energy cost recovery procedures followed by the other
subsidiaries' regulatory commissions, and is primarily subject to
deferred power cost accounting procedures with the result that
changes in such costs, except those incurred by West Penn, have
little effect on consolidated net income. West Penn's purchased
power expenses were 51% and 60% of consolidated purchased power
expenses in the quarter and nine months ended September 30, 1997.
The increases in other operation expense for the three
and nine months ended September 1997, were due primarily to
expenses associated with AYP Energy, which began operations in
late 1996. A contributing factor to the cost increases in the
third quarter of 1997 was $1.3 million of advertising
expenditures by Allegheny Energy Solutions, Inc. Both West Penn
and Allegheny Energy Solutions, Inc. have applied for and
obtained licenses as energy suppliers to Pennsylvania customers
participating in Pennsylvania's retail access pilot program.
Both companies expect to incur increased advertising and other
sales expenditures in order to enhance sales and to build brand
name recognition. See Notes 5 and 6 to the consolidated
financial statements for additional information regarding
Pennsylvania deregulation of electric generation and the
Pennsylvania retail access pilot program.
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. Maintenance expenses
decreased $7.5 million and $5.6 million for the third quarter and
first nine months of 1997, respectively, due primarily to reduced
expenses achieved through restructuring efforts and other cost
controls. AYP Energy's maintenance expenses were $1.4 million
and $2.5 million in the third quarter and nine months ended
September 30, 1997, respectively.
Restructuring charges in the third quarter and first
nine-month periods of 1996, and an asset write-off in the first
nine months of 1996 include expenses associated with a
reorganization, which is essentially complete.
The increases in depreciation expense for the third
quarter and first nine months of 1997 resulted from additions to
electric plant, the largest portion of which was depreciation
related to AYP Energy's ownership in the Fort Martin Power
Station. Future depreciation expense increases for utility
operations are expected to be less than historical increases
because of reduced levels of planned capital expenditures.
<PAGE>
- 18 -
Taxes other than income taxes increased $.8 million in
the first nine months due to increased West Virginia Business and
Occupation Taxes (B&O) resulting from AYP Energy's purchase of an
ownership interest in the Fort Martin Power Station, and
increased property taxes. The B&O tax is based on generating
capacity. These increases were offset in part by decreases in
gross receipts taxes resulting from lower revenues from retail
customers and lower FICA taxes due to the Company's recent
restructuring.
The net increases in federal and state income taxes for
the third quarter and first nine-month periods, respectively,
resulted primarily from increases in income before taxes. The
nine-month period increase in income before taxes was primarily
related to restructuring charges recorded in 1996.
The increases in allowance for other than borrowed funds
used during construction (AOFDC) of $.4 million and $2.0 million
for the three and nine-month periods ended September 1997
resulted primarily from application of the Federal Energy
Regulatory Commission AOFDC formula under which in 1997 a larger
percentage of construction was financed by more expensive equity
funds rather than less expensive short-term debt funds.
The increases in other income, net, of $9.4 million and
$13.5 million for the three and nine-month periods ended
September 30, 1997, were due to an interest refund on a tax-
related contract settlement, and in the first nine-month period
also due to the sale of land and timber by West Virginia Power
and Transmission Company, a subsidiary of West Penn.
Interest on long-term debt increased $2.5 million in the
third quarter and $6.7 million for the first nine months due to
the October 1996 issuance of $160 million of five-year notes by
AYP Energy related to its purchase of an ownership interest in
the Fort Martin Power Station. Other interest expense reflects
changes in the levels of short-term debt maintained by the
companies throughout the year, as well as the associated rates.
Financial Condition and Requirements
The Company's discussion on Financial Condition and
Requirements, Competition in Core Business, and Nonutility
Business in the Allegheny Power System companies' combined Annual
Report on Form 10-K for the year ended December 31, 1996, should
be read with the following information.
In the normal course of business, the subsidiaries are
subject to various contingencies and uncertainties relating to
their operations and construction programs, including cost
recovery in the regulatory process, laws, regulations and
uncertainties related to environmental matters, legal actions,
restructuring of the electric utility industry, and, as described
in Notes 4, 5, and 6 to the Consolidated Financial Statements,
the Pennsylvania restructuring legislation and merger activities.
The Company expects to use exchange-traded and over-the-
counter futures, options, and swap contracts both to hedge its
exposure to changes in electric power prices and for trading
purposes. The risks to which the Company is exposed include
underlying price volatility, credit risk, and variations in cash
flows, among others. The Company has implemented risk management
policies and procedures consistent with industry practices and
Company goals.
<PAGE>
- 19 -
The Company is working actively within its states to
advance customer choice. However, the Company 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 (PUHCA) and the Public Utility Regulatory
Policies Act of 1978 (PURPA).
In addition to Pennsylvania which has enacted legislation
to bring competition to the electric utility industry, the
Company serves customers in four other states which are actively
exploring the move toward competition and deregulation.
This fall, in Maryland, a task force will examine issues
involved in retail electric competition and will include its
findings in a report to the General Assembly in mid-December.
The task force is looking at how the electric utility industry in
Maryland can be restructured to reduce energy costs and better
meet the needs of consumers. The Company holds a seat on the
advisory group which is assisting the task force in its
deliberations. Also, the Maryland Public Service Commission
(PSC) recently held hearings on the restructuring issue. In
addition, the PSC has issued a report recommending that all
electric consumers in the state have the opportunity to choose
their electric supplier, with service beginning April 2, 2001.
The West Virginia Public Service Commission also created
a task force to study electric utility restructuring and
competition. On October 15, the group issued a final report
addressing various issues of competition and customer choice.
The task force, which includes the Company as a member, will
continue to further discuss issues relevant to electric utility
competition.
In early November, the staff of the State Corporation
Commission of Virginia is expected to file recommendations on
competition and electric utility restructuring. Five working
groups, which included representatives from the Company, have
been working with the staff to develop recommendations. In
addition, the Virginia General Assembly has established a Joint
Subcommittee to examine electric utility restructuring.
A House and Senate legislative committee in Ohio is
developing a report on electric utility restructuring and
competition. The Public Utilities Commission of Ohio continues
roundtable discussion on universal service and stranded costs.
<PAGE>
- 20 -
ALLEGHENY ENERGY, INC.
Part II - Other Information to Form 10-Q
for Quarter Ended September 30, 1997
ITEM 1. LEGAL PROCEEDINGS
On September 29, 1997, the City of Pittsburgh filed an
antitrust and conspiracy lawsuit in Federal District Court for
the Western District of Pennsylvania against the Company, West
Penn, DQE, Inc. and Duquesne Light Company. The verified
complaint alleges eight counts, two of which are claimed
violations of the federal antitrust statutes and six are state
law claims. The relief sought includes a request that the
proposed merger between the Company and DQE, Inc. be stopped, and
a request for unspecified monetary damages relating to alleged
collusion by the two companies in their actions dealing with
proposals to provide electric service to the city's redevelopment
zones. On October 27, 1997, the Company, West Penn, DQE, Inc.,
and Duquesne Light Company filed motions to dismiss the
complaint. While the Company cannot predict the outcome of this
action, it believes the suit is without merit.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
(a) Date and kind of meeting:
Shown below is the voting breakdown for the special
shareholders meeting held on August 7, 1997.
Votes Abstain/
Proposal Votes For Against Withhold Unvoted
Issuance of shares of
common stock pursuant
to merger agreement 80,516,581 3,099,537 1,048,398 37,752,120
Amend charter to change
Company's name 93,151,085 2,120,423 1,030,198 26,114,930
The shareholders did approve the proposals for the
issuance of shares of common stock pursuant to a merger agreement
and to amend the charter to change the Company's name to
Allegheny Energy, Inc.
<PAGE>
- 21 -
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
(27) Financial Data Schedule
(b) On August 25, 1997, the Company filed a Form 8-K
concerning the special meeting of shareholders of the
Company which was held on August 7, 1997.
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.
ALLEGHENY ENERGY, INC.
/s/ K. M. JONES
K. M. Jones, Vice President
(Chief Accounting Officer)
November 13, 1997
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170,086
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