<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 March 31, 1998
Commission File Number 1-3376-2
THE POTOMAC EDISON COMPANY
(Exact name of registrant as specified in its charter)
Maryland and Virginia 13-5323955
(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 May 14, 1998, 22,385,000 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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THE POTOMAC EDISON COMPANY
Form 10-Q for Quarter Ended March 31, 1998
Index
Page
No.
PART I--FINANCIAL INFORMATION:
Statement of income - Three months ended
March 31, 1998 and 1997 3
Balance sheet - March 31, 1998
and December 31, 1997 4
Statement of cash flows - Three months ended
March 31, 1998 and 1997 5
Notes to 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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THE POTOMAC EDISON COMPANY
Statement of Income
Three Months Ended
March 31
1998 1997
(Thousands of Dollars)
ELECTRIC OPERATING REVENUES:
Residential $ 90,329 $ 91,563
Commercial 37,691 37,496
Industrial 48,512 46,737
Wholesale and other, including affiliates 10,984 10,482
Bulk power transactions, net 4,182 5,950
Total Operating Revenues 191,698 192,228
OPERATING EXPENSES:
Operation:
Fuel 35,557 35,397
Purchased power and exchanges, net 35,925 37,597
Deferred power costs, net 33 (323)
Other 21,178 21,722
Maintenance 14,736 15,584
Depreciation 18,645 18,377
Taxes other than income taxes 12,909 12,174
Federal and state income taxes 15,093 14,638
Total Operating Expenses 154,076 155,166
Operating Income 37,622 37,062
OTHER INCOME AND DEDUCTIONS:
Allowance for other than borrowed funds
used during construction 197 407
Other income, net 2,216 2,607
Total Other Income and Deductions 2,413 3,014
Income Before Interest Charges 40,035 40,076
INTEREST CHARGES:
Interest on long-term debt 11,800 11,914
Other interest 584 752
Allowance for borrowed funds used during
construction (271) (313)
Total Interest Charges 12,113 12,353
NET INCOME $ 27,922 $ 27,723
See accompanying notes to financial statements.
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THE POTOMAC EDISON COMPANY
Balance Sheet
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
ASSETS: (Thousands of Dollars)
Property, Plant, and Equipment:
<S> <C> <C>
At original cost, including $57,619,000
and $55,702,000 under construction $ 2,209,132 $ 2,196,262
Accumulated depreciation (877,627) (859,076)
1,331,505 1,337,186
Investments:
Allegheny Generating Company - common stock at equity 55,269 55,847
Other 512 529
55,781 56,376
Current Assets:
Cash 2,375 2,319
Deposit with trustee for redemption
of long-term debt 3,237 -
Accounts receivable:
Electric service, net of $1,991,000 and $1,683,000
uncollectible allowance 86,845 83,431
Affiliated and other 9,103 5,302
Notes receivable from affiliates 43,050 1,450
Materials and supplies - at average cost:
Operating and construction 23,762 23,715
Fuel 19,145 15,843
Prepaid taxes 14,212 15,052
Other 2,701 4,716
204,430 151,828
Deferred Charges:
Regulatory assets 78,617 80,651
Unamortized loss on reacquired debt 17,018 17,094
Other 17,256 17,512
112,891 115,257
Total Assets $ 1,704,607 $ 1,660,647
CAPITALIZATION AND LIABILITIES:
Capitalization:
Common stock $ 447,700 $ 447,700
Other paid-in capital 2,690 2,690
Retained earnings 267,109 239,391
717,499 689,781
Preferred stock 16,378 16,378
Long-term debt and QUIDS 628,107 627,012
1,361,984 1,333,171
Current Liabilities:
Long-term debt due within one year 3,200 1,800
Accounts payable 27,165 29,125
Accounts payable to affiliates 20,150 19,929
Taxes accrued:
Federal and state income 14,235 2,106
Other 14,542 11,461
Interest accrued 13,098 9,487
Payrolls accrued - 6,353
Other 11,059 10,553
103,449 90,814
Deferred Credits and Other Liabilities:
Unamortized investment credit 21,001 21,470
Deferred income taxes 181,889 178,529
Regulatory liabilities 12,150 12,424
Other 24,134 24,239
239,174 236,662
Total Capitalization and Liabilities $ 1,704,607 $ 1,660,647
</TABLE>
See accompanying notes to financial statements.
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THE POTOMAC EDISON COMPANY
Statement of Cash Flows
<TABLE>
<CAPTION>
Three Months Ended
March 31
1998 1997
(Thousands of Dollars)
CASH FLOWS FROM OPERATIONS:
<S> <C> <C>
Net income $ 27,922 $ 27,723
Depreciation 18,645 18,377
Deferred investment credit and income taxes, net 3,184 2,034
Deferred power costs, net 33 (323)
Unconsolidated subsidiaries' dividends in excess of earnings 588 750
Allowance for other than borrowed funds used
during construction (197) (407)
Restructuring liability (598) (4,968)
Changes in certain current assets and
liabilities:
Accounts receivable, net (7,215) (4,123)
Materials and supplies (3,349) (3,926)
Accounts payable (1,739) (4,383)
Taxes accrued 15,210 18,073
Interest accrued 3,611 4,295
Other, net 128 7,511
56,223 60,633
CASH FLOWS FROM INVESTING:
Construction expenditures (less allowance for
equity funds used during construction) (13,526) (10,119)
CASH FLOWS FROM FINANCING:
Issuance of long-term debt 4,200 -
Retirement of long-term debt (1,800) (800)
Deposit with trustee for redemption
of long-term debt (3,237) -
Short-term debt, net - (7,497)
Notes receivable from affiliates (41,600) (36,850)
Dividends on preferred stock (204) (204)
(42,641) (45,351)
NET CHANGE IN CASH 56 5,163
Cash at January 1 2,319 1,444
Cash at March 31 $ 2,375 $ 6,607
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) $7,552 $8,422
Income taxes - -
</TABLE>
See accompanying notes to financial statements.
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THE POTOMAC EDISON COMPANY
Notes to Financial Statements
1. The Company's Notes to Financial Statements in its Annual
Report on Form 10-K for the year ended December 31, 1997,
should be read with the accompanying financial statements and
the following notes. With the exception of the December 31,
1997, balance sheet in the aforementioned annual report on
Form 10-K, the accompanying financial statements appearing on
pages 3 through 5 and these notes to financial statements are
unaudited. In the opinion of the Company such 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 Statement of Income reflects the results of past
operations and is not intended as any representation as to
future results. For purposes of the Balance Sheet and
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 28% of the common stock of Allegheny
Generating Company (AGC), and affiliates of the Company own
the remainder. AGC owns an undivided 40% interest, 840 MW,
in the 2,100-MW pumped-storage hydroelectric station in Bath
County, Virginia, operated by the 60% owner, Virginia
Electric and Power Company, a nonaffiliated utility.
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
The Company's share of the equity in earnings above was $1.7
million and $1.8 million for the three months ended March 31,
1998 and 1997, respectively, and was included in other
income, net, on the Statement of Income.
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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 it 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
review of certain merger-related activities with the Public
Service Commission of West Virginia and the Virginia State
Corporation Commission.
All of the Company's incremental costs of the merger process
($3.8 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.
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5. In December 1997, in an initial Order followed by a second
Order revising certain implementation dates, the Maryland PSC
ordered an electric competition transition plan for Maryland
requiring full retail customer choice by July 1, 2002, in
yearly one-third increments beginning July 1, 2000; a price
cap mechanism; recovery of verifiable and prudent stranded
costs (after mitigation); and roundtable and adjudicatory
proceedings to address issues such as universal service,
demand-side management programs, customer education, etc. In
its Order, the PSC stated its belief that it had the
authority under existing law to implement the Order, but
requested the legislature to enact certain "technical
amendments" to facilitate the transition.
In December 1996, Pennsylvania enacted the Electricity
Generation Customer Choice and Competition Act (Customer
Choice Act) to restructure the electric industry in
Pennsylvania to create retail access to a competitive
electric energy generation market. On August 1, 1997,
concurrent with Allegheny Power's merger approval filing, the
Company's Pennsylvania utility affiliate, West Penn Power
Company (West Penn), filed with the PUC a comprehensive stand-
alone restructuring plan to implement full customer choice of
electric generation suppliers as required by the Customer
Choice Act. The filing included an unbundling of West Penn's
electric service rates into generation, transmission, and
distribution components; a plan to revise how West Penn and
its utility affiliates, including the Company, share
capacity, energy, capacity reserves, transmission resources,
and costs; and a plan for recovery of stranded costs through
a Competitive Transition Charge (CTC). Recovery of stranded
costs is a key issue.
On April 30, 1998, the PUC, in a non-binding polling,
outlined a restructuring plan for West Penn. According to
the polling, West Penn is allowed to collect $524 million in
stranded costs over seven years, starting in January 1999,
through a CTC. In its restructuring application, West Penn
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. Starting in 1999,
West Penn 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, West Penn would continue to provide transmission
and distribution services to its customers at PUC and FERC
regulated rates. Allegheny Energy and West Penn believe that
the $524 million of stranded costs recommended for recovery
is inadequate and financially harmful to West Penn. The non-
binding polling of the PUC is a preliminary step leading up
to a final order on West Penn's restructuring plan expected
May 21, 1998. If the PUC's final order remains as
financially harmful as the polling, West Penn plans to seek
redress through reconsideration by the PUC and/or full
judicial review and/or legislative revision of the Customer
Choice Act.
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 December 1997 Maryland PSC Order requiring customer
choice establishes such
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processes, the Company has determined that it will be
required to discontinue use of SFAS No. 71 for the generation
portion of its business (the Maryland portion only) on an
uncertain future date. One of the conclusions of the EITF is
that after discontinuing SFAS No. 71, utilities should
continue to carry on their books the assets and liabilities
recorded under SFAS No. 71 if the regulatory cash flows to
settle them will be derived from the continuing regulated
transmission and distribution business. Additionally,
continuing costs and obligations of the deregulated
generation business which are similarly covered by the cash
flows from the continuing regulated business will meet the
criteria as regulatory assets and liabilities. The Maryland
Order establishes definitive processes for transition to
deregulation and market-based pricing for electric
generation, which include continuing cost-of-service based
ratemaking for transmission and distribution services,
subject to rate caps, and provide for a 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 $53 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 remaining recovery period for
items other than income taxes is from three to seven years in
businesses that remain subject to regulation.
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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THE POTOMAC EDISON COMPANY
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 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
In Maryland on January 30, 1998, the Office of People's
Counsel filed a petition to reduce the rates of the Company. In
response, the Maryland PSC ordered the Company to file a rate
case by May 22, 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 it 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 West Penn. According to the
polling, West Penn 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, West Penn 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.
Starting in 1999, West Penn 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, West Penn would continue to provide
transmission and distribution services to its customers at PUC
and FERC regulated rates. Allegheny Energy and West Penn believe
that the $524 million of stranded costs recommended for recovery
is inadequate and financially harmful to West Penn. The non-
binding polling of the PUC is a preliminary step leading up to a
final order on West Penn's restructuring plan expected May 21,
1998. If the PUC's final order remains as financially harmful as
the polling, West Penn 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
Net income for the first quarter of 1998 was up slightly
from the first quarter of 1997 despite a 2.1% reduction in
residential kilowatt-hour (kWh) sales resulting from the
extremely mild winter weather in 1998. The 1998 winter was 11%
warmer than 1997 and 22% warmer than normal as measured by
heating degree days and was the warmest in more than 100 years.
The slight increase in earnings was achieved by continuing
efforts to reduce operations and maintenance (O&M) expenses and a
2.2% and 2.3% increase in kWh sales to commercial and industrial
customers, respectively.
SALES AND REVENUES
Percentage changes in revenues and kWh sales by major
retail customer classes were:
Change from Prior Period
Quarter
Revenues kWh
Residential (1.3)% (2.1)%
Commercial .5 2.2
Industrial 3.8 2.3
Total .4% .5%
The change in residential kWh sales, which are more
weather sensitive than the other classes, was due primarily to
changes in customer usage because of weather conditions. The
1998 first quarter winter weather was 11% warmer than 1997 and
22% warmer than normal as measured by heating degree days.
Commercial kWh sales are also affected by weather, but to a
lesser extent than residential. The 2.2% increase in the first
quarter primarily reflects growth in the number of customers.
The increase of 2.3% in industrial kWh sales reflects continued
economic growth in the service territory.
The changes in revenues from sales to residential,
commercial, and industrial customers resulted from the following:
Change from Prior Period
Quarter
(Millions of Dollars)
Fuel clauses $1.1
All other (.4)
Net change in retail revenues $ .7
Revenues reflect not only the changes in kWh sales, but
also any changes in revenues from fuel and energy cost adjustment
clauses (fuel clauses) which have little effect on net income
because increases and decreases in fuel and purchased power costs
and sales of transmission services and bulk power are passed on
to customers by adjustment of customer bills through fuel
clauses.
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All other is the net effect of kWh sales changes due to
changes in customer usage (primarily weather for residential
customers), growth in the number of customers, and changes in
pricing other than changes in general tariff and fuel clause
rates. The decrease in the first quarter all other retail
revenues was primarily the result of mild weather.
Wholesale and other revenues were as follows:
Three Months Ended
March 31
1998 1997
(Millions of Dollars)
Wholesale customers $ 6.9 $ 7.8
Affiliated companies 2.6 1.8
Street lighting and other 1.5 .9
Total wholesale and other revenues $11.0 $10.5
Wholesale customers are cooperatives and municipalities
that own their own distribution systems and buy all or part of
their bulk power needs from the Company under regulation by the
FERC. Competition in the wholesale market for electricity was
initiated by the National Energy Policy Act of 1992 (EPACT),
which permits wholesale generators, utility-owned and otherwise,
and wholesale customers to request from owners of bulk power
transmission facilities a commitment to supply transmission
services. A five-year contract with estimated annual revenues
totaling about $3 million was signed in 1997 with one of the
Company's wholesale customers. The existing contracts with four
Maryland wholesale customers expire in 1998. The Company is
bidding to continue as their wholesale supplier. The decrease in
wholesale revenues in 1998 was primarily due to the mild 1998
winter as mentioned above and the shut-down in early 1997 of a
large fiber plant on a wholesale customer's system.
Revenues from affiliated companies represent sales of
energy and intercompany allocations of generation spinning
reserves and transmission services pursuant to a power supply
agreement among the Company and the other regulated utility
subsidiaries of Allegheny Energy. The increase in such revenues
in 1998 resulted primarily from an increase in the allocation of
transmission services revenues to the Company.
Revenues from bulk power transactions consist of the
following items:
Three Months Ended
March 31
1998 1997
(Millions of Dollars)
Revenues:
Transmission services to
nonaffiliated companies $2.8 $4.2
Bulk power 1.4 1.8
Total bulk power transactions, net $4.2 $6.0
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The final rules on open transmission access, issued by
the FERC in early 1996, require utilities to offer to others
transmission service that is comparable to service they provide
to themselves. Revenues from transmission services to
nonaffiliated companies in the first quarter of 1998 decreased
due to reduced demand, primarily because of mild weather.
OPERATING EXPENSES
Fuel expenses for the first quarter remained relatively
unchanged from the previous quarter. Fuel expenses are primarily
subject to deferred power cost accounting procedures with the
result that changes in fuel expenses have little effect on net
income.
Purchased power and exchanges, net represents power
purchases from and exchanges with nonaffiliated utilities,
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 $ 2.7 $ 2.7
Power exchanges, net 1.3 1.4
Affiliated transactions:
AGC capacity charges 6.2 6.6
Other affiliated capacity charges 11.9 12.7
Energy and spinning reserve charges 13.8 14.2
Purchased power and exchanges, net $35.9 $37.6
A Public Utility Regulatory Policies Act of 1978 (PURPA)
power station project in the Company's Maryland jurisdiction is
scheduled to commence generation in 1999. Because of the high
cost of this energy, the Company unsuccessfully sought a buyout
or restructuring of the existing contract to reduce the cost of
power purchases ($60 million or more annually) and the Company's
rates in Maryland.
The decrease in other operation expenses resulted
primarily from a reduction in expenses related to provisions for
uninsured claims.
Maintenance expenses decreased $.8 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.
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Depreciation expense increased primarily due to
additions to electric plant.
Taxes other than income taxes increased $.7 million due
to increased property taxes related to an increase in the
assessment of property in Maryland.
Other interest expense reflects changes in the levels of
short-term debt maintained by the Company throughout the year, as
well as the associated interest rates.
Financial Condition 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 Financial Statements for information
about merger activities, the Pennsylvania Customer Choice Act,
and the Maryland initial Order.
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
<PAGE>
- 16 -
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.
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.
The West Virginia Legislature passed a House Bill on
March 14, 1998, which sets the stage for the restructuring of the
electric utility industry in West Virginia. The House Bill
directs the West Virginia Public Service Commission to determine
if deregulation is in the best interests of the state and, if so,
to develop a transition plan. It also sets up a task force of
all interested parties to participate in the plan development.
When complete, the plan will be returned to the Legislature for
approval or rejection.
In early March, the Virginia Senate joined the House of
Delegates in approving a timetable for restructuring the state's
electric utility industry to allow retail competition. The
legislation will give Virginians choice of their electric power
suppliers beginning on January 1, 2004. The details will be
worked out over the coming year by a special Senate-House
subcommittee that has been studying restructuring for two years.
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 -
THE POTOMAC EDISON COMPANY
Part II - Other Information to Form 10-Q
for Quarter Ended March 31, 1998
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
Hagerstown, Maryland, on April 22, 1998. No proxies
were solicited.
(b) Election of Directors:
The holder of all 22,385,000 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
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.
<PAGE>
- 18 -
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.
THE POTOMAC EDISON COMPANY
/s/ T. J. KLOC
T. J. Kloc, Controller
(Chief Accounting Officer)
May 14, 1998
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