<PAGE>
Page 1 of 24
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, 1999
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 November 12, 1999, 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 September 30, 1999
Index
Page
No.
PART I--FINANCIAL INFORMATION:
Statement of Income - Three and nine months ended
September 30, 1999 and 1998 3
Balance Sheet - September 30, 1999
and December 31, 1998 4
Statement of Cash Flows - Nine months ended
September 30, 1999 and 1998 5
Notes to Financial Statements 6-8
Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-22
PART II--OTHER INFORMATION 23-24
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THE POTOMAC EDISON COMPANY
Statement of Income
(Thousands of Dollars)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
ELECTRIC OPERATING REVENUES:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Residential $ 78,215 $ 76,633 $ 248,797 $ 232,894
Commercial 43,472 41,743 126,637 118,231
Industrial 55,509 52,883 159,328 153,807
Wholesale and other, including affiliates 2,594 9,299 12,250 30,648
Bulk power transactions, net 9,699 9,975 20,146 24,170
Total Operating Revenues 189,489 190,533 567,158 559,750
OPERATING EXPENSES:
Operation:
Fuel 37,461 37,527 106,677 109,008
Purchased power and exchanges, net 31,228 38,610 92,732 104,053
Deferred power costs, net 5,356 (890) 14,250 4,798
Other 23,552 20,727 70,831 64,426
Maintenance 13,982 12,746 41,289 39,974
Depreciation 19,219 18,660 57,327 56,025
Taxes other than income taxes 13,068 12,368 38,353 37,432
Federal and state income taxes 11,275 14,105 38,713 39,696
Total Operating Expenses 155,141 153,853 460,172 455,412
Operating Income 34,348 36,680 106,986 104,338
OTHER INCOME AND DEDUCTIONS:
Allowance for other than borrowed funds
used during construction 232 193 558 408
Other income, net 2,701 2,596 6,404 7,158
Total Other Income and Deductions 2,933 2,789 6,962 7,566
Income Before Interest Charges 37,281 39,469 113,948 111,904
INTEREST CHARGES:
Interest on long-term debt 10,758 11,740 32,112 35,280
Other interest 389 666 1,389 1,617
Allowance for borrowed funds used during
construction (358) (236) (945) (718)
Total Interest Charges 10,789 12,170 32,556 36,179
NET INCOME $ 26,492 $ 27,299 $ 81,392 $ 75,725
</TABLE>
See accompanying notes to financial statements.
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THE POTOMAC EDISON COMPANY
Balance Sheet
(Thousands of Dollars)
<TABLE>
<CAPTION>
September 30, December 31,
ASSETS: 1999 1998
Property, Plant, and Equipment:
At original cost, including $56,729
<S> <C> <C>
and $46,353 under construction $ 2,284,508 $ 2,249,716
Accumulated depreciation (971,440) (926,840)
1,313,068 1,322,876
Investments:
Allegheny Generating Company - common stock at equity 44,001 46,277
Other 432 473
44,433 46,750
Current Assets:
Cash 4,232 1,805
Accounts receivable:
Electric service 83,235 79,373
Affiliated and other 44,897 7,091
Allowance for uncollectible accounts (3,875) (2,203)
Notes receivable from affiliate 45,000 9,300
Notes receivable from subsidiary - 66,750
Materials and supplies - at average cost:
Operating and construction 29,683 29,922
Fuel 13,355 14,098
Prepaid taxes 13,486 15,727
Other, including current portion of regulatory assets 8,941 1,092
238,954 222,955
Deferred Charges:
Regulatory assets 60,578 66,792
Unamortized loss on reacquired debt 18,230 19,012
Other 10,288 23,742
89,096 109,546
Total Assets $ 1,685,551 $ 1,702,127
CAPITALIZATION AND LIABILITIES:
Capitalization:
Common stock $ 447,700 $ 447,700
Other paid-in capital 2,690 2,690
Retained earnings 313,826 312,522
764,216 762,912
Preferred stock - 16,378
Long-term debt and QUIDS 513,388 578,817
Funds on deposit with trustees (6,537) -
1,271,067 1,358,107
Current Liabilities:
Long-term debt due within one year 75,000 -
Accounts payable 11,598 35,572
Accounts payable to affiliates 19,118 31,011
Deferred income taxes - 11,311
Taxes accrued:
Federal and state income 18,919 6,430
Other 16,988 18,922
Interest accrued 12,508 7,193
Other 24,252 8,770
178,383 119,209
Deferred Credits and Other Liabilities:
Unamortized investment credit 18,188 19,592
Deferred income taxes 181,064 170,349
Regulatory liabilities 18,419 11,233
Other 18,430 23,637
236,101 224,811
Total Capitalization and Liabilities $ 1,685,551 $ 1,702,127
</TABLE>
See accompanying notes to financial statements.
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THE POTOMAC EDISON COMPANY
Statement of Cash Flows
(Thousands of Dollars)
<TABLE>
<CAPTION>
Nine Months Ended
September 30
1999 1998
CASH FLOWS FROM OPERATIONS:
<S> <C> <C> <C> <C>
Net income $ 81,392 $ 75,725
Depreciation 57,327 56,025
Deferred investment credit and income taxes, net (10,542) 3,603
Deferred power costs, net 14,250 4,798
Unconsolidated subsidiaries' dividends in excess of earnings 2,315 10,788
Allowance for other than borrowed funds used
during construction (558) (408)
Changes in certain current assets and
liabilities:
Accounts receivable, net (39,996) (10,070)
Materials and supplies 982 3,288
Accounts payable (35,867) 13,665
Taxes accrued 10,555 13,393
Interest accrued 5,315 3,498
Maryland settlement 15,462 -
Other, net 5,392 (1,920)
106,027 172,385
CASH FLOWS FROM INVESTING:
Construction expenditures (less allowance for other
than borrowed funds used during construction) (47,484) (44,630)
CASH FLOWS FROM FINANCING:
Retirement of preferred stock (16,902) -
Issuance of long-term debt 9,300 33,200
Retirement of long-term debt - (34,000)
Notes receivable from affiliates (35,700) (32,300)
Notes receivable from subsidiary 66,750 (66,250)
Dividends on capital stock:
Preferred stock (545) (613)
Common stock (79,019) (27,534)
(56,116) (127,497)
NET CHANGE IN CASH AND TEMPORARY CASH INVESTMENTS 2,427 258
Cash at January 1 1,805 2,319
Cash at September 30 $ 4,232 $ 2,577
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the period for:
Interest (net of amount capitalized) $26,143 $30,492
Income taxes 39,836 31,603
</TABLE>
See accompanying notes to financial statements.
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THE POTOMAC EDISON COMPANY
Notes to Financial Statements
1. The Potomac Edison Company (the Company) is a wholly-owned
subsidiary of Allegheny Energy, Inc. (the Parent). The
Company's Notes to Financial Statements in its Annual Report
on Form 10-K for the year ended December 31, 1998 should be
read with the accompanying financial statements and the
following notes. With the exception of the December 31, 1998
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 September 30, 1999, the results of operations for the
three and nine months ended September 30, 1999 and 1998, and
cash flows for the nine months ended September 30, 1999 and
1998.
2. 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 is reported by the Company in its
financial statements using the equity method of accounting.
AGC owns an undivided 40% interest, 840 megawatts (MW), in
the 2,100 MW pumped-storage hydroelectric station in Bath
County, Virginia, operated by the 60% owner, Virginia
Electric and Power Company, a nonaffiliated utility.
AGC recovers from the Company and its affiliates all of its
operation and maintenance expenses, depreciation, taxes, and
a return on its investment under a wholesale rate schedule
approved by the Federal Energy Regulatory Commission (FERC).
AGC's rates are set by a formula filed with and previously
accepted by the FERC. The only component which changes is
the return on equity (ROE). Pursuant to a settlement
agreement filed April 4, 1996 with the FERC, AGC's ROE was
set at 11% for 1996 and will continue until the time any
affected party seeks renegotiation of the ROE.
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Following is a summary of income statement information for
AGC:
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
(Thousands of Dollars)
Electric operating revenues $18,072 $18,303 $53,739 $56,033
Operation and maintenance
expense 1,207 888 4,122 3,383
Depreciation 4,245 4,242 12,735 12,710
Taxes other than income taxes 1,137 1,168 3,398 3,505
Federal income taxes 2,662 2,708 7,622 8,480
Interest charges 3,305 3,707 9,993 10,518
Other income, net - (35) (2) (86)
Net income $ 5,516 $ 5,625 $15,871 $17,523
The Company's share of the equity in earnings above was $1.5
million and $1.6 million for the three months ended September
30, 1999 and 1998, respectively, and $4.4 million and $4.9
million for the nine months ended September 30, 1999 and
1998, respectively, and was included in other income, net, on
the Company's Statement of Income.
4. As previously reported, on October 5, 1998, DQE, Inc. (DQE),
parent company of Duquesne Light Company in Pittsburgh, Pa.,
notified the Company's parent, Allegheny Energy, Inc.
(Allegheny Energy) that it had unilaterally decided to
terminate the merger. In response, Allegheny Energy filed
with the United States District Court for the Western
District of Pennsylvania on October 5, 1998, a lawsuit for
specific performance of the Merger Agreement or,
alternatively, damages. On March 11, 1999, the United States
Court of Appeals for the Third Circuit vacated the United
States District Court for the Western District of
Pennsylvania's denial of Allegheny Energy's motion for
preliminary injunction, enjoining DQE from taking actions
prohibited by the Merger Agreement. The Circuit Court stated
that if DQE breached the Merger Agreement, Allegheny Energy
may be entitled to specific performance of the Merger
Agreement. The Circuit Court also stated that Allegheny
Energy could be irreparably harmed if DQE took actions that
would prevent Allegheny Energy from receiving the specific
performance remedy. The Circuit Court remanded the case to
the District Court for further proceedings consistent with
its opinion.
The District Court denied DQE's motion for summary judgement.
The District Court has held a trial on October 18-28, 1999,
without a jury, on the issues of whether DQE's termination of
the Merger Agreement breached the agreement and whether
Allegheny Energy is entitled to specific performance. A
decision by the District Court is expected by the end of
1999. Allegheny Energy cannot predict the outcome of this
litigation. However, Allegheny Energy believes that DQE's
basis for terminating the merger is without merit.
Accordingly, Allegheny Energy continues to seek the necessary
regulatory approvals. It is not likely any agency will act
further on the merger unless Allegheny Energy obtains
judicial relief requiring DQE to move forward.
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The $5.2 million deferred incremental costs of the merger
process recorded by the Company through March 31, 1999 were
transferred to the Parent company in the second quarter of
1999. The accumulated merger costs will be written off by
the Parent company when the merger occurs or if it is
determined that the merger will not occur.
5. SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," established standards for
reporting information about operating segments in financial
statements. The Company's principal business segment is utility
operations which includes the generation, purchase, transmission,
distribution, and sale of electricity.
6. The Company redeemed all outstanding shares of its
cumulative preferred stock on September 30, 1999 with funds on
hand. The cumulative preferred stock was redeemed at its
combined par value of $16.4 million plus redemption premiums of
$.5 million. The redemption of the preferred stock will allow
the Company to revise its Articles of Incorporation providing
greater financial flexibility in restructuring debt.
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THE POTOMAC EDISON COMPANY
Management's Discussion and Analysis of Financial Condition
and Results of Operations
COMPARISON OF THIRD QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 1999
WITH THIRD QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 1998
The Notes to Financial Statements and Management's
Discussion and Analysis of Financial Condition and Results of
Operations in The Potomac Edison Company's Annual Report on Form
10-K for the year ended December 31, 1998 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. These include
statements with respect to deregulation activities and movements
toward competition in states served by the Company, the proposed
merger of the Company's parent, Allegheny Energy, Inc. (Allegheny
Energy) and related litigation against DQE, Inc. (DQE), parent
company of Duquesne Light Company in Pittsburgh, Pa., Year 2000
readiness disclosure, and results of operations. All such
forward-looking information is necessarily only estimated. There
can be no assurance that actual results will not materially
differ from expectations. Actual results have varied materially
and unpredictably from past expectations.
Factors that could cause actual results to differ
materially include, among other matters, electric utility
restructuring, including the ongoing state and federal
activities; potential Year 2000 operation problems; developments
in the legislative, regulatory, and competitive environments in
which the Company operates, including regulatory proceedings
affecting rates charged by the Company; environmental,
legislative, and regulatory changes; future economic conditions;
developments relating to the proposed merger of Allegheny Energy
with DQE; and other circumstances that could affect anticipated
revenues and costs such as significant volatility in the market
price of wholesale power, unscheduled maintenance or repair
requirements, weather, and compliance with laws and regulations.
Significant Events in the First Nine Months of 1999
* Proposed Merger with DQE
See Note 4 to the financial statements for information
about the proposed merger of Allegheny Energy with DQE and
related litigation.
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* Virginia Rate Settlement and Agreement
On February 25, 1999, the Virginia State Corporation
Commission (Virginia SCC) approved the Company's rate reduction
request which decreased the fuel portion of Virginia customers'
bills by approximately 7.6% (a decrease in annual fuel revenue of
about $2.2 million). The decrease is primarily due to refunding
a prior overrecovery of fuel costs, coupled with a small decrease
in projected energy costs. The new rates were effective with
bills rendered on or after March 9, 1999.
On May 21, 1999, the Virginia SCC approved an agreement
reached between the Company and the staff of the Virginia SCC
which reduced base rates for Virginia customers effective June 1,
1999 by about $3 million annually. The review of rates is
required by an annual information filing in Virginia.
* West Virginia Fuel Review
On February 26, 1999, the Public Service Commission of
West Virginia (W.Va. PSC) entered an Order to initiate a fuel
review proceeding to establish a fuel increment in rates for the
Company to be effective July 1, 1999 through June 30, 2000. On
June 29, 1999, the W.Va. PSC approved a joint stipulation and
agreement between the Company and the intervenors. Under the
agreement, the parties are to negotiate further in an effort to
more closely align the Company's West Virginia rate schedules
with the West Virginia rate schedules of Monongahela Power
Company, an affiliate, and to petition to reopen this case if
they are successful. Absent such agreement by October 15, 1999,
the rates were to revert to the originally proposed rates in this
case. This change would have been effective November 1, 1999 and
would have decreased the Company's fuel rates by $8.0 million.
On October 15, 1999, the parties filed a "Status Report and
Agreement to Continue." The Agreement stated that the parties
had met and exchanged proposals but more time was needed to
review the matter. The parties agreed to continue discussions
until January 31, 2000. If the parties have not reached an
agreement by that date, then the rates as previously proposed
would become effective February 15, 2000 with no further approval
or action required of the W.Va. PSC. These changes, if
implemented, will have no effect on the Company's net income.
* Maryland Fuel Rate Filing
On November 8, 1999, the Company filed with the Maryland
Public Service Commission (Maryland PSC) a request to decrease
the fuel portion of Maryland customers' bills by about $6.4
million annually. The requested decrease is primarily due to
greater efficiencies, lower fuel costs, and increased
nonaffiliated generation and transmission sales. If approved by
the Maryland PSC, the new fuel rates will become effective with
bills rendered on or after December 7, 1999. This change, if
implemented, will have no effect on the Company's net income.
* Maryland, Virginia, and West Virginia Deregulation
See Electric Energy Competition starting on page 18 for
ongoing information regarding restructuring in Maryland,
Virginia, and West Virginia.
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* Toxics Release Inventory (TRI)
On Earth Day 1997, President Clinton announced the
expansion of Right-to-Know TRI reporting to include electric
utilities, limited to facilities that combust coal and/or oil for
the purpose of generating power for distribution in commerce.
The purpose of TRI is to provide site-specific information on
chemical releases to the air, land, and water. On June 4, 1999,
the Allegheny Energy companies (the System) joined with other
members of the Edison Electric Institute in reporting power
station releases to the public. Packets of information about the
System's releases were provided to media in the System's area and
posted on the Parent Company's web site. The System filed its
first TRI report with the Environmental Protection Agency prior
to the July 1, 1999 deadline date, reporting 18 million pounds of
total releases for calendar year 1998.
Review of Operations
EARNINGS SUMMARY
Net income in the third quarter of 1999 was $26.5 million
compared with $27.3 million in the corresponding 1998 period.
For the first nine months of 1999, net income was $81.4 million
compared with $75.7 million for the corresponding 1998 period.
The decrease in net income for the third quarter of 1999
was due primarily to increased operation and maintenance
expenses, reductions in revenues due to a provision to share
earnings above a return on equity of 11.4% per the settlement
agreement discussed on page 13 and renegotiated contracts with
some wholesale customers.
The increase in year-to-date net income was due primarily
to increased kilowatt-hour (kWh) sales to retail customers, and
to a lesser extent, to reduced interest expenses. The 1999 first
quarter winter weather was 19% cooler than the relatively warm
winter of 1998, as measured by heating degree days, but was still
7% warmer than normal.
SALES AND REVENUES
Percentage changes in revenues and kWh sales by major
retail customer classes were:
Change from Prior Periods
Three Months Ended Nine Months Ended
September 30 September 30
Revenues kWh Revenues kWh
Residential 2.1% .9% 6.8% 5.5%
Commercial 4.1 3.0 7.1 6.5
Industrial 5.0 (1.6) 3.6 (1.4)
Total 3.5% .2% 5.9% 2.5%
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The increase in residential kWh sales for the three
months ended September 30, 1999, which are more weather sensitive
than the other classes, was due primarily to growth in the number
of customers. The increase for the nine month ended period was
due primarily to changes in customer usage because of weather
conditions. Commercial kWh sales are also affected by weather
but to a lesser extent than residential. The increase in
commercial kwh sales for the three and nine months ended period
reflects increased usage and growth in the number of customers.
The decrease in industrial kWh sales in both periods results
primarily from decreased sales to primary metals industry
customers.
The changes in revenues from retail customers resulted
from the following:
Change from Prior Periods
Three Months Ended Nine Months Ended
September 30 September 30
(Millions of Dollars)
Fuel clauses $(.2) $10.6
All other 6.1 19.2
Net change in retail
revenues $5.9 $29.8
Revenues reflect not only the changes in kWh sales and
base rate changes, but also any changes in revenues from fuel and
energy cost adjustment clauses (fuel clauses) which have little
effect on net income because increases and decreases in fuel and
purchased power costs and sales of transmission services and bulk
power are passed on to customers by adjustment of customer bills
through fuel clauses.
All other is the net effect of kWh sales changes due to
changes in customer usage (primarily weather for residential
customers), growth in the number of customers, and changes in
pricing other than changes in general tariff and fuel clause
rates. The increase in all other retail revenues in the third
quarter was primarily due to increased kWh sales due to customer
growth, and the increase in the nine months ended period was due
to increased kWh sales due to customer growth, and to a lesser
extent, changes in customer usage because of weather conditions.
Wholesale and other revenues were as follows:
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
(Millions of Dollars)
Wholesale customers $5.8 $5.8 $16.2 $18.5
Affiliated companies 2.8 2.2 8.8 7.5
Street lighting and other .5 1.3 2.7 4.6
Settlement agreement reduction (6.5) (15.4)
Total wholesale and other
revenues $2.6 $9.3 $12.3 $30.6
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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 Federal Energy
Regulatory Commission (FERC) regulation. Competition in the
wholesale market for electricity was initiated by the National
Energy Policy Act of 1992 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. The decrease in wholesale revenues
in the nine months ended period was primarily due to renegotiated
contracts with some wholesale customers.
Revenues from affiliated companies represent sales of
energy and intercompany allocations of generating capacity,
generation spinning reserves, and transmission services pursuant
to a power supply agreement among the Company and the other
regulated utility subsidiaries of Allegheny Energy.
Settlement agreement revenue reductions in the three and
nine months ended September 30, 1999 of $6.5 million and $15.4
million, respectively, reflect a settlement agreement by the
Company settling the Maryland Office of People's Counsel's
petition for a reduction in the Company's Maryland rates. Of
that amount, in the three and nine months ended September 30,
1999, $3.9 million and $7.7 million, respectively, are related to
the Company creating a provision to share earnings above a return
on equity of 11.4% in Maryland as discussed below, and in the
three and nine months ended September 30, 1999, $2.6 million and
$7.7 million, respectively, are related to a deferral of 1999
revenues per the settlement agreement. The agreement, which
includes recognition of costs to be incurred from the AES Warrior
Run cogeneration project being developed under the Public Utility
Regulatory Policies Act of 1978 (PURPA), was approved by the
Maryland PSC on October 27, 1998. Under the terms of that
agreement, the Company will increase its rates about 4% ($13
million) in each of the years 1999, 2000, and 2001 (a $39 million
annual effect in 2001). The increases are designed to recover
additional costs of about $131 million over the period 1999-2001
for capacity purchases from the AES Warrior Run cogeneration
project, net of alleged over-earnings of $52 million for the same
period. The net effect of these changes over the 1999-2001 time
frame results in a pre-tax income reduction of $12 million in
1999, $18 million in 2000, and $22 million in 2001. In addition,
the settlement requires that the Company share, on a 50%
customer, 50% shareholder basis, earnings above a return on
equity of 11.4% in Maryland for 1999-2001. This sharing will
occur through an annual true-up.
Revenues from bulk power transactions include sales of
bulk power and transmission services to power marketers and other
utilities. Revenues from bulk power transactions consist of the
following items:
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
(Millions of Dollars)
Revenues:
Transmission services to
nonaffiliated companies $6.0 $ 6.1 $13.0 $12.4
Bulk power 3.7 3.9 7.1 11.8
Total bulk power trans-
actions, net $9.7 $10.0 $20.1 $24.2
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Revenues from bulk power transactions decreased in the
first nine months of 1999. Revenues from bulk power transactions
in the first nine months of 1998 were high due to increased sales
of energy which occurred primarily in the month of June 1998 as a
result of a heat wave which increased the demand and prices for
energy. The costs of purchased power and revenues from sales to
power marketers and other utilities, including transmission
services, are currently recovered from or credited to customers
under fuel and energy cost recovery procedures. The impact to
the fuel and energy cost recovery clauses, either positively or
negatively, depends on whether the Company is a net buyer or
seller of electricity during such periods.
OPERATING EXPENSES
Fuel expenses for the three and nine months ended
September 30, 1999 decreased .2% and 2.1%, respectively,
primarily due to a decrease in average fuel prices of 8.3% and
6.1%, respectively, offset in part by a 6.6% and a 3.3%,
respectively, increase in kwh's generated. 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 other companies, 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 Nine Months Ended
September 30 September 30
1999 1998 1999 1998
(Millions of Dollars)
Nonaffiliated transactions:
Purchased power $ 4.4 $ 6.0 $10.4 $ 10.8
Power exchanges, net (2.6) (1.1) (2.8) (.4)
Affiliated transactions:
AGC capacity charges 5.0 5.8 15.0 18.1
Other affiliated capacity
charges 9.5 10.2 29.3 33.0
Energy and spinning
reserve charges 14.9 17.7 40.8 42.6
Purchased power and
exchanges, net $31.2 $38.6 $92.7 $104.1
The AES Warrior Run PURPA cogeneration contract in the
Company's Maryland service territory will increase the cost of
power purchases $60 million or more annually. Commencement of
operation was scheduled for October 1999. Pre-commencement
testing is not completed. AES Warrior Run has until October 1,
2000 to complete pre-commencement testing. The Maryland Public
Utility Commission has approved the Company's recovery of the AES
Warrior Run purchased power cost as part of a settlement
agreement. See Sales and Revenues starting on page 11 for more
information on the settlement agreement.
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Other operations expenses in the three months ended
September 30, 1999 increased $2.8 million primarily due to
increased salaries and wages and employee benefits. The increase
in total other operations expenses in the nine months ended
September 30, 1999 of $6.4 million was due primarily to costs
associated with certain PURPA regulations, salaries and wages,
Year 2000 expenses, and increased provisions for uninsured
claims. These increases were offset in part by lower
transmission and distribution operations expenses.
Maintenance expenses for the third quarter and nine
months ended September 30, 1999 increased from the same periods
in 1998 by $1.2 million and $1.3 million, respectively, due
primarily to increased power station maintenance expenses.
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 expenses in the three and nine months ended
September 30, 1999 increased due to increased investment.
Taxes other than income taxes increased in the three and
nine months ended September 30, 1999 due primarily to an
increased assessment related to Maryland property taxes.
Federal and state income taxes decreased $2.8 million
and $1.0 million in the third quarter and first nine months of
1999, respectively, primarily due to the Company's share of tax
savings in consolidation related to its parent, Allegheny Energy,
Inc. and for the third quarter of 1999 was also due to decreased
income before taxes.
The decrease in interest on long-term debt in the three
and nine months ended September 30, 1999 of $1.0 million and $3.2
million, respectively, resulted primarily from reduced long-term
debt and lower interest rates.
Other interest expense reflects changes in the levels of
short-term debt maintained by the Company, as well as the
associated 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,
1998 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 Note 4 to the Financial Statements for information about
Allegheny Energy's proposed merger with DQE.
<PAGE>
- 16 -
* Market Risk
The Company supplies power in the bulk power market. At
September 30, 1999, the marketing books for such operations
consisted primarily of fixed-priced, forward-purchase and/or sale
contracts which require settlement by 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.
* Redemption of Preferred Stock
The Company redeemed all outstanding shares of its
cumulative preferred stock on September 30, 1999 with funds on
hand. The cumulative preferred stock was redeemed at its
combined par value of $16.4 million plus redemption premiums of
$.5 million. The redemption of the preferred stock will allow
the Company to revise its Articles of Incorporation providing
greater financial flexibility in restructuring debt.
* Issuance of Long-Term Debt
In April 1999, the Company issued $9.3 million of 5.50%
30-year pollution control revenue notes to Pleasants County, West
Virginia.
* Long-Term Debt Due Within One Year
The Company's long-term debt due within one year at
September 30, 1999 represents $75 million of 5-7/8% first
mortgage bonds due March 1, 2000.
* Year 2000 Readiness Disclosure
The transition from 1999 into the Year 2000 (Y2K) has the
potential to cause serious problems to most organizations,
including the Company, related to software and various equipment
with embedded chips which may not properly recognize calendar
dates. To minimize such problems, the Company and its affiliates
in the System have been working under a comprehensive Y2K program
to identify and remediate the problem areas in order to continue
operations without significant problems in 2000 and beyond. An
Executive Task Force is coordinating the efforts of 24 separate
Y2K Teams, representing all business and support units in the
System.
In May 1998, the North American Electric Reliability
Council (NERC), of which the System is a member, accepted a
request from the United States Department of Energy to coordinate
the industry's Y2K efforts. The electric utility industry and
the System have segmented the Y2K problem into the following
components:
* Computer hardware and software;
* Embedded chips in various equipment; and
* Vendors and other organizations on which the System
relies for critical materials and services.
The industry's and the System's efforts for each of these
three components include inventory, assessment and, where
possible, remediation of the problem areas by repair, replacement
or removal, supplemented by confirmation testing and contingency
plans. Contingency plans include alternate methods of certain
operations to help avoid electric service or
<PAGE>
- 17 -
business interruptions, and the review and update of restoration
of service plans to mitigate the severity and length of
interruptions in the unlikely event that any should occur.
Based on this work, the Company has determined that as of
September 30, 1999 all of its critical components and systems
related to safety and the production and distribution of
electricity are Y2K Ready, and all but one of its important
business systems are also Ready. Remediation on this one
remaining system related to customer billing has been completed
and system testing is in progress. Although the system is
expected to be Y2K Ready in November, the Company has contingency
plans to continue operations without the system if necessary.
The Company has defined Y2K Ready to mean that a determination
has been made by testing or other means that a component or
system will be able to perform its critical functions.
The Company's readiness program has been conducted in
accordance with time schedules recommended by state regulatory
commissions and by NERC. As is the case of most electric
utilities, the System is interconnected with neighboring
utilities, which provides added strength of supply diversity and
flexibility. But the interconnections also mean that any one
utility's Y2K readiness is related to the readiness of the group.
Integrated electric utilities are uniquely reliant on each other
to avoid, in a worst case situation, a cascading failure of the
entire electrical system. The System is working with the Edison
Electric Institute, the Electric Power Research Institute, the
NERC, and the East Central Area Reliability Agreement group
(ECAR) to capitalize on industry-wide experiences and to
participate in industry-wide testing and contingency planning.
Since the Company and its neighboring utilities in the ECAR group
are all participants in the NERC Y2K effort (which had a target
completion date of June 30 for critical systems related to
production and delivery of electricity), the Company believes
that this worst case possibility has been reduced to an unlikely
event. The Company has recently re-tested its existing
contingency plans for restoration of service even if this
unlikely event were to occur.
As part of the on-going NERC program, the Company
participated in industry-wide Y2K drills on April 9, and
September 9, 1999. While the electric utility industry is aware
of the extensive Y2K programs of the major telecommunications
companies, the industry has determined that telecommunication
facilities are so important to continued operations that we must
have contingency plans just in case some of those facilities may
not be available. The drills were dry runs designed primarily to
test the ability of utilities to continue to operate with less
than normal telecommunication facilities. During the tests, the
Company was able to maintain adequate communications under
simulated failures of selected systems, and obtained valuable
information for improvement of its plans. NERC has reported that
the industry-wide tests produced similar results. On December
31, 1999, the Company will have extra staff in critical areas of
the system to implement these and other contingency plans if they
are required.
The Securities and Exchange Commission requires that each
company disclose its estimate of the "most reasonably likely
worst case scenario" of a negative Y2K event. Since the Company
and the industry are working diligently to avoid any disruption
of electric service, the Company believes its customers will not
experience any significant long-term disruptions of electric
service. It is the Company's opinion that the "most reasonably
likely worst case scenario" is a Y2K event or series of events
that may cause
<PAGE>
- 18 -
isolated disruptions of service. All utilities, including the
Company, have experience in the implementation of existing
restoration of service plans. As stated above, the Company's Y2K
program includes a review and update of these plans to respond
quickly to any such events.
The Company is aware of the importance of electricity to
its customers and is using its best efforts to avoid any serious
Y2K problems. Despite the Company's best efforts, including
working with internal resources, external vendors, and industry
associations, the Company cannot guarantee that it will be able
to conduct all of its operations without Y2K interruptions. To
the extent that any Y2K problem may be encountered, the Company
is committed to resolution as expeditiously as possible to
minimize the effect of any such event.
Expenditures for Y2K readiness are not expected to have a
material effect on the Company's results of operations or
financial position primarily because of the significant time and
money expended over the past several years on upgrading and
replacing its large mainframe computer systems and software.
While the Y2K work has been significant, it primarily represents
a labor-intensive effort of remediation, component testing,
multiple systems testing, documentation, and contingency
planning. While outside contractors and equipment vendors have
been employed for some of the work, the Company has used its own
employees for most of the effort because of their experience with
the Company's systems and equipment. The Company currently
estimates that its total incremental expenditures for the Y2K
effort since it began identification of Y2K costs will be up to
about $5 million of which about $4 million has been incurred
through September 30, 1999. These expenditures are financed by
internal sources and primarily result from the purchase of
external expert assistance by the Generation and Information
Services departments. The expenditures have not required a
material reduction in the normal budgets and work efforts of
these departments.
The descriptions herein of the Company's Y2K effort are
made pursuant to the Year 2000 Information and Readiness
Disclosure Act. Forward-looking statements herein are made
pursuant to the Private Securities Litigation Reform Act of 1995.
There can be no assurance that actual results will not materially
differ from expectations.
* Electric Energy Competition
The electricity supply segment of the electric utility
industry in the United States is becoming increasingly
competitive. The Energy Policy Act of 1992 began the process of
deregulating the wholesale exchange of power within the electric
industry by permitting the FERC to compel electric utilities to
allow third parties to sell electricity to wholesale customers
over their transmission systems. Since 1992, the wholesale
electricity market has become more competitive as companies began
to engage in nationwide power trading. In addition, an
increasing number of states have taken active steps toward
allowing retail customers the right to choose their electricity
supplier. The Company has been an advocate of federal
legislation to create competition in the retail electricity
markets to avoid regional dislocations and ensure level playing
fields. Legislation before the U.S. Congress to restructure the
nation's electric utility industry cleared an important hurdle on
October 28, 1999 when a House Commerce Committee subcommittee
gave its approval to the bill. The bill will now move onto the
full Commerce Committee where it will be considered next year.
<PAGE>
- 19 -
In the absence of federal legislation, state-by-state
implementation has begun. All of the states served by the
utility subsidiaries of Allegheny Energy are at various stages of
implementation or investigation of programs that allow customers
to choose their electric supplier. Pennsylvania is furthest
along with a retail program in place, while Maryland, Virginia,
and Ohio passed legislation this year to implement retail choice.
West Virginia continues to actively study this issue. West Penn,
an affiliate, is currently implementing a settlement agreement to
create competition for electricity supply in Pennsylvania. The
Company filed a settlement agreement to introduce generation
competition with the Maryland PSC on September 23, 1999.
Maryland PSC approval is expected before the end of 1999.
Activities at the Federal Level
The System continues to seek enactment of federal
legislation to bring choice to all retail electric customers,
deregulate the generation and sale of electricity on a national
level, and create a more liquid, free market for electric power.
Fully meeting challenges in the emerging competitive environment
will be difficult for the System unless certain outmoded and anti-
competitive laws, specifically the Public Utility Holding Company
Act of 1935 (PUHCA) and Section 210 of the Public Utility
Regulatory Policies Act of 1978 (PURPA), are repealed or
significantly revised. The System continues to advocate the
repeal of PUHCA and PURPA on the grounds that they are obsolete
and anti-competitive and that PURPA results in utility customers
paying above-market prices for power. H.R. 2944, which was
sponsored by Representative Joe Barton, was favorably reported
out of the House Commerce Subcommittee on Energy and Power.
While the bill does not mandate a date certain for customer
choice, several key provisions favored by the System are included
in the legislation, including an amendment that allows existing
state restructuring plans and agreements to remain in effect.
Other provisions address important System priorities by repealing
the PUHCA and the mandatory purchase provisions of the PURPA.
Consensus remains elusive with significant hurdles remaining in
both houses of Congress. It is too early to tell whether
momentum on the issue will result in legislation in the current
Congress.
Maryland
On April 8, 1999, Maryland Governor Glendening signed the
legislation that will bring competition to Maryland's electric
generation market. The Maryland PSC is in the process of
implementing the new law. Final Electric Restructuring
Roundtable reports were filed with the Commission in May and
legislative-style hearings were held this summer on the
Roundtable reports. The Commission is expected to issue
decisions on those aspects of restructuring by the end of the
year.
On September 23, Allegheny Energy filed a Settlement
Agreement (covering Allegheny Energy's stranded costs
quantification mechanism, price protection mechanism, and
unbundled rates) with the Maryland PSC. The Agreement was signed
by all parties active in the case except Eastalco, who stated
although they did not sign the agreement, they would not oppose
it. The settlement agreement, which is subject to Commission
approval, includes the following provisions:
* The ability for nearly all of our 208,000 Maryland
customers to have the option of choosing an electric generation
supplier starting July 1, 2000.
<PAGE>
- 20 -
* The authorization to transfer generating assets to a non-
regulated corporate entity at book value on July 1, 2000.
* A reduction in base rates of 7% for residential
customers from 2002 through 2008 ($10.4 million each year,
totaling $72.8 million). A reduction in base rates of one-half a
percent for the majority of commercial and industrial customers
from 2002 through 2008 ($1.5 million each year, totaling $10.5
million).
* Standard Offer Service (provider of last resort) will be
provided to residential customers during a transition period from
July 1, 2000 to December 31, 2008 and to all other customers
during a transition period of July 1, 2000 to December 31, 2004.
* A cap on generation rates for residential customers from
2002 through 2008. Generation rates for non-residential customers
are capped from 2002 through 2004.
* A cap on transmission and distribution rates for all
customers from 2002 through 2004.
* Unless Allegheny Energy is subject to significant
changes that would materially affect the Company's financial
condition, the parties agree not to seek a reduction in rates
which would be effective prior to January 1, 2005.
* The recovery of all purchased power costs incurred as a
result of our contract to buy generation from the AES Warrior Run
PURPA cogeneration contract.
* The establishment of a fund for the development and use
of energy-efficient technologies.
On October 4, Allegheny Energy filed unbundled rates
covering the period 2000-2008. The Commission held public
hearings regarding the settlement agreement on October 14 and
October 18. A final Commission decision is expected before the
end of 1999.
Virginia
The Virginia Electric Utility Restructuring Act (the
"Restructuring Act") was passed by the Virginia General Assembly
on March 25, 1999 and signed by the Governor of Virginia on March
29, 1999. The Legislative Transition Task Force on Electric
Utility Restructuring, which was established by the Restructuring
Act, held hearings this summer on a number of issues concerning
the implementation of retail competition in Virginia. Working
groups continued to meet with State Corporation Commission staff,
comments were filed, and Commission hearings were held to discuss
the nature of and the rules governing the proposed retail pilot
programs of other utilities in the state.
<PAGE>
- 21 -
West Virginia
In March 1998, legislation was passed by the West
Virginia Legislature that directed the W.Va. PSC to meet with all
interested parties to develop a restructuring plan which would
meet the dictates and goals of the legislation. Interested
parties formed a Task Force that met during 1998, but the Task
Force was unable to reach a consensus on a model for
restructuring. The W.Va. PSC held hearings in August 1999 that
addressed certification, licensing, bonding, reliability,
universal service, consumer protection, code of conduct,
subsidies, and stranded costs. The August hearings have
concluded and the W.Va. PSC has stated that it would issue an
Order after November 1, 1999. The Order will have a
determination as to whether deregulation is in the best interest
of West Virginia, and if so, a plan may be issued with it.
Informal negotiations with all of the parties will continue
beyond the November 1 Commission-imposed deadline to seek
consensus on a restructuring plan, although no agreements have
been reached to date.
The status of electric energy competition in Pennsylvania and
Ohio in which affiliates of the Company serve are as follows.
Ohio
The Ohio General Assembly ended five years of debate on
June 22, 1999 when it passed legislation to restructure the
electric utility industry. Governor Taft added his signature soon
thereafter, and all of the state's customers will be able to
choose their electricity supplier starting January 1, 2001,
beginning with a five-year transition to market rates. Total
electric rates will be frozen over that period, and residential
customers are guaranteed a five percent cut in the generation
portion of their rate. The determination of stranded cost
recovery will be handled by The Public Utilities Commission of
Ohio. The bill stipulates that no entity shall own or control
transmission facilities after the start of competitive retail
electric service. Customer protections were kept intact with a
low-income assistance plan and a one-time forgiveness of past
debts for low-income and handicapped customers. In regard to
renewable energy, the bill requires that electric generators
purchase excess electricity from small businesses and homes using
renewable energy sources. In addition, a customer's bill will
list what fuel was expended to produce the electricity and what
emissions were created.
Pennsylvania
As previously disclosed, beginning in January 1999, two-
thirds of the customers of the Company's Pennsylvania affiliate,
West Penn Power Company, were permitted to choose an alternate
electricity supplier. Remaining customers can do so in January
2000.
<PAGE>
- 22 -
Accounting for the Effects of Price Deregulation
In July 1997, the Emerging Issues Task Force (EITF) of
the Financial Accounting Standards Board (FASB) released Issue
No. 97-4, "Deregulation of the Pricing of Electricity - Issues
Related to the Application of FASB Statement Nos. 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. Because Maryland and Virginia
have passed legislation for a deregulation plan, 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
and Virginia portion) on an uncertain future date. West Virginia
has not yet developed a 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 Maryland and Virginia
legislations establish definitive processes for transition to
deregulation and market-based pricing for electric generation.
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.
<PAGE>
- 23 -
THE POTOMAC EDISON COMPANY
Part II - Other Information to Form 10-Q
for Quarter Ended September 30, 1999
ITEM 1. LEGAL PROCEEDINGS
The MidAtlantic case, previously reported as an ongoing
litigation matter, has been settled and an Order was entered on
July 9, 1999 dismissing the case with prejudice.
As of September 30, 1999, Monongahela Power Company, an
affiliate of the Company, has been named as a defendant, along
with multiple other defendants in a total of approximately 8,626
asbestos cases. The Company and West Penn Power Company, also an
affiliate of the Company, were named as defendants along with
multiple other defendants in approximately one-half of those
cases. As of September 30, 1999, a total of 878 cases have been
settled and/or dismissed against the Company, Monongahela Power
Company, and West Penn Power Company for reasonable settlement
amounts. While the Company, Monongahela Power Company, and West
Penn Power Company believe that all of the cases are without
merit, they cannot predict the outcome nor are they able to
determine whether additional cases will be filed.
As previously reported, on October 5, 1998, DQE, Inc.
(DQE), parent company of Duquesne Light Company in Pittsburgh,
Pa., notified the Company's parent, Allegheny Energy, Inc.
(Allegheny Energy) that it had unilaterally decided to terminate
the merger. In response, Allegheny Energy filed with the United
States District Court for the Western District of Pennsylvania on
October 5, 1998, a lawsuit for specific performance of the Merger
Agreement or, alternatively, damages. On March 11, 1999, the
United States Court of Appeals for the Third Circuit vacated the
United States District Court for the Western District of
Pennsylvania's denial of Allegheny Energy's motion for
preliminary injunction, enjoining DQE from taking actions
prohibited by the Merger Agreement. The Circuit Court stated
that if DQE breached the Merger Agreement, Allegheny Energy may
be entitled to specific performance of the Merger Agreement. The
Circuit Court also stated that Allegheny Energy could be
irreparably harmed if DQE took actions that would prevent
Allegheny Energy from receiving the specific performance remedy.
The Circuit Court remanded the case to the District Court for
further proceedings consistent with its opinion.
The District Court denied DQE's motion for summary
judgement. The District Court has held a trial on October 18-28,
1999, without a jury, on the issues of whether DQE's termination
of the Merger Agreement breached the agreement and whether
Allegheny Energy is entitled to specific performance. A decision
by the District Court is expected by the end of 1999. Allegheny
Energy cannot predict the outcome of this litigation. However,
Allegheny Energy believes that DQE's basis for terminating the
merger is without merit. Accordingly, Allegheny Energy continues
to seek the necessary regulatory approvals. It is not likely any
agency will act further on the merger unless Allegheny Energy
obtains judicial relief requiring DQE to move forward.
<PAGE>
- 24 -
ITEM 5. OTHER EVENTS
The Attorney General of the State of New York and the
Attorney General of the State of Connecticut in their letters
dated September 15, 1999 and November 3, 1999, respectively,
notified Allegheny Energy, Inc. (Allegheny Energy) of their
intent to commence civil actions against Allegheny Energy or its
subsidiaries (West Penn Power Company, Monongahela Power Company,
The Potomac Edison Company, and AYP Energy, Inc.) alleging
violations at the Fort Martin power station under the Federal
Clean Air Act, which requires power plants that make major
modifications to comply with the same emission standards
applicable to new power plants. Similar actions may be commenced
by other governmental authorities in the future. Fort Martin is
a station located in West Virginia jointly owned by West Penn
Power Company, Monongahela Power Company, The Potomac Edison
Company, and AYP Energy, Inc. Both Attorneys General stated
their intent to seek injunctive relief and penalties.
In addition, the Attorney General of the State of New York
in his letter indicated that he may assert claims under the State
common law of public nuisance seeking to recover, among other
things, compensation for alleged environmental damage caused in
New York by the operation of Fort Martin power station.
At this time, Allegheny Energy and its subsidiaries are
not able to determine what impact, if any, these actions taken by
the Attorneys General of New York and Connecticut may have on
them.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
(27) Financial Data Schedule
(b) No reports on Form 8-K were filed on behalf of
the Company for the quarter ended September 30, 1999.
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)
November 15, 1999
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<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUL-01-1999
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0
0
<COMMON> 447,700
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