<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, 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 May 14, 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 March 31, 1999
Index
Page
No.
PART I--FINANCIAL INFORMATION:
Statement of Income - Three months ended
March 31, 1999 and 1998 3
Balance Sheet - March 31, 1999
and December 31, 1998 4
Statement of Cash Flows - Three months ended
March 31, 1999 and 1998 5
Notes to Financial Statements 6-7
Management's Discussion and Analysis of Financial
Condition and Results of Operations 8-19
PART II--OTHER INFORMATION 20
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THE POTOMAC EDISON COMPANY
Statement of Income
(Thousands of Dollars)
Three Months Ended
March 31
1999 1998
ELECTRIC OPERATING REVENUES:
Residential $ 100,488 $ 90,329
Commercial 42,525 37,691
Industrial 50,063 48,512
Wholesale and other, including affiliates 5,763 10,984
Bulk power transactions, net 4,139 4,182
Total Operating Revenues 202,978 191,698
OPERATING EXPENSES:
Operation:
Fuel 36,648 35,557
Purchased power and exchanges, net 32,849 35,925
Deferred power costs, net 3,404 33
Other 22,684 21,178
Maintenance 13,919 14,736
Depreciation 18,957 18,645
Taxes other than income taxes 11,307 12,909
Federal and state income taxes 18,115 15,093
Total Operating Expenses 157,883 154,076
Operating Income 45,095 37,622
OTHER INCOME AND DEDUCTIONS:
Allowance for other than borrowed funds
used during construction 149 197
Other income, net 1,821 2,216
Total Other Income and Deductions 1,970 2,413
Income Before Interest Charges 47,065 40,035
INTEREST CHARGES:
Interest on long-term debt 10,632 11,800
Other interest 567 584
Allowance for borrowed funds used during
construction (298) (271)
Total Interest Charges 10,901 12,113
NET INCOME $ 36,164 $ 27,922
See accompanying notes to financial statements.
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THE POTOMAC EDISON COMPANY
Balance Sheet
(Thousands of Dollars)
<TABLE>
<CAPTION>
March 31, December 31,
ASSETS: 1999 1998
Property, Plant, and Equipment:
<S> <C> <C>
At original cost, including $45,104
and $46,353 under construction $ 2,254,747 $ 2,249,716
Accumulated depreciation (938,414) (926,840)
1,316,333 1,322,876
Investments:
Allegheny Generating Company - common stock at equity 45,452 46,277
Other 457 473
45,909 46,750
Current Assets:
Cash 3,469 1,805
Accounts receivable:
Electric service 96,165 79,373
Affiliated and other 37,003 7,091
Allowance for uncollectible accounts (2,985) (2,203)
Notes receivable from affiliates 54,000 9,300
Notes receivable from subsidiary 63,800 66,750
Materials and supplies - at average cost:
Operating and construction 29,361 29,922
Fuel 17,023 14,098
Prepaid taxes 13,077 15,727
Other, including current portion of regulatory assets 853 1,092
311,766 222,955
Deferred Charges:
Regulatory assets 64,659 66,792
Unamortized loss on reacquired debt 18,751 19,012
Other 25,641 23,742
109,051 109,546
Total Assets $ 1,783,059 $ 1,702,127
CAPITALIZATION AND LIABILITIES:
Capitalization:
Common stock $ 447,700 $ 447,700
Other paid-in capital 2,690 2,690
Retained earnings 348,482 312,522
798,872 762,912
Preferred stock 16,378 16,378
Long-term debt and QUIDS 579,039 578,817
1,394,289 1,358,107
Current Liabilities:
Accounts payable 16,005 35,572
Accounts payable to affiliates 64,867 31,011
Deferred income taxes 12,755 11,311
Taxes accrued:
Federal and state income 28,571 6,430
Other 13,527 18,922
Interest accrued 12,253 7,193
Other 11,847 8,770
159,825 119,209
Deferred Credits and Other Liabilities:
Unamortized investment credit 19,124 19,592
Deferred income taxes 166,211 170,349
Regulatory liabilities 13,535 11,233
Other 30,075 23,637
228,945 224,811
Total Capitalization and Liabilities $ 1,783,059 $ 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>
Three Months Ended
March 31
1999 1998
CASH FLOWS FROM OPERATIONS:
<S> <C> <C> <C> <C>
Net income $ 36,164 $ 27,922
Depreciation 18,957 18,645
Deferred investment credit and income taxes, net (3,642) 3,184
Deferred power costs, net 3,404 33
Unconsolidated subsidiaries' dividends in excess of earnings 839 588
Allowance for other than borrowed funds used
during construction (149) (197)
Internal restructuring liability - (598)
Changes in certain current assets and
liabilities:
Accounts receivable, net (45,922) (7,215)
Materials and supplies (2,364) (3,349)
Accounts payable 14,289 (1,739)
Taxes accrued 16,746 15,210
Interest accrued 5,060 3,611
Other, net 12,676 128
56,058 56,223
CASH FLOWS FROM INVESTING:
Construction expenditures (less allowance for other
than borrowed funds used during construction) (12,440) (13,526)
CASH FLOWS FROM FINANCING:
Issuance of long-term debt - 33,200
Retirement of long-term debt - (30,800)
Deposit with trustee for redemption
of long-term debt - (3,237)
Notes receivable from affiliates (44,700) 850
Notes receivable from subsidiary 2,950 (42,450)
Dividends on preferred stock (204) (204)
(41,954) (42,641)
NET CHANGE IN CASH 1,664 56
Cash at January 1 1,805 2,319
Cash at March 31 $ 3,469 $ 2,375
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the period for:
Interest (net of amount capitalized) $ 5,463 $ 7,552
Income taxes 497 -
</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 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 March 31, 1999, and the results of operations and cash
flows for the three months ended March 31, 1999 and 1998.
2. Statement of Financial Accounting Standards (SFAS) No. 130,
"Reporting Comprehensive Income," established standards for
reporting comprehensive income and its components (revenues,
expenses, gains, and losses) in the financial statements.
The Company does not have any elements of other comprehensive
income to report in accordance with SFAS No. 130. 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 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
March 31
1999 1998
(Thousands of Dollars)
Electric operating revenues $17,857 $18,604
Operation and maintenance expense 1,611 953
Depreciation 4,245 4,226
Taxes other than income taxes 1,132 1,160
Federal income taxes 2,414 2,865
Interest charges 3,403 3,513
Other income, net (1) (50)
Net income $ 5,053 $ 5,937
The Company's share of the equity in earnings above was $1.4
million and $1.7 million for the three months ended March 31,
1999 and 1998, respectively, and is included in other income,
net, on the Company's Statement of Income. Dividends
received from AGC in the first quarter of 1999 approximated
$2.2 million which reflects an effort to reduce AGC equity to
about 45% of total capitalization and short-term debt.
4. 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 the
Company's parent, Allegheny Energy, Inc. (Allegheny Energy)
motion for preliminary injunction, enjoining DQE, Inc. (DQE),
parent company of Duquesne Light Company in Pittsburgh, Pa.,
from taking actions prohibited by the Merger Agreement. The
Circuit Court stated that if DQE breached the Merger
Agreement, Allegheny Energy would be entitled to specific
performance of the Merger Agreement. The Circuit Court also
stated that Allegheny Energy would 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.
In the District Court, discovery is ongoing, and Allegheny
Energy cannot predict the outcome of this litigation.
However, Allegheny Energy believes that DQE's basis for
seeking to terminate the merger is without merit.
Accordingly, Allegheny Energy continues to seek the remaining
regulatory approvals from the Department of Justice and the
Securities and Exchange Commission. It is not likely either
agency will act on the requests unless Allegheny Energy
obtains judicial relief requiring DQE to move forward.
All of the Company's incremental costs of the merger process
($5.2 million through March 31, 1999) are deferred. The
accumulated merger costs will be written off by the 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.
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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 1999 WITH FIRST QUARTER OF 1998
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, 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 Potomac Edison Company
(the Company), the proposed merger of 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, including expenses that may be incurred in litigation;
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 Quarter of 1999
- - Merger with DQE
See Note 4 to the financial statements for information
about the proposed merger of Allegheny Energy, Inc., the
Company's parent, with DQE, Inc. (DQE), parent company of
Duquesne Light Company in Pittsburgh, Pa., and proposed
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 will decrease the fuel portion of Virginia
customers' bills by approximately 7.6% from 1.278 cents per
kilowatt-hour (kWh) to 1.181 cents per kWh (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.
As a result of the Company's March 31, 1999 Annual
Information filing in Virginia, the staff of the Virginia SCC and
the Company have reached an agreement, pending Virginia SCC
approval, which will reduce 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.
- - Maryland and Virginia Deregulation
See Electric Energy Competition starting on page 15 for
ongoing information regarding restructuring in Maryland and
Virginia.
Review of Operations
EARNINGS SUMMARY
Net income in the first quarter of 1999 was $36.2 million
compared with $27.9 million in the corresponding 1998 period.
The increase in net income for the first quarter of 1999 was due
primarily to colder weather that led to increased kilowatt-hour
(kWh) sales to retail customers and, to a lesser extent, to
reduced interest expenses. The winter of 1999 was 19% cooler
than the relatively warm winter of 1998, as measured by heating
degree days, but was still more than 7% warmer than normal.
Residential kWh sales, which are very weather sensitive,
increased 10% in the first quarter of 1999.
SALES AND REVENUES
Percentage changes in revenues and kWh sales by major
retail customer classes were:
Change from Comparable Period
of the Prior Year
Revenues kWh
Residential 11.2% 9.8%
Commercial 12.8 11.8
Industrial 3.2 (.1)
Total 9.4% 6.0%
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
1999 first quarter winter weather was 19% cooler than 1998 and 7%
warmer than normal as measured by heating
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degree days. Commercial kWh sales are also affected by weather
but to a lesser extent than residential. The 11.8% increase in
commercial kWh sales in the first quarter primarily reflects
increased usage and growth in the number of customers.
The changes in revenues from retail customers resulted
from the following:
Change from Comparable Period
of the Prior Year
(Millions of Dollars)
Fuel clauses $ 6.7
All other 9.8
Net change in retail revenues $16.5
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 the first quarter for all other retail
revenues was primarily the result of colder weather and its
effect on kWh sales.
Wholesale and other revenues were as follows:
Three Months Ended
March 31
1999 1998
(Millions of Dollars)
Wholesale customers $5.8 $ 6.9
Affiliated companies 3.2 2.6
Street lighting and other 1.3 1.5
Settlement agreement reductions (4.5)
Total wholesale and other revenues $5.8 $11.0
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 1999 was primarily due to decreased kWh sales to one wholesale
customer.
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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 reductions of $4.5 million in the
first quarter of 1999 reflect a reduction as a result of a
settlement agreement by the Company with various parties on the
Maryland Office of People's Counsel's petition for a reduction in
the Company's Maryland rates. Of that amount, $2.6 million is
related to the Company creating a provision to share earnings
above a return on equity of 11.4% as discussed below, and $1.9
million is 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 Public
Service Commission (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% 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. Bulk power and transmission services revenues for the
first quarter of 1999 and 1998 were as follows:
Three Months Ended
March 31
1999 1998
(Millions of Dollars)
Revenues:
Transmission services to nonaffiliated
companies $2.9 $2.8
Bulk power 1.2 1.4
Total bulk power transactions, net $4.1 $4.2
Revenues from bulk power transactions in the first
quarter of 1999 remained about the same as the first quarter of
1998. 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.
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OPERATING EXPENSES
Fuel expenses for the first quarter of 1999 increased 3%
due to a 6% increase in kWh's generated, offset in part by a 3%
decrease in average fuel prices. The increase in kWh's generated
was primarily the result of increased sales to retail customers
and to affiliated companies. 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
March 31
1999 1998
(Millions of Dollars)
Nonaffiliated transactions:
Purchased power $ 2.9 $ 2.7
Power exchanges, net 1.1 1.3
Affiliated transactions:
AGC capacity charges 5.0 6.2
Other affiliated capacity charges 10.1 11.9
Energy and spinning reserve charges 13.7 13.8
Purchased power and exchanges, net $32.8 $35.9
The AES Warrior Run Public Utility Regulatory Policies
Act of 1978 (PURPA) cogeneration contract in the Company's
Maryland service territory, scheduled to commence operation in
October 1999, will increase the cost of power purchases $60
million or more annually. In 1999, utility revenues will reflect
a reduction for a settlement agreement with various parties on
the Maryland Office of People's Counsel's for a reduction in the
Company's Maryland rates. The net effect of changes related to
the settlement results in a pre-tax income reduction of $12
million in 1999. See Sales and Revenues starting on page 9 for
more information on the settlement agreement.
The increase in other operation expenses of $1.5 million
resulted from expenses related to FICA taxes ($1.0 million),
increased allowances for uncollectible accounts ($.5 million),
and increased expenses related to provisions for uninsured claims
($.4 million).
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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Taxes other than income taxes decreased $1.6 million in
the first quarter of 1999 due primarily to expenses related to
FICA taxes being recorded in other operation expense ($1.0
million) and an adjustment made to a prior period ($.5 million).
The first quarter increase in federal and state income
taxes was primarily due to increased income in the first quarter
of 1999 compared with 1998.
The decease in total interest on long-term debt in the
first quarter of 1999 of $1.2 million resulted primarily from
reduced long-term debt and lower 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,
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
merger activities.
- - Market Risk
The Company supplies power in the bulk power market. At
March 31, 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.
- - Year 2000 Readiness Disclosure
As the Year 2000 (Y2K) approaches, most organizations,
including the Company, could experience serious problems related
to software and various equipment with embedded chips which may
not properly recognize calendar dates. To minimize such problems,
the Company and its affiliates in the System are proceeding with
a comprehensive effort 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.
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The industry's and the System's efforts for each of these
three components include assessment of the problem areas and
remediation, testing, and contingency plans for critical
functions for which remediation and testing are not possible or
which do not provide reasonable assurance.
The NERC has established a goal of having the industry
achieve a state of Y2K readiness for critical systems by June 30,
1999, and to monitor progress, requires each utility to prepare
and submit a monthly report showing progress and dated plans. By
Order dated July 9, 1998, the Pennsylvania Public Utility
Commission (Pennsylvania PUC) initiated a proceeding requiring
each utility that cannot meet a Y2K readiness date of March 31,
1999 for mission critical systems to file contingency plans by
that date. On March 30, 1999, the System reported to the
Pennsylvania PUC that, except for a few items, its critical
electricity production and delivery systems were Y2K ready
pending final confirmation system testing of its power stations
in April and May. The Company anticipates that all of its
critical systems, including its business applications systems as
well as the electricity production and delivery systems, will be
Y2K ready by June 30, 1999 in accordance with the NERC targets.
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,
or that contingency plans are in place to overcome any inability
to do so. The Company's progress towards completion of the Y2K
processes on its critical systems (business applications systems
and electricity production and delivery systems) at mid-April,
1999, is as follows: inventory, 100%; assessment, 99%; remediation,
75%; testing, 70%; and contingency planning, 64% for a total of 77%.
As stated above, the Company expects all such systems to be Y2K
Ready by June 30, 1999.
Integrated electric utilities are uniquely reliant on
each other to avoid, in a worst case situation, cascading failure
of the entire electrical system. The System is working with the
Edison Electric Institute, 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.
The NERC, on April 30, 1999, issued a press release stating "that
millennium-related problems in most of the electric utility
industry will have been tested and fixed by June 30," and that it
will focus its attention on the exceptions which are expected to
be completed later in the year. Since the Company and its
neighboring utilities in the ECAR group are all participants in
the NERC Y2K effort, 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 an industry-wide Y2K drill on April 9, 1999 and
will participate in a more extensive industry-wide drill planned
for 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 are
designed to test the ability of utilities to continue to operate
if telecommunications service is interrupted. During the April
test, the Company was able to maintain adequate communications
under a simulated failure of selected systems, and obtained
valuable information for
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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 SEC 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 does not believe it or its customers will experience any
significant long-term disruptions of electric service. It is
the Company's opinion that the "most reasonably likely worst case
scenario" is that there could be isolated problems at various
Company facilities or at the facilities of neighboring utilities
that may have somehow escaped discovery in the identification,
remediation, and testing process, and that these problems may
cause isolated disruptions of service. All utilities, including
the Company, have experience in the implementation of existing
emergency plans and are currently expanding their emergency plans
to include contingency 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 remaining Y2K work is 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 are
being employed for some of the work, the Company believes it must
rely on System employees for most of the effort because of their
experience with 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
within a range of $4 to $5 million, of which about $2 million has
been incurred through March 31, 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.
Of necessity, the Company's Y2K effort is based on estimates of
assessment, remediation, testing, and contingency planning
activities. There can be no assurance that actual results will
not materially differ from expectations.
<PAGE>
- 16 -
- - Electric Energy Competition
The electricity supply segment of the electric utility
industry in the United States is in the midst of becoming a
competitive marketplace. 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 increasingly competitive
as companies began to engage in nationwide power trading. In
addition, some states have taken active steps toward allowing
retail customers the right to choose their electricity supplier.
All of the states served by the utility subsidiaries of
Allegheny Energy have investigated or implemented retail access
to alternate electricity suppliers. 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. In the absence of federal
legislation, state-by-state implementation has begun.
The Company has franchised regulated customers in
Virginia, Maryland, and West Virginia.
Virginia
Legislation concerning restructuring was introduced in
the Virginia General Assembly on January 21, 1999. The Virginia
General Assembly passed the Virginia Electric Utility
Restructuring Act (the "Restructuring Act") on March 25, 1999.
On March 29, 1999, the Governor of Virginia signed the
Restructuring Act. Major provisions of the Restructuring Act
include:
- Customer choice of electric energy supply begins January
1, 2002, to be phased in by January 1, 2004, a schedule which is
subject to acceleration or delay under certain conditions.
- Incumbent utilities are required to join a regional
transmission entity by January 1, 2001.
- The Virginia State Corporation Commission (Virginia SCC)
is to develop rules and regulations to implement customer choice.
- Utilities are required to unbundle rates, functionally
separate generation, transmission, and distribution, and separate
regulated and unregulated functions.
- Utilities are permitted but not required to sell
generation.
- Retail rates for generation, transmission, and
distribution are capped from January 1, 2001 through July 1,
2007, although after January 1, 2004 a utility may petition the
Virginia SCC for termination of capped rates under certain
circumstances or petition for a one-time change in the
nongeneration component of rates.
- A wires charge mechanism is set forth for recovery of
stranded costs and other costs associated with the transition to
retail choice.
- The utility may be designated in its service territory
as default service provider at regulated rates.
<PAGE>
- 17 -
Maryland
On April 2, 1999, the Maryland General Assembly passed
legislation to restructure the electric utility industry. On
April 8, 1999, the Governor of Maryland signed the legislation
that will bring competition to Maryland's electric generation
market. Major provisions of the restructuring legislation
include:
- Phase-in of retail choice begins July 1, 2000, with all
customers being able to shop for electricity by July 1, 2002, a
schedule subject to acceleration or delay under certain
conditions.
- A methodology is set forth to provide an opportunity to
recover certain net costs associated with the transition to
retail choice.
- Retail rates are capped from July 1, 2000, through July
1, 2004, with residential rate reductions of between 3% and 7.5%
during the cap period, and certain flexibility in price
protection matters if approved as part of a settlement.
- Generation, supply, and pricing of electricity are
deregulated, and the legislation provides for the transfer of
generating assets to an affiliate.
- Voluntary sales of generating assets are permitted but
not mandated.
- Costs of purchased power contracts may remain regulated
or be recovered through the distribution function as part of a
settlement.
- Functional, operational, structural, or legal separation
between regulated and unregulated utility businesses is required,
and utilities must unbundle their electric rate components into
separate charges.
- Creates a Universal Service fund and program to benefit
low-income customers.
- Requires utilities to provide Standard Offer Service at
regulated rates through July 1, 2003 with certain provisions for
extension thereafter.
As previously reported, the Company filed testimony in
Maryland's investigation into transition costs, price protection,
and unbundled rates. The filing requested recovery of transition
costs and a surcharge to recover the cost of the AES Warrior Run
cogeneration project beyond 2001. The staff of the Maryland
Public Service Commission (Maryland PSC) advised the commission
that a tentative settlement agreement was achieved with the
majority of the parties participating in the negotiations. The
parties are in the process of finalizing the agreement for
presentation to the Maryland PSC. The restructuring proceeding
hearings that were scheduled to begin the week of April 26, 1999
were suspended.
<PAGE>
- 18 -
West Virginia
A task force established to further investigate
restructuring issues anticipates reconvening in 1999 to further
discuss restructuring. The Public Service Commission of West
Virginia has since issued an Order setting a schedule for a
series of hearings in 1999 on major issues such as transition
costs, codes of conduct, and customer protections.
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 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 and Virginia
legislation establishes 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.
The status of electric energy competition in Pennsylvania
and Ohio in which affiliates of the Company serve are as follows.
Ohio
In early 1999, Ohio's legislative leadership developed a
framework that would restructure the state's electric utility
industry. Since that time, active input has continued from all
interested parties, but a formal bill is still not available.
Major provisions of the anticipated legislation include a start
date for competition of January 1, 2001; a four-year transition
to full competition; stranded cost recovery; require owners to
join an independent transmission entity; and following the
transition period, an annual competitive auction of generation
service would be held for customers who do not choose an
alternate supplier; and a reduction in utilities' personal
property taxes to the same level as other businesses, with the
difference to be made up by a kilowatt-hour tax on consumers.
Hearings are currently being held in both the Senate and House.
<PAGE>
- 19 -
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>
- 20 -
THE POTOMAC EDISON COMPANY
Part II - Other Information to Form 10-Q
for Quarter Ended March 31, 1999
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 28, 1999. 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) The Company filed a Form 8-K on April 19, 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, Vice President
(Chief Accounting Officer)
May 17, 1999
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