<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): February 3,
2000
THE POTOMAC EDISON COMPANY
(Exact name of registrant as specified in its charter)
Maryland and
Virginia 1-3376-2 13-5323955
(State or other (Commission File (IRS Employer
jurisdiction of Number) Identification
incorporation) Number)
10435 Downsville Pike
Hagerstown, MD 21740-1766
(Address of principal executive offices)
Registrant's telephone number,
including area code: (301) 790-3400
<PAGE>
Item 7 Financial Statements and Exhibits
(c) Exhibits
Ex. 99.1 Audited Financial Statements of The Potomac
Edison Company for the year ended December
31, 1999.
Ex. 99.2 Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the year ended December 31, 1999.
SIGNATURES
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
Dated: March 10, 2000 By: /s/ Michael P. Morrell
Name: Michael P. Morrell
Title: Vice President
<PAGE>
EXHIBIT INDEX
Ex. 99.1 Audited Financial
Statements of The Potomac Edison Company
for the year ended December 31, 1999.
Ex. 99.2 Management's
Discussion and Analysis of Financial
Condition and Results of Operations for
the year ended December 31, 1999
EXHIBIT 99.1
<PAGE>
1999 Annual Report
The Potomac Edison
The Potomac Edison Company
STATEMENT OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
(Thousands of Dollars)
1999 1998 1997
Electric Operating Revenues:
<S> <C> <C> <C>
Residential...........................................$330,299 $309,058 $299,876
Commercial............................................ 168,469 156,973 148,287
Industrial............................................ 212,205 206,638 198,174
Wholesale and other, including affiliates.............. 17,712 38,426 38,857
Bulk power transactions, net........................... 24,572 26,399 23,587
Total Operating Revenues.............................753,257 737,494 708,781
Operating Expenses:
Operation:
Fuel.................................................138,194 143,124 140,206
Purchased power and exchanges, net...................127,010 138,277 140,183
Deferred power costs, net............................ 30,650 1,812 (4,944)
Other................................................100,299 86,785 83,905
Maintenance............................................ 57,257 52,186 56,815
Depreciation and amortization.......................... 75,917 74,344 71,763
Taxes other than income taxes.......................... 50,924 49,567 47,585
Federal and state income taxes......................... 37,284 52,603 44,496
Total Operating Expenses.............................617,535 598,698 580,009
Operating Income.....................................135,722 138,796 128,772
Other Income and Deductions:
Allowance for other than borrowed funds used
during construction.................................. 748 597 1,716
Other income, net...................................... 7,770 9,297 13,976
Total Other Income and Deductions.................... 8,518 9,894 15,692
Income Before Interest Charges and
Extraordinary Charge....... 144,240 148,690 144,464
Interest Charges:
Interest on long-term debt............................. 42,870 46,010 47,659
Other interest......................................... 2,032 2,177 2,164
Allowance for borrowed funds used during construction.. (1,245) (979) (1,114)
Total Interest Charges............................... 43,657 47,208 48,709
Income Before Extraordinary
Charge................................................ $100,583 $101,482 $ 95,755
Extraordinary Charge, Net............................. (16,949)
Net Income............................................ $ 83,634 $101,482 $ 95,755
STATEMENT OF RETAINED EARNINGS
Balance at January 1................................... $312,522 $239,391 $227,726
Add:
Net income........................................... 83,634 101,482 95,755
396,156 340,873 323,481
Deduct:
Dividends on capital stock:
Preferred stock.................................... 545 818 818
Common stock....................................... 145,055 27,533 83,272
Cumulative preferred stock redemption premiums....... 524
Total deductions................................. 146,124 28,351 84,090
Balance at December 31................................. $250,032 $312,522 $239,391
</TABLE>
See accompanying notes to financial statements.
<PAGE>
The Potomac Edison Company
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
(Thousands of Dollars)
1999 1998* 1997*
Cash Flows from Operations:
<S> <C> <C> <C>
Net income.........................................$ 83,634 $ 101,482 $ 95,755
Extraordinary charge, net of taxes................. 16,949 - -
Income before extraordinary charge................. 100,583 101,482 95,755
Depreciation and amortization...................... 75,917 74,344 71,763
Deferred revenues.................................. 34,849 - -
Deferred investment credit and income taxes, net... (13,702) 8,682 5,984
Deferred power costs, net.......................... 30,650 1,812 (4,944)
Unconsolidated subsidiaries'
dividends in excess of earnings.................. 3,080 9,607 1,058
Allowance for other than borrowed funds used during
construction..................................... (748) (597) (1,716)
Internal restructuring liability................... - (1,187) (13,783)
Write-off of generation project costs.............. 5,344 - -
Changes in certain current assets and liabilities:
Accounts receivable, net......................... 5,559 3,185 (1,905)
Materials and supplies........................... 2,389 (4,462) (764)
Accounts payable................................. (37,429) 14,889 9,826
Other, net......................................... (2,629) 8,065 10,020
203,863 215,820 171,294
Cash Flows from Investing:
Construction expenditures (less allowance for other
than borrowed funds used during construction).... (90,874) (59,928) (76,582)
Cash Flows from Financing:
Retirement of preferred stock...................... (16,902) - -
Issuance of long-term debt......................... 9,300 33,200 -
Retirement of long-term debt....................... - (86,655) (800)
Funds on deposit with trustee...................... (3,133) -
Short-term debt, net............................... - - (7,497)
Notes receivable from affiliates................... 9,300 (7,850) (1,450)
Notes receivable from subsidiary................... 66,750 (66,750) -
Dividends on capital stock:
Preferred stock.................................. (545) (818) (818)
Common stock..................................... (145,055) (27,533) (83,272)
(80,285) (156,406) (93,837)
Net Change in Cash and Temporary Cash Investments.... 32,704 (514) 875
Cash at January 1.................................... 1,805 2,319 1,444
Cash and temporary cash investments at December 31...$ 34,509 $ 1,805 $ 2,319
Supplemental Cash Flow Information:
Cash paid during the year for:
Interest (net of amount capitalized).............$ 41,939 $ 46,770 $ 47,642
Income taxes..................................... 54,770 41,132 36,705
</TABLE>
*Certain amounts have been reclassified for comparative purposes.
See accompanying notes to financial statements.
<PAGE>
The Potomac Edison Company
BALANCE SHEET
<TABLE>
<CAPTION>
(Thousands of Dollars)
DECEMBER 31
ASSETS
1999 1998*
<S> <C> <C>
Property, Plant, and Equipment:
Utility plant...............................................$2,264,783 $2,199,509
Nonutility plant............................................ 3,967 3,854
Construction work in progress............................... 53,354 46,353
2,322,104 2,249,716
Accumulated depreciation.................................... (998,710) (926,840)
1,323,394 1,322,876
Investments and Other Assets:
Allegheny Generating Company--common stock at equity........ 43,258 46,277
Other......................................................... 410 473
43,668 46,750
Current Assets:
Cash and temporary cash investments......................... 34,509 1,805
Accounts receivable:
Electric service.......................................... 88,789 79,373
Affiliated and other...................................... 27,494 41,138
Allowance for uncollectible accounts...................... (3,534) (2,203)
Notes receivable from affiliate............................. 9,300
Notes receivable from subsidiary............................ 66,750
Materials and supplies--at average cost:
Operating and construction................................ 26,047 29,922
Fuel...................................................... 15,584 14,098
Prepaid taxes............................................... 15,914 15,727
Other....................................................... 2,877 1,987
207,680 257,897
Deferred Charges:
Regulatory assets........................................... 46,121 66,792
Unamortized loss on reacquired debt......................... 14,226 19,012
Other......................................................... 3,762 15,292
64,109 101,096
Total.........................................................$1,638,851 $1,728,619
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock, other paid-in capital, and retained earnings..$ 700,422 $ 762,912
Preferred stock............................................. 16,378
Long-term debt and QUIDS.................................... 510,344 578,817
$1,210,766 1,358,107
Current Liabilities:
Long-term debt due within one year.......................... 75,000
Accounts payable............................................ 31,331 35,087
Accounts payable to affiliates.............................. 36,433 70,106
Taxes accrued:
Federal and state income.................................. 5,861 6,430
Other..................................................... 19,211 18,922
Interest accrued............................................ 7,321 7,193
Other....................................................... 33,170 8,770
208,327 146,508
Deferred Credits and Other Liabilities:
Unamortized investment credit............................... 17,720 19,592
Deferred income taxes....................................... 159,351 182,555
Regulatory liabilities...................................... 25,319 11,233
Other....................................................... 17,368 10,624
219,758 224,004
Commitments and Contingencies (Note L)
Total.........................................................$1,638,851 $1,728,619
</TABLE>
*Certain amounts have been reclassified for comparative purposes.
See accompanying notes to financial statements.
<PAGE>
The Potomac Edison Company
STATEMENT OF CAPITALIZATION
<TABLE>
<CAPTION>
DECEMBER 31
1999 1998 1999 1998
(Thousands of Dollars) (Capitalization Ratios)
Common Stock:
<S> <C> <C> <C> <C>
Common stock--no par value, authorized 23,000,000
shares, outstanding 22,385,000 shares............ $ 447,700 $ 447,700
Other paid-in capital.............................. 2,690 2,690
Retained earnings.................................. 250,032 312,522
Total.......................................... 700,422 762,912 57.8% 56.2%
Preferred Stock:
Cumulative preferred stock-par value $100
per share, 5,378,611 shares authorized:
</TABLE>
December 31, 1999
Shares Date of
Series Outstanding Issue
[S] [C] [C] [C] [C]
3.60% .... None 1946 6,378
$5.88 C... None 1967 10,000
Total ........................................16,378 1.2
See Note I for information regarding the redemption
of Cumulative preferred stock.
Long-Term Debt and QUIDS:
<TABLE>
<CAPTION>
First mortgage Date of Date Date
bonds: Issue Redeemable Due
<S> <C> <C> <C> <C> <C>
5-7/8% ...... 1993 2000 2000 75,000 75,000
8 % ...... 1991 2001 2006 50,000 50,000
8 % ...... 1992 2002 2022 55,000 55,000
7-3/4% ...... 1993 2003 2023 45,000 45,000
8 % ...... 1994 2004 2024 75,000 75,000
7-5/8% ...... 1995 2005 2025 80,000 80,000
7-3/4% ...... 1995 2005 2025 65,000 65,000
</TABLE>
December 31, 1999
Interest Rate
<TABLE>
<CAPTION>
Quarterly Income Debt Securities
<S> <C> <C> <C> <C> <C>
due 2025........................ 8.00% 45,457 45,457
Secured notes due 2007-2029....... 4.70%-6.875% 101,000 91,700
Unsecured note due 2002........... 4.35% 3,200 3,200
Unamortized debt discount.......................... (6,180) (6,540)
Total (annual interest requirements $43,037)... 588,477 578,817
Less current maturities............................ (75,000)
Less amounts on deposit with trustee............... (3,133)
Total............................................ 510,344 578,817 42.2 42.6
Total Capitalization................................. $1,210,766 $1,358,107 100.0% 100.0%
</TABLE>
See accompanying notes to financial statements.
<PAGE>
The Potomac Edison Company
NOTES TO FINANCIAL STATEMENTS
(These notes are an integral part of the financial statements.)
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Potomac Edison Company (the Company) is a wholly owned
utility subsidiary of Allegheny Energy, Inc. (Allegheny Energy)
and is a part of the Allegheny Energy integrated electric utility
system (the System). The Company and its utility affiliates,
Monongahela Power Company (Monongahela Power) and West Penn Power
Company (West Penn), collectively now doing business as Allegheny
Power, are engaged in the generation (except West Penn),
purchase, transmission, distribution, and sale of electric
energy. The Company operates as a single utility segment in the
states of Maryland, Virginia, and West Virginia.
See Note B for significant changes in the Maryland regulatory
environment. Certain amounts in the December 31, 1998, balance
sheet and in the December 31, 1998, and 1997 statement of cash
flows have been reclassified for comparative purposes.
The Company is subject to regulation by the Securities and
Exchange Commission (SEC), the Maryland Public Service Commission
(Maryland PSC), the Public Service Commission of West Virginia
(W.Va. PSC) and the Virginia State Corporation Commission
(Virginia SCC), and by the Federal Energy Regulatory Commission
(FERC). Significant accounting policies of the Company are
summarized below.
Use of Estimates
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates that affect the reported amounts of assets,
liabilities, revenues, expenses, and disclosures of contingencies
during the reporting period, which in the normal course of
business are subsequently adjusted to actual results.
Revenues
Revenues, including amounts resulting from the application of
fuel and energy cost adjustment clauses, are recognized in the
same period in which the related electric services are provided
to customers. Revenues of $63 million from one industrial
customer were 8% of total electric operating revenues in 1999.
Deferred Power Costs, Net
The costs of fuel, purchased power, and certain other costs, and
revenues from sales to other utilities and power marketers,
including transmission services, are deferred until they are
either recovered from or credited to customers under fuel and
energy cost-recovery procedures in Maryland, Virginia, and West
Virginia. The Company will discontinue this practice in
Maryland, effective July 1, 2000.
Property, Plant, and Equipment
Property, plant, and equipment, including facilities owned with
affiliates in the System, are stated at original cost, less
contributions in aid of construction, except for capital leases,
which are recorded at present value. Costs include direct labor
and material; allowance for funds used during construction
(AFUDC) on property for which construction work in progress is
not included in rate base; and indirect costs such as
administration, maintenance, and depreciation of transportation
and construction equipment,
<PAGE>
The Potomac Edison Company
postretirement benefits, taxes, and other benefits related to
employees engaged in construction.
The cost of depreciable property units retired, plus removal
costs less salvage, are charged to accumulated depreciation.
The Company capitalizes the cost of software developed for
internal use. These costs are amortized on a straight-line basis
over a five-year period beginning upon a project's completion.
Allowance for Funds Used During Construction
AFUDC, an item that does not represent current cash income, is
defined in applicable regulatory systems of accounts as including
"the net cost for the period of construction of borrowed funds
used for construction purposes and a reasonable rate on other
funds when so used." AFUDC is recognized as a cost of property,
plant, and equipment. Rates used for computing AFUDC in 1999,
1998, and 1997 were 9.68%, 9.83%, and 9.75%, respectively.
AFUDC is not included in the cost of construction when the cost
of financing the construction is being recovered through rates,
which is the treatment in Virginia.
Depreciation and Maintenance
Depreciation expense is determined generally on a straight-line
method based on estimated service lives of depreciable properties
and amounted to approximately 3.5% of average depreciable
property in each of the years 1999, 1998, and 1997. The cost of
maintenance and of certain replacements of property, plant, and
equipment is charged principally to operating expense when
incurred.
Temporary Cash Investments
For purposes of the 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.
Regulatory Assets and Liabilities
In accordance with the Financial Accounting Standards Board's
(FASB) Statement of Financial Accounting Standards (SFAS) No. 71,
"Accounting for the Effects of Certain Types of Regulation," the
Company's financial statements include certain assets and
liabilities resulting from cost-based ratemaking regulation.
Income Taxes
The Company joins with its parent and affiliates in filing a
consolidated federal income tax return. The consolidated tax
liability is allocated among the participants generally in
proportion to the taxable income of each participant, except that
no subsidiary pays tax in excess of its separate return tax
liability.
Financial accounting income before income taxes differs from
taxable income principally because certain income and deductions
for tax purposes are recorded in the financial income statement
in another period. Deferred tax assets and liabilities represent
the tax effect of temporary differences
between the financial statement and tax basis of assets and
liabilities computed using the most current tax rates.
<PAGE>
The Potomac Edison Company
The Company has deferred the tax benefit of investment tax
credits. Investment tax credits are amortized over the estimated
service lives of the related properties.
Postretirement Benefits
All of the employees of Allegheny Energy are employed by
Allegheny Energy Service Corporation (AESC), which performs
services at cost for the Company and its affiliates in accordance
with the Public Utility Holding Company Act of 1935 (PUHCA).
Through AESC, the Company is responsible for its proportionate
share of postretirement benefit costs. AESC provides a
noncontributory, defined benefit pension plan covering
substantially all employees, including officers. Benefits are
based on the employee's years of service and compensation. The
funding policy is to contribute annually at least the minimum
amount required under the Employee Retirement Income Security Act
and not more than can be deducted for federal income tax
purposes. Plan assets consist of equity securities, fixed income
securities, short-term investments, and insurance contracts.
AESC also provides partially contributory medical and life
insurance plans for eligible retirees and dependents. Medical
benefits, which make up the largest component of the plans, are
based upon an age and years-of-service vesting schedule and other
plan provisions. Subsidized medical coverage is not provided in
retirement to employees hired on or after January 1, 1993. The
funding policy is to contribute the maximum amount that can be
deducted for federal income tax purposes. Funding of these
benefits is made primarily into Voluntary Employee Beneficiary
Association trust funds. Medical benefits are self-insured. The
life insurance plan is paid through insurance premiums.
Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income," effective for
1998, 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.
NOTE B: INDUSTRY RESTRUCTURING
Maryland Deregulation
On September 23, 1999, the Company filed a settlement agreement
(covering its stranded cost 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, which stated that it would not oppose it. The
settlement agreement, which was approved by the Maryland PSC on
December 23, 1999, includes the following provisions:
- - The ability for nearly all of our 211,000 Maryland customers
to have the option of choosing an electric generation supplier
starting July 1, 2000.
- - The transfer of the Company's Maryland jurisdictional
generating assets to a nonutility affiliate at book value as of
July 1, 2000.
- - A reduction in base rates of 7% ($10.4 million each year
totaling $72.8 million) for residential customers from 2002
through 2008. A reduction in base rates of one-half of 1% ($1.5
million each year totaling $10.5 million) for the majority of
commercial and industrial customers from 2002 through 2008.
<PAGE>
The Potomac Edison Company
- - 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 the Company 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 the contract to buy generation from the AES Warrior Run
cogeneration facility.
- - The establishment of a fund (not to exceed $.001 per
Kilowatt-hour (kWh) for residential customers) for the
development and use of energy-efficient technologies.
The Maryland PSC on December 23, 1999 also approved the Company's
unbundled rates covering the period 2000 through 2008.
West Virginia Activities
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 W.Va. PSC on December 20,
1999 released for comment and hearings a modified version of a
proposal submitted by members of the Task Force, including the
Company and its affiliate, Monongahela Power, following the
August 1999 hearings that could open full retail competition as
early as January 1, 2001. The production of power would be
deregulated and electricity rates would be frozen for four years
with rates gradually transitioning to market rates over the six
years thereafter. After hearings in January 2000, the W.Va. PSC
submitted a restructuring plan endorsed by members of the Task
Force, including the Company and Monongahela Power, to the
Legislature for approval.
Virginia Activities
On March 25, 1999, the Governor of Virginia signed the Virginia
Electric Utility Restructuring Act (Restructuring Act) passed by
the Virginia General Assembly. All utilities must submit a
restructuring plan by January 1, 2001, to be effective on January
1, 2002. Customer choice will be phased in beginning on January
1, 2002, with full customer choice by January 1, 2004. The
Legislative Transition Task Force on Electric Utility
Restructuring, which was established by the Restructuring Act to
oversee the implementation of customer choice, held hearings in
the summer and fall of 1999 on a number of issues concerning the
implementation of retail competition in Virginia. Parties have
also been working with the Virginia SCC Staff to develop the
<PAGE>
The Potomac Edison Company
rules governing the proposed retail pilot programs of other
utilities in the state.
NOTE C: ACCOUNTING FOR THE EFFECTS OF PRICE DEREGULATION
In 1997, the Emerging Issues Task Force (EITF) issued EITF No. 97-
4, "Deregulation of the Pricing of Electricity - Issues Related
to the Application of FASB Statement Nos. 71 and 101." The EITF
agreed that, when a rate order that contains sufficient detail
for the enterprise to reasonably determine how the transition
plan will affect the separable portion of its business whose
pricing is being deregulated is issued, the entity should cease
to apply SFAS No. 71 to that separable portion of its business.
On December 23, 1999, the Maryland PSC approved a settlement
agreement dated September 23, 1999, setting forth the transition
plan to deregulate electric generation for the Company's Maryland
jurisdiction. As required by EITF 97-4, the Company discontinued
the application of SFAS No. 71 for its Maryland jurisdiction
electric generation operations in the fourth quarter of 1999. As
a result, the Company recorded under the provisions of SFAS No.
101, "Accounting for the Discontinuation of Application of FASB
Statement No. 71," an extraordinary charge of $26.9 million
($17.0 million after taxes)
reflecting the impairment of certain generating assets as
determined under SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
based on the expected future cash flows,
and net regulatory assets associated with generating assets that
will not be collected from customers as shown below:
(Millions of Dollars) Gross Net-of-Tax
Impaired generating assets $14.5 $9.9
Net regulatory assets 12.4 7.1
Total 1999 extraordinary charge $26.9 $17.0
The Balance Sheet includes the amounts listed below for
generation assets not subject to SFAS No. 71.
December December
(Millions of Dollars) 1999 1998
Property, plant, and equipment at original
cost $ 563.9 $ -
Amounts under construction included above 17.6 -
Accumulated depreciation (298.7) -
The legislation passed in Virginia established a definitive
process for transition to deregulation and market-based pricing
for electric generation. However, the deregulation plans and
their terms in Virginia will not be known until relevant
regulatory proceedings are complete and final orders are
received. The Company is unable to predict the effect of
discontinuing SFAS No. 71 in Virginia, but it may be required to
write off unrecoverable regulatory assets, impaired assets, and
uneconomic commitments. Also the Company is unable to predict
the outcome of the deregulation process in West Virginia until
further actions are taken by the Legislature and the W.Va. PSC.
<PAGE>
The Potomac Edison Company
NOTE D: INCOME TAXES
Details of federal and state income tax provisions are:
<TABLE>
<CAPTION>
(Thousands of Dollars) 1999 1998 1997
Income taxes--current:
<S> <C> <C> <C>
Federal.............................. $48,024 $40,003 $36,126
State................................ 6,291 5,569 5,264
Total.............................. 54,315 45,572 41,390
Income taxes--deferred, net of
amortization......................... (11,830) 10,559 8,136
Income taxes--deferred,
extraordinary charge................. (9,949)
Amortization of deferred investment
credit............................... (1,872) (1,877) (2,152)
Total income taxes................. 30,664 54,254 47,374
Income taxes--charged to other
income and deductions................ (3,329) (1,651) (2,878)
Income taxes-credited to
extraordinary charge................. 9,949
Income taxes--charged to operating
income............................... $37,284 $52,603 $44,496
</TABLE>
The total provision for income taxes is different from the amount
produced by applying the federal income statutory tax rate of 35%
to financial accounting income, as set forth below:
<TABLE>
<CAPTION>
(Thousands of Dollars) 1999 1998 1997
<S> <C> <C> <C>
Income before income taxes
and extraordinary charge............. $137,867 $154,085 $140,251
Amount so produced..................... $ 48,253 $ 53,930 $ 49,088
Increased (decreased) for:
Tax deductions for which deferred
tax was not provided:
Lower tax depreciation........... 1,065 2,800 2,900
Plant removal costs.............. (2,596) (800) (700)
State income tax, net of federal
income tax benefit................. 2,692 5,100 4,400
Amortization of deferred investment
credit............................. (1,872) (1,878) (2,152)
Equity in earnings of subsidiaries... (2,058) (2,200) (3,100)
Other, net........................... (8,200) (4,349) (5,940)
Total.............................. $ 37,284 $ 52,603 $ 44,496
</TABLE>
<PAGE>
The Potomac Edison Company
The provision for income taxes for the extraordinary charge is
different from the amount produced by applying the federal income
statutory tax rate of 35% to the gross amount, as set forth
below:
(Thousands of Dollars) 1999
Extraordinary charge before
income taxes......................... $26,899
Amount so produced..................... $ 9,415
Increased for state income tax, net
of federal income tax benefit........ 534
Total.............................. $ 9,949
Federal income tax returns through 1995 have been examined and
substantially settled. At December 31, the deferred tax assets
and liabilities consisted of the following:
<TABLE>
<CAPTION>
(Thousands of Dollars) 1999 1998
<S> <C> <C>
Deferred tax assets:
Contributions in aid of construction............ $ 12,645 $ 13,845
Tax interest capitalized........................ 12,218 12,096
Unamortized investment tax credit............... 11,578 11,442
Postretirement benefits other than pensions..... 6,523 5,770
Unbilled revenue................................ 3,492 3,492
Internal restructuring.......................... 2,344 2,344
Advances for construction....................... 387 914
Other........................................... 15,598 3,685
64,785 53,588
Deferred tax liabilities:
Book vs. tax plant basis differences, net....... 219,388 218,434
Other........................................... 2,570 16,814
221,958 235,248
Total net deferred tax liabilities................ 157,173 181,660
Portion above included in current assets.......... 2,178 895
Total long-term net deferred tax liabilities.. $159,351 $182,555
</TABLE>
NOTE E: ALLEGHENY GENERATING COMPANY
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 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
<PAGE>
The Potomac Edison Company
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.
Following is a summary of financial information for AGC:
<TABLE>
<CAPTION>
December 31
(Thousands of Dollars) 1999 1998
Balance sheet information:
<S> <C> <C>
Property, plant, and equipment............... $601,717 $618,608
Current assets............................... 7,261 5,857
Deferred charges............................. 11,905 14,993
Total assets............................... $620,883 $639,458
Total capitalization......................... $303,422 $314,105
Current liabilities.......................... 65,463 75,849
Deferred credits............................. 251,998 249,504
Total capitalization and liabilities....... $620,883 $639,458
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31
(Thousands of Dollars) 1999 1998 1997
Income statement information:
<S> <C> <C> <C>
Electric operating revenues......... $70,592 $73,816 $76,458
Operation and maintenance expense... 5,023 4,592 4,877
Depreciation........................ 16,980 16,949 17,000
Taxes other than income taxes....... 4,510 4,662 4,835
Federal income taxes................ 9,997 10,959 11,213
Interest charges.................... 13,261 13,987 15,391
Other income, net................... (394) (86) (9,126)
Net income........................ $21,215 $22,753 $32,268
</TABLE>
The Company's share of the equity in earnings was $5.9 million,
$6.4 million, and $9.0 million for 1999, 1998, and 1997,
respectively, and is included in other income, net, on the
Company's Statement of Income.
NOTE F: POSTRETIREMENT BENEFITS
As described in Note A, the Company is responsible for its
proportionate share of the cost of the pension plan and medical
and life insurance plans for eligible employees and dependents
provided by AESC. The Company's share of the (credits) costs of
these plans, a portion of which (approximately 35%) was credited
or charged to plant construction, is shown below:
<TABLE>
<CAPTION>
(Thousands of Dollars) 1999 1998 1997
<S> <C> <C> <C>
Pension................................ $(1,210) $ (323) $(1,745)
Medical and life insurance............. $ 4,756 $4,893 $ 4,007
</TABLE>
<PAGE>
The Potomac Edison Company
NOTE G: REGULATORY ASSETS AND LIABILITIES
The Company's operations are subject to the provisions of SFAS
No. 71. Regulatory assets represent probable future revenues
associated with deferred costs that are expected to be recovered
from customers through the ratemaking process. Regulatory
liabilities represent probable future reductions in revenues
associated with amounts that are to be credited to customers
through the ratemaking process. Regulatory assets, net of
regulatory liabilities, reflected in the balance sheet at
December 31 relate to:
<TABLE>
<CAPTION>
(Thousands of Dollars) 1999 1998
Long-term assets (liabilities), net:
<S> <C> <C>
Income taxes, net............................. $34,451 $45,847
Postretirement benefits....................... 1,292 1,292
Demand-side management........................ 184 8,157
Deferred revenues............................. (14,900)
Other, net.................................... (225) 263
Subtotal.................................... 20,802 55,559
Deferred power costs, net (reported in other
deferred credits)............................. (9,900) (2,455)
Subtotal................................... 10,902 53,104
Current assets (liabilities), net (reported in
other current assets/liabilities):
Deferred power costs, net..................... (7,859) 333
Deferred revenues............................. (19,949)
Subtotal.................................... (27,808) 333
Net Regulatory (Liability) Asset.......... ($16,906) $53,437
</TABLE>
Future deregulation proceedings in Virginia and West Virginia may
affect the ratemaking treatment of the net regulatory assets
related to generation in these jurisdictions. See Notes B and C
for a discussion of the deregulation plan approved in Maryland.
At this time, the Company cannot determine the effect of
deregulation plans in Virginia and West Virginia.
- 30 -
The Potomac Edison Company
NOTE H: FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair value of financial
instruments at December 31 were as follows:
<TABLE>
<CAPTION>
1999 1998
Carrying Fair Carrying Fair
(Thousands of Dollars) Amount Value Amount Value
Assets:
<S> <C> <C> <C> <C>
Temporary cash
investments.......... $ 31,350 $ 31,350 $ - $ -
Liabilities:
Long-term debt and
QUIDS................ 594,657 556,732 585,357 607,726
</TABLE>
The carrying amount of temporary cash investments approximates
the fair value because of the short maturity of these
instruments. The fair value of long-term debt and QUIDS was
estimated based on actual market prices or market prices of
similar issues. The Company had no financial instruments held or
issued for trading purposes.
NOTE I: CAPITALIZATION
Preferred Stock
The Company called all outstanding shares of its cumulative
preferred stock with a combined par value of $16.4 million plus
redemption premiums of $.5 million on September 30, 1999, with
funds on hand.
Long-Term Debt and QUIDS
Maturities for long-term debt in thousands of dollars for the
next five years are: 2000, $75,000; 2001, none; 2002, $3,200;
2003, none; and 2004, none. Substantially all of the properties
of the Company are held subject to the lien securing its first
mortgage bonds. Some properties are also subject to a second
lien securing certain pollution control and solid waste disposal
notes. Certain first mortgage bond series are not redeemable by
certain refunding until dates established in the respective
supplemental indentures.
NOTE J: SHORT-TERM DEBT
To provide interim financing and support for outstanding
commercial paper, the Company has established lines of credit
with several banks. The Company has SEC authorization for total
short-term borrowings of $130 million, including money pool
borrowings described below. The Company has fee arrangements on
all of its lines of credit and no compensating balance
requirements. In addition to bank lines of credit, an Allegheny
Energy internal money pool accommodates intercompany short-term
borrowing needs, to the extent that certain of the regulated
companies have funds available. The Company had no short-term
debt outstanding at December 31, 1999 or December 31, 1998.
NOTE K: RELATED PARTY TRANSACTION
All of the employees of Allegheny Energy are employed by AESC,
which performs services at cost for the Company and its
affiliates in accordance with the PUHCA. Through AESC, the
Company is responsible for its proportionate share of services
provided by AESC. The total billings by AESC (including capital)
<PAGE>
The Potomac Edison Company
to the Company for each of the years of 1999, 1998, and 1997 were
$114.2 million, $89.7 million, and $80.7 million, respectively.
The Company buys power from and sells power to its affiliates at
tariff rates approved by the FERC.
NOTE L: COMMITMENTS AND CONTINGENCIES
Construction Program
The Company has entered into commitments for its construction
programs, for which expenditures are estimated to be $88 million
for 2000 and $72 million for 2001. Construction expenditure
levels in 2002 and beyond will depend upon, among other things,
the strategy eventually selected for complying with
Phase II of the Clean Air Act Amendments of 1990 (CAAA) and the
extent to which environmental initiatives currently being
considered become mandated. The Company estimates that its banked
emission allowances will allow it to comply with Phase II sulfur
dioxide (SO2) limits through 2005. Studies to evaluate cost-
effective options to comply with Phase II SO2 limits beyond 2005,
including those available in connection with the emission
allowance trading market, are continuing.
Environmental Matters and Litigation
The Company is subject to various laws, regulations, and
uncertainties as to environmental matters. Compliance may
require the Company to incur substantial additional costs to
modify or replace existing and proposed equipment and facilities
and may adversely affect the cost of future operations.
The Environmental Protection Agency (EPA) issued its final
regional nitrogen oxides (NOx) State Implementation Plan (SIP)
call rule on September 24, 1998. The EPA's SIP call rule found
that 22 eastern states (including Maryland, Pennsylvania, and
West Virginia) and the District of Columbia are all contributing
significantly to ozone nonattainment in downwind states. The
final rule declares that this downwind nonattainment will be
eliminated (or sufficiently mitigated) if the upwind states
reduce their NOx emissions by an amount that is precisely set by
the EPA on a state-by-state basis. The final SIP call rule
requires that all state-adopted NOx reduction measures must be
incorporated into SIPs by September 1999 and must be implemented
by May 1, 2003. However, the EPA's NOx SIP call regulation is
currently under litigation in the District of Columbia Circuit
Court of Appeals, and a decision is expected by spring 2000. The
Company's compliance with these requirements would require the
installation of post-combustion control technologies on most, if
not all, of its power stations at a cost of approximately $106
million. The Company continues to work with other coal-burning
utilities and other affected constituencies in coal-producing
states to challenge this EPA action.
On March 4, 1994, the Company and its regulated affiliates
received notice that identified them as potentially responsible
parties (PRPs) under the Comprehensive Environmental Response,
Compensation, and Liability Act of 1980, as amended, with respect
to a Superfund site. There are approximately 175 other PRPs
involved. A final determination has not been made for the
Company and its regulated affiliates' share of remediation costs
based on the amount of materials sent to the site. However, the
Company and its regulated affiliates estimate that their combined
share of the cleanup liability will not exceed $1 million, which
has been accrued by the Company and its regulated affiliates as a
liability at December 31, 1999.
<PAGE>
The Potomac Edison Company
The Company and its regulated affiliates have also been named as
defendants along with multiple other defendants in pending
asbestos cases involving
multiple plaintiffs. While the Company believes that all of the
cases are without merit, the Company cannot predict the outcome
of the litigation. The Company has accrued a reserve of $1.7
million as of December 31, 1999, related to the asbestos cases as
the potential cost to settle the cases to avoid the anticipated
cost of defense.
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 of their intent to commence
civil actions against Allegheny Energy or certain of its
subsidiaries alleging violations at the Fort Martin Power Station
under the Federal Clean Air Act, which requires existing 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 and is now jointly owned by the Company and its
affiliates, Allegheny Energy Supply Company and Monongahela
Power. 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
effect, if any, these actions threatened by the Attorneys General
of New York and Connecticut may have on them.
In the normal course of business, the Company becomes involved in
various legal proceedings. The Company does not believe that the
ultimate outcome of these proceedings will have a material effect
on its financial position.
Leases
The Company's lease obligations as of December 31, 1999, and 1998
were not material.
<PAGE>
The Potomac Edison Company
REPORT OF MANAGEMENT
The management of the Company is responsible for the information
and representations in the Company's financial statements. The
Company prepares the financial statements in accordance with
generally accepted accounting principles based upon available
facts and circumstances and management's best estimates and
judgements of known conditions.
The Company maintains an accounting system and related system of
internal controls designed to provide reasonable assurance that
the financial records are accurate and that the Company's assets
are protected. The Company's staff of internal auditors conducts
periodic reviews designed to assist management in maintaining the
effectiveness of internal control procedures.
PricewaterhouseCoopers LLP, an independent accounting firm,
audits the financial statements and expresses its opinion on
them. The independent accountants perform their audit in
accordance with generally accepted auditing standards.
The Audit Committee of the Board of Directors, which consists of
three outside Directors, meets periodically with management,
internal auditors, and PricewaterhouseCoopers LLP to review the
activities of each in discharging their responsibilities. The
internal audit staff and PricewaterhouseCoopers LLP have free
access to all of the Company's records and to the Audit
Committee.
Alan J. Noia Michael P. Morrell
Chairman and Vice President and
Chief Executive Officer Chief Financial Officer
<PAGE>
The Potomac Edison Company
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and the Shareholder
of The Potomac Edison Company
In our opinion, the accompanying balance sheets, statements of
capitalization and the related statements of income, of retained
earnings and of cash flows present fairly, in all material
respects, the financial position of The Potomac Edison Company (a
subsidiary of Allegheny Energy, Inc.) at December 31, 1999, and
1998, and the results of its operations and its cash flows for
each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the
United States. These financial statements are the responsibility
of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States, which
require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used
and significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
February 3, 2000
<PAGE>
The Potomac Edison Company
QUARTERLY FINANCIAL INFORMATION
(Thousands of Dollars)
<TABLE>
<CAPTION>
Quarter Ended
1999 1998
Dec.* Sept. June March Dec. Sept. June March
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Electric operating
revenues............. $186,099 $189,489 $174,691 $202,978 $177,744 $190,533 $177,519 $191,698
Operating income....... 28,736 34,348 27,543 45,095 34,458 36,680 30,036 37,622
Income before
extraordinary charge,
net.................. 19,191 26,492 18,736 36,164 25,757 27,299 20,504 27,922
Extraordinary charge, net (16,949)
Net income............. 2,242 26,492 18,736 36,164 25,757 27,299 20,504 27,922
</TABLE>
*Results for the fourth quarter of 1999 reflect charges for Maryland
restructuring and a long dormant pumped-storage generation project.
SUMMARY OF OPERATIONS
Year ended December 31
(Thousands of Dollars)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
1999 1998 1997 1996 1995 1994
Electric operating revenues:
Residential.......................... $330,299 $309,058 $299,876 $324,120 $316,714 $296,090
Commercial........................... 168,469 156,973 148,287 146,432 145,096 135,937
Industrial........................... 212,205 206,638 198,174 196,813 200,890 195,089
Wholesale and street lighting....... 5,821(a) 27,667 30,443 32,907 27,028 26,109
Revenues from regular customers.... 716,794 700,336 676,780 700,272 689,728 653,225
Affiliated........................... 11,352 9,401 9,687 2,399 2,525 2,716
Other non-kWh........................ 539 1,358 (1,273) (405) (961) (4,647)
Bulk power........................... 8,410 11,690 10,035 7,577 4,566 8,932
Transmission and other
energy services.................... 16,162 14,709 13,552 16,917 14,811 12,675
Total.............................. 753,257 737,494 708,781 726,760 710,669 672,901
Operation expense...................... 396,153 369,998 359,350 373,133 374,731 362,167
Maintenance............................ 57,257 52,186 56,815 62,248 60,052 58,624
Internal restructuring charges
and asset write-off.................. 26,094 6,847
Depreciation........................... 75,917 74,344 71,763 71,254 68,826 59,989
Taxes other than income................ 50,924 49,567 47,585 45,809 47,629 46,740
Taxes on income........................ 37,284 52,603 44,496 34,132 36,936 33,126
Allowance for funds used
during construction.................. (1,993) (1,576) (2,830) (2,491) (1,752) (5,874)
Interest charges....................... 44,902 48,187 49,823 50,197 51,179 46,456
Other income, net...................... (7,770) (9,297) (13,976) (11,791) (12,044) (10,310)
Income before extraordinary charge and
cumulative effect of accounting
change............................... 100,583 101,482 95,755 78,175 78,265 81,983
Extraordinary charge, net (b) ......... (16,949)
Cumulative effect of accounting
change, net (c)...................... 16,471
Net income............................. $ 83,634 $101,482 $ 95,755 $ 78,175 $ 78,265 $ 98,454
Return on average common equity (d).... 13.20% 13.90% 13.44% 11.42% 11.34% 11.86%
</TABLE>
(a) Includes reduction of $19,949 related to Maryland settlement.
(b) Write-off in connection with deregulation proceedings in Maryland.
(c) To record unbilled revenues, net of income taxes.
(d) Excludes the cumulative effect of the accounting change in 1994 and
the extraordinary charge, net and a charge for a long dormant
pumped-storage generation project in 1999. Includes the effect of
internal restructuring in 1995 and 1996.
The Potomac Edison Company
FINANCIAL AND OPERATING STATISTICS
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
1999 1998 1997 1996 1995 1994
PROPERTY, PLANT, AND EQUIPMENT
at Dec. 31 (Thousands):
Gross................................ $2,322,104 $2,249,716 $2,196,262 $2,124,956 $2,050,835 $1,978,396
Accumulated depreciation............. (998,710) (926,840) (859,076) (791,257) (729,653) (673,853)
Net................................ 1,323,394 $1,322,876 $1,337,186 $1,333,699 $1,321,182 $1,304,543
GROSS ADDITIONS TO PROPERTY
(Thousands)............................ $ 91,622 $ 60,525 $ 78,298 $ 86,256 $ 92,240 $ 142,826
TOTAL ASSETS at Dec. 31
(Thousands)............................ $1,638,851 $1,728,619 $1,688,482 $1,696,904 $1,654,444 $1,629,535
CAPITALIZATION at Dec. 31:
(Thousands):
Common stock......................... $ 700,422 $ 762,912 $ 689,781 $ 678,116 $ 667,242 $ 658,146
Preferred stock:
Not subject to mandatory redemption. 16,378 16,378 16,378 16,378 36,378
Subject to mandatory redemption.... 25,200
Long-term debt and QUIDS............. 510,344 578,817 627,012 628,431 628,854 604,749
$1,210,766 $1,358,107 $1,333,171 $1,322,925 $1,312,474 $1,324,473
Ratios:
Common stock......................... 57.8% 56.2% 51.8% 51.3% 50.8% 49.7%
Preferred stock:
Not subject to mandatory redemption. 1.2 1.2 1.2 1.3 2.7
Subject to mandatory redemption.... 1.9
Long-term debt and QUIDS............. 42.2 42.6 47.0 47.5 47.9 45.7
100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
GENERATING CAPABILITY--
kW at Dec. 31 2,099,120 2,073,292 2,073,292 2,072,292 2,072,292 2,072,292
KILOWATT-HOURS (Thousands):
Sales Volumes:
Residential.......................... 4,643,621 4,401,238 4,290,117 4,599,758 4,377,416 4,214,997
Commercial........................... 2,667,928 2,498,546 2,331,789 2,288,229 2,213,052 2,136,081
Industrial........................... 5,841,102 5,922,274 5,593,722 5,567,088 5,485,220 5,339,737
Wholesale and street lighting........ 683,691 657,357 666,383 724,011 603,572 591,799
Sales to regular customers......... 13,836,342 13,479,415 12,882,011 13,179,086 12,679,260 12,282,614
Affiliated........................... 894,094 498,069 591,876 47,781 52,967 61,815
Bulk power........................... 233,189 402,635 369,732 315,808 173,110 331,832
Transmission and other
energy services.................... 2,789,957 2,470,365 4,044,837 5,617,912 4,740,010 3,031,339
Total sales volumes................ 17,753,582 16,850,484 17,888,456 19,160,587 17,645,347 15,707,600
Output and Delivery:
Steam generation..................... 11,483,502 11,254,505 11,002,533 10,762,678 10,410,118 10,464,607
Hydro and pumped-storage generation.. 413,206 416,983 370,026 401,998 395,315 426,550
Pumped-storage input................. (499,497) (486,823) (426,087) (455,142) (452,151) (506,213)
Purchased power...................... 4,493,128 4,190,098 3,934,815 3,639,519 3,318,302 3,033,744
Transmission and other
energy services.................... 2,789,957 2,470,365 4,044,837 5,617,912 4,740,010 3,031,339
Losses and system uses............... (926,714) (994,644) (1,037,668) (806,378) (766,247) (742,427)
Total transactions as above........ 17,753,582 16,850,484 17,888,456 19,160,587 17,645,347 15,707,600
CUSTOMERS at Dec. 31:
Residential............................ 346,821 339,584 333,224 327,344 321,813 315,309
Commercial............................. 45,968 44,828 43,794 42,670 41,759 40,927
Industrial............................. 5,235 5,122 5,010 4,887 4,733 4,595
Other.................................. 620 641 598 571 543 524
Total customers...................... 398,644 390,175 382,626 375,472 368,848 361,355
RESIDENTIAL SERVICE:
Average use-
kWh per customer..................... 13,523 13,093 13,003 14,179 13,729 13,506
Average revenue-
dollars per customer................. 961.92 919.42 908.87 999.10 993.35 948.76
Average rate-
cents per kWh........................ 7.11 7.02 6.99 7.05 7.24 7.02
</TABLE>
<PAGE>
EXHIBIT 99.2
The Potomac Edison Company
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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), 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 ongoing state and federal activities; developments in the
legislative and regulatory environments in which the Company
operates, including regulatory proceedings affecting rates charged
by the Company; environmental, legislative, and regulatory changes;
future economic conditions; and other circumstances that could
affect anticipated revenues and costs such as significant volatility
in the market price of wholesale power and fuel for electric
generation, unscheduled maintenance or repair requirements, weather,
and compliance with laws and regulations.
BUSINESS STRATEGY
In July 2000, the Company plans to transfer the Maryland
jurisdictional portion of its electric generation assets at net book
value to Allegheny Energy Supply Company, LLC (Allegheny Energy
Supply), in accordance with a settlement agreement approved by the
Maryland Public Service Commission (Maryland PSC). Allegheny Energy
Supply is a subsidiary of Allegheny Energy, Inc. (Allegheny Energy),
the Company's Parent. See Note B to the financial statements for
additional information regarding the settlement agreement. The
Company expects to transfer approximately 1,300 megawatts (MW) of
generating capacity as of July 1, 2000. At December 31, 1999, the
generation assets to be transferred had a net book value of
approximately $282 million.
A component of the deregulation plans sponsored by the Company in
West Virginia and Virginia is the authority to transfer the
Company's remaining electric generation assets to Allegheny Energy
Supply at net book value. The Company intends to transfer its
remaining generation assets subject to receiving the necessary
approvals of West Virginia and Virginia deregulation plans as well
as other required regulatory approvals.
The settlement agreement in Pennsylvania permitted the Company's
affiliate, West Penn Power Company (West Penn), to transfer 3,778
megawatts (MW) of generating capacity at net book value to Allegheny
Energy Supply in 1999. The recent settlement in Maryland will allow
approximately 1,300 MW of additional generating capacity to be
transferred at net book value in 2000. Allegheny Energy is seeking
to transfer the remaining generating assets in Ohio, Virginia, and
West Virginia to its unregulated subsidiary at book value in
deregulation proceedings in these jurisdictions. The unregulated
electric supply is being sold in both the wholesale and retail
competitive marketplaces, allowing greater earnings growth
potential, subject to market risk, while allowing Allegheny Energy
to capitalize
<PAGE>
The Potomac Edison Company
on its strengths in the generation business.
Following the transfer of generation assets to Allegheny Energy
Supply, the Company will be part of Allegheny Energy's delivery
business (wires and pipes). The delivery business will remain an
important part of Allegheny Energy's business which Allegheny Energy
plans to expand.
SIGNIFICANT EVENTS IN 1999, 1998, AND 1997
Maryland Deregulation
On September 23, 1999, a settlement agreement between the Company,
the Staff of the Maryland PSC, and other parties working to
implement customer choice and deregulation of electric generation
for the Company in Maryland was filed with the Maryland PSC. On
December 23, 1999, the Maryland PSC approved the settlement
agreement, which provides nearly all of the Company's 211,000
Maryland customers with the ability to choose an electric generation
supplier starting July 1, 2000.
As a result of the Maryland settlement agreement, the Company
discontinued the application of the Financial Accounting Standards
Board's (FASB) Statement of Financial Accounting Standards (SFAS)
No. 71, "Accounting for the Effects of Certain Types of Regulation,"
for the electric generation portion of its Maryland operations and
has adopted SFAS No. 101, "Accounting for the Discontinuation of
Application of FASB Statement No. 71." Accordingly, the Company
recorded an extraordinary charge of $26.9 million ($17.0 million
after taxes) during the fourth quarter of 1999. This write-off
reflects the impairment of certain electric generation assets as
determined by applying SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
and the write-off of the Maryland portion of generation-related net
regulatory assets. See Notes B and C to the financial statements for
details of the settlement agreement and the effect on the Company.
PURPA Power Project Termination
In 1999, the Company settled for $2.7 million litigation by a
developer alleging failure by the Company to comply with the Public
Utility Regulatory Policies Act of 1978 (PURPA) regulations.
Electric Industry Restructuring
See Electric Energy Competition on page 10 for more information
regarding electric industry restructuring activities.
Recapitalization
On September 30, 1999, the Company called $16.4 million of preferred
stock. The Company also plans to revise its Articles of
Incorporation to provide greater financial flexibility.
<PAGE>
<PAGE>
The Potomac Edison Company
REVIEW OF OPERATIONS
Earnings Summary
Earnings
(Millions of Dollars) 1999 1998 1997
Operations................................... $100.6 $101.5 $95.8
Extraordinary charge, net (Notes B and C
to the financial statements)............... (17.0)
Net Income................................... $ 83.6 $101.5 $95.8
The decrease in 1999 earnings from operations, before the
extraordinary charge, resulted from increased operation and
maintenance (O&M) expenses and lower other income, net. Included as
part of other operation expenses is a $5.3 million write-off of a
pumped-storage generation project no longer considered useful. The
decrease in earnings was offset in part by increased kilowatt-hour
(kWh) sales to retail customers, tax benefits related to plant
removal costs
and to the Company's share of tax savings in consolidation related
to its parent, Allegheny Energy, and reduced interest expenses. The
extraordinary charge in 1999 resulted from the Maryland electric
utility restructuring order as discussed in Notes B and C to the
financial statements.
The increase in 1998 earnings from operations resulted from
increased sales to retail customers and from reduced power station
O&M spending.
Sales and Revenues
Percentage changes in revenues and kWh sales in 1999 and 1998 by
major retail customer classes were:
1999 vs. 1998 1998 vs. 1997
Revenues kWh Revenues kWh
Residential................... 6.9% 5.5% 3.1% 2.6%
Commercial.................... 7.3 6.8 5.9 7.2
Industrial.................... 2.7 (1.4) 4.3 5.9
Total....................... 5.7% 2.6% 4.1% 5.0%
The changes in residential kWh sales, which are more weather
sensitive than the other classes, were due primarily to changes in
customer usage because of weather conditions and growth in the
number of customers. The growth in the number of residential
customers was 2.1% and 1.9% in 1999 and 1998, respectively.
Commercial kWh sales are also affected by weather, but to a lesser
extent than residential. The increase in commercial kWh sales of
6.8% and 7.2% in 1999 and 1998, respectively, reflects increased
usage due to weather and commercial activity as well as growth in
the number of customers. The growth in the number of commercial
customers was 2.5% and 2.4% in 1999 and 1998, respectively.
The decrease in industrial kWh sales in 1999 results primarily from
decreased sales to primary metals industry customers. The increase
in 1998 reflects increased sales to paper and printing customers and
to the Eastalco aluminum reduction plant.
On August 7, 1998, the Virginia State Corporation Commission
(Virginia SCC) approved an agreement reached between the Company and
the staff of the Virginia SCC which reduced base rates for Virginia
customers beginning September 1, 1998,
<PAGE>
The Potomac Edison Company
by about $2.5 million annually. The review of rates was required by
an annual information filing in Virginia.
On February 25, 1999, the 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 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.
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 and its
affiliate, Monongahela Power Company, to be effective July 1, 1999,
through June 30, 2000. The parties have exchanged proposals which
continue to be discussed. If an agreement is not reached, the
proposed fuel rates which would decrease the Company's fuel rates by
$8.0 million will become effective March 15, 2000.
On November 8, 1999, the Company filed with the 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. The new fuel rates
were effective with bills rendered on or after December 7, 1999,
subject to refund, based on the outcome of proceedings before the
Maryland PSC.
On October 27, 1998, the Maryland PSC approved a settlement
agreement for the Company. Under the terms of that agreement, the
Company increased its rates $13 million in 1999, will increase its
rates an additional $13 million in 2000, and an additional increase
of $13 million will go into effect in 2001 (a $79 million total
revenue increase during 1999 through 2001). The increases are
designed to recover additional costs of about $131 million over the
1999 through 2001 period 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 through 2001 time frame results in a pre-tax income
reduction of $12 million in 1999, $21 million in 2000, and $19
million in 2001. Also, the Company will share, on a 50% customer,
50% shareholder basis, earnings above a return on equity of 11.4% in
Maryland for 1999 and 2000. This sharing will occur through an
annual true-up. The Company's 1999 revenues reflect an estimated
obligation for shared earnings above an 11.4% return on equity.
Changes in revenues from retail customers resulted from the
following:
Changes from Prior Year
(Millions of Dollars) 1999 vs. 1998 1998 vs. 1997
Fuel clauses............................. $ 5.7 $10.9
All other................................ 32.6 15.4
Net change in retail revenues.......... $38.3 $26.3
Revenues reflect not only changes in kWh sales and base rate
changes, but also any changes in revenues from fuel and energy cost
adjustment clauses (fuel clauses)
<PAGE>
The Potomac Edison Company
which are still applicable in the Company's jurisdictions. Effective
July 1, 2000, the Company's Maryland jurisdiction will cease to have
a fuel clause under the terms of the September 23, 1999, settlement
agreement. Changes in fuel revenues in jurisdictions for which a
fuel clause continues to exist have no 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 customers' bills through fuel clauses. Effective
July 1, 2000, the Company will assume the risks and benefits of
changes in fuel and purchased power costs and sales of transmission
services and bulk power in its Maryland jurisdiction. The Company
expects that the fuel clause rates in Virginia and West Virginia
will cease as these states implement customer choice. The Company
will then assume the risks and benefits of changes in fuel and
purchased power costs and sales of transmission services and bulk
power.
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
1999 in all other retail revenues was primarily due to increased kWh
sales as customer usage increased as a result of weather conditions
and to customer growth. The increase in 1998 all other retail
revenues was primarily the result of increased customer usage and
growth in the number of customers.
Wholesale and other revenues were as follows:
(Millions of Dollars) 1999 1998 1997
Wholesale customers....................... $21.5 $23.5 $26.6
Affiliated companies...................... 11.4 9.4 9.7
Street lighting and other................. 4.7 5.5 2.6
Deferred revenues......................... (19.9)
Total wholesale and other revenues...... $17.7 $38.4 $38.9
Wholesale customers are cooperatives and municipalities that own
their 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 due
primarily to renegotiated contracts with some wholesale customers.
The decrease in wholesale revenues in 1998 was primarily due to the
mild 1998 winter weather.
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. Revenues from affiliated
companies increased $2.0 million in 1999 due primarily to increased
transmission revenues from affiliates.
The increase in street lighting and other revenues in 1998 was
primarily due to the recording in 1998 of additional pole attachment
revenues.
Deferred revenues of $19.9 million in 1999 result from settlement
agreements approved by the Maryland PSC.
<PAGE>
The Potomac Edison Company
Bulk power transactions include sales of bulk power and transmission
and other energy services to power marketers and other utilities.
Bulk power and transmission and other energy services sales for
1999, 1998, and 1997 were as follows:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
kWh Transactions (in billions):
Bulk power................................ .2 .4 .4
Transmission and other energy services
to nonaffiliated companies.............. 2.8 2.5 4.0
Total................................. 3.0 2.9 4.4
Revenues (in millions):
Bulk power................................ $ 8.4 $11.7 $10.0
Transmission and other energy services
to nonaffiliated companies.............. 16.2 14.7 13.6
Total................................. $24.6 $26.4 $23.6
</TABLE>
Revenues from bulk power transactions decreased in 1999 due to
decreased sales to power marketers and other utilities. The 1998
increase in revenues from bulk power was due to increased sales that
occurred primarily in the second quarter as a result of warm weather
which increased the demand and price for energy.
In 1999, revenues from transmission and other energy services
increased primarily due to increased megawatt-hours (MWh)
transmitted. Revenues from transmission and other energy services
in 1998 increased, despite decreased transmission services activity.
The increase in 1998 revenues was due to transmission services
reservation charges paid to the Company by others for the right to
transmit energy. Transmission services activity was affected as a
result of some of the reservations to transmit energy not being
used. In 1998, revenues from transmission and other energy services
were affected by a revenue refund resulting from a reduction in the
Company's standard transmission rate and rates for ancillary
services which were approved by the FERC. A provision of $2.2
million for these rate reductions was recorded in 1998, with
revenues refunded to customers in the first quarter of 1999.
In June and July 1999 and June and July 1998, certain events
combined to produce significant volatility in the spot prices for
electricity at the wholesale level. These events included extremely
hot weather, generation unit outages, and transmission constraints.
Wholesale prices for electricity rose from a normal range of $25 to
$40 per MWh to as high as $3,500 to $7,000 per MWh. 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
may be positive or negative depending on whether the Company is a
net buyer or seller of electricity during such periods and the open
commitments which exist at such times. The impact of such price
volatility in 1999 and 1998 was insignificant to the Company because
changes are passed to customers through operation of fuel clauses.
However, effective July 1, 2000, the fuel clause will be
discontinued in Maryland which may cause an increase in the
volatility of earnings for the Company.
The Company expects that the fuel clause rates in Virginia and West
Virginia will cease as these states implement customer choice. The
Company will then assume the risks and benefits of changes in fuel
and purchased power costs and sales of
transmission services and bulk power.
<PAGE>
The Potomac Edison Company
Operating Expenses
Fuel expenses decreased 3.4% in 1999 due to a 6.0% decrease in
average fuel prices offset in part by a 2.6% increase related to
kWhs generated to meet retail customer requirements and increased
sales to affiliates. The decrease in average fuel prices was due to
renegotiated fuel contracts. In 1998 fuel expenses increased 2.1%
due to increased kWhs generated. The 1998 increase in kWhs
generated was primarily the result of increased bulk power sales to
power marketers and other utilities and also due to increased sales
to retail customers.
Purchased power and exchanges, net, represents power purchases from
and exchanges with other companies, capacity charges paid to
Allegheny Generating Company (AGC), purchases from qualified
facilities under the PURPA, and other transactions with affiliates
made pursuant to a power supply agreement whereby each company uses
the most economical generation available in the System at any given
time, and consists of the following items:
(Millions of Dollars) 1999 1998 1997
Nonaffiliated transactions:
Purchased power:
Other.................................. $15.7 $ 15.2 $ 13.2
From PURPA generation.................. 1.5
Power exchanges, net..................... (2.6) (.1)
Affiliated transactions:
AGC capacity charges..................... 19.8 23.8 25.5
Other affiliated capacity charges........ 39.0 42.9 50.8
Energy and spinning reserve charges...... 53.6 56.5 50.7
Purchased power and exchanges, net..... $127.0 $138.3 $140.2
The increases in other purchased power in 1999 and 1998 resulted
primarily from increased kWh purchases to supply retail customers.
An increase in price caused by volatility in the spot prices for
electricity at the wholesale level in the second and third quarters
of 1998 also contributed to the 1998 increase.
The AES Warrior Run PURPA cogeneration project in the Company's
Maryland service territory will increase the cost of power purchases
by about $60 million annually. Commencement of operation was
scheduled for October 1999. Pre-commencement testing is not
completed. Although AES Warrior Run has until October 1, 2000, to
complete pre-commencement testing, it is anticipated that it will be
in commercial operation in the first quarter of 2000. The Maryland
PSC has approved the Company's full recovery of the AES Warrior Run
purchased power costs as part of the September 23, 1999, settlement
agreement. See Sales and Revenues starting on page 3 for more
information on the settlement agreement.
On January 1, 1999, an amendment to the Company and its affiliates'
power supply agreement became effective. The amendment sets the
generation demand for each owner proportional to its ownership in
AGC. Previously, demand for each shared owner of AGC fluctuated due
to customer usage. The decrease in AGC capacity charges in 1999 was
primarily due to this change. Energy and spinning reserve
charges decreased in 1999 due to decreased kWh purchases from
affiliates.
The increase in other operation expenses in 1999 of $13.5 million
resulted primarily from increased expenses due to a write-off of
$5.3 million of costs related to a pumped-storage generation project
no longer considered useful, $2.7
<PAGE>
The Potomac Edison Company
million of costs associated with settling litigation concerning a
PURPA project, increases in salaries and wages of $1.9 million, and
increased provisions for uninsured claims of $1.4 million. The
increase in other operation expenses of $2.9 million in 1998
resulted primarily from increased expenses related to competition in
Maryland of $1.6 million.
The increase in maintenance expenses in 1999 of $5.1 million was due
to a $2.8 million increase in power station maintenance, a $1.4
million increase in transmission and distribution maintenance, and a
$.9 million increase in general plant maintenance which includes
renovations of office facilities. The decrease in maintenance
expenses in 1998 was due primarily to a management program to
postpone such expenses for the year in response to limited sales
growth in the first quarter due to the warm winter weather. The
Company postponed these expenses primarily by extending the time
between maintenance outages and experienced no measurable effect on
system performance.
Maintenance expenses represent costs incurred to maintain the power
stations, the transmission and distribution (T&D) system and general
plant, and to reflect routine maintenance of equipment and rights-of-
way, as well as planned major repairs and unplanned expenditures,
primarily from forced outages at the power stations and periodic
storm damage on the T&D system. Variations in maintenance expense
result primarily from unplanned events and planned major projects,
which vary in timing and magnitude depending upon the length of time
equipment has been in service without a major overhaul and the
amount of work found necessary when the equipment is dismantled.
Depreciation expense increases resulted from increased investment.
The increase in taxes other than income taxes of $1.4 million in
1999 was due to an increase in the assessment of property in
Maryland. The increase in taxes other than income taxes of $2
million in 1998 was primarily due to an increase in gross receipts
taxes resulting from greater revenues from retail customers and
increased property taxes.
The 1999 decrease in federal and state income taxes was due
primarily to decreased taxable income, tax benefits related to plant
removal costs for which deferred taxes were not provided, and to the
Company's share of tax savings in consolidation related to its
parent, Allegheny Energy. The 1998 increase in federal and state
income taxes was primarily due to increased taxable income. Note D
to the financial statements provides a further analysis of income
tax expenses.
Other Income and Deductions
The decrease in allowance for other than borrowed funds used during
construction of $1.1 million in 1998 was due to property placed in
service.
The decrease in other income, net of $1.5 million in 1999 was due
primarily to the discontinuance of a demand side management program.
The decrease in other income, net, of $4.7 million in 1998 was
primarily due to a 1997 interest refund on a tax-related contract
settlement ($2.5 million, after taxes) received by AGC, which is
partly owned by the Company.
Interest Charges
The decrease in interest on long-term debt in 1999 of $3.1 million
and in 1998 of
$1.6 million resulted from reduced average long-term debt
outstanding and, in 1998, also lower interest rates. Other interest
expense reflects changes in the
<PAGE>
The Potomac Edison Company
levels of short-term debt maintained by the Company throughout the
year, as well as the associated interest rates.
Extraordinary Item
The extraordinary charge in 1999 of $26.9 million ($17.0 million
after taxes) was required to reflect a write-off of certain
disallowances in the Maryland PSC's December 1999 order. See Notes B
and C to the financial statements for additional information.
FINANCIAL CONDITION, REQUIREMENTS, AND RESOURCES
Liquidity and Capital Requirements
To meet cash needs for operating expenses, the payment of interest
and dividends, retirement of debt and certain preferred stocks, and
for its construction program, the Company has used internally
generated funds and external financings, such as the sale of common
and preferred stock, debt instruments, installment loans, and lease
arrangements. The timing and amount of external financings depend
primarily upon economic and financial market conditions, the
Company's cash needs, and capitalization ratio objectives. The
availability and cost of external financings depend upon the
financial health of the companies seeking those funds and market
conditions.
Construction expenditures in 1999 were $92 million and, for 2000 and
2001, are estimated at $88 million and $72 million, respectively.
The 2000 and 2001 estimated expenditures include $31 million and $40
million, respectively, for construction of environmental control
technology. It is the Company's goal to constrain future
construction spending to the approximate level of depreciation
currently in rates. As described under Environmental Issues
starting on page 13, the Company could potentially face significant
mandated increases in construction expenditures and operating costs
related to environmental issues. Whether the Company can continue
to meet the majority of its construction needs with internally
generated cash is largely dependent upon the outcome of these
issues. The Company also has additional capital requirements for
debt maturities (see Note I to the financial statements). The
Company anticipates issuing new debt to replace the $75 million of
long-term debt maturing in 2000.
Internal Cash Flow
Internal generation of cash, consisting of cash flows from
operations reduced by dividends, was $58 million in 1999, compared
with $187 million in 1998. The decrease in 1999 cash flows resulted
primarily from an increase in the level of common stock dividends
payable to its Parent, Allegheny Energy, Inc. Current rate levels
permitted the Company to finance 64% of its construction
expenditures in 1999 and all of its construction expenditures in
1998 with internal cash flow.
Financing
Short-term debt is used to meet temporary cash needs. The Company
had no short-term debt outstanding at December 31, 1999 or December 31,
1998. At December 31, 1999, the Company had Securities and Exchange
Commission (SEC) authorization to issue up to $130 million of short-
term debt. The Company and its regulated affiliates use an Allegheny Energy
internal money pool as a facility to accommodate intercompany short-
term borrowing needs, to the extent that certain of the companies
have funds available. The Company anticipates meeting its 2000 cash
<PAGE>
The Potomac Edison Company
needs through internal cash generation, cash on hand, short-term
borrowings as necessary, and by issuing debt to refinance maturing
first mortgage bonds.
The Company called all outstanding shares of its cumulative
preferred stock with a combined par value of $16.4 million plus
redemption premiums of $.5 million on September 30, 1999, with funds
on hand. The redemptions of the preferred stock will allow the
Company to revise its Articles of Incorporation, providing greater
financial flexibility in restructuring debt.
In April 1999, the Company issued $9.3 million of 5.5% 30-year
pollution control revenue notes to Pleasants County, West Virginia.
The Company's long-term debt due within one year at December 31,
1999 was $75 million of 5-7/8% first mortgage bonds due March 1,
2000.
SIGNIFICANT CONTINUING ISSUES
Electric Energy Competition
The electricity supply segment of the electric utility industry in
the United States is becoming increasingly competitive. The
national Energy Policy Act of 1992 deregulated 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 are engaging 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 and its parent, Allegheny Energy
have been advocates 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 a bill. The bill will
now move on to the full Commerce Committee where it will be
considered in 2000.
In the absence of federal legislation, state-by-state implementation
of deregulation of electric generation is under way. The Company
has franchised customers in Maryland, Virginia, and West Virginia.
The five states in which the Company and its affiliates serve
customers 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, Ohio, and Virginia passed legislation in 1999 to implement
retail choice. West Virginia continues to actively study this
issue. On December 23, 1999, the Maryland PSC approved a settlement
agreement for the Company to implement generation competition in
Maryland.
At this time, the Company cannot determine the effect of
deregulation plans that may be approved in West Virginia and
Virginia. However, the approval of deregulation plans could have a
material impact on the Company regarding potential impairment of
electric generation assets and the Company's ability to recover
generation-related regulatory assets.
Activities at the Federal Level
The Company continues to seek enactment of federal legislation to
bring choice to all retail electric customers, deregulate the
generation and sale of electricity
<PAGE>
The Potomac Edison Company
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 Company unless
certain outmoded and anti-competitive laws, specifically the Public
Utility Holding Company Act of 1935 (PUHCA) and Section 210
(Mandatory Purchase Provisions) of PURPA, are repealed or
significantly revised. The Company continues to advocate the repeal
of PUHCA and Section 210 of 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 U.S. 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 Company are included in the
legislation, including an amendment that allows existing state
restructuring plans and agreements to remain in effect. Other
provisions address important Company 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 2000.
Maryland Activities
On April 8, 1999, Maryland Governor Glendening signed the
legislation that will bring competition to Maryland's electric
generation market beginning July 1, 2000. The Maryland PSC is in the
process of implementing the new law. Final Electric Restructuring
Roundtable reports were filed with the Maryland PSC on May 3, 1999,
and legislative-style hearings were held last summer on the reports.
The Company filed testimony in Maryland's investigation into
transition costs, price protection, and unbundled rates, and a
consensus settlement agreement was achieved with no protest by any
of the parties participating in the negotiations. The agreement was
filed on September 23, 1999, and a hearing before the Commission was
held on October 14, 1999. On December 23, 1999, the Maryland PSC
issued an order approving the settlement. The Company filed an
application on December 15, 1999, to transfer its Maryland
generation assets at book value to an affiliate under Section 7-508
of the Electric Customer Choice and Competition Act of 1999. A
Maryland PSC decision approving the transfer of the generating
assets is due by July 1, 2000.
Virginia Activities
On March 25, 1999, Governor Gilmore signed the Virginia Electric
Utility Restructuring Act (Restructuring Act) passed by the Virginia
General Assembly. All utilities must submit a restructuring plan by
January 1, 2001, to be effective on January 1, 2002. Customer
choice will be phased in beginning on January 1, 2002, with full
customer choice by January 1, 2004. The Legislative Transition Task
Force on Electric Utility Restructuring, which was established by
the Restructuring Act to oversee the implementation of customer
choice, held hearings in the summer and fall of 1999 on a number of
issues concerning the implementation of retail competition in
Virginia. Parties have also been working with the Virginia SCC
Staff to develop the rules governing the proposed retail pilot
programs of other utilities in the state.
West Virginia Activities
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
<PAGE>
The Potomac Edison Company
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 W.Va. PSC on December 20, 1999
released for comment and hearings a modified version of a proposal
submitted by members
of the Task Force, including the Company and its affiliate,
Monongahela Power, following the August 1999 hearings that could
open full retail competition as early as January 1, 2001. The
production of power would be deregulated and electricity rates would
be frozen for four years with rates gradually transitioning to
market rates over the six years thereafter. After hearings in
January 2000, the W.Va. PSC submitted a restructuring plan endorsed
by members of the Task Force, including the Company and Monongahela
Power, to the Legislature for approval.
The status of electric energy competition in Ohio and Pennsylvania
in which affiliates of the Company serve are as follows:
Ohio Activities
On June 22, 1999, the Ohio General Assembly passed legislation to
restructure its electric utility industry. The Governor of Ohio
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 a five-year transition to market rates.
Total electric rates will be frozen over that period, and
residential customers are guaranteed a 5% cut in the generation
portion of their rate. The determination of stranded cost recovery
will be handled by the Public Utilities Commission of Ohio (Ohio
PUC). On January 3, 2000, the Company's affiliate, Monongahela
Power filed a transition plan with the Ohio PUC, including its claim
for recovery of stranded costs of $21.3 million. The Ohio PUC is
expected to hold hearings on Monongahela Power's transition plan
filing and issue a decision by October 2000.
The Ohio legislation stipulates that an entity independent of the
utilities shall own or control transmission facilities after the
start of competitive retail electric service on January 2001, but
not later than December 31, 2003. 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.
Pennsylvania Activities
In December 1996, Pennsylvania enacted the Electricity Generation
Customer Choice and Competition Act to restructure the electric
industry to create retail access to a competitive electric energy
supply market. On May 29, 1998 (as amended on November 19, 1998),
the Pennsylvania Public Utility Commission granted final approval to
West Penn's restructuring plan. As of January 2, 2000, all
electricity customers in Pennsylvania had the right to choose their
electric suppliers. Two-thirds of all retail customers had a choice
throughout 1999, the first year of retail choice following a pilot
program. The number of customers who have switched suppliers and
the amount of electrical load transferred in Pennsylvania far exceed
that in any other state so far. However, for West Penn, only about
12,700 of its Pennsylvania customers eligible to shop in 1999 have
chosen an alternate energy supplier. West Penn has retained about
98% of its Pennsylvania customers through December 31, 1999. More
than 100 electric generation suppliers have been licensed to sell to
retail customers in Pennsylvania.
<PAGE>
The Potomac Edison Company
Accounting for the Effects of Price Deregulation
In July 1997, the Emerging Issues Task Force (EITF) of the 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 SFAS No. 71 for the generation portion of their business when a
deregulation plan is in place and its terms are known. In accordance
with guidance of EITF Issue No. 97-4, the Company has discontinued
the application of SFAS No. 71 to its electric generation business
in Maryland. See Note C to the financial statements for information
regarding the impact of the Maryland deregulation plan on the 1999
financial statements. The legislation passed in Virginia
established a definitive process for transition to deregulation and
market-based pricing for electric generation. However, the
deregulation plans and their terms in Virginia will not be known
until relevant regulatory proceedings are complete and final orders
are received. The Company is unable to predict the effect of
discontinuing SFAS No. 71 in Virginia, but it may be required to
write off unrecoverable regulatory assets, impaired assets, and
uneconomic commitments. Also the Company is unable to predict the
outcome of the deregulation process in West Virginia until further
actions are taken by the Legislature and the W.Va PSC.
Environmental Issues
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.
The significant costs of complying with Title IV (acid rain)
provisions of Phase I of the Clean Air Act Amendments of 1990 (CAAA)
have been incurred and are included in the cost of the related
generation facilities. The Company estimates that its banked
emission allowances will allow it to comply with Phase II sulfur
dioxide (SO2) limits through 2005. Studies to evaluate cost-
effective options to comply with Phase II limits beyond 2005,
including those available in connection with the emission allowance
trading market, are continuing.
Title I of the CAAA established an Ozone Transport Commission to
ascertain additional nitrogen oxides (NOx) reductions to allow the
Ozone Transport Region (OTR) to meet the ozone National Ambient Air
Quality Standards (NAAQS). Under terms of a Memorandum of
Understanding (MOU) among the OTR states, the
Company's generating stations located in Maryland and Pennsylvania
were required to reduce NOx emissions by approximately 55% from the
1990 baseline emissions, with a compliance date of May 1999.
Further reductions of 75% from the 1990 baseline may be required by
May 2003 under Phase III of the MOU. However, this reduction will
most likely be superceded by the proposed NOx State Implementation
Plan (SIP) call rule discussed below. If reductions of 75% are
required, installation of post-combustion control technologies would
be very expensive. Pennsylvania and Maryland promulgated regulations
to implement Phase II of the MOU in November 1997 and May 1998,
respectively. However, as a result of litigation, the Maryland
regulation was revised to postpone compliance to May 2000.
The Ozone Transport Assessment Group issued its final report in June
1997 and recommended that the Environmental Protection Agency (EPA)
consider a range of NOx controls between existing CAAA Title IV
controls and the less stringent of 85% reduction from the 1990
emission rate or 0.15 lb/mmBtu. The EPA initiated
the regulatory process to adopt the recommendations and issued its
final NOx SIP call rule on September 24, 1998. The EPA's SIP call
rule finds that 22 eastern
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The Potomac Edison Company
states (including Maryland, Pennsylvania, and West Virginia) and the
District of Columbia are all contributing significantly to ozone
nonattainment in downwind states. The final rule declares that this
downwind nonattainment will be eliminated (or sufficiently
mitigated) if the upwind states reduce their NOx emissions by an
amount that is precisely set by the EPA on a state-by-state basis.
The final SIP call rule requires that all state-adopted NOx
reduction measures must be incorporated into SIPs by September 24,
1999, and must be implemented by May 1, 2003. The Company's
compliance with these requirements would require the installation of
post-combustion control technologies on most, if not all, of its
power stations. The Company continues to work with other coal-
burning utilities and other affected constituencies in coal-
producing states to challenge this EPA action. While the SIP call
is being litigated, the Company is making preliminary plans to
comply by applying NOx reduction facilities to existing units at
various power stations.
In August 1997, eight northeastern states filed Section 126
petitions with the EPA requesting the immediate imposition of up to
an 85% NOx reduction from utilities located in the Midwest and
Southeast (West Virginia included). The petitions claim NOx
emissions from these upwind sources are preventing their attainment
with the ozone standard. In December 1997, the petitioning states
and the EPA signed a Memorandum of Agreement to address these
petitions in conjunction with the related SIP call. In May 1999,
the EPA issued a technical approval of the petition and in December
1999, granted final approval of four of the petitions. The Section
126 petition rulemaking is also under litigation.
The EPA is required by law to regularly review the NAAQS for
criteria pollutants. Recent court orders in litigation by the
American Lung Association have expedited these reviews. The EPA in
1996 decided not to revise the SO2 and NOx standards. Revisions to
particulate matter and ozone standards were proposed by the EPA in
1996 and finalized in July 1997. However, the revised standards
were legally challenged, and, in May 1999, the District of Columbia
Circuit Court of Appeals remanded the revised standards back to the
EPA for further consideration. Also, in May 1999, the EPA
promulgated final regional haze regulations to improve visibility in
Class I federal areas (national parks and wilderness areas). If
eventually upheld in court, subsequent state regulations could
require additional reduction of SO2 and/or NOx emissions from
Company facilities. The effect on the Company of revision to any of
these standards or regulations is unknown at this time, but could be
substantial.
The final outcome of the revised ambient standards, Phase III of the
MOU, SIP call rule, and Section 126 petitions cannot be determined
at this time. All are being challenged by rulemaking, petition,
and/or the litigation process. Implementation dates are also
uncertain at this time, but could be as early as 2003, which would
require substantial capital expenditures in the 2000 through 2003
period. The Company's construction forecast includes the
expenditure of $103 million of capital costs during the 2000 through
2003 period to comply with the SIP call. In addition, $3 million
was spent in 1999.
Global climate change is alleged to be the result of the atmospheric
accumulation of certain gases collectively referred to as greenhouse
gases (GHG), the most significant of which is carbon dioxide (CO2).
Human activities, particularly combustion of fossil fuels, are
alleged to be responsible for this accumulation of GHG. The Clinton
Administration has signed an international treaty called the Kyoto
Protocol, which will require the United States to reduce emissions
of GHG by 7% from 1990 levels in the 2008 through 2012 time period.
The United States Senate must ratify the Kyoto Protocol before it
enters into force. The Senate passed a resolution in 1997 that
placed two conditions on entering into any
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The Potomac Edison Company
international climate change treaty. First, any treaty must include
all nations, and, second, any treaty must not cause serious harm to
the United States' economy. The Kyoto Protocol does not appear to
satisfy either of these conditions, and, therefore, the Clinton
Administration has withheld it from consideration by the Senate.
Because coal combustion in power plants produces about 33% of the
United States' CO2 emissions, implementation of the Kyoto Protocol
would raise considerable uncertainty about the future viability of
coal as a fuel source for new and existing power plants. The Company
has taken numerous voluntary, precautionary steps to address the
issue of global climate change.
Many uncertainties remain in the global climate change debate,
including the relative contributions of human activities and natural
processes, the
extremely high potential costs of extensive mitigation efforts, and
the significant economic and social disruptions which may result
from a large-
scale reduction in the use of fossil fuels. The Company will
continue to explore cost-effective opportunities to improve
efficiency and performance.
The Company actively participates in climate-related research
programs and is responsive to the voluntary guidelines suggested in
the national Energy Policy Act of 1992, under Section 1605(b),
directed toward reducing, controlling, avoiding, and sequestering
greenhouse gases. The Company has taken many concrete steps to
reduce greenhouse gases and help stimulate a business climate that
encourages improved efficiency, performance, electrical loss
reductions, and cost-effectiveness.
The Company previously reported that the EPA had identified the
Company and its regulated utility affiliates as potentially
responsible parties, along with approximately 175 others, in a
Superfund site subject to cleanup. A final determination has not
been made for the Company's share of the remediation costs based on
the amount of materials sent to the site. The Company and its
regulated affiliates have also been named as defendants along with
multiple other defendants in pending asbestos cases involving one or
more plaintiffs. The Company believes that provisions for liability
and insurance recoveries are such that final resolution of these
claims will not have a material effect on its financial position
(See Note L to the financial statements for additional information).
On Earth Day 1997, President Clinton announced the expansion of the
federal Emergency Planning and Community Right-to-Know Act (RTK)
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 RTK 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 the news
media in the System's service area and posted on the Parent
Company's web site. The System filed its first RTK-related report
with the EPA in advance of the July 1, 1999, deadline, reporting 18
million pounds of total releases for calendar year 1998.
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 of their intent to commence civil actions against Allegheny
Energy and/or its subsidiaries alleging violations at the Fort
Martin Power Station under the federal Clean Air Act, which requires
existing 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
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The Potomac Edison Company
station located in West Virginia and is now jointly owned by the
Company and its affiliates, Allegheny Energy Supply, and Monongahela
Power. 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 effect, if any, these actions threatened
by the Attorneys General of New York and Connecticut may have on
them.
Regional Transmission Organization
In adopting its Rule 2000, the FERC defined requirements for
transmission facility owners to participate in some form of Regional
Transmission Organization. Additionally, the state jurisdictions
within which the Company operates have, to different degrees,
started to define their transition to a competitive marketplace. As
part of this, they have identified transmission as a key link to
making the electricity market efficient. The nature of this issue
is at least regional in scope. As a result, any solution will need
to be one that satisfies a diverse group of stakeholders. The
Company has actively participated in this debate and continues to
evaluate the available options to provide its customers with the
most reliable, cost-effective service while maintaining a clear
focus on the financial interests of its shareholders.
Derivative Instruments and Hedging Activities
In June 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." The Company will be
required to recognize derivatives as defined by SFAS No. 133 on the
balance sheet at fair value. The Company is evaluating the impact
of adopting SFAS No. 133 on its results of operations and financial
position which will be completed during the year 2000. Accounting
for changes in the fair value of a derivative depends on the
intended use of the derivative and whether the instrument meets the
requirements for designation as a hedge. The Company expects to
adopt SFAS No. 133 no later than January 1, 2001.
