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Allegheny Energy 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-10.1
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2005

 


 

Commission

File Number


  

Name of Registrant

State of Incorporation

Address of Principal Executive

Offices and Telephone Number


  

IRS Employer

Identification Number


1-267   

ALLEGHENY ENERGY, INC.

(A Maryland Corporation)

800 Cabin Hill Drive

Greensburg, Pennsylvania 15601

Telephone (724) 837-3000

   13-5531602
1-5164   

MONONGAHELA POWER COMPANY

(An Ohio Corporation)

1310 Fairmont Avenue

Fairmont, West Virginia 26554

Telephone (304) 366-3000

   13-5229392
1-3376-2   

THE POTOMAC EDISON COMPANY

(A Maryland and Virginia Corporation)

800 Cabin Hill Drive

Greensburg, Pennsylvania 15601

Telephone (724) 837-3000

   13-5323955
0-14688   

ALLEGHENY GENERATING COMPANY

(A Virginia Corporation)

800 Cabin Hill Drive

Greensburg, Pennsylvania 15601

Telephone (724) 837-3000

   13-3079675

 


 

This combined Form 10-Q is separately filed by Allegheny Energy, Inc., Monongahela Power Company, The Potomac Edison Company and Allegheny Generating Company. Information contained in the Form 10-Q relating to Monongahela Power Company, The Potomac Edison Company and Allegheny Generating Company is filed by each such registrant on its own behalf. Each of Monongahela Power Company, The Potomac Edison Company and Allegheny Generating Company makes no representation as to information relating to registrants other than itself.

 

Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports) and (2) have been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrants are accelerated filers (as defined in Rule 12b-2 of the Exchange Act).

 

Allegheny Energy, Inc.

   Yes  x    No  ¨

Monongahela Power Company

   Yes  ¨    No  x

The Potomac Edison Company

   Yes  ¨    No  x

Allegheny Generating Company

   Yes  ¨    No  x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    Yes  ¨    No  x

 

Number of shares outstanding of each class of common stock as of October 31, 2005:

 

Allegheny Energy, Inc.

   162,852,561      ($1.25 par value)

Monongahela Power Company

   5,891,000      ($50.00 par value)

The Potomac Edison Company

   22,385,000      ($0.01 par value)

Allegheny Generating Company

   1,000      ($1.00 par value)

 



Table of Contents

TABLE OF CONTENTS

 

     Page No.

PART I. FINANCIAL INFORMATION

    

Item 1. Financial Statements (unaudited)

    

Allegheny Energy, Inc.:

    

Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2005 and 2004

   5

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004

   6

Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004

   7

Notes to Consolidated Financial Statements

   9

Monongahela Power Company:

    

Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2005 and 2004

   33

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004

   34

Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004

   35

Notes to Consolidated Financial Statements

   37

The Potomac Edison Company:

    

Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2005 and 2004

   48

Consolidated Statements of Cash Flows for the Nine Months Ended September, 2005 and 2004

   49

Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004

   50

Notes to Consolidated Financial Statements

   52

Allegheny Generating Company:

    

Statements of Operations for the Three and Nine Months Ended September 30, 2005 and 2004

   57

Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004

   58

Balance Sheets as of September 30, 2005 and December 31, 2004

   59

Notes to Financial Statements

   61

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

   64

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   113

Item 4. Controls and Procedures

   113

PART II. OTHER INFORMATION

    

Item 1. Legal Proceedings

   114

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

   114

Item 3. Defaults Upon Senior Securities

   114

Item 4. Submission of Matters to a Vote of Security Holders

   114

Item 5. Other Information

   114

Item 6. Exhibits

   115

Signatures

   119

 

2


Table of Contents

GLOSSARY

 

I. The following abbreviations and terms are used in this report to identify Allegheny Energy, Inc. and its subsidiaries:

 

AE

   Allegheny Energy, Inc., a diversified utility holding company.

AE Supply

   Allegheny Energy Supply Company, LLC, an unregulated generation subsidiary of AE.

AGC

   Allegheny Generating Company, an unregulated generation subsidiary of AE Supply, which is approximately 23% owned by Monongahela.

Allegheny

   AE together with its consolidated subsidiaries.

Allegheny Energy Solutions

   Allegheny Energy Solutions, Inc., a subsidiary of Allegheny Ventures.

Allegheny Ventures

   Allegheny Ventures, Inc., an unregulated subsidiary of AE.

Capital Trust

   Allegheny Capital Trust I, a wholly owned special purpose finance subsidiary of AE

Distribution Companies

   Collectively, Monongahela, Potomac Edison and West Penn. The Distribution Companies do business as “Allegheny Power.”

Monongahela

   Monongahela Power Company, a regulated subsidiary of AE.

Mountaineer

   Mountaineer Gas Company, a subsidiary of Monongahela which was sold on September 30, 2005.

Potomac Edison

   The Potomac Edison Company, a regulated subsidiary of AE.

West Penn

   West Penn Power Company, a regulated subsidiary of AE.

WVP

   West Virginia Power, a division of Monongahela.
II. The following abbreviations and acronyms are used in this report to identify entities and terms relevant to Allegheny’s business and operations:

2004 Annual Report on Form 10-K

   Combined Annual Report on Form 10-K of AE, Monongahela, Potomac Edison and AGC for the year ended December 31, 2004.

CDWR

   California Department of Water Resources.

Clean Air Act

   Clean Air Act of 1970.

Exchange Act

   Securities Exchange Act of 1934, as amended.

FASB

   Financial Accounting Standards Board.

FERC

   Federal Energy Regulatory Commission, an independent commission within the U.S. Department of Energy.

GAAP

   Generally accepted accounting principles in the United States of America.

KWh

   Kilowatt-hour, a unit of electric energy equivalent to one kilowatt operating for one hour.

Maryland PSC

   Maryland Public Service Commission.

MW

   Megawatt.

MWh

   Megawatt-hour, a unit of electric energy equivalent to one megawatt operating for one hour.

OVEC

   Ohio Valley Electric Corporation.

Pennsylvania PUC

   Pennsylvania Public Utility Commission.

PJM

   PJM Interconnection, LLC, a regional transmission organization.

 

3


Table of Contents

PLR

   Provider-of-last-resort.

PUCO

   Public Utilities Commission of Ohio.

PUHCA

   Public Utility Holding Company Act of 1935, as amended.

PURPA

   Public Utility Regulatory Policies Act of 1978.

SEC

   United States Securities and Exchange Commission.

SFAS No. 133

   FASB’s Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended.

SMEPA

   Southern Mississippi Electric Power Association.

Supercritical

   Allegheny’s coal-fired plants that utilize steam pressure in excess of 3,200 psi.

T&D

   Transmission and Distribution.

Virginia SCC

   Virginia State Corporate Commission.

West Virginia PSC

   Public Service Commission of West Virginia.

 

4


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

    

Three Months Ended

September 30,


   

Nine Months Ended

September 30,


 

(In thousands, except per share amounts)


   2005

    2004

    2005

    2004

 

Operating revenues

   $ 845,064     $ 723,279     $ 2,313,744     $ 2,067,624  

Operating expenses:

                                

Fuel consumed in electric generation

     211,428       163,136       551,454       465,940  

Purchased power and transmission

     124,111       85,926       337,176       246,816  

Impairment charge on Ohio T&D assets

     30,500       —         30,500       —    

Deferred energy costs, net

     (4,181 )     (1,688 )     (4,800 )     435  

Operations and maintenance

     182,095       190,213       545,678       623,855  

Depreciation and amortization

     76,724       75,057       230,493       222,894  

Taxes other than income taxes

     53,300       51,552       160,096       149,665  
    


 


 


 


Total operating expenses

     673,977       564,196       1,850,597       1,709,605  
    


 


 


 


Operating income

     171,087       159,083       463,147       358,019  

Other income and expenses, net (Note 13)

     7,294       3,115       33,781       15,598  

Interest expense and preferred dividends:

                                

Interest expense

     111,803       90,112       365,874       300,978  

Preferred dividends of subsidiary

     1,259       1,259       3,778       3,778  
    


 


 


 


Total interest expense and preferred dividends

     113,062       91,371       369,652       304,756  
    


 


 


 


Income from continuing operations before income taxes and minority interest

     65,319       70,827       127,276       68,861  

Income tax expense from continuing operations

     21,428       26,126       54,619       25,196  

Minority interest in net income (loss) of subsidiaries

     433       (5,943 )     900       (4,804 )
    


 


 


 


Income from continuing operations

     43,458       50,644       71,757       48,469  

Loss from discontinued operations, net of tax (Note 3)

     (7,758 )     (427,487 )     (11,822 )     (431,489 )
    


 


 


 


Net income (loss)

   $ 35,700     $ (376,843 )   $ 59,935     $ (383,020 )
    


 


 


 


Common Shares Data:

                                

Weighted average common shares outstanding

                                

Basic

     162,711       127,117       152,379       127,020  

Diluted

     166,784       154,218       166,017       128,735  

Basic income (loss) per common share:

                                

Income from continuing operations

   $ 0.27     $ 0.40     $ 0.47     $ 0.38  

Loss from discontinued operations, net

     (0.05 )     (3.36 )     (0.08 )     (3.40 )
    


 


 


 


Net income (loss) per common share

   $ 0.22     $ (2.96 )   $ 0.39     $ (3.02 )
    


 


 


 


Diluted income (loss) per common share:

                                

Income from continuing operations

   $ 0.26     $ 0.37     $ 0.45     $ 0.38  

Loss from discontinued operations, net

     (0.05 )     (2.77 )     (0.07 )     (3.35 )
    


 


 


 


Net income (loss) per common share

   $ 0.21     $ (2.40 )   $ 0.38     $ (2.97 )
    


 


 


 


 

See accompanying Notes to Consolidated Financial Statements.

 

5


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

    

Nine Months Ended

September 30,


 

(In thousands)


   2005

    2004

 

Cash Flows From Operating Activities:

                

Net income (loss)

   $ 59,935     $ (383,020 )

Adjustments for discontinued operations and non-cash charges and (credits):

                

Loss from discontinued operations, net

     11,822       431,489  

Depreciation and amortization

     230,493       222,894  

Amortization of debt issuance costs

     19,728       30,631  

Impairment charge on Ohio T&D assets

     30,500       —    

Gain on asset sales and disposals

     (2,238 )     (12,262 )

Minority interest in net income (loss) of subsidiaries

     900       (4,804 )

Deferred investment credit and income taxes, net

     (21,436 )     21,525  

Stock-based compensation expense

     8,552       16,928  

Unrealized (gains) losses on commodity contracts, net

     (18,176 )     10,735  

Other, net

     (10,068 )     23,645  

Changes in certain assets and liabilities:

                

Accounts receivable, net

     (73,232 )     34,315  

Materials, supplies and fuel

     3,281       9,622  

Prepaid taxes

     (8,971 )     (12,132 )

Collateral deposits

     (50,953 )     (60,655 )

Accounts payable

     29,719       (20,605 )

Accrued taxes

     61,984       (16,886 )

Accrued interest

     46,826       28,939  

Assets and liabilities held for sale

     49,017       548  

Other, net

     (41,384 )     10,926  
    


 


Net cash provided by operating activities

     326,299       331,833  
    


 


Cash Flows From Investing Activities:

                

Capital expenditures

     (204,387 )     (199,238 )

Proceeds from sale of businesses and assets

     247,404       14,070  

Decrease in restricted funds

     205,969       8,305  

Other investments

     (2,947 )     2,123  
    


 


Net cash provided by (used in) investing activities

     246,039       (174,740 )
    


 


Cash Flows From Financing Activities:

                

Net repayments of short-term debt

     —         (53,610 )

Issuance of long-term debt

     1,782,361       1,594,921  

Retirement of long-term debt

     (2,202,021 )     (1,994,315 )

Exercise of stock options

     1,892       —    
    


 


Net cash used in financing activities

     (417,768 )     (453,004 )
    


 


Net increase (decrease) in cash and cash equivalents

     154,570       (295,911 )

Cash and cash equivalents at beginning of period

     189,482       528,612  
    


 


Cash and cash equivalents at end of period

   $ 344,052     $ 232,701  
    


 


Supplemental Cash Flow Information:

                

Cash paid for interest (net of amount capitalized)

   $ 305,766     $ 245,728  
    


 


 

See accompanying Notes to Consolidated Financial Statements.

 

6


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(unaudited)

 

(In thousands)


  

September 30,

2005


   

December 31,

2004


 

ASSETS

                

Current Assets:

                

Cash and cash equivalents

   $ 344,052     $ 189,482  

Accounts receivable:

                

Customer

     204,906       164,666  

Unbilled utility revenue

     126,287       145,498  

Wholesale and other

     81,707       32,966  

Allowance for uncollectible accounts

     (16,585 )     (19,854 )

Materials and supplies

     97,228       100,054  

Fuel

     61,093       61,812  

Deferred income taxes

     102,598       44,590  

Prepaid taxes

     55,871       46,900  

Assets held for sale (Note 3)

     2,274       150,031  

Collateral deposits

     139,661       88,708  

Commodity contracts

     11,862       13,523  

Restricted funds

     22,888       228,857  

Regulatory assets

     42,234       37,626  

Other

     15,197       20,273  
    


 


Total current assets

     1,291,273       1,305,132  
    


 


Property, Plant and Equipment, Net:

                

Generation

     5,717,427       5,695,851  

Transmission

     1,019,052       1,015,751  

Distribution

     3,418,859       3,366,217  

Other

     446,517       463,515  

Accumulated depreciation

     (4,468,666 )     (4,341,282 )
    


 


Subtotal

     6,133,189       6,200,052  

Construction work in progress

     111,741       102,966  
    


 


Total property, plant and equipment, net

     6,244,930       6,303,018  
    


 


Investments and Other Assets:

                

Assets held for sale (Note 3)

     71,902       340,457  

Goodwill

     367,287       367,287  

Investments in unconsolidated affiliates

     28,711       29,991  

Intangible assets

     32,821       33,215  

Other

     48,165       46,628  
    


 


Total investments and other assets

     548,886       817,578  
    


 


Deferred Charges:

                

Commodity contracts

     1,608       3,667  

Regulatory assets

     552,220       562,843  

Other

     40,423       52,902  
    


 


Total deferred charges

     594,251       619,412  
    


 


Total Assets

   $ 8,679,340     $ 9,045,140  
    


 


 

See accompanying Notes to Consolidated Financial Statements.

 

7


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (continued)

(unaudited)

 

(In thousands)


  

September 30,

2005


   

December 31,

2004


 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                

Current Liabilities:

                

Long-term debt due within one year (Note 2)

   $ 78,415     $ 385,142  

Accounts payable

     252,945       223,584  

Accrued taxes

     114,575       112,866  

Commodity contracts

     98,456       40,835  

Accrued interest

     105,049       61,726  

Liabilities associated with assets held for sale (Note 3)

     1,718       37,471  

Other

     143,021       144,082  
    


 


Total current liabilities

     794,179       1,005,706  
    


 


Long-term Debt (Note 2)

     4,153,615       4,540,764  

Deferred Credits and Other Liabilities:

                

Commodity contracts

     35,787       56,501  

Investment tax credit

     78,551       83,307  

Deferred income taxes

     710,665       635,374  

Obligations under capital leases

     18,266       23,788  

Regulatory liabilities

     454,603       453,913  

Adverse power purchase commitment

     188,512       201,377  

Liabilities associated with assets held for sale (Note 3)

     9,220       89,356  

Other

     455,368       505,620  
    


 


Total deferred credits and other liabilities

     1,950,972       2,049,236  
    


 


Commitments and Contingencies (Note 16)

                

Minority Interest

     22,301       21,618  

Preferred Stock of Subsidiary

     74,000       74,000  

Common Stockholders’ Equity:

                

Common stock— $1.25 par value per share, 260,000,000 shares authorized, 162,865,654 and 137,430,137 shares issued, and 162,816,161 and 137,380,644 shares outstanding at September 30, 2005 and December 31, 2004, respectively

     203,582       171,788  

Other paid-in capital

     1,875,551       1,600,215  

Accumulated deficit

     (247,753 )     (307,690 )

Treasury stock

     (1,756 )     (1,756 )

Accumulated other comprehensive loss

     (145,351 )     (108,741 )
    


 


Total common stockholders’ equity

     1,684,273       1,353,816  
    


 


Total Liabilities and Stockholders’ Equity

   $ 8,679,340     $ 9,045,140  
    


 


 

See accompanying Notes to Consolidated Financial Statements.

 

8


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note No.


       Page No.

1

  Basis of Presentation    10

2

  Debt    13

3

  Discontinued Operations and Assets Held for Sale    15

4

  Asset Sales    17

5

  Goodwill and Intangible Assets    17

6

  Derivative Instruments and Hedging Activities    18

7

  Asset Retirement Obligations (“AROs”)    19

8

  Comprehensive Income (Loss)    20

9

  Business Segments    20

10

  Accounting for the Effects of Price Regulation    21

11

  Income (Loss) Per Share    22

12

  Pension Benefits and Postretirement Benefits Other Than Pensions    22

13

  Other Income and Expenses, Net    24

14

  Guarantees and Letters of Credit    24

15

  Variable Interest Entities    24

16

  Commitments and Contingencies    25

17

  Subsequent Events    32

 

9


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 1: BASIS OF PRESENTATION

 

Allegheny Energy, Inc. (“AE”) operates primarily through directly and indirectly owned subsidiaries (together with AE, “Allegheny”). Allegheny’s two business segments are the Delivery and Services segment and the Generation and Marketing segment.

 

The Delivery and Services segment primarily consists of AE’s regulated utility subsidiaries. These subsidiaries include Monongahela Power Company (“Monongahela”), excluding its generation operations, The Potomac Edison Company (“Potomac Edison”) and West Penn Power Company (“West Penn”) (collectively, the “Distribution Companies”). The Distribution Companies primarily operate electric transmission and distribution (“T&D”) systems in Pennsylvania, West Virginia, Maryland, Virginia and Ohio. The Distribution Companies are subject to federal and state regulation. The Delivery and Services segment also includes Allegheny Ventures, Inc. (“Allegheny Ventures”).

 

The Generation and Marketing segment primarily consists of AE’s subsidiaries, Allegheny Energy Supply Company, LLC (“AE Supply”), Allegheny Generating Company (“AGC”) and Monongahela’s generation operations. AE Supply owns, operates and controls electric generation capacity and supplies and trades energy and energy-related commodities. AGC owns and sells generation capacity to AE Supply and Monongahela, which own approximately 77% and 23% of AGC, respectively. The Generation and Marketing segment is subject to federal regulation, but is not subject to state regulation of rates, except that Monongahela’s generation is subject to state regulation in West Virginia.

 

Allegheny Energy Service Corporation (“AESC”) is a wholly owned subsidiary of AE that employs all of the people who are employed by Allegheny. On September 19, 2005, AE entered into a Professional Services Agreement (the “PSA”) with Electronic Data Systems Corporation (“EDS”) and EDS Information Services, L.L.C. (“EIS”, together with EDS, the “Service Provider”). On November 1, 2005, the Service Provider assumed responsibility for many of Allegheny’s information technology functions and the coordination and installation of an enterprise resource planning system. Unless extended by AE, the PSA will expire on December 31, 2012. Most of the AESC employees performing Allegheny’s information technology functions were offered employment with EDS.

 

AE and AE Supply are both holding companies registered under the Public Utility Holding Company Act of 1935 (“PUHCA”). Allegheny is subject to regulation by the Securities and Exchange Commission (“the SEC”) under PUHCA. Currently, PUHCA imposes financial and operational conditions and restrictions on many aspects of Allegheny’s business. For example, PUHCA requires pre-approval from the SEC for, among other things, the issuance of debt or equity securities and for the sale or acquisition of utility assets. On August 8, 2005, the Energy Policy Act of 2005 (the “Energy Policy Act”) was enacted. The Energy Policy Act provides for the repeal of PUHCA effective February 2006. Following PUHCA’s repeal, Allegheny will continue to be subject to substantial regulation, including increased authority of the Federal Energy Regulatory Commission (“FERC”). The Energy Policy Act provides FERC additional jurisdiction over utility mergers, acquisitions and certain asset transfers. FERC has issued notices of proposed rulemaking related to the implementation of the Energy Policy Act. Allegheny is assessing the impact this legislation and FERC’s proposed rules will have on its operations.

 

The accompanying unaudited interim financial statements should be read in conjunction with the Combined Annual Report on Form 10-K of AE, Monongahela, Potomac Edison and AGC for the year ended December 31, 2004 (the “2004 Annual Report on Form 10-K”).

 

The interim financial statements included herein have been prepared by Allegheny, without audit, pursuant to the rules and regulations of the SEC. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles used in the United States of America (“GAAP”) have been condensed or omitted. Management believes that the disclosures are adequate to make the information not misleading.

 

In the opinion of management, the unaudited interim financial statements included herein reflect all normal recurring adjustments that are necessary for a fair statement of the results of operations for the three and nine months ended September 30, 2005 and 2004, cash flows for the nine months ended September 30, 2005 and 2004 and financial position at September 30, 2005 and December 31, 2004. Because of the seasonal nature of Allegheny’s operations, results for the three and nine months ended September 30, 2005 are not necessarily indicative of results that may be expected for the year ending December 31, 2005.

 

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Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

During the third quarter of 2004, AE and certain of its subsidiaries entered into agreements to sell, or made the decision to sell, certain non-core assets. The results of operations relating to these assets were classified as discontinued operations in the accompanying Consolidated Statements of Operations for all periods presented. In accordance with the provisions of the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), the assets and liabilities associated with these discontinued operations have been classified as held for sale in the Consolidated Balance Sheets from September 30, 2004 to the date of sale.

 

On August 2, 2005, Monongahela signed an agreement to sell its Ohio electric T&D assets to Columbus Southern Power Company, a subsidiary of American Electric Power. In accordance with the provisions of SFAS No. 144, the assets and liabilities associated with these operations was classified as held for sale in the Consolidated Balance Sheets as of that date and will remain as held for sale through the date on which the sale concludes. The results of operations related to the Ohio T&D assets have not been reclassified as discontinued operations because the terms of the sale include a power sales agreement under which Monongahela will sell power to the purchaser for Monongahela’s Ohio retail customer base from the time of closing through May 31, 2007.

 

Certain prior period amounts have been reclassified to conform to the financial statement presentation for the current period.

 

Federal and State Income Taxes. Allegheny allocates income tax expense (benefit) to its subsidiaries pursuant to its consolidated tax sharing agreement. This corporate allocation may cause significant fluctuations in the effective quarterly and year to date tax rates from the statutory rates for certain of Allegheny’s subsidiaries, depending on the level of pre-tax income.

 

Consolidated income tax expense (benefit) differs from an amount calculated at the federal statutory income tax rate of 35%, principally due to state income taxes, tax credits, the effects of utility rate-making and certain non-deductible expenses, as well as additional tax adjustments recorded during the second and third quarter of 2005, which are described below.

 

During the second quarter of 2005, Allegheny determined that it had not claimed certain income tax deductions in its 2003 income tax returns relating to commodity trading contracts. Allegheny plans to file amended 2003 federal and state income tax returns to claim these additional deductions, which will increase Allegheny’s recorded tax net operating loss carryforwards in the amount of approximately $210 million and decrease other recorded deferred tax assets in a similar amount, except for certain state income tax effects. Allegheny recorded a charge of $3.8 million during the second quarter of 2005 to write off state deferred tax assets that will not be realized due to state limitations on the use of net operating loss carryforwards arising from the correction of this error. The effect of this adjustment was not material to Allegheny’s results of operations for the three or six months ended June 30, 2005 or the year ended December 31, 2003.

 

On June 30, 2005, the state of Ohio enacted broad changes to its business tax system including a phase-out of the state’s income-based franchise tax over a five-year period beginning in 2006. The phase-out of the franchise tax will reduce the benefit of recorded tax assets by $1.9 million, and deferred tax assets were written down by this amount in the second quarter of 2005. The franchise tax has been replaced by a gross receipts tax that will be phased-in over a five year period beginning July 1, 2005.

 

On September 27, 2005, WPP Funding LLC, a subsidiary of West Penn, issued $115.0 million of 4.46% Transition Bonds, Series 2005-A with an expected maturity of June 2010. These bonds securitized an intangible right to receive a revenue stream from ratepayers. The intangible right was transferred to an entity that has a lower effective tax rate than Allegheny’s statutory state tax rate. The reduction in the expected tax liability of $3.8 million was recorded as a benefit in the third quarter. This reduced the effective income tax rate for the third quarter to approximately 33%.

 

Stock-Based Compensation. AE maintains certain stock-based employee compensation arrangements, which are described in greater detail in Item 8, Note 18, Stock-Based Compensation, in the 2004 Annual Report on Form 10-K. These arrangements include AE’s Long-Term Incentive Plan, under which stock option awards, restricted share awards and performance awards may be granted. Options to purchase approximately 0.4 million shares of AE’s common stock were granted under the Long-Term Incentive Plan during the nine months ended September 30, 2005.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Through July 2, 2004, Allegheny recorded compensation expense related to stock units issued to certain of its executive officers using the variable method of accounting. On that date, Allegheny received authorization from the SEC to settle stock units in shares of AE’s common stock as the units vest. As a result, Allegheny began recording compensation expense relating to stock unit awards using the fixed method of accounting effective July 3, 2004.

 

Allegheny accounts for stock options under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. No stock option based compensation expense has been recognized in consolidated net income, because all options granted under the Long-Term Incentive Plan had an exercise price equal to the market price of the underlying stock on the date of grant.

 

Allegheny follows the disclosure provisions of SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure, an Amendment of SFAS No. 123.” The following table illustrates the effect on consolidated net income (loss) and income (loss) per share as if Allegheny had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” to all stock-based employee compensation:

 

     Three Months Ended
September 30,


    Nine Months Ended
September 30,


 

(In millions, except per share amounts)


   2005

   2004

    2005

   2004

 

Consolidated net income (loss), as reported

   $ 35.7    $ (376.8 )   $ 59.9    $ (383.0 )

Add:

                              

Stock-based employee compensation expense included in consolidated net income (loss), net of related tax effects

     1.2      1.2       4.8      10.0  

Deduct:

                              

Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

     2.5      2.5       8.6      13.8  
    

  


 

  


Consolidated net income (loss), pro forma

   $ 34.4    $ (378.1 )   $ 56.1    $ (386.8 )
    

  


 

  


Basic income (loss) per share:

                              

As reported

   $ 0.22    $ (2.96 )   $ 0.39    $ (3.02 )

Pro forma

   $ 0.21    $ (2.97 )   $ 0.37    $ (3.05 )

Diluted income (loss) per share:

                              

As reported

   $ 0.21    $ (2.40 )   $ 0.38    $ (2.97 )

Pro forma

   $ 0.21    $ (2.41 )   $ 0.36    $ (3.00 )

 

In April 2005, the SEC adopted a new rule that amended the compliance dates for SFAS No. 123R, “Share-Based Payment.” SFAS No. 123R was issued by the FASB in December 2004 and will require companies to measure compensation cost for all share-based payments (including employee stock options) at fair value. As permitted by the new SEC rule, Allegheny plans to adopt SFAS No. 123R on January 1, 2006 and is currently evaluating its financial statement impact.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 2: DEBT

 

The following issuances and redemptions of debt were made during the periods indicated:

 

    

Three Months Ended

September 30, 2005


  

Nine Months Ended

September 30, 2005


(In millions)


   Issuances

   Redemptions

   Issuances

   Redemptions

AE:

                           

Convertible Preferred Securities

   $ —      $ —      $ —      $ 300.0

Prior Credit Facility (a)

     —        —        47.0      147.0

New AE Credit Facility (b)

     300.0      118.0      422.0      118.0

Medium-Term Notes

     —        300.0      —        300.0
    

  

  

  

Total AE

   $ 300.0    $ 418.0    $ 469.0    $ 865.0
    

  

  

  

AE Supply:

                           

Prior AE Supply Loan (c)

   $ —      $ 738.3    $ —      $ 982.1

Medium-Term Notes

     —        365.6      —        380.0

New AE Supply Term Loan (d)

     1,069.0      70.0      1,069.0      70.0
    

  

  

  

Total AE Supply

   $ 1,069.0    $ 1,173.9    $ 1,069.0    $ 1,432.1
    

  

  

  

Potomac Edison:

                           

First Mortgage Bonds

   $ 145.0    $ 145.0    $ 145.0    $ 145.0
    

  

  

  

West Penn:

                           

Transition Bonds

   $ 115.0    $ 17.3    $ 115.0    $ 55.2
    

  

  

  

Consolidated Total

   $ 1,629.0    $ 1,754.2    $ 1,798.0    $ 2,497.3
    

  

  

  

Debt associated with assets held for sale:

                           

Other Notes (e)

   $ —      $ 86.7    $ —      $ 86.7
    

  

  

  


(a) Reflects issuances and redemptions under AE’s prior credit facility, which, as discussed below, was refinanced on June 16, 2005.
(b) Reflects issuances and redemptions under AE’s new revolving credit facility, which, as discussed below, was entered into on June 16, 2005.
(c) Reflects redemptions under AE Supply’s prior term loan, which, as discussed below, was refinanced on July 21, 2005.
(d) Reflects issuances and redemptions under AE Supply’s new term loan, which, as discussed below, was entered into on July 21, 2005.
(e) Represents debt related to Monongahela’s natural gas operations in West Virginia. In connection with the sale of these operations on September 30, 2005, the purchaser assumed this debt.

 

In April 2005, the holders of $295.0 million of the outstanding $300.0 million in Trust Preferred Securities issued by Capital Trust accepted AE and Capital Trust’s tender offer and consent solicitation. Under the terms of the offer, for each $1,000 in liquidation amount of Trust Preferred Securities tendered, a holder received 83.33 shares of AE common stock and $160 in cash. On April 22, 2005, AE issued an aggregate of 24.6 million shares of its common stock and $47.2 million in cash to the holders of the tendered Trust Preferred Securities. In accordance with SFAS No. 84, “Induced Conversions of Convertible Debt,” the $47.2 million cash payment was expensed during the second quarter of 2005. In addition, AE received the required consents from holders of the Trust Preferred Securities for amendments to the indenture governing AE’s 11 7/8% Notes due 2008. The holder of the remaining $5.0 million in liquidation amount of Trust Preferred Securities converted its Trust Preferred Securities into 416,650 shares of AE common stock on May 3, 2005.

 

On June 16, 2005, AE and AE Supply (together, the “Borrowers”) entered into a new $700 million credit facility (the “New AE Credit Facility”) comprised of a $400 million senior unsecured revolving credit facility (the “Revolving Facility”) and a $300 million senior unsecured term loan (the “Term Facility”). The Revolving Facility (a) refinanced the aggregate principal amount of approximately $122 million outstanding under AE’s prior credit facility, (b) continued letters of credit issued under AE’s prior credit facility and (c) provided working capital and letters of credit for AE and, subject to certain limitations, its subsidiaries. The lenders under the Revolving Facility are required to make revolving credit loans to, and issue letters of credit at the request of, AE. In addition, subject

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

to certain limitations, AE Supply may borrow, or request letters of credit for, up to $50 million directly under the Revolving Facility. AE is permitted to request letters of credit in an amount not in excess of $125 million on behalf of AE Supply and its subsidiaries. The Revolving Facility matures June 16, 2010.

 

On August 1, 2005, AE used the proceeds of the Term Facility to refinance the aggregate principal outstanding amount under AE’s 7.75% Notes due August 1, 2005. AE must repay the principal amount borrowed under the Term Facility in consecutive quarterly installments equal to 0.25% of the aggregate principal amount initially advanced to AE under the Term Facility, with the balance due in full at maturity on June 16, 2010. AE may not re-borrow any part of the Term Facility that it repays or prepays.

 

Loans under the New AE Credit Facility bear interest, depending on the type of loan requested by the Borrowers, at a rate equal to either (i) the higher of the rate announced publicly by Citibank in New York, from time to time, as Citibank’s base rate or 0.50% above the Federal Funds Rate (as defined in the Credit Agreement) (the “Base Rate”), plus the applicable margin, which is between 1.50% and 0.50% for Base Rate loans, or (ii) the Eurodollar Rate (as defined in the Credit Agreement), plus the applicable margin, which is between 2.50% and 1.50% for Eurodollar Rate-based loans. The applicable margin for LIBOR borrowings was 2.00% at September 30, 2005. With respect to each letter of credit, the relevant Borrower is required to pay to the Administrative Agent a letter of credit fee equal to the applicable margin, which ranges from 2.50% to 1.50%, times the daily maximum amount available to be drawn under such letter of credit. In each case of a Base Rate loan, Eurodollar Rate loan or letter of credit, the applicable margin varies depending upon Standard & Poor’s (“S&P”) and Moody’s Investors Service, Inc.’s ratings of certain of AE’s public debt. The Borrowers’ ability to request and maintain Eurodollar Rate loans is subject to certain limitations.

 

On July 21, 2005, AE Supply and certain of its subsidiaries entered into a secured term loan facility (the “New AE Supply Term Loan”) of $1.07 billion. The New AE Supply Term Loan matures in 2011 and has an initial interest rate equal to LIBOR plus 1.75%. The interest rate will improve to LIBOR plus 1.50% if AE Supply’s S&P credit rating improves from current levels. Proceeds from the New AE Supply Term Loan were used, in part, to refinance approximately $738 million outstanding under the prior AE Supply loan.

 

Proceeds from the New AE Supply Term Loan were also used on August 22, 2005 to redeem AE Supply’s 10.25% Senior Notes due 2007, which had a principal amount outstanding of approximately $331 million. Also on August 22, 2005, AE Supply used cash on hand to redeem its 13.0% Senior Notes due 2007, which had a principal amount outstanding of approximately $35 million. AE Supply expensed premiums and costs associated with the redemption of its 10.25% Senior Notes and 13.0% Senior Notes in the amount of $32.6 million during the three months ended September 30, 2005.

 

On August 15, 2005, Potomac Edison issued $145 million of 5.125% First Mortgage Bonds due 2015. Approximately $143 million of the proceeds, together with available cash, was used to redeem Potomac Edison’s $65 million of outstanding 7.75% First Mortgage Bonds due 2025 and its $80 million of outstanding 7.625% First Mortgage Bonds due 2025.

 

On September 27, 2005, WPP Funding LLC, a subsidiary of West Penn, issued $115.0 million of 4.46% Transition Bonds, Series 2005-A with an expected maturity of June 2010. These bonds securitize funds to be collected from West Penn’s customers for stranded cost recovery. Interest on these bonds will accrue and be added to the principal amount of the bonds until the first scheduled interest payment date following final payment of the Transition Bonds, Series 1999-A issued by West Penn Funding LLC, which is expected to occur in June 2008. Thereafter, interest on these bonds will be paid quarterly.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

At September 30, 2005, contractual maturities of long-term debt for the remainder of 2005 and for full years thereafter are as follows:

 

(In millions)


   2005

    2006

    2007

    2008

    2009

    Thereafter

    Total

 

AE:

                                                        

New AE Credit Facility

   $ —       $ 1.5     $ 3.0     $ 3.0     $ 3.0     $ 293.5     $ 304.0  
    


 


 


 


 


 


 


Total AE

   $ —       $ 1.5     $ 3.0     $ 3.0     $ 3.0     $ 293.5     $ 304.0  
    


 


 


 


 


 


 


AE Supply:

                                                        

Pollution Control Bonds

   $ —       $ —       $ 91.7     $ —       $ —       $ 191.4     $ 283.1  

Medium-Term Notes

     —         —         —         —         —         1,050.0       1,050.0  

Debentures-AGC

     —         —         —         —         —         100.0       100.0  

New AE Supply Term Loan

     —         5.3       10.7       10.7       10.7       961.6       999.0  
    


 


 


 


 


 


 


Total AE Supply

   $ —       $ 5.3     $ 102.4     $ 10.7     $ 10.7     $ 2,303.0     $ 2,432.1  
    


 


 


 


 


 


 


Monongahela:

                                                        

First Mortgage Bonds

   $ —       $ 300.0     $ —       $ —       $ —       $ 190.0     $ 490.0  

Pollution Control Bonds

     —         —         15.5       —         —         70.2       85.7  

Medium-Term Notes

     —         —         —         —         —         110.0       110.0  
    


 


 


 


 


 


 


Total Monongahela

   $ —       $ 300.0     $ 15.5     $ —       $ —       $ 370.2     $ 685.7  
    


 


 


 


 


 


 


Potomac Edison:

                                                        

First Mortgage Bonds

   $ —       $ —       $ —       $ —       $ —       $ 320.0     $ 320.0  

Medium-Term Notes

     —         100.0       —         —         —         —         100.0  
    


 


 


 


 


 


 


Total Potomac Edison

   $ —       $ 100.0     $ —       $ —       $ —       $ 320.0     $ 420.0  
    


 


 


 


 


 


 


West Penn:

                                                        

Transition Bonds

   $ 17.8     $ 75.8     $ 79.9     $ 74.4     $ 70.7     $ 14.2     $ 332.8  

Medium-Term Notes

     —         —         —         —         —         80.0       80.0  
    


 


 


 


 


 


 


Total West Penn

   $ 17.8     $ 75.8     $ 79.9     $ 74.4     $ 70.7     $ 94.2     $ 412.8  
    


 


 


 


 


 


 


AGC:

                                                        

Debentures

   $ —       $ —       $ —       $ —       $ —       $ 100.0     $ 100.0  
    


 


 


 


 


 


 


Sub-total

   $ 17.8     $ 482.6     $ 200.8     $ 88.1     $ 84.4     $ 3,480.9     $ 4,354.6  

Unamortized debt discounts, premiums and terminated Interest rate swaps

     (0.3 )     (1.4 )     (1.3 )     (1.3 )     (1.3 )     (4.2 )     (9.8 )

Eliminations

     —         —         (2.3 )     —         —         (110.5 )     (112.8 )
    


 


 


 


 


 


 


Total consolidated debt

   $ 17.5     $ 481.2     $ 197.2     $ 86.8     $ 83.1     $ 3,366.2     $ 4,232.0  
    


 


 


 


 


 


 


 

On October 17, 2005, Monongahela issued $70.0 million of 5.375% First Mortgage Bonds due 2015. Monongahela intends to utilize the proceeds to redeem $70.0 million of its 7 5/8% First Mortgage Bonds due 2025 on November 19, 2005.

 

Certain of Allegheny’s properties are subject to liens of various relative priorities securing debt. For additional information regarding property liens, see Item 2, “Properties,” in the 2004 Annual Report on Form 10-K.

 

NOTE 3: DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE

 

During the third quarter of 2004, Allegheny and certain of its subsidiaries entered into agreements to sell, or made the decision to sell, certain non-core assets. The results of operations relating to these assets have been classified as discontinued operations in the accompanying Consolidated Statements of Operations for all periods presented. In addition, the assets and liabilities associated with these discontinued operations have been classified as held for sale in the consolidated balance sheets through the dates on which the sales concluded.

 

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Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The components of (loss) income from discontinued operations are as follows:

 

    

Three Months Ended

September 30,


   

Nine Months Ended

September 30,


 

(In millions)


   2005

    2004

    2005

    2004

 

AE Supply:

                                

Operating revenues

   $ —       $ 14.7     $ 0.4     $ 27.2  

Operating expenses

     8.5       (6.8 )     6.2       (26.4 )

Other income

     0.1       —         0.1       —    

Interest expense

     (3.2 )     (5.9 )     (9.4 )     (20.7 )
    


 


 


 


Income (loss) before income taxes

     5.4       2.0       (2.7 )     (19.9 )

Income tax benefit (expense)

     (1.9 )     (0.4 )     0.9       7.6  

Impairment charge, net of tax

     (4.4 )     (403.9 )     (7.6 )     (403.9 )
    


 


 


 


Loss from discontinued operations, net of tax

   $ (0.9 )   $ (402.3 )   $ (9.4 )   $ (416.2 )
    


 


 


 


Monongahela:

                                

Operating revenues

   $ 21.3     $ 22.3     $ 218.1     $ 212.2  

Operating expenses

     (25.3 )     (26.0 )     (201.5 )     (197.1 )

Other income (expenses)

     0.1       (0.2 )     1.0       0.1  

Interest expense

     (2.0 )     (2.1 )     (6.1 )     (6.2 )
    


 


 


 


(Loss) income before income taxes

     (5.9 )     (6.0 )     11.5       9.0  

Income tax benefit (expense)

     2.2       1.5       (4.5 )     (3.6 )

Impairment charge, net of tax

     (3.1 )     (20.7 )     (9.4 )     (20.7 )
    


 


 


 


Loss from discontinued operations, net of tax

   $ (6.8 )   $ (25.2 )   $ (2.4 )   $ (15.3 )
    


 


 


 


Consolidated:

                                

Operating revenues

   $ 21.3     $ 37.0     $ 218.5     $ 239.4  

Operating expenses

     (16.8 )     (32.8 )     (195.3 )     (223.5 )

Other income (expenses)

     0.2       (0.2 )     1.1       0.1  

Interest expense

     (5.2 )     (8.0 )     (15.5 )     (26.9 )
    


 


 


 


(Loss) income before income taxes

     (0.5 )     (4.0 )     8.8       (10.9 )

Income tax benefit

     0.3       1.1       (3.6 )     4.0  

Impairment charge, net of tax

     (7.5 )     (424.6 )     (17.0 )     (424.6 )
    


 


 


 


Loss from discontinued operations, net of tax

   $ (7.7 )   $ (427.5 )   $ (11.8 )   $ (431.5 )
    


 


 


 


 

Impairment charges reflected in the table above represent adjustments of the carrying values of assets held for sale to current estimates of sales proceeds, less costs to sell.

 

During the third quarter of 2005, Monongahela recorded an impairment charge relating to the anticipated sale of its Ohio electric T&D assets in the amount of $30.5 million. The impairment was recorded based on the estimated value, at September 30, 2005, of Monongahela’s agreement with Columbus Southern Power Company to deliver power at below-market prices from the time of closing through May 31, 2007, partially offset by approximately $8.0 million, representing the purchase price less the estimated net book value of the assets at the time of closing and approximately $2.0 million in expenses associated with the sale. Monongahela will record additional charges or credits as the value of the purchase agreement increases or decreases up to the closing date of the sale. The sale is contingent upon certain closing conditions, third party consents and state and federal regulatory approvals. The sale is expected to close by the end of 2005.

 

The Ohio electric T&D assets were classified as held for sale as of August 2, 2005. The results of operations relating to the Ohio electric T&D assets have not been included in discontinued operations because the terms of the sale include a power sales agreement under which Monongahela will sell power to the purchaser for Monongahela’s Ohio retail customer base from the time of closing through May 31, 2007.

 

16


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Assets held for sale and liabilities associated with assets held for sale at September 30, 2005 were as follows:

 

(In millions)


   Monongahela

   AE Supply

   Consolidated

Assets:

                    

Current assets

   $ 0.8    $ 1.5    $ 2.3

Property, plant and equipment

     20.7      22.0      42.7

Deferred charges

     4.2      —        4.2

Tennessee Valley Authority interconnection deposit

     —        25.0      25.0
    

  

  

Total assets

   $ 25.7    $ 48.5    $ 74.2
    

  

  

Liabilities:

                    

Current liabilities

   $ 1.7    $ —      $ 1.7

Deferred credits and other liabilities

     9.2      —        9.2
    

  

  

Total liabilities

   $ 10.9    $ —      $ 10.9
    

  

  

 

Assets held for sale and liabilities associated with assets held for sale at December 31, 2004 were as follows:

 

(In millions)


   Monongahela

   Potomac Edison

   AE Supply

   Eliminations

    Consolidated

Assets:

                                   

Current assets

   $ 147.8    $ —      $ 2.2    $ —       $ 150.0

Property, plant and equipment

     163.7      10.8      128.3      —         302.8

Investments and other assets

     6.8      —        —        —         6.8

Deferred charges

     6.3      —        —        (0.5 )     5.8

Tennessee Valley Authority interconnection deposit

     —        —        25.0      —         25.0
    

  

  

  


 

Total assets

   $ 324.6    $ 10.8    $ 155.5    $ (0.5 )   $ 490.4
    

  

  

  


 

Liabilities:

                                   

Current liabilities

   $ 95.5    $ —      $ —      $ (58.0 )   $ 37.5

Long-term debt

     83.4      —        —        —         83.4

Deferred credits and other liabilities

     17.6      —        —        (11.6 )     6.0
    

  

  

  


 

Total liabilities

   $ 196.5    $ —      $ —      $ (69.6 )   $ 126.9
    

  

  

  


 

 

NOTE 4: ASSET SALES

 

On September 30, 2005, Monongahela completed the sale of its natural gas operations in West Virginia to Mountaineer Gas Holdings Limited Partnership, a partnership composed of IGS Utilities LLC, IGS Holdings LLC and affiliates of ArcLight Capital Partners, LLC, for approximately $161.0 million in cash and the assumption of approximately $87.0 million of long-term debt, subject to certain post-closing adjustments. The assets sold included all of the issued and outstanding capital stock of Mountaineer Gas and certain other assets related to the West Virginia natural gas operations.

 

On August 12, 2005, AE Supply and its subsidiaries, Allegheny Energy Supply Wheatland Generating Facility, LLC and Lake Acquisition Company, LLC completed the sale of certain assets relating to AE Supply’s Wheatland generating facility (the “Wheatland Assets”) to PSI Energy, Inc. and The Cincinnati Gas & Electric Company for approximately $100 million and the assumption of certain liabilities related to the Wheatland Assets.

 

During May 2005, Potomac Edison completed the sale of its Hagerstown, Maryland property for $10.6 million in net cash proceeds.

 

NOTE 5: GOODWILL AND INTANGIBLE ASSETS

 

There were no changes in goodwill during the nine months ended September 30, 2005.

 

17


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The intangible assets included in “Investments and Other Assets” on the Consolidated Balance Sheets of $32.8 million and $33.2 million at September 30, 2005 and December 31, 2004, respectively, relate to an additional minimum pension liability.

 

See Item 8, Note 17, “Pension Benefits and Postretirement Benefits Other Than Pensions,” in the 2004 Annual Report on Form 10-K for more information.

 

The components of intangible assets included in “Property, Plant and Equipment, Net” on the Consolidated Balance Sheets were as follows:

 

     As of September 30, 2005

   As of December 31, 2004

(In millions)


  

Gross Carrying

Amount


  

Accumulated

Amortization


  

Gross Carrying

Amount


  

Accumulated

Amortization


Land easements, amortized

   $ 97.8    $ 26.9    $ 96.5    $ 25.8

Land easements, unamortized

     31.8      —        31.8      —  

Software

     83.1      59.2      82.7      55.8
    

  

  

  

Total

   $ 212.7    $ 86.1    $ 211.0    $ 81.6
    

  

  

  

 

In addition, “Assets held for sale” included intangible assets related to natural gas rights, amortized, with a gross carrying amount and accumulated amortization of $8.4 million and $4.9 million, respectively, at December 31, 2004.

 

Amortization expense for intangible assets was $3.7 million and $4.3 million for the three months ended September 30, 2005 and 2004, respectively, and $11.3 million and $13.2 million for the nine months ended September 30, 2005 and 2004, respectively.

 

Amortization expense is estimated to be as follows:

 

(In millions)


   2005

   2006

   2007

   2008

   2009

Annual amortization expense

   $ 15.2    $ 11.0    $ 12.6    $ 8.2    $ 7.5

 

NOTE 6: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

 

Allegheny utilizes derivative instruments to manage its exposure to various market risks, as described in the 2004 Annual Report on Form 10-K. The following information supplements, and should be read in conjunction with, Item 8, Note 5, “Wholesale Energy Activities,” and Note 10, “Derivative Instruments and Hedging Activities,” in the 2004 Annual Report on Form 10-K.

 

AE Supply records any commodity contract related to energy trading that is a derivative instrument at its fair value as a component of operating revenues, unless the contract falls within the “normal purchases and normal sales” scope exception of SFAS No. 133 or is designated as a hedge for accounting purposes. The normal purchases and normal sales scope exception requires, among other things, physical delivery in quantities expected to be used or sold over a reasonable period in the normal course of business. Contracts that are designated as normal purchases and normal sales are accounted for under accrual accounting and, therefore, are not recorded on the balance sheet at fair value. For certain transactions that are designed to hedge the cash flows of a forecasted transaction, the effective portion of the hedge is recorded as a separate component of stockholders’ equity under the caption “Accumulated other comprehensive income (loss)” and subsequently reclassified into earnings when the forecasted transaction is completed or settled. The ineffective portion of the hedge is immediately reflected in earnings.

 

AE Supply has designated certain contracts as cash flow hedges. The first contracts were designated effective July 1, 2004 and were related to legacy mark to market contracts that are going to be serviced by anticipated excess generation. These contracts expire at various dates through December 31, 2006. During the third quarter 2005, additional contracts were executed and designated as cash flow hedges to lock in prices for a portion of anticipated excess generation for the period October 2005 through April 2006.

 

18


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Changes in the fair value of these contracts are reflected in “Accumulated other comprehensive income (loss).” For the contracts designated as cash flow hedges on July 1, 2004, the existing derivative liabilities associated with each contract as of that designation date will be recognized in earnings over the remaining term of the contract, in accordance with the estimated cash flow of the contract at the time of the designation. The contracts represent an aggregate liability at September 30, 2005 of $83.2 million. The $52.1 million increase in this liability since December 31, 2004 is a result of the change in the fair value of contracts in existence at December 31, 2004 and new cash flow hedge contracts entered into during the third quarter of 2005 and is reflected in “Accumulated other comprehensive income (loss).” The accumulated other comprehensive loss balance at September 30, 2005 was $62.1 million. Based on the fair value of AE Supply’s financial instruments as of September 30, 2005, accumulated other comprehensive loss of $53.9 million is expected to be reclassified as a reduction in earnings over the next twelve months. The ineffective portion of the cash flow hedges is reflected in earnings for the three and nine months ended September 30, 2005 and is not material.

 

Net unrealized gains (losses) of $4.9 million and $(2.5) million, before income taxes, for the three months ended September 30, 2005 and 2004, respectively, were recorded in “Operating revenues.” Net unrealized gains (losses) of $18.2 million and $(10.8) million, before income taxes, for the nine months ended September 30, 2005 and 2004, respectively, were recorded in “Operating revenues.” These net unrealized gains (losses) were recorded to reflect the change in fair value of the trading contracts.

 

NOTE 7: ASSET RETIREMENT OBLIGATIONS (“AROs”)

 

Allegheny recorded AROs primarily related to ash landfills and underground and aboveground storage tanks. Allegheny also has identified a number of AROs associated with certain of its electric generation and transmission assets that have not been recorded because the fair value of these obligations cannot be reasonably estimated, primarily due to the indeterminate lives of the assets.

 

The estimated cost of removal of these assets currently is being recovered through the rate-making process. Allegheny believes it is probable that any difference between expenses under SFAS No. 143, “Accounting for Asset Retirement Obligations,” and expenses recovered currently in rates with respect to these assets will be recoverable in future rates. Therefore, Allegheny is deferring these differences in expenses as a regulatory asset.

 

For the nine months ended September 30, 2005, Allegheny’s ARO balance increased $2.8 million, from $28.8 million at December 31, 2004 to $31.6 million at September 30, 2005, primarily due to accretion expense.

 

Certain estimated removal costs that are not qualified as AROs are being recovered through the ratemaking process. These costs are recorded by Allegheny’s subsidiaries as regulatory liabilities (assets) as follows:

 

(In millions)


  

September 30,

2005


   

December 31,

2004


 

Monongahela

   $ 239.0     $ 241.8  

Potomac Edison

     168.3       162.3  

West Penn

     (18.2 )     (17.2 )
    


 


Total

   $ 389.1     $ 386.9  
    


 


 

In accordance with SFAS No. 144, Monongahela’s $8.8 million regulatory liability at September 30, 2005 for removal costs related to Ohio T&D assets was recorded in liabilities associated with assets held for sale in the accompanying Consolidated Balance Sheets. See Note 3, “Discontinued Operations and Assets Held for Sale” for additional information.

 

In March 2005, the FASB issued Interpretation No. 47 (“FIN 47”), “Accounting for Conditional Asset Retirement Obligations,” which will require entities with an ARO that is conditional on a future event to record the ARO, even if the event has not yet occurred and uncertainty exists as to the timing and method of settlement. This interpretation is effective for fiscal years ending after December 15, 2005. Obligations as a result of the adoption of FIN 47 will be presented as a cumulative effect due to a change in accounting principle. Allegheny currently is evaluating the impact of FIN 47.

 

19


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 8: COMPREHENSIVE INCOME (LOSS)

 

Allegheny’s consolidated comprehensive income (loss), net of income taxes, was as follows:

 

    

Three Months Ended

September 30,


   

Nine Months Ended

September 30,


 

(In millions)


   2005

    2004

    2005

    2004

 

Consolidated net income (loss)

   $ 35.7     $ (376.8 )   $ 59.9     $ (383.0 )

Other comprehensive (loss) income, net of tax:

                                

Minimum pension liability adjustment

     —         (2.7 )     (0.2 )     (0.4 )

Changes in value of available for sale securities

     0.1       —         (0.2 )     0.1  

Changes in value of cash flow hedges

     (26.8 )     (2.6 )     (36.2 )     (2.6 )
    


 


 


 


Consolidated comprehensive income (loss)

   $ 9.0     $ (382.1 )   $ 23.3     $ (385.9 )
    


 


 


 


 

NOTE 9: BUSINESS SEGMENTS

 

Allegheny manages and evaluates its operations in two business segments, the Delivery and Services segment and the Generation and Marketing segment. Monongahela operates in both segments. All other Allegheny subsidiaries operate in only one segment. The Delivery and Services segment includes the operations of Potomac Edison, West Penn, Allegheny Ventures and Monongahela’s electric T&D business. The Generation and Marketing segment includes the operations of AE Supply, AGC and Monongahela’s West Virginia generating assets.

 

Business segment information for Allegheny is summarized below. Significant transactions between reportable segments are shown as eliminations to reconcile the segment information to consolidated amounts.

 

    

Three Months Ended

September 30,


   

Nine Months Ended

September 30,


 

(In millions)


   2005

    2004

    2005

    2004

 

Total operating revenues:

                                

Delivery and Services

   $ 731.0     $ 689.3     $ 2,133.6     $ 2,069.2  

Generation and Marketing

     496.4       417.6       1,317.8       1,160.4  

Eliminations

     (382.4 )     (383.6 )     (1,137.7 )     (1,162.0 )
    


 


 


 


Total

   $ 845.0     $ 723.3     $ 2,313.7     $ 2,067.6  
    


 


 


 


Depreciation and amortization:

                                

Delivery and Services

   $ 38.2     $ 37.4     $ 115.3     $ 111.1  

Generation and Marketing

     38.5       37.7       115.2       111.8  
    


 


 


 


Total

   $ 76.7     $ 75.1     $ 230.5     $ 222.9  
    


 


 


 


Operating income:

                                

Delivery and Services

   $ 36.3     $ 72.5     $ 191.1     $ 215.5  

Generation and Marketing

     134.7       86.6       272.0       142.5  
    


 


 


 


Total

   $ 171.0     $ 159.1     $ 463.1     $ 358.0  
    


 


 


 


Interest Expense:

                                

Delivery and Services

   $ 24.2     $ 30.6     $ 99.5     $ 94.6  

Generation and Marketing

     88.0       59.6       267.0       206.5  

Eliminations

     (0.4 )     (0.1 )     (0.6 )     (0.1 )
    


 


 


 


Total

   $ 111.8     $ 90.1     $ 365.9     $ 301.0  
    


 


 


 


Income (loss) from continuing operations:

                                

Delivery and Services

   $ 10.7     $ 30.2     $ 77.3     $ 83.6  

Generation and Marketing

     32.7       20.6       (5.5 )     (35.0 )

Eliminations

     —         (0.1 )     (0.1 )     (0.1 )
    


 


 


 


Total

   $ 43.4     $ 50.7     $ 71.7     $ 48.5  
    


 


 


 


Loss from discontinued operations, net:

                                

Delivery and Services

   $ (6.8 )   $ (25.2 )   $ (2.5 )   $ (15.4 )

Generation and Marketing

     (0.9 )     (402.4 )     (9.4 )     (416.2 )

Eliminations

     —         0.1       0.1       0.1  
    


 


 


 


Total

   $ (7.7 )   $ (427.5 )   $ (11.8 )   $ (431.5 )
    


 


 


 


Net income (loss):

                                

Delivery and Services

   $ 3.9     $ 5.0     $ 74.8     $ 68.2  

Generation and Marketing

     31.8       (381.8 )     (14.9 )     (451.2 )
    


 


 


 


Total

   $ 35.7     $ (376.8 )   $ 59.9     $ (383.0 )
    


 


 


 


 

20


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 10: ACCOUNTING FOR THE EFFECTS OF PRICE REGULATION

 

As of September 30, 2005, Allegheny’s reserve for adverse power purchase commitments, which is recorded entirely on West Penn’s Consolidated Balance Sheets, was $205.6 million and decreased as follows:

 

    

Three Months Ended

September 30,


  

Nine Months Ended

September 30,


(In millions)


   2005

   2004

   2005

   2004

Decrease in reserve for adverse power purchase commitments

   $ 4.2    $ 4.5    $ 12.6    $ 13.5

 

Allegheny’s Consolidated Balance Sheets include the amounts listed below for generating assets no longer subject to SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation.”

 

(In millions)


  

September 30,

2005


   

December 31,

2004


 

Property, plant and equipment

   $ 4,129.0     $ 4,121.2  

Amounts under construction included above

   $ 58.3     $ 36.1  

Accumulated depreciation

   $ (1,968.7 )   $ (1,925.6 )

 

21


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 11: INCOME (LOSS) PER SHARE

 

The information used to compute Allegheny’s income (loss) per share is as follows:

 

     Three Months Ended
September 30,


    Nine Months Ended
September 30,


 

(In thousands)


   2005

    2004

    2005

    2004

 

Basic Income (Loss) Per Share—Numerator

                                

Income from continuing operations

   $ 43,458     $ 50,644     $ 71,757     $ 48,469  

Loss from discontinued operations

     (7,758 )     (427,487 )     (11,822 )     (431,489 )
    


 


 


 


Net income (loss)

   $ 35,700     $ (376,843 )   $ 59,935     $ (383,020 )
    


 


 


 


Diluted Income (Loss) Per Share—Numerator

                                

Income from continuing operations

   $ 43,458     $ 50,644     $ 71,757     $ 48,469  

Add back: Interest expense on convertible securities, net of tax

     —         5,754       2,873       —    

Loss from discontinued operations

     (7,758 )     (427,487 )     (11,822 )     (431,489 )
    


 


 


 


Diluted earnings (loss) per share- numerator

   $ 35,700     $ (371,089 )   $ 62,808     $ (383,020 )
    


 


 


 


Basic Income (Loss) Per Share—Denominator

                                

Weighted average common shares outstanding

     162,711       127,117       152,379       127,020  
    


 


 


 


Diluted Income (Loss) Per Share—Denominator

                                

Weighted average common shares outstanding

     162,711       127,117       152,379       127,020  

Stock options

     1,823       338       1,274       182  

Performance shares

     41       71       55       94  

Non-employee stock awards

     28       —         22       —    

Stock units

     2,181       1,692       2,106       1,439  

Trust preferred securities

     —         25,000       10,181       —    
    


 


 


 


Total

     166,784       154,218       166,017       128,735  
    


 


 


 


Shares potentially issuable under:

                                

Trust preferred securities

     —         —         —         25,000  
    


 


 


 


Total

     —         —         —         25,000  
    


 


 


 


 

The effects of shares potentially issuable are not included in the calculation of diluted earnings per share, as these amounts are antidilutive. The Trust Preferred Securities were converted into shares of AE common stock in the second quarter of 2005. See Note 2, “Debt” for additional information.

 

NOTE 12: PENSION BENEFITS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS

 

Substantially all of Allegheny’s employees, including officers, are employed by AESC and are covered by noncontributory, defined benefit pension plans. Benefits are based on each employee’s years of service and compensation. Allegheny makes annual contributions in an amount not less than the minimum amount required under the Employee Retirement Income Security Act of 1974 (“ERISA”). Annual contributions are capped at the maximum amount that may be deducted for federal income tax purposes.

 

Allegheny 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, with the exception of certain union employees. The postretirement health care plans include a limit on Allegheny’s share of costs for recent and future retirees.

 

22


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The components of the net periodic cost for pension benefits and for postretirement benefits other than pensions (principally health care and life insurance) for employees and covered dependents and the allocation by Allegheny, through AESC, of costs for pension benefits and postretirement benefits other than pensions were as follows:

 

     Pension Benefits

 
    

Three Months Ended

September 30,


   

Nine Months Ended

September 30,


 

(In millions)


   2005

    2004

    2005

    2004

 

Components of net periodic cost:

                                

Service cost

   $ 6.0     $ 5.9     $ 17.7     $ 17.6  

Interest cost

     15.8       15.6       47.6       46.9  

Expected return on plan assets

     (17.3 )     (17.1 )     (51.9 )     (51.7 )

Amortization of unrecognized transition obligation

     0.1       0.1       0.3       0.4  

Amortization of prior service cost

     0.9       1.1       2.7       3.2  

Recognized actuarial loss

     2.3       1.5       6.9       4.0  
    


 


 


 


Subtotal

     7.8       7.1       23.3       20.4  

Curtailments, settlements and special termination benefits

     1.1       2.7       1.3       6.0  
    


 


 


 


Net periodic cost

   $ 8.9     $ 9.8     $ 24.6     $ 26.4  
    


 


 


 


Allocation of net periodic cost:

                                

Monongahela

   $ 3.0     $ 5.0     $ 8.0     $ 9.4  

AE Supply

     2.4       2.0       6.8       8.4  

West Penn

     1.9       1.5       5.4       4.7  

Potomac Edison

     1.4       1.2       4.0       3.5  

AE

     0.2       0.1       0.4       0.4  
    


 


 


 


Net periodic cost

   $ 8.9     $ 9.8     $ 24.6     $ 26.4  
    


 


 


 


Portion of net periodic cost above included in discontinued operations

   $ 1.0     $ 3.1     $ 1.7     $ 3.9  
     Postretirement Benefits Other Than Pensions

 
    

Three Months Ended

September 30,


   

Nine Months Ended

September 30,


 

(In millions)


   2005

    2004

    2005

    2004

 

Components of net periodic cost:

                                

Service cost

   $ 1.0     $ 1.0     $ 3.0     $ 3.2  

Interest cost

     4.2       3.9       12.6       11.7  

Expected return on plan assets

     (1.6 )     (1.5 )     (4.6 )     (4.6 )

Amortization of unrecognized transition obligation

     1.5       1.5       4.4       4.4  

Amortization of prior service cost

     —         —         —         0.2  

Recognized actuarial loss

     0.6       0.1       1.6       0.1  
    


 


 


 


Subtotal

     5.7       5.0       17.0       15.0  

Curtailments and settlements

     3.3       3.4       3.3       3.4  
    


 


 


 


Net periodic cost

   $ 9.0     $ 8.4     $ 20.3     $ 18.4  
    


 


 


 


Allocation of net periodic cost:

                                

Monongahela

   $ 4.3     $ 4.9     $ 7.5     $ 7.9  

West Penn

     1.8       1.3       4.9       3.8  

Potomac Edison

     1.3       1.1       3.7       3.2  

AE Supply

     1.5       1.1       4.0       3.4  

AE

     0.1       —         0.2       0.1  
    


 


 


 


Net periodic cost

   $ 9.0     $ 8.4     $ 20.3     $ 18.4  
    


 


 


 


Portion of net periodic cost above included in discontinued operations

   $ 1.9     $ 3.7     $ 2.6     $ 4.2  

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Employer Contributions. Allegheny contributed approximately $32.2 million and $60.6 million to its pension plans during the three and nine months ended September 30, 2005, respectively, including voluntary contributions of $0.1 million and $0.2 million, respectively, to the Supplemental Executive Retirement Plan (“SERP”). Allegheny also contributed $5.8 million and $17.4 million to its postretirement benefits other than pension plans during the three and nine months ended September 30, 2005, respectively. Allegheny anticipates contributing a total amount of approximately $60.7 million to its pension plans during 2005, including $0.3 million to the SERP. Allegheny also currently anticipates contributing a total amount ranging from $23.0 million to $27.5 million to fund postretirement benefits other than pensions during 2005.

 

Allegheny made matching contributions to the 401(k) Employee Stock Ownership and Savings Plan (the “ESOSP”) by issuing shares of AE’s common stock. AE issued a total of 70,240 shares and 238,233 shares of its common stock as matching contributions to the ESOSP for the three and nine months ended September 30, 2005, respectively. Allegheny recorded expense for these contributions of $2.2 million and $6.0 million for the three and nine months ended September 30, 2005, respectively.

 

NOTE 13: OTHER INCOME AND EXPENSES, NET

 

Other income and expenses, net, represents non-operating income and expenses before income taxes. The following table summarizes Allegheny’s other income and expenses, net.

 

     Three Months Ended
September 30,


   Nine Months Ended
September 30,


(In millions)


   2005

   2004

   2005

   2004

Cash received from a former trading executive’s forfeited assets

   $ —      $ —      $ 11.2    $ —  

Proceeds from sale of AFN

     —        —        3.0      —  

Gain on sale of non-operating assets

     —        0.1      2.4      7.2

Interest and dividend income

     4.4      1.3      9.4      4.0

Coal brokering income

     0.4      0.5      1.5      1.5

Premium services

     1.5      0.6      3.3      2.2

Other

     1.0      0.6      3.0      0.7
    

  

  

  

Total

   $ 7.3    $ 3.1    $ 33.8    $ 15.6
    

  

  

  

 

NOTE 14: GUARANTEES AND LETTERS OF CREDIT

 

As of September 30, 2005, Allegheny’s Consolidated Balance Sheet reflected liabilities of $6.6 million, primarily related to AE Supply’s guarantee of the performance of a put option issued in connection with an asset sale.

 

As of September 30, 2005, Allegheny had an additional $16.3 million in guarantees for which no liability has been recorded. Of these guarantees, approximately $2.9 million relates to the purchase, sale, exchange or transportation of wholesale natural gas, electric power and related services, $4.7 million relates to a lease agreement that was signed in 2001 and $8.7 million relates to loans and other financing-related matters.

 

In addition, $136.5 million in letters of credit was outstanding at September 30, 2005 under AE’s revolving credit facility. Of this amount, a letter of credit for $125.0 million that expires in June 2006 was issued on September 23, 2005 on behalf of Allegheny as collateral to stay enforcement of the judgment in Allegheny’s litigation against Merrill Lynch while an appeal is pending, and letters of credit for $9.5 million and $2.0 million that expire in July 2006 and September 2006, respectively, were issued on behalf of Allegheny Energy Solutions, Inc. AE Supply also has a $1.6 million letter of credit outstanding that is collateralized by cash and is not issued under AE’s revolving facility. This $1.6 million letter of credit expires in February 2006. None of these letters of credit are recorded on Allegheny’s Consolidated Balance Sheets.

 

NOTE 15: VARIABLE INTEREST ENTITIES

 

Under FASB’s Interpretation No. 46 (Revised December 2003) “Consolidation of Variable Interest Entities” (“FIN 46R”), Allegheny consolidated Hunlock Creek Energy Ventures, LLC as of March 31, 2004. This entity operates two plants that produce and sell electricity to Allegheny and a third party.

 

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(unaudited)

 

Potomac Edison and West Penn each have a long-term electricity purchase contract with an unrelated independent power producer (“IPP”) that represents a variable interest under FIN 46R. Allegheny has been unable to obtain certain information from the IPPs necessary to determine if the related variable interest entities (“VIEs”) should be consolidated under FIN 46R.

 

Potomac Edison and West Penn had power purchases from these two IPPs in the amount of $26.7 million and $11.1 million, respectively, for the three months ended September 30, 2005 and $25.8 million and $11.7 million, respectively, for the three months ended September 30, 2004.

 

Potomac Edison and West Penn had power purchases from these two IPPs in the amount of $79.3 million and $32.3 million, respectively, for the nine months ended September 30, 2005 and $70.3 million and $34.8 million, respectively, for the nine months ended September 30, 2004.

 

Potomac Edison recovers the full amount, and West Penn recovers a portion, of the cost of the applicable power contract in their respective rates charged to consumers or through customer surcharges. Neither Potomac Edison nor West Penn is subject to any risk of loss associated with the applicable VIE, because neither of them has any obligation to the applicable IPP other than to purchase the power that the IPP produces according to the terms of the applicable electricity purchase contract.

 

NOTE 16: COMMITMENTS AND CONTINGENCIES

 

Reference is made to Item 8, Note 27, “Commitments and Contingencies,” in the 2004 Annual Report on Form 10-K.

 

Environmental Matters and Litigation

 

Allegheny is subject to various laws, regulations and uncertainties as to environmental matters. Compliance may require Allegheny to incur substantial additional costs to modify or replace existing and proposed equipment and facilities that may adversely affect the cost of future operations.

 

Clean Air Act Matters: Allegheny currently meets applicable standards for particulate matter emissions at its generation stations through the use of high-efficiency electrostatic precipitators, cleaned coal, flue-gas conditioning, optimization software and fuel combustion modifications and, at times, through reduction of output. From time to time, minor excursions of stack emission opacity that are normal to fossil fuel operations are experienced and accommodated by the regulatory process.

 

Allegheny meets current emission standards for sulfur dioxide (“SO2”) by using scrubbers, burning low-sulfur coal, purchasing cleaned coal (which has lower sulfur content), blending lower-sulfur coal with higher sulfur coal and using emission allowances.

 

Allegheny’s compliance with the Clean Air Act of 1970 (the “Clean Air Act”) has required, and may require in the future, that Allegheny install expensive post-combustion control technologies on many of its generation stations. The Clean Air Interstate Rule promulgated by the United States Environmental Protection Agency (the “EPA”) on March 10, 2005 may accelerate the need to install this equipment by phasing out a portion of currently available allowances.

 

The Clean Air Act mandates annual reductions of SO2 and created a SO2 emission allowance trading program. AE Supply and Monongahela comply with current SO2 emission standards through a system-wide plan combining the use of emission controls, lower sulfur fuel and emission allowances. Based on current forecasts, Allegheny expects that it will have little to no exposure to the SO2 allowance market in 2005. Allegheny estimates that it may have SO2 allowance market exposure of 20,000 to 30,000 tons in 2006 and an average exposure of less than 50,000 tons per year in 2007 and 2008. Allegheny’s allowance needs, to a large extent, are affected at any given time by the amount of output produced and the type of fuel used by its generation facilities, as well as the implementation of environmental controls. Therefore, there can be no assurance that Allegheny’s need to purchase SO2 allowances for these periods will not vary from current estimates.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

In 1998, the EPA finalized its Nitrogen Oxide (“NOx”) State Implementation Plan (“SIP”) call rule (known as the “NOx SIP call”), which addressed the regional transport of ground-level ozone and required the equivalent of a uniform 0.15 lb/mmBtu emission rate throughout a 22-state region, including Pennsylvania, Maryland and West Virginia. Compliance with the NOx SIP call was required beginning in May 2004. Pennsylvania and Maryland implemented their respective SIP call rules in May 2003. West Virginia’s SIP call rules were effective as of May 2004.

 

AE Supply and Monongahela have completed installation of substantially all NOx controls to meet the Pennsylvania, Maryland and West Virginia SIP calls. These NOx controls include selective catalytic reduction at the Harrison and Pleasants generation stations and selective noncatalytic reduction at the Hatfield’s Ferry and Fort Martin generation stations, as well as burner modifications at the Mitchell generation station. The NOx compliance plan functions on a system-wide basis, similar to the SO2 compliance plan. AE Supply and Monongahela also have the option, in some cases, to purchase alternate fuels or NOx allowances, if needed, to supplement their compliance strategies. Allegheny currently estimates that its emission control activities, in concert with its inventory of banked allowances, will facilitate its compliance with NOx limits established by the SIP through 2008. Allegheny’s allowance needs, to a large extent, are affected at any given time by the amount of output produced and the type of fuel used by its generation facilities. Allegheny’s capital expenditure forecast includes the expenditure of $4.7 million of capital costs during the 2005 through 2007 period for additional NOx emission controls.

 

On March 15, 2005, the EPA issued the Clean Air Mercury Rule (“CAMR”) establishing a cap and trade system designed to reduce mercury emissions from coal-fired power plants in two phases due 2010 and 2018. This rule will be implemented through state implementation plans currently under development. The rule has been challenged by several parties. AE is currently assessing CAMR and its strategy for compliance.

 

Clean Air Act Litigation: In August 2000, AE received a letter from the EPA requesting that it provide information and documentation relevant to the operation and maintenance of the following ten electric generation stations, which collectively include 22 generation units: Albright, Armstrong, Fort Martin, Harrison, Hatfield’s Ferry, Mitchell, Pleasants, Rivesville, R. Paul Smith and Willow Island. AE Supply and Monongahela own these generation stations. The letter requested information under Section 114 of the Clean Air Act to determine compliance with the Clean Air Act and related requirements, including potential application of the New Source Review (“NSR”) standards of the Clean Air Act, which can require the installation of additional emission control equipment when the major modification of an existing facility results in an increase in emissions. AE provided responsive information to this and a subsequent request. At this time, AE is engaged in continuing discussions with the EPA with respect to environmental matters, including NSR issues.

 

If NSR requirements are imposed on Allegheny’s generation stations, in addition to the possible imposition of fines, compliance would entail significant capital investments in pollution control technology. There are three recent, significant federal court decisions that have addressed the application of NSR requirements to electric utility generating units: the Ohio Edison decision, the Duke Energy decision and the Alabama Power decision. The Ohio Edison decision is favorable to the EPA. The Duke Energy and Alabama Power decisions support the industry’s understanding of NSR requirements. The United States Court of Appeals for the Fourth Circuit affirmed the Duke Energy decision on June 15, 2005.

 

In 2003, the U.S. EPA issued the Equipment Replacement Rule, which sets forth a clearer set of rules for projects that may be undertaken without triggering NSR requirement. This rule would apply the Routine Maintenance, Repair and Replacement (“RMRR”) exception to the NSR requirement in a manner that is more consistent with the energy industry’s historical compliance approach. That rule was challenged by some states and environmental groups and, on December 24, 2003, the U.S. Court of Appeals for the District of Columbia Circuit issued an order to stay the implementation of that rule. At this time, AE and its subsidiaries are not able to determine the effect that these actions may have on them.

 

On May 20, 2004, AE, AE Supply, Monongahela and West Penn received a Notice of Intent to Sue Pursuant to Clean Air Act §7604 (the “Notice”) from the Attorneys General of New York, New Jersey and Connecticut and from the Pennsylvania Department of Environmental Protection (“PA DEP”). The Notice alleged that Allegheny made major modifications to some of its West Virginia facilities in violation of the Prevention of Significant Deterioration (“PSD”) provisions of the Clean Air Act at the following coal-fired facilities: Albright Unit No. 3; Fort Martin Units No. 1 and 2; Harrison Units No. 1, 2 and 3; Pleasants Units No. 1 and 2 and Willow Island Unit No. 2.

 

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(unaudited)

 

The Notice also alleged PSD violations at the Armstrong, Hatfield’s Ferry and Mitchell generation stations in Pennsylvania and identifies PA DEP as the lead agency regarding those facilities. On September 8, 2004, AE, AE Supply, Monongahela and West Penn received a separate Notice of Intent to Sue from the Maryland Attorney General that essentially mirrored the previous Notice.

 

On January 6, 2005, AE Supply and Monongahela filed a declaratory judgment action against the Attorneys General of New York, Connecticut and New Jersey in federal district court in West Virginia (“West Virginia DJ Action”). This action requests that the court declare that AE Supply’s and Monongahela’s coal-fired generation facilities in Pennsylvania and West Virginia comply with the Clean Air Act. The Attorneys General filed a motion to dismiss the West Virginia DJ Action. It is also possible that the EPA and other state authorities may join or move to transfer the West Virginia DJ Action or, if it is dismissed, that a new action may be filed by the Attorneys General.

 

On February 16, 2005, Citizens for Pennsylvania’s Future, an environmental group, sued Allegheny in the U.S. District Court for the Western District of Pennsylvania. The action alleges violations of opacity limits and particulate matter emission limits at the Hatfield’s Ferry generation facility.

 

On June 28, 2005, the PA DEP and the Attorneys General of New York, New Jersey, Connecticut and Maryland filed suit against AE, AE Supply and the Distribution Companies in the United States District Court for the Western District of Pennsylvania (“PA Enforcement Action”). This action alleges NSR violations under the federal Clean Air Act and the Pennsylvania Air Pollution Control Act at the Hatfield’s Ferry, Armstrong and Mitchell facilities in Pennsylvania. The PA Enforcement Action appears to raise the same issues regarding Allegheny’s Pennsylvania plants that are before the federal District Court in the West Virginia DJ Action, except that the PA Enforcement Action also includes the PA DEP and the Maryland AG. Allegheny has filed a motion to stay the PA Enforcement Action. If the Attorneys General’s motion to dismiss the West Virginia DJ Action is denied and the Allegheny motion to stay the PA Enforcement Action is granted, Allegheny may move to have the PA Enforcement Action transferred to and consolidated with the West Virginia DJ Action.

 

Allegheny intends to vigorously pursue and defend against the environmental matters described above but cannot predict their outcomes.

 

Comprehensive Environmental Response Compensation and Liability Act of 1980 (“CERCLA”) Claim: On March 4, 1994, Monongahela and certain affiliated companies received notice that the EPA had identified them as potentially responsible parties (“PRPs”) with respect to the Jack’s Creek/Sitkin Smelting Superfund Site in Pennsylvania. Initially, approximately 175 PRPs were involved; however, the current number of active PRPs has been reduced as a result of settlements with de minimis contributors and other contributors to the site. The costs of remediation will be shared by all past and active responsible parties. In 1999, a PRP group that included Monongahela and certain affiliated companies entered into a consent order with the EPA to remediate the site. It is currently estimated that the total remediation costs to be borne by all of the responsible parties will not exceed $30.0 million. Allegheny has an accrued liability representing its estimated share of the remediation costs as of September 30, 2005.

 

Claims Related to Alleged Asbestos Exposure: The Distribution Companies have been named as defendants, along with multiple other defendants, in pending asbestos cases alleging bodily injury involving multiple plaintiffs and multiple sites. These suits have been brought mostly by seasonal contractors’ employees and do not involve allegations of either the manufacture, sale or distribution of asbestos-containing products by Allegheny. These asbestos suits arise out of historical operations and are related to the installation and removal of asbestos-containing materials at Allegheny’s generation facilities. Allegheny’s historical operations were insured by various foreign and domestic insurers, including Lloyd’s of London. Asbestos-related litigation expenses have to date been reimbursed in full by recoveries from these historical insurers, and Allegheny believes that it has sufficient insurance to respond fully to the asbestos suits. Certain insurers, however, have contested their obligations to pay for the future defense and settlement costs relating to the asbestos suits. Allegheny is currently involved in two asbestos insurance-related actions, Certain Underwriters at Lloyd’s, London et al. v. Allegheny Energy, Inc. et al., Case No. 21-C-03-16733 (Washington County, Md.), and Monongahela Power Company et al. v. Certain Underwriters at Lloyd’s London and London Market Companies, et al., Civil Action No. 03-C-281 (Monongalia County, W.Va.). The parties in these actions are seeking an allocation of responsibility for historic and potential future asbestos liability. Allegheny and numerous others are plaintiffs in a similar action filed against Zurich Insurance Company in California, Fuller-Austin Asbestos Settlement Trust, et al. v. Zurich-American Insurance Co., et al., Case No. CGC 04 431719 (Superior Court of California, County of San Francisco).

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

In connection with a settlement, Allegheny received payment from one of its insurance companies in the amount of $625,000 on July 5, 2005, with the next payment of $625,000 due July 1, 2006. As part of the settlement, Allegheny released this insurance company from potential liabilities associated with claims against Allegheny alleging asbestos exposure.

 

Allegheny does not believe that the existence or pendency of either the asbestos suits or the actions involving its insurance will have a material impact on its consolidated financial position, results of operations or cash flows. Allegheny believes that it has established adequate reserves, net of insurance receivables and recoveries, to cover existing and future asbestos claims. As of October 12, 2005, Allegheny had 836 open cases remaining in West Virginia, and five in Pennsylvania.

 

Allegheny intends to vigorously defend against these actions but cannot predict their outcomes.

 

Canadian Toxic-Tort Class Action: On June 30, 2005, AE Supply, Monongahela and AGC, along with 18 other companies with coal-fired generating plants, were named as defendants in a toxic-tort, purported class action lawsuit filed in the Ontario Superior Court of Justice. On behalf of a purported class comprised of all persons residing in Ontario within the past six years (and/or their family members or heirs), the named plaintiffs allege that the defendants negligently failed to prevent their plants from emitting air pollutants in such a manner as to cause death and multiple adverse health effects, as well as economic damages, to the plaintiff class. The plaintiffs seek damages in the approximate amount of Canadian $49.1 billion (approximately US $41.6 billion, assuming an exchange rate of 1.18 Canadian dollars per US dollar), along with continuing damages in the amount of Canadian $4.1 billion per year and punitive damages of Canadian $1.0 billion (approximately US $3.5 billion and US $850 million, respectively, assuming an exchange rate of 1.18 Canadian dollars per US dollar) along with such other relief as the court deems just. Allegheny has not yet been served with this lawsuit. Allegheny intends to vigorously defend against this action but cannot predict its outcome.

 

Other Litigation

 

Putative Class Actions Under California Statutes: Eight related putative class action lawsuits were filed against and served on AE Supply and more than two dozen other named defendant power suppliers in various California superior courts during 2002. These class action suits were removed from state court and transferred to the U.S. District Court for the Southern District of California. Seven of the suits were commenced by consumers of wholesale electricity in California. The eighth, Millar v. Allegheny Energy Supply Co., et al., was filed on behalf of California consumers and taxpayers. The complaints allege, among other things, that AE Supply and the other defendant power suppliers violated California’s antitrust statute and the California unfair business practices statutes by manipulating the California electricity market. The suits also challenge the validity of various long-term power contracts with the State of California, including the CDWR contract.

 

On August 25, 2003, the U.S. District Court granted AE Supply’s motion to dismiss the seven consumer class actions with prejudice. On February 25, 2005, the United States Court of Appeals for the Ninth Circuit affirmed the District Court’s judgment dismissing the seven class actions with prejudice.

 

The District Court separately granted plaintiffs’ motion to remand in the eighth action, Millar, on July 9, 2003. On December 18, 2003, the plaintiffs filed an amended complaint in California state court, solely on behalf of consumers, naming certain additional defendants, including The Goldman Sachs Group, Inc. (“Goldman Sachs”). The case was removed to federal court based on the amended complaint. On January 11, 2005, the federal district court remanded the case back to the state court in San Francisco. On May 6, 2005, the defendants in the Millar action filed a series of demurrers seeking to have the action dismissed. On September 7, 2005, the state court ruled that the plaintiff’s complaint would be dismissed without leave to amend. On October 7, 2005, the state court entered judgment dismissing the complaint without leave to amend. Plaintiffs have agreed not to appeal the state court’s judgment.

 

Nevada Power Contracts: On December 7, 2001, Nevada Power Company (“NPC”) filed a complaint with FERC against AE Supply seeking action by FERC to modify prices payable to AE Supply under three trade confirmations between Merrill Lynch and NPC. NPC’s claim was based, in part, on the assertion that

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

dysfunctional California spot markets had an adverse effect on the prices NPC was able to negotiate with Merrill Lynch under the contracts. NPC filed substantially identical complaints against a number of other energy suppliers. On December 19, 2002, the Administrative Law Judge (“ALJ”) issued findings that no contract modification was warranted. The ALJ determined in favor of NPC that AE Supply, rather than Merrill Lynch, was a proper subject of NPC’s complaint.

 

On June 26, 2003, FERC affirmed the ALJ’s decision upholding the long-term contracts negotiated between NPC and Merrill Lynch, among others, and did not render a decision on whether AE Supply, rather than Merrill Lynch, was the real party in interest. On November 10, 2003, FERC issued an order, on rehearing, affirming its conclusion that the long-term contracts should not be modified. Snohomish County and other parties filed petitions for review of FERC’s June 26, 2003 order with the U.S. Court of Appeals for the Ninth Circuit (the “NPC Petitions”). The NPC Petitions were consolidated in the Ninth Circuit. On December 17, 2003, AE Supply filed a motion to intervene in this proceeding in the Ninth Circuit. The Ninth Circuit heard oral argument in these cases on December 8, 2004.

 

AE Supply intends to vigorously defend against these actions but cannot predict their outcomes.

 

Sierra/Nevada: On April 2, 2003, NPC and Sierra Pacific Resources, Inc. (together, “Sierra/Nevada”) initiated a lawsuit in U.S. District Court in Nevada against AE and AE Supply, together with Merrill Lynch & Co. and Merrill Lynch Capital Services, Inc. (together, “Merrill”). The complaint alleged that AE, AE Supply and Merrill engaged in fraudulent conduct in connection with NPC’s application to the Public Utilities Commission of Nevada (the “Nevada PUC”) for a deferred energy accounting adjustment, which allegedly caused the Nevada PUC to disallow $180 million of NPC’s deferred energy expenses. Sierra/Nevada asserted claims against AE and AE Supply for: (a) tortious interference with Sierra/Nevada’s contractual and prospective economic advantages; (b) conspiracy and (c) violations of the Nevada state Racketeer Influenced and Corrupt Organization (“RICO”) Act. Sierra/Nevada filed an amended complaint on May 30, 2003, which asserted a fourth cause of action against AE and AE Supply for wrongful hiring and supervision. Sierra/Nevada seeks $180 million in compensatory damages plus attorneys’ fees and seeks in excess of $850 million under the RICO count. AE and AE Supply filed motions to dismiss the complaints on May 6, 2003 and June 23, 2003. Thereafter, plaintiffs filed a motion to stay the action, pending the outcome of certain state court proceedings in which they are seeking to reverse the Nevada PUC’s disallowance of expenses. On April 4, 2005, the District Court granted the stay motion, and the action is currently stayed.

 

AE Supply intends to vigorously defend against this action but cannot predict its outcome.

 

Litigation Involving Merrill Lynch: AE and AE Supply entered into an asset purchase agreement with Merrill Lynch and affiliated parties in 2001, under which AE and AE Supply purchased Merrill Lynch’s energy marketing and trading business for approximately $489 million and an equity interest in AE Supply of nearly 2%. The asset purchase agreement provided that Merrill Lynch would have the right to require AE to purchase Merrill Lynch’s equity interest in AE Supply for $115 million plus interest calculated from March 16, 2001 in the event that certain conditions were not met.

 

On September 24, 2002, certain Merrill Lynch entities filed a complaint against AE in the U.S. District Court for the Southern District of New York, alleging that AE breached the asset purchase agreement by failing to repurchase the equity interest in AE Supply from Merrill Lynch and seeking damages in excess of $125 million. On September 25, 2002, AE and AE Supply filed an action against Merrill Lynch in New York state court. The complaint in that action alleged that Merrill Lynch fraudulently induced AE to enter into the purchase agreement and that Merrill Lynch breached certain representations and warranties contained in the agreement.

 

On May 29, 2003, the U.S. District Court for the Southern District of New York denied AE’s motion to stay Merrill Lynch’s action and ordered that AE and AE Supply assert their claims against Merrill Lynch, which were initially brought in New York state court, as counterclaims in Merrill Lynch’s federal court action. As a result, AE and AE Supply dismissed the New York state action and filed an answer and asserted affirmative defenses and counterclaims against Merrill Lynch in the U.S. District Court for the Southern District of New York. The counterclaims, as amended, alleged that Merrill Lynch fraudulently induced AE and AE Supply to enter into the purchase agreement, that Merrill Lynch breached certain representations and warranties contained in the purchase agreement, that Merrill Lynch negligently misrepresented certain facts relating to the purchase agreement and that Merrill Lynch breached fiduciary duties owed to AE and AE Supply. The counterclaims seek damages in excess of $605 million, among other relief.

 

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On November 24, 2003, the court dismissed AE and AE Supply’s counterclaim for rescission and struck their demand for a jury trial. On February 2, 2005, following discovery, the parties filed separate motions for summary judgment. On April 12, 2005, the court granted Merrill Lynch’s motion for summary judgment on its breach of contract claim, thereby requiring AE to purchase Merrill Lynch’s equity interest in AE Supply for $115 million plus interest from March 16, 2001, to be offset by any judgment in favor of AE and AE Supply on their counterclaims. The court denied Merrill Lynch’s summary judgment motion with respect to AE and AE Supply’s counterclaims for fraudulent inducement and breach of contract, and granted Merrill Lynch’s motion with respect to the counterclaims for breach of fiduciary duty and negligent misrepresentations. The court also denied AE and AE Supply’s motion for partial summary judgment on their breach of contract claims.

 

In May and June of 2005, the court conducted a trial with respect to the damages owed Merrill Lynch on its breach of contract claim and with respect to AE and AE Supply’s counterclaims for fraudulent inducement and breach of contract. Following the trial, on July 18, 2005, the court entered an order: (a) ruling against AE and AE Supply on their fraudulent inducement and breach of contract claims; (b) requiring AE to pay $115 million plus interest to Merrill Lynch; and (c) requiring Merrill Lynch to return its equity interest in AE Supply to AE. On August 26, 2005, the court entered its final judgment in accordance with its July 18, 2005 ruling. On September 22, 2005, AE and AE Supply filed a notice of appeal of the trial court’s judgment to the United States Court of Appeals for the Second Circuit. Although AE will not be required to pay Merrill Lynch the amount of the judgment while the appeal is pending, AE has posted a letter of credit to secure the judgment.

 

As a result of the court ruling, AE recorded a charge during the first quarter of 2005 in the amount of $38.5 million, representing interest from March 16, 2001 through March 31, 2005, and continues to accrue interest expense thereafter.

 

The federal government is holding certain assets of Daniel L. Gordon, the former head of energy trading for AE Supply. Both AE and AE Supply, on the one hand, and Merrill Lynch, on the other hand, filed petitions with the U.S. District Court for the Southern District of New York claiming rights to the funds. In June 2005, AE, AE Supply, Merrill Lynch and the U.S. Attorney’s Office entered into a settlement agreement pursuant to which AE Supply and Merrill Lynch will receive equal portions of certain of the assets held by the federal government. AE Supply has received approximately $11 million from the forfeited assets and may receive additional amounts if certain funds are released from a separate escrow.

 

Putative Shareholder, Benefit Plan Class Actions and Derivative Actions: From October 2002 through December 2002, plaintiffs claiming to represent purchasers of AE’s securities filed 14 putative class action lawsuits against AE and several of its former senior managers in U.S. District Courts for the Southern District of New York and the District of Maryland. The complaints alleged that AE and senior management violated federal securities laws when AE purchased Merrill Lynch’s energy marketing and trading business with the knowledge that the business was built on illegal wash or round-trip trades with Enron, which the complaints alleged artificially inflated trading revenue, volume and growth. The complaints asserted that AE’s fortunes fell when Enron’s collapse exposed what plaintiffs claim were illegal trades in the energy markets. All of the securities cases were transferred to the District of Maryland and consolidated. The plaintiffs filed an amended complaint on May 3, 2004 that alleged that the defendants violated federal securities laws by failing to disclose weaknesses in Merrill Lynch’s energy marketing and trading business, as well as other internal control and accounting deficiencies. The amended complaint seeks unspecified compensatory damages and equitable relief.

 

In June 2003, a shareholder derivative action was filed against AE’s Board of Directors and several former senior managers in the Supreme Court of the State of New York for the County of New York. The suit alleges that the Board and former senior management breached fiduciary duties to AE that have exposed AE to the securities class action lawsuits. The New York state court derivative action has been stayed pending the commencement of discovery in the securities cases. On April 8, 2005, a second shareholder derivative action was filed against AE’s Board of Directors and several former senior managers and former directors. The action was filed in the U.S. District Court for the District of Maryland and consolidated with the securities class actions pending in that court. The Maryland derivative action contains allegations similar to the New York state court derivative action.

 

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(unaudited)

 

AE has reached agreements in principle to settle the consolidated securities class action as well as the related shareholder derivative actions. The proposed settlements remain subject to a number of conditions, including the negotiation of final settlement documents and court approval follo