10-Q 1 d10q.htm FORM 10-Q 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 quarter ended June 30, 2010

Commission File Number 1-267

 

 

ALLEGHENY ENERGY, INC.

(Name of Registrant)

 

 

 

Maryland   13-5531602
(State of Incorporation)   (IRS Employer Identification Number)
800 Cabin Hill Drive, Greensburg, Pennsylvania   15601
(Address of Principal Executive Offices)   (Zip Code)

(724) 837-3000

(Telephone Number)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  þ

   Accelerated filer    ¨
Non-accelerated filer  ¨    Smaller reporting company    ¨

(Do not check if a smaller reporting company)

     

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

As of July 31, 2010, 169,615,021 shares of the common stock, par value of $1.25 per share, of the registrant were outstanding.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page
No.

PART I. FINANCIAL INFORMATION

  

Item 1.

  

Financial Statements (unaudited)

   4

Item 2.

  

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

   50

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   89

Item 4.

  

Controls and Procedures

   90

PART II. OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

   91

Item 1A.

  

Risk Factors

   91

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   91

Item 3.

  

Defaults Upon Senior Securities

   91

Item 4.

  

Reserved

   91

Item 5.

  

Other Information

   91

Item 6.

  

Exhibits

   92
  

Signature

   93

 

2


Table of Contents

GLOSSARY

 

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

 

AE

   Allegheny Energy, Inc., a diversified utility holding company

AESC

   Allegheny Energy Service Corporation, a subsidiary of AE

AE Supply

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

AGC

   Allegheny Generating Company, a generation subsidiary of AE Supply and Monongahela

Allegheny

   Allegheny Energy, Inc., together with its consolidated subsidiaries

Distribution Companies

   Monongahela, Potomac Edison and West Penn, which collectively do business as Allegheny Power

Monongahela

   Monongahela Power Company, a regulated subsidiary of AE

PATH, LLC

   Potomac-Appalachian Transmission Highline, LLC, a joint venture between Allegheny and a subsidiary of American Electric Power Company, Inc.

PATH Allegheny

   PATH Allegheny Transmission Company, LLC

PATH Allegheny MD

   PATH Allegheny Maryland Transmission Company, LLC

PATH Allegheny VA

   PATH Allegheny Virginia Transmission Corporation

PATH WV

   PATH West Virginia Transmission Company, LLC

Potomac Edison

   The Potomac Edison Company, a regulated subsidiary of AE

TrAIL Company

   Trans-Allegheny Interstate Line Company

West Penn

   West Penn Power Company, a regulated subsidiary of AE

 

II. The following abbreviations and acronyms are used in this report to identify entities and terms relevant to Allegheny’s business and operations:

 

CDD

   Cooling Degree-Days

Clean Air Act

   Clean Air Act of 1970

CO2

   Carbon dioxide

EPA

   United States Environmental Protection Agency

Exchange Act

   Securities Exchange Act of 1934, as amended

ENEC

   Expanded Net Energy Clause in West Virginia

FERC

   Federal Energy Regulatory Commission

FirstEnergy

   FirstEnergy Corp.

FPA

   Federal Power Act

FTRs

   Financial Transmission Rights

GAAP

   Generally accepted accounting principles used in the United States of America

HDD

   Heating Degree-Days

kW

   Kilowatt, which is equal to 1,000 watts

kWh

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

Maryland PSC

   Maryland Public Service Commission

MW

   Megawatt, which is equal to 1,000,000 watts

MWh

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

NERC

   North American Electric Reliability Corporation

NOX

   Nitrogen Oxide

NSR

   The New Source Performance Review Standards, or “New Source Review,” applicable to facilities deemed “new” sources of emissions by the EPA

PATH

   Potomac-Appalachian Transmission Highline

Pennsylvania PUC

   Pennsylvania Public Utility Commission

PJM

   PJM Interconnection, L.L.C., a regional transmission organization

PLR

   Provider-of-last-resort

PURPA

   Public Utility Regulatory Policies Act of 1978

RPM

   Reliability Pricing Model, which is PJM’s capacity market

RTEP

   Regional Transmission Expansion Plan

RTO

   Regional Transmission Organization

Scrubbers

   Flue-gas desulfurization equipment

SEC

   Securities and Exchange Commission

SO2

   Sulfur dioxide

SOS

   Standard Offer Service

T&D

   Transmission and distribution

TrAIL

   Trans-Allegheny Interstate Line

Virginia SCC

   Virginia State Corporation Commission

West Virginia PSC

   Public Service Commission of West Virginia

 

3


Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 

(In millions, except per share amounts)

      2010             2009             2010             2009      

Operating revenues

  $ 945.7      $ 814.7      $ 1,994.5      $ 1,771.9   
                               

Operating expenses:

       

Fuel

    295.7        216.8        613.7        475.7   

Purchased power and transmission

    126.3        112.2        275.2        246.1   

Deferred energy costs, net

    2.3        (7.6     10.4        (24.6

Gain on sale of Virginia distribution business

    (45.1     0        (45.1     0   

Operations and maintenance

    158.6        200.5        377.1        367.8   

Depreciation and amortization

    80.6        67.2        160.4        135.7   

Taxes other than income taxes

    56.6        46.5        113.7        102.3   
                               

Total operating expenses

    675.0        635.6        1,505.4        1,303.0   
                               

Operating income

    270.7        179.1        489.1        468.9   

Other income (expense), net

    2.9        1.8        5.3        4.2   

Interest expense

    79.6        59.1        156.4        116.3   
                               

Income before income taxes

    194.0        121.8        338.0        356.8   

Income tax expense

    73.8        48.9        129.6        149.8   
                               

Net income

    120.2        72.9        208.4        207.0   

Net income attributable to noncontrolling interest

    0        (0.3     0        (0.5
                               

Net income attributable to Allegheny Energy, Inc.

  $ 120.2      $ 72.6      $ 208.4      $ 206.5   
                               

Earnings per common share attributable to Allegheny Energy, Inc.:

       

Basic

  $ 0.71      $ 0.43      $ 1.23      $ 1.22   

Diluted

  $ 0.71      $ 0.43      $ 1.23      $ 1.22   

Average common shares outstanding:

       

Basic

    169.7        169.5        169.7        169.5   

Diluted

    170.1        169.9        170.1        169.9   

Dividends per common share

  $ 0.15      $ 0.15      $ 0.30      $ 0.30   

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

     Six Months Ended
June 30,
 

(In millions)

       2010             2009      

Cash Flows From Operating Activities:

    

Net income

   $ 208.4      $ 207.0   

Adjustments for non-cash items included in income:

    

Depreciation and amortization

     160.4        135.7   

Amortization of debt related costs

     13.0        5.6   

Amortization of liability for adverse power purchase commitment

     (9.0     (8.7

Gain on sale of Virginia distribution business

     (45.1     0   

Provision for uncollectible accounts

     5.5        7.2   

Deferred income taxes and investment tax credit, net

     111.2        135.8   

Deferred energy costs, net

     10.4        (24.6

Stock-based compensation expense

     8.9        8.6   

Unrealized losses (gains) on derivative contracts, net

     11.2        (35.6

Pension and other postretirement employee benefit plan expense

     33.1        20.1   

Contributions to pension and other postretirement plans

     (3.8     (4.2

Deferred revenue—Fort Martin scrubber project

     (1.9     4.8   

Deferred revenue recognized—Virginia

     0        (28.3

Deferred revenue—energy efficiency programs

     8.7        0   

Uncollected transmission revenue

     (31.4     (7.2

Other, net

     (6.1     4.2   

Changes in certain assets and liabilities:

    

Accounts receivable, net

     (54.3     (26.6

Materials, supplies and fuel

     43.7        (75.2

Prepaid taxes

     (9.7     (11.6

Collateral deposits

     (16.8     (0.7

Accounts payable

     (17.3     (12.7

Accrued taxes

     (17.6     (66.1

Accrued interest

     5.3        (1.5

Regulatory assets and liabilities

     (21.6     26.9   

Deferred income taxes

     0.8        (22.5

Distributions from equity method investee

     0        1.3   

Assets and liabilities held for sale

     (8.6     3.0   

Other operating assets and liabilities

     (13.4     6.3   
                

Net cash provided by operating activities

     364.0        241.0   
                

 

See accompanying Notes to Consolidated Financial Statements.

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Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(unaudited)

 

     Six Months Ended
June 30,
 

(In millions)

       2010             2009      

Cash Flows From Investing Activities:

    

Capital expenditures

     (511.0     (550.2

Proceeds from sale of Virginia distribution business

     317.2        0   

Decrease in restricted funds

     25.1        104.6   

Deconsolidation of PATH WV

     (3.4     0   

Other

     1.3        (1.2
                

Net cash used in investing activities

     (170.8     (446.8

Cash Flows From Financing Activities:

    

Issuance of long-term debt

     917.1        277.1   

Repayment of long-term debt

     (863.3     (167.4

Equity contribution to PATH, LLC by the joint venture partner

     0        0.5   

Return of capital, PATH, LLC

     0        (0.2

Payments on capital lease obligations

     (5.6     (4.4

Share-based excess tax benefits

     0        19.7   

Proceeds from exercise of employee stock options

     0.5        1.2   

Cash dividends paid on common stock

     (50.9     (50.8
                

Net cash provided by (used in) financing activities

     (2.2     75.7   

Net increase (decrease) in cash and cash equivalents

     191.0        (130.1

Cash and cash equivalents at beginning of period

     286.6        362.1   
                

Cash and cash equivalents at end of period

   $ 477.6      $ 232.0   
                

Supplemental Cash Flow Information:

    

Cash paid during the period for interest (net of amounts capitalized)

   $ 137.9      $ 112.0   

Accounts payable at June 30 relating to capital expenditures

   $ 132.1      $ 165.8   

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(unaudited)

 

(In millions)

   June 30,
2010
    December 31,
2009
 

ASSETS

    

Current Assets:

    

Cash and cash equivalents

   $ 477.6      $ 286.6   

Accounts receivable:

    

Customer

     237.7        188.2   

Unbilled utility revenue

     97.9        116.4   

Wholesale and other

     87.5        64.4   

Allowance for uncollectible accounts

     (14.7     (14.0

Materials and supplies

     111.8        110.6   

Fuel

     165.1        206.4   

Deferred income taxes

     0        81.5   

Prepaid taxes

     58.2        48.4   

Collateral deposits

     22.1        20.8   

Derivative assets

     12.6        4.6   

Restricted funds

     24.9        25.9   

Regulatory assets

     128.6        132.7   

Assets held for sale

     0        32.4   

Other

     38.2        40.4   
                

Total current assets

     1,447.5        1,345.3   
                

Property, Plant and Equipment:

    

Generation

     7,536.9        7,469.4   

Transmission

     1,403.9        1,313.2   

Distribution

     3,856.6        3,784.4   

Other

     444.4        440.7   

Accumulated depreciation

     (5,232.6     (5,104.9
                

Subtotal

     8,009.2        7,902.8   

Construction work in progress

     982.7        800.6   

Property, plant and equipment held for sale, net

     0        253.7   
                

Total property, plant and equipment, net

     8,991.9        8,957.1   
                

Other Noncurrent Assets:

    

Regulatory assets

     736.0        717.3   

Goodwill

     367.3        367.3   

Restricted funds

     36.0        60.2   

Investments in unconsolidated affiliates

     44.8        26.7   

Derivative assets

     4.0        0   

Other

     103.4        115.2   
                

Total other noncurrent assets

     1,291.5        1,286.7   
                

Total Assets

   $ 11,730.9      $ 11,589.1   
                

 

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (Continued)

(unaudited)

 

     June  30,
2010
    December 31,
2009
 

(In millions, except share amounts)

    

LIABILITIES AND EQUITY

    

Current Liabilities:

    

Long-term debt due within one year

   $ 165.6      $ 140.8   

Accounts payable

     357.8        411.4   

Accrued taxes

     66.1        87.3   

Payable to PJM for FTRs

     2.0        31.7   

Derivative liabilities

     7.6        24.4   

Regulatory liabilities

     18.8        37.4   

Accrued interest

     73.6        68.3   

Security deposits

     53.1        51.0   

Liabilities associated with assets held for sale

     0        10.1   

Deferred income taxes

     8.5        0   

Other

     108.1        123.2   
                

Total current liabilities

     861.2        985.6   
                

Long-term Debt

     4,463.2        4,417.0   

Deferred Credits and Other Liabilities:

    

Derivative liabilities

     5.6        6.7   

Income taxes payable

     116.5        85.7   

Investment tax credit

     60.1        61.6   

Deferred income taxes

     1,509.4        1,501.3   

Regulatory liabilities

     470.3        461.2   

Pension and other postretirement employee benefit plan liabilities

     627.5        597.4   

Adverse power purchase commitment

     105.4        114.4   

Liabilities associated with assets held for sale

     0        53.1   

Other

     205.8        177.0   
                

Total deferred credits and other liabilities

     3,100.6        3,058.4   
                

Commitments and Contingencies (Note 17)

    

Equity:

    

Common stock—$1.25 par value per share, 260,000,000 shares authorized and 169,666,019 and 169,620,917 shares issued at June 30, 2010 and December 31, 2009, respectively

     212.1        212.0   

Other paid-in capital

     1,979.6        1,970.2   

Retained earnings

     1,180.2        1,022.7   

Treasury stock at cost—51,313 shares at June 30, 2010 and December 31, 2009, respectively

     (1.8     (1.8

Accumulated other comprehensive loss

     (64.2     (89.9
                

Total Allegheny Energy, Inc. common stockholders’ equity

     3,305.9        3,113.2   

Noncontrolling interest

     0        14.9   
                

Total equity

     3,305.9        3,128.1   
                

Total Liabilities and Equity

   $ 11,730.9      $ 11,589.1   
                

 

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(unaudited)

 

(In millions, except shares)

  Shares
outstanding
  Common
stock
  Other
paid-in
capital
    Retained
earnings
    Treasury
stock
    Accumulated
other
comprehensive
loss
    Total
Allegheny
Energy, Inc.
common
stockholders’
equity
    Noncontrolling
interest
    Total
equity
 

Balance at March 31, 2010

  169,578,004   $ 212.0   $ 1,974.1      $ 1,085.5      $ (1.8   $ (43.8   $ 3,226.0      $ —        $ 3,226.0   

Net income

  —       —       —          120.2        —          —          120.2        —          120.2   

Defined benefit pension and other benefit plan amortization, net of tax of $0.6

  —       —       —          —          —          0.8        0.8        —          0.8   

Cash flow hedges, net of tax of $(13.3)

  —       —       —          —          —          (21.2     (21.2     —          (21.2

Dividends on common stock

  —       —       —          (25.5     —          —          (25.5     —          (25.5

Stock-based compensation expense:

                 

Non-employee director stock awards

  3,000     —       0.2        —          —          —          0.2        —          0.2   

Stock options

  —       —       1.2        —          —          —          1.2        —          1.2   

Performance shares

  —       —       3.7        —          —          —          3.7        —          3.7   

Exercise of stock options

  33,702     0.1     0.4        —          —          —          0.5        —          0.5   
                                                                 

Balance at June 30, 2010

  169,614,706   $ 212.1   $ 1,979.6      $ 1,180.2      $ (1.8   $ (64.2   $ 3,305.9      $ —        $ 3,305.9   
                                                                 

(In millions, except shares)

  Shares
outstanding
  Common
stock
  Other
paid-in
capital
    Retained
earnings
    Treasury
stock
    Accumulated
other
comprehensive
loss
    Total
Allegheny
Energy, Inc.
common
stockholders’
equity
    Noncontrolling
interest
    Total
equity
 

Balance at March 31, 2009

  169,399,045   $ 211.8   $ 1,976.0      $ 840.1      $ (1.8   $ (21.4   $ 3,004.7      $ 5.1      $ 3,009.8   

Net income

  —       —       —          72.6        —          —          72.6        0.3        72.9   

Defined benefit pension and other benefit plan amortization, net of tax of $0.6

  —       —       —          —          —          0.8        0.8        —          0.8   

Cash flow hedges, net of tax of $(8.5)

  —       —       —          —          —          (13.0     (13.0     —          (13.0

PATH, LLC return of capital

  —       —       —          —          —          —          —          (0.3     (0.3

Equity contribution to PATH, LLC by AEP

  —       —       —          —          —          —          —          0.5        0.5   

Dividends on common stock

  —       —       —          (25.4     —          —          (25.4     —          (25.4

Stock-based compensation expense:

                 

Non-employee director stock awards

  2,706     —       0.2        —          —          —          0.2        —          0.2   

Stock options

  —       —       2.3        —          —          —          2.3        —          2.3   

Performance shares

  —       —       2.5        —          —          —          2.5        —          2.5   

Exercise of stock options

  80,840     0.1     1.1        —          —          —          1.2        —          1.2   

Other

  —       —       (0.2     —          —          —          (0.2     —          (0.2
                                                                 

Balance at June 30, 2009

  169,482,591   $ 211.9   $ 1,981.9      $ 887.3      $ (1.8   $ (33.6   $ 3,045.7      $ 5.6      $ 3,051.3   
                                                                 

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(unaudited)

 

(In millions, except shares)

  Shares
outstanding
  Common
stock
  Other
paid-in
capital
  Retained
earnings
    Treasury
stock
    Accumulated
other
comprehensive
loss
    Total
Allegheny
Energy, Inc.
common
stockholders’
equity
    Noncontrolling
interest
    Total
equity
 

Balance at December 31, 2009

  169,569,604   $ 212.0   $ 1,970.2   $ 1,022.7      $ (1.8   $ (89.9   $ 3,113.2      $ 14.9      $ 3,128.1   

Net income

  —       —       —       208.4        —          —          208.4        —          208.4   

Defined benefit pension and other benefit plans:

                 

Net loss during period, net of tax of $(0.3)

  —       —       —       —          —          (0.4     (0.4     —          (0.4

Amortization, net of tax of $1.2

  —       —       —       —          —          1.6        1.6        —          1.6   

Cash flow hedges, net of tax of $15.6

  —       —       —       —          —          24.5        24.5        —          24.5   

Deconsolidation of PATH WV

  —       —       —       —          —          —          —          (14.9     (14.9

Dividends on common stock

  —       —       —       (50.9     —          —          (50.9     —          (50.9

Stock-based compensation expense:

                 

Non-employee director stock awards

  6,000     —       0.4     —          —          —          0.4        —          0.4   

Stock options

  —       —       2.7     —          —          —          2.7        —          2.7   

Performance shares

  —       —       5.7     —          —          —          5.7        —          5.7   

Restricted shares

  —       —       0.1     —          —          —          0.1        —          0.1   

Exercise of stock options

  39,102     0.1     0.5     —          —          —          0.6        —          0.6   
                                                               

Balance at June 30, 2010

  169,614,706   $ 212.1   $ 1,979.6   $ 1,180.2      $ (1.8   $ (64.2   $ 3,305.9      $ —        $ 3,305.9   
                                                               

(In millions, except shares)

  Shares
outstanding
  Common
stock
  Other
paid-in
capital
  Retained
earnings
    Treasury
stock
    Accumulated
other
comprehensive
loss
    Total
Allegheny
Energy, Inc.
common
stockholders’
equity
    Noncontrolling
interest
    Total
equity
 

Balance at December 31, 2008

  169,364,394   $ 211.8   $ 1,952.5   $ 731.6      $ (1.8   $ (43.3   $ 2,850.8      $ 4.9      $ 2,855.7   

Net income

  —       —       —       206.5        —          —          206.5        0.5        207.0   

Defined benefit pension and other benefit plan amortization, net of tax of $1.1

  —       —       —       —          —          1.7        1.7        —          1.7   

Cash flow hedges, net of tax of $4.9

  —       —       —       —          —          8.0        8.0        —          8.0   

PATH, LLC return of capital

  —       —       —       —          —          —          —          (0.3     (0.3

Equity contribution to PATH, LLC by AEP

  —       —       —       —          —          —          —          0.5        0.5   

Dividends on common stock

  —       —       —       (50.8     —          —          (50.8     —          (50.8

Stock-based compensation expense:

                 

Non-employee director stock awards

  15,907     —       0.4     —          —          —          0.4        —          0.4   

Stock options

  —       —       4.0     —          —          —          4.0        —          4.0   

Performance shares

  —       —       4.1     —          —          —          4.1        —          4.1   

Restricted shares

  17,850     —       —       —          —          —          —          —          —     

Exercise of stock options

  84,440     0.1     1.2     —          —          —          1.3        —          1.3   

Share-based excess tax benefits

  —       —       19.7     —          —          —          19.7        —          19.7   
                                                               

Balance at June 30, 2009

  169,482,591   $ 211.9   $ 1,981.9   $ 887.3      $ (1.8   $ (33.6   $ 3,045.7      $ 5.6      $ 3,051.3   
                                                               

See accompanying Notes to Consolidated Financial Statements.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Note

        Page
Number

1

   Business and Basis of Presentation    12

2

   Merger Agreement    13

3

   Recently Adopted and Recently Issued Accounting Standards    13

4

   Sale of Virginia Distribution Business    14

5

   Rates and Regulation    15

6

   Regulatory Assets and Liabilities    17

7

   Income Taxes    17

8

   Common Stock and Debt    18

9

   Segment Information    21

10

   Fair Value Measurements, Derivative Instruments and Hedging Activities    23

11

   Stock-Based Compensation    30

12

   Pension Benefits and Postretirement Benefits Other Than Pensions    33

13

   Financial Instruments    35

14

   Comprehensive Income and Accumulated Other Comprehensive Loss    36

15

   Earnings Per Share    37

16

   Variable Interest Entities    37

17

   Commitments and Contingencies    39

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

NOTE 1: BUSINESS AND BASIS OF PRESENTATION

Business Description

Allegheny Energy, Inc. (“AE” and, together with its subsidiaries, “Allegheny”) is an integrated energy business. Allegheny owns and operates electric generation facilities primarily in Pennsylvania, West Virginia and Maryland. Additionally, Allegheny owns transmission assets in Pennsylvania, West Virginia, Maryland and Virginia and provides distribution services to customers in Pennsylvania, West Virginia and Maryland. Allegheny manages its operations through two business segments: Merchant Generation and Regulated Operations. These business segments are also referred to as reportable segments.

The Merchant Generation segment includes Allegheny’s unregulated electric generation operations including Allegheny Energy Supply Company, LLC (“AE Supply”) and AE Supply’s interest in Allegheny Generating Company (“AGC”). 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 Power Company (“Monongahela”), which own approximately 59% and 41% of AGC, respectively. The Merchant Generation segment is subject to federal and state regulation but, unlike the Regulated Operations segment, is not generally subject to state regulation of rates.

The Regulated Operations segment includes the operations of Monongahela, The Potomac Edison Company (“Potomac Edison”) and West Penn Power Company (“West Penn” and, together with Monongahela and Potomac Edison, the “Distribution Companies”), which primarily operate electric transmission and distribution (“T&D”) systems in Pennsylvania, West Virginia and Maryland, as well as transmission in Virginia. Monongahela also owns and operates electric generation facilities in West Virginia and has a 41% interest in AGC. The Distribution Companies are subject to federal and state regulation, including state regulation of rates.

The Regulated Operations segment also includes the operations of Trans-Allegheny Interstate Line Company (“TrAIL Company”) and Allegheny’s interests in Potomac-Appalachian Transmission Highline, LLC (“PATH, LLC”). These entities were created to construct or facilitate the construction of high voltage transmission lines and other transmission facilities, including the Trans-Allegheny Interstate Line (“TrAIL”) and the Potomac-Appalachian Transmission Highline (“PATH”). TrAIL Company and PATH, LLC are subject to the regulation of rates by the Federal Energy Regulatory Commission (“FERC”). PATH, LLC is a series limited liability company that is comprised of multiple series, each of which has separate rights, powers and duties regarding specified property and the series profits and losses associated with such property. A subsidiary of AE owns 100% of the Allegheny Series and 50% of the West Virginia Series (“PATH WV”), which is a joint venture with a subsidiary of American Electric Power Company, Inc. (“AEP”). Allegheny accounts for its interest in PATH WV using the equity method of accounting, effective January 1, 2010. See Note 3, “Recently Adopted and Recently Issued Accounting Standards” for additional information.

On June 1, 2010, Potomac Edison sold its electric distribution business in Virginia. See Note 4, “Sale of Virginia Distribution Business” for additional information.

Allegheny Energy Service Corporation (“AESC”) is a wholly-owned subsidiary of AE that employs substantially all of Allegheny’s personnel.

Financial Statement Presentation

As permitted by the rules and regulations of the Securities and Exchange Commission (the “SEC”), Allegheny’s accompanying unaudited Consolidated Financial Statements contain certain condensed financial information and exclude certain footnote disclosures normally included in annual audited consolidated financial

 

12


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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). These unaudited Consolidated Financial Statements should be read in conjunction with Allegheny’s Consolidated Financial Statements and Notes in its Annual Report on Form 10-K for the year ended December 31, 2009.

The accompanying unaudited Consolidated Financial Statements contain all adjustments, including normal recurring accruals, necessary to present fairly Allegheny’s financial position, results of operations, cash flows and changes in equity for the periods presented therein. The results of operations for the interim periods are not necessarily indicative of the results expected for the full year. Information for quarterly periods is affected by seasonal variations in revenues, fuel and energy purchases and other factors. The year-end 2009 balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. Certain amounts in previously issued financial statements have been reclassified to conform to the current presentation, including a change in the composition of reportable segments made during the fourth quarter of 2009.

NOTE 2: MERGER AGREEMENT

On February 10, 2010, AE entered into an Agreement and Plan of Merger (as amended on June 4, 2010, the “Merger Agreement”) with FirstEnergy Corp. (“FirstEnergy”) and Element Merger Sub, Inc. (“Merger Sub”), a wholly owned subsidiary of FirstEnergy. Upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and into AE (the “Merger”), with AE becoming a wholly owned subsidiary of FirstEnergy. The Merger is intended to qualify as a tax-free reorganization under the Internal Revenue Code of 1986, as amended, and be tax-free to AE stockholders. Pursuant to the Merger Agreement, upon completion of the Merger, each issued and outstanding share of AE’s common stock, including grants of restricted stock, will automatically be converted into the right to receive 0.667 of a share of the common stock of FirstEnergy. This ratio is fixed, and the Merger Agreement does not provide for any adjustment to reflect stock price changes prior to completion of the Merger.

Completion of the Merger is subject to various customary conditions, including, among others, (i) requisite approvals of AE and FirstEnergy stockholders, (ii) expiration or termination of the applicable Hart-Scott-Rodino Act waiting period, (iii) receipt of all required regulatory approvals, including approvals from FERC and certain state public service and utility commissions, (iv) the absence of any governmental action challenging or seeking to prohibit the Merger, and (v) the absence of any material adverse effect with respect to either Allegheny or FirstEnergy.

FirstEnergy’s S-4 registration statement regarding the proposed Merger was declared effective by the SEC on July 16, 2010, and AE and FirstEnergy will each hold a special stockholder meeting on September 14, 2010 to consider and vote on proposals related to the Merger. AE and FirstEnergy currently anticipate completing the Merger in the first half of 2011.

NOTE 3: RECENTLY ADOPTED AND RECENTLY ISSUED ACCOUNTING STANDARDS

Consolidations and Variable Interest Entities

Allegheny adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2009-17 (Consolidations Topic 810), “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities,” on January 1, 2010. Under this new guidance, consolidation of a variable interest entity (“VIE”) is required by an enterprise (the “primary beneficiary”), if any, that is determined qualitatively to have both the power to direct the activities that most significantly impact the VIE’s economic success and the

 

13


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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. Under the prior guidance, the primary beneficiary (consolidator) of a VIE was the party that absorbed a majority of the expected losses or the majority of the expected residual returns of the VIE using a quantitative analysis.

Through December 31, 2009, Allegheny consolidated PATH WV for financial statement purposes, because Allegheny determined that PATH WV was a VIE and that Allegheny was its primary beneficiary under the prior accounting standard. Under the new accounting standard, Allegheny determined that it is not the primary beneficiary of PATH WV, and therefore deconsolidated PATH WV for financial statement purposes, effective January 1, 2010. Allegheny did not retrospectively apply this new guidance by deconsolidating PATH WV in its financial statements for periods prior to January 1, 2010. The deconsolidation of PATH WV did not impact retained earnings or net income attributable to Allegheny Energy, Inc. See Note 16, “Variable Interest Entities,” for additional information.

Fair Value Measurements and Disclosures

Allegheny adopted the FASB’s ASU on “Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements” in January 2010. The ASU added new requirements for disclosures about transfers into and out of fair value Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. The ASU also clarified existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. Allegheny’s adoption of this ASU did not affect its results of operations or financial position.

NOTE 4: SALE OF VIRGINIA DISTRIBUTION BUSINESS

On June 1, 2010, Potomac Edison sold its electric distribution business in Virginia (the “Virginia distribution business”) to Rappahannock Electric Cooperative and Shenandoah Valley Electric Cooperative. Cash proceeds from the sale were approximately $317 million, resulting in a pre-tax gain of approximately $45 million. In connection with the sale, Potomac Edison agreed to contribute $27.5 million between July 1, 2011 and July 1, 2014 to reduce the impact of any future rate increases, the present value of which was included in the calculation of the $45 million pre-tax gain. In addition, on June 1, 2010, Potomac Edison entered into an agreement to purchase Shenandoah Valley Electric Cooperative’s West Virginia distribution business for approximately $13 million, subject to certain adjustments through the closing date.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

The Virginia distribution business was included in the Regulated Operations segment. Assets and liabilities relating to the Virginia distribution business were classified as “held for sale” in Allegheny’s consolidated balance sheet, and depreciation expense on those assets ceased as of May 1, 2009. The operating results of the Virginia distribution business have not been reported as discontinued operations, because AE Supply will continue to provide the majority of the power to serve the customers of this business under a power sales agreement through June 30, 2011. Assets held for sale and liabilities associated with assets held for sale at December 31, 2009 were as follows:

 

(In millions)

   December 31,
2009
 

Current Assets:

  

Accounts receivable

   $ 31.2   

Materials and supplies

     0.7   

Regulatory assets

     0.5   
        

Total current assets

     32.4   

Property, Plant and Equipment:

  

Distribution property, plant and equipment

     344.9   

Accumulated depreciation

     (91.2
        

Property, plant and equipment, net

     253.7   
        

Total assets held for sale

   $ 286.1   
        

Current Liabilities:

  

Customer deposits

   $ 5.5   

Regulatory liabilities

     3.7   

Other

     0.9   
        

Total current liabilities

     10.1   

Deferred Credits and Other Liabilities:

  

Regulatory liabilities

     51.8   

Other

     1.3   
        

Total deferred credits and other liabilities

     53.1   
        

Total liabilities associated with assets held for sale

   $ 63.2   
        

NOTE 5: RATES AND REGULATION

Rate Case

On April 2, 2010, Monongahela and Potomac Edison filed with the Public Service Commission of West Virginia (“West Virginia PSC”) a Joint Stipulation and Agreement of Settlement (the “West Virginia Stipulation”) reached with the other parties in a rate case filed by Monongahela and Potomac Edison in August 2009. The West Virginia Stipulation provides for:

 

   

a $40 million annualized base rate increase effective June 29, 2010;

 

   

the deferral of February 2010 storm restoration expenses in West Virginia over a maximum five-year period;

 

   

an additional $20 million annualized base rate increase effective January 2011;

 

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Table of Contents

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

   

a decrease of $20 million in the Expanded Net Energy Clause (“ENEC”) rates effective January 2011, which amount is deferred for later recovery in 2012; and

 

   

a moratorium on filing for further increases in base rates before December 1, 2011, except under specified circumstances.

The West Virginia PSC conducted a hearing on the West Virginia Stipulation on April 6, 2010 and approved the stipulation on June 25, 2010.

Transmission Expansion

PATH Project. PATH is a 765 kV transmission line that is proposed to extend through West Virginia and into Maryland. PJM Interconnection, L.L.C. (“PJM”), which is a regional transmission organization, initially authorized the construction of PATH in June 2007. A subsidiary of AE and a subsidiary of AEP formed PATH, LLC to build PATH, and in December 2007, PATH, LLC submitted a filing to FERC under Section 205 of the Federal Power Act (the “FPA”) to implement a formula rate tariff effective March 1, 2008. The filing also included a request for certain incentive rate treatments. In February 2008, FERC issued an order setting the cost of service formula rate to calculate annual revenue requirements for the project and authorizing: a return on equity of 14.3%; a return on construction work in progress (“CWIP”); recovery of prudently incurred start-up business and administrative costs incurred prior to the time the rates go into effect; and recovery of prudently incurred development and construction costs if all or any portion of PATH is abandoned as a result of factors beyond the control of PATH, LLC.

In December 2008, PATH, LLC submitted to FERC a settlement of the formula rate and protocols with the active parties. FERC approval of the settlement is pending. Rehearing of the February 29, 2008 order with respect to return on equity remains pending before FERC.

In December 2009, PJM conducted certain sensitivity analyses as directed by a Virginia State Corporation Commission (the “Virginia SCC”) Hearing Examiner and advised that, based on these analyses, the PATH Project might not be needed in 2014 as previously expected as a result of a reduction in the scope and severity of observed NERC reliability violations. PJM advised that, consistent with PJM processes, the PATH Project would be considered in the 2010 Regional Transmission Expansion Plan (“RTEP”) to determine when it would be needed to resolve NERC reliability violations. On June 17, 2010, in connection with the 2010 RTEP, PJM requested that PATH, LLC proceed with all efforts related to the PATH Project, including state regulatory proceedings, assuming a required in-service date for the project of June 1, 2015.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

NOTE 6: REGULATORY ASSETS AND LIABILITIES

Allegheny’s regulated utility operations are subject to regulated industry-specific accounting provisions. Regulatory assets represent probable future revenues associated with incurred costs that are expected to be recovered in the future from customers through the rate-making process. Regulatory liabilities represent probable future reductions in revenues associated with amounts that are to be credited or refunded to customers through the rate-making process or amounts collected for costs not yet incurred. Regulatory assets and regulatory liabilities reflected in the Consolidated Balance Sheets were as follows:

 

(In millions)

   June 30,
2010
   December 31,
2009

Regulatory assets, including current portion:

     

Income taxes (a)(b)

   $ 230.2    $ 234.9

Pension benefits and postretirement benefits other than pensions (a)(c)

     385.4      396.5

Deferred ENEC charges (d)

     88.3      109.5

Transmission revenue requirement (e)

     62.0      29.8

Unamortized loss on reacquired debt (a)(f)

     35.8      26.8

Unrealized loss on financial transmission rights (a)

     0      1.7

Other (g)

     62.9      50.8
             

Subtotal

     864.6      850.0

Regulatory liabilities, including current portion:

     

Net asset removal costs (h)

     380.6      374.2

Income taxes

     28.4      29.3

SO2 allowances

     12.5      12.8

Fort Martin Scrubber project—environmental control surcharge

     38.2      40.1

Maryland rate stabilization and transition plan surcharge

     12.2      30.1

Unrealized gain on financial transmission rights

     6.1      0

Other

     11.1      12.1
             

Subtotal

     489.1      498.6
             

Net regulatory assets

   $ 375.5    $ 351.4
             

 

(a) Does not earn a return.
(b) Amount is being recovered over various periods associated with the remaining useful life of related regulated utility property, plant and equipment.
(c) Amount is being recovered over various periods up to 13 years.
(d) Includes amounts that do not earn a return with recovery periods through 2012.
(e) Amount earns interest at the approved FERC interest rate and will be recovered through 2012.
(f) Amount is being recovered over various periods through 2025, based upon the maturities of reacquired debt.
(g) Includes amounts that do not earn a return with various recovery periods through 2027.
(h) Net asset removal costs of $51.0 million are included in liabilities associated with assets held for sale at December 31, 2009 in the consolidated balance sheet.

NOTE 7: INCOME TAXES

Allegheny records income taxes under the liability method of accounting. Deferred income tax balances are generally determined based on the difference between the financial statement and tax basis of assets and liabilities using the statutory income tax rates in effect for years in which the differences are expected to reverse. Investment tax credits are amortized over the estimated useful life of the related property. Tax benefits are

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

recognized in the financial statements when it is more likely than not that a tax position will be sustained upon examination by the tax authorities based on the technical merits of the position. Such tax positions are measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the tax authority, assuming full knowledge of the position and all relevant facts.

Allegheny allocates federal income tax expense (benefit) among its subsidiaries pursuant to its consolidated tax sharing agreement.

The following is a reconciliation of reported income tax expense to income tax expense calculated by applying the federal statutory rate of 35% to income before income taxes:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010     2009     2010     2009  

(In millions, except percentages)

   Amount     %     Amount     %     Amount     %     Amount     %  

Income before income taxes

   $ 194.0        $ 121.8        $ 338.0        $ 356.8     
                                        

Income tax expense calculated at the federal statutory rate of 35%

     67.9      35.0     42.6      35.0     118.3      35.0     124.9      35.0

Increases (reductions) resulting from:

                

Rate-making effects of depreciation differences and removal costs

     0.9      0.5        0.7      0.6        1.8      0.5        1.4      0.4   

Other state income tax, net of federal income tax benefit

     6.2      3.2        4.3      3.5        10.5      3.1        12.5      3.5   

Amortization of deferred investment tax credits

     (0.8   (0.4     (0.9   (0.7     (1.7   (0.5     (1.8   (0.5

Change in estimated Pennsylvania net operating loss benefits

     0      0        0      0        0      0        9.5      2.7   

Changes in tax reserves related to uncertain tax positions and audit settlements

     0.6      0.3        1.5      1.2        2.2      0.6        3.2      0.9   

Other, net

     (1.0   (0.6     0.7      0.5        (1.5   (0.4     0.1      0   
                                                        

Income tax expense

   $ 73.8      38.0   $ 48.9      40.1   $ 129.6      38.3   $ 149.8      42.0
                                                        

The Commonwealth of Pennsylvania limits the amount of net operating loss carryforwards that may be used to reduce current year taxable income to the greater of $3 million or 15% of taxable income per year for 2010 and the greater of $3 million or 20% of taxable income for years after 2010.

During the six months ended June 30, 2009, a charge of $9.5 million was recorded, net of applicable federal income tax, to adjust the recorded Pennsylvania net operating loss carryforward asset to reflect current estimates of future Pennsylvania taxable income during the carryforward period.

NOTE 8: COMMON STOCK AND DEBT

Common Stock

On June 21, 2010 and March 22, 2010, AE paid cash dividends on its common stock of $0.15 per share to shareholders of record at the close of business on June 7, 2010 and March 8, 2010, respectively. On July 8, 2010, AE’s Board of Directors authorized a cash dividend on its common stock of $0.15 per share payable on September 27, 2010 to shareholders of record on September 13, 2010.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Debt

Outstanding debt and scheduled debt repayments at June 30, 2010 were as follows:

 

(In millions)

   July 1, 2010
through
December 31,
2010
    2011     2012     2013     2014     Thereafter     Total  

AE Supply:

              

Medium-Term Notes

   $ 0      $ 150.5      $ 503.2      $ 0      $ 0      $ 600.0      $ 1,253.7   

Pollution Control Bonds

     0        0        1.3        0        15.4        251.7        268.4   

Exempt Facilities Revenue Bonds

     0        0        0        0        0        235.0        235.0   

Debentures-AGC

     0        0        0        0        0        100.0        100.0   
                                                        

Total AE Supply

     0        150.5        504.5        0        15.4        1,186.7        1,857.1   

Monongahela:

              

Environmental Control Bonds (a)

     5.7        11.6        12.2        12.8        13.5        322.1        377.9   

First Mortgage Bonds

     0        0        0        300.0        120.0        220.0        640.0   

Pollution Control Bonds

     0        0        6.0        7.1        0        57.1        70.2   
                                                        

Total Monongahela

     5.7        11.6        18.2        319.9        133.5        599.2        1,088.1   

West Penn:

              

First Mortgage Bonds

     0        0        0        0        0        420.0        420.0   

Medium-Term Notes

     0        0        80.0        0        0        0        80.0   

Revolving Credit Facility

     0        0        0        15.0        0        0        15.0   
                                                        

Total West Penn

     0        0        80.0        15.0        0        420.0        515.0   

Potomac Edison:

              

First Mortgage Bonds

     0        0        0        0        175.0        245.0        420.0   

Environmental Control Bonds (a)

     2.0        3.9        4.1        4.3        4.5        107.5        126.3   
                                                        

Total Potomac Edison

     2.0        3.9        4.1        4.3        179.5        352.5        546.3   

TrAIL Company:

              

Medium-Term Notes

     0        0        0        0        0        450.0        450.0   

Revolving Loan

     0        0        0        195.0        0        0        195.0   
                                                        

Total TrAIL

     0        0        0        195.0        0        450.0        645.0   

Unamortized debt discounts

     (0.8     (1.5     (1.2     (1.1     (0.9     (2.8     (8.3

Eliminations (b)

     0        0        (1.3     0        0        (13.1     (14.4
                                                        

Total consolidated debt

   $ 6.9      $ 164.5      $ 604.3      $ 533.1      $ 327.5      $ 2,992.5      $ 4,628.8   
                                                        

 

(a) Amounts represent repayments based upon estimated surcharge collections from customers.
(b) Amounts represent the elimination of certain pollution control bonds, for which Monongahela and AE Supply are co-obligors.

The environmental control bonds shown in the table above were issued by two bankruptcy remote, special purpose limited liability companies (the “Funding Companies”) that are indirect subsidiaries of Monongahela and Potomac Edison, respectively. Proceeds from the bonds were used to construct environmental control facilities. The Funding Companies own the irrevocable right to collect non-bypassable environmental control charges (the “Environmental Control Charge”) from all customers who receive electric delivery service in Monongahela’s and Potomac Edison’s West Virginia service territories. Principal and interest owing on the environmental control bonds is secured by and payable solely from the proceeds of the Environmental Control

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Charge. The right to collect Environmental Control Charges is not included on Allegheny’s consolidated balance sheets. Creditors of AE and its subsidiaries other than the Funding Companies have no recourse to any assets or revenues of the Funding Companies.

Certain of Allegheny’s properties are subject to liens of various relative priorities securing debt.

2010 Debt Activity

Borrowings and principal repayments on debt during the six months ended June 30, 2010 were as follows:

 

(In millions)

   Issuances    Repayments

AE:

     

AE Revolving Credit Facility

   $ 130.1    $ 130.1

TrAIL Company:

     

Medium-Term Notes

     450.0      0

New TrAIL Company Credit Facility—Revolver

     195.0      0

TrAIL Company Credit Facility—Term Loan (a)

     30.0      465.0

TrAIL Company Credit Facility—Revolver (a)

     0      20.0

West Penn:

     

Transition Bonds

     0      16.0

Revolving Credit Facility

     20.0      5.0

Monongahela:

     

Medium-Term Notes

     0      110.0

Environmental Control Bonds

     0      5.5

Potomac Edison:

     

Environmental Control Bonds

     0      1.7

Revolving Credit Facility

     110.0      110.0
             

Consolidated Total

   $ 935.1    $ 863.3
             

 

(a) Represents debt under TrAIL Company’s previous credit facility, which was repaid and replaced in January 2010 by a new revolving credit facility, which is described below.

On January 15, 2010, Monongahela repaid its $110 million 7.36% medium-term notes.

On January 25, 2010, TrAIL Company issued $450 million aggregate principal amount of 4.0% senior unsecured notes due in 2015 and also entered into a new $350 million senior unsecured revolving credit facility with a three-year maturity. Borrowings under the new facility bear interest at a rate that is calculated based on the London Interbank Offered Rate (“LIBOR”), plus a margin based on TrAIL Company’s senior unsecured credit rating. TrAIL Company used the net proceeds from the sale of the notes, together with funds from its new credit facility, to repay all amounts outstanding under the $550 million senior unsecured credit facility that it had entered into in 2008.

On May 3, 2010, Potomac Edison and West Penn entered into new $150 million and $200 million senior unsecured revolving credit facilities, respectively. On May 4, 2010, AE entered into a new $250 million senior unsecured revolving credit facility. The new AE revolving credit facility replaces AE’s previous $376 million revolving credit facility, which was scheduled to mature in May 2011. The AE and West Penn facilities mature April 30, 2013. The Potomac Edison facility matures on December 31, 2011, but it will be automatically extended to April 30, 2013, subject to Potomac Edison securing necessary authorization under Virginia law.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Loans under all three new facilities generally bear interest that is calculated based on LIBOR, plus a margin based on such entity’s senior unsecured credit rating. Currently, the margins are 3.0% for AE and 2.75% for Potomac Edison and West Penn. Allegheny capitalized approximately $5.6 million in debt issuance costs related to the three new facilities.

On July 16, 2010, AE Supply redeemed all $150.5 million of its outstanding 7.80% Medium Term Notes due 2011 and expensed approximately $7.2 million in redemption premiums associated with the notes.

NOTE 9: SEGMENT INFORMATION

The following tables summarize the results of operations for Allegheny’s two reportable segments. The information for the Regulated Operations segment includes the operations of the Virginia distribution business through the date of its sale on June 1, 2010. See Note 4, “Sale of Virginia Distribution Business,” for additional information.

Allegheny changed the composition of its reportable segments during the fourth quarter of 2009, consistent with changes made to its management structure and the internal financial reporting used by its chief operating decision maker to regularly assess the performance of the business and allocate resources. Segment information for the three and six months ended June 30, 2009 has been reclassified to conform to the 2010 presentation included below.

 

    Three Months Ended
June 30, 2010
    Three Months Ended
June 30, 2009
 

(In millions)

  Merchant
Generation
    Regulated
Operations
    Eliminations
(a)
    Total     Merchant
Generation
    Regulated
Operations
    Eliminations
(a)
    Total  

Operating revenues:

               

External operating revenues

  $ 151.7      $ 794.0      $ 0      $ 945.7      $ 93.7      $ 721.0      $ 0      $ 814.7   

Internal operating revenues

    306.2        1.3        (307.5     0        280.5        1.4        (281.9     0   
                                                               

Total operating revenues

    457.9        795.3        (307.5     945.7        374.2        722.4        (281.9     814.7   
                                                               

Operating expenses:

               

Fuel

    230.1        65.6        0        295.7        153.6        63.2        0        216.8   

Purchased power and transmission

    9.2        423.3        (306.2     126.3        8.8        383.9        (280.5     112.2   

Deferred energy costs, net

    0        2.3        0        2.3        0        (7.6     0        (7.6

Gain on sale of Virginia distribution business

    0        (45.1     0        (45.1     0        0        0        0   

Operations and maintenance

    52.5        107.4        (1.3     158.6        88.7        113.2        (1.4     200.5   

Depreciation and amortization

    32.4        48.6        (0.4     80.6        24.0        43.7        (0.5     67.2   

Taxes other than income taxes

    12.9        43.7        0        56.6        8.5        38.0        0        46.5   
                                                               

Total operating expenses

    337.1        645.8        (307.9     675.0        283.6        634.4        (282.4     635.6   
                                                               

Operating income

    120.8        149.5        0.4        270.7        90.6        88.0        0.5        179.1   

Other income (expense), net

    0.8        5.4        (3.3     2.9        0.4        4.2        (2.8     1.8   

Interest expense

    36.4        44.1        (0.9     79.6        20.0        39.3        (0.2     59.1   
                                                               

Income before income taxes

    85.2        110.8        (2.0     194.0        71.0        52.9        (2.1     121.8   

Income tax expense

    30.0        43.8        0        73.8        26.8        22.1        0        48.9   
                                                               

Net income

    55.2        67.0        (2.0     120.2        44.2        30.8        (2.1     72.9   

Net income attributable to noncontrolling interest

    (2.2     0        2.2        0        (2.3     (0.3     2.3        (0.3
                                                               

Net income attributable to Allegheny Energy, Inc.

  $ 53.0      $ 67.0      $ 0.2      $ 120.2      $ 41.9      $ 30.5      $ 0.2      $ 72.6   
                                                               

 

(a) Represents elimination of transactions between reportable segments.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

    Six Months Ended
June 30, 2010
    Six Months Ended
June 30, 2009
 

(In millions)

  Merchant
Generation
    Regulated
Operations
    Eliminations
(a)
    Total     Merchant
Generation
    Regulated
Operations
    Eliminations
(a)
    Total  

Operating revenues:

               

External operating revenues

  $ 241.0      $ 1,753.5      $ 0      $ 1,994.5      $ 196.0      $ 1,575.9      $ 0      $ 1,771.9   

Internal operating revenues

    679.5        2.8        (682.3     0        633.7        4.5        (638.2     0   
                                                               

Total operating revenues

    920.5        1,756.3        (682.3     1,994.5        829.7        1,580.4        (638.2     1,771.9   
                                                               

Operating expenses:

               

Fuel

    464.6        149.1        0        613.7        338.9        136.8        0        475.7   

Purchased power and transmission

    18.8        935.9        (679.5     275.2        18.2        863.3        (635.4     246.1   

Deferred energy costs, net

    0        10.4        0        10.4        0        (24.6     0        (24.6

Gain on sale of Virginia distribution business

    0        (45.1     0        (45.1     0        0        0        0   

Operations and maintenance

    118.5        261.4        (2.8     377.1        150.8        219.8        (2.8     367.8   

Depreciation and amortization

    64.5        96.7        (0.8     160.4        47.7        88.9        (0.9     135.7   

Taxes other than income taxes

    26.1        87.6        0        113.7        21.3        81.0        0        102.3   
                                                               

Total operating expenses

    692.5        1,496.0        (683.1     1,505.4        576.9        1,365.2        (639.1     1,303.0   
                                                               

Operating income

    228.0        260.3        0.8        489.1        252.8        215.2        0.9        468.9   

Other income (expense), net

    1.4        10.5        (6.6     5.3        1.0        8.7        (5.5     4.2   

Interest expense

    72.5        85.6        (1.7     156.4        37.8        78.9        (0.4     116.3   
                                                               

Income before income taxes

    156.9        185.2        (4.1     338.0        216.0        145.0        (4.2     356.8   

Income tax expense

    57.0        72.6        0        129.6        89.6        60.2        0        149.8   
                                                               

Net income

    99.9        112.6        (4.1     208.4        126.4        84.8        (4.2     207.0   

Net income attributable to noncontrolling interest

    (4.5     0        4.5        0        (4.6     (0.5     4.6        (0.5
                                                               

Net income attributable to Allegheny Energy, Inc.

  $ 95.4      $ 112.6      $ 0.4      $ 208.4      $ 121.8      $ 84.3      $ 0.4      $ 206.5   
                                                               

 

(a) Represents elimination of transactions between reportable segments.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

NOTE 10: FAIR VALUE MEASUREMENTS, DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Allegheny’s assets and liabilities measured at fair value on a recurring basis at June 30, 2010 consisted of the following:

 

(In millions)

   Assets    Liabilities  

Cash equivalents (a)

   $ 484.0    $ 0   

Derivative instruments (b):

     

Current

     266.8      (7.6

Non-current

     4.0      (9.8
               

Total derivative instruments

     270.8      (17.4
               

Total recurring fair value measurements

   $ 754.8    $ (17.4
               

 

(a) Cash equivalents represent amounts invested in money market mutual funds and are valued using Level 1 inputs.
(b) Before netting of cash collateral and financial transmission right (“FTR”) obligation.

The following table disaggregates the net fair values of derivative assets and liabilities by class, before netting of cash collateral and FTR obligation, based on their level within the fair value hierarchy at June 30, 2010. This table excludes derivatives that have been designated as normal purchases or normal sales.

 

     Fair Value at June 30, 2010 Using  

(In millions)

   Level 1     Level 2     Level 3    Total  

Derivative assets:

         

Power contracts futures

   $ (0.8   $ 0      $ 0    $ (0.8

Power contracts forwards

     0        13.7        0      13.7   

Gas contracts futures

     15.9        0        0      15.9   

Gas contracts forwards

     0        0.3        0      0.3   

FTRs

     0        0        241.7      241.7   
                               

Total derivative assets

     15.1        14.0        241.7      270.8   
                               

Derivative liabilities:

         

Power contracts futures

     (5.9     0        0      (5.9

Power contracts forwards

     0        (6.3     0      (6.3

Gas contracts forwards

     0        (0.1     0      (0.1

Interest rate swaps

     0        (5.1     0      (5.1
                               

Total derivative liabilities

     (5.9     (11.5     0      (17.4
                               

Net derivative assets

   $ 9.2      $ 2.5      $ 241.7    $ 253.4   
                               

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

The following table shows the expected settlement year for derivative assets and liabilities outstanding before netting of cash collateral and FTR obligation at June 30, 2010. This table excludes derivatives that have been designated as normal purchases or normal sales:

 

(In millions)

   2010     2011     2012     2013    Total

Level 1

   $ 15.8      $ (0.1   $ (6.5   $ 0    $ 9.2

Level 2

     (6.4     15.5        (6.6     0      2.5

Level 3

     141.3        100.4        0        0      241.7
                                     

Net derivative assets (liabilities)

   $ 150.7      $ 115.8      $ (13.1   $ 0    $ 253.4
                                     

The following table disaggregates the net fair values of derivative assets and liabilities, before netting of cash collateral and FTR obligation, based on their level within the fair value hierarchy at December 31, 2009. This table excludes derivatives that have been designated as normal purchases or normal sales.

 

     December 31, 2009  

(In millions)

   Derivative
Assets
   Derivative
Liabilities
    Net Derivative
Assets
 

Level 1

   $ 31.9    $ (4.7   $ 27.2   

Level 2

     0.2      (29.5     (29.3

Level 3

     96.2      0        96.2   
                       

Total

   $ 128.3    $ (34.2   $ 94.1   
                       

Derivative assets and liabilities included in Level 1 primarily consist of exchange-traded futures and other exchange-traded transactions that are valued using closing prices for identical instruments in active markets. Derivative assets and liabilities included in Level 2 primarily consist of commodity forward contracts and interest rate swaps. Derivatives included in Level 2 are valued using a pricing model with inputs that are observable in the market, such as quoted forward prices of commodities, or that can be derived from or corroborated by observable market data. Derivative assets included in Level 3 consist of FTRs and are valued using an internal model based on data from PJM annual and monthly FTR auctions.

The following tables provide a reconciliation of the beginning and ending balance of FTR derivative assets measured at fair value (Level 3):

 

     Three Months Ended
June 30,
 

(In millions)

       2010            2009      

Balance at April 1

   $ 26.8    $ 55.5   

Total realized and unrealized gains (losses):

     

Included in earnings, in operating revenues

     16.0      (64.2

Included in regulatory assets or liabilities

     8.3      (32.4

Purchases, issuances and settlements

     190.6      291.6   

Transfers in / out of Level 3

     0      0   
               

Balance at June 30

   $ 241.7    $ 250.5   
               

Amount of total gains (losses) included in earnings attributable to the change in unrealized gains (losses) related to Level 3 assets held at June 30

   $ 11.5    $ (9.3
               

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

     Six Months Ended
June 30,
 

(In millions)

       2010            2009      

Balance at January 1

   $ 96.2    $ 189.8   

Total realized and unrealized gains (losses):

     

Included in earnings, in operating revenues

     23.9      (102.1

Included in regulatory assets or liabilities

     12.5      (50.8

Purchases, issuances and settlements

     109.1      213.6   

Transfers in / out of Level 3

     0      0   
               

Balance at June 30

   $ 241.7    $ 250.5   
               

Amount of total gains (losses) included in earnings attributable to the change in unrealized gains (losses) related to Level 3 assets held at June 30

   $ 11.5    $ (9.3
               

There were no transfers between Level 1 and Level 2, and no transfers into or out of Level 3, of the fair value hierarchy for the six months ended June 30, 2010. To the extent that Allegheny has transfers between these levels, Allegheny accounts for the transfers at the end of the reporting period.

The volume and expiration of Allegheny’s derivative contracts at June 30, 2010 that did not qualify under the normal purchase or normal sale exemption were as follows:

 

(In millions)

   2010    2011    2012    2013    Total

Electricity contracts (MWh):

              

Forward and future sales of power

     1.9      7.7      2.4      0      12.0

Forward and future purchases of power

     0.5      0.1      0.6      0      1.2

FTRs (MWh)

     32.5      26.7      0      0      59.2

Gas contracts—Kern River (decatherms):

              

Forward and future sales of gas

     13.8      0      0      0      13.8

Forward and future purchases of gas

     14.4      0      0      0      14.4

Interest rate swaps (notional dollars):

              

Interest rate swap agreements (fixed rate to floating rate)

   $ 143.0    $ 200.0    $ 0    $ 0    $ 343.0

Interest rate swap agreements (floating rate to fixed rate)

   $ 143.0    $ 200.0    $ 0    $ 0    $ 343.0

Allegheny enters into derivative contracts for the sale or purchase of power to hedge the variable price risks related to forecasted sales or purchases of power. To the extent that such contracts qualify and are designated as cash flow hedging instruments, the effective portion of unrealized gain or loss on the derivative contract is reported as a component of OCI and is subsequently reclassified into earnings in the period during which the hedged forecasted transaction affects earnings. Changes in the fair value of derivative power contracts that are not qualifying cash flow hedge instruments are reported in revenues on a mark-to-market basis.

Allegheny entered into derivative contracts for the forward purchase and sale of gas to hedge a portion of the value of a capacity contract related to the Kern River pipeline that do not qualify for cash flow hedge accounting. Interest rate swaps at June 30, 2010 include three interest rate swap agreements with an aggregate notional value of $343 million that were entered into during 2003 to substantially offset three existing interest rate swaps with the same counterparty. The 2003 agreements effectively locked in a net liability and substantially eliminated future income volatility from the interest rate swap positions but do not qualify for cash flow hedge accounting.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

Allegheny also holds FTRs that generally represent an economic hedge of future congestion charges that will be incurred in connection with Allegheny’s load obligations. These future obligations are not reflected on Allegheny’s Consolidated Balance Sheets, and the FTRs have not been designated as cash flow hedge instruments. As a result, the timing of recognition of gains or losses on FTRs will differ from the timing of power purchases, including incurred congestion charges. Allegheny acquires its FTRs in an annual auction through a self-scheduling process involving the use of auction revenue rights (“ARRs”) allocated to members of PJM that have load serving obligations. Allegheny initially records FTRs and an FTR obligation payable to PJM at the annual FTR auction price, and subsequently adjusts the carrying value of remaining FTRs to their estimated fair value at the end of each accounting period prior to settlement. Changes in the fair value of FTRs held by Allegheny’s unregulated subsidiaries are included in operating revenues as unrealized gains or losses. Unrealized gains or losses on FTRs held by Allegheny’s regulated subsidiaries are recorded as regulatory assets or liabilities.

Derivative contracts that have been designated as normal purchases or normal sales are not subject to mark-to-market accounting treatment, and their effects are included in earnings at the time of contract performance.

The recorded fair values of derivatives at June 30, 2010 were as follows:

 

    Power Contracts     Gas
Contracts
-Kern
River
    Interest
Rate
Swaps
    FTRs   Gross
Derivatives
    Netting     Net
Derivatives
    FTR
Obligation
(a)
    Collateral     Balance
Sheet
Derivatives
 

(In millions)

  Sales     Purchases                    

Derivatives designated as hedging instruments:

  

Derivative assets:

                     

Current

  $ 17.0      $ 0      $ 0      $ 0      $ 0   $ 17.0      $ (6.7   $ 10.3      $ 0      $ 0      $ 10.3   

Long-term

    9.7        0        0        0        0     9.7        (5.9     3.8        0        0        3.8   
                                                                                     

Total derivative assets

    26.7        0        0        0        0     26.7        (12.6     14.1        0        0        14.1   

Derivative liabilities:

                     

Current

    (3.4     0        0        0        0     (3.4     6.0        2.6        0        0        2.6   

Long-term

    (4.8     0        0        0        0     (4.8     3.5        (1.3     0        4.2        2.9   
                                                                                     

Total derivative liabilities

    (8.2     0        0        0        0     (8.2     9.5        1.3        0        4.2        5.5   
                                                                                     

Total designated

    18.5        0        0        0        0     18.5        (3.1     15.4        0        4.2        19.6   
                                                                                     

Derivatives not designated as hedging instruments:

  

Derivative assets:

                     

Current

    3.3        0        19.6        0        241.7     264.6        (8.1     256.5        (241.7     (12.5     2.3   

Long-term

    0.1        0        0        0        0     0.1        0.1        0.2        0        0        0.2   
                                                                                     

Total derivative assets

    3.4        0        19.6        0        241.7     264.7        (8.0     256.7        (241.7     (12.5     2.5   

Derivative liabilities:

                     

Current

    (5.5     (5.9     (3.5     (4.1     0     (19.0     8.8        (10.2     0        0        (10.2

Long-term

    (2.1     (7.7     0        (1.0     0     (10.8     2.3        (8.5     0        0        (8.5
                                                                                     

Total derivative liabilities

    (7.6     (13.6     (3.5     (5.1     0     (29.8     11.1        (18.7     0        0        (18.7
                                                                                     

Total not designated

    (4.2     (13.6     16.1        (5.1     241.7     234.9        3.1        238.0        (241.7     (12.5     (16.2
                                                                                     

Total derivatives

  $ 14.3      $ (13.6   $ 16.1      $ (5.1   $ 241.7   $ 253.4      $ 0      $ 253.4      $ (241.7   $ (8.3   $ 3.4   
                                                                                     

 

(a) The FTR obligation at June 30, 2010 was $243.7 million and is payable to PJM in approximately equal weekly amounts beginning June 1, 2010 through the PJM planning year ending May 31, 2011. Of this obligation, $241.7 million has been netted against the FTR derivative asset balance and the remaining $2.0 million is included in non-derivative current liabilities on the consolidated balance sheet.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

The recorded fair values of derivatives at December 31, 2009 were as follows:

 

    Power Contracts     Gas
Contracts

-Kern
River
    Interest
Rate
Swaps
    FTRs   Gross
Derivatives
    Netting     Net
Derivatives
    FTR
Obligation
(a)
    Collateral     Balance
Sheet
Derivatives
 

(In millions)

  Sales     Purchases                    

Derivatives designated as hedging instruments:

  

Derivative assets:

                     

Current

  $ 0.3      $ 0      $ 0      $ 0      $ 0   $ 0.3      $ (0.3   $ 0      $ 0      $ 0      $ 0   

Long-term

    0.6        0        0        0        0     0.6        (0.6     0        0        0        0   
                                                                                     

Total derivative assets

    0.9        0        0        0        0     0.9        (0.9     0        0        0        0   

Derivative liabilities:

                     

Current

    (12.1     (4.8     0        0        0     (16.9     (1.4     (18.3     0        0.1        (18.2

Long-term

    (1.5     (5.9     0        0        0     (7.4     (0.3     (7.7     0        3.0        (4.7
                                                                                     

Total derivative liabilities

    (13.6     (10.7     0        0        0     (24.3     (1.7     (26.0     0        3.1        (22.9
                                                                                     

Total designated

    (12.7     (10.7     0        0        0     (23.4     (2.6     (26.0     0        3.1        (22.9
                                                                                     

Derivatives not designated as hedging instruments:

  

Derivative assets:

                     

Current

    0.9        0        44.4        0        96.2     141.5        (13.2     128.3        (96.2     (27.5     4.6   

Long-term

    0        0        0        0        0     0        0        0        0        0        0   
                                                                                     

Total derivative assets

    0.9        0        44.4        0        96.2     141.5        (13.2     128.3        (96.2     (27.5     4.6   

Derivative liabilities:

                     

Current

    (0.9     (1.7     (12.4     (6.1     0     (21.1     14.9        (6.2     0        0        (6.2

Long-term

    0        (0.9     0        (2.0     0     (2.9     0.9        (2.0     0        0        (2.0
                                                                                     

Total derivative liabilities

    (0.9     (2.6     (12.4     (8.1     0     (24.0     15.8        (8.2     0        0        (8.2
                                                                                     

Total not designated

    0        (2.6     32.0        (8.1     96.2     117.5        2.6        120.1        (96.2     (27.5     (3.6
                                                                                     

Total derivatives

  $ (12.7   $ (13.3   $ 32.0      $ (8.1   $ 96.2   $ 94.1      $ 0      $ 94.1      $ (96.2   $ (24.4   $ (26.5
                                                                                     

 

(a) The FTR obligation at December 31, 2009 was $127.9 million and was payable to PJM in approximately equal weekly amounts through the PJM planning year ending May 31, 2010. Of this obligation, $96.2 million has been netted against the FTR derivative asset balance and the remaining $31.7 million is included in non-derivative current liabilities on the consolidated balance sheet.

 

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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(unaudited)

 

The following table provides details on the changes in accumulated other comprehensive income (“OCI”) relating to derivative assets and liabilities that qualified for cash flow hedge accounting:

 

     Three Months Ended
June 30,
 

(In millions)

       2010             2009      

Accumulated OCI derivative gain at April 1 (before tax effect of $18.2 million and $31.1 million, respectively)

   $ 47.1      $ 80.2   

Effective portion of changes in fair value (before tax effect of $(14.7) million and $3.5 million, respectively)

     (38.0     9.2   

Reclassifications of (gains) losses from accumulated OCI to earnings (before tax effect of $1.4 million and $(12.0) million, respectively)

     3.5        (30.7
                

Accumulated OCI derivative gain at June 30 (before tax effect of $4.9 million and $22.6 million, respectively)

   $ 12.6      $ 58.7   
                

 

     Six Months Ended
June 30,
 

(In millions)

       2010             2009      

Accumulated OCI derivative gain (loss) at January 1 (before tax effect of $(10.7) million and $17.7 million, respectively)

   $ (27.6   $ 45.8   

Effective portion of changes in fair value (before tax effect of $14.3 million and $16.8 million, respectively)

     36.9        43.4   

Reclassifications of (gains) losses from accumulated OCI to earnings (before tax effect of $1.3 million and $(11.9) million, respectively)

     3.3        (30.5
                

Accumulated OCI derivative gain at June 30 (before tax effect of $4.9 million and $22.7 million, respectively)

   $ 12.6      $ 58.7