##### 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 March 31, 2008
 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(Address of Principal Executive
    
    15601Offices)
    
    (Zip Code)
 (724) 837-3000
(Telephone Number)
 þ o
  Large accelerated filer
þ
    
    Accelerated filer
o
    
    Non-accelerated filer o
    
    Smaller reporting company o(Do not check if a smaller reporting company)
 o þ




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TABLE OF CONTENTS
  
 Page No.PART I. FINANCIAL INFORMATIONItem 1. Financial Statements (unaudited)
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
    
    
    34Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    65Item 4. Controls and Procedures
    
    
    65PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    66Item 1A. Risk Factors
    
    
    66Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    68Item 3. Defaults Upon Senior Securities
    
    
    68Item 4. Submission of Matters to a Vote of Security Holders
    
    
    68Item 5. Other Information
    
    
    68Item 6. Exhibits
    
    
    69Signatures
    
    
    70EX-31.1EX-31.2EX-32.1EX-32.2
  2




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GLOSSARY
 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 companyAllegheny Ventures
    
    Allegheny Ventures, Inc., a nonutility, unregulated subsidiary of AEAE Supply
    
    Allegheny Energy Supply Company, LLC, an unregulated generation subsidiary of AEAGC
    
    Allegheny Generating Company, an unregulated generation subsidiary of AE Supply and
MonongahelaAllegheny
    
    Allegheny Energy, Inc., together with its consolidated subsidiariesDistribution Companies
    
    Monongahela, Potomac Edison and West Penn, which collectively do business as Allegheny PowerMonongahela
    
    Monongahela Power Company, a regulated subsidiary of AEPATH, LLC
    
    Potomac-Appalachian Transmission Highline, LLC, a joint venture between Allegheny and a
subsidiary of American Electric Power Company, Inc.Potomac Edison
    
    The Potomac Edison Company, a regulated subsidiary of AETrAIL Company
    
    Trans-Allegheny Interstate Line CompanyWest Penn
    
    West Penn Power Company, a regulated subsidiary of AE
 3




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
 Three Months EndedMarch 31,(In thousands, except per share amounts)
    
    2008
    
    
    2007Operating revenues
    
    $
    875,026
    
    
    $
    847,625Operating expenses:Fuel
    
    
    249,826
    
    
    
    232,225Purchased power and transmission
    
    
    97,380
    
    
    
    93,266Deferred energy costs, net
    
    
    (10,454
    )
    
    
    (1,455
    )Operations and maintenance
    
    
    168,700
    
    
    
    160,544Depreciation and amortization
    
    
    70,289
    
    
    
    71,981Taxes other than income taxes
    
    
    52,439
    
    
    
    55,890Total operating expenses
    
    
    628,180
    
    
    
    612,451Operating income
    
    
    246,846
    
    
    
    235,174Other income and expenses, net
    
    
    6,209
    
    
    
    5,862Interest expense and preferred dividends of subsidiary
    
    
    58,431
    
    
    
    59,529Income before income taxes and minority interest
    
    
    194,624
    
    
    
    181,507Income tax expense
    
    
    58,293
    
    
    
    71,378Minority interest in net income of subsidiaries
    
    
    206
    
    
    
    387Net income
    
    $
    136,125
    
    
    $
    109,742Common share data:Weighted average common shares outstanding:Basic
    
    
    167,560
    
    
    
    165,494Diluted
    
    
    169,950
    
    
    
    169,181Basic income per common share
    
    $
    0.81
    
    
    $
    0.66Diluted income per common share
    
    $
    0.80
    
    
    $
    0.65
  4




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 Three Months EndedMarch 31,(In thousands)
    
    2008
    
    
    2007Cash Flows From Operating Activities:Net income
    
    $
    136,125
    
    
    $
    109,742Adjustments for non-cash items included in income:Depreciation and amortization
    
    
    70,289
    
    
    
    71,981Amortization of debt related costs
    
    
    2,861
    
    
    
    2,695Amortization of power sale liability related to Ohio sale
    
    
    
    
    
    
    (9,100
    )Amortization of liability for adverse power purchase commitment
    
    
    (4,284
    )
    
    
    (4,322
    )Amortization of Pennsylvania stranded cost recovery asset
    
    
    5,427
    
    
    
    4,664(Gain) loss on disposal or retirement of assets
    
    
    (358
    )
    
    
    17Minority interest in net income of subsidiaries
    
    
    206
    
    
    
    387Deferred income taxes and investment tax credit, net
    
    
    41,435
    
    
    
    74,955Deferred energy costs, net
    
    
    (10,454
    )
    
    
    (1,455
    )Stock-based compensation expense
    
    
    2,735
    
    
    
    2,823Unrealized gains on commodity contracts, net
    
    
    (1,320
    )
    
    
    (2,450
    )Pension and other postretirement employee benefit plan expense
    
    
    7,995
    
    
    
    9,414Pension and other postretirement employee benefit plan contributions
    
    
    (39,055
    )
    
    
    (39,322
    )Deferred revenue  Fort Martin Scrubber project
    
    
    5,437
    
    
    
    Other, net
    
    
    3,875
    
    
    
    930Changes in certain assets and liabilities:Accounts receivable, net
    
    
    (54,734
    )
    
    
    (44,519
    )Materials, supplies and fuel
    
    
    (1,952
    )
    
    
    851Prepaid taxes
    
    
    (34,809
    )
    
    
    (34,542
    )Collateral deposits
    
    
    12,489
    
    
    
    (8,333
    )Prepaid assets
    
    
    (1,017
    )
    
    
    (1,304
    )Other current assets
    
    
    977
    
    
    
    10,668Accounts payable
    
    
    (45,496
    )
    
    
    24,958Accrued taxes
    
    
    (10,201
    )
    
    
    (11,433
    )Accrued interest
    
    
    (2,244
    )
    
    
    8,189Other current liabilities
    
    
    8,631
    
    
    
    92Regulatory asset  PATH
    
    
    (582
    )
    
    
    Other assets
    
    
    454
    
    
    
    (2,076
    )Deferred income taxes
    
    
    (752
    )
    
    
    (12,262
    )Regulatory liabilities
    
    
    16,283
    
    
    
    Other liabilities
    
    
    (1,901
    )
    
    
    2,599Net cash provided by operating activities
    
    
    106,060
    
    
    
    153,847Cash Flows From Investing Activities:Capital expenditures
    
    
    (239,816
    )
    
    
    (168,439
    )Proceeds from asset sales
    
    
    400
    
    
    
    260Purchase of Merrill Lynch interest in subsidiary
    
    
    (50,000
    )
    
    
    Decrease in restricted funds
    
    
    64,777
    
    
    
    1,322Other investments
    
    
    (1,575
    )
    
    
    (992
    )Net cash used in investing activities
    
    
    (226,214
    )
    
    
    (167,849
    )Cash Flows From Financing Activities:Issuance of long-term debt
    
    
    124,347
    
    
    
    Repayment of long-term debt
    
    
    (159,393
    )
    
    
    (36,073
    )Equity contribution to PATH, LLC by AEP
    
    
    3,070
    
    
    
    Proceeds from exercise of employee stock options
    
    
    8,256
    
    
    
    4,580Cash dividends paid on common stock
    
    
    (25,161
    )
    
    
    Other
    
    
    
    
    
    
    (1
    )Net cash used in financing activities
    
    
    (48,881
    )
    
    
    (31,494
    )Net decrease in cash and cash equivalents
    
    
    (169,035
    )
    
    
    (45,496
    )Cash and cash equivalents at beginning of period
    
    
    258,750
    
    
    
    114,138Cash and cash equivalents at end of period
    
    $
    89,715
    
    
    $
    68,642Supplemental Cash Flow Information:Cash paid during the period for:Interest (net of amounts capitalized)
    
    $
    57,763
    
    
    $
    48,493Income taxes, net
    
    $
    624
    
    
    $
    2,365
  5




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
 March 31,
    
    
    December 31,(In thousands)
    
    2008
    
    
    2007ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    89,715
    
    
    $
    258,750Accounts receivable:Customer
    
    
    234,347
    
    
    
    195,545Unbilled utility revenue
    
    
    87,808
    
    
    
    110,569Wholesale and other
    
    
    92,693
    
    
    
    57,626Allowance for uncollectible accounts
    
    
    (15,132
    )
    
    
    (14,252
    )Materials and supplies
    
    
    104,353
    
    
    
    103,075Fuel
    
    
    78,783
    
    
    
    72,506Deferred income taxes
    
    
    223,194
    
    
    
    286,440Prepaid taxes
    
    
    83,152
    
    
    
    48,343Collateral deposits `
    
    
    44,609
    
    
    
    59,527Derivative assets
    
    
    5,266
    
    
    
    29Restricted funds
    
    
    29,553
    
    
    
    47,501Regulatory assets
    
    
    78,408
    
    
    
    73,299Other
    
    
    63,936
    
    
    
    16,001Total current assets
    
    
    1,200,685
    
    
    
    1,314,959Property, Plant and Equipment, Net:Generation
    
    
    6,028,017
    
    
    
    5,992,919Transmission
    
    
    1,133,197
    
    
    
    1,126,657Distribution
    
    
    3,808,384
    
    
    
    3,761,438Other
    
    
    463,304
    
    
    
    452,525Accumulated depreciation
    
    
    (4,837,615
    )
    
    
    (4,795,925
    )Subtotal
    
    
    6,595,287
    
    
    
    6,537,614Construction work in progress
    
    
    792,722
    
    
    
    658,966Total property, plant and equipment, net
    
    
    7,388,009
    
    
    
    7,196,580Investments and Other Assets:Restricted funds  Fort Martin scrubber project
    
    
    302,574
    
    
    
    347,023Goodwill
    
    
    367,287
    
    
    
    367,287Investments in unconsolidated affiliates
    
    
    27,811
    
    
    
    27,875Other
    
    
    17,552
    
    
    
    15,974Total investments and other assets
    
    
    715,224
    
    
    
    758,159Deferred Charges:Regulatory assets
    
    
    559,042
    
    
    
    601,603Other
    
    
    57,519
    
    
    
    35,288Total deferred charges
    
    
    616,561
    
    
    
    636,891Total Assets
    
    $
    9,920,479
    
    
    $
    9,906,589
  6




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
(unaudited)
 March 31,
    
    
    December 31,(In thousands, except share amounts)
    
    2008
    
    
    2007LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Short-term debt
    
    $
    10,000
    
    
    $
    10,000Long-term debt due within one year (Note 8)
    
    
    89,561
    
    
    
    95,367Accounts payable
    
    
    296,731
    
    
    
    380,688Accrued taxes
    
    
    70,100
    
    
    
    83,580Derivative liabilities
    
    
    76,862
    
    
    
    14,117Accrued interest
    
    
    63,339
    
    
    
    65,583Security deposits
    
    
    39,939
    
    
    
    38,976Other
    
    
    150,826
    
    
    
    99,192Total current liabilities
    
    
    797,358
    
    
    
    787,503Long-term Debt (Note 8)
    
    
    3,917,135
    
    
    
    3,943,947Deferred Credits and Other Liabilities:Derivative liabilities
    
    
    21,391
    
    
    
    12,815Income taxes payable
    
    
    70,007
    
    
    
    68,050Investment tax credit
    
    
    68,540
    
    
    
    69,353Deferred income taxes
    
    
    1,299,490
    
    
    
    1,345,953Obligations under capital leases
    
    
    44,409
    
    
    
    38,765Regulatory liabilities
    
    
    505,375
    
    
    
    488,393Adverse power purchase commitment
    
    
    145,433
    
    
    
    149,799Other
    
    
    429,285
    
    
    
    453,418Total deferred credits and other liabilities
    
    
    2,583,930
    
    
    
    2,626,546Commitments and Contingencies (Note 16)Minority Interest
    
    
    3,279
    
    
    
    13,241Common Stockholders Equity:Common stock$1.25 par value per share, 260 million
shares authorized and 167,896,292 and 167,273,069
shares issued at March 31, 2008 and December 31,
2007, respectively
    
    
    209,870
    
    
    
    209,091Other paid-in capital
    
    
    1,934,346
    
    
    
    1,924,072Retained earnings
    
    
    555,065
    
    
    
    444,177Treasury stock at cost49,493 shares
    
    
    (1,756
    )
    
    
    (1,756
    )Accumulated other comprehensive loss
    
    
    (78,748
    )
    
    
    (40,232
    )Total common stockholders equity
    
    
    2,618,777
    
    
    
    2,535,352Total Liabilities and Stockholders Equity
    
    $
    9,920,479
    
    
    $
    9,906,589
  7




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMMON STOCKHOLDERS EQUITY
For the Three Months Ended March 31, 2008
(unaudited)
 AccumulatedOther
    
    
    
    
    
    
    
    
    
    
    other
    
    
    Total commonShares
    
    
    Common
    
    
    paid-in
    
    
    Retained
    
    
    Treasury
    
    
    comprehensive
    
    
    stockholders(In thousands, except shares)
    
    outstanding
    
    
    stock
    
    
    capital
    
    
    earnings
    
    
    stock
    
    
    loss
    
    
    equityBalance at December 31, 2007
    
    
    167,223,576
    
    
    $
    209,091
    
    
    $
    1,924,072
    
    
    $
    444,177
    
    
    $
    (1,756
    )
    
    $
    (40,232
    )
    
    $
    2,535,352Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    136,125
    
    
    
    
    
    
    
    
    
    
    
    136,125Defined benefit pension and other
benefit plan amortization:Net actuarial loss, net of
tax of $42
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41
    
    
    
    41Net transition obligation,
net of tax of $197
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    192
    
    
    
    192Net prior service cost, net
of tax of $95
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    94
    
    
    
    94Unrealized losses on
available-for-sale securities, net
of tax of $1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )Cash flow hedges, net of tax of
$24,386
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (38,842
    )
    
    
    (38,842
    )Dividends on common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (25,161
    )
    
    
    
    
    
    
    
    
    
    
    (25,161
    )Stock-based compensation expense:Stock units
    
    
    
    
    
    
    
    
    
    
    342
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    342Non-employee director stock awards
    
    
    16,267
    
    
    
    20
    
    
    
    257
    
    
    
    (8
    )
    
    
    
    
    
    
    
    
    
    
    269Stock options
    
    
    
    
    
    
    
    
    
    
    2,110
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,110Exercise of stock options
    
    
    606,902
    
    
    
    759
    
    
    
    7,497
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,256Settlement of stock units
    
    
    54
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Dividends on stock units
    
    
    
    
    
    
    
    
    
    
    68
    
    
    
    (68
    )
    
    
    
    
    
    
    
    
    
    
    Balance at March 31, 2008
    
    
    167,846,799
    
    
    $
    209,870
    
    
    $
    1,934,346
    
    
    $
    555,065
    
    
    $
    (1,756
    )
    
    $
    (78,748
    )
    
    $
    2,618,777
  8




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 Note No.
    
    Page No.1 Basis of Presentation
    
    
    102 Recent Accounting Pronouncements
    
    
    113 Transmission Expansion Projects
    
    
    114 Acquisition of Minority Interest in AE Supply
    
    
    125 Rates and Regulation
    
    
    136 Regulatory Assets and Liabilities
    
    
    167 Income Taxes
    
    
    178 Capitalization and Short-Term Debt
    
    
    189 Business Segments
    
    
    1910 Derivative Instruments and Hedging Activities
    
    
    2011 Stock-Based Compensation
    
    
    2312 Pension Benefits and Postretirement Benefits Other Than Pensions
    
    
    2513 Comprehensive Income and Accumulated Other Comprehensive Loss
    
    
    2614 Income Per Common Share
    
    
    2715 Other Income and Expenses, Net
    
    
    2716 Commitments and Contingencies
    
    
    28
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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
 NOTE 1: BASIS OF PRESENTATION
 Business Description
     Financial Statement Presentation
   10




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
 NOTE 2: RECENT ACCOUNTING PRONOUNCEMENTS
     
 NOTE 3: TRANSMISSION EXPANSION PROJECTS
 Trans-Allegheny Interstate Line
    11




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
   Potomac-Appalachian Transmission Highline
     
 NOTE 4: ACQUISITION OF MINORITY INTEREST IN AE SUPPLY
   12




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
 NOTE 5: RATES AND REGULATION
 West Virginia
   
    
    Monongahela, Potomac Edison and TrAIL Company will locate 100 to 150
managerial, professional, technical and administrative jobs in north-central West
Virginia no later than the in-service date of the West Virginia segment of TrAIL, which
will involve construction of a new facility in the state with an estimated cost of
approximately $50 million;
    
    Monongahela and Potomac Edison will not seek recovery in West Virginia of
transmission charges associated with TrAIL for the period from January 2007 through the
latest of December 31, 2013, the date which is two and one-half years following the
in-service date of TrAILs West Virginia segment or the month in which Alleghenys new
West Virginia facility is placed in service;
    
    TrAIL Company will contribute $5 million to fund energy conservation programs
and assistance plans for low-income customers in West Virginia over a five year period;
    
    Monongahela and Potomac Edison will provide rate relief in the form of credits
totaling approximately $5.7 million in the aggregate to industrial customers in West
Virginia in 2010 and 2011;
    
    The West Virginia segment of TrAIL should follow the route set forth in TrAIL
Companys application to the West Virginia PSC, except for certain modifications south
of Morgantown, West Virginia, which will more closely follow existing transmission
corridors;
    
    The Consumer Advocate, the staff of the West Virginia PSC and the WVEUG will
support the need for the portion of TrAIL that is proposed to run from Alleghenys 502
Junction in Greene County, Pennsylvania through West Virginia to Loudoun, Virginia; and
    
    Each landowner on the right-of-way will be provided with transmission credits
that can be used for up to 12,000 kWh of power per year.
   13




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
  Virginia
        
    
    granted a rate adjustment effective immediately that would permit Potomac Edison to
collect an additional $9.5 million (pre-tax) on an annualized basis through June 30,
2008, a substantially lower amount than the $42.3 million requested;
    
    directed Potomac Edison to implement deferred accounting effective immediately with
respect to the over- or under-recovery of the increased purchase power costs approved in
the order; and
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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
    
    directed Potomac Edison to file an application with the Virginia SCC on or before
July 1, 2008, for proposed recovery of purchased power costs for the 12-month period
beginning July 1, 2008, including for treatment of any over- or under-recovery incurred
for service rendered prior to July 1, 2008 and whether and how its proposed recovery of
purchased power costs for service rendered on and after January 1, 2009 would be
consistent with the MOU and certain amendments to the Restructuring Act.
     15




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
 NOTE 6: REGULATORY ASSETS AND LIABILITIES
  March 31,
    
    
    December 31,(In millions)
    
    2008
    
    
    2007Regulatory assets, including current portion:Income taxes (a)(b)
    
    $
    232.1
    
    
    $
    251.4Pension benefits and postretirement benefits other than pensions (a)(c)
    
    
    199.4
    
    
    
    202.7Pennsylvania stranded cost recovery
    
    
    7.1
    
    
    
    17.6Pennsylvania Competitive Transition Charge (CTC) reconciliation
    
    
    120.5
    
    
    
    117.7Unamortized loss on reacquired debt (a)(d)
    
    
    34.2
    
    
    
    35.3Deferred ENEC charges (e)(f)
    
    
    3.6
    
    
    
    9.4Other (g)
    
    
    40.5
    
    
    
    40.8Subtotal
    
    
    637.4
    
    
    
    674.9Regulatory liabilities, including current portion:Net asset removal costs
    
    
    402.0
    
    
    
    396.4Income taxes
    
    
    36.3
    
    
    
    36.8SO2 allowances
    
    
    13.7
    
    
    
    13.8Fort Martin scrubber projectenvironmental control surcharge (e)
    
    
    23.8
    
    
    
    33.4Maryland rate stabilization and transition plan surcharge
    
    
    23.3
    
    
    
    6.9Other
    
    
    6.8
    
    
    
    1.6Subtotal
    
    
    505.9
    
    
    
    488.9Net regulatory assets
    
    $
    131.5
    
    
    $
    186.0
 
 (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 a period up to 13 years.(d)
    
    Amount is being recovered over various periods through 2025, based upon the maturities of
reacquired debt.(e)
    
    Interest earnings on the Fort Martin scrubber project escrow fund represented an offset to
regulatory assets at March 31, 2008 and a regulatory liability at December 31, 2007. By order
dated January 14, 2008, the West Virginia PSC approved a modification to the ENEC directing
the interest earnings to be applied to the ENEC.(f)
    
    Includes certain amounts that do not earn a return with recovery periods up to one year.(g)
    
    Includes certain amounts that do not earn a return with recovery periods through 2027. 16




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
 NOTE 7: INCOME TAXES
    Three Months Ended March 31,2008
    
    
    2007(In millions, except percent)
    
    Amount
    
    
    %
    
    
    Amount
    
    
    %Income before income taxes and minority interest
    
    $
    194.6
    
    
    
    
    
    
    $
    181.5Income tax expense calculated at the federal statutory rate of 35%
    
    
    68.1
    
    
    
    35.0
    
    
    
    63.5
    
    
    
    35.0Increases (reductions) resulting from:Rate-making effects of depreciation differences
    
    
    2.0
    
    
    
    1.0
    
    
    
    1.9
    
    
    
    1.0Plant removal costs
    
    
    (1.4
    )
    
    
    (0.7
    )
    
    
    (0.6
    )
    
    
    (0.3
    )State income tax, net of federal income tax benefit
    
    
    5.8
    
    
    
    3.0
    
    
    
    5.3
    
    
    
    2.9Amortization of deferred investment tax credits
    
    
    (0.8
    )
    
    
    (0.4
    )
    
    
    (0.9
    )
    
    
    (0.5
    )March 2008 West Virginia state income tax rate change
    
    
    (6.7
    )
    
    
    (3.4
    )
    
    
    
    
    
    
    January 2007 West Virginia state income tax rate change
    
    
    
    
    
    
    
    
    
    
    (0.7
    )
    
    
    (0.4
    )Changes in tax reserves related to uncertain tax
positions and resolution of audit issues
    
    
    (7.6
    )
    
    
    (3.9
    )
    
    
    2.6
    
    
    
    1.4Other, net
    
    
    (1.1
    )
    
    
    (0.6
    )
    
    
    0.3
    
    
    
    0.2Income tax expense
    
    $
    58.3
    
    
    
    30.0
    
    
    $
    71.4
    
    
    
    39.3
   17




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
 NOTE 8: CAPITALIZATION AND SHORT-TERM DEBT
 Common Stock
  Debt
  (In millions)
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    2012
    
    
    Thereafter
    
    
    TotalAE Supply:Medium-Term Notes
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    400.0
    
    
    $
    650.0
    
    
    $
    
    
    
    $
    1,050.0AE Supply Credit Facility:Term Loan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    447.0
    
    
    
    
    
    
    
    
    
    
    
    447.0Revolving Loan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    125.0
    
    
    
    
    
    
    
    
    
    
    
    125.0Pollution Control Bonds
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.3
    
    
    
    267.2
    
    
    
    268.5Debentures-AGC
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100.0
    
    
    
    100.0Total AE Supply
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    972.0
    
    
    $
    651.3
    
    
    $
    367.2
    
    
    $
    1,990.5Monongahela:Environmental Control Bonds (a)
    
    $
    5.5
    
    
    $
    10.6
    
    
    $
    11.1
    
    
    $
    11.6
    
    
    $
    12.2
    
    
    $
    284.0
    
    
    $
    335.0First Mortgage Bonds
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    340.0
    
    
    
    340.0Medium-Term Notes
    
    
    
    
    
    
    
    
    
    
    110.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    110.0Pollution Control Bonds
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6.0
    
    
    
    64.3
    
    
    
    70.3Total Monongahela
    
    $
    5.5
    
    
    $
    10.6
    
    
    $
    121.1
    
    
    $
    11.6
    
    
    $
    18.2
    
    
    $
    688.3
    
    
    $
    855.3West Penn:First Mortgage Bonds
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    420.0
    
    
    $
    420.0Transition Bonds (a)
    
    
    55.0
    
    
    
    79.8
    
    
    
    16.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    150.8Medium-Term Notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    80.0
    
    
    
    
    
    
    
    80.0Total West Penn
    
    $
    55.0
    
    
    $
    79.8
    
    
    $
    16.0
    
    
    $
    
    
    
    $
    80.0
    
    
    $
    420.0
    
    
    $
    650.8Potomac Edison:First Mortgage Bonds
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    420.0
    
    
    $
    420.0Environmental Control Bonds (a)
    
    
    1.9
    
    
    
    3.5
    
    
    
    3.7
    
    
    
    3.9
    
    
    
    4.1
    
    
    
    94.8
    
    
    
    111.9Total Potomac Edison
    
    $
    1.9
    
    
    $
    3.5
    
    
    $
    3.7
    
    
    $
    3.9
    
    
    $
    4.1
    
    
    $
    514.8
    
    
    $
    531.9TrAIL Company:Short-Term Promissory Note
    
    $
    10.0
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    10.0Total TrAIL
    
    $
    10.0
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    10.0Unamortized debt discounts
    
    
    (1.1
    )
    
    
    (1.5
    )
    
    
    (1.3
    )
    
    
    (1.0
    )
    
    
    (0.6
    )
    
    
    (1.9
    )
    
    
    (7.4
    )Eliminations (b)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1.3
    )
    
    
    (13.1
    )
    
    
    (14.4
    )Total consolidated debt
    
    $
    71.3
    
    
    $
    92.4
    
    
    $
    139.5
    
    
    $
    986.5
    
    
    $
    751.7
    
    
    $
    1,975.3
    
    
    $
    4,016.7
 
 (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.  18




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 2008 Debt Activity
  (In millions)
    
    Issuances
    
    
    RepaymentsMonongahela:Environmental Control Bonds
    
    $
    
    
    
    $
    9.4Potomac Edison:Environmental Control Bonds
    
    
    
    
    
    
    2.9West Penn:Transition Bonds
    
    
    1.4
    
    
    
    22.0AE Supply:AE Supply Credit Facility:Term Loan
    
    
    
    
    
    
    125.0Revolving Loan
    
    
    125.0
    
    
    
    Consolidated Total
    
    $
    126.4
    
    
    $
    159.3
 
 NOTE 9: BUSINESS SEGMENTS
  Three Months Ended March 31, 2008Delivery
    
    
    Generationand
    
    
    and(In millions)
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    TotalExternal operating revenues
    
    $
    772.4
    
    
    $
    102.6
    
    
    $
    
    
    
    $
    875.0Internal operating revenues
    
    
    2.1
    
    
    
    465.6
    
    
    
    (467.7
    )
    
    
    Total operating revenues
    
    $
    774.5
    
    
    $
    568.2
    
    
    $
    (467.7
    )
    
    $
    875.0Depreciation
    
    $
    37.4
    
    
    $
    27.5
    
    
    $
    
    
    
    $
    64.9Amortization
    
    $
    5.3
    
    
    $
    0.1
    
    
    $
    
    
    
    $
    5.4Operating income
    
    $
    65.2
    
    
    $
    181.6
    
    
    $
    
    
    
    $
    246.8Interest expense
    
    $
    21.9
    
    
    $
    37.9
    
    
    $
    (1.4
    )
    
    $
    58.4Income tax expense
    
    $
    12.8
    
    
    $
    45.5
    
    
    $
    
    
    
    $
    58.3Net income
    
    $
    33.7
    
    
    $
    102.4
    
    
    $
    
    
    
    $
    136.1
 Three Months Ended March 31, 2007Delivery
    
    
    Generationand
    
    
    and(In millions)
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    TotalExternal operating revenues
    
    $
    754.8
    
    
    $
    92.8
    
    
    $
    
    
    
    $
    847.6Internal operating revenues
    
    
    3.1
    
    
    
    431.7
    
    
    
    (434.8
    )
    
    
    Total operating revenues
    
    $
    757.9
    
    
    $
    524.5
    
    
    $
    (434.8
    )
    
    $
    847.6Depreciation
    
    $
    35.3
    
    
    $
    31.8
    
    
    $
    
    
    
    $
    67.1Amortization
    
    $
    4.9
    
    
    $
    
    
    
    $
    
    
    
    $
    4.9Operating income
    
    $
    96.6
    
    
    $
    138.6
    
    
    $
    
    
    
    $
    235.2Interest expense
    
    $
    18.4
    
    
    $
    42.0
    
    
    $
    (1.2
    )
    
    $
    59.2Income tax expense
    
    $
    35.5
    
    
    $
    35.9
    
    
    $
    
    
    
    $
    71.4Net income
    
    $
    45.4
    
    
    $
    64.3
    
    
    $
    
    
    
    $
    109.7
 19




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
 NOTE 10: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
  Level 1  
    
    Quoted prices for identical instruments in active markets.
 Level 2  
    
    Quoted prices for similar instruments in active markets; quoted prices for identical or similar
instruments in markets that are not active; and model-derived valuations for which all significant inputs
are observable market data.
 Level 3  
    
    Unobservable inputs significant to the fair value measurement supported by little or no market activity.
    20




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
  March 31, 2008(In millions)
    
    Current
    
    
    Long-termDerivative assets:Power transaction cash flow hedges
    
    $
    (0.2
    )
    
    $
    Power transaction mark-to-market
    
    
    5.5
    
    
    
    FTRs (a)
    
    
    51.4
    
    
    
    Total derivative assets
    
    
    56.7
    
    
    
    Cash collateral
    
    
    
    
    
    
    Total derivative assets, net of cash collateral
    
    
    56.7
    
    
    
    Derivative liabilities:Interest rate swaps
    
    
    (6.0
    )
    
    
    (10.7
    )Power transaction cash flow hedges
    
    
    (65.6
    )
    
    
    (7.2
    )Power transaction mark-to-market
    
    
    (5.5
    )
    
    
    (3.5
    )Total derivative liabilities
    
    
    (77.1
    )
    
    
    (21.4
    )Cash collateral
    
    
    0.2
    
    
    
    Total derivative liabilities, net of cash collateral
    
    
    (76.9
    )
    
    
    (21.4
    )Net derivative assets and liabilities, net of cash collateral
    
    $
    (20.2
    )
    
    $
    (21.4
    )
 
 (a)
    
    The FTR derivative assets have been netted against the related FTR obligation of $89.7
million included in other current liabilities in the Consolidated Balance Sheet.  (In millions)
    
    Level 1
    
    
    Level 2
    
    
    Level 3
    
    
    TotalDerivative assets
    
    $
    0.3
    
    
    $
    5.0
    
    
    $
    51.4
    
    
    $
    56.7Derivative liabilities
    
    
    (1.2
    )
    
    
    (97.3
    )
    
    
    
    
    
    
    (98.5
    )Net derivative asset (liability)
    
    $
    (0.9
    )
    
    $
    (92.3
    )
    
    $
    51.4
    
    
    $
    (41.8
    )
  (In millions)
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    2012
    
    
    TotalLevel 1
    
    $
    (2.0
    )
    
    $
    1.1
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (0.9
    )Level 2
    
    
    (69.4
    )
    
    
    (15.7
    )
    
    
    (5.3
    )
    
    
    (1.9
    )
    
    
    
    
    
    
    (92.3
    )Level 3
    
    
    51.4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    51.4Net derivative liability
    
    $
    (20.0
    )
    
    $
    (14.6
    )
    
    $
    (5.3
    )
    
    $
    (1.9
    )
    
    $
    
    
    
    $
    (41.8
    )
 21




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
  (In millions)Balance at January 1, 2008
    
    $
    150.0Total gains or losses (realized/unrealized):Included in earnings
    
    
    38.3Included in regulatory assets or liabilities
    
    
    18.3Purchases, issuances, and settlements
    
    
    (155.2
    )Transfers in and/or out of Level 3
    
    
    Balance at March 31, 2008
    
    $
    51.4Amount of total gains (losses) included in earnings attributable to the change in unrealized gains (losses) related
to Level 3 assets held at March 31, 2008
    
    $
    4.4
    (In millions, net of tax)Balance at January 1, 2008
    
    $
    (4.3
    )Changes in fair value
    
    
    (43.8
    )Reclassifications from accumulated other comprehensive loss to net earnings
    
    
    5.0Balance at March 31, 2008
    
    $
    (43.1
    )
 22




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
 NOTE 11: STOCK-BASED COMPENSATION
   Three Months EndedMarch 31,(In millions)
    
    2008
    
    
    2007Stock options
    
    $
    2.1
    
    
    $
    1.6Stock units
    
    
    0.3
    
    
    
    0.8Other
    
    
    0.3
    
    
    
    0.4Stock-based compensation expense included in operations and maintenance expense
    
    
    2.7
    
    
    
    2.8Income tax benefit
    
    
    1.1
    
    
    
    1.1Total stock-based compensation expense, net of tax
    
    $
    1.6
    
    
    $
    1.7
  Stock Options
  2008
    
    2007Annual risk-free interest rate
    
    
    3.14
    %
    
    
    4.60
    %Expected term of the option (in years)
    
    
    6.00
    
    
    
    5.75Expected annual dividend yield
    
    
    1.11
    %
    
    
    
    %Expected stock price volatility
    
    
    27.39
    %
    
    
    24.17
    %Grant date fair value per stock option
    
    $
    15.50
    
    
    $
    16.34
   AggregateWeighted-
    
    
    IntrinsicNumber of
    
    
    Average
    
    
    Value (a)Stock Options
    
    
    Exercise Price
    
    
    (in millions)Outstanding at December 31, 2007
    
    
    3,191,409
    
    
    $
    16.10Granted
    
    
    547,852
    
    
    $
    53.56Exercised
    
    
    (606,902
    )
    
    $
    13.60Outstanding at March 31, 2008
    
    
    3,132,359
    
    
    $
    23.14
    
    
    $
    87.5Exercisable at March 31, 2008
    
    
    1,539,188
    
    
    $
    16.29
    
    
    $
    52.7
 
 (a)
    
    Represents the total pre-tax intrinsic value based on stock options with an exercise price
less than AEs closing stock price of $50.50 on March 31, 2008. 23




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
     Stock Units
  Weighted-
    
    
    AggregateAverage
    
    
    IntrinsicNumber of
    
    
    Grant Date
    
    
    Value (a)Stock Units
    
    
    Fair Value
    
    
    (in millions)Outstanding at December 31, 2007
    
    
    451,055
    
    
    $
    15.40Units converted into common shares
    
    
    (54
    )
    
    $
    60.66Dividend on unvested units
    
    
    1,385
    
    
    $
    48.84Outstanding at March 31, 2008
    
    
    452,386
    
    
    $
    15.50
    
    
    $
    22.8
 
 (a)
    
    Represents the total pre-tax intrinsic value based on stock units outstanding multiplied
by AEs closing stock price of $50.50 on March 31, 2008.    Non-Employee Director Stock Plan
  Number ofSharesShares earned but not issued at December 31, 2007
    
    
    65,177Granted
    
    
    5,346Issued
    
    
    (16,267
    )Dividends on earned but not issued shares
    
    
    154Shares earned but not issued at March 31, 2008
    
    
    54,410
 24




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
 NOTE 12: PENSION BENEFITS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
    Postretirement Benefits OtherPension Benefits
    
    
    Than PensionsThree Months Ended
    
    
    Three Months EndedMarch 31,
    
    
    March 31,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Components of net periodic cost:Service cost
    
    $
    5.3
    
    
    $
    5.3
    
    
    $
    1.1
    
    
    $
    1.1Interest cost
    
    
    17.1
    
    
    
    16.2
    
    
    
    4.3
    
    
    
    4.3Expected return on plan assets
    
    
    (19.2
    )
    
    
    (18.3
    )
    
    
    (1.8
    )
    
    
    (1.7
    )Amortization of unrecognized transition obligation
    
    
    0.1
    
    
    
    0.1
    
    
    
    1.4
    
    
    
    1.4Amortization of prior service cost
    
    
    0.8
    
    
    
    0.8
    
    
    
    
    
    
    
    Recognized actuarial loss
    
    
    1.8
    
    
    
    2.7
    
    
    
    0.2
    
    
    
    0.6Net periodic cost
    
    $
    5.9
    
    
    $
    6.8
    
    
    $
    5.2
    
    
    $
    5.7
    25




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
 NOTE 13: COMPREHENSIVE INCOME AND ACCUMULATED OTHER COMPREHENSIVE LOSS
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    
    2007Net income
    
    $
    136.1
    
    
    $
    109.7Defined benefit pension and other benefit plan amortization, net of tax
    
    
    0.3
    
    
    
    1.6Cash flow hedges, net of tax
    
    
    (38.8
    )
    
    
    (3.3
    )Comprehensive income
    
    $
    97.6
    
    
    $
    108.0
  March 31,
    
    
    December 31,(In millions)
    
    2008
    
    
    2007Cash flow hedges, net of tax
    
    $
    (43.1
    )
    
    $
    (4.3
    )Net unrecognized pension and other benefit plan costs, net of tax
    
    
    (35.6
    )
    
    
    (35.9
    )Total
    
    $
    (78.7
    )
    
    $
    (40.2
    )
 26




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
 NOTE 14: INCOME PER COMMON SHARE
  Three Months EndedMarch 31,(In millions, except share and per share amounts)
    
    2008
    
    
    2007Basic Income per Common Share:Numerator:Net income
    
    $
    136.1
    
    
    $
    109.7Denominator:Weighted average common shares outstanding
    
    
    167,560,075
    
    
    
    165,494,332Basic income per common share
    
    $
    0.81
    
    
    $
    0.66Diluted Income per Common Share:Numerator:Net income
    
    $
    136.1
    
    
    $
    109.7Denominator:Weighted average common shares outstanding
    
    
    167,560,075
    
    
    
    165,494,332Effect of dilutive securities:Stock options (a)
    
    
    1,895,355
    
    
    
    2,721,411Stock units
    
    
    442,194
    
    
    
    885,176Non-employee stock awards
    
    
    51,894
    
    
    
    54,559Performance shares
    
    
    
    
    
    
    25,497Total shares
    
    
    169,949,518
    
    
    
    169,180,975Diluted income per common share
    
    $
    0.80
    
    
    $
    0.65
 
 (a)
    
    The dilutive share calculations for the three months ended March 31, 2008 and 2007 exclude
265,442 shares and 86,500 shares, respectively, relating to stock options because the
inclusion of these amounts would have been antidilutive under the treasury stock method. 
 NOTE 15: OTHER INCOME AND EXPENSES, NET
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    
    2007Interest and dividend income
    
    $
    2.7
    
    
    $
    3.5Cash received from a former trading executives forfeited assets
    
    
    1.6
    
    
    
    Tax reimbursement on contributions in aid of construction
    
    
    0.9
    
    
    
    1.1Equity component of AFUDC
    
    
    0.7
    
    
    
    0.7Gain on the sale of real estate
    
    
    0.4
    
    
    
    Premium services
    
    
    0.4
    
    
    
    0.4Other
    
    
    (0.5
    )
    
    
    0.2Total
    
    $
    6.2
    
    
    $
    5.9
 27




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 
 NOTE 16: COMMITMENTS AND CONTINGENCIES
 Environmental Matters and Litigation
  Global Climate Change . 2
 2 2 2 2
 2
 2
  
    
    developing an accurate CO2 emissions inventory;
    
    improving the efficiency of its existing coal-burning generation fleet;
    
    following developing technologies for clean-coal energy and for CO2 emission controls
at coal-fired power plants;
    
    following developing technologies for carbon sequestration;
    
    participating in CO2 sequestration efforts (e.g. reforestation projects)
both domestically and abroad;
    
    analyzing options for future energy investment (e.g. renewables, clean-coal, etc.);
and
    
    improving demand-side efficiency programs, as evidenced by customer conservation
outreach plans and Alleghenys Watt Watchers initiatives.
  28




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 2
 Clean Air Act Compliance. 2
  2 2 2
  2
   2 2 X 2 X 2 2
 29




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
  Clean Air Act Litigation .
        30




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
 Global Warming Class Action:
 Claims Related to Alleged Asbestos Exposure: ., .
   Other Litigation
 Nevada Power Contracts .
  Sierra/Nevada .
 31




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
   Claim by California Parties .
  Litigation Involving Merrill Lynch .
   32




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)
    Ordinary Course of Business .
 33




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Forward-Looking Statements
  
    
    regulatory matters, including but not limited to environmental regulation, state rate
regulation, and the status of retail generation service supply competition in states
served by the Distribution Companies;
    
    financing plans;
    
    market demand and prices for energy and capacity;
    
    the cost and availability of raw materials, including coal, and Alleghenys ability
to enter into and enforce long-term fuel purchase agreements;
    
    PLR and power supply contracts;
    
    results of litigation;
    
    results of operations;
    
    internal controls and procedures;
    
    capital expenditures;
    
    status and condition of plants and equipment;
    
    changes in technology and their effects on the competitiveness of Alleghenys
generation facilities;
    
    work stoppages by Alleghenys unionized employees; and
    
    capacity purchase commitments.
  
    
    the results of regulatory proceedings, including proceedings related to rates;
    
    plant performance and unplanned outages;
    
    volatility and changes in the price and demand for energy and capacity;
    
    volatility and changes in the price of coal, natural gas and other energy-related
commodities and Alleghenys ability to enter into and enforce supplier performance under
long term fuel purchase agreements;
    
    changes in the weather and other natural phenomena;
    
    changes in industry capacity, development and other activities by Alleghenys
competitors;
    
    changes in market rules, including changes to PJMs participant rules and tariffs;
    
    the loss of any significant customers or suppliers;
    
    changes in customer switching behavior and their resulting effects on existing and
future PLR load requirements;
    
    dependence on other electric transmission and gas transportation systems and their
constraints on availability;
    
    environmental regulations;
    
    changes in other laws and regulations applicable to Allegheny, its markets or its
activities;
    
    changes in the underlying inputs and assumptions, including market conditions, used
to estimate the fair values of commodity contracts;
    
    complications or other factors that make it difficult or impossible to obtain
necessary lender consents or regulatory authorizations on a timely basis;
 34




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##### Table of Contents




    
    changes in access to capital markets, the availability of credit and actions of
rating agencies;
    
    inflationary and interest rate trends;
    
    the effect of accounting pronouncements issued periodically by accounting
standard-setting bodies and accounting issues facing Allegheny;
    
    general economic and business conditions; and
    
    other risks, including the effects of global instability, terrorism and war.
  35




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Overview
  Key Indicators and Performance Factors
 The Delivery and Services Segment
  Revenue per megawatt-hour (MWh) sold
 Three Months EndedMarch 31,2008
    
    2007Revenue per MWh sold
    
    $
    61.83
    
    
    $
    60.50
 Operations and maintenance costs (O&M).
 Three Months EndedMarch 31,2008
    
    2007O&M per MWh sold
    
    $
    7.79
    
    
    $
    7.37
 Capital expenditures.
  Three Months Ended March 31,Normal
    
    2008
    
    2007
    
    ChangeRetail electricity sales (million kWhs)
    
    
    N/A
    
    
    
    11,796
    
    
    
    11,712
    
    
    
    0.7
    %HDD (a)
    
    
    2,834
    
    
    
    2,714
    
    
    
    2,744
    
    
    
    (1.1
    )%
 
 (a)
    
    Heating degree-days (HDD).The operations of the Distribution Companies are weather
sensitive. Weather conditions directly influence the volume of electricity delivered by the
Distribution Companies, representing one of several factors that impact the volume of
electricity delivered. Accordingly, deviations in weather from normal levels can affect
Alleghenys financial performance. HDD are most likely to impact the usage of Alleghenys
residential and commercial customers. Industrial customers are less weather sensitive.
Degree-day data is used to estimate amounts of energy required to maintain comfortable indoor
temperature levels based on each days average temperature. HDD is the measure of the
variation in the weather based on the extent to which the average daily temperature falls
below 65° Fahrenheit. Each degree of temperature below 65° Fahrenheit is counted as one
heating degree-day. 36




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The Generation and Marketing Segment
  kWhs generated.
 Equivalent Availability Factor (EAF).
 Station operations and maintenance costs (Station O&M).
  Three Months Ended March 31,2008
    
    
    2007
    
    
    ChangeSupercritical Units:kWhs generated (in millions)
    
    
    10,363
    
    
    
    10,748
    
    
    
    (3.6
    )%EAF
    
    
    89.2
    %
    
    
    89.5
    %
    
    
    (0.3
    )%Station O&M (in millions):Base and operations
    
    $
    27.4
    
    
    $
    25.0
    
    
    
    9.6
    %Special maintenance
    
    
    11.1
    
    
    
    10.4
    
    
    
    6.7
    %Total Station O&M
    
    $
    38.5
    
    
    $
    35.4
    
    
    
    8.8
    %All Generation Units:kWhs generated (in millions)
    
    
    12,541
    
    
    
    13,092
    
    
    
    (4.2
    )%EAF
    
    
    88.6
    %
    
    
    89.1
    %
    
    
    (0.5
    )%Station O&M (in millions):Base and operations
    
    $
    41.6
    
    
    $
    38.0
    
    
    
    9.5
    %Special maintenance
    
    
    14.1
    
    
    
    11.4
    
    
    
    23.7
    %Total Station O&M
    
    $
    55.7
    
    
    $
    49.4
    
    
    
    12.8
    %
 37




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##### Table of Contents



RESULTS OF OPERATIONS
 Income Summary
 Three months ended March 31, 2008Delivery
    
    
    Generationand
    
    
    and(In millions)
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    TotalOperating revenues
    
    $
    774.5
    
    
    $
    568.2
    
    
    $
    (467.7
    )
    
    $
    875.0Fuel
    
    
    
    
    
    
    249.8
    
    
    
    
    
    
    
    249.8Purchased power and transmission
    
    
    535.5
    
    
    
    27.5
    
    
    
    (465.6
    )
    
    
    97.4Deferred energy costs, net
    
    
    3.1
    
    
    
    (13.6
    )
    
    
    
    
    
    
    (10.5
    )Operations and maintenance
    
    
    91.9
    
    
    
    78.9
    
    
    
    (2.1
    )
    
    
    168.7Depreciation and amortization
    
    
    42.7
    
    
    
    27.6
    
    
    
    
    
    
    
    70.3Taxes other than income taxes
    
    
    36.1
    
    
    
    16.4
    
    
    
    
    
    
    
    52.5Total operating expenses
    
    
    709.3
    
    
    
    386.6
    
    
    
    (467.7
    )
    
    
    628.2Operating income
    
    
    65.2
    
    
    
    181.6
    
    
    
    
    
    
    
    246.8Other income and expenses, net
    
    
    3.4
    
    
    
    4.2
    
    
    
    (1.4
    )
    
    
    6.2Interest expense
    
    
    21.9
    
    
    
    37.9
    
    
    
    (1.4
    )
    
    
    58.4Income before income taxes and minority interest
    
    
    46.7
    
    
    
    147.9
    
    
    
    
    
    
    
    194.6Income tax expense
    
    
    12.8
    
    
    
    45.5
    
    
    
    
    
    
    
    58.3Minority interest in net income of subsidiaries
    
    
    0.2
    
    
    
    
    
    
    
    
    
    
    
    0.2Net income
    
    $
    33.7
    
    
    $
    102.4
    
    
    $
    
    
    
    $
    136.1
 Three months ended March 31, 2007Delivery
    
    
    Generationand
    
    
    and(In millions)
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    TotalOperating revenues
    
    $
    757.9
    
    
    $
    524.5
    
    
    $
    (434.8
    )
    
    $
    847.6Fuel
    
    
    
    
    
    
    232.2
    
    
    
    
    
    
    
    232.2Purchased power and transmission
    
    
    500.8
    
    
    
    24.2
    
    
    
    (431.7
    )
    
    
    93.3Deferred energy costs, net
    
    
    (1.5
    )
    
    
    
    
    
    
    
    
    
    
    (1.5
    )Operations and maintenance
    
    
    86.3
    
    
    
    77.3
    
    
    
    (3.1
    )
    
    
    160.5Depreciation and amortization
    
    
    40.2
    
    
    
    31.8
    
    
    
    
    
    
    
    72.0Taxes other than income taxes
    
    
    35.5
    
    
    
    20.4
    
    
    
    
    
    
    
    55.9Total operating expenses
    
    
    661.3
    
    
    
    385.9
    
    
    
    (434.8
    )
    
    
    612.4Operating income
    
    
    96.6
    
    
    
    138.6
    
    
    
    
    
    
    
    235.2Other income and expenses, net
    
    
    3.0
    
    
    
    4.1
    
    
    
    (1.2
    )
    
    
    5.9Interest expense and preferred dividends
    
    
    18.7
    
    
    
    42.1
    
    
    
    (1.2
    )
    
    
    59.6Income before income taxes and minority interest
    
    
    80.9
    
    
    
    100.6
    
    
    
    
    
    
    
    181.5Income tax expense
    
    
    35.5
    
    
    
    35.9
    
    
    
    
    
    
    
    71.4Minority interest in net income of subsidiaries
    
    
    
    
    
    
    0.4
    
    
    
    
    
    
    
    0.4Net income
    
    $
    45.4
    
    
    $
    64.3
    
    
    $
    
    
    
    $
    109.7
 38




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##### Table of Contents



CONSOLIDATED RESULTS
   (In millions)Income before income taxes and minority interest for the three months ended March 31, 2007
    
    
    
    
    
    $
    181.5Increase in operating revenues
    
    
    
    
    
    
    27.4Decreases (increases) in operating expenses:Fuel
    
    
    (17.6
    )Deferred energy costs, net
    
    
    9.0Operations and maintenance
    
    
    (8.2
    )Other operating expenses
    
    
    1.0Operating expenses
    
    
    
    
    
    
    (15.8
    )Increase in other income and expenses, net
    
    
    
    
    
    
    0.3Decrease in interest expense and preferred dividends
    
    
    
    
    
    
    1.2Income before income taxes and minority interest for the three months ended March 31, 2008
    
    
    
    
    
    $
    194.6
 Operating Revenues
  
    
    a $25.4 million increase, primarily resulting from higher market prices including
marketing and hedging activities,
    
    a $16.8 million increase due to higher generation rates charged to Pennsylvania
customers,
    
    a $6.8 million increase due to increased recoverable
expenses and return on investment,
primarily related to TrAIL Company,
    
    a $5.9 million increase due to the collection of an environmental control surcharge from
the West Virginia retail customers of Monongahela and Potomac Edison, which began in April
2007,
    
    a $5.1 million increase due to the expiration of a Maryland customer choice credit and
    
    increased customer load,
    
    partially offset by a $27.8 million decrease due to a 4.2% decrease in total MWhs
generated.
 Operating Expenses
    
    
    increased labor and overhead expense, primarily due to increased employee costs related
to service outages as a result of storm activity and
 39




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##### Table of Contents




    
    increased contractor services expense and materials and supplies expense due to the
timing of special generation maintenance and work related to service outages as a result of
storm activity.
 Interest Expense and Preferred Dividends
  Income Tax Expense
  40




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##### Table of Contents



DISCUSSION OF SEGMENT RESULTS OF OPERATIONS
 Delivery and Services Segment Results
  Three Months Ended March 31,Normal
    
    2008
    
    2007
    
    ChangeRetail electricity sales (million kWhs)
    
    
    N/A
    
    
    
    11,796
    
    
    
    11,712
    
    
    
    0.7
    %HDD
    
    
    2,834
    
    
    
    2,714
    
    
    
    2,744
    
    
    
    (1.1
    )%
 Operating Revenues
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    
    2007Retail electric:Generation
    
    $
    501.0
    
    
    $
    471.6Transmission
    
    
    44.4
    
    
    
    43.8Distribution
    
    
    184.0
    
    
    
    193.2Total retail electric
    
    
    729.4
    
    
    
    708.6Transmission services and bulk power
    
    
    34.8
    
    
    
    38.5Other affiliated and nonaffiliated energy services
    
    
    10.3
    
    
    
    10.8Operating revenues
    
    $
    774.5
    
    
    $
    757.9
  
    
    a $29.4 million increase in generation revenues,
    
    partially offset by an $8.6 million decrease in T&D revenues.
    
    
    an $18.4 million decrease due to the May 2007 expiration of a fixed price power supply
agreement to serve Monongahelas former Ohio service territory,
    
    partially offset by:
 §
    
    an $8.3 million increase related to the Warrior Run PURPA generation facility output
being sold into PJM at market prices effective January 1, 2008 and§
    
    a $6.8 million increase due to increased recoverable expenses and return on
investment, primarily related to TrAIL Company. See Note 3, Transmission Expansion Projects and
Regulatory Matters below for additional information.
 41




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##### Table of Contents



Operating Expenses
 Purchased Power and Transmission:
 Three Months EndedMarch 31,(In millions)
    
    2008
    
    
    2007Other purchased power and transmission
    
    $
    495.7
    
    
    $
    461.6From PURPA generation
    
    
    39.8
    
    
    
    39.2Purchased power and transmission
    
    $
    535.5
    
    
    $
    500.8
   
    
    a $24.6 million increase due to market-based rates in Virginia beginning July 1, 2007
(see Note 5, Rates and Regulation, Regulatory Matters and Risk Factors below for
additional information regarding market-based rates in Virginia) and
    
    a $16.8 million increase due to higher generation rates charged to Pennsylvania
customers, which is passed on to AE Supply under the terms of a power supply agreement
between West Penn and AE Supply,
    
    partially offset by a $9.3 million decrease due to the expiration in May 2007 of a fixed
price supply agreement to serve Monongahelas former Ohio service territory.
 Deferred Energy Costs, Net:
 AES Warrior Run PURPA Generation.
 Market-based Maryland Generation Costs.
 42




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##### Table of Contents



Three Months EndedMarch 31,(In millions)
    
    2008
    
    
    2007AES Warrior Run PURPA generation
    
    $
    5.2
    
    
    $
    0.8Market-based Maryland generation and other costs
    
    
    (2.1
    )
    
    
    (2.3
    )Deferred energy costs, net
    
    $
    3.1
    
    
    $
    (1.5
    )
  Operations and Maintenance:
 Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Operations and maintenance
    
    $
    91.9
    
    
    $
    86.3
  
    
    a $2.9 million increase in contractor services due to work related to service outages as
a result of storm activity and
    
    a $2.5 million increase in uncollectible expense, primarily due to increased accounts
receivable reserves resulting from higher average accounts receivable.
 Depreciation and Amortization:
 Three Months EndedMarch 31,(In millions)
    
    2008
    
    
    2007Depreciation and amortization
    
    $
    42.7
    
    
    $
    40.2
  Interest Expense and Preferred Dividends
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Interest expense and preferred dividends
    
    $
    21.9
    
    

    $
    18.7
  Income Tax Expense
  43




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##### Table of Contents



Transmission Expansion
  Income Summary
 Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Operating revenues
    
    $
    8.3
    
    
    $
    1.8Operating income
    
    $
    5.7
    
    
    $
    0.4Income before income taxes
    
    $
    4.7
    
    
    $
    0.5Net income
    
    $
    2.6
    
    
    $
    0.3
 44




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##### Table of Contents



The Generation and Marketing Segment
   Three months ended March 31, 2008Eliminations(In millions)
    
    Unregulated
    
    
    Regulated
    
    
    and other
    
    
    TotalOperating revenues
    
    $
    442.5
    
    
    $
    137.0
    
    
    $
    (11.3
    )
    
    $
    568.2Fuel
    
    
    180.9
    
    
    
    68.9
    
    
    
    
    
    
    
    249.8Purchased power and transmission
    
    
    9.4
    
    
    
    29.4
    
    
    
    (11.3
    )
    
    
    27.5Deferred energy costs, net
    
    
    
    
    
    
    (13.6
    )
    
    
    
    
    
    
    (13.6
    )Operations and maintenance
    
    
    49.7
    
    
    
    28.9
    
    
    
    0.3
    
    
    
    78.9Depreciation and amortization
    
    
    23.3
    
    
    
    4.8
    
    
    
    (0.5
    )
    
    
    27.6Taxes other than income taxes
    
    
    10.3
    
    
    
    6.1
    
    
    
    
    
    
    
    16.4Total operating expenses
    
    
    273.6
    
    
    
    124.5
    
    
    
    (11.5
    )
    
    
    386.6Operating income
    
    
    168.9
    
    
    
    12.5
    
    
    
    0.2
    
    
    
    181.6Other income and expenses, net
    
    
    3.7
    
    
    
    3.5
    
    
    
    (3.0
    )
    
    
    4.2Interest expense
    
    
    28.2
    
    
    
    10.0
    
    
    
    (0.3
    )
    
    
    37.9Income before income taxes and minority interest
    
    
    144.4
    
    
    
    6.0
    
    
    
    (2.5
    )
    
    
    147.9Income tax expense
    
    
    44.2
    
    
    
    2.1
    
    
    
    (0.8
    )
    
    
    45.5Minority interest in net income of subsidiaries
    
    
    2.4
    
    
    
    
    
    
    
    (2.4
    )
    
    
    Net income
    
    $
    97.8
    
    
    $
    3.9
    
    
    $
    0.7
    
    
    $
    102.4
 Three months ended March 31, 2007Eliminations(In millions)
    
    Unregulated
    
    
    Regulated
    
    
    and other
    
    
    TotalOperating revenues
    
    $
    417.9
    
    
    $
    117.2
    
    
    $
    (10.6
    )
    
    $
    524.5Fuel
    
    
    171.8
    
    
    
    60.4
    
    
    
    
    
    
    
    232.2Purchased power and transmission
    
    
    6.1
    
    
    
    28.6
    
    
    
    (10.5
    )
    
    
    24.2Operations and maintenance
    
    
    47.0
    
    
    
    30.6
    
    
    
    (0.3
    )
    
    
    77.3Depreciation and amortization
    
    
    22.4
    
    
    
    10.0
    
    
    
    (0.6
    )
    
    
    31.8Taxes other than income taxes
    
    
    13.4
    
    
    
    7.0
    
    
    
    
    
    
    
    20.4Total operating expenses
    
    
    260.7
    
    
    
    136.6
    
    
    
    (11.4
    )
    
    
    385.9Operating income (loss)
    
    
    157.2
    
    
    
    (19.4
    )
    
    
    0.8
    
    
    
    138.6Other income and expenses, net
    
    
    3.5
    
    
    
    3.7
    
    
    
    (3.1
    )
    
    
    4.1Interest expense and preferred dividends
    
    
    38.4
    
    
    
    4.0
    
    
    
    (0.3
    )
    
    
    42.1Income (loss) before income taxes and minority interest
    
    
    122.3
    
    
    
    (19.7
    )
    
    
    (2.0
    )
    
    
    100.6Income tax expense (benefit)
    
    
    44.7
    
    
    
    (8.8
    )
    
    
    
    
    
    
    35.9Minority interest in net income of subsidiaries
    
    
    2.5
    
    
    
    
    
    
    
    (2.1
    )
    
    
    0.4Net income (loss)
    
    $
    75.1
    
    
    $
    (10.9
    )
    
    $
    0.1
    
    
    $
    64.3
 45




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##### Table of Contents



Generation and Marketing Segment Results
   Three Months EndedMarch 31,2008
    
    2007
    
    ChangekWhs generated (in millions)
    
    
    12,541
    
    
    
    13,092
    
    
    
    (4.2
    )%
  (In millions)Income before income taxes and minority interest for the three months ended March 31, 2007
    
    
    
    
    
    $
    100.6Increase in operating revenues
    
    
    
    
    
    
    43.7Decreases (increases) in operating expenses:Fuel
    
    
    (17.6
    )Deferred energy costs, net
    
    
    13.6Other operating expenses
    
    
    3.3Operating expenses
    
    
    
    
    
    
    (0.7
    )Increase in other income and expenses, net
    
    
    
    
    
    
    0.1Decrease in interest expense
    
    
    
    
    
    
    4.2Income before income taxes and minority interest for the three months ended March 31, 2008
    
    
    
    
    
    $
    147.9
 Operating Revenues
  
    
    a $33.8 million increase in revenues from affiliates, primarily due to higher prices
under a new power sales agreement between AE Supply and Potomac Edison effective July 1,
2007, as well as higher generation rates charged to Pennsylvania customers, which are passed
on to AE Supply under the terms of a power supply agreement between West Penn and AE Supply
and
    
    a $9.3 million increase in PJM revenue, net, primarily due to an increase in the weighted
average round-the-clock price for power in Alleghenys region of PJM, the APS Zone, from
$53.88 per MWh for 2007 to $67.38 per MWh for 2008, partially offset by a 4.2% decrease in
total MWhs generated.
 46




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##### Table of Contents



Operating Expenses
   Interest Expense
  Income Tax Expense
   47




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##### Table of Contents



Generation and Marketing Segment  Unregulated Results
  Three Months EndedMarch 31,2008
    
    2007
    
    ChangekWhs generated (in millions)
    
    
    9,113
    
    
    
    9,858
    
    
    
    (7.6
    )%
 Operating Revenues
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    
    2007Revenue from affiliates
    
    $
    333.0
    
    
    $
    297.6PJM revenue, net
    
    
    114.3
    
    
    
    117.2Other operating revenues, including risk management and trading activities, net
    
    
    (4.8
    )
    
    
    3.1Unregulated revenue
    
    $
    442.5
    
    
    $
    417.9
 Revenue from affiliates
   
    
    a $21.0 million increase due to a new power sales agreement in Virginia between AE Supply
and Potomac Edison at market-based rates, effective July 1, 2007 and
    
    a $16.8 million increase due to higher generation rates charged to Pennsylvania
customers, which are passed on to AE Supply under the terms of a power supply agreement
between West Penn and AE Supply,
    
    partially offset by a $7.4 million decrease related to lower sales volumes for certain of
Potomac Edisons customers in Maryland.
 PJM revenue, net:
 Three Months EndedMarch 31,(In millions)
    
    2008
    
    
    2007Generation sold into PJM
    
    $
    546.8
    
    
    $
    464.3Power purchased from PJM
    
    
    (432.5
    )
    
    
    (347.1
    )Net unregulated PJM revenue
    
    $
    114.3
    
    
    $
    117.2
  48




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##### Table of Contents



Other Operating Revenues:
  Operating Expenses
 Fuel:
 Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Unregulated fuel
    
    $
    180.9
    
    
    $
    171.8
  Purchased Power and Transmission:
 Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Unregulated purchased power and transmission
    
    $
    9.4
    
    
    $
    6.1
  Operations and Maintenance:
 Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Unregulated operations and maintenance
    
    $
    49.7
    
    
    $
    47.0
  49




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##### Table of Contents



Taxes Other than Income Taxes:
 Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Unregulated taxes other than income taxes
    
    $
    10.3
    
    
    $
    13.4
  Interest Expense
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Unregulated interest expense
    
    $
    28.2
    
    
    $
    38.4
  50




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##### Table of Contents



Generation and Marketing Segment  Regulated Results
  Three Months EndedMarch 31,2008
    
    2007
    
    ChangekWhs generated (in millions)
    
    
    3,428
    
    
    
    3,234
    
    
    
    6.0
    %
 Operating Revenues
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Revenue from affiliates
    
    $
    144.0
    
    
    $
    144.7PJM revenue, net
    
    
    (14.9
    )
    
    
    (27.1
    )Fort Martin scrubber surcharge
    
    
    5.9
    
    
    
    Other operating revenues
    
    
    2.0
    
    
    
    (0.4
    )Regulated revenue
    
    $
    137.0
    
    
    $
    117.2
 Revenue from affiliates
   PJM revenue, net:
 Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Generation sold into PJM
    
    $
    220.1
    
    
    $
    165.2Power purchased from PJM
    
    
    (235.0
    )
    
    
    (192.3
    )PJM revenue, net
    
    $
    (14.9
    )
    
    $
    (27.1
    )
  Fort Martin scrubber surcharge:
  51




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##### Table of Contents



Other Operating Revenues:
  Operating Expenses
 Fuel:
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Regulated fuel
    
    $
    68.9
    
    
    $
    60.4
  Deferred Energy Costs, Net:
 Expanded Net Energy Cost (ENEC).
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Regulated deferred energy costs, net
    
    $
    (13.6
    )
    
    $
    
  52




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##### Table of Contents



Operations and Maintenance:
 Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Regulated operations and maintenance
    
    $
    28.9
    
    
    $
    30.6
  Depreciation and Amortization:
 Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Regulated depreciation and amortization
    
    $
    4.8
    
    
    $
    10.0
  Interest Expense
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    2007Regulated interest expense
    
    $
    10.0
    
    
    $
    4.0
  53




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##### Table of Contents



Liquidity and Capital Requirements
    Total
    
    
    
    
    
    
    LOCs
    
    
    Available(In millions)
    
    Capacity
    
    
    Borrowed
    
    
    Issued
    
    
    CapacityAE Revolving Credit Facility
    
    $
    400.0
    
    
    $
    
    
    
    $
    6.7
    (a)
    
    $
    393.3AE Supply Revolving Facility
    
    
    400.0
    
    
    
    125.0
    
    
    
    
    
    
    
    275.0Total
    
    $
    800.0
    
    
    $
    125.0
    
    
    $
    6.7
    
    
    $
    668.3
 
 (a)
    
    This amount represents a letter of credit issued in connection with a contractual obligation
of Allegheny Ventures that expires in July 2008.   March 31, 2008
    
    
    December 31, 2007(In millions)
    
    Amount
    
    
    %
    
    
    Amount
    
    
    %Long-term debt
    
    $
    4,006.7
    
    
    
    60.5
    
    
    $
    4,039.3
    
    
    
    61.4Stockholders equity
    
    
    2,618.8
    
    
    
    39.5
    
    
    
    2,535.4
    
    
    
    38.6Total
    
    $
    6,625.5
    
    
    
    100.0
    
    
    $
    6,574.7
    
    
    
    100.0
 2008 Debt Activity
  (In millions)
    
    Issuances
    
    
    RepaymentsMonongahela:Environmental Control Bonds
    
    $
    
    
    
    $
    9.4Potomac Edison:Environmental Control Bonds
    
    
    
    
    
    
    2.9West Penn:Transition Bonds
    
    
    1.4
    
    
    
    22.0AE Supply:AE Supply Credit Facility:Term Loan
    
    
    
    
    
    
    125.0Revolving Loan
    
    
    125.0
    
    
    
    Consolidated Total
    
    $
    126.4
    
    
    $
    159.3
 54




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##### Table of Contents



Dividends
  Off-Balance Sheet Arrangements
  Cash Flows
 Operating Activities
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    
    2007Net income
    
    $
    136.1
    
    
    $
    109.7Non-cash items included in income
    
    
    123.9
    
    
    
    150.5Pension and other postretirement employee benefit plan contributions
    
    
    (39.1
    )
    
    
    (39.3
    )Changes in certain assets and liabilities
    
    
    (114.8
    )
    
    
    (67.1
    )Net cash provided by operating activities
    
    $
    106.1
    
    
    $
    153.8
   55




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##### Table of Contents



Investing Activities
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    
    2007Capital expenditures
    
    $
    (239.8
    )
    
    $
    (168.4
    )Proceeds from asset sales
    
    
    0.4
    
    
    
    0.3Purchase of Merrill Lynch interest in subsidiary
    
    
    (50.0
    )
    
    
    Decrease in restricted funds
    
    
    64.8
    
    
    
    1.3Other investments
    
    
    (1.6
    )
    
    
    (1.0
    )Net cash used in investing activities
    
    $
    (226.2
    )
    
    $
    (167.8
    )
   Financing Activities
  Three Months EndedMarch 31,(In millions)
    
    2008
    
    
    2007Issuance of long-term debt
    
    $
    124.3
    
    
    $
    Repayment of long-term debt
    
    
    (159.4
    )
    
    
    (36.1
    )Non-controlling interest contribution to joint venture
    
    
    3.1
    
    
    
    Proceeds from exercise of employee stock options
    
    
    8.3
    
    
    
    4.6Cash dividends paid on common stock
    
    
    (25.2
    )
    
    
    Net cash used in financing activities
    
    $
    (48.9
    )
    
    $
    (31.5
    )
   56




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##### Table of Contents



CREDIT RATINGS
  Moodys
    
    S & P
    
    FitchAE:Outlook
    
    Stable
    
    Stable
    
    StableCorporate Credit Rating
    
    Not Rated
    
    BBB-
    
    BBB-
    (a)Senior Unsecured Debt
    
    Ba1
    
    BB+
    
    BBB-AE Supply:Outlook
    
    Stable
    
    Stable
    
    StableSenior Secured Debt
    
    Baa2
    
    BBB
    
    BBBSenior Unsecured Debt
    
    Ba1
    
    BB+
    
    BBB-Monongahela:Outlook
    
    Stable
    
    Stable
    
    StableFirst Mortgage Bonds
    
    Baa2
    
    BBB+
    
    BBB+Senior Unsecured Debt
    
    Baa3
    
    BB+
    
    BBB-Environmental Control Bonds
    
    Aaa
    
    AAA
    
    AAAPotomac Edison:Outlook
    
    Negative
    
    Stable
    
    NegativeFirst Mortgage Bonds
    
    Baa2
    
    BBB+
    
    BBBEnvironmental Control Bonds
    
    Aaa
    
    AAA
    
    AAAWest Penn:Outlook
    
    Stable
    
    Stable
    
    StableFirst Mortgage Bonds
    
    Baa2
    
    BBB+
    
    BBB+Senior Unsecured Debt
    
    Baa3
    
    BBB-
    
    BBB-Transition Bonds
    
    Aaa
    
    AAA
    
    AAAAGC:Outlook
    
    Stable
    
    Stable
    
    StableSenior Unsecured Debt
    
    Baa3
    
    BBB-
    
    BBB-
 
 (a)
    
    Issuer default rating 57




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##### Table of Contents



OTHER MATTERS
 Critical Accounting Policies
  Recent Accounting Pronouncements
  REGULATORY MATTERS
  Federal Regulation and Rate Matters
 Transmission Rate Design
    58




---



##### Table of Contents



Wholesale Markets
   Transmission Expansion
 TrAIL Project.
 59




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##### Table of Contents



PATH Project.
  
    
    a return on equity of 14.3 percent;
    
    inclusion of 100 percent of construction work in progress in rate base;
    
    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 PATH is
abandoned as a result of factors beyond the control of PATH, LLC or its parent
companies.
  National Interest Electric Transmission Corridor.
  State Rate Regulation
 Pennsylvania
 Default Service Regulations.
 60




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##### Table of Contents



Transmission Expansion.
 Management Efficiency Audit.
 
    
    Develop an improvement plan to meet the Pennsylvania PUCs three-year
distribution reliability standards:
    
    Conduct a study to determine utilization practices for contractors and company
line workers;
    
    Enforce an underground damage prevention program;
    
    Charge affiliate pole attachment fees consistent with the fees charged to
non-affiliates;
    
    Intensify efforts toward attaining representation of women and minorities.
  West Virginia
 Transmission Expansion.
 
    
    Monongahela, Potomac Edison and TrAIL Company will locate 100 to 150
managerial, professional, technical and administrative jobs in north-central West
Virginia no later than the in-service date of the West Virginia segment of TrAIL, which
will involve construction of a new facility in the state with an estimated cost of
approximately $50 million;
    
    Monongahela and Potomac Edison will not seek recovery in West Virginia of
transmission charges associated with TrAIL for the period from January 2007 through the
latest of December 31, 2013, the date which is two and one-half
 61




---



##### Table of Contents



years following the
in-service date of TrAILs West Virginia segment or the month in which Alleghenys new
West Virginia facility is placed in service;
    
    TrAIL Company will contribute $5 million to fund energy conservation programs
and assistance plans for low-income customers in West Virginia over a five year period;
    
    Monongahela and Potomac Edison will provide rate relief in the form of credits
totaling approximately $5.7 million in the aggregate to industrial customers in West
Virginia in 2010 and 2011;
    
    The West Virginia segment of TrAIL should follow the route set forth in TrAIL
Companys application to the West Virginia PSC, except for certain modifications south
of Morgantown, West Virginia, which will more closely follow existing transmission
corridors;
    
    The Consumer Advocate, the Staff of the West Virginia PSC and the WVEUG will
support the need for the portion of TrAIL that is proposed to run from Alleghenys 502
Junction in Greene County, Pennsylvania through West Virginia to Loudoun, Virginia; and
    
    Landowners on the right-of-way will be provided with transmission credits that
can be used for up to 12,000 kWh of power per year.
   Rate Case.
 Maryland
 Standard Offer Service.
 62




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##### Table of Contents



Advanced Metering and Demand Side Management Initiatives.
   Virginia
 Transmission Expansion.
 Purchased Power Cost Recovery.
   63




---



##### Table of Contents




    
    granted a rate adjustment effective immediately that would permit Potomac
Edison to collect an additional $9.5 million (pre-tax) on an annualized basis through
June 30, 2008, a substantially lower amount than the $42.3 million requested;
    
    directed Potomac Edison to implement deferred accounting effective immediately
with respect to the over- or under-recovery of the increased purchase power costs
approved in the order; and
    
    directed Potomac Edison to file an application with the Virginia SCC on or
before July 1, 2008, for proposed recovery of purchased power costs for the 12-month
period beginning July 1, 2008, including for treatment of any over- or under-recovery
incurred for service rendered prior to July 1, 2008 and whether and how its proposed
recovery of purchased power costs for service rendered on and after January 1, 2009
would be consistent with the MOU and certain amendments to the Restructuring Act.
     64




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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     
 ITEM 4. CONTROLS AND PROCEDURES
  Disclosure Controls and Procedures.
 Changes in Internal Control over Financial Reporting:
 65




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##### Table of Contents



PART II. OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
 United Coals
  
 ITEM 1A. RISK FACTORS
  State rate regulation may delay or deny full recovery of costs and impose risks on Alleghenys
operations. Any denial of, or delay in, cost recovery could have an adverse effect on Alleghenys
business.
  Virginia
     66




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##### Table of Contents




    
    granted a rate adjustment effective immediately that would permit Potomac
Edison to collect an additional $9.5 million (pre-tax) on an annualized basis through
June 30, 2008, a substantially lower amount than the $42.3 million requested;
    
    directed Potomac Edison to implement deferred accounting effective immediately
with respect to the over- or under-recovery of the increased purchase power costs
approved in the order; and
    
    directed Potomac Edison to file an application with the Virginia SCC on or
before July 1, 2008, for proposed recovery of purchased power costs for the 12-month
period beginning July 1, 2008, including for treatment of any over- or under-recovery
incurred for service rendered prior to July 1, 2008 and whether and how its proposed
recovery of purchased power costs for service rendered on and after January 1, 2009
would be consistent with the MOU and certain amendments to the Restructuring Act.
     67




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##### Table of Contents



West Virginia
    The supply and price of fuel may impact Alleghenys financial results.
   
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 ITEM 5. OTHER INFORMATION
  68




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##### Table of Contents



ITEM 6. EXHIBITS
 
 EXHIBIT INDEX
 Documents31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under Securities Exchange Act of 193431.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under Securities Exchange Act of 193432.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 135032.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350
 69




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##### Table of Contents



SIGNATURE
  ALLEGHENY ENERGY, INC.Date:  May 7, 2008
    By:
    /s/ Philip L. GouldingPhilip L. GouldingSenior Vice President and
Chief Financial Officer 70