##### 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 September 30, 2007
 Commission File Number 1-267
 ALLEGHENY ENERGY, INC.
 Name of Registrant)
 
 Maryland
(State of Incorporation)
    
    13-5531602
(IRS Employer Identification Number)800 Cabin Hill Drive, Greensburg, Pennsylvania
(Address of Principal Executive Offices)
    
    15601
(Zip Code)
 (724) 837-3000
(Telephone Number)
 þ o
  þ o o
 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)
    
    38Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    73Item 4. Controls and Procedures
    
    73PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    74Item 1A. Risk Factors
    
    74Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    76Item 3. Defaults Upon Senior Securities
    
    76Item 4. Submission of Matters to a Vote of Security Holders
    
    76Item 5. Other Information
    
    76Item 6. Exhibits
    
    77Signatures
    
    78Exhibit 10.1Exhibit 10.2Exhibit 10.3Exhibit 10.4Exhibit 10.5Exhibit 10.6Exhibit 10.7Exhibit 10.8Exhibit 10.9Exhibit 10.10Exhibit 10.11Exhibit 10.12Exhibit 10.13Exhibit 10.14Exhibit 10.15Exhibit 10.16Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  2




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##### Table of Contents



GLOSSARY
 I.
    
    The following abbreviations and terms are used in this report to identify Allegheny Energy,
Inc. and its subsidiaries:
 AE
    
    Allegheny Energy, Inc., a diversified utility holding companyAllegheny Ventures
    
    Allegheny Ventures, Inc., an 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
    
    AE, together with its consolidated subsidiariesDistribution Companies
    
    Monongahela, Potomac Edison and West Penn, which collectively do business as
Allegheny PowerMonongahela
    
    Monongahela Power Company, a regulated subsidiary of AEPATH
    
    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 Company, an indirect subsidiary of AEWest Penn
    
    West Penn Power Company, a regulated subsidiary of AE
 3




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In thousands, except per share data)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Operating revenues
    
    $
    846,592
    
    
    $
    816,645
    
    
    $
    2,520,699
    
    
    $
    2,384,526Operating expenses:Fuel
    
    
    245,503
    
    
    
    231,025
    
    
    
    709,057
    
    
    
    641,479Purchased power and transmission
    
    
    93,923
    
    
    
    101,972
    
    
    
    293,597
    
    
    
    298,301Gain on sale of OVEC power agreement and shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,124
    )Deferred energy costs, net
    
    
    3,651
    
    
    
    (181
    )
    
    
    (6,049
    )
    
    
    5,225Operations and maintenance
    
    
    154,856
    
    
    
    150,594
    
    
    
    505,915
    
    
    
    507,266Depreciation and amortization
    
    
    66,748
    
    
    
    68,308
    
    
    
    209,455
    
    
    
    204,319Taxes other than income taxes
    
    
    53,497
    
    
    
    53,762
    
    
    
    158,254
    
    
    
    159,630Total operating expenses
    
    
    618,178
    
    
    
    605,480
    
    
    
    1,870,229
    
    
    
    1,810,096Operating income
    
    
    228,414
    
    
    
    211,165
    
    
    
    650,470
    
    
    
    574,430Other income and expenses, net
    
    
    14,822
    
    
    
    7,841
    
    
    
    27,590
    
    
    
    25,770Interest expense and preferred dividends:Interest expense
    
    
    59,468
    
    
    
    66,073
    
    
    
    181,623
    
    
    
    209,886Preferred dividends of subsidiary
    
    
    114
    
    
    
    293
    
    
    
    700
    
    
    
    879Total interest expense and preferred dividends
    
    
    59,582
    
    
    
    66,366
    
    
    
    182,323
    
    
    
    210,765Income from continuing operations before income taxes
and minority interest
    
    
    183,654
    
    
    
    152,640
    
    
    
    495,737
    
    
    
    389,435Income tax expense
    
    
    67,223
    
    
    
    40,883
    
    
    
    191,481
    
    
    
    130,128Minority interest in net income of subsidiaries
    
    
    1,413
    
    
    
    1,011
    
    
    
    2,452
    
    
    
    2,380Income from continuing operations
    
    
    115,018
    
    
    
    110,746
    
    
    
    301,804
    
    
    
    256,927Loss from discontinued operations, net of tax (Note 13)
    
    
    
    
    
    
    (539
    )
    
    
    
    
    
    
    (2,203
    )Net income
    
    $
    115,018
    
    
    $
    110,207
    
    
    $
    301,804
    
    
    $
    254,724Common share data:Weighted average common shares outstanding:Basic
    
    
    166,101
    
    
    
    164,813
    
    
    
    165,799
    
    
    
    163,813Diluted
    
    
    169,456
    
    
    
    168,629
    
    
    
    169,371
    
    
    
    168,587Basic income (loss) per common share:Income from continuing operations
    
    $
    0.69
    
    
    $
    0.67
    
    
    $
    1.81
    
    
    $
    1.56Loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.01
    )Basic income per common share
    
    $
    0.69
    
    
    $
    0.67
    
    
    $
    1.81
    
    
    $
    1.55Diluted income (loss) per common share:Income from continuing operations
    
    $
    0.67
    
    
    $
    0.65
    
    
    $
    1.78
    
    
    $
    1.52Loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.01
    )Diluted income per common share
    
    $
    0.67
    
    
    $
    0.65
    
    
    $
    1.78
    
    
    $
    1.51
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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 Nine Months EndedSeptember 30,(In thousands)
    
    2007
    
    
    2006Cash Flows From Operating Activities:Net income
    
    $
    301,804
    
    
    $
    254,724Loss from discontinued operations, net of tax
    
    
    
    
    
    
    2,203Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    209,455
    
    
    
    204,319Amortization of debt issuance costs
    
    
    7,602
    
    
    
    20,504Amortization of power sale liability related to Ohio sale
    
    
    (10,500
    )
    
    
    (22,700
    )Amortization of liability for adverse power purchase commitment
    
    
    (12,965
    )
    
    
    (12,866
    )Amortization of Pennsylvania stranded cost recovery asset
    
    
    14,641
    
    
    
    11,457Gain on disposal or retirement of assets
    
    
    (15,439
    )
    
    
    (1,205
    )Minority interest in net income of subsidiaries
    
    
    2,452
    
    
    
    2,380Deferred income taxes and investment tax credit, net
    
    
    188,791
    
    
    
    109,524Deferred energy costs, net
    
    
    (6,049
    )
    
    
    5,225Stock-based compensation expense
    
    
    8,090
    
    
    
    10,988Unrealized gains on commodity contracts, net
    
    
    (4,348
    )
    
    
    (26,831
    )Pension and other postretirement employee benefit plan expense
    
    
    26,972
    
    
    
    31,419Pension and other postretirement employee benefit plan contributions
    
    
    (46,521
    )
    
    
    (75,255
    )Deferred revenue  Fort Martin Scrubber project
    
    
    11,321
    
    
    
    Other, net
    
    
    11,833
    
    
    
    15,493Changes in certain assets and liabilities:Accounts receivable, net
    
    
    (37,079
    )
    
    
    50,770Materials, supplies and fuel
    
    
    (210
    )
    
    
    2,446Prepaid taxes
    
    
    19,215
    
    
    
    17,513Collateral deposits
    
    
    16,459
    
    
    
    127,350Prepaid assets
    
    
    (7,277
    )
    
    
    (2,439
    )Other current assets
    
    
    11,740
    
    
    
    2,601Accounts payable
    
    
    33,673
    
    
    
    (123,299
    )Accrued taxes
    
    
    (14,746
    )
    
    
    (16,155
    )Accrued interest
    
    
    21,462
    
    
    
    20,707Other current liabilities
    
    
    3,192
    
    
    
    1,435Other assets
    
    
    (3,527
    )
    
    
    3,574Deferred income taxes
    
    
    (12,288
    )
    
    
    5,489Regulatory liabilities
    
    
    2,163
    
    
    
    Other liabilities
    
    
    (3,745
    )
    
    
    (293
    )Net cash used in operating activities of discontinued operations
    
    
    
    
    
    
    (3,406
    )Net cash provided by operating activities
    
    
    716,171
    
    
    
    615,672Cash Flows From Investing Activities:Capital expenditures
    
    
    (590,305
    )
    
    
    (310,590
    )Proceeds from sale of assets
    
    
    1,764
    
    
    
    2,308Purchase of minority interest in Hunlock Creek Energy Ventures
    
    
    
    
    
    
    (13,900
    )Increase in restricted funds
    
    
    (388,541
    )
    
    
    (140,247
    )Other investments
    
    
    (3,951
    )
    
    
    (4,181
    )Net cash provided by investing activities of discontinued operations
    
    
    
    
    
    
    27,795Net cash used in investing activities
    
    
    (981,033
    )
    
    
    (438,815
    )Cash Flows From Financing Activities:Issuance of long-term debt
    
    
    450,577
    
    
    
    1,433,115Repayment of long-term debt
    
    
    (91,974
    )
    
    
    (1,644,261
    )Redemption of preferred stock of subsidiary
    
    
    (25,148
    )
    
    
    Payments on capital lease obligations
    
    
    (3
    )
    
    
    (45
    )Exercise of stock options
    
    
    10,335
    
    
    
    22,110Cash dividends paid to minority shareholder in Hunlock Creek Energy Ventures
    
    
    
    
    
    
    (400
    )Net cash provided by (used in) financing activities
    
    
    343,787
    
    
    
    (189,481
    )Net increase (decrease) in cash and cash equivalents
    
    
    78,925
    
    
    
    (12,624
    )Cash and cash equivalents at beginning of period
    
    
    114,138
    
    
    
    262,212Cash and cash equivalents at end of period
    
    $
    193,063
    
    
    $
    249,588Supplemental Cash Flow Information:Cash paid for interest (net of amount capitalized)
    
    $
    152,361
    
    
    $
    170,879
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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
 September 30,
    
    
    December 31,(In thousands)
    
    2007
    
    
    2006ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    193,063
    
    
    $
    114,138Accounts receivable:Customer
    
    
    206,239
    
    
    
    167,792Unbilled utility revenue
    
    
    80,766
    
    
    
    117,977Wholesale and other
    
    
    86,116
    
    
    
    63,894Allowance for uncollectible accounts
    
    
    (14,012
    )
    
    
    (14,591
    )Materials and supplies
    
    
    101,467
    
    
    
    96,117Fuel
    
    
    69,811
    
    
    
    74,951Deferred income taxes
    
    
    133,718
    
    
    
    127,531Prepaid taxes
    
    
    52,123
    
    
    
    44,603Collateral deposits
    
    
    36,344
    
    
    
    39,399Commodity contracts
    
    
    1,763
    
    
    
    1,430Restricted funds
    
    
    33,193
    
    
    
    12,923Regulatory assets
    
    
    61,301
    
    
    
    39,128Other
    
    
    23,286
    
    
    
    24,130Total current assets
    
    
    1,065,178
    
    
    
    909,422Property, Plant and Equipment, Net:Generation
    
    
    5,863,492
    
    
    
    5,820,278Transmission
    
    
    1,062,585
    
    
    
    1,056,759Distribution
    
    
    3,721,410
    
    
    
    3,597,405Other
    
    
    439,515
    
    
    
    412,894Accumulated depreciation
    
    
    (4,783,481
    )
    
    
    (4,636,972
    )Subtotal
    
    
    6,303,521
    
    
    
    6,250,364Construction work in progress
    
    
    636,393
    
    
    
    262,529Total property, plant and equipment, net
    
    
    6,939,914
    
    
    
    6,512,893Investments and Other Assets:Restricted funds  Fort Martin Scrubber project
    
    
    378,491
    
    
    
    Goodwill
    
    
    367,287
    
    
    
    367,287Investments in unconsolidated affiliates
    
    
    28,221
    
    
    
    28,259Other
    
    
    16,179
    
    
    
    27,932Total investments and other assets
    
    
    790,178
    
    
    
    423,478Deferred Charges:Regulatory assets
    
    
    709,026
    
    
    
    674,095Commodity contracts
    
    
    5,196
    
    
    
    Other
    
    
    34,850
    
    
    
    32,558Total deferred charges
    
    
    749,072
    
    
    
    706,653Total Assets
    
    $
    9,544,342
    
    
    $
    8,552,446
  6




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
(unaudited)
 September 30,
    
    
    December 31,(In thousands, except share amounts)
    
    2007
    
    
    2006LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Long-term debt due within one year (Note 6)
    
    $
    184,555
    
    
    $
    201,189Accounts payable
    
    
    301,609
    
    
    
    236,706Accrued taxes
    
    
    127,101
    
    
    
    136,216Commodity contracts
    
    
    11,354
    
    
    
    5,984Accrued interest
    
    
    121,316
    
    
    
    99,854Other
    
    
    134,667
    
    
    
    140,830Total current liabilities
    
    
    880,602
    
    
    
    820,779Long-term Debt (Note 6)
    
    
    3,773,096
    
    
    
    3,383,986Deferred Credits and Other Liabilities:Commodity contracts
    
    
    12,829
    
    
    
    17,982Income taxes payable
    
    
    61,639
    
    
    
    Investment tax credit
    
    
    70,250
    
    
    
    72,938Deferred income taxes
    
    
    1,131,371
    
    
    
    936,911Obligations under capital leases
    
    
    35,640
    
    
    
    26,007Regulatory liabilities
    
    
    470,257
    
    
    
    464,092Adverse power purchase commitment
    
    
    154,084
    
    
    
    166,937Other
    
    
    521,245
    
    
    
    547,706Total deferred credits and other liabilities
    
    
    2,457,315
    
    
    
    2,232,573Commitments and Contingencies (Note 19)Minority Interest
    
    
    12,573
    
    
    
    10,713Preferred Stock of Subsidiary
    
    
    
    
    
    
    24,000Common Stockholders Equity:Common stock$1.25 par value per share, 260
million shares authorized and 166,202,217 and
165,409,908 shares issued at September 30, 2007
and December 31, 2006, respectively
    
    
    207,753
    
    
    
    206,762Other paid-in capital
    
    
    1,907,525
    
    
    
    1,907,879Retained earnings
    
    
    358,778
    
    
    
    74,698Treasury stock at cost49,493 shares
    
    
    (1,756
    )
    
    
    (1,756
    )Accumulated other comprehensive loss
    
    
    (51,544
    )
    
    
    (107,188
    )Total common stockholders equity
    
    
    2,420,756
    
    
    
    2,080,395Total Liabilities and Stockholders Equity
    
    $
    9,544,342
    
    
    $
    8,552,446
  7




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMMON STOCKHOLDERS EQUITY
AND COMPREHENSIVE INCOME
For the Nine Months Ended September 30, 2007
(unaudited)
 AccumulatedOther
    
    
    
    
    
    
    
    
    
    
    other
    
    
    Total commonShares
    
    
    Common
    
    
    paid-in
    
    
    Retained
    
    
    Treasury
    
    
    comprehensive
    
    
    stockholders
    
    
    Comprehensive(In thousands, except shares)
    
    outstanding
    
    
    stock
    
    
    capital
    
    
    earnings
    
    
    stock
    
    
    loss
    
    
    equity
    
    
    incomeBalance at December 31, 2006
    
    
    165,360,415
    
    
    $
    206,762
    
    
    $
    1,907,879
    
    
    $
    74,698
    
    
    $
    (1,756
    )
    
    $
    (107,188
    )
    
    $
    2,080,395Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    301,804
    
    
    
    
    
    
    
    
    
    
    
    301,804
    
    
    $
    301,804Adoption of FIN 48
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (17,722
    )
    
    
    
    
    
    
    
    
    
    
    (17,722
    )Pension and other
postretirement employee
benefit amortization, net of
tax of $1,736
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,676
    
    
    
    2,676
    
    
    
    2,676Unrealized losses on
available-for-sale
securities, net of tax of $3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    (4
    )
    
    
    (4
    )Unrealized gains on cash
flow hedges for the period,
net of tax of $423
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    666
    
    
    
    666
    
    
    
    666Stock-based compensation
expense:Stock units
    
    
    
    
    
    
    
    
    
    
    1,971
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,971Non-employee stock awards
    
    
    14,462
    
    
    
    18
    
    
    
    804
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    822Stock options
    
    
    
    
    
    
    
    
    
    
    5,296
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,296Exercise of stock options
    
    
    445,315
    
    
    
    557
    
    
    
    9,778
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,335Conversion of stock units
    
    
    332,532
    
    
    
    416
    
    
    
    (8,749
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,333
    )Effects of West Virginia
Rate Order:Establishment of
regulatory asset related
to pension obligation, net
of tax of $35,663
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    52,306
    
    
    
    52,306
    
    
    
    52,306Adjustment related to 2005
SO2 allowance
sale, net of tax of $5,777
    
    
    
    
    
    
    
    
    
    
    (8,306
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,306
    )Premium on redemption of
preferred stock of
Monongahela
    
    
    
    
    
    
    
    
    
    
    (1,148
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,148
    )Other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (2
    )Balance at September 30, 2007
    
    
    166,152,724
    
    
    $
    207,753
    
    
    $
    1,907,525
    
    
    $
    358,778
    
    
    $
    (1,756
    )
    
    $
    (51,544
    )
    
    $
    2,420,756
    
    
    $
    357,448
  8




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 Note No.
    
    
    
    Page No.1
    
    Basis of Presentation
    
    102
    
    Potomac-Appalachian Transmission Highline Project
    
    113
    
    Recent Accounting Pronouncements
    
    114
    
    Asset Swap
    
    125
    
    Income Taxes
    
    136
    
    Debt
    
    157
    
    Preferred Stock Redemption
    
    178
    
    Rates and Regulation
    
    179
    
    Regulatory Assets and Liabilities
    
    2010
    
    Stock-Based Compensation
    
    2111
    
    Pension Benefits and Postretirement Benefits Other Than Pensions
    
    2312
    
    Derivative Instruments and Hedging Activities
    
    2513
    
    Discontinued Operations
    
    2614
    
    Business Segments
    
    2715
    
    Comprehensive Income
    
    2816
    
    Income (Loss) Per Common Share
    
    2917
    
    Guarantees and Letters of Credit
    
    3018
    
    Other Income and Expenses, Net
    
    3019
    
    Commitments and Contingencies
    
    3120
    
    Subsequent Events
    
    37
 9




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 1: BASIS OF PRESENTATION
 Business Description
     Financial Statement Presentation
    10




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
   Deferred Energy Costs, Net.
 Restricted Funds.
 Annual Goodwill Impairment Test.
 
 NOTE 2: POTOMAC-APPALACHIAN TRANSMISSION HIGHLINE PROJECT
     
 NOTE 3: RECENT ACCOUNTING PRONOUNCEMENTS
  11




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
       
 NOTE 4: ASSET SWAP
  12




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
    
 NOTE 5: INCOME TAXES
   Three Months Ended
    
    
    
    
    
    
    
    
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006(In millions, except percent)
    
    Amount
    
    
    
    
    
    
    Amount
    
    
    
    
    
    
    Amount
    
    
    
    
    
    
    AmountIncome from continuing
operations before income taxes
and minority interest
    
    $
    183.7
    
    
    
    
    
    
    $
    152.6
    
    
    
    
    
    
    $
    495.7
    
    
    
    
    
    
    $
    389.4Preferred dividends of subsidiary
    
    
    0.1
    
    
    
    
    
    
    
    0.3
    
    
    
    
    
    
    
    0.7
    
    
    
    
    
    
    
    0.9Subtotal
    
    
    183.8
    
    
    
    
    
    
    
    152.9
    
    
    
    
    
    
    
    496.4
    
    
    
    
    
    
    
    390.3Income tax expense calculated
using the federal statutory rate
of 35%
    
    
    64.3
    
    
    
    35.0
    %
    
    
    53.5
    
    
    
    35.0
    %
    
    
    173.7
    
    
    
    35.0
    %
    
    
    136.6
    
    
    
    35.0
    %Increases (reductions) resulting
from:Rate-making effects of
depreciation differences
    
    
    1.3
    
    
    
    0.7
    %
    
    
    0.5
    
    
    
    0.3
    %
    
    
    4.0
    
    
    
    0.8
    %
    
    
    3.8
    
    
    
    1.0
    %State income tax, net of
federal income tax benefit
    
    
    6.4
    
    
    
    3.5
    %
    
    
    4.8
    
    
    
    3.1
    %
    
    
    15.7
    
    
    
    3.2
    %
    
    
    12.4
    
    
    
    3.2
    %Amortization of deferred
investment tax credit
    
    
    (0.9
    )
    
    
    (0.5
    )%
    
    
    (1.1
    )
    
    
    (0.7
    )%
    
    
    (2.7
    )
    
    
    (0.6
    )%
    
    
    (4.3
    )
    
    
    (1.1
    )%Estimated Pennsylvania net
operating loss benefits
    
    
    (4.2
    )
    
    
    (2.3
    )%
    
    
    (16.7
    )
    
    
    (11.0
    )%
    
    
    (4.2
    )
    
    
    (0.8
    )%
    
    
    (16.7
    )
    
    
    (4.3
    )%Changes in tax reserves
related to uncertain tax
positions
    
    
    (1.2
    )
    
    
    (0.6
    )%
    
    
    
    
    
    
    
    %
    
    
    3.5
    
    
    
    0.7
    %
    
    
    
    
    
    
    
    %Other, net
    
    
    1.5
    
    
    
    0.8
    %
    
    
    (0.1
    )
    
    
    
    %
    
    
    1.5
    
    
    
    0.3
    %
    
    
    (1.7
    )
    
    
    (0.5
    )%Total income tax expense
    
    $
    67.2
    
    
    
    36.6
    %
    
    $
    40.9
    
    
    
    26.7
    %
    
    $
    191.5
    
    
    
    38.6
    %
    
    $
    130.1
    
    
    
    33.3
    %
 13




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
         14




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
   
 NOTE 6: DEBT
    Nine Months EndedSeptember 30, 2007(In millions)
    
    Issuances
    
    
    RepaymentsMonongahela:Environmental Control Bonds
    
    $
    344.5
    
    
    $
    Pollution Control Bonds
    
    
    
    
    
    
    1.0Potomac Edison:Environmental Control Bonds
    
    
    114.8
    
    
    
    West Penn:Transition Bonds (a)
    
    
    4.1
    
    
    
    60.2AE Supply:Pollution Control Bonds
    
    
    7.0
    
    
    
    32.0Eliminations (b)
    
    
    (7.0
    )
    
    
    (1.2
    )Consolidated Total
    
    $
    463.4
    
    
    $
    92.0
 
 (a)
    
    The issuance amounts represent interest that was accrued and added to the principal amount of
certain of the bonds.(b)
    
    Represents the elimination of certain pollution control bonds for which Monongahela and AE
Supply are co-obligors. 15




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 Long-Term Debt
  (In millions)
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    Thereafter
    
    
    TotalAE Supply:MediumTerm Notes
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    400.0
    
    
    $
    650.0
    
    
    $
    1,050.0AE Supply Credit Facility
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    747.0
    
    
    
    
    
    
    
    747.0Pollution Control Bonds
    
    
    79.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    179.0
    
    
    
    258.1DebenturesAGC
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100.0
    
    
    
    100.0Total AE Supply
    
    $
    79.1
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    1,147.0
    
    
    $
    929.0
    
    
    $
    2,155.1Monongahela:First Mortgage Bonds
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    340.0
    
    
    $
    340.0MediumTerm Notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    110.0
    
    
    
    
    
    
    
    
    
    
    
    110.0Environmental Control Bonds (a)
    
    
    
    
    
    
    15.0
    
    
    
    10.5
    
    
    
    11.1
    
    
    
    11.6
    
    
    
    296.3
    
    
    
    344.5Pollution Control Bonds
    
    
    14.5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    70.2
    
    
    
    84.7Total Monongahela
    
    $
    14.5
    
    
    $
    15.0
    
    
    $
    10.5
    
    
    $
    121.1
    
    
    $
    11.6
    
    
    $
    706.5
    
    
    $
    879.2Potomac Edison:First Mortgage Bonds
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    420.0
    
    
    $
    420.0Environmental Control Bonds (a)
    
    
    
    
    
    
    4.9
    
    
    
    3.5
    
    
    
    3.7
    
    
    
    3.8
    
    
    
    98.9
    
    
    
    114.8Total Potomac Edison
    
    $
    
    
    
    $
    4.9
    
    
    $
    3.5
    
    
    $
    3.7
    
    
    $
    3.8
    
    
    $
    518.9
    
    
    $
    534.8West Penn:Transition Bonds (a)
    
    $
    19.8
    
    
    $
    77.2
    
    
    $
    77.2
    
    
    $
    15.5
    
    
    $
    
    
    
    $
    
    
    
    $
    189.7First Mortgage Bonds
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    145.0
    
    
    
    145.0MediumTerm Notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    80.0
    
    
    
    80.0Total West Penn
    
    $
    19.8
    
    
    $
    77.2
    
    
    $
    77.2
    
    
    $
    15.5
    
    
    $
    
    
    
    $
    225.0
    
    
    $
    414.7AGC:Debentures
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    100.0
    
    
    $
    100.0Total AGC
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    100.0
    
    
    $
    100.0Unamortized debt discounts,
premiums and terminated
interest rate swaps
    
    
    (0.4
    )
    
    
    (1.4
    )
    
    
    (1.3
    )
    
    
    (1.3
    )
    
    
    (1.0
    )
    
    
    (2.2
    )
    
    
    (7.6
    )Eliminations (b)
    
    
    (4.1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (114.4
    )
    
    
    (118.5
    )Total consolidated debt
    
    $
    108.9
    
    
    $
    95.7
    
    
    $
    89.9
    
    
    $
    139.0
    
    
    $
    1,161.4
    
    
    $
    2,362.8
    
    
    $
    3,957.7
 
 (a)
    
    Amounts represent planned repayments based upon estimated surcharge collections from
customers.(b)
    
    Represents the elimination of AGCs $100 million 6 7/8% Debentures due 2023, which are also
included above under AE Supply, and $18.5 million in the aggregate of pollution control bonds,
for which Monongahela and AE Supply are co-obligors.  16




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
  
 NOTE 7: PREFERRED STOCK REDEMPTION
  
 NOTE 8: RATES AND REGULATION
 West Virginia
   
    
    The West Virginia Rate Order established the annual ENEC method of recovering net power
supply costs, including fuel costs, purchased power costs and other related expenses, net
of related revenue. Under the ENEC, actual costs and revenues are tracked for under and/or
over recoveries, and new ENEC rate filings will be made on an annual basis. Any under
and/or over recovery of costs, net of related revenues, is deferred as a regulatory asset
or regulatory liability, for subsequent recovery and/or refund, with the corresponding
impact on the Consolidated Statements of Operations reflected within Deferred energy
costs, net.
    
    In December 2005, Monongahela sold sulfur dioxide (SO2) allowances to AE
Supply for $14.8 million in cash and recorded the $14.7 million difference between the
carrying value of the allowances and the cash received as a credit to Other paid-in
capital in the amount of $8.8 million, net of the income tax effects of $5.9 million. The
West Virginia Rate Order requires Monongahela to reduce its rate base by $14.7 million, and
requires the subsequent amortization of this amount, net of amortization for the period
from the December 2005 sale date through the effective date of the West Virginia Rate
Order, as a credit to cost of service over a period of approximately 29 years. As a result,
Monongahela reclassified $14.0 million, $8.3 million net of tax, from other paid-in capital
to a Regulatory liability. In addition, Monongahela recorded a related deferred tax asset
in the amount of $5.8 million during the second quarter of 2007. The regulatory liability
will be amortized to revenue, and the deferred tax asset will be amortized to income tax
expense over a period of approximately 29 years.
    
    The West Virginia Rate Order provides for the recovery of pension expense on an accrual
basis. Monongahela and Potomac Edison previously recovered pension costs on a cash basis in
West Virginia, and,
 17




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 therefore, Allegheny did not record a regulatory asset related to the
portion of pension obligations allocable
to the West Virginia jurisdiction when it adopted SFAS No. 158, Employers Accounting for
Defined Benefit Pension and Other Postretirement Plansan amendment of FASB Statements No.
87, 88, 106 and 132R (SFAS No. 158) on December 31, 2006. As a result of the West Virginia
Rate Order, in the second quarter of 2007, Alleghenys service subsidiary, AESC, established
a regulatory asset related to pension obligations recorded upon adoption of SFAS No. 158, in
the amount of $88.0 million, with a corresponding credit to Other comprehensive income, net
of income tax effect.
     
    
    Environmental control surcharge revenues will be recorded as billed;
    
    Interest expense on the bonds will be recorded as incurred;
    
    Depreciation will be recorded over the estimated useful life of the Scrubbers after
they are placed in service; and
    
    A regulatory liability will be recognized with an offsetting charge against revenues to
the extent that environmental control surcharge revenue exceeds interest and depreciation
expense. This liability will decrease, with an offsetting credit to revenue over the
remaining useful life of the Scrubbers, after the environmental control surcharge ends and
the bonds have been repaid.
 Virginia
   18




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
  Maryland
      
 NOTE 9: REGULATORY ASSETS AND LIABILITIES
  19




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 September 30,
    
    
    December 31,(In millions)
    
    2007
    
    
    2006Regulatory assets, including current portion:Income taxes
    
    $
    298.3
    
    
    $
    300.4Pension benefits and postretirement benefits other than pension
    
    
    253.8
    
    
    
    178.2Pennsylvania stranded cost recovery
    
    
    27.1
    
    
    
    55.6Pennsylvania Competitive Transition Charge (CTC) reconciliation
    
    
    115.1
    
    
    
    107.4Unamortized loss on reacquired debt
    
    
    36.4
    
    
    
    39.6Deferred ENEC charges
    
    
    7.3
    
    
    
    Other
    
    
    32.3
    
    
    
    32.0Subtotal
    
    
    770.3
    
    
    
    713.2Regulatory liabilities, including current portion:Net asset removal costs
    
    
    392.9
    
    
    
    421.4Income taxes
    
    
    37.4
    
    
    
    38.9SO2 allowances
    
    
    13.9
    
    
    
    Fort Martin Scrubber project
    
    
    21.5
    
    
    
    Other
    
    
    5.1
    
    
    
    4.5Subtotal
    
    
    470.8
    
    
    
    464.8Net regulatory assets
    
    $
    299.5
    
    
    $
    248.4
  September 30,
    
    December 31,(In millions)
    
    2007
    
    2006Property, plant and equipment
    
    $
    5,337.2
    
    
    $
    5,188.5Amounts under construction included above
    
    $
    423.6
    
    
    $
    143.8Accumulated depreciation
    
    $
    (2,333.9
    )
    
    $
    (2,382.7
    )
 20




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 10: STOCK-BASED COMPENSATION
   Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In millions)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Stock options
    
    $
    1.9
    
    
    $
    1.8
    
    
    $
    5.3
    
    
    $
    5.8Stock units
    
    
    0.5
    
    
    
    1.0
    
    
    
    2.0
    
    
    
    4.3Other
    
    
    0.1
    
    
    
    0.3
    
    
    
    0.8
    
    
    
    0.9Stock-based compensation expense included in
operations and maintenance expense
    
    
    2.5
    
    
    
    3.1
    
    
    
    8.1
    
    
    
    11.0Income tax benefit
    
    
    1.0
    
    
    
    1.3
    
    
    
    3.3
    
    
    
    4.5Total stock-based compensation expense, net of tax
    
    $
    1.5
    
    
    $
    1.8
    
    
    $
    4.8
    
    
    $
    6.5
  Stock Options
  AggregateWeighted-
    
    
    IntrinsicNumber of
    
    
    Average
    
    
    ValueStock Options
    
    
    Exercise Price
    
    
    (in millions)Outstanding at June 30, 2007
    
    
    4,262,958
    
    
    $
    16.092Granted
    
    
    4,000
    
    
    $
    52.230Exercised
    
    
    (67,262
    )
    
    $
    19.184Forfeited
    
    
    (2,400
    )
    
    $
    13.350Outstanding at September 30, 2007
    
    
    4,197,296
    
    
    $
    16.079
    
    
    $
    151.9Exercisable at September 30, 2007
    
    
    2,671,094
    
    
    $
    15.628
    
    
    $
    97.8
  AggregateWeighted-
    
    
    IntrinsicNumber of
    
    
    Average
    
    
    ValueStock Options
    
    
    Exercise Price
    
    
    (in millions)Outstanding at December 31, 2006
    
    
    4,670,338
    
    
    $
    16.504Granted
    
    
    29,000
    
    
    $
    51.850Exercised
    
    
    (445,315
    )
    
    $
    23.207Forfeited
    
    
    (56,727
    )
    
    $
    13.386Outstanding at September 30, 2007
    
    
    4,197,296
    
    
    $
    16.079
    
    
    $
    151.9Exercisable at September 30, 2007
    
    
    2,671,094
    
    
    $
    15.628
    
    
    $
    97.8
  21




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
   Stock Units
  Number ofStock UnitsOutstanding at December 31, 2006
    
    
    1,045,966Units converted into 68,477 common shares
    
    
    (107,220
    )Outstanding at March 31, 2007
    
    
    938,746Units converted into 247,530 common shares
    
    
    (409,888
    )Outstanding at June 30, 2007
    
    
    528,858Units converted into 16,525 common shares
    
    
    (26,985
    )Outstanding at September 30, 2007
    
    
    501,873
    Non-Employee Director Stock Plan
  Number ofSharesShares earned but not issued at December 31, 2006
    
    
    64,893Granted
    
    
    8,000Issued
    
    
    (12,400
    )Shares earned but not issued at March 31, 2007
    
    
    60,493Granted
    
    
    5,600Issued
    
    
    (1,400
    )Shares earned but not issued at June 30, 2007
    
    
    64,693Granted
    
    
    2,648Issued
    
    
    (662
    )Shares earned but not issued at September 30, 2007
    
    
    66,679
 22




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 11: PENSION BENEFITS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
  23




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
  Pension BenefitsThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In millions)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Components of net periodic cost:Service cost
    
    $
    5.3
    
    
    $
    5.4
    
    
    $
    16.1
    
    
    $
    16.3Interest cost
    
    
    16.2
    
    
    
    15.4
    
    
    
    48.5
    
    
    
    46.1Expected return on plan assets
    
    
    (18.3
    )
    
    
    (17.4
    )
    
    
    (54.8
    )
    
    
    (52.2
    )Amortization of unrecognized transition obligation
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.3
    
    
    
    0.3Amortization of prior service cost
    
    
    0.8
    
    
    
    0.8
    
    
    
    2.4
    
    
    
    2.6Recognized actuarial loss
    
    
    2.7
    
    
    
    3.2
    
    
    
    8.0
    
    
    
    9.4Net periodic cost
    
    $
    6.8
    
    
    $
    7.5
    
    
    $
    20.5
    
    
    $
    22.5Allocation of net periodic cost:Monongahela
    
    $
    2.2
    
    
    $
    1.9
    
    
    $
    6.5
    
    
    $
    5.8AE Supply
    
    
    1.6
    
    
    
    2.3
    
    
    
    4.9
    
    
    
    6.8West Penn
    
    
    1.7
    
    
    
    1.8
    
    
    
    5.1
    
    
    
    5.5Potomac Edison
    
    
    1.2
    
    
    
    1.4
    
    
    
    3.8
    
    
    
    4.1AE
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.2
    
    
    
    0.3Net periodic cost
    
    $
    6.8
    
    
    $
    7.5
    
    
    $
    20.5
    
    
    $
    22.5
 Postretirement Benefits Other Than PensionsThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In millions)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Components of net periodic cost:Service cost
    
    $
    1.1
    
    
    $
    1.2
    
    
    $
    3.4
    
    
    $
    3.8Interest cost
    
    
    4.3
    
    
    
    4.2
    
    
    
    12.7
    
    
    
    12.6Expected return on plan assets
    
    
    (1.7
    )
    
    
    (1.7
    )
    
    
    (5.0
    )
    
    
    (5.2
    )Amortization of unrecognized transition obligation
    
    
    1.4
    
    
    
    1.4
    
    
    
    4.2
    
    
    
    4.3Recognized actuarial loss
    
    
    0.6
    
    
    
    1.0
    
    
    
    1.8
    
    
    
    2.9Net periodic cost
    
    $
    5.7
    
    
    $
    6.1
    
    
    $
    17.1
    
    
    $
    18.4Allocation of net periodic cost:Monongahela
    
    $
    1.7
    
    
    $
    1.7
    
    
    $
    5.2
    
    
    $
    5.1West Penn
    
    
    1.6
    
    
    
    1.6
    
    
    
    4.7
    
    
    
    5.0Potomac Edison
    
    
    1.3
    
    
    
    1.4
    
    
    
    3.8
    
    
    
    4.0AE Supply
    
    
    1.1
    
    
    
    1.4
    
    
    
    3.3
    
    
    
    4.2AE
    
    
    
    
    
    
    
    
    
    
    0.1
    
    
    
    0.1Net periodic cost
    
    $
    5.7
    
    
    $
    6.1
    
    
    $
    17.1
    
    
    $
    18.4
   24




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
    
 NOTE 12: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
    Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In millions)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Amounts included in operating revenues:Net realized gains (losses)
    
    $
    5.4
    
    
    $
    (14.1
    )
    
    $
    4.3
    
    
    $
    (18.7
    )Net unrealized gains
    
    $
    2.8
    
    
    $
    8.5
    
    
    $
    4.4
    
    
    $
    26.8
 25




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 13: DISCONTINUED OPERATIONS
  Three Months
    
    
    Nine MonthsEnded
    
    
    Ended(In millions)
    
    September 30, 2006
    
    
    September 30, 2006Operating revenues
    
    $
    
    
    
    $
    Operating expenses
    
    
    (0.4
    )
    
    
    (1.2
    )Interest expense
    
    
    (0.4
    )
    
    
    (2.2
    )Loss before income taxes
    
    
    (0.8
    )
    
    
    (3.4
    )Income tax benefit
    
    
    0.3
    
    
    
    1.3Impairment charge, net of tax
    
    
    
    
    
    
    (0.1
    )Loss from discontinued operations, net of tax
    
    $
    (0.5
    )
    
    $
    (2.2
    )
  26




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 14: BUSINESS SEGMENTS
  Three Months Ended September 30, 2007
    
    
    Three Months Ended September 30, 2006Delivery
    
    
    Generation
    
    
    
    
    
    
    
    
    
    
    Delivery
    
    
    Generationand
    
    
    and
    
    
    
    
    
    
    
    
    
    
    and
    
    
    and(In millions)
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    Total
    
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    TotalExternal operating
revenues
    
    $
    690.2
    
    
    $
    156.4
    
    
    $
    
    
    
    $
    846.6
    
    
    $
    700.4
    
    
    $
    116.2
    
    
    $
    
    
    
    $
    816.6Internal operating
revenues
    
    
    2.2
    
    
    
    424.7
    
    
    
    (426.9
    )
    
    
    
    
    
    
    1.8
    
    
    
    372.4
    
    
    
    (374.2
    )
    
    
    Total operating
revenues
    
    $
    692.4
    
    
    $
    581.1
    
    
    $
    (426.9
    )
    
    $
    846.6
    
    
    $
    702.2
    
    
    $
    488.6
    
    
    $
    (374.2
    )
    
    $
    816.6Depreciation and
amortization
    
    $
    40.4
    
    
    $
    26.3
    
    
    $
    
    
    
    $
    66.7
    
    
    $
    37.7
    
    
    $
    30.6
    
    
    $
    
    
    
    $
    68.3Operating income
    
    $
    37.1
    
    
    $
    191.4
    
    
    $
    
    
    
    $
    228.5
    
    
    $
    80.7
    
    
    $
    130.4
    
    
    $
    
    
    
    $
    211.1Interest expense
    
    $
    18.1
    
    
    $
    43.1
    
    
    $
    (1.8
    )
    
    $
    59.4
    
    
    $
    20.1
    
    
    $
    46.8
    
    
    $
    (0.8
    )
    
    $
    66.1Income from
continuing
operations
    
    $
    12.8
    
    
    $
    102.2
    
    
    $
    
    
    
    $
    115.0
    
    
    $
    43.8
    
    
    $
    66.9
    
    
    $
    
    
    
    $
    110.7Loss from
discontinued
operations, net of
tax
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (0.5
    )
    
    $
    
    
    
    $
    (0.5
    )Net income
    
    $
    12.8
    
    
    $
    102.2
    
    
    $
    
    
    
    $
    115.0
    
    
    $
    43.8
    
    
    $
    66.4
    
    
    $
    
    
    
    $
    110.2
 Nine Months Ended September 30, 2007
    
    
    Nine Months Ended September 30, 2006Delivery
    
    
    Generation
    
    
    
    
    
    
    
    
    
    
    Delivery
    
    
    Generationand
    
    
    and
    
    
    
    
    
    
    
    
    
    
    and
    
    
    and(In millions)
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    Total
    
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    TotalExternal operating
revenues
    
    $
    2,121.3
    
    
    $
    399.4
    
    
    $
    
    
    
    $
    2,520.7
    
    
    $
    2,031.8
    
    
    $
    352.7
    
    
    $
    
    
    
    $
    2,384.5Internal operating
revenues
    
    
    7.5
    
    
    
    1,231.5
    
    
    
    (1,239.0
    )
    
    
    
    
    
    
    5.5
    
    
    
    1,057.1
    
    
    
    (1,062.6
    )
    
    
    Total operating
revenues
    
    $
    2,128.8
    
    
    $
    1,630.9
    
    
    $
    (1,239.0
    )
    
    $
    2,520.7
    
    
    $
    2,037.3
    
    
    $
    1,409.8
    
    
    $
    (1,062.6
    )
    
    $
    2,384.5Depreciation and
amortization
    
    $
    121.7
    
    
    $
    87.7
    
    
    $
    
    
    
    $
    209.4
    
    
    $
    113.3
    
    
    $
    91.0
    
    
    $
    
    
    
    $
    204.3Operating income
    
    $
    203.6
    
    
    $
    446.9
    
    
    $
    
    
    
    $
    650.5
    
    
    $
    227.1
    
    
    $
    347.3
    
    
    $
    
    
    
    $
    574.4Interest expense
    
    $
    55.0
    
    
    $
    131.2
    
    
    $
    (4.6
    )
    
    $
    181.6
    
    
    $
    61.9
    
    
    $
    150.2
    
    
    $
    (2.2
    )
    
    $
    209.9Income from
continuing
operations
    
    $
    91.7
    
    
    $
    210.1
    
    
    $
    
    
    
    $
    301.8
    
    
    $
    113.5
    
    
    $
    143.4
    
    
    $
    
    
    
    $
    256.9Loss from
discontinued
operations, net of
tax
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (2.2
    )
    
    $
    
    
    
    $
    (2.2
    )Net income
    
    $
    91.7
    
    
    $
    210.1
    
    
    $
    
    
    
    $
    301.8
    
    
    $
    113.5
    
    
    $
    141.2
    
    
    $
    
    
    
    $
    254.7
 27




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 15: COMPREHENSIVE INCOME
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In millions)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Net income
    
    $
    115.0
    
    
    $
    110.2
    
    
    $
    301.8
    
    
    $
    254.7Other comprehensive income:West Virginia Rate
Order  establishment
of regulatory asset
related to pension
obligation, net of tax
    
    
    
    
    
    
    
    
    
    
    52.3
    
    
    
    Unrealized gains
(losses) on cash flow
hedges, net of tax
    
    
    (2.5
    )
    
    
    6.0
    
    
    
    0.7
    
    
    
    29.9Pension and other
postretirement employee
benefit amortization,
net of tax
    
    
    0.9
    
    
    
    
    
    
    
    2.7
    
    
    
    Comprehensive income
    
    $
    113.4
    
    
    $
    116.2
    
    
    $
    357.5
    
    
    $
    284.6
  September 30,
    
    
    December 31,(In millions)
    
    2007
    
    
    2006Cash flow hedges, net of tax
    
    $
    0.9
    
    
    $
    0.2Net unrecognized pension and other postretirement benefit costs, net of tax
    
    
    (52.4
    )
    
    
    (107.4
    )Total
    
    $
    (51.5
    )
    
    $
    (107.2
    )
 28




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 16: INCOME (LOSS) PER COMMON SHARE
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In millions, except share and per share amounts)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Basic Income (Loss) per Common Share:Numerator:Income from continuing operations
    
    $
    115.0
    
    
    $
    110.7
    
    
    $
    301.8
    
    
    $
    256.9Redemption of preferred stock(a)
    
    
    (1.1
    )
    
    
    
    
    
    
    (1.1
    )
    
    
    Income from continuing operations available
for common shareholders
    
    
    113.9
    
    
    
    110.7
    
    
    
    300.7
    
    
    
    256.9Loss from discontinued operations
    
    
    
    
    
    
    (0.5
    )
    
    
    
    
    
    
    (2.2
    )Net income available for common
shareholders
    
    $
    113.9
    
    
    $
    110.2
    
    
    $
    300.7
    
    
    $
    254.7Denominator:Weighted average common shares outstanding
    
    
    166,101,169
    
    
    
    164,813,343
    
    
    
    165,798,727
    
    
    
    163,812,973Basic Income (Loss) per Common Share:Income from continuing operations
    
    $
    0.69
    
    
    $
    0.67
    
    
    $
    1.81
    
    
    $
    1.56Loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.01
    )Basic income per common share
    
    $
    0.69
    
    
    $
    0.67
    
    
    $
    1.81
    
    
    $
    1.55Diluted Income (Loss) per Common Share:Numerator:Income from continuing operations
    
    $
    115.0
    
    
    $
    110.7
    
    
    $
    301.8
    
    
    $
    256.9Redemption of preferred stock (a)
    
    
    (1.1
    )
    
    
    
    
    
    
    (1.1
    )
    
    
    Income from continuing operations available
for common shareholders
    
    
    113.9
    
    
    
    110.7
    
    
    
    300.7
    
    
    
    256.9Loss from discontinued operations
    
    
    
    
    
    
    (0.5
    )
    
    
    
    
    
    
    (2.2
    )Net income available for common
shareholders
    
    $
    113.9
    
    
    $
    110.2
    
    
    $
    300.7
    
    
    $
    254.7Denominator:Weighted average common shares outstanding
    
    
    166,101,169
    
    
    
    164,813,343
    
    
    
    165,798,727
    
    
    
    163,812,973Effect of dilutive securities:Stock options
    
    
    2,770,502
    
    
    
    2,692,136
    
    
    
    2,758,665
    
    
    
    2,619,057Stock units
    
    
    493,652
    
    
    
    1,050,672
    
    
    
    728,057
    
    
    
    2,081,523Non-employee stock awards
    
    
    64,715
    
    
    
    47,676
    
    
    
    59,938
    
    
    
    40,677Performance shares
    
    
    25,497
    
    
    
    25,497
    
    
    
    25,497
    
    
    
    32,391Total shares
    
    
    169,455,535
    
    
    
    168,629,324
    
    
    
    169,370,884
    
    
    
    168,586,621Diluted Income (Loss) per Common Share:Income from continuing operations
    
    $
    0.67
    
    
    $
    0.65
    
    
    $
    1.78
    
    
    $
    1.52Loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.01
    )Diluted income per common share
    
    $
    0.67
    
    
    $
    0.65
    
    
    $
    1.78
    
    
    $
    1.51
 
 (a)
    
    See Note 7, Preferred Stock Redemption, for information related to Monongahelas
redemption of preferred stock. 29




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 17: GUARANTEES AND LETTERS OF CREDIT
  September 30, 2007
    
    
    December 31, 2006Amounts
    
    
    Total
    
    
    Amounts
    
    
    TotalRecorded on
    
    
    Guarantees
    
    
    Recorded on
    
    
    Guaranteesthe Consolidated
    
    
    and Letters
    
    
    the Consolidated
    
    
    and Letters(In millions)
    
    Balance Sheet
    
    
    of Credit
    
    
    Balance Sheet
    
    
    of CreditGuarantees:Loans and other financing-related matters
    
    $
    
    
    
    $
    10.2
    
    
    $
    
    
    
    $
    8.4Lease agreement
    
    
    
    
    
    
    4.9
    
    
    
    
    
    
    
    4.7Purchase, sale, exchange or
transportation of wholesale natural gas,
electric power and related services
    
    
    
    
    
    
    36.5
    
    
    
    
    
    
    
    20.4Other
    
    
    0.2
    
    
    
    0.2
    
    
    
    0.2
    
    
    
    0.2Total Guarantees
    
    $
    0.2
    
    
    $
    51.8
    
    
    $
    0.2
    
    
    $
    33.7Letters of Credit:Under AEs Revolving Facility (a)
    
    $
    
    
    
    $
    6.7
    
    
    $
    
    
    
    $
    131.8Other (b)
    
    
    
    
    
    
    2.5
    
    
    
    
    
    
    
    2.1Total Letters of Credit
    
    
    
    
    
    
    9.2
    
    
    
    
    
    
    
    133.9Total Guarantees and Letters of Credit
    
    $
    0.2
    
    
    $
    61.0
    
    
    $
    0.2
    
    
    $
    167.6
 
 (a)
    
    The September 30, 2007 amount is comprised of a letter of credit for $6.7 million issued in
connection with a contractual obligation of Allegheny Ventures that expires in July 2008. The
December 31, 2006 amount also included a letter of credit for $125.0 million on behalf of
Allegheny as collateral to stay enforcement of the judgment in Alleghenys litigation against
Merrill Lynch. The $125.0 million letter of credit was released during the quarter ended
September 30, 2007 as the result of an August 31, 2007 federal appellate court ruling. See
Note 19, Commitments and Contingencies for additional information.(b)
    
    These amounts are not issued under either AEs credit facility or AE Supplys credit
facility. 
 NOTE 18: OTHER INCOME AND EXPENSES, NET
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In millions)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Interest and dividend income
    
    $
    3.5
    
    
    $
    4.2
    
    
    $
    10.9
    
    
    $
    15.0Gain on the sale or exchange of real estate
    
    
    8.9
    
    
    
    0.2
    
    
    
    8.9
    
    
    
    1.0Tax reimbursement on contributions in aid
of construction
    
    
    1.7
    
    
    
    1.8
    
    
    
    4.5
    
    
    
    4.9Premium services
    
    
    (0.4
    )
    
    
    0.7
    
    
    
    0.7
    
    
    
    2.7Coal brokering income
    
    
    
    
    
    
    0.4
    
    
    
    
    
    
    
    1.3Other
    
    
    1.1
    
    
    
    0.6
    
    
    
    2.6
    
    
    
    0.9Total
    
    $
    14.8
    
    
    $
    7.9
    
    
    $
    27.6
    
    
    $
    25.8
 30




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 19: COMMITMENTS AND CONTINGENCIES
 Environmental Matters and Litigation
  Global Climate Change . 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 carbon dioxide 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.
  Clean Air Act Compliance. 2
  31




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 2 2 2
  2
  2 2 2
 32




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 Clean Air Act Litigation
       33




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
  Canadian Toxic-Tort Class Action:
 Global Warming Class Action:
 Claims Related to Alleged Asbestos Exposure: ., .
   34




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 Other Litigation
 Nevada Power Contracts.
  Sierra/Nevada.
  Claim by California Parties.
 35




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 Litigation Involving Merrill Lynch.
      Ordinary Course of Business.
 36




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 20: SUBSEQUENT EVENTS
   37




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
 ITEM 2.
  Forward-Looking Statements
  
    
    rate regulation and the status of retail generation service supply competition in
states served by the Distribution Companies;
    
    financing plans;
    
    demand for energy and the cost and availability of raw materials, including coal;
    
    provider-of-last resort (PLR) and power supply contracts;
    
    results of litigation;
    
    results of operations;
    
    internal controls and procedures;
    
    capital expenditures;
    
    status and condition of plants and equipment;
    
    capacity purchase commitments and
    
    regulatory matters.
   
    
    plant performance and unplanned outages;
    
    volatility and changes in the price of power, coal, natural gas and other
energy-related commodities;
    
    general economic and business conditions;
    
    changes in access to capital markets and actions of rating agencies;
    
    complications or other factors that make it difficult or impossible to obtain necessary
lender consents or regulatory authorizations on a timely basis;
    
    environmental regulations;
 38




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
    
    the results of regulatory proceedings, including proceedings related to rates;
    
    changes in industry capacity, development and other activities by competitors of AE and
its consolidated subsidiaries;
    
    changes in the weather and other natural phenomena;
    
    changes in the underlying inputs and assumptions, including market conditions, used to
estimate the fair values of commodity contracts;
    
    changes in customer switching behavior and their resulting effects on existing and
future PLR load requirements;
    
    changes in laws and regulations applicable to Allegheny, its markets or its activities;
    
    the loss of any significant customers or suppliers;
    
    dependence on other electric transmission systems and their constraints on
availability;
    
    inflationary and interest rate trends;
    
    changes in the market rules, including changes to participant rules and tariffs in the
energy market operated by PJM Interconnection, LLC (PJM), which is a regional
transmission organization;
    
    the effect of accounting pronouncements issued periodically by accounting
standard-setting bodies and accounting issues facing our organization; and
    
    other risks, including the effects of global instability, terrorism and war.
  39




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 Overview
  Key Indicators and Performance Factors
 The Delivery and Services Segment
  Revenue per MWh sold
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2006
    
    2007
    
    2006Revenue per MWh sold
    
    $
    59.56
    
    
    $
    59.01
    
    
    $
    59.80
    
    
    $
    58.78
 Operations and maintenance costs (O&M).
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2006
    
    2007
    
    2006O&M per MWh sold
    
    $
    7.68
    
    
    $
    7.65
    
    
    $
    7.65
    
    
    $
    8.19
 Capital expenditures.
 40




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,Normal
    
    2007
    
    2006
    
    Change
    
    Normal
    
    2007
    
    2006
    
    ChangeRetail electricity
sales (million
kWhs)
    
    
    N/A
    
    
    
    11,164
    
    
    
    11,026
    
    
    
    1.3
    %
    
    
    N/A
    
    
    
    33,540
    
    
    
    32,257
    
    
    
    4.0
    %HDD
    
    
    97
    
    
    
    62
    
    
    
    113
    
    
    
    (45.1
    )%
    
    
    3,594
    
    
    
    3,437
    
    
    
    3,069
    
    
    
    12.0
    %CDD
    
    
    561
    
    
    
    666
    
    
    
    606
    
    
    
    9.9
    %
    
    
    767
    
    
    
    944
    
    
    
    778
    
    
    
    21.3
    %
 
 (a)
    
    Heating degree-days (HDD) and cooling degree-days (CDD).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 and CDD 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, and CDD is the measure of the variation in the weather
based on the extent to which the average daily temperature rises above 65° Fahrenheit. Each
degree of temperature above 65° Fahrenheit is counted as one cooling degree-day, and each
degree of temperature below 65° Fahrenheit is counted as one heating degree-day. The Generation and Marketing Segment
  kWhs generated.
 Equivalent Availability Factor (EAF).
 Station operations and maintenance costs (Station O&M).
 41




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
  Three Months Ended
    
    
    
    
    
    
    Nine Months EndedSeptember 30,
    
    
    
    
    
    
    September 30,2007
    
    
    2006
    
    
    Change
    
    
    2007
    
    
    2006
    
    
    ChangeSupercritical Units:kWhs generated (in millions)
    
    
    10,226
    
    
    
    10,535
    
    
    
    (2.9
    )%
    
    
    30,285
    
    
    
    30,269
    
    
    
    0.1
    %EAF
    
    
    87.5
    %
    
    
    89.6
    %
    
    
    (2.1
    )%
    
    
    85.5
    %
    
    
    86.2
    %
    
    
    (0.7
    )%Station O&M (in millions):Base operations (a)
    
    $
    23.5
    
    
    $
    24.0
    
    
    
    (2.1
    )%
    
    $
    78.1
    
    
    $
    74.3
    
    
    
    5.1
    %Special
    
    
    14.9
    
    
    
    14.2
    
    
    
    4.9
    %
    
    
    57.0
    
    
    
    54.9
    
    
    
    3.8
    %Total Station O&M
    
    $
    38.4
    
    
    $
    38.2
    
    
    
    0.5
    %
    
    $
    135.1
    
    
    $
    129.2
    
    
    
    4.6
    %All Generation Units:kWhs generated (in millions)
    
    
    12,640
    
    
    
    12,798
    
    
    
    (1.2
    )%
    
    
    37,491
    
    
    
    37,050
    
    
    
    1.2
    %EAF
    
    
    86.5
    %
    
    
    91.9
    %
    
    
    (5.4
    )%
    
    
    85.9
    %
    
    
    88.8
    %
    
    
    (2.9
    )%Station O&M (in millions):Base operations (a)
    
    $
    36.7
    
    
    $
    38.0
    
    
    
    (3.4
    )%
    
    $
    120.1
    
    
    $
    116.6
    
    
    
    3.0
    %Special
    
    
    16.5
    
    
    
    15.6
    
    
    
    5.8
    %
    
    
    65.8
    
    
    
    63.9
    
    
    
    3.0
    %Total Station O&M
    
    $
    53.2
    
    
    $
    53.6
    
    
    
    (0.7
    )%
    
    $
    185.9
    
    
    $
    180.5
    
    
    
    3.0
    %
 
 (a)
    
    Reflects the reclassification of certain fuel handling and residual disposal costs as
described in Note 1, Basis of Presentation, to Alleghenys Consolidated Financial
Statements. 42




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 CONSOLIDATED RESULTS OF OPERATIONS
 Income Summary
 Three Months Ended
    
    
    Three Months EndedSeptember 30, 2007
    
    
    September 30, 2006Delivery
    
    
    Generation
    
    
    
    
    
    
    
    
    
    
    Delivery
    
    
    Generationand
    
    
    and
    
    
    
    
    
    
    
    
    
    
    and
    
    
    and(In millions)
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    Total
    
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    TotalOperating revenues
    
    $
    692.4
    
    
    $
    581.1
    
    
    $
    (426.9
    )
    
    $
    846.6
    
    
    $
    702.2
    
    
    $
    488.6
    
    
    $
    (374.2
    )
    
    $
    816.6Fuel
    
    
    
    
    
    
    245.5
    
    
    
    
    
    
    
    245.5
    
    
    
    
    
    
    
    231.0
    
    
    
    
    
    
    
    231.0Purchased power and transmission
    
    
    493.0
    
    
    
    25.6
    
    
    
    (424.7
    )
    
    
    93.9
    
    
    
    466.2
    
    
    
    8.2
    
    
    
    (372.4
    )
    
    
    102.0Deferred energy costs, net
    
    
    2.3
    
    
    
    1.3
    
    
    
    
    
    
    
    3.6
    
    
    
    (0.2
    )
    
    
    
    
    
    
    
    
    
    
    (0.2
    )Operations and maintenance
    
    
    85.7
    
    
    
    71.3
    
    
    
    (2.2
    )
    
    
    154.8
    
    
    
    84.3
    
    
    
    68.2
    
    
    
    (1.8
    )
    
    
    150.7Depreciation and amortization
    
    
    40.4
    
    
    
    26.3
    
    
    
    
    
    
    
    66.7
    
    
    
    37.7
    
    
    
    30.6
    
    
    
    
    
    
    
    68.3Taxes other than income taxes
    
    
    33.9
    
    
    
    19.7
    
    
    
    
    
    
    
    53.6
    
    
    
    33.5
    
    
    
    20.2
    
    
    
    
    
    
    
    53.7Total operating expenses
    
    
    655.3
    
    
    
    389.7
    
    
    
    (426.9
    )
    
    
    618.1
    
    
    
    621.5
    
    
    
    358.2
    
    
    
    (374.2
    )
    
    
    605.5Operating income
    
    
    37.1
    
    
    
    191.4
    
    
    
    
    
    
    
    228.5
    
    
    
    80.7
    
    
    
    130.4
    
    
    
    
    
    
    
    211.1Other income and expenses, net
    
    
    3.0
    
    
    
    13.6
    
    
    
    (1.8
    )
    
    
    14.8
    
    
    
    5.3
    
    
    
    3.4
    
    
    
    (0.8
    )
    
    
    7.9Interest expense and preferred dividends
    
    
    18.2
    
    
    
    43.3
    
    
    
    (1.8
    )
    
    
    59.7
    
    
    
    20.2
    
    
    
    47.0
    
    
    
    (0.8
    )
    
    
    66.4Income from continuing operations
before income taxes and minority
interest
    
    
    21.9
    
    
    
    161.7
    
    
    
    
    
    
    
    183.6
    
    
    
    65.8
    
    
    
    86.8
    
    
    
    
    
    
    
    152.6Income tax expense from continuing
operations
    
    
    9.1
    
    
    
    58.1
    
    
    
    
    
    
    
    67.2
    
    
    
    22.0
    
    
    
    18.9
    
    
    
    
    
    
    
    40.9Minority interest
    
    
    
    
    
    
    1.4
    
    
    
    
    
    
    
    1.4
    
    
    
    
    
    
    
    1.0
    
    
    
    
    
    
    
    1.0Income from continuing operations
    
    
    12.8
    
    
    
    102.2
    
    
    
    
    
    
    
    115.0
    
    
    
    43.8
    
    
    
    66.9
    
    
    
    
    
    
    
    110.7Loss from discontinued operations, net
of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.5
    )
    
    
    
    
    
    
    (0.5
    )Net income
    
    $
    12.8
    
    
    $
    102.2
    
    
    $
    
    
    
    $
    115.0
    
    
    $
    43.8
    
    
    $
    66.4
    
    
    $
    
    
    
    $
    110.2
 Nine Months Ended
    
    
    Nine Months EndedSeptember 30, 2007
    
    
    September 30, 2006Delivery
    
    
    Generation
    
    
    
    
    
    
    
    
    
    
    Delivery
    
    
    Generationand
    
    
    and
    
    
    
    
    
    
    
    
    
    
    and
    
    
    and(In millions)
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    Total
    
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    TotalOperating revenues
    
    $
    2,128.8
    
    
    $
    1,630.9
    
    
    $
    (1,239.0
    )
    
    $
    2,520.7
    
    
    $
    2,037.3
    
    
    $
    1,409.8
    
    
    $
    (1,062.6
    )
    
    $
    2,384.5Fuel
    
    
    
    
    
    
    709.1
    
    
    
    
    
    
    
    709.1
    
    
    
    
    
    
    
    641.5
    
    
    
    
    
    
    
    641.5Purchased power and transmission
    
    
    1,447.9
    
    
    
    77.2
    
    
    
    (1,231.5
    )
    
    
    293.6
    
    
    
    1,328.8
    
    
    
    26.6
    
    
    
    (1,057.1
    )
    
    
    298.3Gain on sale of OVEC power agreement
and shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6.1
    )
    
    
    
    
    
    
    (6.1
    )Deferred energy costs, net
    
    
    (0.5
    )
    
    
    (5.6
    )
    
    
    
    
    
    
    (6.1
    )
    
    
    5.2
    
    
    
    
    
    
    
    
    
    
    
    5.2Operations and maintenance
    
    
    256.6
    
    
    
    256.8
    
    
    
    (7.5
    )
    
    
    505.9
    
    
    
    264.2
    
    
    
    248.6
    
    
    
    (5.5
    )
    
    
    507.3Depreciation and amortization
    
    
    121.7
    
    
    
    87.7
    
    
    
    
    
    
    
    209.4
    
    
    
    113.3
    
    
    
    91.0
    
    
    
    
    
    
    
    204.3Taxes other than income taxes
    
    
    99.5
    
    
    
    58.8
    
    
    
    
    
    
    
    158.3
    
    
    
    98.7
    
    
    
    60.9
    
    
    
    
    
    
    
    159.6Total operating expenses
    
    
    1,925.2
    
    
    
    1,184.0
    
    
    
    (1,239.0
    )
    
    
    1,870.2
    
    
    
    1,810.2
    
    
    
    1,062.5
    
    
    
    (1,062.6
    )
    
    
    1,810.1Operating income
    
    
    203.6
    
    
    
    446.9
    
    
    
    
    
    
    
    650.5
    
    
    
    227.1
    
    
    
    347.3
    
    
    
    
    
    
    
    574.4Other income and expenses, net
    
    
    10.4
    
    
    
    21.8
    
    
    
    (4.6
    )
    
    
    27.6
    
    
    
    16.5
    
    
    
    11.5
    
    
    
    (2.2
    )
    
    
    25.8Interest expense and preferred dividends
    
    
    55.4
    
    
    
    131.6
    
    
    
    (4.6
    )
    
    
    182.4
    
    
    
    62.4
    
    
    
    150.6
    
    
    
    (2.2
    )
    
    
    210.8Income from continuing operations
before income taxes and minority
interest
    
    
    158.6
    
    
    
    337.1
    
    
    
    
    
    
    
    495.7
    
    
    
    181.2
    
    
    
    208.2
    
    
    
    
    
    
    
    389.4Income tax expense from continuing
operations
    
    
    66.9
    
    
    
    124.6
    
    
    
    
    
    
    
    191.5
    
    
    
    67.7
    
    
    
    62.4
    
    
    
    
    
    
    
    130.1Minority interest
    
    
    
    
    
    
    2.4
    
    
    
    
    
    
    
    2.4
    
    
    
    
    
    
    
    2.4
    
    
    
    
    
    
    
    2.4Income from continuing operations
    
    
    91.7
    
    
    
    210.1
    
    
    
    
    
    
    
    301.8
    
    
    
    113.5
    
    
    
    143.4
    
    
    
    
    
    
    
    256.9Loss from discontinued operations, net
of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2.2
    )
    
    
    
    
    
    
    (2.2
    )Net income
    
    $
    91.7
    
    
    $
    210.1
    
    
    $
    
    
    
    $
    301.8
    
    
    $
    113.5
    
    
    $
    141.2
    
    
    $
    
    
    
    $
    254.7
 43




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 CONSOLIDATED RESULTS
  Operating Revenues
  
    
    higher generation rates charged to Pennsylvania customers,
    
    an increase in the weighted average round-the-clock price for power in Alleghenys
region of PJM Interconnection, LLC (PJM), the APS Zone, from $53.43 per MWh for the three
months ended September 30, 2006 to $55.76 per MWh for the three months ended September 30,
2007 and increased net PJM capacity market revenues,
    
    increased revenues related to the collection of an environmental control surcharge
from the West Virginia retail customers of Monongahela and Potomac Edison, which began in
April 2007,
    
    increased transmission and distribution revenues due to increased CDD, increased
customer load and the expiration of a Maryland customer choice credit,
    
    partially offset by a 1.2% decrease in total MWhs generated and the settlement of
certain existing cash flow hedges in 2006.
  
    
    higher generation rates charged to Pennsylvania customers,
    
    an increase in the weighted average round-the-clock price for power in Alleghenys
region of PJM, the APS Zone, from $49.72 per MWh for the nine months ended September 30,
2006 to $54.81 per MWh for the nine months ended September 30, 2007 and increased net PJM
capacity market revenues,
    
    increased revenues related to the collection of the environmental control surcharge
from the West Virginia retail customers of Monongahela and Potomac Edison, which began in
April 2007,
    
    increased transmission and distribution revenues due to increases in HDD and CDD,
increased customer load and the expiration of a Maryland customer choice credit and
    
    a 1.2% increase in total MWhs generated.
 Operating Income
  
    
    the $30.0 million increase in operating revenues discussed above and
    
    an $8.1 million decrease in purchased power and transmission expense, primarily due to
the May 2007 expiration of a power sale agreement related to the sale of the Ohio service
territory that was partially offset by increased costs to purchase power at market-based
rates to serve Virginia customers,
 44




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
    
    partially offset by a $14.5 million increase in fuel expense and a $4.1 million
increase in operations and maintenance expense due to a $4.6 million contingent fee
relating to a consulting project.
   
    
    the $136.2 million increase in operating revenues discussed above and
    
    an $11.3 million change in deferred energy costs, net, representing a net credit to
expense for energy costs incurred but not yet recovered in rates, related primarily to the
May 22, 2007 Public Service Commission of West Virginia (the West Virginia PSC) rate
order (the West Virginia Rate Order), which, effective May 23, 2007, allows certain costs
to be deferred and recovered in future customer rates, and a greater net credit to expense
for deferred energy costs related to the AES Warrior Run Maryland generation facility,
    
    partially offset by a $67.6 million increase in fuel expense.
   Income from Continuing Operations Before Income Taxes and Minority Interest
  
    
    the $17.4 million increase in operating income discussed above,
    
    a $6.9 million increase in other income and expenses, net, primarily due to an $8.4
million gain relating to an exchange transaction involving La Paz, Arizona real estate and
    
    a $6.7 million decrease in interest expense and preferred dividends of Monongahela,
primarily due to lower average debt outstanding, increased capitalization of interest and
the discontinuance of interest expense related to the Merrill Lynch litigation as a result
of a favorable appellate court ruling, partially offset by increased interest expense
associated with the April 2007 issuance of environmental control bonds.
  
    
    the $76.1 million increase in operating income discussed above and
 45




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
    
    a $28.4 million decrease in interest expense and preferred dividends of Monongahela,
primarily due to lower average debt outstanding, increased capitalization of interest and
the discontinuance of interest expense related to the Merrill Lynch litigation as a result
of a favorable appellate court ruling partially offset by increased interest expense
associated with the April 2007 issuance of environmental control bonds.
  Income Tax Expense
  46




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 DISCUSSION OF SEGMENT RESULTS OF OPERATIONS:
 Delivery and Services
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,Normal
    
    2007
    
    2006
    
    Change
    
    Normal
    
    2007
    
    2006
    
    ChangeRetail electricity
sales (million
kWhs)
    
    
    N/A
    
    
    
    11,164
    
    
    
    11,026
    
    
    
    1.3
    %
    
    
    N/A
    
    
    
    33,540
    
    
    
    32,257
    
    
    
    4.0
    %HDD
    
    
    97
    
    
    
    62
    
    
    
    113
    
    
    
    (45.1
    )%
    
    
    3,594
    
    
    
    3,437
    
    
    
    3,069
    
    
    
    12.0
    %CDD
    
    
    561
    
    
    
    666
    
    
    
    606
    
    
    
    9.9
    %
    
    
    767
    
    
    
    944
    
    
    
    778
    
    
    
    21.3
    %
 Operating Revenues
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In millions)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Retail electric:Generation
    
    $
    454.5
    
    
    $
    435.5
    
    
    $
    1,354.9
    
    
    $
    1,266.8Transmission
    
    
    41.0
    
    
    
    40.7
    
    
    
    123.9
    
    
    
    119.9Distribution
    
    
    169.4
    
    
    
    174.4
    
    
    
    527.0
    
    
    
    509.3Total retail electric
    
    
    664.9
    
    
    
    650.6
    
    
    
    2,005.8
    
    
    
    1,896.0Transmission services and bulk power
    
    
    17.5
    
    
    
    41.8
    
    
    
    91.8
    
    
    
    115.7Other affiliated and nonaffiliated energy services
    
    
    10.0
    
    
    
    9.8
    
    
    
    31.2
    
    
    
    25.6Total operating revenues
    
    $
    692.4
    
    
    $
    702.2
    
    
    $
    2,128.8
    
    
    $
    2,037.3
  
    
    a $19.0 million increase in generation revenues, primarily due to a $13.4 million
increase resulting from higher generation rates charged to Pennsylvania customers and a
$9.6 million increase related to the West Virginia Rate Order, which approved an increase
in generation rates charged to customers,
    
    partially offset by a $4.7 million decrease in transmission and distribution (T&D)
revenues, primarily due to a $12.4 million decrease related to rates resulting from the
West Virginia Rate Order, which was partially offset by a $4.2 million increase due to the
expiration of a Maryland customer choice credit and a $3.9 million increase due to
increased customer load.
  
    
    an $88.1 million increase in generation revenues, primarily due to a $39.0 million
increase resulting from higher generation rates charged to Pennsylvania customers, a $13.7
million increase from the West Virginia Rate Order, which approved an increase in
generation rates charged to customers, and a $26.5 million increase due to increased
customer load from increases in HDD and CDD and
    
    a $21.7 million increase in T&D revenues, primarily due to a $32.6 million increase
from increased customer load and a $4.5 million increase due to the expiration of a
Maryland customer choice credit, partially offset by a $19.1 million decrease as a result
of the West Virginia Rate Order.
 47




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
   Operating Expenses
 Purchased Power and Transmission:
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In millions)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Other purchased power and transmission
    
    $
    457.4
    
    
    $
    412.5
    
    
    $
    1,330.0
    
    
    $
    1,175.9From PURPA generation
    
    
    35.6
    
    
    
    53.7
    
    
    
    117.9
    
    
    
    152.9Total purchased power and transmission
    
    $
    493.0
    
    
    $
    466.2
    
    
    $
    1,447.9
    
    
    $
    1,328.8
    
    
    a $35.2 million increase due to market-based rates in Virginia beginning July 1, 2007
(See Note 8, Rates and Regulation, for additional information regarding market-based
rates in Virginia),
    
    a $13.4 million increase, primarily due to a net increase in the price of purchased
power from AE Supply for Pennsylvania customers and
 48




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
    
    an $8.1 million increase due to the West Virginia Rate Order, which approved an
increase in generation rates charged to customers (such increases result in greater costs
to the Delivery and Services segment and greater revenues to the Generation and Marketing
segment),
    
    partially offset by a $14.7 million decrease due to the expiration of a contract to
supply power for Monongahelas former Ohio electric service territory through May 2007.
  
    
    a $61.8 million increase, primarily due to increased purchased power volume as a result
of increases in HDD and CDD and increased customer load,
    
    a $39.0 million increase, primarily due to a net increase in the price of purchased
power from AE Supply for Pennsylvania customers, which is passed on to AE Supply under the
terms of a power supply agreement between West Penn and AE Supply,
    
    a $35.2 million increase due to market-based rates in Virginia beginning July 1, 2007
(See Note 8, Rates and Regulation, for additional information regarding market-based
rates in Virginia),
    
    a $16.6 million increase due to the January 1, 2007 power supply agreement between
Potomac Edison and Monongahela discussed above (Monongahelas revenues relating to this
agreement are included in the Generation and Marketing segment) and
    
    an $11.6 million increase due to the West Virginia Rate Order, which approved an
increase in generation rates charged to customers (such increases result in greater costs
to the Delivery and Services segment and greater revenues to the Generation and Marketing
segment),
    
    partially offset by a $9.9 million decrease due to the expiration of a contract to
supply power for Monongahelas former Ohio electric service territory through May 2007.
   Deferred Energy Costs, Net:
 49




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 AES Warrior Run PURPA Generation
  Market-based Maryland Generation Costs
   Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(In millions)
    
    2007
    
    2006
    
    2007
    
    2006Deferred energy costs, net
    
    $
    2.3
    
    
    $
    (0.2
    )
    
    $
    (0.5
    )
    
    $
    5.2
   Operations and Maintenance:
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(In millions)
    
    2007
    
    2006
    
    2007
    
    2006Operations and maintenance
    
    $
    85.7
    
    
    $
    84.3
    
    
    $
    256.6
    
    
    $
    264.2
  
    
    a $5.7 million increase in outside services expense, primarily due to a $4.6 million
contingent fee relating to a consulting project and increased legal fees and
    
    a $1.0 million increase in labor and overhead expense due to a decrease in capitalized
labor,
    
    partially offset by a $2.8 million decrease due to reduced claim reserves and a $2.3
million decrease in contractor services.
 50




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
  
    
    a $9.0 million decrease in contractor services and
    
    a $2.7 million decrease due to reduced claim reserves,
    
    partially offset by a $5.1 million increase in outside services expense, primarily due
to a $4.6 million contingent fee relating to a consulting project and increased legal fees.
 Depreciation and Amortization:
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(In millions)
    
    2007
    
    2006
    
    2007
    
    2006Depreciation and amortization
    
    $
    40.4
    
    
    $
    37.7
    
    
    $
    121.7
    
    
    $
    113.3
  Other Income and Expenses, Net
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(In millions)
    
    2007
    
    2006
    
    2007
    
    2006Other income and expenses, net
    
    $
    3.0
    
    
    $
    5.3
    
    
    $
    10.4
    
    
    $
    16.5
  Interest Expense and Preferred Dividends:
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(In millions)
    
    2007
    
    2006
    
    2007
    
    2006Interest expense and preferred dividends
    
    $
    18.2
    
    
    $
    20.2
    
    
    $
    55.4
    
    
    $
    62.4
   51




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 Income Tax Expense
     52




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 Generation and Marketing
  Three Months Ended
    
    
    
    
    
    Nine Months EndedSeptember 30,
    
    
    
    
    
    September 30,2007
    
    2006
    
    Change
    
    2007
    
    2006
    
    ChangeGeneration (million kWhs)
    
    
    12,640
    
    
    
    12,798
    
    
    
    (1.2
    )%
    
    
    37,491
    
    
    
    37,050
    
    
    
    1.2
    %
 Operating Revenues
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In millions)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Revenue from affiliates
    
    $
    424.7
    
    
    $
    372.4
    
    
    $
    1,231.5
    
    
    $
    1,057.0Wholesale and other revenue, net (a)
    
    
    156.4
    
    
    
    116.2
    
    
    
    399.4
    
    
    
    352.8Total revenues
    
    $
    581.1
    
    
    $
    488.6
    
    
    $
    1,630.9
    
    
    $
    1,409.8
 
 (a)
    
    Amounts are net of energy trading gains and losses as described in Note 12, Derivative
Instruments and Hedging Activities. Energy trading gains (losses) are presented in the
wholesale and other revenues table below. Revenue from affiliates:
    53




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
  
    
    a $30.6 million increase as a result of higher prices during the third quarter 2007 due
to a new power sales agreement with Potomac Edison effective July 1, 2007 that were
partially offset by decreased sales volumes for certain of Potomac Edisons customers in
Virginia,
    
    a $23.9 million increase in Monongahelas West Virginia affiliated revenues due to an
increase in sales volume and price, including a $14.8 million increase reflecting the
transfer of Monongahelas PURPA contracts to the Generation and Marketing segment from the
Delivery and Services segment, causing a corresponding increase in both revenues and
purchased power, and a $5.3 million increase due to the West Virginia Rate Order, which
increased generation rates charged to customers (such increases result in greater costs to
the Delivery and Services segment and greater revenues to the Generation and Marketing
segment),
    
    a $13.4 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,
    
    a $5.4 million increase in Potomac Edisons affiliated revenues due to the assignment,
in connection with the Asset Swap, of AE Supplys below-market power supply agreement to
serve Potomac Edisons West Virginia load obligations, as a result of which, Potomac Edison
now purchases the power necessary to service its West Virginia customers from Monongahela
at rates that are greater than the rates under the AE Supply agreement at a prorated share
of overall Monongahela generation costs,
    
    increased sales volumes as a result of increased CDD and increased customer load,
    
    partially offset by a $9.4 million decrease related to decreased sales volumes that was
partially offset by higher contractual rates for certain of Potomac Edisons customers in
Maryland and
    
    a $6.0 million decrease in ancillary service revenues from the Delivery and Services
segment due to a contract expiration.
  
    
    a $67.5 million increase in Monongahelas West Virginia affiliated revenues due to an
increase in sales volume and price, including a $48.8 million increase reflecting the
transfer of Monongahelas PURPA contracts to the Generation and Marketing segment from the
Delivery and Services segment, causing a corresponding increase in both revenues and
purchased power, and a $7.5 million increase due to the West Virginia Rate Order, which
increased generation rates charged to customers (such increases result in greater costs to
the Delivery and Services segment and greater revenues to the Generation and Marketing
segment),
    
    a $39.0 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,
    
    a $30.6 million increase as a result of higher prices during the third quarter 2007 due
to a new power sales agreement with Potomac Edison effective July 1, 2007 that were
partially offset by decreased sales volumes for certain of Potomac Edisons customers in
Virginia,
    
    a $28.4 million increase in Potomac Edisons affiliated revenues due to the assignment,
in connection with the Asset Swap, of AE Supplys below-market power supply agreement to
serve Potomac Edisons West Virginia load obligations, as a result of which, Potomac Edison
now purchases from Monongahela the power necessary to service its West Virginia customers
at rates that are greater than the rates under the AE Supply agreement at a prorated share
of overall Monongahela generation costs,
 54




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
    
    a $12.5 million increase related to higher contractual rates with increased sales
volumes for certain of Potomac Edisons customers in Maryland and
    
    increased sales volumes as a result of increases in HDD and CDD and increased customer
load,
    
    partially offset by a $13.5 million decrease in ancillary service revenues from the
Delivery and Services segment due to a contract expiration.
 Wholesale and other revenues, net:
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In millions)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006PJM Revenue:Generation sold into PJM
    
    $
    623.4
    
    
    $
    550.5
    
    
    $
    1,862.0
    
    
    $
    1,601.2Power purchased from PJM
    
    
    (487.5
    )
    
    
    (429.2
    )
    
    
    (1,495.9
    )
    
    
    (1,261.2
    )Net
    
    
    135.9
    
    
    
    121.3
    
    
    
    366.1
    
    
    
    340.0Cash flow hedges and trading activities:Realized gains (losses)
    
    
    5.4
    
    
    
    (14.1
    )
    
    
    4.3
    
    
    
    (18.7
    )Unrealized gains
    
    
    2.8
    
    
    
    8.5
    
    
    
    4.4
    
    
    
    26.8Net
    
    
    8.2
    
    
    
    (5.6
    )
    
    
    8.7
    
    
    
    8.1Fort Martin Scrubber surcharge
    
    
    6.1
    
    
    
    
    
    
    
    11.6
    
    
    
    Other revenues
    
    
    6.2
    
    
    
    0.5
    
    
    
    13.0
    
    
    
    4.7Total wholesale and other revenues
    
    $
    156.4
    
    
    $
    116.2
    
    
    $
    399.4
    
    
    $
    352.8
  
    
    an increase in net PJM revenues of $14.6 million,
    
    a $13.8 million increase related to cash flow hedges and trading activities due to
decreasing PJM market prices subsequent to the transaction of certain cash flow hedges and
the settlement of certain existing cash flow hedges in 2006,
    
    a $6.1 million increase relating to an environmental control surcharge that Monongahela
and Potomac Edison impose on their West Virginia retail customers following the April 2007
Fort Martin Scrubber securitization financing (See Note 6, Debt for additional
information regarding the securitization transaction) and
    
    a $5.7 million increase in other revenues as a result of increased sales related to
load-following contracts.
  55




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
  
    
    an increase in net PJM revenues of $26.1 million,
    
    an $11.6 million increase relating to an environmental control surcharge that
Monongahela and Potomac Edison impose on their West Virginia retail customers following the
April 2007 Fort Martin Scrubber securitization financing and
    
    an $8.3 million increase in other revenues as a result of increased sales related to
load-following contracts.
   Fair Value of Contracts :
  56




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
  Fair value of contracts at September 30, 2007Settlement by:Classification of contracts by source of fair value (In millions)
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    TotalPrices actively quoted
    
    $
    3.6
    
    
    $
    (8.0
    )
    
    $
    (5.7
    )
    
    $
    (5.4
    )
    
    $
    (1.7
    )
    
    $
    (17.2
    )Prices provided by other external sources
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Prices based on models
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    3.6
    
    
    $
    (8.0
    )
    
    $
    (5.7
    )
    
    $
    (5.4
    )
    
    $
    (1.7
    )
    
    $
    (17.2
    )
   Changes in Fair Value :
 Three Months Ended
    
    
    Nine Months Ended(In millions)
    
    September 30, 2007
    
    
    September 30, 2007Net fair value of derivative contract liabilities at July 1 and
January 1, respectively
    
    $
    (15.8
    )
    
    $
    (22.5
    )Changes in fair value of cash flow hedges
    
    
    (4.2
    )
    
    
    0.9Unrealized gains on contracts, net
    
    
    2.8
    
    
    
    4.4Net fair value of derivative contract liabilities at September 30
    
    $
    (17.2
    )
    
    $
    (17.2
    )
  Operating Expenses
 Fuel:
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(In millions)
    
    2007
    
    2006
    
    2007
    
    2006Fuel
    
    $
    245.5
    
    
    $
    231.0
    
    
    $
    709.1
    
    
    $
    641.5
  57




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
   Purchased Power and Transmission:
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(In millions)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Other purchased power and transmission
    
    $
    10.8
    
    
    $
    8.2
    
    
    $
    28.4
    
    
    $
    26.6From PURPA generation
    
    
    14.8
    
    
    
    
    
    
    
    48.8
    
    
    
    Total purchased power and transmission
    
    $
    25.6
    
    
    $
    8.2
    
    
    $
    77.2
    
    
    $
    26.6
   Gain on Sale of OVEC Power Agreement and Shares:
 Deferred Energy Costs, Net:
 Expanded Net Energy Cost (ENEC)
  58




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 Grant Town PURPA generation facility
   Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(In millions)
    
    2007
    
    2006
    
    2007
    
    2006Deferred energy costs, net
    
    $
    1.3
    
    
    $
    
    
    
    $
    (5.6
    )
    
    $
    
  Operations and Maintenance:
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(In millions)
    
    2007
    
    2006
    
    2007
    
    2006Operations and maintenance
    
    $
    71.3
    
    
    $
    68.2
    
    
    $
    256.8
    
    
    $
    248.6
  
    
    an $8.1 million reduction in estimated site remediation costs associated with a
previously terminated generation project, which did not recur during 2007 and
    
    a $0.9 million increase in special maintenance expense due to the timing of maintenance
outages,
    
    partially offset by a $6.5 million reduction in estimated site remediation costs
associated with an ash disposal site.
  
    
    a $6.4 million reversal of a guarantee liability during the first quarter of 2006
associated with the Hunlock Creek Energy Ventures partnership, which did not recur during
2007 and
    
    an $8.1 million reduction in estimated site remediation costs associated with a
previously terminated generation project during the third quarter of 2006, which did not
recur during 2007,
 59




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
    
    partially offset by a $6.5 million reduction in estimated site remediation costs
associated with an ash disposal site.
 Depreciation and Amortization:
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(In millions)
    
    2007
    
    2006
    
    2007
    
    2006Depreciation and amortization
    
    $
    26.3
    
    
    $
    30.6
    
    
    $
    87.7
    
    
    $
    91.0
  Taxes Other than Income Taxes:
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(In millions)
    
    2007
    
    2006
    
    2007
    
    2006Taxes other than income taxes
    
    $
    19.7
    
    
    $
    20.2
    
    
    $
    58.8
    
    
    $
    60.9
  Other Income and Expenses, Net
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(In millions)
    
    2007
    
    2006
    
    2007
    
    2006Other income and expenses, net
    
    $
    13.6
    
    
    $
    3.4
    
    
    $
    21.8
    
    
    $
    11.5
  Interest Expense and Preferred Dividends
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(In millions)
    
    2007
    
    2006
    
    2007
    
    2006Interest expense and preferred dividends
    
    $
    43.3
    
    
    $
    47.0
    
    
    $
    131.6
    
    
    $
    150.6
  60




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
  Income Tax Expense
     Minority Interest
  Discontinued Operations
  61




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 FINANCIAL CONDITION, REQUIREMENTS AND RESOURCES
 Liquidity and Capital Requirements
     Total
    
    
    
    
    
    
    LOCs
    
    
    Available(In millions)
    
    Capacity
    
    
    Borrowed
    
    
    Issued
    
    
    CapacityAE Revolving Credit Facility
    
    $
    400.0
    
    
    $
    
    
    
    $
    6.7
    (a)
    
    $
    393.3AE Supply Revolving Facility
    
    
    400.0
    
    
    
    
    
    
    
    
    
    
    
    400.0Total
    
    $
    800.0
    
    
    $
    
    
    
    $
    6.7
    
    
    $
    793.3
 
 (a)
    
    This amount represents a letter of credit issued in connection with a contractual obligation
of Allegheny Ventures that expires in July 2008. AE Supply also has a $2.5 million letter of
credit outstanding that expires in February 2008 that was not issued under either AEs
revolving credit facility or AE Supplys revolving credit facility. 62




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
  September 30, 2007
    
    
    December 31, 2006(In millions)
    
    Amount
    
    
    
    
    
    
    AmountDebt
    
    $
    3,957.7
    
    
    
    62.0
    %
    
    $
    3,585.2
    
    
    
    63.0
    %Common equity
    
    
    2,420.8
    
    
    
    38.0
    %
    
    
    2,080.4
    
    
    
    36.6
    %Preferred equity (a)
    
    
    
    
    
    
    
    %
    
    
    24.0
    
    
    
    0.4
    %Total
    
    $
    6,378.5
    
    
    
    100.0
    %
    
    $
    5,689.6
    
    
    
    100.0
    %
 
 (a)
    
    On September 4, 2007, Monongahela redeemed all of the shares of its Cumulative Preferred
Stock. See Note 7, Preferred Stock Redemption for additional information. Long-Term Debt and Contractual Obligations
     Off-Balance Sheet Arrangements
  Other Matters Concerning Liquidity and Capital Requirements
   63




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
     Cash Flows
 Operating Activities
  Nine Months EndedSeptember 30,(In millions)
    
    2007
    
    
    2006Net income
    
    $
    301.8
    
    
    $
    254.7Loss from discontinued operations, net of tax
    
    
    
    
    
    
    2.2Non-cash items included in earnings
    
    
    431.9
    
    
    
    347.7Pension and other postretirement employee benefit contributions
    
    
    (46.5
    )
    
    
    (75.2
    )Changes in certain assets and liabilities
    
    
    29.0
    
    
    
    89.7Net cash used in operating activities of discontinued operations
    
    
    
    
    
    
    (3.4
    )Net cash provided by operating activities
    
    $
    716.2
    
    
    $
    615.7
   64




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
  Investing Activities
  Nine Months EndedSeptember 30,(In millions)
    
    2007
    
    
    2006Capital expenditures
    
    $
    (590.3
    )
    
    $
    (310.6
    )Proceeds from sale of assets
    
    
    1.8
    
    
    
    2.3Purchase of minority interest in Hunlock Creek Energy Ventures
    
    
    
    
    
    
    (13.9
    )Increase in restricted funds
    
    
    (388.5
    )
    
    
    (140.2
    )Other investments
    
    
    (4.0
    )
    
    
    (4.2
    )Net cash provided by investing activities of discontinued operations
    
    
    
    
    
    
    27.8Net cash used in investing activities
    
    $
    (981.0
    )
    
    $
    (438.8
    )
   Financing Activities
  Nine Months EndedSeptember 30,(In millions)
    
    2007
    
    
    2006Issuance of long-term debt
    
    $
    450.6
    
    
    $
    1,433.1Repayment of long-term debt
    
    
    (92.0
    )
    
    
    (1,644.3
    )Redemption of preferred stock of subsidiary
    
    
    (25.1
    )
    
    
    Proceeds from the exercise of stock options
    
    
    10.3
    
    
    
    22.1Cash dividends paid to minority shareholder in Hunlock Creek Energy Ventures
    
    
    
    
    
    
    (0.4
    )Net cash provided by (used in) financing activities
    
    $
    343.8
    
    
    $
    (189.5
    )
   65




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
  66




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Credit Ratings
  Moodys
    
    
    S & P
    
    
    FitchAE:Outlook
    
    Stable
    
    Stable
    
    PositiveCorporate Credit Rating
    
    Not Rated
    
    BBB-
    
    Not RatedSenior Unsecured Debt
    
    Ba1
    
    BB+
    
    BB+Short-term Rating
    
    Not Rated
    
    
    A-3
    
    
    Not RatedAE Supply:Outlook
    
    Stable
    
    Stable
    
    PositiveSenior Secured Debt
    
    Baa2
    
    BBB
    
    BBB-Senior Unsecured Debt
    
    Ba1
    
    BB+
    
    BB+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
    
    StableTransition Bonds
    
    Aaa
    
    AAA
    
    AAAFirst Mortgage Bonds
    
    Baa2
    
    BBB+
    
    BBB+Senior Unsecured Debt
    
    Baa3
    
    BBB-
    
    BBB-AGC:Outlook
    
    Stable
    
    Stable
    
    PositiveSenior Unsecured Debt
    
    Baa3
    
    BBB-
    
    BB+
 67




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##### Table of Contents



OTHER MATTERS
 Critical Accounting Policies
  Recent Accounting Pronouncements
  REGULATORY MATTERS
 Federal Legislation, Regulation and Rate Matters
 Transmission Rate Design.
   68




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##### Table of Contents



Wholesale Markets.
  69




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##### Table of Contents



Transmission Expansion.
    State Legislation, Regulation and Rate Matters
 Pennsylvania
 Transmission Expansion.
 Default Service Regulations.
  70




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##### Table of Contents



West Virginia
 Transmission Expansion.
 Rate Case.
 Maryland
 Rate Stabilization and Standard Offer Service.
    71




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##### Table of Contents



Advanced Metering and Demand Side Management Initiatives
 Virginia
 Transmission Expansion.
 Purchased Power Filing.
    72




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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
 73




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##### Table of Contents



PART II. OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 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
     74




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West Virginia
    The TrAIL Project and the PATH Project are subject to permitting and state regulatory approvals.
  Allegheny is currently involved in capital intensive projects that may involve various
implementation and financial risks.
   75




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##### Table of Contents



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
  76




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ITEM 6. EXHIBITS
 EXHIBIT INDEX
 Documents10.1*
    
    Limited Liability Company Agreement of Potomac-Appalachian Transmission Highline, LLC, dated as of
September 1, 200710.2
    
    Amended and Restated Non-Employee Director Stock Plan10.3
    
    Amended and Restated Restricted Stock Plan for Outside Directors10.4
    
    Amended and Restated Revised Plan for Deferral of Compensation of Directors10.5
    
    Amended and Restated 1998 Long-term Incentive Plan10.6
    
    Amended and Restated Stock Unit Plan10.7
    
    Amended and Restated Annual Incentive Plan10.8
    
    Amended and Restated Supplemental Executive Retirement Plan10.9
    
    Amended and Restated Nonqualified Deferred Compensation Plan10.10
    
    Amendment to Employment Agreement of Senior Vice President and Chief Financial Officer10.11
    
    Amendment to Employment Agreement of Vice President10.12
    
    Amendment to Change in Control Agreement of Vice President and General Counsel10.13
    
    Amendment to Change in Control Agreement of Vice President10.14
    
    Amendment to Change in Control Agreement of Vice President and Controller10.15
    
    Amendment to Severance Agreement of Vice President and General Counsel10.16
    
    Amendment to Severance Agreement of Vice President31.1
    
    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
 
 *
    
    Confidential treatment has been requested from the Commission for portions of this
document. 77




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SIGNATURE
  ALLEGHENY ENERGY, INC.Date: November 6, 2007
    
    By:
    
    /s/ Philip L. GouldingPhilip L. GouldingSenior Vice President andChief Financial Officer
 78