##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 
 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarter ended June 30, 2008
 Commission File Number 1-267
 
 ALLEGHENY ENERGY, INC.
 Name of Registrant)
 
 Maryland
    
    13-5531602(State of Incorporation)
    
    (IRS Employer Identification Number)800 Cabin Hill Drive, Greensburg,Pennsylvania
    
    15601(Address of Principal Executive
    
    (Zip Code)Offices)
 (724) 837-3000
(Telephone Number)
 þ o
  Large accelerated filer þ
    
    Accelerated filer o
    
    Non-accelerated filer o
    
    Smaller reporting company o(Do not check if a smaller reporting company)
 o þ




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TABLE OF CONTENTS
 Page No.PART I. FINANCIAL INFORMATIONItem 1. Financial Statements (unaudited)Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations (MD&A)
    
    
    42Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    83Item 4. Controls and Procedures
    
    
    83PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    85Item 1A. Risk Factors
    
    
    85Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    88Item 3. Defaults Upon Senior Securities
    
    
    88Item 4. Submission of Matters to a Vote of Security Holders
    
    
    88Item 5. Other Information
    
    
    89Item 6. Exhibits
    
    
    90Signatures
    
    
    91EX-31.1EX-31.2EX-32.1EX-32.2
  2




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##### Table of Contents



GLOSSARY
 The following abbreviations and terms are used in this report to identify Allegheny Energy, Inc.
and its subsidiaries:
 AE
    
    Allegheny Energy, Inc., a diversified utility holding companyAE Supply
    
    Allegheny Energy Supply Company, LLC, an unregulated generation subsidiary of AEAGC
    
    Allegheny Generating Company, a regulated generation subsidiary of AE Supply
and MonongahelaAllegheny
    
    Allegheny Energy, Inc., together with its consolidated subsidiariesAllegheny Ventures
    
    Allegheny Ventures, Inc., a nonutility, unregulated subsidiary of AEDistribution Companies
    
    Monongahela, Potomac Edison and West Penn, which collectively do business as
Allegheny PowerMonongahela
    
    Monongahela Power Company, a regulated subsidiary of AEPATH, LLC
    
    Potomac-Appalachian Transmission Highline, LLC, a joint venture between
Allegheny and a subsidiary of American Electric Power Company, Inc.Potomac Edison
    
    The Potomac Edison Company, a regulated subsidiary of AETrAIL Company
    
    Trans-Allegheny Interstate Line CompanyWest Penn
    
    West Penn Power Company, a regulated subsidiary of AE
 3




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
 Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In thousands, except per share amounts)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Operating revenues
    
    $
    953,500
    
    
    $
    826,482
    
    
    $
    1,828,526
    
    
    $
    1,674,107Operating expenses:Fuel
    
    
    245,252
    
    
    
    231,330
    
    
    
    495,078
    
    
    
    463,555Purchased power and transmission
    
    
    97,207
    
    
    
    106,407
    
    
    
    194,587
    
    
    
    199,673Deferred energy costs, net
    
    
    1,103
    
    
    
    (8,245
    )
    
    
    (9,351
    )
    
    
    (9,700
    )Operations and maintenance
    
    
    189,931
    
    
    
    190,514
    
    
    
    358,631
    
    
    
    351,058Depreciation and amortization
    
    
    68,794
    
    
    
    70,726
    
    
    
    139,083
    
    
    
    142,707Taxes other than income taxes
    
    
    52,879
    
    
    
    48,868
    
    
    
    105,318
    
    
    
    104,758Total operating expenses
    
    
    655,166
    
    
    
    639,600
    
    
    
    1,283,346
    
    
    
    1,252,051Operating income
    
    
    298,334
    
    
    
    186,882
    
    
    
    545,180
    
    
    
    422,056Other income (expense), net
    
    
    4,661
    
    
    
    6,905
    
    
    
    10,870
    
    
    
    12,767Interest expense and preferred dividends of
subsidiary
    
    
    58,704
    
    
    
    63,212
    
    
    
    117,135
    
    
    
    122,741Income before income taxes and minority interest
    
    
    244,291
    
    
    
    130,575
    
    
    
    438,915
    
    
    
    312,082Income tax expense
    
    
    89,820
    
    
    
    52,878
    
    
    
    148,113
    
    
    
    124,256Minority interest in net income of subsidiaries
    
    
    345
    
    
    
    653
    
    
    
    551
    
    
    
    1,040Net income
    
    $
    154,126
    
    
    $
    77,044
    
    
    $
    290,251
    
    
    $
    186,786Common share data:Weighted average common shares outstanding:Basic
    
    
    168,236
    
    
    
    165,794
    
    
    
    167,898
    
    
    
    165,645Diluted
    
    
    170,106
    
    
    
    169,469
    
    
    
    170,028
    
    
    
    169,326Basic income per common share
    
    $
    0.92
    
    
    $
    0.46
    
    
    $
    1.73
    
    
    $
    1.13Diluted income per common share
    
    $
    0.91
    
    
    $
    0.45
    
    
    $
    1.71
    
    
    $
    1.10Dividends per common share
    
    $
    0.15
    
    
    $
    
    
    
    $
    0.30
    
    
    $
    
  4




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 Six Months EndedJune 30,(In thousands)
    
    2008
    
    
    2007Cash Flows From Operating Activities:Net income
    
    $
    290,251
    
    
    $
    186,786Adjustments for non-cash items included in income:Depreciation and amortization
    
    
    139,083
    
    
    
    142,707Amortization of debt related costs
    
    
    5,439
    
    
    
    5,051Amortization of power sale liability related to Ohio sale
    
    
    
    
    
    
    (10,500
    )Amortization of liability for adverse power purchase commitment
    
    
    (8,568
    )
    
    
    (8,644
    )Amortization of Pennsylvania stranded cost recovery asset
    
    
    8,068
    
    
    
    8,833Provision for uncollectible accounts
    
    
    10,475
    
    
    
    7,915Minority interest in net income of subsidiaries
    
    
    551
    
    
    
    1,040Deferred income taxes and investment tax credit, net
    
    
    121,763
    
    
    
    123,319Deferred energy costs, net
    
    
    (9,351
    )
    
    
    (9,700
    )Stock-based compensation expense
    
    
    6,353
    
    
    
    5,559Unrealized gains on derivatives, net
    
    
    (154,603
    )
    
    
    (1,607
    )Pension and other postretirement employee benefit plan expense
    
    
    15,825
    
    
    
    18,115Pension and other postretirement employee benefit plan contributions
    
    
    (42,039
    )
    
    
    (42,174
    )Deferred revenue  Fort Martin scrubber project
    
    
    7,653
    
    
    
    8,005Other, net
    
    
    14,213
    
    
    
    (1,441
    )Changes in certain assets and liabilities:Accounts receivable, net
    
    
    (76,046
    )
    
    
    (54,017
    )Materials, supplies and fuel
    
    
    (44,918
    )
    
    
    (7,983
    )Taxes receivable / accrued
    
    
    (11,455
    )
    
    
    (12,324
    )Prepaid taxes
    
    
    (6,339
    )
    
    
    (7,361
    )Collateral deposits
    
    
    29,082
    
    
    
    (203
    )Prepaid assets
    
    
    (3,382
    )
    
    
    (3,207
    )Other current assets
    
    
    1,944
    
    
    
    8,137Accounts payable
    
    
    99
    
    
    
    40,430Accrued interest
    
    
    (8,352
    )
    
    
    8,142Other current liabilities
    
    
    3,847
    
    
    
    (2,521
    )Regulatory asset  PATH
    
    
    (702
    )
    
    
    Other assets
    
    
    1,503
    
    
    
    3,412Deferred income taxes
    
    
    (1,452
    )
    
    
    (12,190
    )Regulatory liabilities
    
    
    27,890
    
    
    
    Other liabilities
    
    
    (2,695
    )
    
    
    5,368Net cash provided by operating activities
    
    
    314,137
    
    
    
    398,947Cash Flows From Investing Activities:Capital expenditures
    
    
    (478,391
    )
    
    
    (351,259
    )Proceeds from asset sales
    
    
    400
    
    
    
    268Purchase of Merrill Lynch interest in subsidiary
    
    
    (50,000
    )
    
    
    Decrease (increase) in restricted funds
    
    
    58,250
    
    
    
    (417,871
    )Other investments
    
    
    (1,474
    )
    
    
    (1,259
    )Net cash used in investing activities
    
    
    (471,215
    )
    
    
    (770,121
    )Cash Flows From Financing Activities:Issuance of long-term debt
    
    
    249,148
    
    
    
    451,189Repayment of long-term debt
    
    
    (196,624
    )
    
    
    (56,404
    )Equity contribution to PATH, LLC by AEP
    
    
    4,460
    
    
    
    Payments on capital lease obligations
    
    
    (4,371
    )
    
    
    (4,040
    )Proceeds from exercise of employee stock options
    
    
    16,748
    
    
    
    9,044Cash dividends paid on common stock
    
    
    (50,413
    )
    
    
    Net cash provided by financing activities
    
    
    18,948
    
    
    
    399,789Net increase (decrease) in cash and cash equivalents
    
    
    (138,130
    )
    
    
    28,615Cash and cash equivalents at beginning of period
    
    
    258,750
    
    
    
    114,138Cash and cash equivalents at end of period
    
    $
    120,620
    
    
    $
    142,753Supplemental Cash Flow Information:Cash paid for interest (net of amount capitalized)
    
    $
    119,848
    
    
    $
    108,850
  5




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
 June 30,
    
    
    December 31,(In thousands)
    
    2008
    
    
    2007ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    120,620
    
    
    $
    258,750Accounts receivable:Customer
    
    
    193,616
    
    
    
    195,545Unbilled utility revenue
    
    
    96,466
    
    
    
    110,569Wholesale and other
    
    
    125,826
    
    
    
    57,626Allowance for uncollectible accounts
    
    
    (15,384
    )
    
    
    (14,252
    )Materials and supplies
    
    
    108,537
    
    
    
    103,075Fuel
    
    
    117,565
    
    
    
    72,506Deferred income taxes
    
    
    252,670
    
    
    
    286,440Prepaid taxes
    
    
    54,682
    
    
    
    48,343Collateral deposits
    
    
    38,308
    
    
    
    59,527Derivative assets
    
    
    314,978
    
    
    
    29Restricted funds
    
    
    85,364
    
    
    
    47,501Regulatory assets
    
    
    84,872
    
    
    
    73,299Other
    
    
    27,433
    
    
    
    16,001Total current assets
    
    
    1,605,553
    
    
    
    1,314,959Property, Plant and Equipment, Net:Generation
    
    
    6,055,122
    
    
    
    5,992,919Transmission
    
    
    1,150,929
    
    
    
    1,126,657Distribution
    
    
    3,856,454
    
    
    
    3,761,438Other
    
    
    466,403
    
    
    
    452,525Accumulated depreciation
    
    
    (4,880,280
    )
    
    
    (4,795,925
    )Subtotal
    
    
    6,648,628
    
    
    
    6,537,614Construction work in progress
    
    
    932,035
    
    
    
    658,966Total property, plant and equipment, net
    
    
    7,580,663
    
    
    
    7,196,580Investments and Other Assets:Goodwill
    
    
    367,287
    
    
    
    367,287Restricted funds  Fort Martin scrubber project
    
    
    255,570
    
    
    
    347,023Investments in unconsolidated affiliates
    
    
    27,833
    
    
    
    27,875Other
    
    
    17,535
    
    
    
    15,974Total investments and other assets
    
    
    668,225
    
    
    
    758,159Deferred Charges:Regulatory assets
    
    
    531,843
    
    
    
    601,603Other
    
    
    65,794
    
    
    
    35,288Total deferred charges
    
    
    597,637
    
    
    
    636,891Total Assets
    
    $
    10,452,078
    
    
    $
    9,906,589
  6




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
(unaudited)
 June 30,
    
    
    December 31,(In thousands, except share amounts)
    
    2008
    
    
    2007LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Short-term debt
    
    $
    10,000
    
    
    $
    10,000Long-term debt due within one year (Note 8)
    
    
    88,845
    
    
    
    95,367Accounts payable
    
    
    359,652
    
    
    
    380,688Accrued taxes
    
    
    64,114
    
    
    
    83,580Derivative liabilities
    
    
    158,452
    
    
    
    14,117Regulatory liabilities
    
    
    107,645
    
    
    
    4,029Accrued interest
    
    
    57,231
    
    
    
    65,583Security deposits
    
    
    41,341
    
    
    
    38,976Other
    
    
    103,751
    
    
    
    95,163Total current liabilities
    
    
    991,031
    
    
    
    787,503Long-term Debt (Note 8)
    
    
    4,007,329
    
    
    
    3,943,947Deferred Credits and Other Liabilities:Derivative liabilities
    
    
    51,267
    
    
    
    12,815Income taxes payable
    
    
    73,238
    
    
    
    68,050Investment tax credit
    
    
    67,727
    
    
    
    69,353Deferred income taxes
    
    
    1,387,193
    
    
    
    1,345,953Obligations under capital leases
    
    
    43,053
    
    
    
    38,765Regulatory liabilities
    
    
    529,641
    
    
    
    488,393Adverse power purchase commitment
    
    
    141,067
    
    
    
    149,799Other
    
    
    434,138
    
    
    
    453,418Total deferred credits and other liabilities
    
    
    2,727,324
    
    
    
    2,626,546Commitments and Contingencies (Note 17)Minority Interest
    
    
    5,014
    
    
    
    13,241Common Stockholders Equity:Common stock$1.25 par value per share, 260
million shares authorized and 168,758,746 and
167,273,069 shares issued at June 30, 2008 and
December 31, 2007, respectively
    
    
    210,948
    
    
    
    209,091Other paid-in capital
    
    
    1,937,711
    
    
    
    1,924,072Retained earnings
    
    
    683,925
    
    
    
    444,177Treasury stock at cost49,493 shares
    
    
    (1,756
    )
    
    
    (1,756
    )Accumulated other comprehensive loss
    
    
    (109,448
    )
    
    
    (40,232
    )Total common stockholders equity
    
    
    2,721,380
    
    
    
    2,535,352Total Liabilities and Stockholders Equity
    
    $
    10,452,078
    
    
    $
    9,906,589
  7




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMMON STOCKHOLDERS EQUITY
For the Six Months Ended June 30, 2008
(unaudited)
 Accumulated
    
    
    TotalOther
    
    
    
    
    
    
    
    
    
    
    other
    
    
    commonShares
    
    
    Common
    
    
    paid-in
    
    
    Retained
    
    
    Treasury
    
    
    comprehensive
    
    
    stockholders(In thousands, except shares)
    
    outstanding
    
    
    stock
    
    
    capital
    
    
    earnings
    
    
    stock
    
    
    loss
    
    
    equityBalance at December 31, 2007
    
    
    167,223,576
    
    
    $
    209,091
    
    
    $
    1,924,072
    
    
    $
    444,177
    
    
    $
    (1,756
    )
    
    $
    (40,232
    )
    
    $
    2,535,352Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    290,251
    
    
    
    
    
    
    
    
    
    
    
    290,251Defined benefit pension and
other benefit plan
amortization:Net actuarial loss,
net of tax of $78
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    88
    
    
    
    88Net transition
obligation, net of tax
of $366
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    413
    
    
    
    413Net prior service
cost, net of tax of
$177
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    201
    
    
    
    201Unrealized losses on
available-for-sale
securities, net of tax of $1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )Cash flow hedges, net of tax
of $44,171
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (69,917
    )
    
    
    (69,917
    )Dividends on common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (50,413
    )
    
    
    
    
    
    
    
    
    
    
    (50,413
    )Stock-based compensation
expense:Stock units
    
    
    
    
    
    
    
    
    
    
    609
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    609Non-employee director
stock awards
    
    
    17,465
    
    
    
    22
    
    
    
    534
    
    
    
    (16
    )
    
    
    
    
    
    
    
    
    
    
    540Stock options
    
    
    
    
    
    
    
    
    
    
    4,809
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,809Performance shares
    
    
    
    
    
    
    
    
    
    
    392
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    392Exercise of stock options
    
    
    1,219,130
    
    
    
    1,524
    
    
    
    15,224
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,748Settlement of stock units
    
    
    249,082
    
    
    
    311
    
    
    
    (8,003
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,692
    )Dividends on stock units
    
    
    
    
    
    
    
    
    
    
    74
    
    
    
    (74
    )
    
    
    
    
    
    
    
    
    
    
    Balance at June 30, 2008
    
    
    168,709,253
    
    
    $
    210,948
    
    
    $
    1,937,711
    
    
    $
    683,925
    
    
    $
    (1,756
    )
    
    $
    (109,448
    )
    
    $
    2,721,380
  8




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 Note No.
    
    
    
    Page No.1
    
    Basis of Presentation
    
    
    102
    
    Recent Accounting Pronouncements
    
    
    113
    
    Transmission Expansion Projects
    
    
    124
    
    Acquisition of Minority Interest in AE Supply
    
    
    135
    
    Rates and Regulation
    
    
    136
    
    Regulatory Assets and Liabilities
    
    
    197
    
    Income Taxes
    
    
    208
    
    Common Stock and Debt
    
    
    219
    
    Business Segments
    
    
    2310
    
    Derivative Instruments and Hedging Activities
    
    
    2411
    
    Stock-Based Compensation
    
    
    2712
    
    Pension Benefits and Postretirement Benefits Other Than Pensions
    
    
    3013
    
    Comprehensive Income and Accumulated Other Comprehensive Loss
    
    
    3214
    
    Income Per Common Share
    
    
    3315
    
    Other Income (Expense), Net
    
    
    3416
    
    Guarantees and Letters of Credit
    
    
    3517
    
    Commitments and Contingencies
    
    
    36
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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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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 2: RECENT ACCOUNTING PRONOUNCEMENTS
      11




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 3: TRANSMISSION EXPANSION PROJECTS
 Trans-Allegheny Interstate Line
     Potomac-Appalachian Transmission Highline
    12




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
   
 NOTE 4: ACQUISITION OF MINORITY INTEREST IN AE SUPPLY
   
 NOTE 5: RATES AND REGULATION
 Pennsylvania
 Default Service Regulation.
   13




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
   Transmission Expansion
 West Virginia
 Rate Case.
 Transmission Expansion.
 
    
    Monongahela, Potomac Edison and TrAIL Company will locate 100 to 150 managerial,
professional, technical and administrative jobs in north-central West Virginia no later
than the in-service date of the West Virginia segment of TrAIL, which will involve
construction of a new transmission operations facility in the state with an estimated cost
of approximately $50 million;
    
    Monongahela and Potomac Edison will not seek recovery in West Virginia of transmission
charges associated with TrAIL for the period from January 2007 through the latest of
December 31, 2013, the date which is two and one-half years following the in-service date
of TrAILs West Virginia segment or the month in which Alleghenys new West Virginia
facility is placed in service;
 
 14




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



    
    TrAIL Company will contribute $5 million to fund energy conservation programs and
assistance plans for low-income customers in West Virginia over a five year period; 
    
    Monongahela and Potomac Edison will provide rate relief in the form of credits totaling
approximately $5.7 million in the aggregate to industrial customers in West Virginia in
2010 and 2011;
    
    The West Virginia segment of TrAIL should follow the route set forth in TrAIL Companys
application to the West Virginia PSC, except for certain modifications south of Morgantown,
West Virginia, which will more closely follow existing transmission corridors;
    
    The Consumer Advocate, the staff of the West Virginia PSC and the WVEUG will support
the need for the portion of TrAIL that is proposed to run from Alleghenys 502 Junction in
Greene County, Pennsylvania through West Virginia to northern Virginia; and
    
    Each landowner on the right-of-way will be provided with transmission credits that can
be used for up to 12,000 kWh of power per year.
    Maryland
    15




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
  Virginia
 Purchased Power Cost Recovery.
      16




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
  
    
    granted a rate adjustment effective immediately that would permit Potomac Edison to
collect an additional $9.5 million (pre-tax) on an annualized basis through June 30, 2008,
a substantially lower amount than the $42.3 million requested;
 
    
    directed Potomac Edison to implement deferred accounting effective immediately with
respect to the over- or under-recovery of the increased purchased power costs approved in
the order; and

    
    directed Potomac Edison to file an application with the Virginia SCC on or before July
1, 2008, for proposed recovery of purchased power costs for the 12-month period beginning
July 1, 2008, including for treatment of any over- or under-recovery incurred for service
rendered prior to July 1, 2008 and whether and how its proposed recovery of purchased power
costs for service rendered on and after January 1, 2009 would be consistent with the MOU
and certain amendments to the Restructuring Act.
      17




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
  Transmission Expansion.
 18




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 6: REGULATORY ASSETS AND LIABILITIES
  June 30,
    
    
    December 31,(In millions)
    
    2008
    
    
    2007Regulatory assets, including current portion:Income taxes (a)(b)
    
    $
    228.8
    
    
    $
    251.4Pension benefits and postretirement benefits other than pensions (a)(c)
    
    
    196.1
    
    
    
    202.7Pennsylvania stranded cost recovery
    
    
    2.0
    
    
    
    17.6Pennsylvania Competitive Transition Charge (CTC) reconciliation
    
    
    112.5
    
    
    
    117.7Unamortized loss on reacquired debt (a)(d)
    
    
    33.2
    
    
    
    35.3Deferred ENEC charges (e)(f)
    
    
    6.2
    
    
    
    9.4Other (g)
    
    
    37.9
    
    
    
    40.8Subtotal
    
    
    616.7
    
    
    
    674.9Regulatory liabilities, including current portion:Net asset removal costs
    
    
    407.8
    
    
    
    396.4Unrealized gain on increased fair value of financial transmission rights
    
    
    106.4
    
    
    
    Income taxes
    
    
    35.8
    
    
    
    36.8SO2 allowances
    
    
    13.5
    
    
    
    13.8Fort Martin scrubber projectenvironmental control surcharge (e)
    
    
    26.0
    
    
    
    33.4Maryland rate stabilization and transition plan surcharge
    
    
    35.1
    
    
    
    6.9Other
    
    
    12.7
    
    
    
    5.1Subtotal
    
    
    637.3
    
    
    
    492.4Net regulatory assets (liabilities)
    
    $
    (20.6
    )
    
    $
    182.5
 
 (a)
    
    Does not earn a return.(b)
    
    Amount is being recovered over various periods associated with the
remaining useful life of related regulated utility property, plant and
equipment.(c)
    
    Amount is being recovered over a period up to 13 years.(d)
    
    Amount is being recovered over various periods through 2025, based upon
the maturities of reacquired debt.(e)
    
    Interest earnings on the Fort Martin scrubber project escrow fund
represented an offset to regulatory assets at June 30, 2008 and a
regulatory liability at December 31, 2007. By order dated January 14,
2008, the West Virginia PSC approved a modification to the ENEC
directing the interest earnings to be applied to the ENEC.(f)
    
    Includes certain amounts that do not earn a return with recovery
periods up to one year.(g)
    
    Includes certain amounts that do not earn a return with recovery
periods through 2027. 19




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 7: INCOME TAXES
    Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(In millions, except percent)
    
    Amount
    
    
    %
    
    
    Amount
    
    
    %
    
    
    Amount
    
    
    %
    
    
    Amount
    
    
    %Income before income taxes
and minority interest
    
    $
    244.3
    
    
    
    
    
    
    $
    130.6
    
    
    
    
    
    
    $
    438.9
    
    
    
    
    
    
    $
    312.1Income tax expense
calculated using the federal
statutory rate of 35%
    
    
    85.5
    
    
    
    35.0
    
    
    
    45.7
    
    
    
    35.0
    
    
    
    153.6
    
    
    
    35.0
    
    
    
    109.2
    
    
    
    35.0Increases (reductions)
resulting from:Rate-making effects of
depreciation differences
    
    
    2.0
    
    
    
    0.8
    
    
    
    1.9
    
    
    
    1.5
    
    
    
    3.9
    
    
    
    0.9
    
    
    
    3.9
    
    
    
    1.2Plant removal costs
    
    
    (1.2
    )
    
    
    (0.5
    )
    
    
    (0.6
    )
    
    
    (0.5
    )
    
    
    (2.6
    )
    
    
    (0.6
    )
    
    
    (1.2
    )
    
    
    (0.4
    )State income tax, net of
federal income tax
benefit
    
    
    7.2
    
    
    
    3.0
    
    
    
    3.5
    
    
    
    2.7
    
    
    
    13.0
    
    
    
    3.0
    
    
    
    8.7
    
    
    
    2.8Amortization of deferred
investment tax credit
    
    
    (0.8
    )
    
    
    (0.3
    )
    
    
    (0.9
    )
    
    
    (0.7
    )
    
    
    (1.6
    )
    
    
    (0.4
    )
    
    
    (1.8
    )
    
    
    (0.6
    )Estimated Pennsylvania net
operating loss benefits
    
    
    (3.0
    )
    
    
    (1.2
    )
    
    
    
    
    
    
    
    
    
    
    (3.0
    )
    
    
    (0.7
    )
    
    
    
    
    
    
    West Virginia state income
tax change
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6.7
    )
    
    
    (1.5
    )
    
    
    (0.7
    )
    
    
    (0.2
    )Changes in tax reserves
related to uncertain tax
positions
    
    
    2.5
    
    
    
    1.0
    
    
    
    2.4
    
    
    
    1.8
    
    
    
    (5.1
    )
    
    
    (1.2
    )
    
    
    4.7
    
    
    
    1.5Other, net
    
    
    (2.4
    )
    
    
    (1.0
    )
    
    
    0.9
    
    
    
    0.7
    
    
    
    (3.4
    )
    
    
    (0.8
    )
    
    
    1.5
    
    
    
    0.5Total income tax expense
    
    $
    89.8
    
    
    
    36.8
    
    
    $
    52.9
    
    
    
    40.5
    
    
    $
    148.1
    
    
    
    33.7
    
    
    $
    124.3
    
    
    
    39.8
  20




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
    
 NOTE 8: COMMON STOCK AND DEBT
 Common Stock
  21




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 Debt
  (In millions)
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    2012
    
    
    Thereafter
    
    
    TotalAE Supply:Medium-Term Notes
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    400.0
    
    
    $
    650.0
    
    
    $
    
    
    
    $
    1,050.0AE Supply Credit Facility:Term Loan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    447.0
    
    
    
    
    
    
    
    
    
    
    
    447.0Revolving Loan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    235.0
    
    
    
    
    
    
    
    
    
    
    
    235.0Pollution Control Bonds
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.3
    
    
    
    267.2
    
    
    
    268.5Debentures-AGC
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100.0
    
    
    
    100.0Total AE Supply
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    1,082.0
    
    
    $
    651.3
    
    
    $
    367.2
    
    
    $
    2,100.5Monongahela:Environmental Control Bonds (a)
    
    $
    5.5
    
    
    $
    10.6
    
    
    $
    11.1
    
    
    $
    11.6
    
    
    $
    12.2
    
    
    $
    284.0
    
    
    $
    335.0First Mortgage Bonds
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    340.0
    
    
    
    340.0Medium-Term Notes
    
    
    
    
    
    
    
    
    
    
    110.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    110.0Pollution Control Bonds
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6.0
    
    
    
    64.3
    
    
    
    70.3Total Monongahela
    
    $
    5.5
    
    
    $
    10.6
    
    
    $
    121.1
    
    
    $
    11.6
    
    
    $
    18.2
    
    
    $
    688.3
    
    
    $
    855.3West Penn:First Mortgage Bonds
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    420.0
    
    
    $
    420.0Transition Bonds (a)
    
    
    34.1
    
    
    
    79.8
    
    
    
    16.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    129.9Medium-Term Notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    80.0
    
    
    
    
    
    
    
    80.0Total West Penn
    
    $
    34.1
    
    
    $
    79.8
    
    
    $
    16.0
    
    
    $
    
    
    
    $
    80.0
    
    
    $
    420.0
    
    
    $
    629.9Potomac Edison:First Mortgage Bonds
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    420.0
    
    
    $
    420.0Environmental Control Bonds (a)
    
    
    1.9
    
    
    
    3.5
    
    
    
    3.7
    
    
    
    3.9
    
    
    
    4.1
    
    
    
    94.8
    
    
    
    111.9Total Potomac Edison
    
    $
    1.9
    
    
    $
    3.5
    
    
    $
    3.7
    
    
    $
    3.9
    
    
    $
    4.1
    
    
    $
    514.8
    
    
    $
    531.9TrAIL Company:Short-Term Promissory Note
    
    $
    10.0
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    10.0Total TrAIL
    
    $
    10.0
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    10.0Unamortized debt discounts
    
    
    (0.7
    )
    
    
    (1.5
    )
    
    
    (1.3
    )
    
    
    (1.0
    )
    
    
    (0.6
    )
    
    
    (1.9
    )
    
    
    (7.0
    )Eliminations (b)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1.3
    )
    
    
    (13.1
    )
    
    
    (14.4
    )Total consolidated debt
    
    $
    50.8
    
    
    $
    92.4
    
    
    $
    139.5
    
    
    $
    1,096.5
    
    
    $
    751.7
    
    
    $
    1,975.3
    
    
    $
    4,106.2
 
 (a)
    
    Amounts represent repayments based upon estimated surcharge
collections from customers.(b)
    
    Amounts represent the elimination of certain pollution control
bonds, for which Monongahela and AE Supply are co-obligors.Certain of Alleghenys properties are subject to liens of various relative priorities securing
debt. 22




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 2008 Debt Activity
  (In millions)
    
    Issuances
    
    
    RepaymentsMonongahela:Environmental Control Bonds
    
    $
    
    
    
    $
    9.4Potomac Edison:Environmental Control Bonds
    
    
    
    
    
    
    2.9West Penn:Transition Bonds
    
    
    2.8
    
    
    
    44.3AE Supply:AE Supply Credit Facility:Term Loan
    
    
    
    
    
    
    125.0Revolving Loan
    
    
    250.0
    
    
    
    15.0Consolidated Total
    
    $
    252.8
    
    
    $
    196.6
 
 NOTE 9: BUSINESS SEGMENTS
  Three Months Ended June 30, 2008
    
    
    Three Months Ended June 30, 2007Delivery
    
    
    Generation
    
    
    
    
    
    
    
    
    
    
    Delivery
    
    
    Generationand
    
    
    and
    
    
    
    
    
    
    
    
    
    
    and
    
    
    and(In millions)
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    Total
    
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    TotalExternal operating revenues
    
    $
    670.3
    
    
    $
    283.2
    
    
    $
    
    
    
    $
    953.5
    
    
    $
    676.3
    
    
    $
    150.2
    
    
    $
    
    
    
    $
    826.5Internal operating revenues
    
    
    2.0
    
    
    
    401.3
    
    
    
    (403.3
    )
    
    
    
    
    
    
    2.2
    
    
    
    375.1
    
    
    
    (377.3
    )
    
    
    Total operating revenues
    
    $
    672.3
    
    
    $
    684.5
    
    
    $
    (403.3
    )
    
    $
    953.5
    
    
    $
    678.5
    
    
    $
    525.3
    
    
    $
    (377.3
    )
    
    $
    826.5Depreciation
    
    $
    37.8
    
    
    $
    28.1
    
    
    $
    
    
    
    $
    65.9
    
    
    $
    36.7
    
    
    $
    29.0
    
    
    $
    
    
    
    $
    65.7Amortization
    
    $
    2.9
    
    
    $
    
    
    
    $
    
    
    
    $
    2.9
    
    
    $
    4.4
    
    
    $
    0.6
    
    
    $
    
    
    
    $
    5.0Operating income
    
    $
    28.1
    
    
    $
    270.2
    
    
    $
    
    
    
    $
    298.3
    
    
    $
    69.9
    
    
    $
    116.9
    
    
    $
    
    
    
    $
    186.8Interest expense
    
    $
    23.9
    
    
    $
    35.6
    
    
    $
    (0.8
    )
    
    $
    58.7
    
    
    $
    18.5
    
    
    $
    46.1
    
    
    $
    (1.6
    )
    
    $
    63.0Income tax expense
    
    $
    2.9
    
    
    $
    86.9
    
    
    $
    
    
    
    $
    89.8
    
    
    $
    22.3
    
    
    $
    30.6
    
    
    $
    
    
    
    $
    52.9Net income
    
    $
    4.5
    
    
    $
    149.6
    
    
    $
    
    
    
    $
    154.1
    
    
    $
    33.4
    
    
    $
    43.6
    
    
    $
    
    
    
    $
    77.0
 Six Months Ended June 30, 2008
    
    
    Six Months Ended June 30, 2007Delivery
    
    
    Generation
    
    
    
    
    
    
    
    
    
    
    Delivery
    
    
    Generationand
    
    
    and
    
    
    
    
    
    
    
    
    
    
    and
    
    
    and(In millions)
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    Total
    
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    TotalExternal operating revenues
    
    $
    1,442.7
    
    
    $
    385.9
    
    
    $
    
    
    
    $
    1,828.6
    
    
    $
    1,431.1
    
    
    $
    243.0
    
    
    $
    
    
    
    $
    1,674.1Internal operating revenues
    
    
    4.1
    
    
    
    866.9
    
    
    
    (871.0
    )
    
    
    
    
    
    
    5.3
    
    
    
    806.8
    
    
    
    (812.1
    )
    
    
    Total operating revenues
    
    $
    1,446.8
    
    
    $
    1,252.8
    
    
    $
    (871.0
    )
    
    $
    1,828.6
    
    
    $
    1,436.4
    
    
    $
    1,049.8
    
    
    $
    (812.1
    )
    
    $
    1,674.1Depreciation
    
    $
    75.2
    
    
    $
    55.6
    
    
    $
    
    
    
    $
    130.8
    
    
    $
    72.0
    
    
    $
    61.4
    
    
    $
    
    
    
    $
    133.4Amortization
    
    $
    8.2
    
    
    $
    0.1
    
    
    $
    
    
    
    $
    8.3
    
    
    $
    9.3
    
    
    $
    
    
    
    $
    
    
    
    $
    9.3Operating income
    
    $
    93.3
    
    
    $
    451.9
    
    
    $
    
    
    
    $
    545.2
    
    
    $
    166.5
    
    
    $
    255.5
    
    
    $
    
    
    
    $
    422.0Interest expense
    
    $
    45.8
    
    
    $
    73.5
    
    
    $
    (2.2
    )
    
    $
    117.1
    
    
    $
    36.9
    
    
    $
    88.1
    
    
    $
    (2.8
    )
    
    $
    122.2Income tax expense
    
    $
    15.7
    
    
    $
    132.4
    
    
    $
    
    
    
    $
    148.1
    
    
    $
    57.8
    
    
    $
    66.5
    
    
    $
    
    
    
    $
    124.3Net income
    
    $
    38.2
    
    
    $
    252.1
    
    
    $
    
    
    
    $
    290.3
    
    
    $
    78.9
    
    
    $
    107.9
    
    
    $
    
    
    
    $
    186.8
 23




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 10: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
  Level 1 
    
    Quoted prices for identical instruments in active markets.Level 2 
    
    Quoted prices for similar instruments in active markets; quoted prices for identical or
similar instruments in markets that are not active; and model-derived valuations for which all
significant inputs are observable market data.Level 3 
    
    Unobservable inputs significant to the fair value measurement supported by little or no
market activity.
      24




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
   Othermark-to-Cash flow
    
    
    
    
    
    
    Interest
    
    
    market
    
    
    Total
    
    
    FTR
    
    
    Cash
    
    
    Net(In millions)
    
    hedges
    
    
    FTRs
    
    
    rate swaps
    
    
    contracts
    
    
    derivatives
    
    
    obligation
    
    
    collateral
    
    
    derivativesDerivative assets:Current
    
    $
    8.7
    
    
    $
    958.4
    
    
    $
    
    
    
    $
    19.3
    
    
    $
    986.4
    
    
    $
    (667.1
    )
    
    $
    (4.3
    )
    
    $
    315.0Long-term
    
    
    0.1
    
    
    
    
    
    
    
    
    
    
    
    14.0
    
    
    
    14.1
    
    
    
    
    
    
    
    (2.2
    )
    
    
    11.9Derivative liabilities:Current
    
    
    (112.6
    )
    
    
    
    
    
    
    (6.0
    )
    
    
    (39.9
    )
    
    
    (158.5
    )
    
    
    
    
    
    
    
    
    
    
    (158.5
    )Long-term
    
    
    (34.1
    )
    
    
    
    
    
    
    (10.6
    )
    
    
    (17.8
    )
    
    
    (62.5
    )
    
    
    
    
    
    
    11.2
    
    
    
    (51.3
    )Total derivatives
    
    $
    (137.9
    )
    
    $
    958.4
    
    
    $
    (16.6
    )
    
    $
    (24.4
    )
    
    $
    779.5
    
    
    $
    (667.1
    )
    
    $
    4.7
    
    
    $
    117.1
  (In millions)
    
    Level 1
    
    
    Level 2
    
    
    Level 3
    
    
    TotalDerivative assets
    
    $
    6.5
    
    
    $
    35.6
    
    
    $
    958.4
    
    
    $
    1,000.5Derivative liabilities
    
    
    (11.2
    )
    
    
    (209.8
    )
    
    
    
    
    
    
    (221.0
    )Net derivative assets (liabilities)
    
    $
    (4.7
    )
    
    $
    (174.2
    )
    
    $
    958.4
    
    
    $
    779.5
  (In millions)
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    2012
    
    
    TotalLevel 1
    
    $
    (9.1
    )
    
    $
    10.6
    
    
    $
    (6.2
    )
    
    $
    
    
    
    $
    
    
    
    $
    (4.7
    )Level 2
    
    
    (116.3
    )
    
    
    (53.8
    )
    
    
    (3.1
    )
    
    
    (1.0
    )
    
    
    
    
    
    
    (174.2
    )Level 3
    
    
    560.5
    
    
    
    397.9
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    958.4Net derivative assets (liabilities)
    
    $
    435.1
    
    
    $
    354.7
    
    
    $
    (9.3
    )
    
    $
    (1.0
    )
    
    $
    
    
    
    $
    779.5
 25




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
  Three Months Ended
    
    
    Six Months Ended(In millions)
    
    June 30, 2008
    
    
    June 30, 2008Balance at April 1, 2008 and January 1, 2008, respectively
    
    $
    51.4
    
    
    $
    150.0Total realized and unrealized gains / losses:Included in earnings
    
    
    276.8
    
    
    
    315.1Included in regulatory assets or liabilities
    
    
    134.4
    
    
    
    152.7Purchases, issuances and settlements
    
    
    495.8
    
    
    
    340.6Transfers in / out of Level 3
    
    
    
    
    
    
    Balance at June 30, 2008
    
    $
    958.4
    
    
    $
    958.4Amount of total gains included in earnings attributable to
the change in unrealized gains related to Level 3 assets
held at June 30, 2008
    
    $
    201.0
    
    
    $
    201.0
    Three Months ended
    
    
    Six Months Ended(Pre-tax amounts, in millions)
    
    June 30, 2008
    
    
    June 30, 2008Balance at April 1, 2008 and January 1, 2008, respectively
    
    $
    (69.6
    )
    
    $
    (6.3
    )Changes in fair value
    
    
    (36.8
    )
    
    
    (93.3
    )Reclassifications from accumulated other comprehensive loss to earnings
    
    
    (14.1
    )
    
    
    (20.9
    )Balance at June 30, 2008
    
    $
    (120.5
    )
    
    $
    (120.5
    )
 26




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 11: STOCK-BASED COMPENSATION
    Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Stock options
    
    $
    2.7
    
    
    $
    1.7
    
    
    $
    4.8
    
    
    $
    3.4Performance shares
    
    
    0.4
    
    
    
    
    
    
    
    0.4
    
    
    
    Stock units
    
    
    0.3
    
    
    
    0.7
    
    
    
    0.6
    
    
    
    1.5Other
    
    
    0.3
    
    
    
    0.3
    
    
    
    0.5
    
    
    
    0.7Total stock-based compensation expense
    
    
    3.7
    
    
    
    2.7
    
    
    
    6.3
    
    
    
    5.6Income tax benefit
    
    
    1.5
    
    
    
    1.1
    
    
    
    2.6
    
    
    
    2.3Total stock-based compensation expense, net of tax
    
    $
    2.2
    
    
    $
    1.6
    
    
    $
    3.7
    
    
    $
    3.3
  Stock Options
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2008
    
    2007
    
    2008
    
    2007Annual risk-free interest rate
    
    
    3.51
    %
    
    
    4.69
    %
    
    
    3.14
    %
    
    
    4.65
    %Expected term of the option (in years)
    
    
    5.95
    
    
    
    5.50
    
    
    
    5.99
    
    
    
    5.61Expected annual dividend yield
    
    
    1.15
    %
    
    
    
    %
    
    
    1.11
    %
    
    
    
    %Expected stock price volatility
    
    
    25.8
    %
    
    
    24.6
    %
    
    
    27.4
    %
    
    
    24.4
    %Grant date fair value per stock option
    
    $
    14.57
    
    
    $
    18.23
    
    
    $
    15.49
    
    
    $
    17.40
 27




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
  AggregateWeighted-
    
    IntrinsicNumber of
    
    Average
    
    Value (a)Stock Options
    
    Exercise Price
    
    (in millions)Outstanding at March 31, 2008
    
    
    3,132,359
    
    
    $
    23.14Granted
    
    
    3,494
    
    
    $
    52.23Exercised
    
    
    (612,228
    )
    
    $
    13.87Forfeited
    
    
    (11,758
    )
    
    $
    35.80Outstanding at June 30, 2008
    
    
    2,511,867
    
    
    $
    25.38
    
    
    $
    64.1Exercisable at June 30, 2008
    
    
    1,271,760
    
    
    $
    17.19
    
    
    $
    41.9
 
 (a)
    
    Represents the
total pre-tax
intrinsic value
based on stock
options with an
exercise price less
than AEs closing
stock price of
$50.11 on June 30,
2008.    AggregateWeighted-
    
    IntrinsicNumber of
    
    Average
    
    Value (a)Stock Options
    
    Exercise Price
    
    (in millions)Outstanding at December 31, 2007
    
    
    3,191,409
    
    
    $
    16.10Granted
    
    
    551,346
    
    
    $
    53.55Exercised
    
    
    (1,219,130
    )
    
    $
    13.74Forfeited
    
    
    (11,758
    )
    
    $
    35.80Outstanding at June 30, 2008
    
    
    2,511,867
    
    
    $
    25.38
    
    
    $
    64.1Exercisable at June 30, 2008
    
    
    1,271,760
    
    
    $
    17.19
    
    
    $
    41.9
 
 (a)
    
    Represents the total pre-tax
intrinsic value based on stock
options with an exercise price
less than AEs closing stock price
of $50.11 on June 30, 2008.   28




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
   Stock Units
  Weighted-
    
    AggregateAverage
    
    IntrinsicNumber of
    
    Grant Date
    
    Value (a)Stock Units
    
    Fair Value
    
    (in millions)Outstanding at March 31, 2008
    
    
    452,386
    
    
    $
    15.50Units settled (249,028 common shares issued)
    
    
    (412,164
    )
    
    $
    15.51Dividend on unvested units
    
    
    114
    
    
    $
    52.81Outstanding at June 30, 2008
    
    
    40,336
    
    
    $
    15.47
    
    
    $
    2.0
 
 (a)
    
    Represents the total pre-tax intrinsic
value based on stock units outstanding
multiplied by AEs closing stock price
of $50.11 on June 30, 2008.  Weighted-
    
    AggregateAverage
    
    IntrinsicNumber of
    
    Grant Date
    
    Value (a)Stock Units
    
    Fair Value
    
    (in millions)Outstanding at December 31, 2007
    
    
    451,055
    
    
    $
    15.40Units settled (249,082 common shares issued)
    
    
    (412,218
    )
    
    $
    15.52Dividend on unvested units
    
    
    1,499
    
    
    $
    49.14Outstanding at June 30, 2008
    
    
    40,336
    
    
    $
    15.47
    
    
    
    $2.0
 
 (a)
    
    Represents the total pre-tax intrinsic
value based on stock units outstanding
multiplied by AEs closing stock price
of $50.11 on June 30, 2008.    Performance Share Awards
  29




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 Non-Employee Director Stock Plan
  Number ofSharesShares earned but not issued at March 31, 2008
    
    
    54,410Granted
    
    
    5,391Issued
    
    
    (1,198
    )Dividends on earned but not issued shares
    
    
    154Shares earned but not issued at June 30, 2008
    
    
    58,757
  Number ofSharesShares earned but not issued at December 31, 2007
    
    
    65,177Granted
    
    
    10,737Issued
    
    
    (17,465
    )Dividends on earned but not issued shares
    
    
    308Shares earned but not issued at June 30, 2008
    
    
    58,757
 
 NOTE 12: PENSION BENEFITS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
   30




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ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
  Pension BenefitsThree Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Components of net periodic cost:Service cost
    
    $
    5.3
    
    
    $
    5.3
    
    
    $
    10.6
    
    
    $
    10.7Interest cost
    
    
    17.1
    
    
    
    16.2
    
    
    
    34.2
    
    
    
    32.3Expected return on plan assets
    
    
    (19.2
    )
    
    
    (18.3
    )
    
    
    (38.4
    )
    
    
    (36.5
    )Amortization of unrecognized transition obligation
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.2
    
    
    
    0.2Amortization of prior service cost
    
    
    0.8
    
    
    
    0.8
    
    
    
    1.6
    
    
    
    1.6Recognized actuarial loss
    
    
    1.8
    
    
    
    2.7
    
    
    
    3.6
    
    
    
    5.3Net periodic cost
    
    $
    5.9
    
    
    $
    6.8
    
    
    $
    11.8
    
    
    $
    13.6
  Postretirement Benefits Other than PensionsThree Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Components of net periodic cost:Service cost
    
    $
    1.1
    
    
    $
    1.1
    
    
    $
    2.2
    
    
    $
    2.3Interest cost
    
    
    4.3
    
    
    
    4.3
    
    
    
    8.6
    
    
    
    8.5Expected return on plan assets
    
    
    (1.8
    )
    
    
    (1.7
    )
    
    
    (3.6
    )
    
    
    (3.4
    )Amortization of unrecognized transition obligation
    
    
    1.4
    
    
    
    1.4
    
    
    
    2.8
    
    
    
    2.8Recognized actuarial loss
    
    
    0.2
    
    
    
    0.6
    
    
    
    0.3
    
    
    
    1.2Net periodic cost
    
    $
    5.2
    
    
    $
    5.7
    
    
    $
    10.3
    
    
    $
    11.4
    31




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 13: COMPREHENSIVE INCOME AND ACCUMULATED OTHER COMPREHENSIVE LOSS
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Net income
    
    $
    154.1
    
    
    $
    77.0
    
    
    $
    290.3
    
    
    $
    186.8Cash flow hedges and
other, net of tax of
$19.8, $4.1, $44.3 and
$2.0, respectively
    
    
    (31.1
    )
    
    
    6.5
    
    
    
    (69.9
    )
    
    
    3.2Defined benefit
pension and other
benefit plan
amortization, net of
tax of $0.3, $0.1,
$0.6 and $1.1,
respectively
    
    
    0.4
    
    
    
    0.2
    
    
    
    0.7
    
    
    
    1.8West Virginia Rate
Order  establishment
of regulatory asset
related to pension
obligation, net of tax
of $35.7
    
    
    
    
    
    
    52.3
    
    
    
    
    
    
    
    52.3Comprehensive income
    
    $
    123.4
    
    
    $
    136.0
    
    
    $
    221.1
    
    
    $
    244.1
  June 30,
    
    
    December 31,(In millions)
    
    2008
    
    
    2007Cash flow hedges and other, net of tax of $46.9 and $2.7, respectively
    
    $
    (74.2
    )
    
    $
    (4.3
    )Net unrecognized pension and other benefit plan costs, net of tax of
$23.9 and $24.5, respectively
    
    
    (35.2
    )
    
    
    (35.9
    )Total
    
    $
    (109.4
    )
    
    $
    (40.2
    )
 32




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 14: INCOME PER COMMON SHARE
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions, except share and per share amounts)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Basic Income per Common Share:Numerator:Net income
    
    $
    154.1
    
    
    $
    77.0
    
    
    $
    290.3
    
    
    $
    186.8Denominator:Weighted average common shares outstanding
    
    
    168,236,148
    
    
    
    165,794,012
    
    
    
    167,898,112
    
    
    
    165,645,000Basic income per common share
    
    $
    0.92
    
    
    $
    0.46
    
    
    $
    1.73
    
    
    $
    1.13Diluted Income per Common Share:Numerator:Net income
    
    $
    154.1
    
    
    $
    77.0
    
    
    $
    290.3
    
    
    $
    186.8Denominator:Weighted average common shares outstanding
    
    
    168,236,148
    
    
    
    165,794,012
    
    
    
    167,898,112
    
    
    
    165,645,000Effect of dilutive securities:Stock options (a)
    
    
    1,452,555
    
    
    
    2,784,081
    
    
    
    1,673,955
    
    
    
    2,752,745Stock units
    
    
    349,754
    
    
    
    805,342
    
    
    
    395,974
    
    
    
    845,259Non-employee stock awards
    
    
    54,470
    
    
    
    60,539
    
    
    
    53,182
    
    
    
    57,550Performance shares
    
    
    13,271
    
    
    
    25,497
    
    
    
    6,635
    
    
    
    25,497Total shares
    
    
    170,106,198
    
    
    
    169,469,471
    
    
    
    170,027,858
    
    
    
    169,326,051Diluted income per common share
    
    $
    0.91
    
    
    $
    0.45
    
    
    $
    1.71
    
    
    $
    1.10
 
 (a)
    
    The dilutive share calculations exclude 570,877 shares and 48,747 shares
for the three months ended June 30, 2008 and 2007, respectively, and
418,160 shares and 67,624 shares for the six months ended June 30, 2008 and
2007, respectively, relating to stock options because the inclusion of
these amounts would have been antidilutive under the treasury stock method. 33




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 15: OTHER INCOME (EXPENSE), NET
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Interest and dividend income
    
    $
    1.3
    
    
    $
    3.9
    
    
    $
    4.0
    
    
    $
    7.4Gain on equity investment
    
    
    1.3
    
    
    
    
    
    
    
    1.3
    
    
    
    Tax reimbursement on contributions in aid of construction
    
    
    1.1
    
    
    
    1.7
    
    
    
    2.0
    
    
    
    2.8Cash received from a former trading executives forfeited assets
    
    
    
    
    
    
    
    
    
    
    1.6
    
    
    
    Equity component of AFUDC
    
    
    0.7
    
    
    
    0.6
    
    
    
    1.4
    
    
    
    1.3Premium services
    
    
    0.2
    
    
    
    0.7
    
    
    
    0.6
    
    
    
    1.1Other
    
    
    0.1
    
    
    
    
    
    
    
    
    
    
    
    0.2Total
    
    $
    4.7
    
    
    $
    6.9
    
    
    $
    10.9
    
    
    $
    12.8
 34




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 16: GUARANTEES AND LETTERS OF CREDIT
  June 30, 2008
    
    
    December 31, 2007Amounts
    
    
    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
    
    $
    
    
    
    $
    9.9
    
    
    $
    
    
    
    $
    10.2Lease agreement
    
    
    
    
    
    
    5.0
    
    
    
    
    
    
    
    4.9Purchase, sale, exchange or transportation of
wholesale natural gas, electric power and
related services
    
    
    
    
    
    
    52.0
    
    
    
    
    
    
    
    41.0Other
    
    
    0.2
    
    
    
    0.2
    
    
    
    0.2
    
    
    
    0.2Total Guarantees
    
    $
    0.2
    
    
    $
    67.1
    
    
    $
    0.2
    
    
    $
    56.3Letters of Credit:Under AE Supplys Revolving Facility (a)
    
    $
    
    
    
    $
    10.0
    
    
    $
    
    
    
    $
    Under AEs Revolving Facility (b)
    
    
    
    
    
    
    6.4
    
    
    
    
    
    
    
    6.7Other (c)
    
    
    
    
    
    
    3.0
    
    
    
    
    
    
    
    2.5Total Letters of Credit
    
    $
    
    
    
    $
    19.4
    
    
    $
    
    
    
    $
    9.2Total Guarantees and Letters of Credit
    
    $
    0.2
    
    
    $
    86.5
    
    
    $
    0.2
    
    
    $
    65.5
 
 (a)
    
    This amount was comprised of a letter of credit issued to post collateral for certain power contracts and was
cancelled on July 15, 2008.(b)
    
    These amounts were comprised of a letter of credit issued in connection with a contractual obligation of
Allegheny Ventures that will expire in July 2009.(c)
    
    These amounts were not issued under either AEs credit facility or AE Supplys credit facility. 35




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
 NOTE 17: COMMITMENTS AND CONTINGENCIES
 Environmental Matters and Litigation
  Global Climate Change . 2.
 2 2 2 2
 2
 2
  
    
    maintaining an accurate
CO2
emissions data base;
    
    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;
 36




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
    
    participating in CO2 sequestration efforts (e.g. reforestation
projects) both domestically and abroad;
    
    analyzing options for future energy investment (e.g. renewables, clean-coal,
etc.); and
    
    improving demand-side efficiency programs, as evidenced by customer conservation
outreach plans and Alleghenys Watt Watchers initiatives.
  2
 Clean Air Act Compliance. 2
 2 x
 2 2 2
  2
 37




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
    2 2 2 2 2
 Clean Air Act Litigation .
    38




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
      Global Warming Class Action:
 Claims Related to Alleged Asbestos Exposure:
 39




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 ., .
   Other Litigation
 Nevada Power Contracts .
  Sierra/Nevada .
 40




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##### Table of Contents



ALLEGHENY ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
   Claim by California Parties .
  Ordinary Course of Business .
 41




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Forward-Looking Statements
  
    
    regulatory matters, including but not limited to environmental regulation, state rate
regulation, and the status of retail generation service supply competition in states served
by the Distribution Companies;
    
    financing plans;
    
    market demand and prices for energy and capacity;
    
    the cost and availability of raw materials, including coal, and Alleghenys ability to
enter into and enforce long-term fuel purchase agreements;
    
    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;
    
    changes in technology and their effects on the competitiveness of Alleghenys
generation facilities;
    
    work stoppages by Alleghenys unionized employees; and
    
    capacity purchase commitments.
  
    
    the results of regulatory proceedings, including proceedings related to rates;
    
    plant performance and unplanned outages;
    
    volatility and changes in the price and demand for energy and capacity and changes in the
value of FTRs;
 42




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##### Table of Contents




    
    volatility and changes in the price of coal, natural gas and other energy-related
commodities and Alleghenys ability to enter into and enforce supplier performance under
long term fuel purchase agreements;
    
    changes in the weather and other natural phenomena;
    
    changes in industry capacity, development and other activities by Alleghenys
competitors;
    
    changes in market rules, including changes to PJMs participant rules and tariffs;
    
    the loss of any significant customers or suppliers;
    
    changes in customer switching behavior and their resulting effects on existing and future
PLR load requirements;
    
    dependence on other electric transmission and gas transportation systems and their
constraints on availability;
    
    environmental regulations;
    
    changes in other laws and regulations applicable to Allegheny, its markets or its
activities;
    
    changes in the underlying inputs and assumptions, including market conditions, used to
estimate the fair values of commodity contracts;
    
    complications or other factors that make it difficult or impossible to obtain necessary
lender consents or regulatory authorizations on a timely basis;
    
    changes in access to capital markets, the availability of credit and actions of rating
agencies;
    
    inflationary and interest rate trends;
    
    the effect of accounting pronouncements issued periodically by accounting
standard-setting bodies and accounting issues facing Allegheny;
    
    general economic and business conditions; and
    
    other risks, including the effects of global instability, terrorism and war.
  Overview
  43




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##### Table of Contents



Key Indicators and Performance Factors
 The Delivery and Services Segment
  Revenue per megawatt-hour (MWh) sold
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2008
    
    2007
    
    2008
    
    2007Revenue per MWh sold
    
    $
    59.74
    
    
    $
    59.29
    
    
    $
    60.85
    
    
    $
    59.93
 Operations and maintenance costs (O&M).
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2008
    
    2007
    
    2008
    
    2007O&M per MWh sold
    
    $
    8.75
    
    
    $
    7.93
    
    
    $
    8.25
    
    
    $
    7.64
 Capital expenditures.
  Three Months Ended
    
    
    
    
    
    Six Months EndedJune 30,
    
    
    
    
    
    June 30,2008
    
    2007
    
    Change
    
    2008
    
    2007
    
    ChangeDelivery and Services:Retail electricity
sales (million kWhs)
    
    
    10,478
    
    
    
    10,666
    
    
    
    (1.8
    )%
    
    
    22,274
    
    
    
    22,377
    
    
    
    (0.5
    )%HDD (a)
    
    
    541
    
    
    
    593
    
    
    
    (8.8
    )%
    
    
    3,255
    
    
    
    3,337
    
    
    
    (2.5
    )%CDD (a)
    
    
    230
    
    
    
    280
    
    
    
    (17.9
    )%
    
    
    230
    
    
    
    282
    
    
    
    (18.4
    )%
 
 (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. Normal
(historical) HDDs are 641 and 3,475 for the three and six months ended June 30, respectively
and normal (historical) CDDs are 212 and 213 for the three and six months ended June 30,
respectively, calculated on a weighted-average basis across the geographic areas served by the
Distribution Companies. 44




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##### Table of Contents



The Generation and Marketing Segment
  kWhs generated.
 Equivalent Availability
Factor (EAF).
 Station operations and maintenance costs (Station O&M).
  Three Months Ended
    
    
    
    
    
    
    Six Months EndedJune 30,
    
    
    
    
    
    
    June 30,2008
    
    
    2007
    
    
    Change
    
    
    2008
    
    
    2007
    
    
    ChangeSupercritical Units:kWhs generated (in millions)
    
    
    8,824
    
    
    
    9,311
    
    
    
    (5.2
    )%
    
    
    19,187
    
    
    
    20,060
    
    
    
    (4.4
    )%EAF
    
    
    79.0
    %
    
    
    79.5
    %
    
    
    (0.5
    )%
    
    
    84.1
    %
    
    
    84.5
    %
    
    
    (0.4
    )%Station O&M (in millions):Base and operations
    
    $
    27.3
    
    
    $
    29.6
    
    
    
    (7.8
    )%
    
    $
    54.7
    
    
    $
    54.7
    
    
    
    
    %Special maintenance
    
    
    24.1
    
    
    
    31.7
    
    
    
    (24.0
    )%
    
    
    35.2
    
    
    
    42.1
    
    
    
    (16.4
    )%Total Station O&M
    
    $
    51.4
    
    
    $
    61.3
    
    
    
    (16.2
    )%
    
    $
    89.9
    
    
    $
    96.8
    
    
    
    (7.1
    )%All Generation Units:kWhs generated (in millions)
    
    
    10,603
    
    
    
    11,759
    
    
    
    (9.8
    )%
    
    
    23,144
    
    
    
    24,851
    
    
    
    (6.9
    )%EAF
    
    
    80.3
    %
    
    
    82.1
    %
    
    
    (1.8
    )%
    
    
    84.4
    %
    
    
    85.5
    %
    
    
    (1.1
    )%Station O&M (in millions):Base and operations
    
    $
    42.1
    
    
    $
    45.2
    
    
    
    (6.9
    )%
    
    $
    83.6
    
    
    $
    83.4
    
    
    
    0.2
    %Special maintenance
    
    
    33.1
    
    
    
    38.0
    
    
    
    (12.9
    )%
    
    
    47.3
    
    
    
    49.3
    
    
    
    (4.1
    )%Total Station O&M
    
    $
    75.2
    
    
    $
    83.2
    
    
    
    (9.6
    )%
    
    $
    130.9
    
    
    $
    132.7
    
    
    
    (1.4
    )%
 45




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##### Table of Contents



RESULTS OF OPERATIONS
 Income Summary
 Three Months Ended
    
    
    Three Months EndedJune 30, 2008
    
    
    June 30, 2007Delivery
    
    
    Generation
    
    
    
    
    
    
    
    
    
    
    Delivery
    
    
    Generationand
    
    
    and
    
    
    
    
    
    
    
    
    
    
    and
    
    
    and(In millions)
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    Total
    
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    TotalOperating revenues
    
    $
    672.3
    
    
    $
    684.5
    
    
    $
    (403.3
    )
    
    $
    953.5
    
    
    $
    678.5
    
    
    $
    525.3
    
    
    $
    (377.3
    )
    
    $
    826.5Fuel
    
    
    
    
    
    
    245.3
    
    
    
    
    
    
    
    245.3
    
    
    
    
    
    
    
    231.4
    
    
    
    
    
    
    
    231.4Purchased power and transmission
    
    
    474.1
    
    
    
    24.4
    
    
    
    (401.3
    )
    
    
    97.2
    
    
    
    454.1
    
    
    
    27.4
    
    
    
    (375.1
    )
    
    
    106.4Deferred energy costs, net
    
    
    3.3
    
    
    
    (2.1
    )
    
    
    
    
    
    
    1.2
    
    
    
    (1.3
    )
    
    
    (6.9
    )
    
    
    
    
    
    
    (8.2
    )Operations and maintenance
    
    
    91.8
    
    
    
    100.1
    
    
    
    (2.0
    )
    
    
    189.9
    
    
    
    84.6
    
    
    
    108.2
    
    
    
    (2.2
    )
    
    
    190.6Depreciation and amortization
    
    
    40.7
    
    
    
    28.1
    
    
    
    
    
    
    
    68.8
    
    
    
    41.1
    
    
    
    29.6
    
    
    
    
    
    
    
    70.7Taxes other than income taxes
    
    
    34.3
    
    
    
    18.5
    
    
    
    
    
    
    
    52.8
    
    
    
    30.1
    
    
    
    18.7
    
    
    
    
    
    
    
    48.8Total operating expenses
    
    
    644.2
    
    
    
    414.3
    
    
    
    (403.3
    )
    
    
    655.2
    
    
    
    608.6
    
    
    
    408.4
    
    
    
    (377.3
    )
    
    
    639.7Operating income
    
    
    28.1
    
    
    
    270.2
    
    
    
    
    
    
    
    298.3
    
    
    
    69.9
    
    
    
    116.9
    
    
    
    
    
    
    
    186.8Other income (expense), net
    
    
    3.6
    
    
    
    1.9
    
    
    
    (0.8
    )
    
    
    4.7
    
    
    
    4.4
    
    
    
    4.1
    
    
    
    (1.6
    )
    
    
    6.9Interest expense and preferred
dividends of subsidiary
    
    
    23.9
    
    
    
    35.6
    
    
    
    (0.8
    )
    
    
    58.7
    
    
    
    18.6
    
    
    
    46.2
    
    
    
    (1.6
    )
    
    
    63.2Income before income taxes and
minority interest
    
    
    7.8
    
    
    
    236.5
    
    
    
    
    
    
    
    244.3
    
    
    
    55.7
    
    
    
    74.8
    
    
    
    
    
    
    
    130.5Income tax expense
    
    
    2.9
    
    
    
    86.9
    
    
    
    
    
    
    
    89.8
    
    
    
    22.3
    
    
    
    30.6
    
    
    
    
    
    
    
    52.9Minority interest
    
    
    0.4
    
    
    
    
    
    
    
    
    
    
    
    0.4
    
    
    
    
    
    
    
    0.6
    
    
    
    
    
    
    
    0.6Net income
    
    $
    4.5
    
    
    $
    149.6
    
    
    $
    
    
    
    $
    154.1
    
    
    $
    33.4
    
    
    $
    43.6
    
    
    $
    
    
    
    $
    77.0
 Six Months Ended
    
    
    Six Months EndedJune 30, 2008
    
    
    June 30, 2007Delivery
    
    
    Generation
    
    
    
    
    
    
    
    
    
    
    Delivery
    
    
    Generationand
    
    
    and
    
    
    
    
    
    
    
    
    
    
    and
    
    
    and(In millions)
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    Total
    
    
    Services
    
    
    Marketing
    
    
    Eliminations
    
    
    TotalOperating revenues
    
    $
    1,446.8
    
    
    $
    1,252.8
    
    
    $
    (871.0
    )
    
    $
    1,828.6
    
    
    $
    1,436.4
    
    
    $
    1,049.8
    
    
    $
    (812.1
    )
    
    $
    1,674.1Fuel
    
    
    
    
    
    
    495.1
    
    
    
    
    
    
    
    495.1
    
    
    
    
    
    
    
    463.6
    
    
    
    
    
    
    
    463.6Purchased power and transmission
    
    
    1,009.6
    
    
    
    51.9
    
    
    
    (866.9
    )
    
    
    194.6
    
    
    
    954.9
    
    
    
    51.6
    
    
    
    (806.8
    )
    
    
    199.7Deferred energy costs, net
    
    
    6.4
    
    
    
    (15.7
    )
    
    
    
    
    
    
    (9.3
    )
    
    
    (2.8
    )
    
    
    (6.9
    )
    
    
    
    
    
    
    (9.7
    )Operations and maintenance
    
    
    183.7
    
    
    
    179.0
    
    
    
    (4.1
    )
    
    
    358.6
    
    
    
    170.9
    
    
    
    185.5
    
    
    
    (5.3
    )
    
    
    351.1Depreciation and amortization
    
    
    83.4
    
    
    
    55.7
    
    
    
    
    
    
    
    139.1
    
    
    
    81.3
    
    
    
    61.4
    
    
    
    
    
    
    
    142.7Taxes other than income taxes
    
    
    70.4
    
    
    
    34.9
    
    
    
    
    
    
    
    105.3
    
    
    
    65.6
    
    
    
    39.1
    
    
    
    
    
    
    
    104.7Total operating expenses
    
    
    1,353.5
    
    
    
    800.9
    
    
    
    (871.0
    )
    
    
    1,283.4
    
    
    
    1,269.9
    
    
    
    794.3
    
    
    
    (812.1
    )
    
    
    1,252.1Operating income
    
    
    93.3
    
    
    
    451.9
    
    
    
    
    
    
    
    545.2
    
    
    
    166.5
    
    
    
    255.5
    
    
    
    
    
    
    
    422.0Other income (expense), net
    
    
    7.0
    
    
    
    6.1
    
    
    
    (2.2
    )
    
    
    10.9
    
    
    
    7.4
    
    
    
    8.2
    
    
    
    (2.8
    )
    
    
    12.8Interest expense and preferred
dividends of subsidiary
    
    
    45.8
    
    
    
    73.5
    
    
    
    (2.2
    )
    
    
    117.1
    
    
    
    37.2
    
    
    
    88.3
    
    
    
    (2.8
    )
    
    
    122.7Income before income taxes and
minority interest
    
    
    54.5
    
    
    
    384.5
    
    
    
    
    
    
    
    439.0
    
    
    
    136.7
    
    
    
    175.4
    
    
    
    
    
    
    
    312.1Income tax expense
    
    
    15.7
    
    
    
    132.4
    
    
    
    
    
    
    
    148.1
    
    
    
    57.8
    
    
    
    66.5
    
    
    
    
    
    
    
    124.3Minority interest
    
    
    0.6
    
    
    
    
    
    
    
    
    
    
    
    0.6
    
    
    
    
    
    
    
    1.0
    
    
    
    
    
    
    
    1.0Net income
    
    $
    38.2
    
    
    $
    252.1
    
    
    $
    
    
    
    $
    290.3
    
    
    $
    78.9
    
    
    $
    107.9
    
    
    $
    
    
    
    $
    186.8
 46




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##### Table of Contents



CONSOLIDATED RESULTS
   (In millions)Income before income taxes and minority interest for the three months ended June 30, 2007
    
    
    
    
    
    $
    130.5Increase in operating revenues
    
    
    
    
    
    
    127.0Decreases (increases) in operating expenses:Fuel
    
    
    (13.9
    )Purchased power and transmission
    
    
    9.2Deferred energy costs, net
    
    
    (9.4
    )Other operating expenses
    
    
    (1.4
    )Operating expenses
    
    
    
    
    
    
    (15.5
    )Decrease in other income (expense), net
    
    
    
    
    
    
    (2.2
    )Decrease in interest expense and preferred dividends of subsidiary
    
    
    
    
    
    
    4.5Income before income taxes and minority interest for the three months ended June 30, 2008
    
    
    
    
    
    $
    244.3
 (In millions)Income before income taxes and minority interest for the six months ended June 30, 2007
    
    
    
    
    
    $
    312.1Increase in operating revenues
    
    
    
    
    
    
    154.5Decreases (increases) in operating expenses:Fuel
    
    
    (31.5
    )Purchased power and transmission
    
    
    5.1Operations and maintenance
    
    
    (7.5
    )Other operating expenses
    
    
    2.6Operating expenses
    
    
    
    
    
    
    (31.3
    )Decrease in other income (expense), net
    
    
    
    
    
    
    (1.9
    )Decrease in interest expense and preferred dividends of subsidiary
    
    
    
    
    
    
    5.6Income before income taxes and minority interest for the six months ended June 30, 2008
    
    
    
    
    
    $
    439.0
 Operating Revenues
  
    
    a $196.6 million increase in unrealized gains relating to financial transmission rights
(FTRs),
    
    a $26.8 million increase, primarily relating to higher market prices, including
marketing, hedging and trading activities,
    
    a $15.5 million increase due to higher generation rates charged to Pennsylvania
customers and
    
    an $8.5 million increase due to increased recoverable expenses and return on
investment, primarily related to TrAIL Company.
 47




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##### Table of Contents




    
    a $56.2 million decrease in 2008 revenue resulting from increased unrealized losses on
economic power sale hedges that did not qualify for hedge accounting,
    
    a $45.4 million decrease due to a 9.8% decrease in total MWhs generated,
    
    a $13.1 million decrease resulting from mark-to-market changes related to pipeline
capacity economic hedges that did not qualify for hedge accounting and
    
    a decrease as a result of milder weather.
  
    
    a $201.0 million increase in unrealized gains relating to FTRs,
    
    a $52.2 million increase, primarily relating to higher market prices, including
marketing, hedging and trading activities,
    
    a $32.3 million increase due to higher generation rates charged to Pennsylvania
customers and
    
    a $15.3 million increase due to increased recoverable expenses and return on
investment, primarily related to TrAIL Company.
  
    
    a $63.2 million decrease in 2008 revenue resulting from increased unrealized losses on
economic power sale hedges that did not qualify for hedge accounting,
    
    a $73.2 million decrease due to a 6.9% decrease in total MWhs generated,
    
    a $13.1 million decrease resulting from mark-to-market changes related to pipeline
capacity economic hedges that did not qualify for hedge accounting and
    
    a decrease as a result of milder weather.
  Operating Expenses
   48




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##### Table of Contents




    
    a $3.1 million increase in outside services expense, primarily as a result of information
technology improvement initiatives and activities,
    
    a $3.1 million increase in materials and supplies expense due to the timing of plant
maintenance and storm activity,
    
    a $2.6 million increase in uncollectible expense, primarily due to increased accounts
receivable reserves resulting from higher average accounts receivable and
    
    a $2.3 million increase in costs associated with right-of-way vegetation control
resulting from increased maintenance activities and storm activity,
    
    partially offset by a $3.2 million decrease in contract work resulting from the timing of
plant maintenance.
 Other Income (Expense), Net
  Interest Expense and Preferred Dividends of Subsidiary
  Income Tax Expense
  49




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##### Table of Contents



DISCUSSION OF SEGMENT RESULTS OF OPERATIONS
 Delivery and Services Segment Results
  Three Months Ended
    
    
    
    
    
    Six Months EndedJune 30,
    
    
    
    
    
    June 30,2008
    
    2007
    
    Change
    
    2008
    
    2007
    
    ChangeDelivery and Services:Retail electricity
sales (million kWhs)
    
    
    10,478
    
    
    
    10,666
    
    
    
    (1.8
    )%
    
    
    22,274
    
    
    
    22,377
    
    
    
    (0.5
    )%HDD
    
    
    541
    
    
    
    593
    
    
    
    (8.8
    )%
    
    
    3,255
    
    
    
    3,337
    
    
    
    (2.5
    )%CDD
    
    
    230
    
    
    
    280
    
    
    
    (17.9
    )%
    
    
    230
    
    
    
    282
    
    
    
    (18.4
    )%
 Operating Revenues
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Retail electric:Generation
    
    $
    432.2
    
    
    $
    428.9
    
    
    $
    933.1
    
    
    $
    900.4Transmission
    
    
    38.2
    
    
    
    39.0
    
    
    
    82.7
    
    
    
    82.9Distribution
    
    
    155.6
    
    
    
    164.5
    
    
    
    339.6
    
    
    
    357.7Total retail electric
    
    
    626.0
    
    
    
    632.4
    
    
    
    1,355.4
    
    
    
    1,341.0Transmission services and bulk power
    
    
    35.3
    
    
    
    35.8
    
    
    
    70.0
    
    
    
    74.3Other affiliated and nonaffiliated energy services
    
    
    11.0
    
    
    
    10.3
    
    
    
    21.4
    
    
    
    21.1Total operating revenues
    
    $
    672.3
    
    
    $
    678.5
    
    
    $
    1,446.8
    
    
    $
    1,436.4
  
    
    a $9.7 million decrease in transmission and distribution (T&D) revenues,
    
    partially offset by a $3.3 million increase in generation revenues.
    
    
    a $32.7 million increase in generation revenues,
    
    partially offset by an $18.3 million decrease in T&D revenues.
 50




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##### Table of Contents



Operating Expenses
 Purchased Power and Transmission:
 Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Other purchased power and transmission
    
    $
    435.1
    
    
    $
    411.0
    
    
    $
    930.8
    
    
    $
    872.6From PURPA generation
    
    
    39.0
    
    
    
    43.1
    
    
    
    78.8
    
    
    
    82.3Purchased power and transmission
    
    $
    474.1
    
    
    $
    454.1
    
    
    $
    1,009.6
    
    
    $
    954.9
  51




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##### Table of Contents




    
    a $26.9 million increase due to a new power sales agreement in Virginia between AE Supply
and Potomac Edison at market-based rates beginning July 1, 2007 (see Regulatory Matters
and Risk Factors below and Note 5, Rates and Regulation, for additional information
regarding market-based rates in Virginia) and
    
    a $15.5 million increase due to higher generation rates charged to Pennsylvania
customers, which is passed on to AE Supply under the terms of a power supply agreement
between West Penn and AE Supply,
    
    partially offset by a $12.4 million decrease due to the expiration in May 2007 of a fixed
price supply agreement to serve Monongahelas former Ohio service territory.
  
    
    a $51.5 million increase due to a new power sales agreement in Virginia between AE Supply
and Potomac Edison at market-based rates (see Regulatory Matters and Risk Factors below
and Note 5, Rates and Regulation, for additional information regarding market-based rates
in Virginia) and
    
    a $32.3 million increase due to higher generation rates charged to Pennsylvania
customers, which is passed on to AE Supply under the terms of a power supply agreement
between West Penn and AE Supply,
    
    partially offset by a $21.7 million decrease due to the expiration in May 2007 of a fixed
price supply agreement to serve Monongahelas former Ohio service territory.
  Deferred Energy Costs, Net:
 AES Warrior Run PURPA Generation.
 Market-based Generation Costs.
 52




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##### Table of Contents



Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007AES Warrior Run PURPA generation
    
    $
    1.6
    
    
    $
    (3.5
    )
    
    $
    6.8
    
    
    $
    (2.7
    )Market-based generation and other costs
    
    
    1.7
    
    
    
    2.2
    
    
    
    (0.4
    )
    
    
    (0.1
    )Deferred energy costs, net
    
    $
    3.3
    
    
    $
    (1.3
    )
    
    $
    6.4
    
    
    $
    (2.8
    )
  Operations and Maintenance:
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Operations and maintenance
    
    $
    91.8
    
    
    $
    84.6
    
    
    $
    183.7
    
    
    $
    170.9
  
    
    a $2.6 million increase in outside services expense, primarily as a result of information
technology improvement initiatives and activities,
    
    a $2.0 million increase in right-of-way vegetation expense resulting from increased
maintenance activities and storm activity and
    
    a $1.5 million increase in contract work due to service outages as a result of storm
activity.
  
    
    a $4.2 million increase in outside services expense, primarily as a result of information
technology improvement initiatives and activities,
    
    a $2.7 million increase in contract work due to service outages as a result of storm
activity,
    
    a $2.5 million increase in uncollectible expense, primarily due to increased accounts
receivable reserves resulting from higher average accounts receivable and
    
    a $2.3 million increase in right-of-way vegetation expense resulting from increased
maintenance activities and storm activity.
 53




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##### Table of Contents



Depreciation and Amortization:
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Depreciation and amortization
    
    $
    40.7
    
    
    $
    41.1
    
    
    $
    83.4
    
    
    $
    81.3
  Taxes Other Than Income Taxes
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Taxes other than income taxes
    
    $
    34.3
    
    
    $
    30.1
    
    
    $
    70.4
    
    
    $
    65.6
   Interest Expense and Preferred Dividends of Subsidiary
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Interest expense
    
    $
    23.9
    
    
    $
    18.4
    
    
    $
    45.8
    
    
    $
    36.9Preferred dividends of subsidiary
    
    
    
    
    
    
    0.2
    
    
    
    
    
    
    
    0.3Interest expense and preferred dividends of subsidiary
    
    $
    23.9
    
    
    $
    18.6
    
    
    $
    45.8
    
    
    $
    37.2
  Income Tax Expense
  54




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##### Table of Contents



Transmission Expansion
  Income Summary
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Operating revenues
    
    $
    10.2
    
    
    $
    1.4
    
    
    $
    18.5
    
    
    $
    3.1Operating income (loss)
    
    $
    6.2
    
    
    $
    (0.2
    )
    
    $
    11.8
    
    
    $
    0.2Income before income taxes and minority interest
    
    $
    5.7
    
    
    $
    0.4
    
    
    $
    10.5
    
    
    $
    0.9Net income
    
    $
    3.1
    
    
    $
    0.2
    
    
    $
    5.7
    
    
    $
    0.6
    55




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##### Table of Contents



The Generation and Marketing Segment
   Three Months Ended
    
    
    Three Months EndedJune 30, 2008
    
    
    June 30, 2007(In millions)
    
    Unregulated
    
    
    Regulated
    
    
    Eliminations
    
    
    Total
    
    
    Unregulated
    
    
    Regulated
    
    
    Eliminations
    
    
    TotalOperating revenues
    
    $
    549.5
    
    
    $
    146.0
    
    
    $
    (11.0
    )
    
    $
    684.5
    
    
    $
    395.2
    
    
    $
    141.3
    
    
    $
    (11.2
    )
    
    $
    525.3Fuel
    
    
    174.1
    
    
    
    71.2
    
    
    
    
    
    
    
    245.3
    
    
    
    168.8
    
    
    
    62.6
    
    
    
    
    
    
    
    231.4Purchased power and transmission
    
    
    4.9
    
    
    
    30.5
    
    
    
    (11.0
    )
    
    
    24.4
    
    
    
    7.8
    
    
    
    30.8
    
    
    
    (11.2
    )
    
    
    27.4Deferred energy costs, net
    
    
    
    
    
    
    (2.1
    )
    
    
    
    
    
    
    (2.1
    )
    
    
    
    
    
    
    (6.9
    )
    
    
    
    
    
    
    (6.9
    )Operations and maintenance
    
    
    69.8
    
    
    
    30.2
    
    
    
    0.1
    
    
    
    100.1
    
    
    
    74.6
    
    
    
    33.5
    
    
    
    0.1
    
    
    
    108.2Depreciation and amortization
    
    
    23.7
    
    
    
    4.9
    
    
    
    (0.5
    )
    
    
    28.1
    
    
    
    22.6
    
    
    
    7.6
    
    
    
    (0.6
    )
    
    
    29.6Taxes other than income taxes
    
    
    12.0
    
    
    
    6.5
    
    
    
    
    
    
    
    18.5
    
    
    
    11.7
    
    
    
    7.0
    
    
    
    
    
    
    
    18.7Total operating expenses
    
    
    284.5
    
    
    
    141.2
    
    
    
    (11.4
    )
    
    
    414.3
    
    
    
    285.5
    
    
    
    134.6
    
    
    
    (11.7
    )
    
    
    408.4Operating income
    
    
    265.0
    
    
    
    4.8
    
    
    
    0.4
    
    
    
    270.2
    
    
    
    109.7
    
    
    
    6.7
    
    
    
    0.5
    
    
    
    116.9Other income (expense), net
    
    
    1.4
    
    
    
    3.4
    
    
    
    (2.9
    )
    
    
    1.9
    
    
    
    3.5
    
    
    
    3.8
    
    
    
    (3.2
    )
    
    
    4.1Interest expense
    
    
    25.9
    
    
    
    9.7
    
    
    
    
    
    
    
    35.6
    
    
    
    36.8
    
    
    
    9.4
    
    
    
    
    
    
    
    46.2Income (loss) before income
taxes and minority interest
    
    
    240.5
    
    
    
    (1.5
    )
    
    
    (2.5
    )
    
    
    236.5
    
    
    
    76.4
    
    
    
    1.1
    
    
    
    (2.7
    )
    
    
    74.8Income tax expense (benefit)
    
    
    87.8
    
    
    
    (0.8
    )
    
    
    (0.1
    )
    
    
    86.9
    
    
    
    29.8
    
    
    
    0.9
    
    
    
    (0.1
    )
    
    
    30.6Minority interest
    
    
    2.4
    
    
    
    
    
    
    
    (2.4
    )
    
    
    
    
    
    
    3.2
    
    
    
    
    
    
    
    (2.6
    )
    
    
    0.6Net income (loss)
    
    $
    150.3
    
    
    $
    (0.7
    )
    
    $
    
    
    
    $
    149.6
    
    
    $
    43.4
    
    
    $
    0.2
    
    
    $
    
    
    
    $
    43.6
 Six Months Ended
    
    
    Six Months EndedJune 30, 2008
    
    
    June 30, 2007(In millions)
    
    Unregulated
    
    
    Regulated
    
    
    Eliminations
    
    
    Total
    
    
    Unregulated
    
    
    Regulated
    
    
    Eliminations
    
    
    TotalOperating revenues
    
    $
    992.1
    
    
    $
    283.1
    
    
    $
    (22.4
    )
    
    $
    1,252.8
    
    
    $
    813.1
    
    
    $
    258.5
    
    
    $
    (21.8
    )
    
    $
    1,049.8Fuel
    
    
    354.9
    
    
    
    140.2
    
    
    
    
    
    
    
    495.1
    
    
    
    340.6
    
    
    
    123.0
    
    
    
    
    
    
    
    463.6Purchased power and transmission
    
    
    14.4
    
    
    
    59.9
    
    
    
    (22.4
    )
    
    
    51.9
    
    
    
    13.9
    
    
    
    59.4
    
    
    
    (21.7
    )
    
    
    51.6Deferred energy costs, net
    
    
    
    
    
    
    (15.7
    )
    
    
    
    
    
    
    (15.7
    )
    
    
    
    
    
    
    (6.9
    )
    
    
    
    
    
    
    (6.9
    )Operations and maintenance
    
    
    119.7
    
    
    
    59.1
    
    
    
    0.2
    
    
    
    179.0
    
    
    
    121.3
    
    
    
    64.1
    
    
    
    0.1
    
    
    
    185.5Depreciation and amortization
    
    
    47.0
    
    
    
    9.7
    
    
    
    (1.0
    )
    
    
    55.7
    
    
    
    45.0
    
    
    
    17.6
    
    
    
    (1.2
    )
    
    
    61.4Taxes other than income taxes
    
    
    22.4
    
    
    
    12.5
    
    
    
    
    
    
    
    34.9
    
    
    
    25.1
    
    
    
    14.0
    
    
    
    
    
    
    
    39.1Total operating expenses
    
    
    558.4
    
    
    
    265.7
    
    
    
    (23.2
    )
    
    
    800.9
    
    
    
    545.9
    
    
    
    271.2
    
    
    
    (22.8
    )
    
    
    794.3Operating income (loss)
    
    
    433.7
    
    
    
    17.4
    
    
    
    0.8
    
    
    
    451.9
    
    
    
    267.2
    
    
    
    (12.7
    )
    
    
    1.0
    
    
    
    255.5Other income (expense), net
    
    
    5.1
    
    
    
    6.9
    
    
    
    (5.9
    )
    
    
    6.1
    
    
    
    7.0
    
    
    
    7.5
    
    
    
    (6.3
    )
    
    
    8.2Interest expense
    
    
    54.2
    
    
    
    19.4
    
    
    
    (0.1
    )
    
    
    73.5
    
    
    
    75.2
    
    
    
    13.1
    
    
    
    
    
    
    
    88.3Income (loss) before income
taxes and minority interest
    
    
    384.6
    
    
    
    4.9
    
    
    
    (5.0
    )
    
    
    384.5
    
    
    
    199.0
    
    
    
    (18.3
    )
    
    
    (5.3
    )
    
    
    175.4Income tax expense (benefit)
    
    
    132.0
    
    
    
    0.6
    
    
    
    (0.2
    )
    
    
    132.4
    
    
    
    74.6
    
    
    
    (7.9
    )
    
    
    (0.2
    )
    
    
    66.5Minority interest
    
    
    4.8
    
    
    
    
    
    
    
    (4.8
    )
    
    
    
    
    
    
    6.1
    
    
    
    
    
    
    
    (5.1
    )
    
    
    1.0Net income (loss)
    
    $
    247.8
    
    
    $
    4.3
    
    
    $
    
    
    
    $
    252.1
    
    
    $
    118.3
    
    
    $
    (10.4
    )
    
    $
    
    
    
    $
    107.9
 56




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##### Table of Contents



Generation and Marketing Segment Results
   Three Months Ended
    
    
    
    
    
    Six Months EndedJune 30,
    
    
    
    
    
    June 30,2008
    
    2007
    
    Change
    
    2008
    
    2007
    
    ChangeGeneration (million kWhs)
    
    
    10,603
    
    
    
    11,759
    
    
    
    (9.8
    )%
    
    
    23,144
    
    
    
    24,851
    
    
    
    (6.9
    )%
  (In millions)Income before income taxes and minority interest for the three months ended June 30, 2007
    
    
    
    
    
    $
    74.8Increase in operating revenues
    
    
    
    
    
    
    159.2Decreases (increases) in operating expenses:Fuel
    
    
    (13.9
    )Deferred energy costs, net
    
    
    (4.8
    )Operations and maintenance
    
    
    8.1Other operating expenses
    
    
    4.7Operating expenses
    
    
    
    
    
    
    (5.9
    )Decrease in other income (expense), net
    
    
    
    
    
    
    (2.2
    )Decrease in interest expense
    
    
    
    
    
    
    10.6Income before income taxes and minority interest for the three months ended June 30, 2008
    
    
    
    
    
    $
    236.5
 (In millions)Income before income taxes and minority interest for the six months ended June 30, 2007
    
    
    
    
    
    $
    175.4Increase in operating revenues
    
    
    
    
    
    
    203.0Decreases (increases) in operating expenses:Fuel
    
    
    (31.5
    )Deferred energy costs, net
    
    
    8.8Operations and maintenance
    
    
    6.5Depreciation and amortization
    
    
    5.7Taxes other than income taxes
    
    
    4.2Other operating expenses
    
    
    (0.3
    )Operating expenses
    
    
    
    
    
    
    (6.6
    )Decrease in other income (expense), net
    
    
    
    
    
    
    (2.1
    )Decrease in interest expense
    
    
    
    
    
    
    14.8Income before income taxes and minority interest for the six months ended June 30, 2008
    
    
    
    
    
    $
    384.5
 57




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##### Table of Contents



Operating Revenues
  
    
    a $196.6 million increase in unrealized gains relating to FTRs,
    
    a $26.3 million increase in revenues from affiliates, primarily due to a new power sales
agreement in Virginia between AE Supply and Potomac Edison at market-based rates, effective
July 1, 2007, as well as higher generation rates charged to Pennsylvania customers, which
are passed on to AE Supply under the terms of a power supply agreement between West Penn and
AE Supply, partially offset by lower sales volumes for certain of Potomac Edisons customers
in Maryland and
    
    a $16.2 million increase in PJM revenue, net, primarily due to an increase in the
weighted average round-the-clock price for power in Alleghenys region of PJM, the APS
Zone, from $54.84 per MWh for 2007 to $71.76 per MWh for 2008, partially offset by a 9.8%
decrease in total MWhs generated.
  
    
    a $56.2 million decrease in 2008 revenue resulting from increased unrealized losses on
economic power sale hedges that did not qualify for hedge accounting and
    
    a $13.1 million decrease resulting from mark-to-market changes related to pipeline
capacity economic hedges that did not qualify for hedge accounting.
  
    
    a $201.0 million increase in unrealized gains relating to FTRs,
    
    a $60.2 million increase in revenues from affiliates, primarily due to a new power sales
agreement in Virginia between AE Supply and Potomac Edison at market-based rates, effective
July 1, 2007, as well as higher generation rates charged to Pennsylvania customers, which
are passed on to AE Supply under the terms of a power supply agreement between West Penn and
AE Supply, partially offset by lower sales volumes for certain of Potomac Edisons customers
in Maryland and
    
    a $25.6 million increase in PJM revenue, net, primarily due to an increase in the
weighted average round-the-clock price for power in Alleghenys region of PJM, the APS
Zone, from $54.37 per MWh for 2007 to $69.57 per MWh for 2008, partially offset by a 6.9%
decrease in total MWhs generated.
  
    
    a $63.2 million decrease in 2008 revenue resulting from increased unrealized losses on
economic power sale hedges that did not qualify for hedge accounting and
    
    a $13.1 million decrease resulting from mark-to-market changes related to pipeline
capacity economic hedges that did not qualify for hedge accounting.
 58




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##### Table of Contents



Operating Expenses
     
  Other income (expense), net
  Interest Expense
  Income Tax Expense
  59




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##### Table of Contents



60




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##### Table of Contents



Generation and Marketing Segment  Unregulated Results
  Three Months Ended
    
    
    
    
    
    Six Months EndedJune 30,
    
    
    
    
    
    June 30,2008
    
    2007
    
    Change
    
    2008
    
    2007
    
    ChangekWhs generated (in millions)
    
    
    7,736
    
    
    
    8,548
    
    
    
    (9.5
    )%
    
    
    16,850
    
    
    
    18,406
    
    
    
    (8.5
    )%
 Operating Revenues
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Revenue from affiliates
    
    $
    285.2
    
    
    $
    258.1
    
    
    $
    618.2
    
    
    $
    555.5PJM revenue, net
    
    
    143.9
    
    
    
    132.9
    
    
    
    258.2
    
    
    
    250.1Other operating
revenues, including risk
management and trading
activities, net
    
    
    120.4
    
    
    
    4.2
    
    
    
    115.7
    
    
    
    7.5Unregulated revenue
    
    $
    549.5
    
    
    $
    395.2
    
    
    $
    992.1
    
    
    $
    813.1
 Revenue from affiliates
   
    
    a $25.3 million increase due to a new power sales agreement in Virginia between AE Supply
and Potomac Edison at market-based rates, effective July 1, 2007 and
    
    a $15.5 million increase due to higher generation rates charged to Pennsylvania
customers, which are passed on to AE Supply under the terms of a power supply agreement
between West Penn and AE Supply,
    
    partially offset by a $10.5 million decrease related to lower sales volumes for certain
of Potomac Edisons customers in Maryland.
  
    
    a $46.3 million increase due to a new power sales agreement in Virginia between AE Supply
and Potomac Edison at market-based rates, effective July 1, 2007 and
    
    a $32.3 million increase due to higher generation rates charged to Pennsylvania
customers, which are passed on to AE Supply under the terms of a power supply agreement
between West Penn and AE Supply,
    
    partially offset by a $15.4 million decrease related to lower sales volumes for certain
of Potomac Edisons customers in Maryland.
 61




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##### Table of Contents



PJM revenue, net:
 Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Generation sold into PJM
    
    $
    492.5
    
    
    $
    435.1
    
    
    $
    1,039.3
    
    
    $
    899.4Power purchased from PJM
    
    
    (348.6
    )
    
    
    (302.2
    )
    
    
    (781.1
    )
    
    
    (649.3
    )PJM revenue, net
    
    $
    143.9
    
    
    $
    132.9
    
    
    $
    258.2
    
    
    $
    250.1
  Other Operating Revenues:
  Operating Expenses
 Fuel:
 Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Unregulated fuel
    
    $
    174.1
    
    
    $
    168.8
    
    
    $
    354.9
    
    
    $
    340.6
   62




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##### Table of Contents



Purchased Power and Transmission:
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Unregulated purchased power and transmission expenses
    
    $
    4.9
    
    
    $
    7.8
    
    
    $
    14.4
    
    
    $
    13.9
  Operations and Maintenance:
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Unregulated operations and maintenance
    
    $
    69.8
    
    
    $
    74.6
    
    
    $
    119.7
    
    
    $
    121.3
  Depreciation and Amortization:
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Unregulated depreciation and amortization
    
    $
    23.7
    
    
    $
    22.6
    
    
    $
    47.0
    
    
    $
    45.0
  Taxes Other than Income Taxes:
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Unregulated taxes other than income taxes
    
    $
    12.0
    
    
    $
    11.7
    
    
    $
    22.4
    
    
    $
    25.1
  63




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Other Income (Expense), Net
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Unregulated other income (expense), net
    
    $
    1.4
    
    
    $
    3.5
    
    
    $
    5.1
    
    
    $
    7.0
  Interest Expense
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Unregulated interest expense
    
    $
    25.9
    
    
    $
    36.8
    
    
    $
    54.2
    
    
    $
    75.2
  64




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##### Table of Contents



Generation and Marketing Segment  Regulated Results
  Three Months Ended
    
    
    
    
    
    Six Months EndedJune 30,
    
    
    
    
    
    June 30,2008
    
    2007
    
    Change
    
    2008
    
    2007
    
    ChangekWhs generated (in millions)
    
    
    2,867
    
    
    
    3,210
    
    
    
    (10.7
    )%
    
    
    6,295
    
    
    
    6,444
    
    
    
    (2.3
    )%
 Operating Revenues
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Revenue from affiliates
    
    $
    127.2
    
    
    $
    128.2
    
    
    $
    271.2
    
    
    $
    273.0PJM revenue, net
    
    
    12.4
    
    
    
    7.1
    
    
    
    (2.5
    )
    
    
    (20.0
    )Fort Martin scrubber surcharge
    
    
    6.0
    
    
    
    6.3
    
    
    
    12.0
    
    
    
    6.3Other operating revenues
    
    
    0.4
    
    
    
    (0.3
    )
    
    
    2.4
    
    
    
    (0.8
    )Regulated revenue
    
    $
    146.0
    
    
    $
    141.3
    
    
    $
    283.1
    
    
    $
    258.5
 Revenue from affiliates
    PJM revenue, net:
 Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(In millions)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Generation sold into PJM
    
    $
    205.1
    
    
    $
    174.0
    
    
    $
    425.2
    
    
    $
    339.2Power purchased from PJM
    
    
    (192.7
    )
    
    
    (166.9
    )
    
    
    (427.7
    )
    
    
    (359.2
    )PJM revenue, net
    
    $
    12.4
    
    
    $
    7.1
    
    
    $
    (2.5
    )
    
    $
    (20.0
    )
  65




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##### Table of Contents



Fort Martin scrubber surcharge:
  Other Operating Revenues:
  Operating Expenses
 Fuel:
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Regulated fuel
    
    $
    71.2
    
    
    $
    62.6
    
    
    $
    140.2
    
    
    $
    123.0
   Deferred Energy Costs, Net:
 Expanded Net Energy Cost (ENEC).
 66




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##### Table of Contents



Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Regulated deferred energy costs, net
    
    $
    (2.1
    )
    
    $
    (6.9
    )
    
    $
    (15.7
    )
    
    $
    (6.9
    )
   Operations and Maintenance:
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Regulated operations and maintenance
    
    $
    30.2
    
    
    $
    33.5
    
    
    $
    59.1
    
    
    $
    64.1
  Depreciation and Amortization:
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Regulated depreciation and amortization
    
    $
    4.9
    
    
    $
    7.6
    
    
    $
    9.7
    
    
    $
    17.6
  Taxes Other than Income Taxes:
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Regulated taxes other than income taxes
    
    $
    6.5
    
    
    $
    7.0
    
    
    $
    12.5
    
    
    $
    14.0
  67




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##### Table of Contents



Interest Expense
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(In millions)
    
    2008
    
    2007
    
    2008
    
    2007Regulated interest expense
    
    $
    9.7
    
    
    $
    9.4
    
    
    $
    19.4
    
    
    $
    13.1
  68




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##### Table of Contents



Liquidity and Capital Requirements
    Total
    
    
    
    
    
    
    LOCs
    
    
    Available(In millions)
    
    Capacity
    
    
    Borrowed
    
    
    Issued
    
    
    CapacityAE Revolving Credit Facility
    
    $
    400.0
    
    
    $
    
    
    
    $
    6.4
    
    
    $
    393.6AE Supply Revolving Facility
    
    
    400.0
    
    
    
    235.0
    
    
    
    10.0
    
    
    
    155.0Total
    
    $
    800.0
    
    
    $
    235.0
    
    
    $
    16.4
    
    
    $
    548.6
  June 30, 2008
    
    
    December 31, 2007(In millions)
    
    Amount
    
    
    %
    
    
    Amount
    
    
    %Long-term debt
    
    $
    4,096.2
    
    
    
    60.1
    
    
    $
    4,039.3
    
    
    
    61.4Stockholders equity
    
    
    2,721.4
    
    
    
    39.9
    
    
    
    2,535.4
    
    
    
    38.6Total
    
    $
    6,817.6
    
    
    
    100.0
    
    
    $
    6,574.7
    
    
    
    100.0
 69




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##### Table of Contents



2008 Debt Activity
  (In millions)
    
    Issuances
    
    
    RepaymentsMonongahela:Environmental Control Bonds
    
    $
    
    
    
    $
    9.4Potomac Edison:Environmental Control Bonds
    
    
    
    
    
    
    2.9West Penn:Transition Bonds
    
    
    2.8
    
    
    
    44.3AE Supply:AE Supply Credit Facility:Term Loan
    
    
    
    
    
    
    125.0Revolving Loan
    
    
    250.0
    
    
    
    15.0Consolidated Total
    
    $
    252.8
    
    
    $
    196.6
   Dividends
  Coal Agreement
  Off-Balance Sheet Arrangements
  70




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##### Table of Contents



Cash Flows
 Operating Activities
  Six Months EndedJune 30,(In millions)
    
    2008
    
    
    2007Net income
    
    $
    290.3
    
    
    $
    186.8Non-cash items included in income
    
    
    156.9
    
    
    
    288.6Pension and other postretirement employee benefit plan contributions
    
    
    (42.0
    )
    
    
    (42.2
    )Changes in certain assets and liabilities
    
    
    (91.1
    )
    
    
    (34.3
    )Net cash provided by operating activities
    
    $
    314.1
    
    
    $
    398.9
   71




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##### Table of Contents



Investing Activities
  Six Months EndedJune 30,(In millions)
    
    2008
    
    
    2007Capital expenditures
    
    $
    (478.4
    )
    
    $
    (351.3
    )Proceeds from asset sales
    
    
    0.4
    
    
    
    0.3Purchase of Merrill Lynch interest in subsidiary
    
    
    (50.0
    )
    
    
    Decrease (increase) in restricted funds
    
    
    58.3
    
    
    
    (417.9
    )Other investments
    
    
    (1.5
    )
    
    
    (1.2
    )Net cash used in investing activities
    
    $
    (471.2
    )
    
    $
    (770.1
    )
   Financing Activities
  Six Months EndedJune 30,(In millions)
    
    2008
    
    
    2007Issuance of long-term debt
    
    $
    249.1
    
    
    $
    451.2Repayment of long-term debt
    
    
    (196.6
    )
    
    
    (56.4
    )Equity contribution to PATH, LLC by AEP
    
    
    4.5
    
    
    
    Payments on capital lease obligations
    
    
    (4.4
    )
    
    
    (4.0
    )Proceeds from exercise of employee stock options
    
    
    16.7
    
    
    
    9.0Cash dividends paid on common stock
    
    
    (50.4
    )
    
    
    Net cash provided by financing activities
    
    $
    18.9
    
    
    $
    399.8
   72




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##### Table of Contents



CREDIT RATINGS
  Moodys
    
    S & P
    
    FitchAE:Outlook
    
    Stable
    
    Stable
    
    StableCorporate Credit Rating
    
    Not Rated
    
    BBB-
    
    BBB-(a)Senior Unsecured Debt
    
    Ba1
    
    BB+
    
    BBB-AE Supply:Outlook
    
    Stable
    
    Stable
    
    StableSenior Secured Debt
    
    Baa2
    
    BBB
    
    BBBSenior Unsecured Debt
    
    Ba1
    
    BBB-
    
    BBB-Monongahela:Outlook
    
    Stable
    
    Stable
    
    StableFirst Mortgage Bonds
    
    Baa2
    
    BBB+
    
    BBB+Senior Unsecured Debt
    
    Baa3
    
    BB+
    
    BBB-Environmental Control Bonds
    
    Aaa
    
    AAA
    
    AAAPotomac Edison:Outlook
    
    Negative
    
    Stable
    
    NegativeFirst Mortgage Bonds
    
    Baa2
    
    BBB+
    
    BBBEnvironmental Control Bonds
    
    Aaa
    
    AAA
    
    AAAWest Penn:Outlook
    
    Stable
    
    Stable
    
    StableFirst Mortgage Bonds
    
    Baa2
    
    BBB+
    
    BBB+Senior Unsecured Debt
    
    Baa3
    
    BBB-
    
    BBB-Transition Bonds
    
    Aaa
    
    AAA
    
    AAAAGC:Outlook
    
    Stable
    
    Stable
    
    StableSenior Unsecured Debt
    
    Baa3
    
    BBB-
    
    BBB-
 
 (a)
    
    Issuer default rating 73




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##### Table of Contents



OTHER MATTERS
 Critical Accounting Policies
  Recent Accounting Pronouncements
  REGULATORY MATTERS
  Federal Regulation and Rate Matters
 Transmission Rate Design
    74




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##### Table of Contents



Wholesale Markets
   75




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##### Table of Contents



Transmission Expansion
 TrAIL Project.
  PATH Project.
  
    
    a return on equity of 14.3 percent;
    
    inclusion of 100 percent of construction work in progress in rate base;
    
    recovery of prudently incurred start-up business and administrative costs
incurred prior to the time the rates go into effect; and
    
    recovery of prudently incurred development and construction costs if PATH is
abandoned as a result of factors beyond the control of PATH, LLC or its parent
companies.
  National Interest Electric Transmission Corridor.
 76




---



##### Table of Contents



State Rate Regulation
 Pennsylvania
 Default Service Regulations.
   Transmission Expansion.
 77




---



##### Table of Contents



Management Efficiency Audit.
 
    
    Develop an improvement plan to meet the Pennsylvania PUCs three-year distribution
reliability standards;
    
    Conduct a study to determine utilization practices for contractors and company line
workers;
    
    Enforce an underground damage prevention program;
    
    Charge affiliate pole attachment fees consistent with the fees charged to non-affiliates;
and
    
    Intensify efforts toward attaining representation of women and minorities.
  West Virginia
 Transmission Expansion.
 
    
    Monongahela, Potomac Edison and TrAIL Company will locate 100 to 150 managerial,
professional, technical and administrative jobs in north-central West Virginia no later
than the in-service date of the West Virginia segment of TrAIL, which will involve
construction of a new facility in the state with an estimated cost of approximately $50
million;
    
    Monongahela and Potomac Edison will not seek recovery in West Virginia of
transmission charges associated with TrAIL for the period from January 2007 through the
latest of December 31, 2013, the date which is two and one-half years following the
in-service date of TrAILs West Virginia segment or the month in which Alleghenys new
West Virginia facility is placed in service;
    
    TrAIL Company will contribute $5 million to fund energy conservation programs and
assistance plans for low-income customers in West Virginia over a five year period;
    
    Monongahela and Potomac Edison will provide rate relief in the form of credits
totaling approximately $5.7 million in the aggregate to industrial customers in West
Virginia in 2010 and 2011;
    
    The West Virginia segment of TrAIL should follow the route set forth in TrAIL
Companys application to the West Virginia PSC, except for certain modifications south
of Morgantown, West Virginia, which will more closely follow existing transmission
corridors;
 78




---



##### Table of Contents




    
    The Consumer Advocate, the Staff of the West Virginia PSC and the WVEUG will
support the need for the portion of TrAIL that is proposed to run from Alleghenys 502
Junction in Greene County, Pennsylvania through West Virginia to northern Virginia; and
    
    Landowners on the right-of-way will be provided with transmission credits that
can be used for up to 12,000 kWh of power per year.
   Rate Case.
 Maryland
 Standard Offer Service.
  79




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##### Table of Contents



Advanced Metering and Demand Side Management Initiatives.
   Virginia
 Transmission Expansion.
 Purchased Power Cost Recovery.
 80




---



##### Table of Contents




    
    granted a rate adjustment effective immediately that would permit Potomac Edison
to collect an additional $9.5 million (pre-tax) on an annualized basis through June 30,
2008, a substantially lower amount than the $42.3 million requested;
    
    directed Potomac Edison to implement deferred accounting effective immediately
with respect to the over- or under-recovery of the increased purchased power costs
approved in the order; and
    
    directed Potomac Edison to file an application with the Virginia SCC on or before
July 1, 2008, for proposed recovery of purchased power costs for the 12-month period
beginning July 1, 2008, including for treatment of any over- or under-recovery incurred
for service rendered prior to July 1, 2008 and whether and how its proposed recovery of
purchased power costs for service rendered on and after January 1, 2009 would be
consistent with the MOU and certain amendments to the Restructuring Act.
   81




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##### Table of Contents



th
   82




---



##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
      
 ITEM 4. CONTROLS AND PROCEDURES
  Disclosure Controls and Procedures.
  83




---



##### Table of Contents



Changes in Internal Control over Financial Reporting.
 84




---



##### Table of Contents



PART II. OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
 United Coals .
  
 ITEM 1A. RISK FACTORS
  State rate regulation may delay or deny full recovery of costs and impose risks on Alleghenys
operations. Any denial of, or delay in, cost recovery could have an adverse effect on Alleghenys
business.
  Virginia
     85




---



##### Table of Contents




    
    granted a rate adjustment effective immediately that would permit Potomac Edison
to collect an additional $9.5 million (pre-tax) on an annualized basis through June 30,
2008, a substantially lower amount than the $42.3 million requested;
    
    directed Potomac Edison to implement deferred accounting effective immediately
with respect to the over- or under-recovery of the increased purchased power costs
approved in the order; and
    
    directed Potomac Edison to file an application with the Virginia SCC on or before
July 1, 2008, for proposed recovery of purchased power costs for the 12-month period
beginning July 1, 2008, including for treatment of any over- or under-recovery incurred
for service rendered prior to July 1, 2008 and whether and how its proposed recovery of
purchased power costs for service rendered on and after January 1, 2009 would be
consistent with the MOU and certain amendments to the Restructuring Act.
    86




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##### Table of Contents



West Virginia
    The supply and price of fuel may impact Alleghenys financial results.
  87




---



##### Table of Contents



The TrAIL project and the PATH project are subject to permitting and state regulatory approvals,
and the failure to obtain any of these permits or approvals could have an adverse effect on
Alleghenys business.
  
 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
    88




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##### Table of Contents



Election of directors:
 Nominees for Director
    
    Votes For
    
    Votes WithheldH. Furlong Baldwin
    
    
    122,783,589
    
    
    
    12,297,290Eleanor Baum
    
    
    121,578,201
    
    
    
    13,502,678Paul J. Evanson
    
    
    122,442,748
    
    
    
    12,638,131Cyrus F. Freidheim, Jr.
    
    
    122,518,858
    
    
    
    12,562,021Julia L. Johnson
    
    
    123,379,775
    
    
    
    11,701,104Ted J. Kleisner
    
    
    122,923,552
    
    
    
    12,157,327Christopher D. Pappas
    
    
    132,524,061
    
    
    
    2,556,818Steven H. Rice
    
    
    122,179,879
    
    
    
    12,901,000Gunnar E. Sarsten
    
    
    122,113,847
    
    
    
    12,967,032Michael H. Sutton
    
    
    123,345,696
    
    
    
    11,735,183
 Other items as described above:
 Item
    
    Votes For
    
    Votes Against
    
    Abstentions
    
    Broker Non-Votes(2)
    
    
    133,405,270
    
    
    
    440,314
    
    
    
    1,235,296
    
    
    
    0(3)
    
    
    100,703,562
    
    
    
    14,572,043
    
    
    
    1,400,384
    
    
    
    18,404,890(4)
    
    
    42,634,547
    
    
    
    63,097,086
    
    
    
    10,944,355
    
    
    
    18,404,890
 
 ITEM 5. OTHER INFORMATION
  89




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##### Table of Contents



ITEM 6. EXHIBITS
 EXHIBIT INDEX
 Documents31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under
Securities Exchange Act of 193431.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under
Securities Exchange Act of 193432.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 135032.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350
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SIGNATURE
  ALLEGHENY ENERGY, INC.Date: August 6, 2008
    By:
    /s/ Philip L. GouldingPhilip L. GouldingSenior Vice President and Chief Financial Officer 91