UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005


Commission File Number	Name of Registrant State of Incorporation Address of Principal Executive Offices and Telephone Number	IRS Employer Identification Number
1-267	ALLEGHENY ENERGY, INC. (A Maryland Corporation) 800 Cabin Hill Drive Greensburg, Pennsylvania 15601 Telephone (724) 837-3000	13-5531602

1-5164	MONONGAHELA POWER COMPANY (An Ohio Corporation) 1310 Fairmont Avenue Fairmont, West Virginia 26554 Telephone (304) 366-3000	13-5229392

1-3376-2	THE POTOMAC EDISON COMPANY (A Maryland and Virginia Corporation) 800 Cabin Hill Drive Greensburg, Pennsylvania 15601 Telephone (724) 837-3000	13-5323955

0-14688	ALLEGHENY GENERATING COMPANY (A Virginia Corporation) 800 Cabin Hill Drive Greensburg, Pennsylvania 15601 Telephone (724) 837-3000	13-3079675

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

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

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


Allegheny Energy, Inc.	Yes x	No ¨
Monongahela Power Company	Yes ¨	No x
The Potomac Edison Company	Yes ¨	No x
Allegheny Generating Company	Yes ¨	No x

Number of shares outstanding of each class of common stock as of July 29, 2005:


Allegheny Energy, Inc.	162,740,308	($1.25 par value)
Monongahela Power Company	5,891,000	($50.00 par value)
The Potomac Edison Company	22,385,000	($0.01 par value)
Allegheny Generating Company	1,000	($1.00 par value)

TABLE OF CONTENTS


		Page No.
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)

Allegheny Energy, Inc.:
Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2005 and 2004		4
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2004		5
Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004		6-7
Notes to Consolidated Financial Statements		9-31

Monongahela Power Company:
Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2005 and 2004		32
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2004		33
Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004		34-35
Notes to Consolidated Financial Statements		37-45

The Potomac Edison Company:
Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2005 and 2004		46
Consolidated Statements of Cash Flows for the Six Months Ended June, 2005 and 2004		47
Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004		48-49
Notes to Consolidated Financial Statements		51-54

Allegheny Generating Company:
Statements of Operations for the Three and Six Months Ended June 30, 2005 and 2004		55
Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2004		56
Balance Sheets as of June 30, 2005 and December 31, 2004		57-58
Notes to Financial Statements		60-61

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)		62-104

Item 3. Quantitative and Qualitative Disclosures About Market Risk		105

Item 4. Controls and Procedures		105

PART II. OTHER INFORMATION		105

Item 1. Legal Proceedings		105

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		105

Item 3. Defaults Upon Senior Securities		105

Item 4. Submission of Matters to a Vote of Security Holders		106

Item 5. Other Information		107

Item 6. Exhibits		108-111

Signatures		112

GLOSSARY

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


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

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

AGC		Allegheny Generating Company, an unregulated generation subsidiary of AE Supply.

Allegheny		AE together with its consolidated subsidiaries.

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

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

Monongahela		Monongahela Power Company, a regulated subsidiary of AE.

Mountaineer		Mountaineer Gas Company, a subsidiary of Monongahela.

Potomac Edison		The Potomac Edison Company, a regulated subsidiary of AE.

West Penn		West Penn Power Company, a regulated subsidiary of AE.

WVP		West Virginia Power, a division of Monongahela.

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

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

CDWR		California Department of Water Resources.

Clean Air Act		Clean Air Act of 1970.

Exchange Act		Securities Exchange Act of 1934, as amended.

FASB		Financial Accounting Standards Board.

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

GAAP		Generally accepted accounting principles in the United States of America.

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

Maryland PSC		Maryland Public Service Commission.

MW		Megawatt.

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

OVEC		Ohio Valley Electric Corporation.

Pennsylvania PUC		Pennsylvania Public Utility Commission.

PJM		PJM Interconnection, LLC, a regional transmission organization.

PLR		Provider-of-last-resort.

PUCO		Public Utilities Commission of Ohio.

PUHCA		Public Utility Holding Company Act of 1935, as amended.

PURPA		Public Utility Regulatory Policies Act of 1978.

SEC		United States Securities and Exchange Commission.

SFAS No. 133		FASB’s Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities – Deferral of the Effective Date of FASB Statement No. 133 – an amendment of FASB Statement No. 133,” SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities – an amendment of FASB Statement No. 133,” and SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.”

SFAS No. 144		FASB’s Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets.”

Virginia SCC		Virginia State Corporate Commission.

West Virginia PSC		Public Service Commission of West Virginia.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
(In thousands, except per share amounts)	2005			2004			2005			2004
Operating revenues	$	714,650		$	608,995		$	1,468,680		$	1,344,345

Operating expenses:
Fuel consumed in electric generation		166,139			141,092			340,026			302,804
Purchased power and transmission		108,243			79,877			213,065			160,890
Deferred energy costs, net		(1,805	)		1,209			(619	)		2,123
Operations and maintenance		200,906			232,852			363,583			433,642
Depreciation and amortization		77,358			74,850			153,769			147,837
Taxes other than income taxes		51,738			48,928			106,796			98,113

Total operating expenses		602,579			578,808			1,176,620			1,145,409

Operating income		112,071			30,187			292,060			198,936

Other income and expenses, net (Note 13)		21,234			4,629			26,487			12,483

Interest expense and preferred dividends:
Interest expense		128,277			91,036			254,071			210,866
Preferred dividends of subsidiary		1,260			1,260			2,519			2,519

Total interest expense and preferred dividends		129,537			92,296			256,590			213,385

Income (loss) from continuing operations before income taxes and minority interest		3,768			(57,480	)		61,957			(1,966	)

Income tax expense (benefit) from continuing operations		9,815			(23,948	)		33,191			(930	)

Minority interest in net income (loss) of subsidiaries		52			(720	)		467			1,139

(Loss) income from continuing operations		(6,099	)		(32,812	)		28,299			(2,175	)

Loss from discontinued operations, net of tax (Note 3)		(12,308	)		(6,644	)		(4,064	)		(4,003	)

Net (loss) income	$	(18,407	)	$	(39,456	)	$	24,235		$	(6,178	)

Common Shares Data:
Weighted average common shares outstanding
Basic		156,731			126,971			147,128			126,970
Diluted		156,731			126,971			150,276			126,970
Basic (loss) income per common share:
(Loss) income from continuing operations	$	(0.04	)	$	(0.26	)	$	0.19		$	(0.02	)
Loss from discontinued operations, net		(0.08	)		(0.05	)		(0.03	)		(0.03	)

Net (loss) income per common share	$	(0.12	)	$	(0.31	)	$	0.16		$	(0.05	)

Diluted (loss) income per common share:
(Loss) income from continuing operations	$	(0.04	)	$	(0.26	)	$	0.19		$	(0.02	)
Loss from discontinued operations, net		(0.08	)		(0.05	)		(0.03	)		(0.03	)

Net (loss) income per common share	$	(0.12	)	$	(0.31	)	$	0.16		$	(0.05	)

See accompanying Notes to Consolidated Financial Statements.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


	Six Months Ended June 30,
(In thousands)	2005			2004
Cash Flows From Operating Activities:
Net income (loss)	$	24,235		$	(6,178	)

Adjustments for discontinued operations and non-cash charges and (credits):
Loss from discontinued operations, net		4,064			—
Depreciation and amortization		153,769			168,482
Amortization of debt issuance costs		10,632			26,279
Gain on asset sales and disposals		(1,614	)		(12,074	)
Minority interest in net income of subsidiaries		467			1,139
Deferred investment credit and income taxes, net		27,650			(1,875	)
Stock-based compensation expense		6,390			14,557
Unrealized (gains) losses on commodity contracts, net		(13,278	)		8,350
Other, net		(4,687	)		40,192

Changes in certain assets and liabilities:
Accounts receivable, net		(30,382	)		46,524
Materials, supplies and fuel		(22,701	)		8,468
Prepaid taxes		(4,029	)		(5,803	)
Collateral deposits		(17,111	)		(66,370	)
Accounts payable		(21,769	)		15,148
Accrued taxes		(21,171	)		(38,957	)
Accrued interest		41,082			8,482
Assets and liabilities held for sale		58,077			—
Other, net		(3,922	)		(31,256	)

Net cash provided by operating activities		185,702			175,108

Cash Flows From Investing Activities:
Capital expenditures		(126,641	)		(118,514	)
Proceeds from sale of businesses and assets		13,361			13,680
Decrease in restricted funds		206,562			26,840
Other investments		(767	)		(1,653	)

Net cash provided by (used in) investing activities		92,515			(79,647	)

Cash Flows From Financing Activities:
Net repayments of short-term debt		—			(53,610	)
Issuance of long-term debt		160,040			1,594,921
Retirement of long-term debt		(443,145	)		(1,858,638	)
Exercise of stock options		1,196			—

Net cash used in financing activities		(281,909	)		(317,327	)

Net decrease in cash and cash equivalents		(3,692	)		(221,866	)
Cash and cash equivalents at beginning of period		189,482			528,612

Cash and cash equivalents at end of period	$	185,790		$	306,746

Supplemental Cash Flow Information:
Cash paid for interest (net of amount capitalized)	$	209,157		$	178,139

See accompanying Notes to Consolidated Financial Statements.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(unaudited)


(In thousands)	June 30, 2005			December 31, 2004
ASSETS
Current Assets:
Cash and cash equivalents	$	185,790		$	189,482
Accounts receivable:
Customer		182,063			164,666
Unbilled utility revenue		137,872			145,498
Wholesale and other		50,078			32,966
Allowance for uncollectible accounts		(16,373	)		(19,854	)
Materials and supplies		99,565			100,054
Fuel		85,002			61,812
Deferred income taxes		63,662			44,590
Prepaid taxes		50,929			46,900
Assets held for sale (Note 3)		108,131			150,031
Collateral deposits		105,819			88,708
Commodity contracts		9,364			13,523
Restricted funds		22,295			228,857
Regulatory assets		39,120			37,626
Other		13,093			20,273

Total current assets		1,136,410			1,305,132

Property, Plant and Equipment, Net:
Generation		5,692,267			5,695,851
Transmission		1,029,692			1,015,751
Distribution		3,439,574			3,366,217
Other		462,924			463,515
Accumulated depreciation		(4,426,279	)		(4,341,282	)

Subtotal		6,198,178			6,200,052
Construction work in progress		89,593			102,966

Total property, plant and equipment, net		6,287,771			6,303,018

Investments and Other Assets:
Assets held for sale (Note 3)		316,103			340,457
Goodwill		367,287			367,287
Investments in unconsolidated affiliates		28,835			29,991
Intangible assets		33,010			33,215
Other		46,147			46,628

Total investments and other assets		791,382			817,578

Deferred Charges:
Commodity contracts		1,817			3,667
Regulatory assets		553,945			562,843
Other		46,195			52,902

Total deferred charges		601,957			619,412

Total Assets	$	8,817,520		$	9,045,140

See accompanying Notes to Consolidated Financial Statements.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (continued)

(unaudited)


(In thousands)	June 30, 2005			December 31, 2004
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Long-term debt due within one year (Note 2)	$	384,953		$	385,142
Accounts payable		201,760			223,584
Accrued taxes		89,764			112,866
Commodity contracts		47,102			40,835
Accrued interest		99,305			61,726
Liabilities associated with assets held for sale (Note 3)		47,472			37,471
Other		149,519			144,082

Total current liabilities		1,019,875			1,005,706

Long-term Debt (Note 2)		3,971,835			4,540,764

Deferred Credits and Other Liabilities:
Commodity contracts		46,307			56,501
Investment tax credit		80,136			83,307
Deferred income taxes		679,944			635,374
Obligations under capital leases		20,110			23,788
Regulatory liabilities		462,517			453,913
Adverse power purchase commitment		192,801			201,377
Liabilities associated with assets held for sale (Note 3)		89,295			89,356
Other		489,107			505,620

Total deferred credits and other liabilities		2,060,217			2,049,236

Commitments and Contingencies (Note 16)

Minority Interest		22,085			21,618

Preferred Stock of Subsidiary		74,000			74,000

Common Stockholders’ Equity:

Common stock—$1.25 par value per share, 260,000,000 shares authorized, 162,713,281 and 137,430,137 shares issued, and 162,663,788 and 137,380,644 shares outstanding at June 30, 2005 and December 31, 2004, respectively		203,392			171,788
Other paid-in capital		1,869,953			1,600,215
Accumulated deficit		(283,455	)		(307,690	)
Treasury stock		(1,756	)		(1,756	)
Accumulated other comprehensive loss		(118,626	)		(108,741	)

Total common stockholders’ equity		1,669,508			1,353,816

Total Liabilities and Stockholders’ Equity	$	8,817,520		$	9,045,140

See accompanying Notes to Consolidated Financial Statements.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)


Note No.		Page No.
1	Basis of Presentation	9

2	Debt	12

3	Assets Held for Sale and Discontinued Operations	15

4	Asset Sales	16

5	Goodwill and Intangible Assets	16

6	Derivative Instruments and Hedging Activities	17

7	Asset Retirement Obligations (“AROs”)	18

8	Comprehensive (Loss) Income	18

9	Business Segments	18

10	Accounting for the Effects of Price Regulation	20

11	Income Per Share	21

12	Pension Benefits and Postretirement Benefits Other Than Pensions	21

13	Other Income and Expenses, Net	23

14	Guarantees and Letters of Credit	23

15	Variable Interest Entities	23

16	Commitments and Contingencies	24

17	Subsequent Events	30

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1: BASIS OF PRESENTATION

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

The Delivery and Services segment primarily consists of AE’s regulated utility subsidiaries. These subsidiaries include Monongahela Power Company (“Monongahela”), excluding its generation operations, The Potomac Edison Company (“Potomac Edison”) and West Penn Power Company (“West Penn”) (collectively, the “Distribution Companies”). These subsidiaries primarily operate electric transmission and distribution systems in Pennsylvania, West Virginia, Maryland, Virginia and Ohio. These subsidiaries are subject to federal and state regulation. The Delivery and Services segment also includes Allegheny Ventures, Inc. (“Allegheny Ventures”).

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

Allegheny Energy Service Corporation (“AESC”) is a wholly owned subsidiary of AE that employs substantially all of the people who work at Allegheny.

AE is a holding company registered under the Public Utility Holding Company Act of 1935 (“PUHCA”), and Allegheny is subject to regulation by the Securities and Exchange Commission (“the SEC”) under PUHCA. Currently, PUHCA imposes financial and operational conditions and restrictions on many aspects of Allegheny’s business. For example, PUHCA requires pre-approval from the SEC for, among other things, the issuance of debt or equity securities and for the sale or acquisition of utility assets. In July 2005, both houses of Congress passed comprehensive energy legislation, the Energy Policy Act of 2005 (the “Energy Policy Act”), which is awaiting the President’s signature. Among other things, the Energy Policy Act provides for the repeal of PUHCA effective six months after its enactment. The Energy Policy Act grants the Federal Energy Regulatory Commission (“FERC”) additional jurisdiction to approve utility mergers, acquisitions and certain asset transfers. The Energy Policy Act also provides tax incentives designed to encourage investment in transmission assets and the installation of pollution controls on certain generating facilities. Allegheny is assessing the impact this legislation will have on Allegheny.

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

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

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

During the third quarter of 2004, AE and certain of its subsidiaries entered into agreements to sell, or made the decision to sell, certain non-core assets. The results of operations relating to these assets have been reclassified to discontinued operations in the accompanying Consolidated Statements of Operations for all

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

periods presented. In accordance with the provisions of the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), the assets and liabilities associated with these discontinued operations have been reclassified as held for sale in the Consolidated Balance Sheets as of, and subsequent to, the date that held for sale criteria were met. Certain other prior period amounts in the financial statements have been reclassified to conform to the presentation for the current period.

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

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

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

Stock-Based Compensation. AE maintains certain stock-based employee compensation arrangements, which are described in greater detail in Item 8, Note 18, Stock-Based Compensation, in the 2004 Annual Report on Form 10-K. These arrangements include AE’s Long-Term Incentive Plan, under which stock option awards, restricted share awards and performance awards may be granted. Options to purchase approximately 0.2 million and 0.4 million shares of AE’s common stock were granted under the Long-Term Incentive Plan during the three and six months ended June 30, 2005, respectively.

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

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

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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


	Three Months Ended June 30,						Six Months Ended June 30,
(In millions)	2005			2004			2005		2004
Consolidated net (loss) income, as reported	$	(18.4	)	$	(39.5	)	$	24.2	$	(6.2	)
Add:
Stock-based employee compensation expense included in consolidated net (loss) income, net of related tax effects		1.8			4.8			3.7		8.8
Deduct:
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		3.0			5.8			6.2		11.3

Consolidated net (loss) income, pro forma	$	(19.6	)	$	(40.5	)	$	21.7	$	(8.7	)

Basic (loss) income per share:
As reported	$	(0.12	)	$	(0.31	)	$	0.16	$	(0.05	)
Pro forma	$	(0.13	)	$	(0.32	)	$	0.15	$	(0.07	)

Diluted (loss) income per share:
As reported	$	(0.12	)	$	(0.31	)	$	0.16	$	(0.05	)
Pro forma	$	(0.13	)	$	(0.32	)	$	0.14	$	(0.07	)

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

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 2: DEBT

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


	Three Months Ended June 30, 2005				Six Months Ended June 30, 2005
(In millions)	Issuances		Redemptions		Issuances		Redemptions
AE:
Convertible Preferred Securities	$	—	$	300.0	$	—	$	300.0
Prior Credit Facility (a)		47.0		122.0		47.0		147.0
New AE Credit Facility (b)		122.0		—		122.0		—

Total AE	$	169.0	$	422.0	$	169.0	$	447.0

AE Supply:
Prior AE Supply Loan (c)	$	—	$	35.4	$	—	$	243.8
Medium-Term Notes		—		—		—		14.4

Total AE Supply	$	—	$	35.4	$	—	$	258.2

West Penn:
Transition Bonds	$	—	$	18.5	$	—	$	37.9

Allegheny:
Convertible Preferred Securities	$	—	$	300.0	$	—	$	300.0
New AE Credit Facility (b)		122.0		—		122.0		—
Prior Credit Facility (a)		47.0		122.0		47.0		147.0
Medium-Term Notes		—		—		—		14.4
Prior AE Supply Loan (c)		—		35.4		—		243.8
Transition Bonds		—		18.5		—		37.9

Total Allegheny	$	169.0	$	475.9	$	169.0	$	743.1

(a)	Reflects issuances and redemptions under AE’s prior credit facility, which, as discussed below, was refinanced on June 16, 2005.

(b)	Reflects issuances under AE’s new revolving credit facility, which, as discussed below, was entered into on June 16, 2005.

(c)	Reflects redemptions under AE Supply’s prior term loan, which, as discussed below, was refinanced on July 21, 2005.

In April 2005, the holders of $295.0 million of the outstanding $300.0 million in Trust Preferred Securities issued by Allegheny Capital Trust I (“Capital Trust”) accepted AE and Capital Trust’s tender offer and consent solicitation. Under the terms of the offer, for each $1,000 in liquidation amount of Trust Preferred Securities tendered, a holder received 83.33 shares of AE common stock and $160 in cash. On April 22, 2005, AE issued an aggregate of 24.6 million shares of its common stock and $47.2 million in cash to the holders of the tendered Trust Preferred Securities. In accordance with SFAS No. 84, “Induced Conversions of Convertible Debt,” the $47.2 million cash payment was expensed during the second quarter of 2005. In addition, AE received the required consents from holders of the Trust Preferred Securities for amendments to the indenture governing AE’s 117/8% Notes due 2008. The holder of the remaining $5.0 million in liquidation amount of Trust Preferred Securities converted its Trust Preferred Securities into 416,650 shares of AE common stock on May 3, 2005.

On June 16, 2005, AE and AE Supply (together, the “Borrowers”) entered into a new $700 million credit facility (the “New AE Credit Facility”) comprised of a $400 million senior unsecured revolving credit facility (the “Revolving Facility”) and a $300 million senior unsecured term loan (the “Term Facility”). The terms of the New AE Credit Facility are set forth in a Credit Agreement, dated as of June 16, 2005, among the Borrowers, the initial lenders named therein and Citicorp North America, Inc., as Administrative Agent (the “Credit Agreement”). The Revolving Facility (a) refinanced the aggregate principal amount of approximately $122 million outstanding under AE’s prior credit facility, (b) continues letters of credit issued under AE’s prior credit facility in the aggregate

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

amount of approximately $11.5 million and (c) provides working capital and letters of credit for AE and, subject to certain limitations, its subsidiaries. The lenders under the Revolving Facility are required to make revolving credit loans to, and issue letters of credit at the request of, AE. In addition, subject to certain limitations, AE Supply may borrow, or request letters of credit for, up to $50 million directly under the Revolving Facility. AE is permitted to request letters of credit in an amount not in excess of $125 million on behalf of AE Supply and its subsidiaries. The Revolving Facility matures June 16, 2010.

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

Loans under the New AE Credit Facility bear interest, depending on the type of loan requested by the Borrowers, at a rate equal to either (i) the higher of the rate announced publicly by Citibank in New York, from time to time, as Citibank’s base rate or 0.50% above the Federal Funds Rate (as defined in the Credit Agreement) (the “Base Rate”), plus the applicable margin, which is between 1.50% and 0.50% for Base Rate loans, or (ii) the Eurodollar Rate (as defined in the Credit Agreement), plus the applicable margin, which is between 2.50% and 1.50% for Eurodollar Rate-based loans. The Eurodollar Rate is determined by dividing LIBOR (as defined in the Credit Agreement) by a percentage equal to 1.00 minus the Eurodollar Rate Reserve Percentage (as defined in the Credit Agreement). The applicable margin for LIBOR borrowings was 2.00% at June 30, 2005. With respect to each letter of credit, the relevant Borrower is required to pay to the Administrative Agent a letter of credit fee equal to the applicable margin, which ranges from 2.50% to 1.50%, times the daily maximum amount available to be drawn under such letter of credit. In each case of a Base Rate loan, Eurodollar Rate loan or letter of credit, the applicable margin varies depending upon Standard & Poor’s and Moody’s Investors Service, Inc.’s ratings of certain of AE’s public debt. The Borrowers’ ability to request and maintain Eurodollar Rate loans is subject to certain limitations.

During the six months ended June 30, 2005, AE Supply repaid an aggregate of $243.8 million outstanding under the prior AE Supply loan.

At June 30, 2005, contractual maturities for Allegheny’s long-term debt for the remainder of 2005 and the full years thereafter, excluding $86.7 million of long-term debt included in liabilities associated with assets held for sale, are:


(In millions)	2005			2006			2007			2008			2009			Thereafter			Total
Medium-Term Notes	$	300.0		$	100.0		$	365.6		$	—		$	—		$	1,240.0		$	2,005.6
Prior AE Supply Loan		5.2			10.4			10.4			10.4			10.5			691.4			738.3
First Mortgage Bonds		—			300.0			—			—			—			510.0			810.0
Pollution Control Bonds		—			—			107.2			—			—			261.6			368.8
Transition Bonds		35.1			75.8			80.0			44.3			—			—			235.2
New AE Credit Facility		—			—			—			—			—			122.0			122.0
Debentures		—			—			—			—			—			100.0			100.0
Unamortized debt discounts, premiums and terminated interest rate swaps		(0.3	)		(1.3	)		(1.2	)		(1.3	)		(1.3	)		(4.9	)		(10.3	)
Eliminations		—			—			(2.3	)		—			—			(10.5	)		(12.8	)

Total consolidated debt	$	340.0		$	484.9		$	559.7		$	53.4		$	9.2		$	2,909.6		$	4,356.8

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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


(In millions)	2005			2006			2007			2008			2009			Thereafter			Total
AE:
Medium-Term Notes	$	300.0		$	—		$	—		$	—		$	—		$	—		$	300.0
New AE Credit Facility		—			—			—			—			—			122.0			122.0

Total AE	$	300.0		$	—		$	—		$	—		$	—		$	122.0		$	422.0

AE Supply:
Pollution Control Bonds	$	—		$	—		$	91.7		$	—		$	—		$	191.4		$	283.1
Medium-Term Notes		—			—			365.6			—			—			1,050.0			1,415.6
Debentures-AGC		—			—			—			—			—			100.0			100.0
Prior AE Supply Loan		5.2			10.4			10.4			10.4			10.5			691.4			738.3

Total AE Supply	$	5.2		$	10.4		$	467.7		$	10.4		$	10.5		$	2,032.8		$	2,537.0

Monongahela:
First Mortgage Bonds	$	—		$	300.0		$	—		$	—		$	—		$	190.0		$	490.0
Pollution Control Bonds		—			—			15.5			—			—			70.2			85.7
Medium-Term Notes		—			—			—			—			—			110.0			110.0

Total Monongahela	$	—		$	300.0		$	15.5		$	—		$	—		$	370.2		$	685.7

Potomac Edison:
First Mortgage Bonds	$	—		$	—		$	—		$	—		$	—		$	320.0		$	320.0
Medium-Term Notes		—			100.0			—			—			—			—			100.0

Total Potomac Edison	$	—		$	100.0		$	—		$	—		$	—		$	320.0		$	420.0

West Penn:
Transition Bonds	$	35.1		$	75.8		$	80.0		$	44.3		$	—		$	—		$	235.2
Medium-Term Notes		—			—			—			—			—			80.0			80.0

Total West Penn	$	35.1		$	75.8		$	80.0		$	44.3		$	—		$	80.0		$	315.2

AGC:
Debentures	$	—		$	—		$	—		$	—		$	—		$	100.0		$	100.0

Sub-total	$	340.3		$	486.2		$	563.2		$	54.7		$	10.5		$	3,025.0		$	4,479.9

Unamortized debt discounts, premiums and terminated Interest rate swaps	$	(0.3	)	$	(1.3	)	$	(1.2	)	$	(1.3	)	$	(1.3	)	$	(4.9	)	$	(10.3	)
Eliminations	$	—		$	—		$	(2.3	)	$	—		$	—		$	(110.5	)	$	(112.8	)

Total consolidated debt	$	340.0		$	484.9		$	559.7		$	53.4		$	9.2		$	2,909.6		$	4,356.8

Liabilities associated with assets held for sale:
Other Notes	$	3.3		$	3.3		$	3.4		$	3.3		$	13.4		$	60.0		$	86.7

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

On July 21, 2005, AE Supply obtained a secured credit facility comprised of a term loan (the “New AE Supply Term Loan”) of $1.07 billion. Proceeds from the New AE Supply Term Loan were used, in part, to refinance approximately $738 million outstanding under the prior AE Supply loan. Proceeds from the New AE Supply Term Loan will also be used to redeem AE Supply’s 10.25% Senior Notes due 2007, which have a principal amount outstanding of approximately $331 million. The New AE Supply Term Loan matures in 2011, and has an initial interest rate equal to LIBOR plus 1.75%. The interest rate will improve to LIBOR plus 1.50% if

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

AE Supply’s credit ratings improve from current levels. AE Supply will use cash on hand and may also borrow under the Revolving Facility to redeem its 13.0% Senior Notes due 2007, which have a principal amount outstanding of approximately $35 million, and pay associated costs. AE Supply issued a Notice of Redemption to holders of record of the 10.25% and 13.0% Senior Notes outlining the terms and conditions of the anticipated redemption, which is expected to occur on August 22, 2005. AE Supply expects to take a pre-tax charge of approximately $34 million during the third quarter of 2005 to reflect the premium paid and costs associated with the redemptions.

NOTE 3: ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

During the third quarter of 2004, Allegheny and certain of its subsidiaries entered into agreements to sell, or made the decision to sell, certain non-core assets. The results of operations relating to these assets have been reclassified to discontinued operations in the accompanying Consolidated Statements of Operations for all periods presented. In accordance with the provisions of SFAS No. 144, the assets and liabilities associated with these discontinued operations have been reclassified as held for sale in the accompanying balance sheets.

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


	Three Months Ended June 30,						Six Months Ended June 30,
(In millions)	2005			2004			2005			2004
AE Supply:
Operating revenues	$	0.2		$	7.0		$	0.4		$	12.5
Operating expenses		(1.1	)		(9.9	)		(2.3	)		(19.6	)
Interest expense		(3.1	)		(5.8	)		(6.2	)		(14.8	)

Loss before income taxes		(4.0	)		(8.7	)		(8.1	)		(21.9	)
Income tax benefit		1.4			3.2			2.8			8.1
Impairment charge, net of tax		(3.2	)		—			(3.2	)		—

Loss from discontinued operations, net of tax	$	(5.8	)	$	(5.5	)	$	(8.5	)	$	(13.8	)

Monongahela:
Operating revenues	$	46.6		$	41.1		$	196.8		$	190.0
Operating expenses		(46.0	)		(42.5	)		(176.2	)		(171.1	)
Other income		0.6			0.1			0.9			0.3
Interest expense		(2.0	)		(2.1	)		(4.1	)		(4.1	)

(Loss) income before income taxes		(0.8	)		(3.4	)		17.4			15.1
Income tax benefit (expense)		—			2.2			(6.7	)		(5.3	)
Impairment charge, net of tax		(5.7	)		—			(6.3	)		—

(Loss) income from discontinued operations, net of tax	$	(6.5	)	$	(1.2	)	$	4.4		$	9.8

Allegheny:
Operating revenues	$	46.8		$	48.1		$	197.2		$	202.5
Operating expenses		(47.1	)		(52.4	)		(178.5	)		(190.7	)
Other income		0.6			0.1			0.9			0.3
Interest expense		(5.1	)		(7.9	)		(10.3	)		(18.9	)

(Loss) income before income taxes		(4.8	)		(12.1	)		9.3			(6.8	)
Income tax benefit (expense)		1.4			5.4			(3.9	)		2.8
Impairment charge, net of tax		(8.9	)		—			(9.5	)		—

Loss from discontinued operations, net of tax	$	(12.3	)	$	(6.7	)	$	(4.1	)	$	(4.0	)

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

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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


(In millions)	Monongahela		AE Supply		Eliminations			Allegheny
Assets:
Current assets	$	115.2	$	2.2	$	(9.3	)	$	108.1
Property, plant and equipment		157.1		147.3		—			304.4
Investments and other assets		6.8		—		—			6.8
Deferred charges		5.4		—		(0.5	)		4.9

Total assets	$	284.5	$	149.5	$	(9.8	)	$	424.2

Liabilities:
Current liabilities	$	67.6	$	—	$	(20.1	)	$	47.5
Long-term debt		83.4		—		—			83.4
Deferred credits and other liabilities		15.9		—		(10.0	)		5.9

Total liabilities	$	166.9	$	—	$	(30.1	)	$	136.8

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


(In millions)	Monongahela		Potomac Edison		AE Supply		Eliminations			Allegheny
Assets:
Current assets	$	147.8	$	—	$	2.2	$	—		$	150.0
Property, plant and equipment		163.7		10.8		153.3		—			327.8
Investments and other assets		6.8		—		—		—			6.8
Deferred charges		6.3		—		—		(0.5	)		5.8

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

Liabilities:
Current liabilities	$	95.5	$	—	$	—	$	(58.0	)	$	37.5
Long-term debt		83.4		—		—		—			83.4
Deferred credits and other liabilities		17.6		—		—		(11.6	)		6.0

Total liabilities	$	196.5	$	—	$	—	$	(69.6	)	$	126.9

NOTE 4: ASSET SALES

On May 6, 2005, AE Supply and its subsidiaries, Allegheny Energy Supply Wheatland Generating Facility, LLC and Lake Acquisition Company, LLC, signed an agreement with PSI Energy, Inc. and The Cincinnati Gas & Electric Company (collectively, the “Wheatland Buyers”), pursuant to which the Wheatland Buyers agreed to purchase certain of the assets and assume certain of the liabilities relating to AE Supply’s Wheatland generating facility, which is included in “Assets held for Sale.” The purchase price for the transaction is $100 million, subject to certain post-closing adjustments. The transaction is subject to certain closing conditions and federal regulatory approvals and is expected to close in the third quarter of 2005. Proceeds from the sale are expected to be used to repay debt.

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

NOTE 5: GOODWILL AND INTANGIBLE ASSETS

There were no changes in goodwill during the six months ended June 30, 2005.

The intangible assets included in “Investments and Other Assets” on the Consolidated Balance Sheets of $33.0 million and $33.2 million at June 30, 2005 and December 31, 2004, respectively, relate to an additional minimum pension liability. See Item 8, Note 17, “Pension Benefits and Postretirement Benefits Other Than Pensions,” in the 2004 Annual Report on Form 10-K for more information.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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


	As of June 30, 2005				As of December 31, 2004
(In millions)	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Land easements, amortized	$	97.7	$	26.4	$	96.5	$	25.8
Land easements, unamortized		31.8		—		31.8		—
Software		86.0		62.4		82.7		55.8

Total	$	215.5	$	88.8	$	211.0	$	81.6

In addition, “Assets held for sale” included intangible assets related to natural gas rights, amortized, with a gross carrying amount of $8.4 million at June 30, 2005 and $8.6 million at December 31, 2004, and accumulated amortization of $5.1 million at June 30, 2005 and $4.9 million at December 31, 2004.

Amortization of intangible assets, excluding Mountaineer, which is included in “Assets held for sale,” was $3.8 million and $4.5 million for the three months ended June 30, 2005 and 2004, respectively, and $7.6 million and $8.9 million for the six months ended June 30, 2005 and 2004, respectively.

Amortization expense is estimated to be $15.1 million annually for 2005 through 2009.

NOTE 6: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

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

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

AE Supply has designated certain contracts as cash flow hedges effective July 1, 2004. Changes in the fair value of these contracts are reflected in “Accumulated other comprehensive (loss) income.” Existing derivative liabilities associated with each contract at the time of its designation will be realized in earnings over the remaining term of the contract, in accordance with the estimated cash flow of the contract at the time of the designation. These contracts expire at various dates through December 31, 2006 and represent an aggregate liability at June 30, 2005 of $41.8 million. The $10.7 million increase in this liability since December 31, 2004 is a result of the change in the fair value of these contracts and is reflected in accumulated other comprehensive loss. The accumulated other comprehensive loss balance at June 30, 2005 was $18.7 million. Based on the fair value of AE Supply’s financial instruments as of June 30, 2005, accumulated other comprehensive loss of $10.7 million is expected to be reclassified as a reduction in earnings over the next twelve months. The ineffective portion of the cash flow hedges is reflected in earnings for the three and six months ended June 30, 2005 and is not material.

Net unrealized gains of $9.2 million and $2.8 million, before income taxes, for the three months ended June 30, 2005 and 2004, respectively, were recorded in “Operating revenues.” Net unrealized gains (losses) of $13.3 million and $(8.3) million, before income taxes, for the six months ended June 30, 2005 and 2004, respectively, were recorded in “Operating revenues.” These net unrealized gains (losses) were recorded to reflect the change in fair value of the trading contracts.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 7: ASSET RETIREMENT OBLIGATIONS (“AROs”)

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

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

For the six months ended June 30, 2005, Allegheny’s ARO balance increased $1.8 million, from $28.8 million at December 31, 2004 to $30.6 million at June 30, 2005, primarily due to accretion expense.

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


(In millions)	June 30, 2005			December 31, 2004
Monongahela	$	247.0		$	241.8
Potomac Edison		167.0			162.3
West Penn		(17.8	)		(17.2	)

Total	$	396.2		$	386.9

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

NOTE 8: COMPREHENSIVE (LOSS) INCOME

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


	Three Months Ended June 30,						Six Months Ended June 30,
(In millions)	2005			2004			2005			2004
Consolidated net (loss) income	$	(18.4	)	$	(39.5	)	$	24.2		$	(6.2	)
Other comprehensive (loss) income, net of tax:
Minimum pension liability adjustment		(0.1	)		—			(0.2	)		2.3
Changes in value of available for sale securities		(0.2	)		0.1			(0.3	)		—
Changes in fair value of cash flow hedges		0.4			—			(9.4	)		0.1

Consolidated comprehensive (loss) income	$	(18.3	)	$	(39.4	)	$	14.3		$	(3.8	)

NOTE 9: BUSINESS SEGMENTS

Allegheny manages and evaluates its operations in two business segments, the Delivery and Services segment and the Generation and Marketing segment. Monongahela operates in both segments. All other Allegheny subsidiaries operate in only one segment. The Delivery and Services segment includes the operations of Potomac Edison, West Penn, Allegheny Ventures and Monongahela’s electric and gas transmission and distribution businesses. The Generation and Marketing segment includes the operations of AE Supply, AGC and Monongahela’s West Virginia generating assets.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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


	Three Months Ended June 30,						Six Months Ended June 30,
(In millions)	2005			2004			2005			2004
Total operating revenues:
Delivery and Services	$	663.2		$	658.6		$	1,402.6		$	1,379.9
Generation and Marketing		404.5			320.5			821.4			742.8
Eliminations		(353.0	)		(370.1	)		(755.3	)		(778.4	)

Total	$	714.7		$	609.0		$	1,468.7		$	1,344.3

Depreciation and amortization:
Delivery and Services	$	39.0		$	36.6		$	77.1		$	73.7
Generation and Marketing		38.4			38.2			76.7			74.1

Total	$	77.4		$	74.8		$	153.8		$	147.8

Operating income (expense):
Delivery and Services	$	58.9		$	67.1		$	154.8		$	143.0
Generation and Marketing		53.2			(36.9	)		137.3			55.9

Total	$	112.1		$	30.2		$	292.1		$	198.9

Interest Expense:
Delivery and Services	$	46.5		$	31.5		$	75.4		$	63.9
Generation and Marketing		82.0			59.5			178.9			147.0
Elimination		(0.2	)		—			(0.2	)		—

Total	$	128.3		$	91.0		$	254.1		$	210.9

Income (loss) from continuing operations:
Delivery and Services	$	16.9		$	25.4		$	66.6		$	53.4
Generation and Marketing		(23.0	)		(58.2	)		(38.2	)		(55.6	)
Eliminations		—			—			(0.1	)		—

Total	$	(6.1	)	$	(32.8	)	$	28.3		$	(2.2	)

(Loss) income from discontinued operations, net:
Delivery and Services	$	(6.5	)	$	(1.2	)	$	4.3		$	9.8
Generation and Marketing		(5.8	)		(5.5	)		(8.5	)		(13.8	)
Eliminations		—			—			0.1			—

Total	$	(12.3	)	$	(6.7	)	$	(4.1	)	$	(4.0	)

Net income (loss):
Delivery and Services	$	10.4		$	24.2		$	70.9		$	63.2
Generation and Marketing		(28.8	)		(63.7	)		(46.7	)		(69.4	)

Total	$	(18.4	)	$	(39.5	)	$	24.2		$	(6.2	)

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 10: ACCOUNTING FOR THE EFFECTS OF PRICE REGULATION

As of June 30, 2005, Allegheny’s reserve for adverse power purchase commitments, which is recorded entirely on West Penn’s Consolidated Balance Sheets, was $209.7 million and decreased as follows:


	Six Months Ended June 30,
(In millions)	2005		2004
Decrease in reserve for adverse power purchase commitments	$	8.4	$	9.0

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


(In millions)	June 30, 2005			December 31, 2004
Property, plant and equipment	$	4,109.1		$	4,121.2
Amounts under construction included above	$	43.4		$	36.1
Accumulated depreciation	$	(1,941.3	)	$	(1,925.6	)

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 11: (LOSS) INCOME PER SHARE

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


	Three Months Ended June 30,						Six Months Ended June 30,
(In millions, except share data)	2005			2004			2005			2004
Basic (Loss) Earnings Per Share—Numerator
(Loss) income from continuing operations	$	(6.1	)	$	(32.8	)	$	28.3		$	(2.2	)
Loss from discontinued operations		(12.3	)		(6.7	)		(4.1	)		(4.0	)

Net (loss) income	$	(18.4	)	$	(39.5	)	$	24.2		$	(6.2	)

Diluted (Loss) Earnings Per Share—Numerator
(Loss) income from continuing operations	$	(6.1	)	$	(32.8	)	$	28.3		$	(2.2	)
Loss from discontinued operations		(12.3	)		(6.7	)		(4.1	)		(4.0	)

Diluted earnings per share- numerator	$	(18.4	)	$	(39.5	)	$	24.2		$	(6.2	)

Basic (Loss) Earnings Per Share—Denominator
Weighted average common shares outstanding		156,730,744			126,971,447			147,127,707			126,970,373

Diluted (Loss) Earnings Per Share—Denominator
Weighted average common shares outstanding		156,730,744			126,971,447			147,127,707			126,970,373
Stock options		—			—			999,071			—
Performance shares		—			—			61,065			—
Non-employee stock awards		—			—			19,600			—
Stock units		—			—			2,068,986			—

Total		156,730,744			126,971,447			150,276,429			126,970,373

Shares potentially issuable under:
Stock options		1,041,027			209,319			—			38,985
Performance shares		62,765			106,963			—			106,963
Non-employee stock awards		22,400			—			—			—
Stock units		1,914,873			1,756,859			—			1,398,604
Trust Preferred Securities		5,819,363			25,000,000			15,356,198			25,000,000

Total		8,860,428			27,073,141			15,356,198			26,544,552

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

NOTE 12: PENSION BENEFITS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS

Substantially all of Allegheny’s employees, including officers, are employed by AESC and are covered by noncontributory, defined benefit pension plans. Benefits are based on each employee’s years of service and compensation. Allegheny makes annual contributions based on the minimum amount required under the Employee Retirement Income Security Act of 1974 (“ERISA”). Annual contributions are capped at the maximum amount that may be deducted for federal income tax purposes.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Allegheny also provides partially contributory medical and life insurance plans for eligible retirees and dependents. Medical benefits, which make up the largest component of the plans, are based upon an age and years-of-service vesting schedule and other plan provisions. Subsidized medical coverage is not provided in retirement to employees hired on or after January 1, 1993, with the exception of certain union employees. The postretirement health care plans include a limit on Allegheny’s share of costs for recent and future retirees.

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


	Pension Benefits
	Three Months Ended June 30,						Six Months Ended June 30,
(In millions)	2005			2004			2005			2004
Components of net periodic cost:
Service cost	$	5.8		$	5.9		$	11.7		$	11.7
Interest cost		16.0			15.6			31.8			31.3
Expected return on plan assets		(17.3	)		(17.3	)		(34.6	)		(34.6	)
Amortization of unrecognized transition obligation		0.1			0.1			0.2			0.3
Amortization of prior service cost		0.9			1.1			1.8			2.1
Recognized actuarial loss		2.3			1.3			4.6			2.5

Subtotal		7.8			6.7			15.5			13.3
Curtailments, settlements and special termination benefits		—			1.9			0.2			3.3

Net periodic cost	$	7.8		$	8.6		$	15.7		$	16.6

Allocation of net periodic cost:
Monongahela	$	2.5		$	2.1		$	5.0		$	4.4
AE Supply		2.1			3.8			4.4			6.4
West Penn		1.8			1.5			3.5			3.2
Potomac Edison		1.3			1.1			2.6			2.3
AE		0.1			0.1			0.2			0.3

Net periodic cost	$	7.8		$	8.6		$	15.7		$	16.6


	Postretirement Benefits Other Than Pensions
	Three Months Ended June 30,						Six Months Ended June 30,
(In millions)	2005			2004			2005			2004
Components of net periodic cost:
Service cost	$	1.0		$	1.1		$	2.0		$	2.2
Interest cost		4.2			3.9			8.4			7.8
Expected return on plan assets		(1.5	)		(1.6	)		(3.0	)		(3.1	)
Amortization of unrecognized transition obligation		1.4			1.5			2.9			2.9
Amortization of prior service cost		—			0.1			—			0.2
Recognized actuarial loss		0.5			—			1.0			—

Net periodic cost	$	5.6		$	5.0		$	11.3		$	10.0

Allocation of net periodic cost:
Monongahela	$	1.6		$	1.5		$	3.2		$	3.0
West Penn		1.6			1.3			3.1			2.5
Potomac Edison		1.2			1.1			2.4			2.1
AE Supply		1.2			1.1			2.5			2.3
AE		—			—			0.1			0.1

Net periodic cost	$	5.6		$	5.0		$	11.3		$	10.0

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Employer Contributions. Allegheny contributed approximately $8.3 million and $28.4 million to its pension plans during the three and six months ended June 30, 2005, respectively, including voluntary contributions of $0.1 million and $0.2 million, respectively, to the Supplemental Executive Retirement Plan (“SERP”). Allegheny also contributed $5.6 million and $11.6 million to its postretirement benefits other than pension plans during the three and six months ended June 30, 2005, respectively. Allegheny anticipates contributing a total amount of approximately $58.1 million to its pension plans during 2005, including $0.3 million to the SERP. Allegheny also currently anticipates contributing a total amount ranging from $23.5 million to $28.0 million to fund postretirement benefits other than pensions during 2005.

Allegheny made matching contributions to the 401(k) Employee Stock Ownership and Savings Plan (the “ESOSP”) by issuing shares of AE’s common stock. AE issued a total of 83,783 shares and 167,993 shares of its common stock as matching contributions to the ESOSP for the three and six months ended June 30, 2005, respectively. Allegheny recorded expense for these contributions of $2.1 million and $3.8 million for the three and six months ended June 30, 2005, respectively.

NOTE 13: OTHER INCOME AND EXPENSES, NET

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


	Three Months Ended June 30,				Six Months Ended June 30,
(In millions)	2005		2004		2005		2004
Cash received from a former trading executive’s forfeited assets	$	11.2	$	—	$	11.2	$	—
Proceeds from sale of AFN		3.0		—		3.0		—
Gain on sale of land		—		0.5		1.6		7.1
Gain on sale of asset		0.8		—		0.8		—
Interest and dividend income		3.2		1.1		5.0		2.7
Coal brokering income		1.1		1.0		1.1		1.0
Premium services		0.8		1.4		1.8		1.6
Impairment charges related to unregulated investments		—		—		—		(2.3	)
Other		1.1		0.6		2.0		2.4

Total	$	21.2	$	4.6	$	26.5	$	12.5

NOTE 14: GUARANTEES AND LETTERS OF CREDIT

As of June 30, 2005, Allegheny’s Consolidated Balance Sheet reflected liabilities for $9.1 million of the total $26.7 million in outstanding guarantees. The $9.1 million in guarantees recorded as liabilities were issued by AE Supply in connection with the sale of its contract with the California Department of Water Resources (“CDWR”) and related hedge transactions and the performance of a put option issued in connection with an asset sale.

Of the remaining $17.6 million in unrecorded guarantees, approximately $3.1 million relates to the purchase, sale, exchange or transportation of wholesale natural gas, electric power and related services, $4.7 million relates to a lease agreement that was signed in 2001 and $9.8 million relates to loans and other financing-related matters. In addition, $11.5 million in letters of credit were outstanding at June 30, 2005 under AE’s revolving credit facility. Of this amount, a letter of credit for $9.5 million that expires in July 2006 and a letter of credit for $2.0 million that expires in September 2005 were issued on behalf of Allegheny Energy Solutions, Inc. AE Supply also had a $1.6 million letter of credit outstanding that is collateralized by cash and expires in February 2006. These letters of credit are not recorded on Allegheny’s Consolidated Balance Sheets.

NOTE 15: VARIABLE INTEREST ENTITIES

Under FASB’s Interpretation No. 46 (Revised December 2003) “Consolidation of Variable Interest Entities” (“FIN 46R”), Allegheny consolidated Hunlock Creek Energy Ventures, LLC as of June 30, 2004. This entity operates two plants that produce and sell electricity to Allegheny and a third party.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

Potomac Edison and West Penn had power purchases from these two IPPs in the amount of $26.9 million and $9.8 million, respectively, for the three months ended June 30, 2005 and $19.4 million and $11.3 million, respectively, for the three months ended June 30, 2004.

Potomac Edison and West Penn had power purchases from these two IPPs in the amount of $52.5 million and $21.2 million, respectively, for the six months ended June 30, 2005 and $44.4 million and $23.1 million, respectively, for the six months ended June 30, 2004.

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

NOTE 16: COMMITMENTS AND CONTINGENCIES

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

Environmental Matters and Litigation

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

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

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

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

The Clean Air Act mandates annual reductions of SO₂ and created a SO₂emission allowance trading program. AE Supply and Monongahela comply with current SO₂ emission standards through a system-wide plan combining the use of emission controls, lower sulfur fuel and emission allowances. Based on current forecasts, Allegheny estimates that it will not be required to purchase SO₂ allowances for 2005 or 2006 and estimates that it may be required to purchase an average of less than 50,000 tons of allowances per year for 2007 and 2008. Allegheny’s allowance needs, to a large extent, are affected at any given time by the amount of output produced and the type of fuel used by its generation facilities, as well as the implementation of environmental controls. Therefore, there can be no assurance that Allegheny’s need to purchase SO₂ allowances for these periods will not vary from current estimates.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

AE Supply and Monongahela have completed installation of substantially all NOx controls to meet the Pennsylvania, Maryland and West Virginia SIP calls. These NOx controls include selective catalytic reduction at the Harrison and Pleasants generation stations and selective noncatalytic reduction at the Hatfield’s Ferry and Fort Martin generation stations, as well as burner modifications at the Mitchell generation station. The NOx compliance plan functions on a system-wide basis, similar to the SO₂compliance plan. AE Supply and Monongahela also have the option, in some cases, to purchase alternate fuels or NOx allowances, if needed, to supplement their compliance strategies. Allegheny currently estimates that its emission control activities, in concert with its inventory of banked allowances, will facilitate its compliance with NOx limits established by the SIP through 2008. Allegheny’s allowance needs, to a large extent, are affected at any given time by the amount of output produced and the type of fuel used by its generation facilities. Allegheny’s capital expenditure forecast includes the expenditure of $4.7 million of capital costs during the 2005 through 2007 period for additional NOx emission controls.

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

Clean Air Act Litigation: In August 2000, AE received a letter from the EPA requesting that it provide information and documentation relevant to the operation and maintenance of the following ten electric generation stations, which collectively include 22 generation units: Albright, Armstrong, Fort Martin, Harrison, Hatfield’s Ferry, Mitchell, Pleasants, Rivesville, R. Paul Smith and Willow Island. AE Supply and Monongahela own these generation stations. The letter requested information under Section 114 of the Clean Air Act to determine compliance with the Clean Air Act and related requirements, including potential application of the New Source Review (“NSR”) standards of the Clean Air Act, which can require the installation of additional emission control equipment when the major modification of an existing facility results in an increase in emissions. AE provided responsive information to this and a subsequent request. A meeting between the EPA and AE was held on July 16, 2003. At this time, AE is engaged in continuing discussions with the EPA with respect to environmental matters, including NSR issues.

If NSR requirements are imposed on Allegheny’s generation stations, in addition to the possible imposition of fines, compliance would entail significant capital investments in pollution control technology. There are three recent, significant federal court decisions that have addressed the application of NSR requirements to electric utility generating units: the Ohio Edison decision, the Duke Energy decision and the Alabama Power decision. The Ohio Edison decision is favorable to the EPA. The Duke Energy and Alabama Power decisions support the industry’s understanding of NSR requirements. The United States Court of Appeals for the Fourth Circuit affirmed the Duke Energy decision on June 15, 2005. In 2003, the U.S. EPA issued the Equipment Replacement Rule, which set forth a clearer set of rules for projects that may be undertaken without triggering NSR requirement. This rule would apply the Routine Maintenance, Repair and Replacement (“RMRR”) exception to the NSR requirement in a manner that is more consistent with the energy industry’s historical compliance approach. That rule was challenged by some states and environmental groups and, on December 24, 2003, the U.S. Court of Appeals for the District of Columbia Circuit issued an order to stay the implementation of that rule. At this time, AE and its subsidiaries are not able to determine the effect that these actions may have on them.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Martin Units No. 1 and 2; Harrison Units No. 1, 2 and 3; Pleasants Units No. 1 and 2 and Willow Island Unit No. 2. The Notice also alleged PSD violations at the Armstrong, Hatfield’s Ferry and Mitchell generation stations in Pennsylvania and identifies PADEP as the lead agency regarding those facilities. On September 8, 2004, AE, AE Supply, Monongahela and West Penn received a separate Notice of Intent to Sue from the Maryland Attorney General that essentially mirrored the previous Notice.

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

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

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

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

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

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

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

similar action filed against Zurich Insurance Company in California, Fuller-Austin Asbestos Settlement Trust, et al. v. Zurich-American Insurance Co., et al., Case No. CGC 04 431719 (Superior Court of California, County of San Francisco).

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

Allegheny does not believe that the existence or pendency of either the asbestos suits or the actions involving its insurance will have a material impact on its consolidated financial position, results of operations or cash flows. Allegheny believes that it has established adequate reserves, net of insurance receivables and recoveries, to cover existing and future asbestos claims. As of July 9, 2005, Allegheny had 826 open cases remaining in West Virginia, and five in Pennsylvania.

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

Other Litigation

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

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

The District Court separately granted plaintiffs’ motion to remand in the eighth action, Millar, on July 9, 2003. On December 18, 2003, the plaintiffs filed an amended complaint in California state court, solely on behalf of consumers, naming certain additional defendants, including The Goldman Sachs Group, Inc. (“Goldman Sachs”). The case was removed to federal court based on the amended complaint. On January 11, 2005, the federal district court remanded the case back to the state court in San Francisco. On May 6, 2005, the defendants in the Millar action filed a series of demurrers seeking to have the action dismissed. The state court has scheduled oral argument on those demurrers on September 7, 2005.

Under the terms of the agreement relating to the sale of the CDWR contract, AE Supply and one of its affiliates have agreed to indemnify Goldman Sachs and its affiliate J. Aron & Company, under certain conditions, for any losses arising out of the class action litigation up to the amount of the purchase price. AE Supply issued a guarantee to J. Aron & Company in connection with this indemnification obligation.

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

Nevada Power Contracts: On December 7, 2001, Nevada Power Company (“NPC”) filed a complaint with FERC against AE Supply seeking action by FERC to modify prices payable to AE Supply under three trade confirmations between Merrill Lynch and NPC. NPC’s claim was based, in part, on the assertion that dysfunctional California spot markets had an adverse effect on the prices NPC was able to negotiate with Merrill Lynch under the contracts. NPC filed substantially identical complaints against a number of other energy suppliers. On December 19, 2002, the Administrative Law Judge (“ALJ”) issued findings that no contract modification was warranted. The ALJ determined in favor of NPC that AE Supply, rather than Merrill Lynch, was a proper subject of NPC’s complaint.

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

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

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

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

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

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

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

On November 24, 2003, the court dismissed AE and AE Supply’s counterclaim for rescission and struck their demand for a jury trial. On February 2, 2005, following discovery, the parties filed separate motions for summary judgment. On April 12, 2005, the court granted Merrill Lynch’s motion for summary judgment on its

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

breach of contract claim, thereby requiring AE to purchase Merrill Lynch’s equity interest in AE Supply for $115 million plus interest from March 16, 2001, to be offset by any judgment in favor of AE and AE Supply on their counterclaims. The court denied Merrill Lynch’s summary judgment motion with respect to AE and AE Supply’s counterclaims for fraudulent inducement and breach of contract, and granted Merrill Lynch’s motion with respect to the counterclaims for breach of fiduciary duty and negligent misrepresentations. The court also denied AE and AE Supply’s motion for partial summary judgment on their breach of contract claims.

In May and June of 2005, the court conducted a trial with respect to the damages owed Merrill Lynch on its breach of contract claim and with respect to AE and AE Supply’s counterclaims for fraudulent inducement and breach of contract. Following the trial, on July 18, 2005, the court entered an order: (a) ruling against AE and AE Supply on their fraudulent inducement and breach of contract claims; (b) requiring AE to pay $115 million plus interest to Merrill Lynch; and (c) requiring Merrill Lynch to return its equity interest in AE Supply to AE. Allegheny intends to appeal the court’s ruling but cannot predict the outcome. Although AE will not be required to pay Merrill Lynch the amount of the judgment while the appeal is pending, it likely will be required to post some form of collateral.

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

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

Putative Shareholder, Benefit Plan Class Actions and Derivative Actions: From October 2002 through December 2002, plaintiffs claiming to represent purchasers of AE’s securities filed 14 putative class action lawsuits against AE and several of its former senior managers in U.S. District Courts for the Southern District of New York and the District of Maryland. The complaints alleged that AE and senior management violated federal securities laws when AE purchased Merrill Lynch’s energy marketing and trading business with the knowledge that the business was built on illegal wash or round-trip trades with Enron, which the complaints alleged artificially inflated trading revenue, volume and growth. The complaints asserted that AE’s fortunes fell when Enron’s collapse exposed what plaintiffs claim were illegal trades in the energy markets. All of the securities cases were transferred to the District of Maryland and consolidated. The plaintiffs filed an amended complaint on May 3, 2004 that alleged that the defendants violated federal securities laws by failing to disclose weaknesses in Merrill Lynch’s energy marketing and trading business, as well as other internal control and accounting deficiencies. The amended complaint seeks unspecified compensatory damages and equitable relief. On July 2, 2004, the defendants moved to dismiss the amended complaint. Plaintiffs have opposed the motion and it remains outstanding.

In February and March 2003, two putative class action lawsuits were filed against AE in U.S. District Courts for the Southern District of New York and the District of Maryland. The suits alleged that AE and a senior manager violated ERISA by: (a) failing to provide complete and accurate information to plan beneficiaries regarding the energy trading business, among other things; (b) failing to diversify plan assets; (c) failing to monitor investment alternatives; (d) failing to avoid conflicts of interest and (e) violating fiduciary duties. The ERISA cases were consolidated in the District of Maryland. On April 26, 2004, the plaintiffs in the ERISA cases filed an amended complaint, adding a number of current and former directors of AE as defendants and clarifying the nature of their claims. On June 25, 2004, the defendants filed a motion to dismiss the amended complaint. Plaintiffs have opposed the motion and it remains outstanding.

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

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Board of Directors and several former senior managers and former directors. The action was filed in the U.S. District Court for the District of Maryland and consolidated with the securities class actions pending in that court. The Maryland derivative action contains allegations similar to the New York state court derivative action.

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

Suits Related to the Gleason Generating Facility: Allegheny Energy Supply Gleason Generating Facility, LLC, a subsidiary of AE Supply, is the defendant in a suit brought in the Circuit Court for Weakley County, Tennessee, by residents living in the vicinity of the generation facility in Gleason, Tennessee. The original suit was filed on September 16, 2002. AE Supply purchased the generation facility in 2001. The plaintiffs are asserting claims based on trespass and/or nuisance, claiming personal injury and property damage as a result of noise from the generation facility. They seek a restraining order with respect to the operation of the plant and damages of $200 million. A mediation session was held on June 17, 2004, but the parties did not reach settlement. AE has undertaken property purchases and other mitigation measures. AE intends to vigorously defend against this action but cannot predict its outcome.

AE Supply has demanded indemnification from Siemens Westinghouse, the manufacturer of the turbines used in the Gleason Generating Facility, pursuant to the terms of the related equipment purchase agreement. On October 17, 2002, Siemens Westinghouse filed a declaratory judgment action in the Court of Common Pleas of Allegheny County, Pennsylvania, against AE Supply and its subsidiary seeking a declaration that the prior owner released Siemens Westinghouse from this liability through a release executed after AE Supply purchased the Gleason facility. On May 6, 2004, AE Supply filed a motion for summary judgment to dismiss the declaratory judgment action. The motion for summary judgment was granted on September 7, 2004. On October 6, 2004, Siemens Westinghouse appealed the dismissal of the declaratory judgment action. Allegheny intends to vigorously defend against this action but cannot predict its outcome.

SEC Matters: On October 9, October 25 and November 5, 2002, AE received subpoenas from the SEC. The subpoenas principally concerned: (a) the departure of Daniel L. Gordon; (b) AE’s litigation with Merrill Lynch; (c) AE Supply’s valuation and management of its trading business; (d) AE’s November 4, 2002 press release concerning its financial statements; (e) the departure of AE’s and its subsidiaries’ Controller, Thomas Kloc, in June 2002 and (f) AE’s acquisition of power plants from Enron. AE and AE Supply responded to the subpoenas.

On January 16, 2004, the SEC requested that AE voluntarily produce certain documents in connection with an informal investigation of AE, and the SEC has since requested the voluntary production of additional documents. AE has responded to the SEC’s requests for documents. The SEC also has taken testimony from several current and former employees and has expressed an intention to take testimony from additional current and former employees. AE is cooperating fully with the SEC.

LTI Arbitration: On April 22, 2004, Leasing Technologies International, Inc. and its shareholders (collectively, “LTI”) filed a demand for arbitration against Allegheny Ventures and AE before the American Arbitration Association. In December 2000, Allegheny Ventures entered into an agreement to acquire LTI, an equipment leasing company. Allegheny Ventures terminated the agreement on May 4, 2003. LTI alleges that the termination of the agreement was unjustified and seeks damages in an unspecified amount for breach of the agreement, as well as other consequential damages. On June 11, 2004, AE and Allegheny Ventures filed an answer to LTI’s demand, denying all claims. The arbitration hearing currently is scheduled to begin in November 2005. Allegheny intends to vigorously defend against this action, but cannot predict its outcome.

Ordinary Course of Business: The registrants are from time to time involved in litigation and other legal disputes in the ordinary course of business. Each registrant is of the belief that there are no other legal proceedings that could have a material adverse effect on its business or financial condition.

NOTE 17: SUBSEQUENT EVENTS

ALLEGHENY ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

principal amount outstanding of approximately $331 million. The New AE Supply Term Loan matures in 2011, and has an initial interest rate equal to LIBOR plus 1.75%. The interest rate will improve to LIBOR plus 1.50% if AE Supply’s credit ratings improve from current levels. AE Supply will use cash on hand and may also borrow under the Revolving Facility to redeem its 13.0% Senior Notes due 2007, which have a principal amount outstanding of approximately $35 million, and pay associated costs. AE Supply issued a Notice of Redemption to holders of record of the 10.25% and 13.0% Senior Notes outlining the terms and conditions of the anticipated redemption, which is expected to occur on August 22, 2005. AE Supply expects to take a pre-tax charge of approximately $34 million during the third quarter of 2005 to reflect the premium paid and costs associated with the redemptions.

On August 2, 2005, Monongahela signed a definitive agreement to sell its Ohio service territory to American Electric Power’s (“AEP”) Columbus Southern subsidiary for net cash proceeds of approximately $55 million. Under terms of the agreement, Monongahela will transfer its Ohio transmission and distribution assets to AEP. The sale will include a power purchase agreement under which Monongahela will provide generation service to AEP for the Ohio retail customer base through May 31, 2007 at $45 per megawatt-hour. As the rate under the power purchase agreement is below market rates, Monongahela expects to record a loss on the sale. The agreement is subject to certain closing conditions, third party consents and state and federal regulatory approvals. If approved, the sale is expected to close by the end of 2005.

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
(In thousands)	2005			2004			2005			2004
Operating revenues	$	178,117		$	160,266		$	364,698		$	340,423

Operating expenses:
Fuel consumed in electric generation		33,281			25,057			68,258			57,719
Purchased power and transmission		54,839			51,194			113,497			92,538
Operations and maintenance		52,205			64,826			96,116			117,292
Depreciation and amortization		16,734			16,335			33,504			32,601
Taxes other than income taxes		12,693			12,639			25,426			25,020

Total operating expenses		169,752			170,051			336,801			325,170

Operating income (loss)		8,365			(9,785	)		27,897			15,253

Other income and expenses, net (Note 8)		3,480			2,758			5,712			4,741

Interest expense		10,618			10,791			21,361			21,399

Income (loss) from continuing operations before income taxes		1,227			(17,818	)		12,248			(1,405	)

Income tax (benefit) expense from continuing operations		(7,862	)		(7,188	)		(8,163	)		1,537

Income (loss) from continuing operations		9,089			(10,630	)		20,411			(2,942	)

(Loss) income from discontinued operations, net of tax (Note 3)		(6,501	)		(1,133	)		4,370			9,832

Net income (loss)	$	2,588		$	(11,763	)	$	24,781		$	6,890

See accompanying Notes to Consolidated Financial Statements.

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


	Six Months Ended June 30,
(In thousands)	2005			2004
Cash Flows From Operating Activities:
Net income	$	24,781		$	6,890

Adjustments for discontinued operations and non-cash charges and (credits):
Income from discontinued operations, net		(4,370	)		—
Depreciation and amortization		33,504			37,668
Gain on asset sales		(64	)		(61	)
Deferred investment credit and income taxes, net		1,761			32,827
Deferred energy costs, net		—			14,490
Other, net		(420	)		1,067

Changes in certain assets and liabilities:
Accounts receivable, net		(6,177	)		16,468
Materials, supplies and fuel		(1,074	)		17,015
Taxes receivable/accrued, net		(14,192	)		(37,516	)
Prepaid taxes		7,464			8,056
Collateral deposits		(9,540	)		—
Accounts payable		(4,812	)		(4,362	)
Accounts payable to affiliates, net		32,963			(16,143	)
Assets and liabilities held for sale		17,134			—
Other, net		2,798			(9,548	)

Net cash provided by operating activities		79,756			66,851

Cash Flows From Investing Activities:
Capital expenditures		(30,657	)		(33,960	)
Proceeds from sale of assets		129			68
Other investments		—			(1	)

Net cash used in investing activities		(30,528	)		(33,893	)

Cash Flows From Financing Activities:
Note receivable from affiliate		(42,995	)		(47,305	)
Note payable to affiliate		—			78
Net repayments of short-term debt		—			(53,610	)
Issuance of long-term debt		—			117,334
Retirement of long-term debt		—			(8	)
Cash dividends paid on capital stock:
Preferred stock		(2,519	)		(2,519	)
Common stock		—			(13,195	)

Net cash (used in) provided by financing activities		(45,514	)		775

Net increase in cash and cash equivalents		3,714			33,733
Cash and cash equivalents at beginning of period		45,092			43,971

Cash and cash equivalents at end of period	$	48,806		$	77,704

Supplemental Cash Flow Information:
Cash paid for interest (net of amount capitalized)	$	12,022		$	11,384

See accompanying Notes to Consolidated Financial Statements.

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(unaudited)


(In thousands)	June 30, 2005			December 31, 2004
ASSETS
Current Assets:
Cash and cash equivalents	$	48,806		$	45,092
Accounts receivable:
Customer		44,059			39,736
Unbilled utility revenue		38,218			36,332
Wholesale and other		4,016			4,399
Allowance for uncollectible accounts		(2,283	)		(2,616	)
Note receivable from affiliate		47,200			4,205
Materials and supplies		15,875			17,123
Fuel		17,632			15,310
Prepaid taxes		14,115			21,579
Assets held for sale (Note 3)		115,236			147,862
Collateral deposits		9,540			—
Regulatory assets		4,702			4,702
Other		3,756			4,638

Total current assets		360,872			338,362

Property, Plant and Equipment, Net:
Generation		942,558			938,214
Transmission		292,065			291,558
Distribution		965,354			945,431
Other		81,606			82,767
Accumulated depreciation		(892,526	)		(869,077	)

Subtotal		1,389,057			1,388,893
Construction work in progress		16,605			15,533

Total property, plant and equipment, net		1,405,662			1,404,426

Investments and Other Assets:
Assets held for sale (Note 3)		169,314			176,742
Investment in AGC		47,875			46,055
Other		3,778			4,033

Total investments and other assets		220,967			226,830

Deferred Charges:
Regulatory assets		100,576			99,502
Other		7,987			12,307

Total deferred charges		108,563			111,809

Total Assets	$	2,096,064		$	2,081,427

See accompanying Notes to Consolidated Financial Statements.

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (continued)

(unaudited)


(In thousands)	June 30, 2005			December 31, 2004
LIABILITIES AND STOCKHOLDER’S EQUITY

Current Liabilities:
Accounts payable	$	33,480		$	38,292
Accounts payable to affiliates, net		44,905			11,534
Accrued taxes		38,125			40,833
Deferred income taxes		302			5,344
Accrued interest		8,794			8,794
Liabilities associated with assets held for sale (Note 3)		67,559			95,501
Other		27,130			28,078

Total current liabilities		220,295			228,376

Long-term Debt (Note 2)		684,103			684,001

Deferred Credits and Other Liabilities:
Investment tax credit		1,516			2,590
Non-current income taxes payable		45,671			45,671
Deferred income taxes		189,781			190,511
Obligations under capital leases		7,309			8,747
Regulatory liabilities		248,948			243,974
Liabilities associated with assets held for sale (Note 3)		99,252			100,988
Other		24,306			24,197

Total deferred credits and other liabilities		616,783			616,678

Commitments and Contingencies (Note 9)

Preferred Stock		74,000			74,000

Common Stockholder’s Equity:

Common stock—$50 par value per share, 8,000,000 shares authorized and 5,891,000 shares outstanding		294,550			294,550
Other paid-in capital		111,556			111,182
Retained earnings		94,820			72,557
Accumulated other comprehensive (loss) income		(43	)		83

Total common stockholder’s equity		500,883			478,372

Total Liabilities and Stockholder’s Equity	$	2,096,064		$	2,081,427

See accompanying Notes to Consolidated Financial Statements.

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)


Note No.		Page No.
1	Basis of Presentation	37

2	Debt	38

3	Assets Held for Sale and Discontinued Operations	38

4	Intangible Assets	39

5	Asset Retirement Obligations (“AROs”)	39

6	Business Segments	40

7	Pension Benefits and Postretirement Benefits Other Than Pensions	41

8	Other Income and Expenses, Net	42

9	Commitments and Contingencies	42

10	Subsequent Event	45

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1: BASIS OF PRESENTATION

Monongahela Power Company, together with its consolidated subsidiaries (“Monongahela”), is a wholly owned subsidiary of Allegheny Energy, Inc. (“AE,” and together with its consolidated subsidiaries, “Allegheny”). Monongahela, along with its wholly owned subsidiary Mountaineer Gas Company (“Mountaineer”) and its regulated utility affiliates, The Potomac Edison Company (“Potomac Edison”) and West Penn Power Company (“West Penn”), collectively doing business as Allegheny Power, operates electric and natural gas transmission and distribution (“T&D”) systems. Monongahela operates electric T&D systems in Ohio and West Virginia and natural gas T&D systems in West Virginia. Monongahela also generates power for its West Virginia customers. Monongahela has two principal business segments. The Generation and Marketing segment includes Monongahela’s power generation operations. The Delivery and Services segment includes Monongahela’s electric T&D operations.

Monongahela is subject to regulation by the Securities and Exchange Commission (“SEC”), the Public Service Commission of West Virginia, the Public Utilities Commission of Ohio and the Federal Energy Regulatory Commission.

Allegheny Energy Service Corporation (“AESC”) is a wholly owned subsidiary of AE that employs substantially all of the people who work at Monongahela and its subsidiaries.

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

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

In the opinion of management, the unaudited interim financial statements included herein reflect all normal recurring adjustments that are necessary for a fair presentation of the results of operations for the three and six months ended June 30, 2005 and 2004, cash flows for the six months ended June 30, 2005 and 2004 and financial position at June 30, 2005 and December 31, 2004. Because of the seasonal nature of Monongahela’s utility operations, results for the three and six months ended June 30, 2005 are not necessarily indicative of results that may be expected for the year ending December 31, 2005. For more information on the seasonal nature of Monongahela’s utility operations, see Part I, Item 1, Risk Factors, “Other Risk Factors Associated with Our Business,” in the 2004 Annual Report on Form 10-K.

During the third quarter of 2004, Monongahela entered into an agreement to sell its West Virginia natural gas operations. The results of operations relating to these assets have been reclassified to discontinued operations in the accompanying Consolidated Statements of Operations for all periods presented. In accordance with the provisions of the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), the assets and liabilities associated with these discontinued operations have been reclassified as held for sale in the Consolidated Balance Sheets as of, and subsequent to, the date that held for sale criteria were met.

Certain amounts in the financial statements have been reclassified for comparative purposes.

Federal and State Income Taxes. Allegheny allocates income tax expense (benefit) to its subsidiaries pursuant to its consolidated tax sharing agreement. This corporate allocation may cause significant fluctuations in the effective quarterly and year to date tax rates from the statutory rates for certain of Allegheny’s subsidiaries, depending on the level of pre-tax income. Income tax expense (benefit) differs from an amount calculated at the federal statutory income tax rate of 35%, principally due to state income taxes, consolidated tax savings, tax credits, the effects of utility rate-making and certain non-deductible expenses, as well as an additional tax benefit recorded during the second quarter of 2005, which is described below.

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

During the second quarter of 2005, Allegheny determined that it had not claimed certain income tax deductions in its 2003 income tax returns relating to commodity trading contracts. Allegheny plans to file amended 2003 federal and state income tax returns to claim these additional deductions, which will increase Monongahela’s allocated share of consolidated tax savings. Accordingly, Monongahela recorded a tax benefit of $4.3 million during the second quarter of 2005 to recognize the additional tax savings. The effect of this adjustment was not considered material to Monongahela’s results of operations for the three or six months ended June 30, 2005 or the year ended December 31, 2003.

NOTE 2: DEBT

Monongahela did not issue or redeem any debt during the three and six months ended June 30, 2005.

At June 30, 2005, contractual maturities for long-term debt for the remainder of 2005 and for full years thereafter, excluding unamortized discounts of $1.7 million, are as follows:


(In millions)	2005		2006		2007		2008		2009		Thereafter		Total
First Mortgage Bonds	$	—	$	300.0	$	—	$	—	$	—	$	190.0	$	490.0
Pollution Control Bonds		—		—		15.5		—		—		70.2		85.7
Medium-Term Notes		—		—		—		—		—		110.0		110.0

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

Liabilities associated with assets held for sale:
Other Notes	$	3.3	$	3.3	$	3.4	$	3.3	$	13.4	$	60.0	$	86.7

At June 30, 2005, substantially all of Monongahela’s properties were held subject to liens of various relative priorities securing debt obligations.

NOTE 3: ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

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


	Three Months Ended June 30,						Six Months Ended June 30,
(In millions)	2005			2004			2005			2004
Operating revenues	$	46.6		$	41.1		$	196.8		$	190.0
Operating expenses		(46.0	)		(42.5	)		(176.2	)		(171.1	)
Other income		0.6			0.1			0.9			0.3
Interest expense		(2.0	)		(2.1	)		(4.1	)		(4.1	)

(Loss) income before income taxes		(0.8	)		(3.4	)		17.4			15.1
Income tax (expense) benefit		—			2.2			(6.7	)		(5.3	)
Impairment charge, net of tax		(5.7	)		—			(6.3	)		—

(Loss) income from discontinued operations, net of tax	$	(6.5	)	$	(1.2	)	$	4.4		$	9.8

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

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Assets held for sale and liabilities associated with assets held for sale were as follows:


(In millions)	June 30, 2005		December 31, 2004
Assets:
Current assets	$	115.2	$	147.8
Property, plant and equipment		157.1		163.7
Investments and other assets		6.8		6.8
Deferred charges		5.4		6.3

Total assets	$	284.5	$	324.6

Liabilities:
Current liabilities	$	67.6	$	95.5
Long-term debt		83.4		83.4
Deferred credits and other liabilities		15.9		17.6

Total liabilities	$	166.9	$	196.5

NOTE 4: INTANGIBLE ASSETS

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


	June 30, 2005				December 31, 2004
(In millions)	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Land easements, amortized	$	0.5	$	0.2	$	0.5	$	0.2
Land easements, unamortized		31.8		—		31.8		—
Software		8.4		7.9		7.9		7.2

Total	$	40.7	$	8.1	$	40.2	$	7.4

In addition, “Assets held for sale” included intangible assets related to natural gas rights, amortized with a gross carrying amount of $6.7 million at June 30, 2005 and December 31, 2004 and accumulated amortization of $4.2 million and $4.0 million at June 30, 2005 and December 31, 2004, respectively.

Amortization expense for intangible assets, excluding Mountaineer, which is included in “Assets held for sale,” was $0.4 million and $0.7 million for the three months ended June 30, 2005 and 2004, respectively, and $0.7 million and $1.2 million for the six months ended June 30, 2005 and 2004, respectively.

Amortization expense is estimated to be $1.4 million annually for 2005 through 2009.

NOTE 5: ASSET RETIREMENT OBLIGATIONS (“AROs”)

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

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

For the six months ended June 30, 2005, Monongahela’s ARO balance increased $0.2 million, from $6.7 million at December 31, 2004 to $6.9 million at June 30, 2005, primarily due to accretion expense. In accordance with SFAS No. 144, Mountaineer’s $1.9 million ARO liability was recorded in liabilities associated with assets held for sale in the accompanying Consolidated Balance Sheets. See Note 3, “Assets Held for Sale and Discontinued Operations” to Monongahela’s Consolidated Financial Statements for additional information.

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Estimated removal costs of $247.0 million and $241.8 million at June 30, 2005 and December 31, 2004, respectively, that are not qualified as AROs are being recovered through the ratemaking process. These costs are recorded by Monongahela as regulatory liabilities.

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

NOTE 6: BUSINESS SEGMENTS

Monongahela manages and evaluates its operations in two business segments, the Delivery and Services segment and the Generation and Marketing segment. The Delivery and Services segment includes Monongahela’s electric T&D operations. The Generation and Marketing segment owns, operates and manages electric generation capacity. The Generation and Marketing segment includes intersegment sales to provide energy to Monongahela’s Delivery and Services segment.

Monongahela accounts for intersegment sales based on cost or regulatory commission approved tariffs or contracts.

Monongahela entered into an agreement to sell its West Virginia natural gas operations during the third quarter of 2004. The results of operations for these assets have previously been reported as a component of the Delivery and Services segment. The results of operations for these assets have been reclassified to discontinued operations for all periods presented.

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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


	Three Months Ended June 30,						Six Months Ended June 30,
(In millions)	2005			2004			2005			2004
Total operating revenues:
Delivery and Services	$	161.7		$	160.2		$	339.0		$	333.9
Generation and Marketing		91.7			71.1			182.7			157.4
Eliminations		(75.3	)		(71.1	)		(157.0	)		(150.9	)

Total	$	178.1		$	160.2		$	364.7		$	340.4

Depreciation and amortization:
Delivery and Services	$	8.0		$	7.8		$	16.1		$	15.5
Generation and Marketing		8.7			8.5			17.4			17.1

Total	$	16.7		$	16.3		$	33.5		$	32.6

Operating income (loss):
Delivery and Services	$	10.2		$	10.6		$	31.1		$	29.6
Generation and Marketing		(1.8	)		(20.3	)		(3.2	)		(14.3	)

Total	$	8.4		$	(9.7	)	$	27.9		$	15.3

Interest expense:
Delivery and Services	$	6.1		$	6.4		$	12.3		$	11.9
Generation and Marketing		4.6			4.4			9.1			9.5

Total	$	10.7		$	10.8		$	21.4		$	21.4

Income (loss) from continuing operations:
Delivery and Services	$	7.9		$	3.6		$	19.5		$	9.2
Generation and Marketing		1.2			(14.2	)		0.9			(12.1	)

Total	$	9.1		$	(10.6	)	$	20.4		$	(2.9	)

(Loss) income from discontinued operations, net:

Delivery and Services	$	(6.5	)	$	(1.2	)	$	4.4		$	9.8

Net income (loss):
Delivery and Services	$	1.4		$	2.4		$	23.9		$	19.0
Generation and Marketing		1.2			(14.2	)		0.9			(12.1	)

Total	$	2.6		$	(11.8	)	$	24.8		$	6.9

NOTE 7: PENSION BENEFITS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS

Monongahela is responsible for its proportionate share of the net periodic cost for pension and postretirement benefits other than pensions (principally health care and life insurance) for employees and covered dependents provided by AESC. Monongahela’s share of the costs was as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
(In millions)	2005		2004		2005		2004
Pension	$	2.5	$	2.1	$	5.0	$	4.4
Medical and life insurance	$	1.6	$	1.5	$	3.2	$	3.0

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 8: OTHER INCOME AND EXPENSES, NET

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


	Three Months Ended June 30,				Six Months Ended June 30,
(In millions)	2005		2004		2005		2004
Equity in earnings of AGC	$	1.8	$	1.3	$	3.5	$	2.9
Interest income		1.4		0.2		1.5		0.3
Premium services		0.1		0.9		0.2		0.9
Other		0.2		0.3		0.5		0.6

Total	$	3.5	$	2.7	$	5.7	$	4.7

NOTE 9: COMMITMENTS AND CONTINGENCIES

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

Environmental Matters and Litigation

The Clean Air Act mandates annual reductions of SO₂ and created a SO₂emission allowance trading program. AE Supply and Monongahela comply with current SO₂emission standards through a system-wide plan combining the use of emission controls, lower sulfur fuel and emission allowances. Based on current forecasts, Allegheny estimates that it will not be required to purchase SO₂ allowances for 2005 or 2006 and estimates that it may be required to purchase an average of less than 50,000 tons of allowances per year for 2007 and 2008. Allegheny’s allowance needs, to a large extent, are affected at any given time by the amount of output produced and the type of fuel used by its generation facilities, and the level of implementation of environmental controls. Therefore, there can be no assurance that Allegheny’s need to purchase SO₂ allowances for these periods will not vary from current estimates.

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

On May 20, 2004, AE, AE Supply, Monongahela and West Penn received a Notice of Intent to Sue Pursuant to Clean Air Act §7604 (the “Notice”) from the Attorneys General of New York, New Jersey and Connecticut and from the Pennsylvania Department of Environmental Protection (“PADEP”). The Notice alleged that Allegheny made major modifications to some of its West Virginia facilities in violation of the Prevention of Significant Deterioration (“PSD”) provisions of the Clean Air Act at the following coal-fired facilities: Albright Unit No. 3; Fort Martin Units No. 1 and 2; Harrison Units No. 1, 2 and 3; Pleasants Units No. 1 and 2 and Willow Island Unit No. 2. The Notice also alleged PSD violations at the Armstrong, Hatfield’s Ferry and Mitchell generation stations in Pennsylvania and identifies PADEP as the lead agency regarding those facilities. On September 8, 2004, AE, AE Supply, Monongahela and West Penn received a separate Notice of Intent to Sue from the Maryland Attorney General that essentially mirrored the previous Notice.

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

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

MONONGAHELA POWER COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

Ordinary Course of Business: Monongahela is from time to time involved in litigation and other legal disputes in the ordinary course of business. Monongahela is of the belief that there are no other legal proceedings that could have a material adverse effect on its business or financial condition.

NOTE 10: SUBSEQUENT EVENT

THE POTOMAC EDISON COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)


	Three Months Ended June 30,					Six Months Ended June 30,
(In thousands)	2005			2004		2005			2004
Operating revenues	$	221,069		$	216,711	$	478,633		$	463,880

Operating expenses:
Purchased power and transmission		153,094			150,344		330,894			321,964
Deferred energy costs, net		(1,805	)		1,209		(619	)		2,123
Operations and maintenance		25,528			25,180		51,038			52,714
Depreciation and amortization		10,756			9,811		21,412			19,552
Taxes other than income taxes		8,468			7,739		17,761			16,632

Total operating expenses		196,041			194,283		420,486			412,985

Operating income		25,028			22,428		58,147			50,895

Other income, net (Note 7)		1,940			2,130		3,163			2,910

Interest expense		6,784			7,665		13,882			15,452

Income before income taxes		20,184			16,893		47,428			38,353

Income tax expense		5,218			5,917		12,367			13,555

Net income	$	14,966		$	10,976	$	35,061		$	24,798

See accompanying Notes to Consolidated Financial Statements.

THE POTOMAC EDISON COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


	Six Months Ended June 30,
(In thousands)	2005			2004
Cash Flows From Operating Activities:

Net income	$	35,061		$	24,798

Adjustments for non-cash charges and (credits):
Depreciation and amortization		21,412			19,552
Loss (gain) on asset sales		24			(295	)
Deferred investment credit and income taxes, net		514			6,545
Deferred energy costs, net		(619	)		2,123
Other, net		848			699

Changes in certain assets and liabilities:
Accounts receivable, net		(1,498	)		5,912
Materials and supplies		(1,324	)		(1,911	)
Taxes receivable/accrued, net		(3,774	)		(2,041	)
Prepaid taxes		5,311			1,694
Accounts payable		6,328			7,166
Accounts payable to affiliates, net		(8,306	)		(5,677	)
Collateral deposits held		(8,117	)		7,905
Other, net		4,303			4,773

Net cash provided by operating activities		50,163			71,243

Cash Flows From Investing Activities:
Capital expenditures		(32,872	)		(31,404	)
Proceeds from sale of assets		10,603			330
Decrease in restricted funds		8,117			—

Net cash used in investing activities		(14,152	)		(31,074	)

Cash Flows From Financing Activities:
Note receivable from affiliate		(2,045	)		(18,199	)
Cash dividends paid on common stock		(31,073	)		(16,790	)

Net cash used in financing activities		(33,118	)		(34,989	)

Net increase in cash and cash equivalents		2,893			5,180
Cash and cash equivalents at beginning of period		16,231			31,790

Cash and cash equivalents at end of period	$	19,124		$	36,970

Supplemental Cash Flow Information:
Cash paid for interest (net of amount capitalized)	$	12,633		$	14,834

See accompanying Notes to Consolidated Financial Statements.

THE POTOMAC EDISON COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(unaudited)


(In thousands)	June 30, 2005			December 31, 2004
ASSETS

Current Assets:
Cash and cash equivalents	$	19,124		$	16,231
Accounts receivable:
Customer		59,900			52,898
Unbilled utility revenue		33,802			40,057
Wholesale and other		4,869			4,634
Allowance for uncollectible accounts		(2,173	)		(2,689	)
Note receivable from affiliate		16,477			14,432
Materials and supplies		15,572			14,248
Taxes receivable		9,670			7,618
Deferred income taxes		3,102			2,948
Prepaid taxes		3,448			8,759
Regulatory assets		2,022			352
Other		3,959			13,888

Total current assets		169,772			173,376

Property, Plant and Equipment, Net:
Transmission		324,914			323,916
Distribution		1,193,001			1,160,307
Other		73,724			74,998
Accumulated depreciation		(483,680	)		(470,008	)

Subtotal		1,107,959			1,089,213
Construction work in progress		10,723			14,475

Total property, plant and equipment, net		1,118,682			1,103,688

Other Assets:
Assets held for sale (Note 3)		—			10,779
Other		9,568			9,529

Total other assets		9,568			20,308

Deferred Charges:
Regulatory assets		62,534			64,022
Other		3,854			4,186

Total deferred charges		66,388			68,208

Total Assets	$	1,364,410		$	1,365,580

See accompanying Notes to Consolidated Financial Statements.

THE POTOMAC EDISON COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (continued)

(unaudited)


(In thousands)	June 30, 2005		December 31, 2004
LIABILITIES AND STOCKHOLDER’S EQUITY

Current Liabilities:
Accounts payable	$	28,049	$	21,721
Accounts payable to affiliates, net		40,227		48,968
Accrued taxes		7,965		9,687
Accrued interest		3,834		3,652
Other		25,265		31,005

Total current liabilities		105,340		115,033

Long-term Debt (Note 2)		417,985		417,908

Deferred Credits and Other Liabilities:
Investment tax credit		6,122		6,614
Non-current income taxes payable		57,561		57,561
Deferred income taxes		185,380		183,895
Obligations under capital leases		5,519		6,210
Regulatory liabilities		173,249		168,862
Other		8,165		8,397

Total deferred credits and other liabilities		435,996		431,539

Commitments and Contingencies (Note 10)

Stockholder’s Equity:
Common stock—$0.01 par value per share, 26,000,000 shares authorized and 22,385,000 shares outstanding		224		224
Other paid-in capital		221,144		221,144
Retained earnings		183,720		179,731
Accumulated other comprehensive income		1		1

Total stockholder’s equity		405,089		401,100

Total Liabilities and Stockholder’s Equity	$	1,364,410	$	1,365,580

See accompanying Notes to Consolidated Financial Statements.

THE POTOMAC EDISON COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)


Note No.		Page No.
1	Basis of Presentation	51

2	Debt	52

3	Asset Sale	52

4	Intangible Assets	52

5	Asset Retirement Obligations (“AROs”)	52

6	Pension Benefits and Postretirement Benefits Other Than Pensions	53

7	Other Income and Expenses, Net	53

8	Variable Interest Entities	53

9	Commitments and Contingencies	53

THE POTOMAC EDISON COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1: BASIS OF PRESENTATION

The Potomac Edison Company, together with its consolidated subsidiaries (“Potomac Edison”), is a regulated wholly owned subsidiary of Allegheny Energy, Inc. (“AE,” and together with its consolidated subsidiaries, “Allegheny”). Potomac Edison, along with its regulated utility affiliates, Monongahela Power Company (“Monongahela”) and West Penn Power Company, collectively doing business as Allegheny Power, operates electric and natural gas transmission and distribution (“T&D”) systems. Potomac Edison operates an electric T&D system in Maryland, Virginia and West Virginia. Potomac Edison currently operates under a single business segment, Delivery and Services.

Potomac Edison is subject to regulation by the Securities and Exchange Commission (“SEC”), the Maryland Public Service Commission, the Public Service Commission of West Virginia, the Virginia State Corporation Commission and the Federal Energy Regulatory Commission.

Allegheny Energy Service Corporation (“AESC”) is a wholly owned subsidiary of AE that employs substantially all of the people who work at Potomac Edison and its subsidiaries.

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

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

In the opinion of management, the unaudited interim financial statements included herein reflect all normal recurring adjustments that are necessary for a fair presentation of the results of operations for the three and six months ended June 30, 2005 and 2004, cash flows for the six months ended June 30, 2005 and 2004 and financial position at June 30, 2005 and December 31, 2004. Because of the seasonal nature of Potomac Edison’s utility operations, results for the three and six months ended June 30, 2005 are not necessarily indicative of results that may be expected for the year ending December 31, 2005. For more information on the seasonal nature of Allegheny’s utility operations, see Part I, Item 1, Risk Factors, “Other Risk Factors Associated with Our Business,” in the 2004 Annual Report on Form 10-K.

Certain amounts in the financial statements have been reclassified for comparative purposes.

THE POTOMAC EDISON COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 2: DEBT

Potomac Edison did not issue or redeem any debt during the three and six months ended June 30, 2005.

As of June 30, 2005, contractual maturities of long-term debt for the remainder of 2005 and for full years thereafter, excluding unamortized discounts of $2.0 million, were as follows:


(In millions)	2005		2006		2007		2008		2009		Thereafter		Total
First Mortgage Bonds	$	—	$	—	$	—	$	—	$	—	$	320.0	$	320.0
Medium-Term Notes		—		100.0		—		—		—		—		100.0

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

Substantially all of the properties of Potomac Edison are held subject to the lien securing its first mortgage bonds.

NOTE 3: ASSET SALE

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

NOTE 4: INTANGIBLE ASSETS

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


	June 30, 2005				December 31, 2004
(In millions)	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Land easements, amortized	$	55.9	$	15.3	$	55.2	$	14.9
Software		0.3		0.2		0.3		0.2

Total	$	56.2	$	15.5	$	55.5	$	15.1

Amortization expense for intangible assets was $0.2 million and $0.4 million for three and six months ended June 30, 2005 and 2004, respectively.

Amortization expense is estimated to be $0.8 million annually for 2005 through 2009.

NOTE 5: ASSET RETIREMENT OBLIGATIONS (“AROs”)

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

Potomac Edison’s ARO balances were $0.2 million at June 30, 2005 and December 31, 2004.

Estimated removal costs of $167.0 million and $162.3 million at June 30, 2005 and December 31, 2004, respectively, that are not qualified as AROs are being recovered through the ratemaking process. These amounts are shown as regulatory liabilities in the consolidated balance sheets.

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

THE POTOMAC EDISON COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 6: PENSION BENEFITS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS

Potomac Edison is responsible for its proportionate share of the net periodic cost for pension and postretirement benefits other than pensions (principally health care and life insurance) for employees and covered dependents provided by AESC. Potomac Edison’s share of the costs was as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
(In millions)	2005		2004		2005		2004
Pension	$	1.3	$	1.1	$	2.6	$	2.3
Medical and life insurance	$	1.2	$	1.1	$	2.4	$	2.1

NOTE 7: OTHER INCOME AND EXPENSES, NET

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


	Three Months Ended June 30,				Six Months Ended June 30,
(In millions)	2005		2004		2005		2004
Gain on sale of land	$	—	$	0.3	$	—	$	0.3
Interest and dividend income		0.3		0.1		0.5		0.2
Coal brokering income		1.1		1.0		1.1		1.0
Premium services		0.4		0.6		1.0		0.8
Other		0.1		0.1		0.6		0.6

Total	$	1.9	$	2.1	$	3.2	$	2.9

NOTE 8: VARIABLE INTEREST ENTITIES

Potomac Edison has a long-term electricity purchase contract with an unrelated independent power producer (“IPP”) that represents a variable interest under FASB’s Interpretation No. 46 (Revised December 2003) “Consolidation of Variable Interest Entities” (“FIN 46R”). Potomac Edison has been unable to obtain certain information from the IPP necessary to determine if the variable interest entity (“VIE”) should be consolidated under FIN 46R.

Potomac Edison had power purchases from this IPP in the amount of $26.9 million and $19.4 million for the three months ended June 30, 2005 and 2004, respectively. Potomac Edison had power purchases from this IPP in the amount of $52.5 million and $44.4 million for the six months ended June 30, 2005 and 2004, respectively. Potomac Edison recovers the full amount of the cost of the applicable power contract in its rates charged to consumers. Potomac Edison is not subject to any risk of loss associated with the VIE, because it does not have any obligation to the IPP other than to purchase the power that the IPP produces according to the terms of the applicable electricity purchase contract.

NOTE 9: COMMITMENTS AND CONTINGENCIES

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

Environmental Matters and Litigation

THE POTOMAC EDISON COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

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

Ordinary Course of Business: Potomac Edison is, from time to time, involved in litigation and other legal disputes in the ordinary course of business. Potomac Edison is of the belief that there are no other legal proceedings that could have a material adverse effect on its business or financial condition.

ALLEGHENY GENERATING COMPANY

STATEMENTS OF OPERATIONS

(unaudited)


	Three Months Ended June 30,				Six Months Ended June 30,
(In thousands)	2005		2004		2005		2004
Operating revenues	$	16,724	$	17,884	$	33,583	$	35,041

Operating expenses:
Operations and maintenance		1,069		2,162		2,206		3,417
Depreciation		4,309		4,251		8,546		8,502
Taxes other than income taxes		737		812		1,474		1,624

Total operating expenses		6,115		7,225		12,226		13,543

Operating income		10,609

ALLEGHENY GENERATING CO 10-Q