Merger

6 Months Ended

Jun. 30, 2011

Merger [Abstract]

MERGER

2. MERGER

Merger

On February 25, 2011, the merger between FirstEnergy and Allegheny closed. Pursuant to the terms of the Agreement and Plan of Merger among FirstEnergy, Element Merger Sub, Inc., a Maryland corporation and a wholly-owned subsidiary of FirstEnergy (Merger Sub) and AE, Merger Sub merged with and into AE, with AE continuing as the surviving corporation and becoming a wholly-owned subsidiary of FirstEnergy. As part of the merger, AE shareholders received 0.667 of a share of FirstEnergy common stock for each share of AE common stock outstanding as of the date the merger was completed, and all outstanding AE equity-based employee compensation awards were converted into FirstEnergy equity-based awards on the same basis.

The total consideration in the merger was based on the closing price of a share of FirstEnergy common stock on February 24, 2011, the day prior to the date the merger was completed, and was calculated as follows (in millions, except per share data):

Shares of Allegheny common stock outstanding on February 24, 2011		170
Exchange ratio		0.667
Number of shares of FirstEnergy common stock issued		113
Closing price of FirstEnergy common stock on February 24, 2011	$	38.16
Fair value of shares issued by FirstEnergy	$	4,327
Fair value of replacement share-based compensation awards relating to pre-merger service		27
Total consideration transferred	$	4,354

The allocation of the total consideration transferred to the assets acquired and liabilities assumed includes adjustments for the fair value of coal contracts, energy supply contracts, emission allowances, unregulated property, plant and equipment, derivative instruments, goodwill, intangible assets, long-term debt and accumulated deferred income taxes. The preliminary allocation of the purchase price is as follows:

(In millions)
Current assets	$	1,494
Property, plant and equipment		9,656
Investments		138
Goodwill		881
Other noncurrent assets		1,347
Current liabilities		(716	)
Noncurrent liabilities		(3,452	)
Long-term debt and other long-term obligations		(4,994	)
	$	4,354

The allocation of purchase price in the table above reflects a refinement made during the quarter ended June 30, 2011 in the determination of the fair values of income tax benefits, certain coal contracts and an adverse purchase power contract. This resulted in an increase in noncurrent assets of approximately $85 million and decreases in current assets and goodwill of $15 million and $71 million, respectively. The impact of the refinements on the amortization of purchase accounting adjustments recorded during the quarter ended March 31, 2011 was not significant. Further modifications to the purchase price allocation may occur as a result of continuing review of the assets acquired and liabilities assumed.

The estimated fair values of the assets acquired and liabilities assumed have been determined based on the accounting guidance for fair value measurements under GAAP, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed was recognized as goodwill. The Allegheny delivery, transmission and generation businesses have been assigned to the Regulated Distribution, Regulated Independent Transmission and Competitive Energy Services segments, respectively. The preliminary estimate of goodwill from the merger of $881 million has been assigned to the Competitive Energy Services segment based on expected synergies from the merger. The goodwill is not deductible for tax purposes.

Total goodwill recognized by segment in FirstEnergy’s Consolidated Balance Sheet is as follows:

			Competitive		Regulated
	Regulated		Energy		Independent		Other/
(In millions)	Distribution		Services		Transmission		Corporate		Consolidated
Balance as of December 31, 2010	$	5,551	$	24	$	—	$	—	$	5,575
Merger with Allegheny		—		881		—		—		881
Balance as of June 30, 2011	$	5,551	$	905	$	—	$	—	$	6,456

The preliminary valuation of the additional intangible assets and liabilities recorded as result of the merger is as follows:

	Preliminary		Weighted Average
(In millions)	Valuation		Amortization Period
Above market contracts:
Energy contracts	$	189	10 years
NUG contracts		124	25 years
Coal supply contracts		516	8 years
		829
Below market contracts:
NUG contracts		143	13 years
Coal supply contracts		83	7 years
Transportation contract		35	8 years
		261
Net intangible assets	$	568

The fair value measurements of intangible assets and liabilities were based on significant unobservable inputs and thus represent level 3 measurements as defined in accounting guidance for fair value measurements.

The fair value of Allegheny’s energy, NUG and gas transportation contracts, both above-market and below-market, were estimated based on the present value of the above/below market cash flows attributable to the contracts based on the contract type, discounted by a current market interest rate consistent with the overall credit quality of the portfolio. The above/below market cash flows were estimated by comparing the expected cash flow based on existing contracted prices and expected volumes with the cash flows from estimated current market contract prices for the same expected volumes. The estimated current market contract prices were derived considering current market prices, such as the price of energy and transmission, miscellaneous fees and a normal profit margin. The weighted average amortization period was determined based on the expected volumes to be delivered over the life of the contract.

The fair value of coal supply contracts was determined in a similar manner based on the present value of the above/below market cash flows attributable to the contracts. The fair value adjustment for these contracts is being amortized based on expected deliveries under each contract.

As of June 30, 2011, intangible assets on FirstEnergy’s Consolidated Balance Sheet, including those recorded in connection with the merger, include the following:

	Intangible
(In millions)	Assets
Purchase contract assets
NUG	$	198
OVEC		54
		252
Intangible assets
Coal contracts		487
FES customer intangible assets		129
Energy contracts		105
		721
Total intangible assets	$	973

Acquired land easements and software with a fair value of $169 million are included in “Property, plant and equipment” on FirstEnergy’s Consolidated Balance Sheet as of June 30, 2011.

In connection with the merger, FirstEnergy recorded merger transaction costs of approximately $7 million ($5 million net of tax) and $7 million ($5 million net of tax) during the three months ended June 30, 2011 and 2010, respectively and approximately $89 million ($72 million net of tax) and $21 million ($15 million net of tax) during the first six months of 2011 and 2010, respectively. These costs are included in “Other operating expenses” in the Consolidated Statements of Income. Merger transaction costs recognized in the first six months of 2011 include $56 million ($47 net of tax) of change in control and other benefit payments to AE executives.

FirstEnergy also recorded approximately $10 million ($6 million net of tax) and $85 million ($66 million net of tax) in merger integration costs during the three and six months ended June 30 2011, respectively, including an inventory valuation adjustment. In connection with the merger, FirstEnergy reviewed its inventory levels as a result of combining the inventory of both companies. Following this review, FirstEnergy management determined that the combined inventory stock contained excess and duplicative items. FirstEnergy management also adopted a consistent excess and obsolete inventory practice for the combined entity. Application of the revised practice, in conjunction with those items identified as excess and duplicative, resulted in an inventory valuation adjustment of $67 million ($42 million net of tax) in the first quarter of 2011.

Revenues and earnings of Allegheny included in FirstEnergy’s Consolidated Statement of Income for the periods subsequent to the February 25, 2011 merger date are as follows:

	April 1 –		February 26 –
(In millions, except per share amounts)	June 30, 2011		June 30, 2011
Total revenues	$	1,181	$	1,618
Earnings available to FirstEnergy Corp.(1)		63		17
Basic Earnings Per Share	$	0.15	$	0.04
Diluted Earnings Per Share	$	0.15	$	0.04

⁽¹⁾ Includes Allegheny’s after-tax merger costs of $4 million and $56 million, respectively.

Pro Forma Financial Information

The following unaudited pro forma financial information reflects the consolidated results of operations of FirstEnergy as if the merger with Allegheny had taken place on January 1, 2010. The unaudited pro forma information has been calculated after applying FirstEnergy’s accounting policies and adjusting Allegheny’s results to reflect the depreciation and amortization that would have been charged assuming fair value adjustments to property, plant and equipment, debt and intangible assets had been applied on January 1, 2010, together with the consequential tax effects.

FirstEnergy and Allegheny both incurred non-recurring costs directly related to the merger that have been included in the pro forma earnings presented below. Combined pre-tax transaction costs incurred were approximately $7 million and $11 million in the three months ended June 30, 2011 and 2010, respectively, and approximately $90 million and $39 million in the six months ended June 30, 2011 and 2010, respectively. In addition, during the six months ended June 30, 2011, $85 million of pre-tax merger integration costs and $32 million of charges from merger settlements approved by regulatory agencies were recognized. Charges resulting from merger settlements are not expected to be material in future periods.

The unaudited pro forma financial information has been presented below for illustrative purposes only and is not necessarily indicative of results of operations that would have been achieved or the future consolidated results of operations of the combined company.

	Three Months Ended				Six Months Ended
(Pro forma amounts in millions, except	June 30				June 30
per share amounts)	2011		2010		2011		2010
Revenues	$	4,062	$	4,401	$	8,848	$	9,086
Earnings available to FirstEnergy	$	186	$	389	$	323	$	644
Basic Earnings Per Share	$	0.44	$	0.93	$	0.77	$	1.54
Diluted Earnings Per Share	$	0.44	$	0.93	$	0.77	$	1.53