(a) |
All voting and non-voting common equity is owned by Pepco Holdings. |
(b) |
All voting and non-voting common equity is owned by Conectiv, a wholly owned subsidiary of Pepco Holdings. |
(c) |
All voting and non-voting common equity is owned by ACE. |
THIS COMBINED FORM 10-Q IS SEPARATELY FILED BY PEPCO HOLDINGS, PEPCO, DPL, ACE, AND ACE FUNDING. INFORMATION CONTAINED HEREIN RELATING TO ANY INDIVIDUAL REGISTRANT IS FILED BY SUCH REGISTRANT ON ITS OWN BEHALF. EACH REGISTRANT MAKES NO REPRESENTATION AS TO INFORMATION RELATING TO THE OTHER REGISTRANTS. |
________________________________________________________________________________ |
Page |
|||
Glossary of Terms |
i |
||
PART I |
FINANCIAL INFORMATION |
||
Item 1. |
- |
Financial Statements |
1 |
Item 2. |
- |
Management's Discussion and Analysis of
|
76 |
Item 3. |
- |
Quantitative and Qualitative Disclosures
|
131 |
Item 4. |
- |
Controls and Procedures |
133 |
PART II |
OTHER INFORMATION |
||
Item 1. |
- |
Legal Proceedings |
135 |
Item 2. |
- |
Unregistered Sales of Equity Securities and
|
137 |
Item 3. |
- |
Defaults Upon Senior Securities |
137 |
Item 4. |
- |
Submission of Matters to a Vote of Security Holders |
138 |
Item 5. |
- |
Other Information |
138 |
Item 6. |
- |
Exhibits |
138 |
Signatures |
159 |
||
________________________________________________________________________________ |
TABLE OF CONTENTS - EXHIBITS |
|||
Exh. No. |
Registrant(s) |
Description of Exhibit |
Page |
12.1 |
PHI |
Statements Re: Computation of Ratios |
141 |
12.2 |
Pepco |
Statements Re: Computation of Ratios |
142 |
12.3 |
DPL |
Statements Re: Computation of Ratios |
143 |
12.4 |
ACE |
Statements Re: Computation of Ratios |
144 |
31.1 |
PHI |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer |
145 |
31.2 |
PHI |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer |
146 |
31.3 |
Pepco |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer |
147 |
31.4 |
Pepco |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer |
148 |
31.5 |
DPL |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer |
149 |
31.6 |
DPL |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer |
150 |
31.7 |
ACE |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer |
151 |
31.8 |
ACE |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer |
152 |
31.9 |
ACE Funding |
Rule 13a-14(d)/15d-14(d) Certificate of Chief Executive Officer |
153 |
32.1 |
PHI |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
154 |
32.2 |
Pepco |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
155 |
32.3 |
DPL |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
156 |
32.4 |
ACE |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
157 |
32.5 |
ACE Funding |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
158 |
________________________________________________________________________________ |
GLOSSARY OF TERMS |
|
Term |
Definition |
ABO |
Accumulated benefit obligation |
ACE |
Atlantic City Electric Company |
ACE Funding |
Atlantic City Electric Transition Funding LLC |
AOCI |
Accumulated Other Comprehensive Income |
Act |
Medicare Prescription Drug, Improvement and Modernization Act of 2003 |
APB |
Accounting Principles Board Opinion |
APBO |
Accumulated Post-Retirement Benefit Obligation |
Asset Purchase and
|
Asset Purchase and Sale Agreement, dated as of June 7, 2000 and subsequently amended, between Pepco and Mirant (formerly Southern Energy, Inc.) relating to the sale of Pepco's generation assets |
Bankruptcy Court |
Bankruptcy Court for the Northern District of Texas |
BGS |
Basic generation service (the supply of energy to customers in New Jersey who have not chosen a competitive supplier) |
BTP |
Bondable Transition Property |
Competitive Energy
|
Consists of the business operations of Conectiv Energy and Pepco Energy Services |
Conectiv |
A wholly owned subsidiary of PHI which is a PUHCA holding company and the parent of DPL and ACE |
Conectiv Energy |
Conectiv Energy Holding Company and its subsidiaries |
Conectiv Power
|
The trade name under which DPL and ACE conduct their power delivery operations |
CT |
Combustion turbine |
DCPSC |
District of Columbia Public Service Commission |
Debentures |
Junior Subordinated Debentures |
Delivery revenue |
Revenue Pepco receives for delivering energy to its customers |
District Court |
U.S. District Court for the Northern District of Texas |
DMEC |
Delaware Municipal Electric Corporation |
DPL |
Delmarva Power & Light Company |
DPSC |
Delaware Public Service Commission |
EITF |
Emerging Issues Task Force |
EPA |
Environmental Protection Agency |
ERISA |
Employment Retirement Income Security Act of 1974 |
ESS |
Electricity Supply Service |
Exchange Act |
Securities Exchange Act of 1934, as amended |
FASB |
Financial Accounting Standards Board |
FERC |
Federal Energy Regulatory Commission |
FIN 45 |
FASB Interpretation No. 45, entitled "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" |
FIN 46 |
FASB Interpretation No. 46, entitled "Consolidation of Variable Interest Entities" |
FIN 46R |
FASB Interpretation No. 46 (revised December 2003), entitled "Consolidation of Variable Interest Entities" |
FirstEnergy |
FirstEnergy Corp., formerly Ohio Edison |
FirstEnergy PPA |
PPAs between Pepco and FirstEnergy Corp. and Allegheny Energy, Inc. |
FSP |
FASB Staff Position |
FSP 106-2 |
FASB Staff Position 106-2, entitled "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" |
i _________________________________________________________________________________ |
|
Term |
Definition |
GAAP |
Accounting principles generally accepted in the United States of America |
GCR |
Gas Cost Recovery |
GPC |
Generation Procurement Credit |
LTIP |
Long-Term Incentive Plan |
Mirant |
Mirant Corporation and certain of its subsidiaries |
Mirant Pre-Petition
|
Unpaid obligations of Mirant to Pepco existing at the time of filing of Mirant's bankruptcy petition consisting primarily of payments due Pepco in respect of the PPA-Related Obligations |
MPSC |
Maryland Public Service Commission |
MTC |
Market transition charge |
NJBPU |
New Jersey Board of Public Utilities |
NJBPU Financing Orders |
Bondable stranded costs rate orders issued by the NJBPU |
NJDEP |
New Jersey Department of Environmental Protection |
NUG |
Non-utility generator |
OCI |
Other Comprehensive Income |
OPC |
Office of the People's Counsel |
Other energy
|
The competitive energy segments' commodity risk management and other energy market activities |
Panda |
Panda-Brandywine, L.P. |
Panda PPA |
PPA between Pepco and Panda |
PCI |
Potomac Capital Investment Corporation and its subsidiaries |
Pepco |
Potomac Electric Power Company |
Pepco Energy Services |
Pepco Energy Services, Inc. and its subsidiaries |
Pepco Holdings or PHI |
Pepco Holdings, Inc. |
Pepco TPA Claim |
Pepco's $105 million allowed, pre-petition general unsecured claim against Mirant |
Pepcom |
Pepco Communications, Inc. |
PJM |
PJM Interconnection, LLC |
POLR |
Provider of Last Resort (the supply of energy to customers who have not chosen a competitive supplier) |
Power Delivery |
PHI's Power Delivery Businesses |
PPA |
Power Purchase Agreement |
PPA-Related
|
Mirant's obligations to purchase from Pepco the capacity and energy that Pepco is obligated to purchase under the FirstEnergy PPA and the Panda PPA |
Proprietary trading |
Contracts entered into to take a view, capture market price changes, and/or put capital at risk |
PUHCA |
Public Utility Holding Company Act of 1935 |
RARC |
Regulatory Asset Recovery Charge |
RCN |
RCN Corporation |
Regulated electric
|
Revenues for delivery (transmission and distribution) service and electricity supply service |
SEC |
Securities and Exchange Commission |
Settlement Agreement |
Amended Settlement Agreement and Release, dated as of October 24, 2003 between Pepco and the Mirant Parties |
SFAS |
Statement of Financial Accounting Standards |
SFAS No. 5 |
Statement of Financial Accounting Standards No. 5, entitled "Accounting for Contingencies" |
SFAS No. 123 |
Statement of Financial Accounting Standards No. 123, entitled "Accounting for Stock-Based Compensation" |
SFAS No. 131 |
Statement of Financial Accounting Standards No. 131, entitled "Disclosures About Segments of an Enterprise and Related Information" |
ii _________________________________________________________________________________ |
|
Term |
Definition |
SFAS No. 133 |
Statement of Financial Accounting Standards No. 133, entitled "Accounting for Derivative Instruments and Hedging Activities" |
SFAS No. 148 |
Statement of Financial Accounting Standards No. 148 entitled "Accounting For Stock-Based Compensation - Transition and Disclosure" |
SFAS No. 150 |
Statement of Financial Accounting Standards No. 150, entitled "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" |
SMECO |
Southern Maryland Electric Cooperative, Inc. |
SMECO Agreement |
Capacity purchase agreement between Pepco and SMECO |
SOS |
Standard Offer Service (the supply of energy to customers in Maryland and the District of Columbia who have not chosen a competitive supplier) |
Standard Offer Service
|
Revenue Pepco receives for the procurement of energy by Pepco for its SOS customers |
Starpower |
Starpower Communications, LLC |
Stranded costs |
Costs incurred by a utility in connection with providing service which would otherwise be unrecoverable in a competitive or restructured market. Such costs may include costs for generation assets, purchased power costs, and regulatory assets and liabilities, such as accumulated deferred income taxes. |
TBC |
Transition bond charge |
T&D |
Transmission and distribution |
TPAs |
Transition Power Agreements for Maryland and the District of Columbia between Pepco and Mirant |
Transition Bonds |
Transition bonds issued by ACE Funding |
Treasury lock |
A hedging transaction that allows a company to "lock-in" a specific interest rate corresponding to the rate of a designated Treasury bond for a determined period of time |
VaR |
Value at Risk |
VSCC |
Virginia State Corporation Commission |
iii _________________________________________________________________________________ |
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|
_____________________________________________________________________________ |
PART I FINANCIAL INFORMATION |
. FINANCIAL STATEMENTS |
Listed below is a table that sets forth, for each registrant, the page number where the information is contained herein. |
Registrants |
|||||
Item |
Pepco Holdings |
Pepco |
DPL |
ACE |
ACE Funding |
Consolidated Statements
|
3 |
33 |
48 |
59 |
72 |
Consolidated Statements of
|
4 |
N/A |
N/A |
N/A |
N/A |
Consolidated Balance Sheets |
5 |
34 |
49 |
60 |
73 |
Consolidated Statements
|
7 |
36 |
51 |
62 |
74 |
Notes to Consolidated
|
8 |
37 |
52 |
63 |
75 |
1 _____________________________________________________________________________ |
THIS PAGE INTENTIONALLY LEFT BLANK. |
2 _____________________________________________________________________________ |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
PEPCO HOLDINGS, INC. |
(1) ORGANIZATION |
Pepco Holdings, Inc. (Pepco Holdings or PHI) is a diversified energy company that, through its operating subsidiaries, is engaged in three principal areas of business operations: |
· |
regulated power delivery, |
· |
non-regulated competitive energy generation, marketing and supply, and |
· |
other non-regulated activities consisting primarily of investments in energy-related assets. |
The following is a description of each of PHI's areas of operation. |
Power Delivery |
The largest component of PHI's business is Power Delivery, which consists of the transmission and distribution of electricity and the distribution of natural gas. Additionally, PHI's Power Delivery business provides default electricity supply to customers who do not choose a competitive supplier on terms that vary depending on the service territory. PHI's Power Delivery business is conducted by its subsidiaries Potomac Electric Power Company (Pepco), Delmarva Power & Light Company (DPL), and Atlantic City Electric Company (ACE), each of which is a regulated public utility in the jurisdictions in which it serves customers. DPL and ACE conduct their Power Delivery operations under the trade name Conectiv Power Delivery. |
Competitive Energy |
PHI's competitive energy business provides non-regulated generation, marketing and supply of electricity and gas, and related energy management services, in the mid-Atlantic region. PHI's competitive energy operations are conducted through subsidiaries of Conectiv Energy Holding Company (collectively, Conectiv Energy) and Pepco Energy Services, Inc. and its subsidiaries (collectively, Pepco Energy Services). |
Other Non-Regulated |
This component of PHI's business is conducted through its subsidiaries Potomac Capital Investment Corporation (PCI) and Pepco Communications, Inc. (Pepcom). PCI manages a portfolio of financial investments, which primarily includes energy leveraged leases. During the second quarter of 2003, PHI |
8 ____________________________________________________________________________ |
announced the discontinuation of further new investment activity by PCI. Pepco Holdings, through Pepcom, holds a 50% interest in Starpower Communications, LLC (Starpower), a joint venture with RCN Corporation (RCN), which owns the other 50%. |
In the fourth quarter of 2003, Pepco Holdings recorded an impairment charge which reduced the carrying value of Pepcom's investment in Starpower to $39.2 million. The amount of the impairment charge was based on Pepco Holdings' intent to sell its investment and an assessment of the fair value of its investment at December 31, 2003. On July 28, 2004, Pepcom entered into a contract with a third party for the sale of its 50% interest in Starpower. Based on the sales price in the contract and the related selling costs, Pepcom recorded an additional impairment charge of $11.2 million in the second quarter of 2004 reducing the value of Pepco Holdings' equity investment in Starpower to $28 million at June 30, 2004. |
Under a right of first refusal provision in the Starpower joint venture operating agreement between Pepcom and RCN, RCN has the right to match a third party's offer and enter into an agreement to purchase Pepcom's interest in Starpower within 60 days from the receipt of an offer notice from Pepcom. |
On October 15, 2004, RCN notified Pepcom that it has elected to exercise its right of first refusal to match the third party offer and to purchase Pepcom's 50% interest in Starpower. As a result of RCN's election to purchase Pepcom's 50% interest in Starpower, Pepcom will be required to pay a break up fee of $1 million to the third party with which Pepcom entered into the July 28, 2004 contract. This break up fee will be payable upon closing of the sale to RCN of Pepcom's interest in Starpower. |
The sale of Pepcom's interest in Starpower to RCN is subject to the receipt of all necessary regulatory approvals. At this time, the completion date for the sale has not been determined. |
(2) ACCOUNTING POLICY, PRONOUNCEMENTS, AND OTHER DISCLOSURES |
Financial Statement Presentation |
Pepco Holdings' unaudited consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Pursuant to the rules and regulations of the SEC, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted. Therefore, these financial statements should be read along with the annual financial statements included in PHI's Annual Report on Form 10-K/A for the year ended December 31, 2003. In the opinion of PHI's management, the consolidated financial statements contain all adjustments (which all are of a normal recurring nature) necessary to present fairly Pepco Holdings' financial condition as of September 30, 2004, in accordance with GAAP. Interim results for the three and nine months ended September 30, 2004 may not be indicative of PHI's results that will be realized for the full year ending December 31, 2004, since its Power Delivery subsidiaries' sales of electric energy are seasonal. Additionally, certain prior period balances have been reclassified in order to conform to current period presentation. |
FIN 45 |
Pepco Holdings applied the provisions of FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45), commencing in 2003 to its agreements that contain guarantee and indemnification clauses. These |
9 ____________________________________________________________________________ |
provisions expand those required by FASB Statement No. 5, "Accounting for Contingencies," by requiring a guarantor to recognize a liability on its balance sheet for the fair value of obligations it assumes under certain guarantees issued or modified after December 31, 2002 and to disclose certain types of guarantees, even if the likelihood of requiring the guarantor's performance under the guarantee is remote. |
As of September 30, 2004 Pepco Holdings did not have material obligations under guarantees or indemnifications issued or modified after December 31, 2002, which are required to be recognized as a liability on its consolidated balance sheets; however, certain energy marketing obligations of Conectiv Energy were recorded as liabilities. |
FIN 46 |
On December 31, 2003, FIN 46 was implemented by Pepco Holdings. FIN 46 was revised and superseded by FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities" (FIN 46R) which clarified some of the provisions of FIN 46 and exempted certain entities from its requirements. The implementation of FIN 46R (including the evaluation of interests in purchase power arrangements) did not impact Pepco Holdings' financial condition or results of operations for the three or nine months ended September 30, 2004. |
As part of the FIN 46R evaluation, Pepco Holdings reviewed its subsidiaries' power purchase agreements (PPAs), including its Non-Utility Generation (NUG) contracts, to determine (i) if the subsidiary's interest in each entity that is a counterparty to a PPA was a variable interest, (ii) whether the entity was a variable interest entity and (iii) if so, whether Pepco Holdings' subsidiary was the primary beneficiary. Due to a variable element in the pricing structure of PPAs with four entities, including Pepco's agreement with Panda-Brandywine, L.P. (Panda), Pepco Holdings' subsidiaries potentially assume the variability in the operations of the plants of these entities and therefore have a variable interest in the entities. Pepco Holdings was unable to obtain sufficient information from these entities to conduct the analysis required under FIN 46R to determine whether these four entities were variable interest entities or if Pepco Holdings' subsidiaries were the primary beneficiary. As a result, Pepco Holdings has applied the scope exemption from the application of FIN 46R for enterprises that have conducted exhaustive efforts to obtain the necessary information. |
Net purchase activities with these four entities in the quarters ended September 30, 2004 and 2003 were approximately $89 million and $88 million, respectively, of which approximately $82 million and $80 million, respectively, related to power purchases under the PPAs. Net purchase activities with these four entities for the nine months ended September 30, 2004 and 2003 were approximately $258 million and $247 million, respectively, of which approximately $236 million and $228 million, respectively related to power purchases under the PPAs. Net purchase activities with these four entities in the years ended December 31, 2003, 2002 and 2001 were approximately $326 million, $316 million and $318 million, respectively, of which approximately $299 million, $295 million and $302 million, respectively related to power purchases under the PPAs. Pepco Holdings' exposure to loss under the Panda PPA is discussed in Note (4) Commitments and Contingencies, under "Relationship with Mirant Corporation." Pepco Holdings does not have loss exposure under the remaining three PPAs because cost recovery will be achieved from its customers through regulated rates. |
10 ____________________________________________________________________________ |
EITF 03-11 |
On January 1, 2004, Pepco Holdings implemented EITF Issue No. 03-11 (EITF 03-11), "Reporting Realized Gains and Losses on Derivative Instruments That Are Subject to FASB Statement No. 133, 'Accounting for Derivative Instruments and Hedging Activities,' and not 'Held for Trading Purposes' as Defined in EITF Issue No. 02-3, 'Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities.'" As a result of the implementation of this EITF, $67.0 million and $148.6 million of operating revenues and operating expenses related to certain of Conectiv Energy's energy contracts are reported on a net basis in the accompanying consolidated statements of earnings for the three and nine months ended September 30, 2004, respectively, as these energy contracts did not physically settle. Had EITF 03-11 been effective for the three and nine months ended September 30, 2003, Pepco Holdings' operating revenues and operating expenses would have been reduced by $88.9 million and $192.6 million, respectively. The implementation of EITF 03-11 did not have an impact on Pepco Holdings' financial condition or earnings. |
Components of Net Periodic Benefit Cost |
The following Pepco Holdings information is for the three months ended September 30, 2004 and 2003. |
Pension Benefits |
Other
|
|||
2004 |
2003 |
2004 |
2003 |
|
(In Millions) |
||||
Service cost |
$ 9.0 |
$ 8.0 |
$ 2.1 |
$ 2.4 |
Interest cost |
23.7 |
22.6 |
8.7 |
8.2 |
Expected return on plan assets |
(31.1) |
(26.3) |
(2.4) |
(2.1) |
Amortization of prior service cost |
.3 |
.3 |
(.5) |
- |
Amortization of net loss |
1.6 |
3.3 |
2.8 |
2.0 |
Net periodic benefit cost |
$ 3.5 |
$ 7.9 |
$10.7 |
$10.5 |
The following Pepco Holdings information is for the nine months ended September 30, 2004 and 2003. |
Pension Benefits |
Other
|
|||
2004 |
2003 |
2004 |
2003 |
|
(In Millions) |
||||
Service cost |
$ 27.0 |
$ 24.6 |
$ 6.4 |
$ 6.9 |
Interest cost |
71.0 |
69.6 |
26.6 |
24.0 |
Expected return on plan assets |
(93.2) |
(80.1) |
(7.5) |
(6.1) |
Amortization of prior service cost |
.8 |
.8 |
(1.3) |
- |
Amortization of net loss |
4.9 |
10.3 |
8.5 |
5.9 |
Net periodic benefit cost |
$ 10.5 |
$ 25.2 |
$32.7 |
$30.7 |
The actual components of net periodic benefit cost for the 2003 interim periods are not available. The component amounts presented above for the 2003 interim periods were calculated in proportion to the annual amounts presented in Pepco Holdings' financial statements for the year ended December 31, 2003. These component amounts are presented for comparison purposes only. |
11 ____________________________________________________________________________ |
Pension |
The 2004 pension net periodic benefit cost for the three months ended September 30, of $3.5 million includes $1.9 million for Pepco, $1.8 million for ACE, and $(2.2) million for DPL. The 2004 pension net periodic benefit cost for the nine months ended September 30, of $10.5 million includes $5.6 million for Pepco, $5.3 million for ACE, and $(6.5) million for DPL. The remaining pension net periodic benefit cost is for other PHI subsidiaries. The 2003 pension net periodic benefit cost for the three months ended September 30, of $7.9 million includes $3.8 million for Pepco, $2.6 million for ACE, and $(.7) million for DPL. The 2003 pension net periodic benefit cost for the nine months ended September 30, of $25.2 million includes $14.1 million for Pepco, $9.0 million for ACE, and $(3.5) million for DPL. The remaining pension net periodic benefit cost is for other PHI subsidiaries. |
Pension Contributions |
Pepco Holdings' current funding policy with regard to its defined benefit pension plan is to maintain a funding level in excess of 100% of its accumulated benefit obligation (ABO). In 2003 and 2002 PHI made discretionary tax-deductible cash contributions to the plan of $50 million and $35 million, respectively. PHI's pension plan currently meets the minimum funding requirements of the Employment Retirement Income Security Act of 1974 (ERISA) without any additional funding. PHI may elect, however, to make a discretionary tax-deductible contribution to maintain the pension plan's assets in excess of its ABO. As of September 30, 2004, no contributions have been made. The potential discretionary funding of the pension plan in 2004 will depend on many factors, including the actual investment return earned on plan assets over the remainder of the year. |
Other Post-Retirement Benefits |
The 2004 other post-retirement net periodic benefit cost for the three months ended September 30, of $10.7 million includes $3.5 million for Pepco, $2.9 million for ACE, and $2.5 million for DPL. The 2004 other post-retirement net periodic benefit cost for the nine months ended September 30, of $32.7 million includes $12.5 million for Pepco, $7.8 million for ACE, and $7.1 million for DPL. The remaining other post-retirement net periodic benefit cost is for other PHI subsidiaries. The 2003 other post-retirement net periodic benefit cost for the three months ended September 30, of $10.5 million includes $4.5 million for Pepco, $2.5 million for ACE, and $2.2 million for DPL. The 2003 other post-retirement net periodic benefit cost for the nine months ended September 30, of $30.7 million includes $12.9 million for Pepco, $7.7 million for ACE, and $5.5 million for DPL. The remaining other post-retirement net periodic benefit cost is for other PHI subsidiaries. |
FASB Staff Position (FSP 106-2), Accounting and Disclosure
|
The Act became effective on December 8, 2003. The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. |
Pepco Holdings sponsors post-retirement health care plans that provide prescription drug benefits. Pepco Holdings did not elect the deferral of appropriate accounting permitted by the FASB Staff position (FSP) 106-1. The |
12 ____________________________________________________________________________ |
Accumulated Post-retirement Benefit Obligation (APBO) as of December 31, 2003 was reduced by $28 million to reflect the effects of the Act. For the three and nine months ended September 30, 2004, Pepco Holdings' net periodic post-retirement benefit expense has been reduced to reflect the Act. PHI estimates that the annual post-retirement benefit cost is reduced by approximately $3.7 million due to effects of the Act. This reduction includes both the decrease in the cost of future benefits being earned and an amortization of the APBO reduction over the future average working lifetime of the participants, or 12 years . The anticipated claims costs expected to be incurred have been adjusted to reflect the cost sharing between Medicare and Pepco Holdings. Participation rates have not been changed. In reflecting the effects of the Act, Pepco Holdings has determined which plans are eligible for Medicare cost sharing by analyzing the terms of each of its plans. It has recognized Medicare cost sharing for a plan only if Pepco Holdings' projected prescription drug coverage is expected to be at least as generous as the expected contribution by Medicare to a prescription drug plan not provided by Pepco Holdings. |
The effect of the subsidy on the three months ended September 30, 2004 other post-retirement net periodic benefit cost of $10.7 million is approximately a $.9 million reduction due to the subsidy. Approximately $.5 million is related to the amortization of the actuarial gain, and approximately $.4 million is a subsidy-related reduction in interest cost on the APBO. The effect of the subsidy on the nine months ended September 30, 2004 other post-retirement net periodic benefit cost of $32.7 million is approximately a $2.8 million reduction due to the subsidy. Approximately $1.5 million is related to the amortization of the actuarial gain, and approximately $1.3 million is a subsidy-related reduction in interest cost on the APBO. |
Summarized Income Statement Information for Starpower |
Pepco Holdings, through a subsidiary of Pepcom, owns a 50% interest in Starpower. Unaudited summarized financial information for Starpower for the three and nine months ended September 30, 2004, is as follows: |
Three Months Ended
|
Nine Months Ended
|
|
(Millions of Dollars) |
||
Total Revenue |
$19.5 |
$59.4 |
Cost of Sales |
5.8 |
17.1 |
Gross Margin |
13.7 |
42.3 |
Operating Expenses |
10.2 |
30.8 |
Depreciation and Amortization and Other |
6.8 |
19.7 |
Loss |
$(3.3) |
$(8.2) |
As discussed in Note (1), Organization, herein, Pepcom has entered into a contract to sell its interest in Starpower. |
Stock-Based Compensation |
The objective of Pepco Holdings' Long-Term Incentive Plan (the LTIP) is to increase shareholder value by providing a long-term incentive to reward officers, key employees, and directors of Pepco Holdings and its subsidiaries and to increase the ownership of Pepco Holdings' common stock by such individuals. Any officer or key employee of Pepco Holdings or its subsidiaries may be designated by PHI's Board of Directors as a participant |
13 ____________________________________________________________________________ |
in the LTIP. Under the LTIP, awards to officers and key employees may be in the form of restricted stock, options, performance units, stock appreciation rights, or dividend equivalents. No awards were granted during the three or nine months ended September 30, 2004. |
Pepco Holdings recognizes compensation costs for the LTIP based on the provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." In accordance with FASB Statement No. 123, Accounting for Stock-Based Compensation (SFAS No. 123), as amended by FASB Statement No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure," the following table illustrates what the effect on net income and basic and diluted earnings per share would have been if Pepco Holdings had applied the fair value based method of expense recognition and measurement provisions of SFAS No. 123 to stock-based employee compensation. |
For the Three Months Ended September 30, |
For the Nine Months Ended September 30, |
|||
2004 |
2003 |
2004 |
2003 |
|
(Millions, except Per Share Data) |
||||
Net Income, as reported |
$111.0 |
$157.3 |
$252.6 |
$175.5 |
Add: Total stock-based employee compensation cost, net of related tax effects, included in net income as reported |
0.5 |
1.0 |
1.9 |
1.2 |
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects |
(0.8 ) |
(1.3 ) |
(2.8 ) |
(2.2 ) |
Pro forma net income |
$110.7 |
$157.0 |
$251.7 |
$174.5 |
Average common shares outstanding
|
175.2 |
171.0 |
173.1 |
170.5 |
Basic and diluted earnings per share
|
$.64 |
$.92 |
$1.46 |
$1.03 |
Pro forma basic and diluted earnings
|
$.63 |
$.92 |
$1.46 |
$1.02 |
Issuance of Common Stock |
In September 2004, Pepco Holdings sold 14,950,000 shares of common stock at $19.25 per share. Proceeds received on the transaction, net of issuance costs of $10.3 million, were $277.5 million. These proceeds, in combination with short-term debt, were used to pre-pay in its entirety a term loan in the amount of $335 million of Conectiv Bethlehem, LLC. |
Debt |
In July 2004, Pepco Holdings, Pepco, DPL and ACE entered into a five-year credit agreement with an aggregate borrowing limit of $650 million. This agreement replaces a $550 million 364-day credit agreement that was entered into on July 29, 2003. The respective companies also are parties to a three-year credit agreement that was entered into in July 2003 and terminates in July 2006 with an aggregate borrowing limit of $550 million. Pepco Holdings' credit limit under these agreements is $700 million and the credit limit of each of Pepco, DPL and ACE is the lower of $300 million and the maximum amount of short-term debt authorized by the applicable regulatory authority, except |
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that the aggregate amount of credit utilized by Pepco, DPL and ACE at any given time under the agreements may not exceed $500 million. The credit agreements primarily serve as a source of liquidity to support the commercial paper programs of the respective companies. The companies can also borrow funds for general corporate purposes and issue letters of credit under the Agreements. The credit agreements contain customary financial and other covenants that, if not satisfied, could result in the acceleration of repayment obligations under the agreements or restrict the ability of the companies to borrow under the agreements. Among these covenants is the requirement that each borrowing company maintain a ratio of total indebtedness to total capitalization of 65% or less, computed in accordance with the terms of the credit agreements. The credit agreements also contain a number of customary events of default that could result in the acceleration of repayment obligations under the agreements, including (i) the failure of any borrowing company or any of its significant subsidiaries to pay when due, or the acceleration of certain indebtedness under other borrowing arrangements, (ii) certain bankruptcy events, judgments or decrees against any borrowing company or its significant subsidiaries, and (iii) a change in control (as defined in the credit agreements) of Pepco Holdings or the failure of Pepco Holdings to own all of the voting stock of Pepco, DPL and ACE. |
In July 2004, ACE Funding paid at maturity $4.0 million of 2.89% Transition Bonds. |
In August 2004, Pepco repurchased 65,000 shares of its $2.28 series, par value $50.00 per share preferred stock at an average price of $45.50 per share. |
In August 2004, on behalf of ACE, the Pollution Control Financing Authority of Salem County, New Jersey issued $23.15 million of insured auction rate tax-exempt bonds due 2029 and loaned the proceeds to ACE. ACE's obligations under the insurance agreement are secured by a like amount of ACE First Mortgage Bonds. In September 2004, ACE used the proceeds to redeem $23.15 million of 6.15% First Mortgage Bonds due 2029 at 102%. |
In August 2004, on behalf of ACE, the Pollution Control Financing Authority of Cape May County, New Jersey issued $25 million of Series 2004A and $6.5 million of Series 2004B insured auction rate tax-exempt bonds due 2029 and loaned the proceeds to ACE. ACE's obligations under the insurance agreement are secured by a like amount of ACE First Mortgage Bonds. In November 2004, ACE used the proceeds to redeem $25 million of 7.2% First Mortgage Bonds due 2029 at 102% and $6.5 million of 7.0% First Mortgage Bonds due 2029 at 102%. |
In September 2004, Conectiv Bethlehem prepaid its entire $335 million term loan due 2006. Additionally, Conectiv Bethlehem paid $6.8 million to unwind an interest rate swap agreement that had converted a portion of the variable interest rate on the term loan balance to a fixed rate. Approximately $6.0 million in unamortized debt issuance costs related to the term loan were expensed at the time of the loan repayment. |
In September 2004, Pepco repurchased 16,400 shares of its $2.28 series preferred stock, par value $50.00 per share, at an average price of $47.25 per share. |
In September 2004, Pepco redeemed $2.5 million, or 50,000 shares, of its $3.40 Serial Preferred Stock Series of 1992 pursuant to mandatory sinking fund provisions. |
15 ____________________________________________________________________________ |
Effective Tax Rate |
PHI's effective tax rate for the three months ended September 30, 2004 was 38.9% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and tax benefits related to certain leveraged leases. |
PHI's effective tax rate for the three months ended September 30, 2003 was 39.0% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and tax benefits related to certain leveraged leases. |
PHI's effective tax rate for the nine months ended September 30, 2004 was 35.5% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit, including the benefit associated with the retroactive adjustment for the issuance of final consolidated return regulations by a local taxing authority, which is the primary reason for the lower effective tax rate as compared to 2003) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and tax benefits related to certain leveraged leases. |
PHI's effective tax rate for the nine months ended September 30, 2003 was 36.4% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and tax benefits related to certain leveraged leases. |
Based on the provisions of Statement of Financial Accounting Standards (SFAS) No. 131 "Disclosures about Segments of an Enterprise and Related Information," Pepco Holdings' management has identified its reportable segments at September 30, 2004 as Power Delivery, Conectiv Energy, Pepco Energy Services, and Other Non-Regulated. Prior to December 31, 2003, Pepco Holdings' Power Delivery business consisted of two reportable segments, Pepco and Conectiv Power Delivery. However, with the continued integration of the Power Delivery businesses, effective January 1, 2004 these two businesses represent a single segment. Additionally, during the quarter ended March 31, 2004, Pepco Holdings transferred several operating businesses from one reportable segment to another in order to better align their operations going forward. In accordance with the provisions of SFAS No. 131, results for the three and nine months ended September 30, 2003 have been reclassified to conform to the current period segment presentation. Intercompany (intersegment) revenues and expenses are not eliminated at the segment level for purposes of presenting segment financial results. Elimination of these intercompany amounts is accomplished for Pepco Holdings' consolidated results through the "Corporate and Other" column. Segment financial information for the three and nine months ended September 30, 2004 and 2003, is as follows. |
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17 ____________________________________________________________________________ |
18 ____________________________________________________________________________ |
19 ____________________________________________________________________________ |
(4) COMMITMENTS AND CONTINGENCIES |
Relationship with Mirant Corporation |
In 2000, Pepco sold substantially all of its electricity generation assets to Mirant Corporation, formerly Southern Energy, Inc., pursuant to an Asset Purchase and Sale Agreement. As part of the Asset Purchase and Sale Agreement, Pepco entered into several ongoing contractual arrangements with Mirant and certain of its subsidiaries (collectively, Mirant). On July 14, 2003, Mirant Corporation and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of Texas (the Bankruptcy Court). |
Depending on the outcome of the matters discussed below, the Mirant bankruptcy could have a material adverse effect on the results of operations of Pepco Holdings and Pepco. However, management currently believes that Pepco Holdings and Pepco currently have sufficient cash, cash flow and borrowing capacity under their credit facilities and in the capital markets to be able to satisfy any additional cash requirements that have arisen or may arise due to the Mirant bankruptcy. Accordingly, management does not anticipate that the Mirant bankruptcy will impair the ability of Pepco Holdings or Pepco to fulfill their contractual obligations or to fund projected capital expenditures. On this basis, management currently does not believe that the Mirant bankruptcy will have a material adverse effect on the financial condition of either company. |
Transition Power Agreements |
For a discussion of the Transition Power Agreements between Pepco and Mirant and the amendment of these agreements in connection with the Mirant bankruptcy, see Note (4), Commitments and Contingencies, to the financial statements of Pepco Holdings included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
Power Purchase Agreements |
Under agreements with FirstEnergy Corp., formerly Ohio Edison (FirstEnergy), and Allegheny Energy, Inc., both entered into in 1987, Pepco is obligated to purchase from FirstEnergy 450 megawatts of capacity and energy annually through December 2005 (the FirstEnergy PPA). Under an agreement with Panda-Brandywine L.P. (Panda), entered into in 1991, Pepco is obligated to purchase from Panda 230 megawatts of capacity and energy annually through 2021 (the Panda PPA). In each case, the purchase price is substantially in excess of current market prices. As a part of the Asset Purchase and Sale Agreement, Pepco entered into a "back-to-back" arrangement with Mirant. Under this arrangement, Mirant is obligated, among other things, to purchase from Pepco the capacity and energy that Pepco is obligated to purchase under the FirstEnergy PPA and the Panda PPA at a price equal to the price Pepco is obligated to pay under the PPAs (the PPA-Related Obligations). |
Pepco Pre-Petition Claims |
For a discussion of the claims that Pepco has filed against Mirant with respect to amounts owed by Mirant to Pepco under the PPAs at the time of the filing of Mirant's bankruptcy petition and the accounting treatment of these claims, see Note (4), Commitments and Contingencies, to the financial |
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statements of Pepco Holdings included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
Mirant's Attempt to Reject the PPA-Related Obligations |
On August 28, 2003, Mirant filed with the Bankruptcy Court a motion seeking authorization to reject its PPA-Related Obligations. Upon motions filed with the U.S. District Court for the Northern District of Texas (the District Court) by Pepco and the Federal Energy Regulatory Commission (FERC), in October 2003, the District Court withdrew jurisdiction over the rejection proceedings from the Bankruptcy Court. In December 2003, the District Court denied Mirant's motion to reject the PPA-Related Obligations. The District Court's decision was appealed by Mirant and The Official Committee of Unsecured Creditors of Mirant Corporation in the U.S. Court of Appeals for the Fifth Circuit. On August 4, 2004, the Court of Appeals remanded the case to the District Court saying that it has jurisdiction to rule on the merits of Mirant's rejection motion, suggesting that in doing so the court apply a "more rigorous standard" than the business judgment rule usually applied by bankruptcy courts in ruling on rejection motions, and noting that there are other "important issues which must still be resolved before a decision on the merits would be appropriate." On October 4, 2004, the District Court issued an order stating that the District Court will retain jurisdiction over the matter and invited parties to submit comments on the appropriate standard to be applied in determining whether to grant Mirant's rejection motion. All parties submitted comments. On November 3, 2004, the District Court issued an order stating that the Court concluded that the "separate agreement" issue ( i.e ., whether the PPA-Related Obligations are severable from the Asset Purchase and Sale Agreement) relating to the sale of Pepco's generation assets should be resolved before the District Court deals further with the issue of the standard to be applied in determining whether the motion to reject should be granted. The order permits the parties to submit further evidentiary material related to the separate agreement issue. |
Pepco is exercising all available legal remedies and vigorously opposing Mirant's attempt to reject the PPA-Related Obligations in order to protect the interests of its customers and shareholders. While Pepco believes that it has substantial legal bases to oppose the attempt to reject the agreements, the outcome of Mirant's efforts to reject the PPA-Related Obligations is uncertain. |
In accordance with the Bankruptcy Court's order, Mirant is continuing to perform the PPA-Related Obligations pending the resolution of the ongoing proceedings. However, if Mirant ultimately is successful in rejecting, and is otherwise permitted to stop performing the PPA-Related Obligations, Pepco could be required to repay to Mirant, for the period beginning on the effective date of the rejection (which date could be prior to the date of the court's order and possibly as early as September 18, 2003) and ending on the date Mirant is entitled to cease its purchases of energy and capacity from Pepco, all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity. Pepco estimates that the amount it could be required to repay to Mirant in the unlikely event September 18, 2003, is determined to be the effective date of rejection, is approximately $118.8 million as of November 1, 2004. This repayment would entitle Pepco to file a claim against the bankruptcy estate in an amount equal to the amount repaid. Mirant has also asked the Bankruptcy Court to require Pepco to disgorge all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity, for the period July 14, 2003 (the date on which Mirant filed |
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its bankruptcy petition) to September 18, 2003, on the theory that Mirant did not receive value for those payments. Pepco estimates that the amount it would be required to repay to Mirant on the disgorgement theory is approximately $22.5 million. Pepco believes a claim based on this theory should be entitled to administrative expense status for which complete recovery could be expected in the Bankruptcy Court. If Pepco were required to repay any such amounts for either period, the payment would be expensed at the time the payment is made. However, Pepco believes that, to the extent such amounts were not recovered from the Mirant bankruptcy estate, the expensed amounts would be recoverable as stranded costs from customers through distribution rates as described below. |
The following are estimates prepared by Pepco of its potential future exposure if Mirant's motion to reject its PPA-Related Obligations ultimately is successful. These estimates are based in part on current market prices and forward price estimates for energy and capacity, and do not include financing costs, all of which could be subject to significant fluctuation. The estimates assume no recovery from the Mirant bankruptcy estate and no regulatory recovery, either of which would mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recoveries. Based on these assumptions, Pepco estimates that its pre-tax exposure as of November 1, 2004, representing the loss of the future benefit of the PPA-Related Obligations to Pepco, is as follows: |
· |
If Pepco were required to purchase capacity and energy from FirstEnergy commencing as of November 1, 2004, at the rates provided in the PPA (with an average price per kilowatt hour of approximately 6.0 cents) and resold the capacity and energy at market rates projected, given the characteristics of the FirstEnergy PPA, to be approximately 5.0 cents per kilowatt hour, Pepco estimates that it would cost approximately $9 million for the remainder of 2004, and $33 million in 2005, the last year of the FirstEnergy PPA. |
· |
If Pepco were required to purchase capacity and energy from Panda commencing as of November 1, 2004, at the rates provided in the PPA (with an average price per kilowatt hour of approximately 18.4 cents), and resold the capacity and energy at market rates projected, given the characteristics of the Panda PPA, to be approximately 8.4 cents per kilowatt hour, Pepco estimates that it would cost approximately $8 million for the remainder of 2004, $35 million in 2005, and $35 million in 2006 and approximately $35 million to $48 million annually thereafter through the 2021 contract termination date. |
The ability of Pepco to recover from the Mirant bankruptcy estate in respect to the Mirant Pre-Petition Obligations and damages if the PPA-Related Obligations are successfully rejected will depend on whether Pepco's claims are allowed, the amount of assets available for distribution to creditors and Pepco's priority relative to other creditors. At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate, whether the recovery would be in cash or another form of payment, or the timing of any recovery. |
If Mirant ultimately is successful in rejecting the PPA-Related Obligations and Pepco's full claim is not recovered from the Mirant bankruptcy estate, Pepco may seek authority from the Maryland Public Service Commission (MPSC) and the District of Columbia Public Service Commission (DCPSC) to recover its additional costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its |
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shareholders and customers. Under the provisions of the settlement agreements approved by the MPSC and the DCPSC in the deregulation proceedings in which Pepco agreed to divest its generation assets under certain conditions, the PPAs were to become assets of Pepco's distribution business if they could not be sold. Pepco believes that, if Mirant ultimately is successful in rejecting the PPA-Related Obligations, these provisions would allow the stranded costs of the PPAs that are not recovered from the Mirant bankruptcy estate to be recovered from Pepco's customers through its distribution rates. If Pepco's interpretation of the settlement agreements is confirmed, Pepco expects to be able to establish the amount of its anticipated recovery as a regulatory asset. However, there is no assurance that Pepco's interpretation of the settlement agreements would be confirmed by the respective public service commissions. |
If the PPA-Related Obligations are successfully rejected, and there is no regulatory recovery, Pepco will incur a loss. However, the accounting treatment of such a loss depends on a number of legal and regulatory factors, and is not determinable at this time. |
The SMECO Agreement |
As a term of the Asset Purchase and Sale Agreement, Pepco assigned to Mirant a facility and capacity agreement with Southern Maryland Electric Cooperative, Inc. For a discussion of the status of this agreement in the context of the Mirant bankruptcy, see Note (4), Commitments and Contingencies, to the financial statements of Pepco Holdings included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
Federal Tax Legislation Affecting Cross-border=0Leases |
On October 22, 2004, President Bush signed into law the American Jobs Creation Act of 2004 (FSC-ETI Bill, H.R. 4520). This legislation provides, in part, new passive loss limitation rules that will be applied prospectively to leases (including cross-border=0leases) entered into after March 12, 2004 with tax indifferent parties (i.e., municipalities and tax exempt or governmental entities). The assets of PCI include a cross-border=0energy lease portfolio with a book value of approximately $1.2 billion at September 30, 2004. Cross-border=0leases are leases by a U.S. taxpayer of property located in a foreign country. All of PCI's cross-border=0leases are with tax indifferent parties and were entered into prior to 2004. Therefore, the legislation, as finally enacted, will not affect PCI's existing leases. Although this legislation is prospective in nature, it does not prohibit the Internal Revenue Service from challenging prior leasing transactions. |
PHI Potential Earnings Charge Relating to Additional Tax Liability |
PHI files a consolidated federal income tax return. PHI's federal income tax liabilities for Pepco legacy companies for all years through 2000, and for Conectiv legacy companies for all years through 1997, have been determined, subject to adjustment to the extent of any net operating loss or other loss or credit carrybacks from subsequent years. The Internal Revenue Service (IRS), as part of its normal audit of PHI's income tax returns, has questioned whether PHI was entitled to certain tax deductions as the result of the adoption of a carry-over tax basis for a non-lease financial asset acquired in 1998 by a subsidiary of PHI. If the position asserted by the IRS were to prevail and the deductions were disallowed, PHI may be required to take a charge to earnings for financial reporting purposes due to the reversal of the tax benefits recognized in prior periods (including years |
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1998 through 2000, which remain open due to net operating loss carrybacks). At September 30, 2004, the amount of this potential charge consisted of approximately $16.3 million reflecting the reversal of the tax benefits and approximately $3 million of estimated interest on the additional taxes owed. PHI is in discussions with the IRS regarding a settlement of this matter; however the ultimate outcome and financial effect are not known at this time. |
Rate Proceedings |
For a discussion of the history of ACE's proceeding filed with the New Jersey Board of Public Utilities (NJBPU) to increase its electric distribution rates and Regulatory Asset Recovery Charge (RARC) in New Jersey, see Note (4), Commitments and Contingencies, to the financial statements of Pepco Holdings included in Pepco Holdings' Quarterly Reports on Form 10-Q for the quarters ended March 31, 2004 and June 30, 2004. The Ratepayer Advocate and Staff of the NJBPU filed their briefs in this proceeding in August 2004. The Ratepayer Advocate's brief supported its earlier proposal of an annual rate decrease of $4.5 million. The Staff's brief, however, stated for the first time its position calling for an overall decrease of $10.8 million. Reply briefs were filed on August 23, 2004. Settlement discussions between ACE, the NJBPU Staff and the Ratepayer Advocate have been ongoing. ACE cannot predict the outcome of this proceeding. |
For a discussion of the history of Phase II to ACE's base rate proceeding, see Note (4), Commitments and Contingencies, to the financial statements of Pepco Holdings included in Pepco Holdings' Quarterly Reports on Form 10-Q for the quarters ended March 31, 2004 and June 30, 2004. In August 2004, the Ratepayer Advocate filed testimony proposing a cost-sharing mechanism related to the operation and maintenance costs of the B. L. England generating facility and also proposing the disallowance and/or continued deferral of approximately $30.7 million of previously deferred costs related to industry restructuring, the divestiture efforts related to the ACE's fossil generating assets, the arbitration proceeding with an unaffiliated non-utility generator, and capacity purchases from an affiliate. ACE cannot predict the outcome of this proceeding. |
On August 31, 2004, ACE filed requests with the NJBPU proposing changes to its Transition Bond Charge (TBC), its Market Transition Charge - Tax rate (MTC-Tax), and its Basic Generation Service (BGS) Reconciliation charges. The net impact of these rate changes will be a decrease in ACE's annual revenues of approximately 1.5%. All of these rate changes were implemented on October 1, 2004. |
On October 1, 2004, DPL submitted its annual Gas Cost Rate (GCR) filing to the DPSC. In its filing, DPL seeks to increase its GCR by approximately 16.8% in anticipation of increasing natural gas commodity costs. The GCR, which permits DPL to recover its procurement gas costs through customer rates, becomes effective November 1, 2004 and is subject to refund pending evidentiary hearings. A final order is expected in the spring of 2005. DPL cannot predict the outcome of this proceeding. |
Restructuring Deferral |
For a discussion of the history of ACE's restructuring deferral proceeding under the New Jersey Electric Discount and Energy Competition Act, see Note (14), Commitments and Contingencies to the financial statements of Pepco Holdings included in Pepco Holdings' Annual Report on Form 10-K/A for the year ended December 31, 2003, and Note (4), Commitments and Contingencies, to the financial statements of Pepco Holdings included in |
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Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. In July 2004, the NJBPU issued its final order in the restructuring deferral proceeding. The final order did not modify the amount of the disallowances set forth in the summary order issued in July 2003, but did provide a much more detailed analysis of evidence and other information relied on by the NJBPU as justification for the disallowances. ACE believes the record does not justify the level of disallowance imposed by the NJBPU. In August 2004, ACE filed with the Appellate Division of the Superior Court of New Jersey, which hears appeals of New Jersey administrative agencies, including the NJBPU, a Notice of Appeal and a Case Information Statement related to the July 2004 Final Decision and Order. ACE cannot predict the outcome of this appeal. |
SOS and Default Service Proceedings |
District of Columbia |
For a history of the Standard Offer Service (SOS) proceeding pending before the DCPSC, see Note (14), Commitments and Contingencies to the financial statements of Pepco Holdings included in Pepco Holdings' 2003 10-K/A and Note (4), Commitments and Contingencies, to the financial statements of Pepco Holdings included in Pepco Holdings' Quarterly Reports on Form 10-Q for the quarters ended March 31, 2004 and June 30, 2004. In August 2004, the DCPSC issued an order adopting administrative charges for residential, small and large commercial DC SOS customers that are intended to allow Pepco to recover the administrative costs incurred to provide the SOS supply. The approved administrative charges include an average margin for Pepco of approximately $0.00248 per kilowatt hour, calculated based on total sales to residential, small and large commercial DC SOS customers over the twelve months ended December 31, 2003. Because margins vary by customer class, the actual average margin over any given time period will depend on the number of DC SOS customers from each customer class and the load taken by such customers over the time period. The administrative charges will go into effect for Pepco's DC SOS sales beginning February 8, 2005. Pepco completed the first competitive procurement process for DC SOS at the end of October and filed the proposed new SOS rates with the DCPSC on November 3, 2004. |
The Transition Power Agreement (TPA) with Mirant under which Pepco obtains the DC SOS supply ends on January 22, 2005, while the new SOS supply contracts with the winning bidders in the competitive procurement process provide for supply to begin on February 1, 2005. Pepco will procure power separately on the spot market to cover the period from January 23 through January 31, 2005, before the new DC SOS contracts begin. Consequently, Pepco will have to pay the difference between the procurement cost of power on the spot market and the current DC SOS rates charged to customers during the period from January 23 through January 31, 2005. In addition, because the new DC SOS rates do not go into effect until February 8, 2005, Pepco will have to pay the difference between the procurement cost of power under the new DC SOS contracts and the current DC SOS rates charged to customers for the period from February 1 to February 7, 2005. The amount of the difference for these periods will depend on spot market power prices during the first period, weather, and the amount of DC SOS load that Pepco is serving. Pepco estimates that the total amount of the difference will be in the range from approximately $7.6 million to approximately $11.4 million. This difference, however, will be included in the calculation of the Generation Procurement Credit (GPC) for DC for the period February 8, 2004 through February 7, 2005. The GPC provides for a sharing between Pepco's customers and shareholders, on an annual basis, of any margins, but not losses, that Pepco earns providing SOS in the District of Columbia during the four-year period from February 8, |
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2001 through February 7, 2005. When the GPC is calculated, Pepco expects that the cost difference it will pay after the expiration of the Mirant TPA and before the new DC SOS rates go into effect will reduce to zero the margins earned from February 8, 2004 through February 7, 2005 that otherwise would have been shared between Pepco's customers and shareholders. The amount of the difference that exceeded such margins would be recorded on Pepco's books as a loss. In the event that Pepco were to ultimately realize a significant recovery from the Mirant bankruptcy estate associated with the TPA, the GPC would be recalculated, potentially reducing the amount of any loss recorded on Pepco's books. |
Virginia |
Under amendments to the Virginia Electric Utility Restructuring Act implemented in March 2004, DPL is obligated to offer default service to customers in Virginia for an indefinite period until relieved of that obligation by the Virginia State Corporation Commission (VSCC). DPL currently obtains all of the energy and capacity needed to fulfill its default service obligations in Virginia under a supply agreement with Conectiv Energy. Conectiv Energy has served notice that the power supply agreement will terminate effective December 31, 2004. After conducting a competitive bid procedure, DPL has entered into a new supply agreement with Conectiv Energy, which was the lowest bidder, to provide wholesale power supply for DPL's Virginia default service customers. The new supply agreement commences January 1, 2005 and expires in May 2006. On October 26, 2004, DPL filed an application with the VSCC for approval to increase the rates that DPL charges its Virginia default service customers to allow it to recover its costs for power under the new supply agreement plus an administrative charge and an average margin of approximately $0.00179 per kilowatt hour, calculated based on total sales to residential and non-residential Virginia default service customers over the twelve months ended December 31, 2003. Because margins vary by customer class, the actual average margin over any given time period will depend on the number of Virginia default service customers from each customer class and the load taken by such customers over the time period. DPL cannot predict the outcome of this proceeding. Contemporaneously, DPL and Conectiv Energy jointly filed an application with the VSCC under Virginia's Affiliates Act requesting authorization for DPL to enter into a contract to purchase power from an affiliate. On October 29, 2004, Conectiv Energy also made a filing with FERC requesting authorization to enter into a contract to supply power to an affiliate. |
Proposed Shut-Down of B.L. England Generating Station |
As discussed in Note (4), Commitments and Contingencies, to the financial statements of Pepco Holdings included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, ACE filed a report in April 2004 with the NJBPU in compliance with the NJBPU order issued in September 2003. This report recommended that the B.L. England generating plant be shut down in accordance with the terms of the preliminary settlement agreement among PHI, Conectiv and ACE, the New Jersey Department of Environmental Protection and the Attorney General of New Jersey. In letters dated May and September 2004 to the PJM Interconnection, LLC (PJM), ACE informed PJM of its intent, as owner of the B.L. England generating plant, to retire the entire plant (447 MW) on December 15, 2007. PJM has completed its independent analysis to determine the upgrades required to eliminate any identified reliability problems resulting from the retirement of B.L. England and has recommended that certain transmission upgrades be installed prior to the summer of 2008. ACE's independent assessment confirmed that the |
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transmission upgrades identified by PJM are the transmission upgrades necessary to maintain reliability in the Atlantic zone after the retirement of B.L. England. The amount of the costs incurred by ACE to construct the recommended transmission upgrades that ACE would be permitted to recover from load serving entities that use ACE's transmission system would be subject to approval by FERC. The amount of construction costs that ACE would be permitted to recover from retail ratepayers would be determined in accordance with the treatment of transmission-related revenue requirements in retail rates under the jurisdiction of the appropriate state regulatory commission. ACE cannot predict how the recovery of such costs will ultimately be treated by FERC and the state regulatory commissions and, therefore, cannot predict the financial impact to ACE of installing the recommended transmission upgrades. However, in the event that the NJBPU makes satisfactory findings and grants other requested approvals concerning the retirement of B.L. England and approves the construction of the transmission upgrades required to maintain reliability in the Atlantic zone after such retirement, ACE expects to begin construction of the appropriate transmission upgrades while final decisions by FERC and state regulatory commissions concerning the methodology for recovery of the costs of such construction are still pending. |
On November 1, 2004, ACE made a filing with the NJBPU requesting approval of the transmission upgrades required to maintain reliability in the Atlantic zone after the retirement of B.L. England. Late in November or shortly thereafter, ACE will file a request that the NJBPU (i) make a finding that the retirement of the B.L. England generating station is prudent and (ii) approve the categories of costs that will be stranded costs associated with the retirement, dismantling and remediation of B.L. England. ACE cannot predict the outcome of these two proceedings. |
Environmental Matters |
For a discussion of environmental matters involving Pepco Holdings and its subsidiaries, see Note (14), Commitments and Contingencies to the financial statements of Pepco Holdings included in Pepco Holdings' Annual Report on Form 10-K/A for the year ended December 31, 2003 and Note (4), Commitments and Contingencies, to the financial statements of Pepco Holdings included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
The Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) authorizes the Environmental Protection Agency (EPA) and, indirectly, the states, to issue orders and bring enforcement actions to compel responsible parties to investigate and take remedial actions at any site that is determined to present an actual or potential threat to human health or the environment because of an actual or threatened release of one or more hazardous substances. Parties that generated or transported hazardous substances to such sites, as well as the owners and operators of such sites, may be deemed liable under CERCLA. Pepco, DPL and ACE each has been named by the EPA or a state environmental agency as a potentially responsible party at certain contaminated sites. In July 2004, DPL entered into an Administrative Consent Order with the Maryland Department of the Environment (MDE) to perform a Remedial Investigation/Feasibility Study (RI/FS) to further identify the extent of soil, sediment and ground and surface water contamination related to former MGP operations at the Cambridge, Maryland site on DPL-owned property and to investigate the extent of MGP contamination on adjacent property. The costs for completing the RI/FS for this site are expected to be approximately $150,000 between 2004 and 2005; however, the costs of cleanup resulting from the RI/FS are not determinable until the RI/FS is completed and an agreement with respect to |
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cleanup is reached with the MDE. DPL expects to complete the RI/FS in the first quarter of 2005. |
Third Party Guarantees, Indemnifications, and Off-Balance Sheet Arrangements |
Pepco Holdings and certain of its subsidiaries have various financial and performance guarantees and indemnification obligations which are entered into in the normal course of business to facilitate commercial transactions with third parties as discussed below. |
As of September 30, 2004, Pepco Holdings and its subsidiaries were parties to a variety of agreements pursuant to which they were guarantors for standby letters of credit, performance residual value, and other commitments and obligations. The fair value of these commitments and obligations was not required to be recorded in Pepco Holdings' Consolidated Balance Sheets; however, certain energy marketing obligations of Conectiv Energy were recorded. The commitments and obligations, in millions of dollars, were as follows: |
|
Guarantor |
|
||
|
PHI |
Conectiv |
PCI |
Total |
Energy marketing obligations of
|
$148.6 |
$ 1.3 |
$ - |
$149.9 |
Energy procurement obligations
|
5.0 |
- |
- |
5.0 |
Standby letters of credit of
|
4.2 |
- |
- |
4.2 |
Guaranteed lease residual values (3) |
- |
6.4 |
- |
6.4 |
Loan agreement (4) |
13.1 |
- |
- |
13.1 |
Construction performance guarantees (5) |
- |
4.1 |
- |
4.1 |
Other (6) |
14.9 |
4.0 |
5.3 |
24.2 |
Total |
$185.8 |
$15.8 |
$5.3 |
$206.9 |
1. |
Pepco Holdings and Conectiv have contractual commitments for performance and related payments of Conectiv Energy and Pepco Energy Services to counterparties related to routine energy sales and procurement obligations, including requirements under Basic Generation Service contracts for ACE. |
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2. |
Pepco Holdings has issued standby letters of credit of $4.2 million on behalf of subsidiaries' operations related to Conectiv Energy's competitive energy activities and third party construction performance. These standby letters of credit were put into place in order to allow the subsidiaries the flexibility needed to conduct business with counterparties without having to post substantial cash collateral. While the exposure under these standby letters of credit is $4.2 million, Pepco Holdings does not expect to fund the full amount. |
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3. |
Subsidiaries of Pepco Holdings have guaranteed residual values in excess of fair value related to certain equipment and fleet vehicles held through lease agreements. As of September 30, 2004, obligations under the guarantees were approximately $6.4 million. Assets leased under agreements subject to residual value guarantees are typically for periods ranging from 2 years to 10 years. Historically, payments under the guarantees have not been made by the guarantor as, under normal conditions, the contract runs to full term at which time the |
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residual value is minimal. As such, Pepco Holdings believes the likelihood of requiring payment under the guarantee is remote. |
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4. |
Pepco Holdings has issued a guarantee on the behalf of a subsidiary's 50% unconsolidated investment in a limited liability company for repayment borrowings under a loan agreement of approximately $13.1 million. |
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5. |
Conectiv has performance obligations of $4.1 million relating to obligations to third party suppliers of equipment. |
|
6. |
Other guarantees comprise: |
|
· |
Pepco Holdings has guaranteed payment of a bond issued by a subsidiary of $14.9 million. Pepco Holdings does not expect to fund the full amount of the exposure under the guarantee. |
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· |
Conectiv has guaranteed a subsidiary building lease of $4.0 million. Conectiv does not expect to fund the full amount of the exposure under the guarantee. |
|
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· |
PCI has guaranteed facility rental obligations related to contracts entered into by Starpower Communications LLC. In addition, PCI has agreed to indemnify RCN for 50% of any payments RCN makes under the Starpower franchise and construction performance bonds. As of September 30, 2004, the guarantees cover the remaining $3.2 million in rental obligations and $2.1 million in franchise and construction performance bonds issued. |
Pepco Holdings and certain of its subsidiaries have entered into various indemnification agreements related to purchase and sale agreements and other types of contractual agreements with vendors and other third parties. These indemnification agreements typically cover environmental, tax, litigation and other matters, as well as breaches of representations, warranties and covenants set forth in these agreements. Typically, claims may be made by third parties under these indemnification agreements over various periods of time depending on the nature of the claim. The maximum potential exposure under these indemnification agreements can range from a specified dollar amount to an unlimited amount depending on the nature of the claim and the particular transaction. The total maximum potential amount of future payments under these indemnification agreements is not estimable due to several factors, including uncertainty as to whether or when claims may be made under these indemnities. |
Planned Workforce Reduction |
On November 5, 2004, PHI announced that its Power Delivery business will reduce its 4,200 employee work force by about 2% to 3% by the end of 2004. This work force reduction will be accomplished through a combination of retirements and targeted reductions. PHI expects to accrue approximately $8 to $11 million in the fourth quarter of 2004 for this work force reduction and existing severance plans. |
Dividends |
On October 28, 2004, Pepco Holdings' Board of Directors declared a dividend on common stock of 25 cents per share payable December 31, 2004, to shareholders of record on December 10, 2004. |
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(5) USE OF DERIVATIVES IN ENERGY AND INTEREST RATE HEDGING ACTIVITIES |
PHI accounts for its derivative activities in accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133) as amended by subsequent pronouncements. See the "Accounting for Derivatives" discussion in Note 3 to the Consolidated Financial Statements of PHI included in PHI's Annual Report on Form 10-K/A for the year ended December 31, 2003, for a discussion of the accounting treatment of the derivatives used by PHI and its subsidiaries. |
PHI's competitive energy segments use derivative instruments primarily to reduce their financial exposure to changes in the value of their assets and obligations due to commodity price fluctuations. The derivative instruments used by the competitive energy segments include forward contracts, futures, swaps, and exchange-traded and over-the-counter options. In addition, the competitive energy segments also manage commodity risk with contracts that are not classified as derivatives. The primary goal of these activities is to manage the spread between the cost of fuel used to operate electric generation plants and the revenue received from the sale of the power produced by those plants and manage the spread between retail sales commitments and the cost of supply used to service those commitments in order to ensure stable and known minimum cash flows and fix favorable prices and margins when they become available. To a lesser extent, Conectiv Energy also engages in market activities in an effort to profit from short-term geographical price differentials in electricity prices among markets. PHI collectively refers to these energy market activities, including its commodity risk management activities, as "other energy commodity" activities and identifies this activity separate from that of the discontinued proprietary trading activity described below. |
As of March 2003, Conectiv Energy ceased all proprietary trading activities, which generally consisted of the entry into contracts to take a view of market direction, capture market price change, and put capital at risk. PHI's competitive energy segments are no longer engaged in proprietary trading; however, the market exposure under certain contracts entered into prior to cessation of proprietary trading activities was not eliminated due to the illiquid market environment to execute such elimination. These illiquid contracts will remain in place until they are terminated and their values are realized. |
PHI and its subsidiaries also use derivative instruments from time to time to mitigate the effects of fluctuating interest rates on debt incurred in connection with the operation of their business. In June 2002, PHI entered into several treasury lock transactions in anticipation of the issuance of several series of fixed rate debt commencing in July 2002. Based on this transaction, there remains a loss balance of $48.9 million in Accumulated Other Comprehensive Income (AOCI) at September 30, 2004. The portion expected to be reclassified to earnings during the next 12 months is $7.0 million. In addition, interest rate swaps have been executed in support of PCI's medium-term note program. |
The table below provides detail on effective cash flow hedges under SFAS 133 included in PHI's consolidated balance sheet as of September 30, 2004. Under SFAS 133, cash flow hedges are marked-to-market on the balance sheet with corresponding adjustments to AOCI. The data in the table indicates the magnitude of the effective cash flow hedges by hedge type (i.e., other energy commodity and interest rate hedges), maximum term, and portion expected to be reclassified to earnings during the next 12 months. |
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Cash Flow Hedges Included in Accumulated Other Comprehensive Loss
|
|||
Contracts |
Accumulated OCI
|
Portion Expected
|
Maximum Term |
Other Energy Commodity |
$ 27.4 |
$ 29.0 |
43 months |
Interest Rate |
(49.3) |
(7.4) |
335 months |
Total |
$(21.9) |
$ 21.6 |
|
The following table shows, in millions of dollars, the pre-tax gain or (loss) recognized but not realized in earnings for cash flow hedge ineffectiveness for the nine months ended September 30, 2004 and 2003, and where they were reported in PHI's Consolidated Statements of Earnings during the period. |
September 30, 2004 |
September 30, 2003 |
|
Revenue |
$(8.4) |
$ 0.4 |
Cost of Goods Sold |
.2 |
(3.9 ) |
Total |
$(8.2 ) |
$(3.5 ) |
For the nine months ended September 30, 2004 and 2003, gains totaling $0.8 million ($0.5 million after-tax) and $6.8 million ($4.1 million after-tax), respectively, were reclassified out of other comprehensive income to earnings because the forecasted hedged transactions were deemed no longer probable. |
In connection with their other energy commodity activities and discontinued proprietary trading activities, PHI's competitive energy segments hold certain derivatives that do not qualify as hedges. Under SFAS 133, these derivatives are marked-to-market through earnings with corresponding adjustments on the balance sheet. The pre-tax gains (losses) on these derivatives are summarized in the following table, in millions of dollars, for the nine months ended September 30, 2004 and 2003. |
September 30, 2004 |
September 30, 2003 |
|
Proprietary Trading |
$(0.2) |
$(66.8) |
Other Energy Commodity |
16.5 |
14.0 |
Total |
$16.3 |
$(52.8 ) |
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POTOMAC ELECTRIC POWER COMPANY |
(1) ORGANIZATION |
Potomac Electric Power Company (Pepco) is engaged in the transmission and distribution of electricity in Washington, D.C. and major portions of Prince George's and Montgomery Counties in suburban Maryland. Additionally, Pepco provides default electricity supply to customers who do not choose a competitive supplier. Pepco's service territory covers approximately 640 square miles and has a population of approximately 2 million. Pepco is a wholly owned subsidiary of Pepco Holdings, Inc. (Pepco Holdings or PHI). |
(2) ACCOUNTING POLICY, PRONOUNCEMENTS, AND OTHER DISCLOSURES |
Financial Statement Presentation |
Pepco's unaudited financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Pursuant to the rules and regulations of the SEC, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted. Therefore, these financial statements should be read along with the annual financial statements included in Pepco's Annual Report on Form 10-K for the year ended December 31, 2003. In the opinion of Pepco's management, the financial statements contain all adjustments (which all are of a normal recurring nature) necessary to present fairly Pepco's financial condition as of September 30, 2004, in accordance with GAAP. Interim results for the three and nine months ended September 30, 2004 may not be indicative of results that will be realized for the full year ending December 31, 2004 since the sales of electric energy are seasonal. Additionally, certain prior period balances have been reclassified in order to conform to current period presentation. |
FIN 45 |
Pepco applied the provisions of FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45), commencing in 2003 to its agreements that contain guarantee and indemnification clauses. These provisions expand those required by FASB Statement No. 5, "Accounting for Contingencies," by requiring a guarantor to recognize a liability on its balance sheet for the fair value of obligations it assumes under certain guarantees issued or modified after December 31, 2002 and to disclose certain types of guarantees, even if the likelihood of requiring the guarantor's performance under the guarantee is remote. |
As of September 30, 2004, Pepco did not have material obligations under guarantees or indemnifications issued or modified after December 31, 2002, which are required to be recognized as a liability on its balance sheets. |
FIN 46 |
On December 31, 2003, FIN 46 was implemented by Pepco. FIN 46 was revised and superseded by FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities" (FIN 46R) which clarified some of the provisions of FIN 46 and exempted certain entities from its requirements. The implementation of FIN 46R (including the evaluation of |
37
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interests in purchase power arrangements) did not impact Pepco's financial condition or results of operations for the three or nine months ended September 30, 2004. |
As part of the FIN 46R evaluation, Pepco reviewed its power purchase agreements (PPAs), including its Non-Utility Generation (NUG) contracts, to determine (i) if its interest in each entity that is a counterparty to a PPA agreement was a variable interest, (ii) whether the entity was a variable interest entity and (iii) if so, whether Pepco was the primary beneficiary. Due to a variable element in the pricing structure of its PPA with one entity, Panda-Brandywine, L.P. (Panda), Pepco potentially assumes the variability in the operations of the plant of this entity and therefore has a variable interest in the entity. However, due to Pepco's inability to obtain information considered to be confidential and proprietary from the entity, Pepco was unable to obtain sufficient information to conduct the analysis required under FIN 46R to determine whether the entity was a variable interest entity or if Pepco was the primary beneficiary. As a result, Pepco has applied the scope exemption from the application of FIN 46R for enterprises that have conducted exhaustive efforts to obtain the necessary information. |
Power purchases related to the Panda PPA in the three months ended September 30, 2004 and 2003 were approximately $19 million and $20 million, respectively and for the nine months ended September 30, 2004 and 2003 were $58 million and $61 million, respectively. Power purchases related to the Panda PPA in the years ended December 31, 2003, 2002 and 2001 were approximately $80 million, $74 million and $75 million, respectively. Pepco's exposure to loss under the Panda PPA is discussed in Note (4), Commitments and Contingencies, under "Relationship with Mirant Corporation." |
Components of Net Periodic Benefit Cost |
The following Pepco Holdings information is for the three months ended September 30, 2004 and 2003. |
Pension Benefits |
Other
|
|||
2004 |
2003 |
2004 |
2003 |
|
(In Millions) |
||||
Service cost |
$ 9.0 |
$ 8.0 |
$ 2.1 |
$ 2.4 |
Interest cost |
23.7 |
22.6 |
8.7 |
8.2 |
Expected return on plan assets |
(31.1) |
(26.3) |
(2.4) |
(2.1) |
Amortization of prior service cost |
.3 |
.3 |
(.5) |
- |
Amortization of net loss |
1.6 |
3.3 |
2.8 |
2.0 |
Net periodic benefit cost |
$ 3.5 |
$ 7.9 |
$10.7 |
$10.5 |
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The following Pepco Holdings information is for the nine months ended September 30, 2004 and 2003. |
Pension Benefits |
Other
|
|||
2004 |
2003 |
2004 |
2003 |
|
(In Millions) |
||||
Service cost |
$ 27.0 |
$ 24.6 |
$ 6.4 |
$ 6.9 |
Interest cost |
71.0 |
69.6 |
26.6 |
24.0 |
Expected return on plan assets |
(93.2) |
(80.1) |
(7.5) |
(6.1) |
Amortization of prior service cost |
.8 |
.8 |
(1.3) |
- |
Amortization of net loss |
4.9 |
10.3 |
8.5 |
5.9 |
Net periodic benefit cost |
$ 10.5 |
$ 25.2 |
$32.7 |
$30.7 |
The actual components of net periodic benefit cost for the 2003 interim periods are not available. The component amounts presented above for the 2003 interim periods were calculated in proportion to the annual amounts presented in Pepco Holdings' financial statements for the year ended December 31, 2003. These component amounts are presented for comparison purposes only. |
Pension |
The 2004 pension net periodic benefit cost for the three months ended September 30, of $3.5 million includes $1.9 million for Pepco. The 2004 pension net periodic benefit cost for the nine months ended September 30, of $10.5 million includes $5.6 million for Pepco. The remaining pension net periodic benefit cost is for other PHI subsidiaries. The 2003 pension net periodic benefit cost for the three months ended September 30, of $7.9 million includes $3.8 million for Pepco. The 2003 pension net periodic benefit cost for the nine months ended September 30, of $25.2 million includes $14.1 million for Pepco. The remaining pension net periodic benefit cost is for other PHI subsidiaries. |
Pension Contributions |
Pepco Holdings' current funding policy with regard to its defined benefit pension plan is to maintain a funding level in excess of 100% of its accumulated benefit obligation (ABO). In 2003 and 2002 PHI made discretionary tax-deductible cash contributions to the plan of $50 million and $35 million, respectively. PHI's pension plan currently meets the minimum funding requirements of the Employment Retirement Income Security Act of 1974 (ERISA) without any additional funding. PHI may elect, however, to make a discretionary tax-deductible contribution to maintain the pension plan's assets in excess of its ABO. As of September 30, 2004, no contributions have been made. The potential discretionary funding of the pension plan in 2004 will depend on many factors, including the actual investment return earned on plan assets over the remainder of the year. |
Other Post-Retirement Benefits |
The 2004 other post-retirement net periodic benefit cost for the three months ended September 30, of $10.7 million includes $3.5 million for Pepco. The 2004 other post-retirement net periodic benefit cost for the nine months ended September 30, of $32.7 million includes $12.5 million for Pepco. The remaining other post-retirement net periodic benefit cost is for other PHI subsidiaries. The 2003 other post-retirement net periodic benefit cost for the three months ended September 30, of $10.5 million includes $4.5 million |
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for Pepco. The 2003 other post-retirement net periodic benefit cost for the nine months ended September 30, of $30.7 million includes $12.9 million for Pepco. The remaining other post-retirement net periodic benefit cost is for other PHI subsidiaries. |
FASB Staff Position (FSP 106-2), Accounting and Disclosure
|
The Act became effective on December 8, 2003. The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. |
Pepco Holdings sponsors post-retirement health care plans that provide prescription drug benefits. Pepco Holdings did not elect the deferral of appropriate accounting permitted by the FASB Staff position (FSP) 106-1. The Accumulated Post-retirement Benefit Obligation (APBO) as of December 31, 2003 was reduced by $28 million to reflect the effects of the Act. For the three and nine months ended September 30, 2004, Pepco Holdings' net periodic post-retirement benefit expense has been reduced to reflect the Act. PHI estimates that the annual post-retirement benefit cost is reduced by approximately $3.7 million due to effects of the Act. This reduction includes both the decrease in the cost of future benefits being earned and an amortization of the APBO reduction over the future average working lifetime of the participants, or 12 years . The anticipated claims costs expected to be incurred have been adjusted to reflect the cost sharing between Medicare and Pepco Holdings. Participation rates have not been changed. In reflecting the effects of the Act, Pepco Holdings has determined which plans are eligible for Medicare cost sharing by analyzing the terms of each of its plans. It has recognized Medicare cost sharing for a plan only if Pepco Holdings' projected prescription drug coverage is expected to be at least as generous as the expected contribution by Medicare to a prescription drug plan not provided by Pepco Holdings. |
The effect of the subsidy on the three months ended September 30, 2004 other post-retirement net periodic benefit cost of $10.7 million is approximately a $.9 million reduction due to the subsidy. Approximately $.5 million is related to the amortization of the actuarial gain, and approximately $.4 million is a subsidy-related reduction in interest cost on the APBO. The effect of the subsidy on the nine months ended September 30, 2004 other post-retirement net periodic benefit cost of $32.7 million is approximately a $2.8 million reduction due to the subsidy. Approximately $1.5 million is related to the amortization of the actuarial gain, and approximately $1.3 million is a subsidy-related reduction in interest cost on the APBO. |
Debt |
In July 2004, Pepco Holdings, Pepco, DPL and ACE entered into a five-year credit agreement with an aggregate borrowing limit of $650 million. This agreement replaces a $550 million 364-day credit agreement that was entered into on July 29, 2003. The respective companies also are parties to a three-year credit agreement that was entered into in July 2003 and terminates in July 2006 with an aggregate borrowing limit of $550 million. Pepco Holdings' credit limit under these agreements is $700 million and the credit limit of each of Pepco, DPL and ACE is the lower of $300 million and the maximum amount of short-term debt authorized by the applicable regulatory authority, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at |
40
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any given time under the agreements may not exceed $500 million. The credit agreements primarily serve as a source of liquidity to support the commercial paper programs of the respective companies. The companies can also borrow funds for general corporate purposes and issue letters of credit under the Agreements. The credit agreements contain customary financial and other covenants that, if not satisfied, could result in the acceleration of repayment obligations under the agreements or restrict the ability of the companies to borrow under the agreements. Among these covenants is the requirement that each borrowing company maintain a ratio of total indebtedness to total capitalization of 65% or less, computed in accordance with the terms of the credit agreements. The credit agreements also contain a number of customary events of default that could result in the acceleration of repayment obligations under the agreements, including (i) the failure of any borrowing company or any of its significant subsidiaries to pay when due, or the acceleration of certain indebtedness under other borrowing arrangements, (ii) certain bankruptcy events, judgments or decrees against any borrowing company or its significant subsidiaries, and (iii) a change in control (as defined in the credit agreements) of Pepco Holdings or the failure of Pepco Holdings to own all of the voting stock of Pepco, DPL and ACE. |
In August 2004, Pepco repurchased 65,000 shares of its $2.28 series, par value $50.00 per share preferred stock at an average price of $45.50 per share. |
In September 2004, Pepco repurchased 16,400 shares of its $2.28 series preferred stock, par value $50.00 per share, at an average price of $47.25 per share. |
In September 2004, Pepco redeemed $2.5 million, or 50,000 shares, of its $3.40 Serial Preferred Stock Series of 1992 pursuant to mandatory sinking fund provisions. |
Effective Tax Rate |
Pepco's effective tax rate for the three months ended September 30, 2004 was 36.9% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and changes in estimates related to tax liabilities of prior tax years subject to audit (which was the primary reason for the lower effective tax rate as compared to 2003). |
Pepco's effective tax rate for the three months ended September 30, 2003 was 40.5% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and certain removal costs. |
Pepco's effective tax rate for the nine months ended September 30, 2004 was 38.2% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and certain removal costs and changes in estimates related to tax liabilities of prior tax years subject to audit (which was the primary reason for the lower effective tax rate as compared to 2003). |
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Pepco's effective tax rate for the nine months ended September 30, 2003 was 40.3% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and certain removal costs. |
` In accordance with SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information," Pepco has one segment, its regulated utility business. |
(4) COMMITMENTS AND CONTINGENCIES |
Relationship with Mirant Corporation |
In 2000, Pepco sold substantially all of its electricity generation assets to Mirant Corporation, formerly Southern Energy, Inc., pursuant to an Asset Purchase and Sale Agreement. As part of the Asset Purchase and Sale Agreement, Pepco entered into several ongoing contractual arrangements with Mirant and certain of its subsidiaries (collectively, Mirant). On July 14, 2003, Mirant Corporation and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of Texas (the Bankruptcy Court). |
Depending on the outcome of the matters discussed below, the Mirant bankruptcy could have a material adverse effect on the results of operations of Pepco Holdings and Pepco. However, management currently believes that Pepco Holdings and Pepco currently have sufficient cash, cash flow and borrowing capacity under their credit facilities and in the capital markets to be able to satisfy any additional cash requirements that have arisen or may arise due to the Mirant bankruptcy. Accordingly, management does not anticipate that the Mirant bankruptcy will impair the ability of Pepco Holdings or Pepco to fulfill their contractual obligations or to fund projected capital expenditures. On this basis, management currently does not believe that the Mirant bankruptcy will have a material adverse effect on the financial condition of either company. |
Transition Power Agreements |
For a discussion of the Transition Power Agreements between Pepco and Mirant and the amendment of these agreements in connection with the Mirant bankruptcy, see Note (4), Commitments and Contingencies, to the financial statements of Pepco included in Pepco's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
Power Purchase Agreements |
Under agreements with FirstEnergy Corp., formerly Ohio Edison (FirstEnergy), and Allegheny Energy, Inc., both entered into in 1987, Pepco is obligated to purchase from FirstEnergy 450 megawatts of capacity and energy annually through December 2005 (the FirstEnergy PPA). Under an agreement with Panda-Brandywine L.P. (Panda), entered into in 1991, Pepco is obligated to purchase from Panda 230 megawatts of capacity and energy annually through 2021 (the Panda PPA). In each case, the purchase price is substantially in excess of current market prices. As a part of the Asset Purchase and Sale Agreement, Pepco entered into a "back-to-back" arrangement with Mirant. Under this arrangement, Mirant is obligated, |
42
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among other things, to purchase from Pepco the capacity and energy that Pepco is obligated to purchase under the FirstEnergy PPA and the Panda PPA at a price equal to the price Pepco is obligated to pay under the PPAs (the PPA-Related Obligations). |
Pepco Pre-Petition Claims |
For a discussion of the claims that Pepco has filed against Mirant with respect to amounts owed by Mirant to Pepco under the PPAs at the time of the filing of Mirant's bankruptcy petition and the accounting treatment of these claims, see Note (4), Commitments and Contingencies, to the financial statements of Pepco included in Pepco's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
Mirant's Attempt to Reject the PPA-Related Obligations |
On August 28, 2003, Mirant filed with the Bankruptcy Court a motion seeking authorization to reject its PPA-Related Obligations. Upon motions filed with the U.S. District Court for the Northern District of Texas (the District Court) by Pepco and the Federal Energy Regulatory Commission (FERC), in October 2003, the District Court withdrew jurisdiction over the rejection proceedings from the Bankruptcy Court. In December 2003, the District Court denied Mirant's motion to reject the PPA-Related Obligations. The District Court's decision was appealed by Mirant and The Official Committee of Unsecured Creditors of Mirant Corporation in the U.S. Court of Appeals for the Fifth Circuit. On August 4, 2004, the Court of Appeals remanded the case to the District Court saying that it has jurisdiction to rule on the merits of Mirant's rejection motion, suggesting that in doing so the court apply a "more rigorous standard" than the business judgment rule usually applied by bankruptcy courts in ruling on rejection motions, and noting that there are other "important issues which must still be resolved before a decision on the merits would be appropriate." On October 4, 2004, the District Court issued an order stating that the District Court will retain jurisdiction over the matter and invited parties to submit comments on the appropriate standard to be applied in determining whether to grant Mirant's rejection motion. All parties submitted comments. On November 3, 2004, the District Court issued an order stating that the Court concluded that the "separate agreement" issue ( i.e ., whether the PPA-Related Obligations are severable from the Asset Purchase and Sale Agreement) relating to the sale of Pepco's generation assets should be resolved before the District Court deals further with the issue of the standard to be applied in determining whether the motion to reject should be granted. The order permits the parties to submit further evidentiary material related to the separate agreement issue. |
Pepco is exercising all available legal remedies and vigorously opposing Mirant's attempt to reject the PPA-Related Obligations in order to protect the interests of its customers and shareholders. While Pepco believes that it has substantial legal bases to oppose the attempt to reject the agreements, the outcome of Mirant's efforts to reject the PPA-Related Obligations is uncertain. |
In accordance with the Bankruptcy Court's order, Mirant is continuing to perform the PPA-Related Obligations pending the resolution of the ongoing proceedings. However, if Mirant ultimately is successful in rejecting, and is otherwise permitted to stop performing the PPA-Related Obligations, Pepco could be required to repay to Mirant, for the period beginning on the effective date of the rejection (which date could be prior to the date of the court's order and possibly as early as September 18, 2003) and ending on the date Mirant is entitled to cease its purchases of energy and capacity from |
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Pepco, all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity. Pepco estimates that the amount it could be required to repay to Mirant in the unlikely event September 18, 2003, is determined to be the effective date of rejection, is approximately $118.8 million as of November 1, 2004. This repayment would entitle Pepco to file a claim against the bankruptcy estate in an amount equal to the amount repaid. Mirant has also asked the Bankruptcy Court to require Pepco to disgorge all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity, for the period July 14, 2003 (the date on which Mirant filed its bankruptcy petition) to September 18, 2003, on the theory that Mirant did not receive value for those payments. Pepco estimates that the amount it would be required to repay to Mirant on the disgorgement theory is approximately $22.5 million. Pepco believes a claim based on this theory should be entitled to administrative expense status for which complete recovery could be expected in the Bankruptcy Court. If Pepco were required to repay any such amounts for either period, the payment would be expensed at the time the payment is made. However, Pepco believes that, to the extent such amounts were not recovered from the Mirant bankruptcy estate, the expensed amounts would be recoverable as stranded costs from customers through distribution rates as described below. |
The following are estimates prepared by Pepco of its potential future exposure if Mirant's motion to reject its PPA-Related Obligations ultimately is successful. These estimates are based in part on current market prices and forward price estimates for energy and capacity, and do not include financing costs, all of which could be subject to significant fluctuation. The estimates assume no recovery from the Mirant bankruptcy estate and no regulatory recovery, either of which would mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recoveries. Based on these assumptions, Pepco estimates that its pre-tax exposure as of November 1, 2004, representing the loss of the future benefit of the PPA-Related Obligations to Pepco, is as follows: |
· |
If Pepco were required to purchase capacity and energy from FirstEnergy commencing as of November 1, 2004, at the rates provided in the PPA (with an average price per kilowatt hour of approximately 6.0 cents) and resold the capacity and energy at market rates projected, given the characteristics of the FirstEnergy PPA, to be approximately 5.0 cents per kilowatt hour, Pepco estimates that it would cost approximately $9 million for the remainder of 2004, and $33 million in 2005, the last year of the FirstEnergy PPA. |
· |
If Pepco were required to purchase capacity and energy from Panda commencing as of November 1, 2004, at the rates provided in the PPA (with an average price per kilowatt hour of approximately 18.4 cents), and resold the capacity and energy at market rates projected, given the characteristics of the Panda PPA, to be approximately 8.4 cents per kilowatt hour, Pepco estimates that it would cost approximately $8 million for the remainder of 2004, $35 million in 2005, and $35 million in 2006 and approximately $35 million to $48 million annually thereafter through the 2021 contract termination date. |
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The ability of Pepco to recover from the Mirant bankruptcy estate in respect to the Mirant Pre-Petition Obligations and damages if the PPA-Related Obligations are successfully rejected will depend on whether Pepco's claims are allowed, the amount of assets available for distribution to creditors and Pepco's priority relative to other creditors. At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate, whether the recovery would be in cash or another form of payment, or the timing of any recovery. |
If Mirant ultimately is successful in rejecting the PPA-Related Obligations and Pepco's full claim is not recovered from the Mirant bankruptcy estate, Pepco may seek authority from the Maryland Public Service Commission (MPSC) and the District of Columbia Public Service Commission (DCPSC) to recover its additional costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers. Under the provisions of the settlement agreements approved by the MPSC and the DCPSC in the deregulation proceedings in which Pepco agreed to divest its generation assets under certain conditions, the PPAs were to become assets of Pepco's distribution business if they could not be sold. Pepco believes that, if Mirant ultimately is successful in rejecting the PPA-Related Obligations, these provisions would allow the stranded costs of the PPAs that are not recovered from the Mirant bankruptcy estate to be recovered from Pepco's customers through its distribution rates. If Pepco's interpretation of the settlement agreements is confirmed, Pepco expects to be able to establish the amount of its anticipated recovery as a regulatory asset. However, there is no assurance that Pepco's interpretation of the settlement agreements would be confirmed by the respective public service commissions. |
If the PPA-Related Obligations are successfully rejected, and there is no regulatory recovery, Pepco will incur a loss. However, the accounting treatment of such a loss depends on a number of legal and regulatory factors, and is not determinable at this time. |
The SMECO Agreement |
As a term of the Asset Purchase and Sale Agreement, Pepco assigned to Mirant a facility and capacity agreement with Southern Maryland Electric Cooperative, Inc. For a discussion of the status of this agreement in the context of the Mirant bankruptcy, see Note (4), Commitments and Contingencies, to the financial statements of Pepco included in Pepco's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
Standard Offer Service |
District of Columbia |
For a history of the Standard Offer Service (SOS) proceeding pending before the DCPSC, see Note (14), Commitments and Contingencies to the financial statements of Pepco included in Pepco's Annual Report on Form 10-K for the year ended December 31, 2003 and Note (4), Commitments and Contingencies, to the financial statements of Pepco included in Pepco's Quarterly Reports on Form 10-Q for the quarters ended March 31, 2004 and June 30, 2004. In August 2004, the DCPSC issued an order adopting administrative charges for residential, small and large commercial DC SOS customers that are intended to allow Pepco to recover the administrative costs incurred to provide the SOS supply. The approved administrative charges include an average margin for Pepco of approximately $0.00248 per kilowatt hour, |
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calculated based on total sales to residential, small and large commercial DC SOS customers over the twelve months ended December 31, 2003. Because margins vary by customer class, the actual average margin over any given time period will depend on the number of DC SOS customers from each customer class and the load taken by such customers over the time period. The administrative charges will go into effect for Pepco's DC SOS sales beginning February 8, 2005. Pepco completed the first competitive procurement process for DC SOS at the end of October and filed the proposed new SOS rates with the DCPSC on November 3, 2004. |
The TPA with Mirant under which Pepco obtains the DC SOS supply ends on January 22, 2005, while the new SOS supply contracts with the winning bidders in the competitive procurement process provide for supply to begin on February 1, 2005. Pepco will procure power separately on the spot market to cover the period from January 23 through January 31, 2005, before the new DC SOS contracts begin. Consequently, Pepco will have to pay the difference between the procurement cost of power on the spot market and the current DC SOS rates charged to customers during the period from January 23 through January 31, 2005. In addition, because the new DC SOS rates do not go into effect until February 8, 2005, Pepco will have to pay the difference between the procurement cost of power under the new DC SOS contracts and the current DC SOS rates charged to customers for the period from February 1 to February 7, 2005. The amount of the difference for these periods will depend on spot market power prices during the first period, weather, and the amount of DC SOS load that Pepco is serving. Pepco estimates that the total amount of the difference will be in the range from approximately $7.6 million to approximately $11.4 million. This difference, however, will be included in the calculation of the Generation Procurement Credit (GPC) for DC for the period February 8, 2004 through February 7, 2005. The GPC provides for a sharing between Pepco's customers and shareholders, on an annual basis, of any margins, but not losses, that Pepco earns providing SOS in the District of Columbia during the four-year period from February 8, 2001 through February 7, 2005. When the GPC is calculated, Pepco expects that the cost difference it will pay after the expiration of the Mirant TPA and before the new DC SOS rates go into effect will reduce to zero the margins earned from February 8, 2004 through February 7, 2005 that otherwise would have been shared between Pepco's customers and shareholders. The amount of the difference that exceeded such margins would be recorded on Pepco's books as a loss. In the event that Pepco were to ultimately realize a significant recovery from the Mirant bankruptcy estate associated with the TPA, the GPC would be recalculated, potentially reducing the amount of any loss recorded on Pepco's books. |
Planned Workforce Reduction |
On November 5, 2004, PHI announced that its Power Delivery business, of which Pepco is a part, will reduce its 4,200 employee work force by about 2% to 3% by the end of 2004. This work force reduction will be accomplished through a combination of retirements and targeted reductions. PHI expects to accrue approximately $8 to $11 million in the fourth quarter of 2004 for this work force reduction and existing severance plans. The anticipated impact that this planned reduction will have on Pepco has not been determined. |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
DELMARVA POWER & LIGHT COMPANY |
(1) ORGANIZATION |
Delmarva Power & Light Company (DPL) is engaged in the transmission and distribution of electricity in Delaware and portions of Maryland and Virginia and provides gas distribution service in northern Delaware. Additionally, DPL provides default electricity supply to customers who do not choose a competitive supplier. DPL's electricity distribution service territory covers approximately 6,000 square miles and has a population of approximately 1.25 million. DPL's natural gas distribution service territory covers approximately 275 square miles and has a population of approximately 523,000. DPL is a wholly owned subsidiary of Conectiv, which is wholly owned by Pepco Holdings, Inc. (Pepco Holdings or PHI). |
(2) ACCOUNTING POLICY, PRONOUNCEMENTS, AND OTHER DISCLOSURES |
Financial Statement Presentation |
DPL's unaudited consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Pursuant to the rules and regulations of the SEC, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted. Therefore, these financial statements should be read along with the annual financial statements included in DPL's Annual Report on Form 10-K/A for the year ended December 31, 2003. In the opinion of DPL's management, the consolidated financial statements contain all adjustments (which all are of a normal recurring nature) necessary to present fairly DPL's financial condition as of September 30, 2004, in accordance with GAAP. Interim results for the three and nine months ended September 30, 2004 may not be indicative of results that will be realized for the full year ending December 31, 2004 since the sales of electric energy are seasonal. Additionally, certain prior period balances have been reclassified in order to conform to current period presentation. |
FIN 45 |
DPL applied the provisions of FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45), commencing in 2003 to its agreements that contain guarantee and indemnification clauses. These provisions expand those required by FASB Statement No. 5, "Accounting for Contingencies," by requiring a guarantor to recognize a liability on its balance sheet for the fair value of obligations it assumes under certain guarantees issued or modified after December 31, 2002 and to disclose certain types of guarantees, even if the likelihood of requiring the guarantor's performance under the guarantee is remote. |
As of September 30, 2004, DPL did not have material obligations under guarantees or indemnifications issued or modified after December 31, 2002, which are required to be recognized as a liability on its consolidated balance sheets. |
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FIN 46 |
On December 31, 2003, FIN 46 was implemented by DPL. FIN 46 was revised and superseded by FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities" (FIN 46R) which clarified some of the provisions of FIN 46 and exempted certain entities from its requirements. The implementation of FIN 46R did not impact DPL's financial condition or results of operations for the three or nine months ended September 30, 2004. |
Components of Net Periodic Benefit Cost |
The following Pepco Holdings information is for the three months ended September 30, 2004 and 2003. |
Pension Benefits |
Other
|
|||
2004 |
2003 |
2004 |
2003 |
|
(In Millions) |
||||
Service cost |
$ 9.0 |
$ 8.0 |
$ 2.1 |
$ 2.4 |
Interest cost |
23.7 |
22.6 |
8.7 |
8.2 |
Expected return on plan assets |
(31.1) |
(26.3) |
(2.4) |
(2.1) |
Amortization of prior service cost |
0.3 |
0.3 |
(.5) |
- |
Amortization of net loss |
1.6 |
3.3 |
2.8 |
2.0 |
Net periodic benefit cost |
$ 3.5 |
$ 7.9 |
$10.7 |
$10.5 |
The following Pepco Holdings information is for the nine months ended September 30, 2004 and 2003. |
Pension Benefits |
Other
|
|||
2004 |
2003 |
2004 |
2003 |
|
(In Millions) |
||||
Service cost |
$ 27.0 |
$ 24.6 |
$ 6.4 |
$ 6.9 |
Interest cost |
71.0 |
69.6 |
26.6 |
24.0 |
Expected return on plan assets |
(93.2) |
(80.1) |
(7.5) |
(6.1) |
Amortization of prior service cost |
0.8 |
0.8 |
(1.3) |
- |
Amortization of net loss |
4.9 |
10.3 |
8.5 |
5.9 |
Net periodic benefit cost |
$ 10.5 |
$ 25.2 |
$32.7 |
$30.7 |
The actual components of net periodic benefit cost for the 2003 interim periods are not available. The component amounts presented above for the 2003 interim periods were calculated in proportion to the annual amounts presented in Pepco Holdings' financial statements for the year ended December 31, 2003. These component amounts are presented for comparison purposes only. |
Pension |
The 2004 pension net periodic benefit cost for the three months ended September 30, of $3.5 million includes $(2.2) million for DPL. The 2004 pension net periodic benefit cost for the nine months ended September 30, of $10.5 million includes $(6.5) million for DPL. The remaining pension net periodic benefit cost is for other PHI subsidiaries. The 2003 pension net periodic benefit cost for the three months ended September 30, of $7.9 million includes $(.7) million for DPL. The 2003 pension net periodic benefit |
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cost for the nine months ended September 30, of $25.2 million includes $(3.5) million for DPL. The remaining pension net periodic benefit cost is for other PHI subsidiaries. |
Pension Contributions |
Pepco Holdings' current funding policy with regard to its defined benefit pension plan is to maintain a funding level in excess of 100% of its accumulated benefit obligation (ABO). In 2003 and 2002 PHI made discretionary tax-deductible cash contributions to the plan of $50 million and $35 million, respectively. PHI's pension plan currently meets the minimum funding requirements of the Employment Retirement Income Security Act of 1974 (ERISA) without any additional funding. PHI may elect, however, to make a discretionary tax-deductible contribution to maintain the pension plan's assets in excess of its ABO. As of September 30, 2004, no contributions have been made. The potential discretionary funding of the pension plan in 2004 will depend on many factors, including the actual investment return earned on plan assets over the remainder of the year. |
Other Post-Retirement Benefits |
The 2004 other post-retirement net periodic benefit cost for the three months ended September 30, of $10.7 million includes $2.5 million for DPL. The 2004 other post-retirement net periodic benefit cost for the nine months ended September 30, of $32.7 million includes $7.1 million for DPL. The remaining other post-retirement net periodic benefit cost is for other PHI subsidiaries. The 2003 other post-retirement net periodic benefit cost for the three months ended September 30, of $10.5 million includes $2.2 million for DPL. The 2003 other post-retirement net periodic benefit cost for the nine months ended September 30, of $30.7 million includes $5.5 million for DPL. The remaining other post-retirement net periodic benefit cost is for other PHI subsidiaries. |
FASB Staff Position (FSP 106-2), Accounting and Disclosure
|
The Act became effective on December 8, 2003. The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. |
Pepco Holdings sponsors post-retirement health care plans that provide prescription drug benefits. Pepco Holdings did not elect the deferral of appropriate accounting permitted by the FASB Staff position (FSP) 106-1. The Accumulated Post-retirement Benefit Obligation (APBO) as of December 31, 2003 was reduced by $28 million to reflect the effects of the Act. For the three and nine months ended September 30, 2004, Pepco Holdings' net periodic post-retirement benefit expense has been reduced to reflect the Act. PHI estimates that the annual post-retirement benefit cost is reduced by approximately $3.7 million due to effects of the Act. This reduction includes both the decrease in the cost of future benefits being earned and an amortization of the APBO reduction over the future average working lifetime of the participants, or 12 years . The anticipated claims costs expected to be incurred have been adjusted to reflect the cost sharing between Medicare and Pepco Holdings. Participation rates have not been changed. In reflecting the effects of the Act, Pepco Holdings has determined which plans are eligible for Medicare cost sharing by analyzing the terms of each of its plans. It has recognized Medicare cost sharing for a plan only if Pepco Holdings' projected |
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prescription drug coverage is expected to be at least as generous as the expected contribution by Medicare to a prescription drug plan not provided by Pepco Holdings. |
The effect of the subsidy on the three months ended September 30, 2004 other post-retirement net periodic benefit cost of $10.7 million is approximately a $.9 million reduction due to the subsidy. Approximately $.5 million is related to the amortization of the actuarial gain, and approximately $.4 million is a subsidy-related reduction in interest cost on the APBO. The effect of the subsidy on the nine months ended September 30, 2004 other post-retirement net periodic benefit cost of $32.7 million is approximately a $2.8 million reduction due to the subsidy. Approximately $1.5 million is related to the amortization of the actuarial gain, and approximately $1.3 million is a subsidy-related reduction in interest cost on the APBO. |
Debt |
In July 2004, Pepco Holdings, Pepco, DPL and ACE entered into a five-year credit agreement with an aggregate borrowing limit of $650 million. This agreement replaces a $550 million 364-day credit agreement that was entered into on July 29, 2003. The respective companies also are parties to a three-year credit agreement that was entered into in July 2003 and terminates in July 2006 with an aggregate borrowing limit of $550 million. Pepco Holdings' credit limit under these agreements is $700 million and the credit limit of each of Pepco, DPL and ACE is the lower of $300 million and the maximum amount of short-term debt authorized by the applicable regulatory authority, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at any given time under the agreements may not exceed $500 million. The credit agreements primarily serve as a source of liquidity to support the commercial paper programs of the respective companies. The companies can also borrow funds for general corporate purposes and issue letters of credit under the Agreements. The credit agreements contain customary financial and other covenants that, if not satisfied, could result in the acceleration of repayment obligations under the agreements or restrict the ability of the companies to borrow under the agreements. Among these covenants is the requirement that each borrowing company maintain a ratio of total indebtedness to total capitalization of 65% or less, computed in accordance with the terms of the credit agreements. The credit agreements also contain a number of customary events of default that could result in the acceleration of repayment obligations under the agreements, including (i) the failure of any borrowing company or any of its significant subsidiaries to pay when due, or the acceleration of certain indebtedness under other borrowing arrangements, (ii) certain bankruptcy events, judgments or decrees against any borrowing company or its significant subsidiaries, and (iii) a change in control (as defined in the credit agreements) of Pepco Holdings or the failure of Pepco Holdings to own all of the voting stock of Pepco, DPL and ACE. |
Effective Tax Rate |
DPL's effective tax rate for the three months ended September 30, 2004 was 43.7% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit), changes in estimates related to tax liabilities of prior tax years subject to audit (which was the primary reason for the higher effective tax rate as compared to 2003) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits. |
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DPL's effective tax rate for the three months ended September 30, 2003 was 39.2% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) partially offset by the flow-through of Deferred Investment Tax Credits. |
DPL's effective tax rate for the nine months ended September 30, 2004 was 41.9% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit), changes in estimates related to tax liabilities of prior tax years subject to audit and the flow-through of certain book tax depreciation differences (which was the primary reason for the higher effective tax rate as compared to 2003) partially offset by the flow-through of Deferred Investment Tax Credits. |
DPL's effective tax rate for the nine months ended September 30, 2003 was 39.4% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) partially offset by the flow-through of Deferred Investment Tax Credits. |
(3) SEGMENT INFORMATION |
In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," DPL has one segment, its regulated utility business. |
DPL's operating expenses and revenues include amounts for transactions with other PHI subsidiaries. DPL purchased electric energy, electric capacity and natural gas from PHI subsidiaries in the amounts of $135.7 million and $426.4 million for the three and nine months ended September 30, 2004 and $207.9 million and $515.5 million for the three and nine months ended September 30, 2003. DPL also sold natural gas and electricity and leased certain assets to other PHI subsidiaries. At September 30, 2004 and December 31, 2003, DPL had a payable to PHI subsidiaries related to these transactions totaling $44 million and $31 million, respectively. |
(4) COMMITMENTS AND CONTINGENCIES |
Rate Proceedings |
On October 1, 2004, DPL submitted its annual Gas Cost Rate (GCR) filing to the Delaware Public Service Commission. In its filing, DPL seeks to increase its GCR by approximately 16.8% in anticipation of increasing natural gas commodity costs. The GCR, which permits DPL to recover its procurement gas costs through customer rates, becomes effective November 1, 2004 and is subject to refund pending evidentiary hearings. A final order is expected in the spring of 2005. DPL cannot predict the outcome of the hearings. |
Default Service Proceedings |
Under amendments to the Virginia Electric Utility Restructuring Act implemented in March 2004, DPL is obligated to offer default service to customers in Virginia for an indefinite period until relieved of that obligation by the Virginia State Corporation Commission (VSCC). DPL currently obtains all of the energy and capacity needed to fulfill its default service obligations in Virginia under a supply agreement with Conectiv Energy. Conectiv Energy has served notice that the power supply agreement will terminate effective December 31, 2004. After conducting a competitive bid procedure, DPL has entered into a new supply agreement with Conectiv Energy, which was the lowest bidder, to provide wholesale power |
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supply for DPL's Virginia default service customers. The new supply agreement commences January 1, 2005 and expires in May 2006. On October 26, 2004, DPL filed an application with the VSCC for approval to increase the rates that DPL charges its Virginia default service customers to allow it to recover its costs for power under the new supply agreement plus an administrative charge and an average margin of approximately $0.00179 per kilowatt hour, calculated based on total sales to residential and non-residential Virginia default service customers over the twelve months ended December 31, 2003. Because margins vary by customer class, the actual average margin over any given time period will depend on the number of Virginia default service customers from each customer class and the load taken by such customers over the time period. DPL cannot predict the outcome of this proceeding. Contemporaneously, DPL and Conectiv Energy jointly filed an application with the VSCC under Virginia's Affiliates Act requesting authorization for DPL to enter into a contract to purchase power from an affiliate. On October 29, 2004, Conectiv Energy also made a filing with FERC requesting authorization to enter into a contract to supply power to an affiliate. |
Environmental Matters |
For a discussion of environmental matters involving DPL, see Note (13), Commitments and Contingencies to the financial statements of DPL included in DPL's Annual Report on Form 10-K/A for the year ended December 31, 2003 and Note (4), Commitments and Contingencies, to the financial statements of DPL included in DPL's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
The Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) authorizes the Environmental Protection Agency (EPA) and, indirectly, the states, to issue orders and bring enforcement actions to compel responsible parties to investigate and take remedial actions at any site that is determined to present an actual or potential threat to human health or the environment because of an actual or threatened release of one or more hazardous substances. Parties that generated or transported hazardous substances to such sites, as well as the owners and operators of such sites, may be deemed liable under CERCLA. DPL has been named by the EPA or a state environmental agency as a potentially responsible party at certain contaminated sites. In July 2004, DPL entered into an Administrative Consent Order with the Maryland Department of the Environment to perform a Remedial Investigation/Feasibility Study (RI/FS) to further identify the extent of soil, sediment and ground and surface water contamination related to former MGP operations at the Cambridge, Maryland site on DPL-owned property and to investigate the extent of MGP contamination on adjacent property. The costs for completing the RI/FS for this site are expected to be approximately $150,000 between 2004 and 2005; however, the costs of cleanup resulting from the RI/FS are not determinable until the RI/FS is completed and an agreement with respect to cleanup is reached with the MDE. DPL expects to complete the RI/FS in the first quarter of 2005. |
Planned Workforce Reduction |
On November 5, 2004, PHI announced that its Power Delivery business, of which DPL is a part, will reduce its 4,200 employee work force by about 2% to 3% by the end of 2004. This work force reduction will be accomplished through a combination of retirements and targeted reductions. PHI expects to accrue approximately $8 to $11 million in the fourth quarter of 2004 for this work force reduction and existing severance plans. The anticipated impact that this planned reduction will have on DPL has not been determined. |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
ATLANTIC CITY ELECTRIC COMPANY |
(1) ORGANIZATION |
Atlantic City Electric Company (ACE) is engaged in the generation, transmission and distribution of electricity in southern New Jersey. Additionally, ACE provides default electricity supply to customers who do not choose a competitive supplier. ACE's service territory covers approximately 2,700 square miles and has a population of approximately 995,000. ACE is a wholly owned subsidiary of Conectiv, which is wholly owned by Pepco Holdings, Inc. (Pepco Holdings or PHI). |
(2) ACCOUNTING POLICY, PRONOUNCEMENTS, AND OTHER DISCLOSURES |
Financial Statement Presentation |
ACE's unaudited consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Pursuant to the rules and regulations of the SEC, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted. Therefore, these financial statements should be read along with the annual financial statements included in ACE's Annual Report on Form 10-K/A for the year ended December 31, 2003. In the opinion of ACE's management, the consolidated financial statements contain all adjustments (which all are of a normal recurring nature) necessary to present fairly ACE's financial condition as of September 30, 2004, in accordance with GAAP. Interim results for the three and nine months ended September 30, 2004 may not be indicative of results that will be realized for the full year ending December 31, 2004 since the sales of electric energy are seasonal. Additionally, certain prior period balances have been reclassified in order to conform to current period presentation. |
FIN 45 |
ACE applied the provisions of FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45), commencing in 2003 to its agreements that contain guarantee and indemnification clauses. These provisions expand those required by FASB Statement No. 5, "Accounting for Contingencies," by requiring a guarantor to recognize a liability on its balance sheet for the fair value of obligations it assumes under certain guarantees issued or modified after December 31, 2002 and to disclose certain types of guarantees, even if the likelihood of requiring the guarantor's performance under the guarantee is remote. |
As of September 30, 2004, ACE did not have material obligations under guarantees or indemnifications issued or modified after December 31, 2002, which are required to be recognized as a liability on its consolidated balance sheets. |
FIN 46 |
On December 31, 2003, FIN 46 was implemented by ACE. FIN 46 was revised and superseded by FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities" (FIN 46R) which clarified some of the provisions of FIN 46 and exempted certain entities from its |
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requirements. The implementation of FIN 46R (including the evaluation of interests in purchase power arrangements) did not impact ACE's financial condition or results of operations for the three or nine months ended September 30, 2004. |
As part of the FIN 46R evaluation, ACE reviewed its power purchase agreements (PPAs), including its Non-Utility Generation (NUG) contracts, to determine (i) if its interest in each entity that is a counterparty to a PPA agreement was a variable interest, (ii) whether the entity was a variable interest entity and (iii) if so, whether ACE was the primary beneficiary. Due to a variable element in the pricing structure of PPAs with three entities, ACE potentially assumes the variability in the operations of the plants of these entities and therefore has a variable interest in the entities. However, due to ACE's inability to obtain information considered to be confidential and proprietary from certain of these entities or the certain entities' own determination that they qualified for exemption as a business, ACE was unable to obtain sufficient information to conduct the analysis required under FIN 46R to determine whether these three entities were variable interest entities or if ACE was the primary beneficiary. As a result, ACE has applied the scope exemption from the application of FIN 46R for enterprises that have conducted exhaustive efforts to obtain the necessary information. |
Net purchase activities with these three entities in the quarters ended September 30, 2004 and 2003 were approximately $70 million and $68 million, respectively, of which $63 million and $60 million, respectively, related to power purchases under the PPA agreements. Net purchase activities with these three entities for the nine months ended September 30, 2004 and 2003 were approximately $200 million and $186 million, respectively, of which $178 million and $167 million, respectively, related to purchases under the PPA agreements. Net purchase activities with these three entities in the years ended December 31, 2003, 2002 and 2001 were approximately $247 million, $241 million and $244 million, respectively, of which $220 million, $221 million and $227 million, respectively, related to purchases under the PPA agreements. ACE does not have exposure to loss under the PPA agreements since cost recovery will be achieved from its customers through regulated rates. |
Components of Net Periodic Benefit Cost |
The following Pepco Holdings information is for the three months ended September 30, 2004 and 2003. |
Pension Benefits |
Other
|
|||
2004 |
2003 |
2004 |
2003 |
|
(In Millions) |
||||
Service cost |
$ 9.0 |
$ 8.0 |
$ 2.1 |
$ 2.4 |
Interest cost |
23.7 |
22.6 |
8.7 |
8.2 |
Expected return on plan assets |
(31.1) |
(26.3) |
(2.4) |
(2.1) |
Amortization of prior service cost |
0.3 |
0.3 |
(0.5) |
- |
Amortization of net loss |
1.6 |
3.3 |
2.8 |
2.0 |
Net periodic benefit cost |
$ 3.5 |
$ 7.9 |
$10.7 |
$10.5 |
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The following Pepco Holdings information is for the nine months ended September 30, 2004 and 2003. |
Pension Benefits |
Other
|
|||
2004 |
2003 |
2004 |
2003 |
|
(In Millions) |
||||
Service cost |
$ 27.0 |
$ 24.6 |
$ 6.4 |
$ 6.9 |
Interest cost |
71.0 |
69.6 |
26.6 |
24.0 |
Expected return on plan assets |
(93.2) |
(80.1) |
(7.5) |
(6.1) |
Amortization of prior service cost |
0.8 |
0.8 |
(1.3) |
- |
Amortization of net loss |
4.9 |
10.3 |
8.5 |
5.9 |
Net periodic benefit cost |
$ 10.5 |
$ 25.2 |
$32.7 |
$30.7 |
The actual components of net periodic benefit cost for the 2003 interim periods are not available. The component amounts presented above for the 2003 interim periods were calculated in proportion to the annual amounts presented in Pepco Holdings' financial statements for the year ended December 31, 2003. These component amounts are presented for comparison purposes only. |
Pension |
The 2004 pension net periodic benefit cost for the three months ended September 30, of $3.5 million includes $1.8 million for ACE. The 2004 pension net periodic benefit cost for the nine months ended September 30, of $10.5 million includes $5.3 million for ACE. The remaining pension net periodic benefit cost is for other PHI subsidiaries. The 2003 pension net periodic benefit cost for the three months ended September 30, of $7.9 million includes $2.6 million for ACE. The 2003 pension net periodic benefit cost for the nine months ended September 30, of $25.2 million includes $9.0 million for ACE. The remaining pension net periodic benefit cost is for other PHI subsidiaries. |
Pension Contributions |
Pepco Holdings' current funding policy with regard to its defined benefit pension plan is to maintain a funding level in excess of 100% of its accumulated benefit obligation (ABO). In 2003 and 2002 PHI made discretionary tax-deductible cash contributions to the plan of $50 million and $35 million, respectively. PHI's pension plan currently meets the minimum funding requirements of the Employment Retirement Income Security Act of 1974 (ERISA) without any additional funding. PHI may elect, however, to make a discretionary tax-deductible contribution to maintain the pension plan's assets in excess of its ABO. As of September 30, 2004, no contributions have been made. The potential discretionary funding of the pension plan in 2004 will depend on many factors, including the actual investment return earned on plan assets over the remainder of the year. |
Other Post-Retirement Benefits |
The 2004 other post-retirement net periodic benefit cost for the three months ended September 30, of $10.7 million includes $2.9 million for ACE. The 2004 other post-retirement net periodic benefit cost for the nine months ended September 30, of $32.7 million includes $7.8 million for ACE. The remaining other post-retirement net periodic benefit cost is for other PHI subsidiaries. The 2003 other post-retirement net periodic benefit cost for the three months ended September 30, of $10.5 million includes $2.5 million |
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for ACE. The 2003 other post-retirement net periodic benefit cost for the nine months ended September 30, of $30.7 million includes $7.7 million for ACE. The remaining other post-retirement net periodic benefit cost is for other PHI subsidiaries. |
FASB Staff Position (FSP 106-2), Accounting and Disclosure
|
The Act became effective on December 8, 2003. The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. |
Pepco Holdings sponsors post-retirement health care plans that provide prescription drug benefits. Pepco Holdings did not elect the deferral of appropriate accounting permitted by the FASB Staff position (FSP) 106-1. The Accumulated Post-retirement Benefit Obligation (APBO) as of December 31, 2003 was reduced by $28 million to reflect the effects of the Act. For the three and nine months ended September 30, 2004, Pepco Holdings' net periodic post-retirement benefit expense has been reduced to reflect the Act. PHI estimates that the annual post-retirement benefit cost is reduced by approximately $3.7 million due to effects of the Act. This reduction includes both the decrease in the cost of future benefits being earned and an amortization of the APBO reduction over the future average working lifetime of the participants, or 12 years . The anticipated claims costs expected to be incurred have been adjusted to reflect the cost sharing between Medicare and Pepco Holdings. Participation rates have not been changed. In reflecting the effects of the Act, Pepco Holdings has determined which plans are eligible for Medicare cost sharing by analyzing the terms of each of its plans. It has recognized Medicare cost sharing for a plan only if Pepco Holdings' projected prescription drug coverage is expected to be at least as generous as the expected contribution by Medicare to a prescription drug plan not provided by Pepco Holdings. |
The effect of the subsidy on the three months ended September 30, 2004 other post-retirement net periodic benefit cost of $10.7 million is approximately a $.9 million reduction due to the subsidy. Approximately $.5 million is related to the amortization of the actuarial gain, and approximately $.4 million is a subsidy-related reduction in interest cost on the APBO. The effect of the subsidy on the nine months ended September 30, 2004 other post-retirement net periodic benefit cost of $32.7 million is approximately a $2.8 million reduction due to the subsidy. Approximately $1.5 million is related to the amortization of the actuarial gain, and approximately $1.3 million is a subsidy-related reduction in interest cost on the APBO. |
Debt |
In July 2004, Pepco Holdings, Pepco, DPL and ACE entered into a five-year credit agreement with an aggregate borrowing limit of $650 million. This agreement replaces a $550 million 364-day credit agreement that was entered into on July 29, 2003. The respective companies also are parties to a three-year credit agreement that was entered into in July 2003 and terminates in July 2006 with an aggregate borrowing limit of $550 million. Pepco Holdings' credit limit under these agreements is $700 million and the credit limit of each of Pepco, DPL and ACE is the lower of $300 million and the maximum amount of short-term debt authorized by the applicable regulatory authority, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at |
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any given time under the agreements may not exceed $500 million. The credit agreements primarily serve as a source of liquidity to support the commercial paper programs of the respective companies. The companies can also borrow funds for general corporate purposes and issue letters of credit under the Agreements. The credit agreements contain customary financial and other covenants that, if not satisfied, could result in the acceleration of repayment obligations under the agreements or restrict the ability of the companies to borrow under the agreements. Among these covenants is the requirement that each borrowing company maintain a ratio of total indebtedness to total capitalization of 65% or less, computed in accordance with the terms of the credit agreements. The credit agreements also contain a number of customary events of default that could result in the acceleration of repayment obligations under the agreements, including (i) the failure of any borrowing company or any of its significant subsidiaries to pay when due, or the acceleration of certain indebtedness under other borrowing arrangements, (ii) certain bankruptcy events, judgments or decrees against any borrowing company or its significant subsidiaries, and (iii) a change in control (as defined in the credit agreements) of Pepco Holdings or the failure of Pepco Holdings to own all of the voting stock of Pepco, DPL and ACE. |
In August 2004, on behalf of ACE, the Pollution Control Financing Authority of Salem County, New Jersey issued $23.15 million of insured auction rate tax-exempt bonds due 2029 and loaned the proceeds to ACE. ACE's obligations under the insurance agreement are secured by a like amount of ACE First Mortgage Bonds. In September 2004, ACE used the proceeds to redeem $23.15 million of 6.15% First Mortgage Bonds due 2029 at 102%. |
In August 2004, on behalf of ACE, the Pollution Control Financing Authority of Cape May County, New Jersey issued $25 million of Series 2004A and $6.5 million of Series 2004B insured auction rate tax-exempt bonds due 2029 and loaned the proceeds to ACE. ACE's obligations under the insurance agreement are secured by a like amount of ACE First Mortgage Bonds. In November 2004, ACE used the proceeds to redeem $25 million of 7.2% First Mortgage Bonds due 2029 at 102% and $6.5 million of 7.0% First Mortgage Bonds due 2029 at 102%. |
Effective Tax Rate |
ACE's effective tax rate for the three months ended September 30, 2004 was 42.3% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences (which was the primary reason for the higher effective tax rate as compared to 2003) partially offset by the flow-through of Deferred Investment Tax Credits. |
ACE's effective tax rate for the three months ended September 30, 2003 was 40.6% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) partially offset by the flow-through of Deferred Investment Tax Credits. |
ACE's effective tax rate for the nine months ended September 30, 2004 was 41.7% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences (which was the primary reason for the higher effective tax rate as compared to 2003) partially offset by the flow-through of Deferred Investment Tax Credits. |
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ACE's effective tax rate for the nine months ended September 30, 2003 was 39.6% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) partially offset by the flow-through of Deferred Investment Tax Credits. |
(3) SEGMENT INFORMATION |
In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," ACE has one segment, its regulated utility business. |
ACE's operating expenses and revenues include amounts for transactions with other PHI subsidiaries. ACE purchased electric energy and electric capacity from PHI subsidiaries in the amount of $23.0 million and $29.6 million for the three and nine months ended September 30, 2004. There were no similar transactions for the corresponding periods in 2003. At September 30, 2004, ACE had a payable to PHI subsidiaries related to these transactions totaling $6.6 million. |
(4) COMMITMENTS AND CONTINGENCIES |
Rate Proceedings |
For a discussion of the history of ACE's proceeding filed with the New Jersey Board of Public Utilities (NJBPU) to increase its electric distribution rates and Regulatory Asset Recovery Charge (RARC) in New Jersey, see Note (4), Commitments and Contingencies, to the financial statements of ACE included in ACE's Quarterly Reports on Form 10-Q for the quarters ended March 31, 2004 and June 30, 2004. The Ratepayer Advocate and Staff of the NJBPU filed their briefs in this proceeding in August 2004. The Ratepayer Advocate's brief supported its earlier proposal of an annual rate decrease of $4.5 million. The Staff's brief, however, stated for the first time its position calling for an overall decrease of $10.8 million. Reply briefs were filed on August 23, 2004. Settlement discussions between ACE, the NJBPU Staff and the Ratepayer Advocate have been ongoing. ACE cannot predict the outcome of this proceeding. |
For a discussion of the history of Phase II to ACE's base rate proceeding, see Note (4), Commitments and Contingencies, to the financial statements of ACE included in ACE's Quarterly Reports on Form 10-Q for the quarters ended March 31, 2004 and June 30, 2004. In August 2004, the Ratepayer Advocate filed testimony proposing a cost-sharing mechanism related to the operation and maintenance costs of the B. L. England generating facility and also proposing the disallowance and/or continued deferral of approximately $30.7 million of previously deferred costs related to industry restructuring, the divestiture efforts related to the ACE's fossil generating assets, the arbitration proceeding with an unaffiliated non-utility generator, and capacity purchases from an affiliate. ACE cannot predict the outcome of this proceeding. |
On August 31, 2004, ACE filed requests with the NJBPU proposing changes to its Transition Bond Charge (TBC), its Market Transition Charge - Tax rate (MTC-Tax), and its Basic Generation Service (BGS) Reconciliation charges. The net impact of these rate changes will be a decrease in ACE's annual revenues of approximately 1.5%. All of these rate changes were implemented on October 1, 2004. |
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Restructuring Deferral |
For a discussion of the history of ACE's restructuring deferral proceeding under the New Jersey Electric Discount and Energy Competition Act, see Note (14), Commitments and Contingencies to the financial statements of ACE included in ACE's Annual Report on Form 10-K/A for the year ended December 31, 2003, and Note (4), Commitments and Contingencies, to the financial statements of ACE included in ACE's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. In July 2004, the NJBPU issued its final order in the restructuring deferral proceeding. The final order did not modify the amount of the disallowances set forth in the summary order issued in July 2003, but did provide a much more detailed analysis of evidence and other information relied on by the NJBPU as justification for the disallowances. ACE believes the record does not justify the level of disallowance imposed by the NJBPU. In August 2004, ACE filed with the Appellate Division of the Superior Court of New Jersey, which hears appeals of New Jersey administrative agencies, including the NJBPU, a Notice of Appeal and a Case Information Statement related to the July 2004 Final Decision and Order. ACE cannot predict the outcome of this appeal. |
Proposed Shut-Down of B.L. England Generating Station |
As discussed in Note (4), Commitments and Contingencies, to the financial statements of ACE included in ACE's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, ACE filed a report in April 2004 with the NJBPU in compliance with the NJBPU order issued in September 2003. This report recommended that the B.L. England generating plant be shut down in accordance with the terms of the preliminary settlement agreement among PHI, Conectiv and ACE, the New Jersey Department of Environmental Protection and the Attorney General of New Jersey. In letters dated May and September 2004 to the PJM Interconnection, LLC (PJM), ACE informed PJM of its intent, as owner of the B.L. England generating plant, to retire the entire plant (447 MW) on December 15, 2007. PJM has completed its independent analysis to determine the upgrades required to eliminate any identified reliability problems resulting from the retirement of B.L. England and has recommended that certain transmission upgrades be installed prior to the summer of 2008. ACE's independent assessment confirmed that the transmission upgrades identified by PJM are the transmission upgrades necessary to maintain reliability in the Atlantic zone after the retirement of B.L. England. The amount of the costs incurred by ACE to construct the recommended transmission upgrades that ACE would be permitted to recover from load serving entities that use ACE's transmission system would be subject to approval by FERC. The amount of construction costs that ACE would be permitted to recover from retail ratepayers would be determined in accordance with the treatment of transmission-related revenue requirements in retail rates under the jurisdiction of the appropriate state regulatory commission. ACE cannot predict how the recovery of such costs will ultimately be treated by FERC and the state regulatory commissions and, therefore, cannot predict the financial impact to ACE of installing the recommended transmission upgrades. However, in the event that the NJBPU makes satisfactory findings and grants other requested approvals concerning the retirement of B.L. England and approves the construction of the transmission upgrades required to maintain reliability in the Atlantic zone after such retirement, ACE expects to begin construction of the appropriate transmission upgrades while final decisions by FERC and state regulatory commissions concerning the methodology for recovery of the costs of such construction are still pending. |
On November 1, 2004, ACE made a filing with the NJBPU requesting approval of the transmission upgrades required to maintain reliability in the |
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Atlantic zone after the retirement of B.L. England. Late in November or shortly thereafter, ACE will file a request that the NJBPU (i) make a finding that the retirement of the B.L. England generating station is prudent and (ii) approve the categories of costs that will be stranded costs associated with the retirement, dismantling and remediation of B.L. England. ACE cannot predict the outcome of these two proceedings. |
Planned Workforce Reduction |
On November 5, 2004, PHI announced that its Power Delivery business, of which ACE is a part, will reduce its 4,200 employee work force by about 2% to 3% by the end of 2004. This work force reduction will be accomplished through a combination of retirements and targeted reductions. PHI expects to accrue approximately $8 to $11 million in the fourth quarter of 2004 for this work force reduction and existing severance plans. The anticipated impact that this planned reduction will have on ACE has not been determined. |
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72
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73
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74
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NOTES TO FINANCIAL STATEMENTS |
ATLANTIC CITY ELECTRIC TRANSITION FUNDING LLC |
(1) ORGANIZATION |
Atlantic City Electric Transition Funding LLC (ACE Funding), a limited liability company established by Atlantic City Electric Company (ACE) under the laws of the State of Delaware, was formed on March 28, 2001 pursuant to a limited liability company agreement with ACE dated April 11, 2001 as amended, as sole member of ACE Funding. ACE is a wholly owned subsidiary of Conectiv, which is a wholly owned subsidiary of Pepco Holdings, Inc. |
ACE Funding was organized for the sole purpose of purchasing and owning Bondable Transition Property (BTP), issuing transition bonds (Transition Bonds) to fund the purchasing of BTP, pledging its interest in BTP and other collateral to the Trustee to collateralize the Transition Bonds, and performing activities that are necessary, suitable or convenient to accomplish these purposes. BTP represents the irrevocable right of ACE or its successor or assignee to collect a non-bypassable transition bond charge (TBC) from customers pursuant to bondable stranded costs rate orders (NJBPU Financing Orders), issued by the New Jersey Board of Public Utilities (NJBPU) in accordance with the Electric Discount and Energy Competition Act enacted by the state of New Jersey in February 1999. |
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICY |
Financial Statement Presentation |
ACE Funding's unaudited financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Pursuant to the rules and regulations of the SEC, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted. Therefore, these financial statements should be read along with the annual financial statements included in ACE Funding's Annual Report on Form 10-K for the year ended December 31, 2003. In the opinion of ACE Funding's management, the financial statements contain all adjustments (which all are of a normal recurring nature) necessary to present fairly ACE Funding's financial condition as of September 30, 2004, in accordance with GAAP. Interim results for the three and nine months ended September 30, 2004 may not be indicative of results that will be realized for the full year ending December 31, 2004. |
Debt |
In July 2004, ACE Funding paid at maturity $4.0 million of 2.89% Transition Bonds. |
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.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS |
The information required by this item is contained herein, as follows: |
Registrants |
Page No. |
Pepco Holdings |
77 |
Pepco |
107 |
DPL |
120 |
ACE |
125 |
ACE Funding |
130 |
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
|
PEPCO HOLDINGS |
OVERVIEW |
Pepco Holdings is a diversified energy company that, through its operating subsidiaries, is engaged in three principal areas of business operations: |
· |
regulated power delivery, |
· |
non-regulated competitive energy generation, marketing and supply, and |
· |
other non-regulated activities consisting primarily of investments in energy-related assets. |
For the Three Months Ended
|
Power Delivery |
Conectiv
|
Pepco Energy Services |
Other Non- Regulated |
Corp. & Other |
PHI Consolidated |
|||
(In Millions) |
|||||||||
2004 Net Income/(Loss) |
$ 95.4 |
$19.8 |
$ 1.2 |
$ 9.5 |
$(14.9) |
$111.0 |
|||
2004 Supplemental
|
|||||||||
Bethlehem loan payment (b) |
- |
7.7 |
- |
- |
- |
7.7 |
|||
2004 Adjusted |
$ 95.4 |
$27.5 |
$ 1.2 |
$ 9.5 |
$(14.9) |
$118.7 |
|||
2003 Net Income/(Loss) |
$ 95.6 |
$23.1 |
$3.6 |
$50.4 |
$(15.4) |
$157.3 |
|||
2003 Supplemental
|
|||||||||
Mirant Receivable Reserve (c) |
8.7 |
- |
- |
- |
- |
8.7 |
|||
Building sale gain (d) |
- |
- |
- |
(44.7) |
- |
(44.7) |
|||
2003 Adjusted |
$104.3 |
$ 23.1 |
$ 3.6 |
$ 5.7 |
$(15.4) |
$121.3 |
|||
$ Variance for 2004 Adjusted
|
$ (8.9) |
$ 4.4 |
$(2.4) |
$ 3.8 |
$ 0.5 |
$(2.6) |
|||
(a) |
These adjustments, which are net of tax, represent non-GAAP financial information. Management believes that the adjusted earnings amounts may be useful to investors because they show results before giving effect to the adjustment items. This allows investors to compare earnings information and make decisions without the impact of supplemental items. |
||||||||
(b) |
This amount represents the income statement impact of the expenses associated with the pre-payment of the Bethlehem debt. |
||||||||
(c) |
This amount represents a reserve recorded against a delinquent receivable from Mirant. |
||||||||
(d) |
This amount represents a gain on the sale of the Edison Place office building. |
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A summary of the factors contributing to the three months ended September 30, 2004 and 2003 earnings variances is as follows. |
Power Delivery's third quarter 2004 earnings were $8.9 million lower than its adjusted earnings for the corresponding 2003 period primarily due to the unfavorable impact of lower earnings from ESS at Pepco of approximately $13.6 million and unfavorable cooler summer weather that resulted in approximately $2.1 million lower T&D revenue, partially offset by $3.5 million net earnings from ESS at Conectiv. |
Conectiv Energy's third quarter 2004 adjusted earnings were $4.4 million higher than the corresponding 2003 period due to favorable Provider of Last Resort (POLR) margins and Power, Oil and Gas Marketing margins of $4.3 million, and the recognition of an adjustment related to fuel supply contracts of $5.6 million, offset by lower generation output and margins resulting from milder than normal weather ($4.3 million). In addition, interest expense was higher by $.8 million and depreciation expense by $.5 million primarily because of the completion of the Company's Bethlehem Power Plant. |
Pepco Energy Services' third quarter 2004 earnings were $2.4 million lower than its earnings for the corresponding 2003 period primarily due to lower run time at its power plants resulting from mild summer weather. |
Other Non-Regulated third quarter 2004 earnings were $3.8 million higher than its adjusted earnings for the corresponding 2003 period primarily due to the $1.4 million gain on the sale of PCI's final aircraft and $1.4 million in reduced interest expense. |
Corporate and Other's third quarter 2004 earnings were $.5 million higher than its earnings for the corresponding period in 2003 primarily due to the fact that software was fully amortized in early 2004. |
Nine Months Ended September 30, 2004 and 2003 Results |
The earnings of Pepco Holdings for the nine months ended September 30, 2004, were $252.6 million compared to $175.5 million for the corresponding period in 2003. A comparison of earnings for these periods, adjusted for supplemental items, is as follows: |
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|
For the Nine Months Ended
|
Power Delivery |
|
Conectiv
|
Pepco Energy Services |
Other Non- Regulated |
|
Corp. & Other |
PHI Consolidated |
|
2004 Net Income/(Loss) |
$208.7 |
$49.4 |
$7.6 |
$36.5 |
$(49.6) |
$252.6 |
|||
2004 Supplemental
|
|||||||||
Starpower Impairment (b) |
- |
- |
- |
7.3 |
- |
7.3 |
|||
Local Tax Benefit (c) |
(.8) |
- |
(1.5) |
(8.8) |
(2.0) |
(13.1) |
|||
Gain on disposition
|
- |
(6.6) |
- |
- |
- |
(6.6) |
|||
Bethlehem loan payment (e) |
- |
7.7 |
- |
- |
- |
7.7 |
|||
Gain on Vineland
|
(8.6) |
- |
- |
- |
- |
(8.6) |
|||
2004 Adjusted |
$199.3 |
$50.5 |
$6.1 |
$35.0 |
$(51.6) |
$239.3 |
|||
2003 Net Income/(Loss) |
$188.7 |
$(62.7) |
$1.3 |
$68.5 |
$(20.3) |
$175.5 |
|||
2003 Supplemental
|
|||||||||
Trading Losses (g) |
- |
26.7 |
- |
- |
- |
26.7 |
|||
CT Cancellation (h) |
- |
65.7 |
- |
- |
(34.6) |
31.1 |
|||
ACE New Jersey Deferral
|
16.3 |
- |
- |
- |
- |
16.3 |
|||
ACE accrual reversal (j) |
(5.9) |
- |
- |
- |
- |
(5.9) |
|||
Mirant Receivable Reserve (k) |
8.7 |
- |
- |
- |
- |
8.7 |
|||
Building Sale Gain (l) |
- |
- |
- |
(44.7) |
- |
(44.7) |
|||
2003 Adjusted |
$207.8 |
$ 29.7 |
$1.3 |
$23.8 |
$(54.9) |
$207.7 |
|||
$ Variance for
|
$ (8.5) |
$ 20.8 |
$4.8 |
$11.2 |
$ 3.3 |
$ 31.6 |
|||
(a) |
These adjustments, which are net of tax, represent non-GAAP financial information. Management believes that the adjusted earnings amounts may be useful to investors because they show results before giving effect to the adjustment items. This allows investors to compare earnings information and make decisions without the impact of supplemental items. |
||||||||
(b) |
This amount represents an impairment charge used to reduce the value of the Starpower investment to $28 million at June 30, 2004. |
||||||||
(c) |
In February 2004, a local jurisdiction issued final consolidated tax return regulations, which were retroactive to 2001. These regulations have provided Pepco Holdings and its affiliated subsidiaries doing business in this location with the necessary guidance to file a consolidated income tax return. This allows Pepco Holdings' subsidiaries with taxable losses to utilize those losses against tax liabilities of Pepco Holdings' companies with taxable income. Pepco Holdings and its affected subsidiaries recorded the impact of the new regulations in the first quarter of 2004 for the period 2001 through 2003. |
||||||||
(d) |
This amount represents the favorable impact at Conectiv Energy resulting from the disposition of a joint venture associated with the Vineland co-generation facility. |
||||||||
(e) |
This amount represents the income statement impact of the expenses associated with the pre-payment of the Bethlehem debt. |
||||||||
(f) |
This amount represents the favorable impact resulting from a gain on the condemnation settlement associated with the transfer of Vineland distribution assets. |
||||||||
(g) |
This amount represents the unfavorable impact resulting from net trading losses prior to the cessation of proprietary trading. |
||||||||
(h) |
This amount represents, for Conectiv Energy, the unfavorable impact related to the cancellation of a CT contract to purchase combustion turbines and for Corp. & Other the reversal of a purchase accounting fair value adjustment made on the date of the merger of Pepco and Conectiv relating to this contract. |
||||||||
(i) |
This amount represents the unfavorable impact related to ACE's New Jersey deferral disallowance. |
||||||||
(j) |
This amount represents the favorable impact related to ACE's accrual reversal. |
||||||||
(k) |
This amount represents a reserve recorded against a delinquent receivable from Mirant. |
||||||||
(l) |
This amount represents a gain on the sale of the Edison Place office building. |
A summary of the factors contributing to the nine months ended September 30, 2004 and 2003 adjusted earnings variances is as follows. |
Power Delivery's year-to-date 2004 adjusted earnings were $8.5 million lower than its adjusted earnings for the corresponding period in 2003 primarily due to the unfavorable impact of lower earnings from ESS at Pepco of approximately $33.6 million, partially offset by: (i) $20.4 million in regulated electric and gas revenues due to sales growth and rate increases and (ii) $8.8 million in net earnings from ESS at Conectiv. |
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Conectiv Energy's year-to-date 2004 adjusted earnings were $20.8 million higher than the corresponding 2003 period due to higher generation gross margins of $19.7 million, which resulted primarily from fuel switching, hedging, and use of power plant flexibility. Recognition of an adjustment related to fuel supply contracts also helped to improve earnings this year. In addition, gross margins from the provision of Provider of Last Resort (POLR) services improved due to an increase in the average sales price and somewhat lower cost of goods. Power, Oil and Gas Marketing benefited from lower cost of goods driven by mild summer weather. In total, the fuel supply adjustment, POLR services, and Power, Oil and Gas Marketing gross margins were $10 million higher than 2003. Several items offsetting the positive variances included higher interest cost resulting from the completion of the Bethlehem power plant ($4.2 million), higher depreciation expense also associated with the Bethlehem plant ($3.2 million), and other ($4.0 million). |
Pepco Energy Services' year to date 2004 adjusted earnings were $4.8 million higher than its earnings for the corresponding period in 2003 due to improved gross margins in the retail commodity business. |
Other Non-Regulated year-to-date 2004 adjusted earnings were $11.2 million higher than its adjusted earnings for the corresponding period in 2003 primarily due to the $5.2 million gain on the sale of PCI's final three aircraft and from $6.1 million in reduced interest expense. |
Corporate and Other's year-to-date 2004 adjusted earnings were $3.3 million higher than its adjusted earnings for the corresponding period in 2003 primarily due to lower amortization associated with certain purchase accounting adjustments and software which was fully amortized in early 2004. The items were partially offset by higher intercompany net interest expense, which is offset in the lines of businesses resulting in no effect on consolidated earnings. |
CONSOLIDATED RESULTS OF OPERATIONS |
The accompanying results of operations discussion is for the three months ended September 30, 2004 compared to September 30, 2003. |
Operating Revenue |
PHI's operating revenue decreased by $84.1 million to $2,046.5 million for the three months ended September 30, 2004, from $2,130.6 million for the corresponding period in 2003. The decrease was primarily due to a decrease of $146.4 million at Conectiv Energy that was partially offset by an increase of $45.0 million at Power Delivery and an increase of $24.1 million at Pepco Energy Services. |
The increase in Power Delivery's operating revenue of $45.0 million is primarily due to the following: (i) a $62.2 million increase in electricity supply service revenue primarily of which $42.6 million is a result of lower Pepco customer migration to alternative energy suppliers and $15.5 million is related to ACE PJM interchange revenue and rate increases due to the higher price of energy; partially offset by (ii) a $14.7 million decrease in other revenue, primarily due to the expiration of DPL wholesale contracts. Delivery sales were 14,028,000 MwH, compared to 14,190,000 MwH for the comparable period in 2003. Cooling degree days decreased 8.9% for the three months ended September 30, 2004 as compared to the same period in 2003. Gas sales were 2,220,000 mcf, compared to 2,527,000 mcf for the comparable period in |
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2003 due to lower industrial customer sales as a result of economic conditions. |
The table below shows the amount of Power Delivery operating revenue earned that is subject to price regulation (regulated T&D electric and gas revenue and electricity supply service revenue). Regulated T&D (Transmission and Distribution) electric revenue includes revenue Power Delivery receives for delivery of energy to its customers. Regulated gas revenue includes on-system natural gas sales and the transportation of natural gas to customers. Electricity supply service (ESS) also known as Standard Offer Service (SOS), Basic Generation Service (BGS), and Provider of Last Resort (POLR) includes revenue within the service areas of Power Delivery. Other electric revenue includes work and services performed on behalf of customers including other utilities; other gas revenue includes off-system gas sales; and the resale of excess gas or system capacity. |
Three Months Ended September 30, |
2004 |
2003 |
Change |
|
(Dollars in Millions) |
|
|
Regulated T&D Electric Revenue |
$ 458.1 |
$ 462.1 |
$ (4.0) |
Electricity Supply Service Revenue |
814.3 |
752.1 |
62.2 |
Other Electric Revenue |
16.3 |
28.6 |
(12.3 ) |
Total Electric Operating Revenue |
1,288.7 |
1,242.8 |
45.9 |
Regulated Gas Revenue |
16.0 |
14.5 |
1.5 |
Other Gas Revenue |
8.7 |
11.1 |
(2.4 ) |
Total Gas Operating Revenue |
24.7 |
25.6 |
(0.9 ) |
Total Power Delivery Operating Revenue |
$1,313.4 |
$1,268.4 |
$ 45.0 |
The decrease in Conectiv Energy's operating revenue of $146.4 million is primarily due to the following: a $44.8 million decrease in revenue from PJM due primarily to a change in power scheduling procedures by Conectiv to schedule power directly to DPL, a decrease of $88.9 million that related to the implementation of EITF 03-11 on January 1, 2004, and a $12.7 million decrease resulting primarily from a decrease in Power, Oil and Gas Marketing activities. The impact of the decrease in operating revenue was substantially offset by decreases in fuel and purchased energy expenses, discussed below. |
The increase in Pepco Energy Services' operating revenue of $24.1 million is primarily due to electricity sold to retail customers at higher prices than in 2003. |
Operating Expenses |
Fuel and Purchased Energy |
PHI's fuel and purchased energy decreased $129.9 million to $1,197.3 million for the three months ended September 30, 2004, from $1,327.2 million for the corresponding period in 2003. The decrease was primarily due to a decrease of $216.7 million at Conectiv Energy, partially offset by a $72.5 million increase at Power Delivery and a $17.1 million increase at Pepco Energy Services. |
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The increase in Power Delivery's fuel and purchased energy of $72.5 million was primarily due to the following: (i) a $75.7 million increase in net energy procurement due to higher sales of ESS; (ii) a $13.5 million increase in energy procurement costs to provide ESS due to the TPA Settlement with Mirant (entered into in November 2003) that increased the price of energy purchased from Mirant (the TPA Settlement); partially offset by (iii) a $14.5 million reserve recorded in September 2003 to reflect a potential exposure related to a pre-petition receivable from Mirant Corp. for which Pepco filed a creditor's claim in the bankruptcy proceedings. See the Regulatory and Other Matters - Relationship with Mirant section herein for additional information related to Mirant. |
The decrease in Conectiv Energy's fuel and purchased energy of $216.7 million was primarily due to the following: a change in power scheduling procedures by Conectiv to schedule power directly to DPL which resulted in a decrease of approximately $17.0 million in expenses from PJM, a decrease of $88.9 million related to the implementation of EITF 03-11 on January 1, 2004, and a decrease of approximately $110.8 million primarily due to reduced Power, Oil and Gas Marketing costs of goods sold from lower sales volume. |
The increase in Pepco Energy Services' fuel and purchased energy of $17.1 million was primarily due to higher electricity supply costs associated with sales to retail customers. |
Other Operation and Maintenance |
PHI's other operation and maintenance, which includes costs associated with Conectiv Energy's petroleum division, increased $17.5 million to $348.1 million for the three months ended September 30, 2004, from $330.6 million for the corresponding period in 2003 primarily due to an increase of $17 million in Conectiv Energy's cost of sales expense associated with its petroleum division due to higher fuel costs. Additionally, higher electric system maintenance costs of $3.7 million and other operating costs of $4.8 million in 2004 were partially offset by $13.1 million in storm costs in 2003 primarily from Hurricane Isabel. |
Other Taxes |
PHI's other taxes increased by $9.9 million to $91.3 million for the three months ended September 30, 2004, from $81.4 million for the corresponding period in 2003 primarily due to an $8.9 million higher county surcharge (which is a pass-through). |
Deferred Electric Service Costs |
Deferred electric service costs increased by $19.6 million to $18.7 million for the three months ended September 30, 2004 from a $0.9 million credit to operating expense for the corresponding period in 2003. The $19.6 million increase represents a net over-recovery associated with non-utility generation contracts (NUGs), market transition charge (MTC), BGS and other restructuring items. Customers in New Jersey who do not choose a competitive supplier receive default electricity supply from suppliers selected through auctions approved by the NJBPU. ACE's rates for the recovery of these costs are reset annually. On ACE's consolidated balance sheet a regulatory asset includes an under-recovery of $110.9 million as of September 30, 2004. This amount is net of a $46.1 million reserve on previously disallowed items under appeal. |
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Gain on Sale of Assets |
PHI's gain on sale of assets decreased by $66.7 million for the three months ended September 30, 2004 due to the fact that the corresponding period in 2003 included the $68.8 million gain on the sale of PCI's office building. |
Other Income (Expenses) |
PHI's other expenses (which is net of other income) increased $7.2 million to $96.3 million for the three months ended September 30, 2004, from $89.1 million for the corresponding period in 2003. The increase was primarily due to an increase in interest expense of $12.8 million at Conectiv Energy from costs associated with the pre-payment of debt related to the Bethlehem mid-merit facility, partially offset by a $5.1 million decrease in PCI and Pepcom expenses from reduced interest expense at PCI and decreased investment losses at Pepcom. |
Income Tax Expense |
PHI's effective tax rate for the three months ended September 30, 2004 was 38.9% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and tax benefits related to certain leveraged leases. |
PHI's effective tax rate for the three months ended September 30, 2003 was 39.0% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and tax benefits related to certain leveraged leases. |
The accompanying results of operations discussion is for the nine months ended September 30, 2004 compared to September 30, 2003. |
Operating Revenue |
PHI's operating revenue decreased by $255.6 million to $5,502.1 million for the nine months ended September 30, 2004, from $5,757.7 million for the corresponding period in 2003. The decrease was primarily due to a decrease of $536.9 million at Conectiv Energy, partially offset by a $272.3 million increase by Power Delivery businesses. |
The increase in Power Delivery's operating revenue of $272.3 million is primarily due to the following: (i) a $229.3 million increase in ESS revenue primarily of which $107.6 million is a result of lower customer migration to alternative energy suppliers and $113.9 million is related to sales into the PJM market and rate increases due to the higher price of energy; (ii) a $54.8 million increase in delivery revenue, of which $28.3 million is due to an increase for a county surcharge which is a pass through; partially offset by (iii) an $11.8 million decrease in other revenue primarily due to the expiration of DPL wholesale contracts. For the nine months ended September 30, 2004, delivery sales were 39,090,000 MwH, compared to 38,144,000 MwH for the comparable period in 2003. Cooling degree days increased 12.5% and heating degree days decreased 10.3% for the nine months ended September 30, 2004 as compared to 2003. Gas sales were 15,357,000 mcf, compared to 17,006,000 mcf for the comparable period in 2003. |
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The table below shows the amount of Power Delivery operating revenue earned that is subject to price regulation and its other electric and gas revenue. |
Nine Months Ended September 30, |
2004 |
2003 |
Change |
|
(Dollars in Millions) |
|
|
Regulated T&D Electric Revenue |
$1,219.0 |
$1,175.9 |
$ 43.1 |
Electricity Supply Service Revenue |
1,981.9 |
1,752.6 |
229.3 |
Other Electric Revenue |
51.1 |
80.7 |
(29.6 ) |
Total Electric Operating Revenue |
3,252.0 |
3,009.2 |
242.8 |
Regulated Gas Revenue |
127.1 |
115.4 |
11.7 |
Other Gas Revenue |
46.7 |
28.9 |
17.8 |
Total Gas Operating Revenue |
173.8 |
144.3 |
29.5 |
Total Power Delivery Operating Revenue |
$3,425.8 |
$3,153.5 |
$272.3 |
September 30, 2004 |
December 31, 2003 |
|||
Common Shareholders' Equity |
$3,428.5 |
38.9% |
$3,003.3 |
34.7% |
Preferred Stock of subsidiaries (a) |
101.6 |
1.2% |
108.2 |
1.2% |
Debentures Issued to
|
- |
-% |
98.0 |
1.1% |
Long-Term Debt (c) |
5,089.2 |
57.7% |
5,101.3 |
58.8% |
Short-Term Debt (d) |
196.5 |
2.2% |
360.0 |
4.2 % |
Total |
$8,815.8 |
100.0% |
$8,670.8 |
100.0% |
(a) |
Includes Mandatorily Redeemable Serial Preferred Stock, Serial Preferred Stock, and Redeemable Serial Preferred Stock, which is accounted for as a liability on the balance sheet. |
(b) |
Represents debentures issued pursuant to financing trusts, including the current portion. |
(c) |
Excludes capital lease obligations and transition bonds issued by ACE Funding. Includes first mortgage bonds, medium-term notes, other long-term debt (other than debt issued by ACE Funding), current maturities of long-term debt (other than debt issued by ACE Funding), and Variable Rate Demand Bonds. |
(d) |
Excludes current maturities of long-term debt, capital lease obligations due within one year, and Variable Rate Demand Bonds. |
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Issuance of Common Stock |
In September 2004, Pepco Holdings sold 14,950,000 shares of common stock at $19.25 per share. Proceeds received on the transaction, net of issuance costs of $10.3 million, were $277.5 million. These proceeds, in combination with short-term debt, were used to pre-pay in its entirety a term loan in the amount of $335 million of Conectiv Bethlehem, LLC. |
Financing Activity During the Three Months Ended September 30, 2004 |
In July 2004, Pepco Holdings, Pepco, DPL and ACE entered into a five-year credit agreement with an aggregate borrowing limit of $650 million. This agreement replaces a $550 million 364-day credit agreement that was entered into on July 29, 2003. The respective companies also are parties to a three-year credit agreement that was entered into in July 2003 and terminates in July 2006 with an aggregate borrowing limit of $550 million. Pepco Holdings' credit limit under these agreements is $700 million and the credit limit of each of Pepco, DPL and ACE is the lower of $300 million and the maximum amount of short-term debt authorized by the applicable regulatory authority, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at any given time under the agreements may not exceed $500 million. The credit agreements primarily serve as a source of liquidity to support the commercial paper programs of the respective companies. The companies can also borrow funds for general corporate purposes and issue letters of credit under the Agreements. The credit agreements contain customary financial and other covenants that, if not satisfied, could result in the acceleration of repayment obligations under the agreements or restrict the ability of the companies to borrow under the agreements. Among these covenants is the requirement that each borrowing company maintain a ratio of total indebtedness to total capitalization of 65% or less, computed in accordance with the terms of the credit agreements. The credit agreements also contain a number of customary events of default that could result in the acceleration of repayment obligations under the agreements, including (i) the failure of any borrowing company or any of its significant subsidiaries to pay when due, or the acceleration of certain indebtedness under other borrowing arrangements, (ii) certain bankruptcy events, judgments or decrees against any borrowing company or its significant subsidiaries, and (iii) a change in control (as defined in the credit agreements) of Pepco Holdings or the failure of Pepco Holdings to own all of the voting stock of Pepco, DPL and ACE. |
Other Long-Term Financing |
Set forth below is a summary of long-term financing activity during the quarter ended September 30, 2004. |
In July 2004, ACE Funding paid at maturity $4.0 million of 2.89% Transition Bonds. |
In August 2004, Pepco repurchased 65,000 shares of its $2.28 series, par value $50.00 per share preferred stock at an average price of $45.50 per share. |
In August 2004, on behalf of ACE, the Pollution Control Financing Authority of Salem County, New Jersey issued $23.15 million of insured auction rate tax-exempt bonds due 2029 and loaned the proceeds to ACE. ACE's obligations under the insurance agreement are secured by a like amount of ACE First Mortgage Bonds. In September 2004, ACE used the proceeds to redeem $23.15 million of 6.15% First Mortgage Bonds due 2029 at 102%. |
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In August 2004, on behalf of ACE, the Pollution Control Financing Authority of Cape May County, New Jersey issued $25 million of Series 2004A and $6.5 million of Series 2004B insured auction rate tax-exempt bonds due 2029 and loaned the proceeds to ACE. ACE's obligations under the insurance agreement are secured by a like amount of ACE First Mortgage Bonds. In November 2004, ACE used the proceeds to redeem $25 million of 7.2% First Mortgage Bonds due 2029 at 102% and $6.5 million of 7.0% First Mortgage Bonds due 2029 at 102%. |
In September 2004, Conectiv Bethlehem prepaid its entire $335 million term loan due 2006. Additionally, Conectiv Bethlehem paid $6.8 million to unwind an interest rate swap agreement that had converted a portion of the variable interest rate on the term loan balance to a fixed rate. Approximately $6.0 million in unamortized debt issuance costs related to the term loan were expensed at the time of the loan repayment. |
In September 2004, Pepco repurchased 16,400 shares of its $2.28 series preferred stock, par value $50.00 per share, at an average price of $47.25 per share. |
In September 2004, Pepco redeemed $2.5 million, or 50,000 shares, of its $3.40 Serial Preferred Stock Series of 1992 pursuant to mandatory sinking fund provisions. |
Financing Activity Subsequent to September 30, 2004 |
Set forth below is a summary of long-term financing activity subsequent to September 30, 2004. |
In October 2004, Pepco repurchased 84,502 shares of its $2.28 series preferred stock, par value $50.00 per share, at an average price of $47.02 per share. |
In October 2004, ACE Funding paid at maturity $12.3 million 2.89% Transition Bonds. |
In October 2004, PCI paid at maturity $50 million of 7.97% Medium-Term Notes. |
In October 2004, Pepco called for early redemption, at par, on December 1, 2004, all of the remaining 850,000 shares of its $3.40 Serial Preferred Stock Series of 1992. |
In November 2004, DPL redeemed at maturity $4.5 million of 8.3% Medium-Term Notes. |
Working Capital |
At September 30, 2004, Pepco Holdings' current assets on a consolidated basis totaled $1.8 billion, which consisted primarily of accounts receivable, materials and supplies and cash and cash equivalents. Current liabilities totaled $2.2 billion, of which $.9 billion was the current portion of long-term debt and Variable Rate Demand Bonds, which have maturities ranging from 2007 to 2031. Excluding these amounts related to long-term debt, current assets of $1.8 billion exceeded current liabilities of $1.3 billion. At September 30, 2003, current assets totaled $1.9 billion, which consisted primarily of accounts receivable, materials and supplies, cash and cash equivalents and marketable securities. Current liabilities totaled $2.4 billion, of which $.8 billion consisted of the current portion of long-term debt, Variable Rate Demand Bonds, which have maturities ranging from 2007 to 2031, and $.4 billion of short term loans which were subsequently converted to long-term debt. Excluding these amounts related to long-term debt, current assets of $1.9 billion exceeded current liabilities of $1.6 billion. |
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A detail of Pepco Holdings' $1.1 billion of short-term debt at September 30, 2004 is as follows: |
|
As of September 30, 2004 ($ in Millions) |
||||||||
Type |
PHI |
Pepco |
DPL |
ACE |
ACE
|
PES |
PCI |
Conectiv |
PHI
|
Variable Rate
|
$ - |
$ - |
$104.8 |
$ 22.6 |
$ - |
$31.0 |
$ - |
$ - |
$ 158.4 |
Current Portion
|
200.0 |
100.0 |
7.2 |
71.5 |
31.9 |
.1 |
69.0 |
280.0 |
759.7 |
Commercial Paper |
134.0 |
- |
- |
62.5 |
- |
- |
- |
- |
196.5 |
Total |
$334.0 |
$100.0 |
$112.0 |
$156.6 |
$31.9 |
$31.1 |
$69.0 |
$280.0 |
$1,114.6 |
Capital Requirements |
Construction Expenditures |
Pepco Holdings' construction expenditures for the nine months ended September 30, 2004 totaled $357.0 million of which $340.6 million was related to its Power Delivery businesses. The remainder was primarily related to Conectiv Energy. The Power Delivery expenditures were primarily related to capital costs associated with new customer services (customer driven), distribution reliability, and transmission. |
Dividends |
On October 28, 2004, Pepco Holdings' Board of Directors declared a dividend on common stock of 25 cents per share payable December 31, 2004, to shareholders of record on December 10, 2004. |
Third Party Guarantees, Indemnifications and
|
Pepco Holdings and certain of its subsidiaries have various financial and performance guarantees and indemnification obligations which are entered into in the normal course of business to facilitate commercial transactions with third parties as discussed below. |
As of September 30, 2004, Pepco Holdings and its subsidiaries were parties to a variety of agreements pursuant to which they were guarantors for standby letters of credit, performance residual value, and other commitments and obligations. The fair value of these commitments and obligations was not required to be recorded in Pepco Holdings' Consolidated Balance Sheets; however, certain energy marketing obligations of Conectiv Energy were recorded. The commitments and obligations, in millions of dollars, were as follows: |
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|
Guarantor |
|
||
|
PHI |
Conectiv |
PCI |
Total |
Energy marketing obligations of
|
$148.6 |
$ 1.3 |
$ - |
$149.9 |
Energy procurement obligations
|
5.0 |
- |
- |
5.0 |
Standby letters of credit of
|
4.2 |
- |
- |
4.2 |
Guaranteed lease residual values (3) |
- |
6.4 |
- |
6.4 |
Loan agreement (4) |
13.1 |
- |
- |
13.1 |
Construction performance guarantees (5) |
- |
4.1 |
- |
4.1 |
Other (6) |
14.9 |
4.0 |
5.3 |
24.2 |
Total |
$185.8 |
$15.8 |
$5.3 |
$206.9 |
1. |
Pepco Holdings and Conectiv have contractual commitments for performance and related payments of Conectiv Energy and Pepco Energy Services to counterparties related to routine energy sales and procurement obligations, including requirements under Basic Generation Service contracts for ACE. |
|
2. |
Pepco Holdings has issued standby letters of credit of $4.2 million on behalf of subsidiaries' operations related to Conectiv Energy's competitive energy activities and third party construction performance. These standby letters of credit were put into place in order to allow the subsidiaries the flexibility needed to conduct business with counterparties without having to post substantial cash collateral. While the exposure under these standby letters of credit is $4.2 million, Pepco Holdings does not expect to fund the full amount. |
|
3. |
Subsidiaries of Pepco Holdings have guaranteed residual values in excess of fair value related to certain equipment and fleet vehicles held through lease agreements. As of September 30, 2004, obligations under the guarantees were approximately $6.4 million. Assets leased under agreements subject to residual value guarantees are typically for periods ranging from 2 years to 10 years. Historically, payments under the guarantees have not been made by the guarantor as, under normal conditions, the contract runs to full term at which time the residual value is minimal. As such, Pepco Holdings believes the likelihood of requiring payment under the guarantee is remote. |
|
4. |
Pepco Holdings has issued a guarantee on the behalf of a subsidiary's 50% unconsolidated investment in a limited liability company for repayment borrowings under a loan agreement of approximately $13.1 million. |
|
5. |
Conectiv has performance obligations of $4.1 million relating to obligations to third party suppliers of equipment. |
|
6. |
Other guarantees comprise: |
|
· |
Pepco Holdings has guaranteed payment of a bond issued by a subsidiary of $14.9 million. Pepco Holdings does not expect to fund the full amount of the exposure under the guarantee. |
|
· |
Conectiv has guaranteed a subsidiary building lease of $4.0 million. Conectiv does not expect to fund the full amount of the exposure under the guarantee. |
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|
· |
PCI has guaranteed facility rental obligations related to contracts entered into by Starpower Communications LLC. In addition, PCI has agreed to indemnify RCN for 50% of any payments RCN makes under the Starpower franchise and construction performance bonds. As of September 30, 2004, the guarantees cover the remaining $3.2 million in rental obligations and $2.1 million in franchise and construction performance bonds issued. |
Pepco Holdings and certain of its subsidiaries have entered into various indemnification agreements related to purchase and sale agreements and other types of contractual agreements with vendors and other third parties. These indemnification agreements typically cover environmental, tax, litigation and other matters, as well as breaches of representations, warranties and covenants set forth in these agreements. Typically, claims may be made by third parties under these indemnification agreements over various periods of time depending on the nature of the claim. The maximum potential exposure under these indemnification agreements can range from a specified dollar amount to an unlimited amount depending on the nature of the claim and the particular transaction. The total maximum potential amount of future payments under these indemnification agreements is not estimable due to several factors, including uncertainty as to whether or when claims may be made under these indemnities. |
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Energy Contract Net Asset Activity |
The following table provides detail on changes in the competitive energy segments' net asset or liability position with respect to energy commodity contracts from one period to the next: |
Roll-forward of Mark-to-Market Energy Contract Net Assets
|
|||
|
Proprietary Trading (2) |
Other Energy Commodity (3) |
Total |
Total Marked-to-market (MTM) Energy Contract Net Assets
|
$ 11.0 |
$60.6 |
$ 71.6 |
Total change in unrealized fair value excluding
|
(0.2) |
26.9 |
26.7 |
Reclassification to realized at settlement of contracts |
(7.8) |
(31.1) |
(38.9) |
Effective portion of changes in fair value - recorded
|
- |
14.9 |
14.9 |
Ineffective portion of charges in fair value -
|
- |
(8.2) |
(8.2) |
Changes in valuation techniques and assumptions |
- |
- |
- |
Purchase/sale of existing contracts or portfolios
|
- |
- |
- |
Total MTM Energy Contract Net Assets at September 30, 2004 (a) |
$ 3.0 (4) |
$63.1 |
$ 66.1 |
(a) Detail of MTM Energy Contract Net Assets at September 30, 2004 (above) |
Total |
||
Current Assets |
$136.0 |
||
Noncurrent Assets |
30.5 |
||
Total MTM Energy Assets |
166.5 |
||
Current Liabilities |
(73.0) |
||
Noncurrent Liabilities |
(27.4 ) |
||
Total MTM Energy Contract Liabilities |
(100.4 ) |
||
Total MTM Energy Contract Net Assets |
$ 66.1 |
Notes: |
|
(1) |
This table reflects $.3 million (pre-tax) of net assets that existed at the time of the Pepco/Conectiv merger that are not reflected in PHI's consolidated balance sheet as of September 30, 2004 due to purchase accounting. |
(2) |
Includes all remaining contracts held for proprietary trading. |
(3) |
Includes all SFAS 133 hedge activity and non-proprietary trading activities marked-to-market through earnings. |
(4) |
This amount will not be materially sensitive to commodity price movements because it represents positions that have been volumetrically offset almost 100% since the first quarter of 2003. |
The following table provides the source of fair value information (exchange-traded, provided by other external sources, or modeled internally) used to determine the carrying amount of the competitive energy segments' total mark-to-market energy contract net assets. The table also provides the maturity, by year, of the competitive energy segments' mark-to-market energy contract net assets, which indicates when the amounts will settle and either generate cash for, or require payment of cash by, PHI. |
PHI uses its best estimates to determine the fair value of the commodity and derivative contracts that its competitive energy segments hold and sell. The fair values in each category presented below reflect forward prices and volatility factors as of September 30, 2004 and are subject to change as a result of changes in these factors: |
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Notes: |
|
(1) |
This table reflects $.3 million (pre-tax) of net assets that existed at the time of the Pepco/Conectiv merger that are not reflected in PHI's consolidated balance sheet as of September 30, 2004 due to purchase accounting. |
(2) |
Includes all remaining contracts held for proprietary trading. |
(3) |
The forward value of the trading contracts represents positions held prior to the cessation of proprietary trading. The values were locked-in during the exit from trading and will be realized during the normal course of business through the year 2005. |
(4) |
Prices provided by other external sources reflect information obtained from over-the-counter brokers, industry services, or multiple-party on-line platforms. As of March 2003, Conectiv Energy ceased all proprietary trading activities; however, the market exposure under certain contracts associated with proprietary trading activities was not eliminated due to the illiquid market environment to execute such elimination. These illiquid contracts will remain in place until they are terminated and their values are realized. |
(5) |
Includes all SFAS No. 133 hedge activity and non-trading activities marked-to-market through AOCI or on the Income Statement as required. As of the second quarter of 2003, this category also includes the activities of the 24-Hour Power Desk. |
(6) |
The modeled hedge position is a power swap for 50% of Conectiv Energy's POLR obligation in the DPL territory. The model is used to approximate the forward load quantities. Pricing is derived from the broker market. |
Contractual Arrangements with Credit Rating Triggers or Margining Rights |
Under certain contractual arrangements entered into by PHI's subsidiaries in connection with competitive energy and other transactions, the affected company may be required to provide cash collateral or letters of credit as security for its contractual obligations if the credit ratings of the applicable company are downgraded one or more levels. In the event of a downgrade, the amount required to be posted would depend on the amount of the underlying contractual obligation existing at the time of the downgrade. As of September 30, 2004, a one-level downgrade in the credit rating of PHI and all of its affected subsidiaries would have required PHI and such subsidiaries to provide aggregate cash collateral or letters of credit of approximately up to $144 million. An additional amount of approximately $176 |
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million of aggregate cash collateral or letters of credit would have been required in the event of subsequent downgrades to below investment grade. |
Many of the contractual arrangements entered into by PHI's subsidiaries in connection with competitive energy activities include margining rights pursuant to which the PHI subsidiary or a counterparty may request collateral if the market value of the contractual obligations reaches levels that are in excess of the credit thresholds established in the applicable arrangements. Pursuant to these margining rights, the affected PHI subsidiary may receive, or be required to post, collateral due to energy price movements. As of September 30, 2004, Pepco Holdings' subsidiaries that engaged in competitive energy activities were in receipt of (a net holder of) cash collateral in the amount of $15.5 million as recorded in connection with their competitive energy activities. |
REGULATORY AND OTHER MATTERS |
Relationship with Mirant Corporation |
In 2000, Pepco sold substantially all of its electricity generation assets to Mirant Corporation, formerly Southern Energy, Inc., pursuant to an Asset Purchase and Sale Agreement. As part of the Asset Purchase and Sale Agreement, Pepco entered into several ongoing contractual arrangements with Mirant and certain of its subsidiaries (collectively, Mirant). On July 14, 2003, Mirant Corporation and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of Texas (the Bankruptcy Court). |
Depending on the outcome of the matters discussed below, the Mirant bankruptcy could have a material adverse effect on the results of operations of Pepco Holdings and Pepco. However, management currently believes that Pepco Holdings and Pepco currently have sufficient cash, cash flow and borrowing capacity under their credit facilities and in the capital markets to be able to satisfy any additional cash requirements that have arisen or may arise due to the Mirant bankruptcy. Accordingly, management does not anticipate that the Mirant bankruptcy will impair the ability of Pepco Holdings or Pepco to fulfill their contractual obligations or to fund projected capital expenditures. On this basis, management currently does not believe that the Mirant bankruptcy will have a material adverse effect on the financial condition of either company. |
Transition Power Agreements |
For a discussion of the Transition Power Agreements between Pepco and Mirant and the amendment of these agreements in connection with the Mirant bankruptcy, see Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Relationship with Mirant included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
Power Purchase Agreements |
Under agreements with FirstEnergy Corp., formerly Ohio Edison (FirstEnergy), and Allegheny Energy, Inc., both entered into in 1987, Pepco is obligated to purchase from FirstEnergy 450 megawatts of capacity and energy annually through December 2005 (the FirstEnergy PPA). Under an agreement with Panda-Brandywine L.P. (Panda), entered into in 1991, Pepco is obligated to purchase from Panda 230 megawatts of capacity and energy |
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annually through 2021 (the Panda PPA). In each case, the purchase price is substantially in excess of current market prices. As a part of the Asset Purchase and Sale Agreement, Pepco entered into a "back-to-back" arrangement with Mirant. Under this arrangement, Mirant is obligated, among other things, to purchase from Pepco the capacity and energy that Pepco is obligated to purchase under the FirstEnergy PPA and the Panda PPA at a price equal to the price Pepco is obligated to pay under the PPAs (the PPA-Related Obligations). |
Pepco Pre-Petition Claims |
For a discussion of the claims that Pepco has filed against Mirant with respect to amounts owed by Mirant to Pepco under the PPAs at the time of the filing of Mirant's bankruptcy petition and the accounting treatment of these claims, see Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Relationship with Mirant included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
Mirant's Attempt to Reject the PPA-Related Obligations |
On August 28, 2003, Mirant filed with the Bankruptcy Court a motion seeking authorization to reject its PPA-Related Obligations. Upon motions filed with the U.S. District Court for the Northern District of Texas (the District Court) by Pepco and the Federal Energy Regulatory Commission (FERC), in October 2003, the District Court withdrew jurisdiction over the rejection proceedings from the Bankruptcy Court. In December 2003, the District Court denied Mirant's motion to reject the PPA-Related Obligations. The District Court's decision was appealed by Mirant and The Official Committee of Unsecured Creditors of Mirant Corporation in the U.S. Court of Appeals for the Fifth Circuit. On August 4, 2004, the Court of Appeals remanded the case to the District Court saying that it has jurisdiction to rule on the merits of Mirant's rejection motion, suggesting that in doing so the court apply a "more rigorous standard" than the business judgment rule usually applied by bankruptcy courts in ruling on rejection motions, and noting that there are other "important issues which must still be resolved before a decision on the merits would be appropriate." On October 4, 2004, the District Court issued an order stating that the District Court will retain jurisdiction over the matter and invited parties to submit comments on the appropriate standard to be applied in determining whether to grant Mirant's rejection motion. All parties submitted comments. On November 3, 2004, the District Court issued an order stating that the Court concluded that the "separate agreement" issue ( i.e ., whether the PPA-Related Obligations are severable from the Asset Purchase and Sale Agreement) relating to the sale of Pepco's generation assets should be resolved before the District Court deals further with the issue of the standard to be applied in determining whether the motion to reject should be granted. The order permits the parties to submit further evidentiary material related to the separate agreement issue. |
Pepco is exercising all available legal remedies and vigorously opposing Mirant's attempt to reject the PPA-Related Obligations in order to protect the interests of its customers and shareholders. While Pepco believes that it has substantial legal bases to oppose the attempt to reject the agreements, the outcome of Mirant's efforts to reject the PPA-Related Obligations is uncertain. |
In accordance with the Bankruptcy Court's order, Mirant is continuing to perform the PPA-Related Obligations pending the resolution of the ongoing proceedings. However, if Mirant ultimately is successful in rejecting, and |
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is otherwise permitted to stop performing the PPA-Related Obligations, Pepco could be required to repay to Mirant, for the period beginning on the effective date of the rejection (which date could be prior to the date of the court's order and possibly as early as September 18, 2003) and ending on the date Mirant is entitled to cease its purchases of energy and capacity from Pepco, all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity. Pepco estimates that the amount it could be required to repay to Mirant in the unlikely event September 18, 2003, is determined to be the effective date of rejection, is approximately $118.8 million as of November 1, 2004. This repayment would entitle Pepco to file a claim against the bankruptcy estate in an amount equal to the amount repaid. Mirant has also asked the Bankruptcy Court to require Pepco to disgorge all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity, for the period July 14, 2003 (the date on which Mirant filed its bankruptcy petition) to September 18, 2003, on the theory that Mirant did not receive value for those payments. Pepco estimates that the amount it would be required to repay to Mirant on the disgorgement theory is approximately $22.5 million. Pepco believes a claim based on this theory should be entitled to administrative expense status for which complete recovery could be expected in the Bankruptcy Court. If Pepco were required to repay any such amounts for either period, the payment would be expensed at the time the payment is made. However, Pepco believes that, to the extent such amounts were not recovered from the Mirant bankruptcy estate, the expensed amounts would be recoverable as stranded costs from customers through distribution rates as described below. |
The following are estimates prepared by Pepco of its potential future exposure if Mirant's motion to reject its PPA-Related Obligations ultimately is successful. These estimates are based in part on current market prices and forward price estimates for energy and capacity, and do not include financing costs, all of which could be subject to significant fluctuation. The estimates assume no recovery from the Mirant bankruptcy estate and no regulatory recovery, either of which would mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recoveries. Based on these assumptions, Pepco estimates that its pre-tax exposure as of November 1, 2004, representing the loss of the future benefit of the PPA-Related Obligations to Pepco, is as follows: |
· |
If Pepco were required to purchase capacity and energy from FirstEnergy commencing as of November 1, 2004, at the rates provided in the PPA (with an average price per kilowatt hour of approximately 6.0 cents) and resold the capacity and energy at market rates projected, given the characteristics of the FirstEnergy PPA, to be approximately 5.0 cents per kilowatt hour, Pepco estimates that it would cost approximately $9 million for the remainder of 2004, and $33 million in 2005, the last year of the FirstEnergy PPA. |
· |
If Pepco were required to purchase capacity and energy from Panda commencing as of November 1, 2004, at the rates provided in the PPA (with an average price per kilowatt hour of approximately 18.4 cents), and resold the capacity and energy at market rates projected, given the characteristics of the Panda PPA, to be approximately 8.4 cents per kilowatt hour, Pepco estimates that it would cost approximately $8 million for the remainder of 2004, $35 million in 2005, and $35 million in 2006 and approximately $35 million to $48 million annually thereafter through the 2021 contract termination date. |
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The ability of Pepco to recover from the Mirant bankruptcy estate in respect to the Mirant Pre-Petition Obligations and damages if the PPA-Related Obligations are successfully rejected will depend on whether Pepco's claims are allowed, the amount of assets available for distribution to creditors and Pepco's priority relative to other creditors. At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate, whether the recovery would be in cash or another form of payment, or the timing of any recovery. |
If Mirant ultimately is successful in rejecting the PPA-Related Obligations and Pepco's full claim is not recovered from the Mirant bankruptcy estate, Pepco may seek authority from the Maryland Public Service Commission (MPSC) and the District of Columbia Public Service Commission (DCPSC) to recover its additional costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers. Under the provisions of the settlement agreements approved by the MPSC and the DCPSC in the deregulation proceedings in which Pepco agreed to divest its generation assets under certain conditions, the PPAs were to become assets of Pepco's distribution business if they could not be sold. Pepco believes that, if Mirant ultimately is successful in rejecting the PPA-Related Obligations, these provisions would allow the stranded costs of the PPAs that are not recovered from the Mirant bankruptcy estate to be recovered from Pepco's customers through its distribution rates. If Pepco's interpretation of the settlement agreements is confirmed, Pepco expects to be able to establish the amount of its anticipated recovery as a regulatory asset. However, there is no assurance that Pepco's interpretation of the settlement agreements would be confirmed by the respective public service commissions. |
If the PPA-Related Obligations are successfully rejected, and there is no regulatory recovery, Pepco will incur a loss. However, the accounting treatment of such a loss depends on a number of legal and regulatory factors, and is not determinable at this time. |
The SMECO Agreement |
As a term of the Asset Purchase and Sale Agreement, Pepco assigned to Mirant a facility and capacity agreement with Southern Maryland Electric Cooperative, Inc. For a discussion of the status of this agreement in the context of the Mirant bankruptcy, see Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Relationship with Mirant included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
PHI Potential Earnings Charge Relating to Additional Tax Liability |
PHI files a consolidated federal income tax return. PHI's federal income tax liabilities for Pepco legacy companies for all years through 2000, and for Conectiv legacy companies for all years through 1997, have been determined, subject to adjustment to the extent of any net operating loss or other loss or credit carrybacks from subsequent years. The Internal Revenue Service (IRS), as part of its normal audit of PHI's income tax returns, has questioned whether PHI was entitled to certain tax deductions as the result of the adoption of a carry-over tax basis for a non-lease financial asset acquired in 1998 by a subsidiary of PHI. If the position asserted by the IRS were to prevail and the deductions were disallowed, PHI may be required to take a charge to earnings for financial reporting purposes due to the reversal of the tax benefits recognized in prior periods (including years 1998 through 2000, which remain open due to net operating loss carrybacks). |
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At September 30, 2004, the amount of this potential charge consisted of approximately $16.3 million reflecting the reversal of the tax benefits and approximately $3 million of estimated interest on the additional taxes owed. PHI is in discussions with the IRS regarding a settlement of this matter; however the ultimate outcome and financial effect are not known at this time. |
Rate Proceedings |
For a discussion of the history of ACE's proceeding filed with the New Jersey Board of Public Utilities (NJBPU) to increase its electric distribution rates and Regulatory Asset Recovery Charge (RARC) in New Jersey, see Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Relationship with Mirant included in Pepco Holdings' Quarterly Reports on Form 10-Q for the quarters ended March 31, 2004 and June 30, 2004. The Ratepayer Advocate and Staff of the NJBPU filed their briefs in this proceeding in August 2004. The Ratepayer Advocate's brief supported its earlier proposal of an annual rate decrease of $4.5 million. The Staff's brief, however, stated for the first time its position calling for an overall decrease of $10.8 million. Reply briefs were filed on August 23, 2004. Settlement discussions between ACE, the NJBPU Staff and the Ratepayer Advocate have been ongoing. ACE cannot predict the outcome of this proceeding. |
For a discussion of the history of Phase II to ACE's base rate proceeding, see Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Relationship with Mirant included in Pepco Holdings' Quarterly Reports on Form 10-Q for the quarters ended March 31, 2004 and June 30, 2004. In August 2004, the Ratepayer Advocate filed testimony proposing a cost-sharing mechanism related to the operation and maintenance costs of the B. L. England generating facility and also proposing the disallowance and/or continued deferral of approximately $30.7 million of previously deferred costs related to industry restructuring, the divestiture efforts related to the ACE's fossil generating assets, the arbitration proceeding with an unaffiliated non-utility generator, and capacity purchases from an affiliate. ACE cannot predict the outcome of this proceeding. |
On August 31, 2004, ACE filed requests with the NJBPU proposing changes to its Transition Bond Charge (TBC), its Market Transition Charge - Tax rate (MTC-Tax), and its Basic Generation Service (BGS) Reconciliation charges. The net impact of these rate changes will be a decrease in ACE's annual revenues of approximately 1.5%. All of these rate changes were implemented on October 1, 2004. |
On October 1, 2004, DPL submitted its annual Gas Cost Rate (GCR) filing to the DPSC. In its filing, DPL seeks to increase its GCR by approximately 16.8% in anticipation of increasing natural gas commodity costs. The GCR, which permits DPL to recover its procurement gas costs through customer rates, becomes effective November 1, 2004 and is subject to refund pending evidentiary hearings. A final order is expected in the spring of 2005. DPL cannot predict the outcome of this proceeding. |
Restructuring Deferral |
For a discussion of the history of ACE's restructuring deferral proceeding under the New Jersey Electric Discount and Energy Competition Act, see Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Restructuring Deferral included in Pepco Holdings' Annual Report on Form 10-K/A for the year ended |
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December 31, 2003, and Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Restructuring Deferral included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. In July 2004, the NJBPU issued its final order in the restructuring deferral proceeding. The final order did not modify the amount of the disallowances set forth in the summary order issued in July 2003, but did provide a much more detailed analysis of evidence and other information relied on by the NJBPU as justification for the disallowances. ACE believes the record does not justify the level of disallowance imposed by the NJBPU. In August 2004, ACE filed with the Appellate Division of the Superior Court of New Jersey, which hears appeals of New Jersey administrative agencies, including the NJBPU, a Notice of Appeal and a Case Information Statement related to the July 2004 Final Decision and Order. ACE cannot predict the outcome of this appeal. |
Standard Offer Service |
District of Columbia |
For a history of the Standard Offer Service (SOS) proceeding pending before the DCPSC, see Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Pepco Regulatory Matters included in Pepco Holdings' Annual Report on Form 10-K/A for the year ended December 31, 2003 and Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - SOS and POLR Proceedings included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 and Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Standard Offer Service included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended June 30, 2004. In August 2004, the DCPSC issued an order adopting administrative charges for residential, small and large commercial DC SOS customers that are intended to allow Pepco to recover the administrative costs incurred to provide the SOS supply. The approved administrative charges include an average margin for Pepco of approximately $0.00248 per kilowatt hour, calculated based on total sales to residential, small and large commercial DC SOS customers over the twelve months ended December 31, 2003. Because margins vary by customer class, the actual average margin over any given time period will depend on the number of DC SOS customers from each customer class and the load taken by such customers over the time period. The administrative charges will go into effect for Pepco's DC SOS sales beginning February 8, 2005. Pepco completed the first competitive procurement process for DC SOS at the end of October and filed the proposed new SOS rates with the DCPSC on November 3, 2004. |
The Transition Power Agreement (TPA) with Mirant under which Pepco obtains the DC SOS supply ends on January 22, 2005, while the new SOS supply contracts with the winning bidders in the competitive procurement process provide for supply to begin on February 1, 2005. Pepco will procure power separately on the spot market to cover the period from January 23 through January 31, 2005, before the new DC SOS contracts begin. Consequently, Pepco will have to pay the difference between the procurement cost of power on the spot market and the current DC SOS rates charged to customers during the period from January 23 through January 31, 2005. In addition, because the new DC SOS rates do not go into effect until February 8, 2005, Pepco will have to pay the difference between the procurement cost of power under the new DC SOS contracts and the current DC SOS rates charged to customers for the period from February 1 to February 7, 2005. The amount of the difference for these periods will depend on spot market power prices during the first |
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period, weather, and the amount of DC SOS load that Pepco is serving. Pepco estimates that the total amount of the difference will be in the range from approximately $7.6 million to approximately $11.4 million. This difference, however, will be included in the calculation of the Generation Procurement Credit (GPC) for DC for the period February 8, 2004 through February 7, 2005. The GPC provides for a sharing between Pepco's customers and shareholders, on an annual basis, of any margins, but not losses, that Pepco earns providing SOS in the District of Columbia during the four-year period from February 8, 2001 through February 7, 2005. When the GPC is calculated, Pepco expects that the cost difference it will pay after the expiration of the Mirant TPA and before the new DC SOS rates go into effect will reduce to zero the margins earned from February 8, 2004 through February 7, 2005 that otherwise would have been shared between Pepco's customers and shareholders. The amount of the difference that exceeded such margins would be recorded on Pepco's books as a loss. In the event that Pepco were to ultimately realize a significant recovery from the Mirant bankruptcy estate associated with the TPA, the GPC would be recalculated, potentially reducing the amount of any loss recorded on Pepco's books. |
Virginia |
Under amendments to the Virginia Electric Utility Restructuring Act implemented in March 2004, DPL is obligated to offer default service to customers in Virginia for an indefinite period until relieved of that obligation by the Virginia State Corporation Commission (VSCC). DPL currently obtains all of the energy and capacity needed to fulfill its default service obligations in Virginia under a supply agreement with Conectiv Energy. Conectiv Energy has served notice that the power supply agreement will terminate effective December 31, 2004. After conducting a competitive bid procedure, DPL has entered into a new supply agreement with Conectiv Energy, which was the lowest bidder, to provide wholesale power supply for DPL's Virginia default service customers. The new supply agreement commences January 1, 2005 and expires in May 2006. On October 26, 2004, DPL filed an application with the VSCC for approval to increase the rates that DPL charges its Virginia default service customers to allow it to recover its costs for power under the new supply agreement plus an administrative charge and an average margin of approximately $0.00179 per kilowatt hour, calculated based on total sales to residential and non-residential Virginia default service customers over the twelve months ended December 31, 2003. Because margins vary by customer class, the actual average margin over any given time period will depend on the number of Virginia default service customers from each customer class and the load taken by such customers over the time period. DPL cannot predict the outcome of this proceeding. Contemporaneously, DPL and Conectiv Energy jointly filed an application with the VSCC under Virginia's Affiliates Act requesting authorization for DPL to enter into a contract to purchase power from an affiliate. On October 29, 2004, Conectiv Energy also made a filing with FERC requesting authorization to enter into a contract to supply power to an affiliate. |
Proposed Shut-Down of B.L. England Generating Station |
As discussed in Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Preliminary Settlement Agreement with NJDEP included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, ACE filed a report in April 2004 with the NJBPU in compliance with the NJBPU order issued in September 2003. This report recommended that the B.L. England generating plant be shut down in accordance with the terms of the preliminary |
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settlement agreement among PHI, Conectiv and ACE, the New Jersey Department of Environmental Protection and the Attorney General of New Jersey. In letters dated May and September 2004 to the PJM Interconnection, LLC (PJM), ACE informed PJM of its intent, as owner of the B.L. England generating plant, to retire the entire plant (447 MW) on December 15, 2007. PJM has completed its independent analysis to determine the upgrades required to eliminate any identified reliability problems resulting from the retirement of B.L. England and has recommended that certain transmission upgrades be installed prior to the summer of 2008. ACE's independent assessment confirmed that the transmission upgrades identified by PJM are the transmission upgrades necessary to maintain reliability in the Atlantic zone after the retirement of B.L. England. The amount of the costs incurred by ACE to construct the recommended transmission upgrades that ACE would be permitted to recover from load serving entities that use ACE's transmission system would be subject to approval by FERC. The amount of construction costs that ACE would be permitted to recover from retail ratepayers would be determined in accordance with the treatment of transmission-related revenue requirements in retail rates under the jurisdiction of the appropriate state regulatory commission. ACE cannot predict how the recovery of such costs will ultimately be treated by FERC and the state regulatory commissions and, therefore, cannot predict the financial impact to ACE of installing the recommended transmission upgrades. However, in the event that the NJBPU makes satisfactory findings and grants other requested approvals concerning the retirement of B.L. England and approves the construction of the transmission upgrades required to maintain reliability in the Atlantic zone after such retirement, ACE expects to begin construction of the appropriate transmission upgrades while final decisions by FERC and state regulatory commissions concerning the methodology for recovery of the costs of such construction are still pending. |
On November 1, 2004, ACE made a filing with the NJBPU requesting approval of the transmission upgrades required to maintain reliability in the Atlantic zone after the retirement of B.L. England. Late in November or shortly thereafter, ACE will file a request that the NJBPU (i) make a finding that the retirement of the B.L. England generating station is prudent and (ii) approve the categories of costs that will be stranded costs associated with the retirement, dismantling and remediation of B.L. England. ACE cannot predict the outcome of these two proceedings. |
Environmental Matters |
For a discussion of environmental matters involving Pepco Holdings and its subsidiaries, see Item 1, Environmental Matters - Hazardous Substance Regulation included in Pepco Holdings' Annual Report on Form 10-K/A for the year ended December 31, 2003 and Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Preliminary Settlement Agreement with NJDEP included in Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
The Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) authorizes the Environmental Protection Agency (EPA) and, indirectly, the states, to issue orders and bring enforcement actions to compel responsible parties to investigate and take remedial actions at any site that is determined to present an actual or potential threat to human health or the environment because of an actual or threatened release of one or more hazardous substances. Parties that generated or transported hazardous substances to such sites, as well as the owners and operators of such sites, may be deemed liable under CERCLA. Pepco, DPL and ACE each has been named by the EPA or a state environmental agency as a potentially |
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responsible party at certain contaminated sites. In July 2004, DPL entered into an Administrative Consent Order with the Maryland Department of the Environment (MDE) to perform a Remedial Investigation/Feasibility Study (RI/FS) to further identify the extent of soil, sediment and ground and surface water contamination related to former MGP operations at the Cambridge, Maryland site on DPL-owned property and to investigate the extent of MGP contamination on adjacent property. The costs for completing the RI/FS for this site are expected to be approximately $150,000 between 2004 and 2005; however, the costs of cleanup resulting from the RI/FS are not determinable until the RI/FS is completed and an agreement with respect to cleanup is reached with the MDE. DPL expects to complete the RI/FS in the first quarter of 2005. |
CRITICAL ACCOUNTING POLICIES |
No material changes to Pepco Holdings' Critical Accounting Policies occurred during the third quarter of 2004. Accordingly, for a discussion of these policies, please refer to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations of Pepco Holdings' Annual Report on Form 10-K/A for the year ended December 31, 2003. |
RISK FACTORS |
Federal Tax Legislation Affecting Cross-border=0Leases |
On October 22, 2004, President Bush signed into law the American Jobs Creation Act of 2004 (FSC-ETI Bill, H.R. 4520). This legislation provides, in part, new passive loss limitation rules that will be applied prospectively to leases (including cross-border=0leases) entered into after March 12, 2004 with tax indifferent parties (i.e., municipalities and tax exempt or governmental entities). The assets of PCI include a cross-border=0energy lease portfolio with a book value of approximately $1.2 billion at September 30, 2004. Cross-border=0leases are leases by a U.S. taxpayer of property located in a foreign country. All of PCI's cross-border=0leases are with tax indifferent parties and were entered into prior to 2004. Therefore, the legislation, as finally enacted, will not affect PCI's existing leases. Although this legislation is prospective in nature, it does not prohibit the Internal Revenue Service from challenging prior leasing transactions. |
For information concerning additional risk factors, please refer to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in Pepco Holdings' Annual Report on Form 10-K/A for the year ended December 31, 2003. |
FORWARD LOOKING STATEMENTS |
Some of the statements contained in this Quarterly Report on Form 10-Q are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. These statements include declarations regarding Pepco Holdings' intents, beliefs and current expectations. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms or other comparable terminology. Any forward-looking statements are not guarantees of future performance, and actual results could differ materially from those indicated by the forward-looking statements. Forward-looking statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that |
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may cause our or our industry's actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. |
The forward-looking statements contained herein are qualified in their entirety by reference to the following important factors, which are difficult to predict, contain uncertainties, are beyond Pepco Holdings' control and may cause actual results to differ materially from those contained in forward-looking statements: |
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Prevailing governmental policies and regulatory actions affecting the energy industry, including with respect to allowed rates of return, industry and rate structure, acquisition and disposal of assets and facilities, operation and construction of plant facilities, recovery of purchased power expenses, and present or prospective wholesale and retail competition; |
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Changes in and compliance with environmental and safety laws and policies; |
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Weather conditions; |
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Population growth rates and demographic patterns; |
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Competition for retail and wholesale customers; |
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General economic conditions, including potential negative impacts resulting from an economic downturn; |
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Growth in demand, sales and capacity to fulfill demand; |
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Changes in tax rates or policies or in rates of inflation; |
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Changes in project costs; |
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Unanticipated changes in operating expenses and capital expenditures; |
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The ability to obtain funding in the capital markets on favorable terms; |
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Restrictions imposed by PUHCA; |
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Legal and administrative proceedings (whether civil or criminal) and settlements that influence our business and profitability; |
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Pace of entry into new markets; |
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Volatility in market demand and prices for energy, capacity and fuel; |
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Interest rate fluctuations and credit market concerns; and |
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Effects of geopolitical events, including the threat of domestic terrorism. |
Any forward-looking statements speak only as to the date of this Quarterly Report and Pepco Holdings undertakes no obligation to update any forward-looking statements to reflect events or circumstances after the date on which such statements are made or to reflect the occurrence of |
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unanticipated events. New factors emerge from time to time, and it is not possible for Pepco Holdings to predict all of such factors, nor can Pepco Holdings assess the impact of any such factor on our business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. |
Pepco Holdings undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The foregoing review of factors should not be construed as exhaustive. |
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|
2004 |
2003 |
Change |
|
(Dollars in Millions) |
|
|
Regulated T&D Electric Revenue |
$255.7 |
$244.2 |
$11.5 |
Electricity Supply Service Revenue |
310.8 |
268.2 |
42.6 |
Other Electric Revenue |
9.0 |
6.0 |
3.0 |
Total Operating Revenue |
$575.5 |
$518.4 |
|
The table above shows the amount of operating revenue earned that is subject to price regulation (regulated and ESS) and that which is not subject to price regulation (other). Regulated T&D (Transmission & Distribution) electric revenue consists of the revenue Pepco receives for delivery of energy to its customers for which service Pepco is paid regulated rates. Electricity supply service (ESS) also known as Standard Offer Service (SOS) consists of revenue Pepco receives for the procurement of energy for its customers within the service areas of Pepco. Other revenue includes work and services performed on behalf of customers including other utilities, which is not subject to price regulation. Work and services includes mutual assistance to other utilities, highway relocation, rents, late payments, and collection fees. |
Regulated T&D Electric Revenue |
Regulated T&D electric revenue increased by $11.5 million primarily due to the following: (i) an $8.3 million increase in a county surcharge which is a pass through to the taxing authority (see Other Taxes); (ii) a $4.5 million increase due to sales growth of 1.0%; partially offset by (iii) a $1.0 million decrease due to the difference in weather. Delivery sales were 7,410,000 MwH, compared to 7,334,000 MwH for the comparable period in 2003. Cooling degree days decreased 3.2% for the three months ended September 30, 2004 compared to the same period in 2003. |
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Electricity Supply Service Revenue |
Electricity supply service (ESS) revenue increased by $42.6 million primarily due to lower customer migration resulting in a 9.0% increase in MwH sales. |
At September 30, 2004, 11% of Pepco's Maryland customers and 8% of Pepco's DC customers had chosen alternate suppliers. The portion of Pepco's Maryland customers served by an alternate supplier represented 33% of Pepco's total Maryland load, and Pepco's DC customers served by an alternate supplier represented 34% of Pepco's total DC load. |
At September 30, 2003, 16% of Pepco's Maryland customers and 12% of Pepco's DC customers had chosen alternate suppliers. The portion of Pepco's Maryland customers served by an alternate supplier represented 29% of Pepco's total Maryland load, and Pepco's DC customers served by an alternate supplier represented 45% of Pepco's total DC load. |
Other Electric Revenue |
Other electric revenue increased $3.0 million for the three month period primarily due to increased demands for services from customers and other utilities. Related expenses are discussed under Other Operation and Maintenance. |
Operating Expenses |
Fuel and Purchased Energy |
Electric fuel and purchased energy increased by $48.4 million to $289.9 million for the three months ended September 30, 2004, from $241.5 million for the corresponding period in 2003. The increase was primarily due to the following: (i) $65.9 million higher ESS costs resulting from a 9.0% increase in ESS sales; and (ii) $13.5 million higher costs as a result of the Transition Power Agreements (TPA) settlement with Mirant (entered into in November 2003) that increased the price of energy purchased from Mirant. These increases were partially offset by: (i) $14.5 million reserve recorded in September 2003 to reflect a potential exposure related to a pre-petition receivable from Mirant Corp. for which Pepco filed a creditor's claim in the bankruptcy proceedings; (ii) $15.9 million reduction in the Generation Procurement Credit (GPC) which resulted from the lower ESS margin, which in turn provided less customer sharing; and (iii) $.6 million lower transmission service costs. See the Regulatory and Other Matters - Relationship with Mirant section herein for additional information related to Mirant. |
Other Operation and Maintenance |
Other operation and maintenance expenses increased by $6.9 million to $66.4 million for the three months ended September 30, 2004, from $59.5 million for the corresponding period in 2003. The increase was primarily due to the following: (i) $3.7 million higher electric system maintenance costs, (ii) $2.6 million miscellaneous charges billed to customers (see Other Electric Revenue), (iii) $2.4 million for uncollectibles, (iv) $1.4 million for severance and incentive costs, (v) $1.0 million SOS Administrative expenses, and (vi) $5.4 million various other items. These increases were partially offset by the nonrecurrence of storm costs of $9.6 million primarily related to Hurricane Isabel in September 2003. |
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Other Taxes |
Other taxes increased by $9.3 million to $72.5 million for the three months ended September 30, 2004, from $63.2 million for the corresponding period in 2003. The increase was primarily due to a higher county surcharge of $7.9 million, which is a pass through (see Regulated Electric Revenue) and $.9 million for gross receipts tax. The tax rate on the county surcharge based on kilowatt hours delivered on and after July 1, 2004 increased by approximately 52%. |
Income Tax Expense |
Pepco's effective tax rate for the three months ended September 30, 2004 was 36.9% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and changes in estimates related to tax liabilities of prior tax years subject to audit (which was the primary reason for the lower effective tax rate as compared to 2003). |
Pepco's effective tax rate for the three months ended September 30, 2003 was 40.5% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and certain removal costs. |
The accompanying results of operations discussion is for the nine months ended September 30, 2004 compared to September 30, 2003. |
Operating Revenue |
|
2004 |
2003 |
Change |
|
(Dollars in Millions) |
|
|
Regulated T&D Electric Revenue |
$658.9 |
$ 607.1 |
$51.8 |
Electricity Supply Service Revenue |
719.6 |
597.7 |
121.9 |
Other Electric Revenue |
27.8 |
17.1 |
10.7 |
Total Operating Revenue |
$1,406.3 |
$1,221.9 |
|
Regulated T&D Electric Revenue |
Regulated T&D electric revenue increased by $51.8 million primarily due to the following: (i) a $28.3 million increase in a county surcharge pass through (see Other Taxes); ii) a $12.7 million increase due to sales growth of 4.3% (excluding the effects of weather); and (iii) a $9.9 million increase due to net favorable warmer weather. Delivery sales were 20,771,000 MwH, compared to 19,909,000 MwH for the comparable period in 2003. Cooling degree days increased by 21.1% and heating degree days decreased by 9.7% for the nine months ended September 30, 2004 as compared to the same period in 2003. |
Electricity Supply Service Revenue |
Electricity supply service (ESS) revenue increased by $121.9 million due to lower customer migration resulting in a 16.6% increase in kilowatt-hour sales. |
For a discussion of customer migration at September 30, 2004 refer to the three months results of Electricity Supply Service Revenue. |
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Other Electric Revenue |
Other electric revenue increased $10.7 million primarily due to increased demands for services from customers and other utilities for the nine month period (See Other Operation and Maintenance). |
Operating Expenses |
Fuel and Purchased Energy |
Electric fuel and purchased energy increased by $156.6 million to $696.9 million for the nine months ended September 30, 2004, from $540.3 million for the corresponding period in 2003. The increase was primarily due to the following: (i) $127.1 million higher ESS costs resulting from a 16.6% increase in ESS sales, (ii) $71.1 million higher costs as a result of the TPA Settlement with Mirant (entered into in November 2003) that increased the price of energy purchased from Mirant, and (iii) $3.3 million higher transmission service costs. These increases were partially offset by (i) $30.4 million reduction in the GPC which resulted from the lower ESS margin, which in turn provided less customer sharing; and (ii) $14.5 million reserve recorded in September 2003 to reflect a potential exposure related to a pre-petition receivable from Mirant Corp. for which Pepco filed a creditor's claim in the bankruptcy proceedings. See the Regulatory and Other Matters - Relationship with Mirant section herein for additional information related to Mirant. |
Other Operation and Maintenance |
Other operation and maintenance expenses increased by $19.8 million to $196.9 million for the nine months ended September 30, 2004, from $177.1 million for the corresponding period in 2003. The increase was primarily due to (i) $11.1 million higher electric system maintenance costs, (ii) $7.4 million of costs related to the increase in miscellaneous charges billed to customers (see Other Electric Revenue), (iii) $3.7 million for increased professional fees, (iv) $4.6 million for uncollectibles, and (v) $2.4 million for various other items, partially offset by the nonrecurrence of storm costs of approximately $9.4 million primarily related to Hurricane Isabel in September 2003. |
Other Taxes |
Other taxes increased by $34.6 million to $187.7 million for the nine months ended September 30, 2004, from $153.1 million for the corresponding period in 2003. The increase was primarily due to $27.6 million higher county surcharge, which is a pass through (see Regulated Electric Revenue), $3.9 million higher gross receipts tax, $1.1 million county Right-of-Way fee adjustment in 2003, and $.9 million higher use tax. The tax rate on the county surcharge based on kilowatt hours delivered on and after July 1, 2004 increased by approximately 52%. |
Gain on Sale of Asset |
Gain on sale of asset of $6.6 million represents the sale of land in the first quarter of 2004. |
Other Income (Expenses) |
Other expenses increased by $4.3 million to a net expense of $55.4 million for the nine months ended September 30, 2004 from a net expense of $51.1 million for the corresponding period in 2003. This was primarily due |
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to $2.5 million in lower interest income from Edison Capital Reserves which was dissolved in December 2003, and $.9 million of additional finance costs. |
Income Tax Expense |
Pepco's effective tax rate for the nine months ended September 30, 2004 was 38.2% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and certain removal costs and changes in estimates related to tax liabilities of prior tax years subject to audit (which was the primary reason for the lower effective tax rate as compared to 2003). |
Pepco's effective tax rate for the nine months ended September 30, 2003 was 40.3% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences partially offset by the flow-through of Deferred Investment Tax Credits and certain removal costs. |
CAPITAL RESOURCES AND LIQUIDITY |
Financing Activity During the Three Months Ended September 30, 2004 |
In July 2004, Pepco Holdings, Pepco, DPL and ACE entered into a five-year credit agreement with an aggregate borrowing limit of $650 million. This agreement replaces a $550 million 364-day credit agreement that was entered into on July 29, 2003. The respective companies also are parties to a three-year credit agreement that was entered into in July 2003 and terminates in July 2006 with an aggregate borrowing limit of $550 million. Pepco Holdings' credit limit under these agreements is $700 million and the credit limit of each of Pepco, DPL and ACE is the lower of $300 million and the maximum amount of short-term debt authorized by the applicable regulatory authority, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at any given time under the agreements may not exceed $500 million. The credit agreements primarily serve as a source of liquidity to support the commercial paper programs of the respective companies. The companies can also borrow funds for general corporate purposes and issue letters of credit under the Agreements. The credit agreements contain customary financial and other covenants that, if not satisfied, could result in the acceleration of repayment obligations under the agreements or restrict the ability of the companies to borrow under the agreements. Among these covenants is the requirement that each borrowing company maintain a ratio of total indebtedness to total capitalization of 65% or less, computed in accordance with the terms of the credit agreements. The credit agreements also contain a number of customary events of default that could result in the acceleration of repayment obligations under the agreements, including (i) the failure of any borrowing company or any of its significant subsidiaries to pay when due, or the acceleration of certain indebtedness under other borrowing arrangements, (ii) certain bankruptcy events, judgments or decrees against any borrowing company or its significant subsidiaries, and (iii) a change in control (as defined in the credit agreements) of Pepco Holdings or the failure of Pepco Holdings to own all of the voting stock of Pepco, DPL and ACE. |
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In August 2004, Pepco repurchased 65,000 shares of its $2.28 series, par value $50.00 per share preferred stock at an average price of $45.50 per share. |
In September 2004, Pepco repurchased 16,400 shares of its $2.28 series preferred stock, par value $50.00 per share, at an average price of $47.25 per share. |
In September 2004, Pepco redeemed $2.5 million, or 50,000 shares, of its $3.40 Serial Preferred Stock Series of 1992 pursuant to mandatory sinking fund provisions. |
Capital Requirements |
Construction Expenditures |
Pepco's construction expenditures for the nine months ended September 30, 2004 totaled $146.7 million. These expenditures related to capital costs associated with new customer services (customer driven), distribution reliability, and transmission. |
REGULATORY AND OTHER MATTERS |
Relationship with Mirant Corporation |
In 2000, Pepco sold substantially all of its electricity generation assets to Mirant Corporation, formerly Southern Energy, Inc., pursuant to an Asset Purchase and Sale Agreement. As part of the Asset Purchase and Sale Agreement, Pepco entered into several ongoing contractual arrangements with Mirant and certain of its subsidiaries (collectively, Mirant). On July 14, 2003, Mirant Corporation and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of Texas (the Bankruptcy Court). |
Depending on the outcome of the matters discussed below, the Mirant bankruptcy could have a material adverse effect on the results of operations of Pepco Holdings and Pepco. However, management currently believes that Pepco Holdings and Pepco currently have sufficient cash, cash flow and borrowing capacity under their credit facilities and in the capital markets to be able to satisfy any additional cash requirements that have arisen or may arise due to the Mirant bankruptcy. Accordingly, management does not anticipate that the Mirant bankruptcy will impair the ability of Pepco Holdings or Pepco to fulfill their contractual obligations or to fund projected capital expenditures. On this basis, management currently does not believe that the Mirant bankruptcy will have a material adverse effect on the financial condition of either company. |
Transition Power Agreements |
For a discussion of the Transition Power Agreements between Pepco and Mirant and the amendment of these agreements in connection with the Mirant bankruptcy, see Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Relationship with Mirant Corporation included in Pepco's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
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Power Purchase Agreements |
Under agreements with FirstEnergy Corp., formerly Ohio Edison (FirstEnergy), and Allegheny Energy, Inc., both entered into in 1987, Pepco is obligated to purchase from FirstEnergy 450 megawatts of capacity and energy annually through December 2005 (the FirstEnergy PPA). Under an agreement with Panda-Brandywine L.P. (Panda), entered into in 1991, Pepco is obligated to purchase from Panda 230 megawatts of capacity and energy annually through 2021 (the Panda PPA). In each case, the purchase price is substantially in excess of current market prices. As a part of the Asset Purchase and Sale Agreement, Pepco entered into a "back-to-back" arrangement with Mirant. Under this arrangement, Mirant is obligated, among other things, to purchase from Pepco the capacity and energy that Pepco is obligated to purchase under the FirstEnergy PPA and the Panda PPA at a price equal to the price Pepco is obligated to pay under the PPAs (the PPA-Related Obligations). |
Pepco Pre-Petition Claims |
For a discussion of the claims that Pepco has filed against Mirant with respect to amounts owed by Mirant to Pepco under the PPAs at the time of the filing of Mirant's bankruptcy petition and the accounting treatment of these claims, see Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Relationship with Mirant Corporation included in Pepco's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
Mirant's Attempt to Reject the PPA-Related Obligations |
On August 28, 2003, Mirant filed with the Bankruptcy Court a motion seeking authorization to reject its PPA-Related Obligations. Upon motions filed with the U.S. District Court for the Northern District of Texas (the District Court) by Pepco and the Federal Energy Regulatory Commission (FERC), in October 2003, the District Court withdrew jurisdiction over the rejection proceedings from the Bankruptcy Court. In December 2003, the District Court denied Mirant's motion to reject the PPA-Related Obligations. The District Court's decision was appealed by Mirant and The Official Committee of Unsecured Creditors of Mirant Corporation in the U.S. Court of Appeals for the Fifth Circuit. On August 4, 2004, the Court of Appeals remanded the case to the District Court saying that it has jurisdiction to rule on the merits of Mirant's rejection motion, suggesting that in doing so the court apply a "more rigorous standard" than the business judgment rule usually applied by bankruptcy courts in ruling on rejection motions, and noting that there are other "important issues which must still be resolved before a decision on the merits would be appropriate." On October 4, 2004, the District Court issued an order stating that the District Court will retain jurisdiction over the matter and invited parties to submit comments on the appropriate standard to be applied in determining whether to grant Mirant's rejection motion. All parties submitted comments. On November 3, 2004, the District Court issued an order stating that the Court concluded that the "separate agreement" issue ( i.e ., whether the PPA-Related Obligations are severable from the Asset Purchase and Sale Agreement) relating to the sale of Pepco's generation assets should be resolved before the District Court deals further with the issue of the standard to be applied in determining whether the motion to reject should be granted. The order permits the parties to submit further evidentiary material related to the separate agreement issue. |
Pepco is exercising all available legal remedies and vigorously opposing Mirant's attempt to reject the PPA-Related Obligations in order to protect |
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the interests of its customers and shareholders. While Pepco believes that it has substantial legal bases to oppose the attempt to reject the agreements, the outcome of Mirant's efforts to reject the PPA-Related Obligations is uncertain. |
In accordance with the Bankruptcy Court's order, Mirant is continuing to perform the PPA-Related Obligations pending the resolution of the ongoing proceedings. However, if Mirant ultimately is successful in rejecting, and is otherwise permitted to stop performing the PPA-Related Obligations, Pepco could be required to repay to Mirant, for the period beginning on the effective date of the rejection (which date could be prior to the date of the court's order and possibly as early as September 18, 2003) and ending on the date Mirant is entitled to cease its purchases of energy and capacity from Pepco, all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity. Pepco estimates that the amount it could be required to repay to Mirant in the unlikely event September 18, 2003, is determined to be the effective date of rejection, is approximately $118.8 million as of November 1, 2004. This repayment would entitle Pepco to file a claim against the bankruptcy estate in an amount equal to the amount repaid. Mirant has also asked the Bankruptcy Court to require Pepco to disgorge all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity, for the period July 14, 2003 (the date on which Mirant filed its bankruptcy petition) to September 18, 2003, on the theory that Mirant did not receive value for those payments. Pepco estimates that the amount it would be required to repay to Mirant on the disgorgement theory is approximately $22.5 million. Pepco believes a claim based on this theory should be entitled to administrative expense status for which complete recovery could be expected in the Bankruptcy Court. If Pepco were required to repay any such amounts for either period, the payment would be expensed at the time the payment is made. However, Pepco believes that, to the extent such amounts were not recovered from the Mirant bankruptcy estate, the expensed amounts would be recoverable as stranded costs from customers through distribution rates as described below. |
The following are estimates prepared by Pepco of its potential future exposure if Mirant's motion to reject its PPA-Related Obligations ultimately is successful. These estimates are based in part on current market prices and forward price estimates for energy and capacity, and do not include financing costs, all of which could be subject to significant fluctuation. The estimates assume no recovery from the Mirant bankruptcy estate and no regulatory recovery, either of which would mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recoveries. Based on these assumptions, Pepco estimates that its pre-tax exposure as of November 1, 2004, representing the loss of the future benefit of the PPA-Related Obligations to Pepco, is as follows: |
· |
If Pepco were required to purchase capacity and energy from FirstEnergy commencing as of November 1, 2004, at the rates provided in the PPA (with an average price per kilowatt hour of approximately 6.0 cents) and resold the capacity and energy at market rates projected, given the characteristics of the FirstEnergy PPA, to be approximately 5.0 cents per kilowatt hour, Pepco estimates that it would cost approximately $9 million for the remainder of 2004, and $33 million in 2005, the last year of the FirstEnergy PPA. |
· |
If Pepco were required to purchase capacity and energy from Panda commencing as of November 1, 2004, at the rates provided in the PPA |
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(with an average price per kilowatt hour of approximately 18.4 cents), and resold the capacity and energy at market rates projected, given the characteristics of the Panda PPA, to be approximately 8.4 cents per kilowatt hour, Pepco estimates that it would cost approximately $8 million for the remainder of 2004, $35 million in 2005, and $35 million in 2006 and approximately $35 million to $48 million annually thereafter through the 2021 contract termination date. |
The ability of Pepco to recover from the Mirant bankruptcy estate in respect to the Mirant Pre-Petition Obligations and damages if the PPA-Related Obligations are successfully rejected will depend on whether Pepco's claims are allowed, the amount of assets available for distribution to creditors and Pepco's priority relative to other creditors. At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate, whether the recovery would be in cash or another form of payment, or the timing of any recovery. |
If Mirant ultimately is successful in rejecting the PPA-Related Obligations and Pepco's full claim is not recovered from the Mirant bankruptcy estate, Pepco may seek authority from the Maryland Public Service Commission (MPSC) and the District of Columbia Public Service Commission (DCPSC) to recover its additional costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers. Under the provisions of the settlement agreements approved by the MPSC and the DCPSC in the deregulation proceedings in which Pepco agreed to divest its generation assets under certain conditions, the PPAs were to become assets of Pepco's distribution business if they could not be sold. Pepco believes that, if Mirant ultimately is successful in rejecting the PPA-Related Obligations, these provisions would allow the stranded costs of the PPAs that are not recovered from the Mirant bankruptcy estate to be recovered from Pepco's customers through its distribution rates. If Pepco's interpretation of the settlement agreements is confirmed, Pepco expects to be able to establish the amount of its anticipated recovery as a regulatory asset. However, there is no assurance that Pepco's interpretation of the settlement agreements would be confirmed by the respective public service commissions. |
If the PPA-Related Obligations are successfully rejected, and there is no regulatory recovery, Pepco will incur a loss. However, the accounting treatment of such a loss depends on a number of legal and regulatory factors, and is not determinable at this time. |
The SMECO Agreement |
As a term of the Asset Purchase and Sale Agreement, Pepco assigned to Mirant a facility and capacity agreement with Southern Maryland Electric Cooperative, Inc. For a discussion of the status of this agreement in the context of the Mirant bankruptcy, see Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Relationship with Mirant Corporation included in Pepco's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
Standard Offer Service |
For a history of the Standard Offer Service (SOS) proceeding pending before the DCPSC, see Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory Matters included in Pepco's Annual Report on Form 10-K for the year ended December 31, 2003 |
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and Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - SOS Proceedings included in Pepco's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 and Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Standard Offer Service included in Pepco's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004. In August 2004, the DCPSC issued an order adopting administrative charges for residential, small and large commercial DC SOS customers that are intended to allow Pepco to recover the administrative costs incurred to provide the SOS supply. The approved administrative charges include an average margin for Pepco of approximately $0.00248 per kilowatt hour, calculated based on total sales to residential, small and large commercial DC SOS customers over the twelve months ended December 31, 2003. Because margins vary by customer class, the actual average margin over any given time period will depend on the number of DC SOS customers from each customer class and the load taken by such customers over the time period. The administrative charges will go into effect for Pepco's DC SOS sales beginning February 8, 2005. Pepco completed the first competitive procurement process for DC SOS at the end of October and filed the proposed new SOS rates with the DCPSC on November 3, 2004. |
The TPA with Mirant under which Pepco obtains the DC SOS supply ends on January 22, 2005, while the new SOS supply contracts with the winning bidders in the competitive procurement process provide for supply to begin on February 1, 2005. Pepco will procure power separately on the spot market to cover the period from January 23 through January 31, 2005, before the new DC SOS contracts begin. Consequently, Pepco will have to pay the difference between the procurement cost of power on the spot market and the current DC SOS rates charged to customers during the period from January 23 through January 31, 2005. In addition, because the new DC SOS rates do not go into effect until February 8, 2005, Pepco will have to pay the difference between the procurement cost of power under the new DC SOS contracts and the current DC SOS rates charged to customers for the period from February 1 to February 7, 2005. The amount of the difference for these periods will depend on spot market power prices during the first period, weather, and the amount of DC SOS load that Pepco is serving. Pepco estimates that the total amount of the difference will be in the range from approximately $7.6 million to approximately $11.4 million. This difference, however, will be included in the calculation of the Generation Procurement Credit (GPC) for DC for the period February 8, 2004 through February 7, 2005. The GPC provides for a sharing between Pepco's customers and shareholders, on an annual basis, of any margins, but not losses, that Pepco earns providing SOS in the District of Columbia during the four-year period from February 8, 2001 through February 7, 2005. When the GPC is calculated, Pepco expects that the cost difference it will pay after the expiration of the Mirant TPA and before the new DC SOS rates go into effect will reduce to zero the margins earned from February 8, 2004 through February 7, 2005 that otherwise would have been shared between Pepco's customers and shareholders. The amount of the difference that exceeded such margins would be recorded on Pepco's books as a loss. In the event that Pepco were to ultimately realize a significant recovery from the Mirant bankruptcy estate associated with the TPA, the GPC would be recalculated, potentially reducing the amount of any loss recorded on Pepco's books. |
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CRITICAL ACCOUNTING POLICIES |
No material changes to Pepco's Critical Accounting Policies occurred during the third quarter of 2004. Accordingly, for a discussion of these policies, please refer to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations of Pepco's Annual Report on Form 10-K for the year ended December 31, 2003. |
FORWARD LOOKING STATEMENTS |
Some of the statements contained in this Quarterly Report on Form 10-Q are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. These statements include declarations regarding Pepco's intents, beliefs and current expectations. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms or other comparable terminology. Any forward-looking statements are not guarantees of future performance, and actual results could differ materially from those indicated by the forward-looking statements. Forward-looking statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that may cause our or our industry's actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. |
The forward-looking statements contained herein are qualified in their entirety by reference to the following important factors, which are difficult to predict, contain uncertainties, are beyond Pepco's control and may cause actual results to differ materially from those contained in forward-looking statements: |
· |
Prevailing governmental policies and regulatory actions affecting the energy industry, including with respect to allowed rates of return, industry and rate structure, acquisition and disposal of assets and facilities, operation and construction of plant facilities, recovery of purchased power expenses, and present or prospective wholesale and retail competition; |
· |
Changes in and compliance with environmental and safety laws and policies; |
· |
Weather conditions; |
· |
Population growth rates and demographic patterns; |
· |
Competition for retail and wholesale customers; |
· |
General economic conditions, including potential negative impacts resulting from an economic downturn; |
· |
Growth in demand, sales and capacity to fulfill demand; |
· |
Changes in tax rates or policies or in rates of inflation; |
· |
Changes in project costs; |
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Unanticipated changes in operating expenses and capital expenditures; |
· |
The ability to obtain funding in the capital markets on favorable terms; |
· |
Restrictions imposed by PUHCA; |
· |
Legal and administrative proceedings (whether civil or criminal) and settlements that influence our business and profitability; |
· |
Pace of entry into new markets; |
· |
Volatility in market demand and prices for energy, capacity and fuel; |
· |
Interest rate fluctuations and credit market concerns; and |
· |
Effects of geopolitical events, including the threat of domestic terrorism. |
Any forward-looking statements speak only as to the date of this Quarterly Report and Pepco undertakes no obligation to update any forward-looking statements to reflect events or circumstances after the date on which such statements are made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for Pepco to predict all of such factors, nor can Pepco assess the impact of any such factor on our business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. |
Pepco undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The foregoing review of factors should not be construed as exhaustive. |
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2004 2003 |
Change |
||
(Dollars in Millions) |
|||
Regulated T&D Electric Revenue |
$283.9 |
$296.1 |
$(12.2) |
Electricity Supply Services Revenue |
494.8 |
483.7 |
11.1 |
Other Electric Revenue |
15.6 |
53.3 |
(37.7) |
Total Electric Operating Revenue |
$794.3 |
$833.1 |
|
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The table above shows the amounts of operating revenue earned that is subject to price regulation (regulated T&D electric revenue and electricity supply service revenue) and that which is not subject to price regulation (other electric revenue). Regulated T&D (Transmission & Distribution) electric revenue includes revenue DPL receives for delivery of energy to its customers. Electricity supply service (ESS), also known as Standard Offer Service (SOS) in Maryland and Provider of Last Resort (POLR) in Delaware, includes revenue DPL receives for the procurement of energy for its customers within the service areas of DPL. Other revenue includes work and services performed on behalf of customers including other utilities, which is not subject to price regulation. Work and services includes mutual assistance to other utilities, highway relocation, rents, late payments, and collection fees. |
Regulated T&D Electric Revenue |
The $12.2 million decrease in regulated T&D electric revenue was primarily due to the following unfavorable variances: (i) $3.6 million related to unbilled revenue and industrial customer adjustments, (ii) $3.9 million other sales and rate variances, (iii) $2.1 million related to a transition charge that ended in 2003, and (iv) $1.9 million lower industrial sales. Delivered sales for the nine months ended September 30, 2004 were 10,674,000 MwH compared to 10,796,000 MwH for the comparable period in 2003. Cooling degree days increased by 2.3% and heating degree days decreased by 8.4% for the nine months ended September 30, 2004 compared to the same period in 2003. |
Electricity Supply Service |
The $11.1 million increase in ESS revenue primarily resulted from the following: (i) $22.8 million due to higher energy costs; offset by (ii) $4.3 million primarily due to lower industrial sales, (iii) $3.6 million unfavorable unbilled revenue adjustment; and (iv) $2.5 million of lower revenue due to Maryland customer migration. |
At September 30, 2004, DPL's Delaware customers serviced by an alternative supplier represented 6% of DPL's total Delaware load and DPL's Maryland customers served by alternative suppliers represented 23% of DPL's total Maryland load. At September 30, 2003, the DPL's Delaware customers serviced by an alternative supplier represented 6% of DPL's total Delaware load and DPL's Maryland customers served by alternative suppliers represented 10% of DPL's total Maryland load. |
Other Electric Revenue |
The $37.7 million decrease in other electric revenues was primarily due to a $32.6 million decrease in sales to Delaware Municipal Electric Corporation (DMEC) due to DPL's contracts with DMEC expiring at year-end 2003. Corresponding fuel and purchased energy costs were also reduced with the expiration of the DMEC contract. |
Gas Operating Revenue |
2004
Change
(Dollars in Millions)
Regulated Gas Revenue
$127.1
$115.4
$11.7
Other Gas Revenue
46.7
28.9
17.8
Total Gas Operating Revenue
$173.8
$144.3
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|
The table above shows the amounts of gas revenue from sources that were subject to price regulation (regulated gas revenue) and that were generally not subject to price regulation (other gas revenue). Regulated gas revenue includes on-system natural gas sales and the transportation of natural gas for customers. Other Gas Revenue includes off-system gas sales and the resale of excess gas or system capacity. |
Regulated Gas Revenue |
The $11.7 million increase in Regulated gas revenue primarily resulted from the following: (i) a $17.1 million increase in the Gas Cost Rate effective November 1, 2003; (ii) a $6.5 million increase in Gas base rates effective December 9, 2003; (iii) partially offset by a $9.4 million decrease due to 2003 being significantly colder than normal winter weather and $2.5 million of other decreases. For the nine months ended September 30, 2004, gas sales were 15,357,284 mcf as compared to 17,006,246 mcf for the comparable period in 2003. Heating degree days for the nine months ended September 30, 2004 were 1% above normal and the heating degree days for the comparable period in 2003 were 16% above normal. |
Other Gas Revenue |
The $17.8 million increase in Other Gas Revenue is largely related to an increase in off-system sales revenues of $18 million. The gas sold off-system was made available by unfavorable warmer winter weather and, as a result, reduced customer demand. Fuel costs, however, increased to offset the off-system sales. |
Operating Expenses |
Fuel and Purchased Energy |
Fuel and purchased energy decreased by $32.7 million to $518.7 million for the nine months ended September 30, 2004, from $551.4 million for the corresponding period in 2003 due primarily to the expiration of the DMEC contract of $32.6 million as mentioned in other electric revenue above. |
Gas Purchased |
Total gas purchased increased by $26.2 million to $126.9 million for the nine months ended September 30, 2004, from $100.7 million for the corresponding period in 2003. Regulated gas purchased primarily resulted from the following: (i) a net $23.4 million increase (substantially offset in revenue) from the settlement of financial hedges (entered into as part of DPL's regulated Natural Gas Hedge program), (ii) offset by a $12.3 million decrease in system purchases due to warmer weather and more natural gas withdrawn from storage partially net of higher unit commodity costs. In addition, other gas purchased increased by $15.3 million due to the increase in sales volume. |
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|
Other Operation and Maintenance |
Other Operation and Maintenance decreased by $8.3 million to $129.8 million for the nine months ended September 30, 2004, from $138.1 million for the nine months ended September 30, 2003. The decrease primarily resulted from (i) $3 million lower IT systems costs, (ii) approximately $2.5 million incremental storm costs related to Hurricane Isabel in September 2003, (iii) $1 million lower uncollectible expense, and (iv) $1.8 million other various cost reductions. |
Other Taxes |
Other Taxes decreased by $8.6 million to $18.7 million for the nine months ended September 30, 2004, from $27.3 million for the nine months ended September 30, 2003. The decrease primarily resulted from a tax expense true-up in June 2004 for property taxes. |
Other Income (Expenses) |
Other expenses decreased by $2.6 million to a net expense of $21.9 million for the nine months ended September 30, 2004, from a net expense of $24.5 million for the nine months ended September 30, 2003. This decrease is primarily due to the following: (i) $5.0 million decrease in interest charges due to a reduction in long-term debt; partially offset by (ii) $1.7 million increase in short-term interest charges; and (iii) $1.1 million increase in interest expense due to the implementation of FAS 150, which required a change in the designation for DPL's trust preferred securities. |
Income Tax Expense |
DPL's effective tax rate for the nine months ended September 30, 2004 was 41.9% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit), changes in estimates related to tax liabilities of prior tax years subject to audit and the flow-through of certain book tax depreciation differences (which was the primary reason for the higher effective tax rate as compared to 2003) partially offset by the flow-through of Deferred Investment Tax Credits. |
DPL's effective tax rate for the nine months ended September 30, 2003 was 39.4% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) partially offset by the flow-through of Deferred Investment Tax Credits. |
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2004 2003 |
Change |
||
(Dollars in Millions) |
|||
Regulated T&D Electric Revenue |
$276.2 |
$272.7 |
$ 3.5 |
Electricity Supply Service Revenue |
767.5 |
671.2 |
96.3 |
Other Electric Revenue |
15.1 |
24.6 |
(9.5) |
Total Operating Revenue |
$1,058.8 |
$968.5 |
|
The table above shows the amounts of operating revenue earned that is subject to price regulation (regulated T&D electric revenue and electricity supply service revenue) and that which is not subject to price regulation (other electric revenue). Regulated T&D (Transmission & Distribution) electric revenue includes revenue ACE receives for delivery of energy to its customers. Electricity supply service revenue (ESS) also known as Basic Generation Service (BGS) includes revenue ACE receives for the procurement of energy for its customers within the service areas of ACE. Also included in ESS is revenue from non-utility generators (NUGs), transition bond charges (TBC), market transition charges (MTC) and other restructuring related revenues (see Deferred Electric Service Cost). Other revenue includes work and services performed on behalf of customers including other utilities, which is not subject to price regulation. Work and services includes mutual assistance to other utilities, highway relocation, rents, late payments, and collection fees. |
125
|
Regulated T&D Electric Revenue |
The $3.5 million increase in regulated T&D electric revenue was primarily due to the following: (i) $9.5 million of additional delivery revenue related primarily to increased customer usage among residential and commercial customers; (ii) $1.3 million of other favorable delivery revenue variances, and (iii) partially offset by a decrease in unfavorable mild winter weather related sales revenue of $2.9 million and PJM network transmission revenue of $4.4 million. Delivered sales for the nine months ended September 30, 2004 were 7,645,000 MwH compared to 7,439,000 MwH for the comparable period in 2003. Cooling degree days increased by .8% and heating degree days decreased by 13.5% for the nine months ended September 30, 2004 compared to the same period in 2003. |
Electricity Supply Service Revenue |
ESS revenue is offset in operating expenses and has minimal earnings impact due to deferral accounting as a result of electric restructuring in New Jersey. The $96.3 million increase in ESS revenue resulted from the following: (i) $69.9 million of higher energy prices in 2004; (ii) $30.3 million due to an increase in NUG rates set in August 2003; (iii) $17.0 million of transition bond charges due to the securitization of the BL England power plant in December 2003; partially offset by (iv) $11.8 million of lower BGS revenue due to an increase in customer migration and (v) $9.1 million of lower revenue associated with other restructuring initiatives. |
At September 30, 2004, ACE's New Jersey customers served by an alternate supplier represented 21% of ACE's total load. At September 30, 2003, ACE's New Jersey customers served by an alternate supplier represented 9% of ACE's total load. |
Other Electric Revenue |
The $9.5 million decrease in other electric revenue was primarily due to a $3.2 million fuel oil sale in the first quarter of 2003 and the transfer of the Deepwater power plant to Conectiv Energy at the end of 2003, which in 2003 accounted for $5.3 million of ACE's other revenues for the nine months period ended September 30, 2003. |
Operating Expenses |
Fuel and Purchased Energy |
Fuel and purchased energy increased by $35.9 million to $641.4 million for the nine months ended September 30, 2004, from $605.5 million for the nine months ended September 30, 2003. This increase was primarily due to higher average costs per KwH and higher volumes of electricity supplied to customers due to an increase in average use per customer. |
Other Operation and Maintenance |
Other Operation and Maintenance decreased by $12.0 million to $143.2 million for the nine months ended September 30, 2004, from $155.2 million for the nine months ended September 30, 2003. The decrease primarily resulted from lower pension costs of $3.6 million in 2004 and incremental storm costs of approximately $1 million related to Hurricane Isabel in September 2003. In addition, costs associated with providing ESS and other restructuring items decreased by $5.4 million in 2004 but were offset through the deferral accounting. |
126
|
Depreciation and Amortization |
Depreciation and amortization expenses increased by $14.6 million to $104.2 million for the nine months ended September 30, 2004, from $89.6 million for the nine months ended September 30, 2003 primarily due to a $12.2 million increase for amortization of bondable transition property as a result of additional transition bonds issued in December 2003 and due to a $3.4
|
Deferred Electric Service Costs |
Deferred electric service costs increased by $27.1 million to $27.7 million for the nine months ended September 30, 2004 from $.6 million for the nine months ended September 30, 2003. The $27.1 million increase represents a net over-recovery associated with NUGs, MTC, BGS and other restructuring items. Additionally, the 2003 period contained a $27.5 million charge related to the New Jersey deferral disallowance regarding the procurement of fuel and purchased energy. Customers in New Jersey who do not choose a competitive supplier receive default electricity supply from suppliers selected through auctions approved by the NJBPU. ACE's rates for the recovery of these costs are reset annually. On ACE's balance sheet a regulatory asset includes an under-recovery of $110.9 million as of September 30, 2004. This amount is net of a $46.1 million reserve on previously disallowed items under appeal. |
Gain on Sale of Asset |
During the second quarter of 2004, ACE and the City of Vineland, New Jersey finalized a condemnation settlement under which ACE transferred to the City of Vineland its distribution assets within the geographical limits of the City of Vineland and related customer accounts. The transaction resulted in a pre-tax gain of approximately $14.4 million, which is recorded as a reduction to operating expenses in the line item entitled "gain on sale of asset" on the consolidated statements of earnings. |
Other Income (Expenses) |
Other expenses increased by $3.5 million to a net expense of $39.3 million for the nine months ended September 30, 2004, from a net expense of $35.8 million for the nine months ended September 30, 2003. This increase is primarily due to the following: (i) $4.3 million increase in interest expense on Transition Bonds issued by ACE Transition Funding due to additional transition bonds issued in December, 2003; (ii) $2.1 million decrease in income derived from customers to recover income tax expense on contributions in aid of construction; (iii) $.4 million decrease in interest income accrued on the balance for ACE's deferred electric service costs due to a lower interest rate used, effective September 1, 2003; (iv) partially offset by a $2.8 million decrease in long-term debt interest expense due to lower outstanding long-term debt balances for ACE. |
Income Tax Expense |
ACE's effective tax rate for the nine months ended September 30, 2004 was 41.7% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) and the flow-through of certain book tax depreciation differences (which was the primary reason for the higher effective tax rate as compared to 2003) partially offset by the flow-through of Deferred Investment Tax Credits. |
127
|
ACE's effective tax rate for the nine months ended September 30, 2003 was 39.6% as compared to the federal statutory rate of 35%. The major reasons for this difference were state income taxes (net of federal benefit) partially offset by the flow-through of Deferred Investment Tax Credits. |
128
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129
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. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Pepco Holdings |
As of March 2003, Conectiv Energy ceased all proprietary trading activities which generally consist of the entry into contracts to take a view of market direction, capture market price change, and put capital at risk. PHI's competitive energy segments are no longer engaged in proprietary trading; however, the market exposure under certain contracts entered into prior to cessation of proprietary trading activities was not eliminated due to the illiquid market environment to execute such elimination. These illiquid contracts will remain in place until they are terminated and their values are realized. As of September 30, 2004, approximately 73% of the unrealized value of Conectiv Energy's remaining proprietary trading contracts will be realized as they mature in 2004. |
The competitive energy segments actively engage in commodity risk management activities to reduce their financial exposure to changes in the value of their assets and obligations due to commodity price fluctuations. Certain of these risk management activities are conducted using instruments classified as derivatives under SFAS 133. In addition, the competitive energy segments also manage commodity risk with contracts that are not classified as derivatives. The competitive energy segments' primary risk management objectives are to manage the spread between the cost of fuel used to operate their electric generation plants and the revenue received from the sale of the power produced by those plants and manage the spread between retail sales commitments and the cost of supply used to service those commitments in order to ensure stable and known minimum cash flows and fix favorable prices and margins when they become available. To a lesser extent, Conectiv Energy also engages in market activities in an effort to profit from short-term geographical price differentials in electricity prices among markets. PHI collectively refers to these energy market activities, including its commodity risk management activities, as "other energy commodity" activities and identifies this activity separate from that of the discontinued proprietary trading activity. |
PHI's risk management policies place oversight at the senior management level through the Corporate Risk Management Committee which has the responsibility for establishing corporate compliance requirements for the competitive energy segments' energy market participation. PHI uses a value-at-risk (VaR) model to assess the market risk of its competitive energy segments' other energy commodity activities and its remaining proprietary trading contracts. PHI also uses other measures to limit and monitor risk in its commodity activities, including limits on the nominal size of positions and periodic loss limits. VaR represents the potential mark-to-market loss on energy contracts or portfolios due to changes in market prices for a specified time period and confidence level. PHI estimates VaR using a delta-gamma variance/ covariance model with a 95 percent, one-tailed confidence level and assuming a one-day holding period. Since VaR is an estimate, it is not necessarily indicative of actual results that may occur. |
131
|
Value at Risk Associated with Energy Contracts
|
|||
|
Proprietary
|
VaR for Energy
|
VaR for
|
95% confidence level, one-day
|
|
|
|
Period end |
$ 0.0 |
$ 2.8 |
$ 4.5 |
Average for the period |
$ 0.0 |
$ 6.4 |
$ 4.2 |
High |
$ 0.1 |
$10.1 |
$ 8.9 |
Low |
$ 0.0 |
$ 2.7 |
$ 2.1 |
Notes: |
|
(1) |
Includes all remaining proprietary trading contracts entered into prior to cessation of this activity prior to March 2003. |
(2) |
Includes all derivative contracts under SFAS No. 133, including proprietary trading contracts and derivatives associated with other energy commodity activities. |
(3) |
This column represents all energy derivative contracts, normal purchase & sales contracts, modeled generation output and fuel requirements and modeled customer load obligations for both the discontinued proprietary trading activity and the ongoing other energy commodity activities. |
(4) |
As VaR calculations are shown in a standard delta or delta/gamma closed form 95% 1-day holding period 1-tail normal distribution form, traditional statistical and financial methods can be employed to reconcile prior 10K and 10Q VaRs to the above approach. In this case, 5-day VaRs divided by the square root of 5 equal 1-day VaRs; and 99% 1-tail VaRs divided by 2.326 times 1.645 equal 95% 1-tail VaRs. Note that these methods of conversion are not valid for converting from 5-day or less holding periods to over 1-month holding periods and should not be applied to "non-standard closed form" VaR calculations in any case. |
For additional quantitative and qualitative information on the fair value of energy contracts refer to Note 5, Use of Derivatives in Energy and Interest Rate Hedging Activities in the accompanying Notes to Consolidated Financial Statements. |
The following table provides information on the estimated electricity output of and fuel requirements for the competitive energy segment's generation plants that have been economically hedged (which includes the use of contracts that are classified as cash flow hedges under SFAS 133, other derivative instruments, and normal purchase and sales contracts) as of September 30, 2004 based on economic availability projections. |
The competitive energy segments' portfolio of electric generating plants includes "mid-merit" assets and peaking assets. Mid-merit electric generating plants are typically combined cycle units that can quickly change their megawatt output level on an economic basis. These plants are generally operated during times when demand for electricity rises and power prices are higher. The following table represents an economic hedge position for a single point in time and does not reflect the ongoing transactions executed to carry a balanced position. The competitive energy segments dynamically hedge both the estimated plant output and fuel requirements as the estimated levels of output and fuel needs change. |
132
|
The percentages in the table are based on modeled volumetric requirements using data available at September 30, 2004. |
Generation Assets Economic Hedging Information
|
|||
2004 |
2005 |
2006 |
|
Estimated Plant Output Economically Hedged |
127%(1) |
115%(1) |
67% |
Estimated Plant Gas Requirements
|
108% |
141% |
36% |
Notes: |
|
(1) |
While estimated on-peak generation is 100% economically hedged, Pepco Holdings has provider of last resort (POLR) load requirements that are forecasted to exceed, on average, the dispatch level of generation in the competitive energy segments' plant portfolio. In total, the competitive energy segments have installed capacity that exceeds the level of POLR obligations. |
(2) |
Natural gas is the primary fuel for the majority of the mid-merit fleet. Fuel oil is the primary fuel for the majority of the peaking units. |
For additional information concerning market risk, please refer to Item 7A, Quantitative and Qualitative Disclosure About Market Risk in Pepco Holdings' Annual Report on Form 10-K/A for the year ended December 31, 2003. |
Pepco |
For information concerning market risk, please refer to Item 7A, Quantitative and Qualitative Disclosure About Market Risk in Pepco's Annual Report on Form 10-K for the year ended December 31, 2003. |
INFORMATION FOR THIS ITEM IS NOT REQUIRED FOR DPL, ACE, AND ACE FUNDING AS THEY MEET THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND THEREFORE ARE FILING THIS FORM WITH A REDUCED FILING FORMAT. |
. CONTROLS AND PROCEDURES |
Pepco Holdings, Inc. |
Disclosure controls and procedures are PHI's controls and other procedures that are designed to ensure that information required to be disclosed by PHI in the reports that it files with or submits to the Securities and Exchange Commission (the "SEC") under the Securities Exchange Act of 1934, as amended (the "Exchange Act") is recorded, processed, summarized, and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls, and procedures designed to ensure that information required to be disclosed by PHI in the reports that it files or submits under the Exchange Act is accumulated and communicated to management, including the chief executive officer and the chief financial officer, as appropriate to allow timely decisions regarding required disclosure. |
Under the supervision, and with the participation, of management including the chief executive officer and the chief financial officer, management has evaluated the effectiveness of the design and operation of PHI's disclosure controls and procedures as of September 30, 2004, and, based upon this evaluation, the chief executive officer and the chief financial officer have concluded that these controls and procedures are adequate to ensure that information requiring disclosure is communicated to management in a timely manner and reported within the timeframe specified by the SEC's rules and forms. |
133
|
During the three months ended September 30, 2004, there was no change in PHI's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, PHI's internal controls over financial reporting. |
Potomac Electric Power Company |
Disclosure controls and procedures are Pepco's controls and other procedures that are designed to ensure that information required to be disclosed by Pepco in the reports that it files with or submits to the SEC under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls, and procedures designed to ensure that information required to be disclosed by Pepco in the reports that it files or submits under the Exchange Act is accumulated and communicated to management, including the chief executive officer and the chief financial officer, as appropriate to allow timely decisions regarding required disclosure. |
Under the supervision, and with the participation, of management including the chief executive officer and the chief financial officer, management has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of September 30, 2004, and, based upon this evaluation, the chief executive officer and the chief financial officer have concluded that these controls and procedures are adequate to ensure that information requiring disclosure is communicated to management in a timely manner and reported within the timeframe specified by the SEC's rules and forms. |
During the three months ended September 30, 2004, there was no change in Pepco's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, Pepco's internal controls over financial reporting. |
Delmarva Power & Light Company |
Disclosure controls and procedures are DPL's controls and other procedures that are designed to ensure that information required to be disclosed by DPL in the reports that it files with or submits to the SEC under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls, and procedures designed to ensure that information required to be disclosed by DPL in the reports that it files or submits under the Exchange Act is accumulated and communicated to management, including the chief executive officer and the chief financial officer, as appropriate to allow timely decisions regarding required disclosure. |
Under the supervision, and with the participation, of management including the chief executive officer and the chief financial officer, management has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of September 30, 2004 , and, based upon this evaluation, the chief executive officer and the chief financial officer have concluded that these controls and procedures are adequate to ensure that information requiring disclosure is communicated to management in a timely manner and reported within the timeframe specified by the SEC's rules and forms. |
During the three months ended September 30, 2004, there was no change in DPL's internal control over financial reporting that has materially affected, |
134
|
or is reasonably likely to materially affect, DPL's internal controls over financial reporting. |
Atlantic City Electric Company |
Disclosure controls and procedures are ACE's controls and other procedures that are designed to ensure that information required to be disclosed by ACE in the reports that it files with or submits to the SEC under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls, and procedures designed to ensure that information required to be disclosed by ACE in the reports that it files or submits under the Exchange Act is accumulated and communicated to management, including the chief executive officer and the chief financial officer, as appropriate to allow timely decisions regarding required disclosure. |
Under the supervision, and with the participation of management, including the chief executive officer and the chief financial officer, management has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of September 30, 2004, and, based upon this evaluation, the chief executive officer and the chief financial officer have concluded that these controls and procedures are adequate to ensure that information requiring disclosure is communicated to management in a timely manner and reported within the timeframe specified by the SEC's rules and forms. |
During the three months ended September 30, 2004, there was no change in ACE's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, ACE's internal controls over financial reporting. |
Atlantic City Electric Transition Funding LLC |
ACE Funding is an "asset backed issuer" (as defined by Rule 15d-14(g) under the Exchange Act) and, accordingly, the disclosures required by this Item relate to matters that, as provided in Rule 15d-15 under the Exchange Act, do not apply to ACE Funding. |
Part II OTHER INFORMATION |
. LEGAL PROCEEDINGS |
Pepco Holdings |
Mirant Bankruptcy |
On July 14, 2003, Mirant and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. For additional information refer to Management's Discussion and Analysis of Financial Condition and Results of Operations - Relationship with Mirant Corporation. |
135
|
ACE Appeal of New Jersey Deferral Proceeding |
In August 2004, ACE filed with the Appellate Division of the Superior Court of New Jersey, which hears appeals of New Jersey administrative agencies, including the New Jersey Board of Public Utilities (NJBPU), a Notice of Appeal and a Case Information Statement related to the July 2004 Final Decision and Order issued by the NJBPU in ACE's restructuring deferral proceeding before the NJBPU under the New Jersey Electric Discount and Energy Competition Act. ACE cannot predict the outcome of this appeal. For additional information concerning the New Jersey regulatory proceeding leading up to this appeal, please refer to Management's Discussion and Analysis of Financial Conditions and Results of Operations - Restructuring Deferral. |
For further information concerning litigation matters, please refer to Item 3, Legal Proceedings, of Pepco Holdings' Annual Report on Form 10-K/A for the year ended December 31, 2003, and Part II, Item 1, Legal Proceedings, of Pepco Holdings' Quarterly Report on Form 10-Q for the quarter ended June 30, 2004. |
Pepco |
Mirant Bankruptcy |
On July 14, 2003, Mirant and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. For additional information refer to Management's Discussion and Analysis of Financial Condition and Results of Operations - Relationship with Mirant Corporation. |
For further information concerning litigation matters, please refer to Item 3, Legal Proceedings, of Pepco's Annual Report on Form 10-K for the year ended December 31, 2003. |
Delmarva Power & Light Company |
For information concerning litigation matters, please refer to Item 3, Legal Proceedings, of DPL's Annual Report on Form 10-K/A for the year ended December 31, 2003, and Part II, Item 1, Legal Proceedings, of DPL's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004. |
Atlantic City Electric Company |
In August 2004, ACE filed with the Appellate Division of the Superior Court of New Jersey, which hears appeals of New Jersey administrative agencies, including the New Jersey Board of Public Utilities (NJBPU), a Notice of Appeal and a Case Information Statement related to the July 2004 Final Decision and Order issued by the NJBPU in ACE's restructuring deferral proceeding before the NJPU under the New Jersey Electric Discount and Energy Competition Act. ACE cannot predict the outcome of this appeal. For additional information concerning the New Jersey regulatory proceeding leading up to this appeal, please refer to Note (14), Commitments and Contingencies to the financial statements included in ACE's Annual Report on Form 10-K/A for the year ended December 31, 2003, and Note (4), Commitments and Contingencies, to the financial statements included in ACE's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. |
For information concerning litigation matters, please refer to Item 3, Legal Proceedings, of ACE's Annual Report on Form 10-K/A for the year ended December 31, 2003. |
136
|
Atlantic City Electric Transition Funding LLC |
None. |
. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
(c) Purchases of Equity Securities by the Issuer and Affiliated Purchasers. |
Pepco Holdings |
None. |
Pepco |
Exhibit
|
Registrant(s) |
Description of Exhibit |
Reference |
||
4 |
ACE |
Supplemental Indenture dated August 10, 2004 |
Filed herewith. |
||
10.1 |
PHI
|
Employment Agreement of Anthony J. Kamerick |
Filed herewith. |
138
|
Exhibit
|
Registrant(s) |
Description of Exhibit |
Reference |
10.2 |
PHI |
Form of Employee Non-Qualified Stock Option Agreement |
Filed herewith. |
10.3 |
PHI |
Form of Director Non-Qualified Stock Option Agreement |
Filed herewith. |
10.4 |
PHI |
Form of Election Regarding Payment of Director Retainer/Fees |
Filed herewith. |
10.5 |
PHI |
Form of Executive and Director Deferred Compensation Plan Executive Deferral Agreement |
Filed herewith. |
10.6 |
PHI |
Form of Executive Incentive Compensation Plan Participation Agreement |
Filed herewith. |
10.7 |
PHI |
Form of Restricted Stock Agreement |
Filed herewith. |
10.8 |
PHI |
Form of Election with Respect to Stock Tax Withholding |
Filed herewith. |
12.1 |
PHI |
Statements Re: Computation of Ratios |
Filed herewith. |
12.2 |
Pepco |
Statements Re: Computation of Ratios |
Filed herewith. |
12.3 |
DPL |
Statements Re: Computation of Ratios |
Filed herewith. |
12.4 |
ACE |
Statements Re: Computation of Ratios |
Filed herewith. |
31.1 |
PHI |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer |
Filed herewith. |
31.2 |
PHI |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer |
Filed herewith. |
31.3 |
Pepco |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer |
Filed herewith. |
31.4 |
Pepco |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer |
Filed herewith. |
31.5 |
DPL |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer |
Filed herewith. |
31.6 |
DPL |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer |
Filed herewith. |
31.7 |
ACE |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer |
Filed herewith. |
31.8 |
ACE |
Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer |
Filed herewith. |
31.9 |
ACE Funding |
Rule 13a-14(d)/15d-14(d) Certificate of Chief Executive Officer |
Filed herewith. |
32.1 |
PHI |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
Furnished herewith. |
139
|
Exhibit
|
Registrant(s) |
Description of Exhibit |
Reference |
32.2 |
Pepco |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
Furnished herewith. |
32.3 |
DPL |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
Furnished herewith. |
32.4 |
ACE |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
Furnished herewith. |
32.5 |
ACE Funding |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
Furnished herewith. |
140
|
Statements Re. Computation of Ratios |
|
PEPCO HOLDINGS |
|
Nine Months Ended |
For the Year Ended December 31, |
||||
|
September 30, 2004 |
2003 |
2002 |
2001 |
2000 |
1999 |
|
(Dollar Amounts in Millions) |
|||||
Income before extraordinary item (a) |
$249.4 |
$211.1 |
$220.2 |
$192.3 |
$369.1 |
$256.7 |
|
|
|
|
|
|
|
Income tax expense |
141.6 |
65.9 |
124.1 |
83.5 |
341.2 |
114.5 |
|
|
|
|
|
|
|
Fixed charges: |
|
|
|
|
|
|
Interest on long-term debt,
|
291.3 |
381.4 |
227.2 |
162.0 |
221.5 |
200.5 |
Other interest |
15.3 |
21.7 |
21.0 |
23.8 |
23.6 |
23.8 |
Preferred dividend requirements
|
2.2 |
13.9 |
20.6 |
14.2 |
14.7 |
17.1 |
Total fixed charges |
308.8 |
417.0 |
268.8 |
200.0 |
259.8 |
241.4 |
|
|
|
|
|
|
|
Non-utility capitalized interest |
- |
(10.2) |
(9.9) |
(2.7) |
(3.9) |
(1.8) |
|
|
|
|
|
|
|
Income before extraordinary
|
$699.8 |
$683.8 |
$603.2 |
$473.1 |
$966.2 |
$610.8 |
|
|
|
|
|
|
|
Total fixed charges, shown above |
308.8 |
417.0 |
268.8 |
200.0 |
259.8 |
241.4 |
Increase preferred stock dividend
|
1.2 |
4.3 |
11.6 |
6.2 |
13.5 |
7.7 |
|
|
|
|
|
|
|
Fixed charges for ratio
|
$310.0 |
$421.3 |
$280.4 |
$206.2 |
$273.3 |
$249.1 |
|
|
|
|
|
|
|
Ratio of earnings to fixed charges |
2.26 |
1.62 |
2.15 |
2.29 |
3.54 |
2.45 |
(a) |
Excludes income and losses on equity investments. |
(b) |
Includes distributions on mandatorily redeemable preferred securities subsequent to the July 1, 2003 implementation of SFAS No. 150. |
141
|
Statements Re. Computation of Ratios |
PEPCO |
Nine Months Ended |
For the Year Ended December 31, |
|||||
September 30, 2004 |
2003 |
2002 |
2001 |
2000 |
1999 |
|
|
(Dollar Amounts in Millions) |
|||||
Net income (a) |
$ 91.6 |
$104.6 |
$141.2 |
$192.3 |
$369.1 |
$256.7 |
Income tax expense |
58.2 |
69.1 |
79.9 |
83.5 |
341.2 |
114.5 |
Fixed charges: |
|
|
|
|
|
|
Interest on long-term debt,
|
60.6 |
81.4 |
112.2 |
162.0 |
221.5 |
200.5 |
Other interest |
10.8 |
16.2 |
17.3 |
23.8 |
23.6 |
23.8 |
Preferred dividend requirements
|
- |
4.6 |
9.2 |
9.2 |
9.2 |
9.2 |
Total fixed charges |
71.4 |
102.2 |
138.7 |
195.0 |
254.3 |
233.5 |
Non-utility capitalized interest |
- |
- |
(.2) |
(2.7) |
(3.9) |
(1.8) |
Income before extraordinary
|
$221.2 |
$275.9 |
$359.6 |
$468.1 |
$960.7 |
$602.9 |
|
|
|
|
|
|
|
Ratio of earnings to fixed charges |
3.10 |
2.70 |
2.59 |
2.40 |
3.78 |
2.58 |
Total fixed charges, shown above |
71.4 |
102.2 |
138.7 |
195.0 |
254.3 |
233.5 |
Preferred dividend requirements,
|
1.5 |
5.5 |
7.8 |
7.2 |
10.6 |
11.4 |
Total Fixed Charges and
|
$ 72.9 |
$107.7 |
$146.5 |
$202.2 |
$264.9 |
$244.9 |
|
|
|
|
|
|
|
Ratio of earnings to fixed charges
|
3.03 |
2.56 |
2.45 |
2.32 |
3.63 |
2.46 |
Excludes losses on equity investments. |
|
(b) |
Includes distributions on mandatorily redeemable preferred securities subsequent to the July 1, 2003 implementation of SFAS No. 150. |
142
|
Statements Re. Computation of Ratios |
DELMARVA POWER & LIGHT COMPANY |
Nine Months Ended |
For the Year Ended December 31, |
|||||
September 30, 2004 |
2003 |
2002 |
2001 |
2000 |
1999 |
|
|
(Dollar Amounts in Millions) |
|||||
Net income |
$ 56.4 |
$53.2 |
$ 49.7 |
$200.6 |
$141.8 |
$142.2 |
Income tax expense |
40.7 |
36.4 |
33.7 |
139.9 |
81.5 |
95.3 |
Fixed charges: |
|
|
|
|
|
|
Interest on long-term debt,
|
24.7 |
37.2 |
44.1 |
68.5 |
77.1 |
77.8 |
Other interest |
1.7 |
2.7 |
3.6 |
3.4 |
7.5 |
6.1 |
Preferred dividend requirements
|
- |
2.8 |
5.7 |
5.7 |
5.7 |
5.7 |
Total fixed charges |
26.4 |
42.7 |
53.4 |
77.6 |
90.3 |
89.6 |
Income before extraordinary
|
$123.5 |
$132.3 |
$136.8 |
$418.1 |
$313.6 |
$327.1 |
|
|
|
|
|
|
|
Ratio of earnings to fixed charges |
4.68 |
3.10 |
2.56 |
5.39 |
3.47 |
3.65 |
|
|
|
|
|
|
|
Total fixed charges, shown above |
$ 26.4 |
$42.7 |
$ 53.4 |
$ 77.6 |
$ 90.3 |
$ 89.6 |
Preferred dividend requirements,
|
1.2 |
1.7 |
2.9 |
6.3 |
7.7 |
7.4 |
Total fixed charges and
|
$ 27.6 |
$44.4 |
$ 56.3 |
$ 83.9 |
$ 98.0 |
$ 97.0 |
|
|
|
|
|
|
|
Ratio of earnings to fixed charges
|
4.47 |
2.98 |
2.43 |
4.98 |
3.20 |
3.37 |
(a) |
Includes distributions on mandatorily redeemable preferred securities subsequent to the July 1, 2003 implementation of SFAS No. 150. |
143
|
Statements Re. Computation of Ratios |
ATLANTIC CITY ELECTRIC COMPANY |
|
Nine Months Ended |
For the Year Ended December 31, |
||||
|
September 30, 2004 |
2003 |
2002 |
2001 |
2000 |
1999 |
|
(Dollar Amounts in Millions) |
|||||
Income before extraordinary item |
$ 58.7 |
$41.5 |
$ 28.2 |
$ 75.5 |
$ 54.4 |
$ 63.9 |
|
|
|
|
|
|
|
Income tax expense |
41.9 |
27.3 |
16.3 |
46.7 |
36.7 |
49.3 |
|
|
|
|
|
|
|
Fixed charges: |
|
|
|
|
|
|
Interest on long-term debt,
|
47.1 |
63.7 |
55.6 |
62.2 |
76.2 |
60.6 |
Other interest |
2.3 |
2.6 |
2.4 |
3.3 |
4.5 |
3.8 |
Preferred dividend requirements
|
- |
1.8 |
7.6 |
7.6 |
7.6 |
7.6 |
Total fixed charges |
49.4 |
68.1 |
65.6 |
73.1 |
88.3 |
72.0 |
|
|
|
|
|
|
|
Income before extraordinary
|
$150.0 |
$136.9 |
$110.1 |
$195.3 |
$179.4 |
$185.2 |
|
|
|
|
|
|
|
Ratio of earnings to fixed charges |
3.04 |
2.01 |
1.68 |
2.67 |
2.03 |
2.57 |
|
|
|
|
|
|
|
Total fixed charges, shown above |
$ 49.4 |
$ 68.1 |
$ 65.6 |
$ 73.1 |
$ 88.3 |
$ 72.0 |
|
|
|
|
|
|
|
Preferred dividend requirements
|
0.3 |
0.5 |
1.1 |
2.7 |
3.6 |
3.8 |
|
|
|
|
|
|
|
Total fixed charges and
|
$ 49.7 |
$ 68.6 |
$ 66.7 |
$ 75.8 |
$ 91.9 |
$ 75.8 |
|
|
|
|
|
|
|
Ratio of earnings to fixed charges
|
3.02 |
2.00 |
1.65 |
2.58 |
1.95 |
2.44 |
(a) |
Includes distributions on mandatorily redeemable preferred securities subsequent to the July 1, 2003 implementation of SFAS No. 150. |
144
|
145
|
146
|
147
|
148
|
149
|
150
|
151
|
152
|
153
|
154
|
_____________________________________________________________________________ |
156
|
157
|
158
|
November 8, 2004 |
PEPCO HOLDINGS, INC. (PHI)
By
JOSEPH M. RIGBY
|
November 8, 2004 |
ATLANTIC CITY ELECTRIC TRANSITION FUNDING LLC
By
JAMES P. LAVIN
|
159
|
INDEX TO EXHIBITS FURNISHED HEREWITH |
||
Exhibit No. |
Registrant(s) |
Description of Exhibit |
32.1 |
PHI |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
32.2 |
Pepco |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
32.3 |
DPL |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
32.4 |
ACE |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
32.5 |
ACE Funding |
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
160
|
INDENTURE SUPPLEMENTAL |
TO |
MORTGAGE AND DEED OF TRUST |
(Dated January 15, 1937) |
Executed By |
ATLANTIC CITY ELECTRIC COMPANY |
TO |
THE BANK OF NEW YORK, Trustee. |
_____________________________________ |
Dated as of August 10, 2004 |
This instrument was prepared by Randall V. Griffin |
_______________________________________________________________________________________________________________ |
TABLE OF CONTENTS* |
|||
Page |
|||
PARTIES |
1 |
||
RECITALS |
1 |
||
Execution of Mortgage |
1 |
||
Execution of Supplemental Indentures |
1 |
||
Acquisition of property rights and property |
2 |
||
No Default under Original Indenture |
2 |
||
Provision for issuance of bonds in one or more series |
2 |
||
Right to execute supplemental indenture |
2 |
||
Issue of other series of bonds |
2 |
||
Execution of Senior Note Indenture |
3 |
||
Issue of Senior Notes of Salem Series 2004A |
3 |
||
Issue of Salem Series 2004A bonds pursuant to Article Thirteen of the Senior Note Indenture |
3 |
||
Issue of collateral bonds of the Salem Series 2004A |
3 |
||
Form of collateral bond of the Salem Series 2004A |
4 |
||
Issue of Senior Notes of Cape May Series 2004A |
7 |
||
Issue of Cape May Series 2004A bonds pursuant to Article Thirteen of the Senior Note Indenture |
7 |
||
Issue of collateral bonds of the Cape May Series 2004A |
7 |
||
Form of collateral bond of the Cape May Series 2004A |
8 |
||
Issue of Senior Notes of Cape May Series 2004B |
11 |
||
Issue of Cape May Series 2004B bonds pursuant to Article Thirteen of the Senior Note Indenture |
11 |
||
Issue of collateral bonds of the Cape May Series 2004B |
11 |
||
Form of collateral bond of the Cape May Series 2004B |
12 |
||
Trustee's Authentication Certificate |
15 |
||
Supplemental Indenture |
15 |
||
Compliance with legal requirements |
15 |
||
GRANT |
15 |
||
DESCRIPTION OF PROPERTY |
16 |
||
APPURTENANCES, ETC. |
16 |
||
HABENDUM |
17 |
||
ENCUMBRANCES |
17 |
||
TRUST |
17 |
||
SEC. 1. |
Creation of Bonds of the Salem Series 2004A |
17 |
|
Date of Maturity |
17 |
||
Interest Rate |
18 |
||
Redemption |
18 |
||
SEC. 2. |
Creation of Bonds of the Cape May Series 2004A |
19 |
|
Date of Maturity |
19 |
||
Interest Rate |
20 |
||
Redemption |
20 |
||
SEC. 3. |
Creation of Bonds of the Cape May Series 2004B |
21 |
|
- i -
|
|||
Date of Maturity |
21 |
||
Interest Rate |
21 |
||
Redemption |
22 |
||
SEC. 4. |
Issuance of Collateral Bonds |
23 |
|
SEC. 5. |
Approval of Supplemental Indenture by Board of Public Utilities,
|
23 |
|
SEC. 6. |
Supplemental Indenture and Original Indenture to be construed as
|
24 |
|
Limitation on rights of others |
24 |
||
Trustee assumes no responsibility for correctness of recitals of fact |
24 |
||
Execution in counterparts |
24 |
||
TESTIMONIUM |
25 |
||
SIGNATURES AND SEALS |
26 |
||
ACKNOWLEDGEMENTS |
27 |
||
*The Table of Contents shall not be deemed to be any part of the Indenture Supplemental to Mortgage and Deed of Trust. |
|||
- ii -
|
[Signature page (continued) to Indenture Supplemental to Mortgage and Deed of Trust, dated as of August 10, 2004, by and between Atlantic City Electric Company and The Bank of New York, as Trustee, supplemental to Mortgage and Deed of Trust, dated January 15, 1937.] |
||
THE BANK OF NEW YORK,
|
||
(SEAL) |
||
By:
DOROTHY MILLER
|
||
ATTEST:
MING RYAN
|
||
Signed, sealed and delivered by THE BANK OF NEW YORK in the presence of: |
||
GEOVANNI BARRIS |
||
/s/ |
||
- S-2 -
|
STATE OF DELAWARE
|
|
BE IT REMEMBERED that on this 10th day of August, in the year of our Lord two thousand four before me, a Notary Public in and for the State and County aforesaid, personally appeared Nina J. Clements, who being by me duly sworn on her oath says that she is Assistant Secretary of Atlantic City Electric Company, the grantor in the foregoing Indenture Supplemental to Mortgage and Deed of Trust, and that Gary R. Stockbridge is a Vice President; that deponent knows the common or corporate seal of said grantor, and the seal annexed to the said Indenture Supplemental to Mortgage and Deed of Trust is such common or corporate seal; that the said Indenture Supplemental to Mortgage and Deed of Trust was signed by the said Vice President and the seal of said grantor affixed thereto in the presence of deponent; that said Indenture Supplemental to Mortgage and Deed of Trust was signed, sealed and delivered as and for the voluntary act and deed of said grantor for the uses and purposes therein expressed, pursuant to a resolution of the Board of Directors of said grantor; and at the execution thereof this deponent subscribed her name thereto as witness. |
|
Sworn and subscribed the day and year aforesaid. |
|
JULIA R. SWINTEK
|
|
My Commission Expires ________________
|
|
( SEAL ) |
|
- S-3 -
|
|
STATE OF NEW YORK
|
|
BE IT REMEMBERED that on this 10th day of August, in the year of our Lord two thousand four before me, a Notary Public in and for the State and County aforesaid, personally appeared Ming Ryan, who being by me duly sworn on her oath says that she is a Vice President of THE BANK OF NEW YORK, the Trustee named in the foregoing Indenture Supplemental to Mortgage and Deed of Trust, and that Dorothy Miller is a Vice President; that deponent knows the common or corporate seal of said Trustee, and that the seal annexed to the said Indenture Supplemental to Mortgage and Deed of Trust is such common or corporate seal; that the said Indenture Supplemental to Mortgage and Deed of Trust was signed by the said Vice President and the seal of said Trustee affixed thereto in the presence of deponent; that said Indenture Supplemental to Mortgage and Deed of Trust was signed, sealed and delivered as and for the voluntary act and deed of said Trustee for the uses and purposes therein expressed, pursuant to authority of the Board of Directors of said Trustee; and at the execution thereof this deponent subscribed her name thereto as witness. |
|
Sworn and subscribed the day and year aforesaid. |
|
WILLIAM J. CASSELS
|
|
( SEAL ) |
|
- S-4 -
|
|
CERTIFICATE OF RESIDENCE |
|
THE BANK OF NEW YORK, Mortgagee and Trustee within named, hereby certifies that its precise residence is 101 Barclay Street, in the Borough of Manhattan, in The City of New York, in the State of New York. |
|
|
THE BANK OF NEW YORK,
|
|
By:
DOROTHY MILLER
|
- S-5 -
|
EMPLOYMENT AGREEMENT |
|||
This EMPLOYMENT AGREEMENT (the" Agreement") is made as of August 1, 2004 between PEPCO HOLDINGS, INC. ("PHI"; the "Company") and ANTHONY J. KAMERICK (the "Executive"). |
|||
WHEREAS, the Company desires to retain the employment of the Executive as a key member of the Company's management team, and the Executive desires to serve the Company in such capacity; and |
|||
WHEREAS, the parties hereto desire to set forth their agreement with respect to the terms and provisions of the Executive's employment with the Company. |
|||
NOW THEREFORE, in consideration of the foregoing and of the mutual covenants and agreements of the parties set forth in this Agreement, and of other good and valuable consideration the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending to be legally bound, agree as follows: |
|||
1. Term of this Agreement . |
|||
The Company hereby agrees to employ the Executive and the Executive hereby agrees to continue to serve the Company, in accordance with the terms and conditions set forth herein, until January 31, 2007, commencing as of the date set forth above, subject, however, to earlier termination as expressly provided herein. |
|||
On or after February 1, 2007, this contract shall expire and the employment of Executive by the Company shall be subject to similar terms and conditions as other similarly situated key members of the Company's management team with similar levels of responsibility as Executive and, as such, shall continue on an at-will basis. |
|||
Any obligations of the Company or the Executive hereunder which have not been satisfied as of the last day of the Term of this Agreement shall survive the expiration of the Term of this Agreement and shall remain in effect until such time as all such obligations have been satisfied. No additional payments are required by the termination of this Agreement. |
|||
2. Duties . |
|||
During the term of this Agreement, the Executive agrees to serve in a key management position with the Company. The Executive (a) will devote his knowledge, skill and best efforts on a full-time basis to performing his duties and obligations to the Company (with the exception of absences on account of illness or vacation in accordance with the Company's policies and civic and charitable commitments not involving a conflict with the Company's business), and (b) will comply with the directions and orders of the Board of Directors, the Chief Executive Officer of the Company, the Chief Financial Officer of the Company, or any designee thereof, with respect to the performance of his duties. Specifically, the parties contemplate that the Executive will complete the following tasks: |
|||
_________________________________________________________________________________________________________ |
|||
i. |
Contribute to the enhancement of the PHI investor relations program, inclusive of training a new manager for the program; revamping and continuously refreshing investor presentations; with the assistance of the manager, developing and executing a comprehensive investor relations plan to improve the image of the Company within the investment community |
||
ii. |
Develop and execute the strategy to complete the anticipated PHI debt reduction in accordance with commitments made to the PHI Board of Directors and investment community |
||
iii. |
Develop a succession plan for Executive's replacement as Treasurer |
||
iv. |
Provide ongoing support and counsel to the PHI Chief Financial Officer |
||
3. Affiliates . |
|||
Employment by an Affiliate of the Company or a successor to the Company will be considered employment by the Company for purposes of this Agreement, and the Executive's employment with the Company shall be considered terminated only if the Executive is no longer employed by the Company or any of its Affiliates or successors. The term "Company" as used in this Agreement will be deemed to include Affiliates and successors. For purposes of this Agreement, the term" Affiliate" means the subsidiaries of the Company and other entities under common control with the Company. If the Executive is employed by an Affiliate or a successor, the term "Board of Directors" as used in this Sections 4 and 5 means the Board of Directors of the Executive's employer. |
|||
4. Compensation and Benefits . |
|||
As remuneration for all services to be rendered by the Executive during the term of this Agreement, and as consideration for complying with the covenants herein, the Company shall pay and provide to the Executive the following: |
|||
4.1. Base Salary . The Company shall pay the Executive a Base Salary in an amount which shall be established from time to time by the Board of Directors of the Company or the Board's designee provided; however, that, subject to Section 5.4 (a), such Base Salary shall not be less than the base salary of the Executive as of the date of this Agreement. Base Salary shall be paid to the Executive in periodic installments at such times as salaries are generally paid to other key members of the Company's management team and consistent with the normal payroll practices of the Company. |
|||
The Executive's Base Salary shall be reviewed at least annually during the term of this Agreement to ascertain whether, in the judgment of the Board or the Board's designee, such Base Salary should be increased, based primarily on the performance of the Executive during the year and the market pay for similarly situated professionals performing similar duties to the Executive. |
|||
4.2. Incentive Award . The Executive will be entitled to receive incentive awards if and to the extent that the Board of Directors determines in good faith that the Executive's |
|||
2
|
|||
performance merits payment of an award according to the terms of any incentive compensation plans applicable to key members of the Company's management team. |
|||
4.3. Other Cash Remuneration . Except as set forth in Section 5, in addition to the remuneration set forth herein, the Company agrees as follows: |
|||
(a) If the Executive remains employed through January 31, 2005, the Company shall make a payment to the Executive in the amount of $50,000.00. |
|||
(b) If the Executive remains employed through January 31, 2006, the Company shall make an additional payment to the Executive in the amount of $100,000.00. |
|||
(c) If the Executive remains employed through January 31, 2007, the Company shall make an additional payment to the Executive in the amount of $200,000.00. |
|||
All payments by the Company to the Executive made pursuant to this Section 4.3 shall be made as soon as possible after the applicable date and in a lump sum, less applicable taxes as determined by the Company. |
|||
4.4. Other Benefits. |
|||
During the Term of this Agreement, while the Executive is employed by the Company, the Executive will be eligible to participate in a similar manner as other key members of the Company's management team in retirement plans, fringe benefit plans, supplemental benefit plans and other plans and programs provided by the Company for its executives or employees from time to time. |
|||
5. Termination of Employment . |
|||
5.1 Disability or Death . If the Executive dies during the term of this Agreement, the Company shall pay to the Executive's estate, in a lump sum and as soon as practicable after the date of death, a pro rata share of the payment next due to the Executive, if the Executive had remained employed through the date such payment would otherwise have become due and payable. Such payment shall be based on the number of full months the Executive was actively employed from the date the of Executive's most recent payment under this Agreement to the date of the Executive's death. If the Executive becomes disabled during the term of this Agreement and is found to be entitled to long-term disability benefits under the Company's disability plan or policy, the Company shall pay to the Executive a pro rata share of the payment next due to the Executive, if the Executive had remained actively employed through the date such payment would otherwise have become due and payable. Such payment shall be based on the number of full months the Executive was actively employed from the date of the Executive's most recent payment under this Agreement to the date of the Executive's disability. |
|||
5.2. Involuntary Termination by the Company Without Cause . The Board may terminate the Executive's employment, as provided under this Agreement, at any time, for reasons other than death, Disability, Retirement, or for Cause, by notifying the Executive in writing of the |
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3
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Company's intent to terminate, at least thirty (30) calendar days prior the effective date of such termination. |
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Upon the effective date of such termination, following the expiration of the thirty (30) day notice period, the Company shall pay to the Executive a lump-sum cash payment equal to the amount the Company would have paid to the Executive under Section 4.3 had the Executive remained employed by the Company through the initial Term of the Agreement. In addition, if the Company makes provisions generally applicable to other key members of the management regarding involuntary termination in the case of a Change in Control, Executive shall be eligible for the same provisions as similarly situated key members of management team. |
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5.3. Termination for Cause . Nothing in this Agreement shall be construed to prevent the Board from terminating the Executive's employment under this Agreement for "Cause." For purposes of this Agreement, the term "Cause" means (i) intentional fraud or material misappropriation with respect to the business or assets of the Company, (ii) persistent refusal or willful failure of the Executive to perform substantially his duties and responsibilities to the Company, which continues after the Executive receives notice of such refusal or failure, (iii) conduct that constitutes disloyalty to the Company, and that materially damages the property, business or reputation of the Company, or (iv) conviction of a felony involving moral turpitude. If the Executive is terminated for Cause, no payments will be due under this Agreement. |
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5.4. Termination by Executive for Good Reason . At any time during the term of this Agreement, the Executive may terminate this Agreement for Good Reason (as defined below) by giving the Board of Directors of the Company thirty (30) calendar days written notice of intent to terminate, which notice sets forth in reasonable detail the facts and circumstances claimed to provide a basis for such termination. |
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Upon the expiration of the thirty (30) day notice period, the Good Reason termination shall become effective, and the Company shall pay and provide to the Executive the benefits set forth in this Section 4.3. Good Reason shall mean, without the Executive's express written consent, the occurrence of any one or more of the following: |
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(a) A reduction by the Company of the Executive's base salary in effect on the date of this Agreement, or as the same shall be increased from time to time, unless such reduction is (i) replaced by an incentive opportunity of equal value; or (ii) is consistent and proportional with an overall reduction in management compensation due to extraordinary business conditions, including but not limited to reduced profitability and other financial stress; |
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(b) The assignment of the Executive to duties materially inconsistent with the Executive's authorities, duties, responsibilities, and status (including offices, titles, and reporting requirements) as an officer of the Company, or a reduction or alteration in the nature or status of the Executive's authorities, duties, or responsibilities from those in effect during the immediately preceding fiscal year, other than an insubstantial and inadvertent act that is remedied by the Company promptly after receipt of notice thereof given by the Executive; |
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(c) Except as provided in Section 4.5, without the Executive's consent, the Company's requires the Executive to be based at a location which is at least fifty (50) miles further from the Executive's residence than is such residence from the Company's current headquarters, except for required travel on the Company's business to an extent substantially consistent with the Executive's business obligations; |
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(d) A failure by the Company to meet any obligation under Section 4 herein. |
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(e) The failure of the Company to obtain a satisfactory agreement from any successor to the Company to assume and agree to perform this Agreement. |
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Upon a termination of the Executive's employment for Good Reason under this Agreement, the Executive shall be entitled to receive the same payments and benefits as he would be entitled to receive following an involuntary termination of his employment by the Company without Cause, as specified in Section 5.2 herein within thirty (30) calendar days following the effective date of employment termination. |
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6. Fees and Expenses . |
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The Company will pay all reasonable fees and expenses, if any, (including, without limitation, legal fees and expenses) that are incurred by the Executive to enforce this Agreement and that result from a breach of this Agreement by the Company, unless such fees and expenses result from a claim made by the Executive that is deemed by an arbitrator, mediator, or court, as applicable, to be frivolous or made in bad faith, in which case each party shall pay its own fees and expenses |
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7. Assignment . |
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The rights and obligations of the Company under this Agreement will inure to the benefit of and will be binding upon the successors and assigns of the Company. If the Company is consolidated or merged with or into another corporation, or if another entity purchases all or substantially all of the Company's assets, the surviving or acquiring corporation will succeed to the Company's rights and obligations under this Agreement. The Executive's rights under this Agreement may not be assigned or transferred in whole or in part. |
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8. Rights Under this Agreement . |
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The right to receive benefits under the Agreement will not give the Executive any proprietary interest in the Company or any of its assets. Benefits under the Agreement will be payable from the general assets of the Company, and there will be no required funding of amounts that may become payable under the Agreement. The Executive will for all purposes be a general creditor of the Company. The interest of the Executive under the Agreement cannot be assigned, anticipated, sold, encumbered or pledged and will not be subject to the claims of the Executive's creditors. |
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5
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9. Notice . |
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For purposes of this Agreement, notices and all other communications to the Executive must be in writing addressed to the Executive or his personal representative at his last known address. All notices to the Company must be directed to the attention of the Chief Executive Officer. Such other addresses may be used as either party may have furnished to the other in writing. Notices are effective when mailed if sent by United States registered mail, return receipt requested, postage prepaid. Notices sent otherwise are effective when received. Notwithstanding the foregoing, notices of change of address are effective only upon receipt. |
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10. Miscellaneous . |
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`To the extent not governed by federal law, this Agreement will be construed in accordance with the laws of the District of Columbia without reference to its conflict of laws rules. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and the writing is signed by the Executive and the Company. A waiver of any breach of or compliance with any provision or condition of this Agreement is not a waiver of similar or dissimilar provisions or conditions. The invalidity or unenforceability of any provision of this Agreement will not affect the validity or enforceability of any other provision of this Agreement, which will remain in full force and effect. This Agreement may be executed in one or more counterparts, all of which will be considered one and the same agreement. |
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11. Entire Agreement . |
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This Agreement constitutes the entire agreement of the parties and supersedes the terms of any agreements or understandings, oral or written, between the parties hereto, or between the Executive and the Company or any of its subsidiaries, and, further, supersedes any right to benefits of the Executive under any executive benefit plan of the Company or any of its subsidiaries with respect to the subject matter hereof. |
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WITNESS the following signatures: |
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PEPCO HOLDINGS, INC. |
EXECUTIVE |
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JOSEPH M. RIGBY |
ANTHONY J. KAMERICK |
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By:
/s/ JOSEPH M. RIGBY
|
/s/ A. J. KAMERICK |
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6
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PEPCO HOLDINGS, INC.
|
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AGREEMENT made as of the _____ day of ____________ , ____, by and between PEPCO HOLDINGS, INC. (the "Company"), and ____________________ ("Optionee"). |
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W I T N E S S E T H |
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1. Grant of Option; Acceptance and Consideration . Pursuant to the provisions of the Pepco Holdings, Inc. Long-Term Incentive Plan (the "Plan"), the Company hereby confirms the grant to the Optionee, subject to the terms and conditions of the Plan (as it presently exists and as it may hereafter be amended) and this Non-Qualified Stock Option Agreement (the "Agreement"), of the right and option to purchase from the Company all or any part of an aggregate of ________________________________________________ shares of the Stock of the Company (the "Shares") at the exercise price of $_______ per Share (the "Option"), such Option to be exercisable as hereinafter provided. This Option is not intended to be, and will not be treated as, an incentive stock option within the meaning of section 422 of the Internal Revenue Code of 1986, as amended. The number of Shares with respect to which this Option is exercisable, and the exercise price with respect to each Share, are each subject to adjustment under certain circumstances, as more fully set forth in the Plan and Section 6 of this Agreement. |
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2. Incorporation of Plan by Reference . The Option has been granted to the Optionee under the Plan, a copy of which is attached hereto as Attachment A. The Optionee hereby acknowledges receipt of the attached copy of the Plan and agrees to be bound by all the terms and provisions thereof (as presently in effect or hereafter amended), and by all decisions and determinations of the Board thereunder. All of the terms, conditions, and other provisions of the Plan are hereby incorporated by reference into this Agreement. Capitalized terms used in this |
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__________________________________________________________________________________________________ |
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Agreement but not defined herein shall have the same meanings as in the Plan. If there is any conflict between the provisions of this Agreement and the provisions of the Plan, the provisions of the Plan shall govern. |
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3. Expiration of Option . The Option, to the extent that it has not theretofore been exercised, shall expire at 11:59 p.m. (District of Columbia time) the day prior to the tenth anniversary of the date hereof, or earlier at such time as the Option shall have lapsed under the second paragraph of Section 4. |
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4. Option Exercise Limitations . Except as otherwise provided in the Plan and this Section 4, 25% of the Options may be exercised on the first anniversary date of the Option's grant, and an additional 25% on the second, third and forth anniversary of the date of the Options grant such that 100% of the options are exercisable on the forth anniversary date of the Options grant. All Option exercise privileges shall be cumulative, so that any part of the Option that has become exercisable but that has not been exercised shall remain exercisable until expiration of the Option regardless of the additional exercise privileges becoming available during such exercise period. Notwithstanding the foregoing, (a) the Option shall, in accordance with Section 12 of the Plan, become exercisable in full if, following a Change in Control, the Optionee (i) is terminated as an employee or (ii) suffers a diminution of responsibility, authority, position, or salary and (b) the Board may, in its discretion, accelerate the exercisability of the Option in appropriate circumstances deemed to be in the best interests of the Company. The Option may be exercised only to purchase whole shares; no fractional shares will be issued upon exercise of the Option. |
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All options granted hereunder shall lapse and shall no longer be exercised upon the effective date of the Optionee's Termination. If the Optionee's service with the Company ceases as a result of Retirement, Early Retirement or Disability, the Option shall lapse and shall no longer be exercised after the fifth anniversary of such cessation of service (or the earlier expiration of the Option under Section 3 of this Agreement). If the Optionee's service with the Company ceases as a result of death, the Option shall be exercisable by the Optionee's personal |
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- 2 -
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representative or beneficiary, in accordance with Section 8.F. of the Plan, until the expiration of the Option under Section 3 of this Agreement and during such period the Option may be exercised only to the extent it was exercisable by the Optionee immediately prior to the Optionee's death. |
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5. Option Exercise . |
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(a) Procedure . The Option may be exercised in whole or in any part, and may be exercised in part from time to time, all subject to the limitations on exercise set forth in Section 4. Exercise shall be accomplished by delivery to the Company of a timely written notice of election to exercise, in a form reasonably acceptable to the Board delivered to the principal office of the Company and addressed to the attention of the Corporate Secretary. |
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(b) Payment of the Exercise Price . At the time of exercise, the exercise price of the Shares as to which this Option is exercised shall be tendered to the Company. The exercise price shall be payable in cash or in other shares of Stock or in a combination of cash or other shares of Stock, in a form and manner required by the Board in its sole discretion. When Stock is used in full or partial payment of the exercise price, it will be valued at the Fair Market Value on the date the Option is exercised. |
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(c) Other Methods of Exercise and Payment of Exercise Price . In addition to the method of exercise and payment set forth in Section 5(a) and (b), the Option may be exercised and payment to the Company made in accordance with any other procedures which the Board deems to be consistent with the terms of the Plan. |
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6. Adjustments . The Option shall be subject to adjustment upon the occurrence of a corporate transaction or event affecting the Stock in accordance with Section 14.H. of the Plan. |
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- 3 -
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7. Nontransferability; Beneficiaries . Except to the extent as may be otherwise permitted by the Plan, no right or interest of the Optionee in the Option shall be pledged, encumbered, or hypothecated to or in favor of any third party or shall be subject to any lien, obligation, or liability of the Optionee to any third party; the Option shall not be transferable to any third party by the Optionee otherwise than by will or the laws of descent and distribution, and the Option shall be exercisable, during the lifetime of the Optionee, only by the Optionee. The foregoing notwithstanding, the Optionee shall be entitled to designate a beneficiary to exercise his rights under the Option upon the death of the Optionee, in the manner and to the extent permitted by the Board under rules and procedures then in effect under the Plan. |
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8. Tax Withholding . The Company or a Subsidiary may withhold any applicable federal, state or local taxes at such time and upon such terms and conditions as required by law or determined by the Company or a Subsidiary. Subject to compliance with any requirements of applicable law, the Board may permit or require a Participant to have any portion of any withholding or other taxes payable in respect to a distribution of Stock satisfied through the payment of cash by the Participant to the Company or a Subsidiary, the retention by the Company or a Subsidiary of shares of Stock, or delivery of previously owned shares of the Participant's Stock. Any fractional share of Common Stock required to satisfy such withholding obligations shall be disregarded and the amount due shall be paid in cash by the Participant. |
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9. Miscellaneous . |
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(a) Binding Agreement . This Agreement shall be binding upon the heirs, executors, administrators, and successors of the parties. In particular, the Optionee's heirs, executors, administrators and successors shall be subject to the terms and conditions of the Plan and this Agreement, and the Board may require any such person to execute an agreement or other documents acknowledging and agreeing to such terms and conditions as a condition precedent to any transfer of the Option or any Shares purchased upon exercise of the Option into the name of any such person. This Agreement constitutes the entire agreement between the parties with respect to the Option and the Shares, and supersedes any prior agreements or documents with respect thereto. |
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(b) Amendments to Agreement . This Agreement may be amended, but no amendment, alteration, suspension, discontinuation, or termination of this Agreement which may impose any additional obligation upon the Company or impair the rights of the Optionee with respect to the Option shall be valid unless in each instance such amendment, alteration, suspension, discontinuation, or termination is expressed in a written instrument duly executed in the name and on behalf of the Company and by the Optionee. |
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(c) No Other Rights Created . Neither this Agreement nor the Option shall be deemed to create a condition of employment or a right to continued employment on the part of the Optionee. The Optionee shall remain subject to termination of his employment to the same extent as though this Agreement did not exist. |
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(d) Notices . Any notice hereunder to the Company shall be addressed to it as Corporate Secretary, Attention: Stock Plan Committee. Any notice hereunder to the Optionee shall be addressed to him/her at the address set forth below, subject to the right of either party to designate at any time hereafter in writing a different address. |
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(e) Counterparts . This Agreement has been executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same Agreement. |
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IN WITNESS WHEREOF , the Company has caused this Agreement to be executed by its duly authorized officer and the Optionee has executed this Agreement as of the day and year first above written. |
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PEPCO HOLDINGS, INC. |
By: |
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Date: |
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Optionee: |
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Signature: |
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Address of Optionee: __________________________
|
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- 6 -
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PEPCO HOLDINGS, INC.
|
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AGREEMENT made as of the _____ day of ______, ____, by and between PEPCO HOLDINGS, INC. (the "Company"), and ( "Optionee"). |
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W I T N E S S E T H |
|
1. Grant of Option; Acceptance and Consideration . Pursuant to the provisions of the Pepco Holdings, Inc. Long-Term Incentive Plan (the "Plan"), the Company hereby confirms the grant to the Optionee, subject to the terms and conditions of the Plan (as it presently exists and as it may hereafter be amended) and this Non-Qualified Stock Option Agreement (the "Agreement"), of the right and option to purchase from the Company all or any part of an aggregate of One Thousand (1,000) shares of the Stock of the Company (the "Shares") at the exercise price of $______ per Share (the "Option"), such Option to be exercisable as hereinafter provided. This Option is not intended to be, and will not be treated as, an incentive stock option within the meaning of section 422 of the Internal Revenue Code of 1986, as amended. The number of Shares with respect to which this Option is exercisable, and the exercise price with respect to each Share, are each subject to adjustment under certain circumstances, as more fully set forth in the Plan and Section 6 of this Agreement. |
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2. Incorporation of Plan by Reference . The Option has been granted to the Optionee under the Plan, a copy of which is attached hereto as Attachment A. The Optionee hereby acknowledges receipt of the attached copy of the Plan and agrees to be bound by all the terms and provisions thereof (as presently in effect or hereafter amended), and by all decisions and determinations of the Board thereunder. All of the terms, conditions, and other provisions of the Plan are hereby incorporated by reference into this Agreement. Capitalized terms used in this |
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__________________________________________________________________________________________________ |
|
Agreement but not defined herein shall have the same meanings as in the Plan. If there is any conflict between the provisions of this Agreement and the provisions of the Plan, the provisions of the Plan shall govern. |
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3. Expiration of Option . The Option, to the extent that it has not theretofore been exercised, shall expire at 11:59 p.m. (District of Columbia time) the day prior to the tenth anniversary of the date hereof, or earlier at such time as the Option shall have lapsed under the second paragraph of Section 4. |
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4. Option Exercise Limitations . Except as otherwise provided in the Plan and this Section 4, 25% of the Options may be exercised on the first anniversary date of the Option's grant, and an additional 25% on the second, third and forth anniversary of the date of the Options grant such that 100% of the options are exercisable on the forth anniversary date of the Options grant. All Option exercise privileges shall be cumulative, so that any part of the Option that has become exercisable but that has not been exercised shall remain exercisable until expiration of the Option regardless of the additional exercise privileges becoming available during such exercise period. Notwithstanding the foregoing, (a) the Option shall, in accordance with Section 12 of the Plan, become exercisable in full if, following a Change in Control, the Optionee (i) is terminated as a director or (ii) suffers a diminution of responsibility, authority, position, or compensation and (b) the Board may, in its discretion, accelerate the exercisability of the Option in appropriate circumstances deemed to be in the best interests of the Company. The Option may be exercised only to purchase whole shares; no fractional shares will be issued upon exercise of the Option. |
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All options granted hereunder shall lapse and shall no longer be exercised upon the effective date of the Optionee's Termination. Notwithstanding the foregoing, if the Optionee has 10 or more years of service as a director upon the effective date of Termination or if the Optionee's service with the Company ceases as a result of retirement at age 70 in accordance with the Company's by-laws, the Option shall lapse and shall no longer be exercised after the |
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fifth anniversary of such cessation of service (or the earlier expiration of the Option under Section 3 of this Agreement). If the Optionee's service with the Company ceases as a result of death, the Option shall be exercisable by the Optionee's personal representative or beneficiary, in accordance with Section 8.F. of the Plan, until the expiration of the Option under Section 3 of this Agreement and during such period the Option may be exercised only to the extent it was exercisable by the Optionee immediately prior to the Optionee's death. |
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5. Option Exercise . |
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(a) Procedure . The Option may be exercised in whole or in any part, and may be exercised in part from time to time, all subject to the limitations on exercise set forth in Section 4. Exercise shall be accomplished by delivery to the Company of a timely written notice of election to exercise, in a form reasonably acceptable to the Board delivered to the principal office of the Company and addressed to the attention of the Corporate Secretary. |
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(b) Payment of the Exercise Price . At the time of exercise, the exercise price of the Shares as to which this Option is exercised shall be tendered to the Company. The exercise price shall be payable in cash or in other shares of Stock or in a combination of cash or other shares of Stock, in a form and manner required by the Board in its sole discretion. When Stock is used in full or partial payment of the exercise price, it will be valued at the Fair Market Value on the date the Option is exercised. |
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(c) Other Methods of Exercise and Payment of Exercise Price . In addition to the method of exercise and payment set forth in Section 5(a) and (b), the Option may be exercised and payment to the Company made in accordance with any other procedures which the Board deems to be consistent with the terms of the Plan. |
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6. Adjustments . The Option shall be subject to adjustment upon the occurrence of a corporate transaction or event affecting the Stock in accordance with Section 14.H. of the Plan. |
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7. Nontransferability; Beneficiaries . Except to the extent as may be otherwise permitted by the Plan, no right or interest of the Optionee in the Option shall be pledged, encumbered, or hypothecated to or in favor of any third party or shall be subject to any lien, obligation, or liability of the Optionee to any third party; the Option shall not be transferable to any third party by the Optionee otherwise than by will or the laws of descent and distribution, and the Option shall be exercisable, during the lifetime of the Optionee, only by the Optionee. The foregoing notwithstanding, the Optionee shall be entitled to designate a beneficiary to exercise his rights under the Option upon the death of the Optionee, in the manner and to the extent permitted by the Board under rules and procedures then in effect under the Plan. |
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8. Miscellaneous . |
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(a) Binding Agreement . This Agreement shall be binding upon the heirs, executors, administrators, and successors of the parties. In particular, the Optionee's heirs, executors, administrators and successors shall be subject to the terms and conditions of the Plan and this Agreement, and the Board may require any such person to execute an agreement or other documents acknowledging and agreeing to such terms and conditions as a condition precedent to any transfer of the Option or any Shares purchased upon exercise of the Option into the name of any such person. This Agreement constitutes the entire agreement between the parties with respect to the Option and the Shares, and supersedes any prior agreements or documents with respect thereto. |
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(b) Amendments to Agreement . This Agreement may be amended, but no amendment, alteration, suspension, discontinuation, or termination of this Agreement which may impose any additional obligation upon the Company or impair the rights of the |
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- 4 -
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Optionee with respect to the Option shall be valid unless in each instance such amendment, alteration, suspension, discontinuation, or termination is expressed in a written instrument duly executed in the name and on behalf of the Company and by the Optionee. |
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(c) No Other Rights Created . Neither this Agreement nor the Option shall be deemed to create a right on the part of the Optionee to be continued as a director. The Optionee shall remain subject to termination of his status as a director to the same extent as though this Agreement did not exist. |
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(d) Notices . Any notice hereunder to the Company shall be addressed to it as Corporate Secretary, Attention: Stock Plan Committee. Any notice hereunder to the Optionee shall be addressed to him/her at the address set forth below, subject to the right of either party to designate at any time hereafter in writing a different address. |
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(e) Counterparts . This Agreement has been executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same Agreement. |
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IN WITNESS WHEREOF , the Company has caused this Agreement to be executed by its duly authorized officer and the Optionee has executed this Agreement as of the day and year first above written. |
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PEPCO HOLDINGS, INC. |
By: |
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Date: |
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Optionee: |
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Signature: |
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Address of Optionee: ___________________________
|
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- 6 -
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PEPCO HOLDINGS, INC. |
||||
EXECUTIVE INCENTIVE COMPENSATION PLAN |
||||
PARTICIPATION AGREEMENT FOR _____ PLAN YEAR |
||||
This Agreement is made by and between ________________________ (the "Participant") and Pepco Holdings, Inc. (the "Company"). |
||||
The Parties agree to and acknowledge the following: |
||||
A. |
The Participant has been designated as a Participant on the Pepco Holdings, Inc.'s Executive Incentive Compensation Plan for the _____ Plan Year, has received a copy of the Plan and is familiar with the terms and conditions of the Plan, all of which are hereby incorporated into this Agreement. |
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B. |
1. |
In the event that an incentive award becomes payable to the Participant for the _____ Plan Year, the Participant hereby irrevocable elects: |
||
a. |
That ______ % of the award is paid in a lump sum upon determination of the award. |
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b. |
That ______ % of the award is deferred as set forth below. |
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C. |
PAYMENT OF AMOUNT DEFERRED (This section should be completed only if the Participant has elected to defer all or part of the award.) |
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1. |
Commencement of Payment . Any amount deferred under paragraph B.1.b. above shall be paid to the Participant (or, if applicable, to the Participant's Beneficiary) in the manner described in paragraph C.2., commencing at the time selected below (check one): |
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a. |
_____ |
On the date of commencement of benefits under the General Retirement Plan. |
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b. |
_____ |
On January 31 of the year following commencement of benefits under the General Retirement Plan. |
||
c. |
_____ |
On the first day of the month following the Participant's separation from the Company's service. |
||
________________________________________________________________________________________________ |
||||
d. |
_____ |
On January 31 of the calendar year following the Participant's separation from the Company's service. |
||
e. |
_____ |
On January 31 of the calendar year following the later of the Participant's attainment of age ___ or separation from the Company's service. |
||
f. |
_____ |
On January 31 of ______. (Note: The designated year may not be earlier than _____.) |
||
2. |
Manner of Payment . Benefits deferred under the Plan shall be paid to the Participant (or, if applicable, the Participant's Beneficiary) in the following manner (check one): |
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a. |
_____ |
In a lump sum. |
||
b. |
_____ |
In annual installments over ______ (two through fifteen) years. |
||
c. |
_____ |
In monthly installments over ______ (twenty-four through one-hundred and eighty) months. |
||
D. |
BENEFICARY |
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The Participant designates the following Beneficiary (or beneficiaries) to receive any benefits due under the Plan in the event of the Participant's death (specify full name, relationship and address): |
||||
Primary: |
||||
__________________________________________________________
|
||||
Contingent: |
||||
__________________________________________________________
|
||||
Signed this _____ day of _______________, _____. |
||||
By: ________________________________
|
||||
PEPCO HOLDINGS, INC. By: _________________________ |
||||
________________________________________________________________________________________________ |
PEPCO HOLDINGS, INC. |
|||
Restricted Stock Agreement |
|||
THIS AGREEMENT is made this ___ day of __________, _____ (hereinafter referred to as the "Date of Grant") by and between Pepco Holdings, Inc. (the "Company"), and _________________, an employee of the Company (the "Participant"). |
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WHEREAS, the Company has adopted the Pepco Holdings, Inc. Long-Term Incentive Plan (the "Plan") which is incorporated in this Agreement by reference. |
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WHEREAS, the Company desires to grant to Participant a Restricted Stock Award on the terms and conditions hereinafter set forth. |
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NOW, THEREFORE, In consideration of the mutual covenants hereinafter set forth and for other good and valuable consideration, the Company and Participant agree as follows: |
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1. |
Restricted Stock Award . The Company hereby grants to Participant a Restricted Stock Award consisting of a total of ________________________ __________________________________ (_________) shares of Stock upon the terms and conditions set forth herein. Any dividends declared with respect to these shares shall by payable to Participant from the Date of Grant. |
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2. |
Restriction Period . The maximum Restricted Period applicable to the Restricted Stock award granted hereunder is ________ years, as follows: |
||
(a) |
On the _____________ (____) anniversary of the Date of Grant, ________ percent (___%) of the shares of Stock initially subject to the Restricted Stock Award shall be released from restriction. |
||
(b) |
In the event Participant attains the age of sixty-five (65) while in the employment of the Company and prior to the ___________ (____) anniversary of the date of this Agreement, all remaining shares subject to the Restricted Stock Award shall be released from restriction upon the date of retirement from active employment. |
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(c) |
Notwithstanding any other provision of this Agreement, all shares subject to restriction shall be released from restriction in the event that a Participant is terminated or suffers a diminution of responsibility, authority, position or salary following an event described in (i) through (iii) following: (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Security and Exchange Act of 1934, as amended (the "Exchange Act"), other than a trustee or |
||
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other fiduciary holding securities under an employment benefit plan of the Company or a corporation owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 30% or more of the combined voting power of the Company's then outstanding securities: or (ii) during the period of twenty-four (24) consecutive months (not including any period prior to the execution of this Agreement), individuals who at the beginning of such period constitute the Board and any new director (other than a director designated by a person who has entered into an agreement with the Company to effect a transaction described in clauses (i) or (iii) of the Section) whose election by the Board or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either was directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof: or (iii) the stockholders of the Company approve a merger or consolidation of the Company with any other corporation other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of surviving entity) at least 70% of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, stockholders of the Company approve a plan of complete liquidation of the Company, or the stockholders of the Company approve an agreement for the sale or disposition by the Company of all or substantially all the Company's assets. |
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3. |
Nontransferability of Award . Participant's Restricted Stock Award is not assignable or transferable except by will or pursuant to the laws of descent and distribution, and shall not be subject to attachment or other legal process of whatever nature. |
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4. |
Terms and Conditions . The terms and conditions included in the Plan are incorporated herein by reference, and to the extent that any conflict may exist between the terms and conditions included in this Agreement and the terms and conditions included in the Plan, the terms and conditions included in the Plan shall control. By execution of this Agreement, the Participant acknowledges receipt of a copy of the Plan and further agrees to be bound thereby and by the actions of the Committee and/or the Board pursuant to the Plan. |
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5. |
No Section 83(b) Election . In consideration of the grant of the Restricted Stock Award hereunder, Participant acknowledges that Participant shall not make an election under Section 83(b) of the Internal Revenue Code of 1986, as amended, to treat any portion of the Restricted Stock Award as taxable compensation prior to the time the restrictions are removed from the stock subject to the Restricted Stock Award. |
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6. |
Delivery of Stock . Participant shall be provided with the certificate or certificate numbers evidencing ownership of the shares of Stock subject to the Restricted Stock Award. Whenever shares of Stock subject to the Restricted Stock Award are released from restriction, the Company shall, subject to the implementation of an arrangement with the Participant to effectuate all necessary tax withholding, release to Participant the certificate representing such unrestricted shares. Such certificate may, however, reflect the fact that the unrestricted shares have not been registered under the Securities Act of 1933 and may not be sold or transferred unless such shares are registered in the future or unless the Participant meets an exemption from registration under the Securities Act of 1933. The Company shall follow all requisite procedures to deliver such certificates to Participant; provided, however, that such delivery may be postponed to enable the Company to comply with any applicable procedures, regulations or listing requirements of any government agency, stock exchange or regulatory agency. |
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7. |
Tax Withholding . The Participant agrees to use shares of Stock subject to the Restricted Stock Award as full payment of taxes due at the time Participant's Restricted Stock Award is released from restrictions. |
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8. |
Other Plans and Agreements . Any gain realized by the Participant pursuant to this agreement shall not be taken into account as compensation in the determination of the Participant's benefits under any pension, savings, group insurance, or other benefit plan maintained by the Company or a Subsidiary, except as determined by the board of directors of such company. The Participant acknowledges that receipt of this Agreement or any prior agreement under the Plan shall not entitle the Participant to any other benefits under the Plan or any plans maintained by the Company or a Subsidiary. |
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9. |
Committee Authority . The Committee shall have complete discretion in the exercise of its rights, powers, and duties under this Agreement and the Plan. Any interpretation or construction of any provision of, and the determination of any question arising under, this Agreement shall be made by the Committee in its |
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sole discretion and shall be final, conclusive, and binding. The Committee may designate any individual or individuals to perform any of its functions hereunder. |
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IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by its duly authorized officers, under its corporate seal and the Participant has hereunder set his hand and seal, all as of the date first above written. |
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ATTEST: |
PEPCO HOLDINGS, INC. |
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PARTICIPANT |
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