NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
PEPCO HOLDINGS, INC. |
For additional information, other than the information disclosed in the Notes to Consolidated Financial Statements section herein, refer to Item 8. Financial Statements and Supplementary Data of the Company's 2002 Form 10-K. |
(1) ORGANIZATION |
Pepco Holdings, Inc. (Pepco Holdings or the Company), a registered holding company under the Public Utility Holding Company Act of 1935 (PUHCA), was incorporated under the laws of Delaware on February 9, 2001 for the purpose of effecting Potomac Electric Power Company's (Pepco) acquisition of Conectiv. In accordance with the terms of the merger agreement, upon the consummation of the merger on August 1, 2002, Pepco and Conectiv became wholly owned subsidiaries of Pepco Holdings. Additionally, Pepco, through a series of transactions, transferred its ownership interests in its pre-merger subsidiaries Potomac Capital Investment Corporation (PCI) and Pepco Energy Services, Inc. (Pepco Energy Services) to Pepco Holdings and PCI transferred its ownership interest in its pre-merger subsidiary Pepco Communications, Inc. (Pepcom) to Pepco Holdings. These transactions resulted in PCI, Pepco Energy Services, and Pepcom becoming wholly owned subsidiar ies of Pepco Holdings. Additionally, PUHCA imposes certain restrictions on the operations of registered holding companies and their subsidiaries; therefore, Pepco Holdings has a subsidiary service company that provides a variety of support services to Pepco Holdings and its subsidiaries. The costs of the service company are directly assigned or allocated to Pepco Holdings and its subsidiaries based on prescribed allocation factors listed in the service agreement filed with, and approved by, the Securities and Exchange Commission (SEC). Pepco Holdings manages its operations as described below. |
Power Delivery |
The largest component of Pepco Holdings' business is power delivery, which is conducted through its subsidiaries Pepco, Delmarva Power & Light Company (DPL), and Atlantic City Electric Company (ACE). Pepco, DPL and ACE are all regulated public utilities in the jurisdictions in which they serve customers. The operations of DPL and ACE are collectively referred to herein as "Conectiv Power Delivery." |
Pepco |
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. Under settlements entered into with regulatory authorities in connection with the divestiture of its generation assets in 2000, Pepco is required to provide default electricity supply (referred to as "standard offer service" or "SOS") at specified rates to customers in Maryland until July 2004 and to customers in Washington, D.C. until February 2005, which supply it purchases from an affiliate of Mirant Corporation ("Mirant"). 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 a discussion of Pepco's relationship with Mirant, see Note (5) "Commitments and Contingencies" herein. For the twelve months ended June 30, 2003, Pepco delivered 5.7 million megawatt hours to SOS cus tomers in the District of Columbia and 10.3 million megawatt hours to SOS customers in Maryland. For this period total deliveries were 11.2 million megawatt hours in the District of Columbia and 15.4 million megawatt hours in Maryland. |
On April 29, 2003, the Maryland Public Service Commission approved a settlement in Phase 1 of Maryland Case No. 8908 under which Pepco will supply retail customers with standard offer service electricity at market prices, including a margin, after existing rate caps expire in July 2004. Under this settlement, Pepco will provide standard offer service to its Maryland residential customers from July 2004 through May 2008 and to its non-residential customers for periods of one to four years. Pepco will obtain power for this market rate standard offer service through a competitive wholesale bidding process. In the District of Columbia, under current law, Pepco will not provide standard offer service after the expiration of its current obligations in February 2005, unless the District of Columbia Public Service Commission determines that there are insufficient bids to provide standard offer service, in which case Pepco may be directed to provide suc h service. |
Conectiv Power Delivery |
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. Under regulatory settlements, DPL is required to provide standard offer electricity service at specified rates to residential customers in Maryland until July 2004 and to non-residential customers in Maryland until June 2004 and to provide default electricity service at specified rates to customers in Delaware until May 2006. It is currently expected that DPL will also provide default electric service at specified rates to customers in Virginia until July 2007. However, the Virginia State Corporation Commission could terminate the obligation for some or all classes of customers sooner if it finds that an effectively competitive market exists. Conectiv Energy (described in the "Competitive Energy" section) supplies all of DPL's standard offer and default service load requ irements under a supply agreement that ends May 31, 2006. The terms of the supply agreement are structured to coincide with DPL's load requirements under each of its regulatory settlements. Conectiv Energy's resources for supplying DPL's standard offer and default service load include electricity generated by Conectiv Energy's plants and electricity purchased under long-term agreements or in the spot market. DPL purchases gas supplies for its customers from marketers and producers in the spot market and under short-term and long-term agreements. |
As discussed above, on April 29, 2003, the Maryland Commission approved a settlement in Phase I of Maryland Case No. 8908 to extend the provision of standard offer service that requires local utilities to continue to supply customers with electricity after existing rate caps/freezes expire in July 2004 at market prices. DPL will provide SOS to its Maryland residential customers from July 1, 2004 through May 31, 2008 and to its non-residential customers for periods of one to four years. DPL will obtain power for the market rate standard offer service through a competitive wholesale bidding process. |
ACE is engaged in the generation, transmission, and distribution of electricity in southern New Jersey. ACE has default service obligations, known as Basic Generation Service (BGS), for approximately 20 percent of the electricity supply to its customers. ACE expects to fulfill these obligations through the generation output from its fossil fuel-fired generating plants and through existing purchase power agreements with non-utility generators (NUG). In January 2003, ACE terminated its competitive bidding process to sell these generation assets. |
ACE formed Atlantic City Electric Transition Funding LLC (ACE Funding) during 2001. ACE Transition Funding is a wholly owned subsidiary of ACE. ACE Funding was organized for the sole purpose of purchasing and owning Bondable Transition Property (BTP), issuing transition bonds (Bonds) to fund the purchasing of BTP, pledging its interest in BTP and other collateral to the Trustee to collateralize the Bonds, and to perform activities that are necessary, suitable or convenient to accomplish these purposes. |
Competitive Energy |
The competitive energy component of the Company's business is conducted through subsidiaries of Conectiv Energy Holding Company (collectively referred to herein as "Conectiv Energy") and Pepco Energy Services. |
Conectiv Energy |
Conectiv Energy provides wholesale power and ancillary services to the Pennsylvania/New Jersey/Maryland (PJM) power pool and supplies power under contract, to customers including DPL and ACE. Conectiv Energy's generation asset strategy focuses on mid-merit plants with operating flexibility and multi-fuel capability that can quickly change their output level on an economic basis. Mid-merit plants generally are operated during times when demand for electricity rises and prices are higher. |
As of June 30, 2003, Conectiv Energy owned and operated electric generating plants with 3,302 MW of capacity. In January 2002, Conectiv Energy began construction of a 1,100 MW combined cycle plant with six combustion turbines at a site in Bethlehem, Pennsylvania. The plant has become operational in stages that added 306 MW in 2002(resulting from the installation of three CTs), 279 MW in the first quarter of 2003 (resultingfrom the installation of an additional two CTs and an upgrade of the CTs installed during 2002), 296 MW in the second quarter (resulting from the installation of one additional CT and one waste heat recovery boiler and steam generating unit), and is expected to add an additional 209 MW of capacity by the end of 2003 (resulting from the installation of a second waste heat recovery boiler and steam generating unit and upgrades of the existing CTs). |
On June 25, 2003, Conectiv Energy entered into an agreement consisting of a series of energy contracts with an international investment banking firm with a senior unsecured debt rating of A+ / Stable from Standard & Poors (the "Counterparty"). The agreement is designed to more effectively hedge approximately fifty percent of Conectiv Energy's generation output and approximately fifty percent of its supply obligations, with the intention of providing Conectiv Energy with a more predictable earnings stream during the term of the agreement. For additional information about this agreement and Conectiv Energy, refer to Note 6. Conectiv Energy Events, herein. |
Pepco Energy Services |
Pepco Energy Services provides retail electricity and natural gas to residential, commercial, industrial and governmental customers in the mid-Atlantic region. Pepco Energy Services also provides integrated energy management solutions to commercial, industrial and governmental customers, including energy-efficiency contracting, development and construction of "green power" facilities, equipment operation and maintenance, fuel management, and home service agreements. In addition, Pepco Energy Services owns electricity generation plants with approximately 800 MW of peaking capacity, the output of which is sold in the wholesale market. Pepco Energy Services also purchases and sells electricity and natural gas in the wholesale markets to support its commitments to its retail customers. |
Other Non-Regulated |
This component of Pepco Holdings' business is conducted through its subsidiaries PCI and Pepcom. |
PCI |
PCI manages a portfolio of financial investments. During the second quarter of 2003, Pepco Holdings announced the discontinuation of further new investment activity by PCI. In the future, PCI's existing portfolio of financial investments will be managed at Pepco Holdings. The majority of PCI's investments are focused on investments related to the energy industry, such as energy leveraged leases. These transactions involve PCI's purchase and leaseback of utility assets, located outside of the United States, that provide a long term, stable stream of cash flow and earnings. PCI also owns a ten-story, 360,000 square foot office building in downtown Washington, D.C., known as Edison Place, which is leased to Pepco and serves as Pepco Holdings' and Pepco's corporate headquarters. PCI will continue to pursue opportunities to divest its remaining aircraft assets and plans to sell its final real estate property - Edison Place. The sale of the Edison Pl ace building, which was announced on July 21, 2003, will occur by competitive bid and is expected to close during 2003. PCI's book basis in the building at June 30, 2003, is approximately $79 million. |
At June 30, 2003, PCI's utility industry products and services were provided through various operating companies, including W.A. Chester and Severn Cable, which effective August 1, 2003 were transferred to Pepco Energy Services. W.A. Chester, an underground electric services company, provides high voltage construction and maintenance services to utilities and to other customers throughout the United States. Severn Cable provides low voltage electric and telecommunication construction and maintenance services in the Washington, D.C. area. |
Pepcom |
Pepcom owns a 50% interest in Starpower Communications, LLC (Starpower), a joint venture with RCN Corporation, which provides cable and telecommunication services to households in the Washington, D.C. area. |
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND IMPACT OF OTHER
ACCOUNTING STANDARDS |
Significant Accounting Policies |
Principles of Consolidation |
The accompanying consolidated financial statements include the accounts of Pepco Holdings and its wholly owned subsidiaries. All intercompany balances and transactions between subsidiaries have been eliminated. Investments in entities in which Pepco Holdings has a 20% to 50% interest are accounted for using the equity method of accounting. Under the equity method, investments are initially carried at cost and subsequently adjusted for Pepco Holdings' proportionate share of the investees' undistributed earnings or losses and dividends. Ownership interests in other entities of less than 20% are accounted for using the cost method of accounting. |
Consolidated Financial Statement Presentation |
The Company'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 U.S. Securities and Exchange Commission, 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 our Annual Report on Form 10K for the year ended December 31, 2002. In management's opinion, the consolidated financial statements contain all adjustments (which all are of a normal recurring nature) necessary to present fairly Pepco Holdings' financial position as of June 30, 2003 and 2002, in accordance with GAAP. Interim results for the three-months and six months ended March 31, and June 30, 2003 may not be indicative of results that will be realized for the full year ending Decembe r 31, 2003. Certain prior period amounts have been reclassified in order to conform to current period presentation. |
Pepco Holdings' independent accountants have performed a review of, and issued a report on, these consolidated interim financial statements in accordance with standards established by the American Institute of Certified Public Accountants. Pursuant to Rule 436(c) under the U.S. Securities Act of 1933, this report should not be considered a part of any registration statement prepared or certified within the meanings of Section 7 and 11 of the Securities Act. |
The accompanying consolidated statements of earnings and the consolidated statements of comprehensive income for the three and six months ended June 30, 2003 and the consolidated statements of cash flows for the six months ended June 30, 2003 include Pepco Holdings and its subsidiaries results for the full periods. However, these statements for the corresponding periods in 2002, as previously reported by Pepco, include only the consolidated operations of Pepco and its pre-merger subsidiaries. Accordingly, the consolidated balances included in the statements referred to above for the three and six months ended June 30, 2003 and 2002 are not comparable. The amounts presented in the accompanying consolidated balance sheets as of June 30, 2003 and December 31, 2002, respectively, are comparable as both periods presented reflect the impact of the merger transaction with Conectiv. |
Use of Estimates |
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, such as Statement of Position 94-6 "Disclosure of Certain Significant Risks and Uncertainties," requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Examples of estimates used by Pepco Holdings include the calculation of the allowance for uncollectible accounts, environmental remediation costs and anticipated collections, unbilled revenue, pension assumptions, and fair values used in the purchase method of accounting and the resulting goodwill balance. Although Pepco Holdings believes that its estimates and assumptions are reasonable, they are based upon information presently available. Actual results m ay differ significantly from these estimates. |
Impact of Other Accounting Standards |
Energy Trading Reclassifications |
In 2002, the Emerging Issues Task Force issued a pronouncement entitled EITF Issue No. 02-3 (EITF 02-3) "Accounting for Contracts Involved in Energy Trading and Risk Management Activities." Beginning with July 2002, all trades were recorded net in accordance with EITF 02-3 and therefore no reclassification was required for activities after July 2002. Accordingly, due to the timing of the August 2002 merger, no revenue or expense reclassifications are required for Conectiv Energy's portion of Pepco Holdings' results. However, Pepco Energy Services' revenues decreased from $183.5 million to $170.9 million for the three months ended June 30, 2002 and from $340.3 million to $317.7 million for the six months ended June 30, 2002. There is no impact on Conectiv Energy's or Pepco Energy Services' overall financial position or net results of operations as a result of the implementation of EITF 02-3. |
Severance Costs |
During 2002, Pepco Holdings' management approved initiatives by Pepco and Conectiv to streamline their operating structure by reducing the number of employees at each company. These initiatives met the criteria for the accounting treatment provided under EITF No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." As of December 31, 2002, Pepco Holdings accrued $23.2 million of severance costs in connection with the plan. As of June 30, 2003, the severance liability had a balance of $15.9 million. Based on the number of employees that have or are expected to accept the severance packages, substantially all of the severance liability at June 30, 2003 will be paid through mid 2005. Employees have the option of taking severance payments in a lump sum or over a period of time. |
Asset Retirement Obligations |
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143 entitled "Accounting for Asset Retirement Obligations," which was adopted by Pepco Holdings on January 1, 2003. This Statement establishes the accounting and reporting standards for measuring and recording asset retirement obligations. Based on the implementation of SFAS No. 143, at June 30, 2003, $252.2 million in asset removal costs that are not legal obligations pursuant to the statement ($177.3 million for DPL and $74.9 million for Pepco) and $245.3 million at December 31, 2002 ($173.2 million for DPL and $72.1 million for Pepco) have been accrued and are embedded in accumulated depreciation in the accompanying consolidated balance sheets. |
Accounting for Guarantees |
Pepco Holdings and its subsidiaries have applied the provisions of FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," to their agreements that contain guarantee 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 obligation 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 June 30, 2003, Pepco Holdings and its subsidiaries did not have material obligations under guarantees issued or modified after December 31, 2002, which are required to be recognized as a liability on the consolidated balance sheets. Refer to Note 5. Commitments and Contingencies, herein, for a summary of Pepco Holdings' guarantees and other commitments. |
New Accounting Standards |
In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149 entitled "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement amends and clarifies SFAS No. 133 for certain interpretive guidance issued by the Derivatives Implementation Group. SFAS No. 149 is effective after June 30, 2003, for contracts entered into or modified and for hedges designated after the effective date. The Company is in the process of assessing the provisions of SFAS No. 149 to determine its impact on the Company's financial position and results of operations. |
In May 2003, the FASB issued SFAS No. 150 entitled "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 (the Company's third quarter 2003 financial statements). This Statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity and will result in the Company's reclassification of its "Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Which Holds Solely Parent Junior Subordinated Debentures" on its consolidated balance sheets to a liability classification. There will be no impact on the Company's results of operations from the implementatio n of this Statement. |
(3) DEBT |
During the quarter ended June 30, 2003, and subsequent thereto through August 7, 2003, Pepco Holdings and its subsidiaries engaged in the following capital market transactions: |
On May 1, 2003, DPL redeemed $32 million of 8.15% First Mortgage Bonds due October 1, 2015. |
On May 20, 2003, Pepco purchased on the open market and subsequently redeemed $15 million of 7% Medium Term Notes due January 15, 2024. |
On May 29, 2003, PHI issued $400 million of notes. $200 million were issued at a fixed rate of 4% due May 15, 2010 and $200 million were issued at a floating rate (3 month LIBOR plus 80 basis points) due November 15, 2004. Proceeds were used to pay down PHI commercial paper. |
On June 2, 2003, Conectiv redeemed at maturity $50 million of 6.73% Medium-Term Notes. |
On June 2, 2003, DPL redeemed at maturity $2.2 million of 6.95% First Mortgage Bonds. |
On June 2, 2003, ACE redeemed at maturity $30 million of 6.63% Medium Term Notes. |
On July 1, 2003, DPL redeemed at maturity $85 million of 6.4% First Mortgage Bonds. |
On July 21, 2003, Pepco redeemed the following First Mortgage Bonds: $40 million of 7.5% series due March 15, 2028 and $100 million of 7.25% series due July 1, 2023. |
PCI redeemed the following Medium Term-Notes at maturity: on April 1, 2003, $10 million of its 6.5% Series; on June 2, 2003, $3.5 million of its 7.38% Series; on June 18, 2003, $1 million of its 7.3% Series; on July 15, 2003, $5 million of its 7.04% Series; and on July 28, 2003, $7 million of its 7% Series. |
On July 29, 2003, Pepco Holdings, Pepco, DPL and ACE entered into (i) a three-year working capital credit facility with an aggregate credit limit of $550 million and (ii) a 364-day working capital credit facility with an aggregate credit limit of $550 million. Pepco Holdings' credit limit under these facilities is $700 million, and the credit limit of each of Pepco, DPL and ACE under these facilities is $300 million, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at any given time under these facilities may not exceed $400 million. Funds borrowed under these facilities are available for general corporate purposes. Either credit facility also can be used as credit support for the commercial paper programs of the respective companies. These credit facilities replaced a $1.5 billion 364-day credit facility entered into on August 1, 2002. |
On August 1, 2003 Pepco mailed official notice to the holders of its Serial Preferred Stock, $3.40 Series of 1992 for mandatory sinking fund redemption on September 1, 2003 of 50,000 shares at par value of $50.00 per share. |
In September 2002, Pepco Holdings issued in a private placement $1.5 billion of notes. In connection with the sale of the notes, Pepco Holdings agreed to cause an exchange offer for the notes to be completed no later than June 3, 2003. By May 22, 2003, all of the exchange notes were issued and all of the original notes were tendered. |
On August 7, 2003 on behalf of DPL, the Delaware Economic Development Authority issued $33.2 million of long-term bonds and loaned the proceeds to DPL. The bonds issued included $15.0 million of variable rate Exempt Facilities Refunding Revenue Bonds, Series A due August 1, 2038, and $18.2 million of 3.15% Pollution Control Refunding Revenue Bonds, Series B due February 1, 2023. The Series B bonds are subject to mandatory tender on August 1, 2008. All or a portion of the tendered bonds may be redeemed and/or remarketed. After August 1, 2008, the bonds may bear interest at a variable rate or fixed rate and may be subject to optional redemption prior to maturity, as provided for in the indenture for the bonds. On September 15, 2003, DPL will use the proceeds to redeem $33.2 million of bonds outstanding, as follows: $15.0 million of 6.05% bonds, due June 1, 2032, and $18.2 million of 5.90% bonds, due June 1, 2021. |
(4) SEGMENT INFORMATION |
Pepco Holdings' management has identified the following reportable segments: Pepco, Conectiv Power Delivery, Conectiv Energy, Pepco Energy Services, and Other Non-Regulated. 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 through the "Corporate and Other" column. Segment financial information for the three and six months ended June 30, 2003 and 2002 is as follows. |
Based on the foregoing assumptions, Pepco estimates that its pre-tax exposure aggregates approximately $700 million on a net present value basis (based on a discount rate of 7.5 percent). |
If Mirant were to successfully reject any or all of the contracts, the ability of Pepco to recover damages from the Mirant bankruptcy estate would depend on 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 make a prediction regarding the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate. However, if Mirant successfully rejects the TPAs and Pepco's full claim is not paid by Mirant's bankruptcy estate, Pepco may seek authority from the Maryland and District of Columbia Public Service Commissions to recover these costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers. |
In view of the foregoing, the consequences of a successful rejection by Mirant of one or more of the TPAs and its PPA-Related Obligations could have a material adverse effect on Pepco Holdings' results of operations. However, Pepco Holdings currently does not believe that a rejection by Mirant of one or more of the contracts would have a material adverse effect on its financial condition. |
Rate Changes |
On February 3, 2003, ACE filed a petition with the New Jersey Board of Public Utilities (NJBPU) to increase its electric distribution rates in New Jersey. The petition seeks a rate increase of approximately $68.4 million in electric delivery revenues, which equates to an increase in average total electricity rates of 6.9 percent overall. The filing requests a continuation of the currently authorized 12.5% ROE as well as the recovery of several regulatory assets, including carrying costs, over a four-year period. This is the first increase requested for electric distribution rates since 1991. ACE's Petition requested that this increase be made effective for service rendered on and after August 1, 2003. ACE cannot predict at this time the outcome of this filing, except that any change in rates relating to the filing will occur sometime after August 1, 2003. |
On March 31, 2003, DPL filed with the Delaware Public Service Commission for a gas base rate increase of $16.8 million, or an increase of 12.7% in total operating revenue. The filing includes a request for a ROE of 12.5%. DPL is currently authorized a ROE of 11.5% in Delaware. This is the first increase requested for its gas distribution since 1994. The Commission suspended the requested increase pending evidentiary hearings, so DPL has exercised its statutory right to place an interim base rate increase of 1.9% into effect on May 30, 2003, subject to refund. |
Stranded Cost Determination and Securitization |
On January 31, 2003, ACE filed a petition with the NJBPU seeking an administrative determination of stranded costs associated with the B. L. England ("BLE") generating facility. The net after tax stranded costs included in the petition were approximately $151 million. An administrative determination of the stranded costs is needed due to the cancelled sale of the plant. On July 25, 2003 the NJBPU rendered an oral decision approving the administrative determination of stranded costs at a level of $149.5 million. As a result of this order, ACE reversed $10.0 million ($5.9 million after-tax) of previously accrued liability for possible disallowance of stranded costs. This credit to expense is classified as an extraordinary item in the Consolidated Statements of Earnings because the original accrual was part of an extraordinary charge resulting from the discontinuation of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation" in conjunction with the deregulation of ACE's energy business in September 1999. It is anticipated that in the third quarter, the NJBPU will issue a ruling on ACE's request to securitize these stranded costs. |
On February 5, 2003, the NJBPU issued an order on its own initiative seeking input from ACE and the Ratepayer Advocate within 10 days as to whether and by how much to cut the 13% pre-tax return that ACE was then authorized to earn on BLE. ACE responded on February 18 with arguments that: 1) reduced costs to ratepayers could be achieved legally through timely approvals by the NJBPU of the stranded cost filing made by ACE on January 31, 2003, and a securitization filing made the week of February 10; and 2) it would be unlawful, perhaps unconstitutional, and a breach of settlement and prior orders for the NJBPU to deny a fair recovery on prudently incurred investment and to do so without evidentiary hearings or other due process. On April 21, 2003, the NJBPU issued an order making the return previously allowed on BLE interim, as of the date of the order, and directing that the issue of the appropriate return for BLE be included in the stranded cos t proceeding. On July 25, 2003, the NJBPU voted to approve a pre-tax return reflecting a 9.75% Return on Equity for the period April 21, 2003 through August 1, 2003. The rate from August 1, 2003 through such time as ACE securitizes the stranded costs will be 5.25%, which the NJBPU represents as being approximately equivalent to the securitization rate. A written order had not been issued as of August 8, 2003. |
On February 14, 2003, ACE filed a Bondable Stranded Costs Rate Order Petition with the NJBPU. The petition requests authority to issue $160 million of Transition Bonds to finance the recovery of stranded costs associated with BLE and costs of issuances. This proceeding is related to the proceeding seeking an administrative determination of the stranded costs associated with BLE that was the subject of the July 25, 2003 NJBPU vote. The Company cannot predict at this time the outcome of these proceedings. |
Restructuring Deferral |
On August 1, 2002, in accordance with the provisions of New Jersey's Electric Discount and Energy Competition Act (EDECA) and the NJBPU Final Decision and Order concerning the restructuring of ACE's electric utility business, ACE petitioned the NJBPU for the recovery of about $176.4 million in actual and projected deferred costs incurred by ACE over the four-year period August 1999 through July 31, 2003. The requested 8.4% increase was to recover those deferred costs over a new four-year period beginning August 1, 2003 and to reset rates so that there would be no under-recovery of costs embedded in ACE's rates on or after that date. ACE's recovery of the deferred costs is subject to review and approval by the NJBPU in accordance with EDECA. An Initial Decision by the Administrative Law Judge was rendered on June 3, 2003. The Initial Decision was consistent with the recommendations of the auditors hired by the NJBPU to audit ACE's deferral balances. |
On July 31, 2003, the NJBPU issued its Summary Order permitting ACE to begin collecting a portion of the deferred costs that were incurred as a result of EDECA and to reset rates to recover on-going costs incurred as a result of EDECA. |
The Summary Order approved the recovery of $125 million of the deferred balance over a ten-year amortization period beginning August 1, 2003. The Summary Order also transferred to ACE's pending base case for further consideration approximately $25.4 million of the deferred balance. The Summary Order estimated the overall deferral balance as of July 31, 2003 at $195 million, of which $44.6 million was disallowed recovery by ACE. Since the amounts included in this decision are based on estimates through July 31, 2003, the actual ending deferred cost balance will be subject to review and finalization by the NJPBU and ACE. The approved rates became effective on August 6, 2003. Based on analysis of the order and in accordance with prevailing accounting rules, ACE recorded a charge of $27.5 million ($16.3 million after-tax) during the second quarter of 2003. This charge is in addition to amounts previously accrued for disallowance. ACE believes the record does not justify the level of disallowance imposed by the NJBPU. ACE is awaiting the final written order from the NJBPU and is evaluating its options related to this decision. The NJBPU's action is not appealable until a final written order has been issued. |
Pepco Regulatory Contingencies |
Final briefs on Pepco's District of Columbia divestiture proceeds sharing application were filed on July 31, 2002 following an evidentiary hearing in June 2002. That application was filed to implement a provision of Pepco's D.C. Commission approved divestiture settlement that provided for a sharing of any net proceeds from the sale of its generation related assets. A principal issue in the case is whether a sharing between customers and shareholders of the excess deferred income taxes and accumulated deferred investment tax credits associated with the sold assets would violate the normalization provisions of the Internal Revenue Code and implementing regulations. On March 4, 2003, the Internal Revenue Service (IRS) issued a notice of proposed rulemaking (NOPR) that is relevant to that principal issue. Comments on the NOPR were filed by several parties on June 2, 2003, and the IRS held a public hearing on June 25, 2003. Three of the parties in t he case filed comments urging the D.C. Commission to decide the tax issues now on the basis of the proposed rule. Pepco filed comments in reply to those comments, in which Pepco stated that the courts have held and the IRS has stated that proposed rules are not authoritative and that no decision should be issued on the basis of proposed rules. Instead, Pepco argued that the only prudent course of action is for the D.C. Commission to await the issuance of final regulations relating to the tax issues and then allow the parties to file supplemental briefs on the tax issues. Pepco cannot predict whether the IRS will adopt the regulations as proposed, make changes before issuing final regulations or decide not to adopt regulations. Other issues deal with the inclusion of internal costs and cost allocations. Pepco believes that its calculation of the customers' share of divestiture proceeds is correct. However, the potential exists that Pepco could be required to make additional gain sharing payments to D.C. custo mers. Such additional payments, which cannot be estimated, would be charged to expense and could have a material adverse effect on results of operations in the quarter and year in which a decision is rendered; however, Pepco does not believe that additional payments, if any, will have a material adverse impact on its financial position. It is uncertain when the D.C. Commission will issue a decision. |
Pepco filed its divestiture proceeds plan application in Maryland in April 2001. Reply briefs were filed in May 2002 and Pepco is awaiting a Proposed Order from the Hearing Examiner. The principal issue in the case is the same normalization issue that was raised in the D.C. case. Following the filing of comments by Pepco and two other parties, the Hearing Examiner on April 8, 2003: (1) postponed his earlier decision establishing briefing dates on the question of the impact of the proposed rules on the tax issues until after the June 25, 2003 public hearing on the IRS NOPR;(2) allowed the Staff of the Commission and any other parties to submit motions by April 21, 2003 relating to the interpretation of current tax law as set forth in the preamble to the proposed rules and the effect thereof on the tax issues; and (3) allowed Pepco and any other party to file a response to any motion filed by Staff and other parties by April 30, 2003. Staff filed a motion on April 21, 2003, in which it argued that immediate flow through to customers of a portion of the excess deferred income taxes and accumulated deferred investment tax credits can be authorized now based on the NOPR. Pepco filed a response in opposition to Staff's motion on April 30, 2003, in which, among other things, Pepco argued that no action should be taken on the basis of proposed regulations because, as Pepco stated in a similar pleading in the District of Columbia divestiture proceeds case, proposed regulations are not authoritative. The Hearing Examiner will issue a ruling on Staff's motion, although there is no time within which he must issue a ruling. Pepco cannot predict whether the IRS will adopt the regulations as proposed, make changes before issuing final regulations or decide not to adopt regulations. Other issues deal with the inclusion of internal costs and cost allocations. Pepco believes that its calculation of the customers' share of divestiture proceeds is correct. Howev er, the potential also exists that Pepco would be required to make additional gain sharing payments to Maryland customers. Such additional payments, which cannot be estimated, would be charged to expense and could have a material adverse effect on results of operations in the quarter and year in which a decision is rendered; however, Pepco does not believe that additional payments, if any, will have a material adverse impact on its financial position. It is uncertain when the Hearing Examiner or the Maryland Commission will issue their decisions. |
Standard Offer Service (SOS) |
District of Columbia |
On February 21, 2003, the D.C. Public Service Commission opened a new proceeding to consider issues relating to (a) the establishment of terms and conditions for providing SOS in the District of Columbia after Pepco's obligation to provide SOS terminates on February 7, 2005, and (b) the selecting of a new SOS provider. Pepco and other parties filed comments on issues identified by the Commission and some parties suggested additional issues. In its comments, Pepco, among other things, suggested that the D.C. law be changed to allow Pepco to continue to be the SOS provider after February 7, 2005. Under existing law, the Commission is to adopt, before January 2, 2004, terms and conditions for SOS and for the selection of a new SOS provider. The Commission is also required, under existing law, to select the new SOS provider before July 2004. Existing law also allows the selection of Pepco as the SOS provider in the event of insufficient bids. By or der issued on June 24, 2003, the Commission decided that all participating parties should individually propose, by August 29, 2003, regulations setting forth such terms and conditions. The Commission will then issue proposed regulations by September 30, 2003 and allow initial and reply comments from interested parties to be filed by October 30 and November 17, 2003, respectively. Pepco continues to pursue legislation that would allow it to remain as the SOS provider after early 2005. |
Maryland |
In accordance with the terms of an agreement approved by the Maryland Commission, customers who are unable to receive generation services from another supplier, or who do not select another supplier, are entitled to receive services from Pepco until July 1, 2004. Pepco has entered into a settlement in Phase I of Maryland Case No. 8908 to extend its provision of SOS services in Maryland. The settlement was approved by the Maryland Commission on April 29, 2003. One party has filed for rehearing of the Commission's April 29 order. The Commission subsequently denied that application for rehearing on July 26, 2003. The settlement provides for an extension of SOS for four years for residential and small commercial customers, an extension of two years for medium sized commercial customers, and an extension of one year for large commercial customers. The settlement also provides for a policy review by the Commission to consider how SOS will be provided after the current extension expires. In addition, the settlement provides for SOS to be procured from the wholesale marketplace and that Pepco will be able to recover its costs of procurement and a return. Following months of meetings in Phase II, final settlement documents were filed on July 2, 2003. The Phase II settlement documents include the Phase II settlement agreement, a model request for proposals for wholesale power to be delivered to the utility SOS providers and a full requirements service agreement between the wholesale suppliers and the utility SOS providers. Initial testimony on the settlement was filed by numerous parties on July 18, 2003. No party filed testimony opposing the Phase II settlement, although at least one party has stated that it opposes the Phase II settlement. The Commission will set hearing and briefing dates. |
Third Party Guarantees |
As of June 30, 2003, 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, as follows: |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
POTOMAC ELECTRIC POWER COMPANY |
For additional information, other than the information disclosed in the Notes to Consolidated Financial Statements section herein, refer to Item 8. Financial Statements and Supplementary Data of the Company's 2002 Form 10-K. |
(1) ORGANIZATION |
On August 1, 2002, Potomac Electric Power Company (Pepco or the Company) closed on its acquisition of Conectiv for a combination of cash and stock valued at approximately $2.2 billion. In accordance with the terms of the merger agreement, both Pepco and Conectiv became subsidiaries of Pepco Holdings, Inc. (Pepco Holdings, formerly New RC, Inc.) a registered holding company under the Public Utility Holding Company Act of 1935. Pepco Holdings was incorporated under the laws of Delaware on February 9, 2001 for the purpose of effecting the merger. As part of the merger transaction, holders of Pepco's common stock immediately prior to the August 1, 2002 merger received in exchange for their Pepco shares approximately 107,125,976 shares of Pepco Holdings common stock, par value $.01 per share. Additionally, Pepco issued 100 shares of common stock, par value $.01, all of which are owned by Pepco Holdings. |
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. Under settlements entered into with regulatory authorities in connection with the divestiture of its generation assets in 2000, Pepco is required to provide default electricity supply (referred to as "standard offer service" or "SOS") at specified rates to customers in Maryland until July 2004 and to customers in Washington, D.C. until February 2005, which supply it purchases from an affiliate of Mirant Corporation ("Mirant"). 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 a discussion of Pepco's relationship with Mirant, see Note (5) "Commitments and Contingencies" herein. For the twelve months ended June 30, 2003, Pepco delivered 5.7 million megawatt hours to SOS cus tomers in the District of Columbia and 10.3 million megawatt hours to SOS customers in Maryland. For this period total deliveries were 11.2 million megawatt hours in the District of Columbia and 15.4 million megawatt hours in Maryland. |
On April 29, 2003, the Maryland Public Service Commission approved a settlement in Phase 1 of Maryland Case No. 8908 under which Pepco will supply retail customers with standard offer service electricity at market prices, including a margin, after existing rate caps expire in July 2004. Under this settlement, Pepco will provide standard offer service to its Maryland residential customers from July 2004 through May 2008 and to its non-residential customers for periods of one to four years. Pepco will obtain power for this market rate standard offer service through a competitive wholesale bidding process. In the District of Columbia, under current law, Pepco will not provide standard offer service after the expiration of its current obligations in February 2005, unless the District of Columbia Public Service Commission determines that there are insufficient bids to provide standard offer service, in which case Pepco may be directed to provide suc h service. |
Prior to the August 1, 2002 merger, Pepco was also engaged in the management of a diversified financial investments portfolio and the supply of energy products and services in competitive retail markets (Competitive businesses). These activities were performed through Pepco's wholly owned unregulated subsidiary at that time, POM Holdings, Inc. (POM) which until August 1, 2002, was the parent company of two wholly owned subsidiaries, Potomac Capital Investment Corporation (PCI) and Pepco Energy Services, Inc. (Pepco Energy Services). PCI managed Pepco's financial investment portfolio and Pepco Energy Services provided competitive energy products and services. PCI's investment in Starpower Communications, LLC, which provides cable and telecommunication services in the Washington, D.C. area, is owned by its wholly owned subsidiary Pepco Communications, Inc. (Pepcom). After the merger, the stock of PCI, Pepco Energy Services, and Pepcom was distrib uted as a dividend to Pepco Holdings, which resulted in Pepco Holdings becoming the new parent company of PCI, Pepco Energy Services, and Pepcom. |
Additionally, the Company has a wholly owned Delaware statutory business trust, Potomac Electric Power Company Trust I, and a wholly owned Delaware Investment Holding Company, Edison Capital Reserves Corporation. |
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND IMPACT OF OTHER
ACCOUNTING STANDARDS |
Significant Accounting Policies |
Financial Statement Presentation |
Pepco'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 U.S. Securities and Exchange Commission, 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 our Annual Report on Form 10K for the year ended December 31, 2002. In management's opinion, the consolidated financial statements contain all adjustments (which all are of a normal recurring nature) necessary to present fairly Pepco's financial position as of June 30, 2003 and 2002, in accordance with GAAP. Interim results for the three-months and six months ended March 31, and June 30, 2003 may not be indicative of results that will be realized for the full year ending December 31, 200 3. Certain prior period amounts have been reclassified in order to conform to current period presentation. |
Pepco's independent accountants have performed a review of, and issued a report on, these consolidated interim financial statements in accordance with standards established by the American Institute of Certified Public Accountants. Pursuant to Rule 436(c) under the U.S. Securities Act of 1933, this report should not be considered a part of any registration statement prepared or certified within the meanings of Section 7 and 11 of the Securities Act. |
The accompanying consolidated statements of earnings for the three and six months ended June 30, 2003 and the consolidated statements of cash flows for the six months ended June 30, 2003 include only Pepco's utility operations for the full periods. These statements for the three and six months ended June 30, 2002, as previously reported by Pepco, include the consolidated operations of Pepco and its pre-merger subsidiaries, for the entire periods. Accordingly, the financial statements referred to above for the three and six months ended June 30, 2003, are not comparable with the 2002 amounts. The amounts presented in the accompanying consolidated balance sheets as of June 30, 2003 and December 31, 2002, respectively, are comparable as both periods presented reflect the impact of the merger transaction. |
Use of Estimates |
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, such as Statement of Position 94-6 "Disclosure of Certain Significant Risks and Uncertainties," requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Examples of estimates used by Pepco include the calculation of the allowance for uncollectible accounts, environmental remediation costs and anticipated collections, unbilled revenue, and pension assumptions. Although Pepco believes that its estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates. |
Impact of Other Accounting Standards |
Energy Trading Reclassifications |
In 2002, the Emerging Issues Task Force issued a pronouncement entitled EITF Issue No. 02-3 (EITF 02-3) "Accounting for Contracts Involved in Energy Trading and Risk Management Activities." Beginning with July 2002, all trades were recorded net in accordance with EITF 02-3. Pepco Energy Services' revenues decreased from $183.5 million to $170.9 million for the three months ended June 30, 2002 and from $340.3 million to $317.7 million for the six months ended June 30, 2002. There is no impact on Pepco's overall financial position or net results of operations as a result of the implementation of EITF 02-3. |
Severance Costs |
During 2002, Pepco Holdings' management approved initiatives by Pepco to streamline their operating structure by reducing their number of employees. These initiatives met the criteria for the accounting treatment provided under EITF No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." As of December 31, 2002, Pepco accrued $17.5 million of severance costs in connection with the plan. As of June 30, 2003, the severance liability on Pepco's books (excluding $3.4 million of the liability related to corporate services that was transferred to the Pepco Holdings subsidiary service company) was $6.8 million. Based on the number of employees that have or are expected to accept the severance package, substantially all of the severance liability at June 30, 2003 will be paid through mid 2005. Employees have the option of taking severance payments in a lump sum or over a period of time. |
Asset Retirement Obligations |
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143 entitled "Accounting for Asset Retirement Obligations," which was adopted by Pepco on January 1, 2003. This Statement establishes the accounting and reporting standards for measuring and recording asset retirement obligations. Pepco identified $74.9 million and $72.1 million in asset removal costs at June 30, 2003 and December 31, 2002, respectively, that are not legal obligations pursuant to the statement. These removal costs have been accrued and are embedded in accumulated depreciation in the accompanying consolidated balance sheets. |
Accounting for Guarantees |
Pepco has applied the provisions of FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," to its agreements that contain guarantee 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 obligation 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 June 30, 2003, Pepco was not party to any material guarantees that required disclosure or recognition as a liability on its consolidated balance sheets. |
New Accounting Standards |
In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149 entitled "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement amends and clarifies SFAS No. 133 for certain interpretive guidance issued by the Derivatives Implementation Group. SFAS No. 149 is effective after June 30, 2003, for contracts entered into or modified and for hedges designated after the effective date. Pepco is in the process of assessing the provisions of SFAS No. 149 to determine its impact on Pepco's financial position and results of operations. |
In May 2003, the FASB issued SFAS No. 150 entitled "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 (the Company's third quarter 2003 financial statements). This Statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity and will result in the Company's reclassification of its "Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Which Holds Solely Parent Junior Subordinated Debentures" on its consolidated balance sheets to a liability classification. There will be no impact on Pepco's results of operations from the implementation of t his Statement. |
(3) DEBT |
During the quarter ended June 30, 2003, and subsequent thereto through August 7, 2003, Pepco engaged in the following capital market transactions: |
On May 20, 2003, Pepco purchased on the open market and subsequently redeemed $15 million of 7% Medium Term Notes due January 15, 2024. |
On July 21, 2003, Pepco redeemed the following First Mortgage Bonds: $40 million of 7.5% series due March 15, 2028 and $100 million of 7.25% series due July 1, 2023. |
On July 29, 2003, Pepco Holdings, Pepco, DPL and ACE entered into (i) a three-year working capital credit facility with an aggregate credit limit of $550 million and (ii) a 364-day working capital credit facility with an aggregate credit limit of $550 million. Pepco Holdings' credit limit under these facilities is $700 million, and the credit limit of each of Pepco, DPL and ACE under these facilities is $300 million, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at any given time under these facilities may not exceed $400 million. Funds borrowed under these facilities are available for general corporate purposes. Either credit facility also can be used as credit support for the commercial paper programs of the respective companies. These credit facilities replaced a $1.5 billion 364-day credit facility entered into on August 1, 2002. |
On August 1, 2003 Pepco mailed official notice to the holders of its Serial Preferred Stock, $3.40 Series of 1992 for mandatory sinking fund redemption on September 1, 2003 of 50,000 shares at par value of $50.00 per share. |
(4) SEGMENT INFORMATION |
As a result of the merger transaction on August 1, 2002, Pepco determined that its regulated utility operations represent its only reportable segment. Segment financial information for the three and six months ended June 30, 2003 and 2002, along with financial information for Pepco Energy Services and PCI, is as follows: |
Based on the foregoing assumptions, Pepco estimates that its pre-tax exposure aggregates approximately $700 million on a net present value basis (based on a discount rate of 7.5 percent). |
If Mirant were to successfully reject any or all of the contracts, the ability of Pepco to recover damages from the Mirant bankruptcy estate would depend on 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 make a prediction regarding the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate. However, if Mirant successfully rejects the TPAs and Pepco's full claim is not paid by Mirant's bankruptcy estate, Pepco may seek authority from the Maryland and District of Columbia Public Service Commissions to recover these costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers. |
In view of the foregoing, the consequences of a successful rejection by Mirant of one or more of the TPAs and its PPA-Related Obligations could have a material adverse effect on Pepco's results of operations. However, Pepco currently does not believe that a rejection by Mirant of one or more of the contracts would have a material adverse effect on its financial condition. |
Regulatory Contingencies |
Final briefs on Pepco's District of Columbia divestiture proceeds sharing application were filed on July 31, 2002 following an evidentiary hearing in June 2002. That application was filed to implement a provision of Pepco's D.C. Commission approved divestiture settlement that provided for a sharing of any net proceeds from the sale of its generation related assets. A principal issue in the case is whether a sharing between customers and shareholders of the excess deferred income taxes and accumulated deferred investment tax credits associated with the sold assets would violate the normalization provisions of the Internal Revenue Code and implementing regulations. On March 4, 2003, the Internal Revenue Service (IRS) issued a notice of proposed rulemaking (NOPR) that is relevant to that principal issue. Comments on the NOPR were filed by several parties on June 2, 2003, and the IRS held a public hearing on June 25, 2003. Three of the parties in t he case filed comments urging the D. C. Commission to decide the tax issues now on the basis of the proposed rule. Pepco filed comments in reply to those comments, in which Pepco stated that the courts have held and the IRS has stated that proposed rules are not authoritative and that no decision should be issued on the basis of proposed rules. Instead, Pepco argued that the only prudent course of action is for the D.C. Commission to await the issuance of final regulations relating to the tax issues and then allow the parties to file supplemental briefs on the tax issues. Pepco cannot predict whether the IRS will adopt the regulations as proposed, make changes before issuing final regulations or decide not to adopt regulations. Other issues deal with the inclusion of internal costs and cost allocations. Pepco believes that its calculation of the customers' share of divestiture proceeds is correct. However, the potential exists that Pepco could be required to make additional gain sharing payments to D.C. cust omers. Such additional payments, which cannot be estimated, would be charged to expense and could have a material adverse effect on results of operations in the quarter and year in which a decision is rendered; however, Pepco does not believe that additional payments, if any, will have a material adverse impact on its financial position. It is uncertain when the D.C. Commission will issue a decision. |
Pepco filed its divestiture proceeds plan application in Maryland in April 2001. Reply briefs were filed in May 2002 and Pepco is awaiting a Proposed Order from the Hearing Examiner. The principal issue in the case is the same normalization issue that was raised in the D.C. case. Following the filing of comments by Pepco and two other parties, the Hearing Examiner on April 8, 2003: (1) postponed his earlier decision establishing briefing dates on the question of the impact of the proposed rules on the tax issues until after the June 25, 2003 public hearing on the IRS NOPR;(2) allowed the Staff of the Commission and any other parties to submit motions by April 21, 2003 relating to the interpretation of current tax law as set forth in the preamble to the proposed rules and the effect thereof on the tax issues; and (3) allowed Pepco and any other party to file a response to any motion filed by Staff and other parties by April 30, 2003. Staff filed a motion on April 21, 2003, in which it argued that immediate flow through to customers of a portion of the excess deferred income taxes and accumulated deferred investment tax credits can be authorized now based on the NOPR. Pepco filed a response in opposition to Staff's motion on April 30, 2003, in which, among other things, Pepco argued that no action should be taken on the basis of proposed regulations because, as Pepco stated in a similar pleading in the District of Columbia divestiture proceeds case, proposed regulations are not authoritative. The Hearing Examiner will issue a ruling on Staff's motion, although there is no time within which he must issue a ruling. Pepco cannot predict whether the IRS will adopt the regulations as proposed, make changes before issuing final regulations or decide not to adopt regulations. Other issues deal with the inclusion of internal costs and cost allocations. Pepco believes that its calculation of the customers' share of divestiture proceeds is correct. Howev er, the potential also exists that Pepco would be required to make additional gain sharing payments to Maryland customers. Such additional payments, which cannot be estimated, would be charged to expense and could have a material adverse effect on results of operations in the quarter and year in which a decision is rendered; however, Pepco does not believe that additional payments, if any, will have a material adverse impact on its financial position. It is uncertain when the Hearing Examiner or the Maryland Commission will issue their decisions. |
Standard Offer Service (SOS) |
District of Columbia |
On February 21, 2003, the D.C. Public Service Commission opened a new proceeding to consider issues relating to (a) the establishment of terms and conditions for providing SOS in the District of Columbia after Pepco's obligation to provide SOS terminates on February 7, 2005, and (b) the selecting of a new SOS provider. Pepco and other parties filed comments on issues identified by the Commission and some parties suggested additional issues. In its comments, Pepco, among other things, suggested that the D.C. law be changed to allow Pepco to continue to be the SOS provider after February 7, 2005. Under existing law, the Commission is to adopt, before January 2, 2004, terms and conditions for SOS and for the selection of a new SOS provider. The Commission is also required, under existing law, to select the new SOS provider before July 2004. Existing law also allows the selection of Pepco as the SOS provider in the event of insufficient bids. At a prehearing conference held on May 15, 2003, the Commission agreed with the recommendations of all but one of the parties to allow a working group, like the one that has been meeting in Maryland, to develop for the Commission's consideration regulations setting the terms and conditions for the provision of SOS service and for the selection of an SOS provider after Pepco's obligation ends in early 2005. However, by order issued on June 24, 2003, the Commission decided that all participating parties should individually propose, by August 29, 2003, regulations setting forth such terms and conditions. The Commission will then issue proposed regulations by September 30, 2003 and allow initial and reply comments from interested parties to be filed by October 30 and November 17, 2003, respectively. Pepco continues to pursue legislation that would allow it to remain as the SOS provider after early 2005. |
Maryland |
In accordance with the terms of an agreement approved by the Maryland Commission, customers who are unable to receive generation services from another supplier, or who do not select another supplier, are entitled to receive services from Pepco until July 1, 2004. Pepco has entered into a settlement in Phase I of Maryland Case No. 8908 to extend its provision of SOS services in Maryland. The Settlement was approved by the Maryland Commission on April 29, 2003. One party has filed for rehearing of the Commission's April 29 order. The Commission subsequently denied that application for rehearing on July 26, 2003. The Settlement provides for an extension of SOS for four years for residential and small commercial customers, an extension of two years for medium sized commercial customers, and an extension of one year for large commercial customers. The Settlement also provides for a policy review by the Commission to consider how SOS will be provided after the current extension expires. In addition, the settlement provides for SOS to be procured from the wholesale marketplace and that Pepco will be able to recover its costs of procurement and a return. Following months of meetings in Phase II, final settlement documents were filed on July 2, 2003. The Phase II settlement documents include the Phase II settlement agreement, a model request for proposals for wholesale power to be delivered to the utility SOS providers and a full requirements service agreement between the wholesale suppliers and the utility SOS providers. Initial testimony on the settlement was filed by numerous parties on July 18, 2003. No party filed testimony opposing the Phase II settlement, although at least one party has stated that it opposes the Phase II settlement. The Commission will set hearing and briefing dates. |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
CONECTIV |
For additional information, other than the information disclosed in the Notes to Consolidated Financial Statements section herein, refer to Item 8. Financial Statements and Supplementary Data of the Company's 2002 Form 10-K. |
(1) ORGANIZATION |
Conectiv was formed on March 1, 1998 (the 1998 Merger), through a series of merger transactions and an exchange of common stock with Delmarva Power & Light Company (DPL) and Atlantic Energy, Inc., which owned Atlantic City Electric Company (ACE) prior to the 1998 Merger. Conectiv owns other subsidiaries in addition to ACE and DPL, including Conectiv Energy Holding Company (CEH). Conectiv, along with CEH and ACE REIT, Inc., is a registered holding company under the Public Utility Holding Company Act of 1935 (PUHCA). |
References herein to Conectiv may mean the activities of one or more subsidiary companies. |
On August 1, 2002, Conectiv was acquired by Pepco Holdings, Inc. (PHI) in a transaction pursuant to an Agreement and Plan of Merger (the Conectiv/Pepco Merger Agreement), dated as of February 9, 2001, among PHI (formerly New RC, Inc.), Conectiv and Potomac Electric Power Company (Pepco), in which Pepco and Conectiv merged with subsidiaries of PHI (the Conectiv/Pepco Merger). As a result of the Conectiv/Pepco Merger, Conectiv and Pepco each became subsidiaries of PHI. |
ACE and DPL are public utilities that supply and deliver electricity through their transmission and distribution systems to approximately 999,400 customers under the trade name Conectiv Power Delivery. DPL also supplies and delivers natural gas to approximately 115,400 customers in a 275 square mile area in northern Delaware. ACE's regulated service area is located in the southern one-third of New Jersey and DPL's regulated electric service area is located on the Delmarva Peninsula (Delaware and portions of Maryland and Virginia). On a combined basis, ACE's and DPL's regulated electric service areas encompass about 8,700 square miles and have a population of approximately 2.2 million. |
Conectiv Energy provides wholesale power and ancillary services to the Pennsylvania/New Jersey/Maryland (PJM) power pool and provides power, under contract, to customers including DPL and ACE. Conectiv Energy's generation asset strategy focuses on mid-merit plants with operating flexibility and multi-fuel capability that can quickly change their output level on an economic basis. Mid-merit plants generally are operated during times when demand for electricity rises and prices are higher. |
As of June 30, 2003, Conectiv Energy owned and operated electric generating plants with 3,302 MW of capacity. In January 2002, Conectiv Energy began construction of a 1,100 MW combined cycle plant with six combustion turbines at a site in Bethlehem, Pennsylvania that is expected to becomefully operational in stages that added 306 MW in 2002(resulting from the installation of three CTs), 279 MW in the first quarter of 2003 (resultingfrom the installation of an additional two CTs and an upgrade of the CTs installed during 2002), 296 MW in the second quarter (resulting from the installation of one additional CT and one waste heat recovery boiler and steam generating unit), and is expected to add an additional 209 MW of capacity by the end of 2003 (resulting from the installation of a second waste heat reco very boiler and steam generating unit and upgrades of the existing CTs). |
On June 25, 2003, Conectiv Energy entered into an agreement consisting of a series of energy contracts with an international investment banking firm with over $400 billion in assets and a senior unsecured debt rating of A+ / Stable from Standard & Poors (the "Counterparty"). The agreement is designed to more effectively hedge approximately fifty percent of Conectiv Energy's generation output and approximately fifty percent of its supply obligations, with the intention of providing Conectiv Energy with a more predictable earnings stream during the term of the agreement. For additional information, refer to Note 6. Conectiv Energy Events, herein. |
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND IMPACT OF OTHER
ACCOUNTING STANDARDS |
Significant Accounting Policies |
Principles of Consolidation |
The Consolidated Financial Statements include the accounts of Conectiv and its majority owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. Ownership interests of 20% or more in entities not controlled by Conectiv are accounted for under the equity method of accounting. Ownership interests in other entities of less than 20% are accounted for under the cost method of accounting. Investments in entities accounted for under the equity and cost methods are included in "Other investments" on the Consolidated Balance Sheets. Earnings from equity method investments and distributions from cost method investments are included in "Other income (expenses)" in the Consolidated Statements of Income. |
Consolidated Financial Statement Presentation |
Conectiv'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 U.S. Securities and Exchange Commission, 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 our Annual Report on Form 10K for the year ended December 31, 2002. In management's opinion, the consolidated financial statements contain all adjustments (which all are of a normal recurring nature) necessary to present fairly our financial position as of June 30, 2003 and 2002, in accordance with GAAP. Interim results for the three-months and six months ended March 31, and June 30, 2003 may not be indicative of results that will be realized for the full year ending December 31, 2003 . Certain prior period amounts have been reclassified in order to conform to current period presentation. |
Conectiv's independent accountants have performed a review of, and issued a report on, these consolidated interim financial statements in accordance with standards established by the American Institute of Certified Public Accountants. Pursuant to Rule 436(c) under the U.S. Securities Act of 1933, this report should not be considered a part of any registration statement prepared or certified within the meanings of Section 7 and 11 of the Securities Act. |
Use of Estimates |
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, such as Statement of Position 94-6 "Disclosure of Certain Significant Risks and Uncertainties," requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Examples of estimates used by the Company include the calculation of the allowance for uncollectible accounts, environmental remediation costs and anticipated collections, unbilled revenue, and pension assumptions. Although Conectiv believes that its estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates. |
Impact of Other Accounting Standards |
Energy Trading Reclassifications |
In 2002, the Emerging Issues Task Force issued a pronouncement entitled EITF Issue No. 02-3 (EITF 02-3) "Accounting for Contracts Involved in Energy Trading and Risk Management Activities." Beginning with July 2002, all trades were recorded net in accordance with EITF 02-3. Conectiv's revenues decreased from $1,100.2 million to $819.2 million for the three months ended June 30, 2002 and from $2,152.0 million to $1,603.5 million for the six months ended June 30, 2002. There was no impact on Conectiv's overall financial position or net results of operations as a result of the implementation of EITF 02-3. |
Asset Retirement Obligations |
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143 entitled "Accounting for Asset Retirement Obligations," which was adopted by the Company on January 1, 2003. This Statement establishes the accounting and reporting standards for measuring and recording asset retirement obligations. The Company has identified $177.3 million and $173.2 million at June 30, 2003 and December 31, 2002, respectively, in asset removal costs for regulated assets related to DPL that are not legal obligations pursuant to the statement. These removal costs have been accrued and are embedded in accumulated depreciation in the accompanying consolidated balance sheets. The implementation of SFAS No. 143 for non-regulated assets at Conectiv subsidiaries resulted in Conectiv's recording of a Cumulative Effect of Change in Accounting Principle of $7.2 million, net of taxes of $4.9 million, in its consolidated statements of earnings during th e first quarter of 2003. |
Accounting for Guarantees |
Conectiv and its subsidiaries have applied the provisions of FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," to their agreements that contain guarantee 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 obligation 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 June 30, 2003, Conectiv and its subsidiaries did not have material obligations and other commitments under guarantees issued or modified after December 31, 2002 which were required to be recognized as a liability on its balance sheet. Refer to Note 5. Commitments and Contingencies, herein, for a summary of Conectiv's guarantees and other commitments. |
New Accounting Standards |
In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149 entitled "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement amends and clarifies SFAS No. 133 for certain interpretive guidance issued by the Derivatives Implementation Group. SFAS No. 149 is effective after June 30, 2003, for contracts entered into or modified and for hedges designated after the effective date. The Company is in the process of assessing the provisions of SFAS No. 149 to determine its impact on the Company's financial position and results of operations. |
In May 2003, the FASB issues SFAS No. 150 entitles "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 (the Company's third quarter 2003 financial statements). This Statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity and will result in the Company's reclassification of its "Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Which Holds Solely Parent Junior Subordinated Debentures" on its consolidated balance sheets to a liability classification. There will be no impact on the Company's results of operations from the implementatio n of this Statement. |
(3) DEBT |
During the quarter ended June 30, 2003, and subsequent thereto through August 7, 2003, Conectiv and its subsidiaries engaged in the following capital market transactions: |
�� On May 1, 2003, DPL redeemed $32 million of 8.15% First Mortgage Bonds due October 1, 2015. |
On June 2, 2003, Conectiv redeemed at maturity $50 million of 6.73% Medium-Term Notes. |
On June 2, 2003, DPL redeemed at maturity $2.2 million First Mortgage Bonds, 6.95% Series. |
On June 2, 2003, ACE redeemed at maturity $30 million of 6.63% Medium-Term Notes. |
On July 1, 2003, DPL redeemed at maturity $85 million of 6.4% First Mortgage Bonds. |
On July 29, 2003, Pepco Holdings, Pepco, DPL and ACE entered into (i) a three-year working capital credit facility with an aggregate credit limit of $550 million and (ii) a 364-day working capital credit facility with an aggregate credit limit of $550 million. Pepco Holdings' credit limit under these facilities is $700 million, and the credit limit of each of Pepco, DPL and ACE under these facilities is $300 million, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at any given time under these facilities may not exceed $400 million. Funds borrowed under these facilities are available for general corporate purposes. Either credit facility also can be used as credit support for the commercial paper programs of the respective companies. These credit facilities replaced a $1.5 billion 364-day credit facility entered into on August 1, 2002. |
On August 7, 2003 on behalf of DPL, the Delaware Economic Development Authority issued $33.2 million of long-term bonds and loaned the proceeds to DPL. The bonds issued included $15.0 million of variable rate Exempt Facilities Refunding Revenue Bonds, Series A due August 1, 2038, and $18.2 million of 3.15% Pollution Control Refunding Revenue Bonds, Series B due February 1, 2023. The Series B bonds are subject to mandatory tender on August 1, 2008. All or a portion of the tendered bonds may be redeemed and/or remarketed. After August 1, 2008, the bonds may bear interest at a variable rate or fixed rate and may be subject to optional redemption prior to maturity, as provided for in the indenture for the bonds. On September 15, 2003, DPL will use the proceeds to redeem $33.2 million of bonds outstanding, as follows: $15.0 million of 6.05% bonds, due June 1, 2032, and $18.2 million of 5.90% bonds, due June 1, 2021. |
(4) SEGMENT INFORMATION |
Conectiv's reportable segments were determined from its internal organization and management reporting, which are based primarily on differences in products and services. Conectiv's reportable segments are as follows: |
(5) COMMITMENTS AND CONTINGENCIES |
Rate Changes |
On February 3, 2003, ACE filed a petition with the New Jersey Board of Public Utilities (NJBPU) to increase its electric distribution rates in New Jersey. The petition seeks a rate increase of approximately $68.4 million in electric delivery revenues, which equates to an increase in average total electricity rates of 6.9 percent overall. The filing requests a continuation of the currently authorized 12.5% ROE as well as the recovery of several regulatory assets, including carrying costs, over a four-year period. This is the first increase requested for electric distribution rates since 1991. ACE's Petition requested that this increase be made effective for service rendered on and after August 1, 2003. ACE cannot predict at this time the outcome of this filing, except that any change in rates relating to the filing will occur sometime after August 1, 2003. |
On March 31, 2003, DPL filed with the Delaware Public Service Commission for a gas base rate increase of $16.8 million, or an increase of 12.7% in total operating revenue. The filing includes a request for a ROE of 12.5%. DPL is currently authorized a ROE of 11.5% in Delaware. This is the first increase requested for its gas distribution since 1994. The Commission suspended the requested increase pending evidentiary hearings, so DPL has exercised its statutory right to place an interim base rate increase of 1.9% into effect on May 30, 2003, subject to change. |
Stranded Cost Determination and Securitization |
On January 31, 2003, ACE filed a petition with the NJBPU seeking an administrative determination of stranded costs associated with the B. L. England ("BLE") generating facility. The net after tax stranded costs included in the petition were approximately $151 million. An administrative determination of the stranded costs is needed due to the cancelled sale of the plant. On July 25, 2003 the NJBPU rendered an oral decision approving the administrative determination of stranded costs at a level of $149.5 million. As a result of this order, ACE reversed $10.0 million ($5.9 million after-tax) of previously accrued liability for possible disallowance of stranded costs. This credit to expense is classified as an extraordinary item in the Consolidated Statements of Earnings because the original accrual was part of an extraordinary charge resulting from the discontinuation of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation" in conjunction with the deregulation of ACE's energy business in September 1999. It is anticipated that in the third quarter, the NJBPU will issue a ruling on ACE's request to securitize these stranded costs. |
On February 5, 2003, the NJBPU issued an order on its own initiative seeking input from ACE and the Ratepayer Advocate within 10 days as to whether and by how much to cut the 13% pre-tax return that ACE was then authorized to earn on BLE. ACE responded on February 18 with arguments that: 1) reduced costs to ratepayers could be achieved legally through timely approvals by the NJBPU of the stranded cost filing made by ACE on January 31, 2003, and a securitization filing made the week of February 10; and 2) it would be unlawful, perhaps unconstitutional, and a breach of settlement and prior orders for the NJBPU to deny a fair recovery on prudently incurred investment and to do so without evidentiary hearings or other due process. On April 21, 2003, the NJBPU issued an order making the return previously allowed on BLE interim, as of the date of the order, and directing that the issue of the appropriate return for BLE be included in the stranded cos t proceeding. On July 25, 2003, the NJBPU voted to approve a pre-tax return reflecting a 9.75% Return on Equity for the period April 21, 2003 through August 1, 2003. The rate from August 1, 2003 through such time as ACE securitizes the stranded costs will be 5.25%, which the NJBPU represents as being approximately equivalent to the securitization rate. A written order had not been issued as of August 8, 2003. |
On February 14, 2003, ACE filed a Bondable Stranded Costs Rate Order Petition with the NJBPU. The petition requests authority to issue $160 million of Transition Bonds to finance the recovery of stranded costs associated with BLE and costs of issuances. This proceeding is related to the proceeding seeking an administrative determination of the stranded costs associated with BLE that was the subject of the July 25, 2003 NJBPU vote. The Company cannot predict at this time the outcome of these proceedings. |
Restructuring Deferral |
On August 1, 2002, in accordance with the provisions of New Jersey's Electric Discount and Energy Competition Act (EDECA) and the NJBPU Final Decision and Order concerning the restructuring of ACE's electric utility business, ACE petitioned the NJBPU for the recovery of about $176.4 million in actual and projected deferred costs incurred by ACE over the four-year period August 1999 through July 31, 2003. The requested 8.4% increase was to recover those deferred costs over a new four-year period beginning August 1, 2003 and to reset rates so that there would be no under-recovery of costs embedded in ACE's rates on or after that date. ACE's recovery of the deferred costs is subject to review and approval by the NJBPU in accordance with EDECA. An Initial Decision by the Administrative Law Judge was rendered on June 3, 2003. The Initial Decision was consistent with the recommendations of the auditors hired by the NJBPU to audit ACE's deferral balances. |
On July 31, 2003, the NJBPU issued its Summary Order permitting ACE to begin collecting a portion of the deferred costs that were incurred as a result of EDECA and to reset rates to recover on-going costs incurred as a result of EDECA. |
The Summary Order approved the recovery of $125 million of the deferred balance over a ten-year amortization period beginning August 1, 2003. The Summary Order also transferred to ACE's pending base case for further consideration approximately $25.4 million of the deferred balance. The Summary Order estimated the overall deferral balance as of July 31, 2003 at $195 million, of which $44.6 million was disallowed recovery by ACE. Since the amounts included in this decision are based on estimates through July 31, 2003, the actual ending deferred cost balance will be subject to review and finalization by the NJPBU and ACE. The approved rates became effective on August 6, 2003. Based on analysis of the order and in accordance with prevailing accounting rules, ACE recorded a charge of $27.5 million ($16.3 million after-tax) during the second quarter of 2003. This charge is in addition to amounts previously accrued for disallowance. ACE believes the record does not justify the level of disallowance imposed by the NJBPU. ACE is awaiting the final written order from the NJBPU and is evaluating its options related to this decision. The NJBPU's action is not appealable until a final written order has been issued. |
Third Party Guarantees |
As of June 30, 2003, Conectiv and its subsidiaries were a party to a variety of agreements pursuant to which they were a guarantor for standby letters of credit, performance residual value, and other commitments and obligations, as follows (in Millions of Dollars): |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
DELMARVA POWER & LIGHT COMPANY |
For additional information, other than the information disclosed in the Notes to Consolidated Financial Statements section herein, refer to Item 8. Financial Statements and Supplementary Data of the Company's 2002 Form 10-K. |
(1) ORGANIZATION |
Delmarva Power & Light Company (DPL) is a subsidiary of Conectiv, which is a registered holding company under the Public Utility Holding Company Act of 1935 (PUHCA). On March 1, 1998, Conectiv was formed (the 1998 Merger) through an exchange of common stock with DPL and Atlantic Energy, Inc. |
On August 1, 2002, Conectiv was acquired by Pepco Holdings, Inc. (PHI) in a transaction pursuant to an Agreement and Plan of Merger (the Conectiv/Pepco Merger Agreement), dated as of February 9, 2001, among PHI (formerly New RC, Inc.), Conectiv and Potomac Electric Power Company (Pepco), in which Pepco and Conectiv merged with subsidiaries of PHI (the Conectiv/Pepco Merger). As a result of the Conectiv/Pepco Merger, Conectiv and Pepco and their respective subsidiaries (including DPL) each became subsidiaries of PHI. DPL continues as a wholly-owned, direct subsidiary of Conectiv. |
DPL is a public utility that supplies and delivers electricity and natural gas to its customers under the trade name Conectiv Power Delivery. DPL delivers electricity to approximately 485,100 regulated customers through its transmission and distribution systems and also supplies electricity to most of its electricity delivery customers, who have the option of choosing an alternative supplier. DPL's regulated electric service territory is located on the Delmarva Peninsula (Delaware and portions of Maryland and Virginia). DPL's electric service area encompasses about 6,000 square miles and has a population of approximately 1.2 million. |
DPL provides regulated gas service (supply and/or delivery) in a service territory that covers about 275 square miles with a population of approximately 500,000 in New Castle County, Delaware. DPL also sells gas off-system and in markets that are not subject to price regulation. |
Under regulatory settlements, DPL is required to provide standard offer electricity service at specified rates to residential customers in Maryland until July 2004 and to non-residential customers in Maryland until July 2003 and to provide default electricity service at specified rates to customers in Delaware until May 2006. It is currently expected that DPL will also provide default electric service at specified rates to customers in Virginia until July 2007. However, the Virginia State Corporation Commission could terminate the obligation for some or all classes of customers sooner if it finds that an effectively competitive market exists. Subsidiaries of Conectiv Energy Holding Company, a wholly owned subsidiary of Conectiv, supplies all of DPL's standard offer and default service load requirements under a supply agreement that ends May 31, 2006. The terms of the supply agreement are structured to coincide with DPL's load requirements under each of its regulatory settlements. DPL purchases gas supplies for its customers from marketers and producers in the spot market and under short-term and long-term agreements. |
On April 29, 2003, the Maryland Commission approved a settlement in Phase I of Maryland Case No. 8908 to extend the provision of standard offer service that requires local utilities to continue to supply customers with electricity after existing rate caps/ freezes expire in July 2004 at market prices. DPL will provide SOS to all residential customers from July 1, 2004 through May 31, 2008 and to its non-residential customers for periods of one to four years. DPL will obtain power for the market rate standard offer service through a competitive wholesale bidding process. |
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND IMPACT OF OTHER
ACCOUNTING STANDARDS |
Significant Accounting Policies |
Principles of Consolidation |
The Consolidated Financial Statements include the accounts of DPL's wholly-owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. |
Financial Statement Presentation |
The Company'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 U.S. Securities and Exchange Commission, 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 our Annual Report on Form 10K for the year ended December 31, 2002. In our management's opinion, the consolidated financial statements contain all adjustments (which all are of a normal recurring nature) necessary to present fairly our financial position as of June 30, 2003 and 2002, in accordance with GAAP. Interim results for the three-months and six months ended March 31, and June 30, 2003 may not be indicative of results that will be realized for the full year ending December 3 1, 2003. Certain prior period amounts have been reclassified in order to conform to current period presentation. |
Our independent accountants have performed a review of, and issued a report on, these consolidated interim financial statements in accordance with standards established by the American Institute of Certified Public Accountants. Pursuant to Rule 436(c) under the U.S. Securities Act of 1933, this report should not be considered a part of any registration statement prepared or certified within the meanings of Section 7 and 11 of the Securities Act. |
Use of Estimates |
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, such as Statement of Position 94-6 "Disclosure of Certain Significant Risks and Uncertainties," requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Examples of estimates used by DPL include the calculation of the allowance for uncollectible accounts, environmental remediation costs and anticipated collections, and unbilled revenue. Although DPL believes that its estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates. |
Impact of Other Accounting Standards |
Asset Retirement Obligations |
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143 entitled "Accounting for Asset Retirement Obligations," which was adopted by DPL on January 1, 2003. This Statement establishes the accounting and reporting standards for measuring and recording asset retirement obligations. DPL has identified $177.3 million and $173.2 million at June 30, 2003 and December 31, 2002, respectively, in asset removal costs that are not legal obligations pursuant to the statement. These removal costs have been accrued and are embedded in accumulated depreciation in the accompanying consolidated balance sheets. |
Accounting for Guarantees |
DPL has applied the provisions of FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," to its agreements that contain guarantee 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 obligation 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. |
DPL has guaranteed residual values related to certain lease agreements for equipment and fleet vehicles under which the Company has guaranteed the portion of residual value in excess of fair value of assets leased. As of June 30, 2003, obligations under the guarantees were approximately $2.1 million. Assets leased under agreements subject to residual value guarantees are typically for a period ranging from 2 years to 10 years. Historically, payments under the guarantee have not been made by the Company as, under normal conditions, the contract runs to full term at which time the residual value is minimal. As such, the Company believes the likelihood of requiring payment under the guarantee is remote. |
As of June 30, 2003, DPL did not have material obligations assumed under guarantees issued or modified after December 31, 2002 which were required to be recognized as a liability on its consolidated balance sheets. |
New Accounting Standards |
In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149 entitled "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement amends and clarifies SFAS No. 133 for certain interpretive guidance issued by the Derivatives Implementation Group. SFAS No. 149 is effective after June 30, 2003, for contracts entered into or modified and for hedges designated after the effective date. The Company is in the process of assessing the provisions of SFAS No. 149 to determine its impact on the Company's financial position and results of operations. |
In May 2003, the FASB issued SFAS No. 150 entitled "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 (the Company's third quarter 2003 financial statements). This Statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity and will result in the Company's reclassification of its "Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Which Holds Solely Parent Junior Subordinated Debentures" balance being reclassified on its consolidated balance sheets to a liability classification. There will be no impact on the Company's results of operat ions from the implementation of this Statement. |
(3) DEBT |
During the quarter ended June 30, 2003, and subsequent thereto through August 7, 2003, DPL engaged in the following capital market transactions: |
On May 1, 2003, DPL redeemed $32 million of 8.15% First Mortgage Bonds due October 1, 2015. |
On June 2, 2003, DPL redeemed at maturity $2.2 million First Mortgage Bonds, 6.95% Series. |
On July 1, 2003, DPL redeemed at maturity $85 million of 6.4% First Mortgage Bonds. |
On July 29, 2003, Pepco Holdings, Pepco, DPL and ACE entered into (i) a three-year working capital credit facility with an aggregate credit limit of $550 million and (ii) a 364-day working capital credit facility with an aggregate credit limit of $550 million. Pepco Holdings' credit limit under these facilities is $700 million, and the credit limit of each of Pepco, DPL and ACE under these facilities is $300 million, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at any given time under these facilities may not exceed $400 million. Funds borrowed under these facilities are available for general corporate purposes. Either credit facility also can be used as credit support for the commercial paper programs of the respective companies. These credit facilities replaced a $1.5 billion 364-day credit facility entered into on August 1, 2002. |
On August 7, 2003 on behalf of DPL, the Delaware Economic Development Authority issued $33.2 million of long-term bonds and loaned the proceeds to DPL. The bonds issued included $15.0 million of variable rate Exempt Facilities Refunding Revenue Bonds, Series A due August 1, 2038, and $18.2 million of 3.15% Pollution Control Refunding Revenue Bonds, Series B due February 1, 2023. The Series B bonds are subject to mandatory tender on August 1, 2008. All or a portion of the tendered bonds may be redeemed and/or remarketed. After August 1, 2008, the bonds may bear interest at a variable rate or fixed rate and may be subject to optional redemption prior to maturity, as provided for in the indenture for the bonds. On September 15, 2003, DPL will use the proceeds to redeem $33.2 million of bonds outstanding, as follows: $15.0 million of 6.05% bonds, due June 1, 2032, and $18.2 million of 5.90% bonds, due June 1, 2021. |
(4) SEGMENT INFORMATION |
Conectiv's organizational structure and management reporting information is aligned with Conectiv's business segments, irrespective of the subsidiary, or subsidiaries, through which a business is conducted. Businesses are managed based on lines of business, not legal entity. Business segment information is not produced, or reported, on a subsidiary by subsidiary basis. Thus, as a Conectiv subsidiary, no business segment information (as defined by SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information") is available for DPL on a stand-alone basis. |
(5) COMMITMENTS AND CONTINGENCIES |
Rate Changes |
On March 31, 2003, DPL filed with the Delaware Public Service Commission for a gas base rate increase of $16.8 million, or an increase of 12.7% in total operating revenue. The filing includes a request for a ROE of 12.5%. DPL is currently authorized a ROE of 11.5% in Delaware. This is the first increase requested for its gas distribution since 1994. The Commission suspended the requested increase pending evidentiary hearings, so DPL has exercised its statutory right to place an interim base rate increase of 1.9% into effect on May 30, 2003, subject to refund. |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
ATLANTIC CITY ELECTRIC COMPANY |
For additional information, other than the information disclosed in the Notes to Consolidated Financial Statements section herein, refer to Item 8. Financial Statements and Supplementary Data of the Company's 2002 Form 10-K. |
(1) ORGANIZATION |
Atlantic City Electric Company (ACE) is a subsidiary of Conectiv, which is a registered holding company under the Public Utility Holding Company Act of 1935 (PUHCA). On March 1, 1998, Conectiv was formed (the 1998 Merger) through an exchange of common stock with Atlantic Energy, Inc. and Delmarva Power & Light Company (DPL). |
On August 1, 2002, Conectiv was acquired by Pepco Holdings, Inc. (PHI) in a transaction pursuant to an Agreement and Plan of Merger (the Conectiv/Pepco Merger Agreement), dated as of February 9, 2001, among PHI (formerly New RC, Inc.), Conectiv and Potomac Electric Power Company (Pepco), in which Pepco and Conectiv merged with subsidiaries of PHI (the Conectiv/Pepco Merger). As a result of the Conectiv/Pepco Merger, Conectiv and Pepco and their respective subsidiaries (including ACE) each became subsidiaries of PHI. ACE continues as a wholly owned, direct subsidiary of Conectiv. |
ACE is a public utility that generates, supplies and delivers electricity to its customers under the trade name Conectiv Power Delivery. ACE delivers electricity within its service area through its transmission and distribution systems. ACE has default service obligations, known as Basic Generation Service (BGS), for approximately 20 percent of the electricity supply to its customers. ACE expects to fulfill these obligations through the generation output from its fossil fuel-fired generating plants and through existing purchase power agreements with non-utility generators. In January 2003, ACE terminated its competitive bidding process to sell these generation assets. ACE's regulated service area covers about 2,700 square miles within the southern one-third of New Jersey and has a population of approximately 0.9 million. |
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND IMPACT OF OTHER
ACCOUNTING STANDARDS |
Significant Accounting Policies |
Principles of Consolidation |
The consolidated financial statements include the accounts of ACE and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. |
Financial Statement Presentation |
The Company'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 U.S. Securities and Exchange Commission, 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 our Annual Report on Form 10K for the year ended December 31, 2002. In our management's opinion, the consolidated financial statements contain all adjustments (which all are of a normal recurring nature) necessary to present fairly our financial position as of June 30, 2003 and 2002, in accordance with GAAP. Interim results for the three-months and six months ended March 31, and June 30, 2003 may not be indicative of results that will be realized for the full year ending December 3 1, 2003. Certain prior period amounts have been reclassified in order to conform to current period presentation. |
Our independent accountants have performed a review of, and issued a report on, these consolidated interim financial statements in accordance with standards established by the American Institute of Certified Public Accountants. Pursuant to Rule 436(c) under the U.S. Securities Act of 1933, this report should not be considered a part of any registration statement prepared or certified within the meanings of Section 7 and 11 of the Securities Act. |
Use of Estimates |
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, such as Statement of Position 94-6 "Disclosure of Certain Significant Risks and Uncertainties," requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Examples of estimates used by ACE include the calculation of the allowance for uncollectible accounts and environmental remediation costs and anticipated collections. Although ACE believes that its estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates. |
Impact of Other Accounting Standards |
Accounting for Guarantees |
ACE has applied the provisions of FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," to its agreements that contain guarantee 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 obligation 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. |
ACE has guaranteed residual values related to certain lease agreements for equipment and fleet vehicles under which the Company has guaranteed the portion of residual value in excess of fair value of assets leased. As of June 30, 2003, obligations under the guarantees were approximately $2.5 million. Assets leased under agreements subject to residual value guarantees are typically for a period ranging from 2 years to 10 years. Historically, payments under the guarantee have not been made by the Company as, under normal conditions, the contract runs to full term at which time the residual value is minimal. As such, the Company believes the likelihood of requiring payment under the guarantee is remote. |
As of June 30, 2003, ACE did not have material obligations assumed under guarantees issued or modified after December 31, 2002 which were required to be recognized as a liability on its consolidated balance sheets. |
New Accounting Standards |
In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149 entitled "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement amends and clarifies SFAS No. 133 for certain interpretive guidance issued by the Derivatives Implementation Group. SFAS No. 149 is effective after June 30, 2003, for contracts entered into or modified and for hedges designated after the effective date. The Company is in the process of assessing the provisions of SFAS No. 149 to determine its impact on the Company's financial position and results of operations. |
In May 2003, the FASB issued SFAS No. 150 entitled "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 (the Company's third quarter 2003 financial statements). This Statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity and will result in the Company's reclassification of its "Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Which Holds Solely Parent Junior Subordinated Debentures" balance being reclassified on its consolidated balance sheets to a liability classification. There will be no impact on the Company's results of operat ions from the implementation of this Statement. |
(3) DEBT |
During the quarter ended June 30, 2003, and subsequent thereto through August 7, 2003, ACE engaged in the following capital market transactions: |
On June 2, 2003, ACE redeemed at maturity $30 million of 6.63% Medium-Term Notes. |
On July 29, 2003, Pepco Holdings, Pepco, DPL and ACE entered into (i) a three-year working capital credit facility with an aggregate credit limit of $550 million and (ii) a 364-day working capital credit facility with an aggregate credit limit of $550 million. Pepco Holdings' credit limit under these facilities is $700 million, and the credit limit of each of Pepco, DPL and ACE under these facilities is $300 million, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at any given time under these facilities may not exceed $400 million. Funds borrowed under these facilities are available for general corporate purposes. Either credit facility also can be used as credit support for the commercial paper programs of the respective companies. These credit facilities replaced a $1.5 billion 364-day credit facility entered into on August 1, 2002. |
(4) SEGMENT INFORMATION |
Conectiv's organizational structure and management reporting information is aligned with Conectiv's business segments, irrespective of the subsidiary, or subsidiaries, through which a business is conducted. Businesses are managed based on lines of business, not legal entity. Business segment information is not produced, or reported, on a subsidiary by subsidiary basis. Thus, as a Conectiv subsidiary, no business segment information (as defined by SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information") is available for ACE on a stand-alone basis. |
(5) COMMITMENTS AND CONTINGENCIES |
Rate Changes |
On February 3, 2003, ACE filed a petition with the New Jersey Board of Public Utilities (NJBPU) to increase its electric distribution rates in New Jersey. The petition seeks a rate increase of approximately $68.4 million in electric delivery revenues, which equates to an increase in average total electricity rates of 6.9 percent overall. The filing requests a continuation of the currently authorized 12.5% ROE as well as the recovery of several regulatory assets, including carrying costs, over a four-year period. This is the first increase requested for electric distribution rates since 1991. ACE's Petition requested that this increase be made effective for service rendered on and after August 1, 2003. ACE cannot predict at this time the outcome of this filing, except that any change in rates relating to the filing will occur sometime after August 1, 2003. |
Stranded Cost Determination and Securitization |
On January 31, 2003, ACE filed a petition with the NJBPU seeking an administrative determination of stranded costs associated with the B. L. England ("BLE") generating facility. The net after tax stranded costs included in the petition were approximately $151 million. An administrative determination of the stranded costs is needed due to the cancelled sale of the plant. On July 25, 2003 the NJBPU rendered an oral decision approving the administrative determination of stranded costs at a level of $149.5 million. As a result of this order, ACE reversed $10.0 million ($5.9 million after-tax) of previously accrued liability for possible disallowance of stranded costs. This credit to expense is classified as an extraordinary item in the Consolidated Statements of Earnings because the original accrual was part of an extraordinary charge resulting from the discontinuation of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation" in conjunction with the deregulation of ACE's energy business in September 1999. It is anticipated that in the third quarter, the NJBPU will issue a ruling on ACE's request to securitize these stranded costs. |
On February 5, 2003, the NJBPU issued an order on its own initiative seeking input from ACE and the Ratepayer Advocate within 10 days as to whether and by how much to cut the 13% pre-tax return that ACE was then authorized to earn on BLE. ACE responded on February 18 with arguments that: 1) reduced costs to ratepayers could be achieved legally through timely approvals by the NJBPU of the stranded cost filing made by ACE on January 31, 2003, and a securitization filing made the week of February 10; and 2) it would be unlawful, perhaps unconstitutional, and a breach of settlement and prior orders for the NJBPU to deny a fair recovery on prudently incurred investment and to do so without evidentiary hearings or other due process. On April 21, 2003, the NJBPU issued an order making the return previously allowed on BLE interim, as of the date of the order, and directing that the issue of the appropriate return for BLE be included in the stranded cos t proceeding. On July 25, 2003, the NJBPU voted to approve a pre-tax return reflecting a 9.75% Return on Equity for the period April 21, 2003 through August 1, 2003. The rate from August 1, 2003 through such time as ACE securitizes the stranded costs will be 5.25%, which the NJBPU represents as being approximately equivalent to the securitization rate. A written order had not been issued as of August 8, 2003. |
On February 14, 2003, ACE filed a Bondable Stranded Costs Rate Order Petition with the NJBPU. The petition requests authority to issue $160 million of Transition Bonds to finance the recovery of stranded costs associated with BLE and costs of issuances. This proceeding is related to the proceeding seeking an administrative determination of the stranded costs associated with BLE that was the subject of the July 25, 2003 NJBPU vote. The Company cannot predict at this time the outcome of these proceedings. |
Restructuring Deferral |
On August 1, 2002, in accordance with the provisions of New Jersey's Electric Discount and Energy Competition Act (EDECA) and the NJBPU Final Decision and Order concerning the restructuring of ACE's electric utility business, ACE petitioned the NJBPU for the recovery of about $176.4 million in actual and projected deferred costs incurred by ACE over the four-year period August 1999 through July 31, 2003. The requested 8.4% increase was to recover those deferred costs over a new four-year period beginning August 1, 2003 and to reset rates so that there would be no under-recovery of costs embedded in ACE's rates on or after that date. ACE's recovery of the deferred costs is subject to review and approval by the NJBPU in accordance with EDECA. An Initial Decision by the Administrative Law Judge was rendered on June 3, 2003. The Initial Decision was consistent with the recommendations of the auditors hired by the NJBPU to audit ACE's deferral balances. |
On July 31, 2003, the NJBPU issued its Summary Order permitting ACE to begin collecting a portion of the deferred costs that were incurred as a result of EDECA and to reset rates to recover on-going costs incurred as a result of EDECA. |
The Summary Order approved the recovery of $125 million of the deferred balance over a ten-year amortization period beginning August 1, 2003. The Summary Order also transferred to ACE's pending base case for further consideration approximately $25.4 million of the deferred balance. The Summary Order estimated the overall deferral balance as of July 31, 2003 at $195 million, of which $44.6 million was disallowed recovery by ACE. Since the amounts included in this decision are based on estimates through July 31, 2003, the actual ending deferred cost balance will be subject to review and finalization by the NJPBU and ACE. The approved rates became effective on August 6, 2003. Based on analysis of the order and in accordance with prevailing accounting rules, ACE recorded a charge of $27.5 million ($16.3 million after-tax) during the second quarter of 2003. This charge is in addition to amounts previously accrued for disallowance. ACE believes the record does not justify the level of disallowance imposed by the NJBPU. ACE is awaiting the final written order from the NJBPU and is evaluating its options related to this decision. The NJBPU's action is not appealable until a final written order has been issued. |
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS |
For additional information, other than the information disclosed herein, refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company's 2002 Form 10-K. |
PEPCO HOLDINGS |
OVERVIEW -- PEPCO |
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. Under settlements entered into with regulatory authorities in connection with the divestiture of its generation assets in 2000, Pepco is required to provide default electricity supply (referred to as "standard offer service") at specified rates to customers in Maryland until July 2004 and to customers in Washington, D.C. until February 2005, which supply it purchases from an affiliate of Mirant Corporation ("Mirant"). For the twelve months ended June 30, 2003, Pepco delivered 5.7 million megawatt hours to SOS customers in the District of Columbia and 10.3 million megawatt hours to SOS customers in Maryland. For this period total deliveries were 11.2 million megawatt hours in the District of Columbia and 15.4 million megawatt hours in Maryland. |
On April 29, 2003, the Maryland Public Service Commission approved a settlement in Phase 1 of Maryland Case No. 8908 under which Pepco will supply retail customers with standard offer service electricity at market prices, including a margin, after existing rate caps expire in July 2004. Under this settlement, Pepco will provide standard offer service to its Maryland residential customers from July 2004 through May 2008 and to its non-residential customers for periods of one to four years. Pepco will obtain power for this market rate standard offer service through a competitive wholesale bidding process. In the District of Columbia, under current law, Pepco will not provide standard offer service after the expiration of its current obligations in February 2005, unless the District of Columbia Public Service Commission determines that there are insufficient bids to provide standard offer service, in which case Pepco may be directed to provide suc h service. |
Relationship with Mirant Corporation |
In 2000, Pepco sold substantially all of its electricity generation assets to Mirant, formerly Southern Energy, Inc. As part of the asset purchase and sale agreement (the "Asset Purchase and Sale Agreement"), Pepco and Mirant entered into Transition Power Agreements for Maryland and the District of Columbia, respectively (collectively, the "TPAs"). Under these agreements an affiliate of Mirant is obligated to supply Pepco with all of the capacity and energy needed to fulfill its standard offer service obligations in Maryland until July 2004 and in the District of Columbia until February 2005. The prices paid by Pepco under the TPAs consist of a $3.50 per megawatt hour capacity price and a $.50 per megawatt hour charge for certain ancillary services, and an energy payment price of $35.50 per megawatt hour during summer months (May 1 through September 30) and $25.30 per megawatt hour during winter months (October 1 through April 30) in Maryland a nd $40.00 per megawatt hour during summer months and $22.20 per megawatt hour during winter months in the District of Columbia. The average purchase price is approximately 3.4 cents per kilowatt hour. These rates result in payments to the Mirant affiliate that are lower than the revenues produced by the currently approved tariff rates that Pepco charges its customers for providing standard offer service, which average 4.1 cents per kilowatt hour. The difference in revenues is shared with customers pursuant to regulatory settlements. |
Under agreements with FirstEnergy Corp., formerly Ohio Edison ("FirstEnergy"), and Allegheny Energy, Inc., 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"), 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 term of the Asset Purchase and Sale Agreement, Pepco, in connection with the sale of substantially all of its electricity generation assets to Mirant, entered into "back-to-back" agreements with Mirant. Under the agreements, Mirant is obligated 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 PPA s. |
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. Mirant is continuing to supply power to Pepco under the terms of the TPAs and is performing its contractual obligations to Pepco corresponding to Pepco's obligations under the PPAs (the "PPA-Related Obligations"). Retail prices paid by Pepco's standard offer service customers have not been affected by the bankruptcy filing. These retail prices can be changed only by order of the Maryland and the District of Columbia Public Service Commissions. |
Under bankruptcy law, a debtor may affirm or reject executory contracts. A rejection of an executory contract entitles the counterparty to file a claim as an unsecured creditor against the bankruptcy estate for damages incurred due to the rejection of the contract. Mirant has not informed Pepco and, to the knowledge of Pepco, has not otherwise stated that it intends to reject either of the TPAs or its PPA-Related Obligations. However, there is no assurance that Mirant will not seek to reject the agreements in the course of the bankruptcy proceedings. |
If Mirant were to attempt to reject either of the TPAs or its PPA-Related Obligations, Pepco intends to exercise all available legal remedies and vigorously oppose any actions that could adversely affect Pepco's rights under its agreements with Mirant. While Pepco believes that it has substantial legal bases to oppose any attempt at rejection of the agreements, the outcome of the bankruptcy proceeding cannot be predicted with any degree of certainty. Pepco intends to be actively involved in the bankruptcy proceeding to protect the interests of its customers and shareholders. If Mirant were to fail to fulfill its obligations under the TPAs, Pepco would be required to replace the electricity supply under the TPAs, likely through one or more supply contracts supplemented by spot market purchases. Pepco is confident that it would have alternative sources of supply sufficient to fulfill its standard offer service obligations to customers in Washingt on, D.C. and Maryland. |
To evaluate the potential financial impact of the Mirant bankruptcy, Pepco has prepared the following estimates of its exposure if Mirant successfully rejected the TPAs and its PPA-Related Obligations as of September 1, 2003. These estimates are based on current spot market prices and forward price estimates for energy and capacity, and on current percentages of service territory load served by competitive suppliers and by standard offer service and do not include financing costs, all of which could be subject to significant fluctuation. These estimates do not take into account alternative supply arrangements that might be entered into by Pepco that could mitigate the losses that might otherwise be incurred. They also assume no recovery on either the bankruptcy claims or regulatory recovery of costs, which would also mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recover y. Based on these assumptions, Pepco estimates that its pre-tax exposure, representing the loss of the benefit of the contracts to Pepco is as follows: |
Based on the foregoing assumptions, Pepco estimates that its pre-tax exposure aggregates approximately $700 million on a net present value basis (based on a discount rate of 7.5 percent). |
If Mirant were to successfully reject any or all of the contracts, the ability of Pepco to recover damages from the Mirant bankruptcy estate would depend on 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 make a prediction regarding the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate. However, if Mirant successfully rejects the TPAs and Pepco's full claim is not paid by Mirant's bankruptcy estate, Pepco may seek authority from the Maryland and District of Columbia Public Service Commissions to recover these costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers. |
In view of the foregoing, the consequences of a successful rejection by Mirant of one or more of the TPAs and its PPA-Related Obligations could have a material adverse effect on Pepco Holdings' and Pepco's results of operations. However, Pepco Holdings currently does not believe that a rejection by Mirant of one or more of the contracts would have a material adverse effect on its financial condition. |
CRITICAL ACCOUNTING POLICIES |
The U.S. Securities and Exchange Commission (SEC) has defined a company's most critical accounting policies as the ones that are most important to the portrayal of the Company's financial condition and results of operations, and which require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, Pepco Holdings has identified the critical accounting policies and judgments as addressed below. |
Principles of Consolidation |
The accompanying consolidated financial statements include the accounts of Pepco Holdings and its wholly owned subsidiaries. All intercompany balances and transactions between subsidiaries have been eliminated. Investments in entities in which Pepco Holdings has a 20% to 50% interest are accounted for using the equity method. Under the equity method, investments are initially carried at cost and subsequently adjusted for the Company's proportionate share of the investees' undistributed earnings or losses and dividends. |
Accounting Policy Choices |
Pepco Holdings' management believes that based on the nature of the businesses that its subsidiaries operate, the Company has very little choice regarding the accounting policies it utilizes. For instance, approximately 70% of Pepco Holdings' business consists of its regulated utility operations, which are subject to the provisions of Statement of Financial Accounting Standards (SFAS) No. 71 "Accounting for the Effects of Certain Types of Regulation." However, in the areas that Pepco Holdings is afforded accounting policy choices, management does not believe that the application of different accounting policies than those that it chose would materially impact its financial condition or results of operations. |
Use of Estimates |
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, such as Statement of Position 94-6 "Disclosure of Certain Significant Risks and Uncertainties," requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Examples of estimates used by the Company include the calculation of the allowance for uncollectible accounts, environmental remediation costs and anticipated collections, unbilled revenue, pension assumptions, fair values used in the purchase method of accounting and the resulting goodwill balance. Although Pepco Holdings believes that its estimates and assumptions are reasonable, they are based upon information presently available. Actual results may d iffer significantly from these estimates. |
New Accounting Standards |
In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149 entitled "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement amends and clarifies SFAS No. 133 for certain interpretive guidance issued by the Derivatives Implementation Group. SFAS No. 149 is effective after June 30, 2003, for contracts entered into or modified and for hedges designated after the effective date. The Company is in the process of assessing the provisions of SFAS No. 149 to determine its impact on the Company's financial condition and results of operations. |
In May 2003, the FASB issued SFAS No. 150 entitled "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 (the Company's third quarter 2003 financial statements). This Statement establishes standards for how an issuer classifies and measures in its statement of financial condition certain financial instruments with characteristics of both liabilities and equity and will result in the Company's reclassification of its "Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Which Holds Solely Parent Junior Subordinated Debentures" on its consolidated balance sheets to a liability classification. There will be no impact on the Company's results of operations from the implementati on of this Statement. |
CONSOLIDATED RESULTS OF OPERATIONS |
LACK OF COMPARABILITY OF OPERATING RESULTS WITH PRIOR PERIODS |
The accompanying results of operations for the three and six months ended June 30, 2003 include Pepco Holdings and its subsidiaries' results. However, the results of operations for the corresponding 2002 periods, as previously reported by Pepco, include only the consolidated operations of Pepco and its pre-merger subsidiaries. Accordingly, due to the application of the purchase method of accounting that was used to record the merger transaction, Pepco Holdings' results of operations for the three and six months ended June 30, 2003, are not comparable to the corresponding 2002 amounts. |
Pepco Holdings maintains a commercial paper program of up to $700 million. Pepco, DPL, and ACE have up to $300 million, up to $275 million, and up to $250 million commercial paper programs, respectively. |
On July 29, 2003, Pepco Holdings, Pepco, DPL and ACE entered into (i) a three-year working capital credit facility with an aggregate credit limit of $550 million and (ii) a 364-day working capital credit facility with an aggregate credit limit of $550 million. Pepco Holdings' credit limit under these facilities is $700 million, and the credit limit of each of Pepco, DPL and ACE under these facilities is $300 million, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at any given time under these facilities may not exceed $400 million. Funds borrowed under these facilities are available for general corporate purposes. Either credit facility also can be used as credit support for the commercial paper programs of the respective companies. These credit facilities replaced a $1.5 billion 364-day credit facility entered into on August 1, 2002. |
The ability of the companies to borrow under the facilities and the availability of the facilities to support the issuance of commercial paper is subject to customary terms and conditions, including the requirement that each credit extension, together with other credit extensions outstanding under the facility, must not exceed such company's borrowing authority as allowed by all applicable governmental and regulatory authorities, and to the continuing accuracy of the representation and warranty that there has been no change in the business, property, financial condition or results of operations of the borrowing company and its subsidiaries since December 31, 2002 (except as disclosed in such company's Quarterly Report on Form 10-Q for the quarter ending March 31, 2003) that could reasonably be expected to have a material adverse effect on the business, property, financial condition or results of operations of such company and its subs idiaries taken as a whole. |
PUHCA Restrictions |
Because Pepco Holdings is a public utility holding company registered under PUHCA, it must obtain SEC approval to issue securities. PUHCA also prohibits Pepco Holdings from borrowing from its subsidiaries. Under an SEC Financing Order dated July 31, 2002 (the "Financing Order"), Pepco Holdings is authorized to issue equity, preferred securities and debt securities in an aggregate amount not to exceed $3.5 billion through an authorization period ending June 30, 2005, subject to a ceiling on the effective cost of such funds. The external financing limit includes a short-term debt limitation of $2.5 billion, also subject to a ceiling on the effective cost of such funds. Pepco Holdings is also authorized to enter into guarantees to third parties or otherwise provide credit support with respect to obligations of its subsidiaries for up to $3.5 billion. |
The Financing Order requires that, in order to issue debt or equity securities, including commercial paper, Pepco Holdings must maintain a ratio of common stock equity to total capitalization (consisting of common stock, preferred stock, if any, long-term debt and short-term debt) of at least 30 percent. At June 30, 2003, Pepco Holdings' common equity ratio was 31.1 percent, or approximately $147.5 million in excess of the 30 percent threshold. The Financing Order also requires that all rated securities issued by Pepco Holdings be rated "investment grade" by at least one nationally recognized rating agency. Accordingly, if Pepco Holdings' common equity ratio were less than 30 percent or if no nationally recognized rating agency rated a security investment grade, Pepco Holdings could not issue the security without first obtaining from the SEC an amendment to the Financing Order. |
If an amendment to the Financing Order is required to enable Pepco Holdings or any of its subsidiaries to effect a financing, there is no certainty that such an amendment could be obtained, as to the terms and conditions on which an amendment could be obtained or as to the timing of SEC action. The failure to obtain timely relief from the SEC, in such circumstances, could have a material adverse effect on the financial condition of Pepco Holdings and its subsidiaries. |
The foregoing financing limitations also generally apply to Pepco, Conectiv, DPL, ACE and certain other Pepco Holdings' subsidiaries. |
Financing Activities |
During the quarter ended June 30, 2003 and subsequent thereto through August 7, 2003, Pepco Holdings and its subsidiaries engaged in the following capital market transactions: |
On May 1, 2003, DPL redeemed $32 million of 8.15% First Mortgage Bonds due October 1, 2015. |
On May 20, 2003, Pepco purchased on the open market $15 million of 7% Medium-Term Notes due January 15, 2024. |
On May 29, 2003, Pepco Holdings issued $400 million of notes. $200 million were issued at a fixed rate of 4% due May 15, 2010 and $200 million were issued at a floating rate (3 month LIBOR plus 80 basis points) due November 15, 2004. Proceeds were used to pay down Pepco Holdings commercial paper. |
On June 2, 2003, Conectiv redeemed at maturity $50 million of 6.73% series Medium-Term Notes. |
On June 2, 2003, DPL redeemed at maturity $2.2 million of 6.95% First Mortgage Bonds. |
On June 2, 2003, ACE redeemed at maturity $30 million of 6.63% Medium Term Notes. |
On July 1, 2003, DPL redeemed at maturity $85 million of 6.4% First Mortgage Bonds. |
On July 21, 2003, Pepco redeemed the following First Mortgage Bonds: $40 million of 7.5% series due March 15, 2028 and $100 million of 7.25% series due July 1, 2023. |
PCI redeemed the following Medium Term-Notes at maturity: on April 1, 2003, $10 million of its 6.5% Series; on June 2, 2003, $3.5 million of its 7.38% Series; on June 18, 2003, $1 million of its 7.3% Series; on July 15, 2003, $5 million of its 7.04% Series and on July 28, 2003; $7 million of its 7% Series. |
On August 1, 2003 Pepco mailed official notice to the holders of its Serial Preferred Stock, $3.40 Series of 1992 for mandatory sinking fund redemption on September 1, 2003 of 50,000 shares at par value of $50.00 per share. |
In September 2002, Pepco Holdings issued in a private placement $1.5 billion of notes. In connection with the sale of the notes, Pepco Holdings agreed to cause an exchange offer for the notes to be completed no later than June 3, 2003. By May 22, 2003, all of the exchange notes were issued and all of the original notes were tendered. |
On August 7, 2003 on behalf of DPL, the Delaware Economic Development Authority issued $33.2 million of long-term bonds and loaned the proceeds to DPL. The bonds issued included $15.0 million of variable rate Exempt Facilities Refunding Revenue Bonds, Series A due August 1, 2038, and $18.2 million of 3.15% Pollution Control Refunding Revenue Bonds, Series B due February 1, 2023. The Series B bonds are subject to mandatory tender on August 1, 2008. All or a portion of the tendered bonds may be redeemed and/or remarketed. After August 1, 2008, the bonds may bear interest at a variable rate or fixed rate and may be subject to optional redemption prior to maturity, as provided for in the indenture for the bonds. On September 15, 2003, DPL will use the proceeds to redeem $33.2 million of bonds outstanding, as follows: $15.0 million of 6.05% bonds, due June 1, 2032, and $18.2 million of 5.90% bonds, due June 1, 2021. |
Effect of Mirant Bankruptcy on Liquidity |
As more fully described in the "Overview - Pepco" section, Pepco Holdings currently estimates that if Mirant were successfully to reject contractual obligations it has with Pepco, Pepco could incur certain pre-tax losses over the remaining terms of the respective agreements. These estimates are based on current spot market prices and forward price estimates for energy and capacity, and on current percentages of service territory load served by competitive suppliers and by standard offer service and do not include financing costs, all of which could be subject to significant fluctuation. These estimates do not take into account alternative supply arrangements that might be entered into by Pepco that could mitigate the losses that might otherwise be incurred. They also assume no recovery on either the bankruptcy claims or regulatory recovery of costs, which would also mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recovery. Applying the assumptions discussed above under "Relationship with Mirant Corporation," the estimated effect on Pepco Holdings' cash position as a result of a rejection as of September 1, 2003, for the balance of 2003, 2004 and 2005 would be as follows ($ in Millions): |
REGULATORY AND OTHER MATTERS |
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 see the "Overview - Pepco" and "Capital Resources and Liquidity -- Effect of Mirant Bankruptcy on Liquidity" sections herein. |
Rate Changes |
On February 3, 2003, ACE filed a petition with the NJBPU to increase its electric distribution rates in New Jersey. The petition seeks a rate increase of approximately $68.4 million in electric delivery revenues, which equates to an increase in average total electricity rates of 6.9 percent overall. The filing requests a continuation of the currently authorized 12.5% ROE as well as the recovery of several regulatory assets, including carrying costs, over a four-year period. This is the first increase requested for electric distribution rates since 1991. ACE's Petition requested that this increase be made effective for service rendered on and after August 1, 2003. ACE cannot predict at this time the outcome of this filing, except that any change in rates relating to the filing will occur sometime after August 1, 2003. |
On March 31, 2003, DPL filed with the Delaware Public Service Commission for a gas base rate increase of $16.8 million, or an increase of 12.7% in total operating revenue. The filing includes a request for a ROE of 12.5%. DPL is currently authorized a ROE of 11.5% in Delaware. This is the first increase requested for its gas distribution since 1994. The Commission suspended the requested increase pending evidentiary hearings, so the Company has exercised its statutory right to place an interim base rate increase of 1.9% into effect on May 30, 2003, subject to refund. |
Stranded Cost Determination and Securitization |
On January 31, 2003, ACE filed a petition with the NJBPU seeking an administrative determination of stranded costs associated with the B. L. England ("BLE") generating facility. The net after tax stranded costs included in the petition were approximately $151 million. An administrative determination of the stranded costs is needed due to the cancelled sale of the plant. On July 25, 2003 the NJBPU rendered an oral decision approving the administrative determination of stranded costs at a level of $149.5 million. As a result of this order, ACE reversed $10.0 million ($5.9 million after-tax) of previously accrued liability for possible disallowance of stranded costs. This credit to expense is classified as an extraordinary item in the Consolidated Statements of Earnings because the original accrual was part of an extraordinary charge resulting from the discontinuation of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation" in conjunction with the deregulation of ACE's energy business in September 1999. It is anticipated that in the third quarter, the NJBPU will issue a ruling on ACE's request to securitize these stranded costs. |
On February 5, 2003, the NJBPU issued an order on its own initiative seeking input from ACE and the Ratepayer Advocate within 10 days as to whether and by how much to cut the 13% pre-tax return that ACE was then authorized to earn on BLE. ACE responded on February 18 with arguments that: 1) reduced costs to ratepayers could be achieved legally through timely approvals by the NJBPU of the stranded cost filing made by ACE on January 31, 2003, and a securitization filing made the week of February 10; and 2) it would be unlawful, perhaps unconstitutional, and a breach of settlement and prior orders for the NJBPU to deny a fair recovery on prudently incurred investment and to do so without evidentiary hearings or other due process. On April 21, 2003, the NJBPU issued an order making the return previously allowed on BLE interim, as of the date of the order, and directing that the issue of the appropriate return for BLE be included in the stranded cos t proceeding. On July 25, 2003, the NJBPU voted to approve a pre-tax return reflecting a 9.75% Return on Equity for the period April 21, 2003 through August 1, 2003. The rate from August 1, 2003 through such time as ACE securitizes the stranded costs will be 5.25%, which the NJBPU represents as being approximately equivalent to the securitization rate. A written order had not been issued as of August 8, 2003. |
On February 14, 2003, ACE filed a Bondable Stranded Costs Rate Order Petition with the NJBPU. The petition requests authority to issue $160 million of Transition Bonds to finance the recovery of stranded costs associated with BLE and costs of issuances. This proceeding is related to the proceeding seeking an administrative determination of the stranded costs associated with BLE that was the subject of the July 25, 2003 NJBPU vote. The Company cannot predict at this time the outcome of these proceedings. |
Restructuring Deferral |
On August 1, 2002, in accordance with the provisions of New Jersey's Electric Discount and Energy Competition Act (EDECA) and the NJBPU Final Decision and Order concerning the restructuring of ACE's electric utility business, ACE petitioned the NJBPU for the recovery of about $176.4 million in actual and projected deferred costs incurred by ACE over the four-year period August 1999 through July 31, 2003. The requested 8.4% increase was to recover those deferred costs over a new four-year period beginning August 1, 2003 and to reset rates so that there would be no under-recovery of costs embedded in ACE's rates on or after that date. ACE's recovery of the deferred costs is subject to review and approval by the NJBPU in accordance with EDECA. An Initial Decision by the Administrative Law Judge was rendered on June 3, 2003. The Initial Decision was consistent with the recommendations of the auditors hired by the NJBPU to audit ACE's deferral balances. |
On July 31, 2003, the NJBPU issued its Summary Order permitting ACE to begin collecting a portion of the deferred costs that were incurred as a result of EDECA and to reset rates to recover on-going costs incurred as a result of EDECA. |
The Summary Order approved the recovery of $125 million of the deferred balance over a ten-year amortization period beginning August 1, 2003. The Summary Order also transferred to ACE's pending base case for further consideration approximately $25.4 million of the deferred balance. The Summary Order estimated the overall deferral balance as of July 31, 2003 at $195 million, of which $44.6 million was disallowed recovery by ACE. Since the amounts included in this decision are based on estimates through July 31, 2003, the actual ending deferred cost balance will be subject to review and finalization by the NJPBU and ACE. The approved rates became effective on August 6, 2003. Based on analysis of the order and in accordance with prevailing accounting rules, ACE recorded a charge of $27.5 million ($16.3 million after-tax) during the second quarter of 2003. This charge is in addition to amounts previously accrued for disallowance. ACE believes the record does not justify the level of disallowance imposed by the NJBPU. ACE is awaiting the final written order from the NJBPU and is evaluating its options related to this decision. The NJBPU's action is not appealable until a final written order has been issued. |
Pepco Regulatory Contingencies |
Final briefs on Pepco's District of Columbia divestiture proceeds sharing application were filed on July 31, 2002 following an evidentiary hearing in June 2002. That application was filed to implement a provision of Pepco's D.C. Commission approved divestiture settlement that provided for a sharing of any net proceeds from the sale of its generation related assets. A principal issue in the case is whether a sharing between customers and shareholders of the excess deferred income taxes and accumulated deferred investment tax credits associated with the sold assets would violate the normalization provisions of the Internal Revenue Code and implementing regulations. On March 4, 2003, the Internal Revenue Service (IRS) issued a notice of proposed rulemaking (NOPR) that is relevant to that principal issue. Comments on the NOPR were filed by several parties on June 2, 2003, and the IRS held a public hearing on June 25, 2003. Three of the parties in t he case filed comments urging the D. C. Commission to decide the tax issues now on the basis of the proposed rule. Pepco filed comments in reply to those comments, in which Pepco stated that the courts have held and the IRS has stated that proposed rules are not authoritative and that no decision should be issued on the basis of proposed rules. Instead, Pepco argued that the only prudent course of action is for the D.C. Commission to await the issuance of final regulations relating to the tax issues and then allow the parties to file supplemental briefs on the tax issues. Pepco cannot predict whether the IRS will adopt the regulations as proposed, make changes before issuing final regulations or decide not to adopt regulations. Other issues deal with the inclusion of internal costs and cost allocations. Pepco believes that its calculation of the customers' share of divestiture proceeds is correct. However, the potential exists that Pepco could be required to make additional gain sharing payments to D.C. cust omers. Such additional payments, which cannot be estimated, would be charged to expense and could have a material adverse effect on results of operations in the quarter and year in which a decision is rendered; however, Pepco does not believe that additional payments, if any, will have a material adverse impact on its financial condition. It is uncertain when the D.C. Commission will issue a decision. |
Pepco filed its divestiture proceeds plan application in Maryland in April 2001. Reply briefs were filed in May 2002 and Pepco is awaiting a Proposed Order from the Hearing Examiner. The principal issue in the case is the same normalization issue that was raised in the D.C. case. Following the filing of comments by Pepco and two other parties, the Hearing Examiner on April 8, 2003: (1) postponed his earlier decision establishing briefing dates on the question of the impact of the proposed rules on the tax issues until after the June 25, 2003 public hearing on the IRS NOPR;(2) allowed the Staff of the Commission and any other parties to submit motions by April 21, 2003 relating to the interpretation of current tax law as set forth in the preamble to the proposed rules and the effect thereof on the tax issues; and (3) allowed Pepco and any other party to file a response to any motion filed by Staff and other parties by April 30, 2003. Staff filed a motion on April 21, 2003, in which it argued that immediate flow through to customers of a portion of the excess deferred income taxes and accumulated deferred investment tax credits can be authorized now based on the NOPR. Pepco filed a response in opposition to Staff's motion on April 30, 2003, in which, among other things, Pepco argued that no action should be taken on the basis of proposed regulations because, as Pepco stated in a similar pleading in the District of Columbia divestiture proceeds case, proposed regulations are not authoritative. The Hearing Examiner will issue a ruling on Staff's motion, although there is no time within which he must issue a ruling. Pepco cannot predict whether the IRS will adopt the regulations as proposed, make changes before issuing final regulations or decide not to adopt regulations. Other issues deal with the inclusion of internal costs and cost allocations. Pepco believes that its calculation of the customers' share of divestiture proceeds is correct. Howev er, the potential also exists that Pepco would be required to make additional gain sharing payments to Maryland customers. Such additional payments, which cannot be estimated, would be charged to expense and could have a material adverse effect on results of operations in the quarter and year in which a decision is rendered; however, Pepco does not believe that additional payments, if any, will have a material adverse impact on its financial condition. It is uncertain when the Hearing Examiner or the Maryland Commission will issue their decisions. |
Standard Offer Service (SOS) |
District of Columbia |
On February 21, 2003, the D.C. Public Service Commission opened a new proceeding to consider issues relating to (a) the establishment of terms and conditions for providing SOS in the District of Columbia after Pepco's obligation to provide SOS terminates on February 7, 2005, and (b) the selecting of a new SOS provider. Pepco and other parties filed comments on issues identified by the Commission and some parties suggested additional issues. In its comments, Pepco, among other things, suggested that the D.C. law be changed to allow Pepco to continue to be the SOS provider after February 7, 2005. Under existing law, the Commission is to adopt, before January 2, 2004, terms and conditions for SOS and for the selection of a new SOS provider. The Commission is also required, under existing law, to select the new SOS provider before July 2004. Existing law also allows the selection of Pepco as the SOS provider in the event of insufficient bids. At a prehearing conference held on May 15, 2003, the Commission agreed with the recommendations of all but one of the parties to allow a working group, like the one that has been meeting in Maryland, to develop for the Commission's consideration regulations setting the terms and conditions for the provision of SOS service and for the selection of an SOS provider after Pepco's obligation ends in early 2005. However, by order issued on June 24, 2003, the Commission decided that all participating parties should individually propose, by August 29, 2003, regulations setting forth such terms and conditions. The Commission will then issue proposed regulations by September 30, 2003 and allow initial and reply comments from interested parties to be filed by October 30 and November 17, 2003, respectively. Pepco continues to pursue legislation that would allow it to remain as the SOS provider after early 2005. |
Maryland |
In accordance with the terms of an agreement approved by the Maryland Commission, customers who are unable to receive generation services from another supplier, or who do not select another supplier, are entitled to receive services from Pepco until July 1, 2004. Pepco has entered into a settlement in Phase I of Maryland Case No. 8908 to extend its provision of SOS services in Maryland. The settlement was approved by the Maryland Commission on April 29, 2003. One party has filed for rehearing of the Commission's April 29 order. The Commission subsequently denied that application for rehearing on July 26, 2003. The settlement provides for an extension of SOS for four years for residential and small commercial customers, an extension of two years for medium sized commercial customers, and an extension of one year for large commercial customers. The settlement also provides for a policy review by the Commission to consider how SOS will be provided after the current extension expires. In addition, the settlement provides for SOS to be procured from the wholesale marketplace and that Pepco will be able to recover its costs of procurement and a return. Following months of meetings in Phase II, final settlement documents were filed on July 2, 2003. The Phase II settlement documents include the Phase II settlement agreement, a model request for proposals for wholesale power to be delivered to the utility SOS providers and a full requirements service agreement between the wholesale suppliers and the utility SOS providers. Initial testimony on the settlement was filed by numerous parties on July 18, 2003. No party filed testimony opposing the Phase II settlement, although at least one party has stated that it opposes the Phase II settlement. The Commission will set hearing and briefing dates. |
Third Party Guarantees |
As of June 30, 2003, 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 as follows: |
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS |
POTOMAC ELECTRIC POWER COMPANY |
For additional information, other than the information disclosed herein, refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of Pepco's 2002 Form 10-K. |
OVERVIEW -- PEPCO |
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. Under settlements entered into with regulatory authorities in connection with the divestiture of its generation assets in 2000, Pepco is required to provide default electricity supply (referred to as "standard offer service") at specified rates to customers in Maryland until July 2004 and to customers in Washington, D.C. until February 2005, which supply it purchases from an affiliate of Mirant Corporation ("Mirant"). For the twelve months ended June 30, 2003, Pepco delivered 5.7 million megawatt hours to SOS customers in the District of Columbia and 10.3 million megawatt hours to SOS customers in Maryland. For this period total deliveries were 11.2 million megawatt hours in the District of Columbia and 15.4 million megawatt hours in Maryland. |
On April 29, 2003, the Maryland Public Service Commission approved a settlement in Phase 1 of Maryland Case No. 8908 under which Pepco will supply retail customers with standard offer service electricity at market prices, including a margin, after existing rate caps expire in July 2004. Under this settlement, Pepco will provide standard offer service to its Maryland residential customers from July 2004 through May 2008 and to its non-residential customers for periods of one to four years. Pepco will obtain power for this market rate standard offer service through a competitive wholesale bidding process. In the District of Columbia, under current law, Pepco will not provide standard offer service after the expiration of its current obligations in February 2005, unless the District of Columbia Public Service Commission determines that there are insufficient bids to provide standard offer service, in which case Pepco may be directed to provide suc h service. |
Relationship with Mirant Corporation |
In 2000, Pepco sold substantially all of its electricity generation assets to Mirant, formerly Southern Energy, Inc. As part of the asset purchase and sale agreement (the "Asset Purchase and Sale Agreement"), Pepco and Mirant entered into Transition Power Agreements for Maryland and the District of Columbia, respectively (collectively, the "TPAs"). Under these agreements an affiliate of Mirant is obligated to supply Pepco with all of the capacity and energy needed to fulfill its standard offer service obligations in Maryland until July 2004 and in the District of Columbia until February 2005. The prices paid by Pepco under the TPAs consist of a $3.50 per megawatt hour capacity price and a $.50 per megawatt hour charge for certain ancillary services, and an energy payment price of $35.50 per megawatt hour during summer months (May 1 through September 30) and $25.30 per megawatt hour during winter months (October 1 through April 30) in Maryl and and $40.00 per megawatt hour during summer months and $22.20 per megawatt hour during winter months in the District of Columbia. The average purchase price is approximately 3.4 cents per kilowatt hour. These rates result in payments to the Mirant affiliate that are lower than the revenues produced by the currently approved tariff rates that Pepco charges its customers for providing standard offer service, which average 4.1 cents per kilowatt hour. The difference in revenues is shared with customers pursuant to regulatory settlements. |
Under agreements with FirstEnergy Corp., formerly Ohio Edison ("FirstEnergy"), and Allegheny Energy, Inc., 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"), 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 term of the Asset Purchase and Sale Agreement, Pepco, in connection with the sale of substantially all of its electricity generation assets to Mirant, entered into "back-to-back" agreements with Mirant. Under the agreements, Mirant is obligated 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 PPA s. |
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. Mirant is continuing to supply power to Pepco under the terms of the TPAs and is performing its contractual obligations to Pepco corresponding to Pepco's obligations under the PPAs (the "PPA-Related Obligations"). Retail prices paid by Pepco's standard offer service customers have not been affected by the bankruptcy filing. These retail prices can be changed only by order of the Maryland and the District of Columbia Public Service Commissions. |
Under bankruptcy law, a debtor may affirm or reject executory contracts. A rejection of an executory contract entitles the counterparty to file a claim as an unsecured creditor against the bankruptcy estate for damages incurred due to the rejection of the contract. Mirant has not informed Pepco and, to the knowledge of Pepco, has not otherwise stated that it intends to reject either of the TPAs or its PPA-Related Obligations. However, there is no assurance that Mirant will not seek to reject the agreements in the course of the bankruptcy proceedings. |
If Mirant were to attempt to reject either of the TPAs or its PPA-Related Obligations, Pepco intends to exercise all available legal remedies and vigorously oppose any actions that could adversely affect Pepco's rights under its agreements with Mirant. While Pepco believes that it has substantial legal bases to oppose any attempt at rejection of the agreements, the outcome of the bankruptcy proceeding cannot be predicted with any degree of certainty. Pepco intends to be actively involved in the bankruptcy proceeding to protect the interests of its customers and shareholders. If Mirant were to fail to fulfill its obligations under the TPAs, Pepco would be required to replace the electricity supply under the TPAs, likely through one or more supply contracts supplemented by spot market purchases. Pepco is confident that it would have alternative sources of supply sufficient to fulfill its standard offer service obligations to customers in Washingt on, D.C. and Maryland. |
To evaluate the potential financial impact of the Mirant bankruptcy, Pepco has prepared the following estimates of its exposure if Mirant successfully rejected the TPAs and its PPA-Related Obligations as of September 1, 2003. These estimates are based on current spot market prices and forward price estimates for energy and capacity, and on current percentages of service territory load served by competitive suppliers and by standard offer service and do not include financing costs, all of which could be subject to significant fluctuation. These estimates do not take into account alternative supply arrangements that might be entered into by Pepco that could mitigate the losses that might otherwise be incurred. They also assume no recovery on either the bankruptcy claims or regulatory recovery of costs, which would also mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recover y. Based on these assumptions, Pepco estimates that its pre-tax exposure, representing the loss of the benefit of the contracts to Pepco is as follows: |
Based on the foregoing assumptions, Pepco estimates that its pre-tax exposure aggregates approximately $700 million on a net present value basis (based on a discount rate of 7.5 percent). |
If Mirant were to successfully reject any or all of the contracts, the ability of Pepco to recover damages from the Mirant bankruptcy estate would depend on 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 make a prediction regarding the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate. However, if Mirant successfully rejects the TPAs and Pepco's full claim is not paid by Mirant's bankruptcy estate, Pepco may seek authority from the Maryland and District of Columbia Public Service Commissions to recover these costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers. |
In view of the foregoing, the consequences of a successful rejection by Mirant of one or more of the TPAs and its PPA-Related Obligations could have a material adverse effect on Pepco's results of operations. However, Pepco currently does not believe that a rejection by Mirant of one or more of the contracts would have a material adverse effect on its financial condition. |
CRITICAL ACCOUNTING POLICIES |
The U.S. Securities and Exchange Commission (SEC) has defined a company's most critical accounting policies as the ones that are most important to the portrayal of Pepco's financial condition and results of operations, and which require Pepco to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, Pepco has identified the critical accounting policies and judgments as addressed below. |
Accounting Policy Choices |
Pepco's management believes that based on the nature of its business it has very little choice regarding the accounting policies it utilize as Pepco's business consists of its regulated utility operations, which are subject to the provisions of Statement of Financial Accounting Standards (SFAS) No. 71 "Accounting for the Effects of Certain Types of Regulation." However, in the areas that Pepco is afforded accounting policy choices, management does not believe that the application of different accounting policies than those that it chose would materially impact its financial condition or results of operations. |
Use of Estimates |
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, such as Statement of Position 94-6 "Disclosure of Certain Significant Risks and Uncertainties," requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Examples of estimates used by Pepco include the calculation of the allowance for uncollectible accounts, environmental remediation costs and anticipated collections, unbilled revenue, and pension assumptions. Although Pepco believes that its estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates. |
New Accounting Standards |
In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149 entitled "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement amends and clarifies SFAS No. 133 for certain interpretive guidance issued by the Derivatives Implementation Group. SFAS No. 149 is effective after June 30, 2003, for contracts entered into or modified and for hedges designated after the effective date. The Company is in the process of assessing the provisions of SFAS No. 149 to determine its impact on the Company's financial condition and results of operations. |
In May 2003, the FASB issued SFAS No. 150 entitled "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 (the Company's third quarter 2003 financial statements). This Statement establishes standards for how an issuer classifies and measures in its statement of financial condition certain financial instruments with characteristics of both liabilities and equity and will result in the Company's reclassification of its "Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Which Holds Solely Parent Junior Subordinated Debentures" on its consolidated balance sheets to a liability classification. There will be no impact on the Company's results of operations from the implementati on of this Statement. |
CONSOLIDATED RESULTS OF OPERATIONS |
LACK OF COMPARABILITY OF OPERATING RESULTS WITH PRIOR YEARS |
The accompanying results of operations for the three and six months ended June 30, 2003 include only Pepco's operations. The results of operations for the corresponding 2002 periods, as previously reported by Pepco, include the consolidated operations of Pepco and its pre-merger subsidiaries. Accordingly, the results of operations for the three and six months ended June 30, 2003, are not comparable to the corresponding 2002 amounts. |
OPERATING REVENUE |
Results for Three Months Ended June 30, 2003 Compared to June 30, 2002 |
Total operating revenue for the three months ended June 30, 2003, was $370.1 million compared to $581.2 million for the corresponding period in 2002. Intercompany revenue has been eliminated for purposes of this analysis. |
The decrease in Pepco's income tax expense during the six months ended June 30, 2003 primarily results from lower net income due to higher pension and OPEB expenses. |
Pepco Energy Services and PCI's operating results during this 2003 period were not recorded by Pepco as in July 2002 Pepco transferred ownership of Pepco Energy Services and PCI to Pepco Holdings in connection with the Conectiv merger. |
CAPITAL RESOURCES AND LIQUIDITY |
Sources of Liquidity |
Pepco relies on access to the bank and capital markets as the primary source of liquidity not satisfied by cash provided by its operations. The ability of Pepco to borrow funds or issue securities, and the associated financing costs, are affected by its credit ratings. Due to $103.8 million of cash provided by operating activities, $89.6 million of cash used by investing activities, and $10.8 million of cash used by financing activities, cash and cash equivalents increased by $3.4 million during the six months ended June 30, 2003 to $17.3 million. |
Working Capital |
At June 30, 2003, Pepco's current assets totaled $502.2 million, whereas current liabilities totaled $702.2 million. Current liabilities include $190 million in long-term debt due within one year and an additional $24.8 million of outstanding commercial paper. Pepco has a commercial paper program of up to $300 million. |
On July 29, 2003, Pepco Holdings, Pepco, DPL and ACE entered into (i) a three-year working capital credit facility with an aggregate credit limit of $550 million and (ii) a 364-day working capital credit facility with an aggregate credit limit of $550 million. Pepco Holdings' credit limit under these facilities is $700 million, and the credit limit of each of Pepco, DPL and ACE under these facilities is $300 million, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at any given time under these facilities may not exceed $400 million. Funds borrowed under these facilities are available for general corporate purposes. Either credit facility also can be used as credit support for the commercial paper programs of the respective companies. These credit facilities replaced a $1.5 billion 364-day credit facility entered into on August 1, 2002. |
The ability of the companies to borrow under the facilities and the availability of the facilities to support the issuance of commercial paper is subject to customary terms and conditions, including the requirement that each credit extension, together with other credit extensions outstanding under the facility, must not exceed such company's borrowing authority as allowed by all applicable governmental and regulatory authorities, and to the continuing accuracy of the representation and warranty that there has been no change in the business, property, financial condition or results of operations of the borrowing company and its subsidiaries since December 31, 2002 (except as disclosed in such company's Quarterly Report on Form 10-Q for the quarter ending March 31, 2003) that could reasonably be expected to have a material adverse effect on the business, property, financial condition or results of operations of such company and its subs idiaries taken as a whole. |
PUHCA Restrictions |
An SEC Financing Order dated July 31, 2002 (the "Financing Order"), requires that, in order to issue debt or equity securities, including commercial paper, Pepco must maintain a ratio of common stock equity to total capitalization (consisting of common stock, preferred stock, if any, long-term debt and short-term debt) of at least 30 percent. At June 30, 2003, Pepco's common equity ratio was 41.8 percent, or approximately $392 million in excess of the 30 percent threshold. The Financing Order also requires that all rated securities issued by Pepco be rated "investment grade" by at least one nationally recognized rating agency. Accordingly, if Pepco's common equity ratio were less than 30 percent or if no nationally recognized rating agency rated a security investment grade, Pepco could not issue the security without first obtaining from the SEC an amendment to the Financing Order. |
If an amendment to the Financing Order is required to enable Pepco to effect a financing, there is no certainty that such an amendment could be obtained, as to the terms and conditions on which an amendment could be obtained or as to the timing of SEC action. The failure to obtain timely relief from the SEC, in such circumstances, could have a material adverse effect on the financial condition of Pepco. |
Financing Activities |
During the quarter ended June 30, 2003, and subsequent thereto through August 7, 2003, Pepco engaged in the following capital market transactions: |
On May 20, 2003, Pepco purchased on the open market and subsequently redeemed $15 million of 7% Medium Term Notes due January 15, 2024. |
On July 21, 2003, Pepco redeemed the following First Mortgage Bonds: $40 million of 7.5% series due March 15, 2028 and $100 million of 7.25% series due July 1, 2023. |
On August 1, 2003 Pepco mailed official notice to the holders of its Serial Preferred Stock, $3.40 Series of 1992 for mandatory sinking fund redemption on September 1, 2003 of 50,000 shares at par value of $50.00 per share. |
Effect of Mirant Bankruptcy on Liquidity |
As more fully described in the "Overview - Pepco" section, Pepco currently estimates that if Mirant were successfully to reject contractual obligations it has with Pepco, Pepco could incur certain pre-tax losses over the remaining terms of the respective agreements. These estimates are based on current spot market prices and forward price estimates for energy and capacity, and on current percentages of service territory load served by competitive suppliers and by standard offer service and do not include financing costs, all of which could be subject to significant fluctuation. These estimates do not take into account alternative supply arrangements that might be entered into by Pepco that could mitigate the losses that might otherwise be incurred. They also assume no recovery on the bankruptcy claims or regulatory recovery of costs, which would also mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recovery. Applying the assumptions discussed above under "Relationship with Mirant Corporation," the estimated effect on Pepco's cash position as a result of a rejection as of September 1, 2003, for the balance of 2003, 2004 and 2005 would be as follows ($ in Millions): |
In the event of the rejection by Mirant of one or more of the contracts, Pepco anticipates that it may not have sufficient internally generated funds to meet its liquidity needs, including the additional cost resulting from a rejection. Accordingly, to meet its liquidity needs, Pepco would need to rely on access to the capital markets and reliance on its existing credit facilities, supplemented, if necessary, with funds provided by Pepco Holdings. Subject to the conditions described above under "Working Capital," Pepco has a borrowing capacity and credit support for its commercial paper of up to $300 million under its credit facilities. In this regard, Pepco anticipates that it will continue to satisfy the borrowing conditions set forth in the SEC Financing Order. |
Accordingly, while a successful rejection by Mirant of one or more of the contracts could have a material adverse effect on its results of operations, Pepco believes that it currently has sufficient cash flow and borrowing capacity under its credit facilities and in the capital markets to be able to satisfy the additional cash requirements. Therefore, Pepco does not anticipate that a rejection of one or more of the contracts would impair the ability of Pepco to fulfill its contractual obligations or to fund projected capital expenditures. Therefore, while a rejection by Mirant of one or more of the contracts could require Pepco to incur significant additional debt, Pepco does not believe that it would have a material adverse effect on its financial condition. |
Construction Expenditures |
Pepco's construction expenditures totaled $89.6 million for the six months ended June 30, 2003. For the five-year period 2003 through 2007, construction expenditures are projected to total approximately $900 million. Pepco intends to fund these expenditures through internally generated cash. |
REGULATORY AND OTHER MATTERS |
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 the "Overview - Pepco" and "Capital Resources and Liquidity -- Mirant Bankruptcy" sections herein. |
Regulatory Contingencies |
Final briefs on Pepco's District of Columbia divestiture proceeds sharing application were filed on July 31, 2002 following an evidentiary hearing in June 2002. That application was filed to implement a provision of Pepco's D.C. Commission approved divestiture settlement that provided for a sharing of any net proceeds from the sale of its generation related assets. A principal issue in the case is whether a sharing between customers and shareholders of the excess deferred income taxes and accumulated deferred investment tax credits associated with the sold assets would violate the normalization provisions of the Internal Revenue Code and implementing regulations. On March 4, 2003, the Internal Revenue Service (IRS) issued a notice of proposed rulemaking (NOPR) that is relevant to that principal issue. Comments on the NOPR were filed by several parties on June 2, 2003, and the IRS held a public hearing on June 25, 2003. Three of the parties in t he case filed comments urging the D. C. Commission to decide the tax issues now on the basis of the proposed rule. Pepco filed comments in reply to those comments, in which Pepco stated that the courts have held and the IRS has stated that proposed rules are not authoritative and that no decision should be issued on the basis of proposed rules. Instead, Pepco argued that the only prudent course of action is for the D.C. Commission to await the issuance of final regulations relating to the tax issues and then allow the parties to file supplemental briefs on the tax issues. Pepco cannot predict whether the IRS will adopt the regulations as proposed, make changes before issuing final regulations or decide not to adopt regulations. Other issues deal with the inclusion of internal costs and cost allocations. Pepco believes that its calculation of the customers' share of divestiture proceeds is correct. However, the potential exists that Pepco could be required to make additional gain sharing payments to D.C. cust omers. Such additional payments, which cannot be estimated, would be charged to expense and could have a material adverse effect on results of operations in the quarter and year in which a decision is rendered; however, Pepco does not believe that additional payments, if any, will have a material adverse impact on its financial condition. It is uncertain when the D.C. Commission will issue a decision. |
Pepco filed its divestiture proceeds plan application in Maryland in April 2001. Reply briefs were filed in May 2002 and Pepco is awaiting a Proposed Order from the Hearing Examiner. The principal issue in the case is the same normalization issue that was raised in the D.C. case. Following the filing of comments by Pepco and two other parties, the Hearing Examiner on April 8, 2003: (1) postponed his earlier decision establishing briefing dates on the question of the impact of the proposed rules on the tax issues until after the June 25, 2003 public hearing on the IRS NOPR;(2) allowed the Staff of the Commission and any other parties to submit motions by April 21, 2003 relating to the interpretation of current tax law as set forth in the preamble to the proposed rules and the effect thereof on the tax issues; and (3) allowed Pepco and any other party to file a response to any motion filed by Staff and other parties by April 30, 2003. Staff filed a motion on April 21, 2003, in which it argued that immediate flow through to customers of a portion of the excess deferred income taxes and accumulated deferred investment tax credits can be authorized now based on the NOPR. Pepco filed a response in opposition to Staff's motion on April 30, 2003, in which, among other things, Pepco argued that no action should be taken on the basis of proposed regulations because, as Pepco stated in a similar pleading in the District of Columbia divestiture proceeds case, proposed regulations are not authoritative. The Hearing Examiner will issue a ruling on Staff's motion, although there is no time within which he must issue a ruling. Pepco cannot predict whether the IRS will adopt the regulations as proposed, make changes before issuing final regulations or decide not to adopt regulations. Other issues deal with the inclusion of internal costs and cost allocations. Pepco believes that its calculation of the customers' share of divestiture proceeds is correct. Howev er, the potential also exists that Pepco would be required to make additional gain sharing payments to Maryland customers. Such additional payments, which cannot be estimated, would be charged to expense and could have a material adverse effect on results of operations in the quarter and year in which a decision is rendered; however, Pepco does not believe that additional payments, if any, will have a material adverse impact on its financial condition. It is uncertain when the Hearing Examiner or the Maryland Commission will issue their decisions. |
Standard Offer Service (SOS) |
District of Columbia |
On February 21, 2003, the D.C. Public Service Commission opened a new proceeding to consider issues relating to (a) the establishment of terms and conditions for providing SOS in the District of Columbia after Pepco's obligation to provide SOS terminates on February 7, 2005, and (b) the selecting of a new SOS provider. Pepco and other parties filed comments on issues identified by the Commission and some parties suggested additional issues. In its comments, Pepco, among other things, suggested that the D.C. law be changed to allow Pepco to continue to be the SOS provider after February 7, 2005. Under existing law, the Commission is to adopt, before January 2, 2004, terms and conditions for SOS and for the selection of a new SOS provider. The Commission is also required, under existing law, to select the new SOS provider before July 2004. Existing law also allows the selection of Pepco as the SOS provider in the event of insufficient bids. At a prehearing conference held on May 15, 2003, the Commission agreed with the recommendations of all but one of the parties to allow a working group, like the one that has been meeting in Maryland, to develop for the Commission's consideration regulations setting the terms and conditions for the provision of SOS service and for the selection of an SOS provider after Pepco's obligation ends in early 2005. However, by order issued on June 24, 2003, the Commission decided that all participating parties should individually propose, by August 29, 2003, regulations setting forth such terms and conditions. The Commission will then issue proposed regulations by September 30, 2003 and allow initial and reply comments from interested parties to be filed by October 30 and November 17, 2003, respectively. Pepco continues to pursue legislation that would allow it to remain as the SOS provider after early 2005. |
Maryland |
In accordance with the terms of an agreement approved by the Maryland Commission, customers who are unable to receive generation services from another supplier, or who do not select another supplier, are entitled to receive services from Pepco until July 1, 2004. Pepco has entered into a settlement in Phase I of Maryland Case No. 8908 to extend its provision of SOS services in Maryland. The settlement was approved by the Maryland Commission on April 29, 2003. One party has filed for rehearing of the Commission's April 29 order. The Commission subsequently denied that application for rehearing on July 26, 2003. The settlement provides for an extension of SOS for four years for residential and small commercial customers, an extension of two years for medium sized commercial customers, and an extension of one year for large commercial customers. The settlement also provides for a policy review by the Commission to consider how SOS will be provided after the current extension expires. In addition, the settlement provides for SOS to be procured from the wholesale marketplace and that Pepco will be able to recover its costs of procurement and a return. Following months of meetings in Phase II, final settlement documents were filed on July 2, 2003. The Phase II settlement documents include the Phase II settlement agreement, a model request for proposals for wholesale power to be delivered to the utility SOS providers and a full requirements service agreement between the wholesale suppliers and the utility SOS providers. Initial testimony on the settlement was filed by numerous parties on July 18, 2003. No party filed testimony opposing the Phase II settlement, although at least one party has stated that it opposes the Phase II settlement. The Commission will set hearing and briefing dates. |
FORWARD LOOKING STATEMENTS |
Some of the statements contained in this Quarterly Report are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act 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 resul ts, 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: |
DPL has gas revenues from on-system natural gas sales, which generally are subject to price regulation, and from the transportation of natural gas for customers. The table above shows the amounts of gas revenues from sources that were subject to price regulation (regulated) and that were not subject to price regulation (non-regulated). |
The increase in "Regulated gas revenues" primarily resulted from higher revenues of $21.8 million from colder winter weather in 2003, partially offset by lower revenues of $14.5 million resulting from a Gas Cost Rate decrease effective November 2002.Heating degree days increased by 18.5% for the six months ended June 30, 2003. |
"Non-regulated gas revenues" for all periods presented reflect the effects of the netting of expenses with revenues for "energy trading book" contracts, per the provisions of EITF 02-3. |
"Non-regulated gas revenues" decreased during the six months ended June 30, 2003. For the six months ended June 30, 2003, Conectiv Energy had a loss of $85.1 million. Excluding the impact of the previously reported first-quarter after-tax cost of $65.7 million on the cancellation of a combustion turbine contract, Conectiv Energy lost $19.4 million. The $19.4 million was primarily due to net trading losses that resulted from a dramatic rise in natural gas futures prices during February 2003. Pepco Holdings had previously reported a net trading loss of $20 million for February in the Form 8-K dated March 3, 2003. The net trading loss of approximately $19.4 million is net of an after-tax gain of $15 million on the sale of a purchase power contract in February 2003. In response to the trading losses, in early March 2003, Pepco Holdings ceased all proprietary trading activities. |
Other Services Revenues |
"Other services" revenues increased $126.0 million to $314.8 million for the six months ended June 30, 2003. The increase was primarily due to higher revenues from the sale of petroleum products, including heating oil, mainly due to higher volume and prices, due to colder winter weather in 2003. |
Operating Expenses |
Electric Fuel and Purchased Energy |
"Electric fuel and purchased energy" related to non-regulated electric revenue activities for all periods presented reflect the effects of the netting of expenses with revenues for "energy trading book" contracts, per the provisions of EITF 02-3, as discussed in Note 3 to Conectiv's Consolidated Financial Statements included in Item 8 of Part II of Pepco Holdings, Inc. 2002 Annual Report on Form 10-K."Electric fuel and purchased energy" increased by $550.6 million to $1,296.1 million for the six months ended June 30, 2003, from $745.5 million for the six months ended June 30, 2002. The increase was due to a $462.7 million increase in "non-regulated electric fuel and purchased energy", primarily related to procuring energy for a new contract resulting from the BGS auction held in February 2002, as noted above in the discussion of "Non-regulated electric revenues." In addition, there was a $130.4 million increase in "regulated electric fu el and purchased energy" primarily related to higher volumes of kilowatt hours delivered due to colder winter weather and higher prices. |
Gas Purchased |
"Gas purchased" related to non-regulated gas revenue activities for all periods presented reflect the effects of the netting of expenses with revenues for "energy trading book" contracts, per the provisions of EITF 02-3, as discussed in Note 3 to Conectiv's Consolidated Financial Statements included in Item 8 of Part II of Conectiv's 2002 Annual Report on Form 10-K. "Gas purchased" increased by $107.9 million to $276.2 million for the six months ended June 30, 2003, from $168.3 million for the six months ended June 30, 2002. The increase was mainly due to a $106.3 million increase in the prices paid for gas purchased for trading. |
Other Services' Cost of Sales |
Other services' cost of sales increased by $122.7 million to $286.5 million for the six months ended June 30, 2003, from $163.8 million for the six months ended June 30, 2002. The primary reason for the increase was related to higher volumes of petroleum products purchased to support increased sales. |
Other Operation and Maintenance |
Other operation and maintenance expenses decreased by $6.4 million to $232.3 million for the six months ended June 30, 2003, from $238.7 million for the six months ended June 30, 2002. The decrease was mainly due to lower amounts of estimated uncollectible accounts receivable of $17.1 million which resulted in less bad debt expenses. This decrease was partially offset by higher pension and other postretirement benefits expense of $3.5 million and service company costs of $5.9 million incurred during the six months ended June 30, 2003. |
Impairment Loss |
The impairment loss of $110.7 million (before tax) for the six months ended June 30, 2003 is a result of Conectiv Energy's previously disclosed decision to cancel a contract with General Electric for the delivery of four combustion turbines (CTs). Conectiv Energy cancelled the CTs due to uncertainty in the energy markets and current high level of capacity reserves within PJM. The $57.9 million before-tax purchase accounting reversal offset is not pushed down to Conectiv but is recorded at the Pepco Holdings' level. |
Depreciation and Amortization |
Depreciation and amortization expenses increased for the six months ended June 30, 2003 primarily due a $15.6 million increase in the amortization of recoverable stranded costs and an increase of $3.9 million for depreciation of new mid-merit electric generating plants, partially offset by a decrease of $6.4 million in service company depreciation and amortization during the six months ended June 30, 2002. |
Deferred Electric Service Costs |
Deferred electric service costs decreased by $41.9 million due to lower costs related to ACE providing Basic Generation Service and due to the $27.5 million charge described below. The balance for ACE's deferred electric service costs was $182.5 million as of June 30, 2003. On July 31, 2003, the NJBPU issued its Summary Order permitting ACE to begin collecting a portion of the deferred costs that were incurred as a result of the New Jersey Electric Discount and Energy Competition Act (EDECA) and to reset rates to recover on-going costs incurred as a result of EDECA. |
The Summary Order approved the recovery of $125 million of the deferred balance over a ten-year amortization period beginning August 1, 2003. The Summary Order also transferred to ACE's pending base case for further consideration approximately $25.4 million of the deferred balance. The Summary Order estimated the overall deferral balance as of July 31, 2003 at $195 million, of which $44.6 million was disallowed recovery by ACE. Since the amounts included in this decision are based on estimates through July 31, 2003, the actual ending deferred cost balance will be subject to review and finalization by the NJPBU and ACE. The approved rates became effective on August 6, 2003. Based on analysis of the order and in accordance with prevailing accounting rules, ACE recorded a charge of $27.5 million ($16.3 million after-tax) during the second quarter of 2003. This charge is in addition to amounts previously accrued for disallowance. ACE believes the record does not justify the level of disallowance imposed by the NJBPU. ACE is awaiting the final written order from the NJBPU and is evaluating its options related to this decision. The NJBPU's action is not appealable until a final written order has been issued. |
Other Income (Expenses) |
Other Income (Expenses) decreased by $3.6 million to a net expense of $(59.2) million for the six months ended June 30, 2003, from a net expense of $(62.8) million for the six months ended June 30, 2002. The decrease is primarily due to a gain of $3.9 million from the sale of Conectiv Operating Services Company and a $1.5 million distribution from Burney Forest Products, partially offset by higher interest expense of $2.0 million due to increased amounts of outstanding long term debt. |
Income Taxes |
Income taxes decreased by $80.8 million mainly due to lower income from continuing operations before income taxes. |
Extraordinary Item |
On July 25, the New Jersey Board of Public Utilities (NJBPU) approved the determination of stranded costs related to ACE's January 31 petition relating to its B.L. England generating facility. The NJBPU approved recovery of $149.5 million. As a result of the order, ACE reversed $10 million of accruals for the three and six months ended June 30 for the possible disallowances related to these stranded costs. The credit to income of $5.9 million is classified as an extraordinary gain in Conectiv's financial statements, since the original accrual was part of an extraordinary charge in conjunction with the accounting for competitive restructuring in 1999. |
The table above shows the amounts of electric revenues earned that are subject to price regulation (regulated) and that are not subject to price regulation (non-regulated). "Regulated electric revenues" include revenues for delivery (transmission and distribution) service and electricity supply service within the service areas of ACE. |
Regulated Electric Revenues |
The increase in "Regulated electric revenues" was due to the following: (i) regulated electric retail revenues increased $6.5 million due to the colder winter weather in 2003, and (ii) Interchange increased $84.9 million due to the New Jersey BPU mandate that each New Jersey utility participate in an auction to allow third-party energy suppliers to provide Basic Generation Service to the customers in its territory. As of August 1, 2002, approximately 80% of the customer MWH load, which ACE was serving, began to be served by other suppliers. This means that ACE now has generation to sell to PJM, which was previously used by supply customers in the territory. |
Operating Expenses |
Electric Fuel and Purchased Energy |
"Electric fuel and purchased energy" increased by $66.6 million to $346.3 million for the six months ended June 30, 2003, from $279.7 million for the six months ended June 30, 2002. The increase was due to colder winter weather, higher fuel prices and increased interchange sales. |
Other Operation and Maintenance |
Other operation and maintenance expenses decreased by $16.5 million to $104.3 million for the six months ended June 30, 2003, from $120.8 million for the six months ended June 30, 2002. The decrease was mainly due to a reduction in estimated uncollectible accounts receivable which resulted in lower bad debt expense. |
Depreciation and Amortization |
Depreciation and amortization expenses increased by $21.6 million to $55.5 million for the six months ended June 30, 2003, from $33.9 million for the six months ended June 30, 2002 primarily due to the following: (i) $11.1 million for amortization of bondable transition property on ACE Funding as result of transition bonds in December 2002, and (ii) $9.8 million for amortization of a regulatory tax asset related to New Jersey stranded costs. |
Other Taxes |
Other taxes increased by $0.8 million to $12.1 million for the six months ended June 30, 2003, from $11.3 million for the six months ended June 30, 2002. The increase was mainly due to higher tax expense for the Transitional Energy Facility Assessment, which is based on kilowatt-hour sales. |
Deferred Electric Service Costs |
Deferred electric service costs decreased by $41.9 million due to lower costs related to ACE providing Basic Generation Service and due to the $27.5 million charge described below. The balance for ACE's deferred electric service costs was $182.5 million as of June 30, 2003. On July 31, 2003, the NJBPU issued its Summary Order permitting ACE to begin collecting a portion of the deferred costs that were incurred as a result of the New Jersey Electric Discount and Energy Competition Act (EDECA) and to reset rates to recover on-going costs incurred as a result of EDECA. |
The Summary Order approved the recovery of $125 million of the deferred balance over a ten-year amortization period beginning August 1, 2003. The Summary Order also transferred to ACE's pending base case for further consideration approximately $25.4 million of the deferred balance. The Summary Order estimated the overall deferral balance as of July 31, 2003 at $195 million, of which $44.6 million was disallowed recovery by ACE. Since the amounts included in this decision are based on estimates through July 31, 2003, the actual ending deferred cost balance will be subject to review and finalization by the NJPBU and ACE. The approved rates became effective on August 6, 2003. Based on analysis of the order and in accordance with prevailing accounting rules, ACE recorded a charge of $27.5 million ($16.3 million after-tax) during the second quarter of 2003. This charge is in addition to amounts previously accrued for disallowance. ACE believes the record does not justify the level of disallowance imposed by the NJBPU. ACE is awaiting the final written order from the NJBPU and is evaluating its options related to this decision. The NJBPU's action is not appealable until a final written order has been issued. |
Other Income (Expenses) |
Other (expenses) increased by $0.9 million to a net expense of $(21.5) million for the six months ended June 30, 2003, from a net expense of $(20.6) million for the six months ended June 30, 2002. This increase is primarily due to higher interest expense due to increased amounts of outstanding long term debt. |
Income Taxes |
Income taxes decreased by $8.5 million to $5.4 million for the six months ended June 30, 2003, from $13.9 million for the six months ended June 30, 2002, primarily due to lower income from continuing operations before income taxes. |
Extraordinary Item |
On July 25, the New Jersey Board of Public Utilities (NJBPU) approved the determination of stranded costs related to ACE's January 31 petition relating to its B.L. England generating facility. The NJBPU approved recovery of $149.5 million. As a result of the order, ACE reversed $10 million of accruals for the three and six months ended June 30 for the possible disallowances related to these stranded costs. The credit to income of $5.9 million is classified as an extraordinary gain in ACE's financial statements, since the original accrual was part of an extraordinary charge in conjunction with the accounting for competitive restructuring in 1999. |
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Pepco Holdings |
For the information required to be disclosed in this section, refer to Item 7A Quantitative and Qualitative Disclosure About Market Risk of the Company's 2002 Form 10-K. |
Pepco |
For the information required to be disclosed in this section, refer to Item 7A Quantitative and Qualitative Disclosure About Market Risk of the Company's 2002 Form 10-K. |
INFORMATION FOR THIS ITEM IS NOT REQUIRED FOR CONECTIV, 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. |
Item 4.CONTROLS AND PROCEDURES |
Pepco Holdings, Inc. |
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by the company in the reports that the company 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 the company in the reports that we file 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, the company has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2003, 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 six months ended June 30, 2003, there were no changes in the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting. |
Potomac Electric Power Company |
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by the company in the reports that the company 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 the company in the reports that we file 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, the company has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2003, 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 six months ended June 30, 2003, there were no changes in the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting. |
Conectiv |
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by the company in the reports that the company 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 the company in the reports that we file 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, the company has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2003, 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 six months ended June 30, 2003, there were no changes in the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting. |
Delmarva Power and Light Company |
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by the company in the reports that the company 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 the company in the reports that we file 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, the company has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2003, 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 six months ended June 30, 2003, there were no changes in the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting. |
Atlantic City Electric Company |
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by the company in the reports that the company 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 the company in the reports that we file 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, the company has evaluated the effectiveness of the design and operation of our disclosure controls and procedures s of June 30, 2003, 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 six months ended June 30, 2003, there were no changes in the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting. |
Atlantic City Electric Transition Funding LLC |
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by the company in the reports that the company 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 the company in the reports that we file 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, the company has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2003, 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 six months ended June 30, 2003, there were no changes in the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting. |
Part II OTHER INFORMATION |
Item 1. 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 the "Overview - Pepco" section. |
Other |
In 1991, Pepco entered into a power purchase agreement ("PPA") with Panda Brandywine, L.P. ("Panda"), the operator/lessee of a qualifying facility, under which Pepco agreed to purchase 230 megawatts of capacity and energy from 1996 through 2021. In connection with the sale by Pepco of its generation assets to affiliates of Mirant Corporation in 2000, Pepco entered into a "back-to-back" arrangement with Mirant whereby Mirant has agreed to purchase from Pepco the entire output under the PPA at a cost equal to the amount Pepco is required to pay to Panda under the PPA. Panda or its affiliates challenged the back-to-back arrangement before the Maryland Public Service Commission (the "Maryland PSC"), the D.C. Public Service Commission (the "DC PSC"), and the Federal Energy Regulatory Commission ("FERC") and in Texas state court ("Texas Action"). In each case Panda contended that the back-to-back arrangement was an assignment, delegation or transfer requiring Panda's consent under the PPA. Panda's requests for relief in the Texas Action and from the DC PSC and the FERC were denied. In the proceeding before the Maryland PSC, Pepco submitted its own motion for an order declaring that the back-to back arrangement does not violate the anti-assignment provisions in the PPA. The Maryland PSC issued a ruling that the back-to-back arrangement did not constitute an assignment or a delegation under the PPA. Panda then sought judicial review of the Maryland PSC ruling in the Maryland Circuit Court for Montgomery County. On April 23, 2001, the Circuit Court reversed the Maryland PSC and ruled that the back-to-back arrangement constituted an assignment of the PPA by Pepco to Mirant, but stayed its decision pending appeal. The Maryland PSC, Maryland People's Counsel and Pepco appealed the Circuit Court ruling to the Maryland Court of Special Appeals. In July 2002, the Court of Special Appeals ruled that, while the Maryland PSC decision could not be sustained as a mat ter of contract interpretation, the Maryland PSC could approve the back-to-back arrangement as a matter of public policy. In December 2002, the Maryland Court of Appeals granted various petitions for review. On June 10, 2003, the Court of Appeals decided that the "Administration" provisions in Paragraph II.D of Schedule 2.4 to the Asset Purchase and Sale Agreement (APSA) violates the anti-assignment provision in Section 19.1 of the power purchase and sale agreement (PPA) between Pepco and Panda-Brandywine, L.P. (Panda). It did not rule that the power resale provisions of the contract violate Section 19.1 and did not rule that the Pepco resales of power to Mirant violated the PPA. |
In connection with the purchase of Pepco's generation assets, Mirant agreed to an adjustment of the purchase price if the back-to-back arrangement should be determined to violate the PPA as a prohibited assignment, delegation or transfer in a binding court order issued on or before March 19, 2005. The amount that Mirant would be obligated to pay to Pepco pursuant to this adjustment provision is designed to compensate Pepco for loss of the benefit of its arrangement with Mirant at then prevailing market prices. If Mirant were unable to fulfill its contractual obligations to Pepco, the Company believes that its restructuring settlement agreements, which have been approved by the Maryland PSC and the DC PSC, will permit Pepco to recover in its retail distribution rates the above-market power purchase costs that it likely would incur under the PPA. |
For the information required by this item, refer also to Item 3, Legal Proceedings of the Company's 2002 Form 10-K. |
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 the "Overview - Pepco" section. |
Other |
In 1991, Pepco entered into a power purchase agreement ("PPA") with Panda Brandywine, L.P. ("Panda"), the operator/lessee of a qualifying facility, under which Pepco agreed to purchase 230 megawatts of capacity and energy from 1996 through 2021. In connection with the sale by Pepco of its generation assets to affiliates of Mirant Corporation in 2000, Pepco entered into a "back-to-back" arrangement with Mirant whereby Mirant has agreed to purchase from Pepco the entire output under the PPA at a cost equal to the amount Pepco is required to pay to Panda under the PPA. Panda or its affiliates challenged the back-to-back arrangement before the Maryland Public Service Commission (the "Maryland PSC"), the D.C. Public Service Commission (the "DC PSC"), and the Federal Energy Regulatory Commission ("FERC") and in Texas state court ("Texas Action"). In each case Panda contended that the back-to-back arrangement was an assignment, delegation or transfer requiring Panda's consent under the PPA. Panda's requests for relief in the Texas Action and from the DC PSC and the FERC were denied. In the proceeding before the Maryland PSC, Pepco submitted its own motion for an order declaring that the back-to back arrangement does not violate the anti-assignment provisions in the PPA. The Maryland PSC issued a ruling that the back-to-back arrangement did not constitute an assignment or a delegation under the PPA. Panda then sought judicial review of the Maryland PSC ruling in the Maryland Circuit Court for Montgomery County. On April 23, 2001, the Circuit Court reversed the Maryland PSC and ruled that the back-to-back arrangement constituted an assignment of the PPA by Pepco to Mirant, but stayed its decision pending appeal. The Maryland PSC, Maryland People's Counsel and Pepco appealed the Circuit Court ruling to the Maryland Court of Special Appeals. In July 2002, the Court of Special Appeals ruled that, while the Maryland PSC decision could not be sustained as a mat ter of contract interpretation, the Maryland PSC could approve the back-to-back arrangement as a matter of public policy. In December 2002, the Maryland Court of Appeals granted various petitions for review. On June 10, 2003, the Court of Appeals decided that the "Administration" provisions in Paragraph II.D of Schedule 2.4 to the Asset Purchase and Sale Agreement (APSA) violates the anti-assignment provision in Section 19.1 of the power purchase and sale agreement (PPA) between Pepco and Panda-Brandywine, L.P. (Panda). It did not rule that the power resale provisions of the contract violate Section 19.1 and did not rule that the Pepco resales of power to Mirant violated the PPA. |
In connection with the purchase of Pepco's generation assets, Mirant agreed to an adjustment of the purchase price if the back-to-back arrangement should be determined to violate the PPA as a prohibited assignment, delegation or transfer in a binding court order issued on or before March 19, 2005. The amount that Mirant would be obligated to pay to Pepco pursuant to this adjustment provision is designed to compensate Pepco for loss of the benefit of its arrangement with Mirant at then prevailing market prices. If Mirant were unable to fulfill its contractual obligations to Pepco, the Company believes that its restructuring settlement agreements, which have been approved by the Maryland PSC and the DC PSC, will permit Pepco to recover in its retail distribution rates the above-market power purchase costs that it likely would incur under the PPA. |
For the information required by this item, refer also to Item 3, Legal Proceedings of the Company's 2002 Form 10-K. |
Conectiv |
For the information required by this item, refer to Item 3, Legal Proceedings of the Company's 2002 Form 10-K. |
Delmarva Power and Light Company |
For the information required by this item, refer to Item 3, Legal Proceedings of the Company's 2002 Form 10-K. |
Atlantic City Electric Company |
For the information required by this item, refer to Item 3, Legal Proceedings of the Company's 2002 Form 10-K. |
Atlantic City Electric Transition Funding LLC |
For the information required by this item, refer to Item 3, Legal Proceedings of the Company's 2002 Form 10-K. |
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS |
Pepco Holdings - None |
Pepco - None |
INFORMATION FOR THIS ITEM IS NOT REQUIRED FOR CONECTIV, 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. |
Item 3. DEFAULTS UPON SENIOR SECURITIES |
Pepco Holdings - None |
Pepco - None |
INFORMATION FOR THIS ITEM IS NOT REQUIRED FOR CONECTIV, 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. |
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
Pepco Holdings - None |
Pepco - None |
INFORMATION FOR THIS ITEM IS NOT REQUIRED FOR CONECTIV, DPL, ACE, AND ACE FUNDING AS THEY MEET THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q. |
Item 5. OTHER INFORMATION |
Pepco Holdings - None |
Pepco - None |
Conectiv - None |
DPL - None |
ACE - None |
ACE Funding - None |
Exhibit
No. | Registrant(s) | Description of Exhibit | Reference |
3.1 | PHI | Bylaws | Filed herewith. |
3.2 | Pepco | Articles of Incorporation | Filed herewith. |
10.1 | PHI
Pepco
DPL
ACE | 364-Day Credit Agreement, dated July 29, 2003, among Pepco Holdings, Inc., Potomac Electric Power Company, Delmarva Power & Light Company, Atlantic City Electric Company, Bank One, NA, as agent, and the Lenders named therein among the Registrants and Bank One, NA, as administrative agent | Filed herewith. |
10.2 | PHI
Pepco
DPL
ACE | 3-Year Credit Agreement, dated July 29, 2003, among Pepco Holdings, Inc., Potomac Electric Power Company, Delmarva Power & Light Company, Atlantic City Electric Company, Bank One, NA, as agent, and the Lenders named therein among the Registrants and Bank One, NA, as administrative agent | Filed herewith |
12.1 | PHI | Statements Re: Computation of Ratios | Filed herewith. |
12.2 | Pepco | Statements Re: Computation of Ratios | Filed herewith. |
12.3 | Conectiv | Statements Re: Computation of Ratios | Filed herewith. |
12.4 | DPL | Statements Re: Computation of Ratios | Filed herewith. |
12.5 | ACE | Statements Re: Computation of Ratios | Filed herewith. |
15 | PHI | Independent Accountants' Awareness Letter | 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 | Conectiv | Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer | Filed herewith. |
31.6 | Conectiv | Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer | Filed herewith. |
31.7 | DPL | Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer | Filed herewith. |
31.8 | DPL | Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer | Filed herewith. |
31.9 | ACE | Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer | Filed herewith. |
31.10 | ACE | Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer | Filed herewith. |
31.11 | ACEF | Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer | Filed herewith. |
31.12 | ACEF | Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial 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. |
32.2 | Pepco | Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 | Furnished herewith. |
32.3 | Conectiv | Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 | Furnished herewith. |
32.4 | DPL | Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 | Furnished herewith. |
32.5 | ACE | Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 | Furnished herewith. |
32.6 | ACEF | Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 | Furnished herewith. |
