(4) COMMITMENTS AND CONTINGENCIES |
REGULATORY AND OTHER MATTERS |
Relationship with Mirant Corporation |
In 2000, Pepco sold substantially all of its electricity generation assets to Mirant Corporation, formerly Southern Energy, Inc. As part of the Asset Purchase and Sale Agreement, Pepco entered into several ongoing contractual arrangements with Mirant Corporation and certain of its subsidiaries (collectively, Mirant). On July 14, 2003, Mirant Corporation and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of Texas (the Bankruptcy Court). |
Depending on the outcome of the matters discussed below, the Mirant bankruptcy could have a material adverse effect on the results of operations of Pepco Holdings and Pepco. However, management believes that Pepco Holdings and Pepco currently have sufficient cash, cash flow and borrowing capacity under their credit facilities and in the capital markets to be able to satisfy any additional cash requirements that may arise due to the Mirant bankruptcy. Accordingly, management does not anticipate that the Mirant bankruptcy will impair the ability of Pepco Holdings or Pepco to fulfill their contractual obligations or to fund projected capital expenditures. On this basis, management currently does not believe that the Mirant bankruptcy will have a material adverse effect on the financial condition of either company. |
Transition Power Agreements |
As part of 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, Mirant was obligated to supply Pepco with all of the capacity and energy needed to fulfill its SOS obligations in Maryland through June 2004 and its SOS obligations in the District of Columbia through January 22, 2005. |
To avoid the potential rejection of the TPAs, Pepco and Mirant entered into an Amended Settlement Agreement and Release dated as of October 24, 2003 (the Settlement Agreement) pursuant to which Mirant assumed both of the TPAs and the terms of the TPAs were modified. The Settlement Agreement also provided that Pepco has an allowed, pre-petition general unsecured claim against Mirant Corporation in the amount of $105 million (the Pepco TPA Claim). |
Pepco has also asserted the Pepco TPA Claim against other Mirant entities, which Pepco believes are liable to Pepco under the terms of the Asset Purchase and Sale Agreement's Assignment and Assumption Agreement (the Assignment Agreement). Under the Assignment Agreement, Pepco believes that each of the Mirant entities assumed and agreed to discharge certain liabilities and obligations of Pepco as defined in the Asset Purchase and Sale Agreement. Mirant has filed objections to these claims. Under the original plan of reorganization filed by the Mirant entities with the Bankruptcy Court, certain Mirant entities other than Mirant Corporation would pay significantly higher percentages of the claims of their creditors than would Mirant Corporation. The amount that Pepco will be able to recover from the Mirant bankruptcy estate with respect to the Pepco TPA Claim will depend on the amount of assets available for distribution to creditors of the Mirant entities determined to be li able for the Pepco TPA Claim. |
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At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover, whether the recovery would be in cash or another form of payment, or the timing of any recovery. |
Power Purchase Agreements |
Under agreements with FirstEnergy Corp., formerly Ohio Edison (FirstEnergy), and Allegheny Energy, Inc., both entered into in 1987, Pepco is obligated to purchase from FirstEnergy 450 megawatts of capacity and energy annually through December 2005 (the FirstEnergy PPA). Under the Panda PPA, entered into in 1991, Pepco is obligated to purchase from Panda 230 megawatts of capacity and energy annually through 2021. In each case, the purchase price is substantially in excess of current market price. As a part of the Asset Purchase and Sale Agreement, Pepco entered into a "back-to-back" arrangement with Mirant. Under this arrangement, Mirant is obligated, among other things, to purchase from Pepco the capacity and energy that Pepco is obligated to purchase under the FirstEnergy PPA and the Panda PPA at a price equal to the price Pepco is obligated to pay under the FirstEnergy PPA and the Panda PPA (the PPA-Related Obligations). |
Pepco Pre-Petition Claims |
When Mirant filed its bankruptcy petition on July 14, 2003, Mirant had unpaid obligations to Pepco of approximately $29 million, consisting primarily of payments due to Pepco with respect to the PPA-Related Obligations (the Mirant Pre-Petition Obligations). The Mirant Pre-Petition Obligations constitute part of the indebtedness for which Mirant is seeking relief in its bankruptcy proceeding. Pepco has filed Proofs of Claim in the Mirant bankruptcy proceeding in the amount of approximately $26 million to recover this indebtedness; however, the amount of Pepco's recovery, if any, is uncertain. The $3 million difference between Mirant's unpaid obligation to Pepco and the $26 million Proofs of Claim primarily represents a TPA settlement adjustment that is included in the $105 million Proofs of Claim filed by Pepco against the Mirant debtors in respect of the Pepco TPA Claim. In view of the uncertainty as to recoverability, Pepco, in the third quarter of 2003, expensed $14.5 mi llion to establish a reserve against the $29 million receivable from Mirant. In January 2004, Pepco paid approximately $2.5 million to Panda in settlement of certain billing disputes under the Panda PPA that related to periods after the sale of Pepco's generation assets to Mirant. Pepco believes that under the terms of the Asset Purchase and Sale Agreement, Mirant is obligated to reimburse Pepco for the settlement payment. Accordingly, in the first quarter of 2004, Pepco increased the amount of the receivable due from Mirant by approximately $2.5 million and amended its Proofs of Claim to include this amount. Pepco currently estimates that the $14.5 million expensed in the third quarter of 2003 represents the portion of the entire $31.5 million receivable unlikely to be recovered in bankruptcy, and no additional reserve has been established for the $2.5 million increase in the receivable. The amount expensed represents Pepco's estimate of the possible outcome in bankruptcy, although the amount ultimately recovered could be higher or lower. |
Mirant's Attempt to Reject the PPA-Related Obligations |
In August 2003, Mirant filed with the Bankruptcy Court a motion seeking authorization to reject its PPA-Related Obligations. Upon motions filed with the U.S. District Court for the Northern District of Texas (the District Court) by Pepco and FERC, in October 2003, the District Court withdrew jurisdiction over the rejection proceedings from the Bankruptcy Court. |
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In December 2003, the District Court denied Mirant's motion to reject the PPA-Related Obligations on jurisdictional grounds. The District Court's decision was appealed by Mirant and The Official Committee of Unsecured Creditors of Mirant Corporation (the Creditors' Committee) to the U.S. Court of Appeals for the Fifth Circuit (the Court of Appeals). In August 2004, the Court of Appeals remanded the case to the District Court saying that the District Court had jurisdiction to rule on the merits of Mirant's rejection motion, suggesting that in doing so the court apply a "more rigorous standard" than the business judgment rule usually applied by bankruptcy courts in ruling on rejection motions. |
On December 9, 2004, the District Court issued an order again denying Mirant's motion to reject the PPA-Related Obligations. The District Court found that the PPA-Related Obligations are not severable from the Asset Purchase and Sale Agreement and that the Asset Purchase and Sale Agreement cannot be rejected in part, as Mirant was seeking to do. Both Mirant and the Creditors' Committee appealed the District Court's order to the Court of Appeals. Briefing of this matter by the interested parties has been completed. Oral arguments have not yet been scheduled. |
Until December 9, 2004, Mirant had been making regular periodic payments in respect of the PPA-Related Obligations. However, on that date, Mirant filed a notice with the Bankruptcy Court that it was suspending payments to Pepco in respect of the PPA-Related Obligations and subsequently failed to make certain full and partial payments due to Pepco. Proceedings ensued in the Bankruptcy Court and the District Court, ultimately resulting in Mirant being ordered to pay to Pepco all past-due unpaid amounts under the PPA-Related Obligations. On April 13, 2005, Pepco received a payment from Mirant in the amount of approximately $57.5 million, representing the full amount then due in respect of the PPA-Related Obligations. |
On January 21, 2005, Mirant filed in the Bankruptcy Court a motion seeking to reject certain of its ongoing obligations under the Asset Purchase and Sale Agreement, including the PPA-Related Obligations (the Second Motion to Reject). On March 1, 2005, the District Court entered an order (as amended by a second order issued on March 7, 2005) granting Pepco's motion to withdraw jurisdiction over these rejection proceedings from the Bankruptcy Court.Mirant and the Creditor's Committee have appealed these orders to the Court of Appeals. Amicus briefs, which are briefs filed by persons who are not parties to the proceeding, but who nevertheless have a strong interest -- in this instance a broad public interest -- in the case, in support of Pepco's position have been filed with the Court of Appeals by the Maryland Public Service Commission (MPSC) and theOffice of People's Counsel of M aryland (Maryland OPC). Briefing of this matter by the interested parties has been completed. Oral arguments have not yet been scheduled. |
On March 28, 2005, Pepco, FERC, the Office of People's Counsel of the District of Columbia (the District of Columbia OPC), the MPSC and the Maryland OPC filed in the District Court oppositions to the Second Motion to Reject. By order entered August 16, 2005,the District Court hasinformally stayed this matter, pending a decision by the Court of Appeals on the District Court's orders withdrawing jurisdiction from the Bankruptcy Court. |
Pepco is exercising all available legal remedies and vigorously opposing Mirant'sefforts to reject the PPA-Related Obligations and other obligations under the Asset Purchase and Sale Agreement in order to protect the interests of its customers and shareholders. While Pepco 20
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believes that it has substantial legal bases to opposethese efforts by Mirant, the ultimate outcome is uncertain.
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If Mirant ultimately is successful in rejecting the PPA-Related Obligations, Pepco could be required to repay to Mirant, for the period beginning on the effective date of the rejection (which date could be prior to the date of the court's order granting the rejection and possibly as early as September 18, 2003) and ending on the date Mirant is entitled to cease its purchases of energy and capacity from Pepco, all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity. Pepco estimates that the amount it could be required to repay to Mirant in the unlikely event that September 18, 2003 is determined to be the effective date of rejection, is approximately $225.1 million as of November 1, 2005. |
Mirant has also indicated to the Bankruptcy Court that it will move to require Pepco to disgorge all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity, for the period July 14, 2003 (the date on which Mirant filed its bankruptcy petition) through rejection, if approved, on the theory that Mirant did not receive value for those payments. Pepco estimates that the amount it would be required to repay to Mirant on the disgorgement theory, in addition to the amounts described above, is approximately $22.5 million. |
Any repayment by Pepco of amountsreceived from Mirant in respect of the PPA-Related Obligations would entitle Pepco to file a claim against the bankruptcy estate in an amount equal to the amount repaid. To the extent such amounts were not recovered from the Mirant bankruptcy estate, Pepco believes they would be recoverable as stranded costs from customers through distribution rates as described below. |
The following are estimates prepared by Pepco of its potential future exposure if Mirant's attempt to reject the PPA-Related Obligations ultimately is successful. These estimates are based in part on current market prices and forward price estimates for energy and capacity, and do not include financing costs, all of which could be subject to significant fluctuation. The estimates assume no recovery from the Mirant bankruptcy estate and no regulatory recovery, either of which would mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recoveries. Based on these assumptions, Pepco estimates that its pre-tax exposure as of November 1, 2005 representing the loss of the future benefit of the PPA-Related Obligations to Pepco, is as follows: |
The ability of Pepco to recover from the Mirant bankruptcy estate in respect to the Mirant Pre-Petition Obligations and damages if the PPA-Related Obligations are successfully rejected will depend on whether Pepco's claims are allowed, the amount of assets available for distribution to the creditors of the Mirant companies determined to be liable for those claims, and Pepco's priority relative to other creditors. At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate, whether the recovery would be in cash or another form of payment, or the timing of any recovery. |
If Mirant ultimately were successful in rejecting the PPA-Related Obligations and Pepco's full claim were not recovered from the Mirant bankruptcy estate, Pepco would seek authority from the MPSC and the District of Columbia Public Service Commission (DCPSC) to recover its additional costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers. Under the provisions of the settlement agreements approved by the MPSC and the DCPSC in the deregulation proceedings in which Pepco agreed to divest its generation assets under certain conditions, the PPAs were to become assets of Pepco's distribution business if they could not be sold. Pepco believes that, if Mirant ultimately is successful in rejecting the PPA-Related Obligations, these provisions would allow the stranded costs of the PPAs that are not recovered from the Mirant bankruptcy estate to be recovered from Pepco's customers through its dist ribution rates. If Pepco's interpretation of the settlement agreements is confirmed, Pepco expects to be able to establish the amount of its anticipated recovery as a regulatory asset. However, there is no assurance that Pepco's interpretation of the settlement agreements would be confirmed by the respective public service commissions. |
If the PPA-Related Obligations are successfully rejected, and there is no regulatory recovery, Pepco will incur a loss; the accounting treatment of such a loss, however, would depend on a number of legal and regulatory factors. |
Mirant's Fraudulent Transfer Claim |
On July 13, 2005, Mirant filed a complaint in the Bankruptcy Court against Pepco alleging that Mirant's$2.65 billion purchase of Pepco's generating assets in June 2000 constituted a fraudulent transfer. Mirant alleges in the complaint that the value of Pepco's generation assets was "not fair consideration or fair or reasonably equivalent value for the consideration paid to Pepco" and that it thereby rendered Mirant insolvent, or, alternatively, that Pepco and Southern Energy, Inc. (as predecessor to Mirant) intended that Mirant would incur debts beyond its ability to pay them. Mirant asks that the Court enter an order "declaring that the consideration paid for the Pepco assets, to the extent it exceeds the fair value of the Pepco assets, to be a conveyance or transfer in fraud of the rights of Creditors under state law" and seeks compensatory and punitive damages. |
Pepco believes this claim has no merit and is vigorously contesting the claim. On September 20, 2005, Pepco filed a motion to withdraw this complaint to the District Court and |
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on September 30, 2005, Pepco filed its answer in the Bankruptcy Court. On October 20, 2005, the Bankruptcy Court issued a report and recommendation to the District Court, which recommends that the District Court grant the motion to withdraw the reference. The District Court will now consider whether to accept the recommendation to withdraw the reference. Pepco cannot predict when the District Court will make a decision or whether it will accept the recommendation of the Bankruptcy Court. |
The SMECO Agreement |
As a term of the Asset Purchase and Sale Agreement, Pepco assigned to Mirant a facility and capacity agreement with Southern Maryland Electric Cooperative, Inc. (SMECO) under which Pepco was obligated to purchase the capacity of an 84-megawatt combustion turbine installed and owned by SMECO at a former Pepco generating facility (the SMECO Agreement). The SMECO Agreement expires in 2015 and contemplates a monthly payment to SMECO of approximately $.5 million. Pepco is responsible to SMECO for the performance of the SMECO Agreement if Mirant fails to perform its obligations thereunder. At this time, Mirant continues to make post-petition payments due to SMECO. |
On March 15, 2004, Mirant filed a complaint with the Bankruptcy Court seeking a declaratory judgment that the SMECO Agreement is an unexpired lease of non-residential real property rather than an executory contract and that if Mirant were to successfully reject the agreement, any claim against the bankruptcy estate for damages made by SMECO (or by Pepco as subrogee) would be subject to the provisions of the Bankruptcy Code that limit the recovery of rejection damages by lessors. Pepco believes that there is no reasonable factual or legal basis to support Mirant's contention that the SMECO Agreement is a lease of real property. The outcome of this proceeding cannot be predicted. |
Mirant Plan of Reorganization |
On January 19, 2005, Mirant filed its Plan of Reorganization and Disclosure Statement with the Bankruptcy Court (the Original Reorganization Plan) under which Mirant proposed to transfer all assets to "New Mirant" (an entity it proposed to create in the reorganization), with the exception of the PPA-Related Obligations. Mirant proposed that the PPA-Related Obligations would remain in "Old Mirant," which would be a shell entity as a result of the reorganization. On March 25, 2005, Mirant filed its First Amended Plan of Reorganization and First Amended Disclosure Statement (the Amended Reorganization Plan), in which Mirant abandoned the proposal that the PPA-Related Obligations would remain in "Old Mirant," but did not clarify how the PPA-Related Obligations would be treated. On September 22, 2005, Mirant filed its Second Amended Disclosure Statement and Second Amended Plan of Reorganization. Pepco filed objections to the Second Amended Disclosure Statement on September 28, 2005 and a revised version of the Second Amended Disclosure Statement, including the changes and clarifications requested by Pepco, was filed and approved by the Bankruptcy Court on September 30, 2005. Pepco is still analyzing, and has not yet determined whether to file an objection to, the Second Amended Plan of Reorganization. Objections to confirmation of the Second Amended Plan of Reorganization are due November 10, 2005. |
On March 11, 2005, Mirant filed an application with FERC seeking approval for the internal transfers and corporate restructuring that will result from the Original Reorganization Plan. FERC approval for these transactions is required under Section 203 of the Federal Power Act. |
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On April 1, 2005, Pepco filed a motion to intervene and protest at FERC in connection with this application. On the same date, the District of Columbia OPC also filed a motion to intervene and protest. Pepco, the District of Columbia OPC, the Maryland OPC and the MPSC filed pleadings arguing that the application was premature inasmuch as it was unclear whether the planned reorganization would be approved by the Bankruptcy Court and asking that FERC refrain from acting on the application. |
On June 17, 2005, FERC issued anorder approving the planned restructuring outlined in the Original Reorganization Plan, which has since been superseded by the Second Amended Plan of Reorganization, as discussed above. The Second Amended Plan of Reorganization does not provide for the same restructuring contemplated in the Original Reorganization Plan. While the FERC order had no direct impact on Pepco, the order included a discussion regarding potential future rate impacts if the courts were to permit rejection of the PPAs. Because Pepco disagreed with this discussion, Pepco filed a motion for rehearing on July 18, 2005 (before Mirant filed its Second Amended Plan of Reorganization). On August 17, 2005, the FERC entered an order granting the request for rehearing "for the limited purpose of further consideration." This order simply means that the request for rehearing remains pending. Pepco cannot predict the outcome of its motion for rehearing. |
Rate Proceedings |
New Jersey |
In February 2003, ACE filed a petition with the NJBPU to increase its electric distribution rates and its Regulatory Asset Recovery Charge (RARC) in New Jersey.In an order dated May 26, 2005, the NJBPU approved the settlement reached among ACE, the staff of the NJBPU, the New Jersey Ratepayer Advocate and active intervenor parties that resolved the issues pertaining to this base rate proceeding as well as other outstanding issues from several other proceedingsthat were consolidated with the base rate proceeding, includingACE's petition to recover $25.4 million of deferred restructuring costs related to the provision of BGS. |
The settlement allows for an increase in ACE's base rates of approximately $18.8 million annually, of which $2.8 million will consist of an increase in RARC revenue collections each year for the four years ending 2008. The $16 million of the base rate increase, not related to RARC collections, will be collected annually from ACE's customers until such time as base rates change in a subsequent base rate proceeding. The $18.8 million increase in base rate revenue is offset by a base rate revenue decrease in a similar amount in total resulting from a change in depreciation rates similar to changes adopted by the NJBPU for other New Jersey electric utility companies. Overall, the settlement provides for a net decrease in annual revenues of approximately $.3 million, consisting of a $3.1 million reduction of distribution revenues offset by the $2.8 million increase in RARC revenue collections discussed above. The settlement specifies an overall rate of return of 8.14%. The change i n depreciation ratesreferred to above is the result of a change in average service lives. In addition, the settlement provides for a change in depreciation technique from remaining life to whole life, including amortization of any calculated excess or deficiencies in the depreciation reserve. As a result of these changes, PHI and ACE each had a net excess depreciation reserve. Accordingly, PHI and ACE each recorded a regulatory liability in March 2005 by reducing its depreciation reserve by approximately $131 million. The regulatory liability will be amortized over 8.25 years and will result in a reduction of depreciation and amortization expense on PHI's and ACE's consolidated |
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statements of earnings. While the impact of the settlement is essentially revenue and cash neutral to PHI and ACE, there is a positive annual pre-tax earnings impact to PHI and ACE of approximately $20 million. |
The settlement also establishes an adjusted deferred balance of approximately $116.8 million as of October 31, 2004, which reflects an approved amount of deferred restructuring costs related to the provision of BGS, various other pre-November 2004 additions and reductions to the deferred balance, and a disallowance of $13.0 million of previously recorded supply-related deferred costs. This adjusted deferred balance is to be recovered in rates over a four-year period and the rate effects are offset by a one-year return of over-collected balances in certain other deferred accounts. The net result of these changes is that there will be no rate impact from the deferral account recoveries and credits for at least one year. Net rate effects in future years will depend in part on whether rates associated with those other deferred accounts continue to generate over-collections relative to costs. |
The settlement does not affect the pending appeal filed by ACE with the Appellate Division of the Superior Court of New Jersey (the NJ Superior Court) related to the Final Decision and Order issued in July 2004 by the NJBPU in ACE's restructuring deferral proceeding before the NJBPU under the New Jersey Electric Discount and Energy Competition Act (EDECA), discussed below under "Restructuring Deferral." |
Delaware |
In October 2004, DPL submitted its annual Gas Cost Rate (GCR) filing, which permits DPL to recover gas procurement costs through customer rates, to the Delaware Public Service Commission (DPSC). In its filing, DPL sought to increase its GCR by approximately 16.8% in anticipation of increasing natural gas commodity costs. In addition, in November 2004, DPL filed a supplemental filing seeking approval to further increase GCR rates by an additional 6.5% effective December 29, 2004. A final order approving both increases was issued by the DPSC on August 9, 2005. |
On October 3, 2005, DPL submitted its 2005 GCR filing to the DPSC. In its filing, DPL seeks to increase its GCR by approximately 38% in anticipation of increasing natural gas commodity costs. The proposed rate became effective November 1, 2005, subject to refund pendingfinal DPSC approval after evidentiary hearings. |
As authorized by the April 16, 2002 settlement agreement in Delaware relating to the merger of Pepco and Conectiv (the DE Merger Settlement Agreement), on May 4, 2005, DPL filed with the DPSC a proposed increase of approximately $6.2 million in electric transmission service revenues, or about 1.1% of total Delaware retail electric revenues. This proposed revenue increase is the Delaware retail portion of the increase in the "Delmarva zonal" transmission rates on file with FERC under the Open Access Transmission Tariff (OATT) of the PJM Interconnection, LLC (PJM). This level of revenue increase will decrease to the extent that competitive retail suppliers provide a supply and transmission service to retail customers. In that circumstance, PJM would charge the competitive retail supplier the PJM OATT rate for transmission service into the Delmarva zone and DPL's charges to the retail customer would exclude as a "shopping credit" an amount equal to the SOS supply charge and t he transmission and ancillary charges that would otherwise be charged by DPL to the retail customer. DPL 25
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began collecting this rate change for service rendered on and after June 3, 2005, subject to refundpending final approval by the DPSC.
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On September 1, 2005, DPL filed with the DPSC its first comprehensive base rate case in ten years. This application was filed as a result of increasing costs and is consistent with a provision in the DE Merger Settlement Agreement permittingDPL to apply for an increase in rates effective as of May 1, 2006. DPL is seeking approval of an annual increase of approximately $5.1 million in its electric rates, with an increase of approximately $1.6 million to its electric distribution base rates after proposing to assign approximately $3.5 million in costs to the supply component of rates to be collected as part of the SOS. Of the approximately $1.6 million in net increases to its electric distribution base rates, DPL proposed that approximately $1.2 million be recovered through changes in delivery charges and that the remaining approximately $.4 million be recovered through changes in premise collection and reconnect fees. The full proposed revenue increa se is approximately 0.9% of total annual electric utility revenues, while the proposed net increase to distribution rates is 0.2% of total annual electric utility revenues. DPL's distribution revenue requirement is based on a return on common equity of 11%. DPL also has proposed revised depreciation rates and a number of tariff modifications. On September 20, 2005, the DPSC issued an order approving DPL's request that the rate increase go into effect on May 1, 2006; subject to refund and pending evidentiary hearings. The order also suspends effectiveness of various proposed tariff rule changes until the case is concluded. |
Federal Energy Regulatory Commission |
On January 31, 2005, Pepco, DPL, and ACE filed at the FERC to reset their rates for network transmission service using a formula methodology. The companies also sought a 12.4% return on common equity and a 50-basis-point return on equity adder that the FERC had made available to transmission utilities who had joined Regional Transmission Organizations and thus turned over control of their assets to an independent entity. The FERC issued an order on May 31, 2005, approving the rates to go into effect June 1, 2005, subject to refund, hearings, and further orders. The new rates reflect a decrease of 7.7% in Pepco's transmission rate, and increases of 6.5% and 3.3% in DPL's and ACE's transmission rates, respectively. The companies continue in settlement discussions and cannot predict the ultimate outcome of this proceeding. |
Restructuring Deferral |
Pursuant to a July 1999 summary order issued by the NJBPU under EDECA (which order was subsequently affirmed by a final decision and order issued in March 2001), ACE was obligated to provide BGS from August 1, 1999 to at least July 31, 2002 to retail electricity customers in ACE's service territory who did not choose a competitive energy supplier. The order allowed ACE to recover through customer rates certain costs incurred in providing BGS. ACE's obligation to provide BGS was subsequently extended to July 31, 2003. At the allowed rates, for the period August 1, 1999 through July 31, 2003, ACE's aggregate allowed costs exceeded its aggregate revenues from supplying BGS. These under-recovered costs were partially offset by a $59.3 million deferred energy cost liability existing as of July 31, 1999 (LEAC Liability) that was related to ACE's Levelized Energy Adjustment Clause and ACE's Demand Side Management Programs. ACE established a regulatory asset in an amount eq ual to the balance of under-recovered costs. |
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In August 2002, ACE filed a petition with the NJBPU for the recovery of approximately $176.4 million in actual and projected deferred costs relating to the provision of BGS and other restructuring related costs incurred by ACE over the four-year period August 1, 1999 through July 31, 2003, net of the $59.3 million offset for the LEAC Liability. The petition also requested that ACE's rates be reset as of August 1, 2003 so that there would be no under-recovery of costs embedded in the rates on or after that date. The increase sought represented an overall 8.4% annual increase in electric rates and was in addition to the base rate increase discussed above. ACE's recovery of the deferred costs is subject to review and approval by the NJBPU in accordance with EDECA. |
In July 2003, the NJBPU issued a summary order, which (i) permitted ACE to begin collecting a portion of the deferred costs and reset rates to recover on-going costs incurred as a result of EDECA, (ii) approved the recovery of $125 million of the deferred balance over a ten-year amortization period beginning August 1, 2003, (iii) as described above under "Rate Proceedings--New Jersey," transferred to ACE's then pending base rate case for further consideration approximately $25.4 million of the deferred balance, and (iv) estimated the overall deferral balance as of July 31, 2003 at $195 million, of which $44.6 million was disallowed recovery by ACE. In July 2004, the NJBPU issued its final order in the restructuring deferral proceeding. The final order did not modify the amount of the disallowances set forth in the July 2003 summary order, but did provide a much more detailed analysis of evidence and other information relied on by the NJBPU as ju stification for the disallowances. ACE believes the record does not justify the level of disallowance imposed by the NJBPU. In August 2004, ACE filed with the NJ Superior Court a Notice of Appeal with respect to the July 2004 final order. ACE's initial brief was filed on August 17, 2005. Cross-appellant briefs on behalf of the Division of the NJ Ratepayer Advocate and Cogentrix Energy Inc., the co-owner of two cogeneration power plants with contracts to sell ACE approximately 397 megawatts of electricity, were filed on October 3, 2005. ACE cannot predict the outcome of this appeal. |
Divestiture Cases |
District of Columbia |
Final briefs on Pepco's District of Columbia divestiture proceeds sharing application were filed in July 2002 following an evidentiary hearing in June 2002. That application was filed to implement a provision of Pepco's DCPSC-approved divestiture settlement that provided for a sharing of any net proceeds from the sale of Pepco's generation-related assets. One of the principal issues in the case is whether Pepco should be required to share with customers the excess deferred income taxes (EDIT) and accumulated deferred investment tax credits (ADITC) associated with the sold assets and, if so, whether such sharing would violate the normalization provisions of the Internal Revenue Code and its implementing regulations. As of September 30, 2005, the District of Columbia allocated portions of EDIT and ADITC associated with the divested generation assets were approximately $6.5 million and $5.8 million, respectively. In March 2003, the Internal Revenue Servic e (IRS) issued a notice of proposed rulemaking (NOPR) that is relevant to that principal issue. The NOPR would allow for the sharing of EDIT and ADITC related to divested assets with utility customers on a prospective basis and at the election of the taxpayer on a retroactive basis. Comments on the NOPR were filed by several parties in June 2003, and the IRS held a public hearing later in June 2003; however, no final rules have been issued. As a result of the NOPR, three of the parties in the divestiture case filed comments with the DCPSC urging the DCPSC to decide the tax issues now on the basis of the |
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proposed rule. Pepco filed comments with the DCPSC 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 DCPSC 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 in the proceeding deal with the treatment of internal costs and cost allocations as deductions from the gross proceeds of the divestiture. |
Pepco believes that a sharing of EDIT and ADITC would violate the normalization rules. If Pepco were required to share EDIT and ADITC and, as a result, the normalization rules were violated, Pepco would be unable to use accelerated depreciation on District of Columbia allocated or assigned property. Pepco, in addition to sharing with customers the generation-related EDIT and ADITC balances, would have to pay to the IRS an amount equal to Pepco's District of Columbia jurisdictional generation-related ADITC balance($5.8 million as of September 30, 2005),as well as its District of Columbia jurisdictional transmission and distribution-related ADITC balance($5.5 million as of September 30, 2005) in each case as those balances exist as of the later of the date a DCPSC order is issued and all rights to appeal have been exhausted or lapsed, or the date the DCPSC order becomes operative. |
Pepco believes that its calculation of the District of Columbia customers' share of divestiture proceeds is correct. However, depending on the ultimate outcome of this proceeding, Pepco could be required to make additional gain-sharing payments to District of Columbia customers, including the payments described above related to EDIT and ADITC. Such additional payments (which, other than the EDIT and ADITC related payments, cannot be estimated) would be charged to expense in the quarter and year in which a final decision is rendered and could have a material adverse effect on Pepco's and PHI's results of operations for those periods. However, neither PHI nor Pepco believes that additional gain-sharing payments, if any, or the ADITC-related payments to the IRS, if required, would have a material adverse impact on its financial condition. It is uncertain when the DCPSC will issue a decision regarding Pepco's divestiture proceeds sharing application. |
Maryland |
Pepco filed its divestiture proceeds plan application in Maryland in April 2001. The principal issue in the Maryland case is the same EDIT and ADITC sharing issue that has been raised in the District of Columbia case. See the discussion above under "Divestiture Cases - District of Columbia." As of September 30, 2005, the Maryland allocated portions of EDIT and ADITC associated with the divested generation assets were approximately $9.1 million and $10.4 million, respectively. Other issues deal with the treatment of certain costs as deductions from the gross proceeds of the divestiture. In November 2003, the Hearing Examiner in the Maryland proceeding issued a proposed orderwith respect to the application that concluded that Pepco's Maryland divestiture settlement agreement provided for a sharing between Pepco and customers of the EDIT and ADITC associated with the sold assets. Pepco believes that such a sharing would violate the normaliz ation rules and would result in Pepco's inability to use accelerated depreciation on Maryland allocated or assigned property. If the proposed order is affirmed, Pepco would have to share with its Maryland customers, on an approximately 50/50 basis, the Maryland allocated portion of the generation-related EDIT ($9.1 million as of |
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September 30, 2005), and the Maryland-allocated portion of generation-related ADITC. If such sharing were to violate the normalization rules, Pepco, in addition to sharing with customers an amount equal to approximately 50 percent of the generation-related ADITC balance, would be unable to use accelerated depreciation on Maryland allocated or assigned property. Furthermore, Pepco would have to pay to the IRS an amount equal to Pepco's Maryland jurisdictional generation-related ADITC balance($10.4 millionas of September 30, 2005), as well as its Maryland retail jurisdictional ADITC transmission and distribution-related balance($9.8 million as of September 30, 2005), in each case as those balances exist as of the later of the date a MPSC order is issued and all rights to appeal have been exhausted or lapsed, or the date the MPSC order becomes operative. The Hearing Examiner decided all other issues in favor o f Pepco, except for the determination that only one-half of the severance payments that Pepco included in its calculation of corporate reorganization costs should be deducted from the sales proceeds before sharing of the net gain between Pepco and customers. See also the disclosure above under "Divestiture Cases - District of Columbia" regarding the March 2003 IRS NOPR. |
Under Maryland law, if the proposed order is appealed to the MPSC, the proposed order is not a final, binding order of the MPSC and further action by the MPSC is required with respect to this matter. Pepco has appealed the Hearing Examiner's decisionas it relates to the treatment of EDIT and ADITC and corporate reorganization costs to the MPSC. Consistent with Pepco's position in the District of Columbia, Pepco has argued that the only prudent course of action is for the MPSC 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 believes that its calculation of the Maryland customers' share of divestiture proceeds is correct. However, depending on the ultimate outcome of this proceeding, Pepco could be required to share with its customers approximately 50 percent of the EDIT and ADITC balances described above and make additional gain-sharing payments rel ated to the disallowed severance payments. Such additional payments would be charged to expense in the quarter and year in which a final decision is rendered and could have a material adverse effect on results of operations for those periods. However, neither PHI nor Pepco believes that additional gain-sharing payments, if any, or the ADITC-related payments to the IRS, if required, would have a material adverse impact on its financial condition. It is uncertain when the MPSC will rule on the appeal. |
SOS, Default Service, POLR and BGS Proceedings |
District of Columbia |
For a history of Pepco's SOS proceeding before the DCPSC, please refer to Note (12), Commitments and Contingencies, to the Consolidated Financial Statements of PHI included in PHI's Annual Report on Form 10-K for the year ended December 31, 2004. The TPA with Mirant under which Pepco obtained the fixed-rate District of Columbia SOS supply ended on January 22, 2005, while the new SOS supply contracts with the winning bidders in the competitive procurement process began on February 1, 2005. Pepco procured power separately on the market for next-day deliveries to cover the period from January 23 through January 31, 2005, before the new District of Columbia SOS contracts began. Consequently, Pepco had to pay the difference between the procurement cost of power on the market for next-day deliveries and the current District of Columbia SOS rates charged to customers during the period from January 23 through January 31, 2005. In addition, because the new District of Columbi a SOS rates did not go into effect until February 8, 2005, Pepco had to pay the difference between the |
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procurement cost of power under the new District of Columbia SOS contracts and the District of Columbia SOS rates charged to customers for the period from February 1 to February 7, 2005. The total amount of the difference is estimated to be approximately $8.7 million. This difference, however, was included in the calculation of the Generation Procurement Credit (GPC) for the District of Columbia for the period February 8, 2004 through February 7, 2005. The GPC provides for a sharing between Pepco's customers and shareholders, on an annual basis, of any margins, but not losses, that Pepco earned providing SOS in the District of Columbia during the four-year period from February 8, 2001 through February 7, 2005. Currently, based on the rates paid by Pepco to Mirant under the TPA Settlement, there is no customer sharing. However, in the event that Pepco were to ultimately realize a significant recovery from the Mirant bankruptcy estate associated with the TPA Settlement, the GPC would be recalculat ed, and the amount of customer sharing with respect to such recovery would be reduced because of the $8.7 million loss being included in the GPC calculation. |
Virginia |
Under amendments to the Virginia Electric Utility Restructuring Act implemented in March 2004, DPL is obligated to offer Default Service to customers in Virginia for an indefinite period until relieved of that obligation by the Virginia State Corporation Commission (VSCC). DPL currently obtains all of the energy and capacity needed to fulfill its Default Service obligations in Virginia under a supply agreement with Conectiv Energy that commenced on January 1, 2005 and expires in May 2006 (the 2005 Supply Agreement). A prior agreement, also with Conectiv Energy, terminated effective December 31, 2004. DPL entered into the 2005 Supply Agreement after conducting a competitive bid procedure in which Conectiv Energy was the lowest bidder. |
In October 2004, DPL filed an application with the VSCC for approval to increase the rates that DPL charges its Virginia Default Service customers to allow it to recover its costs for power under the 2005 Supply Agreement plus an administrative charge and a margin. A VSCC order issued in November 2004 allowed DPL to put interim rates into effect on January 1, 2005, subject to refund if the VSCC subsequently determined the rate is excessive. The interim rates reflected an increase of 1.0247 cents per kilowatt hour (Kwh) to the fuel rate, which provide for recovery of the entire amount being paid by DPL to Conectiv Energy, but did not include an administrative charge or margin, pending further consideration of this issue. In January 2005, the VSCC ruled that the administrative charge and margin are base rate items not recoverable through a fuel clause. On March 25, 2005, the VSCC approved a settlement resolving all other issues and making the interim rates final, contingent only on possible future adjustment depending on the result of a related FERC proceeding, described below. However, in the VSCC proceeding addressing "Proposed Rules Governing Exemptions to Minimum Stay Requirements and Wires Charges" (the Wires Charges Proceeding), the VSCC staff recognized that DPL should be entitled to earn a reasonable margin related to hourly pricing customers. The size of any margin that may be allowed with respect to hourly priced customers has no current impact because DPL has no hourly priced customers in Virginia. DPL continues to maintain in the Wires Charges Proceeding that a margin should be earned on all customer classes. Discussions in the Wires Charges Proceeding regarding the size of the margin and the customer classes to which it will apply are continuing. DPL cannot predict the outcome of the Wires Charges Proceeding. |
In October 2004, Conectiv Energy made a filing with FERC requesting authorization to enter into a contract to supply power to an affiliate, DPL, under the 2005 Supply Agreement. In |
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December 2004, FERC granted the requested authorization effective January 1, 2005, subject to refund and hearings on the narrow question whether, given the absence of direct VSCC oversight over the DPL competitive bid process, DPL unduly preferred its own affiliate, Conectiv Energy, in the design and implementation of the DPL competitive bid process or in the credit criteria and analysis applied. On June 8, 2005, Conectiv Energy entered into a stipulation with FERC staff and the Virginia Office of Attorney General resolving all issues regarding DPL's procurement process. The stipulation concludes that DPL did not favor Conectiv Energy in awarding it the 2005 Supply Agreement. As part of the stipulation, DPL sent a letter to FERC committing to use a third-party independent monitor in future Virginia solicitations. On October 14, 2005, FERC issued an Order Approving Uncontested Settlement in which it approved the stipulation entered into by Conectiv Energy and the FERC staff and terminated the proceeding. |
Delaware |
Under a settlement approved by the DPSC, DPL is required to provide POLR service to retail customers in Delaware until May 1, 2006. In October 2004, the DPSC initiated a proceeding to investigate and determine which entity should act as the SOS supplier in DPL's Delaware service territory after May 1, 2006, and what prices should be charged for SOS after May 1, 2006. On March 22, 2005, the DPSC issued an order approving DPL as the SOS provider at market rates after May 1, 2006, when DPL's current fixed rate POLR obligation ends. The DPSC also approved a structure whereby DPL will retain the SOS obligation for an indefinite period until changed by the DPSC, and will purchase the power supply required to satisfy its market rate fixed-price SOS obligations from wholesale suppliers under contracts entered into pursuant to a competitive bid procedure. |
On July 18, 2005, the DPSC staff, the Division of the Public Advocate, a group representing DPL's industrial and commercial customers, Conectiv Energy and DPL filed with the Hearing Examiner a comprehensive settlement agreementaddressing the process under which supply would be acquired by DPL and the way in which SOS prices would be set and monitored. The settlement agreement was approved in an order issued on October 11, 2005. The agreement calls for DPL to provide SOS to all customer classes, with no specified termination date for SOS. Two categories of SOS will exist: (i) a fixed price SOS available to all but the largest customers; and (ii) an Hourly Priced Service (HPS) for the largest customers. A competitive bid process will be used to procure the full requirements of customers eligible for a fixed-price SOS. Power to supply the HPS customers will be acquired on next-day and other short-term PJM markets. In addition to the costs of capaci ty, energy, transmission, and ancillary services associated with the fixed-price SOS and HPS, DPL's initial rates will include a component referred to as the Reasonable Allowance for Retail Margin (RARM). Components of the RARM include estimated incremental expenses, a $2.75 million return, a cash working capital allowance, and recovery with a return over five years of the capitalized costs of a billing system to be used for billing HPS customers. |
New Jersey |
Pursuant to a May 5, 2005 order from the NJBPU, on July 1, 2005, ACE along with the other three electric distribution companies in New Jersey, filed a proposal addressing the procurement of BGS for the period beginning June 1, 2006. The areas addressed in the July 1, 2005 filings include, but are not limited to: the type of procurement process, the size, make-up and pricing |
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options for the Commercial and Industrial Energy Pricing class, and the level of the retail margin and corresponding utilization of the retail margin funds. ACE cannot predict the outcome of this proceeding. |
Proposed Shut Down of B.L. England Generating Facility;
Construction of Transmission Facilities |
In April 2004, pursuant to aNJBPU order, ACE filed a report with the NJBPU recommending thatACE'sB.L. England generating facility, a 447 megawattplant, be shut down. The report stated that, while operation of the B.L. England generating facility was necessary at the time of the report to satisfy reliability standards, those reliability standards could also be satisfied in other ways. The report concluded that, based on B.L. England's current and projected operating costs resulting from compliance with more restrictive environmental requirements, the most cost-effective way in which to meet reliability standardsis to shut down the B.L. England generating facility and construct additional transmission enhancements in southern New Jersey. |
In a preliminary settlementamong PHI, Conectiv, ACE,the New Jersey Department of Environmental Protection (NJDEP) and the Attorney General of New Jersey, which is further discussed under "Preliminary Settlement Agreement with NJDEP," below,ACE agreed to seek necessary approvals fromthe relevantagencies to shut down and permanently cease operations attheB.L. England generating facility by December 15,2007. An Administrative Consent Order (ACO) finalizing the provisions of the preliminary settlement agreement is currently being negotiated. |
In December 2004, ACE filed a petition with the NJBPU requesting that the NJBPU establish a proceeding that will consist of a Phase I and Phase II and that the procedural process for the Phase I proceeding require intervention and participation by all persons interested in the prudence of the decision to shut down B.L. England generating facility and the categories of stranded costs associated with shutting down and dismantling the facility and remediation of the site. ACE contemplates that Phase II of this proceeding, which would be initiated by an ACE filing in 2008 or 2009, would establish the actual level of prudently incurred stranded costs to be recovered from customers in rates. |
ACE Auction of Generation Assets |
In May 2005, ACE announced that it would again auction its electric generation assets,consisting of its B.L. England generating facility and its ownership interests in the Keystone and Conemaugh generating stations. Under the terms of sale, any successful bid for B.L. England must include assumption of all environmental liabilities associated with the plant in accordance with the auction standards previously issued by the NJBPU. |
Final bids for ACE's interests in the Keystone and Conemaugh generating stations were received on September 30, 2005. Based on the expressed need of the potential B.L. England bidders for the details of the ACOrelating to the shut down of the plant that isbeing negotiated between ACE and the NJDEP, ACE has elected to delay the final bid due date for B.L. England until such time as a final ACO is complete and available to bidders. |
Any sale of B.L. England will not affect the stranded costs associated with the plant that already have been securitized. If B.L. England is sold, ACE anticipates that, subject to regulatory approval in Phase II of the proceeding described above, approximately $9.1 million |
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of additional assets may be eligible for recovery as stranded costs. If there are net gains on the sale of the Keystone and Conemaugh generating stations, these net gains would be an offset to stranded costs. |
General Litigation |
During 1993, Pepco was served with Amended Complaints filed in the state Circuit Courts of Prince George's County, Baltimore City and Baltimore County, Maryland in separate ongoing, consolidated proceedings known as "In re: Personal Injury Asbestos Case." Pepco and other corporate entities were brought into these cases on a theory of premises liability. Under this theory, the plaintiffs argued that Pepco was negligent in not providing a safe work environment for employees or its contractors, who allegedly were exposed to asbestos while working on Pepco's property. Initially, a total of approximately 448 individual plaintiffs added Pepco to their complaints. While the pleadings are not entirely clear, it appears that each plaintiff sought $2 million in compensatory damages and $4 million in punitive damages from each defendant. |
Since the initial filings in 1993, additional individual suits have been filed against Pepco, and significant numbers of cases have been dismissed. As a result of two motions to dismiss, numerous hearings and meetings and one motion for summary judgment, Pepco has had approximately 400 of these cases successfully dismissed with prejudice, either voluntarily by the plaintiff or by the court. Of the approximately 250 remaining asbestos cases pending against Pepco, approximately 85 cases were filed after December 19, 2000, and have been tendered to Mirant for defense and indemnification pursuant to the terms of the Asset Purchase and Sale Agreement. |
While the aggregate amount of monetary damages sought in the remaining suits (excluding those tendered to Mirant) exceeds $400 million, Pepco believes the amounts claimed by current plaintiffs are greatly exaggerated. The amount of total liability, if any, and any related insurance recovery cannot be determined at this time; however, based on information and relevant circumstances known at this time, Pepco does not believe these suits will have a material adverse effect on its financial condition. However, if an unfavorable decision were rendered against Pepco, it could have a material adverse effect on Pepco's and PHI's results of operations. |
Environmental Litigation |
PHI, through its subsidiaries, is subject to regulation by various federal, regional, state, and local authorities with respect to the environmental effects of its operations, including air and water quality control, solid and hazardous waste disposal, and limitations on land use. In addition, federal and state statutes authorize governmental agencies to compel responsible parties to clean up certain abandoned or unremediated hazardous waste sites. PHI's subsidiaries may incur costs to clean up currently or formerly owned facilities or sites found to be contaminated, as well as other facilities or sites that may have been contaminated due to past disposal practices. Although penalties assessed for violations of environmental laws and regulations are not recoverable from customers of the operating utilities, environmental clean-up costs incurred by Pepco, DPL and ACE would be included by each company in its respective cost of service for ratemaking purposes. |
In July 2004, DPL entered into an ACO with the Maryland Department of the Environment (MDE) to perform a Remedial Investigation/Feasibility Study (RI/FS) to further identify the |
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extent of soil, sediment and ground and surface water contamination related to former manufactured gas plant (MGP) operations at the Cambridge, Maryland site on DPL-owned property and to investigate the extent of MGP contamination on adjacent property. The costs for completing the RI/FS for this site are approximately $300,000, approximately $50,000 of which will be expended in 2005. The costs of cleanup resulting from the RI/FS will not be determinable until the RI/FS is completed and an agreement with respect to cleanup is reached with the MDE. The MDE has approved the RI and DPL has commenced the FS. |
In October 1995, Pepco and DPL each received notice from the Environmental Protection Agency (EPA) that it, along with several hundred other companies, might be a potentially responsible party (PRP) in connection with the Spectron Superfund Site in Elkton, Maryland. The site was operated as a hazardous waste disposal, recycling and processing facility from 1961 to 1988. |
In August 2001, Pepco entered into a consent decree for de minimis parties with EPA to resolve its liability at the Spectron site. Under the terms of the consent decree, which was approved by the U.S. District Court for the District of Maryland in March 2003, Pepco made de minimis payments to the United States and a group of PRPs. In return, those parties agreed not to sue Pepco for past and future costs of remediation at the site and the United States will also provide protection against third-party claims for contributions related to response actions at the site. The consent decree does not cover any damages to natural resources. However, Pepco believes that any liability that it might incur due to natural resource damage at this site would not have a material adverse effect on its financial condition or results of operations. In April 1996, DPL, along with numerous other PRPs, entered into an ACO with the EPA to perform an RI/FS at the Spectron site. In February 2003, the EPA excused DPL from any further involvement at the site in accordance with agency policy. |
In the early 1970s, both Pepco and DPL sold scrap transformers, some of which may have contained some level of PCBs, to a metal reclaimer operating at the Metal Bank/Cottman Avenue site in Philadelphia, Pennsylvania, owned by a nonaffiliated company. In December 1987, Pepco and DPL were notified by EPA that they, along with a number of other utilities and non-utilities, were PRPs in connection with the PCB contamination at the site. |
In October 1994, an RI/FS including a number of possible remedies was submitted to the EPA. In December 1997, the EPA issued a Record of Decision that set forth a selected remedial action plan with estimated implementation costs of approximately $17 million. In June 1998, the EPA issued a unilateral administrative order to Pepco and 12 other PRPs directing them to conduct the design and actions called for in its decision. In May 2003, two of the potentially liable owner/operator entities filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code. In October 2003, the bankruptcy court confirmed a reorganization plan that incorporates the terms of a settlement among the debtors, the United States and a group of utility PRPs including Pepco (the Utility PRPs). Under the bankruptcy settlement, the reorganized entity/site owner will pay a total of $13.25 million to remediate the site (the Bankruptcy Settlement). |
On September 2, 2005 the United States lodged with the U.S. District Court for the Eastern District of Pennsylvania global consent decrees for the Metal Bank site, which the Utility PRPs entered into on August 23, 2005 with the U.S. Department of Justice, EPA, The City of Philadelphia and two owner/operators of the site with respect to clean up of the site. The global settlement includes three Companion Consent Decrees (for the Utility PRPs and one each for the |
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two owner/operators) and an agreement with The City of Philadelphia. Under the terms of the settlement, the two owner/operators will make payments totaling $5.55 million to the U.S. and totaling $4.05 million to the Utility PRPs. The Utility PRPs will perform the remedy at the site and will be able to draw on the $13.25 million from the Bankruptcy Settlement to accomplish the remediation (the Bankruptcy Funds). The Utility PRPs will contribute funds to the extent remediation costs exceed the Bankruptcy Funds available. The Utility PRPs will not be liable for any of the United States' past costs in connection with the site, but will be liable for EPA costs associated with overseeing the monitoring and operation of the site remedy after the remedy construction is certified to be complete and also the cost of performing the "5 year" review of site conditions required by the Comprehensive Environmental Response, Compensation, and Liability Act of 1980. Any Bankruptcy Funds not spent on the remedy may be used to cover the Utility PRPs' liabilities for future costs. No parties are released from potential liability for damages to natural resources. The global settlement agreement is subject to a public comment period and approval by the court. If for any reason the court declines to enter one or more Companion Consent Decrees, the United States and the Utility PRPs will have 30 days to withdraw or withhold consent for the other Companion Consent Decrees. Court approval could be obtained as early as the fourth quarter 2005. |
As of September 30, 2005, Pepco had accrued $1.7 million to meet its liability for a remedy at the Metal Bank/Cottman Avenue site. While final costs to Pepco of the settlement have not been determined, Pepco believes that its liability at this site will not have a material adverse effect on its financial condition or results of operations. |
In 1999, DPL entered into a de minimis settlement with EPA and paid approximately $107,000 to resolve its liability for cleanup costs at the Metal Bank/Cottman Avenue site. The de minimis settlement did not resolve DPL's responsibility for natural resource damages, if any, at the site. DPL believes that any liability for natural resource damages at this site will not have a material adverse effect on its financial condition or results of operations. |
In June 1992, EPA identified ACE as a PRP at the Bridgeport Rental and Oil Services Superfund Site in Logan Township, New Jersey. In September 1996, ACE along with other PRPs signed a consent decree with EPA and NJDEP to address remediation of the site. ACE's liability is limited to 0.232 percent of the aggregate remediation liability and thus far ACE has made contributions of approximately $105,000. Based on information currently available, ACEanticipates that it may be required to contribute approximately an additional $100,000. ACE believes that its liability at this site will not have a material adverse effect on its financial condition or results of operations. |
In November 1991, NJDEP identified ACE as a PRP at the Delilah Road Landfill site in Egg Harbor Township, New Jersey. In 1993, ACE, along with other PRPs, signed an ACO with NJDEP to remediate the site. The soil cap remedy for the site has been completed and the NJDEP conditionally approved the report submitted by the parties on the implementation of the remedy in January 2003. In March 2004, NJDEP approved a Ground Water Sampling and Analysis Plan. The results of groundwater monitoring over the first year of this ground water sampling plan will help to determine the extent of post-remedy operation and maintenance costs. In March 2003, EPA demanded from the PRP group reimbursement for EPA's past costs at the site, totaling $168,789. The PRP group objected to the demand for certain costs, but agreed to reimburse EPA approximately $19,000. Based on information currently available, ACE anticipates that it may be required to contribute approximately an additional $626,000. ACE |
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believes that its liability for post-remedy operation and maintenance costs will not have a material adverse effect on its financial condition or results of operations. |
Preliminary Settlement Agreement with the NJDEP |
In an effort to address NJDEP's concerns regarding ACE's compliance with New Source Review (NSR) requirements at the B.L. England generating facility, on April 26, 2004, PHI, Conectiv and ACE entered into a preliminary settlement agreement with NJDEP and the Attorney General of New Jersey. The preliminary settlement agreement outlines the basic parameters for a definitive agreement to resolve ACE's NSR liability at B.L. England and various other environmental issues at ACE and Conectiv Energy facilities in New Jersey. Among other things, the preliminary settlement agreement provides that: |
New Accounting Standards |
SFAS No. 154 |
In May 2005, the Financial Accounting Standards Board (FASB) issued Statement No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3" (SFAS No. 154).SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. The reporting of a correction of an error by restating previously issued financial statements is also addressed by SFAS No. 154. This Statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted. |
FIN 47 |
In March 2005, the FASB published FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations"(FIN 47). FIN 47 clarifies that FASB Statement No. 143," Accounting for Asset Retirement Obligations" applies to conditional asset retirement obligations and requires that the fair value of a reasonably estimable conditional asset retirement obligation be recognized as part of the carrying amounts of the asset. FIN 47 is effective no later than the end of the first fiscal year ending after December 15, 2005 (i.e., December 31, 2005 for Pepco). Pepco is in the process of evaluating the anticipated impact that the implementation of FIN 47 will have on its overall financial condition or results of operations. |
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EITF 04-13 |
In September 2005, the FASB ratified EITF Issue No. 04-13, "Accounting for Purchases and Sales of Inventory with the Same Counterparty" (EITF 04-13). The Issue addresses circumstances under which two or more exchange transactions involving inventory with the same counterparty should be viewed as a single exchange transaction for the purposes of evaluating the effect of APB Opinion 29. EITF 04-13 is effective for new arrangements entered into, or modifications or renewals of existing arrangements, beginning in the first interim or annual reporting period beginning after March 15, 2006 (April 1, 2006 for Pepco). EITF 04-13 may not impact Pepco's net income or overall financial condition but rather may result in certain revenues and costs being presented on a net basis. Pepco is in the process of evaluating the impact of EITF 04-13 on the income statement presentation of purchases and sales covered by the Issue. |
(3) SEGMENT INFORMATION |
In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," Pepco has one segment, its regulated utility business. |
(4) COMMITMENTS AND CONTINGENCIES |
REGULATORY AND OTHER MATTERS |
Relationship with Mirant Corporation |
In 2000, Pepco sold substantially all of its electricity generation assets to Mirant Corporation, formerly Southern Energy, Inc. As part of the Asset Purchase and Sale Agreement, Pepco entered into several ongoing contractual arrangements with Mirant Corporation and certain of its subsidiaries (collectively, Mirant). On July 14, 2003, Mirant Corporation and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of Texas (the Bankruptcy Court). |
Depending on the outcome of the matters discussed below, the Mirant bankruptcy could have a material adverse effect on the results of operations of Pepco Holdings and Pepco. However, management believes that Pepco Holdings and Pepco currently have sufficient cash, cash flow and borrowing capacity under their credit facilities and in the capital markets to be able to satisfy any additional cash requirements that may arise due to the Mirant bankruptcy. Accordingly, management does not anticipate that the Mirant bankruptcy will impair the ability of Pepco Holdings or Pepco to fulfill their contractual obligations or to fund projected capital expenditures. On this basis, management currently does not believe that the Mirant bankruptcy will have a material adverse effect on the financial condition of either company. |
Transition Power Agreements |
As part of 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, Mirant was obligated to supply Pepco with all of the capacity 53
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and energy needed to fulfill its SOS obligations in Maryland through June 2004 and its SOS obligations in the District of Columbia through January 22, 2005.
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To avoid the potential rejection of the TPAs, Pepco and Mirant entered into an Amended Settlement Agreement and Release dated as of October 24, 2003 (the Settlement Agreement) pursuant to which Mirant assumed both of the TPAs and the terms of the TPAs were modified. The Settlement Agreement also provided that Pepco has an allowed, pre-petition general unsecured claim against Mirant Corporation in the amount of $105 million (the Pepco TPA Claim). |
Pepco has also asserted the Pepco TPA Claim against other Mirant entities, which Pepco believes are liable to Pepco under the terms of the Asset Purchase and Sale Agreement's Assignment and Assumption Agreement (the Assignment Agreement). Under the Assignment Agreement, Pepco believes that each of the Mirant entities assumed and agreed to discharge certain liabilities and obligations of Pepco as defined in the Asset Purchase and Sale Agreement. Mirant has filed objections to these claims. Under the original plan of reorganization filed by the Mirant entities with the Bankruptcy Court, certain Mirant entities other than Mirant Corporation would pay significantly higher percentages of the claims of their creditors than would Mirant Corporation. The amount that Pepco will be able to recover from the Mirant bankruptcy estate with respect to the Pepco TPA Claim will depend on the amount of assets available for distribution to creditors of the Mirant entities determined to be li able for the Pepco TPA Claim. At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover, whether the recovery would be in cash or another form of payment, or the timing of any recovery. |
Power Purchase Agreements |
Under agreements with FirstEnergy Corp., formerly Ohio Edison (FirstEnergy), and Allegheny Energy, Inc., both entered into in 1987, Pepco is obligated to purchase from FirstEnergy 450 megawatts of capacity and energy annually through December 2005 (the FirstEnergy PPA). Under the Panda PPA, entered into in 1991, Pepco is obligated to purchase from Panda 230 megawatts of capacity and energy annually through 2021. In each case, the purchase price is substantially in excess of current market price. As a part of the Asset Purchase and Sale Agreement, Pepco entered into a "back-to-back" arrangement with Mirant. Under this arrangement, Mirant is obligated, among other things, to purchase from Pepco the capacity and energy that Pepco is obligated to purchase under the FirstEnergy PPA and the Panda PPA at a price equal to the price Pepco is obligated to pay under the FirstEnergy PPA and the Panda PPA (the PPA-Related Obligations). |
Pepco Pre-Petition Claims |
When Mirant filed its bankruptcy petition on July 14, 2003, Mirant had unpaid obligations to Pepco of approximately $29 million, consisting primarily of payments due to Pepco with respect to the PPA-Related Obligations (the Mirant Pre-Petition Obligations). The Mirant Pre-Petition Obligations constitute part of the indebtedness for which Mirant is seeking relief in its bankruptcy proceeding. Pepco has filed Proofs of Claim in the Mirant bankruptcy proceeding in the amount of approximately $26 million to recover this indebtedness; however, the amount of Pepco's recovery, if any, is uncertain. The $3 million difference between Mirant's unpaid obligation to Pepco and the $26 million Proofs of Claim primarily represents a TPA settlement |
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adjustment that is included in the $105 million Proofs of Claim filed by Pepco against the Mirant debtors in respect of the Pepco TPA Claim. In view of the uncertainty as to recoverability, Pepco, in the third quarter of 2003, expensed $14.5 million to establish a reserve against the $29 million receivable from Mirant. In January 2004, Pepco paid approximately $2.5 million to Panda in settlement of certain billing disputes under the Panda PPA that related to periods after the sale of Pepco's generation assets to Mirant. Pepco believes that under the terms of the Asset Purchase and Sale Agreement, Mirant is obligated to reimburse Pepco for the settlement payment. Accordingly, in the first quarter of 2004, Pepco increased the amount of the receivable due from Mirant by approximately $2.5 million and amended its Proofs of Claim to include this amount. Pepco currently estimates that the $14.5 million expensed in the third quarter of 2003 represents the portion of the entire $31.5 million receivable unlike ly to be recovered in bankruptcy, and no additional reserve has been established for the $2.5 million increase in the receivable. The amount expensed represents Pepco's estimate of the possible outcome in bankruptcy, although the amount ultimately recovered could be higher or lower. |
Mirant's Attempt to Reject the PPA-Related Obligations |
In August 2003, Mirant filed with the Bankruptcy Court a motion seeking authorization to reject its PPA-Related Obligations. Upon motions filed with the U.S. District Court for the Northern District of Texas (the District Court) by Pepco and the Federal Energy Regulatory Commission (FERC), in October 2003, the District Court withdrew jurisdiction over the rejection proceedings from the Bankruptcy Court. In December 2003, the District Court denied Mirant's motion to reject the PPA-Related Obligations on jurisdictional grounds. The District Court's decision was appealed by Mirant and The Official Committee of Unsecured Creditors of Mirant Corporation (the Creditors' Committee) to the U.S. Court of Appeals for the Fifth Circuit (the Court of Appeals). In August 2004, the Court of Appeals remanded the case to the District Court saying that the District Court had jurisdiction to rule on the merits of Mirant's rejection motion, suggesting that in doing so the court apply a "mor e rigorous standard" than the business judgment rule usually applied by bankruptcy courts in ruling on rejection motions. |
On December 9, 2004, the District Court issued an order again denying Mirant's motion to reject the PPA-Related Obligations. The District Court found that the PPA-Related Obligations are not severable from the Asset Purchase and Sale Agreement and that the Asset Purchase and Sale Agreement cannot be rejected in part, as Mirant was seeking to do. Both Mirant and the Creditors' Committee appealed the District Court's order to the Court of Appeals. Briefing of this matter by the interested parties has been completed. Oral arguments have not yet been scheduled. |
Until December 9, 2004, Mirant had been making regular periodic payments in respect of the PPA-Related Obligations. However, on that date, Mirant filed a notice with the Bankruptcy Court that it was suspending payments to Pepco in respect of the PPA-Related Obligations and subsequently failed to make certain full and partial payments due to Pepco. Proceedings ensued in the Bankruptcy Court and the District Court, ultimately resulting in Mirant being ordered to pay to Pepco all past-due unpaid amounts under the PPA-Related Obligations. On April 13, 2005, Pepco received a payment from Mirant in the amount of approximately $57.5 million, representing the full amount then due in respect of the PPA-Related Obligations. |
On January 21, 2005, Mirant filed in the Bankruptcy Court a motion seeking to reject certain of its ongoing obligations under the Asset Purchase and Sale Agreement, including the PPA- |
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Related Obligations (the Second Motion to Reject). On March 1, 2005, the District Court entered an order (as amended by a second order issued on March 7, 2005) granting Pepco's motion to withdraw jurisdiction over these rejection proceedings from the Bankruptcy Court. Mirant and the Creditor's Committee have appealed these orders to the Court of Appeals. Amicus briefs, which are briefs filed by persons who are not parties to the proceeding, but who nevertheless have a strong interest -- in this instance a broad public interest -- in the case, in support Pepco's position have been filed with the Court of Appeals by the Maryland Public Service Commission (MPSC) and the Office of People's Counsel of Maryland (Maryland OPC). Briefing of this matter by the interested parties has been completed. Oral arguments have not yet been scheduled. |
On March 28, 2005, Pepco, FERC, the Office of People's Counsel of the District of Columbia (the District of Columbia OPC), the MPSC and the Maryland OPC filed in the District Court oppositions to the Second Motion to Reject. By order entered August 16, 2005, the District Court has informally stayed this matter, pending a decision by the Court of Appeals on the District Court's orders withdrawing jurisdiction from the Bankruptcy Court. |
Pepco is exercising all available legal remedies and vigorously opposing Mirant's efforts to reject the PPA-Related Obligations and other obligations under the Asset Purchase and Sale Agreement in order to protect the interests of its customers and shareholders. While Pepco believes that it has substantial legal bases to oppose these efforts by Mirant, the ultimate outcome is uncertain. |
If Mirant ultimately is successful in rejecting the PPA-Related Obligations, Pepco could be required to repay to Mirant, for the period beginning on the effective date of the rejection (which date could be prior to the date of the court's order granting the rejection and possibly as early as September 18, 2003) and ending on the date Mirant is entitled to cease its purchases of energy and capacity from Pepco, all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity. Pepco estimates that the amount it could be required to repay to Mirant in the unlikely event that September 18, 2003 is determined to be the effective date of rejection, is approximately $225.1 million as of November 1, 2005. |
Mirant has also indicated to the Bankruptcy Court that it will move to require Pepco to disgorge all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity, for the period July 14, 2003 (the date on which Mirant filed its bankruptcy petition) through rejection, if approved, on the theory that Mirant did not receive value for those payments. Pepco estimates that the amount it would be required to repay to Mirant on the disgorgement theory, in addition to the amounts described above, is approximately $22.5 million. |
Any repayment by Pepco of amounts received from Mirant in respect of the PPA-Related Obligations would entitle Pepco to file a claim against the bankruptcy estate in an amount equal to the amount repaid. To the extent such amounts were not recovered from the Mirant bankruptcy estate, Pepco believes they would be recoverable as stranded costs from customers through distribution rates as described below. |
The following are estimates prepared by Pepco of its potential future exposure if Mirant's attempt to reject the PPA-Related Obligations ultimately is successful. These estimates are |
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based in part on current market prices and forward price estimates for energy and capacity, and do not include financing costs, all of which could be subject to significant fluctuation. The estimates assume no recovery from the Mirant bankruptcy estate and no regulatory recovery, either of which would mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recoveries. Based on these assumptions, Pepco estimates that its pre-tax exposure as of November 1, 2005 representing the loss of the future benefit of the PPA-Related Obligations to Pepco, is as follows: |
The ability of Pepco to recover from the Mirant bankruptcy estate in respect to the Mirant Pre-Petition Obligations and damages if the PPA-Related Obligations are successfully rejected will depend on whether Pepco's claims are allowed, the amount of assets available for distribution to the creditors of the Mirant companies determined to be liable for those claims, and Pepco's priority relative to other creditors. At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate, whether the recovery would be in cash or another form of payment, or the timing of any recovery. |
If Mirant ultimately were successful in rejecting the PPA-Related Obligations and Pepco's full claim were not recovered from the Mirant bankruptcy estate, Pepco would seek authority from the MPSC and the District of Columbia Public Service Commission (DCPSC) to recover its additional costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers. Under the provisions of the settlement agreements approved by the MPSC and the DCPSC in the deregulation proceedings in which Pepco agreed to divest its generation assets under certain conditions, the PPAs were to become assets of Pepco's distribution business if they could not be sold. Pepco believes that, if Mirant ultimately is successful in rejecting the PPA-Related Obligations, these provisions would allow the stranded costs of the PPAs that are not recovered from the Mirant bankruptcy estate to be recovered from Pepco's customers through its dist ribution rates. If Pepco's interpretation of the settlement agreements is confirmed, Pepco expects to be able to establish the amount of its anticipated recovery as a regulatory asset. However, there is no assurance that Pepco's interpretation of the settlement agreements would be confirmed by the respective public service commissions. |
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If the PPA-Related Obligations are successfully rejected, and there is no regulatory recovery, Pepco will incur a loss; the accounting treatment of such a loss, however, would depend on a number of legal and regulatory factors. |
Mirant's Fraudulent Transfer Claim |
On July 13, 2005, Mirant filed a complaint in the Bankruptcy Court against Pepco alleging that Mirant's $2.65 billion purchase of Pepco's generating assets in June 2000 constituted a fraudulent transfer. Mirant alleges in the complaint that the value of Pepco's generation assets was "not fair consideration or fair or reasonably equivalent value for the consideration paid to Pepco" and that it thereby rendered Mirant insolvent, or, alternatively, that Pepco and Southern Energy, Inc. (as predecessor to Mirant) intended that Mirant would incur debts beyond its ability to pay them. Mirant asks that the Court enter an order "declaring that the consideration paid for the Pepco assets, to the extent it exceeds the fair value of the Pepco assets, to be a conveyance or transfer in fraud of the rights of Creditors under state law" and seeks compensatory and punitive damages. |
Pepco believes this claim has no merit and is vigorously contesting the claim. On September 20, 2005, Pepco filed a motion to withdraw this complaint to the District Court and on September 30, 2005, Pepco filed its answer in the Bankruptcy Court. On October 20, 2005, the Bankruptcy Court issued a report and recommendation to the District Court, which recommends that the District Court grant the motion to withdraw the reference. The District Court will now consider whether to accept the recommendation to withdraw the reference. Pepco cannot predict when the District Court will make a decision or whether it will accept the recommendation of the Bankruptcy Court. |
The SMECO Agreement |
As a term of the Asset Purchase and Sale Agreement, Pepco assigned to Mirant a facility and capacity agreement with Southern Maryland Electric Cooperative, Inc. (SMECO) under which Pepco was obligated to purchase the capacity of an 84-megawatt combustion turbine installed and owned by SMECO at a former Pepco generating facility (the SMECO Agreement). The SMECO Agreement expires in 2015 and contemplates a monthly payment to SMECO of approximately $.5 million. Pepco is responsible to SMECO for the performance of the SMECO Agreement if Mirant fails to perform its obligations thereunder. At this time, Mirant continues to make post-petition payments due to SMECO. |
On March 15, 2004, Mirant filed a complaint with the Bankruptcy Court seeking a declaratory judgment that the SMECO Agreement is an unexpired lease of non-residential real property rather than an executory contract and that if Mirant were to successfully reject the agreement, any claim against the bankruptcy estate for damages made by SMECO (or by Pepco as subrogee) would be subject to the provisions of the Bankruptcy Code that limit the recovery of rejection damages by lessors. Pepco believes that there is no reasonable factual or legal basis to support Mirant's contention that the SMECO Agreement is a lease of real property. The outcome of this proceeding cannot be predicted. |
Mirant Plan of Reorganization |
On January 19, 2005, Mirant filed its Plan of Reorganization and Disclosure Statement with the Bankruptcy Court (the Original Reorganization Plan) under which Mirant proposed to |
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transfer all assets to "New Mirant" (an entity it proposed to create in the reorganization), with the exception of the PPA-Related Obligations. Mirant proposed that the PPA-Related Obligations would remain in "Old Mirant," which would be a shell entity as a result of the reorganization. On March 25, 2005, Mirant filed its First Amended Plan of Reorganization and First Amended Disclosure Statement (the Amended Reorganization Plan), in which Mirant abandoned the proposal that the PPA-Related Obligations would remain in "Old Mirant," but did not clarify how the PPA-Related Obligations would be treated. On September 22, 2005, Mirant filed its Second Amended Disclosure Statement and Second Amended Plan of Reorganization. Pepco filed objections to the Second Amended Disclosure Statement on September 28, 2005 and a revised version of the Second Amended Disclosure Statement, including the changes and clarifications requested by Pepco, was filed and approved by the Bankruptcy Court on September 30, 2005. Pepc o is still analyzing, and has not yet determined whether to file an objection to, the Second Amended Plan of Reorganization. Objections to confirmation of the Second Amended Plan of Reorganization are due November 10, 2005. |
On March 11, 2005, Mirant filed an application with FERC seeking approval for the internal transfers and corporate restructuring that will result from the Original Reorganization Plan. FERC approval for these transactions is required under Section 203 of the Federal Power Act. On April 1, 2005, Pepco filed a motion to intervene and protest at FERC in connection with this application. On the same date, the District of Columbia OPC also filed a motion to intervene and protest. Pepco, the District of Columbia OPC, the Maryland OPC and the MPSC filed pleadings arguing that the application was premature inasmuch as it was unclear whether the planned reorganization would be approved by the Bankruptcy Court and asking that FERC refrain from acting on the application. |
On June 17, 2005, FERC issued anorder approving the planned restructuring outlined in the Original Reorganization Plan, which has since been superseded by the Second Amended Plan of Reorganization, as discussed above. The Second Amended Plan of Reorganization does not provide for the same restructuring contemplated in the Original Reorganization Plan. While the FERC order had no direct impact on Pepco, the order included a discussion regarding potential future rate impacts if the courts were to permit rejection of the PPAs. Because Pepco disagreed with this discussion, Pepco filed a motion for rehearing on July 18, 2005 (before Mirant filed its Second Amended Plan of Reorganization). On August 17, 2005, the FERC entered an order granting the request for rehearing "for the limited purpose of further consideration." This order simply means that the request for rehearing remains pending. Pepco cannot predict the outcome of its motion for rehearing. |
Rate Proceedings |
Federal Energy Regulatory Commission |
On January 31, 2005, Pepco filed at the FERC to reset its rates for network transmission service using a formula methodology. Pepco also sought a 12.4% return on common equity and a 50-basis-point return on equity adder that the FERC had made available to transmission utilities who had joined Regional Transmission Organizations and thus turned over control of their assets to an independent entity. The FERC issued an order on May 31, 2005, approving the rates to go into effect June 1, 2005, subject to refund, hearings, and further orders. The new rates reflect a decrease of 7.7% in Pepco's transmission rate. Pepco continues in settlement discussions and cannot predict the ultimate outcome of this proceeding. |
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Divestiture Cases |
District of Columbia |
Final briefs on Pepco's District of Columbia divestiture proceeds sharing application were filed in July 2002 following an evidentiary hearing in June 2002. That application was filed to implement a provision of Pepco's DCPSC-approved divestiture settlement that provided for a sharing of any net proceeds from the sale of Pepco's generation-related assets. One of the principal issues in the case is whether Pepco should be required to share with customers the excess deferred income taxes (EDIT) and accumulated deferred investment tax credits (ADITC) associated with the sold assets and, if so, whether such sharing would violate the normalization provisions of the Internal Revenue Code and its implementing regulations. As of September 30, 2005, the District of Columbia allocated portions of EDIT and ADITC associated with the divested generation assets were approximately $6.5 million and $5.8 million, respectively. In March 2003, the Internal Revenue Servic e (IRS) issued a notice of proposed rulemaking (NOPR) that is relevant to that principal issue. The NOPR would allow for the sharing of EDIT and ADITC related to divested assets with utility customers on a prospective basis and at the election of the taxpayer on a retroactive basis. Comments on the NOPR were filed by several parties in June 2003, and the IRS held a public hearing later in June 2003; however, no final rules have been issued. As a result of the NOPR, three of the parties in the divestiture case filed comments with the DCPSC urging the DCPSC to decide the tax issues now on the basis of the proposed rule. Pepco filed comments with the DCPSC 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 DCPSC to await the issuance of final regulations relating to the tax issu es 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 in the proceeding deal with the treatment of internal costs and cost allocations as deductions from the gross proceeds of the divestiture. |
Pepco believes that a sharing of EDIT and ADITC would violate the normalization rules. If Pepco were required to share EDIT and ADITC and, as a result, the normalization rules were violated, Pepco would be unable to use accelerated depreciation on District of Columbia allocated or assigned property. Pepco, in addition to sharing with customers the generation-related EDIT and ADITC balances, would have to pay to the IRS an amount equal to Pepco's District of Columbia jurisdictional generation-related ADITC balance ($5.8 million as of September 30, 2005), as well as its District of Columbia jurisdictional transmission and distribution-related ADITC balance ($5.5 million as of September 30, 2005) in each case as those balances exist as of the later of the date a DCPSC order is issued and all rights to appeal have been exhausted or lapsed, or the date the DCPSC order becomes operative. |
Pepco believes that its calculation of the District of Columbia customers' share of divestiture proceeds is correct. However, depending on the ultimate outcome of this proceeding, Pepco could be required to make additional gain-sharing payments to District of Columbia customers, including the payments described above related to EDIT and ADITC. Such additional payments (which, other than the EDIT and ADITC related payments, cannot be estimated) would be charged to expense in the quarter and year in which a final decision is rendered and could have a material adverse effect on Pepco's and PHI's results of operations for those periods. However, |
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neither PHI nor Pepco believes that additional gain-sharing payments, if any, or the ADITC-related payments to the IRS, if required, would have a material adverse impact on its financial condition. It is uncertain when the DCPSC will issue a decision regarding Pepco's divestiture proceeds sharing application. |
Maryland |
Pepco filed its divestiture proceeds plan application in Maryland in April 2001. The principal issue in the Maryland case is the same EDIT and ADITC sharing issue that has been raised in the District of Columbia case. See the discussion above under "Divestiture Cases - District of Columbia." As of September 30, 2005, the Maryland allocated portions of EDIT and ADITC associated with the divested generation assets were approximately $9.1 million and $10.4 million, respectively. Other issues deal with the treatment of certain costs as deductions from the gross proceeds of the divestiture. In November 2003, the Hearing Examiner in the Maryland proceeding issued a proposed order with respect to the application that concluded that Pepco's Maryland divestiture settlement agreement provided for a sharing between Pepco and customers of the EDIT and ADITC associated with the sold assets. Pepco believes that such a sharing would violate the normalization rules and would r esult in Pepco's inability to use accelerated depreciation on Maryland allocated or assigned property. If the proposed order is affirmed, Pepco would have to share with its Maryland customers, on an approximately 50/50 basis, the Maryland allocated portion of the generation-related EDIT ($9.1 million as of September 30, 2005), and the Maryland-allocated portion of generation-related ADITC. If such sharing were to violate the normalization rules, Pepco, in addition to sharing with customers an amount equal to approximately 50 percent of the generation-related ADITC balance, would be unable to use accelerated depreciation on Maryland allocated or assigned property. Furthermore, Pepco would have to pay to the IRS an amount equal to Pepco's Maryland jurisdictional generation-related ADITC balance ($10.4 million as of September 30, 2005), as well as its Maryland retail jurisdictional ADITC transmission and distribution-related balance ($9.8 million as of September 30, 2005), in ea ch case as those balances exist as of the later of the date a MPSC order is issued and all rights to appeal have been exhausted or lapsed, or the date the MPSC order becomes operative. The Hearing Examiner decided all other issues in favor of Pepco, except for the determination that only one-half of the severance payments that Pepco included in its calculation of corporate reorganization costs should be deducted from the sales proceeds before sharing of the net gain between Pepco and customers. See also the disclosure above under "Divestiture Cases - District of Columbia" regarding the March 2003 IRS NOPR. |
Under Maryland law, if the proposed order is appealed to the MPSC, the proposed order is not a final, binding order of the MPSC and further action by the MPSC is required with respect to this matter. Pepco has appealed the Hearing Examiner's decision as it relates to the treatment of EDIT and ADITC and corporate reorganization costs to the MPSC. Consistent with Pepco's position in the District of Columbia, Pepco has argued that the only prudent course of action is for the MPSC 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 believes that its calculation of the Maryland customers' share of divestiture proceeds is correct. However, depending on the ultimate outcome of this proceeding, Pepco could be required to share with its customers approximately 50 percent of the EDIT and ADITC balances described above and make additional gain-sharing payments related to the disallowed severance payments. Such additional payments would be charged to expense in the quarter and year in which a final decision is |
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rendered and could have a material adverse effect on results of operations for those periods. However, neither PHI nor Pepco believes that additional gain-sharing payments, if any, or the ADITC-related payments to the IRS, if required, would have a material adverse impact on its financial condition. It is uncertain when the MPSC will rule on the appeal. |
SOS Proceeding |
District of Columbia |
For a history of Pepco's SOS proceeding before the DCPSC, please refer to Note (12), Commitments and Contingencies, to the Consolidated Financial Statements of PHI included in PHI's Annual Report on Form 10-K for the year ended December 31, 2004. The TPA with Mirant under which Pepco obtained the fixed-rate District of Columbia SOS supply ended on January 22, 2005, while the new SOS supply contracts with the winning bidders in the competitive procurement process began on February 1, 2005. Pepco procured power separately on the market for next-day deliveries to cover the period from January 23 through January 31, 2005, before the new District of Columbia SOS contracts began. Consequently, Pepco had to pay the difference between the procurement cost of power on the market for next-day deliveries and the current District of Columbia SOS rates charged to customers during the period from January 23 through January 31, 2005. In addition, because the new District of Columbi a SOS rates did not go into effect until February 8, 2005, Pepco had to pay the difference between the procurement cost of power under the new District of Columbia SOS contracts and the District of Columbia SOS rates charged to customers for the period from February 1 to February 7, 2005. The total amount of the difference is estimated to be approximately $8.7 million. This difference, however, was included in the calculation of the Generation Procurement Credit (GPC) for the District of Columbia for the period February 8, 2004 through February 7, 2005. The GPC provides for a sharing between Pepco's customers and shareholders, on an annual basis, of any margins, but not losses, that Pepco earned providing SOS in the District of Columbia during the four-year period from February 8, 2001 through February 7, 2005. Currently, based on the rates paid by Pepco to Mirant under the TPA Settlement, there is no customer sharing. However, in the event that Pepco were to ultimately realize a significant recove ry from the Mirant bankruptcy estate associated with the TPA Settlement, the GPC would be recalculated, and the amount of customer sharing with respect to such recovery would be reduced because of the $8.7 million loss being included in the GPC calculation. |
General Litigation |
During 1993, Pepco was served with Amended Complaints filed in the state Circuit Courts of Prince George's County, Baltimore City and Baltimore County, Maryland in separate ongoing, consolidated proceedings known as "In re: Personal Injury Asbestos Case." Pepco and other corporate entities were brought into these cases on a theory of premises liability. Under this theory, the plaintiffs argued that Pepco was negligent in not providing a safe work environment for employees or its contractors, who allegedly were exposed to asbestos while working on Pepco's property. Initially, a total of approximately 448 individual plaintiffs added Pepco to their complaints. While the pleadings are not entirely clear, it appears that each plaintiff sought $2 million in compensatory damages and $4 million in punitive damages from each defendant. |
Since the initial filings in 1993, additional individual suits have been filed against Pepco, and significant numbers of cases have been dismissed. As a result of two motions to dismiss, |
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numerous hearings and meetings and one motion for summary judgment, Pepco has had approximately 400 of these cases successfully dismissed with prejudice, either voluntarily by the plaintiff or by the court. Of the approximately 250 remaining asbestos cases pending against Pepco, approximately 85 cases were filed after December 19, 2000, and have been tendered to Mirant for defense and indemnification pursuant to the terms of the Asset Purchase and Sale Agreement. |
While the aggregate amount of monetary damages sought in the remaining suits (excluding those tendered to Mirant) exceeds $400 million, Pepco believes the amounts claimed by current plaintiffs are greatly exaggerated. The amount of total liability, if any, and any related insurance recovery cannot be determined at this time; however, based on information and relevant circumstances known at this time, Pepco does not believe these suits will have a material adverse effect on its financial condition. However, if an unfavorable decision were rendered against Pepco, it could have a material adverse effect on Pepco's and PHI's results of operations. |
Environmental Litigation |
Pepco is subject to regulation by various federal, regional, state, and local authorities with respect to the environmental effects of its operations, including air and water quality control, solid and hazardous waste disposal, and limitations on land use. In addition, federal and state statutes authorize governmental agencies to compel responsible parties to clean up certain abandoned or unremediated hazardous waste sites. Pepco may incur costs to clean up currently or formerly owned facilities or sites found to be contaminated, as well as other facilities or sites that may have been contaminated due to past disposal practices. Although penalties assessed for violations of environmental laws and regulations are not recoverable from Pepco's customers, environmental clean-up costs incurred by Pepco would be included by in its cost of service for ratemaking purposes. |
In October 1995, Pepco received notice from the Environmental Protection Agency (EPA) that it, along with several hundred other companies, might be a potentially responsible party (PRP) in connection with the Spectron Superfund Site in Elkton, Maryland. The site was operated as a hazardous waste disposal, recycling and processing facility from 1961 to 1988. |
In August 2001, Pepco entered into a consent decree for de minimis parties with EPA to resolve its liability at the Spectron site. Under the terms of the consent decree, which was approved by the U.S. District Court for the District of Maryland in March 2003, Pepco made de minimis payments to the United States and a group of PRPs. In return, those parties agreed not to sue Pepco for past and future costs of remediation at the site and the United States will also provide protection against third-party claims for contributions related to response actions at the site. The consent decree does not cover any damages to natural resources. However, Pepco believes that any liability that it might incur due to natural resource damage at this site would not have a material adverse effect on its financial condition or results of operations. |
In the early 1970s, Pepco sold scrap transformers, some of which may have contained some level of PCBs, to a metal reclaimer operating at the Metal Bank/Cottman Avenue site in Philadelphia, Pennsylvania, owned by a nonaffiliated company. In December 1987, Pepco was notified by EPA that it, along with a number of other utilities and non-utilities, was a PRP in connection with the PCB contamination at the site. |
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In October 1994, an Remedial Investigation/Feasibility Study (RI/FS) including a number of possible remedies was submitted to the EPA. In December 1997, the EPA issued a Record of Decision that set forth a selected remedial action plan with estimated implementation costs of approximately $17 million. In June 1998, the EPA issued a unilateral administrative order to Pepco and 12 other PRPs directing them to conduct the design and actions called for in its decision. In May 2003, two of the potentially liable owner/operator entities filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code. In October 2003, the bankruptcy court confirmed a reorganization plan that incorporates the terms of a settlement among the debtors, the United States and a group of utility PRPs including Pepco (the Utility PRPs). Under the bankruptcy settlement, the reorganized entity/site owner will pay a total of $13.25 million to remediate the site (the Bankruptcy Settlement). |
On September 2, 2005 the United States lodged with the U.S. District Court for the Eastern District of Pennsylvania global consent decrees for the Metal Bank site, which the Utility PRPs entered into on August 23, 2005 with the U.S. Department of Justice, EPA, The City of Philadelphia and two owner/operators of the site with respect to clean up of the site. The global settlement includes three Companion Consent Decrees (for the Utility PRPs and one each for the two owner/operators) and an agreement with The City of Philadelphia. Under the terms of the settlement, the two owner/operators will make payments totaling $5.55 million to the U.S. and totaling $4.05 million to the Utility PRPs. The Utility PRPs will perform the remedy at the site and will be able to draw on the $13.25 million from the Bankruptcy Settlement to accomplish the remediation (the Bankruptcy Funds). The Utility PRPs will contribute funds to the extent remediation costs exceed the Bankruptcy Funds availa ble. The Utility PRPs will not be liable for any of the United States' past costs in connection with the site, but will be liable for EPA costs associated with overseeing the monitoring and operation of the site remedy after the remedy construction is certified to be complete and also the cost of performing the "5 year" review of site conditions required by the Comprehensive Environmental Response, Compensation, and Liability Act of 1980. Any Bankruptcy Funds not spent on the remedy may be used to cover the Utility PRPs' liabilities for future costs. No parties are released from potential liability for damages to natural resources. The global settlement agreement is subject to a public comment period and approval by the court. If for any reason the court declines to enter one or more Companion Consent Decrees, the United States and the Utility PRPs will have 30 days to withdraw or withhold consent for the other Companion Consent Decrees. Court approval could be obtained as early as the fourth quarter 2 005. |
As of September 30, 2005, Pepco had accrued $1.7 million to meet its liability for a remedy at the Metal Bank/Cottman Avenue site. While final costs to Pepco of the settlement have not been determined, Pepco believes that its liability at this site will not have a material adverse effect on its financial condition or results of operations. |
IRS Mixed Service Cost Issue |
During 2001, Pepco changed its methods of accounting with respect to capitalizable construction costs for income tax purposes, which allow the companies to accelerate the deduction of certain expenses that were previously capitalized and depreciated. Through September 30, 2005, these accelerated deductions have generated incremental tax cash flow benefits for Pepco of approximately $94 million, primarily attributable to its 2001 tax returns. On August 2, 2005, the IRS issued Revenue Ruling 2005-53 (the Revenue Ruling) that will limit the ability of the companies to utilize this method of accounting for income tax purposes on their |
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tax returns for 2004 and prior years. Pepco intends to contest any IRS adjustment to its prior year income tax returns based on the Revenue Ruling. However, if the IRS is successful in applying this Revenue Ruling, Pepco would be required to capitalize and depreciate a portion of the construction costs previously deducted and repay the associated income tax benefits, along with interest thereon. During the third quarter 2005, Pepco recorded a $4.6 million increase in income tax expense to account for the accrued interest that would be paid on the portion of tax benefits that Pepco estimates would be deferred to future years if the construction costs previously deducted are required to be capitalized and depreciated. |
On the same day as the Revenue Ruling was issued, the Treasury Department released regulations that, if adopted in their current form, would require Pepco to change its method of accounting with respect to capitalizable construction costs for income tax purposes for all future tax periods beginning in 2005. Under these regulations, Pepco will have to capitalize and depreciate a portion of the construction costs that they have previously deducted and repay, over a two year period beginning with tax year 2005, the associated income tax benefits. Pepco is continuing to work with the industry to determine an alternative method of accounting for capitalizable construction costs acceptable to the IRS to replace the method disallowed by the new regulations. |
(5) SALE OF BUZZARD POINT PROPERTY |
On August 25, 2005, John Akridge Development Company ("Akridge") purchased 384,051 square feet of excess non-utility land owned by Pepco located at Buzzard Point in the District of Columbia. The contract price was $75 million in cash and resulted in a pre-tax gain of $68.1 million which is recorded as a reduction of Operating Expenses in the accompanying Consolidated Statements of Earnings in the third quarter of 2005. The after-tax gain was $40.7 million. The sale agreement provides that Akridge will release Pepco from, and has agreed to indemnify Pepco for, substantially all environmental liabilities associated with the land, except that Pepco will retain liability for claims by third parties arising from the release, if any, of hazardous substances from the land onto the adjacent property occurring before the closing of the sale. |
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New Accounting Standards |
SFAS No. 154 |
In May 2005, the Financial Accounting Standards Board (FASB) issued Statement No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3" (SFAS No. 154).SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. The reporting of a correction of an error by restating previously issued financial statements is also addressed by SFAS No. 154. This Statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted. |
FIN 47 |
In March 2005, the FASB published FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations"(FIN 47). FIN 47 clarifies that FASB Statement No. 143, "Accounting for Asset Retirement Obligations," applies to conditional asset retirement obligations and requires that the fair value of a reasonably estimable conditional asset retirement obligation be recognized as part of the carrying amounts of the asset. FIN 47 is effective no later than the end of the first fiscal year ending after December 15, 2005 (i.e., December 31, 2005 for DPL). DPL is in the process of evaluating the anticipated impact that the implementation of FIN 47 will have on its overall financial condition or results of operations. |
EITF 04-13 |
In September 2005, the FASB ratified EITF Issue No. 04-13, "Accounting for Purchases and Sales of Inventory with the Same Counterparty" (EITF 04-13). The Issue addresses circumstances under which two or more exchange transactions involving inventory with the same counterparty should be viewed as a single exchange transaction for the purposes of |
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evaluating the effect of APB Opinion 29. EITF 04-13 is effective for new arrangements entered into, or modifications or renewals of existing arrangements, beginning in the first interim or annual reporting period beginning after March 15, 2006 (April 1, 2006 for DPL). EITF 04-13 may not impact DPL's net income or overall financial condition but rather may result in certain revenues and costs being presented on a net basis. DPL is in the process of evaluating the impact of EITF 04-13 on the income statement presentation of purchases and sales covered by the Issue. |
(3) SEGMENT INFORMATION |
In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," DPL has one segment, its regulated utility business. |
(4) COMMITMENTS AND CONTINGENCIES |
REGULATORY AND OTHER MATTERS |
Rate Proceedings |
Delaware |
In October 2004, DPL submitted its annual Gas Cost Rate (GCR) filing, which permits DPL to recover gas procurement costs through customer rates, to the Delaware Public Service Commission (DPSC). In its filing, DPL sought to increase its GCR by approximately 16.8% in anticipation of increasing natural gas commodity costs. In addition, in November 2004, DPL filed a supplemental filing seeking approval to further increase GCR rates by an additional 6.5% effective December 29, 2004. A final order approving both increases was issued by the DPSC on August 9, 2005. |
On October 3, 2005, DPL submitted its 2005 GCR filing to the DPSC. In its filing, DPL seeks to increase its GCR by approximately 38% in anticipation of increasing natural gas commodity costs. The proposed rate became effective November 1, 2005, subject to refund pending final DPSC approval after evidentiary hearings. |
As authorized by the April 16, 2002 settlement agreement in Delaware relating to the merger of Pepco and Conectiv (the DE Merger Settlement Agreement), on May 4, 2005, DPL filed with the DPSC a proposed increase of approximately $6.2 million in electric transmission service revenues, or about 1.1% of total Delaware retail electric revenues. This proposed revenue increase is the Delaware retail portion of the increase in the "Delmarva zonal" transmission rates on file with FERC under the Open Access Transmission Tariff (OATT) of the PJM Interconnection, LLC (PJM). This level of revenue increase will decrease to the extent that competitive retail suppliers provide a supply and transmission service to retail customers. In that circumstance, PJM would charge the competitive retail supplier the PJM OATT rate for transmission service into the Delmarva zone and DPL's charges to the retail customer would exclude as a "shopping credit" an amount equal to the SOS supply charge and t he transmission and ancillary charges that would otherwise be charged by DPL to the retail customer. DPL began collecting this rate change for service rendered on and after June 3, 2005, subject to refund pending final approval by the DPSC. |
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On September 1, 2005, DPL filed with the DPSC its first comprehensive base rate case in ten years. This application was filed as a result of increasing costs and is consistent with a provision in the DE Merger Settlement Agreement permitting DPL to apply for an increase in rates effective as of May 1, 2006. DPL is seeking approval of an annual increase of approximately $5.1 million in its electric rates, with an increase of approximately $1.6 million to its electric distribution base rates after proposing to assign approximately $3.5 million in costs to the supply component of rates to be collected as part of the SOS. Of the approximately $1.6 million in net increases to its electric distribution base rates, DPL proposed that approximately $1.2 million be recovered through changes in delivery charges and that the remaining approximately $.4 million be recovered through changes in premise collection and reconnect fees. The full proposed revenue increase is approximately 0. 9% of total annual electric utility revenues, while the proposed net increase to distribution rates is 0.2% of total annual electric utility revenues. DPL's distribution revenue requirement is based on a return on common equity of 11%. DPL also has proposed revised depreciation rates and a number of tariff modifications. On September 20, 2005, the DPSC issued an order approving DPL's request that the rate increase go into effect on May 1, 2006; subject to refund and pending evidentiary hearings. The order also suspends effectiveness of various proposed tariff rule changes until the case is concluded. |
Federal Energy Regulatory Commission |
On January 31, 2005, DPL filed at the Federal Energy Regulatory Commission (FERC) to reset its rates for network transmission service using a formula methodology. DPL also sought a 12.4% return on common equity and a 50-basis-point return on equity adder that the FERC had made available to transmission utilities who had joined Regional Transmission Organizations and thus turned over control of their assets to an independent entity. The FERC issued an order on May 31, 2005, approving the rates to go into effect June 1, 2005, subject to refund, hearings, and further orders. The new rates reflect an increase of 6.5% in DPL's transmission rates. DPL continues in settlement discussions and cannot predict the ultimate outcome of this proceeding. |
SOS, Default Service and POLR Proceedings |
Virginia |
Under amendments to the Virginia Electric Utility Restructuring Act implemented in March 2004, DPL is obligated to offer Default Service to customers in Virginia for an indefinite period until relieved of that obligation by the Virginia State Corporation Commission (VSCC). DPL currently obtains all of the energy and capacity needed to fulfill its Default Service obligations in Virginia under a supply agreement with Conectiv Energy Supply, Inc. (Conectiv Energy) that commenced on January 1, 2005 and expires in May 2006 (the 2005 Supply Agreement). A prior agreement, also with Conectiv Energy, terminated effective December 31, 2004. DPL entered into the 2005 Supply Agreement after conducting a competitive bid procedure in which Conectiv Energy was the lowest bidder. |
In October 2004, DPL filed an application with the VSCC for approval to increase the rates that DPL charges its Virginia Default Service customers to allow it to recover its costs for power under the 2005 Supply Agreement plus an administrative charge and a margin. A VSCC order issued in November 2004 allowed DPL to put interim rates into effect on January 1, 2005, subject to refund if the VSCC subsequently determined the rate is excessive. The interim rates reflected an increase of 1.0247 cents per kilowatt hour (Kwh) to the fuel rate, which provide for |
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recovery of the entire amount being paid by DPL to Conectiv Energy, but did not include an administrative charge or margin, pending further consideration of this issue. In January 2005, the VSCC ruled that the administrative charge and margin are base rate items not recoverable through a fuel clause. On March 25, 2005, the VSCC approved a settlement resolving all other issues and making the interim rates final, contingent only on possible future adjustment depending on the result of a related FERC proceeding, described below. However, in the VSCC proceeding addressing "Proposed Rules Governing Exemptions to Minimum Stay Requirements and Wires Charges" (the Wires Charges Proceeding), the VSCC staff recognized that DPL should be entitled to earn a reasonable margin related to hourly pricing customers. The size of any margin that may be allowed with respect to hourly priced customers has no current impact because DPL has no hourly priced customers in Virginia. DPL continues to maintain in the Wires Charges Proceeding that a margin should be earned on all customer classes. Discussions in the Wires Charges Proceeding regarding the size of the margin and the customer classes to which it will apply are continuing. DPL cannot predict the outcome of the Wires Charges Proceeding. |
In October 2004, Conectiv Energy made a filing with FERC requesting authorization to enter into a contract to supply power to an affiliate, DPL, under the 2005 Supply Agreement. In December 2004, FERC granted the requested authorization effective January 1, 2005, subject to refund and hearings on the narrow question whether, given the absence of direct VSCC oversight over the DPL competitive bid process, DPL unduly preferred its own affiliate, Conectiv Energy, in the design and implementation of the DPL competitive bid process or in the credit criteria and analysis applied. On June 8, 2005, Conectiv Energy entered into a stipulation with FERC staff and the Virginia Office of Attorney General resolving all issues regarding DPL's procurement process. The stipulation concludes that DPL did not favor Conectiv Energy in awarding it the 2005 Supply Agreement. As part of the stipulation, DPL sent a letter to FERC committing to use a third-party independent monitor in future Virginia solicitations. On October 14, 2005, FERC issued an Order Approving Uncontested Settlement in which it approved the stipulation entered into by Conectiv Energy and the FERC staff and terminated the proceeding. |
Delaware |
Under a settlement approved by the DPSC, DPL is required to provide POLR service to retail customers in Delaware until May 1, 2006. In October 2004, the DPSC initiated a proceeding to investigate and determine which entity should act as the SOS supplier in DPL's Delaware service territory after May 1, 2006, and what prices should be charged for SOS after May 1, 2006. On March 22, 2005, the DPSC issued an order approving DPL as the SOS provider at market rates after May 1, 2006, when DPL's current fixed rate POLR obligation ends. The DPSC also approved a structure whereby DPL will retain the SOS obligation for an indefinite period until changed by the DPSC, and will purchase the power supply required to satisfy its market rate fixed-price SOS obligations from wholesale suppliers under contracts entered into pursuant to a competitive bid procedure. |
On July 18, 2005, the DPSC staff, the Division of the Public Advocate, a group representing DPL's industrial and commercial customers, Conectiv Energy and DPL filed with the Hearing Examiner a comprehensive settlement agreement addressing the process under which supply would be acquired by DPL and the way in which SOS prices would be set and monitored. The settlement agreement was approved in an order issued on October 11, 2005. The agreement |
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calls for DPL to provide SOS to all customer classes, with no specified termination date for SOS. Two categories of SOS will exist: (i) a fixed price SOS available to all but the largest customers; and (ii) an Hourly Priced Service (HPS) for the largest customers. A competitive bid process will be used to procure the full requirements of customers eligible for a fixed-price SOS. Power to supply the HPS customers will be acquired on next-day and other short-term PJM markets. In addition to the costs of capacity, energy, transmission, and ancillary services associated with the fixed-price SOS and HPS, DPL's initial rates will include a component referred to as the Reasonable Allowance for Retail Margin (RARM). Components of the RARM include estimated incremental expenses, a $2.75 million return, a cash working capital allowance, and recovery with a return over five years of the capitalized costs of a billing system to be used for billing HPS customers. |
Environmental Litigation |
DPL is subject to regulation by various federal, regional, state, and local authorities with respect to the environmental effects of its operations, including air and water quality control, solid and hazardous waste disposal, and limitations on land use. In addition, federal and state statutes authorize governmental agencies to compel responsible parties to clean up certain abandoned or unremediated hazardous waste sites. DPL may incur costs to clean up currently or formerly owned facilities or sites found to be contaminated, as well as other facilities or sites that may have been contaminated due to past disposal practices. Although penalties assessed for violations of environmental laws and regulations are not recoverable from DPL's customers, environmental clean-up costs incurred by DPL would be included in its cost of service for ratemaking purposes. |
In July 2004, DPL entered into an Administrative Consent Order (ACO) with the Maryland Department of the Environment (MDE) to perform a Remedial Investigation/Feasibility Study (RI/FS) to further identify the extent of soil, sediment and ground and surface water contamination related to former manufactured gas plant (MGP) operations at the Cambridge, Maryland site on DPL-owned property and to investigate the extent of MGP contamination on adjacent property. The costs for completing the RI/FS for this site are approximately $300,000, approximately $50,000 of which will be expended in 2005. The costs of cleanup resulting from the RI/FS will not be determinable until the RI/FS is completed and an agreement with respect to cleanup is reached with the MDE. The MDE has approved the RI and DPL has commenced the FS. |
In October 1995, DPL received notice from the Environmental Protection Agency (EPA) that it, along with several hundred other companies, might be a potentially responsible party (PRP) in connection with the Spectron Superfund Site in Elkton, Maryland. The site was operated as a hazardous waste disposal, recycling and processing facility from 1961 to 1988. In April 1996, DPL, along with numerous other PRPs, entered into an ACO with the EPA to perform an RI/FS at the Spectron site. In February 2003, the EPA excused DPL from any further involvement at the site in accordance with agency policy. |
In the early 1970s, DPL sold scrap transformers, some of which may have contained some level of PCBs, to a metal reclaimer operating at the Metal Bank/Cottman Avenue site in Philadelphia, Pennsylvania, owned by a nonaffiliated company. In December 1987, DPL was 79
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notified by EPA that it, along with a number of other utilities and non-utilities, were PRPs in connection with the PCB contamination at the site.
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In October 1994, an RI/FS including a number of possible remedies was submitted to the EPA. In December 1997, the EPA issued a Record of Decision that set forth a selected remedial action plan with estimated implementation costs of approximately $17 million. In 1999, DPL entered into a de minimis settlement with EPA and paid approximately $107,000 to resolve its liability for cleanup costs at the Metal Bank/Cottman Avenue site. The de minimis settlement did not resolve DPL's responsibility for natural resource damages, if any, at the site. DPL believes that any liability for natural resource damages at this site will not have a material adverse effect on its financial condition or results of operations. |
IRS Mixed Service Cost Issue |
During 2001, DPL changed its methods of accounting with respect to capitalizable construction costs for income tax purposes, which allow the companies to accelerate the deduction of certain expenses that were previously capitalized and depreciated. Through September 30, 2005, these accelerated deductions have generated incremental tax cash flow benefits for DPL of approximately $62 million, primarily attributable to its 2001 tax returns. On August 2, 2005, the IRS issued Revenue Ruling 2005-53 (the Revenue Ruling) that will limit the ability of the companies to utilize this method of accounting for income tax purposes on their tax returns for 2004 and prior years. DPL intends to contest any IRS adjustment to its prior year income tax returns based on the Revenue Ruling. However, if the IRS is successful in applying this Revenue Ruling, DPL would be required to capitalize and depreciate a portion of the construction costs previously deducted and repay the associated income tax benefits, along with interest thereon. During the third quarter 2005, DPL recorded a $2.0 million increase in income tax expense to account for the accrued interest that would be paid on the portion of tax benefits that DPL estimates would be deferred to future years if the construction costs previously deducted are required to be capitalized and depreciated. |
On the same day as the Revenue Ruling was issued, the Treasury Department released regulations that, if adopted in their current form, would require DPL to change its method of accounting with respect to capitalizable construction costs for income tax purposes for all future tax periods beginning in 2005. Under these regulations, DPL will have to capitalize and depreciate a portion of the construction costs that they have previously deducted and repay, over a two year period beginning with tax year 2005, the associated income tax benefits. DPL is continuing to work with the industry to determine an alternative method of accounting for capitalizable construction costs acceptable to the IRS to replace the method disallowed by the new regulations. |
(5) CHANGES IN ACCOUNTING ESTIMATES |
During the second quarter of 2005, DPL recorded the impact of a reduction in estimated unbilled revenue, primarily reflecting an increase in the estimated amount of power line losses (estimates of electricity expected to be lost in the process of its transmission and distribution to customers). This change in accounting estimate reduced earnings for the nine months ended September 30, 2005 by approximately $1.0 million. |
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New Accounting Standards |
SFAS No. 154 |
In May 2005, the Financial Accounting Standards Board (FASB) issued Statement No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB |
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Statement No. 3" (SFAS No. 154).SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. The reporting of a correction of an error by restating previously issued financial statements is also addressed by SFAS No. 154. This Statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted. |
FIN 47 |
In March 2005, the FASB published FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations"(FIN 47). FIN 47 clarifies that FASB Statement No. 143, "Accounting for Asset Retirement Obligations," applies to conditional asset retirement obligations and requires that the fair value of a reasonably estimable conditional asset retirement obligation be recognized as part of the carrying amounts of the asset. FIN 47 is effective no later than the end of the first fiscal year ending after December 15, 2005 (i.e., December 31, 2005 for ACE). ACE is in the process of evaluating the anticipated impact that the implementation of FIN 47 will have on its overall financial condition or results of operations. |
EITF 04-13 |
In September 2005, the FASB ratified EITF Issue No. 04-13, "Accounting for Purchases and Sales of Inventory with the Same Counterparty" (EITF 04-13). The Issue addresses circumstances under which two or more exchange transactions involving inventory with the same counterparty should be viewed as a single exchange transaction for the purposes of evaluating the effect of APB Opinion 29. EITF 04-13 is effective for new arrangements entered into, or modifications or renewals of existing arrangements, beginning in the first interim or annual reporting period beginning after March 15, 2006 (April 1, 2006 for ACE). EITF 04-13 may not impact ACE's net income or overall financial condition but rather may result in certain revenues and costs, including wholesale revenues and purchased power expenses, being presented on a net basis. ACE is in the process of evaluating the impact of EITF 04-13 on the income statement presentation of purchases and sales covered by the Issue. |
(3) SEGMENT INFORMATION |
In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," ACE has one segment, its regulated utility business. |
(4) COMMITMENTS AND CONTINGENCIES |
REGULATORY AND OTHER MATTERS |
Rate Proceedings |
New Jersey |
In February 2003, ACE filed a petition with the NJBPU to increase its electric distribution rates and its Regulatory Asset Recovery Charge (RARC) in New Jersey. In an order dated May 26, 2005, the NJBPU approved the settlement reached among ACE, the staff of the |
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NJBPU, the New Jersey Ratepayer Advocate and active intervenor parties that resolved the issues pertaining to this base rate proceeding as well as other outstanding issues from several other proceedings that were consolidated with the base rate proceeding, including ACE's petition to recover $25.4 million of deferred restructuring costs related to the provision of BGS. |
The settlement allows for an increase in ACE's base rates of approximately $18.8 million annually, of which $2.8 million will consist of an increase in RARC revenue collections each year for the four years ending 2008. The $16 million of the base rate increase, not related to RARC collections, will be collected annually from ACE's customers until such time as base rates change in a subsequent base rate proceeding. The $18.8 million increase in base rate revenue is offset by a base rate revenue decrease in a similar amount in total resulting from a change in depreciation rates similar to changes adopted by the NJBPU for other New Jersey electric utility companies. Overall, the settlement provides for a net decrease in annual revenues of approximately $.3 million, consisting of a $3.1 million reduction of distribution revenues offset by the $2.8 million increase in RARC revenue collections discussed above. The settlement specifies an overall rate of return of 8.14%. The change i n depreciation rates referred to above is the result of a change in average service lives. In addition, the settlement provides for a change in depreciation technique from remaining life to whole life, including amortization of any calculated excess or deficiencies in the depreciation reserve. As a result of these changes, ACE had a net excess depreciation reserve. Accordingly, ACE recorded a regulatory liability in March 2005 by reducing its depreciation reserve by approximately $131 million. The regulatory liability will be amortized over 8.25 years and will result in a reduction of depreciation and amortization expense on ACE's consolidated statements of earnings. While the impact of the settlement is essentially revenue and cash neutral to ACE, there is a positive annual pre-tax earnings impact to ACE of approximately $20 million. |
The settlement also establishes an adjusted deferred balance of approximately $116.8 million as of October 31, 2004, which reflects an approved amount of deferred restructuring costs related to the provision of BGS, various other pre-November 2004 additions and reductions to the deferred balance, and a disallowance of $13.0 million of previously recorded supply-related deferred costs. This adjusted deferred balance is to be recovered in rates over a four-year period and the rate effects are offset by a one-year return of over-collected balances in certain other deferred accounts. The net result of these changes is that there will be no rate impact from the deferral account recoveries and credits for at least one year. Net rate effects in future years will depend in part on whether rates associated with those other deferred accounts continue to generate over-collections relative to costs. |
The settlement does not affect the pending appeal filed by ACE with the Appellate Division of the Superior Court of New Jersey (the NJ Superior Court) related to the Final Decision and Order issued in July 2004 by the NJBPU in ACE's restructuring deferral proceeding before the NJBPU under the New Jersey Electric Discount and Energy Competition Act (EDECA), discussed below under "Restructuring Deferral." |
Federal Energy Regulatory Commission |
On January 31, 2005, ACE filed at the Federal Energy Regulatory Commission (FERC) to reset its rates for network transmission service using a formula methodology. ACE also sought a 12.4% return on common equity and a 50-basis-point return on equity adder that the FERC had made available to transmission utilities who had joined Regional Transmission |
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Organizations and thus turned over control of their assets to an independent entity. The FERC issued an order on May 31, 2005, approving the rates to go into effect June 1, 2005, subject to refund, hearings, and further orders. The new rates reflect an increase of 3.3% in ACE's transmission rates. ACE continues in settlement discussions and cannot predict the ultimate outcome of this proceeding. |
Restructuring Deferral |
Pursuant to a July 1999 summary order issued by the NJBPU under EDECA (which order was subsequently affirmed by a final decision and order issued in March 2001), ACE was obligated to provide BGS from August 1, 1999 to at least July 31, 2002 to retail electricity customers in ACE's service territory who did not choose a competitive energy supplier. The order allowed ACE to recover through customer rates certain costs incurred in providing BGS. ACE's obligation to provide BGS was subsequently extended to July 31, 2003. At the allowed rates, for the period August 1, 1999 through July 31, 2003, ACE's aggregate allowed costs exceeded its aggregate revenues from supplying BGS. These under-recovered costs were partially offset by a $59.3 million deferred energy cost liability existing as of July 31, 1999 (LEAC Liability) that was related to ACE's Levelized Energy Adjustment Clause and ACE's Demand Side Management Programs. ACE established a regulatory asset in an amount eq ual to the balance of under-recovered costs. |
In August 2002, ACE filed a petition with the NJBPU for the recovery of approximately $176.4 million in actual and projected deferred costs relating to the provision of BGS and other restructuring related costs incurred by ACE over the four-year period August 1, 1999 through July 31, 2003, net of the $59.3 million offset for the LEAC Liability. The petition also requested that ACE's rates be reset as of August 1, 2003 so that there would be no under-recovery of costs embedded in the rates on or after that date. The increase sought represented an overall 8.4% annual increase in electric rates and was in addition to the base rate increase discussed above. ACE's recovery of the deferred costs is subject to review and approval by the NJBPU in accordance with EDECA. |
In July 2003, the NJBPU issued a summary order, which (i) permitted ACE to begin collecting a portion of the deferred costs and reset rates to recover on-going costs incurred as a result of EDECA, (ii) approved the recovery of $125 million of the deferred balance over a ten-year amortization period beginning August 1, 2003, (iii) as described above under "Rate Proceedings--New Jersey," transferred to ACE's then pending base rate case for further consideration approximately $25.4 million of the deferred balance, and (iv) estimated the overall deferral balance as of July 31, 2003 at $195 million, of which $44.6 million was disallowed recovery by ACE. In July 2004, the NJBPU issued its final order in the restructuring deferral proceeding. The final order did not modify the amount of the disallowances set forth in the July 2003 summary order, but did provide a much more detailed analysis of evidence and other information relied on by the NJBPU as ju stification for the disallowances. ACE believes the record does not justify the level of disallowance imposed by the NJBPU. In August 2004, ACE filed with the NJ Superior Court a Notice of Appeal with respect to the July 2004 final order. ACE's initial brief was filed on August 17, 2005. Cross-appellant briefs on behalf of the Division of the NJ Ratepayer Advocate and Cogentrix Energy Inc., the co-owner of two cogeneration power plants with contracts to sell ACE approximately 397 megawatts of electricity, were filed on October 3, 2005. ACE cannot predict the outcome of this appeal. |
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BGS Proceeding |
New Jersey |
Pursuant to a May 5, 2005 order from the NJBPU, on July 1, 2005, ACE along with the other three electric distribution companies in New Jersey, filed a proposal addressing the procurement of BGS for the period beginning June 1, 2006. The areas addressed in the July 1, 2005 filings include, but are not limited to: the type of procurement process, the size, make-up and pricing options for the Commercial and Industrial Energy Pricing class, and the level of the retail margin and corresponding utilization of the retail margin funds. ACE cannot predict the outcome of this proceeding. |
Proposed Shut Down of B.L. England Generating Facility;
Construction of Transmission Facilities |
In April 2004, pursuant to a NJBPU order, ACE filed a report with the NJBPU recommending that ACE's B.L. England generating facility, a 447 megawatt plant, be shut down. The report stated that, while operation of the B.L. England generating facility was necessary at the time of the report to satisfy reliability standards, those reliability standards could also be satisfied in other ways. The report concluded that, based on B.L. England's current and projected operating costs resulting from compliance with more restrictive environmental requirements, the most cost-effective way in which to meet reliability standards is to shut down the B.L. England generating facility and construct additional transmission enhancements in southern New Jersey. |
In a preliminary settlement among PHI, Conectiv, ACE, the New Jersey Department of Environmental Protection (NJDEP) and the Attorney General of New Jersey, which is further discussed under "Preliminary Settlement Agreement with NJDEP," below, ACE agreed to seek necessary approvals from the relevant agencies to shut down and permanently cease operations at the B.L. England generating facility by December 15, 2007. An Administrative Consent Order (ACO) finalizing the provisions of the preliminary settlement agreement is currently being negotiated. |
In December 2004, ACE filed a petition with the NJBPU requesting that the NJBPU establish a proceeding that will consist of a Phase I and Phase II and that the procedural process for the Phase I proceeding require intervention and participation by all persons interested in the prudence of the decision to shut down B.L. England generating facility and the categories of stranded costs associated with shutting down and dismantling the facility and remediation of the site. ACE contemplates that Phase II of this proceeding, which would be initiated by an ACE filing in 2008 or 2009, would establish the actual level of prudently incurred stranded costs to be recovered from customers in rates. |
ACE Auction of Generation Assets |
In May 2005, ACE announced that it would again auction its electric generation assets, consisting of its B.L. England generating facility and its ownership interests in the Keystone and Conemaugh generating stations. Under the terms of sale, any successful bid for B.L. England must include assumption of all environmental liabilities associated with the plant in accordance with the auction standards previously issued by the NJBPU. |
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Final bids for ACE's interests in the Keystone and Conemaugh generating stations were received on September 30, 2005. Based on the expressed need of the potential B.L. England bidders for the details of the ACO relating to the shut down of the plant that is being negotiated between ACE and the NJDEP, ACE has elected to delay the final bid due date for B.L. England until such time as a final ACO is complete and available to bidders. |
Any sale of B.L. England will not affect the stranded costs associated with the plant that already have been securitized. If B.L. England is sold, ACE anticipates that, subject to regulatory approval in Phase II of the proceeding described above, approximately $9.1 million of additional assets may be eligible for recovery as stranded costs. If there are net gains on the sale of the Keystone and Conemaugh generating stations, these net gains would be an offset to stranded costs. |
Environmental Litigation |
ACE is subject to regulation by various federal, regional, state, and local authorities with respect to the environmental effects of its operations, including air and water quality control, solid and hazardous waste disposal, and limitations on land use. In addition, federal and state statutes authorize governmental agencies to compel responsible parties to clean up certain abandoned or unremediated hazardous waste sites. ACE may incur costs to clean up currently or formerly owned facilities or sites found to be contaminated, as well as other facilities or sites that may have been contaminated due to past disposal practices. Although penalties assessed for violations of environmental laws and regulations are not recoverable from ACE's customers, environmental clean-up costs incurred by ACE would be included in its cost of service for ratemaking purposes. |
In June 1992, the Environmental Protection Agency (EPA) identified ACE as a potentially responsible party (PRP) at the Bridgeport Rental and Oil Services Superfund Site in Logan Township, New Jersey. In September 1996, ACE along with other PRPs signed a consent decree with EPA and NJDEP to address remediation of the site. ACE's liability is limited to 0.232 percent of the aggregate remediation liability and thus far ACE has made contributions of approximately $105,000. Based on information currently available, ACE anticipates that it may be required to contribute approximately an additional $100,000. ACE believes that its liability at this site will not have a material adverse effect on its financial condition or results of operations. |
In November 1991, NJDEP identified ACE as a PRP at the Delilah Road Landfill site in Egg Harbor Township, New Jersey. In 1993, ACE, along with other PRPs, signed an ACO with NJDEP to remediate the site. The soil cap remedy for the site has been completed and the NJDEP conditionally approved the report submitted by the parties on the implementation of the remedy in January 2003. In March 2004, NJDEP approved a Ground Water Sampling and Analysis Plan. The results of groundwater monitoring over the first year of this ground water sampling plan will help to determine the extent of post-remedy operation and maintenance costs. In March 2003, EPA demanded from the PRP group reimbursement for EPA's past costs at the site, totaling $168,789. The PRP group objected to the demand for certain costs, but agreed to reimburse EPA approximately $19,000. Based on information currently available, ACE anticipates that it may be required to contribute approximately an additional $626,000. ACE |
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believes that its liability for post-remedy operation and maintenance costs will not have a material adverse effect on its financial condition or results of operations. |
Preliminary Settlement Agreement with the NJDEP |
In an effort to address NJDEP's concerns regarding ACE's compliance with New Source Review (NSR) requirements at the B.L. England generating facility, on April 26, 2004, PHI, Conectiv and ACE entered into a preliminary settlement agreement with NJDEP and the Attorney General of New Jersey. The preliminary settlement agreement outlines the basic parameters for a definitive agreement to resolve ACE's NSR liability at B.L. England and various other environmental issues at ACE and Conectiv Energy facilities in New Jersey. Among other things, the preliminary settlement agreement provides that: |
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Financing Activity During the Three Months Ended September 30, 2005 |
In July 2005, ACE retired at maturity $20.3 million of medium-term notes with a weighted average interest rate of 6.37%. |
In July 2005, ACE Funding made principal payments of $4.5 million on Series 2002-1 Bonds, Class A-1 and $1.6 million on Series 2003-1 Bonds, Class A-1 with a weighted average interest rate of 2.89%. |
In August 2005, ACE retired at maturity $7.8 million of medium-term notes with a weighted average interest rate of 6.34%. |
In August 2005, PCI retired at maturity $19 million of 6.47% medium-term notes. |
In September 2005, Pepco retired at maturity $100 million of 6.50% first mortgage bonds, and redeemed prior to maturity $75 million of 7.375% first mortgage bonds due 2025. Proceeds from the June issuance of $175 million of 5.40% senior secured notes were used to fund these payments. |
Financing Activity Subsequent to September 30, 2005 |
In October 2005, ACE Funding made principal payments of $6.1 million on Series 2002-1 Bonds, Class A-1 and $2.3 million on Series 2003-1 Bonds, Class A-1 with a weighted average interest rate of 2.89%. |
In October 2005, DPL called for redemption, on December 1, 2005, all outstanding shares of its 6.75% series preferred stock, at par, totaling $3.5 million. |
In October 2005, Pepco repurchased 74,103 shares of its $2.46 series preferred stock, par value $50 per share, at a weighted average price of $49.89 per share. Pepco also repurchased 13,148 shares of its $2.28 series at a weighted average price of $49.78 per share and 22,795 shares of its $2.44 series, par value $50 per share, at $49.875 per share. |
Sale of Buzzard Point Property |
On August 25, 2005, John Akridge Development Company ("Akridge") purchased 384,051 square feet of excess non-utility land owned by Pepco located at Buzzard Point in the District of Columbia. The contract price was $75 million in cash and resulted in a pre-tax gain of $68.1 million which is recorded as a reduction of Operating Expenses in the accompanying Consolidated Statements of Earnings in the third quarter of 2005. The after-tax gain was $40.7 million. The sale agreement provides that Akridge will release Pepco from, and has agreed to indemnify Pepco for, substantially all environmental liabilities associated with the land, except that Pepco will retain liability for claims by third parties arising from the release, if any, of hazardous substances from the land onto the adjacent property occurring before the closing of the sale. |
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Financial Investment Liquidation |
On October 11, 2005, PCI received $13.3 million in cash related to the final liquidation of a financial investment that was written-off in 2001. PCI recorded an after-tax gain of $8.9 million in October 2005 as a result of the receipt of proceeds from the liquidation. |
IRS Mixed Service Cost Issue |
During 2001, Pepco, DPL, and ACE changed their methods of accounting with respect to capitalizable construction costs for income tax purposes, which allow the companies to accelerate the deduction of certain expenses that were previously capitalized and depreciated. Through September 30, 2005, these accelerated deductions have generated incremental tax cash flow benefits of approximately $205 million (consisting of $94 million for Pepco, $62 million for DPL, and $49 million for ACE) for the companies, primarily attributable to their 2001 tax returns. On August 2, 2005, the IRS issued Revenue Ruling 2005-53 (the Revenue Ruling) that will limit the ability of the companies to utilize this method of accounting for income tax purposes on their tax returns for 2004 and prior years. PHI intends to contest any IRS adjustment to its prior year income tax returns based on the Revenue Ruling. However, if the IRS is successful in applying this Revenue Ruling, Pepco, DPL, and ACE wou ld be required to capitalize and depreciate a portion of the construction costs previously deducted and repay the associated income tax benefits, along with interest thereon. During the third quarter 2005, PHI recorded an $8.3 million increase in income tax expense (consisting of $4.6 million for Pepco, $2.0 million for DPL, and $1.7 million for ACE) to account for the accrued interest that would be paid on the portion of tax benefits that PHI estimates would be deferred to future years if the construction costs previously deducted are required to be capitalized and depreciated. |
On the same day as the Revenue Ruling was issued, the Treasury Department released regulations that, if adopted in their current form, would require Pepco, DPL, and ACE to change their method of accounting with respect to capitalizable construction costs for income tax purposes for all future tax periods beginning in 2005. Under these regulations, Pepco, DPL, and ACE will have to capitalize and depreciate a portion of the construction costs that they have previously deducted and repay, over a two year period beginning with tax year 2005, the associated income tax benefits. PHI is continuing to work with the industry to determine an alternative method of accounting for capitalizable construction costs acceptable to the IRS to replace the method disallowed by the new regulations. PHI believes that it has adequate liquidity, with its operating cash flow and borrowing capacity, to fund any cash payment that might be required under the regulation or the Revenue Ruling. |
Working Capital |
At September 30, 2005, Pepco Holdings did not have a working capital deficit as its current assets on a consolidated basis totaled $2.3 billion and its current liabilities on a consolidated basis totaled $2.3 billion. At December 31, 2004, Pepco Holdings had a working capital deficit as its current assets on a consolidated basis totaled approximately $1.7 billion and its current liabilities totaled approximately $2.0 billion. |
Typically, Pepco Holdings has a working capital deficit resulting in large part from the fact that, in the normal course of business, Pepco Holdings' utility subsidiaries acquire and pay for energy supplies for their customers before the supplies are metered and then billed to customers. |
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Short-term financings are used to meet liquidity needs. Short-term financings are also used, at times, to temporarily fund redemptions of long-term debt, until long-term replacement financing is completed. |
At September 30, 2005, Pepco Holdings' subsidiaries in aggregate were in receipt of (a net holder of) cash collateral in the amount of $224 million, of which $7.7 million was held as restricted cash. Pepco Holdings' cash and cash equivalents and its restricted cash, as shown on its consolidated balance sheet at September 30, 2005 totaled $280.3 million. At December 31, 2004, Pepco Holdings' subsidiaries in aggregate were in receipt of (a net holder of) cash collateral in the amount of $21 million, of which $7.6 was held as restricted cash. Pepco Holdings' cash and cash equivalents and restricted cash, as shown on its consolidated balance sheet at December 31, 2004 totaled $71.6 million. Refer to the Capital Requirements - Contractual Arrangements with Credit Rating Triggers or Margining Rights section, herein for additional information. |
A detail of Pepco Holdings' short-term debt balances at September 30, 2005, and December 31, 2004, in millions, is as follows: |
Contractual Arrangements with Credit Rating Triggers or Margining Rights |
Under certain contractual arrangements entered into by PHI's subsidiaries in connection with competitive energy and other transactions, the affected company may be required to provide cash collateral or letters of credit as security for its contractual obligations if the credit rating for long-term unsecured debt of the applicable company is downgraded one or more levels. In the event of a downgrade, the amount required to be posted would depend on the amount of the underlying contractual obligation existing at the time of the downgrade. As of September 30, 2005, a one-level downgrade in the credit rating of long-term unsecured debt of PHI and all of its affected subsidiaries would have required PHI and such subsidiaries to provide aggregate cash collateral or letters of credit of up to approximately $178 million. An additional amount of approximately $312 million of aggregate cash collateral or letters of credit would have been required in the event of subsequent downgr ades to below investment grade. |
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Many of the contractual arrangements entered into by PHI's subsidiaries in connection with competitive energy activities include margining rights pursuant to which the PHI subsidiary or a counterparty may request collateral if the market value of the contractual obligations reaches levels that are in excess of the credit thresholds established in the applicable arrangements. Pursuant to these margining rights, the affected PHI subsidiary may receive, or be required to post, collateral due to energy price movements. As of September 30, 2005, Pepco Holdings' subsidiaries that engaged in competitive energy activities and default supply activities were in receipt of (a net holder of) cash collateral in the amount of $224 million as recorded in connection with the activities. |
REGULATORY AND OTHER MATTERS |
Relationship with Mirant Corporation |
In 2000, Pepco sold substantially all of its electricity generation assets to Mirant Corporation, formerly Southern Energy, Inc. As part of the Asset Purchase and Sale Agreement, Pepco entered into several ongoing contractual arrangements with Mirant Corporation and certain of its subsidiaries (collectively, Mirant). On July 14, 2003, Mirant Corporation and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of Texas (the Bankruptcy Court). |
Depending on the outcome of the matters discussed below, the Mirant bankruptcy could have a material adverse effect on the results of operations of Pepco Holdings and Pepco. However, management believes that Pepco Holdings and Pepco currently have sufficient cash, cash flow and borrowing capacity under their credit facilities and in the capital markets to be able to satisfy any additional cash requirements that may arise due to the Mirant bankruptcy. Accordingly, management does not anticipate that the Mirant bankruptcy will impair the ability of Pepco Holdings or Pepco to fulfill their contractual obligations or to fund projected capital expenditures. On this basis, management currently does not believe that the Mirant bankruptcy will have a material adverse effect on the financial condition of either company. |
Transition Power Agreements |
As part of 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, Mirant was obligated to supply Pepco with all of the capacity and energy needed to fulfill its SOS obligations in Maryland through June 2004 and its SOS obligations in the District of Columbia through January 22, 2005. |
To avoid the potential rejection of the TPAs, Pepco and Mirant entered into an Amended Settlement Agreement and Release dated as of October 24, 2003 (the Settlement Agreement) pursuant to which Mirant assumed both of the TPAs and the terms of the TPAs were modified. The Settlement Agreement also provided that Pepco has an allowed, pre-petition general unsecured claim against Mirant Corporation in the amount of $105 million (the Pepco TPA Claim). |
Pepco has also asserted the Pepco TPA Claim against other Mirant entities, which Pepco believes are liable to Pepco under the terms of the Asset Purchase and Sale Agreement's Assignment and Assumption Agreement (the Assignment Agreement). Under the Assignment |
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Agreement, Pepco believes that each of the Mirant entities assumed and agreed to discharge certain liabilities and obligations of Pepco as defined in the Asset Purchase and Sale Agreement. Mirant has filed objections to these claims. Under the original plan of reorganization filed by the Mirant entities with the Bankruptcy Court, certain Mirant entities other than Mirant Corporation would pay significantly higher percentages of the claims of their creditors than would Mirant Corporation. The amount that Pepco will be able to recover from the Mirant bankruptcy estate with respect to the Pepco TPA Claim will depend on the amount of assets available for distribution to creditors of the Mirant entities determined to be liable for the Pepco TPA Claim. At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover, whether the recovery would be in cash or another form of payment, or the timing of any recovery. |
Power Purchase Agreements |
Under agreements with FirstEnergy Corp., formerly Ohio Edison (FirstEnergy), and Allegheny Energy, Inc., both entered into in 1987, Pepco is obligated to purchase from FirstEnergy 450 megawatts of capacity and energy annually through December 2005 (the FirstEnergy PPA). Under the Panda PPA, entered into in 1991, Pepco is obligated to purchase from Panda 230 megawatts of capacity and energy annually through 2021. In each case, the purchase price is substantially in excess of current market price. As a part of the Asset Purchase and Sale Agreement, Pepco entered into a "back-to-back" arrangement with Mirant. Under this arrangement, Mirant is obligated, among other things, to purchase from Pepco the capacity and energy that Pepco is obligated to purchase under the FirstEnergy PPA and the Panda PPA at a price equal to the price Pepco is obligated to pay under the FirstEnergy PPA and the Panda PPA (the PPA-Related Obligations). |
Pepco Pre-Petition Claims |
When Mirant filed its bankruptcy petition on July 14, 2003, Mirant had unpaid obligations to Pepco of approximately $29 million, consisting primarily of payments due to Pepco with respect to the PPA-Related Obligations (the Mirant Pre-Petition Obligations). The Mirant Pre-Petition Obligations constitute part of the indebtedness for which Mirant is seeking relief in its bankruptcy proceeding. Pepco has filed Proofs of Claim in the Mirant bankruptcy proceeding in the amount of approximately $26 million to recover this indebtedness; however, the amount of Pepco's recovery, if any, is uncertain. The $3 million difference between Mirant's unpaid obligation to Pepco and the $26 million Proofs of Claim primarily represents a TPA settlement adjustment that is included in the $105 million Proofs of Claim filed by Pepco against the Mirant debtors in respect of the Pepco TPA Claim. In view of the uncertainty as to recoverability, Pepco, in the third quarter of 2003, expensed $14.5 mi llion to establish a reserve against the $29 million receivable from Mirant. In January 2004, Pepco paid approximately $2.5 million to Panda in settlement of certain billing disputes under the Panda PPA that related to periods after the sale of Pepco's generation assets to Mirant. Pepco believes that under the terms of the Asset Purchase and Sale Agreement, Mirant is obligated to reimburse Pepco for the settlement payment. Accordingly, in the first quarter of 2004, Pepco increased the amount of the receivable due from Mirant by approximately $2.5 million and amended its Proofs of Claim to include this amount. Pepco currently estimates that the $14.5 million expensed in the third quarter of 2003 represents the portion of the entire $31.5 million receivable unlikely to be recovered in bankruptcy, and no additional reserve has been established for the $2.5 million 134
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increase in the receivable. The amount expensed represents Pepco's estimate of the possible outcome in bankruptcy, although the amount ultimately recovered could be higher or lower.
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Mirant's Attempt to Reject the PPA-Related Obligations |
In August 2003, Mirant filed with the Bankruptcy Court a motion seeking authorization to reject its PPA-Related Obligations. Upon motions filed with the U.S. District Court for the Northern District of Texas (the District Court) by Pepco and FERC, in October 2003, the District Court withdrew jurisdiction over the rejection proceedings from the Bankruptcy Court. In December 2003, the District Court denied Mirant's motion to reject the PPA-Related Obligations on jurisdictional grounds. The District Court's decision was appealed by Mirant and The Official Committee of Unsecured Creditors of Mirant Corporation (the Creditors' Committee) to the U.S. Court of Appeals for the Fifth Circuit (the Court of Appeals). In August 2004, the Court of Appeals remanded the case to the District Court saying that the District Court had jurisdiction to rule on the merits of Mirant's rejection motion, suggesting that in doing so the court apply a "more rigorous standard" than the business judg ment rule usually applied by bankruptcy courts in ruling on rejection motions. |
On December 9, 2004, the District Court issued an order again denying Mirant's motion to reject the PPA-Related Obligations. The District Court found that the PPA-Related Obligations are not severable from the Asset Purchase and Sale Agreement and that the Asset Purchase and Sale Agreement cannot be rejected in part, as Mirant was seeking to do. Both Mirant and the Creditors' Committee appealed the District Court's order to the Court of Appeals. Briefing of this matter by the interested parties has been completed. Oral arguments have not yet been scheduled. |
Until December 9, 2004, Mirant had been making regular periodic payments in respect of the PPA-Related Obligations. However, on that date, Mirant filed a notice with the Bankruptcy Court that it was suspending payments to Pepco in respect of the PPA-Related Obligations and subsequently failed to make certain full and partial payments due to Pepco. Proceedings ensued in the Bankruptcy Court and the District Court, ultimately resulting in Mirant being ordered to pay to Pepco all past-due unpaid amounts under the PPA-Related Obligations. On April 13, 2005, Pepco received a payment from Mirant in the amount of approximately $57.5 million, representing the full amount then due in respect of the PPA-Related Obligations. |
On January 21, 2005, Mirant filed in the Bankruptcy Court a motion seeking to reject certain of its ongoing obligations under the Asset Purchase and Sale Agreement, including the PPA-Related Obligations (the Second Motion to Reject). On March 1, 2005, the District Court entered an order (as amended by a second order issued on March 7, 2005) granting Pepco's motion to withdraw jurisdiction over these rejection proceedings from the Bankruptcy Court. Mirant and the Creditor's Committee have appealed these orders to the Court of Appeals. Amicus briefs, which are briefs filed by persons who are not parties to the proceeding, but who nevertheless have a strong interest -- in this instance a broad public interest -- in the case, in support Pepco's position have been filed with the Court of Appeals by the Maryland Public Service Commission (MPSC) and the Office of People's Counsel of Maryland (Maryland OPC). Briefing of this matter by the interested parties has been com pleted. Oral arguments have not yet been scheduled. |
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On March 28, 2005, Pepco, FERC, the Office of People's Counsel of the District of Columbia (the District of Columbia OPC), the MPSC and the Maryland OPC filed in the District Court oppositions to the Second Motion to Reject. By order entered August 16, 2005, the District Court has informally stayed this matter, pending a decision by the Court of Appeals on the District Court's orders withdrawing jurisdiction from the Bankruptcy Court. |
Pepco is exercising all available legal remedies and vigorously opposing Mirant's efforts to reject the PPA-Related Obligations and other obligations under the Asset Purchase and Sale Agreement in order to protect the interests of its customers and shareholders. While Pepco believes that it has substantial legal bases to oppose these efforts by Mirant, the ultimate outcome is uncertain. |
If Mirant ultimately is successful in rejecting the PPA-Related Obligations, Pepco could be required to repay to Mirant, for the period beginning on the effective date of the rejection (which date could be prior to the date of the court's order granting the rejection and possibly as early as September 18, 2003) and ending on the date Mirant is entitled to cease its purchases of energy and capacity from Pepco, all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity. Pepco estimates that the amount it could be required to repay to Mirant in the unlikely event that September 18, 2003 is determined to be the effective date of rejection, is approximately $225.1 million as of November 1, 2005. |
Mirant has also indicated to the Bankruptcy Court that it will move to require Pepco to disgorge all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity, for the period July 14, 2003 (the date on which Mirant filed its bankruptcy petition) through rejection, if approved, on the theory that Mirant did not receive value for those payments. Pepco estimates that the amount it would be required to repay to Mirant on the disgorgement theory, in addition to the amounts described above, is approximately $22.5 million. |
Any repayment by Pepco of amounts received from Mirant in respect of the PPA-Related Obligations would entitle Pepco to file a claim against the bankruptcy estate in an amount equal to the amount repaid. To the extent such amounts were not recovered from the Mirant bankruptcy estate, Pepco believes they would be recoverable as stranded costs from customers through distribution rates as described below. |
The following are estimates prepared by Pepco of its potential future exposure if Mirant's attempt to reject the PPA-Related Obligations ultimately is successful. These estimates are based in part on current market prices and forward price estimates for energy and capacity, and do not include financing costs, all of which could be subject to significant fluctuation. The estimates assume no recovery from the Mirant bankruptcy estate and no regulatory recovery, either of which would mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recoveries. Based on these assumptions, Pepco estimates that its pre-tax exposure as of November 1, 2005 representing the loss of the future benefit of the PPA-Related Obligations to Pepco, is as follows: |
The ability of Pepco to recover from the Mirant bankruptcy estate in respect to the Mirant Pre-Petition Obligations and damages if the PPA-Related Obligations are successfully rejected will depend on whether Pepco's claims are allowed, the amount of assets available for distribution to the creditors of the Mirant companies determined to be liable for those claims, and Pepco's priority relative to other creditors. At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate, whether the recovery would be in cash or another form of payment, or the timing of any recovery. |
If Mirant ultimately were successful in rejecting the PPA-Related Obligations and Pepco's full claim were not recovered from the Mirant bankruptcy estate, Pepco would seek authority from the MPSC and the District of Columbia Public Service Commission (DCPSC) to recover its additional costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers. Under the provisions of the settlement agreements approved by the MPSC and the DCPSC in the deregulation proceedings in which Pepco agreed to divest its generation assets under certain conditions, the PPAs were to become assets of Pepco's distribution business if they could not be sold. Pepco believes that, if Mirant ultimately is successful in rejecting the PPA-Related Obligations, these provisions would allow the stranded costs of the PPAs that are not recovered from the Mirant bankruptcy estate to be recovered from Pepco's customers through its dist ribution rates. If Pepco's interpretation of the settlement agreements is confirmed, Pepco expects to be able to establish the amount of its anticipated recovery as a regulatory asset. However, there is no assurance that Pepco's interpretation of the settlement agreements would be confirmed by the respective public service commissions. |
If the PPA-Related Obligations are successfully rejected, and there is no regulatory recovery, Pepco will incur a loss; the accounting treatment of such a loss, however, would depend on a number of legal and regulatory factors. |
Mirant's Fraudulent Transfer Claim |
On July 13, 2005, Mirant filed a complaint in the Bankruptcy Court against Pepco alleging that Mirant's $2.65 billion purchase of Pepco's generating assets in June 2000 constituted a fraudulent transfer. Mirant alleges in the complaint that the value of Pepco's generation assets was "not fair consideration or fair or reasonably equivalent value for the consideration paid to |
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Pepco" and that it thereby rendered Mirant insolvent, or, alternatively, that Pepco and Southern Energy, Inc. (as predecessor to Mirant) intended that Mirant would incur debts beyond its ability to pay them. Mirant asks that the Court enter an order "declaring that the consideration paid for the Pepco assets, to the extent it exceeds the fair value of the Pepco assets, to be a conveyance or transfer in fraud of the rights of Creditors under state law" and seeks compensatory and punitive damages. |
Pepco believes this claim has no merit and is vigorously contesting the claim. On September 20, 2005, Pepco filed a motion to withdraw this complaint to the District Court and on September 30, 2005, Pepco filed its answer in the Bankruptcy Court. On October 20, 2005, the Bankruptcy Court issued a report and recommendation to the District Court, which recommends that the District Court grant the motion to withdraw the reference. The District Court will now consider whether to accept the recommendation to withdraw the reference. Pepco cannot predict when the District Court will make a decision or whether it will accept the recommendation of the Bankruptcy Court. |
The SMECO Agreement |
As a term of the Asset Purchase and Sale Agreement, Pepco assigned to Mirant a facility and capacity agreement with Southern Maryland Electric Cooperative, Inc. (SMECO) under which Pepco was obligated to purchase the capacity of an 84-megawatt combustion turbine installed and owned by SMECO at a former Pepco generating facility (the SMECO Agreement). The SMECO Agreement expires in 2015 and contemplates a monthly payment to SMECO of approximately $.5 million. Pepco is responsible to SMECO for the performance of the SMECO Agreement if Mirant fails to perform its obligations thereunder. At this time, Mirant continues to make post-petition payments due to SMECO. |
On March 15, 2004, Mirant filed a complaint with the Bankruptcy Court seeking a declaratory judgment that the SMECO Agreement is an unexpired lease of non-residential real property rather than an executory contract and that if Mirant were to successfully reject the agreement, any claim against the bankruptcy estate for damages made by SMECO (or by Pepco as subrogee) would be subject to the provisions of the Bankruptcy Code that limit the recovery of rejection damages by lessors. Pepco believes that there is no reasonable factual or legal basis to support Mirant's contention that the SMECO Agreement is a lease of real property. The outcome of this proceeding cannot be predicted. |
Mirant Plan of Reorganization |
On January 19, 2005, Mirant filed its Plan of Reorganization and Disclosure Statement with the Bankruptcy Court (the Original Reorganization Plan) under which Mirant proposed to transfer all assets to "New Mirant" (an entity it proposed to create in the reorganization), with the exception of the PPA-Related Obligations. Mirant proposed that the PPA-Related Obligations would remain in "Old Mirant," which would be a shell entity as a result of the reorganization. On March 25, 2005, Mirant filed its First Amended Plan of Reorganization and First Amended Disclosure Statement (the Amended Reorganization Plan), in which Mirant abandoned the proposal that the PPA-Related Obligations would remain in "Old Mirant," but did not clarify how the PPA-Related Obligations would be treated. On September 22, 2005, Mirant filed its Second Amended Disclosure Statement and Second Amended Plan of Reorganization. Pepco filed objections to the Second Amended Disclosure Statement on September 28, 2005 and |
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a revised version of the Second Amended Disclosure Statement, including the changes and clarifications requested by Pepco, was filed and approved by the Bankruptcy Court on September 30, 2005. Pepco is still analyzing, and has not yet determined whether to file an objection to, the Second Amended Plan of Reorganization. Objections to confirmation of the Second Amended Plan of Reorganization are due November 10, 2005. |
On March 11, 2005, Mirant filed an application with FERC seeking approval for the internal transfers and corporate restructuring that will result from the Original Reorganization Plan. FERC approval for these transactions is required under Section 203 of the Federal Power Act. On April 1, 2005, Pepco filed a motion to intervene and protest at FERC in connection with this application. On the same date, the District of Columbia OPC also filed a motion to intervene and protest. Pepco, the District of Columbia OPC, the Maryland OPC and the MPSC filed pleadings arguing that the application was premature inasmuch as it was unclear whether the planned reorganization would be approved by the Bankruptcy Court and asking that FERC refrain from acting on the application. |
On June 17, 2005, FERC issued anorder approving the planned restructuring outlined in the Original Reorganization Plan, which has since been superseded by the Second Amended Plan of Reorganization, as discussed above. The Second Amended Plan of Reorganization does not provide for the same restructuring contemplated in the Original Reorganization Plan. While the FERC order had no direct impact on Pepco, the order included a discussion regarding potential future rate impacts if the courts were to permit rejection of the PPAs. Because Pepco disagreed with this discussion, Pepco filed a motion for rehearing on July 18, 2005 (before Mirant filed its Second Amended Plan of Reorganization). On August 17, 2005, the FERC entered an order granting the request for rehearing "for the limited purpose of further consideration." This order simply means that the request for rehearing remains pending. Pepco cannot predict the outcome of its motion for rehearing. |
Rate Proceedings |
Delaware |
For a discussion of the history DPL's 2004 annual Gas Cost Rate (GCR) filings, please refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- Rate Proceedings" of PHI's Annual Report on Form 10-K for the year ended December 31, 2004 (the PHI 2004 10-K), Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- Rate Proceedings" of PHI's Quarterly Report on Form 10-Q for the Quarter ended March 31, 2005 (the PHI 2005 First Quarter 10-Q) and Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- Rate Proceedings" of PHI's Quarterly Report on Form 10-Q for the Quarter ended June 30, 2005 (the PHI 2005 Second Quarter 10-Q). A final order approving both the GCR increases was issued by the Delaware Public Service Commission (DPSC) on August 9, 2005. |
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On October 3, 2005, DPL submitted its 2005 GCR filing to the DPSC. In its filing, DPL seeks to increase its GCR by approximately 38% in anticipation of increasing natural gas commodity costs. The proposed rate became effective November 1, 2005, subject to refund pending final DPSC approval after evidentiary hearings. |
On September 1, 2005, DPL filed with the DPSC its first comprehensive base rate case in ten years. This application was filed as a result of increasing costs and is consistent with a provision in the April 16, 2002 settlement agreement in Delaware relating to the merger of Pepco and Conectiv permitting DPL to apply for an increase in rates effective as of May 1, 2006. DPL is seeking approval of an annual increase of approximately $5.1 million in its electric rates, with an increase of approximately $1.6 million to its electric distribution base rates after proposing to assign approximately $3.5 million in costs to the supply component of rates to be collected as part of the SOS. Of the approximately $1.6 million in net increases to its electric distribution base rates, DPL proposed that approximately $1.2 million be recovered through changes in delivery charges and that the remaining approximately $.4 million be recovered through changes in premise collection and reconnect fees. The full proposed revenue increase is approximately 0.9% of total annual electric utility revenues, while the proposed net increase to distribution rates is 0.2% of total annual electric utility revenues. DPL's distribution revenue requirement is based on a return on common equity of 11%. DPL also has proposed revised depreciation rates and a number of tariff modifications. On September 20, 2005, the DPSC issued an order approving DPL's request that the rate increase go into effect on May 1, 2006; subject to refund and pending evidentiary hearings. The order also suspends effectiveness of various proposed tariff rule changes until the case is concluded. |
Federal Energy Regulatory Commission |
On January 31, 2005, Pepco, DPL, and ACE filed at the FERC to reset their rates for network transmission service using a formula methodology. The companies also sought a 12.4% return on common equity and a 50-basis-point return on equity adder that the FERC had made available to transmission utilities who had joined Regional Transmission Organizations and thus turned over control of their assets to an independent entity. The FERC issued an order on May 31, 2005, approving the rates to go into effect June 1, 2005, subject to refund, hearings, and further orders. The new rates reflect a decrease of 7.7% in Pepco's transmission rate, and increases of 6.5% and 3.3% in DPL's and ACE's transmission rates, respectively. The companies continue in settlement discussions and cannot predict the ultimate outcome of this proceeding. |
Restructuring Deferral |
For a discussion of the history of ACE's appeal filed with the Appellate Division of the Superior Court of New Jersey related to the July 2004 Final Decision and Order issued by the NJBPU in ACE's restructuring deferral proceeding before the NJBPU under the New Jersey Electric Discount and Energy Competition Act, and the New Jersey regulatory proceeding leading up to this appeal, please refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- Restructuring Deferral " of the PHI 2004 10-K and Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- Restructuring Deferral " of the PHI 2005 Second Quarter 10-Q. ACE's initial brief was filed on August 17, 2005. Cross-appellant briefs on behalf of the Division of the NJ Ratepayer Advocate and |
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Cogentrix Energy Inc., the co-owner of two cogeneration power plants with contracts to sell ACE approximately 397 megawatts of electricity, were filed on October 3, 2005. ACE cannot predict the outcome of this appeal. |
SOS, Default Service, POLR and BGS Proceedings |
Virginia |
For a discussion of the history of Conectiv Energy's filing with FERC requesting authorization to enter into a contract to supply power to DPL, please refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- SOS and Default Service Proceedings" of the PHI 2004 10-K and Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- SOS, Default Service and BGS Proceedings" of the PHI 2005 Second Quarter 10-Q. On October 14, 2005, FERC issued an Order Approving Uncontested Settlement in which it approved the stipulation entered into by Conectiv Energy and the FERC staff and terminated the proceeding. |
ACE Auction of Generation Assets |
For a discussion of the history of ACE's auction of its generation assets, please refer to Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- ACE Auction of Generation Assets" of the PHI 2005 Second Quarter 10-Q. Final bids for ACE's interests in the Keystone and Conemaugh generating stations were received on September 30, 2005. Based on the expressed need of the potential B.L. England bidders for the details of the Administrative Consent Order (ACO) relating to the shut down of the plant that is being negotiated between PHI, Conectiv, ACE, the New Jersey Department of Environmental Protection (NJDEP) and the Attorney General of New Jersey, ACE has elected to delay the final bid due date for B.L. England until such time as a final ACO is complete and available to bidders. |
Any sale of B.L. England will not affect the stranded costs associated with the plant that already have been securitized. If B.L. England is sold, ACE anticipates that, subject to regulatory approval in a proceeding that will be filed by ACE with the NJBPU to establish the actual level of prudently incurred stranded costs related to the shut down of B.L. England to be recovered from customers in rates, approximately $9.1 million of additional assets may be eligible for recovery as stranded costs. If there are net gains on the sale of the Keystone and Conemaugh generating stations, these net gains would be an offset to stranded costs. |
Environmental Litigation |
For a discussion of the history of DPL's ACO with the Maryland Department of the Environment (MDE) to perform a Remedial Investigation/Feasibility Study (RI/FS) related to former manufactured gas plant operations at the Cambridge, Maryland site, please refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- Environmental Litigation" of the PHI 2004 10-K. The MDE has approved the RI and DPL has commenced the FS. |
For a discussion of the history of Pepco's environmental litigation related to the Metal Bank/Cottman Avenue site in Philadelphia, Pennsylvania, please refer to Item 7, "Management's |
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Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- Environmental Litigation" of the PHI 2004 10-K. On September 2, 2005 the United States lodged with the U.S. District Court for the Eastern District of Pennsylvania global consent decrees for the Metal Bank site, which a group of utility potentially responsible parties (PRPs) including Pepco (the Utility PRPs) entered into on August 23, 2005 with the U.S. Department of Justice, Environmental Protection Agency (EPA), The City of Philadelphia and two owner/operators of the site with respect to clean up of the site. The global settlement includes three Companion Consent Decrees (for the Utility PRPs and one each for the two owner/operators) and an agreement with The City of Philadelphia. Under the terms of the settlement, the two owner/operators will make payments totaling $5.55 million to the U.S. and totaling $4.05 million to the Utility PRPs. The Utility PRPs will perform the remedy at the site a nd will be able to draw on the funds from the bankruptcy settlement, which provides that the reorganized entity/site owner will pay a total of $13.25 million to remediate the site (the Bankruptcy Settlement) to accomplish the remediation (the Bankruptcy Funds). The Utility PRPs will contribute funds to the extent remediation costs exceed the Bankruptcy Funds available. The Utility PRPs will not be liable for any of the United States' past costs in connection with the site, but will be liable for EPA costs associated with overseeing the monitoring and operation of the site remedy after the remedy construction is certified to be complete and also the cost of performing the "5 year" review of site conditions required by the Comprehensive Environmental Response, Compensation, and Liability Act of 1980. Any Bankruptcy Funds not spent on the remedy may be used to cover the Utility PRPs' liabilities for future costs. No parties are released from potential liability for damages to natural resources. The gl obal settlement agreement is subject to a public comment period and approval by the court. If for any reason the court declines to enter one or more Companion Consent Decrees, the United States and the Utility PRPs will have 30 days to withdraw or withhold consent for the other Companion Consent Decrees. Court approval could be obtained as early as the fourth quarter 2005. |
As of September 30, 2005, Pepco had accrued $1.7 million to meet its liability for a remedy at the Metal Bank/Cottman Avenue site. While final costs to Pepco of the settlement have not been determined, Pepco believes that its liability at this site will not have a material adverse effect on its financial condition or results of operations. |
Preliminary Settlement Agreement with the NJDEP |
For a discussion of the history and details of the April 26, 2004 preliminary settlement agreement entered into by PHI, Conectiv, ACE, NJDEP and the Attorney General of New Jersey, please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- Preliminary Settlement Agreement with the NJDEP" of the PHI 2004 10-K, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- Preliminary Settlement Agreement with the NJDEP" of the PHI 2005 First Quarter 10-Q and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- Preliminary Settlement Agreement with the NJDEP" of the PHI 2005 Second Quarter 10-Q. As discussed in the PHI 2004 10-K, the PHI 2005 First Quarter 10-Q and the PHI 2005 Second Quarter 10-Q, under the preliminary settlement agreement, in order to address ACE's appeal of NJDEP actions relating to NJDEP's July 2001 denial of ACE's request to renew a permit variance from sulfur-in-fuel requirements under New Jersey regulations, effective through July 30, 2001, that authorized Unit 1 at B.L. England generating facility to burn bituminous coal |
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containing greater than 1% sulfur, ACE will be permitted to combust coal with a sulfur content of greater than 1% at the B.L. England facility in accordance with the terms of B.L. England's current permit until December 15, 2007 and NJDEP will not impose new, more stringent short-term SO2 emissions limits on the B.L. England facility during this period. By letter dated October 24, 2005, NJDEP extended, until December 30, 2005, the deadline for ACE to file an application to renew its current fuel authorization for the B.L. England generating plant, which is scheduled to expire on July 30, 2006. |
CRITICAL ACCOUNTING POLICIES |
For a discussion of Pepco Holdings' critical accounting policies, please refer to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in Pepco Holdings' Annual Report on Form 10-K for the year ended December 31, 2004. During the second quarter of 2005, Pepco Holdings identified the following as an additional critical accounting policy. |
Unbilled Revenue |
Unbilled revenue represents an estimate of revenue earned from services rendered by Pepco Holding's utility operations that have not yet been billed. Pepco Holdings utility operations calculate unbilled revenue using an output based methodology. (This methodology is based on the supply of electricity or gas distributed to customers.) Pepco Holdings believes that the estimates involved in its unbilled revenue process represent "Critical Accounting Estimates" because management is required to make assumptions and judgments about input factors such as customer sales mix, and estimated power line losses (estimates of electricity expected to be lost in the process of its transmission and distribution to customers), which are all inherently uncertain and susceptible to change from period to period, the impact of which could be material. |
NEW ACCOUNTING STANDARDS |
SFAS No. 154 |
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3" (SFAS No. 154).SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. The reporting of a correction of an error by restating previously issued financial statements is also addressed by SFAS No. 154. This Statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted. |
SAB 107 and SFAS No. 123R |
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107) which provides implementation guidance on the interaction between FASB Statement No. 123 (revised 2004), "Share-Based Payment" (SFAS No. 123R) and certain SEC rules and regulations, as well as guidance on the valuation of share-based payment arrangements for public companies. |
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In April 2005, the SEC adopted a rule delaying the effective date of SFAS No. 123R for public companies. Under the rule, most registrants must comply with SFAS No. 123R beginning with the first interim or annual reporting period of their first fiscal year beginning after June 15, 2005 (i.e., the year ended December 31, 2006 for Pepco Holdings). Pepco Holdings is in the process of completing its evaluation of the impact of SFAS No. 123R and does not anticipate that its implementation or SAB 107 will have a material effect on Pepco Holdings' overall financial condition or results of operations. |
FIN 47 |
In March 2005, the FASB published FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations"(FIN 47). FIN 47 clarifies that FASB Statement No. 143, "Accounting for Asset Retirement Obligations," applies to conditional asset retirement obligations and requires that the fair value of a reasonably estimable conditional asset retirement obligation be recognized as part of the carrying amounts of the asset. FIN 47 is effective no later than the end of the first fiscal year ending after December 15, 2005 (i.e., December 31, 2005 for Pepco Holdings). Pepco Holdings is in the process of evaluating the anticipated impact that the implementation of FIN 47 will have on its overall financial condition or results of operations. |
EITF 04-13 |
In September 2005, the FASB ratified EITF Issue No. 04-13, "Accounting for Purchases and Sales of Inventory with the Same Counterparty" (EITF 04-13). The Issue addresses circumstances under which two or more exchange transactions involving inventory with the same counterparty should be viewed as a single exchange transaction for the purposes of evaluating the effect of APB Opinion 29. EITF 04-13 is effective for new arrangements entered into, or modifications or renewals of existing arrangements, beginning in the first interim or annual reporting period beginning after March 15, 2006 (April 1, 2006 for Pepco Holdings). EITF 04-13 may not impact Pepco Holdings' net income or overall financial condition but rather may result in certain revenues and costs, including wholesale revenues and purchased power expenses, being presented on a net basis. Pepco Holdings is in the process of evaluating the impact of EITF 04-13 on the income statement presentation of purchases and sales covered by the Issue. |
RISK FACTORS |
The businesses of Pepco Holdings and its subsidiaries are subject to numerous risks and uncertainties. The occurrence of one or more of these events or conditions could have an adverse effect on the business of PHI and its subsidiaries, including, depending on the circumstances, their results of operations and financial condition. For a discussion of these risk factors, please refer to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in Pepco Holdings' Annual Report on Form 10-K for the year ended December 31, 2004. Set forth below is an update of one of those risk factors. |
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The IRS challenge to cross-border energy sale and lease-back transactions entered into by a PHI subsidiary could result in loss of prior and future tax benefits. |
PCI maintains a portfolio of cross-border energy sale-leaseback transactions, which, as of September 30, 2005, had a book value of approximately $1.2 billion and from which PHI currently derives approximately $55 million per year in tax benefits in the form of interest and depreciation deductions. All of PCI's cross-border energy leases are with tax indifferent parties and were entered into prior to 2004. On February 11, 2005, the Treasury Department and IRS issued a notice informing taxpayers that the IRS intends to challenge the tax benefits claimed by taxpayers with respect to certain of these transactions. In addition, on June 29, 2005, the IRS published a Coordinated Issue Paper with respect to such transactions. |
PCI's leases have been under examination by the IRS as part of the normal PHI tax audit. On May 4, 2005, the IRS issued a Notice of Proposed Adjustment to PHI that challenges the tax benefits realized from interest and depreciation deductions claimed by PHI with respect to these leases for the tax years 2001 and 2002. The tax benefits claimed by PHI with respect to these leases from 2001 through the third quarter of 2005 were approximately $217 million. The ultimate outcome of this issue is uncertain; however, if the IRS prevails, PHI would be subject to additional taxes, along with interest and possibly penalties on the additional taxes, which could have a material adverse effect on PHI's results of operations and cash flows. |
In addition, a disallowance, rather than a deferral, of tax benefits to be realized by PHI from these leases will require PHI to adjust the book value of its leases and record a charge to earnings equal to the repricing impact of the disallowed deductions. Such a change would likely have a material adverse effect on PHI's results of operations for the period in which the charge is recorded. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters." |
FORWARD LOOKING STATEMENTS |
Some of the statements contained in this Quarterly Report on Form 10-Q are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. These statements include declarations regarding Pepco Holdings' intents, beliefs and current expectations. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms or other comparable terminology. Any forward-looking statements are not guarantees of future performance, and actual results could differ materially from those indicated by the forward-looking statements. Forward-looking statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that may cause our or our industry's ac tual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. |
The forward-looking statements contained herein are qualified in their entirety by reference to the following important factors, which are difficult to predict, contain uncertainties, are beyond Pepco Holdings' control and may cause actual results to differ materially from those contained in forward-looking statements: |
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Net cash used by financing activities increased $20.6 million to $82.4 million for the nine months ended September 30, 2005 from $61.8 million for the same period in 2004. |
Proceeds from the June 2005 issuance of $175 million in senior secured notes were used to fund the retirement of $100 million in first mortgage bonds in September 2005 as well as the redemption of $75 million in first mortgage bonds prior to maturity. Debt issuances for the nine months ended September 30, 2004 totaled $275 million. Proceeds were used to redeem $175 million of 6.875% First Mortgage Bonds and $35 million of 7% Medium-Term Notes prior to maturity. |
Capital Requirements |
Construction Expenditures |
Pepco's construction expenditures for the nine months ended September 30, 2005 totaled $129.2 million. These expenditures were related to capital costs associated with new customer services, distribution reliability, and transmission. |
REGULATORY AND OTHER MATTERS |
Relationship with Mirant Corporation |
In 2000, Pepco sold substantially all of its electricity generation assets to Mirant Corporation, formerly Southern Energy, Inc. As part of the Asset Purchase and Sale Agreement, Pepco entered into several ongoing contractual arrangements with Mirant Corporation and certain of its subsidiaries (collectively, Mirant). On July 14, 2003, Mirant Corporation and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of Texas (the Bankruptcy Court). |
Depending on the outcome of the matters discussed below, the Mirant bankruptcy could have a material adverse effect on the results of operations of Pepco Holdings and Pepco. However, management believes that Pepco Holdings and Pepco currently have sufficient cash, cash flow |
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and borrowing capacity under their credit facilities and in the capital markets to be able to satisfy any additional cash requirements that may arise due to the Mirant bankruptcy. Accordingly, management does not anticipate that the Mirant bankruptcy will impair the ability of Pepco Holdings or Pepco to fulfill their contractual obligations or to fund projected capital expenditures. On this basis, management currently does not believe that the Mirant bankruptcy will have a material adverse effect on the financial condition of either company. |
Transition Power Agreements |
As part of 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, Mirant was obligated to supply Pepco with all of the capacity and energy needed to fulfill its SOS obligations in Maryland through June 2004 and its SOS obligations in the District of Columbia through January 22, 2005. |
To avoid the potential rejection of the TPAs, Pepco and Mirant entered into an Amended Settlement Agreement and Release dated as of October 24, 2003 (the Settlement Agreement) pursuant to which Mirant assumed both of the TPAs and the terms of the TPAs were modified. The Settlement Agreement also provided that Pepco has an allowed, pre-petition general unsecured claim against Mirant Corporation in the amount of $105 million (the Pepco TPA Claim). |
Pepco has also asserted the Pepco TPA Claim against other Mirant entities, which Pepco believes are liable to Pepco under the terms of the Asset Purchase and Sale Agreement's Assignment and Assumption Agreement (the Assignment Agreement). Under the Assignment Agreement, Pepco believes that each of the Mirant entities assumed and agreed to discharge certain liabilities and obligations of Pepco as defined in the Asset Purchase and Sale Agreement. Mirant has filed objections to these claims. Under the original plan of reorganization filed by the Mirant entities with the Bankruptcy Court, certain Mirant entities other than Mirant Corporation would pay significantly higher percentages of the claims of their creditors than would Mirant Corporation. The amount that Pepco will be able to recover from the Mirant bankruptcy estate with respect to the Pepco TPA Claim will depend on the amount of assets available for distribution to creditors of the Mirant entities determined to be li able for the Pepco TPA Claim. At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover, whether the recovery would be in cash or another form of payment, or the timing of any recovery. |
Power Purchase Agreements |
Under agreements with FirstEnergy Corp., formerly Ohio Edison (FirstEnergy), and Allegheny Energy, Inc., both entered into in 1987, Pepco is obligated to purchase from FirstEnergy 450 megawatts of capacity and energy annually through December 2005 (the FirstEnergy PPA). Under the Panda PPA, entered into in 1991, Pepco is obligated to purchase from Panda 230 megawatts of capacity and energy annually through 2021. In each case, the purchase price is substantially in excess of current market price. As a part of the Asset Purchase and Sale Agreement, Pepco entered into a "back-to-back" arrangement with Mirant. Under this arrangement, Mirant is obligated, among other things, to purchase from Pepco the capacity and energy that Pepco is obligated to purchase under the FirstEnergy PPA and the Panda PPA at a 159
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price equal to the price Pepco is obligated to pay under the FirstEnergy PPA and the Panda PPA (the PPA-Related Obligations).
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Pepco Pre-Petition Claims |
When Mirant filed its bankruptcy petition on July 14, 2003, Mirant had unpaid obligations to Pepco of approximately $29 million, consisting primarily of payments due to Pepco with respect to the PPA-Related Obligations (the Mirant Pre-Petition Obligations). The Mirant Pre-Petition Obligations constitute part of the indebtedness for which Mirant is seeking relief in its bankruptcy proceeding. Pepco has filed Proofs of Claim in the Mirant bankruptcy proceeding in the amount of approximately $26 million to recover this indebtedness; however, the amount of Pepco's recovery, if any, is uncertain. The $3 million difference between Mirant's unpaid obligation to Pepco and the $26 million Proofs of Claim primarily represents a TPA settlement adjustment that is included in the $105 million Proofs of Claim filed by Pepco against the Mirant debtors in respect of the Pepco TPA Claim. In view of the uncertainty as to recoverability, Pepco, in the third quarter of 2003, expensed $14.5 mi llion to establish a reserve against the $29 million receivable from Mirant. In January 2004, Pepco paid approximately $2.5 million to Panda in settlement of certain billing disputes under the Panda PPA that related to periods after the sale of Pepco's generation assets to Mirant. Pepco believes that under the terms of the Asset Purchase and Sale Agreement, Mirant is obligated to reimburse Pepco for the settlement payment. Accordingly, in the first quarter of 2004, Pepco increased the amount of the receivable due from Mirant by approximately $2.5 million and amended its Proofs of Claim to include this amount. Pepco currently estimates that the $14.5 million expensed in the third quarter of 2003 represents the portion of the entire $31.5 million receivable unlikely to be recovered in bankruptcy, and no additional reserve has been established for the $2.5 million increase in the receivable. The amount expensed represents Pepco's estimate of the possible outcome in bankruptcy, although the amount ultimately recovered could be higher or lower. |
Mirant's Attempt to Reject the PPA-Related Obligations |
In August 2003, Mirant filed with the Bankruptcy Court a motion seeking authorization to reject its PPA-Related Obligations. Upon motions filed with the U.S. District Court for the Northern District of Texas (the District Court) by Pepco and the Federal Energy Regulatory Commission (FERC), in October 2003, the District Court withdrew jurisdiction over the rejection proceedings from the Bankruptcy Court. In December 2003, the District Court denied Mirant's motion to reject the PPA-Related Obligations on jurisdictional grounds. The District Court's decision was appealed by Mirant and The Official Committee of Unsecured Creditors of Mirant Corporation (the Creditors' Committee) to the U.S. Court of Appeals for the Fifth Circuit (the Court of Appeals). In August 2004, the Court of Appeals remanded the case to the District Court saying that the District Court had jurisdiction to rule on the merits of Mirant's rejection motion, suggesting that in doing so the court apply a "mor e rigorous standard" than the business judgment rule usually applied by bankruptcy courts in ruling on rejection motions. |
On December 9, 2004, the District Court issued an order again denying Mirant's motion to reject the PPA-Related Obligations. The District Court found that the PPA-Related Obligations are not severable from the Asset Purchase and Sale Agreement and that the Asset Purchase and Sale Agreement cannot be rejected in part, as Mirant was seeking to do. Both Mirant and the Creditors' Committee appealed the District Court's order to the Court of Appeals. Briefing of 160
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this matter by the interested parties has been completed. Oral arguments have not yet been scheduled.
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Until December 9, 2004, Mirant had been making regular periodic payments in respect of the PPA-Related Obligations. However, on that date, Mirant filed a notice with the Bankruptcy Court that it was suspending payments to Pepco in respect of the PPA-Related Obligations and subsequently failed to make certain full and partial payments due to Pepco. Proceedings ensued in the Bankruptcy Court and the District Court, ultimately resulting in Mirant being ordered to pay to Pepco all past-due unpaid amounts under the PPA-Related Obligations. On April 13, 2005, Pepco received a payment from Mirant in the amount of approximately $57.5 million, representing the full amount then due in respect of the PPA-Related Obligations. |
On January 21, 2005, Mirant filed in the Bankruptcy Court a motion seeking to reject certain of its ongoing obligations under the Asset Purchase and Sale Agreement, including the PPA-Related Obligations (the Second Motion to Reject). On March 1, 2005, the District Court entered an order (as amended by a second order issued on March 7, 2005) granting Pepco's motion to withdraw jurisdiction over these rejection proceedings from the Bankruptcy Court. Mirant and the Creditor's Committee have appealed these orders to the Court of Appeals. Amicus briefs, which are briefs filed by persons who are not parties to the proceeding, but who nevertheless have a strong interest -- in this instance a broad public interest -- in the case, in support Pepco's position have been filed with the Court of Appeals by the Maryland Public Service Commission (MPSC) and the Office of People's Counsel of Maryland (Maryland OPC). Briefing of this matter by the interested parties has been com pleted. Oral arguments have not yet been scheduled. |
On March 28, 2005, Pepco, FERC, the Office of People's Counsel of the District of Columbia (the District of Columbia OPC), the MPSC and the Maryland OPC filed in the District Court oppositions to the Second Motion to Reject. By order entered August 16, 2005, the District Court has informally stayed this matter, pending a decision by the Court of Appeals on the District Court's orders withdrawing jurisdiction from the Bankruptcy Court. |
Pepco is exercising all available legal remedies and vigorously opposing Mirant's efforts to reject the PPA-Related Obligations and other obligations under the Asset Purchase and Sale Agreement in order to protect the interests of its customers and shareholders. While Pepco believes that it has substantial legal bases to oppose these efforts by Mirant, the ultimate outcome is uncertain. |
If Mirant ultimately is successful in rejecting the PPA-Related Obligations, Pepco could be required to repay to Mirant, for the period beginning on the effective date of the rejection (which date could be prior to the date of the court's order granting the rejection and possibly as early as September 18, 2003) and ending on the date Mirant is entitled to cease its purchases of energy and capacity from Pepco, all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity. Pepco estimates that the amount it could be required to repay to Mirant in the unlikely event that September 18, 2003 is determined to be the effective date of rejection, is approximately $225.1 million as of November 1, 2005. |
Mirant has also indicated to the Bankruptcy Court that it will move to require Pepco to disgorge all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an |
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amount equal to the price at which Mirant resold the purchased energy and capacity, for the period July 14, 2003 (the date on which Mirant filed its bankruptcy petition) through rejection, if approved, on the theory that Mirant did not receive value for those payments. Pepco estimates that the amount it would be required to repay to Mirant on the disgorgement theory, in addition to the amounts described above, is approximately $22.5 million. |
Any repayment by Pepco of amounts received from Mirant in respect of the PPA-Related Obligations would entitle Pepco to file a claim against the bankruptcy estate in an amount equal to the amount repaid. To the extent such amounts were not recovered from the Mirant bankruptcy estate, Pepco believes they would be recoverable as stranded costs from customers through distribution rates as described below. |
The following are estimates prepared by Pepco of its potential future exposure if Mirant's attempt to reject the PPA-Related Obligations ultimately is successful. These estimates are based in part on current market prices and forward price estimates for energy and capacity, and do not include financing costs, all of which could be subject to significant fluctuation. The estimates assume no recovery from the Mirant bankruptcy estate and no regulatory recovery, either of which would mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recoveries. Based on these assumptions, Pepco estimates that its pre-tax exposure as of November 1, 2005 representing the loss of the future benefit of the PPA-Related Obligations to Pepco, is as follows: |
The ability of Pepco to recover from the Mirant bankruptcy estate in respect to the Mirant Pre-Petition Obligations and damages if the PPA-Related Obligations are successfully rejected will depend on whether Pepco's claims are allowed, the amount of assets available for distribution to the creditors of the Mirant companies determined to be liable for those claims, and Pepco's priority relative to other creditors. At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate, whether the recovery would be in cash or another form of payment, or the timing of any recovery. |
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If Mirant ultimately were successful in rejecting the PPA-Related Obligations and Pepco's full claim were not recovered from the Mirant bankruptcy estate, Pepco would seek authority from the MPSC and the District of Columbia Public Service Commission (DCPSC) to recover its additional costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers. Under the provisions of the settlement agreements approved by the MPSC and the DCPSC in the deregulation proceedings in which Pepco agreed to divest its generation assets under certain conditions, the PPAs were to become assets of Pepco's distribution business if they could not be sold. Pepco believes that, if Mirant ultimately is successful in rejecting the PPA-Related Obligations, these provisions would allow the stranded costs of the PPAs that are not recovered from the Mirant bankruptcy estate to be recovered from Pepco's customers through its dist ribution rates. If Pepco's interpretation of the settlement agreements is confirmed, Pepco expects to be able to establish the amount of its anticipated recovery as a regulatory asset. However, there is no assurance that Pepco's interpretation of the settlement agreements would be confirmed by the respective public service commissions. |
If the PPA-Related Obligations are successfully rejected, and there is no regulatory recovery, Pepco will incur a loss; the accounting treatment of such a loss, however, would depend on a number of legal and regulatory factors. |
Mirant's Fraudulent Transfer Claim |
On July 13, 2005, Mirant filed a complaint in the Bankruptcy Court against Pepco alleging that Mirant's $2.65 billion purchase of Pepco's generating assets in June 2000 constituted a fraudulent transfer. Mirant alleges in the complaint that the value of Pepco's generation assets was "not fair consideration or fair or reasonably equivalent value for the consideration paid to Pepco" and that it thereby rendered Mirant insolvent, or, alternatively, that Pepco and Southern Energy, Inc. (as predecessor to Mirant) intended that Mirant would incur debts beyond its ability to pay them. Mirant asks that the Court enter an order "declaring that the consideration paid for the Pepco assets, to the extent it exceeds the fair value of the Pepco assets, to be a conveyance or transfer in fraud of the rights of Creditors under state law" and seeks compensatory and punitive damages. |
Pepco believes this claim has no merit and is vigorously contesting the claim. On September 20, 2005, Pepco filed a motion to withdraw this complaint to the District Court and on September 30, 2005, Pepco filed its answer in the Bankruptcy Court. On October 20, 2005, the Bankruptcy Court issued a report and recommendation to the District Court, which recommends that the District Court grant the motion to withdraw the reference. The District Court will now consider whether to accept the recommendation to withdraw the reference. Pepco cannot predict when the District Court will make a decision or whether it will accept the recommendation of the Bankruptcy Court. |
The SMECO Agreement |
As a term of the Asset Purchase and Sale Agreement, Pepco assigned to Mirant a facility and capacity agreement with Southern Maryland Electric Cooperative, Inc. (SMECO) under which Pepco was obligated to purchase the capacity of an 84-megawatt combustion turbine installed and owned by SMECO at a former Pepco generating facility (the SMECO Agreement). The SMECO Agreement expires in 2015 and contemplates a monthly payment to SMECO of |
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approximately $.5 million. Pepco is responsible to SMECO for the performance of the SMECO Agreement if Mirant fails to perform its obligations thereunder. At this time, Mirant continues to make post-petition payments due to SMECO. |
On March 15, 2004, Mirant filed a complaint with the Bankruptcy Court seeking a declaratory judgment that the SMECO Agreement is an unexpired lease of non-residential real property rather than an executory contract and that if Mirant were to successfully reject the agreement, any claim against the bankruptcy estate for damages made by SMECO (or by Pepco as subrogee) would be subject to the provisions of the Bankruptcy Code that limit the recovery of rejection damages by lessors. Pepco believes that there is no reasonable factual or legal basis to support Mirant's contention that the SMECO Agreement is a lease of real property. The outcome of this proceeding cannot be predicted. |
Mirant Plan of Reorganization |
On January 19, 2005, Mirant filed its Plan of Reorganization and Disclosure Statement with the Bankruptcy Court (the Original Reorganization Plan) under which Mirant proposed to transfer all assets to "New Mirant" (an entity it proposed to create in the reorganization), with the exception of the PPA-Related Obligations. Mirant proposed that the PPA-Related Obligations would remain in "Old Mirant," which would be a shell entity as a result of the reorganization. On March 25, 2005, Mirant filed its First Amended Plan of Reorganization and First Amended Disclosure Statement (the Amended Reorganization Plan), in which Mirant abandoned the proposal that the PPA-Related Obligations would remain in "Old Mirant," but did not clarify how the PPA-Related Obligations would be treated. On September 22, 2005, Mirant filed its Second Amended Disclosure Statement and Second Amended Plan of Reorganization. Pepco filed objections to the Second Amended Disclosure Statement on September 28, 2005 and a revised version of the Second Amended Disclosure Statement, including the changes and clarifications requested by Pepco, was filed and approved by the Bankruptcy Court on September 30, 2005. Pepco is still analyzing, and has not yet determined whether to file an objection to, the Second Amended Plan of Reorganization. Objections to confirmation of the Second Amended Plan of Reorganization are due November 10, 2005. |
On March 11, 2005, Mirant filed an application with FERC seeking approval for the internal transfers and corporate restructuring that will result from the Original Reorganization Plan. FERC approval for these transactions is required under Section 203 of the Federal Power Act. On April 1, 2005, Pepco filed a motion to intervene and protest at FERC in connection with this application. On the same date, the District of Columbia OPC also filed a motion to intervene and protest. Pepco, the District of Columbia OPC, the Maryland OPC and the MPSC filed pleadings arguing that the application was premature inasmuch as it was unclear whether the planned reorganization would be approved by the Bankruptcy Court and asking that FERC refrain from acting on the application. |
On June 17, 2005, FERC issued anorder approving the planned restructuring outlined in the Original Reorganization Plan, which has since been superseded by the Second Amended Plan of Reorganization, as discussed above. The Second Amended Plan of Reorganization does not provide for the same restructuring contemplated in the Original Reorganization Plan. While the FERC order had no direct impact on Pepco, the order included a discussion regarding potential future rate impacts if the courts were to permit rejection of the PPAs. Because Pepco disagreed with this discussion, Pepco filed a motion for rehearing on July 18, 2005 (before Mirant filed its |
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Second Amended Plan of Reorganization). On August 17, 2005, the FERC entered an order granting the request for rehearing "for the limited purpose of further consideration." This order simply means that the request for rehearing remains pending. Pepco cannot predict the outcome of its motion for rehearing. |
Rate Proceedings |
Federal Energy Regulatory Commission |
On January 31, 2005, Pepco filed at the FERC to reset its rates for network transmission service using a formula methodology. Pepco also sought a 12.4% return on common equity and a 50-basis-point return on equity adder that the FERC had made available to transmission utilities who had joined Regional Transmission Organizations and thus turned over control of their assets to an independent entity. The FERC issued an order on May 31, 2005, approving the rates to go into effect June 1, 2005, subject to refund, hearings, and further orders. The new rates reflect a decrease of 7.7% in Pepco's transmission rate. Pepco continues in settlement discussions and cannot predict the ultimate outcome of this proceeding. |
Environmental Litigation |
For a discussion of the history of Pepco's environmental litigation related to the Metal Bank/Cottman Avenue site in Philadelphia, Pennsylvania, please refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Regulatory and Other Matters -- Environmental Litigation" of Pepco's Annual Report on Form 10-K for the year ended December 31, 2004. On September 2, 2005 the United States lodged with the U.S. District Court for the Eastern District of Pennsylvania global consent decrees for the Metal Bank site, which a group of utility potentially responsible parties (PRPs) including Pepco (the Utility PRPs) entered into on August 23, 2005 with the U.S. Department of Justice, Environmental Protection Agency (EPA), The City of Philadelphia and two owner/operators of the site with respect to clean up of the site. The global settlement includes three Companion Consent Decrees (for the Utility PRPs and one each for the two owner/operators ) and an agreement with The City of Philadelphia. Under the terms of the settlement, the two owner/operators will make payments totaling $5.55 million to the U.S. and totaling $4.05 million to the Utility PRPs. The Utility PRPs will perform the remedy at the site and will be able to draw on the funds from the bankruptcy settlement, which provides that the reorganized entity/site owner will pay a total of $13.25 million to remediate the site (the Bankruptcy Settlement) to accomplish the remediation (the Bankruptcy Funds). The Utility PRPs will contribute funds to the extent remediation costs exceed the Bankruptcy Funds available. The Utility PRPs will not be liable for any of the United States' past costs in connection with the site, but will be liable for EPA costs associated with overseeing the monitoring and operation of the site remedy after the remedy construction is certified to be complete and also the cost of performing the "5 year" review of site conditions required by the Comprehensive Envi ronmental Response, Compensation, and Liability Act of 1980. Any Bankruptcy Funds not spent on the remedy may be used to cover the Utility PRPs' liabilities for future costs. No parties are released from potential liability for damages to natural resources. The global settlement agreement is subject to a public comment period and approval by the court. If for any reason the court declines to enter one or more Companion Consent Decrees, the United States and the Utility PRPs will have 30 days to withdraw or withhold 165
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consent for the other Companion Consent Decrees. Court approval could be obtained as early as the fourth quarter 2005.
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As of September 30, 2005, Pepco had accrued $1.7 million to meet its liability for a remedy at the Metal Bank/Cottman Avenue site. While final costs to Pepco of the settlement have not been determined, Pepco believes that its liability at this site will not have a material adverse effect on its financial condition or results of operations. |
CRITICAL ACCOUNTING POLICIES |
For a discussion of Pepco's critical accounting policies, please refer to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in Pepco's Annual Report on Form 10-K for the year ended December 31, 2004. During the second quarter of 2005, Pepco identified the following as an additional critical accounting policy. |
Unbilled Revenue |
Unbilled revenue represents an estimate of revenue earned from services rendered that have not yet been billed. Pepco calculates unbilled revenue using an output based methodology. (This methodology is based on the supply of electricity distributed to customers.) Pepco believes that the estimates involved in its unbilled revenue process represent "Critical Accounting Estimates" because management is required to make assumptions and judgments about input factors such as customer sales mix and estimated power line losses (estimates of electricity expected to be lost in the process of its transmission and distribution to customers), which are all inherently uncertain and susceptible to change from period to period, the impact of which could be material. |
NEW ACCOUNTING STANDARDS |
SFAS No. 154 |
In May 2005, the Financial Accounting Standards Board (FASB) issued Statement No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3" (SFAS No. 154).SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. The reporting of a correction of an error by restating previously issued financial statements is also addressed by SFAS No. 154. This Statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted. |
FIN 47 |
In March 2005, the FASB published FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations"(FIN 47). FIN 47 clarifies that FASB Statement No. 143, "Accounting for Asset Retirement Obligations" applies to conditional asset retirement obligations and requires that the fair value of a reasonably estimable conditional asset retirement obligation be recognized as part of the carrying amounts of the asset. FIN 47 is effective no later than the end of the first fiscal year ending after December 15, 2005 (i.e., December 31, 2005 for |
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Pepco). Pepco is in the process of evaluating the anticipated impact that the implementation of FIN 47 will have on its overall financial condition or results of operations. |
EITF 04-13 |
In September 2005, the FASB ratified EITF Issue No. 04-13, "Accounting for Purchases and Sales of Inventory with the Same Counterparty" (EITF 04-13). The Issue addresses circumstances under which two or more exchange transactions involving inventory with the same counterparty should be viewed as a single exchange transaction for the purposes of evaluating the effect of APB Opinion 29. EITF 04-13 is effective for new arrangements entered into, or modifications or renewals of existing arrangements, beginning in the first interim or annual reporting period beginning after March 15, 2006 (April 1, 2006 for Pepco). EITF 04-13 may not impact Pepco's net income or overall financial condition but rather may result in certain revenues and costs being presented on a net basis. Pepco is in the process of evaluating the impact of EITF 04-13 on the income statement presentation of purchases and sales covered by the Issue. |
RISK FACTORS |
For information concerning risk factors, please refer to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in Pepco's Annual Report on Form 10-K for the year ended December 31, 2004. |
FORWARD LOOKING STATEMENTS |
Some of the statements contained in this Quarterly Report on Form 10-Q are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. These statements include declarations regarding Pepco's intents, beliefs and current expectations. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms or other comparable terminology. Any forward-looking statements are not guarantees of future performance, and actual results could differ materially from those indicated by the forward-looking statements. Forward-looking statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that may cause Pepco's or Pepco's industry's ac tual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. |
The forward-looking statements contained herein are qualified in their entirety by reference to the following important factors, which are difficult to predict, contain uncertainties, are beyond Pepco's control and may cause actual results to differ materially from those contained in forward-looking statements: |
For additional information concerning market risk, please refer to Item 7A, Quantitative and Qualitative Disclosure About Market Risk, in Pepco Holdings' Annual Report on Form 10-K for the year ended December 31, 2004. |
Pepco |
For information concerning market risk, please refer to Item 7A, Quantitative and Qualitative Disclosure About Market Risk, in Pepco's Annual Report on Form 10-K for the year ended December 31, 2004. |
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INFORMATION FOR THIS ITEM IS NOT REQUIRED FOR DPL AND ACE 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. |
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures |
Under the supervision, and with the participation of management, including the chief executive officer and the chief financial officer, Pepco Holdings has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of September 30, 2005, and, based upon this evaluation, the chief executive officer and the chief financial officer of Pepco Holdings have concluded that these controls and procedures are effective to provide reasonable assurance that material information relating to Pepco Holdings and its subsidiaries that is required to be disclosed in reports filed with, or submitted to, the SEC under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified by the SEC rules and forms, and (ii) is accumulated and communicated to management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosur e. |
Changes in Internal Control Over Financial Reporting |
During the three months ended September 30, 2005, there was no change in Pepco Holdings' internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, Pepco Holdings' internal controls over financial reporting. |
Pepco Holdings' subsidiary, Conectiv Energy, which operates a competitive energy business, is in the process of installing new energy transaction software that provides additional functionality, such as enhanced PJM invoice reconciliation capability, hedge accounting, greater risk analysis capability, and enhanced regulatory reporting capability. Conectiv Energy anticipates implementing the new software for all electric power transactions in the fourth quarter of 2005, with the goal of extending it to all of Conectiv energy commodity transactions over time. The Conectiv Energy implementation will be the first implementation of this software and extensive pre-implementation testing has been performed to ensure internal controls over financial reporting continue to be effective. Operating effectiveness of internal controls over financial reporting will continue to be evaluated post implementation. |
Potomac Electric Power Company |
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures |
Under the supervision, and with the participation of management, including the chief executive officer and the chief financial officer, Pepco has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of September 30, 2005, and, based upon this evaluation, the chief executive officer and the chief financial officer of Pepco have concluded that these controls and procedures are effective to provide reasonable assurance that material information relating to Pepco and its subsidiaries that is required to be disclosed in |
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reports filed with, or submitted to, the SEC under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified by the SEC rules and forms, and (ii) is accumulated and communicated to management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. |
Changes in Internal Control Over Financial Reporting |
During the three months ended September 30, 2005, there was no change in Pepco's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, Pepco's internal controls over financial reporting. |
Delmarva Power & Light Company |
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures |
Under the supervision, and with the participation of management, including the chief executive officer and the chief financial officer, DPL has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of September 30, 2005, and, based upon this evaluation, the chief executive officer and the chief financial officer of DPL have concluded that these controls and procedures are effective to provide reasonable assurance that material information relating to DPL that is required to be disclosed in reports filed with, or submitted to, the SEC under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified by the SEC rules and forms, and (ii) is accumulated and communicated to management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. |
Changes in Internal Control Over Financial Reporting |
During the three months ended September 30, 2005, there was no change in DPL's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, DPL's internal controls over financial reporting. |
Atlantic City Electric Company |
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures |
Under the supervision, and with the participation of management, including the chief executive officer and the chief financial officer, ACE has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of September 30, 2005, and, based upon this evaluation, the chief executive officer and the chief financial officer of ACE have concluded that these controls and procedures are effective to provide reasonable assurance that material information relating to ACE and its subsidiaries that is required to be disclosed in reports filed with, or submitted to, the SEC under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified by the SEC rules and forms, and (ii) is accumulated and communicated to management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. |
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Changes in Internal Control Over Financial Reporting |
During the three months ended September 30, 2005, there was no change in ACE's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, ACE's internal controls over financial reporting. |
Part II OTHER INFORMATION |
Item 1. LEGAL PROCEEDINGS |
Pepco Holdings |
On July 14, 2003, Mirant Corporation and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. For information concerning the potential impacts of these proceedings on PHI, please refer to Note (4), Commitments and Contingencies, to the financial statements of PHI included herein. |
For further information concerning litigation matters, please refer to Item 3, "Legal Proceedings," included in Pepco Holdings' Annual Report on Form 10-K for the year ended December 31, 2004 and Note (4), Commitments and Contingencies, to the financial statements of PHI included herein. |
Pepco |
On July 14, 2003, Mirant Corporation and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. For information concerning the potential impacts of these proceedings on Pepco, please refer to Note (4), Commitments and Contingencies, to the financial statements of Pepco included herein. |
For further information concerning litigation matters, please refer to Item 3, "Legal Proceedings," included in Pepco's Annual Report on Form 10-K for the year ended December 31, 2004 and Note (4), Commitments and Contingencies, to the financial statements of Pepco included herein. |
DPL |
For information concerning litigation matters, please refer to Item 3, "Legal Proceedings," included in DPL's Annual Report on Form 10-K for the year ended December 31, 2004 and Note (4), Commitments and Contingencies, to the financial statements of DPL included herein. |
ACE |
For information concerning litigation matters, please refer to Item 3, "Legal Proceedings," included in ACE's Annual Report on Form 10-K for the year ended December 31, 2004 and Note (4), Commitments and Contingencies, to the financial statements of ACE included herein. |
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Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
Pepco Holdings |
None. |
Pepco |
None. |
INFORMATION FOR THIS ITEM IS NOT REQUIRED FOR DPL AND ACE 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 DPL AND ACE 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 DPL AND ACE 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 5. OTHER INFORMATION |
Pepco Holdings |
None. |
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Pepco |
None. |
DPL |
None. |
ACE |
None. |
Item 6. EXHIBITS |
The documents listed below are being filed or furnished on behalf of Pepco Holdings, Inc. (PHI), Potomac Electric Power Company (Pepco), Delmarva Power & Light Company (DPL), and Atlantic City Electric Company (ACE) as indicated. |
