DEF 14A 1 ddef14a.htm DEFINITIVE PROXY STATEMENT Definitive Proxy Statement
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

SCHEDULE 14A

 

Proxy Statement Pursuant to Section 14(a) of the

Securities Exchange Act of 1934

 

 

Filed by the Registrant x

 

Filed by a Party other than the Registrant ¨

 

Check the appropriate box:

 

¨ Preliminary Proxy Statement

 

¨ Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2))

 

x Definitive Proxy Statement

 

¨ Definitive Additional Materials

 

¨ Soliciting Material Pursuant to §240.14a-12

 

 

 

PEPCO HOLDINGS, INC.


(Name of Registrant as Specified In Its Charter)

 

 

 

  


(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

 

 

Payment of Filing Fee (Check the appropriate box):

 

x No fee required.

 

¨ Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.

 

  (1) Title of each class of securities to which transaction applies:

 

  

 
  (2) Aggregate number of securities to which transaction applies:

 

  

 
  (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined.):

 

  

 
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  (5) Total fee paid:

 

  

 

 

 

¨ Fee paid previously with preliminary materials.

 

¨ Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a) (2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing.

 

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LOGO

Proxy Statement and

2007 Annual Report to Shareholders

 

Dear Fellow Shareholders,

 

I am pleased to report that in 2007 Pepco Holdings, Inc. (PHI) continued to make significant progress executing its strategic plan. We received approval to move forward with a $1 billion transmission project, completed four distribution base rate cases, implemented a revenue decoupling mechanism in Maryland, advanced our Blueprint for the Future programs in all jurisdictions we serve, and commenced expansion of our state-of-the-art generation fleet.

 

Financially, we had a solid year with earnings amounting to $334.2 million, or $1.72 per share, compared to $248.3 million, or $1.30 per share, in 2006. PHI stock significantly outperformed the average of its peers, and over the past three years the company has provided shareholders a 56 percent total return. In addition, in January 2008 our Board of Directors declared a 4 percent increase in the annual dividend rate, increasing the dividend to $1.08 on an annual basis.

 

These results reflect strong performances from all of our businesses, continued confidence in our long-term outlook, and execution of our carefully developed strategic plan, which is focused on delivering steady long-term earnings and dividend growth.

 

Focusing on Energy Efficiency

 

About a year ago, I announced a new focus on creating a greener energy future based on advanced digital technologies and customer-focused energy-efficiency programs. We call it our “Blueprint for the Future,” and it serves as our guide for partnering with

customers and addressing their concerns around high energy costs, power reliability, customer service and a clean environment.

 

The Blueprint plan includes simple conservation steps we can offer now, and others that will require time and investment, including installing advanced metering, communication systems and distribution automation technologies. All are needed if we are to meet customers’ energy needs and do our part to mitigate climate change, a critical issue that has significantly changed our strategic operating environment.

 

Our commitment to the environment goes beyond our customer focus. For example, we are working to reduce the environmental impact of company operations by transforming our fleet to environmentally friendly alternative vehicles and fuels such as hybrids and bio-diesel; placing solar panels atop substations to help supply conventional station service; and installing energy-efficiency measures in selected company facilities. We also are monitoring and supporting next-generation technologies, such as fuel cells and vehicle-to-grid capabilities, which hold promise for longer-term solutions to our country’s energy efficiency and conservation needs.

 

In September, I joined seven of my colleagues in New York City to announce PHI’s partnership with the Clinton Global Initiative, and earlier in the year, while addressing industry and government leaders at GridWeek, I announced that PHI had joined IBM’s Intelligent Utility Network Coalition. Both efforts are focused on solving national energy problems—the Clinton Initiative by reducing


 

Letter to Shareholders

   Cover Page

Notice of 2008 Annual Meeting and Proxy Statement

   1

Policy on the Approval of Services Provided by the Independent Auditor

   A-1

2007 Annual Report to Shareholders

   B-1

•  Business of the Company

   B-8

•  Management’s Discussion and Analysis

   B-19

•  Quantitative and Qualitative Disclosures about Market Risk

   B-78

•  Consolidated Financial Statements

   B-84

Board of Directors and Officers

   B-157

Investor Information

   B-158


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greenhouse gas emissions through energy efficiency, and the IBM Coalition by accelerating the adoption of advanced utility technologies to modernize the electric grid.

 

In addition, we are taking the lead in the Environmental Protection Agency’s National Action Plan for Energy Efficiency, a broad-based group that is making plans and recommendations to meet the challenges of high energy prices, energy security and independence, air pollution and global climate change.

 

Preparing for the Future

 

Engaging in national energy policy efforts is essential because government actions will have a great impact on the utility industry. Climate change legislation is moving through Congress that will likely establish a carbon cap and trade regime. States we serve are joining the Regional Greenhouse Gas Initiative, which sets carbon limits and aggressive goals to reduce energy use. Increased costs associated with pollution controls may lead to the retirement of some older coal-fired power plants, and legislators are beginning to mandate ever higher renewable generation portfolios.

 

According to the Electric Power Research Institute, if every U.S. utility implemented its energy efficiency programs, carbon emissions could be reduced nine percent by 2030. This falls short of what experts agree is needed. Energy efficiency measures must be supplemented by renewable generating sources, nuclear power, advanced coal technologies, increased transmission capacity, carbon capture and distributed generation strategies.

 

While governments seek to reduce energy use, consumers—reliant on an increasingly digital world—are demanding more power and service reliability. Globally, utility investment in plant and equipment is rapidly expanding. This has led to increasing cost pressures as material and human resources become constrained. It also has led to utility consolidation in Europe and the possibility of increased mergers in the U.S. as utilities seek to leverage access to scarce resources.

 

With this background, we developed strategies to position PHI to be successful no matter what the future holds. Investment in the transmission and delivery infrastructure is required under any future scenario, and that supports our low-risk, stable return utility business. We strive to maintain constructive regulatory relationships; provide a high degree of reliability for the robust service area that we serve; and we continue to improve our balance sheet. Our fleet of power plants is among the cleanest in the

nation. We have a solid plan for continued growth in all our businesses and for playing a role in helping to solve the energy challenges before us.

 

Growing our Core Investments

 

Over the next five years, we plan to invest substantially in utility infrastructure, which will drive our power delivery business and likely double our rate base. Investment in our Blueprint for the Future alone will exceed $500 million.

 

A major part of our infrastructure plan is our 500-kilovolt Mid-Atlantic Power Pathway (MAPP) transmission project, which PJM, our regional independent grid operator, approved in October 2007. MAPP is designed to relieve congestion in southern Maryland and on the Delmarva Peninsula. The line will originate in Virginia, cross the Potomac River into southern Maryland, then go under the Chesapeake Bay to the Delmarva Peninsula and extend north through the Peninsula to southern New Jersey.

 

MAPP constitutes a significant $1 billion investment, but even so, over the next five years more than 70 percent of our utility construction expenditures will be driven by reliability investments in transmission and distribution assets needed because of load growth, aging equipment and retiring power plants.

 

Adding Value Through Competitive Energy

 

Our strategic wholesale and retail energy businesses provide important complementary value to the transmission and distribution companies that comprise PHI’s core business. In 2007, Conectiv Energy’s gross margin increased $64 million and played a key role in supplementing utility earnings. Near-term business risks have been significantly reduced as plant output has been substantially hedged for the next two years.

 

The wholesale business holds a sustainable competitive advantage in PJM due to its favorable plant locations, flexible and dual-fueled combined cycle plants, intimate knowledge of the market and ability to economically expand its fleet.

 

To that point, we are modestly growing our generation business at Conectiv Energy, with two projects currently under way. In New Jersey, we are building the Cumberland Project, a 100-megawatt, dual-fuel combustion turbine that will begin commercial operation in early 2009. This is a flexible and efficient unit that will help meet growing peak demand in the Atlantic City area.


 

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Our Delta Project, a 545-megawatt combined cycle plant that will be located at a new site in Delta, Pennsylvania, will be the first new combined cycle generation project in Eastern PJM in over five years. Conectiv Energy has substantial recent design and construction experience building similar plants on schedule and within budget. The business risk associated with this project has been significantly reduced by a “tolling agreement” with a third party that has agreed to purchase the plant’s output over its first six years of operation.

 

I am proud to say that Pepco Energy Services, PHI’s retail energy business, is now the fourth largest electricity retail marketer in the U.S. Contract signings in 2007 remained strong, coming off a record 2006 level. The business serves almost 4,300 megawatts of load, an increase of 21 percent over 2006, as it continues to expand in markets such as Illinois, New York, and Massachusetts.

 

Pepco Energy Services also is active in the energy-efficiency business and renewable energy supply. For example, the company is partnering with Virginia Tech to form the Energy Efficiency Partnership of Greater Washington with the goal of conducting energy audits and infrastructure retrofits for commercial facilities throughout the Washington area. This effort combines efficiency and renewable energy sources to offset between 20 to 50 percent of a facility’s load.

 

Management Transition

 

On September 1, 2007, Thomas S. Shaw retired as PHI’s Executive Vice President and Chief Operating Officer after more than 36 years of service. Tom was instrumental in implementing the Conectiv/Pepco merger in 2002, and subsequently led integration efforts to forge common values, systems and processes. On behalf of the Board of Directors, I thank Tom for his dedicated and outstanding service.

 

Succeeding Tom as President and Chief Operating Officer of PHI is Joseph M. Rigby. In his new role, Joe has responsibility for the regulated utility subsidiaries, the competitive energy businesses, and PHI’s information technology and corporate communications groups. Joe has strong operating experience having served as Vice President of Gas and Electric Delivery at Conectiv, and President of Conectiv Power Delivery. He most recently served for three years as PHI’s Senior Vice President and Chief Financial Officer, during which time he led the

development of our strategic plan and greatly enhanced PHI’s outreach to the financial community.

 

Succeeding Joe as Chief Financial Officer is Paul H. Barry, who previously was Senior Vice President and Chief Development Officer of Duke Energy, where he was responsible for corporate development including mergers and acquisitions. Paul also gained experience at General Electric, CBS (formerly Westinghouse), and Amoco, and is an alumnus of GE’s highly regarded Financial Management Program and Corporate Audit Staff.

 

These executive changes provide for continued focus on delivering excellent service to our customers and solid return to our shareholders.

 

An Attractive Investment

 

Over the past year, PHI reached many important milestones: inclusion in the S&P 500; completion of rate cases in the District of Columbia, Delaware and Maryland; approval of our new Mid-Atlantic Power Pathway project; the filing of our Blueprint for the Future plans in all the jurisdictions we serve and initiation of our generation fleet expansion.

 

This progress, along with our strong fundamentals, makes PHI an attractive investment. Our core regulated transmission and distribution utility business provides a stable earnings base, our earnings growth potential is expanding across all of our businesses, and we offer a secure and growing dividend.

 

I want to thank PHI’s Board of Directors, which has provided expert leadership and support, as the company executes its plan to provide premier energy delivery and competitive energy services in the mid-Atlantic region.

 

On December 4, 2007, PHI rang the closing bell at the New York Stock Exchange celebrating 60 years on the Exchange. PHI’s future looks bright, and I want to thank PHI’s shareholders for their continued confidence in our company, strategic direction and ability to deliver long-term earnings and dividend growth.

 

Sincerely,

 

LOGO

 

Dennis R. Wraase

Chairman of the Board and Chief Executive Officer

March 27, 2008


 

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YOUR VOTE IS IMPORTANT.

PLEASE VOTE YOUR SHARES PROMPTLY.

TO VOTE YOUR SHARES, USE THE INTERNET

OR CALL THE TOLL-FREE TELEPHONE NUMBER

AS DESCRIBED IN THE INSTRUCTIONS ATTACHED TO YOUR PROXY CARD,

OR COMPLETE, SIGN, DATE AND RETURN YOUR PROXY CARD

IN THE ENVELOPE PROVIDED.

 

THANK YOU FOR ACTING PROMPTLY.

 

 

 


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LOGO

 

701 Ninth Street, N.W.

Washington, D.C. 20068

 

Notice of Annual Meeting of Shareholders

 

March 27, 2008

 

NOTICE IS HEREBY GIVEN that the Annual Meeting of Shareholders of Pepco Holdings, Inc. will be held at 10:00 a.m. local time on Friday, May 16, 2008 (the doors will open at 9:00 a.m.), at the Company’s offices located at 701 Ninth Street, N.W., Edison Place Conference Center (second floor), Washington, D.C. for the following purposes:

 

  1. To elect 12 directors to serve for a term of one year;

 

  2. To ratify the appointment of PricewaterhouseCoopers LLP as independent registered public accounting firm of the Company for 2008;

 

  3. To transact such other business as may properly be brought before the meeting.

 

All holders of record of the Company’s common stock at the close of business on Monday, March 17, 2008, will be entitled to vote on each matter submitted to a vote of shareholders at the meeting.

 

By order of the Board of Directors,

ELLEN SHERIFF ROGERS

Vice President and Secretary

 

 

 

IMPORTANT

 

You are cordially invited to attend the meeting in person.

 

Even if you plan to be present, you are urged to vote your shares promptly. To vote your shares, use the Internet or call the toll-free telephone number as described in the instructions attached to your proxy card, or complete, sign, date and return your proxy card in the envelope provided.

 

If you attend the meeting, you may vote either in person or by proxy.

 

Important Notice Regarding the Availability of Proxy Materials for the Shareholder Meeting to be held on May 16, 2008. The Company’s 2008 Proxy Statement and 2007 Annual Report to Shareholders are available at www.pepcoholdings.com.


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Election of Directors

   4

Nominees for Election as Directors

   5

Board Meetings

   10

Board Committees

   10

2007 Director Compensation

   14

Security Ownership of Certain Beneficial Owners and Management

   16

Compensation/Human Resources Committee Report

   18

Compensation Discussion and Analysis

   18

Executive Compensation

   30

2007 Summary Compensation Table

   30

2007 Grants of Plan-Based Awards

   34

Outstanding Equity Awards at December 31, 2007

   38

2007 Option Exercises and Stock Vested

   39

Pension Benefits at December 31, 2007

   40

Nonqualified Deferred Compensation at December 31, 2007

   45

Board Review of Transactions with Related Parties

   54

Audit Committee Report

   55

Ratification of Independent Registered Public Accounting Firm

   56

Shareholder Proposals and Director Nominations

   57

Other Matters Which May Come Before the Meeting

   59

Policy on the Approval of Services Provided by the Independent Auditor

   A-1

2007 Annual Report to Shareholders

   B-1


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PROXY STATEMENT

 

Annual Meeting of Shareholders

 

Pepco Holdings, Inc.

 

March 27, 2008

 

This Proxy Statement is being furnished by the Board of Directors of Pepco Holdings, Inc. (the “Company,” “Pepco Holdings” or “PHI”) in connection with its solicitation of proxies to vote on the matters to be submitted to a vote of shareholders at the 2008 Annual Meeting. This Proxy Statement, together with the Company’s 2007 Annual Report to Shareholders, which is attached as Annex B to the Proxy Statement, the Notice of Annual Meeting, and a proxy card, is being first mailed to shareholders of record on or about April 3, 2008.

 

The address of the Company’s principal executive offices is 701 Ninth Street, N.W., Washington, D.C. 20068.

 

When and where will the Annual Meeting be held?

 

The Annual Meeting will be held at 10:00 a.m. local time on Friday, May 16, 2008 (the doors will open at 9:00 a.m.), at the Company’s offices located at 701 Ninth Street, N.W., Edison Place Conference Center (second floor), Washington, D.C. To obtain directions to attend the Annual Meeting and vote in person, please contact the Company by sending an e-mail to pepco@amstock.com. Admission to the meeting will be limited to Company shareholders or their authorized proxies. Admission tickets are not required.

 

Will the Annual Meeting be Webcast?

 

The live audio and slide presentation of the meeting can be accessed at the Company’s Web site, www.pepcoholdings.com/investors. An audio-only version will also be available. The dial-in information will be announced in a news release at a later date. The Annual Meeting Webcast will be archived and available on the Company’s Web site (www.pepcoholdings.com) by first clicking on the link: Investor Relations and then the link: Webcasts and Presentations.

 

What matters will be voted on at the Annual Meeting?

 

1. The election of 12 directors, each for a one-year term.

 

The Board recommends a vote FOR each of the 12 candidates nominated by the Board of Directors and identified in Item 1 in this Proxy Statement.

 

2. The ratification of the appointment by the Audit Committee of PricewaterhouseCoopers LLP as the Company’s independent registered public accounting firm for 2008.

 

The Board recommends a vote FOR this proposal.

 

How do I vote shares held in my own name?

 

If you own shares in your own name, you can attend the Annual Meeting and vote in person or you can vote by proxy without attending the meeting. You can vote by proxy in any of three ways:

 

   

Via Internet: Go to www.voteproxy.com. Have your proxy card in hand when you access the Web site. You will be given simple voting instructions to follow to obtain your records and to create an electronic voting instruction form. At this Web site, you also can elect to receive future proxy statements and annual reports electronically via the Internet rather than by mail.

 

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By Telephone: Call toll-free 1-800-PROXIES (1-800-776-9437). Have your proxy card in hand when you call, and you will be given simple voting instructions to follow.

 

   

In Writing: Complete, sign, date and return the enclosed proxy card in the postage-paid envelope that has been enclosed with this Proxy Statement.

 

The Internet and telephone voting facilities for shareholders of record will close at 5:00 p.m. Eastern time on May 15, 2008. Your signed proxy card or the proxy you grant via the Internet or by telephone will be voted in accordance with your instructions. If you return a signed proxy card or grant a proxy via the Internet or by telephone, but do not indicate how you wish your shares to be voted, your shares will be voted FOR the election of each of the Board’s director nominees and FOR the ratification of PricewaterhouseCoopers LLP as the Company’s independent registered public accounting firm for 2008.

 

How do I vote shares held through a brokerage firm, bank or other financial intermediary?

 

If you hold shares through a brokerage firm, bank or other financial intermediary, you will receive from that intermediary directions on how to direct the voting of your shares by the intermediary, which may include voting instructions given via the Internet or by telephone. If you hold your shares through a brokerage firm, bank or other financial intermediary, you may not vote in person at the Annual Meeting unless you obtain a proxy from the recordholder of the shares.

 

Who is eligible to vote?

 

All shareholders of record at the close of business on Monday, March 17, 2008 (the “record date”) are entitled to vote at the Annual Meeting. As of the close of business on the record date 201,121,625 shares of Pepco Holdings common stock, par value $.01 per share (the “common stock”), were outstanding. Each outstanding share of common stock entitles the holder of record to one vote on each matter submitted to the vote of shareholders at the Annual Meeting.

 

What is the quorum requirement?

 

In order to hold the Annual Meeting, the holders of a majority of the outstanding shares of common stock must be present at the meeting either in person or by proxy.

 

What shares are included on the enclosed proxy card?

 

The number of shares printed on the enclosed proxy card indicates the number of shares of common stock that, as of the record date, you held of record, plus (i) any shares held for your account under the Pepco Holdings Dividend Reinvestment Plan and (ii) if you are a participant in the Pepco Holdings, Inc. Retirement Savings Plan, the shares held for your account under that plan.

 

How is stock in the Pepco Holdings Dividend Reinvestment Plan voted?

 

Shares held by the Pepco Holdings Dividend Reinvestment Plan will be voted by the plan administrator in accordance with your instructions on the proxy card or given via the Internet or by telephone. Any shares held in the Dividend Reinvestment Plan for which no voting instructions are given will not be voted.

 

How is stock in the Retirement Savings Plan voted?

 

If you are a current or former employee who is a participant in the Pepco Holdings, Inc. Retirement Savings Plan the number of shares printed on the enclosed proxy card includes shares of common stock held through that

 

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plan. By completing, dating, signing and returning the proxy card or granting a proxy via the Internet or by telephone, you will be providing the plan trustee with instructions on how to vote the shares held in your account. If you do not provide voting instructions for your plan shares, the plan trustee will vote your shares on each matter in proportion to the voting instructions given by all of the other participants in the plan. The Retirement Savings Plan is the successor plan to the (i) Potomac Electric Power Company Savings Plan for Bargaining Unit Employees, (ii) Potomac Electric Power Company Retirement Savings Plan for Management Employees (which itself is the successor to the Potomac Electric Power Company Savings Plan for Non-Exempt, Non-Bargaining Unit Employees; the Potomac Electric Power Company Retirement Savings Plan for Management Employees was formerly known as the Potomac Electric Power Company Savings Plan for Exempt Employees), (iii) Conectiv Savings and Investment Plan and the Conectiv PAYSOP/ESOP and (iv) Atlantic Electric 401(k) Savings and Investment Plan-B.

 

What does it mean if I receive more than one proxy card?

 

If you receive more than one proxy card, it is because your shares are registered in different names or with different addresses. You must sign, date and return each proxy card that you receive (or grant a proxy for the shares represented by each proxy card via the Internet or by telephone) in order for all of your shares to be voted at the Annual Meeting. To enable us to provide better shareholder service, we encourage shareholders to have all the shares they hold of record registered in the same name with the same address.

 

How can I change my vote after I have returned my proxy card or granted a proxy via the Internet or by telephone?

 

If you own your shares in your own name or through the Dividend Reinvestment Plan or Retirement Savings Plan, you may revoke your proxy, regardless of the manner in which it was submitted, by:

 

   

sending a written statement to that effect to the Secretary of the Company before your proxy is voted;

 

   

submitting a properly signed proxy card dated a later date;

 

   

submitting a later dated proxy via the Internet or by telephone; or

 

   

voting in person at the Annual Meeting.

 

If you hold shares through a brokerage firm, bank or other financial intermediary, you should contact that intermediary for instructions on how to change your vote.

 

How can I obtain more information about the Company?

 

The Company’s 2007 Annual Report to Shareholders is included as Annex B after page A-3 of this Proxy Statement. You may also visit the Company’s Web site at www.pepcoholdings.com.

 

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1. ELECTION OF DIRECTORS

 

Twelve directors currently constitute the entire Board of Directors of the Company. The Board of Directors, on the recommendation of the Corporate Governance/Nominating Committee, has nominated each of the current members of the Board of Directors for re-election at the 2008 Annual Meeting, each to hold office for a one-year term that expires at the 2009 Annual Meeting, and until his or her successor is elected and qualified.

 

The Board of Directors unanimously recommends a vote FOR each nominee listed on pages 5-7.

 

What vote is required to elect the directors?

 

Each director shall be elected by a majority of the votes cast “for” his or her election.

 

The Company’s Bylaws provide that each director shall be elected by a majority of the votes cast “for” his or her election, except that in a contested election where the number of nominees exceeds the number of directors to be elected, directors shall be elected by a plurality of the votes cast. Accordingly, at the 2008 Annual Meeting, a nominee will be elected as a director only if a majority of the votes cast with respect to the election of a director are cast “for” his or her election. In accordance with the Company’s Bylaws any incumbent nominee who fails to receive a majority of votes cast “for” his or her election is required to resign from the Board no later than 90 days after the date of the certification of the election results.

 

What happens if a nominee is unable to serve as a director?

 

Each nominee identified in this Proxy Statement has confirmed that he or she is willing and able to serve as a director. However, should any of the nominees, prior to the Annual Meeting, become unavailable to serve as a director for any reason, the Board of Directors either may reduce the number of directors to be elected or, on the recommendation of the Corporate Governance/Nominating Committee, select another nominee. If another nominee is selected, all proxies will be voted for that nominee.

 

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NOMINEES FOR ELECTION AS DIRECTORS

 

For Terms Expiring in 2009

 

LOGO

   Jack B. Dunn, IV, age 57, since October 1995 has been Chief Executive Officer and since October 2004 has been President of FTI Consulting, Inc., a publicly held multi-disciplined consulting firm with practices in the areas of corporate finance/restructuring, forensic and litigation consulting, economic consulting, technology and strategic and financial communications, located in Baltimore, Maryland. He has served as a Director of FTI since 1992 and served as Chairman of the Board from December 1998 to October 2004. Mr. Dunn is a limited partner of the Baltimore Orioles and is a director of NexCen Brands, Inc. He has been a director of the Company since May 21, 2004.
LOGO    Terence C. Golden, age 63, since 2000 has been Chairman of Bailey Capital Corporation in Washington, D.C. Bailey Capital Corporation is a private investment company. From 1995 until 2000, Mr. Golden was President, Chief Executive Officer and a director of Host Marriott Corporation. He serves as a director of Host Hotels and Resorts, Inc. and the Morris & Gwendolyn Cafritz Foundation. Mr. Golden also currently serves as Chairman of the Federal City Council. He has been a director of the Company since August 1, 2002, and was a director of Potomac Electric Power Company (“Pepco”) from 1998 until it merged with Conectiv on August 1, 2002.
LOGO    Frank O. Heintz, age 64, is retired President and Chief Executive Officer of Baltimore Gas and Electric Company, the gas and electric utility serving central Maryland, a position he held from 2000 through 2004. From 1982 to 1995, Mr. Heintz was Chairman of the Maryland Public Service Commission, the state agency regulating gas, electric, telephone and certain water and sewerage utilities. Previously he served as agency head of the Maryland Employment Security Administration and was an elected member of the Maryland legislature. He has been a director of the Company since May 19, 2006.
LOGO    Barbara J. Krumsiek, age 55, since 1997 has been President and Chief Executive Officer and since 2006 Chair of Calvert Group, Ltd. Calvert is based in Bethesda, Maryland, and offers a range of fixed income, money market and equity mutual funds including a full family of socially responsible mutual funds. She serves as a trustee or director for 40 Calvert-sponsored mutual funds, including serving as Chair of the Calvert Variable Series of funds. She has been a director of the Company since May 18, 2007.

 

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LOGO    George F. MacCormack, age 64, is retired Group Vice President, DuPont, Wilmington, Delaware, a position he held from 1999 through 2003. He was previously Vice President and General Manager (1998), White Pigments & Mineral Products Strategic Business Unit and Vice President and General Manager (1995), Specialty Chemicals Strategic Business Unit for DuPont. He has been a director of the Company since August 1, 2002, and was a director of Conectiv from 2000 until it merged with Pepco on August 1, 2002.

LOGO

   Richard B. McGlynn, age 69, is an attorney. From 1995-2000, he was Vice President and General Counsel of United Water Resources, Inc., Harrington Park, New Jersey and from 1992-1995, he was a partner in the law firm LeBoeuf, Lamb, Greene & MacRae. He was a director of Atlantic Energy, Inc. from 1986 to 1998. He has been a director of the Company since August 1, 2002, and was a director of Conectiv from 1998 until it merged with Pepco on August 1, 2002.
LOGO    Lawrence C. Nussdorf, age 61, since 1998 has been President and Chief Operating Officer of Clark Enterprises, Inc., a privately held investment and real estate company based in Bethesda, Maryland, whose interests include the Clark Construction Group, LLC, a general contracting company, of which Mr. Nussdorf has been Vice President and Treasurer since 1977. He serves as a director of CapitalSource Inc. He has been a director of the Company since August 1, 2002, and was a director of Pepco from 2001 until it merged with Conectiv on August 1, 2002. He currently serves as Lead Independent Director.
LOGO    Frank K. Ross, age 64, is retired managing partner for the mid-Atlantic Audit and Risk Advisory Services Practice and managing partner of the Washington, D.C. office of the accounting firm KPMG LLP, positions he held from July 1, 1996 to December 31, 2003. He is currently a Visiting Professor of Accounting at Howard University, Washington, D.C. and the Director of its Center for Accounting Education. He is a director of Cohen & Steers Mutual Funds and serves as a director of 22 of these Funds. Mr. Ross serves on The Greater Washington, D.C. Urban League, Howard University Math and Science Middle School and The Hoop Dreams Scholarship Fund boards. He has been a director of the Company since May 21, 2004.

 

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LOGO    Pauline A. Schneider, age 64, joined the Washington office of the law firm of Orrick, Herrington & Sutcliffe LLP in September 2006. From 1985 to September 2006, she was with the law firm of Hunton & Williams. From October 2000 to October 2002, Ms. Schneider served as Chair of the Board of MedStar Health, Inc., a community-based healthcare organization that includes seven major hospitals in the Washington, D.C./Baltimore area. From 1998 to 2002, she chaired the Board of The Access Group, Inc., a not-for-profit student loan provider headquartered in Wilmington, Delaware. She continues her service on the Access Group board. She is a director of Diamond Management and Technology Consultants. She has been a director of the Company since August 1, 2002, and was a director of Pepco from 2001 until it merged with Conectiv on August 1, 2002.
LOGO    Lester P. Silverman, age 61, is Director Emeritus of McKinsey & Company, Inc., having retired from the international management consulting firm in 2005. Mr. Silverman joined McKinsey in 1982 and was head of the firm’s Electric Power and Natural Gas practice from 1991 to 1999. From 2000 to 2004, Mr. Silverman was the leader of McKinsey’s Global Nonprofit Practice. Previous positions included Principal Deputy Assistant Secretary for Policy and Evaluation in the U.S. Department of Energy from 1980 to 1981 and Director of Policy Analysis in the U.S. Department of the Interior from 1978 to 1980. Mr. Silverman is currently an Adjunct Lecturer at Georgetown University, Washington, D.C., and a trustee of several national and Washington, D.C.-area nonprofit organizations. He has been a director of the Company since May 19, 2006.
LOGO    William T. Torgerson, age 63, has been Vice Chairman of the Company since June 1, 2003 and has been Chief Legal Officer of the Company since March 15, 2008. From August 1, 2002 to March 14, 2008, he was General Counsel of the Company. From August 1, 2002 to June 2003, he was also Executive Vice President of the Company. He has been a director of the Company since May 21, 2004.
LOGO    Dennis R. Wraase, age 64, is Chairman and Chief Executive Officer of the Company. Since May 2004 he has been Chairman of Pepco, Atlantic City Electric Company and Delmarva Power & Light Company. He was Chief Executive Officer from August 2002 through October 2005. Mr. Wraase was President of the Company from August 2002 to March 14, 2008. From August 2002 through May 2003, Mr. Wraase was Chief Operating Officer of the Company. Mr. Wraase became CEO of the Company in June 2003. He has been a director of the Company since 2001, and has been Chairman since May 2004.

 

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Which directors are “independent”?

 

The listing standards of the New York Stock Exchange (“NYSE”) require that a majority of the Company’s directors be “independent” as defined by the NYSE listing standards. Applying these standards, the Board has determined that ten of the Company’s current 12 directors, consisting of Messrs. Dunn, Golden, Heintz, MacCormack, McGlynn, Nussdorf, Ross and Silverman and Mmes. Krumsiek and Schneider, qualify as independent. Accordingly, if each nominee is elected at the Annual Meeting, ten of the Company’s 12 directors will qualify as independent.

 

For a director to be considered independent under the NYSE listing standards, a director cannot have any of the disqualifying relationships enumerated by the NYSE listing standards and the Board must determine that the director does not otherwise have any direct or indirect material relationship with the Company. In accordance with the NYSE listing standards, the Board of Directors has adopted, as part of the Company’s Corporate Governance Guidelines, categorical standards to assist it in determining whether a relationship between a director and the Company is a relationship that would impair the director’s independence. The Company’s Corporate Governance Guidelines can be found on the Company’s Web site (www.pepcoholdings.com) under the link: Corporate Governance. Under these standards, which incorporate the disqualifying relationships enumerated by the NYSE listing standards, a Company director is not “independent” if any of the conditions specified are met.

 

  a. The director is, or has been within the last three years, an employee of the Company, or an immediate family member is, or has been within the last three years, an executive officer of the Company. The executive officers of the Company consist of the president, principal financial officer, controller, any vice-president in charge of a principal business unit, division or function, any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the Company. Officers of the Company’s subsidiaries are deemed to be officers of the Company if they perform such policy-making functions for the Company.

 

  b. The director has received, or has an immediate family member who has received, during any twelve-month period within the last three years, more than $100,000 in direct compensation from the Company, other than director and committee fees and pension or other forms of deferred compensation for prior service (provided such compensation is not contingent in any way on continued service).

 

  c. (A) The director or an immediate family member is a current partner of a firm that is the Company’s internal or external auditor; (B) the director is a current employee of such a firm; (C) the director has an immediate family member who is a current employee of such a firm and who participates in the firm’s audit, assurance or tax compliance (but not tax planning) practice; or (D) the director or an immediate family member was within the last three years (but is no longer) a partner or employee of such a firm and personally worked on the Company’s audit within that time.

 

  d. The director or an immediate family member is, or has been within the last three years, employed as an executive officer of another company where any of the Company’s present executive officers at the same time serves or served on that company’s compensation committee.

 

  e. The director is a current employee, or an immediate family member is a current executive officer, of a company that has made payments to, or received payments from, the Company for property or services in an amount which, in any of the last three fiscal years, exceeds the greater of $1 million or 2% of such other company’s consolidated gross revenues. Contributions to tax exempt organizations shall not be considered “payments” for purposes of this categorical standard, provided, however, that the Company shall disclose in its annual proxy statement any such contributions made by the Company to any tax exempt organization in which any independent director serves as an executive officer if, within the preceding three years, contributions in any single fiscal year from the Company to the tax exempt organization exceed the greater of $1 million, or 2% of such tax exempt organization’s consolidated gross revenues.

 

  f.

For purposes of considering the existence or materiality of a director’s relationship with the Company or the relationship with the Company of an organization with which the director is associated,

 

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payments for electricity, gas or other products or services made in the normal course of business at prices generally applicable to similarly situated customers shall not be included.

 

  g. Additional provisions applicable to members of the Audit Committee.

 

  i. A director who is a member of the Audit Committee may not accept directly or indirectly any consulting, advisory, or other compensatory fee from the Company or any subsidiary of the Company, provided that, unless the rules of the NYSE provide otherwise, compensatory fees do not include the receipt of fixed amounts of compensation under a retirement plan (including deferred compensation) for prior service (provided that such compensation is not contingent in any way on continued service). The term “indirect acceptance” by a member of the Audit Committee of any consulting, advisory, or other compensatory fee includes acceptance of such fee by a spouse, a minor child or stepchild or a child or stepchild sharing a home with the member or by an entity in which such member is a partner, member, an officer such as a managing director occupying a comparable position or executive officer, or occupies a similar position (except limited partners, non-managing members and those occupying similar positions who, in each case, have no active role in providing services to the entity) and which provides accounting, consulting, legal, investment banking or financial advisory services to the Company or any subsidiary of the Company.

 

  ii. A director who is an “affiliated person” of the Company or its subsidiaries (other than in his or her capacity as a member of the Board or a Board Committee) as defined by the Securities and Exchange Commission (“SEC”) shall not be considered independent for purposes of Audit Committee membership. A director who beneficially owns more than 3% of the Company’s common stock will be considered to be an “affiliated person.”

 

In making independence determinations, the Board considered the following relationships in accordance with its procedures for evaluating related person transactions described under the heading “Board Review of Transactions with Related Parties.”

 

In October 2006, Ms. Schneider became a partner in the law firm of Orrick, Herrington & Sutcliffe LLP. Orrick, Herrington & Sutcliffe rendered legal services to certain Company subsidiaries in 2007 and is expected to render services to certain Company subsidiaries in 2008 with respect to certain contract matters. Ms. Schneider has informed the Board that she did not work on any of these matters, nor did she direct Orrick, Herrington & Sutcliffe’s work on any of these matters and Orrick’s representation had no affect on her compensation. Until October 2006, Ms. Schneider was a partner in the law firm of Hunton & Williams. Hunton & Williams rendered legal services to the Company and certain Company subsidiaries in 2006 in the areas of environmental, regulatory, tax and administrative law. Ms. Schneider has informed the Board that she did not work on any of these matters, nor did she direct Hunton & Williams’ work on any of these matters and Hunton & Williams’ representation had no affect on her compensation.

 

In determining that Ms. Schneider is an independent director, the Board examined the specific transactions that the Company and its subsidiaries had with Orrick, Herrington & Sutcliffe LLP and Hunton & Williams and concluded that (1) the relationship between each law firm and the Company and its subsidiaries was solely a business relationship which did not afford Ms. Schneider any special benefits and (2) the amounts paid to each law firm in each of the last three years were below the numerical threshold set forth in the Corporate Governance Guidelines with respect to payments for property and services between the Company or its subsidiaries and an entity with which the director is affiliated. For these reasons, the Board determined that these business relationships did not disqualify Ms. Schneider as an independent director.

 

Mr. Dunn is President and Chief Executive Officer of FTI Consulting, Inc. (“FTI”). In February 2008, a Company subsidiary, Pepco Energy Services, Inc. (“Pepco Energy Services”), entered into a contract to supply electricity to FTI for one year commencing in March 2008. The Board determined that (1) the relationship between Pepco Energy Services and FTI was solely a business relationship which did not afford Mr. Dunn any

 

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special benefits; (2) the amount to be paid to Pepco Energy Services under the contract is below the numerical threshold set forth in the Corporate Governance Guidelines with respect to payments for property and services between the Company or its subsidiaries and an entity with which the director is affiliated; and (3) the amount to be paid to Pepco Energy Services under the contract constitutes payment for electricity made in the normal course of business at prices generally applicable to similarly situated customers. For these reasons, the Board determined that this business relationship did not disqualify Mr. Dunn as an independent director.

 

BOARD MEETINGS

 

The Board held nine meetings during 2007 to review significant developments affecting the Company, engage in strategic planning, and act on matters requiring Board approval. In 2007, each director attended at least 75% of the Board meetings and the meetings of the Board Committees on which he or she served. The Board has adopted an attendance policy, set forth in the Corporate Governance Guidelines, under which attendance in person is required at all regularly scheduled shareholder, Board and Committee meetings (except where scheduled as a conference call) and is the preferred method of attendance at specially called meetings. The Chairman has the authority to waive this requirement and allow participation by telephone if, in the Chairman’s opinion, it is in the Company’s best interests to do so. Of the Company’s 12 directors at the time, all attended the 2007 Annual Meeting.

 

At each Board meeting, time is set aside for the directors to meet in executive session without any management director or other management personnel present. The executive session of the Board is convened by the Lead Independent Director.

 

BOARD COMMITTEES

 

The Board has five separately designated standing Committees:

 

   

the Audit Committee;

 

   

the Compensation/Human Resources Committee;

 

   

the Corporate Governance/Nominating Committee;

 

   

the Executive Committee; and

 

   

the Finance Committee.

 

Each Committee’s charter can be found on the Company’s Web site (www.pepcoholdings.com) under the link: Corporate Governance.

 

Each of the Committees (other than the Executive Committee) sets aside time to meet in executive session without management personnel present. The Compensation/Human Resources Committee regularly meets separately with its compensation consultant. The Audit Committee regularly meets separately with the Vice President, Internal Audit and the independent registered public accounting firm.

 

The Audit Committee held eight meetings in 2007. The Committee represents and assists the Board in discharging its responsibility of oversight with respect to the accounting and control functions and financial statement presentation (but the existence of the Committee does not alter the traditional roles and responsibilities of the Company’s management and its independent registered public accounting firm). The Audit Committee is responsible for, among other things, representing and assisting the Board in oversight of (i) the integrity of the Company’s financial statements, accounting and financial reporting processes and audits of the Company’s consolidated financial statements, (ii) the Company’s compliance with legal and regulatory requirements, (iii) the qualifications, independence and the retention, compensation and performance of the Company’s independent

 

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registered public accounting firm, and (iv) the design and performance of the Company’s internal audit function. The Audit Committee also reviews the Company’s guidelines and policies with respect to risk assessment, and has full power and authority to obtain advice and assistance from independent legal, accounting or other advisors as it may deem appropriate to carry out its duties.

 

Committee members are Directors Golden, Krumsiek, McGlynn, Nussdorf and Ross (Chairman). The Board has determined that directors Golden, Krumsiek, Nussdorf and Ross each is an “audit committee financial expert” as defined by the rules of the SEC. The Board has determined that each member of the Audit Committee is independent as defined by the Company’s Corporate Governance Guidelines and the listing standards of the NYSE.

 

The Compensation/Human Resources Committee held six meetings in 2007. The Committee evaluates annually the performance of the Company’s Chief Executive Officer and, together with the other independent members of the Board of Directors, sets the CEO’s compensation level after taking into account the annual evaluation and such other factors as the Committee deems appropriate. The Committee reviews the performance of elected officers and other executives in the context of the administration of the Company’s executive compensation programs. The Committee, on the recommendation of the CEO, (i) approves the salaries for the executive officers, the heads of the business units, and all PHI Vice Presidents and any salary that exceeds the approval level of the CEO, (ii) establishes performance guidelines under the annual Executive Incentive Compensation Plan, and (iii) exercises the powers of the Board with respect to the Company’s annual salary increase for all management employees. The Committee sets target award levels and approves payments for the executive officers and the heads of the business units pursuant to the Executive Incentive Compensation Plan, establishes the structure of compensation and amounts of awards under the shareholder-approved Long-Term Incentive Plan, and reviews other elements of compensation and benefits for management employees and makes recommendations to the Board as appropriate. The Committee makes recommendations to the Board concerning the Company’s retirement and other benefit plans and oversees corporate workforce diversity issues, and also receives input on compensation matters from the Chief Executive Officer and management, as it deems appropriate.

 

In order to assist it in carrying out these responsibilities, the Committee in 2007 employed Pearl Meyer & Partners (“PM&P”) as its independent compensation consultant. Pursuant to this engagement, PM&P provided the following services: reviewed the compensation philosophy; advised on construction of and determination of a peer group of 23 utility companies (collectively, the “2007 Peer Group”); reviewed new salary ranges; reviewed the Executive Incentive Compensation Plan; reviewed the Long-Term Incentive Plan; reviewed proposed compensation plans or amendments to other existing plans; reviewed the total executive compensation structure for the coming year; attended the Compensation/Human Resources Committee meetings dealing with executive compensation, as requested; presented comparative information to assist the Compensation/Human Resources Committee in its deliberations and decision-making concerning executive compensation; advised senior management, as requested by the Compensation/Human Resources Committee; and provided various industry performance and other comparative information.

 

Committee members are Directors Dunn (Chairman), Heintz, McGlynn, Nussdorf and Ross. The Board has determined that each member of the Compensation/Human Resources Committee is independent as defined by the Company’s Corporate Governance Guidelines and the listing standards of the NYSE.

 

The Corporate Governance/Nominating Committee held seven meetings in 2007. The Committee’s duties and responsibilities include making recommendations to the Board regarding the governance of the Company and the Board, and helping ensure that the Company is properly managed to protect and enhance shareholder value and to meet the Company’s obligations to shareholders, customers, the industry and under the law. The Committee reviews and recommends to the Board candidates for nomination for election as directors, makes recommendations to the Board regarding Board structure, practices and policies, including Board committee chairmanships and assignments and the compensation of Board members, evaluates Board performance and effectiveness, and oversees the development of corporate strategy and structure, including management

 

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development, management succession, management performance criteria, business plans and corporate and government affairs. The Committee also oversees the technology and systems used by the Company with the goal of ensuring that they are adequate to properly run the business and for the Company to remain competitive.

 

Committee members are Directors Dunn, MacCormack, McGlynn (Chairman), Schneider and Silverman. The Board has determined that each member of the Corporate Governance/Nominating Committee is independent as defined by the Company’s Corporate Governance Guidelines and the listing standards of the NYSE.

 

The Executive Committee held one meeting in 2007. The Committee has, and may exercise when the Board is not in session, all the powers of the Board in the management of the property, business and affairs of the Company, except as otherwise provided by law. The Committee does not hold regularly scheduled meetings. Committee members are Directors MacCormack, Nussdorf (Chairman), Schneider, Torgerson and Wraase.

 

The Finance Committee held eight meetings in 2007. The Committee oversees the financial objectives, policies, procedures and activities of the Company and considers the long- and short-term strategic plans of the Company. The Committee reviews with management the Company’s risk mitigation profile and reviews the Company’s insurance program. Committee members are Directors Golden (Chairman), Heintz, MacCormack, Schneider and Silverman.

 

How do I send a communication to the Board of Directors or to a specific individual director?

 

The Company’s directors encourage interested parties, including employees and shareholders, to contact them directly and, if desired, confidentially or anonymously regarding matters of concern or interest, including concerns regarding questionable accounting or auditing matters. The names of the Company’s directors can be found on pages 5-7 of this Proxy Statement and on the Company’s Web site (www.pepcoholdings.com) under the link: Corporate Governance. The Company’s directors may be contacted by writing to them either individually or as a group or partial group (such as all non-management directors), c/o Corporate Secretary, Pepco Holdings, Inc., 701 Ninth Street, N.W., Room 1300, Washington, D.C. 20068. If you wish your communication to be treated confidentially, please write the word “CONFIDENTIAL” prominently on the envelope and address it to the director by name so that it can be forwarded without being opened. A communication addressed to multiple recipients (such as to “directors,” “all directors,” “all non-management directors,” “independent directors”) will necessarily have to be opened and copied by the Office of the Corporate Secretary in order to forward it to each director, and hence cannot be transmitted unopened, but will be treated as a confidential communication. If you wish to remain anonymous, do not sign your letter or include a return address on the envelope. Communications from Company employees regarding accounting, internal accounting controls, or auditing matters may be submitted in writing addressed to: Vice President, Internal Audit, Pepco Holdings, Inc., 701 Ninth Street, N.W., Room 8220, Washington, D.C. 20068 or by telephone to 202-872-3524. Such communications will be handled initially by the Internal Audit Group, which reports to the Audit Committee, and will be reported by the Internal Audit Group to the Audit Committee. If for any reason the employee does not wish to submit a communication to the Vice President, Internal Audit, it may be addressed to the Chairman of the Audit Committee using the procedure set forth above, or can be sent via mail, telephone, facsimile or e-mail to the Company’s Ethics Officer. Employees may also leave messages on the Company’s Ethics Officer’s hotline.

 

What are the directors paid for their services?

 

Each of the Company’s non-management directors is paid an annual retainer of $85,000, plus a fee of $2,000 for each Board or Committee meeting attended. The Chairman of the Audit Committee receives an additional annual retainer of $7,500 and a non-management director who chairs any one of the other standing Committees of the Board receives an additional annual retainer of $5,000. A director who serves as Lead Independent Director receives an annual retainer of $15,000 for service in that capacity.

 

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Each non-management director is required to own at least 7,500 shares of Company common stock or common stock equivalents (“phantom stock”). Each current non-management director who has been a director for three years has met this requirement. Newly elected or appointed non-management directors are required to reach this ownership level within three years after the date of their election or appointment.

 

Under the Non-Management Director Compensation Plan, each non-management director is entitled to elect to receive his or her annual retainer, retainer for service as a Committee chairman, if any, retainer for services as the Lead Independent Director, if any, and meeting fees exclusively in or as a combination of: (i) cash, (ii) shares of Company common stock, or (iii) a credit to an account for the director established under the PHI Executive and Director Deferred Compensation Plan as described below under the heading “Deferred Compensation Plans — PHI Executive and Director Deferred Compensation Plan.”

 

The following table sets forth, as of March 17, 2008, for each non-management director who has elected to receive all or a portion of his or her annual retainer and meeting fees in phantom stock under the PHI Executive and Director Deferred Compensation Plan, the number of credited phantom stock units (each corresponding to one share of common stock).

 

Name of Director

   Pepco Holdings
Phantom Stock Units

Terence C. Golden

   19,419

Barbara J. Krumsiek (first elected May 18, 2007)

   2,981

George F. MacCormack

   4,584

Richard B. McGlynn

   2,305

Lawrence C. Nussdorf

   3,304

Pauline A. Schneider

   815

Lester P. Silverman

   6,639

 

Although under the terms of the Company’s Long-Term Incentive Plan, each non-management director is entitled to a grant, on May 1 of each year, of an option to purchase 1,000 shares of common stock, the Board of Directors beginning in 2003 discontinued these grants.

 

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The following table sets forth the compensation paid by the Company to its non-management directors for the year ended December 31, 2007.

 

2007 DIRECTOR COMPENSATION

 

Name

  Fees
Earned or
Paid in
Cash (1)
  Stock
Awards
  Option
Awards (2)
  Non-Equity
Incentive Plan
Compensation
  Changes in
Pension Value
and
Nonqualified
Deferred
Compensation
Earnings (3)
  All Other
Compensation
  Total

Jack B. Dunn, IV

  $ 94,104   $ 0   $ 0   $ 0   $ 0   $ 0   $ 94,104

Terence C. Golden

    106,000     0     0     0     0     0     106,000

Frank O. Heintz

    97,000     0     0     0     0     0     97,000

Barbara J. Krumsiek (first elected May 18, 2007)

    51,940     0     0     0     0     0     51,940

George F. MacCormack

    99,500     0     0     0     0     0     99,500

Richard B. McGlynn

    112,000     0     0     0     0     0     112,000

Lawrence C. Nussdorf

    109,750     0     0     0     0     0     109,750

Frank K. Ross

    99,657     0     0     0     0     0     99,657

Pauline A. Schneider

    99,000     0     0     0     0     0     99,000

Lester P. Silverman

    93,000     0     0     0     0     0     93,000

Edmund B. Cronin, Jr. (retired May 18, 2007)

    31,184     0     0     0     0     0     31,184

Peter F. O’Malley (retired May 18, 2007)

    37,093     0     0     0     69,954     0     107,047

 

(1) Consists of retainer and meeting fees, which the director may elect to receive in cash or Company common stock or to defer under the terms of the PHI Executive and Director Deferred Compensation Plan. The following directors have elected to receive all or a portion of their 2007 retainer and meeting fees in the form of either (i) shares of the Company’s common stock or (ii) as a credit to the director’s account under the PHI Executive and Director Deferred Compensation Plan. As described below under the heading “Deferred Compensation Plans — PHI Executive and Director Deferred Compensation Plan,” a director participating in the plan can elect to have his or her account credited with any or a combination of: (i) the interest at the prime rate that would have been paid on an amount equal to the participant’s account balance or (ii) an amount equal to the return that the participant would have earned had his or her account balance been invested in any one or a combination of the investment funds selected by the Compensation/Human Resources Committee or had the account balance been deemed invested in the Company’s common stock.

 

        Amount of Deferred Compensation Plan Credit

Name

  Shares of
Common Stock
  Phantom
Stock Credit
  Other Investment
Credits

Jack B. Dunn, IV

  0   $ 0   $ 94,104

Barbara J. Krumsiek (first elected May 18, 2007)

  0     51,940     0

George F. MacCormack

  0     0     49,750

Frank K. Ross

  897     0     0

Pauline A. Schneider

  0     0     45,000

Lester P. Silverman

  0     93,000     0

Edmund B. Cronin, Jr. (retired May 18, 2007)

  0     31,184     0

 

(2) At December 31, 2007, the following directors held options to purchase the indicated number of shares of Company common stock: Mr. Cronin — 5,000 shares; Mr. Golden — 4,000 shares; and Mr. Nussdorf — 2,000 shares.

 

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(3) Represents “above-market” earnings (as defined by SEC regulations) on director compensation deferred under the Pepco Director and Executive Deferred Compensation Plan. For a description of the terms of this plan, see “Deferred Compensation Plans — Pepco Director and Executive Deferred Compensation Plan” below.

 

The Company provides directors with travel accident insurance for Company-related travel and directors’ and officers’ liability insurance coverage and reimburses directors for travel, hotel and other out-of-pocket expenses incurred in connection with the performance of their duties as directors.

 

The Company also provides the directors with free parking in the Company’s headquarters building, which is also available for use by the directors other than in connection with the performance of their duties as directors. In addition, in 2007, Company-leased entertainment venues and Company-purchased tickets to sporting and cultural events were made available to one or more directors for personal use when not being used by the Company for business purposes. There was no incremental cost to the Company for providing these benefits.

 

The compensation of the non-management members of the Board of Directors is reviewed periodically by the Corporate Governance/Nominating Committee which makes recommendations for changes, if any, to the Board for its approval. In July 2007, the Company, at the direction of the Corporate Governance/Nominating Committee, retained Towers Perrin to (i) advise the Committee on current trends in director compensation, including stock ownership guidelines, (ii) determine if the Company’s compensation program is competitive, and (iii) evaluate the structure of the compensation program and the relative mix of compensation elements.

 

In October 2007, the Corporate Governance/Nominating Committee reviewed the Towers Perrin report which outlined trends in board of directors’ compensation and included a review of director compensation arrangements of the 2007 Peer Group of 23 utility companies used by the Compensation/Human Resources Committee for executive compensation comparisons and overall pay trends in Fortune 500 companies. The report concluded that the Company’s compensation for non-management directors fell at the fifth percentile of the 2007 Peer Group of companies used for the executive compensation program and recommended that the Company consider confirming the current pay mix and increasing remuneration if the Company desired to be within the competitive range of the Company’s peers. Following a review of the report, the Board of Directors, on the recommendation of the Corporate Governance/Nominating Committee, adopted, effective January 1, 2008, the director compensation arrangements described above.

 

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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

The following table sets forth, as of March 17, 2008, for each director (each of whom is a nominee for election as a director at the 2008 Annual Meeting), each executive officer named in the Summary Compensation Table below and all directors and executive officers as a group (i) the number of shares of common stock beneficially owned, (ii) the number of shares of common stock that could be purchased through the exercise of stock options then-currently exercisable or scheduled to become exercisable within 60 days thereafter, and (iii) the total number of shares of common stock beneficially owned. Each of the individuals listed, and all directors and executive officers as a group, beneficially owned less than 1% of the outstanding shares of common stock.

 

Name of Beneficial Owner

   Shares of
Common Stock
Owned (4)
   Shares of
Common Stock
Acquirable Within
60 Days
   Total
Beneficial
Ownership (5)

Paul H. Barry

   10,660    0    10,660

Jack B. Dunn, IV

   10,495    0    10,495

Terence C. Golden (6)

   44,132    4,000    48,132

Frank O. Heintz (7)

   5,912    0    5,912

Anthony J. Kamerick

   41,931    5,100    47,031

Barbara J. Krumsiek

   1,000    0    1,000

George F. MacCormack

   11,282    0    11,282

Richard B. McGlynn

   5,770    0    5,770

Lawrence C. Nussdorf

   5,000    2,000    7,000

Joseph M. Rigby

   58,776    0    58,776

Frank K. Ross

   7,757    0    7,757

Pauline A. Schneider

   6,915    0    6,915

Thomas S. Shaw

   1,700    0    1,700

Lester P. Silverman

   1,000    0    1,000

William T. Torgerson

   82,958    51,843    134,801

Dennis R. Wraase

   237,237    69,843    307,080

All Directors and Executive Officers as a Group
(21 Individuals)

   629,942    137,886    767,828

 

(4) Includes shares held under the Company’s Dividend Reinvestment Plan and Retirement Savings Plan. Also includes shares awarded under the Company’s Long-Term Incentive Plan that vest over time if the executive officer has the right to vote the shares. Unless otherwise noted, each beneficial holder has sole voting power and sole dispositive power with respect to the shares shown as beneficially owned.

 

(5) Consists of the sum of the two adjacent columns.

 

(6) Includes 11,600 shares owned by Mr. Golden’s spouse. Mr. Golden disclaims beneficial ownership of these shares.

 

(7) Shares are owned in the Frank O. Heintz Trust of which Mr. Heintz is Trustee.

 

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The following table also sets forth, as of March 17, 2008, the number and percentage of shares of common stock reported as beneficially owned by all persons known by the Company to own beneficially 5% or more of the common stock.

 

Name and Address of Beneficial Owner

   Shares of
Common Stock
Owned
    Percent of
Common Stock
Outstanding
 

Barclays Global Investors, NA

45 Fremont Street, 17th Floor

San Francisco, CA 94105

   11,174,126 (8)   5.77 %

UBS AG

Bahnhofstrasse 45

P.O. Box CH-8021

Zurich, Switzerland

   13,272,909 (9)   6.60 %

 

(8) This disclosure is based on information furnished in Schedule 13G, filed with the SEC on February 5, 2008, jointly by Barclays Global Investors, NA, Barclays Global Fund Advisors, Barclays Global Investors, Ltd., Barclays Global Investors Japan Trust and Banking Company Limited, Barclays Global Investors Japan Limited, Barclays Global Investors Canada Limited, and Barclays Global Investors Australia Limited, in which Barclays Global Investors, NA reports that it is the beneficial owner with sole dispositive power of 8,052,453 shares of common stock, Barclays Global Fund Advisors reports that it is the beneficial owner with sole dispositive power of 1,746,498 shares of common stock, Barclays Global Investors, Ltd. reports that it is the beneficial owner with sole dispositive power of 974,162 shares of common stock, Barclays Global Investors Japan Limited reports that it is the beneficial owner with sole dispositive power of 288,835 shares of common stock, Barclays Global Investors Canada Limited reports that it is the beneficial owner with sole dispositive power of 112,178 shares of common stock, and Barclays Global Investors Japan Trust and Banking Company Limited and Barclays Global Investors Australia Limited each reports that it does not beneficially own any shares of common stock.

 

(9) This disclosure is based on information furnished in Schedule 13G/A filed with the SEC on February 11, 2008, by UBS AG (for the benefit and on behalf of the UBS Global Asset Management business group of UBS AG), in which UBS AG reports that it is the beneficial owner of 13,272,909 shares of common stock (consisting of 13,272,909 shares as to which it has shared dispositive power and 11,813,258 shares as to which it has sole voting power).

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) requires the Company’s directors and executive officers and any beneficial owner of more than 10% of the Company’s common stock to file with the SEC reports of holdings and transactions in the Company’s equity securities. Based on a review of such reports filed for 2007 and on written confirmations provided by its directors and executive officers, the Company believes that during 2007 all of its directors and executive officers filed on a timely basis the reports required by Section 16(a), except that Beverly L. Perry, Senior Vice President of the Company, filed one day late a report on Form 4 disclosing a sale of common stock.

 

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COMPENSATION/HUMAN RESOURCES COMMITTEE REPORT

 

Among its duties, the Compensation/Human Resources Committee is responsible for reviewing and discussing with the Company’s management the Compensation Discussion and Analysis (the “CD&A”) section of the Proxy Statement. Based on its review and discussion with management of the CD&A that follows this Report, the Committee has recommended to the Board of Directors that it be included in this Proxy Statement.

 

Jack B. Dunn, IV, Chairman

Frank O. Heintz

Richard B. McGlynn

Lawrence C. Nussdorf

Frank K. Ross

 

COMPENSATION DISCUSSION AND ANALYSIS

 

Introduction

 

The Compensation/Human Resources Committee (the “Committee”), the composition and responsibilities of which are described more fully above under the heading “Compensation/Human Resources Committee,” is responsible for all executive compensation decisions with respect to each of the named executive officers (the “NEOs”), except that the annual salary of the Chief Executive Officer is set by all of the independent directors. To assist it in carrying out its responsibilities, the Committee requests and receives recommendations from the Chief Executive Officer with respect to the compensation packages of the other NEOs, including the selection and weighting of the specific performance objectives applicable to short-term and long-term incentive awards.

 

When structuring compensation arrangements for the NEOs and other executives, the Committee typically receives advice from its independent compensation consultant with respect to pay mix and levels of compensation, as well as information with respect to the financial costs and tax and accounting consequences associated with the various elements of compensation. In 2007, the Committee engaged Pearl Meyer & Partners (“PM&P”) as its independent compensation consultant to advise the Committee on various executive compensation matters. Among other matters, PM&P during 2007 advised the Committee on compensation practices generally and on plan and award design matters. PM&P also provided the Committee with survey data and other comparative information to assist it in its executive compensation decisions, as described herein. The services provided by PM&P are described in greater detail under the heading “Compensation/Human Resources Committee.” While serving as the compensation consultant to the Committee, PM&P has not had any other relationships with the Company or any of its executives, nor does it provide services to the Company other than those related to executive and director compensation.

 

Prior to 2007, the Committee retained Buck Consultants as its compensation consultant. In 2005, Buck assisted the Committee in a comprehensive review of the Company’s executive compensation practices. The review covered base salary and total cash compensation levels, short-term and long-term incentive program design, employment and severance agreements, retirement benefit plans, deferred compensation plans, and perquisites.

 

 

Executive Summary

 

The following provides a brief overview of the more detailed disclosure set forth in this CD&A:

 

   

The objective of the Company’s compensation program is to attract, retain and motivate talented executives while promoting the interests of the Company and its shareholders.

 

   

The Company provides its executive officers with the following types of compensation: salary, cash-based short-term incentives, performance stock, restricted stock, retirement and deferred compensation programs.

 

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Salaries and any increases to salaries are determined with respect to the executive’s position level and the salary range within the level, all as determined with respect to competitive market survey data.

 

   

The Company generally targets compensation levels that are at approximately the 50th percentile of the competitive range for each pay element.

 

   

The Company has adopted a pay-for-performance environment by linking short-term and long-term incentive-based compensation to the achievement of measurable business and individual performance goals.

 

   

Short-term and long-term incentives support the Company’s “pay-for-performance” compensation philosophy; while long-term incentives also serve as a retention mechanism and as a means to focus executives on long-range strategic goals.

 

   

The Company uses equity-based compensation as a means to align the interests of its executives with those of the shareholders.

 

   

The Company also incorporates goals into its short-term incentive plan which balance the interests of the shareholders, customers and employees.

 

   

The Company offers its executive officers limited basic perquisites.

 

   

Three of the NEOs whose employment continued into 2008 are parties to employment agreements and the other two participate in a Change in Control Severance Plan.

 

   

The Company’s executives generally participate in the same group benefit programs available to all employees. In addition, the Company has both tax-qualified retirement plans and non-qualified supplemental excess retirement plans in which certain executives participate.

 

   

The Company maintains a non-qualified deferred compensation plan.

 

   

In 2007 short-term incentive compensation targets for Company/business unit performance were achieved and payouts were made.

 

   

The three-year total return to shareholders for the period ending December 31, 2007 increased 55.7% which also increased the value of the executives’ accumulated equity-based incentives during 2007.

 

   

The Company believes its executive compensation program achieves the program’s objective in an appropriate and reasonable manner, and the Company continues to conduct annual reviews to ensure this remains the case.

 

Compensation Philosophy

 

The objectives of the Company’s executive compensation program are to attract, motivate and retain talented executives and to promote the interests of the Company and its shareholders. To achieve these objectives, the Company’s executive compensation program is designed to:

 

   

provide executives with salaries, incentive compensation opportunities and other benefits that are competitive with comparable companies in the industry;

 

   

reward executives for both the achievement by the Company and its business segments of targeted levels of operational excellence and financial performance, as well as the achievement of individual performance goals; and

 

   

align the financial interests of the executives with those of the shareholders through equity-based incentive awards and stock ownership requirements.

 

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Compensation Levels and Benchmarking

 

Compensation levels for executives are determined based on a number of factors, including the individual’s roles and responsibilities within the Company, the individual’s experience, pay levels in the marketplace for similar positions and performance of the individual and the Company as a whole. The Committee is responsible for approving compensation levels for the executive officers with the exception of the CEO’s base salary, which is approved by the independent Board members.

 

The Committee assesses competitive market compensation practices using a number of sources. One of the primary ways the Committee evaluates the Company’s executive compensation arrangements relative to other companies is to compare the Company’s practices to a group of companies that are primarily electricity and natural gas distribution companies with a similar market capitalization. The composition of that group of peer companies is reassessed annually and its composition may be changed by the Committee year to year to reflect corporate transactions or other changes that may affect the comparability of one or more of the constituent companies. The 2007 peer group consisted of the following 23 companies: Allegheny Energy Inc., Alliant Energy Corp., Ameren Corp., Centerpoint Energy Inc., CMS Energy Corp., Consolidated Edison, DTE Energy Co., Energy East Corp., Hawaiian Electric Co., Keyspan Corp., NiSource Inc., Northeast Utilities, NSTAR, OGE Energy Corp., Pinnacle West Capital Corp., PPL Corp., Puget Energy Inc., SCANA Corp., Sempra Energy, Sierra Pacific Resources, Teco Energy Inc., Wisconsin Energy Corp. and Xcel Energy Corp. (the “2007 Peer Group”). In 2006 (the last year for which data is available), the Company ranked relative to the 2007 Peer Group at the 59th percentile in total assets and at the 56th percentile in market capitalization.

 

As part of its annual compensation review process, one of the tools the Committee uses in its evaluation is a tally sheet. The tally sheet for each NEO is prepared by the Company and identifies the material elements of the executive’s compensation, including salary, short-term and long-term incentive compensation opportunity, pension accruals and other benefits. These sheets also show the severance and other payouts to which the executive would be entitled under various employment termination scenarios.

 

Components of the Executive Compensation Program

 

The compensation program for the Company’s executives, including the NEOs, consists of the following components:

 

   

base salary;

 

   

annual cash incentive awards under the Executive Incentive Compensation Plan;

 

   

equity incentive awards consisting of performance shares and time-based restricted shares under the Long-Term Incentive Plan;

 

   

retirement and deferred compensation programs;

 

   

health and welfare benefits; and

 

   

other perquisites and personal benefits.

 

The following is a discussion of each component of executive compensation.

 

Base Salary.    The base salary level of each of the NEOs is determined primarily by the executive’s position within the Company, years of service, and performance. The Committee considers adjustments to base salary levels annually and also may consider salary adjustments in connection with promotions and other special circumstances. Messrs. Wraase, Torgerson and Rigby each has entered into an employment agreement with the Company which provides that the executive is entitled to an annual base salary that is not less than his salary on the date he entered into the agreement, and which, if increased, may not be subsequently decreased during the term of the agreement.

 

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In its 2005 review of executive compensation, the Committee, in order to provide consistency within the Company, developed salary levels for the executives and senior management and assigned a level to each position based primarily on the decision-making responsibility associated with the position. The Committee then assigned to each salary level a salary range, with the midpoint of the range fixed at approximately the median of the competitive range as determined by a market survey. Each executive’s salary was established within the range based on a combination of factors, including the executive’s level of experience, tenure with the Company in the position and performance.

 

As part of the 2005 review, the Committee also adopted a mechanism for the annual consideration by the Committee of adjustments to the salary range for each salary level and to individual salaries. The process begins with a review by the Committee of available information on projected salary levels of other companies. If the data shows a change in the salary range for a particular salary level, the Committee has the discretion to adjust the Company’s salary range for that salary level up to a corresponding percentage. If the data shows an increase in salary levels, the Committee also may approve a percentage increase in the total salary budget for the Company’s executive group (currently consisting of 56 executives) that corresponds to the market increase in salaries as shown by the data. This increase, which is referred to as a “merit budget,” is available for allocation among the executive group in the form of salary increases based on the Committee’s evaluation of the executive’s performance, length of service and any other factors that the Committee considers relevant. The Committee also may consider whether a further salary adjustment for a particular executive is warranted based on the goal of generally paying an executive at the median of the competitive salary range for the executive’s position.

 

To evaluate the salary ranges for 2008, the Committee relied on data compiled by PM&P using the 2007 Peer Group specific data and other general industry and utility survey data. This data showed an average salary structure adjustment among the companies surveyed of 2.9%. Based on this data, the Committee, in October 2007 approved, effective for 2008, a 2.9% increase in the minimum and maximum levels in the competitive salary range for each salary level. To consider adjustments to executive salaries within the revised salary ranges, the Committee obtained from PM&P published data, compiled from the same sources as the salary structure information, which showed an average salary budget increase of 3.7%. Based on this data, the Committee approved a merit budget increase equal to 3.7% of total salaries, which it allocated among the executive group.

 

As a consequence of this allocation, the Committee, and in the case of Mr. Wraase, the independent directors, approved the following 2008 salary increases for each of the 2007 NEOs, whose employment continued into 2008.

 

Name

   2008 Salary    Percentage Increase
from 2007

Dennis R. Wraase

   $ 1,076,000    4.98%

Paul H. Barry

     518,000    3.6%

William T. Torgerson

     558,000    3.91%

Joseph M. Rigby

     675,000    17.4%

Anthony J. Kamerick

     309,000    3%

 

In approving the increase for Mr. Wraase, the Committee noted his direction and leadership during 2007 in achieving the Company’s strategic initiatives: the successful resolution of the Mirant bankruptcy case, his efforts to make the Company a leader in its responses to climate change, including the approval of the rate decoupling mechanism in Maryland and the successful completion of four rate cases in the Company’s subsidiaries’ retail jurisdictions. During 2007, the Company achieved a 55.7% total return to shareholders and its common stock was added to the S&P 500 stock index. The Committee also reviewed the data related to market information provided by the consultant in relation to the Company’s 2007 Peer Group. Mr. Wraase’s salary increase was slightly higher than the average increase for executives, which is reflective of his role in the Company’s 2007 performance.

 

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In connection with his employment by the Company as its Senior Vice President and Chief Financial Officer, effective September 5, 2007, the Company and Mr. Barry entered into a letter of employment providing for a 2007 (prorated) base salary of $500,000 which was in line with the market for his position. In approving Mr. Barry’s increase to $518,000 for 2008, the Committee noted his contributions to the Company’s strategic initiatives.

 

In approving the increase for Mr. Torgerson, the Committee took into account his experience and tenure in the position of Vice Chairman and General Counsel and noted as achievements in 2007 the successful management of several concurrent rate cases, the successful resolution of the Mirant bankruptcy case and his leadership in the legislative process.

 

In connection with his promotion to Executive Vice President and Chief Operating Officer effective September 1, 2007, the Committee approved an increase in Mr. Rigby’s base salary from $475,000 to $575,000, to bring his salary into line with the market for his new position. The Committee increased Mr. Rigby’s base salary to $600,000 for 2008 in recognition of the improved financial performance of the Power Delivery business since Mr. Rigby assumed responsibility for its operations in September 2007, the completion of critical infrastructure projects and the approval of a proposed major transmission line. In March 2008, the Committee approved an increase in Mr. Rigby’s annual salary to $675,000 in connection with his appointment as the President of the Company and the associated increase in responsibilities.

 

In September 2007, Mr. Kamerick’s base salary was increased from $260,000 to $300,000, to bring his salary into line with the market for his position. Mr. Kamerick’s base salary was increased to $309,000 for 2008 in recognition of his role in several concurrent rate cases and his tenure in the position of Treasurer.

 

Annual Cash Incentive Awards.    The Company provides its executives, including its NEOs, with an opportunity to receive an annual cash bonus under the Executive Incentive Compensation Plan (the “EICP”). Under this plan, payments are based on the extent to which the Company, one or more business segments, or individual performance meets specified short-term objectives (which can be based on financial or other quantitative criteria). The Committee, however, retains the discretion, whether or not the established performance objectives are achieved, to adjust awards either up or down taking into account such factors and circumstances as it determines to be appropriate.

 

In connection with its comprehensive review of executive compensation in 2005, the Committee adopted target short-term incentive opportunities for each executive officer as a percentage of salary that was designed to place the Company’s total cash compensation (consisting of salary and target annual incentive compensation) at a level approximating the midpoint of the competitive range. These target short-term incentive opportunities remained in place for 2007, including Mr. Rigby’s target level which did not change as the result of his appointment as Executive Vice President and Chief Operating Officer. Mr. Barry’s short-term incentive compensation as a percentage of salary was determined in accordance with the Company’s pre-established compensation schedule for the Chief Financial Officer position.

 

The target level of short-term incentive compensation as a percentage of salary for each of the NEOs in 2007 was as follows:

 

Name

  

Target as a
Percent of Salary

Dennis R. Wraase

        100%

Paul H. Barry

     60%

William T. Torgerson

     60%

Joseph M. Rigby

     60%

Anthony J. Kamerick

     50%

Thomas S. Shaw

     60%

 

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Annual cash incentive awards are made under the EICP to the extent performance goals established by the Committee are achieved. The performance criteria used as the basis for awards and the specific targets can vary from year to year. The performance goals can consist entirely, or be a combination, of (i) performance objectives for the Company as a whole, (ii) performance objectives for a particular business unit or (iii) individual performance objectives. Generally, the financial targets are based on the Company’s annual financial plan. Other quantitative targets typically are set at levels that exceed the level of performance in prior years. For a discussion of the 2007 awards under the EICP, see the section headed “Executive Incentive Compensation Plan Awards” following the 2007 Grants of Plan-based Awards table below. The determination by the Committee of the percentage of each NEO’s EICP award opportunity that is attributable to the performance of particular business units within the Company is designed to align the executive’s award opportunity with the executive’s management responsibilities or in the case of executives who do not have management responsibility for a particular business unit, a balanced allocation among the business units. The performance goals for the Company and the respective business units are selected so as to reward the executive for the achievement of targeted financial results and operational goals.

 

In October 2007, the Committee worked with PM&P to analyze the Company’s total cash compensation for its executive officers relative to that of the 2007 Peer Group. This analysis concluded that each of the NEOs’ salaries and short-term incentives were within the market median range of practices, and, accordingly, PM&P recommended no change in the percentage of the NEO’s total cash compensation relative to salary for 2008.

 

Long-Term Incentive Plan Awards.    Long-term incentive awards are made to the NEOs and other executives under the Long-Term Incentive Plan (the “LTIP”). In connection with its comprehensive review of executive compensation in 2005, the Committee adopted target long-term incentive opportunities for each executive officer as a percentage of salary that was designed to place the Company’s total direct compensation (consisting of salary, target annual cash incentive compensation and target long-term incentive compensation) at a level approximating the midpoint of the competitive range. These target long-term incentive opportunities remained in place for 2007, including Mr. Rigby’s which did not change as the result of his appointment as Executive Vice President and Chief Operating Officer. Mr. Barry’s target level of long-term incentive compensation as a percentage of salary was determined in accordance with the Company’s pre-established compensation schedule for the Chief Financial Officer position.

 

The target levels of long-term incentive compensation as a percentage of salary for each of the NEOs in 2007 was as follows:

 

Name

  

Target as a
Percent of Salary

Dennis R. Wraase

   200%

Paul H. Barry

   100%

William T. Torgerson

   100%

Joseph M. Rigby

   100%

Anthony J. Kamerick

     50%

Thomas S. Shaw

   100%

 

In 2003, the Company discontinued the use of stock options as a form of long-term incentive compensation for executives. In 2005, the Committee approved design changes to the Company’s long-term incentive award program under which (i) two-thirds of the targeted long-term incentive award opportunity is in the form of performance stock that vests to the extent that performance objectives are achieved (“Performance Stock”), which the Company refers to as the “Performance Stock Program” and (ii) one-third of the long-term award opportunity is in the form of restricted stock that vests generally upon the completion by the executive of three years of employment from the date of the grant (“Restricted Stock”), which the Company refers to the “Restricted Stock Program.” Whereas Performance Stock is designed to focus the executive on the achievement by the Company or a business segment of specific financial or other performance goals or on the

 

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achievement of individual performance goals, the primary objective of the Restricted Stock is executive retention and the alignment of the financial interests of the executives with the interests of the shareholders. The allocation between the two forms of compensation reflects the Committee’s view that the predominant portion of an executive’s long-term incentive award opportunity should be tied to performance.

 

Performance Stock Program.    With respect to the Performance Stock awards, the performance targets for each year in the three-year performance period typically are established relative to the performance of the Company in the year immediately preceding the first year of the three-year period, and are set at levels that reflect year-to-year improvement over the three-year period and further the Committee’s goal of rewarding executives only if they deliver results that enhance shareholder value. The objective of the Committee is to set target levels, which, if achieved, would place the Company’s performance at the 75th percentile within the 2007 Peer Group.

 

With regard to the selection of performance measures for the vesting of shares of Performance Stock, the Committee has sought to identify measures that would further the Committee’s goal of ensuring that executives are rewarded only if they deliver results that enhance shareholder value. The Committee has determined that this goal can be best achieved by selecting performance measures that are closely tied to the achievement of important objectives under the Company’s financial plan. To achieve this objective, the Committee has elected the following performance measures for the vesting of Performance Stock: (i) earnings per share or, in the case of business unit performance, earnings (excluding in each instance extraordinary items and other gains and losses relating to matters that are not reflective of the Company’s ongoing business), which serve as a measure of improvements in the Company’s operating results, and (ii) free cash flow, which reflects the generation of the cash available for dividends and debt reduction.

 

To take into account an executive’s specific responsibilities, the selected performance measures, depending on the executive’s position within the Company, apply in whole or in part to the performance of the Company as a whole or to one or more regulated (consisting of Power Delivery) or unregulated (consisting of Conectiv Energy and Pepco Energy Services) business units and could be weighted differently as between the two performance measures. The extent to which Performance Stock awards would be earned depends on actual performance relative to the target level, with no award or a reduced award to the extent performance fell below the target and an increased award if the target is exceeded (with awards interpolated for performance between the threshold and maximum levels). The table below shows the relationship between (i) performance relative to the targeted performance level and (ii) the amount of the award earned as a percentage of the target award.

 

Percentage Performance Relative to
Target Level (Company as a whole and
Power Delivery)

 

Percentage Performance Relative to
Target Level (unregulated business units)

 

Amount of Award (as a Percentage of
Target Award)

below 90%

  below 80%   0%

90%

  80%   50%

100%

  100%   100%

115%

  120%   200%

 

The narrower performance range for the Company and Power Delivery performance targets reflects the historically lower volatility of the results from regulated operations as compared to the Company’s unregulated businesses. As in the case of the EICP, the determination by the Committee of the percentage of each NEO’s Performance Stock Program award opportunity that is attributable to the performance of particular business units within the Company is designed to align the executive’s award opportunity with the executive’s management responsibilities or in the case of executives who do not have management responsibility for a particular business unit, a balanced allocation among the business units. The performance goals for the Company and the respective business units are selected so as to reward the executive for the achievement of targeted financial results.

 

In January 2007, the Committee established award opportunities pursuant to the Performance Stock Program and made awards of restricted stock pursuant to the Restricted Stock Program to each of the NEOs (except Mr. Barry, whose award was made at the time of his employment). For a discussion of the 2007 awards

 

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under the LTIP, see the section headed “Long-Term Incentive Plan Awards” following the 2007 Grants of Plan-Based Awards table below and for a discussion of the vesting in 2007 of awards made in prior years under the LTIP, see the 2007 Option Exercises and Stock Vested table and the accompanying narrative.

 

Restricted Stock Program.    The number of shares of Restricted Stock awarded to each of the NEOs under the Restricted Stock Program, which accounts for one-third of each executive’s aggregate 2007 LTIP award opportunity, are shown on the “2007 Grants of Plan-Based Awards” table below under the heading “All Other Stock Awards: Number of Shares of Stock or Units.” In each case, the shares are subject to forfeiture if the employment of the executive terminates before January 24, 2010, subject to certain exceptions described below under the heading “Termination of Employment and Change in Control Benefits.” During the vesting period, the executive has all rights of ownership with respect to the shares, including the right to vote the shares and the right to receive dividends on the shares. The executive is entitled to retain the dividends paid whether or not the shares vest.

 

In October 2007, PM&P, at the request of the Committee, conducted a compensation review of the total direct compensation opportunity of the Company’s executives. PM&P found that the total direct compensation of the NEOs was somewhat below the midpoint of the competitive range. PM&P concluded, however, that the total program of benefits provided to the NEOs, including retirement plans and other benefits, rendered their total compensation opportunity as reasonable, and therefore made no recommendation to increase the long-term incentive payout targets of the NEOs.

 

Retirement Programs.    The Company’s retirements plans, including both its general employee retirement plan and its supplemental retirement plans, are discussed in detail in the narrative headed “Retirement Plans” following the Pension Benefits at December 31, 2007 table below. Under the Pepco Holdings Retirement Plan, all employees of the Company with at least five years of service are entitled to receive retirement benefits in accordance with the applicable benefit formula up to the maximum level that a qualified pension plan is permitted to provide consistent with Internal Revenue Code regulations.

 

The Company’s supplemental retirement plans (consisting of the Executive Retirement Plan and the Conectiv Supplemental Executive Retirement Plan (“Conectiv SERP”)) provide retirement benefits in addition to the benefits the individual receives under the Pepco Holdings Retirement Plan due to certain benefit calculation features which have the effect of augmenting the individual’s aggregate retirement benefit. If the benefit payment that otherwise would have been available under the applicable benefit formula of the Pepco Holdings Retirement Plan is reduced due to a contribution or benefit limit imposed by law, any participant in the Pepco Holdings Retirement Plan is entitled to a compensating payment under the supplemental retirement plan in which the individual participates. In addition, participants in the Pepco Holdings Retirement Plan, if designated by the Chief Executive Officer, are entitled to one or more of the following enhancements to the calculation of their retirement benefit: (i) the inclusion of compensation deferred under the Company’s deferred compensation plans in calculating retirement benefits, (ii) to the extent not permitted by the Pepco Holdings Retirement Plan, the inclusion of annual cash incentive compensation received by the participant in calculating retirement benefits, or (iii) the crediting of the participant with additional years of service. As negotiated at the time of his employment, Mr. Barry will be entitled to receive three additional years of service after completing five years of employment and an additional three years of credited service after completing ten years of employment.

 

The various components of the Company’s supplemental retirement plans have been in effect for many years. The plans were adopted in order to assist the efforts of the Company to attract and retain executives by offering a total compensation package that is competitive with those offered by other companies, particularly other electric and gas utilities. As part of the 2005 review of executive compensation, the Committee directed its compensation consultant to review the Pepco Holdings Retirement Plan and the Company’s supplemental retirement plans, and was advised by the consultant that the plans are fairly typical among the then-current peer group companies.

 

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All employees of the Company, including the NEOs, are entitled to participate on the same terms in the Company’s 401(k) savings plan (the “Retirement Savings Plan”), and as participants receive a 100% Company matching contribution on employee contributions up to 3% of annual salary and a 50% Company matching contribution on employee contributions in excess of 3% of annual salary up to 6% of annual salary. Executives of the Company, including each of the NEOs, also are eligible to participate in the PHI Executive and Director Deferred Compensation Plan which, as discussed below under the heading “Deferred Compensation Plan,” allows for deferrals (and credits corresponding to the Company matching contribution up to the limits described above) of amounts in excess of the limitations imposed on contributions to the Retirement Savings Plan by the Internal Revenue Code.

 

Health and Welfare Benefits.    Each of the NEOs participates in the Company’s healthcare, life insurance, and disability insurance plans on the same terms as are made available to Company employees generally. With the exception of Company payment for an annual executive physical, as more fully described in Note 13 to the Summary Compensation Table, the Company has no health or welfare plans, programs, or arrangements that are available only to executives.

 

Other Perquisites and Personal Benefits.    As more fully described in Note 13 to the Summary Compensation Table, the Company provides certain NEOs with perquisites and other personal benefits, including: (i) a Company car or a car allowance, (ii) Company-paid parking, (iii) tax preparation and financial planning fees, (iv) certain club dues, (v) personal use of Company-leased entertainment venues and Company-purchased tickets to sporting and cultural events when not otherwise used for business purposes and (vi) reimbursement for spousal travel. The Company also paid for Mr. Barry’s housing costs because his family did not wish to relocate during the school year. The cost of these benefits is not significant in relation to an executive’s total compensation. These benefits generally are provided to ensure that the Company’s total compensation package is competitive with peer companies. In its 2005 review of executive compensation, the Company’s benefits compensation consultant concluded that the perquisites and other personal benefits provided to executives were conservative and generally in line with those provided by the then-current peer group companies.

 

Deferred Compensation Plan.    Under the terms of the Company’s Executive and Director Deferred Compensation Plan (the “Deferred Compensation Plan”), which is described in greater detail in the narrative headed “Deferred Compensation Plans” following the Nonqualified Deferred Compensation table below, the NEOs and other executives of the Company are permitted to defer the receipt of all or any portion of their compensation, including incentive compensation. In addition, to the extent an executive is prevented from making a contribution to the Retirement Savings Plan due to limitations imposed by the Internal Revenue Code, the executive is entitled to defer the excluded amount under the Deferred Compensation Plan and receive an additional credit under the Deferred Compensation Plan equal to the matching contribution, if any, that the Company would have made with respect to the excluded amount under the Retirement Savings Plan. Balances under the Deferred Compensation Plan are credited on a monthly basis with an amount corresponding to, as elected by the participant, any or a combination of: (i) interest at the prime rate or (ii) the return that would have been earned had the account balance been invested in any one or a combination of the investment funds selected by the Committee. The Deferred Compensation Plan is designed to allow participating executives to save for retirement in a tax-effective way. The Company funds its future financial obligations under the Deferred Compensation Plan through the purchase of Company-owned life insurance policies and other investments.

 

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Compensation Mix

 

At-Risk versus Fixed Compensation.    The percentages of each NEO’s short-term and long-term incentive compensation opportunities relative to the executive’s salary as established by the Committee are designed to reflect the Committee’s view that, as the level of an executive’s responsibility increases, the percentage of the executive’s compensation that is at risk and tied to company or individual performance likewise should increase. The following table shows the allocation of each NEO’s total salary and short-term and long-term incentive compensation opportunities between fixed and at-risk compensation (at the target level).

 

Name

  

Fixed
Compensation

 

At-Risk
Compensation

Dennis R. Wraase    25%   75%
Paul H. Barry    38%   62%
William T. Torgerson    38%   62%
Joseph M. Rigby    38%   62%
Anthony J. Kamerick    50%   50%
Thomas S. Shaw    38%   62%

 

Short-Term versus Long-Term Incentive Compensation.    The Committee also believes that with increasing seniority, a larger percentage of an executive’s compensation opportunity should be in the form of long-term incentive compensation. This reflects the view of the Committee that the senior executives should have a greater focus on developing and implementing the Company’s long-term strategic goals. The following table shows the allocation between each NEO’s target short-term and long-term incentive compensation opportunities (each at the target level).

 

Name

  

Short-Term
Incentive
Opportunity

 

Long-Term
Incentive
Opportunity

Dennis R. Wraase    33%   67%
Paul H. Barry    38%   62%
William T. Torgerson    38%   62%
Joseph M. Rigby    38%   62%
Anthony J. Kamerick    50%   50%
Thomas S. Shaw    38%   62%

 

Severance and Change in Control Benefits

 

The employment agreements of Messrs. Torgerson and Rigby, each entered into at the time of the merger of Pepco and Conectiv, provide for severance payments and other benefits if the employment of the executive is terminated other than for “cause” or the executive voluntarily terminates his employment for certain specified reasons, whether or not such termination is in connection with a change in control of the Company. These provisions are generally designed to provide assurance to the executive that, if the executive’s employment is actually or constructively terminated by the Company, the executive will receive for a period of time thereafter the compensation and benefits that the executive would have received had the termination not occurred. These benefits also address the concern that the fear of job loss might influence the executive when considering strategic opportunities that may include a change in control of the Company. The specific benefits to which Messrs. Torgerson and Rigby are entitled are described in detail under the heading “Termination of Employment and Change in Control Benefits” below.

 

The Company also maintains a Change in Control Severance Plan in which 53 executives who are not covered by a change in control provision in an employment agreement currently participate. Under this plan, which is described under the heading “Termination of Employment and Change in Control Benefits” below, if, within one year following a change in control, a participating executive’s employment is terminated by the Company without “cause” or is terminated by the executive for “good reason,” the executive will be entitled to termination benefits similar to those described above for executives with employment agreements, except with a severance payment equal to

 

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1.5, 2 or 3 times the salary of the affected executive depending upon the executive’s position. The purpose of the plan is to ensure that the participating executives are able to stay focused on their responsibilities to the Company in a change in control situation and are not distracted by the uncertainty of their continued employment. Messrs. Barry and Kamerick are participants in the Change in Control Severance Plan.

 

As an inducement to his employment, Mr. Barry’s letter of employment also provides that if his employment is terminated by the Company (other than for cause) within the first 12 months of his employment, he will receive a lump sum payment in an amount equal to the sum of (i) his then-current salary and (ii) his target annual bonus for the year in which the termination occurs. This provision would not apply in a circumstance where Mr. Barry is entitled to a severance payment under the Change in Control Severance Plan.

 

Employment Agreements and Compensation Arrangements

 

In July 2007, the Company entered into a new employment agreement with Mr. Wraase, which is described in greater detail under the heading “Employment Agreements” below. The new employment agreement replaces the employment agreement that Mr. Wraase entered into in 2002. Like the 2002 agreement, the term of the new agreement extends until April 1, 2009, the date Mr. Wraase reaches normal retirement age under the Pepco General Retirement Subplan. Under the terms of the new agreement, Mr. Wraase has relinquished the right to receive, as provided for in the prior agreement, both (i) a severance payment in an amount equal to three times his combined salary and bonus and (ii) a lump sum supplemental retirement benefit, if, prior to April 1, 2009, his employment were to have been terminated by the Company without “cause” or he elected to terminate his employment for certain specified reasons generally involving the diminution of status or a reduction in benefits. In addition, Mr. Wraase has given up the right to receive a gross-up payment for any excise tax payments he would have incurred had any payments made to him in connection with a termination of his employment been determined to be payments related to a change in control within the meaning of Section 280G of the Internal Revenue Code.

 

In setting the terms of the new employment agreement, the Committee took into account Mr. Wraase’s age and projected near-term retirement date and determined that the protections afforded Mr. Wraase in the event of a termination of his employment were no longer necessary or appropriate within this timeframe. In consideration for relinquishing his severance and other termination of employment benefits, including the tax gross-up payment, the Committee authorized an enhancement in Mr. Wraase’s retirement benefits in the form of a supplemental retirement benefit with actuarial present value of approximately $4.2 million at December 31, 2007, which is described in the narrative following the Pension Benefits at December 31, 2007 table under the heading “Wraase Supplemental Retirement Benefit.” The benefits Mr. Wraase agreed to forego, which would have been payable had the Company terminated his employment without cause before April 1, 2009, based on the elements of his compensation at December 1, 2006, had a value of approximately $11.9 million or approximately $20.4 million had his termination followed a change in control of the Company.

 

At time of the employment of Mr. Barry in September 2007, the Company and Mr. Barry entered into a letter of employment specifying his base salary, the annual and long-term incentive award opportunities (which were awarded on the same basis as other similarly situated executives prorated for time of service), his participation in various of the Company’s benefit programs and reimbursement for relocation expenses, including a gross-up for any tax incurred on amounts reimbursed.

 

In September 2007, the Company entered into an agreement with Mr. Kamerick under which, in addition to the salary increase described above, he was awarded 5,409 shares of the Company’s common stock, which will vest on September 1, 2009, if Mr. Kamerick is employed by the Company.

 

Deductibility of Executive Compensation Expenses

 

Under Section 162(m) of the Internal Revenue Code, a public company is prohibited from deducting for federal income tax purposes compensation in excess of $1 million paid to any of the Company’s principal executive officers and the Company’s three highest compensated executive officers (other than the principal

 

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executive officer or the principal financial officer), except that this prohibition does not apply to compensation that qualifies as “performance-based compensation.” Under the LTIP, which has been approved by the Company’s shareholders, shares of Performance Stock are contingent on the achievement of pre-established performance objectives and therefore qualify as performance-based compensation, except if the Committee were to alter the performance objectives after the commencement of the performance period or were to exercise its discretion to pay an award notwithstanding that the specified performance objectives were not satisfied. There may be circumstances where the Committee determines that it is in the best interests of the Company to take either of such actions with respect to one or more awards, even though the result may be a loss of a tax deduction for the compensation.

 

The issuance of shares of Restricted Stock under the LTIP does not qualify as performance-based compensation because the award vests on the basis of continued employment, rather than pre-established performance objectives. Because the EICP has not been approved by shareholders, awards under the plan cannot qualify as performance-based compensation even when the payment of awards under the plan is based on the achievement of pre-established performance objectives.

 

Stock Ownership Requirements

 

To align further the financial interests of the Company’s executives with those of the shareholders, the Board of Directors in 2005 adopted stock ownership requirements for officers of the Company. The requirements, which are expressed as a multiple of salary, are a function of the executive’s seniority:

 

Chief Executive Officer, President

   5 times salary
Executive Vice President, Vice Chairman    3 times salary
Senior Vice President    2 times salary
Vice President    1 times salary

 

Each officer has until December 31, 2010, or five years from the date of his election as an officer, whichever is later, to achieve the required ownership level. Each of the NEOs, except Mr. Barry whose employment commenced in September 2007, meets this requirement. An individual who is appointed as an officer or is promoted to a position with a higher stock ownership requirement has five years from the date of appointment or promotion to achieve the applicable stock ownership level. Shares of Company common stock owned through the Retirement Savings Plan, unvested shares of Restricted Stock, and the number of shares of Company common stock corresponding to the target level of the executive’s unearned Performance Stock awards are considered owned by the executive for the purpose of meeting the ownership requirement. The Company does not have a policy with respect to hedging the economic risk of shares that the officer is required to own.

 

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EXECUTIVE COMPENSATION

 

The following table sets forth compensation information for the Company’s (i) principal executive officer, (ii) principal financial officer and (iii) its three other most highly compensated executive officers employed as of December 31, 2007, determined on the basis of their total compensation for 2007 (excluding the amounts under the heading “Change in Pension Value and Nonqualified Deferred Compensation Earnings” in the table below). The table also includes Thomas S. Shaw, whose employment terminated prior to December 31, 2007, but whose 2007 compensation exceeded the 2007 compensation of one or more of the three other most highly compensated executive officers employed at December 31, 2007. The information in this table includes compensation paid by the Company or its subsidiaries.

 

2007 SUMMARY COMPENSATION TABLE

 

Name and Principal Position

  Year   Salary   Bonus   Stock
Awards (10)
  Option
Awards
  Non-Equity
Incentive
Plan
Compen-

sation (11)
  Change in
Pension
Value and
Nonqualified
Deferred
Compen-

sation
Earnings (12)
  All Other
Compen-

sation (13)
  Total
Compen-

sation

Dennis R. Wraase

  2007   $ 1,026,941   $ 0   $ 1,339,512   $ 0   $ 1,127,500   $ 4,656,627   $ 284,189   $ 8,434,769

Chairman and Chief Executive

Officer

  2006     950,000     0     1,280,884     0     0     2,462,563     228,103     4,921,550

Paul H. Barry

  2007     161,932     0     42,102     0     106,007     1,944     51,435     363,420

Senior Vice President and Chief

Financial Officer (14)

                 

William T. Torgerson

  2007     538,017     0     412,916     0     579,960     733,283     143,354     2,407,530

Vice Chairman and Chief Legal

Officer

  2006     512,000     0     478,237     0     0     698,459     128,393     1,817,089

Joseph M. Rigby

  2007     509,044     0     303,384     0     335,500     134,856     103,718     1,386,502

President and Chief Operating

Officer

  2006     412,500     0     288,480     0     0     38,805     76,860     816,645

Anthony J. Kamerick

  2007     273,750     200,000     98,608     0     140,083     118,501     47,962     878,904

Vice President and Treasurer (15)

                 

Thomas S. Shaw

  2007     349,977     0     0     0     229,680     0     5,155,451     5,735,108

Retired Executive Vice President

and Chief Operating Officer

  2006     502,000     0     488,258     0     0     201,174     113,238     1,304,670

 

(10) Represents the dollar amount of expense recognized by the Company for financial statement reporting purposes in 2007, as determined in accordance with Financial Accounting Standard 123R, with respect to shares of Restricted Stock and Performance Stock awards made to the executive in 2007 and in prior years under the LTIP. For a further description of these awards, see the discussion under the heading “Long-Term Incentive Plan Awards” below. The amount of the annual expense for the Restricted Stock awards was determined by dividing the market value of the shares as of the date of the grant by three (representing the number of years of service from the date of the grant required for the vesting of the award). The assumptions used to calculate the expense recognized for the Performance Stock awards are set forth in Note 10 to the Company’s consolidated financial statements, which are included in the Company’s Annual Report to Shareholders attached as Annex B to this Proxy Statement.

 

(11) See the description of the EICP following the 2007 Grants of Plan-Based Awards table below.

 

(12)

Consists of (i) the aggregate increase in the actuarial present value of the executive’s accumulated benefits under all deferred benefit and actuarial pension plans from December 31, 2006 to December 31, 2007 (or, in the case of Mr. Barry, from the date of his employment to December 31, 2007), combined with (ii) “above-

 

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market earnings” (as defined by SEC regulations) on non-tax-qualified deferred compensation plans of $14,209 for Mr. Wraase and $11,931 for Mr. Torgerson. See the discussion under the heading “Deferred Compensation Plans — Pepco Director and Executive Deferred Compensation Plan” below.

 

(13) The totals shown in this column consist of:

 

(a) Dividends paid on unvested shares of Restricted Stock held by the executive: Mr. Wraase — $56,824; Mr. Barry — $2,430; Mr. Torgerson — $15,108; Mr. Rigby — $14,539; Mr. Kamerick — $6,339 and Mr. Shaw — $7,377. For a further description of these payments, see “Long-Term Incentive Plan Awards — Restricted Stock Program” below.

 

(b) The market value on December 31, 2007, of additional shares of Company common stock (calculated by multiplying the number of shares by the closing market price on December 31, 2007, the last trading day of the year) issued to the executive equal to the number of shares that the executive would have owned on December 31, 2007 had the number of shares earned by the executive for the 2005-2007 Performance Stock award cycle under the LTIP been issued to the executive on January 1, 2005, the commencement date of the performance cycle, and had the dividends on such shares (and the reinvestment shares) been invested in additional shares of common stock: Mr. Wraase — $148,887; Mr. Barry — $0; Mr. Torgerson — $66,100; Mr. Rigby — $36,647; Mr. Kamerick — $13,743 and Mr. Shaw — $0. For a further description of these payments, see “Long-Term Incentive Plan Awards — Performance Stock Program” below.

 

(c) Company-paid premiums on a term life insurance policy: Mr. Wraase — $2,272; Mr. Barry — $281; Mr. Torgerson — $1,196; Mr. Rigby — $1,122; Mr. Kamerick — $603 and Mr. Shaw — $774.

 

(d) Company Retirement Savings Plan matching contributions: Mr. Wraase — $10,125; Mr. Barry — $0; Mr. Torgerson — $10,125; Mr. Rigby — $10,125; Mr. Kamerick — $10,125 and Mr. Shaw — $9,599.

 

(e) Company matching contributions on deferred compensation: Mr. Wraase — $35,743; Mr. Barry — $0; Mr. Torgerson — $13,993; Mr. Rigby — $12,466; Mr. Kamerick — $0 and Mr. Shaw — $0. For a further discussion, see “Deferred Compensation Plans — PHI Executive and Director Deferred Compensation Plan.”

 

(f) Tax gross-up payments of $15,557 made to Mr. Barry on the amount shown under the heading “Reimbursement of Employment Transition Expenses” in the table to note (g) below.

 

(g) The following perquisites and other personal benefits (all amounts shown reflect cash payments made by the Company, except as otherwise stated)

 

Name

  Company
Car(i)
  Auto
Allowance(ii)
  Parking   Tax
Preparation
Fee
  Financial
Planning
Fee
  Executive
Physical
Fee
  Club
Dues
  Spousal
Travel
  Reimbursement
of Employment
Transition
Expenses(iii)

Dennis R. Wraase

  $ 9,587   $ 0   $ 2,400   $ 2,500   $ 9,250   $ 520   $ 4,336   $ 1,745   $ 0

Paul H. Barry

    0     3,413     800     0     0     0     0     0     28,954

William T. Torgerson

    9,907     0     2,400     2,500     9,250     326     6,800     5,649     0

Joseph M. Rigby

    0     11,700     2,400     2,500     9,250     800     0     2,169     0

Anthony J. Kamerick

    0     11,700     2,400     2,500     0     552     0     0     0

Thomas S. Shaw

    0     7,800     1,600     2,500     6,161     800     1,800     317     0

 

  (i) Consists of lease and registration costs paid by the Company and variable costs, including gasoline, service and parts.

 

  (ii) Consists of a nonaccountable expense allowance to compensate executives who are not provided with a Company car.

 

  (iii) Consists of reimbursement of Mr. Barry for housing, meals and transportation costs incurred prior to the relocation of his residence following his employment by the Company.

 

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In addition, in 2007, Company-leased entertainment venues and Company-purchased tickets to sporting and cultural events were made available to employees, including the executive officers listed in the Summary Compensation Table, for personal use when not being used by the Company for business purposes. There was no incremental cost to the Company of providing these benefits.

 

(h) A payment of $5,116,723 to Mr. Shaw under the Conectiv SERP.

 

(14) Mr. Barry became an employee of the Company on September 5, 2007.

 

(15) Mr. Kamerick did not meet the requirements for inclusion in the Summary Compensation Table in 2006.

 

Employment Agreements

 

Each of the executive officers listed in the Summary Compensation Table was an employee of the Company as of December 31, 2007, with the exception of Mr. Shaw, who retired on September 1, 2007. The Company has employment agreements with each of Messrs. Wraase, Barry, Torgerson and Rigby and had an employment agreement with Mr. Shaw prior to his retirement.

 

   

Mr. Wraase’s agreement provides for his employment until his normal retirement date under the Company’s defined benefit retirement plan of April 1, 2009.

 

   

Mr. Barry is an employee at will. The terms of his employment are governed by the letter of employment he executed with the Company, effective September 5, 2007.

 

   

Mr. Torgerson’s agreement provides for his employment until his normal retirement date under the Company’s defined benefit retirement plan of June 1, 2009.

 

   

Mr. Rigby’s agreement provides for his employment through August 1, 2008.

 

   

Mr. Shaw’s agreement provided for his employment through August 1, 2007.

 

Each executive’s employment agreement, except Mr. Barry’s, provides for

 

   

An annual salary in an amount, in the case of Mr. Wraase, not less than his base salary in effect on July 26, 2007, and in the cases of Messrs. Torgerson and Rigby, not less than his base salary in effect as of August 1, 2002, with the condition that, if at any time during the term of the agreement the annual base salary of the executive is increased, it may not subsequently be decreased during the remainder of the term of the agreement.

 

   

Incentive compensation as determined by the Board of Directors under plans applicable to senior executives of the Company.

 

   

Participation, in a manner similar to other senior executives, in retirement plans, fringe benefit plans, supplemental benefit plans and other plans and programs provided by the Company for its executives or employees.

 

   

As more fully described below under the heading “Termination of Employment and Change in Control Benefits,” various payments and other benefits in connection with the termination of the executive’s employment.

 

Upon his employment, the Company entered into a letter of employment with Mr. Barry, which provides for the following:

 

   

An annual base salary in the amount of $500,000, which will be reviewed annually beginning in 2008.

 

   

Participation in the Company’s EICP and LTIP on the same basis as other similarly situated executives prorated for time of service, with the terms of awards in 2007 as follows:

 

  n A minimum bonus of $100,000 under the EICP, with the opportunity to earn up to $180,000 depending on performance results.

 

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  n Awards under the LTIP consisting of:

 

  o shares of Restricted Stock with a fair market value of $129,631 on the date of the grant, which vest in 2010, and

 

  o a Performance Stock award, with target award value of $259,262 and a maximum award value of $518,524, depending on results for the 2007 to 2009 performance period.

 

   

Participation in (i) the Pepco Holdings Retirement Plan in accordance with its terms and (ii) the Supplemental Executive Retirement Benefit Structure, under which he will receive three additional years of credited service after completing five years of employment and an additional three years of credited service after completing ten years of employment.

 

   

Participation in the Company’s perquisites program.

 

   

Participation in the Company’s Change in Control Severance Plan at a level that provides for payment in the amount of three times salary and bonus if employment terminates as the result of a change in control of the Company.

 

   

A severance payment in an amount equal to the sum of annual base salary and target annual bonus, if terminated by the Company, other than for cause, within the first 12 months of employment.

 

   

Reimbursement for relocation expenses, including a gross-up for any taxes incurred on amounts reimbursed.

 

Relationship of Salary and Bonus to Total Compensation

 

The following table sets forth the 2007 salary of each of the executive officers listed in the Summary Compensation Table as a percentage of the executive’s Total Compensation, as set forth in the Summary Compensation Table:

 

Name

   Salary as a Percentage
of Total Compensation
 

Dennis R. Wraase

   12.2 %

Paul H. Barry

   44.6 %

William T. Torgerson

   22.3 %

Joseph M. Rigby

   36.7 %

Anthony J. Kamerick

   31.1 %

Thomas S. Shaw

   6.1 %

 

The percentage for Mr. Shaw reflects that a significant portion of his total 2007 compensation involved payments associated with his retirement. Of the continuing executives, the lower percentage for Mr. Wraase evidences in substantial part the higher at-risk component of his total compensation and the modification of his pension benefits. For a further discussion see the “Compensation Discussion and Analysis.”

 

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2007 Incentive Compensation Awards

 

2007 GRANTS OF PLAN-BASED AWARDS

 

        Estimated Future Payouts
Under Non-Equity
Incentive Plan Awards
  Estimated Future Payouts
Under Equity
Incentive Plan Awards
  All
Other
Stock
Awards:
Number
of
Shares
of Stock
or Units
  Grant Date
Fair Value
of Stock
and Options
Awards
(16)

Name

  Grant
Date
  Threshold     Target   Maximum   Threshold
Number
of Shares
  Target
Number
of
Shares
  Maximum
Number
of Shares
   
        ($)     ($)   ($)                   ($)

Dennis R. Wraase

                 

Executive Incentive Compensation Plan

  1-25-07   $ 0     $ 1,025,000   $ 1,845,000          

LTIP—Restricted Stock Program

  1-25-07               26,154   $ 667,712

LTIP—Performance Stock Program

  1-25-07         0   52,315   104,630       1,335,602

Paul H. Barry

                 

Executive Incentive Compensation Plan

  9-5-07     100,000 (17)     100,000     180,000          

LTIP—Restricted Stock Program

  9-5-07               4,674     130,077

LTIP—Performance Stock Program

  9-5-07         0   9,350   18,700       260,211

William T. Torgerson

                 

Executive Incentive Compensation Plan

  1-25-07     0       322,200     579,960          

LTIP—Restricted Stock Program

  1-25-07               6,851     174,906

LTIP—Performance Stock Program

  1-25-07         0   13,704   27,408       349,863

Joseph M. Rigby

                 

Executive Incentive Compensation Plan

  1-25-07     0       305,000     549,000          

LTIP—Restricted Stock Program

  1-25-07               6,060     154,712

LTIP—Performance Stock Program

  1-25-07         0   12,122   24,244       309,475

Anthony J. Kamerick

                 

Executive Incentive Compensation Plan

  1-25-07     0       136,667     246,001          

LTIP—Restricted Stock Program

  1-25-07               1,659     42,354

LTIP—Performance Stock Program

  1-25-07         0   3,318   6,636       84,709

LTIP—Restricted Stock Program

  9-1-07               5,409     150,803

Thomas S. Shaw

                 

Executive Incentive Compensation Plan

  1-25-07     0       313,200     563,760          

LTIP—Restricted Stock Program

  1-25-07               6,660     170,030

LTIP—Performance Stock Program

  1-25-07         0   13,321   26,642       340,085

 

(16) Represents the grant date fair value, as determined in accordance with Financial Accounting Standard 123R, of shares of Restricted Stock granted under the Restricted Stock Program and Performance Stock awards under the Performance Stock Program. The value of the shares of Restricted Stock has been calculated by multiplying the number of shares granted by the closing price for the Company’s common stock on the grant date. The value of the Performance Stock awards has been calculated by multiplying the target number of shares that the executive is entitled to earn by the closing price for the Company’s common stock on the grant date. Mr. Shaw’s awards were forfeited upon his retirement.

 

(17) Mr. Barry’s threshold bonus of $100,000 is in accordance with the terms of his letter of employment.

 

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Executive Incentive Compensation Plan Awards

 

Under the EICP, participating executives are entitled to receive annual cash bonuses to the extent performance goals established by the Compensation/Human Resources Committee are achieved. The performance goals can consist entirely, or be a combination, of (i) performance objectives for the Company as a whole, (ii) performance objectives for a particular business unit or (iii) individual performance objectives. In making awards under the EICP, the Compensation/Human Resources Committee takes into account actual performance relative to the performance goals as well as any other factors that the Committee in its sole discretion determines to take into consideration. Under the EICP as in effect for 2007, each of the executive officers listed in the Summary Compensation Table had the opportunity to earn a cash bonus of between 0% and 180% of the following percentage of his 2007 base salary: Mr. Wraase: 100%; Messrs. Barry, Torgerson, Rigby and Mr. Shaw (in the case of Mr. Shaw pro-rated for the eight-month period of his employment in 2007): 60%; and Mr. Kamerick: 50%.

 

The performance goals in 2007 for Messrs. Wraase, Barry, Torgerson, Rigby and Shaw consisted entirely of corporate performance goals. These goals consisted of: (i) Company net earnings relative to budgeted net earnings of $252.6 million (40%), (ii) Company free cash flow relative to budgeted free cash flow of ($176) million (25%), (iii) utility customer satisfaction as measured by the results of customer surveys and other performance metrics (15%), (iv) diversity as measured by the attainment or good faith efforts toward the attainment of established affirmative action goals (10%), and (v) safety as measured by the absence of fatalities and the number of recordable injuries and fleet accidents (10%). Free cash flow is defined as net cash flow from operating activities and proceeds from asset dispositions minus capital expenditures and dividend payments.

 

The performance goals for Mr. Kamerick, as a corporate services participant, consisted of 60% Power Delivery business unit performance goals, 7.5% Pepco Energy Services business unit performance goals, 7.5% Conectiv Energy business unit performance goals and 25% individual performance goals. The Power Delivery business unit goals for 2007 consisted of: (i) Power Delivery net earnings relative to budgeted net earnings of $181.3 million (40%), (ii) Power Delivery operation and maintenance spending relative to a budgeted amount of $610.8 million (15%), (iii) Power Delivery capital expenditures relative to a budgeted amount of $581 million (10%), (iv) utility customer satisfaction as measured by the results of customer surveys and other performance metrics (15%), (v) diversity as measured by the attainment or good faith efforts toward the attainment of established affirmative action goals (10%) and (vi) safety as measured by the absence of fatalities and the number of recordable injuries and fleets accidents (10%). Each of the Pepco Energy Services and Conectiv Energy business units had similar performance goals tied to its financial and operational performance. Mr. Kamerick’s individual performance goals concerned the activities of the Company’s treasury and regulatory groups and included achievements involving the regulatory proceedings of the Company’s utility subsidiaries, working capital management and the Company’s accounting system.

 

These 2007 award opportunities are shown in the above table under the heading “Estimated Future Payouts Under Non-Equity Incentive Plan Awards,” with the threshold representing overall performance at the 50% level (meaning no award is made if performance is below the 50% level relative to the target), the target amount representing overall performance at the 100% level, and the maximum amount representing overall performance at or above the 180% level.

 

In 2008, the Committee made the following awards for 2007 to each of the executive officers listed in the Summary Compensation Table:

 

   

Messrs. Wraase, Rigby, Barry and Shaw received awards at the 110% level. This was based on corporate performance with respect to net earnings relative to budgeted net earnings and free cash flow relative to budgeted free cash flow that in each case significantly exceeded targets, with performance with respect to diversity at the target level and performance with respect to customer satisfaction and safety below the target levels.

 

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For Mr. Torgerson, the Committee approved the maximum payout amount of 180% based on an individual performance adjustment to the award that would have been payable solely on the basis of the pre-established performance goals. In making this adjustment, the Committee recognized Mr. Torgerson’s role in the successful resolution of Pepco’s Mirant bankruptcy claim in which Pepco received net proceeds of $413.9 million, including recovery of all associated expenses incurred by Pepco.

 

   

Mr. Kamerick received an award at the 102.5% level based on the combination of (i) aggregate Power Delivery performance below target reflecting a combination of net earnings relative to budgeted net earnings slightly below target, operation and maintenance spending above budgeted amounts and capital expenditures below budgeted amounts, with performance with respect to diversity at the target level and performance with respect to customer satisfaction and safety below the target levels, (ii) the achievement by the Pepco Energy Services and the Conectiv Energy business units that in the aggregate exceeded the targets, and (iii) the achievement of individual performance goals that exceeded targets.

 

Long-Term Incentive Plan Awards

 

In January 2007, the Compensation/Human Resources Committee established award opportunities pursuant to the Performance Stock Program under the LTIP and made awards of Restricted Stock pursuant to the Restricted Stock Program under the LTIP to each of the executive officers listed in the Summary Compensation Table. Mr. Shaw retired on September 1, 2007, and forfeited his awards at that time.

 

Performance Stock Program.    The award opportunities established under the Performance Stock Program, which account for two-thirds of each participant’s aggregate 2007 LTIP award opportunity, relate to performance over a three-year period beginning in 2007 and ending in 2009.

 

   

For Messrs. Wraase, Barry, Torgerson and Rigby, 75% of their award opportunity is based on a Company earnings per share goal and 25% of their award opportunity is based on a Company free cash flow per share goal. Mr. Barry’s award was prorated based on the number of months from the date of his employment to the end of the cycle in 2009, resulting in a target award of 73% of what would have been awarded if his employment had commenced on January 1, 2007.

 

   

For Mr. Shaw, 37.5% of his award opportunity was based on a Company earnings per share goal, 37.5% was based on a Power Delivery earnings goal, 12.5% was based on a Company free cash flow per share goal and 12.5% was based on a Power Delivery free cash flow goal. Mr. Shaw’s award was forfeited upon his retirement.

 

   

For Mr. Kamerick, 60% of his award opportunity is based on a Power Delivery earnings per share goal, 7.5% is based on Conectiv Energy’s earnings goal, 7.5% is based on Pepco Energy’s earnings goal, 20% is based on a Power Delivery free cash flow goal, 2.5% is based on a Conectiv Energy free cash flow goal and 2.5% is based on a Pepco Energy Services free cash flow goal.

 

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The following table sets forth the performance targets for each year in the three-year period.

 

     2007    2008    2009

Company

        

Earnings per share

   $ 1.45    $ 1.59    $ 1.74

Free cash flow per share

   $ 0.71    $ 0.10    $ 0.73

Power Delivery Business Unit

        

Earnings (in millions)

   $ 214.2    $ 239.8    $ 268.5

Free cash flow (in millions)

   $ 72.9    $ 16.0    $ 122.4

Conectiv Energy Business Unit

        

Earnings (in millions)

   $ 45.3    $ 52.3    $ 60.5

Free cash flow (in millions)

   $ 61.9    $ 30.1    $ 60.7

Pepco Energy Services Business Unit

        

Earnings (in millions)

   $ 33.0    $ 31.8    $ 30.7

Free cash flow (in millions)

   $ 30.2    $ 16.6    $ 12.4

 

The earnings targets exclude extraordinary items and gains or losses relating to matters that are not reflective of the Company’s ongoing business. Free cash flow is defined as net income available for common stock dividends, plus depreciation and amortization, plus or minus changes in working capital and minus capital expenditures. Free cash flow per share is calculated by dividing free cash flow by the weighted average number of outstanding shares of common stock during the year.

 

These award opportunities are shown in the above table under the heading “Estimated Future Payouts Under Equity Incentive Plan Awards,” with the threshold number of shares representing performance at 90% of the target level, the target number of shares representing performance at the target level, and the maximum number of shares representing performance at or above 115% of the target level. The award that the executive earns at the end of the three-year performance period is equal to the average of the award percentage for each of the three years, with the award percentage for performance below the threshold target level being zero and the maximum award percentage for performance above the target being 200%. If, however, during the course of the three-year performance period, a significant event occurs, as determined in the discretion of the Compensation/Human Resources Committee, that the Committee expects to have a substantial effect on a performance objective during the period, the Committee may revise performance targets. If at the end of the three-year performance period shares are earned, the executive also will be entitled to receive additional shares of Company common stock equal to the number of shares that the executive would have owned at the end of the performance period had the cash dividends that would have been paid during the performance period on a number of shares equal to the number of shares earned been reinvested in additional shares of common stock.

 

Restricted Stock Program.    Under the Restricted Stock Program, each of the executive officers listed in the Summary Compensation Table received a grant of shares of Restricted Stock, which accounts for one-third of the executive’s aggregate 2007 LTIP award opportunity. The entire award of shares of Restricted Stock, which are shown in the above table under the heading “All Other Stock Awards: Number of Shares of Stock or Units,” are subject to forfeiture if the employment of the executive terminates before January 24, 2010, except that, unless the Committee determines otherwise, and subject to any contrary provision in the executive officer’s employment agreement (see “Termination of Employment and Change in Control Benefits — Employment Agreements” below), in the event of death, disability or retirement of the executive or if the employment of the executive is terminated or the executive terminates his employment for “good reason” following a “change in control” (see “Termination of Employment and Change in Control Benefits — Long-Term Incentive Plan” below), the award is prorated to the date of termination. Mr. Barry’s award was prorated based on the number of months from the date of his employment to January 24, 2010. Mr. Shaw’s award was forfeited upon his retirement. In addition to the award that he received in January 2007, Mr. Kamerick was granted a supplemental award of 5,409 shares of Restricted Stock, which will vest on September 1, 2009, if he is employed by the Company on that date. During the vesting period, the executive has all rights of ownership with respect to the shares, including the right to vote the shares and the right to receive dividends on the shares. The executive is entitled to retain the dividends paid whether or not the shares vest.

 

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OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2007

 

    Option Awards   Stock Awards

Name

  Number of
Securities
Underlying
Unexercised
Options
(Exercisable)
  Number of
Securities
Underlying
Unexercised
Options
(Unexercisable)
  Equity
Incentive
Plan
Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options
  Option
Exercise
Price
  Option
Expiration
Date
  Number
of
Shares
or Units
of Stock
That
Have
Not
Vested
  Market
Value of
Shares or
Units of
Stock
That
Have Not
Vested
(18)
  Equity
Incentive
Plan
Awards:
Number
of
Unearned
Shares,
Units or
Other
Rights
That
Have Not
Vested
(19)
  Equity
Incentive
Plan
Awards:
Market or
Payout
Value of
Unearned
Shares,
Units or
Other
Rights That
Have Not
Vested (18)

Dennis R. Wraase

                 

Awarded 1-25-07(20)

            26,154   $ 767,097   104,630   $ 3,068,798

Awarded 1-26-06(21)

            28,484     835,436   113,934     3,341,684

Awarded 1-2-05(22)

                91,000     2,669,030

Awarded 1-1-01

  48,000   0   0   $ 24.5900   12-31-10        

Awarded 5-1-98

  21,843   0   0     24.3125   4-30-08        

Paul H. Barry

                 

Awarded 9-5-07(20)

            4,674     137,088   18,700     548,471

William T. Torgerson

                 

Awarded 1-25-07(20)

            6,851     200,940   27,408     803,877

Awarded 1-26-06(21)

            7,676     225,137   30,702     900,490

Awarded 1-2-05(22)

                40,400     1,184,932

Awarded 1-1-01

  30,000   0   0   $ 24.5900   12-31-10        

Awarded 5-1-98

  21,843   0   0     24.3125   4-30-08        

Joseph M. Rigby

                 

Awarded 1-25-07(20)

            6,060     177,740   24,244     711,077

Awarded 1-26-06(21)

            5,997     175,892   23,986     703,509

Awarded 1-2-05(22)

                22,400     656,992

Awarded 1-2-02

            275     8,066    

Anthony J. Kamerick

                 

Awarded 1-25-07(20)

            1,659     48,658   6,636     194,634

Awarded 9-1-07 (23)

            5,409     158,646    

Awarded 1-26-06(21)

            1,732     50,800   6,926     203,140

Awarded 1-2-05(22)

                8,400     246,372

Awarded 1-1-01

  5,100   0   0     24.5900   12-31-10        

 

(18) Calculated by multiplying the number of shares shown in the preceding column by $29.33, the closing market price on December 31, 2007, the last trading day of the year.

 

(19) Reflects the number of shares that would be earned if the maximum level of performance is achieved because 2007 performance was at the “target” level.

 

(20) For a discussion of the vesting provisions relating to this award, see the description of the Restricted Stock Program under the heading “Long-Term Incentive Plan Awards — Restricted Stock Program” above.

 

(21)

These awards, made under the LTIP, entitle the participating executive to earn shares of common stock to the extent the pre-established performance objective for the three-year performance period beginning on January 1, 2006, and ending on December 31, 2008, is satisfied. The performance objectives for the 2006 to 2008 performance period are based 75% on an earning growth target and 25% on a free cash flow target. A participant is eligible to earn a number of shares of common stock ranging from 0% to 200% of the target performance award depending on the extent to which the performance objective is achieved. The performance objective was fixed at the time the awards were made; however, if during the course of the

 

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performance period, a significant event occurs, as determined in the sole discretion of the Compensation/Human Resources Committee, that the Committee expects to have a substantial effect on total shareholder return during the period, the Committee may revise the targeted performance objective. The shares of common stock earned by a participant will be fully vested on the date the performance award is earned.

 

(22) These awards, made under the LTIP, entitle the participating executive to earn shares of common stock to the extent the pre-established performance objective for the three-year performance period beginning on January 1, 2005, and ending on December 31, 2007, is satisfied. The performance objective for the 2005 to 2007 performance period is based on the Company’s total shareholder return compared to other companies in a peer group comprised of 20 gas and electric distribution companies. A participant is eligible to earn a number of shares of common stock ranging from 0% to 200% of the target performance award depending on the extent to which the performance objective is achieved. The performance objective was fixed at the time the awards were made; however, if during the course of the performance period, a significant event occurs, as determined in the sole discretion of the Compensation/Human Resources Committee, that the Committee expects to have a substantial effect on total shareholder return during the period, the Committee may revise the targeted performance objective. The shares of common stock earned by a participant will be fully vested on the date the performance award is earned.

 

(23) These shares will vest on September 1, 2009, subject to Mr. Kamerick’s continued employment.

 

2007 OPTION EXERCISES AND STOCK VESTED

 

     Option Awards    Stock Awards

Name

   Number of
Shares
Acquired on
Exercise
   Value Realized
on Exercise (24)
   Number of
Shares
Acquired on
Vesting (25)
   Value Realized
on Vesting (26)

Dennis R. Wraase

   0    $ 0    102,938    $ 2,633,154

Paul H. Barry

   0      0    0      0

William T. Torgerson

   0      0    45,700      1,169,006

Joseph M. Rigby

   0      0    25,338      648,146

Anthony J. Kamerick

   0      0    9,500      243,010

Thomas S. Shaw

   68,333      748,465    0      0

 

(24) Calculated by aggregating with respect to all of the options exercised the amount by which the closing market price of the Company common stock on the date of exercise exceeded the option exercise price.

 

(25) Shares earned for the 2005 to 2007 Performance Stock award cycle under the LTIP.

 

(26) Represents the aggregate market value of the vested shares calculated by multiplying the number of shares that vested on a given date by the average of the high and low market prices of the Company common stock on the day prior to the vesting date.

 

For the three-year performance cycle ending December 31, 2007, under the LTIP, participating executives, including each of the executive officers listed in the Summary Compensation Table (except Mr. Barry who was not employed by the Company until September 5, 2007), were entitled to earn shares of common stock based on the Company’s total shareholder return (consisting of stock price appreciation and dividends) compared to that of other companies in a peer group comprised of 18 gas and electric distribution companies (including the Company) over the three-year period. During the three-year period, the Company had a total shareholder return of 55.7%, exceeding the median total shareholder return among the peer group companies of 30.8% and ranking the Company fourth within the group of 18. This result entitled each of the participating executives to receive an award of shares equal to 200% of the target number of shares.

 

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PENSION BENEFITS

AT DECEMBER 31, 2007

 

Name

   Plan Name    Number of Years
Of Credited
Service (27)
   Present
Value of
Accumulated
Benefits (28)
   Payments
During Last
Fiscal Year

Dennis R. Wraase

   Pepco General Retirement Subplan    33 yrs., 11 mos.    $ 1,255,537    $ 0
   Executive Retirement Plan    38 yrs., 9 mos.      8,189,380      0
   Employment Agreement
Supplemental Retirement
Benefit
   N/A      4,241,162      0

Paul H. Barry

   PHI Subplan    0 yrs., 3 mos.      1,883      0
   Executive Retirement Plan    0 yrs., 3 mos.      61      0

William T. Torgerson

   Pepco General Retirement Subplan    25 yrs., 2 mos.      838,303      0
   Executive Retirement Plan    38 yrs., 7 mos.      4,073,444      0

Joseph M. Rigby

   Conectiv Cash Balance Subplan    28 yrs., 11 mos.      1,397,024      0
   Conectiv SERP    28 yrs., 11 mos.      993,283      0

Anthony J. Kamerick

   Pepco General Retirement Subplan    37 yrs., 2 mos.      1,424,329      0
   Executive Retirement Plan    37 yrs., 2 mos.      684,705      0

Thomas S. Shaw(29)

   Conectiv Cash Balance Subplan    36 yrs., 1 mo.      0      2,009,203
   Conectiv SERP    39 yrs., 1 mo.      963,559      5,116,723

 

(27) Number of years of service credited at December 31, 2007.

 

(28) Represents the actuarial present value, in the case of Messrs. Wraase, Barry, Torgerson, Rigby, and Kamerick, of the executive’s accumulated pension benefit calculated as of December 31, 2007, assuming the executive retires at the earliest time he may retire under the applicable plan without any benefit reduction due to age and, in the case of Mr. Shaw, of the executive’s actual retirement benefit. The valuation method and all material assumptions applied in calculating the actuarial present value are set forth in Note 6 to the Company’s consolidated financial statements which are included in the Company’s Annual Report to Shareholders attached as Annex B to this Proxy Statement.

 

(29) In October 2007, Mr. Shaw received lump sum payments of $2,009,203 under the Conectiv Cash Balance Subplan and $5,116,723 under the Conectiv SERP, representing payments to which he was entitled by reason of his retirement.

 

Retirement Plans

 

The Company’s retirement plans consist of a tax-qualified defined benefit pension plan and two supplemental executive retirement plans.

 

Pepco Holdings Retirement Plan

 

The Pepco Holdings Retirement Plan consists of several subplans. Each of the executives listed in the Summary Compensation Table participates in either the PHI Subplan, the Pepco General Retirement Subplan or the Conectiv Cash Balance Subplan.

 

Pepco General Retirement Subplan.    All employees who were employed by (i) Pepco on August 1, 2002, the date of the merger of Pepco and Conectiv, or (ii) the Company in the Pepco service territory prior to December 31, 2004, are eligible to participate in the Pepco General Retirement Subplan. The plan provides participating employees who have at least five years of service with retirement benefits based on the participant’s average salary for the final three years of employment and the number of years of credited service under the plan

 

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at the time of retirement. Normal retirement age under the Pepco General Retirement Subplan is 65. Participants who have reached age 55 and have at least 30 years of credited service are eligible for early retirement without any reduction in benefits. Participants who have reached age 55 and who have ten years of credited service are eligible for retirement benefits prior to normal retirement age, at a benefit level that is reduced from the benefit level at normal retirement age by 2% for each year that the early retirement date precedes the normal retirement date. Plan benefits are partially offset by the Social Security benefits received by the participant. Benefits under the plan are paid in the form of a monthly annuity selected by the participant from among several available annuity options. Messrs. Wraase, Torgerson and Kamerick are participants in the Pepco General Retirement Subplan. Messrs. Wraase and Kamerick are eligible for retirement under the plan without any reduction in benefits and Mr. Torgerson is eligible for early retirement with reduced benefits. If Mr. Torgerson had retired on December 31, 2007, the actuarial present value of his retirement benefit under the Pepco General Retirement Subplan as of that date would have been $918,671; however, the additional supplemental retirement benefit he would be entitled to receive under the Supplemental Executive Retirement Benefit Structure of the Executive Retirement Plan, as described below, would offset the reduction in benefits that he would have incurred under the Pepco General Retirement Subplan by reason of his early retirement.

 

Conectiv Cash Balance Subplan.    Most non-unionized employees who were employed by (i) Conectiv on August 1, 2002, or (ii) the Company in the Conectiv service territory prior to December 31, 2004, are eligible to participate in the Conectiv Cash Balance Subplan, including Mr. Rigby and, prior to his retirement on September 1, 2007, Mr. Shaw. The Conectiv Cash Balance Subplan is a cash balance pension plan. Under the plan, a record-keeping account in a participant’s name is credited with an amount equal to a percentage, which varies depending on the participant’s age at the end of the plan year, of the participant’s total pay, consisting of base pay, overtime and bonuses. Also, participants in the Atlantic City Electric Retirement Plan, in which Mr. Rigby participated, and the Delmarva Retirement Plan, in which Mr. Shaw participated, who had at least ten years of credited service as of December 31, 1998, the inception date of the Conectiv Cash Balance Subplan, are eligible to receive additional transition credits until the participant’s combined years of service under the prior plan and the Conectiv Cash Balance Subplan total 35.

 

Participants employed on the inception date of the Conectiv Cash Balance Subplan were credited with an initial cash balance equal to the present value of their annuity benefits as of that date earned under the Atlantic City Electric Retirement Plan or the Delmarva Retirement Plan. Each participant’s account balance is supplemented annually with interest credits equal to the prevailing 30-year U.S. Treasury bond rate. Benefits become vested after five years of service. When a participant terminates employment (regardless of age), the amount credited to his or her account, at the election of the participant, is converted into one of several actuarially equivalent annuities selected by the participant or is paid to the participant in a lump sum (which cannot exceed 6.5 times the participant’s final average compensation). For 2007, Mr. Rigby had a Company credit percentage of 10%, and until December 31, 2013, receives an annual transition credit of 4%, of total pay. For 2007, Mr. Shaw had a Company credit percentage of 10% of total pay.

 

The Conectiv Cash Balance Subplan also provides for certain “grandfathered” rights that existed under the Delmarva Retirement Plan and under the Atlantic City Electric Retirement Plan, which apply to employees who had either 20 years of credited service or had attained age 50 on or before January 1, 1999. Under these grandfathering provisions, employees who participated in the Delmarva Retirement Plan or the Atlantic City Electric Retirement Plan are assured a minimum retirement benefit calculated for all years of service up to the earlier of December 31, 2008, or retirement, according to their original benefit formula under the applicable plan. There is no Social Security offset under either the Delmarva Retirement Plan or the Atlantic City Electric Retirement Plan. Normal retirement age under both the Delmarva Retirement Plan and the Atlantic City Electric Retirement Plan is 65. Under the Delmarva Retirement Plan, participants who have reached age 55 and have at least 15 years of continuous service are eligible for retirement benefits prior to normal retirement age, at a reduced level of benefit that is a function of retirement age and years of service. Under the Atlantic City Electric Retirement Plan, participants who have reached age 55 and have at least five years of credited service are eligible for retirement without any reduction in the benefits they would be entitled to receive at normal retirement age.

 

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Benefits under the Atlantic City Electric Retirement Plan are paid either in the form of a monthly annuity selected by the participant from among several available annuity options or in a lump sum of an actuarial equivalent amount. Benefits under the Delmarva Retirement Plan are payable only in the form of a monthly annuity selected by the participant from several actuarially equivalent annuity options. At the time of an employee’s retirement, the benefit under the Delmarva Retirement Plan or the Atlantic City Electric Retirement Plan is compared to the employee’s cash balance account under the Conectiv Cash Balance Subplan and the employee will receive whichever is greater. On December 31, 2008, the participant’s grandfathered benefit under the Delmarva Retirement Plan or Atlantic City Electric Retirement Plan will be frozen, and all future benefit accruals will be under the cash balance formula of the Conectiv Cash Balance Subplan.

 

Mr. Rigby continues to accrue benefits under the Atlantic City Electric Retirement Plan formula. In the case of Mr. Rigby, the present value of accumulated benefits under the Conectiv Cash Balance Subplan, as shown in the Pension Benefits at December 31, 2007 table above, reflects the value of his grandfathered benefits under the Atlantic City Electric Retirement Plan, which exceeds the value of his accumulated benefits as otherwise calculated under the Conectiv Cash Balance Subplan.

 

Mr. Rigby is not eligible for early retirement under the Atlantic City Electric Retirement Plan formula of the Conectiv Cash Balance Subplan. At December 31, 2007, the amount credited to his account under the Conectiv Cash Balance Subplan was $717,206. Had Mr. Rigby retired on that date, that balance, at his election, would have been converted into one of several actuarially equivalent annuities or would have been paid to him in a lump sum.

 

PHI Subplan.    Persons who become employees of the Company on or after January 1, 2005 are eligible to participate in the PHI Subplan. The plan provides participating employees who are 21 years or older and have at least five years of service with retirement benefits based on the participant’s average salary for the final five years of employment and the number of years of credited service under the plan at the time of retirement. Normal retirement age is 65. Participants who have reached age 55 and who have ten years of credited service are eligible for retirement benefits prior to normal retirement age, at a benefit level that is reduced from the benefit level at normal retirement age by 3% for each year that the early retirement date precedes the normal retirement date. A participant may retire with full benefits at age 62 and with 20 years of service. Benefits under the plan are paid in the form of a monthly annuity selected by the participant from among several available annuity options. Mr. Barry is a participant in the PHI Subplan, but is not currently vested because he has less than five years of service.

 

Executive Retirement Plan

 

The Executive Retirement Plan is a non-tax-qualified supplemental retirement plan. Eligibility to participate in the Executive Retirement Plan is determined by the Company’s Chief Executive Officer (and, in the case of the Chief Executive Officer, by the Board of Directors). The following benefit structures make up the Executive Retirement Plan:

 

Supplemental Benefit Structure.    Under provisions of the Internal Revenue Code, the level of a participant’s pension benefit under a tax-qualified pension plan and the amount of compensation that may be taken into account in calculating that benefit are limited (the “Qualified Plan Limitations”). In addition, under the terms of the Pepco Holdings Retirement Plan, salary deferrals elected by the participant under the Company’s deferred compensation plans (other than the participant’s pre-tax contributions made under the Retirement Savings Plan) are not taken into account as compensation for purposes of calculating a participant’s retirement benefit. If applicable, these provisions have the effect of reducing the participant’s retirement benefit relative to what the participant otherwise would be entitled to receive under the plan’s benefit formula. If a participant’s retirement benefits under the Pepco Holdings Retirement Plan are reduced by either or both of these limitations, the Company, under the Supplemental Benefit Structure, will pay a supplemental retirement benefit to a participant equal to the difference between (i) the participant’s actual benefit under the Pepco Holdings

 

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Retirement Plan and (ii) what the participant would have received under the Pepco Holdings Retirement Plan (A) were the Qualified Plan Limitations not applicable and (B) had the deferred compensation earned by the executive that was excluded from the executive’s compensation base used in determining retirement benefits under the Pepco Holdings Retirement Plan been included in such compensation base. The benefit under the Supplemental Benefit Structure vests under the same terms and conditions as the participant’s retirement benefits under the Pepco Holdings Retirement Plan. Messrs. Wraase, Torgerson, Barry and Kamerick are participants in the Supplemental Benefit Structure. The purpose of the Supplemental Benefit Structure is to enable participants to receive the full retirement benefits they are entitled to receive under the Pepco Holdings Retirement Plan without reduction due the Internal Revenue Code limits and compensation deferral elections made by the participant.

 

Supplemental Executive Retirement Benefit Structure.    Under the Supplemental Executive Retirement Benefit Structure, a participating executive whose employment by the Company terminates on or after age 59 for any reason other than death (or prior to age 59, if such termination follows a change in control of the Company) is entitled to a supplemental retirement benefit equal to the difference between (i) the executive’s actual benefit under the Pepco Holdings Retirement Plan and his supplemental benefits under the Supplemental Benefit Structure and the Executive Performance Supplemental Retirement Benefit Structure (as described below) and (ii) what the executive would have received had the executive been credited with the additional years of service provided for under the Supplemental Executive Retirement Benefit Structure. As of December 31, 2007, the additional years of service credited under the Supplemental Executive Retirement Benefit Structure to the executive officers listed in the Summary Compensation Table were: Mr. Wraase — 4 years, 10 months and Mr. Torgerson — 13 years, 5 months. No years of service credits have been made under the Supplemental Executive Retirement Benefit Structure since 1998. The Company has retained the plan primarily to preserve a mechanism that can be used by the Company, when hiring a new executive, to equate the Company’s pension benefits with those of the executive’s former employer and, if credits are made, to operate as a retention incentive because the benefits under the plan do not vest until age 59. In this regard, the Company, in connection with the employment of Mr. Barry, has agreed to credit him with three additional years of service after five years of employment and an additional three years of service after ten years of employment under the Supplemental Executive Retirement Benefit Structure.

 

Executive Performance Supplemental Retirement Benefit Structure.    Under the Executive Performance Supplemental Retirement Benefit Structure, a participating executive whose employment by the Company terminates on or after age 59 for any reason other than death (or prior to age 59, if either (i) the executive had been designated as a recipient of this benefit prior to August 1, 2002, or (ii) if such termination follows a change in control of the Company) is entitled to a supplemental retirement benefit equal to the difference between (i) the executive’s actual benefit under the Pepco Holdings Retirement Plan and his supplemental retirement benefits under the Supplemental Benefit Structure and the Supplemental Executive Retirement Benefit Structure and (ii) what the executive would have received (A) had the average of the highest three annual incentive awards in the last five consecutive years been added to the executive’s average salary over the final three years of his employment (without regard to any deferral of the receipt of the award by the executive) in calculating the executive’s retirement benefit under the Pepco Holdings Retirement Plan and under the Supplemental Benefit Structure and the Supplemental Executive Retirement Benefit Structure, (B) had the benefits of the executive under the Pepco Holdings Retirement Plan and under the Supplemental Benefit Structure and the Supplemental Executive Retirement Benefit Structure not been reduced by the Qualified Plan Limitations and (C) had the deferred compensation earned by the executive that was excluded from the executive’s compensation base used in determining retirement benefits under the Pepco Holdings Retirement Plan and under the Supplemental Benefit Structure and the Supplemental Executive Retirement Benefit Structure been included in such compensation base. The supplemental benefits provided by the Executive Performance Supplemental Retirement Benefit Structure allow a greater percentage of a participant’s total compensation to be used in the calculation of the executive’s pension benefit and benefits senior executives who typically receive a larger percentage of their total compensation in the form of incentive compensation. The Executive Performance Supplemental Retirement Benefit Structure also has had the effect of making the retirement benefits for participants in the Pepco General

 

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Retirement Subplan more comparable to the retirement benefits received by participants in the Conectiv Cash Balance Subplan, which takes into account bonuses in calculating retirement benefits. Of the executive officers listed in the Summary Compensation Table, only Messrs. Wraase, Torgerson and Kamerick have been designated as participants in the Executive Performance Supplemental Retirement Benefit Structure.

 

The benefits under the Executive Retirement Plan are payable in the form of a monthly annuity, except that if the employment of a participant terminates before age 59 following a “change in control” of the Company (as defined by the plan), the payments due under the Supplemental Executive Retirement Benefit Structure and Executive Performance Supplemental Retirement Benefit Structure will be paid in a lump sum amount equal to the present value of the annuity payments to which the participant otherwise would be entitled. If a participant in the Executive Retirement Plan is discharged by the Company because of misfeasance, malfeasance, dishonestly, fraud, misappropriation of funds, or commission of a felony, the participant’s benefits under the plan will be forfeited.

 

Conectiv Supplemental Executive Retirement Plan

 

Under the Conectiv SERP, a participating executive’s retirement benefit is calculated as it would be under the Conectiv Cash Balance Subplan (i) without giving effect to the Qualified Plan Limitations, (ii) if salary deferrals elected by the participant under the Company’s deferred compensation plans (other than the participant’s pre-tax contributions made under the Retirement Savings Plan) were taken into account as compensation for purposes of calculating a participant’s retirement benefit in the year earned, rather than the year actually paid, and (iii) giving effect to any additional years of service credited to the executive in excess of the executive’s actual years of service. The executive’s benefit under the Conectiv SERP is the amount by which the Conectiv SERP benefit exceeds the executive’s benefit under the Conectiv Cash Balance Subplan, calculated under the cash balance component or based on the executive’s “grandfathered” benefit under the Atlantic City Electric Retirement Plan or the Delmarva Retirement Plan, as applicable. The benefit under the Conectiv SERP is payable at or beginning at the same time as, and in the same manner as, the benefits payable to the participant under the Conectiv Cash Balance Subplan. Only employees who were employed by Conectiv on August 1, 2002, are eligible to participate in the Conectiv SERP. Mr. Rigby is, and Mr. Shaw was, a participant in the Conectiv SERP. The primary purpose of the Conectiv SERP is to enable participating executives to receive the full retirement benefits they are entitled to receive under the Conectiv Cash Balance Plan without reduction due to Internal Revenue Code limits.

 

Under his employment agreement, entered into in 2002, Mr. Shaw was credited with three additional years of service and was deemed three years older than his actual age for purposes of determining his benefits under the Conectiv SERP. This entitled him to three additional years of credited service and added three years to his actual age in calculating his retirement benefit under the Conectiv SERP as compared to the calculation of this benefit under the Delmarva Retirement Plan and to three additional years of pay and interest credits in calculating his cash balance under the Conectiv SERP as compared to his cash balance under the Conectiv Cash Balance Subplan. The purpose of the supplement to his retirement benefits was to encourage him to remain employed by the Company following the merger of Pepco and Conectiv. If Mr. Rigby had retired on December 31, 2007, the net present value of his retirement benefits as of that date under the Conectiv SERP would have been $509,924.

 

Wraase Supplemental Retirement Benefit

 

In connection with the entry into a new employment agreement with Mr. Wraase in July 2007, as more fully described under the heading “Employment Agreements” above, the Company, in consideration for the relinquishment by Mr. Wraase of certain other benefits, agreed to provide Mr. Wraase with a supplemental retirement benefit. Under this arrangement, Mr. Wraase, commencing upon the termination of his employment, will receive a lifetime monthly supplemental retirement benefit, payable in cash, equal to (i) 1/12 of 65% of the sum of (A) his annual base salary rate in effect at the time of the termination of his employment and (B) the

 

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highest annual bonus received during the four calendar years preceding the year in which the termination of his employment occurs (the “Calculation Amount”), less the monthly retirement benefit he receives for that month under the Pepco Holdings Retirement Plan and the Executive Retirement Plan. If Mr. Wraase is survived by his spouse, his spouse is entitled to receive a lifetime monthly supplemental retirement benefit, payable in cash, equal to 75% of the Calculation Amount, less the monthly retirement benefit, if any, payable to her under the Pepco Holdings Retirement Plan and the Executive Retirement Plan.

 

NONQUALIFIED DEFERRED COMPENSATION AT DECEMBER 31, 2007

 

Name

   Executive
Contributions
in Last Fiscal
Year (30)
   Registrant
Contributions
in Last Fiscal
Year (31)
   Aggregate
Earnings
in Last
Fiscal
Year (32)
    Aggregate
Withdrawals/
Distributions
   Aggregate
Balance at
Last Fiscal
Year
End (33)

Dennis R. Wraase

             

Pepco Director and Executive Deferred Compensation Plan

   $ 0    $ 0    $ 133,970     $ 0    $ 1,048,565

PHI Executive and Director Deferred Compensation Plan

     47,915      35,743      87,609       0      1,186,324

Paul H. Barry

             

PHI Executive and Director Deferred Compensation Plan

     5,000      0      (77 )     0      4,923

William T. Torgerson

             

Pepco Director and Executive Deferred Compensation Plan

     0      0      101,687       0      779,598

PHI Executive and Director Deferred Compensation Plan

     18,692      13,993      (3,977 )     0      259,585

Joseph M. Rigby

             

Conectiv Deferred Compensation Plan

     0      0      96,630       0      1,781,533

PHI Executive and Director Deferred Compensation Plan

     16,791      12,466      855       0      36,379

Anthony J. Kamerick

             

PHI Executive and Director Deferred Compensation Plan

     27,182      0      27,698       0      372,724

Thomas S. Shaw

             

Conectiv Deferred Compensation Plan

     0      0      586,693       6,595,054      0

PHI Executive and Director Deferred Compensation Plan

     0      0      40,187       697,453      402,336

 

(30) All amounts shown are included in the “Salary” column of the Summary Compensation Table above.

 

(31) All amounts shown are included in the “All Other Compensation” column of the Summary Compensation Table above.

 

(32) Includes the following amounts previously reported in the Company’s Summary Compensation Table in years prior to 2007 as “above-market” earnings (as defined by SEC regulations) on deferred compensation: Mr. Wraase — $14,209 and Mr. Torgerson — $11,931.

 

(33) Includes the following amounts reported as compensation in the Company’s Summary Compensation Table in years prior to 2007:

 

The PHI Executive and Director Deferred Compensation Plan: Mr. Wraase—$663,766; Mr. Barry—$0; Mr. Torgerson — $123,958; Mr. Rigby — $24,603; Mr. Kamerick — $0; and Mr. Shaw — $972,112 (a portion of this amount was paid to Mr. Shaw upon his retirement on September 1, 2007).

 

The Conectiv Deferred Compensation Plan: Mr. Rigby — $21,468 and Mr. Shaw — $180,866.

 

Deferred Compensation Plans

 

The Company maintains the following deferred compensation plans in which one or more of the executive officers listed in the Summary Compensation Table participate.

 

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PHI Executive and Director Deferred Compensation Plan

 

Under the PHI Executive and Director Deferred Compensation Plan participating executives and directors are permitted to defer the receipt of all or any portion of the compensation to which they are entitled for services performed, including, in the case of executives, incentive compensation. In addition, to the extent an executive is precluded from making contributions to the Retirement Savings Plan, a tax-qualified 401(k) plan, due to limitations imposed by the Internal Revenue Code, the executive is entitled to defer under the plan an amount equal to the contribution the executive is prevented from contributing to the Retirement Savings Plan and receive an additional credit under the plan equal to the matching contribution, if any, that the Company would have made to the executive’s account under the Retirement Savings Plan. Under the terms of the Retirement Savings Plan, employees can contribute to the Retirement Savings Plan up to 6% of their annual salary, with the Company matching 100% the employee’s contribution up to 3% of salary and 50% of any contributions in excess of 3% of salary up to 6% of salary.

 

Under the plan, the Company also credits to each participant’s account on a monthly basis an amount corresponding to, as elected by the participant, any or a combination of: (i) the interest at the prime rate that would have been paid on an amount equal to the participant’s account balance, or (ii) an amount equal to the return that the participant would have earned had his or her account balance been invested in any one or a combination of the investment funds selected by the Compensation/Human Resources Committee or, in the case of directors only, had the account balance been deemed invested in the Company’s common stock. A participant may reallocate his account balance among these investment choices at any time.

 

The distribution to a participant of accrued balances under the plan commences, at the election of the participant, (i) if an executive, on the date of the commencement of payments under the tax-qualified defined benefit plan in which the executive is a participant, (ii) the calendar year following the year in which the participant reaches retirement age, (iii) when the participant’s employment by the Company or service as a director ceases, (iv) when the participant’s employment by the Company or service as a director ceases and the participant attains an age specified by the participant or (v) the date specified by the participant, which may not be earlier than the second calendar year following the year in which the deferrals occurred to which the distribution relates. Distributions may be made, at the election of the participant, either in a lump sum or in monthly or annual installments over a period of between two and fifteen years.

 

Eligibility of executives to participate in the plan is determined by the Company’s Chief Executive Officer (and, in the case of the Chief Executive Officer, by the Board of Directors). All of the executive officers listed in the Summary Compensation Table are eligible to participate in the plan. All non-management directors also are eligible to participate in the plan.

 

Conectiv Deferred Compensation Plan

 

Prior to the merger of Pepco and Conectiv, Conectiv maintained the Conectiv Deferred Compensation Plan under which participating executives were permitted to defer the receipt of all or any portion of the compensation to which the executive was entitled for services performed, including incentive compensation, and to receive employer matching credits on deferrals corresponding to contributions the executive was precluded from making to the Conectiv tax-qualified 401(k) plan due to limitations imposed by the Internal Revenue Code. On August 1, 2002, employee deferrals and matching employer credits under the plan were discontinued.

 

Pre-August 1, 2002, participant deferrals and employer matching contributions are credited to a deferred compensation account and are deemed invested, as elected by the executive, in any of the investment options available to participants under the Conectiv tax-qualified 401(k) plan as of August 1, 2002. A participant may reallocate his account balance among these investment choices at any time. Prior to August 1, 2002, employer matching contributions were credited to an employer matching account in the form of Conectiv common stock equivalents, to which additional credits are made when cash dividends are paid on the Company common stock based on the number of shares that could be purchased with the cash dividend. Of the executive officers listed in the Summary Compensation Table, only Mr. Rigby maintains an account balance under the plan.

 

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Distributions under the plan commence at a time selected by the executive at the time of deferral, provided the date specified by the executive may not be earlier than two years after the year in which a deferral occurs or later than the year in which the executive reaches age 70, and may be made in a lump sum or in equal installment over periods of five, ten or fifteen years, as selected by the executive. In the event of the termination of the executive’s employment following a change in control (as defined by the plan), the committee responsible for the administration of the plan may in its discretion, after consultation with the executive, elect to distribute the executive’s account balances in a lump sum, rather than in accordance with the distribution elections originally selected by the executive.

 

Pepco Director and Executive Deferred Compensation Plan

 

Under the Pepco Director and Executive Deferred Compensation Plan, participating executives were permitted to defer up to 15% of their salary earned between September 1, 1985 and August 31, 1989. Participating directors were permitted to defer all or any portion of their fees for services as a director paid during the same period. In addition, the Board of Directors authorized the deferral by Mr. Wraase, in accordance with the terms of the plan of his 1985 annual incentive award, in the amount of $9,563 and his target 1986 annual incentive award in the amount of $12,800.

 

Under this plan, participant account balances attributed to salary and director fee deferrals are credited annually with an amount corresponding to a fixed interest rate of 15%, and Mr. Wraase’s incentive deferrals are credited annually with an amount corresponding to a fixed interest rate of 12%, which in each case were established at the time of deferral.

 

Under the terms of the plan, amounts deferred (other than Mr. Wraase’s deferral of his 1985 annual incentive award) by an executive or director who on his nearest birthday to September 1, 1985, was below age 54, but not the interest credits thereon, were distributed to that person in a lump sum on the first day of the eighth plan year following the date of the deferral. The distribution of the remaining balance to which an executive is entitled (including Mr. Wraase’s 1985 annual incentive award deferral) will commence at age 65 and will be paid out over a 15-year period in substantially equal monthly installments, subject to reduction by an adjustment factor if the executive’s employment terminates prior to age 62 for any reason other than death, total or permanent disability or a change in control. In the event of the termination of the executive’s employment before age 62 following a change in control, the executive will receive a lump sum payment equal to the net present value of the expected monthly annuity payments beginning at age 65. The distribution of the remaining balance to which a director is entitled commences at age 65 and is paid out in substantially equal monthly installments until age 80.

 

Of the executive officers listed in the Summary Compensation Table, only Messrs. Wraase and Torgerson maintain account balances under this plan and of the Company’s directors, only Mr. O’Malley, who retired in 2007, maintains an account balance under this plan.

 

Termination of Employment and Change in Control Benefits

 

The following is a description of the Company’s plans and arrangements that provide for payments to the executive officers listed in the Summary Compensation Table, following or in connection with the termination of the executive’s employment, a change in control of the Company, or a change in the executive’s responsibilities. Because Mr. Shaw ceased to be an executive officer of the Company on or before December 31, 2007, the description of such plans and arrangements as they relate to him is limited, as permitted by SEC rules, to a discussion of the consequences of the termination of his employment.

 

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Employment Agreements

 

The employment agreements of Messrs. Wraase, Torgerson, Rigby and Shaw, and the letter of employment entered into with Mr. Barry, each provides the executive with specified benefits if the employment of the executive is terminated under various circumstances, as described below:

 

Mr. Wraase.    The employment agreement of Mr. Wraase provides that upon the termination of his employment at any time and for any reason, including voluntary resignation or retirement, Mr. Wraase will be entitled to receive the following benefits:

 

   

The supplemental retirement benefit described under the heading “Executive Retirement Plan — Wraase Supplemental Retirement Benefit.”

 

   

All unvested Restricted Stock Program awards under the LTIP will vest on April 1, 2009 regardless of whether Mr. Wraase is employed on that date.

 

   

All outstanding Performance Stock Program awards under the LTIP will be pro-rated for the time Mr. Wraase was employed during the applicable performance period to the extent the pre-established performance objectives are achieved at the end of the performance period.

 

 

 

Tax preparation and planning services until his 70th birthday at the same level he was receiving such services at the time his employment terminated.

 

Messrs. Torgerson and Rigby.    The employment agreements of Messrs. Torgerson and Rigby each provides the executive with specified benefits if the employment of the executive is terminated under any of the circumstances described below, whether or not such termination is connected with a change in control of the Company:

 

Termination by the Company Other Than for Cause.    If at any time during the term of the executive’s employment the Company terminates the executive’s employment other than for cause (“cause” is defined as (i) intentional fraud or material misappropriation with respect to the business or assets of the Company, (ii) the persistent refusal or willful failure of the executive to perform substantially his duties and responsibilities to the Company after the executive receives notice of such failure, (iii) conduct that constitutes disloyalty to the Company and that materially damages the property, business or reputation of the Company, or (iv) the conviction of a felony involving moral turpitude), the executive will be entitled to:

 

   

A lump sum severance payment equal to three times the sum of (i) the executive’s highest annual base salary in effect at any time during the three-year period preceding the termination of employment and (ii) the higher of (A) the executive’s annual bonus for the year in which the termination of employment occurs or (B) the highest annual bonus received by the executive during the three calendar years preceding the calendar year in which the termination of employment occurs.

 

   

The executive’s annual bonus for the year in which the termination occurs, if the Board of Directors, before the termination date, has made a good faith determination of the executive’s bonus for the year, and otherwise a prorated portion (based on the number of days the executive was employed during the year) of the executive’s target annual bonus for the year.

 

   

Any shares under the Restricted Stock Program the vesting of which is contingent solely on the continued employment of the executive and that would have become vested had he remained employed for the remainder of the term of his employment agreement will become vested and non-forfeitable on the date the executive’s employment terminates.

 

   

Any shares under the Performance Stock Program that are the subject of an award the vesting of which is contingent on the achievement of specified performance goals during a performance period that ends within the term of the executive’s employment agreement will become vested at the end of the performance period if and to the extent the performance goals are achieved.

 

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In addition to the retirement benefits to which the executive is entitled under the Pepco Holdings Retirement Plan and the Company’s supplemental retirement plans in which he participates, as more fully described under the heading “Retirement Plans” above, a lump sum supplemental retirement benefit paid in cash equal to the difference between (i) the present value of the executive’s vested retirement benefit accrued at the time of termination under the Pepco Holdings Retirement Plan and any excess or supplemental retirement plan in which the executive is a participant and (ii) the benefit the executive would be entitled to receive under the Pepco Holdings Retirement Plan and such excess and supplemental retirement plans assuming: (i) in the case of Mr. Torgerson that (A) his earnings for the benefit computation are equal to his annual base salary rate in effect immediately prior to his termination, plus the highest annual bonus awarded to him in any of the three years preceding his termination of employment or, if higher, his annual bonus for the year in which the termination occurs and (B) he has reached age 62 and has completed 40 years of service (or, if greater, the age and years of service that he would have reached at the end of the term of his employment agreement in effect at the time his employment terminates), and (ii) in the case of Mr. Rigby that he is three years older than his actual age and is credited with three additional years of service.

 

Voluntary Resignation by the Executive under Specified Circumstances.    If, at any time during the term of the executive’s employment agreement, the executive terminates his employment under any of the following circumstances, he will receive under his employment agreement the same benefits that he would have received had the Company terminated his employment without cause as described above: (i) the base salary of the executive is reduced (other than a reduction consistent and proportional with the overall reduction, due to extraordinary business conditions, in the compensation of all other senior executives of the Company), (ii) the executive is not in good faith considered for incentive awards under the Company’s plans in which senior executives are eligible to participate, (iii) the Company fails to provide the executive with retirement, fringe and supplemental benefits in a manner similar to other senior executives, (iv) the Company relocates the executive’s place of employment to a location further than 50 miles from Washington, D.C. (or, in the case of Mr. Rigby, a location further than 50 miles from Wilmington, Delaware, other than the Washington, D.C. metropolitan area) or (v) the executive is demoted to a position that is not a senior management position (other than due to the executive’s disability).

 

Resignation or Termination Due to Disability or Death.    Upon his resignation (other than under the circumstances specified above) or upon his death or disability (which shall be deemed to have occurred if he becomes entitled to long-term disability benefits under the Company’s disability plan or policy), the employment agreements provide that the executive will not be entitled to any benefits beyond those provided for under the terms of the Company benefit plans in which the executive participates.

 

Gross-up Payments.    Each of the employment agreements also provides that, if any payments or benefits provided to the executive under his employment agreement, or under any other plan, program, agreement or arrangement of the Company, are determined to be payments related to a change in control within the meaning of Section 280G of the Internal Revenue Code, and as a result the executive incurs an excise tax under Section 4999 of the Internal Revenue Code, the executive will be entitled to receive a gross-up payment in an amount equal to the amount of all excise taxes imposed upon compensation payable upon termination of employment and the additional taxes that result from such payment, such that the aggregate net payments received by the executive will be the same as they would have been had such excise tax not been imposed.

 

Mr. Barry.    At time of his employment in September 2007, the Company entered into a letter of employment with Mr. Barry which included his base salary, the annual and long-term incentive award opportunities which were awarded on the same basis as other similarly situated executives prorated for time of service, his participation in various of the Company’s benefit programs previously described and reimbursement for relocation expenses, including a gross-up for any tax incurred on amounts reimbursed.

 

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Mr. Kamerick.    In September 2007, the Company entered into an agreement with Mr. Kamerick which awarded him 5,409 shares of the Company’s stock which will vest on September 1, 2009, assuming Mr. Kamerick is still employed by the Company, and increased his salary as discussed above. In 2004, the Company entered into an employment agreement with Mr. Kamerick that provided for a payment of $200,000 if he remained employed through January 31, 2007. The employment agreement terminated on January 31, 2007 and Mr. Kamerick then became an at will employee.

 

Change in Control Severance Plan

 

Under the Change in Control Severance Plan, if, within one year following a change in control, a participating executive’s employment is terminated by the Company without “cause” or the executive terminates his or her employment for “good reason,” the executive will be entitled to the following termination benefits:

 

   

A severance payment equal to the sum of executive’s salary and target annual bonus for the year in which the termination occurs, multiplied by a factor of 1.5, 2 or 3, depending upon the executive’s position (a “Benefit Factor”).

 

   

The executive’s prorated portion (based on the number of days the executive was employed during the year) of the executive’s target annual bonus for the year.

 

   

A lump sum supplemental retirement benefit paid in cash equal to the difference between (i) the present value of the executive’s vested retirement benefit accrued at the time of termination under the Pepco Holdings Retirement Plan and any excess or supplemental retirement plan in which the executive is a participant and (ii) the benefit the executive would be entitled to receive under such plans assuming that the executive was the number of years older and had been credited with the number of years of service equal to the executive’s Benefit Factor.

 

   

For a period of time equal to the executive’s Benefit Factor, medical, dental, group life and disability benefits that generally are at least at a level substantially similar to the level in effect prior to the change in control.

 

   

A gross-up payment in an amount equal to the amount of all excise taxes imposed upon compensation payable upon termination of employment and the additional taxes that result from such payment, such that the aggregate net payments received by the executive will be the same as they would have been had such excise tax not been imposed.

 

The receipt of the benefits is contingent upon the execution by the employee of (i) a general release and a non-disparagement agreement and (ii) a covenant against competition with the Company or a solicitation of its employees, each in form and substance satisfactory to the Company. Of the executive officers named in the Summary Compensation Table, only Mr. Barry (with a Benefit Factor of 3) and Mr. Kamerick (with a Benefit Factor of 2) are participants in the Change in Control Severance Plan.

 

Long-Term Incentive Plan

 

Under the LTIP, if the employment of a recipient of an award is terminated by the Company or the recipient terminates his or her employment for “good reason” within 12 months following a “change in control,” the recipient’s outstanding awards under the LTIP will be affected as follows:

 

   

A pro-rata portion of any Restricted Stock Program or restricted stock unit award that is subject to vesting contingent on the continued employment of the recipient (“service-based vesting”) will become immediately vested based on the number of months of the restricted period that have elapsed as of the termination date.

 

   

A pro-rata portion of any Performance Stock Program or restricted stock unit award that is subject to vesting contingent on the satisfaction of established performance criteria (“performance-based vesting”)

 

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will become immediately vested based on the number of months of the restricted period that have elapsed as of the termination date and on the assumption that the target level of performance has been achieved.

 

   

Any stock option or stock appreciation right not then exercisable will become immediately exercisable.

 

A “change in control” will occur under the terms of the LTIP if generally: (i) any person is or becomes the “beneficial owner” (as defined under SEC rules), directly or indirectly, of securities of the Company (excluding any securities acquired directly from the Company) representing 35% or more of the combined voting power of the Company’s then outstanding securities, (ii) during any period of 12 consecutive months, the individuals who, at the beginning of such period, constitute the Company’s Board of Directors cease for any reason other than death to constitute at least a majority of the Board of Directors, (iii) the consummation of a merger or consolidation of the Company with any other corporation, other than a merger or consolidation that would result in the voting securities of the Company outstanding immediately prior to the merger or consolidation continuing to represent at least 50% of the combined voting power of the voting securities of the Company or the surviving company, or (iv) the stockholders of the Company approve a plan of complete liquidation or dissolution of the Company or there is consummated an agreement for the sale or disposition by the Company of all or substantially all of the Company’s assets.

 

Under the LTIP, a recipient of an award will have “good reason” to terminate his or her employment if, without the written consent of the recipient, any of the following events occurs following a “change in control”: (i) the assignment to the recipient of any duties inconsistent in any materially adverse respect with his or her position, authority, duties or responsibilities in effect immediately prior to the change in control, (ii) there is a reduction in the recipient’s base salary from that in effect immediately before the change in control, (iii) there is a material reduction in the recipient’s aggregate compensation opportunity, consisting of base salary, bonus opportunity, and long-term or other incentive compensation opportunity, (iv) the Company requires the recipient to be based at any office or location more than 50 miles from that location at which he or she performed his or her services immediately prior to the occurrence of the change in control, or (v) any successor company fails to agree to assume the Company’s obligations to the recipient under the LTIP.

 

Under the terms of the LTIP, if a “change in control” of the Company were to occur, and within 12 months thereafter the employment of any of Messrs. Wraase, Barry, Torgerson, Rigby or Kamerick were to be terminated by the Company or a successor company or such executive were to terminate his employment for “good reason,” the provisions of the LTIP, with respect to the vesting of Restricted Stock Program and Performance Stock Program stock, would apply only to any such awards with a performance period that ended after the term of the executive’s employment agreement. For those awards with a performance period ending within the executive’s employment agreement, the provisions of the LTIP would be superseded by the terms of each executive’s employment agreement, as more fully described above under the heading “Termination of Employment and Change in Control Benefits — Employment Agreements.”

 

If the employment of a recipient of a Restricted Stock Program or Performance Stock Program award terminates because of retirement, early retirement at the Company’s request, death or disability prior to vesting, the payout of the award will be prorated, in the case of an award subject to service-based vesting, for service during the performance period and, in the case of an award subject to performance-based vesting, taking into account factors including, but not limited to, service and the performance of the participant before employment ceases, unless the Compensation/Human Resources Committee determines in either case that special circumstances warrant modification of the payment to which the participant is entitled. If the employment of a recipient of a Restricted Stock Program or Performance Stock Program award terminates for any other reason, the award is forfeited, except in the case of early retirement at the request of the participant, in which case the payout or forfeiture is at the discretion of the Compensation/Human Resources Committee.

 

If employment of the holder of a stock option terminates because of retirement, early retirement, death or disability, the option will remain exercisable for the remainder of its term, unless the Compensation/Human Resources Committee determines that special circumstances warrant modification of this result. Otherwise, the option will lapse on the effective date of the holder’s termination of employment.

 

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Executive Incentive Compensation Plan

 

Under the EICP, if a participant retires, dies or becomes disabled prior to the end of a plan year, the participant is entitled to a pro rated portion of the award to which the participant otherwise would be entitled based on the portion of the year that the participant was employed. If the employment of the participant terminates for any other reason during the plan year, the participant will be entitled to an award only to the extent provided for in his employment agreement or under the Change in Control Severance Plan. See “Termination of Employment and Change in Control Benefits — Employment Agreements and — Change in Control Severance Plan.”

 

Retirement Plan Benefits

 

Messrs. Wraase, Torgerson and Kamerick are participants in the Pepco General Retirement Subplan of the Pepco Holdings Retirement Plan and Mr. Rigby is a participant in the Conectiv Cash Balance Subplan of the Pepco Holdings Retirement Plan. Mr. Barry is a participant in the PHI Subplan of the Pepco Holdings Retirement Plan. For a discussion of their benefits under these defined benefit retirement plans and under the corresponding supplemental retirement plans and arrangements in the event of a termination of employment, see the discussion under the heading “Retirement Plans” above.

 

Deferred Compensation Plans

 

Messrs. Wraase, Barry, Torgerson, Rigby, and Kamerick each is a participant in one or more Company deferred compensation plans. For a discussion of the payments to which they are entitled to under these plans following a termination of employment, see the discussion under the heading, “Deferred Compensation Plans” above.

 

Quantification of Termination of Employment Benefits

 

The following discussion quantifies the benefits that each of Messrs. Wraase, Barry, Torgerson, Rigby, and Kamerick would have been entitled to receive under his employment agreement and the Company’s compensation plans (other than under the Company’s defined benefit retirement plans and corresponding supplemental retirement plans and arrangements and under the Company’s deferred compensation plans, the benefits under which are described above under the headings “Retirement Plans” and “Deferred Compensation Plans”) if his employment had terminated on December 31, 2007, under specified circumstances:

 

Termination by the Company Other Than for Cause or Voluntary Resignation By the Executive under Specified Circumstances (no change in control).    If, as of December 31, 2007, the employment of Messrs. Wraase, Torgerson or Rigby, had been terminated by the Company other than for cause, or the executive had voluntarily terminated his employment for any of the reasons specified in his employment agreement, the executive would have received the benefits shown in the following table. If, as of December 31, 2007, Mr. Barry’s employment had been terminated by the Company other than for cause, he would have received under the terms of his letter of employment, the benefits shown in the following table. Because Mr. Kamerick does not have an employment agreement, he was not entitled to benefits under these circumstances.

 

    Severance
Payment
  EICP Payment
(34)
  Accelerated
Vesting of
Service-
Based
Restricted
Stock (35)
  Target
Performance-Based
Restricted Stock
(36)
  Lump Sum
Supplemental
Retirement
Benefit

Payment

Dennis R. Wraase

  $ 0   $ 0   $ 1,602,533   $ 1,625,351   $ 0

Paul H. Barry

    500,000     100,000     0     0     0

William T. Torgerson

    3,350,880     579,960     225,137     450,245     913,490

Joseph M. Rigby

    2,731,500     335,500     48,336     0     2,560,767

Anthony J. Kamerick

    0     0     0     0     0

 

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(34) For Messrs. Torgerson and Rigby, reflects the Compensation/Human Resources Committee’s determination of the actual bonus paid for 2007. Mr. Barry would be entitled to his target bonus of $100,000 in accordance with his letter of employment. Messrs. Wraase and Kamerick are not entitled to an award under these circumstances.

 

(35) Represents the market value on December 31, 2007 of the shares of Restricted Stock that would vest and become non-forfeitable, as calculated by multiplying the number of shares by $29.33, the closing market price on that day.

 

(36) Represents the market value on December 31, 2007 of shares of Company common stock issuable under the LTIP to which the executive would be entitled at the end of the performance cycle periods in which he participates, assuming that the targeted level of performance is achieved. If Performance Stock is earned, each executive also is entitled under the terms of his award to receive, in addition to the award shares earned, shares of Company common stock equal in number to the shares that the executive would have acquired had the cash dividends paid during the performance period on the number of shares of common stock equal to the number of Performance Stock earned been reinvested in shares of common stock. The additional number of shares that would be received by the executive is as follows: Mr. Wraase — 12,973 shares; Mr. Torgerson — 1,877 shares.

 

Termination by the Company Other Than for Cause or Voluntary Resignation By the Executive under Specified Circumstances (following a change in control).    If, as of December 31, 2007, the employment of the executive following a change in control had been terminated by the Company other than for cause, or the executive had voluntarily terminated his employment for any of the reasons specified in his employment agreement, or in the case of Messrs. Barry and Kamerick, as specified in the Change in Control Severance Plan, the executive would have received, in addition to the benefits shown in the preceding table, the following benefits. The benefit in the column headed “Section 280G Gross-up Payment” would have been made only if the payments made to the executive would have caused the executive to incur an excise tax under Section 4999 of the Internal Revenue Code.

 

    Severance
Payment
  Lump Sum
Supplemental
Retirement
Benefit

Payment
  Accelerated
Vesting of
Service-
based
Restricted

Stock (37)
  Target
Performance-
Based
Restricted

Stock (38)
  Welfare
Plan
Benefit
Payment
  Section
280G Gross-
Up Payment

Dennis R. Wraase

  $ 0   $ 0   $ 0   $ 0   $ 0   $ 0

Paul H. Barry

    1,900,000     118,774     19,592     39,185     13,863     1,254,064

William T. Torgerson

    0     0     66,990     133,979     0     2,314,526

Joseph M. Rigby

    0     0     176,508     353,016     0     2,970,239

Anthony J. Kamerick

    1,050,000     890,320     76,552     100,162     27,244     914,740

 

(37) Represents the market value on December 31, 2007 of the additional shares of restricted Company common stock that would vest and become non-forfeitable under the terms of the LTIP if the termination of the executive’s employment occurred within one year following the change in control.

 

(38) Represents the market value on December 31, 2007 of shares of Company common stock issuable under the LTIP to which the executive would be entitled under the terms of the LTIP at the end of the performance cycle periods in which he participates, assuming that the target level of performance is achieved, if the termination of the executive’s employment occurred within one year following the change in control. The additional shares of Company common stock that the executive would receive based on the reinvestment of cash dividends paid during the performance period on the number of Performance Stock earned is as follows: Mr. Barry — 152 shares; Mr. Torgerson — 524 shares; Mr. Rigby — 1,442 shares and Mr. Kamerick — 409 shares.

 

Retirement or Termination of Employment Due to Death or Disability.    If, as of December 31, 2007, the executive had retired (including early retirement at the Company’s request) or his employment had terminated because of his death or disability, the executive (or his estate) would have been entitled under the terms of the LTIP, unless otherwise determined by the Compensation/Human Resources Committee, to (i) the accelerated

 

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vesting of a pro-rata portion of each outstanding time-based Restricted Stock award issued to the executive under the Restricted Stock Program and (ii) the accelerated vesting of a pro-rata portion of the Performance Stock awards issuable pursuant to any then-uncompleted performance periods as determined by the Compensation/Human Resources Committee taking into account factors including, but not limited to, the period of the executive’s service prior to termination and the performance of the executive before his employment ceased. In addition, under the terms of the EICP, the executive is entitled to a pro-rata portion of his award based on the portion of the year for which he was employed. The executive would not have been entitled to any severance payment or supplemental retirement benefit payment.

 

Resignation by the Executive (Other than Resignation under Specified Circumstances).    If, as of December 31, 2007, any of the NEOs had resigned (other than for specified circumstances), the executive would not have been entitled to receive any severance payment, EICP payment or supplemental retirement benefit payment, and, with the exception of Mr. Wraase, all unvested shares of Restricted Stock issued to the executive under the Restricted Stock Program of the LTIP, and any shares of common stock that the executive had the opportunity to earn under the Performance Stock Program of the LTIP, would have been forfeited. See “Employment Agreements—Mr. Wraase” above.

 

Termination for Cause.    If, as of December 31, 2007, the executive’s employment had been terminated for cause (i) the executive would not have been entitled to any severance payment, EICP payment or supplemental retirement benefit payment and (ii) all unvested shares of restricted stock issued to the executive under the Restricted Stock Program of the LTIP, and any shares of common stock that the executive had the opportunity to earn under the Performance Stock Program of the LTIP, would have been forfeited.

 

Shaw Retirement Arrangements

 

On September 1, 2007, Mr. Shaw retired as an employee of the Company. In connection with his retirement, Mr. Shaw has received (in addition to the benefits he has received or is entitled to receive, under the Company’s defined benefit retirement plans and corresponding supplemental retirement plans and under the Company’s deferred compensation plans, the benefits under which are described above under the headings “Retirement Plans” and “Deferred Compensation Plans”) an annual bonus for 2007 in the amount of $229,680, representing a prorated portion of his target annual bonus for the year.

 

BOARD REVIEW OF TRANSACTIONS WITH RELATED PARTIES

 

The Board of Directors has adopted Procedures for Evaluating Related Person Transactions (the “Procedures”) which set forth the procedures followed by the Board in review and approval or ratification of transactions with related persons to ensure compliance with PHI’s Conflicts of Interest Business Policy, Corporate Governance Guidelines, and applicable law. Related persons include directors, nominees for election as a director and specified executives (“covered persons”) as well as the members of their immediate family. The Procedures apply to any situation where a related person serves as a director, officer or partner of, a consultant to, or in any other key role with respect to, any outside enterprise which does or seeks to do business with, or is a competitor of, the Company or any affiliate of the Company. The Procedures can be found on the Company’s Web site (www.pepcoholdings.com) by first clicking on the link: Corporate Governance and then the link: Business Policies.

 

The Procedures require that each covered person provide to the Corporate Secretary annually a completed questionnaire setting forth all business and other affiliations which relate in any way to the business and other activities of the Company and its affiliates. Each covered person should also, throughout the year, update the information provided in the questionnaire as necessary.

 

When a related person transaction is contemplated, all of the material facts regarding the substance of the proposed transaction, including the material facts relating to the related person’s or other party’s relationship or interest, shall be fully disclosed to the members of the Corporate Governance/Nominating Committee (excluding

 

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any member of the Committee who has an interest in the transaction). The members of the Corporate Governance/Nominating Committee will review the contemplated transaction and will then make a recommendation to the disinterested members of the Board. At a Board meeting, all of the material facts regarding the substance of the proposed transaction, including the facts relating to the related person’s or other party’s relationship or interest and the recommendation of the Corporate Governance/Nominating Committee, shall be fully disclosed to the Board. Approval of the transaction requires the affirmative vote of a majority of the disinterested directors voting.

 

The Procedures generally require that related person transactions be approved in advance. On occasion, however, it may be in the Company’s interest to commence a transaction before the Corporate Governance/Nominating Committee or Board has had an opportunity to meet, or a transaction may commence before it is discovered that a related person is involved with the transaction. In such instances, the Procedures require the covered person to consult with the Chairman of the Corporate Governance/Nominating Committee to determine the appropriate course of action, which may include subsequent ratification by the affirmative vote of a majority of the disinterested directors. If the Chairman of the Corporate Governance/Nominating Committee is an interested director, the Procedures require the covered person to consult with the Lead Independent Director to determine the appropriate course of action.

 

AUDIT COMMITTEE REPORT

 

Among its duties, the Audit Committee is responsible for recommending to the Board of Directors that the Company’s financial statements be included in the Company’s Annual Report on Form 10-K. The Committee took a number of steps as a basis for making this recommendation for 2007. First, the Audit Committee discussed with PricewaterhouseCoopers LLP, the Company’s independent registered public accounting firm for 2007, those matters that PricewaterhouseCoopers LLP is required to communicate to and discuss with the Audit Committee under Statement on Auditing Standards No. 61, as amended (Communication with Audit Committees) as adopted by the Public Company Accounting Oversight Board (the “PCAOB”), which included information regarding the scope and results of the audit. These communications and discussions are intended to assist the Audit Committee in overseeing the financial reporting and disclosure process. Second, the Audit Committee discussed with PricewaterhouseCoopers LLP that firm’s independence and received from PricewaterhouseCoopers LLP a letter concerning independence as required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees) as adopted by the PCAOB. This discussion and disclosure informed the Audit Committee of PricewaterhouseCoopers LLP’s relationships with the Company and was designed to assist the Audit Committee in considering PricewaterhouseCoopers LLP’s independence. Finally, the Audit Committee reviewed and discussed, with the Company’s management and with PricewaterhouseCoopers LLP, the Company’s audited consolidated balance sheets at December 31, 2007 and 2006, and the Company’s consolidated statements of earnings, comprehensive earnings, shareholders’ equity and cash flows for the three years ended December 31, 2007, including the notes thereto. Management is responsible for the consolidated financial statements and reporting process, including the system of internal controls and disclosure controls. The independent registered public accounting firm is responsible for expressing an opinion on the conformity of these consolidated financial statements with accounting principles generally accepted in the United States. Based on the discussions with management and PricewaterhouseCoopers LLP concerning the audit, the independence discussions, and the financial statement review and discussions, and such other matters deemed relevant and appropriate by the Audit Committee, the Audit Committee recommended to the Board that the consolidated financial statements be included in the Company’s 2007 Annual Report on Form 10-K.

 

The Audit Committee, in accordance with its charter, conducts an annual evaluation of the performance of its duties. Based on this evaluation, the Committee concluded that it performed effectively in 2007.

 

AUDIT COMMITTEE

Frank K. Ross, Chairman

Terence C. Golden

Barbara J. Krumsiek

Richard B. McGlynn

Lawrence C. Nussdorf

 

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2. RATIFICATION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Audit Committee of the Board of Directors of the Company appointed PricewaterhouseCoopers LLP as independent registered public accounting firm for the Company for the year 2007. The Audit Committee has reappointed the firm for 2008. A representative of PricewaterhouseCoopers LLP is expected to attend the Annual Meeting and will be given the opportunity to make a statement and to respond to appropriate questions.

 

Although the Company is not required to seek shareholder ratification of this appointment, the Board believes it to be sound corporate governance to do so. If the appointment is not ratified, the Audit Committee will take this fact into consideration when selecting the Company’s independent registered public accounting firm for 2009. Even if the selection is ratified, the Audit Committee may in its discretion direct the appointment of a different independent registered public accounting firm at any time during the year if the Committee determines that a change would be in the best interests of the Company and its shareholders.

 

Audit Fees

 

The aggregate fees billed by PricewaterhouseCoopers LLP for professional services rendered for the audit of the annual financial statements of the Company and its subsidiary reporting companies for the 2007 and 2006 fiscal years, reviews of the financial statements included in the 2007 and 2006 Forms 10-Q of the Company and its subsidiary reporting companies, reviews of public filings, comfort letters and other attest services were $6,074,408 and $5,589,719, respectively. The amount for 2006 includes $74,592 for the 2006 audit that was billed after the 2006 amount was disclosed in Pepco Holdings’ Proxy Statement for the 2007 Annual Meeting.

 

Audit-Related Fees

 

The aggregate fees billed by PricewaterhouseCoopers LLP for audit-related services rendered for the 2007 and 2006 fiscal years were zero and $25,853, respectively. These services consisted of employee benefit plan audits. The amount for 2006 includes $6,117 for the 2006 employee benefit plan audit that was billed after the 2006 amount was disclosed in Pepco Holdings’ proxy statement for the 2007 Annual Meeting.

 

Tax Fees

 

The aggregate fees billed by PricewaterhouseCoopers LLP for tax services rendered for the 2007 and 2006 fiscal years were $126,810 and $121,951 respectively. These services consisted of tax compliance, tax advice and tax planning. The amount for 2006 includes $35,791 for the 2006 tax fees that was billed after the 2006 amount was disclosed in Pepco Holdings’ proxy statement for the 2007 Annual Meeting.

 

All Other Fees

 

The aggregate fees billed by PricewaterhouseCoopers LLP for all other services other than those covered under “Audit Fees,” “Audit-Related Fees” and “Tax Fees” for the 2007 and 2006 fiscal years were $41,740 and $20,419, respectively, which represents the costs of training and technical materials provided by PricewaterhouseCoopers LLP.

 

All of the services described in “Audit Fees,” “Audit-Related Fees,” “Tax Fees” and “All Other Fees” were approved in advance by the Audit Committee, in accordance with the Audit Committee Policy on the Approval of Services Provided by the Independent Auditor, which is attached to this Proxy Statement as Annex A.

 

What vote is required to ratify the selection of the independent registered public accounting firm?

 

Ratification of the appointment of the independent registered public accounting firm requires the affirmative vote of the holders of a majority of the common stock present and entitled to vote at the meeting.

 

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How are the votes counted?

 

Shares, if any, which are the subject of an abstention with regard to the vote on this proposal will be considered present and entitled to vote, and accordingly will have the same effect as a vote against the proposal. Any shares that are the subject of a “broker non-vote” will not be considered present and entitled to vote and, therefore, will not be included in the denominator when determining whether the requisite percentage of shares has been voted in favor of this matter.

 

THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE IN FAVOR OF RATIFICATION OF PRICEWATERHOUSECOOPERS LLP AS THE COMPANY’S INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM, WHICH IS SET FORTH AS ITEM 2 ON THE PROXY CARD.

 

SHAREHOLDER PROPOSALS AND DIRECTOR NOMINATIONS

 

What is the deadline for submission of shareholder proposals for inclusion in the Company’s proxy statement for the 2009 Annual Meeting?

 

In order to be considered for inclusion in the proxy statement for the 2009 Annual Meeting, shareholder proposals must be received by the Company on or before November 27, 2008.

 

May a shareholder introduce a resolution for a vote at a future annual meeting?

 

Under the Company’s Bylaws, a shareholder may introduce a resolution for consideration at a future Annual Meeting if the shareholder complies with the advance notice provisions set forth in the Bylaws. These provisions require that for a shareholder to properly bring business before an Annual Meeting, the shareholder must give written notice to the Company’s Secretary at 701 Ninth Street, N.W., Washington, D.C. 20068, not less than 100 days nor more than 120 days prior to the date of the meeting (or if the date of the meeting is more than 30 days before or after the anniversary date of the Annual Meeting in the prior year, then the written notice must be received no later than the close of business on the tenth day following the earlier of the date on which notice or public announcement of the date of the meeting was given or made by the Company). The shareholder’s notice must set forth a description of the business desired to be brought before the meeting and the reasons for conducting the business at the Annual Meeting, the name and record address of the shareholder, the class and number of shares owned beneficially and of record by the shareholder, and any material interest of the shareholder in the proposed business. The Company will publicly announce the date of its 2009 Annual Meeting at a later date.

 

May a shareholder nominate or recommend an individual for election as a director of the Company?

 

Under the Company’s Bylaws, a shareholder may nominate an individual for election as a director at a future Annual Meeting by giving written notice of the shareholder’s intention to the Company’s Secretary at 701 Ninth Street, N.W., Washington, D.C. 20068, not less than 100 days nor more than 120 days prior to the date of the meeting (or if the date of the meeting is more than 30 days before or after the anniversary date of the Annual Meeting in the prior year, then the written notice must be received no later than the close of business on the tenth day following the earlier of the date on which notice or public announcement of the date of the meeting was first given or made by the Company). The notice provided to the Secretary must set forth the name and record address of the nominating shareholder and the class and number of shares of capital stock of the Company beneficially owned by such shareholder; and, for each nominee, the nominee’s name, age, business address, residence address, principal occupation or employment, the class and number of shares of the Company’s capital stock beneficially owned by the nominee, and any other information concerning the nominee that would be required to be included in a proxy statement. The Company will publicly announce the date of its 2009 Annual Meeting at a later date.

 

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A shareholder also may recommend for the consideration of the Corporate Governance/Nominating Committee one or more candidates to serve as a nominee of the Company for election as a director. Any such recommendations for the 2009 Annual Meeting must be submitted in writing to the Secretary of the Company on or before November 27, 2008, accompanied by the information described in the preceding paragraph.

 

What principles has the Board adopted with respect to Board membership? What are the specific qualities or skills that the Corporate Governance/Nominating Committee has determined are necessary for one or more of the directors to possess?

 

The Board has approved the following principles with respect to Board membership. The Board should include an appropriate blend of independent and management directors, which should result in independent directors being predominant and in the views of the Company’s management being effectively represented. Accordingly, the number of independent directors should never be less than seven and the management directors should always include the Chief Executive Officer, there should never be more than three management directors, and any management directors other than the Chief Executive Office should be selected from the Company’s executive leadership team.

 

For independent directors, the Corporate Governance/Nominating Committee seeks the appropriate balance of experience, skills and personal characteristics required of a director. In order to be considered for nomination to the Board, a director candidate should possess most or all of the following attributes: independence, as defined by the NYSE listing standards as currently in effect; integrity; judgment; credibility; collegiality; professional achievement; constructiveness; and public awareness. The independent directors should possess, in aggregate, skill sets that include but are not limited to: financial acumen equivalent to the level of a Chief Financial Officer or senior executive of a capital market, investment or financial services firm; operational or strategic acumen germane to the energy industry, or other industry with similar characteristics (construction, manufacturing, etc.); public and/or government affairs acumen germane to complex enterprises, especially in regulated industries; customer service acumen germane to a service organization with a large customer base; legal acumen in the field(s) of regulatory or commercial law at the partner or chief legal officer level; salient community ties in areas of operation of Pepco Holdings’ enterprises; and corporate governance acumen, gained through service as a senior officer or director of a large publicly held corporation or through comparable academic or other experience. Independent directors are also selected to ensure diversity, in the aggregate, which diversity should include expertise or experience germane to the Company’s total business needs, in addition to other generally understood aspects of diversity.

 

What is the process for identifying and evaluating nominees for director (including nominees recommended by security holders)?

 

The Corporate Governance/Nominating Committee has developed the following process for the identification and evaluation of director nominees which is contained in the Company’s Corporate Governance Guidelines and can be found on the Company’s Web site (www.pepcoholdings.com) under the link: Corporate Governance:

 

a. List of Potential Candidates.    The Corporate Governance/Nominating Committee develops and maintains a list of potential candidates for Board membership. Potential candidates are recommended by Committee members and other Board members. Shareholders may put forward potential candidates for the Committee’s consideration by following submission requirements published in the Company’s proxy statement for the previous year’s meeting. See the second paragraph of the section headed “May a shareholder nominate or recommend an individual for election as a director of the Company?” above.

 

b. Candidate Attributes, Skill Sets and Other Criteria.    The Committee annually reviews the attributes, skill sets and other qualifications for potential candidates and may modify them from time to time based upon the Committee’s assessment of the needs of the Board and the skill sets required to meet those needs.

 

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c. Review of Candidates.    All potential candidates are reviewed by the Committee against the current attributes, skill sets and other qualifications established by the Board to determine if a candidate is suitable for Board membership. If a candidate is deemed suitable based on this review, a more detailed review will be performed through examination of publicly available information. This examination will include consideration of the independence requirement for outside directors, the number of boards on which the candidate serves, the possible applicability of restrictions on director interlocks or other requirements or prohibitions imposed by applicable laws or regulations, proxy disclosure requirements, and any actual or potentially perceived conflicts of interest or other issues raised by applicable laws or regulations or the Company’s policies or practices.

 

d. Prioritization of Candidates.    The Committee then (i) determines whether any candidate needs to be removed from consideration as a result of the detailed review, and (ii) determines a recommended priority among the remaining candidates for recommendation to and final determination by the Board prior to direct discussion with any candidate.

 

e. Candidate Contact.    Following the Board’s determination of a priority-ranked list of approved potential candidates, the Chairman of the Committee or, at his or her discretion, other member(s) of the Board will contact and interview the potential candidates in priority order. When a potential candidate indicates his or her willingness to accept nomination to the Board, no further candidates will be contacted. Subject to a final review of eligibility under the Company’s policies and applicable laws and regulations using information supplied directly by the candidate, the candidate will then be nominated.

 

3. OTHER MATTERS WHICH MAY COME BEFORE THE MEETING

 

Does the Board of Directors know of any additional matters to be acted upon at the Annual Meeting?

 

The Board of Directors does not know of any other matter to be brought before the meeting.

 

If another matter does come before the meeting, how will my proxy be voted?

 

If any other matter should properly come before the meeting, your signed proxy card, as well as your Internet or telephone proxy, gives the designated proxy holders discretionary authority to vote on such matters in accordance with their best judgment.

 

How are proxies being solicited and who pays for the costs involved?

 

The Company will bear the costs of solicitation of proxies, including the reimbursement of banks and brokers for certain costs incurred in forwarding proxy materials to beneficial owners. In addition to the use of the mails, officers, directors and regular employees of the Company may solicit proxies personally, by telephone or facsimile or via the Internet. These individuals will not receive any additional compensation for these activities.

 

Why was only a single Proxy Statement mailed to households that have multiple holders of common stock?

 

Under the rules of the SEC, a company is permitted to deliver a single proxy statement and annual report to any household at which two or more shareholders reside, if the shareholders at the address of the household have the same last name or the company reasonably believes that the shareholders are members of the same family. Accordingly, the Company is sending only one copy of this Proxy Statement and 2007 Annual Report to Shareholders that shared the same last name and address, unless the Company has received instructions to the contrary from one or more of the shareholders.

 

Under these SEC rules, brokers and banks that hold stock for the account of their customers also are permitted to deliver single copies of proxy statements and annual reports to two or more shareholders that share the same address. If you and other residents at your mailing address own shares of common stock through a

 

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broker or bank, you may have received a notice notifying you that your household will be sent only one copy of proxy statements and annual reports. If you did not notify your broker or bank of your objection, you may have been deemed to have consented to the arrangement.

 

If, in accordance with these rules, your household received only a single copy of this Proxy Statement and 2007 Annual Report to Shareholders and you would like to receive a separate copy or you would like to receive separate copies of the Company’s proxy statements and annual reports in the future, please contact American Stock Transfer & Trust Company, the Company’s transfer agent:

 

By Telephone:    1-866-254-6502 (toll-free)
In Writing:    American Stock Transfer & Trust Company
   6201 15th Avenue
   Brooklyn, NY 11219-9821

 

If you own your shares through a brokerage firm or a bank, your notification should include the name of your brokerage firm or bank and your account number.

 

If you are a record holder of shares of common stock who is receiving multiple copies of the Company’s shareholder communications at your address and you would like to receive only one copy for your household, please contact American Stock Transfer & Trust Company at the telephone number or address set forth above. If you own your shares through a brokerage firm or a bank, please contact your broker or bank.

 

Where do I find the Company’s Corporate Business Policies, Corporate Governance Guidelines and Committee Charters?

 

The Company has in place Corporate Business Policies, which in their totality constitute its code of business conduct and ethics. These policies apply to all directors, employees and others working at the Company and its subsidiaries. The Company’s Board of Directors has also adopted Corporate Governance Guidelines and charters for the Company’s Audit Committee, Compensation/Human Resources Committee and Corporate Governance/Nominating Committee, which conform to the requirements set forth in the NYSE listing standards. The Board of Directors has also adopted charters for the Company’s Executive Committee and Finance Committee. Copies of these documents are available on the Company Web site at http://www.pepcoholdings.com/governance/index.html and also can be obtained by writing to: Ellen Sheriff Rogers, Vice President, Secretary and Assistant Treasurer, 701 Ninth Street, N.W., Suite 1300, Washington, D.C. 20068.

 

Any amendment to, or waiver of, any provision of the Corporate Business Policies with respect to any director or executive officer of the Company will be promptly reported to shareholders through the filing of a Form 8-K with the SEC.

 

 

 

The Letter to Shareholders which begins on the cover page of this document, the sections of this Proxy Statement headed “Compensation/Human Resources Committee Report” and “Audit Committee Report” and the 2007 Annual Report to Shareholders, including the “Five-Year Performance Graph 2003-2007,” attached as Annex B to this proxy statement are not deemed to be “soliciting material” or to be “filed” with the SEC under or pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934 and shall not be incorporated by reference or deemed to be incorporated by reference into any filing by the Company under either such Act, unless otherwise specifically provided for in such filing.

 

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ANNEX A

 

PEPCO HOLDINGS, INC.

AUDIT COMMITTEE

 

 

 

Policy on the Approval of Services

Provided By the Independent Auditor

 

I. Overview

 

Under the federal securities laws and the rules of the Securities and Exchange Commission (the “SEC”), the annual consolidated financial statements of Pepco Holdings, Inc. (the “Company”) and each of its subsidiaries that has a reporting obligation (a “Reporting Company”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), must be audited by an “independent” public accountant. Likewise, the quarterly financial statements of the Company and each Reporting Company must be reviewed by an “independent” public accountant.

 

Under SEC regulations, a public accountant is not “independent” if it provides certain specified non-audit services to an audit client. In addition, a public accountant will not qualify as “independent” unless (i) before the accountant is engaged to provide audit or non-audit services, the engagement is approved by the public company’s audit committee or (ii) the engagement to provide audit or non-audit services is pursuant to pre-approved policies and procedures established by the audit committee.

 

Under the Audit Committee Charter, the Audit Committee of the Company has sole authority (i) to retain and terminate the Company’s independent auditors, (ii) to pre-approve all audit engagement fees and terms and (iii) to pre-approve all significant audit-related relationships with the independent auditor. This Policy sets forth the policies and procedures adopted by the Audit Committee with respect to the engagement of the Company’s independent auditor to provide audit and non-audit services to the Company and its subsidiaries (as defined by Rule 1-02 (x) of SEC Regulation S-X).

 

The Audit Committee also serves as the audit committee for each subsidiary of the Company that is a Reporting Company for the purpose of approving audit and non-audit services to be provided by the independent auditor(s) of such Reporting Companies. In this capacity, the Audit Committee has determined that this Policy also shall govern the engagement of the independent auditor for each such Reporting Company.

 

II. Statement of Principles

 

The Audit Committee recognizes the importance of maintaining the independence of its external auditor both in fact and appearance. In order to ensure that the independence of the Company’s external auditor is not, in the judgment of the Audit Committee, impaired by any other services that the external auditor may provide to the Company and its subsidiaries:

 

   

The Audit Committee shall approve in advance all services—both audit and permitted non-audit services—provided to the Company or any of its subsidiaries by the Company’s independent auditor in accordance with the procedures set forth in this Policy.

 

   

The Audit Committee shall not engage the Company’s independent auditor to provide to the Company or any of its subsidiaries any non-audit services that are unlawful under Section 10A of the Exchange Act or that would impair the independence of the Company’s independent auditor under the standards set forth in Rule 2-01 of SEC Regulation S-X (“Prohibited Non-Audit Services”).

 

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III. Approval of Annual Audit Services

 

The annual audit services provided to the Company and its subsidiaries by the Company’s independent auditor shall consist of:

 

   

The audit of the annual consolidated financial statements of the Company and each other Reporting Company and the other procedures required to be performed by the independent auditor to be able to form an opinion on the financial statements.

 

   

Review of the quarterly consolidated financial statements of the Company and each Reporting Company.

 

   

The attestation engagement for the independent auditor’s report on management’s statement on the effectiveness of the Company’s internal control over financial reports.

 

   

Services associated with SEC registration statements, periodic reports and other documents filed with the SEC or issued in connection with securities offerings, including consents and comfort letters provided to underwriters, reviews of registration statements and prospectuses, and assistance in responding to SEC comment letters.

 

All such audit services must be approved annually by the Audit Committee following a review by the Audit Committee of the proposed terms and scope of the engagement and the projected fees. Any subsequent change of a material nature in the terms, scope or fees associated with such annual audit services shall be approved in advance by the Audit Committee.

 

Any additional audit services may be pre-approved annually at the meeting at which the annual audit services are approved. If not pre-approved, each additional annual audit service must be approved by the Audit Committee in advance on a case-by-case basis.

 

IV. Approval of Audit-Related Services

 

Audit-related services consist of assurance and related services that are reasonably related to the performance of the audit or review of the financial statements of the Company and each Reporting Company, other than the annual audit services described in Section III above. Audit-related services may include, but are not limited to:

 

   

Employee benefit plan audits.

 

   

Due diligence related to mergers and acquisitions.

 

   

Accounting consultations and audits in connection with acquisitions.

 

   

Internal control reviews.

 

   

Attest services related to financial reporting that are not required by statute or regulation.

 

Audit-related services may be pre-approved annually at the meeting at which the annual audit services are approved. If not pre-approved, each audit-related service must be approved by the Audit Committee in advance on a case-by-case basis.

 

V. Approval of Tax Services

 

Tax services consist of professional services rendered by the independent auditor to the Company or any of its subsidiaries for tax compliance, tax advice and tax planning. Tax services may be pre-approved annually at the meeting of the Audit Committee at which the annual audit services are approved. If not pre-approved, each tax service must be approved by the Audit Committee in advance on a case-by-case basis.

 

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VI. Approval of All Other Services

 

Any other services to be provided by the Company’s independent auditor, other than Prohibited Non-Audit Services, may be pre-approved annually at the meeting of the Audit Committee at which the annual audit services are approved. If not pre-approved, each such other service must be approved by the Audit Committee in advance on a case-by-case basis.

 

VII. Procedures

 

At the meeting of the Audit Committee to select the independent auditor for the Company and each of the Reporting Companies, the Chief Financial Officer shall submit to the Audit Committee a list of the additional audit services, audit-related services, tax services and other services, if any, that the Company and the Related Companies wish to have pre-approved for the ensuing year. The list shall be accompanied by:

 

   

a written description (which may consist of or include a description furnished to the Company by the independent auditor) of the services to be provided in detail sufficient to enable the Audit Committee to make an informed decision with regard to each proposed service, and, to the extent determinable, an estimate provided by the independent auditor of the fees for each of the services; and

 

   

confirmation of the independent auditor that (i) it would not be unlawful under Section 10A of the Exchange Act for the independent auditor to provide the listed non-audit services to the Company or any of its subsidiaries and (B) none of the services, if provided by the independent auditor to the Company or any of its subsidiaries, would impair the independence of the auditor under the standards set forth in Rule 2-01 of SEC Regulation S-X.

 

If a type of non-audit service is pre-approved by the Audit Committee, and the Company or any of its subsidiaries subsequently engages the independent auditor to provide that service, the Company’s Chief Financial Officer shall report the engagement to the Audit Committee at its next regularly scheduled meeting.

 

VIII. Delegation

 

The Audit Committee hereby delegates to the Chairman of the Audit Committee the authority to approve, upon the receipt of the documentation referred to in Section VII above, on a case-by-case basis any non-audit service of the types referred to in Sections IV, V and VI above (i.e. an audit-related, tax or other service) at any time other than at a meeting of the Audit Committee. The Chairman shall report any services so approved to the Audit Committee at its next regularly scheduled meeting. In no circumstances shall the responsibilities of the Audit Committee under this Policy be delegated to the management of the Company or any of its subsidiaries.

 

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ANNEX B

LOGO

2007 Annual Report to Shareholders

 

      PAGE

TABLE OF CONTENTS

  

Glossary of Terms

   B-2

Consolidated Financial Highlights

   B-6

Business of the Company

   B-8

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   B-19

Quantitative and Qualitative Disclosures about Market Risk

   B-78

Management’s Report on Internal Control over Financial Reporting

   B-82

Report of Independent Registered Public Accounting Firm

   B-82

Consolidated Statements of Earnings

   B-84

Consolidated Statements of Comprehensive Earnings

   B-85

Consolidated Balance Sheets

   B-86

Consolidated Statements of Cash Flows

   B-88

Consolidated Statements of Shareholders’ Equity

   B-89

Notes to Consolidated Financial Statements

   B-90

Quarterly Financial Information (unaudited)

   B-155

Five-Year Performance Graph—2003-2007

   B-156

Board of Directors and Officers

   B-157

Investor Information

   B-158

Forward-Looking Statements:    Except for historical statements and discussions, the statements in this annual report constitute “forward-looking statements” within the meaning of federal securities law. These statements contain management’s beliefs based on information currently available to management and on various assumptions concerning future events. Forward-looking statements are not a guarantee of future performance or events. They are subject to a number of uncertainties and other factors, many of which are outside the company’s control. Factors that could cause actual results to differ materially from those in the forward-looking statements herein include general economic, business and financing conditions; availability and cost of capital; changes in laws, regulations or regulatory policies; weather conditions; competition; governmental actions; and other presently unknown or unforeseen factors. These uncertainties and factors could cause actual results to differ materially from such statements. Pepco Holdings disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. This information is presented solely to provide additional information to understand further the results and prospects of Pepco Holdings.

 

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GLOSSARY OF TERMS

 

Term

  

Definition

A&N

  

A&N Electric Cooperative, purchaser of DPL’s retail electric distribution business in Virginia

ABO

  

Accumulated benefit obligation

Accounting Hedges

  

Derivatives designated as cash flow and fair value hedges

ACE

  

Atlantic City Electric Company

ACE Funding

  

Atlantic City Electric Transition Funding LLC

ACO

  

Administrative Consent Order

ADFIT

  

Accumulated deferred federal income taxes

ADITC

  

Accumulated deferred investment tax credits

AFUDC

  

Allowance for Funds Used During Construction

Ancillary services

  

Generally, electricity generation reserves and reliability services

APB

  

Accounting Principles Board

Appellate Division

  

Appellate Division of the Superior Court of New Jersey

Bankruptcy Settlement

  

The bankruptcy settlement among the parties concerning the environmental proceedings at the Metal Bank/Cottman Avenue site

Bcf

  

Billion cubic feet

BGS

  

Basic Generation Service (the supply of electricity by ACE to retail customers in New Jersey who have not elected to purchase electricity from a competitive supplier)

BGS-FP

  

BGS-Fixed Price service

BGS-CIEP

  

BGS-Commercial and Industrial Energy Price service

Bondable Transition Property

  

Right to collect a non-bypassable transition bond charge from ACE customers pursuant to bondable stranded costs rate orders issued by the NJBPU

BSA

  

Bill Stabilization Adjustment

CAA

  

Federal Clean Air Act

CAIR

  

EPA’s Clean Air Interstate rule

CAMR

  

EPA’s Clean Air Mercury rule

CERCLA

  

Comprehensive Environmental Response, Compensation, and Liability Act of 1980

Citgo

  

Citgo Asphalt Refining Company

CO2

  

Carbon dioxide

Conectiv

  

A wholly owned subsidiary of PHI which is a holding company under PUHCA 2005 and the parent of DPL and ACE

Conectiv Energy

  

Conectiv Energy Holding Company and its subsidiaries

Conectiv Group

  

Conectiv and certain of its subsidiaries that were involved in a like-kind exchange transaction under examination by the IRS

Cooling Degree Days

  

Daily difference in degrees by which the mean (high and low divided by 2) dry bulb temperature is above a base of 65 degrees Fahrenheit

CRMC

  

PHI’s Corporate Risk Management Committee

CWA

  

Federal Clean Water Act

DCPSC

  

District of Columbia Public Service Commission

Default Electricity Supply

  

The supply of electricity by PHI’s electric utility subsidiaries at regulated rates to retail customers who do not elect to purchase electricity from a competitive supplier, and which, depending on the jurisdiction and period, is also known as SOS, BGS, or POLR service

Default Supply Revenue

  

Revenue received for Default Electricity Supply

Delaware District Court

  

United States District Court for the District of Delaware

Directors Compensation Plan

  

PHI Non-Management Directors Compensation Plan

DNREC

  

Delaware Department of Natural Resources and Environmental Control

 

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Term

  

Definition

DPL

  

Delmarva Power & Light Company

DPSC

  

Delaware Public Service Commission

DRP

  

PHI’s Shareholder Dividend Reinvestment Plan

EDECA

  

New Jersey Electric Discount and Energy Competition Act

EDIT

  

Excess Deferred Income Taxes

EITF

  

Emerging Issues Task Force

EPA

  

U.S. Environmental Protection Agency

ERISA

  

Employment Retirement Income Security Act of 1974

Exchange Act

  

Securities Exchange Act of 1934, as amended

FAS

  

Financial Accounting Standards

FASB

  

Financial Accounting Standards Board

FERC

  

Federal Energy Regulatory Commission

FHACA

  

Flood Hazard Area Control Act

FIN

  

FASB Interpretation Number

Financing Order

  

Financing Order of the SEC under PUHCA 1935 dated June 30, 2005, with respect to PHI and its subsidiaries

FRP

  

Facility Response Plan required by EPA

FSP

  

FASB Staff Position

FSP AUG AIR-1

  

FSP American Institute of Certified Public Accountants Industry Audit Guide, Audits of Airlines—“Accounting for Planned Major Maintenance Activities”

FTB

  

FASB Technical Bulletin

Full Requirements Load Service

  

The supply of energy by Conectiv Energy to utilities to fulfill their default electricity supply obligations

FWPA

  

Freshwater Wetlands Protection Act

GAAP

  

Accounting principles generally accepted in the United States of America

GCR

  

Gas Cost Recovery

GWh

  

Gigawatt hour

Heating Degree Days

  

Daily difference in degrees by which the mean (high and low divided by 2) dry bulb temperature is below a base of 65 degrees Fahrenheit.

HPS

  

Hourly Priced Service DPL is obligated to provide to its largest customers

IRC

  

Internal Revenue Code

IRS

  

Internal Revenue Service

ISONE

  

Independent System Operator—New England

ITC

  

Investment Tax Credit

LEAC Liability

  

ACE’s $59.3 million deferred energy cost liability existing as of July 31, 1999 related to ACE’s Levelized Energy Adjustment Clause and ACE’s Demand Side Management Programs

LDA

  

Locational Deliverability Area within the PJM RTO region that has limited transmission capability to import capacity which, together with internal resources, may not be able to maintain reliability in that area

LTIP

  

Pepco Holdings’ Long-Term Incentive Plan

Mcf

  

One thousand cubic feet

MDE

  

Maryland Department of the Environment

Medicare Act

  

Medicare Prescription Drug, Improvement and Modernization Act of 2003

MGP

  

Manufactured gas plant

Mirant

  

Mirant Corporation

MPSC

  

Maryland Public Service Commission

NFA

  

No Further Action letter issued by the NJDEP

NJBPU

  

New Jersey Board of Public Utilities

NJDEP

  

New Jersey Department of Environmental Protection

 

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Term

  

Definition

NJPDES

  

New Jersey Pollutant Discharge Elimination System

NOPR

  

Notice of Proposed Rulemaking

Normalization provisions

  

Sections of the IRC and related regulations that dictate how excess deferred income taxes resulting from the corporate income tax rate reduction enacted by the Tax Reform Act of 1986 and accumulated deferred investment tax credits should be treated for ratemaking purposes

Notice

  

Notice 2005-13 issued by the Treasury Department and IRS on February 11, 2005

NOx

  

Nitrogen oxide

NPDES

  

National Pollutant Discharge Elimination System

NUGs

  

Non-utility generators

NYDEC

  

New York Department of Environmental Conservation

OCI

  

Other Comprehensive Income

ODEC

  

Old Dominion Electric Cooperative, purchaser of DPL’s wholesale transmission business in Virginia

Panda

  

Panda-Brandywine, L.P.

Panda PPA

  

PPA between Pepco and Panda

PARS

  

Performance Accelerated Restricted Stock

PBO

  

Projected benefit obligation

PCI

  

Potomac Capital Investment Corporation and its subsidiaries

Pepco

  

Potomac Electric Power Company

Pepco Energy Services

  

Pepco Energy Services, Inc. and its subsidiaries

Pepco Holdings or PHI

  

Pepco Holdings, Inc.

PHI Parties

  

The PHI Retirement Plan, PHI and Conectiv, parties to cash balance plan litigation brought by three management employees of PHI Service Company

PHI Retirement Plan

  

PHI’s noncontributory retirement plan

PJM

  

PJM Interconnection, LLC

PLR

  

Private letter ruling from the IRS

POLR

  

Provider of Last Resort service (the supply of electricity by DPL before May 1, 2006 to retail customers in Delaware who did not elect to purchase electricity from a competitive supplier)

POM

  

Pepco Holdings’ NYSE trading symbol

Power Delivery

  

PHI’s Power Delivery Business

PPA

  

Power Purchase Agreement

PRP

  

Potentially responsible party

PUHCA 1935

  

Public Utility Holding Company Act of 1935, which was repealed effective February 8, 2006

PUHCA 2005

  

Public Utility Holding Company Act of 2005, which became effective February 8, 2006

RAR

  

IRS revenue agent’s report

RARM

  

Reasonable Allowance for Retail Margin

RC Cape May

  

RC Cape May Holdings, LLC, an affiliate of Rockland Capital Energy Investments, LLC, and the purchaser of the B.L. England generating facility

Recoverable stranded costs

  

The portion of stranded costs that is recoverable from ratepayers as approved by regulatory authorities

Regulated T&D Electric Revenue

  

Revenue from the transmission and the delivery of electricity to PHI’s customers within its service territories at regulated rates

RGGI

  

Regional Greenhouse Gas Initiative

RI/FS

  

Remedial Investigation/Feasibility Study

ROE

  

Return on equity

 

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Term

  

Definition

SEC

  

Securities and Exchange Commission

SFAS

  

Statement of Financial Accounting Standards

SO2

  

Sulfur dioxide

SOS

  

Standard Offer Service (the supply of electricity by Pepco in the District of Columbia, by Pepco and DPL in Maryland and by DPL in Delaware on and after May 1, 2006, to retail customers who have not elected to purchase electricity from a competitive supplier)

Spark spread

  

The market price for electricity less the product of the cost of fuel times the unit heat rate. It is used to estimate the relative profitability of a generation unit.

SPCC

  

Spill Prevention, Control, and Countermeasure plan required by EPA

Spot

  

Commodities market in which goods are sold for cash and delivered immediately

Standard Offer Service revenue or SOS revenue

  

Revenue Pepco and DPL, respectively, receive for the procurement of energy for its SOS customers

Starpower

  

Starpower Communications, LLC

Stranded costs

  

Costs incurred by a utility in connection with providing service which would be unrecoverable in a competitive or restructured market. Such costs may include costs for generation assets, purchased power costs, and regulatory assets and liabilities, such as accumulated deferred income taxes.

Tolling agreement

  

A physical or financial contract where one party delivers fuel to a specific generating station in exchange for the power output

TPAs

  

Transition power agreements between Pepco and Mirant pursuant to which Mirant agreed to supply all of the energy and capacity needed by Pepco to fulfill its SOS obligations in Maryland and in the District of Columbia

TPA Claim

  

An allowed, pre-petition general unsecured claim by Pepco in the Mirant bankruptcy in the amount of $105 million

Transition Bonds

  

Transition bonds issued by ACE Funding

Treasury lock

  

A hedging transaction that allows a company to “lock-in” a specific interest rate corresponding to the rate of a designated Treasury bond for a determined period of time

VaR

  

Value at Risk

 

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CONSOLIDATED FINANCIAL HIGHLIGHTS

 

    2007     2006     2005     2004     2003  
    (in millions, except per share data)  

Consolidated Operating Results

         

Total Operating Revenue

  $ 9,366.4     $ 8,362.9     $ 8,065.5     $ 7,223.1     $ 7,268.7  

Total Operating Expenses

    8,559.8 (a)     7,669.6 (c)     7,160.1 (e)(f)(g)     6,451.0       6,658.0 (j)(k)

Operating Income

    806.6       693.3       905.4       772.1       610.7  

Other Expenses

    284.2       282.4 (d)     285.5       341.4       433.3 (l)

Preferred Stock Dividend Requirements of Subsidiaries

    .3       1.2       2.5       2.8       13.9  

Income Before Income Tax Expense and Extraordinary Item

    522.1       409.7       617.4       427.9       163.5  

Income Tax Expense

    187.9 (b)     161.4       255.2 (h)     167.3 (i)     62.1  

Income Before Extraordinary Item

    334.2       248.3       362.2       260.6       101.4  

Extraordinary Item

    —         —         9.0       —         5.9  

Net Income

    334.2       248.3       371.2       260.6       107.3  

Redemption Premium on Preferred Stock

    (.6 )     (.8 )     (.1 )     .5       —    

Earnings Available for Common Stock

    333.6       247.5       371.1       261.1       107.3  

Common Stock Information

         

Basic Earnings Per Share of Common Stock Before Extraordinary Item

  $ 1.72     $ 1.30     $ 1.91     $ 1.48     $ .60  

Basic—Extraordinary Item Per Share of Common Stock

    —         —         .05       —         .03  

Basic Earnings Per Share of Common Stock

    1.72       1.30       1.96       1.48       .63  

Diluted Earnings Per Share of Common Stock Before Extraordinary Item

    1.72       1.30       1.91       1.48       .60  

Diluted—Extraordinary Item Per Share of Common Stock

    —         —         .05       —         .03  

Diluted Earnings Per Share of Common Stock

    1.72       1.30       1.96       1.48       .63  

Cash Dividends Per Share of Common Stock

    1.04       1.04       1.00       1.00       1.00  

Year-End Stock Price

    29.33       26.01       22.37       21.32       19.54  

Net Book Value per Common Share

    20.04       18.82       18.88       17.74       17.31  

Weighted Average Shares Outstanding

    194.1       190.7       189.0       176.8       170.7  

Other Information

         

Investment in Property, Plant and Equipment

  $ 12,306.5     $ 11,819.7     $ 11,441.0     $ 11,109.4     $ 10,815.2  

Net Investment in Property, Plant and Equipment

    7,876.7       7,576.6       7,368.8       7,152.2       7,032.9  

Total Assets

    15,111.0       14,243.5       14,038.9       13,374.6       13,390.2  

Capitalization

         

Short-term Debt

  $ 288.8     $ 349.6     $ 156.4     $ 319.7     $ 518.4  

Long-term Debt

    4,174.8       3,768.6       4,202.9       4,362.1       4,588.9  

Current Maturities of Long-Term Debt and Project Funding

    332.2       857.5       469.5       516.3       384.9  

Transition Bonds issued by ACE Funding

    433.5       464.4       494.3       523.3       551.3  

Capital Lease Obligations due within one year

    6.0       5.5       5.3       4.9       4.4  

Capital Lease Obligations

    105.4       111.1       116.6       122.1       126.8  

Long-Term Project Funding

    20.9       23.3       25.5       65.3       68.6  

Debentures issued to Financing Trust

    —         —         —         —         98.0  

Minority Interest

    6.2       24.4       45.9       54.9       108.2  

Common Shareholders’ Equity

    4,018.4       3,612.2       3,584.1       3,339.0       2,974.1  
                                       

Total Capitalization

  $ 9,386.2     $ 9,216.6     $ 9,100.5     $ 9,307.6     $ 9,423.6  
                                       

 

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(a) Includes $33.4 million ($20.0 million after-tax) from settlement of Mirant bankruptcy claims. See “Management’s Discussion and Analysis—Financial Condition and Results of Operations—Capital Resources and Liquidity—Cash Flow Activity—Proceeds from Settlement of Mirant Bankruptcy Claims.”
(b) Includes $19.5 million ($17.7 million net of fees) benefit related to Maryland income tax settlement.
(c) Includes $18.9 million of impairment losses ($13.7 million after-tax) related to certain energy services business assets.
(d) Includes $12.3 million gain ($7.9 million after-tax) on the sale of Conectiv Energy’s equity interest in a joint venture which owns a wood burning cogeneration facility.
(e) Includes $68.1 million ($40.7 million after-tax) gain from sale of non-utility land owned by Pepco at Buzzard Point.
(f) Includes $70.5 million ($42.2 million after-tax) gain (net of customer sharing) from settlement of Mirant bankruptcy claims. See “Management’s Discussion and Analysis—Financial Condition and Results of Operations—Capital Resources and Liquidity—Cash Flow Activity—Proceeds from Settlement of Mirant Bankruptcy Claims.”
(g) Includes $13.3 million ($8.9 million after-tax) related to PCI’s liquidation of a financial investment that was written off in 2001.
(h) Includes $10.9 million in income tax expense related to the mixed service cost issue under IRS Revenue Ruling 2005-53.
(i) Includes a $19.7 million charge related to an IRS settlement. Also includes $13.2 million tax benefit related to issuance of a local jurisdiction’s final consolidated tax return regulations.
(j) Includes a charge of $50.1 million ($29.5 million after-tax) related to a CT contract cancellation. Also includes a gain of $68.8 million ($44.7 million after-tax) on the sale of the Edison Place office building.
(k) Includes the unfavorable impact of $44.3 million ($26.6 million after-tax) resulting from trading losses prior to the cessation of proprietary trading.
(l) Includes an impairment charge of $102.6 million ($66.7 million after-tax) related to prior investment in Starpower Communications, L.L.C.

 

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BUSINESS OF THE COMPANY

OVERVIEW

Pepco Holdings, Inc. (PHI or Pepco Holdings), a Delaware corporation incorporated in 2001, is a diversified energy company that, through its operating subsidiaries, is engaged primarily in two businesses:

 

   

electricity and natural gas delivery (Power Delivery), conducted through the following regulated public utility companies, each of which is a reporting company under the Securities Exchange Act of 1934, as amended (the Exchange Act):

 

   

Potomac Electric Power Company (Pepco), which was incorporated in Washington, D.C. in 1896 and became a domestic Virginia corporation in 1949.

 

   

Delmarva Power & Light Company (DPL), which was incorporated in Delaware in 1909 and became a domestic Virginia corporation in 1979, and

 

   

Atlantic City Electric Company (ACE), which was incorporated in New Jersey in 1924.

 

   

competitive energy generation, marketing and supply (Competitive Energy) conducted through subsidiaries of Conectiv Energy Holding Company (Conectiv Energy) and Pepco Energy Services, Inc. (Pepco Energy Services).

The following chart shows, in simplified form, the corporate structure of PHI and its principal subsidiaries.

LOGO

Conectiv is solely a holding company with no business operations. The activities of Potomac Capital Investment Corporation (PCI) are described below under the heading “Other Business Operations.”

PHI Service Company provides a variety of support services, including legal, accounting, treasury, tax, purchasing and information technology services to PHI and its operating subsidiaries. These services are provided pursuant to a service agreement among PHI, PHI Service Company, and the participating operating subsidiaries. The expenses of the service company are charged to PHI and the participating operating subsidiaries in accordance with costing methodologies set forth in the service agreement.

 

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For financial information relating to PHI’s segments, see Note (3), “Segment Information,” to the consolidated financial statements of PHI. Each of Pepco, DPL and ACE has one operating segment.

Investor Information

Each of PHI, Pepco, DPL and ACE files reports under the Exchange Act. The Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports, of each of the companies are made available free of charge on PHI’s internet Web site as soon as reasonably practicable after such documents are electronically filed with or furnished to the Securities and Exchange Commission (SEC). These reports may be found at http://www.pepcoholdings.com/investors.

Description of Business

The following is a description of each of PHI’s two principal business operations.

Power Delivery

The largest component of PHI’s business is Power Delivery, which consists of the transmission, distribution and default supply of electricity. A minor portion of the Power Delivery business consists of the supply and distribution of natural gas. In 2007, 2006 and 2005, respectively, PHI’s Power Delivery operations produced 56%, 61%, and 58% of PHI’s consolidated operating revenues (including revenue from intercompany transactions) and 66%, 67%, and 74% of PHI’s consolidated operating income (including income from intercompany transactions).

Each of Pepco, DPL and ACE is a regulated public utility in the jurisdictions that comprise its service territory. Each company owns and operates a network of wires, substations and other equipment that is classified either as transmission or distribution facilities. Transmission facilities are high-voltage systems that carry wholesale electricity into, or across, the utility’s service territory. Distribution facilities are low-voltage systems that carry electricity to end-use customers in the utility’s service territory.

Delivery of Electricity and Natural Gas and Default Electricity Supply

Each company is responsible for the delivery of electricity and, in the case of DPL, natural gas in its service territory, for which it is paid tariff rates established by the local regulatory agency. Each company also supplies electricity at regulated rates to retail customers in its service territory who do not elect to purchase electricity from a competitive energy supplier. The regulatory term for this supply service varies by jurisdiction as follows:

 

Delaware

   Provider of Last Resort service—before May 1, 2006 Standard Offer Service (SOS)—on and after May 1, 2006

District of Columbia

   SOS

Maryland

   SOS

New Jersey

   Basic Generation Service (BGS)

Virginia

   Default Service

In this Annual Report, these supply service obligations are referred to generally as Default Electricity Supply.

In the aggregate, the Power Delivery business delivers electricity to more than 1.8 million customers in the mid-Atlantic region and distributes natural gas to approximately 122,000 customers in Delaware.

 

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Transmission of Electricity and Relationship with PJM

The transmission facilities owned by Pepco, DPL and ACE are interconnected with the transmission facilities of contiguous utilities and are part of an interstate power transmission grid over which electricity is transmitted throughout the Mid-Atlantic portion of the United States and parts of the Midwest. The Federal Energy Regulatory Commission (FERC) has designated a number of regional transmission organizations to coordinate the operation and planning of portions of the interstate transmission grid. Pepco, DPL and ACE are members of the PJM Regional Transmission Organization (PJM RTO). In 1997, FERC approved PJM Interconnection, LLC (PJM) as the sole provider of transmission service in the PJM RTO region, which today consists of all or parts of Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia. As the independent grid operator, PJM coordinates the electric power market and the movement of electricity within the PJM RTO region. Any entity that wishes to have electricity delivered at any point in the PJM RTO region must obtain transmission services from PJM at rates approved by FERC. In accordance with FERC rules, Pepco, DPL, ACE and the other transmission-owning utilities in the region make their transmission facilities available to the PJM RTO and PJM directs and controls the operation of these transmission facilities. Transmission rates are proposed by the transmission owner and approved by FERC. PJM, as the tariff administrator, collects transmission service revenue from transmission service customers and distributes the revenue to the transmission owners. PJM also oversees the planning process for the enhancement and expansion of transmission capability on a regional basis within the PJM RTO region. PJM approval is required for transmission upgrades and enhancements undertaken by member utilities.

Distribution of Electricity and Deregulation

Historically, electric utilities, including Pepco, DPL and ACE, were vertically integrated businesses that generated all or a substantial portion of the electric power supply that they delivered to customers in their service territories over their own distribution facilities. Customers were charged a bundled rate approved by the applicable regulatory authority that covered both the supply and delivery components of the retail electric service. However, legislative and regulatory actions in each of the service territories in which Pepco, DPL and ACE operate have resulted in the “unbundling” of the supply and delivery components of retail electric service and in the opening of the supply component to competition from non-regulated providers. Accordingly, while Pepco, DPL and ACE continue to be responsible for the distribution of electricity in their respective service territories, as the result of deregulation, customers in those service territories now are permitted to choose their electricity supplier from among a number of non-regulated, competitive suppliers. Customers who do not choose a competitive supplier receive Default Electricity Supply on terms that vary depending on the service territory, as described more fully below.

In connection with the deregulation of electric power supply, Pepco, DPL and ACE have divested all of their respective generation assets, by either selling them to third parties or transferring them to the non-regulated affiliates of PHI that comprise PHI’s Competitive Energy businesses. Accordingly, Pepco, DPL and ACE are no longer engaged in generation operations.

Seasonality

The Power Delivery business is seasonal and weather patterns can have a material impact on operating performance. In the region served by PHI, demand for electricity is generally higher in the summer months associated with cooling and demand for electricity and natural gas is generally higher in the winter months associated with heating, as compared to other times of the year. Historically, the Power Delivery operations of each of PHI’s utility subsidiaries have generated higher revenues and income when temperatures are colder than normal in the winter and warmer than normal in the summer, and conversely revenues and income typically are lower when the temperature is warmer than normal in the winter and cooler than normal in the summer. In Maryland, however, the decoupling of distribution revenue for a given reporting period from the amount of power delivered during the period as the result of the adoption by the Maryland Public Service Commission

 

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(MPSC) of a bill stabilization adjustment mechanism for retail customers has had the effect of eliminating changes in customer usage due to weather conditions or for other reasons as a factor having an impact on reported revenue and income.

Regulation

The retail operations of PHI’s utility subsidiaries, including the rates they are permitted to charge customers for the delivery of electricity and, in the case of DPL, natural gas, are subject to regulation by governmental agencies in the jurisdictions in which they provide utility service as follows:

 

   

Pepco’s electricity delivery operations are regulated in Maryland by the MPSC and in Washington, D.C. by the District of Columbia Public Service Commission (DCPSC).

 

   

DPL’s electricity delivery operations are regulated in Maryland by the MPSC and in Delaware by the Delaware Public Service Commission (DPSC) and, until the sale of its Virginia operations on January 2, 2008, were regulated in Virginia by the Virginia State Corporation Commission.

 

   

DPL’s natural gas distribution operations in Delaware are regulated by the DPSC.

 

   

ACE’s electricity delivery operations are regulated by the New Jersey Board of Public Utilities (NJBPU).

 

   

The transmission and wholesale sale of electricity by each of PHI’s utility subsidiaries are regulated by FERC.

 

   

The interstate transportation and wholesale sale of natural gas by DPL are regulated by FERC.

Pepco

Pepco is engaged in the transmission, distribution and default supply of electricity in Washington, D.C. and major portions of Prince George’s and Montgomery Counties in suburban Maryland. Pepco’s service territory covers approximately 640 square miles and has a population of approximately 2.1 million. As of December 31, 2007, Pepco delivered electricity to 760,000 customers (of which 241,800 were located in the District of Columbia and 518,200 were located in Maryland), as compared to 753,000 customers as of December 31, 2006 (of which 240,960 were located in the District of Columbia and 512,040 were located in Maryland).

In 2007, Pepco delivered a total of 27,451,000 megawatt hours of electricity, of which 30% was delivered to residential customers, 50% to commercial customers, and 20% to United States and District of Columbia government customers. In 2006, Pepco delivered a total of 26,488,000 megawatt hours of electricity, of which 29% was delivered to residential customers, 51% to commercial customers, and 20% to United States and District of Columbia government customers.

Pepco has been providing SOS in Maryland since July 2004. Pursuant to an order issued by the MPSC in November 2006, Pepco will continue to be obligated to provide SOS to residential and small commercial customers indefinitely until further action of the Maryland General Assembly, and to medium-sized commercial customers through May 2009. Pepco also has an ongoing obligation to provide SOS service at hourly priced rates to the largest customers. Pepco purchases the power supply required to satisfy its SOS obligation from wholesale suppliers under contracts entered into pursuant to competitive bid procedures approved and supervised by the MPSC. Pepco is entitled to recover from its SOS customers the cost of the SOS supply plus an average margin of $.001667 per kilowatt-hour. Because margins vary by customer class, the actual average margin over any given time period depends on the number of Maryland SOS customers from each customer class and the load taken by such customers over the time period. Pepco is paid tariff delivery rates for the delivery of electricity over its transmission and distribution facilities to all electricity customers in its Maryland service territory regardless of whether the customer receives SOS or purchases electricity from another energy supplier.

 

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Pepco has been providing SOS in the District of Columbia since February 2005. Pursuant to orders issued by the DCPSC, Pepco will continue to be obligated to provide SOS for small commercial and residential customers through May 2011 and for large commercial customers through May 2009. Pepco purchases the power supply required to satisfy its SOS obligation from wholesale suppliers under contracts entered into pursuant to a competitive bid procedure approved by the DCPSC. Pepco is entitled to recover from its SOS customers the costs associated with the acquisition of the SOS supply plus administrative charges that are intended to allow Pepco to recover the administrative costs incurred to provide the SOS. These administrative charges include an average margin for Pepco of $.00241 per kilowatt-hour. Because margins vary by customer class, the actual average margin over any given time period depends on the number of District of Columbia SOS customers from each customer class and the load taken by such customers over the time period. Pepco is paid tariff delivery rates for the delivery of electricity over its transmission and distribution facilities to all electricity customers in its District of Columbia service territory regardless of whether the customer receives SOS or purchases electricity from another energy supplier.

For the year ended December 31, 2007, 51% of Pepco’s Maryland sales (measured by megawatt hours) were to SOS customers, as compared to 60% in 2006, and 35% of its District of Columbia sales were to SOS customers in 2007, as compared to 57% in 2006.

DPL

DPL is engaged in the transmission, distribution and default supply of electricity in Delaware and portions of Maryland and Virginia (until the sale of its Virginia operations on January 2, 2008). In northern Delaware, DPL also supplies and distributes natural gas to retail customers and provides transportation-only services to retail customers that purchase natural gas from other suppliers.

Transmission and Distribution of Electricity

In Delaware, electricity service is provided in the counties of Kent, New Castle, and Sussex and in Maryland in the counties of Caroline, Cecil, Dorchester, Harford, Kent, Queen Anne’s, Somerset, Talbot, Wicomico and Worchester. Prior to January 2, 2008, DPL also provided transmission and distribution of electricity in Accomack and Northampton counties in Virginia. As discussed below, under the heading “Sale of Virginia Service Territory,” DPL, on January 2, 2008, completed the sale of substantially all of its Virginia electric service operations.

DPL’s electricity distribution service territory covers approximately 6,000 square miles and has a population of approximately 1.3 million. As of December 31, 2007, DPL delivered electricity to 519,000 customers (of which 298,000 were located in Delaware, 198,000 were located in Maryland, and 23,000 were located in Virginia), as compared to 513,000 electricity customers as of December 31, 2006 (of which 295,000 were located in Delaware, 196,000 were located in Maryland, and 22,000 were located in Virginia).

In 2007, DPL delivered a total of 13,680,000 megawatt hours of electricity to its customers, of which 39% was delivered to residential customers, 40% to commercial customers and 21% to industrial customers. In 2006, DPL delivered a total of 13,477,000 megawatt hours of electricity, of which 38% was delivered to residential customers, 40% to commercial customers and 22% to industrial customers.

DPL has been providing SOS in Delaware since May 2006. Pursuant to orders issued by the DPSC, DPL will continue to be obligated to provide fixed-price SOS to residential, small commercial and industrial customers through May 2009 and to medium, large and general service customers through May 2008. DPL purchases the power supply required to satisfy its fixed-price SOS obligation from wholesale suppliers under contracts entered into pursuant to competitive bid procedures approved by the DPSC. DPL also has an obligation to provide Hourly Priced Service (HPS) for the largest customers. Power to supply the HPS customers is acquired on next-day and other short-term PJM RTO markets. DPL’s rates for supplying fixed-price SOS and

 

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HPS reflect the associated capacity, energy, transmission, and ancillary services costs and a Reasonable Allowance for Retail Margin (RARM). Components of the RARM include a fixed annual margin of $2.75 million, plus estimated incremental expenses, a cash working capital allowance, and recovery with a return over five years of the capitalized costs of the billing system used for billing HPS customers. DPL is paid tariff delivery rates for the delivery of electricity over its transmission and distribution facilities to all electricity customers in its Delaware service territory regardless of whether the customer receives SOS or purchases electricity from another energy supplier.

In Delaware, DPL sales to SOS customers represented 54% of total sales (measured by megawatt hours) for the year ended December 31, 2007, as compared to 69% in 2006.

DPL has been providing SOS in Maryland since June 2004. Pursuant to an order issued by the MPSC in November 2006, DPL will continue to be obligated to provide SOS to residential and small commercial customers indefinitely until further action of the Maryland General Assembly, and to medium-sized commercial customers through May 2009. DPL purchases the power supply required to satisfy its market rate SOS obligation from wholesale suppliers under contracts entered into pursuant to competitive bid procedures approved and supervised by the MPSC. DPL is entitled to recover from its SOS customers the costs of the SOS supply plus an average margin of $.001667 kilowatt-hour. Because margins vary by customer class, the actual average margin over any given time period depends on the number of Maryland SOS customers from each customer class and the load taken by such customers over the time period. DPL is paid tariff delivery rates for the delivery of electricity over its transmission and distribution facilities to all electricity customers in its Maryland service territory regardless of whether the customer receives SOS or purchases electricity from another energy supplier.

In Maryland, DPL sales to SOS customers represented 67% of total sales (measured by megawatt hours) for the year ended December 31, 2007, as compared to 75% in 2006.

DPL provided Default Service in Virginia from March 2004 until the sale of its Virginia retail electric business on January 2, 2008. DPL was paid tariff delivery rates for the delivery of electricity over its transmission and distribution facilities to all electricity customers in its Virginia service territory regardless of whether the customer received Default Service or purchased electricity from another energy supplier.

In Virginia, DPL sales to Default Service customers represented 94% of total sales (measured by megawatt hours) for the years ended December 31, 2007 and 2006.

Sale of Virginia Service Territory

On January 2, 2008, DPL completed (i) the sale of its retail electric distribution business on the Eastern Shore of Virginia to A&N Electric Cooperative (A&N) for a purchase price of approximately $45.2 million, after closing adjustments, and (ii) the sale of its wholesale electric transmission business located on the Eastern Shore of Virginia to Old Dominion Electric Cooperative (ODEC) for a purchase price of approximately $5.4 million, after closing adjustments. Each of A&N and ODEC assumed certain post-closing liabilities and unknown pre-closing liabilities related to the respective assets they are purchasing (including, in the A&N transaction, most environmental liabilities), except that DPL remained liable for unknown pre-closing liabilities if they become known within six months after the January 2, 2008 closing date. These sales resulted in an immaterial financial gain to DPL that will be recorded during the first quarter of 2008.

Natural Gas Distribution

DPL provides regulated natural gas supply and distribution service to customers in a service territory consisting of a major portion of New Castle County in Delaware. This service territory covers approximately 275 square miles and has a population of approximately 500,000. Large volume commercial, institutional, or industrial natural gas customers may purchase natural gas either from DPL or from other suppliers. DPL uses its natural gas distribution facilities to transport natural gas for customers that choose to purchase natural gas from

 

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other suppliers. Transportation customers pay DPL distribution service rates approved by the DPSC. DPL purchases natural gas supplies for resale to its retail service customers from marketers and producers through a combination of long-term agreements and next-day delivery arrangements. For the twelve months ended December 31, 2007, DPL supplied 67% of the natural gas that it delivered, compared to 66% in 2006.

As of December 31, 2007, DPL distributed natural gas to 122,000 customers, as compared to 121,000 customers as of December 31, 2006. In 2007, DPL distributed 20,700,000 Mcf (thousand cubic feet) of natural gas to customers in its Delaware service territory, of which 38% were sales to residential customers, 25% to commercial customers, 4% to industrial customers, and 33% to customers receiving a transportation-only service. In 2006, DPL delivered 18,300,000 Mcf of natural gas, of which 36% were sales to residential customers, 25% were sales to commercial customers, 4% were to industrial customers, and 35% were sales to customers receiving a transportation-only service.

ACE

ACE is primarily engaged in the transmission, distribution and default supply of electricity in a service territory consisting of Gloucester, Camden, Burlington, Ocean, Atlantic, Cape May, Cumberland and Salem counties in southern New Jersey. ACE’s service territory covers approximately 2,700 square miles and has a population of approximately 1.0 million. As of December 31, 2007, ACE delivered electricity to 544,000 customers in its service territory, as compared to 539,000 customers as of December 31, 2006. In 2007, ACE delivered a total of 10,187,000 megawatt hours of electricity to its customers, of which 44% was delivered to residential customers, 44% to commercial customers and 12% to industrial customers. In 2006, ACE delivered a total of 9,931,000 megawatt hours of electricity to its customers, of which 43% was delivered to residential customers, 44% to commercial customers, and 13% to industrial customers.

Electric customers in New Jersey who do not choose another supplier receive BGS from their electric distribution company. New Jersey’s electric distribution companies, including ACE, jointly procure the supply to meet their BGS obligations from competitive suppliers selected through auctions authorized by the NJBPU for New Jersey’s total BGS requirements. The winning bidders in the auction are required to supply a specified portion of the BGS customer load with full requirements service, consisting of power supply and transmission service.

ACE provides two types of BGS:

 

   

BGS-Fixed Price (BGS-FP), which is supplied to smaller commercial and residential customers at seasonally-adjusted fixed prices. BGS-FP rates change annually on June 1 and are based on the average BGS price obtained at auction in the current year and the two prior years. ACE’s BGS-FP load is approximately 2,270 megawatts, which represents approximately 99% of ACE’s total BGS load. Approximately one-third of this total load is auctioned off each year for a three-year term.

 

   

BGS-Commercial and Industrial Energy Price (BGS-CIEP), which is supplied to larger customers at hourly PJM RTO real-time market prices for a term of 12 months. ACE’s BGS-CIEP load is approximately 16 megawatts, which represents approximately 1% of ACE’s BGS load. This total load is auctioned off each year for a one-year term.

ACE is paid tariff rates established by the NJBPU that compensate it for the cost of obtaining the BGS supply. ACE does not make any profit or incur any loss on the supply component of the BGS it provides to customers.

ACE is paid tariff delivery rates for the delivery of electricity over its transmission and distribution facilities to all electricity customers in its New Jersey service territory regardless of whether the customer receives BGS or purchases electricity from another energy supplier.

 

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ACE sales to BGS customers represented 80% of total sales (measured by megawatt hours) for the year ended December 31, 2007 and 78% of total sales (measured by megawatt hours) for the year ended December 31, 2006.

On February 8, 2007, ACE completed the sale of its B.L. England generating facility. B.L. England comprised a significant component of ACE’s generation operations and its sale required discontinued operations presentation under Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long Lived Assets,” on ACE’s consolidated statements of earnings for the years ended December 31, 2007, 2006 and 2005. ACE’s sale of its interests in the Keystone and Conemaugh generating facilities in September 2006 is also reflected as discontinued operations on ACE’s consolidated statements of earnings for the years ended December 31, 2006 and 2005.

ACE has several contracts with non-utility generators (NUGs) under which ACE purchased 3.8 million megawatt hours of power in 2007. ACE sells the electricity purchased under the contracts with NUGs into the wholesale market administered by PJM.

In 2001, ACE established Atlantic City Electric Transition Funding LLC (ACE Funding) solely for the purpose of securitizing authorized portions of ACE’s recoverable stranded costs through the issuance and sale of bonds (Transition Bonds). The proceeds of the sale of each series of Transition Bonds have been transferred to ACE in exchange for the transfer by ACE to ACE Funding of the right to collect a non-bypassable transition bond charge from ACE customers pursuant to bondable stranded costs rate orders issued by the NJBPU in an amount sufficient to fund the principal and interest payments on the Transition Bonds and related taxes, expenses and fees (Bondable Transition Property). The assets of ACE Funding, including the Bondable Transition Property, and the Transition Bond charges collected from ACE’s customers, are not available to creditors of ACE. The holders of Transition Bonds have recourse only to the assets of ACE Funding.

Competitive Energy

PHI’s Competitive Energy business is engaged in the generation of electricity and the non-regulated marketing and supply of electricity and natural gas, and related energy management services, primarily in the mid-Atlantic region. In 2007, 2006 and 2005 PHI’s Competitive Energy operations produced 48%, 43%, and 48%, respectively, of PHI’s consolidated operating revenues. In 2007, 2006 and 2005 PHI’s Competitive Energy operations produced 26%, 20%, and 16%, respectively, of PHI’s consolidated operating income. PHI’s Competitive Energy operations are conducted by Conectiv Energy and Pepco Energy Services which are separate operating segments for financial reporting purposes.

Conectiv Energy

Conectiv Energy provides wholesale electric power, capacity, and ancillary services in the wholesale markets and also supplies electricity to other wholesale market participants under long- and short-term bilateral contracts. Conectiv Energy also supplies electric power to Pepco, DPL and ACE to satisfy a portion of their Default Electricity Supply load, as well as default electricity supply load shares of other utilities within PJM RTO and the ISONE wholesale markets. PHI refers to these activities as Merchant Generation & Load Service. Other than its default electricity supply sales, Conectiv Energy does not participate in the retail competitive power supply market. Conectiv Energy obtains the electricity required to meet its power supply obligations from its own generating plants, under bilateral contracts entered into with other wholesale market participants and through purchases in the wholesale market.

Conectiv Energy’s generation capacity is concentrated in mid-merit plants, which due to their operating flexibility and multi-fuel capability can quickly change their output level on an economic basis. Like “peak-load” plants, mid-merit plants generally operate during times when demand for electricity rises and prices are higher. However, mid-merit plants usually operate more frequently and for longer periods of time than peak-load plants because of better heat rates. As of December 31, 2007, Conectiv Energy owned and operated mid-merit plants

 

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with a combined 2,725 megawatts of capacity, peak-load plants with a combined 639 megawatts of capacity and base-load generating plants with a combined 340 megawatts of capacity. In addition to the generation plants it owns, Conectiv Energy controls another nominal 480 megawatts of capacity through tolling agreements.

On December 14, 2007, Conectiv Energy announced a decision to construct a 545 MW natural gas and oil-fired combined-cycle electricity generation plant to be located in Peach Bottom Township, Pennsylvania. The plant will be owned and operated as part of Conectiv Energy and is expected to go into commercial operation in 2011. Conectiv Energy has entered into a six-year tolling agreement with an unaffiliated energy company under which Conectiv Energy will sell the energy, capacity and most of the ancillary services from the plant for the period June 1, 2011 through May 31, 2017 to the other party. Under the terms of the tolling agreement, Conectiv Energy will be responsible for the operation and maintenance of the plant, subject to the other party’s control over the dispatch of the plant’s output. The other party will be responsible for the purchase and scheduling of the fuel to operate the plant and all required emissions allowances.

Conectiv Energy also sells natural gas and fuel oil to very large end-users and to wholesale market participants under bilateral agreements and operates a short-term power desk, which generates margin by identifying and capturing price differences between power pools and locational and timing differences within a power pool. Conectiv Energy obtains the natural gas and fuel oil required to meet its supply obligations through market purchases for next day delivery and under long- and short-term bilateral contracts with other market participants.

PHI’s Competitive Energy businesses use derivative instruments primarily to reduce their financial exposure to changes in the value of their assets and obligations due to commodity price fluctuations. The derivative instruments used by the Competitive Energy businesses include forward contracts, futures, swaps, and exchange-traded and over-the-counter options. In addition, the Competitive Energy businesses also manage commodity risk with contracts that are not classified as derivatives. The two primary risk management objectives are (1) to manage the spread between the cost of fuel used to operate electric generation plants and the revenue received from the sale of the power produced by those plants, and (2) to manage the spread between retail sales commitments and the cost of supply used to service those commitments to ensure stable and known minimum cash flows, and lock in favorable prices and margins when they become available. To a lesser extent, Conectiv Energy also engages in energy marketing activities. Energy marketing activities consist primarily of wholesale natural gas and fuel oil marketing; the activities of the short-term power desk, which generates margin by capturing price differences between power pools, and locational and timing differences within a power pool; and prior to October 31, 2006, provided operating services under an agreement with an unaffiliated generating plant. PHI collectively refers to these energy marketing activities, including its commodity risk management activities, as “other energy commodity” activities and identifies this activity separately from the proprietary trading activity that was discontinued in 2003.

Conectiv Energy’s goal is to manage the risk associated with the expected power output of its generation facilities and their fuel requirements. The risk management goals are approved by the CRMC and may change from time to time based on market conditions. The actual level of coverage may vary depending on the extent to which Conectiv Energy is successful in implementing its risk management strategies. For additional discussion of Conectiv Energy’s risk management activities, see “Quantitative and Qualitative Disclosures about Market Risk.”

Pepco Energy Services

Pepco Energy Services provides retail energy supply and energy services primarily to commercial, industrial, and government customers. Pepco Energy Services sells electricity, including electricity from renewable resources, to customers located primarily in the mid-Atlantic and northeastern regions of the U.S. and the Chicago, Illinois area. As of December 31, 2007, Pepco Energy Services’ estimated retail electricity backlog was 31.8 million MWH for delivery through 2013, an increase of 2% over December 31, 2006. Pepco Energy Services also sells natural gas to customers primarily located in the mid-Atlantic region.

 

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Pepco Energy Services also provides energy savings performance contracting services principally to federal, state and local government customers, and owns and operates district energy systems in Atlantic City, New Jersey and Wilmington, Delaware and sells steam and chilled water to customers in those cities. Pepco Energy Services also designs, constructs, and operates combined heat and power and central energy plants.

In addition, Pepco Energy Services provides high voltage construction and maintenance services to utilities throughout the United States and low voltage electric and telecommunication construction and maintenance services to utilities and other commercial customers and streetlight asset management services to municipalities in the Washington, D.C. area.

During 2006, Pepco Energy Services sold five businesses that served primarily commercial and industrial customers by providing heating, ventilation, air conditioning, electrical testing and maintenance, and building automation services. Net assets sold were approximately $20.7 million.

Pepco Energy Services also owns and operates two oil-fired power plants. The power plants are located in Washington, D.C. and have a generating capacity rating of approximately 790 MW. Pepco Energy Services sells the output of these plants into the wholesale market administered by PJM. In February 2007, Pepco Energy Services provided notice to PJM of its intention to deactivate these plants. In May 2007, Pepco Energy Services deactivated one combustion turbine at its Buzzard Point facility with a generating capacity of approximately 16 MW. Pepco Energy Services currently plans to deactivate the balance of both plants by May 2012. PJM has informed Pepco Energy Services that these facilities are not expected to be needed for reliability after that time, but that its evaluation is dependent on the completion of transmission upgrades. Pepco Energy Services’ timing for deactivation of these units, in whole or in part, may be accelerated or delayed based on the operating condition of the units, economic conditions, and reliability considerations. Deactivation will not have a material impact on PHI’s financial condition, results of operations or cash flows.

PJM Capacity Markets

One of the sources of revenue of the Competitive Energy Business is the sale of capacity by Conectiv Energy and Pepco Energy Services associated with their respective generating facilities. The wholesale market for capacity is administered by PJM which is responsible for ensuring that within the transmission control area there is sufficient generating capability available to meet the load requirements plus a reserve margin. In accordance with PJM requirements, retail sellers of electricity in the PJM market are required to maintain capacity from generating facilities within the control area or generating facilities outside the control area which have firm transmission rights into the control area that correspond to their load service obligation. This capacity can be obtained through the ownership of generation facilities, the entry into bilateral contracts or the purchase of capacity credits in the auctions administered by PJM. All of the generating facilities owned by PHI’s Competitive Energy businesses are located in the transmission control area administered by PJM. The capacity of a generating unit is determined based on the demonstrated generating capacity of the unit and its forced outage rate.

Beginning on June 1, 2007, PJM replaced its former capacity market rules with a forward capacity auction procedure known as the Reliability Pricing Model (RPM), which provides for differentiation in capacity prices between Locational Deliverability Areas. One of the primary objectives of RPM is to encourage the development of new generation sources, particularly in constrained areas.

Under RPM, PJM has held four auctions, each covering capacity to be supplied over consecutive 12-month periods beginning June 1, 2007. Each of these auctions has yielded higher prices for capacity than in the period preceding implementation of RPM. Auctions of capacity for each subsequent 12-month delivery period will be held 36 months ahead of the scheduled delivery year. The next auction, for the period June 1, 2011 through May 31, 2012, will take place in May 2008.

 

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In addition to participating in the PJM auctions, PHI’s Competitive Energy businesses participate in the forward capacity market as both sellers and buyers in accordance with PHI’s risk management policy, and accordingly, prices realized in the PJM capacity auctions may not be indicative of gross margin that PHI earns in respect to its capacity purchases and sales during a given period.

Competition

The unregulated energy generation, supply and marketing businesses primarily located in the mid-Atlantic region are characterized by intense competition at both the wholesale and retail levels. At the wholesale level, Conectiv Energy and Pepco Energy Services compete with numerous non-utility generators, independent power producers, wholesale power marketers and brokers, and traditional utilities that continue to operate generation assets. In the retail energy supply market and in providing energy management services, Pepco Energy Services competes with numerous competitive energy marketers and other service providers. Competition in both the wholesale and retail markets for energy and energy management services is based primarily on price and, to a lesser extent, the range of services offered to customers and quality of service.

Seasonality

Like the Power Delivery business, the power generation, supply and marketing businesses are seasonal and weather patterns can have a material impact on operating performance. Demand for electricity generally is higher in the summer months associated with cooling and demand for electricity and natural gas generally is higher in the winter months associated with heating, as compared to other times of the year. Historically, the competitive energy operations of Conectiv Energy and Pepco Energy Services have generated less revenue when temperatures are milder than normal in the winter and cooler than normal in the summer. Milder weather can also negatively impact income from these operations. Energy management services generally are not seasonal.

Other Business Operations

Through its subsidiary, Potomac Capital Investment Corporation (PCI), PHI maintains a portfolio of cross-border energy sale-leaseback transactions, with a book value at December 31, 2007 of approximately $1.4 billion. For additional information concerning these cross-border lease transactions, see Note (12), “Commitments and Contingencies,” to the consolidated financial statements included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” This activity constitutes a separate operating segment for financial reporting purposes, which is designated “Other Non-Regulated.”

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CONSOLIDATED RESULTS OF OPERATIONS

The following results of operations discussion compares the year ended December 31, 2007, to the year ended December 31, 2006. All amounts in the tables (except sales and customers) are in millions.

Operating Revenue

A detail of the components of PHI’s consolidated operating revenue is as follows:

 

     2007     2006     Change  

Power Delivery

   $ 5,244.2     $ 5,118.8     $ 125.4  

Conectiv Energy

     2,205.6       1,964.2       241.4  

Pepco Energy Services

     2,309.1       1,668.9       640.2  

Other Non-Regulated

     76.2       90.6       (14.4 )

Corp. & Other

     (468.7 )     (479.6 )     10.9  
                        

Total Operating Revenue

   $ 9,366.4     $ 8,362.9     $ 1,003.5  
                        

Power Delivery

The following table categorizes Power Delivery’s operating revenue by type of revenue.

 

     2007    2006    Change  

Regulated T&D Electric Revenue

   $ 1,631.8    $ 1,533.2    $ 98.6  

Default Supply Revenue

     3,256.9      3,271.9      (15.0 )

Other Electric Revenue

     64.2      58.3      5.9  
                      

Total Electric Operating Revenue

     4,952.9      4,863.4      89.5  
                      

Regulated Gas Revenue

     211.3      204.8      6.5  

Other Gas Revenue

     80.0      50.6      29.4  
                      

Total Gas Operating Revenue

     291.3      255.4      35.9  
                      

Total Power Delivery Operating Revenue

   $ 5,244.2    $ 5,118.8    $ 125.4  
                      

Regulated Transmission and Distribution (T&D) Electric Revenue includes revenue from the transmission and the delivery of electricity, including the delivery of Default Electricity Supply, by PHI’s utility subsidiaries to customers within their service territories at regulated rates.

Default Supply Revenue is the revenue received for Default Electricity Supply. The costs related to Default Electricity Supply are included in Fuel and Purchased Energy and Other Services Cost of Sales. Default Supply Revenue also includes revenue from transition bond charges and other restructuring related revenues.

Other Electric Revenue includes work and services performed on behalf of customers, including other utilities, which is not subject to price regulation. Work and services includes mutual assistance to other utilities, highway relocation, rentals of pole attachments, late payment fees, and collection fees.

Regulated Gas Revenue consists of revenues for on-system natural gas sales and the transportation of natural gas for customers by DPL within its service territories at regulated rates.

Other Gas Revenue consists of DPL’s off-system natural gas sales and the release of excess system capacity.

 

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Electric Operating Revenue

 

Regulated T&D Electric Revenue    2007    2006    Change  

Residential

   $ 606.0    $ 575.7    $ 30.3  

Commercial

     731.2      699.0      32.2  

Industrial

     27.4      28.6      (1.2 )

Other

     267.2      229.9      37.3  
                      

Total Regulated T&D Electric Revenue

   $ 1,631.8    $ 1,533.2    $ 98.6  
                      

Other Regulated T&D Electric Revenue consists primarily of (i) transmission service revenue received by PHI’s utility subsidiaries from PJM as transmission owners, (ii) revenue from the resale of energy and capacity under power purchase agreements between Pepco and unaffiliated third parties in the PJM RTO market, and (iii) either (a) a positive adjustment equal to the amount by which revenue from Maryland retail distribution sales falls short of the revenue that Pepco and DPL are entitled to earn based on the distribution charge per customer approved in the 2007 Maryland Rate Order or (b) a negative adjustment equal to the amount by which revenue from such distribution sales exceeds the revenue that Pepco and DPL are entitled to earn based on the approved distribution charge per customer (a Revenue Decoupling Adjustment).

 

Regulated T&D Electric Sales (GWh)    2007    2006    Change  

Residential

   17,946    17,139    807  

Commercial

   29,398    28,638    760  

Industrial

   3,974    4,119    (145 )
                

Total Regulated T&D Electric Sales

   51,318    49,896    1,422  
                

 

Regulated T&D Electric Customers (in thousands)    2007    2006    Change

Residential

   1,622    1,605    17

Commercial

   199    198    1

Industrial

   2    2    —  
              

Total Regulated T&D Electric Customers

   1,823    1,805    18
              

The Pepco, DPL and ACE service territories are located within a corridor extending from Washington, D.C. to southern New Jersey. These service territories are economically diverse and include key industries that contribute to the regional economic base.

 

   

Commercial activity in the region includes banking and other professional services, government, insurance, real estate, strip malls, casinos, stand alone construction, and tourism.

 

   

Industrial activity in the region includes automotive, chemical, glass, pharmaceutical, steel manufacturing, food processing, and oil refining.

Regulated T&D Electric Revenue increased by $98.6 million primarily due to the following: (i) $43.0 million increase in sales due to higher weather-related sales (a 17% increase in Cooling Degree Days and a 12% increase in Heating Degree Days), (ii) $28.8 million increase in Other Regulated T&D Electric Revenue from the resale of energy and capacity purchased under the power purchase agreement between Panda-Brandywine, L.P. (Panda) and Pepco (the Panda PPA), (offset in Fuel and Purchased Energy and Other Services Cost of Sales), (iii) $20.3 million increase due to a 2007 Maryland Rate Order that became effective in June 2007, which includes a positive $4.9 million Revenue Decoupling Adjustment, (iv) $12.1 million increase due to higher pass-through revenue primarily resulting from tax rate increases in the District of Columbia (offset primarily in Other Taxes), (v) $5.2 million increase due to customer growth of 1% in 2007, partially offset by (vi) $10.0 million decrease due to a change in Delaware rate structure effective May 1, 2006, which shifted revenue from Regulated T&D Electric Revenue to Default Supply Revenue, and (vii) $4.0 million decrease due to a Delaware base rate reduction effective May 1, 2006.

 

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Default Electricity Supply

 

Default Supply Revenue    2007    2006    Change  

Residential

   $ 1,816.4    $ 1,482.9    $ 333.5  

Commercial

     1,061.8      1,352.6      (290.8 )

Industrial

     92.1      108.2      (16.1 )

Other

     286.6      328.2      (41.6 )
                      

Total Default Supply Revenue

   $ 3,256.9    $ 3,271.9    $ (15.0 )
                      

Other Default Supply Revenue consists primarily of revenue from the resale of energy and capacity under non-utility generating contracts between ACE and unaffiliated third parties (NUGs) in the PJM RTO market.

 

Default Electricity Supply Sales (GWh)    2007    2006    Change  

Residential

   17,469    16,698    771  

Commercial

   9,910    14,799    (4,889 )

Industrial

   914    1,379    (465 )

Other

   131    129    2  
                

Total Default Electricity Supply Sales

   28,424    33,005    (4,581 )
                

 

Default Electricity Supply Customers (in thousands)    2007    2006    Change  

Residential

   1,585    1,575    10  

Commercial

   166    170    (4 )

Industrial

   1    1    —    

Other

   2    2    —    
                

Total Default Electricity Supply Customers

   1,754    1,748    6  
                

Default Supply Revenue, which is partially offset in Fuel and Purchased Energy and Other Services Cost of Sales, decreased by $15.0 million primarily due to the following: (i) $345.5 million decrease primarily due to commercial and industrial customers electing to purchase an increased amount of electricity from competitive suppliers, (ii) $94.8 million decrease due to differences in consumption among the various customer rate classes, (iii) $46.3 million decrease in wholesale energy revenue primarily the result of the sales by ACE of its Keystone and Conemaugh interests and the B.L. England generating facilities, (iv) $4.1 million decrease due to a DPL adjustment to reclassify market-priced supply revenue from Regulated T&D Electric Revenue in 2006, partially offset by (v) $379.1 million increase due to annual increases in market-based Default Electricity Supply rates, (vi) $86.6 million increase due to higher weather-related sales (a 17% increase in Cooling Degree Days and a 12% increase in Heating Degree Days), and (vii) $10.0 million increase due to a change in Delaware rate structure effective May 1, 2006 that shifted revenue from Regulated T&D Electric Revenue to Default Supply Revenue.

Other Electric Revenue

Other Electric Revenue increased $5.9 million to $64.2 million in 2007 from $58.3 million in 2006 primarily due to increases in revenue related to pole rentals and late payment fees.

 

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Gas Operating Revenue

 

Regulated Gas Revenue    2007    2006    Change  

Residential

   $ 124.0    $ 116.2    $ 7.8  

Commercial

     72.7      73.0      (.3 )

Industrial

     8.2      10.3      (2.1 )

Transportation and Other

     6.4      5.3      1.1  
                      

Total Regulated Gas Revenue

   $ 211.3    $ 204.8    $ 6.5  
                      

 

Regulated Gas Sales (Bcf)    2007    2006    Change

Residential

   7.9    6.6    1.3

Commercial

   5.2    4.6    .6

Industrial

   .8    .8    —  

Transportation and Other

   6.8    6.3    .5
              

Total Regulated Gas Sales

   20.7    18.3    2.4
              

 

Regulated Gas Customers (in thousands)    2007    2006    Change

Residential

   112    112    —  

Commercial

   10    9    1

Industrial

   —      —      —  

Transportation and Other

   —      —      —  
              

Total Regulated Gas Customers

   122    121    1
              

DPL’s natural gas service territory is located in New Castle County, Delaware. Several key industries contribute to the economic base as well as to growth.

 

   

Commercial activity in the region includes banking and other professional services, government, insurance, real estate, strip malls, stand alone construction and tourism.

 

   

Industrial activity in the region includes automotive, chemical and pharmaceutical.

Regulated Gas Revenue increased by $6.5 million primarily due to (i) $11.7 million increase due to colder weather (a 15% increase in Heating Degree Days), (ii) $5.7 million increase due to base rate increases effective in November 2006 and April 2007, (iii) $4.8 million increase due to differences in consumption among the various customer rate classes, (iv) $2.7 million increase due to customer growth of 1% in 2007, partially offset by (v) $18.4 million decrease due to Gas Cost Rate (GCR) decreases effective November 2006, April 2007 and November 2007 resulting from lower natural gas commodity costs (offset in Fuel and Purchased Energy and Other Services Cost of Sales).

Other Gas Revenue

Other Gas Revenue increased by $29.4 million to $80.0 million in 2007 from $50.6 million in 2006 primarily due to higher off-system sales (partially offset in Fuel and Purchased Energy and Other Services Cost of Sales). The gas sold off-system resulted from increased demand from unaffiliated third party electric generators during periods of low customer demand for natural gas.

 

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Conectiv Energy

The impact of Operating Revenue changes and Fuel and Purchased Energy and Other Services Cost of Sales changes with respect to the Conectiv Energy component of the Competitive Energy business are encompassed within the discussion that follows.

Operating Revenues of the Conectiv Energy segment are derived primarily from the sale of electricity. The primary components of its costs of sales are fuel and purchased power. Because fuel and electricity prices tend to move in tandem, price changes in these commodities from period to period can have a significant impact on Operating Revenue and costs of sales without signifying any change in the performance of the Conectiv Energy segment. For this reason, PHI from a managerial standpoint focuses on gross margin as a measure of performance.

Conectiv Energy Gross Margin

Merchant Generation & Load Service consists primarily of electric power, capacity and ancillary services sales from Conectiv Energy’s generating plants; tolling arrangements entered into to sell energy and other products from Conectiv Energy’s generating plants and to purchase energy and other products from generating plants of other companies; hedges of power, capacity, fuel and load; the sale of excess fuel (primarily natural gas) and emission allowances; electric power, capacity, and ancillary services sales pursuant to competitively bid contracts entered into with affiliated and non-affiliated companies to fulfill their default electricity supply obligations; and fuel switching activities made possible by the multi-fuel capabilities of some of Conectiv Energy’s power plants.

Energy Marketing activities consist primarily of wholesale natural gas and fuel oil marketing; the activities of the short-term power desk, which generates margin by capturing price differences between power pools and locational and timing differences within a power pool; and prior to October 31, 2006, operating services under an agreement with an unaffiliated generating plant. Beginning in 2007, power origination activities, which primarily represent the fixed margin component of structured power transactions such as default electricity supply contracts, have been classified into Energy Marketing from Merchant Generation & Load Service. The 2006 activity has been reclassified for comparative purposes accordingly. Power origination contributed $18.8 million and $18.7 million of gross margin for the years ended December 31, 2007 and 2006, respectively.

 

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     December 31,
     2007    2006

Operating Revenue ($ millions):

     

Merchant Generation & Load Service

   $ 1,086.8    $ 1,073.2

Energy Marketing

     1,118.8      891.0
             

Total Operating Revenue1

   $ 2,205.6    $ 1,964.2
             

Cost of Sales ($ millions):

     

Merchant Generation & Load Service

   $ 805.8    $ 861.3

Energy Marketing

     1,081.0      847.7
             

Total Cost of Sales2

   $ 1,886.8    $ 1,709.0
             

Gross Margin ($ millions):

     

Merchant Generation & Load Service

   $ 281.0    $ 211.9

Energy Marketing

     37.8      43.3
             

Total Gross Margin

   $ 318.8    $ 255.2
             

Generation Fuel and Purchased Power Expenses ($ millions)3:

     

Generation Fuel Expenses4,5

     

Natural Gas6

   $ 267.8    $ 174.5

Coal

     62.4      53.4

Oil

     33.8      26.6

Other7

     2.2      4.1
             

Total Generation Fuel Expenses

   $ 366.2    $ 258.6
             

Purchased Power Expenses5

     479.7      431.3

Statistics:

     2007      2006

Generation Output (MWh):

     

Base-Load8

     2,232,499      1,814,517

Mid-Merit (Combined Cycle)9

     3,341,716      2,081,873

Mid-Merit (Oil Fired)10

     190,253      115,120

Peaking

     146,486      131,930

Tolled Generation

     160,755      94,064
             

Total

     6,071,709      4,237,504
             

Load Service Volume (MWh)11

     7,075,743      8,514,719

Average Power Sales Price12($/MWh):

     

Generation Sales4

   $ 82.19    $ 77.69

Non-Generation Sales13

   $ 70.43    $ 58.49

Total

   $ 74.34    $ 62.54

Average on-peak spot power price at PJM East Hub ($/MWh)14

   $ 77.85    $ 65.29

Average around-the-clock spot power price at PJM East Hub ($/MWh)14

   $ 63.92    $ 53.07

Average spot natural gas price at market area M3 ($/MMBtu)15

   $ 7.76    $ 7.31

Weather (degree days at Philadelphia Airport):16

     

Heating degree days

     4,560      4,205

Cooling degree days

     1,513      1,136

 

1

Includes $441.5 million and $471.1 million of affiliate transactions for 2007 and 2006, respectively. The 2006 amount has been reclassified to exclude $193.1 million of intra-affiliate transactions that were reported gross in 2006 at the segment level.

 

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2

Includes $6.7 million and $4.6 million of affiliate transactions for 2007 and 2006, respectively. The 2006 amount has been reclassified to exclude $193.1 million of intra-affiliate transactions that were reported gross in 2006 at the segment level. Also, excludes depreciation and amortization expense of $37.7 million and $36.3 million, respectively.

3 Consists solely of Merchant Generation & Load Service expenses; does not include the cost of fuel not consumed by the power plants and intercompany tolling expenses.
4 Includes tolled generation.
5 Includes associated hedging gains and losses.
6 Includes adjusted 2006 amount related to change in natural gas hedge allocation methodology.
7 Includes emissions expenses, fuel additives, and other fuel-related costs.
8 Edge Moor Units 3 and 4 and Deepwater Unit 6.
9 Hay Road and Bethlehem, all units.
10 Edge Moor Unit 5 and Deepwater Unit 1. Generation output for these units was negative for the first and fourth quarters of 2006 because of station service consumption.
11 Consists of all default electricity supply sales; does not include standard product hedge volumes.
12 Calculated from data reported in Conectiv Energy’s Electric Quarterly Report (EQR) filed with the FERC; does not include capacity or ancillary services revenue.
13 Consists of default electricity supply sales, standard product power sales, and spot power sales other than merchant generation as reported in Conectiv Energy’s EQR.
14 Source: PJM website (www.pjm.com).
15 Source: Average delivered natural gas price at Tetco Zone M3 as published in Gas Daily.
16 Source: National Oceanic and Atmospheric Administration National Weather Service data.

Merchant Generation & Load Service gross margin increased $69.1 million primarily due to:

 

   

An increase of approximately $76.5 million primarily due to 43% higher generation output attributable to more favorable weather and improved availability at the Hay Road and Deepwater generating plants and improved spark spreads.

 

   

An increase of approximately $25.9 million due to higher capacity prices due to the implementation of the PJM Reliability Pricing Model.

 

   

A decrease of $33.4 million due to less favorable natural gas fuel hedges, and the expiration, in 2006, of an agreement with an international investment banking firm to hedge approximately 50% of the commodity price risk of Conectiv Energy’s generation and Default Electricity Supply commitment to DPL.

Energy Marketing gross margin decreased $5.5 million primarily due to:

 

   

A decrease of $5.2 million due to lower margins in oil marketing.

 

   

A decrease of $4.0 million due to lower margins in natural gas marketing.

 

   

An increase of $2.7 million for adjustments related to an unaffiliated generation operating services agreement that expired in 2006.

Pepco Energy Services

Pepco Energy Services’ operating revenue increased $640.2 million, which corresponds with the increase in Fuel and Purchased Energy and Other Services Costs of Sales, to $2,309.1 million in 2007 from $1,668.9 million in 2006 primarily due to (i) increase of $646.0 million due to higher volumes of retail electric load served at higher prices in 2007 driven by customer acquisitions, (ii) increase of $27.4 million due to higher volumes of wholesale natural gas sales in 2007 that resulted from increased natural gas supply transactions to deliver gas to retail customers, partially offset by (iii) decrease of $32.3 million due primarily to lower construction activity in 2007 and to the sale of five construction businesses in 2006.

 

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Other Non-Regulated

Other Non-Regulated operating revenue decreased $14.4 million to $76.2 million in 2007 from $90.6 million in 2006. The operating revenue of this segment primarily consists of lease earnings recognized under Statement of Financial Accounting Standards No. 13, “Accounting for Leases.” The revenue decrease is primarily due to a change in state income tax lease assumptions that resulted in increased revenue in 2006 as compared to 2007.

Operating Expenses

Fuel and Purchased Energy and Other Services Cost of Sales

A detail of PHI’s consolidated Fuel and Purchased Energy and Other Services Cost of Sales is as follows:

 

     2007     2006     Change

Power Delivery

   $ 3,359.7     $ 3,303.6     $ 56.1

Conectiv Energy

     1,886.8       1,709.0       177.8

Pepco Energy Services

     2,161.7       1,531.1       630.6

Corp. & Other

     (464.9