Mergers, Acquisitions and Dispositions

Merger with Pepco Holdings, Inc. (Exelon)

Description of Transaction

On March 23, 2016, Exelon completed the merger contemplated by the Merger Agreement among Exelon, Purple Acquisition Corp., a wholly owned subsidiary of Exelon (Merger Sub) and Pepco Holdings, Inc. (PHI). As a result of that merger, Merger Sub was merged into PHI (the PHI Merger) with PHI surviving as a wholly owned subsidiary of Exelon and Exelon Energy Delivery Company, LLC (EEDC), a wholly owned subsidiary of Exelon which also owns Exelon's interests in ComEd, PECO and BGE (through a special purpose subsidiary in the case of BGE). Following the completion of the PHI Merger, Exelon and PHI completed a series of internal corporate organization restructuring transactions resulting in the transfer of PHI’s unregulated business interests to Exelon and Generation and the transfer of PHI, Pepco, DPL and ACE to a special purpose subsidiary of EEDC.

Regulatory Matters

On August 27, 2015, the District of Columbia Public Service Commission (DCPSC) issued an Opinion and Order denying approval of the merger, concluding that the merger as presented was not in the public interest. Exelon and PHI filed an Application for Reconsideration with the DCPSC on September 28, 2015. On October 6, 2015, various parties, including Exelon and PHI, entered into a Nonunanimous Full Settlement Agreement and Stipulation (Settlement Agreement) with respect to the merger. Exelon and PHI subsequently filed a motion of joint applicants requesting the DCPSC to reopen the approval application to allow for consideration of the Settlement Agreement and granting additional requested relief.

On October 28, 2015, the DCPSC agreed to reopen the approval application to allow for consideration of the Settlement Agreement. On February 26, 2016, the DCPSC rejected the Settlement Agreement and also voted that the merger would be deemed approved without further DCPSC action if the Settlement Agreement was modified in specific ways (Revised Settlement Agreement), and if such modifications were acceptable to Exelon, PHI, the District of Columbia Government, the Office of People's Counsel, the District of Columbia Water and Sewer Authority, the National Consumer Law Center, National Housing Trust and National Housing Trust-Enterprise Preservation Corporation, and the Apartment and Office Building Association of Metropolitan Washington (collectively, Settling Parties). On March 7, 2016, Exelon and PHI made a filing with the DCPSC requesting approval of the merger through either (1) the adoption of the Settlement Agreement as originally executed by the Settling Parties, (2) the adoption of the Revised Settlement Agreement as a resolution on the merits, or (3) the adoption of a compromise position with modifications to the Revised Settlement Agreement. On March 23, 2016, the DCPSC approved the merger through the adoption of the Revised Settlement Agreement with a minor modification.

Approval of the merger across all jurisdictions was conditioned upon Exelon and PHI agreeing to certain commitments including where applicable: customer rate credits, funding for energy efficiency and delivery system modernization programs, a green sustainability fund, workforce development initiatives, charitable contributions, renewable generation and other required commitments. In addition, the orders approving the merger in Delaware, New Jersey, and Maryland include a “most favored nation” provision which, generally speaking, requires allocation of merger benefits proportionally across all the jurisdictions. Exelon estimates total commitments of approximately $444 million on a net present value basis (excluding charitable contributions and renewable generation commitments) will be provided. The actual cost of commitments may differ by a material amount depending on the result of final negotiations and application of the most favored nation provision. The following pre-tax costs were recognized, including the estimated impacts of applying the most favored nation provision, after the closing of the merger and are included in Operating and maintenance expense in Exelon's, Pepco's, DPL's and ACE's Consolidated Statements of Operations and Comprehensive Income for the three months ended March 31, 2016 and PHI's successor Consolidated Statement of Operations and Comprehensive Income:



								Successor
Description	Expected Payment Period	Pepco		DPL		ACE		PHI		Exelon
Customer bill credit	2016 - 2017	$	65	$	58	$	62	$	185	$	185
Energy efficiency	2016 - 2021	—		—		—		—		64
Charitable contributions	2016 - 2026	28		12		10		50		50
Customer base rate credit	2016 - 2019	26		—		—		26		26
Delivery system modernization	Q2 2016	—		—		—		—		22
Green sustainability fund	Q2 2016	—		—		—		—		14
Workforce development	2016 - 2020	—		—		—		—		11
Most favored nation		19		32		48		99		129
Other		1		2		—		3		7
Total		$	139	$	104	$	120	$	363	$	508

Pursuant to the orders approving the merger, Exelon expects to make $73 million, $46 million and $49 million equity contributions to Pepco, DPL and ACE, respectively, in the second quarter of 2016 to fund the after-tax amounts of the customer bill credit and the customer base rate credit commitments.

In addition, Exelon is committed to develop or to assist in the commercial development of approximately 32 MWs of new generation in Maryland and the District of Columbia, 27MWs of which are expected to be completed by 2018. These investments are expected to total approximately $130 million. These investments are expected to be primarily capital in nature, and will generate future earnings at Exelon and Generation. Investment costs will be recognized as incurred and recorded on Exelon's and Generation's financial statements. Exelon has also committed to purchase 100MW of wind energy to procure, under certain circumstances, wind RECs for the purpose of meeting Delaware's renewable portfolio standards, and to maintain and promote energy efficiency and demand response programs in the PHI jurisdictions.

Pursuant to the various jurisdictions' merger approval conditions, over specified periods Pepco, DPL and ACE are not permitted to reduce employment levels due to involuntary attrition associated with the merger integration process and have made other commitments regarding hiring and relocation of positions.

Exelon has been named in suits filed in the Delaware Chancery Court alleging that individual directors of PHI breached their fiduciary duties by entering into the merger transaction and Exelon aided and abetted the individual directors’ breaches. The suits seek to enjoin PHI from completing the merger or seek rescission of the merger if completed. In addition, they also seek unspecified damages and costs. Exelon was also named in a federal court suit making similar claims. In September 2014, the parties reached a proposed settlement that would resolve all claims, which is subject to court approval, with a decision not anticipated until the second or third quarter of 2016. Exelon does not believe resolution of these suits will have a material impact on Exelon’s results of operations or cash flows.

On July 21, 2015, the OPC filed a motion to stay the MDPSC order approving the merger and to set a schedule for discovery and presentation of new evidence. On July 29, 2015, Public Citizen, Inc. filed a response supporting OPC’s motion to stay, and on July 31, 2015 the Sierra Club and the Chesapeake Climate Action Network (CCAN) filed a joint motion to stay. In July and August, Exelon, PHI, the MDPSC, Prince George’s County and Montgomery County filed responses opposing the motions to stay. The judge issued an order denying the motions for stay on August 12, 2015. On January 8, 2016, the Circuit Court judge affirmed the MDPSC’s order approving the merger and denied the petitions for judicial review filed by the OPC, the Sierra Club, CCAN and Public Citizen, Inc. On January 19, 2016, the OPC filed a notice of appeal to the Maryland Court of Special Appeals, and on January 21, the Sierra Club and CCAN filed a notice of appeal. Exelon believes the matters are without merit. These appeals are not expected to be resolved any earlier than the first quarter of 2017.

On March 25, 2016, Grid 2.0 filed an application for reconsideration of the DCPSC’s March 23, 2016 order approving the merger. On March 30, 2016, Exelon filed a reply to that application. The DCPSC has tolled the date to act upon the application until May 25, 2016 and, therefore, the DCPSC is expected to issue an order ruling on these motions by that date. On April 20, 2016, DC Public Power filed a motion to reconsider the DCPSC's March 23, 2016 order, motion to intervene and motion to consider alternative settlement provisions (namely, that the DCPSC consider requiring the post-merger divestiture of Pepco’s DC-based assets to a not-for-profit independent grid operator). On April 27, 2016, Exelon filed a reply to these motions. The DCPSC is expected to issue an order ruling on these motions by May 20, 2016. On April 22, 2016, (1) the District of Columbia Office of People’s Counsel, (2) the District of Columbia Government, and (3) DC Sun and Public Citizen each filed separate applications for reconsideration of the DCPSC’s March 23, 2016 order. On April 29, 2016, Exelon filed a reply to these applications. The DCPSC is expected to issue an order ruling on these applications by May 23, 2016. These applications for reconsideration generally argue that the DCPSC violated its regulations, utilized improper processes, abused its discretion, acted arbitrarily and capriciously, committed legal error and denied due process in approving the merger under terms that revised the Settlement Agreement offered by the companies and various parties. Exelon believes the matters are without merit.

Accounting for the Merger Transaction

The total purchase price consideration of approximately $7.1 billion for the PHI Merger consisted of cash paid to PHI shareholders, cash paid for PHI preferred securities and cash paid for PHI stock-based compensation equity awards as follows:



(In millions of dollars, except per share data)	Total Consideration
Cash paid to PHI shareholders at $27.25 per share (254 million shares outstanding at March 23, 2016)	$	6,933
Cash paid for PHI preferred stock^(a)	180
Cash paid for PHI stock-based compensation equity awards^(b)	29
Total purchase price	$	7,142

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(a)	As of December 31, 2015, the preferred stock was included in Other non-current assets on Exelon's Consolidated Balance Sheet.

(b)

PHI’s unvested time-based restricted stock units and performance-based restricted stock units issued prior to April 29, 2014 were immediately vested and paid in cash upon the close of the merger. PHI’s remaining unvested time-based restricted stock units as of the close of the merger were cancelled. There were no remaining unvested performance-based restricted stock units as of the close of the merger.

PHI shareholders received $27.25 of cash in exchange for each share of PHI common stock outstanding as of the effective date of the merger. In connection with the Merger Agreement, Exelon entered into a Subscription Agreement under which it purchased $180 million of a new class of nonvoting, nonconvertible and nontransferable preferred securities of PHI prior to December 31, 2015. On March 23, 2016, the preferred securities were cancelled for no consideration to Exelon, and accordingly, the $180 million cash consideration previously paid to acquire the preferred securities was treated as purchase price consideration.

Exelon applied push-down accounting to PHI, and accordingly, the PHI assets acquired and liabilities assumed were recorded on Exelon’s and PHI's Consolidated Balance Sheets as of March 23, 2016, at their estimated fair values as follows:



Preliminary Purchase Price Allocation
Current assets	$	2,107
Property, plant and equipment	11,071
Regulatory assets	5,118
Other assets	656
Goodwill	4,016
Total assets	22,968

Current liabilities	3,425
Unamortized energy contracts	1,550
Regulatory liabilities	297
Long-term debt, including current maturities	6,076
Deferred income taxes	3,441
Pension and OPEB liability	846
Other liabilities	191
Total liabilities	15,826
Total purchase price	$	7,142

On its successor financial statements, PHI has recorded beginning March 24, 2016, Membership interest equity of $7.2 billion, greater than the total $7.1 billion purchase price, reflecting the impacts of a $59 million deferred tax liability recorded only at Exelon Corporate to reflect unitary state income tax consequences of the merger.

The excess of the purchase price over the estimated fair value of the assets acquired and the liabilities assumed totaled $4.0 billion, which was recognized as goodwill by PHI and Exelon at the acquisition date, reflecting the value associated with enhancing Exelon's regulated utility portfolio of businesses, including the ability to leverage experience and best practices across the utilities and the opportunities for synergies. For purposes of future required impairment assessments, the goodwill has been preliminarily assigned to PHI's reportable units Pepco, DPL and ACE in the amounts of $1.7 billion, $1.2 billion and $1.1 billion, respectively. None of this goodwill is expected to be tax deductible.

Immediately following closing of the merger, $235 million of net assets included in the table above associated with PHI's unregulated business interests were distributed by PHI to Exelon. Of this amount, Exelon contributed $163 million of such net assets to Generation.

The fair values of PHI's assets and liabilities were determined based on significant estimates and assumptions that are judgmental in nature, including projected future cash flows (including timing), discount rates reflecting risk inherent in the future cash flows and impacts of utility rate regulation. There were also judgments made to determine the expected useful lives assigned to each class of assets acquired.

Exelon’s and PHI’s carrying amount of goodwill for the three months ended March 31, 2016 was as follows:



	PHI		Exelon^(a)
Beginning balance	$	—	$	2,672
Goodwill from business combination	4,016		4,016
Ending balance	$	4,016	$	6,688

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(a) As of March 31, 2016, there were no changes to the carrying amount of goodwill for ComEd and Generation, see Note 11— Intangible Assets of the Exelon 2015 Form 10-K for further information.

Through its wholly-owned rate regulated utility subsidiaries, most of PHI’s assets and liabilities are subject to cost-of-service rate regulation. Under such regulation, rates charged to customers are established by a regulator to provide for recovery of costs and a fair return on invested capital, or rate base, generally measured at historical cost. In applying the acquisition method of accounting, for regulated assets and liabilities included in rate base or otherwise earning a return (primarily plant, property and equipment and regulatory assets earning a return), no fair value adjustments were recorded as historical cost is viewed as a reasonable proxy for fair value.

Fair value adjustments were applied to the historical cost bases of other assets and liabilities subject to rate regulation but not earning a return (including debt instruments and pension and OPEB obligations). In these instances, a corresponding offsetting regulatory asset or liability was also established, as the underlying utility asset and liability amounts are recoverable from or refundable to customers at historical cost (and not at fair value) through the rate setting process. Similar treatment was applied for fair value adjustments to record intangible assets and liabilities, such as for electricity and gas energy supply contracts as further described below. Regulatory assets and liabilities established to offset fair value adjustments are amortized in amounts and over time frames consistent with the realization or settlement of the fair value adjustments, with no impact on reported net income. See Note 5 - Regulatory Matters for additional information regarding the fair value of regulatory assets and liabilities established by Exelon and PHI.

Fair value adjustments were recorded at Exelon and PHI for the difference between the contract price and the market price of electricity and gas energy supply contracts of PHI’s wholly-owned rate regulated utility subsidiaries. These adjustments are intangible assets and liabilities classified as unamortized energy contracts on Exelon’s and PHI’s Consolidated Balance Sheets as of March 31, 2016. The difference between the contract price and the market price at the acquisition date of the Merger was recognized for each contract as either an intangible asset or liability. In total, Exelon and PHI recorded a net $1.5 billion liability reflecting out-of-the-money contracts. The valuation of the acquired intangible assets and liabilities was estimated by applying either the market approach or the income approach depending on the nature of the underlying contract. The market approach was utilized when prices and other relevant information generated by market transactions involving comparable transactions were available. Otherwise the income approach, which is based upon discounted projected future cash flows associated with the underlying contracts, was utilized. In certain instances, the valuations were based upon certain unobservable inputs, which are considered Level 3 inputs, pursuant to applicable accounting guidance. Key estimates and inputs include forecasted power prices and the discount rate. The unamortized energy contract fair value adjustment amounts and the corresponding offsetting regulatory asset and liability amounts are amortized through Purchase power and fuel expense or Operating revenues, as applicable, over the life of the applicable contract in relation to the present value of the underlying cash flows as of the merger date. Amortizations were not significant for the period March 24, 2016 to March 31, 2016 at Exelon or PHI.

The valuations performed in the first quarter of 2016 to assess the fair value of certain assets acquired and liabilities assumed are considered preliminary as a result of the short time period between the closing of the merger and the end of the first quarter of 2016. Accounting guidance provides that the allocation of the purchase price may be modified up to one year from the date of the merger as more information is obtained about the fair value of assets acquired and liabilities assumed; however, Exelon expects to finalize these amounts by the end of 2016, if not sooner. The significant assets and liabilities for which preliminary valuation amounts are recognized at March 31, 2016 include the fair value of intangible assets and liabilities, uncertain tax positions, deferred income tax assets and liabilities, pension and OPEB plans, long-term debt, and unregulated property, plant and equipment. The preliminary amounts recognized are subject to revision until the valuations are completed and to the extent that additional information is obtained about the facts and circumstances that existed as of the acquisition date. Any changes to the fair value assessments may affect the purchase price allocation and could potentially impact goodwill.

As mentioned, under cost-of-service rate regulation, rates charged to customers are established by a regulator to provide for recovery of costs and a fair return on invested capital, or rate base, generally measured at historical cost. Historical cost information therefore is the most relevant presentation for the financial statements of PHI’s rate regulated utility subsidiary registrants, Pepco, DPL and ACE. As such, Exelon and PHI did not push-down the application of acquisition accounting to PHI's utility registrants, and therefore the financial statements of Pepco, DPL and ACE do not reflect the revaluation of any assets and liabilities.

The current quarter impact of PHI, including its unregulated businesses, on Exelon's Consolidated Statement of Operations and Comprehensive Income includes Operating revenues of $107 million and Net loss of $(315) million during the three months ended March 31, 2016.

For the periods ended March 31, 2016 and 2015, Exelon and PHI have recognized expense to achieve the PHI acquisition as follows:



	Three Months Ended March 31,
Acquisition, Integration and Financing Costs^(a)	2016			2015
Exelon	$	102		$	108
Generation	16			7
ComEd^(b)	(8		)	3
PECO	2			1
BGE	2			1
Pepco	27			1
DPL	16			1
ACE	13			1



	Successor		Predecessor
Acquisition, Integration and Financing Costs^(a)	March 24, 2016 to March 31, 2016		January 1, 2016 to March 23, 2016		Three Months Ended March 31, 2015
PHI	$	56	$	29	$	8

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(a)	The costs incurred are classified primarily within Operating and maintenance expense in the Registrants’ respective Consolidated Statement of Operations and Comprehensive Income, with the exception of the financing costs, which are included within Interest expense. Costs do not include merger commitments discussed above.


(b)	Excludes acquisition, integration and financing costs of $9 million incurred at ComEd that have been recorded as a regulatory asset.

Pro-forma Impact of the Merger

The following unaudited pro forma financial information reflects the consolidated results of operations of Exelon as if the merger with PHI had taken place on January 1, 2015. The unaudited pro forma information was calculated after applying Exelon’s accounting policies and adjusting PHI’s results to reflect purchase accounting adjustments.

The unaudited pro forma financial information has been presented for illustrative purposes only and is not necessarily indicative of results of operations that would have been achieved had the merger events taken place on the dates indicated, or the future consolidated results of operations of the combined company.



	Three Months Ended March 31,				Year Ended December 31,
	2016^(a)		2015^(b)		2015^(c)
Total operating revenues	$	8,556	$	10,062	$	33,823
Net income attributable to common shareholders	577		800		2,618

Basic earnings per share	$	0.63	$	0.87	$	2.85
Diluted earnings per share	0.62		0.87		2.84

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(a)	The amounts above exclude non-recurring costs directly related to the merger of $639 million and intercompany revenue of $170 million for the three months ended March 31, 2016.


(b)	The amounts above exclude non-recurring costs directly related to the merger of $116 million and intercompany revenue of $122 million for the three months ended March 31, 2015.


(c)	The amounts above exclude non-recurring costs directly related to the merger of $92 million and intercompany revenue of $559 million for the year ended December 31, 2015.

Asset Divestitures (Exelon, Generation, PHI, Pepco and ACE)

At March 31, 2016, Generation had net liabilities held for sale of $5 million which were reflected within Other current assets and Other current liabilities in the Consolidated Balance Sheet. The assets held for sale at December 31, 2015 were not material. On April 21, 2016, Generation completed the sale of the retired New Boston generating site, located in the Boston, Massachusetts, resulting in a pre-tax gain of approximately $32 million to be recorded in the second quarter. In addition, Pepco and ACE had net assets held for sale of $4 million and $1 million, respectively, which were reflected within Other current assets and Other current liabilities in their Consolidated Balance Sheets. The assets held for sale at December 31, 2015 were not material. On May 2, 2016, Pepco completed the sale of the New York Avenue land parcel, located in Washington, D.C., resulting in a pre-tax gain of approximately $8 million at Pepco to be recorded in the second quarter. Due to the fair value adjustments recorded at Exelon and PHI as part of purchase accounting, no gain will be recorded in the Exelon and PHI Consolidated Statements of Operations and Comprehensive Income.