-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IVpNepcyCgT4GLT9l2CqWkDY1Av5e8q/L+/ZMS2ODgXh04AB89aRKzdR99ttEowI NI1H49D8ibVMR/+LgP//1A== 0000079732-97-000053.txt : 19970814 0000079732-97-000053.hdr.sgml : 19970814 ACCESSION NUMBER: 0000079732-97-000053 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970813 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: POTOMAC ELECTRIC POWER CO CENTRAL INDEX KEY: 0000079732 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 530127880 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-01072 FILM NUMBER: 97657763 BUSINESS ADDRESS: STREET 1: 1900 PENNSYLVANIA AVE NW STREET 2: C/O M T HOWARD RM 841 CITY: WASHINGTON STATE: DC ZIP: 20068 BUSINESS PHONE: 2028722456 10-Q 1 SECOND QUARTER REPORT ON FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For Quarter Ended June 30, 1997 ------------- Commission file number 1-1072 ------ Potomac Electric Power Company - ---------------------------------------------------------------- (Exact name of registrant as specified in its charter) District of Columbia and Virginia 53-0127880 - ---------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1900 Pennsylvania Avenue, N.W., Washington, D.C. 20068 - ---------------------------------------------------------------- (Address of principal executive office) (Zip Code) (202) 872-2000 - ---------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes /X/. No / /. Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at June 30, 1997 - -------------------------- ---------------------------- Common Stock, $1 par value 118,500,614 TABLE OF CONTENTS PART I - Financial Information Page Item 1 - Consolidated Financial Statements Consolidated Statements of Earnings and Retained Income.. 2 Consolidated Balance Sheets.............................. 3 Consolidated Statements of Cash Flows.................... 4 Notes to Consolidated Financial Statements (1) Summary of Significant Accounting Policies......... 5 (2) Income Taxes....................................... 10 (3) Capitalization..................................... 13 (4) Fair Value of Financial Instruments................ 15 (5) Marketable Securities.............................. 17 (6) Commitments and Contingencies...................... 18 Report of Independent Accountants on Review of Interim Financial Information.................................. 26 Item 2 - Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition Utility Proposed Merger Update................................. 27 Results of Operations.................................. 29 Capital Resources and Liquidity........................ 31 New Accounting Standards............................... 32 Nonutility Subsidiary Results of Operations.................................. 32 Capital Resources and Liquidity........................ 35 PART II - Other Information Item 1 - Legal Proceedings................................. 36 Item 5 - Other Information Other Financing Arrangements............................. 36 Base Rate Proceedings.................................... 36 Restructuring of the Bulk Power Market................... 40 Competition.............................................. 41 Peak Load, Sales, Conservation, and Construction and Generating Capacity.................................... 43 Selected Nonutility Subsidiary Financial Information..... 45 Statistical Data......................................... 48 Unaudited Pro Forma Combined Condensed Financial Information............................................ 49 Item 6 - Exhibits and Reports on Form 8-K.................. 57 Signatures................................................. 58 Computations of Earnings Per Common Share.................. 59 Computation of Ratios - Parent Company Only................ 60 Computation of Ratios - Fully Consolidated................. 61 Independent Accountants Awareness Letter................... 62 1 Part I FINANCIAL INFORMATION - ------ --------------------- Item 1 CONSOLIDATED FINANCIAL STATEMENTS - ------ --------------------------------- POTOMAC ELECTRIC POWER COMPANY Consolidated Statements of Earnings and Retained Income (Unaudited) - -------------------------------------------------------
Three Months Ended Six Months Ended Twelve Months Ended June 30, June 30, June 30, -------------------- - -------------------- ---------------------- 1997 1996 1997 1996 1997 1996 --------- --------- - --------- --------- ---------- ----------- (Thousands of Dollars) Revenue Sales of electricity $ 437,924 $ 461,002 $ 807,577 $ 843,578 $1,788,739 $1,857,355 Other electric revenue 1,631 1,703 6,464 4,399 12,182 9,166 --------- --------- - --------- --------- ---------- ---------- Total Operating Revenue 439,555 462,705 814,041 847,977 1,800,921 1,866,521 Interchange deliveries 11,416 39,075 25,990 90,396 111,048 137,686 --------- --------- - --------- --------- ---------- ---------- Total Revenue 450,971 501,780 840,031 938,373 1,911,969 2,004,207 --------- --------- - --------- --------- ---------- ---------- Operating Expenses Fuel 78,195 74,805 156,702 167,518 316,976 369,801 Purchased energy 44,376 79,195 95,450 160,497 270,932 266,059 Capacity purchase payments 36,781 32,583 72,725 64,861 133,649 126,085 Other operation 53,296 56,263 105,132 111,982 216,476 224,577 Maintenance 23,907 21,267 45,080 42,694 93,910 91,680 --------- --------- - --------- --------- ---------- ---------- Total Operation and Maintenance 236,555 264,113 475,089 547,552 1,031,943 1,078,202 Depreciation and amortization 56,801 54,675 114,401 110,076 227,340 219,474 Income taxes 27,763 37,808 33,058 45,979 121,164 140,044 Other taxes 49,232 49,841 94,641 95,396 199,611 201,433 --------- --------- - --------- --------- ---------- ---------- Total Operating Expenses 370,351 406,437 717,189 799,003 1,580,058 1,639,153 --------- --------- - --------- --------- ---------- ---------- Operating Income 80,620 95,343 122,842 139,370 331,911 365,054 --------- --------- - --------- --------- ---------- ---------- Other Income Nonutility Subsidiary Income 28,665 31,783 68,472 49,096 134,342 117,038 Loss on assets held for disposal - - - (12,320) (424) (12,320) Expenses, including interest and income taxes (27,209) (22,736) (53,566) (25,261) (113,633) (97,726) --------- --------- - --------- --------- ---------- ---------- Net earnings from nonutility subsidiary 1,456 9,047 14,906 11,515 20,285 6,992 Allowance for other funds used during construction and capital cost recovery factor 1,681 1,660 3,341 3,397 6,516 6,657 Other, net 1,638 1,613 2,324 3,368 3,414 2,334 --------- --------- - --------- --------- ---------- ---------- Total Other Income 4,775 12,320 20,571 18,280 30,215 15,983 --------- --------- - --------- --------- ---------- ---------- Income Before Utility Interest Charges 85,395 107,663 143,413 157,650 362,126 381,037 --------- --------- - --------- --------- ---------- ---------- Utility Interest Charges Long-term debt 34,104 33,291 68,847 66,725 135,228 133,687 Other 3,406 4,102 5,505 7,889 11,448 14,382 Allowance for borrowed funds used during construction and capital cost recovery factor (2,239) (1,983) (4,045) (3,951) (7,630) (9,220) --------- --------- - --------- --------- ---------- ---------- Net Utility Interest Charges 35,271 35,410 70,307 70,663 139,046 138,849 --------- --------- - --------- --------- ---------- ---------- Net Income 50,124 72,253 73,106 86,987 223,080 242,188 Dividends on Preferred Stock 4,137 4,137 8,282 8,297 16,590 16,673 --------- --------- - --------- --------- ---------- ---------- Earnings for Common Stock 45,987 68,116 64,824 78,690 206,490 225,515 Retained Income at Beginning of Period 730,197 695,521 760,285 742,296 711,726 689,475 Dividends on Common Stock (49,156) (49,153) (98,304) (98,305) (196,610) (196,610) Subsidiary Marketable Securities Net Unrealized Gain (Loss), Net of Tax 1,213 (2,758) 1,436 (10,955) 6,635 (6,654) --------- --------- - --------- --------- ---------- ---------- Retained Income at End of Period $ 728,241 $ 711,726 $ 728,241 $ 711,726 $ 728,241 $ 711,726 ========= ========= ========= ========= ========== ========== Average Common Shares Outstanding (000's) 118,500 118,496 118,500 118,496 118,499 118,493 Earnings Per Common Share $0.39 $0.57 $0.55 $0.66 $1.74 $1.90 Cash Dividends Per Common Share $0.415 $0.415 $0.83 $0.83 $1.66 $1.66 Book Value Per Share $15.67 $15.53 Dividend Payout Ratio 95.4% 87.4% Effective Federal Income Tax Rate 25.2% 22.1% 2
POTOMAC ELECTRIC POWER COMPANY Consolidated Balance Sheets (Unaudited at June 30, 1997 and 1996) ------------------------------------------
June 30, December 31, June 30, ASSETS 1997 1996 1996 ------ ------------- ------------- ------------- (Thousands of Dollars) Property and Plant - at original cost Electric plant in service $ 6,299,044 $ 6,232,049 $ 6,141,899 Construction work in progress 78,450 62,469 69,035 Electric plant held for future use 4,190 4,152 4,115 Nonoperating property 22,976 22,921 22,771 ------------- ------------- ------------- 6,404,660 6,321,591 6,237,820 Accumulated depreciation (1,961,519) (1,898,342) (1,829,828) ------------- ------------- ------------- Net Property and Plant 4,443,141 4,423,249 4,407,992 ------------- ------------- ------------- Current Assets Cash and cash equivalents 7,640 2,174 6,312 Customer accounts receivable, less allowance for uncollectible accounts of $661, $1,298 and $1,443 164,006 128,600 163,924 Other accounts receivable, less allowance for uncollectible accounts of $300 29,633 38,490 37,015 Accrued unbilled revenue 94,973 70,214 121,915 Prepaid taxes 105 34,202 3,427 Other prepaid expenses 6,892 4,613 11,535 Material and supplies - at average cost Fuel 63,834 68,232 80,254 Construction and maintenance 67,931 69,541 69,852 ------------- ------------- ------------- Total Current Assets 435,014 416,066 494,234 ------------- ------------- ------------- Deferred Charges Income taxes recoverable through future rates, net 239,435 238,467 239,806 Conservation costs, net 229,010 233,793 234,869 Unamortized debt reacquisition costs 54,149 55,552 56,956 Other 171,758 159,139 118,899 ------------- ------------- ------------- Total Deferred Charges 694,352 686,951 650,530 ------------- ------------- ------------- Nonutility Subsidiary Assets Cash and cash equivalents 19,111 804 - Marketable securities 289,293 377,237 409,194 Investment in finance leases 486,049 484,972 477,813 Operating lease equipment, net of accumulated depreciation of $137,492, $117,705 and $99,257 179,337 199,124 252,197 Assets held for disposal 3,700 10,300 20,200 Receivables, less allowance for uncollectible accounts of $6,000 47,981 87,745 77,631 Other investments 186,906 193,002 187,201 Other assets 14,280 12,436 15,599 ------------- ------------- ------------- Total Nonutility Subsidiary Assets 1,226,657 1,365,620 1,439,835 ------------- ------------- ------------- Total Assets $ 6,799,164 $ 6,891,886 $ 6,992,591 ============= ============= ============= CAPITALIZATION AND LIABILITIES - ------------------------------ Capitalization Common stock $ 118,501 $ 118,500 $ 118,497 Other common equity 1,738,619 1,770,692 1,722,167 Serial preferred stock 125,293 125,298 125,307 Redeemable serial preferred stock 141,000 142,500 142,500 Long-term debt 1,727,065 1,767,598 1,718,361 ------------- ------------- ------------- Total Capitalization 3,850,478 3,924,588 3,826,832 ------------- ------------- ------------- Other Non-Current Liabilities Capital lease obligations 161,702 162,936 164,113 ------------- ------------- ------------- Total Other Non-Current Liabilities 161,702 162,936 164,113 ------------- ------------- ------------- Current Liabilities Long-term debt and preferred stock redemption due within one year 100,985 152,445 100,985 Short-term debt 311,600 131,390 327,515 Accounts payable and accrued expenses 158,846 179,289 188,622 Capital lease obligations due within one year 20,772 20,772 20,772 Other 81,710 83,135 82,675 ------------- ------------- ------------- Total Current Liabilities 673,913 567,031 720,569 ------------- ------------- ------------- Deferred Credits Income taxes 1,001,460 973,642 907,032 Investment tax credits 59,133 60,958 62,782 Other 40,561 35,658 37,026 ------------- ------------- ------------- Total Deferred Credits 1,101,154 1,070,258 1,006,840 ------------- ------------- ------------- Nonutility Subsidiary Liabilities Long-term debt 912,709 996,232 978,911 Short-term notes payable - 51,650 159,330 Deferred taxes and other 99,208 119,191 135,996 ------------- ------------- ------------- Total Nonutility Subsidiary Liabilities 1,011,917 1,167,073 1,274,237 ------------- ------------- ------------- Total Capitalization and Liabilities $ 6,799,164 $ 6,891,886 $ 6,992,591 ============= ============= ============= 3
POTOMAC ELECTRIC POWER COMPANY Consolidated Statements of Cash Flows (Unaudited) -------------------------------------
Six Months Ended Twelve Months Ended June 30, June 30, - ----------------------- ----------------------- 1997 1996 1997 1996 --------- --------- --------- --------- (Thousands of Dollars) Operating Activities Income from utility operations $ 58,200 $ 75,472 $ 202,795 $ 235,196 Adjustments to reconcile income to net cash from operating activities: Depreciation and amortization 114,401 110,076 227,340 219,474 Deferred income taxes and investment tax credits 25,350 11,492 95,354 43,508 Deferred conservation costs (17,752) (26,965) (40,191) (69,667) Allowance for funds used during construction and capital cost recovery factor (7,386) (7,348) (14,146) (15,877) Changes in materials and supplies 6,008 (16,406) 18,341 (8,995) Changes in accounts receivable and accrued unbilled revenue (51,308) (75,011) 34,242 (42,099) Changes in accounts payable (20,405) 15,675 (22,456) 20,175 Changes in other current assets and liabilities 29,630 41,222 (5,734) 2,472 Net other operating activities (17,860) (6,856) (59,678) (35,808) Nonutility subsidiary: Net earnings 14,906 11,515 20,285 6,992 Deferred income taxes (25,612) (36,287) (25,723) (15,282) Loss on assets held for disposal - 12,320 424 12,320 Changes in other assets and net other operating activities 33,866 34,483 35,641 63,746 --------- --------- --------- --------- Net Cash From Operating Activities 142,038 143,382 466,494 416,155 --------- --------- --------- --------- Investing Activities Total investment in property and plant (99,554) (91,932) (201,658) (202,721) Allowance for funds used during construction and capital cost recovery factor 7,386 7,348 14,146 15,877 --------- --------- --------- --------- Net investment in property and plant (92,168) (84,584) (187,512) (186,844) Nonutility subsidiary: Purchase of marketable securities (23,133) (11,252) (31,561) (35,152) Proceeds from sale or redemption of marketable securities 119,472 117,242 169,758 129,638 Investment in leased equipment (7,480) (3,056) (7,480) (150,462) Proceeds from sale or disposition of leased equipment - 3,658 - 3,658 Proceeds from assets held for disposal 2,200 29,354 7,000 29,354 Proceeds from sale of assets 2,700 285 2,415 6,251 Purchase of other investments (19,293) (1,996) (40,295) (3,251) Proceeds from sale or distribution of other investments 5,559 1,604 37,822 2,319 Investment in promissory notes (12) (4,388) 131 (8,922) Proceeds from promissory notes 52,992 7,643 62,024 12,079 --------- --------- --------- --------- Net Cash From (Used by) Investing Activities 40,837 54,510 12,302 (201,332) --------- --------- --------- --------- Financing Activities Dividends on common stock (98,304) (98,305) (196,610) (196,610) Dividends on preferred stock (8,282) (8,297) (16,590) (16,673) Redemption of preferred stock (1,500) - (1,500) - Issuance of long-term debt 8,090 - 107,590 172,754 Reacquisition and retirement of long-term debt (101,460) (26,300) (101,480) (126,217) Short-term debt, net 180,210 69,050 (15,915) (26,485) Other financing activities (2,683) (2,573) (5,467) (13,757) Nonutility subsidiary: Issuance of long-term debt - 78,000 105,000 185,000 Repayment of long-term debt (83,523) (146,573) (174,052) (244,142) Short-term debt, net (51,650) (64,020) (159,333) 23,330 --------- --------- --------- --------- Net Cash Used By Financing Activities (159,102) (199,018) (458,357) (242,800) --------- --------- --------- --------- Net Increase (Decrease) in Cash and Cash Equivalents 23,773 (1,126) 20,439 (27,977) Cash and Cash Equivalents at Beginning of Period 2,978 7,438 6,312 34,289 --------- --------- --------- --------- Cash and Cash Equivalents at End of Period $ 26,751 $ 6,312 $ 26,751 $ 6,312 ========= ========= ========= ========= Cash paid for interest (net of capitalized interest) and income taxes: Interest (including nonutility subsidiary interest of $37,275, $43,682, $76,982 and $96,982) $ 103,712 $ 111,887 $ 208,791 $ 230,954 Income taxes $ 1,826 $ 2,559 $ 27,750 $ 44,594 4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------ (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------ The Company is engaged in the generation, transmission, distribution and sale of electric energy in the Washington, D.C. metropolitan area. The Company's retail service territory includes all of the District of Columbia and major portions of Montgomery and Prince George's counties in suburban Maryland. Potomac Capital Investment Corporation (PCI), the Company's wholly owned subsidiary, was formed in 1983 to provide a vehicle to conduct the Company's ongoing nonutility businesses. Effective April 30, 1996, the Company reorganized its nonutility subsidiaries whereby PEPCO Enterprises, Inc. (PEI) became a subsidiary of PCI. PCI's principal investments have been in aircraft and power generation equipment, equipment leasing and marketable securities, primarily preferred stock with mandatory redemption features. PCI is also involved with activities, through PEI, which provide telecommunication and energy services. In addition, PCI has investments in real estate properties in the Washington, D.C. metropolitan area. The Company's utility operations are regulated by the Maryland and District of Columbia Public Service Commissions and its wholesale business by the Federal Energy Regulatory Commission (FERC). The Company complies with the Uniform System of Accounts prescribed by the FERC and adopted by the Maryland and District of Columbia regulatory commissions. Based upon the regulatory framework in which it operates, the Company currently applies the provisions of Statement of Financial Accounting Standards (SFAS) No. 71 entitled "Accounting for the Effects of Certain Types of Regulation" in accounting for certain deferred charges and credits to be recognized in future customer billings pursuant to regulatory authorization, principally deferred income taxes, unamortized conservation costs and unamortized debt reacquisition costs. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates and assumptions. 5 Certain 1996 amounts have been reclassified to conform to the current year presentation. A description of significant accounting policies follows. Principles of Consolidation - --------------------------- The consolidated financial statements combine the financial results of the Company and PCI. All material intercompany balances and transactions have been eliminated. Total Revenue - ------------- Revenue is accrued for service rendered but unbilled as of the end of each month. The Company includes in revenue the amounts received for sales of energy, and resales of purchased energy, to other utilities and to power marketers. Amounts received for such interchange deliveries are a component of the Company's fuel rates. In each jurisdiction, the Company's rate schedules include fuel rates. The fuel rate provisions are designed to provide for separately stated fuel billings which cover applicable net fuel and interchange costs, purchased capacity in the District of Columbia, and emission allowance costs in the Company's retail jurisdictions, or changes in the applicable costs from levels incorporated in base rates. Differences between applicable net costs incurred and fuel rate revenue billed in any given period are accounted for as other current assets or other current liabilities in those cases where specific provision has been made by the appropriate regulatory commission for the resolution of such differences within one year. Where no such provision has been made, the differences are accounted for as other deferred charges or other deferred credits pending regulatory determination. In the District of Columbia, pre-July 1993 conservation costs receive rate base treatment. Conservation expenditures for the period July 1993 to December 1994 are recovered through a surcharge mechanism which initially became effective July 11, 1995, and which is scheduled to be updated annually on June 1 to recover 1995 and subsequent conservation expenditures, including a capital cost recovery factor (CCRF), which is a mechanism that enables the Company to earn a return on certain costs, principally unamortized Demand Side Management (DSM) costs not in rate base. A procedure has been established to consider lost revenue without the need for base rate proceedings. In Maryland, conservation costs are recovered through a surcharge rate which reflects amortization of program costs, including costs in the year during which the surcharge commences, a CCRF, incentives, 6 applicable taxes and estimated lost revenue. The surcharge is established annually in a collaborative process with the recovery of lost revenue subject to an earnings test performed on a quarterly basis. Leasing Transactions - -------------------- Income from PCI investments in direct finance and leveraged lease transactions, in which PCI is an equity participant, is reported using the financing method. In accordance with the financing method, investments in leased property are recorded as a receivable from the lessee to be recovered through the collection of future rentals. For direct finance leases, unearned income is amortized to income over the lease term at a constant rate of return on the net investment. Income, including investment tax credits on leveraged equipment leases, is recognized over the life of the lease at a level rate of return on the positive net investment. PCI investments in equipment under operating leases are stated at cost less accumulated depreciation, except that assets held for disposal are carried at estimated fair value less estimated costs to sell. Depreciation is recorded on a straight line basis over the equipment's estimated useful life. No depreciation is taken on assets held for disposal. Property and Plant - ------------------ The cost of additions to, and replacements or betterments of, retirement units of property and plant is capitalized. Such cost includes material, labor, the capitalization of an Allowance for Funds Used During Construction (AFUDC) and applicable indirect costs, including engineering, supervision, payroll taxes and employee benefits. The original cost of depreciable units of plant retired, together with the cost of removal, net of salvage, is charged to accumulated depreciation. Routine repairs and maintenance are charged to operating expenses as incurred. The Company uses separate depreciation rates for each electric plant account. The rates, which vary from jurisdiction to jurisdiction, were equivalent to a system-wide composite depreciation rate of approximately 3.1% for 1997, 1996 and 1995. 7 Conservation - ------------ In general, the Company accounts for conservation expenditures in connection with its DSM program as a deferred charge, and amortizes the costs over five years in Maryland and ten years in the District of Columbia. At June 30, 1997, unamortized conservation costs totaled $90.3 million in Maryland and $138.7 million in the District of Columbia. Allowance for Funds Used During Construction and Capital Cost - ------------------------------------------------------------- Recovery Factor --------------- In general, the Company capitalizes AFUDC with respect to investments in Construction Work in Progress with the exception of expenditures required to comply with federal, state or local environmental regulations (pollution control projects), which are included in rate base without capitalization of AFUDC. The jurisdictional AFUDC capitalization rates are determined as prescribed by the FERC. The effective capitalization rates were approximately 7.5%, compounded semiannually, for the six months ended June 30, 1997, and approximately 7.4% in 1996 and 7.9% in 1995, compounded semiannually. In Maryland, the Company accrues a CCRF on the retail jurisdictional portion of certain pollution control expenditures related to compliance with the Clean Air Act (CAA). The base for calculating this return is the amount by which the Maryland jurisdictional CAA expenditure balance exceeds the CAA balance being recovered in base rates. The CCRF rate for Maryland is 9.46%. In the District of Columbia, the carrying costs of CAA expenditures not in rate base are recovered through a base rate surcharge. Amortization of Debt Issuance and Reacquisition Costs - ----------------------------------------------------- The Company defers and amortizes expenses incurred in connection with the issuance of long-term debt, including premiums and discounts associated with such debt, over the lives of the respective issues. Costs associated with the reacquisition of debt are also deferred and amortized over the lives of the new issues. 8 Cash and Cash Equivalents - ------------------------- For purposes of the consolidated financial statements, cash and cash equivalents include cash on hand, money market funds and commercial paper with original maturities of three months or less. New Accounting Standards - ------------------------ On June 30, 1997, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards Nos. 130 and 131 entitled "Reporting Comprehensive Income" and "Disclosures about Segments of an Enterprise and Related Information", respectively. Both of these statements will become effective for calendar year 1998 financial statements. The Company is evaluating these statements to determine the impact on its reporting and disclosure requirements. Nonutility Subsidiary Receivables - --------------------------------- PCI, the Company's nonutility subsidiary, continuously monitors its receivables and establishes an allowance for doubtful accounts against its notes receivable, when deemed appropriate, on a specific identification basis. The direct write-off method is used when trade receivables are deemed uncollectible. 9 (2) INCOME TAXES - ---------------- Provision for Income Taxes - --------------------------
Three Months Ended Six Months Ended Twelve Months Ended June 30, June 30, June 30, ---------------------- ----------------------- ---------------------- 1997 1996 1997 1996 1997 1996 ---------- --------- --------- --------- --------- --------- (Thousands of Dollars) Utility current tax expense Federal $ 13,125 $ 23,234 $ 6,683 $ 31,753 $ 22,166 $ 87,294 State and local 1,802 3,569 952 4,346 2,886 12,090 ---------- --------- --------- --------- --------- --------- Total utility current tax expense 14,927 26,803 7,635 36,099 25,052 99,384 ---------- --------- --------- --------- --------- --------- Utility deferred tax expense Federal 12,123 11,208 23,525 11,487 86,799 41,391 State and local 1,866 1,202 3,650 1,830 12,204 5,767 Investment tax credits (912) (913) (1,825) (1,825) (3,649) (3,650) ---------- --------- --------- --------- --------- --------- Total utility deferred tax expense 13,077 11,497 25,350 11,492 95,354 43,508 ---------- --------- --------- --------- --------- --------- Total utility income tax expense 28,004 38,300 32,985 47,591 120,406 142,892 ---------- --------- --------- --------- --------- --------- Nonutility subsidiary current tax expense Federal (4,055) (5,005) 3,151 (9,039) (6,062) (36,691) ---------- --------- --------- --------- --------- --------- Nonutility subsidiary deferred tax expense Federal (3,880) (1,561) (24,068) (36,289) (24,152) (19,744) ---------- --------- --------- --------- --------- --------- Total nonutility subsidiary income tax credit (7,935) (6,566) (20,917) (45,328) (30,214) (56,435) ---------- --------- --------- --------- --------- --------- Total consolidated income tax expense 20,069 31,734 12,068 2,263 90,192 86,457 Income taxes included in other income (7,694) (6,074) (20,990) (43,716) (30,972) (53,587) ---------- --------- --------- --------- --------- --------- Income taxes included in utility operating expenses $ 27,763 $ 37,808 $ 33,058 $ 45,979 $ 121,164 $ 140,044 ========== ========= ========= ========= ========= ========= 10
Reconciliation of Consolidated Income Tax Expense - -------------------------------------------------
Three Months Ended Six Months Ended Twelve Months Ended June 30, June 30, June 30, ---------------------- ----------------------- ---------------------- 1997 1996 1997 1996 1997 1996 ---------- -------- --------- --------- --------- --------- (Thousands of Dollars) Income before income taxes $ 70,193 $ 103,987 $ 85,174 $ 89,250 $ 313,272 $ 328,645 ========== ========= ========= ========= ========= ========= Utility income tax at federal statutory rate $ 26,836 35,527 $ 31,915 $ 43,072 $ 113,120 $ 132,331 Increases (decreases) resulting from Depreciation 2,522 2,543 5,044 5,085 9,826 9,761 Removal costs (1,794) (1,170) (3,186) (1,478) (5,282) (5,783) Allowance for funds used during construction 160 146 365 280 776 548 Other (1,192) (934) (2,319) (1,475) (3,961) (1,449) State income taxes, net of federal effect 2,384 3,101 2,991 3,932 9,808 11,524 Tax credits (912) (913) (1,825) (1,825) (3,881) (4,040) ---------- --------- --------- --------- --------- --------- Total utility income tax expense 28,004 38,300 32,985 47,591 120,406 142,892 ---------- --------- --------- --------- --------- --------- Nonutility subsidiary income tax at federal statutory rate (2,268) 868 (2,104) (11,835) (3,475) (17,305) Increases (decreases) resulting from Dividends received deduction (1,196) (4,408) (2,718) (6,044) (3,788) (10,255) Reversal of previously accrued deferred taxes - (5,193) (10,125) (28,699) (12,230) (28,699) Other (4,471) 2,167 (5,970) 1,250 (10,721) (176) ---------- --------- --------- --------- --------- --------- Total nonutility subsidiary income tax credit (7,935) (6,566) (20,917) (45,328) (30,214) (56,435) ---------- --------- --------- --------- --------- --------- Total consolidated income tax expense 20,069 31,734 12,068 2,263 90,192 86,457 Income taxes included in other income (7,694) (6,074) (20,990) (43,716) (30,972) (53,587) ---------- --------- --------- --------- --------- --------- Income taxes included in utility operating expenses $ 27,763 $ 37,808 $ 33,058 $ 45,979 $ 121,164 $ 140,044 ========== ========= ========= ========= ========= ========= 11
Components of Consolidated Deferred Tax Liabilities (Assets) - ------------------------------------------------------------
June 30, Dec. 31, June 30, 1997 1996 1996 ---------- ---------- ---------- (Thousands of Dollars) Utility deferred tax liabilities (assets) Depreciation and other book to tax basis differences $ 845,159 $ 821,656 $ 794,312 Rapid amortization of certified pollution control facilities 24,036 24,816 26,068 Deferred taxes on amounts to be collected through future rates 90,650 90,284 90,790 Property taxes 13,094 12,664 12,132 Deferred fuel (14,964) (14,663) (12,954) Prepayment premium on debt retirement 20,493 21,025 21,543 Deferred investment tax credit (22,388) (23,079) (23,769) Contributions in aid of construction (29,176) (28,719) (27,551) Contributions to pension plan 16,170 16,170 11,803 Conservation costs (demand side management) 45,764 41,106 - Other 22,218 21,653 20,050 ---------- --------- -------- Total utility deferred tax liabilities (net) 1,011,056 982,913 912,424 Current portion of utility deferred tax liabilities (included in Other Current Liabilities) 9,596 9,271 5,392 ---------- --------- --------- Total utility deferred tax liabilities (net) - non-current $1,001,460 $ 973,642 $ 907,032 ========== ========= ========= Nonutility subsidiary deferred tax liabilities (assets) Finance leases $ 140,216 $ 144,667 $ 161,744 Operating leases 39,861 57,006 31,682 Alternative minimum tax (97,109) (97,109) (88,664) Other (46,739) (43,496) (43,987) ---------- --------- --------- Total nonutility subsidiary deferred tax liabilities (net), (included in Deferred taxes and other) $ 36,229 $ 61,068 $ 60,775 ========== ========= ========= 12
(3) CAPITALIZATION -------------- Common Equity - ------------- At June 30, 1997, 118,500,614 shares of the Company's $1 par value Common Stock were outstanding. A total of 200 million shares is authorized. As of June 30, 1997, 2,324,721 shares were reserved for issuance under the Shareholder Dividend Reinvestment Plan; 1,221,624 shares were reserved for issuance under the Employee Savings Plans; and 2,769,412 and 3,392,500 shares were reserved for conversion of the 7% and 5% Convertible Debentures, respectively. Under the Stock Option Agreement with Baltimore Gas and Electric Company, 23,579,900 shares could become issuable, contingent upon specific events associated with termination of the Merger Agreement. (See Note 6 - Commitments and Contingencies for additional information.) Serial Preferred, Redeemable Serial Preferred and Preference - ------------------------------------------------------------ Stock and Long-Term Debt ------------------------ At June 30, 1997, the Company had outstanding 5,345,547 shares of its $50 par value Serial Preferred Stock, including the Redeemable Serial Preferred Stock. A total of 11,125,649 shares is authorized. At June 30, 1997, the aggregate annual dividend requirements on the Serial Preferred Stock and the Redeemable Serial Preferred Stock were approximately $6.6 million and $10.1 million, respectively. Also, the Company has a total of 8,800,000 shares of cumulative, $25 par value, Preference Stock authorized and unissued. The Company's $2.44 Convertible Preferred Stock, 1966 Series (5,851 shares outstanding at June 30, 1997) is convertible into Common Stock at $8.51 per share. At June 30, 1997, the Company had outstanding one million shares of its Serial Preferred Stock, Auction Series A. The annual dividend rate is 4.5% ($2.25) for the period June 1, 1997, through August 31, 1997. For the period March 1, 1997, through May 31, 1997, the annual dividend rate was 3.92% ($1.96). The average rate at which dividends were paid during the twelve months ended June 30, 1997, was 4.14% ($2.07). At June 30, 1997, the Company had outstanding three series of $50 par value Redeemable Serial Preferred Stock. There are one million shares of the $3.89 (7.78%) Series of 1991 on which the sinking fund requirement commences June 1, 2001; one million shares of the $3.40 (6.80%) Series of 1992 on which the sinking fund requirement commences September 1, 2002; and 839,696 shares of the $3.37 (6.74%) Series of 1987 on which the sinking fund 13 requires redemption, beginning June 1993, at par, of not less than 30,000 nor more than 60,000 shares annually. Sinking fund requirements through 2001 with respect to the three series of Redeemable Serial Preferred Stock are $1 million in 1998, $1.5 million in 1999 through 2000 and $9.8 million in 2001. The Company's Long-Term Debt at June 30, 1997, is summarized below: (Thousands of Dollars) First Mortgage Bonds $1,341,800 Convertible Debentures 178,907 Notes Payable 333,090 Net Unamortized Discount (26,732) Current Portion (100,000) ---------- Net Utility Long-Term Debt $1,727,065 ========== Nonutility Subsidiary Long-Term Debt $ 912,709 ========== At June 30, 1997, the aggregate annual interest requirement on the Company's long-term debt, including debt due within one year, was $126.5 million; and the aggregate amounts of long-term debt maturities are $50 million in 1997, $50 million in 1998, $45 million in 1999, $100 million in 2000 and $165 million in 2001. At June 30, 1997, long-term debt due within one year consisted of $50 million of 9.08% Medium-Term Notes and $50 million of 4-3/8% First Mortgage Bonds. On May 26 and May 28, 1997, the Company redeemed, at maturity, $100 million of 6.66% - 6.73% Medium-Term Notes. Nonutility Subsidiary Long-Term Debt - ------------------------------------ Long-term debt at June 30, 1997, consisted primarily of unsecured borrowings from institutional lenders maturing at various dates between 1997 and 2003. The interest rates of such borrowings ranged from 5% to 10.1%. The weighted average effective interest rate was 7.44% at June 30, 1997, 7.44% at December 31, 1996, and 7.29% at June 30, 1996. Annual aggregate principal repayments on these borrowings are $114 million in 1997, $300.7 million in 1998, $170 million in 1999, $115 million in 2000, $54 million in 2001 and $98.5 million thereafter. Also included in long-term debt is $60.5 million of non-recourse debt which is due in monthly installments with final maturities in 1999, 2001, 2002 and 2011. 14 (4) FAIR VALUE OF FINANCIAL INSTRUMENTS - --------------------------------------- The estimated fair values of the Company's financial instruments at June 30, 1997, December 31, 1996, and June 30, 1996, are shown below.
June 30, December 31, June 30, 1997 1996 1996 -------------------------- - ------------------------- ------------------------- Carrying Fair Carrying Fair Carrying Fair Amount Value Amount Value Amount Value ----------- ---------- ---------- - ---------- ---------- ---------- (Thousands of Dollars) Utility Capitalization and Liabilities Serial preferred stock $ 125,293 119,468 125,298 113,285 125,307 110,157 ========== ========= ========= ========= ========= ========= Redeemable serial preferred stock $ 141,000 142,901 142,500 146,491 142,500 143,496 ========== ========= ========= ========= ========= ========= Long-term debt First mortgage bonds $1,277,803 1,262,424 1,327,389 1,319,976 1,326,975 1,291,083 Medium-term notes $ 281,050 278,457 272,788 274,242 223,152 216,888 Convertible debentures $ 168,212 171,368 167,421 171,880 168,234 170,092 ---------- --------- --------- - --------- --------- --------- Total long-term debt $1,727,065 1,712,249 1,767,598 1,766,098 1,718,361 1,678,063 ========== ========= ========= ========= ========= ========= Nonutility Subsidiary Assets Marketable securities $ 289,293 289,293 377,237 377,237 409,194 409,194 ========== ========= ========= ========= ========= ========= Notes receivable $ 34,253 29,734 72,251 71,593 64,298 62,168 ========== ========= ========= ========= ========= ========= Liabilities Long-term debt $ 912,709 916,229 996,232 1,011,814 978,911 993,426 ========== ========= ========= ========= ========= ========= 15
The methods and assumptions below were used to estimate, at June 30, 1997, December 31, 1996, and June 30, 1996, the fair value of each class of financial instruments shown above for which it is practicable to estimate that value. The fair value of the Company's long-term debt, which includes First Mortgage Bonds, Medium-Term Notes and Convertible Debentures, excluding amounts due within one year, was based on the current market price, or for issues with no market price available, was based on discounted cash flows using current rates for similar issues with similar terms and remaining maturities. The fair value of the Company's Serial Preferred Stock, including Redeemable Serial Preferred Stock, excluding amounts due within one year, was based on quoted market prices or discounted cash flows using current rates of preferred stock with similar terms. The fair value of PCI's Marketable Securities was based on quoted market prices. The fair value of PCI's Notes Receivable was based on discounted future cash flows using current rates and similar terms. The fair value of PCI's long-term debt, including non- recourse debt, was based on current rates offered to similar companies for debt with similar remaining maturities. The carrying amounts of all other financial instruments approximate fair value. 16 (5) MARKETABLE SECURITIES --------------------- PCI's marketable securities are classified as available-for- sale for financial reporting purposes. Investment grade preferred stocks with mandatory redemption features made up 86% of the portfolio at June 30, 1997. Net unrealized gains or losses on such securities are reflected, net of tax, in stockholders' equity. The net unrealized gains (losses) are shown below: As of June 30, 1997 ------------------------------------- Net Market Unrealized Cost Value Gain --------- --------- ----------- (Thousands of Dollars) Mandatory redeemable preferred stock $ 285,443 $ 289,293 $ 3,850 ========= ========= ========= As of December 31, 1996 ------------------------------------- Net Market Unrealized Cost Value Gain (Loss) --------- --------- ----------- (Thousands of Dollars) Mandatory redeemable preferred stock $ 375,595 $ 377,237 $ 1,642 Equity securities 3 - (3) --------- --------- --------- Total $ 375,598 $ 377,237 $ 1,639 ========= ========= ========= As of June 30, 1996 ------------------------------------- Net Market Unrealized Cost Value Loss --------- --------- ----------- (Thousands of Dollars) Mandatory redeemable preferred stock $ 415,550 $ 409,194 $ (6,356) Equity securities 3 - (3) --------- --------- --------- Total $ 415,553 $ 409,194 $ (6,359) ========== ========= ========= 17 Included in net unrealized gains and losses are gross unrealized gains of $9 million and gross unrealized losses of $5.1 million at June 30, 1997; gross unrealized gains of $9.9 million and gross unrealized losses of $8.3 million at December 31, 1996; and gross unrealized gains of $6.1 million and gross unrealized losses of $12.5 million at June 30, 1996. At June 30, 1997, the contractual maturities for mandatory redeemable preferred stock are $4.8 million within one year, $90.6 million from one to five years, $88.2 million from five to 10 years and $101.8 million for over 10 years. In determining gross realized gains and losses on sales or calls of securities, specific identification is used. A summary of realized gains and losses is shown below. Three Months Six Months Twelve Months Ended Ended Ended June 30, June 30, June 30, -------------- -------------- -------------- 1997 1996 1997 1996 1997 1996 ------ ------ ------ ------ ------ ------ (Thousands of Dollars) Gross realized gains $ 928 $ 244 $6,812 $2,505 $8,973 $2,911 Gross realized losses - (121) (623) (792) (882) (956) ------ ------ ------ ------ ------ ------ Net gain $ 928 $ 123 $6,189 $1,713 $8,091 $1,955 ====== ====== ====== ====== ====== ====== (6) COMMITMENTS AND CONTINGENCIES ----------------------------- Proposed Merger - --------------- The Company entered into an Agreement and Plan of Merger with Baltimore Gas and Electric Company (BGE) in September 1995. This Agreement provides for a strategic business combination in which each company will merge into Constellation Energy Corporation (Constellation Energy), a newly formed company, to create an integrated, non-holding company structure (the Merger). Each outstanding share of the Company's common stock will be converted into the right to receive .997 of a share of common stock of Constellation Energy and each outstanding share of BGE common stock will be converted into the right to receive one share of Constellation Energy's common stock. This transaction is expected to qualify as a tax-free exchange of shares for the holders of each company's common stock and as a pooling of interests for accounting purposes. Constellation Energy will 18 serve a population of approximately 4.5 million with approximately 1.8 million electric customers and over 557,000 natural gas customers. Preliminary estimates indicate that savings from the combined utility systems will approximate $1.3 billion over 10 years following the Merger. These savings are net of costs to achieve, which are presently estimated to be approximately $150 million. Approximately two-thirds of the projected savings are expected to result from reduced labor costs, with the remaining savings split between nonfuel purchasing and corporate and administrative programs. The allocation of the net savings between customers and shareholders of Constellation Energy will be determined in regulatory proceedings. The applications for approval of the Merger, filed with the various regulatory commissions, set forth the proposed plans for Constellation Energy to share the benefits of the Merger with customers in the District of Columbia and Maryland. The proposal included: 1) a freeze on base electric rates until at least January 1, 2000, 2) a unique bill credit for all customers if Constellation Energy achieves certain financial targets, 3) an array of economic development incentives, and 4) programs to address the energy needs of low-income customers. The development of estimated savings resulting from the Merger was based upon assumptions which involve judgments with respect to, among other things, future national and regional economic and competitive conditions, inflation rates, regulatory treatment, weather conditions, financial market conditions, interest rates, future business decisions and other uncertainties, all of which are difficult to predict and many of which are beyond the control of the Company and BGE. Accordingly, while the Company believes that such assumptions are reasonable for purposes of the development of estimates of potential savings, there can be no assurance that such assumptions will approximate actual experience or that all such savings will be realized. If the Merger is not completed, a substantial portion of Merger related costs would be written off as a charge against the Company's results of operations. At June 30, 1997, the Company had deferred $37.1 million in costs related to the Merger. Shareholders of the Company and BGE, at separate special meetings during March 1996, approved the Merger Agreement. The Company and BGE filed a joint Application for Authorization and Approval of the Merger with the FERC on January 11, 1996, and with the Maryland and District of Columbia Public Service Commissions on April 8, 1996. The District of Columbia Commission conducted hearings on the proposed Merger in February and March 1997. The case was placed before the District of Columbia Commission for decision in March 1997. On April 16, 1997, FERC announced its finding that the proposed Merger would be in the public interest and approved the transaction without conditions. FERC held that the Merger would 19 not adversely affect competition in the long- or short-term wholesale capacity markets. In addition, FERC indicated that evaluation of the effect of the Merger on retail markets would be left to the Maryland and District of Columbia Public Service Commissions. Also on April 16, 1997, the Maryland Public Service Commission unanimously approved the proposed Merger and ordered Constellation Energy to reduce rates by $56 million ($44 million for BGE and $12 million for PEPCO), beginning on the effective date of the Merger, with base rates to be frozen for three years thereafter. The reductions are premised on an 11.4% return on equity (ROE). In addition, the Commission ordered that 50% of earnings above an 11.4% ROE be used to further reduce customer rates. The Company and BGE believe that the Maryland Order contains elements that must be revised for the Merger to take place. The two companies proposed a regulatory plan designed to share Merger benefits equitably between shareholders and customers. In addition to ordering the rate decrease, the Order also denies the two companies the opportunity to recover the full costs for purchased power contracts previously approved by the Commission. The Maryland Order would put in place a plan that would eliminate any reasonable opportunity for shareholders to share in the benefits. On May 2, 1997, the companies filed a request for reconsideration of the Maryland Order. In the request, the companies detailed areas of the Order that need to be revised for the Merger to proceed and proposed a modified plan to address these concerns. Highlights of this modified plan include: 1) a $26 million rate reduction for Constellation Energy's Maryland customers upon completion of the Merger, followed by a four-year base-rate freeze, 2) a comprehensive surcharge that permits full cost recovery of power purchase contracts the Commission had previously approved, 3) a synergy sharing mechanism premised on an 11.9% ROE that splits Merger benefits on a 50/50 basis between customers and investors, allowing further customer rate reductions if the new company's operations result in additional savings, and 4) an opportunity for recovery of Merger costs over the four-year, base-rate freeze period via the synergy sharing mechanism. Under this proposal, Constellation Energy would write off Merger costs in the year the Merger is consummated. There can be no assurance that the Commission will grant the request for reconsideration or that the Commission's Order will be changed. On May 1, 1997, the International Brotherhood of Electrical Workers (IBEW) Local 1900 filed an appeal of the Maryland Commission's decision with the Circuit Court of Baltimore County. In view of the Commission's conclusion that, under Maryland law, the IBEW's appeal divested it of authority to consider the Application for Rehearing, the joint applicants filed a motion requesting the Circuit Court to remand the case to the 20 Commission. On July 8, 1997, the Circuit Court of Baltimore County decided to hold its ruling on the motion for remand until July 28, 1997 while the Maryland Commission corrected a computational error contained in its April 16, 1997 Order. On July 14, 1997, the Company's and BGE's Chief Executive Officers filed sworn affidavits in the Court stating that the Merger cannot proceed unless other aspects of the Commission's Order were modified. The affidavits stated that even if adjusted for the computational error, the original order does not provide an adequate financial basis upon which the companies could proceed to consummate the Merger. On July 28, 1997, the Circuit Court accepted the correction of the computational error, denied the motion for rehearing and established a procedural schedule for consideration of the IBEW's appeal, which culminates in a hearing on October 20, 1997. The Company is unable to predict when final decisions will be reached by the Maryland and District of Columbia Public Service Commissions or the Circuit Court of Baltimore County. The Merger will not proceed unless the regulatory approvals conform to the fundamental requirement that shareholders have a reasonable opportunity to share in the expected benefits of the Merger. The waiting period under the Hart-Scott-Rodino Antitrust Improvements Act was terminated on January 29, 1997. If the Merger is not completed by January 28, 1998, a new Hart-Scott- Rodino filing would be required. The Nuclear Regulatory Commission has approved the transfer of BGE's ownership interest in the operating licenses for the two generating units at the Calvert Cliffs Nuclear Power Plant to Constellation Energy at the effective time of the Merger. In addition, the Merger has been approved by the State Corporation Commission of Virginia and the Pennsylvania Public Utility Commission. If the Merger Agreement is terminated by either the Company or BGE due to a material breach by the other party, the breaching party must pay the non-breaching party, as liquidated damages, $10 million in cash in respect of out-of-pocket expenses. The Merger Agreement also requires payment of a termination fee of $75 million in cash, plus $10 million in cash in respect of out- of-pocket expenses, by one party to the other if the Merger Agreement is terminated under certain circumstances including, if either the Company or BGE terminates the Merger Agreement after the Board of Directors of the other party withdraws or adversely modifies its recommendation of the transaction. The termination fees payable by the Company under these provisions and the aggregate amount which could be payable by the Company upon a required repurchase of an option (or shares of common stock issued pursuant to the exercise of the option) granted by the Company to BGE in connection with entry into the Merger Agreement may not exceed $125 million in the aggregate. 21 The Company has approved, in conjunction with the Merger with BGE, a severance plan for all exempt and non-bargaining unit employees who are not offered a position in Constellation Energy. Such employees will receive two weeks of pay per year of service, with a minimum payment of eight weeks of pay. In addition, employees will receive company-sponsored health and dental insurance for two weeks per year of service, with a minimum of eight weeks of insurance coverage; employees will also not be obligated to reimburse the Company for tuition payments made by the Company on their behalf within two years of termination. An extension of the current 1993 Labor Agreement between the Company and Local 1900 of the IBEW was ratified by the Union members in December 1995. The 1995 Agreement extends the 1993 Agreement, which was due to expire on June 1, 1996, for two years or until the effective date of the Merger with BGE, whichever occurs first. This Agreement provides severance benefits, previously approved by the Company for exempt and non-bargaining unit employees, for all union members and provided for a lump-sum payment of 2% of base pay on January 5, 1996, a lump-sum payment of 1% of base pay on June 7, 1996, and a lump-sum payment of 3% of base pay on June 6, 1997. On March 31, 1997, the Company signed a contract to purchase land in downtown Washington, D.C. to build a $90 million regional headquarters for Constellation Energy. Environmental Contingencies - --------------------------- As discussed in the March 31, 1997 Form 10-Q, the Company received notice in December 1995 from the U.S. Environmental Protection Agency (EPA) that it is a Potentially Responsible Party (PRP) under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA or Superfund) with respect to the release or threatened release of radioactive and mixed radioactive and hazardous wastes at a site in Denver, Colorado, operated by RAMP Industries, Inc. Evidence indicates that the Company's connection to the site arises from an agreement with a vendor to package, transport and dispose of two laboratory instruments containing small amounts of radioactive material at a Nevada facility. While the Company cannot predict its liability at this site, the Company believes that it will not have a material adverse effect on its financial position or results of operations. As discussed in the March 31, 1997 Form 10-Q, the Company received notice from the EPA in October 1995 that it, along with several hundred other companies, may be a PRP in connection with the Spectron Superfund Site located in Elkton, Maryland. The site was operated as a hazardous waste disposal, recycling, and processing facility from 1961 to 1988. A group of PRPs allege, based on records they have collected, that the Company's share of 22 liability at this site is .0042%. The EPA has also indicated that a de minimis settlement is likely to be appropriate for this site. While the outcome of negotiations and the ultimate liability with respect to this site cannot be predicted, the Company believes that its liability at this site will not have a material adverse effect on its financial position or results of operations. As also discussed in the March 31, 1997 Form 10-Q, a Remedial Investigation/Feasibility Study (RI/FS) report was submitted to the EPA in October 1994, with respect to a site in Philadelphia, Pennsylvania. Pursuant to an agreement among the PRPs, the Company is responsible for 12% of the costs of the RI/FS. Total costs of the RI/FS and associated activities prior to the issuance of a Record of Decision (ROD) by the EPA, including legal fees, are currently estimated to be $7.5 million. The Company has paid $.9 million as of June 30, 1997. The report included a number of possible remedies, the estimated costs of which range from $2 million to $90 million. In July 1995, the EPA announced its proposed remedial action plan for the site and indicated it will accept comments on the plan from any interested parties. The EPA's estimate of the costs associated with implementation of the plan is approximately $17 million. The Company cannot predict whether the EPA will include the plan in its ROD as proposed or make changes as a result of comments received. In addition, the Company cannot estimate the total extent of the EPA's administrative and oversight costs. To date, the Company has accrued $1.7 million for its share of this contingency. As also discussed in the March 31, 1997 Form 10-Q, during 1993 the Company was served with Amended Complaints filed in three jurisdictions (Prince George's County, Baltimore City and Baltimore County), in separate ongoing, consolidated proceedings each denominated "In re: Personal Injury Asbestos Case." The Company (and other defendants) were brought into these cases on a theory of premises liability under which plaintiffs argue that the Company was negligent in not providing a safe work environment for employees of its contractors who allegedly were exposed to asbestos while working on the Company's property. Initially, a total of approximately 448 individual plaintiffs added the Company to their Complaints. While the pleadings are not entirely clear, it appears that each plaintiff seeks $2 million in compensatory damages and $4 million in punitive damages from each defendant. In a related proceeding in the Baltimore City case, the Company was served, in September 1993, with a third party complaint by Owens Corning Fiberglass, Inc. (Owens Corning) alleging that Owens Corning was in the process of settling approximately 700 individual asbestos-related cases and seeking a judgment for contribution against the Company on the same theory of alleged negligence set forth above in the plaintiffs' case. 23 Subsequently, Pittsburgh Corning Corp. (Pittsburgh Corning) filed a third-party complaint against the Company, seeking contribution for the same plaintiffs involved in the Owens Corning third-party complaint. Since the initial filings in 1993, approximately 50 individual suits have been filed against the Company. The third party complaints involving Pittsburgh Corning and Owens Corning were dismissed by the Baltimore City Court during 1994 without any payment by the Company. In 1995 and 1996, approximately 400 of the individual plaintiffs have dismissed their claims against the Company. No payments were made by the Company in connection with the dismissals. While the aggregate amount specified in the remaining suits would exceed $400 million, the Company believes the amounts are greatly exaggerated as were the claims already disposed of. The amount of total liability, if any, and any related insurance recovery cannot be precisely determined at this time; however, based on information and relevant circumstances known at this time, the Company does not believe these suits will have a material adverse effect on its financial position. However, an unfavorable decision rendered against the Company could have a material adverse effect on results of operations in the fiscal year in which a decision is rendered. The Company is involved in other legal and administrative (including environmental) proceedings before various courts and agencies with respect to matters arising in the ordinary course of business. Management is of the opinion that the final disposition of these proceedings will not have a material adverse effect on the Company's financial position or results of operations. 24 * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * The information furnished in the accompanying Consolidated Statements of Earnings and Retained Income, Consolidated Balance Sheets and Consolidated Statements of Cash Flows reflects all adjustments (which consist only of normal recurring accruals) which are, in the opinion of management, necessary to a fair presentation of the results of operations for the interim periods. The accompanying consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes included in the Company's 1996 Annual Report to the Securities and Exchange Commission on Form 10-K. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * This Quarterly Report on Form 10-Q, including the report of Price Waterhouse LLP (on page 26) will automatically be incorporated by reference in the Prospectuses constituting part of the Company's Registration Statements on Form S-3 (Registration Nos. 33-58810 and 33-61379) and Form S-8 (Registration Nos. 33-36798, 33-53685 and 33-54197), in the Joint Proxy Statement/Prospectus constituting part of the Registration Statement on Form S-4 (Registration No. 33-64799) of Constellation Energy Corporation and in the Prospectuses constituting parts of the Registration Statements on Form S-3 (Registration Nos. 333-24705 and 333-24855) of Constellation Energy Corporation filed under the Securities Act of 1933. Such report of Price Waterhouse LLP, however, is not a "report" or "part of the Registration Statement" within the meaning of Sections 7 and 11 of the Securities Act of 1933 and the liability provisions of Section 11(a) of such Act do not apply. 25 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Potomac Electric Power Company We have reviewed the accompanying consolidated balance sheets of Potomac Electric Power Company and consolidated subsidiaries (the Company) at June 30, 1997 and 1996, and the related consolidated statements of earnings and retained income for the three, six and twelve month periods then ended and the consolidated statements of cash flows for the six and twelve month periods then ended. These financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the accompanying financial information for it to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet as of December 31, 1996, and the related consolidated statement of earnings and consolidated statement of cash flows for the year then ended (not presented herein); and in our report dated January 17, 1997, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet information as of December 31, 1996, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. /s/ Price Waterhouse LLP Price Waterhouse LLP Washington, D.C. August 13, 1997 26 Part I FINANCIAL INFORMATION - ------ --------------------- Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED - ------ ---------------------------------------------------- RESULTS OF OPERATIONS AND FINANCIAL CONDITION --------------------------------------------- UTILITY - ------- PROPOSED MERGER UPDATE - ---------------------- Shareholders of the Company and BGE, at separate special meetings during March 1996, approved the Merger to form Constellation Energy. The District of Columbia Commission conducted hearings on the proposed Merger in February and March 1997. The case was placed before the District of Columbia Commission for decision in March 1997. On April 16, 1997, FERC announced its finding that the proposed Merger would be in the public interest and approved the transaction without conditions. FERC held that the Merger would not adversely affect competition in the long- or short-term wholesale capacity markets. In addition, FERC indicated that evaluation of the effect of the Merger on retail markets would be left to the Maryland and District of Columbia Public Service Commissions. Also on April 16, 1997, the Maryland Public Service Commission unanimously approved the proposed Merger and ordered Constellation Energy to reduce rates by $56 million ($44 million for BGE and $12 million for PEPCO), beginning on the effective date of the Merger, with base rates to be frozen for three years thereafter. The reductions are premised on an 11.4% return on equity (ROE). In addition, the Commission ordered that 50% of earnings above an 11.4% ROE be used to further reduce customer rates. The Company and BGE believe that the Maryland Order contains elements that must be revised for the Merger to take place. The two companies proposed a regulatory plan designed to share Merger benefits equitably between shareholders and customers. In addition to ordering the rate decrease, the Order also denies the two companies the opportunity to recover the full costs for purchased power contracts previously approved by the Commission. The Maryland Order would put in place a plan that would eliminate any reasonable opportunity for shareholders to share in the benefits. On May 2, 1997, the companies filed a request for reconsideration of the Maryland Order. In the request, the companies detailed areas of the Order that need to be revised for the Merger to proceed and proposed a modified plan to address 27 these concerns. Highlights of this modified plan include: 1) a $26 million rate reduction for Constellation Energy's Maryland customers upon completion of the Merger, followed by a four-year base-rate freeze, 2) a comprehensive surcharge that permits full cost recovery of power purchase contracts the Commission had previously approved, 3) a synergy sharing mechanism premised on an 11.9% ROE that splits Merger benefits on a 50/50 basis between customers and investors, allowing further customer rate reductions if the new company's operations result in additional savings, and (4) an opportunity for recovery of Merger costs over the four-year, base-rate freeze period via the synergy sharing mechanism. Under this proposal, Constellation Energy would write off Merger costs in the year the Merger is consummated. There can be no assurance that the Commission will grant the request for reconsideration or that the Commission's Order will be changed. On May 1, 1997, IBEW Local 1900 filed an appeal of the Maryland Commission's decision with the Circuit Court of Baltimore County. In view of the Commission's conclusion that, under Maryland law, the IBEW's appeal divested it of authority to consider the Application for Rehearing, the joint applicants filed a motion requesting the Circuit Court to remand the case to the Commission. On July 8, 1997, the Circuit Court of Baltimore County decided to hold its ruling on the motion for remand until July 28, 1997 while the Maryland Commission corrected a computational error contained in its April 16, 1997 Order. On July 14, 1997, the Company's and BGE's Chief Executive Officers filed sworn affidavits in the Court stating that the Merger cannot proceed unless other aspects of the Commission's Order were modified. The affidavits stated that even if adjusted for the computational error, the original order does not provide an adequate financial basis upon which the companies could proceed to consummate the Merger. On July 28, 1997, the Circuit Court accepted the correction of the computational error, denied the motion for rehearing and established a procedural schedule for consideration of the IBEW's appeal, which culminates in a hearing on October 20, 1997. The Company is unable to predict when final decisions will be reached by the Maryland and District of Columbia Public Service Commissions or the Circuit Court of Baltimore County. The Merger will not proceed unless the regulatory approvals conform to the fundamental requirement that shareholders have a reasonable opportunity to share in the expected benefits of the Merger. The waiting period under the Hart-Scott-Rodino Antitrust Improvements Act was terminated on January 29, 1997. If the Merger is not completed by January 28, 1998, a new Hart-Scott- Rodino filing would be required. The Nuclear Regulatory Commission has approved the transfer of BGE's ownership interest in the operating licenses for the two generating units at the 28 Calvert Cliffs Nuclear Power Plant to Constellation Energy at the effective time of the Merger. In addition, the Merger has been approved by the State Corporation Commission of Virginia and the Pennsylvania Public Utility Commission. If the Merger is not completed, a substantial portion of Merger related costs would be written off as a charge against the Company's results of operations. At June 30, 1997, the Company has deferred $37.1 million in costs related to the Merger. See Part I, Item 1, Notes to Consolidated Financial Statements, (6) Commitments and Contingencies, for additional information. RESULTS OF OPERATIONS - --------------------- TOTAL REVENUE Total revenue decreased for the three, six and twelve months ended June 30, 1997, as compared to the corresponding periods in 1996. The decrease in revenue from sales of electricity for the three, six and twelve months ended June 30, 1997, was primarily due to decreases in kilowatt-hour sales of 3.9%, 4.3% and 4.8% from the corresponding periods ended June 30, 1996. The decline in sales reflects milder than average weather in each calendar quarter in the twelve months ended June 30, 1997. The weather in the corresponding quarters in the prior twelve months was more severe than average in the third quarter of 1995 as well as the first and second quarters of 1996. Total revenue also reflects the effects of the Maryland Demand Side Management (DSM) surcharge tariff. Effective June 6, 1997, the surcharge tariff rate was lowered, which will reduce annual revenue by approximately $17 million, reflecting the Company's efforts to narrow conservation program offerings and limit conservation spending. In the second quarter of 1997, the Company recorded a $1.6 million bonus, which was awarded for exceeding 1996 energy saving goals under the conservation incentive provision of the tariff. In the third quarter of 1996, the Company recorded an $8.9 million bonus, which was awarded for exceeding 1995 energy saving goals. Interchange deliveries decreased for the three, six and twelve months ended June 30, 1997. These decreases principally reflect changes in the levels of activity in purchase-for-resale agreements under the Company's wholesale power sales tariff. Beginning in January 1997 through March 1997, and pursuant to FERC's Order No. 888, the Company implemented an open access transmission tariff and terminated the purchase-for-resale agreements. Under the open access transmission tariff, the Company received revenue from service agreements, classified as "Other electric revenue", which totaled $1.4 million in the six and twelve months ended June 30, 1997. In addition, interchange 29 deliveries include revenue from bilateral energy transactions and the sale of short-term generating capacity, which totaled approximately $.9 million and $6.7 million for the three and six months ended June 30, 1997, respectively. The benefits derived from interchange deliveries and revenue under the open access transmission tariff are passed through to the Company's customers through a fuel adjustment clause. Recent rate orders received by the Company provided for changes in annual base rate revenue as shown in the table below: Rate (Decrease) Increase % Effective Regulatory Jurisdiction ($000) Change Date - ----------------------- ---------- ------- --------------- Federal - Wholesale $(2,000) (1.7)% January 1996 District of Columbia 27,900 3.8 July 1995 Federal - Wholesale 2,300 1.8 January 1995 OPERATING EXPENSES Fuel and purchased energy decreased for the three, six and twelve months ended June 30, 1997, as compared to the corresponding periods ended June 30, 1996. Fuel expenses increased for the three months ended June 30, 1997, as compared to the corresponding period in 1996, due to an increase in the system average fuel cost; partially offset by a 2.5% decrease in net generation. Fuel expense decreased for the six and twelve months ended June 30, 1997, as compared to the corresponding periods in 1996, primarily due to decreases of 11% and 16.5%, respectively, in net generation; partially offset by increases in the system average fuel cost. The decrease in purchased energy for the three and six months ended and increase for the twelve months ended June 30, 1997, reflect changes in levels and prices of energy purchased from the Pennsylvania-New Jersey-Maryland Interconnection Association (PJM) and other utilities, primarily the purchases related to the power sales tariff interchange transactions. The unit fuel costs for the comparative periods ended June 30, were as follows: Three Six Twelve Months Ended Months Ended Months Ended June 30, June 30, June 30, ------------ ------------ ------------ 1997 1996 1997 1996 1997 1996 ---- ---- ---- ---- ---- ---- System Average Fuel Cost per MBTU $1.89 $1.78 $1.86 $1.80 $1.82 $1.77 30 System average unit fuel cost increased for the three, six and twelve months ended June 30, 1997, as compared to the corresponding periods in 1996. The increases were primarily attributable to an increase in the cost of coal, partially offset by a decrease in the usage of higher-cost residual oil. For the twelve month periods ended June 30, 1997 and 1996, the Company obtained 90% and 86%, respectively, of its system generation from coal based upon percentage of Btus. The Company's major cycling and certain peaking units can burn either natural gas or oil, adding flexibility in selecting the most cost-effective fuel mix. Capacity purchase payments increased for the three, six and twelve months ended June 30, 1997, as compared to the corresponding periods in 1996. These increases reflect capacity payments made under the Panda contract, which commenced January 1, 1997; partially offset by a slight decrease in fixed operating and maintenance expense associated with the capacity agreements with Ohio Edison and Allegheny Power System (APS). Operating expenses other than fuel, purchased energy and capacity purchase payments decreased for the three, six and twelve months ended June 30, 1997, as compared to the corresponding periods in 1996. The decreases were principally due to a decline in other operation expenses resulting from lower labor and benefits costs, and decreased income taxes due to lower taxable income; partially offset by increased depreciation and amortization expense primarily due to additional investment in property and plant. CAPITAL RESOURCES AND LIQUIDITY - ------------------------------- The Company's investment in property and plant, at original cost before accumulated depreciation, was $6.4 billion at June 30, 1997, an increase of $83.1 million from the investment at December 31, 1996, and an increase of $166.8 million from the investment at June 30, 1996. Cash invested in property and plant construction, excluding AFUDC and CCRF, amounted to $92.2 million for the six months ended June 30, 1997, and $187.5 million for the twelve months then ended. At June 30, 1997, the Company's capital structure, excluding short-term debt, long-term debt and serial preferred stock redemption due within one year, and nonutility subsidiary debt, consisted of 44.9% long-term debt, 3.2% serial preferred stock, 3.7% redeemable serial preferred stock and 48.2% common equity. 31 Cash from utility operations, after dividends, was $12.3 million for the six months ended June 30, 1997, and $222.7 million for the twelve months then ended as compared with $14.7 million and $135.1 million, respectively, for the corresponding periods ended June 30, 1996. Outstanding utility short-term debt totaled $311.6 million at June 30, 1997, an increase of $180.2 million from the $131.4 million outstanding at December 31, 1996, and a decrease of $15.9 million from the $327.5 million outstanding at June 30, 1996. See the discussion included in Note (3) of the Notes to Consolidated Financial Statements, Capitalization, for additional information. NEW ACCOUNTING STANDARDS - ------------------------ See the discussion included in Note (1) of the Notes to Consolidated Financial Statements, Summary of Significant Accounting Policies. NONUTILITY SUBSIDIARY - --------------------- RESULTS OF OPERATIONS - --------------------- PCI's earnings for the three, six and twelve months ended June 30, 1997 were $1.5 million ($.01 per share), $14.9 million ($.13 per share) and $20.3 million ($.17 per share), respectively, compared with $9 million ($.07 per share), $11.5 million ($.10 per share) and $7 million ($.06 per share) for the corresponding periods ended June 30, 1996. Net earnings for the three months ended June 30, 1997, were less than the corresponding period in the prior year primarily as a result of a second quarter 1996 $6.5 million pretax ($4.2 million after-tax) reversal of previously accrued repair and maintenance expense related to aircraft placed on a long-term, net lease. Rental income from operating leases also decreased for the three months ended June 30, 1997, as compared to the corresponding period in 1996. The improvement in net earnings for the six and twelve months ended June 30, 1997, over the corresponding periods in 1996 was primarily the result of first quarter 1996 writedowns of aircraft held for disposal and other investments. During the first six months of 1997, two L-1011 airframes and one L-1011 aircraft were sold, at book value, from the joint venture which was formed in the fourth quarter of 1995 to assist PCI with the disposition and management of certain aircraft. As a result of joint venture operations for the six months ended June 30, 1997, PCI's obligation for previously accrued deferred income taxes was reduced, resulting in after-tax earnings of $7.4 million after the provision for transaction costs. The remaining portfolio of assets held for disposal at June 30, 1997, was $3.7 million. 32 Results for the first six months ended June 30, 1997, also include capital gains totaling $4 million net of taxes, related primarily to tender offers accepted by PCI that reduced the cost basis of its preferred stock marketable securities portfolio by $113.3 million. Purchases of preferred stock during the six months ended June 30, 1997, totaled $23.1 million. The cost basis of the marketable securities portfolio at June 30, 1997, was $285.4 million and market value was $289.3 million. On July 31, 1997, an aircraft owned by PCI and on long-term leveraged lease to Federal Express Corporation crash-landed at Newark International Airport. Based on information provided by Federal Express, there was no loss of life or serious injury resulting from the accident; however, the aircraft is a total loss. The aircraft, which has a book value of $28.4 million at June 30, 1997, is fully insured and PCI expects full recovery of its investment. On August 6, 1997, PCI announced an agreement with RCN Telecom Services, Inc. (RCN) of Princeton, New Jersey to form a joint venture that will provide Washington, D.C. area residents and businesses a package of local and long distance telephone, cable television, Internet and other telecommunications services from a single source. PCI and RCN each intend to invest up to $150 million over a three-year period in order to serve customers over an advanced fiber optic network. The joint venture will be equally owned and managed by PCI and RCN. This agreement is subject to the satisfaction of a number of conditions, including the receipt of certain regulatory approvals and the execution of mutually satisfactory definitive agreements. No assurances can be given that the transaction will be consummated. For the three, six and twelve months ended June 30, 1997, PCI generated income primarily from its leasing activities and securities investments. Income from leasing activity, which includes rental income, gains on asset sales, interest income and fees totaled $14.6 million, $35.8 million and $80.4 million for the three, six and twelve months ended June 30, 1997, respectively, compared to $23.1 million, $47.1 million and $101.8 million for the corresponding periods in 1996. The decrease for all three periods ending June 30, compared to the corresponding periods in 1996, was primarily due to reduced rental income from operating leases. PCI's marketable securities portfolio contributed pretax income of $6.1 million, $17.9 million and $34 million for the three, six and twelve months ended June 30, 1997, respectively, compared to $7.5 million, $17.5 million and $35.1 million for the corresponding periods in 1996, which results include net realized gains of $.9 million, $6.2 million and $8.1 million for the three, six and twelve months ended June 30, 1997, compared to $.1 million, $1.7 million and $2 million for the three, six and twelve months ended June 30, 1996, respectively. 33 Other income was $7.9 million, $14.8 million and $19.9 million for the three, six and twelve months ended June 30, 1997, respectively, compared to $1.2 million, a loss of $15.5 million and a loss of $19.8 million for the corresponding periods ending June 30, 1996. The increase in other income for the three months ended June 30, 1997, over the corresponding three months ended June 30, 1996, was primarily the result of revenue earned from investments made by Pepco Enterprises, Inc. (PEI), a wholly owned subsidiary, which the Company contributed to PCI in the second quarter of 1996. PEI has business interests that include telecommunications, liquefied natural gas storage facilities, underground cable construction and maintenance services and an energy management services company. Other income for the three, six and twelve months ended June 30, 1997, includes $6.4 million, $11.8 million and $12.6 million, respectively, in revenue from PEI activities. Net income from PEI for the three, six and twelve months ended June 30, 1997, was $.1 million, $.7 million and $1.5 million, respectively. In addition to the favorable impact from PEI revenue, the increase in other income for the six and twelve month periods in 1997 over the same periods in 1996 is primarily the result of the first quarter 1996 writedowns of PCI's investments in solar electric generating systems (SEGS), real estate and oil and natural gas. Included in the twelve months ended June 30, 1997 results is a $8.8 million pretax gain ($6.7 million after-tax) related to the sale of PCI's $2.8 million (20%) interest in a Florida-based technology company during the fourth quarter of 1996. Expenses, before income taxes, which include interest, depreciation and operating, and administrative and general expenses totaled $35.1 million, $74.5 million and $144.3 million for the three, six and twelve months ended June 30, 1997, respectively, compared to $29.3 million, $82.9 million and $166.5 million for the corresponding periods in 1996. The increase in expenses, before income taxes for the three months ended June 30, 1997, over the corresponding period in 1996 was primarily the result of the second quarter 1996 reversal of previously accrued repair and maintenance expense totaling $6.5 million, and three months ended June 30, 1997 operating expenses of PEI totaling $6.2 million. Despite an increase resulting from inclusion of PEI operating expenses of $10.7 million for the six and twelve months ended June 30, 1997, total expenses before income taxes decreased during the six and twelve months ended June 30, 1997, compared to the same periods in 1996, primarily due to the $12.3 million pretax first quarter 1996 writedown of assets held for disposal. Interest expense also decreased for the three, six and twelve months ended June 30, 1997, over the corresponding periods in 1996 as a result of reduced debt, as proceeds from sales of marketable securities and aircraft have been used to pay down debt. 34 PCI had income tax credits of $7.9 million, $20.9 million and $30.2 million for the three, six and twelve months ended June 30, 1997, respectively, and $6.6 million, $45.3 million and $56.4 million for the corresponding periods ending June 30, 1996. The increase in income tax credits for the three months ended June 30, 1997, over the three months ended June 30, 1996, was primarily due to a pretax loss in 1997. The decrease in income tax credits for the six and twelve month periods ended June 30, 1997, over the corresponding periods in 1996, was primarily the result of deferred tax reversals of $23.5 million and $5.2 million during the first and second quarters of 1996, respectively, compared to $10.1 million in the first quarter and no reversal in the second quarter of 1997. CAPITAL RESOURCES AND LIQUIDITY - ------------------------------- A $289.3 million securities portfolio at June 30, 1997, consisting primarily of investment grade preferred stocks, provides PCI with liquidity and investment flexibility. During the first six months of 1997, PCI reduced the cost basis of its marketable securities portfolio by $90.2 million as the result of calls and acceptance of tender offers (approximately $113.3 million) offset by purchases of $23.1 million. PCI's fixed rate portfolio is sensitive to fluctuations in interest rates. The reduced size of the preferred stock portfolio lessens the impact of future fluctuations in interest rates, while still maintaining a substantial portfolio for liquidity purposes. The proceeds from the securities activity during the first six months were used primarily to pay down short-term debt and acquire short-term investments. During the first quarter of 1997, PCI received $25.8 million in cash proceeds from the sale of notes receivable from World Airways (World) and recorded an after-tax charge to earnings of $.4 million. PCI also received $15.7 million in cash proceeds during the second quarter of 1997 for the early redemption of a note receivable related to a 1996 sale of an aircraft engine leasing subsidiary. The sale and early redemption of the notes further reduces PCI's exposure to the ongoing credit risk associated with the airline industry as well as the inherent uncertainty regarding the future value of the aircraft and engines which secured the repayment of the notes. PCI had no short-term debt outstanding at June 30, 1997, compared to the $51.7 million outstanding at December 31, 1996, and the $159.3 million outstanding at June 30, 1996. During the three, six and twelve months ended June 30, 1997, PCI issued no medium-term notes, and debt repayments totaled $76.8 million, $83.5 million and $174.1 million, respectively. At June 30, 1997, PCI had $236.3 million available under its Medium-Term Note Program and $400 million of unused bank credit lines. 35 Part II OTHER INFORMATION - ------- ----------------- Item 1 LEGAL PROCEEDINGS - ------ ----------------- See Part I, Item 1, Notes to Consolidated Financial Statements, (6) Commitments and Contingencies, for information on various legal proceedings. Item 5 OTHER INFORMATION - ------ ----------------- OTHER FINANCING ARRANGEMENTS - Credit Agreements - ------------------------------------------------ The Company and PCI satisfy their short-term financing requirements through the sale of commercial promissory notes. The Company and PCI maintain minimum 100 percent lines of credit back-up for their outstanding commercial promissory notes. These lines of credit were unused during 1997 and 1996. BASE RATE PROCEEDINGS - --------------------- Maryland - -------- Effective June 6, 1997, the Maryland Demand Side Management surcharge tariff rate was reduced. The new surcharge tariff rate will reduce annual revenue by approximately $17 million, reflecting the Company's efforts to narrow conservation program offerings and limit conservation spending. The surcharge includes provisions for the recovery of lost revenue, amortization of pre-1997 actual program expenditures plus the initial amortization of 1997 projected program expenditures, a CCRF of 9.46% on unamortized balances and an incentive bonus for exceeding energy saving goals. In the second quarter of 1997, the Company recorded a $1.6 million bonus, awarded for exceeding 1996 energy saving goals. In the third quarter of 1996, the Company recorded an $8.9 million bonus for exceeding 1995 energy saving goals. On May 16, 1997, the Company filed a request for rehearing of the Maryland Public Service Commission's denial, in connection with its Order approving the Merger, of a purchased capacity surcharge designed to recover changes in the level of purchased capacity costs under Commission-approved contracts from levels included in base rates. The filing seeks recovery of capacity payments associated with a 25-year agreement with Panda- Brandywine, L.P. (Panda) for a 230-megawatt gas-fueled combined- cycle cogeneration project, as well as future increases in both the Panda and Ohio Edison purchased power contracts. Capacity payments to Panda commenced in January 1997, and are estimated to 36 total approximately $20 million in 1997. The estimated Maryland portion of these payments is $10.5 million. (See Part I, Item I, Notes to Consolidated Financial Statements, (6) Commitments and Contingencies, for additional information). The rate of return on common stock equity most recently determined for the Company in a fully litigated rate case was 12.75% established by the Commission in a June 1991 rate increase order. District of Columbia - -------------------- In Formal Case No. 939, the District of Columbia Public Service Commission, in June 1995, authorized a $27.9 million, or 3.8%, increase in base rate revenue effective July 1995. The authorized rates are based on a 9.09% rate of return on average rate base, including an 11.1% return on common stock equity and a capital structure which excludes short-term debt. In addition, the Commission approved the Company's Least-Cost Plan filed in June 1994. A four-year DSM spending cap for the period 1995-1998 was approved, consistent with the Company's proposal to narrow the scope of DSM activities by discontinuing operation of certain DSM programs and by reducing expenditures on the remaining programs. This will enable the Company to implement cost- effective DSM programs while limiting the impact of such programs on the price of electricity. An Environmental Cost Recovery Rider (ECRR) was approved to provide for full cost recovery of actual DSM program expenditures, through a billing surcharge. Costs will be amortized over 10 years, with a return on unamortized amounts by means of a CCRF computed at the authorized rate of return. The initial rate, which reflects actual costs expended from July 1993 through December 1994, resulted in additional annual revenue of approximately $15 million. Although the Commission denied the Company's request to recover "lost revenue" due to DSM programs, through a surcharge, a process has been established whereby the Company can seek recovery of lost revenue in a separate proceeding. The Commission also increased the time period for filing Least-Cost Planning cases from two to three years. In June 1996 and June 1997, the Company filed Applications for Authority with the Commission to revise its ECRR. The latest proposed rate seeks recovery of actual costs expended during 1995 and 1996, and is expected to increase annual revenue by approximately $9 million. No action has been taken by the Commission on the revised ECRR. Subsequent rate updates are scheduled to be filed annually on June 1 to reflect the prior year's actual costs, subject to the annual surcharge recovery limit within the four-year spending cap for the period 1995-1998 (amounts spent in excess of the annual surcharge recovery limit, but within the four-year spending cap, are deferred for future recovery). Remaining allowable expenditures under the spending cap totaled $12.8 million at June 30, 1997. Pre-July 1993 DSM costs receive base rate treatment. 37 Federal - Wholesale - ------------------- The Company has a 10-year full service power supply contract with Southern Maryland Electric Cooperative, Inc. (SMECO), a wholesale customer. The contract period is to be extended for an additional year on January 1 of each year, unless notice is given by either party of termination of the contract at the end of the 10-year period. The full service obligation can be reduced by SMECO by up to 20% of its annual requirements with a five-year advance notice for each such reduction. Pursuant to an agreement for the years 1996 through 1998, SMECO rates were reduced by $2 million effective January 1, 1996, with an additional $2.5 million rate reduction scheduled to become effective January 1, 1998. SMECO has agreed not to give the Company a notice of reduction or termination of service prior to December 15, 1998. Federal - Interchange and Purchased Energy - ------------------------------------------ The Company participates in wholesale capacity, energy and transmission purchases and sales transactions, the savings from which are passed along to customers. In compliance with FERC Order No. 888, the Company provided transmission service with its open access tariff from January 1, 1997 until April 1, 1997. On February 28, 1997, the FERC ordered the PJM member companies to implement a poolwide open access transmission tariff based on a proposal made by PJM supporting companies in December 1996. Since April 1, 1997, all transmission service in PJM has been administered by the PJM Interconnection Office. Revenue from transmission sales during January through March 1997 totaled approximately $1.4 million and there have been no sales since April 1, 1997. The Company's generating and transmission facilities are interconnected with those of other members of the PJM power pool and other utilities. Historically, the pricing of most PJM- dispatched internal economy energy transactions was based upon "split savings" whereby such energy was priced halfway between the cost that the purchaser would incur if the energy were supplied by its own sources and the cost of production to the company actually supplying the energy. On April 1, 1997, PJM members implemented an interim restructuring plan which provides for poolwide transmission service under a pool tariff and a bid- price based energy market whereby all energy that clears through the market is priced at the margin. In the initial phase of this plan, bids are being based on cost. Bilateral transactions are also permitted. The restructured PJM is now a Limited Liability Corporation governed by an independent board of directors with membership open to eligible entities. 38 In addition to interchange with PJM, the Company is actively participating in the emerging bilateral energy sales marketplace. The Company's wholesale power sales tariff allows both sales from Company-owned generation and sales of energy purchased by the Company from other market participants. Over 40 utilities and marketers have executed service agreements allowing them to arrange purchases under this tariff. The Company has also executed service agreements allowing it to purchase energy under other market participants' power sales tariffs. These agreements greatly expand the opportunities for economic transactions. The Company's Power Sales Tariff also allows for the sale of generating capacity on a short-term basis. The Company sold capacity to PECO Energy (PECO) in the amount of 150 megawatts during January 1997 and 100 megawatts per month for the period of February through May 1997. In addition, on April 24, 1997, the Company signed an agreement to sell capacity to Delmarva Power & Light Co. in the amount of 100 megawatts per month for the period June 1, 1997, through May 31, 1998. Revenue from capacity and energy transactions totaled approximately $.9 million and $6.7 million for the three and six months ended June 30, 1997, respectively, and are included as components of interchange deliveries. The Company continues to purchase energy from Ohio Edison under the Company's 1987 long-term capacity purchase agreements with Ohio Edison and APS, and from the Northeast Maryland Waste Disposal Authority under an avoided cost-based purchase agreement for a 32-megawatt Montgomery County Resource Recovery Facility. Pursuant to the Company's long-term capacity purchase agreements with Ohio Edison and APS, the Company is purchasing 450 megawatts of capacity and associated energy through the year 2005. Capacity payments for the Montgomery County Resource Recovery facility are not expected to commence until after the year 2000. In August 1996, the Company began purchasing energy from the Panda facility, pursuant to a 25-year power purchase agreement for 230 megawatts of capacity supplied by a gas-fueled combined- cycle cogenerator. The Panda facility achieved full commercial operation in October 1996. Capacity payments under this agreement commenced in January 1997. The capacity expense under these agreements, including an allocation of a portion of Ohio Edison's fixed operating and maintenance costs, was $35.4 million and $70 million for the three and six months ended June 30, 1997, and is estimated at $141 million for 1997. Commitments under these agreements are estimated at $139 million for 1998, $200 million for 1999 and 2000, $211 million for 2001 and $212 million for 2002. The Company has a purchase agreement with Southern Maryland Electric Cooperative, Inc. (SMECO), through 2015, for 84 megawatts of capacity supplied by a combustion turbine installed and owned by SMECO at the Company's Chalk Point Generating Station. The Company is responsible for all costs associated 39 with operating and maintaining the facility. The capacity payment to SMECO is approximately $5.5 million per year. RESTRUCTURING OF THE BULK POWER MARKET - -------------------------------------- In April 1996, the FERC issued its Final Rulemaking Orders No. 888 and No. 889. Both rulemakings address achieving greater competition in the wholesale energy market. Order No. 888 required utilities to file open access transmission tariffs by July 9, 1996. Such filing was made by the Company and was accepted by the FERC. Order No. 889 required utilities to establish or participate in an Open Access Same-Time Information System (OASIS) which requires transmission owners to post certain transmission availability, pricing and service information on an open-access communications medium such as the Internet. On January 3, 1997, the Company's OASIS became operational. Subsequently, on April 1, 1997, PJM implemented an OASIS on behalf of the PJM transmission owners which replaced the Company's OASIS. Order No. 889 also required the Company to establish a code of conduct that complies with FERC's prescribed standards in order to separate utilities' transmission system operations and wholesale marketing functions. The Company's filed code of conduct became effective on January 3, 1997. On July 24, 1996, nine of the ten PJM member companies (the Supporting Companies), excluding PECO, filed, with the FERC, a comprehensive proposal including the contracts and tariff that would establish an Independent System Operator (ISO) to administer transmission service under a PJM control area transmission tariff and operate the energy market in a manner that assures comparable treatment for all participants. Under the Supporting Companies' proposal, reliability of the pool will be maintained under an installed capacity obligation. The ISO will administer a bid-priced energy spot market that will also accommodate bilateral transactions, and the ISO will provide transmission service on a poolwide basis. In early August 1996, PECO filed a competing plan opposing certain key features of the Supporting Companies' proposal. On November 13, 1996, the FERC found that it could not accept either the Supporting Companies' proposal or PECO's opposing proposal. Consequently, FERC ordered the PJM members to amend their proposals to comport with Order No. 888 on ISOs and to attempt to reach a consensus with other stakeholders. At a minimum, FERC ordered that PJM file a poolwide pro forma open access transmission tariff by December 31, 1996, and amend existing PJM pooling agreements for compatibility with the Order. On December 31, 1996, the PJM member companies filed a joint response to FERC's Order. This compliance filing established a single poolwide transmission tariff and modified the membership and governance provisions of the PJM Agreement. The PJM members 40 noted areas of disagreement in the filing and indicated that the compliance filing was an interim solution until a more comprehensive proposal could be developed. On February 28, 1997, the FERC ruled on areas of disagreement between the PJM members and ordered that PJM implement an open access transmission tariff and a bid-based energy market by March 1, 1997. A new PJM Operating Agreement was filed on March 31, 1997, superseding the original PJM Agreement. This Agreement opens PJM's membership to eligible entities. PJM formed a Limited Liability Corporation on March 31, 1997, and the members have elected an independent board of directors to govern the PJM Interconnection Office. The PJM members subsequently moved the implementation date to April 1, 1997. PJM stakeholders continued to meet until the end of May, 1997 in order to develop an Independent System Operator. In early June 1997, the Supporting Companies and PECO each filed with the FERC separate proposals for the development of an Independent System Operator. PJM has many years of experience in providing economically efficient transmission and generation services throughout the mid-Atlantic region, and has achieved for its members, including the Company, significant cost savings through shared generating reserves and integrated operations. The PJM members are working to transform today's coordinated cost-based pool dispatch into a priced-based regional energy market operating under a standard of transmission service comparability. These changes are not expected to have a material effect on the operating results of the Company. COMPETITION - ----------- The electric utility industry is subject to increasing competitive pressures, stemming from a combination of increasing independent power production and regulatory and legislative initiatives intended to increase bulk power competition, including the Energy Policy Act of 1992. Since the early 1980s, the Company has pursued strategies which achieve financial flexibility through conservation and energy use management programs, extension of the useful life of generating equipment, cost-effective purchases of capacity and energy and preservation of scheduling flexibility to add new generating capacity in relatively small increments. The Company serves a unique and stable service territory and is a low-cost energy producer with customer prices which compare favorably with regional and national averages. Pursuant to an August 1995 order in a generic proceeding dealing with electric industry structure and the advent of competition, the Maryland Public Service Commission found that competition at the wholesale level holds the greatest potential 41 for producing significant benefits, while competition at the retail level would carry many potential problems with difficult- to-find solutions. The Commission stated that it was intrigued by a restructuring concept suggested by the Company, which calls for functionally dividing the utility into generation and transmission/distribution segments. The Commission encouraged the Company to develop the concept further and suggested that other electric utilities in the state develop similar proposals specific to their competitive positions. In October 1996, the Maryland Commission reopened the generic proceeding to review regulatory and competitive issues affecting the electricity industry. The Commission cited the evolving nature of the electric industry as the basis for continuing its investigation. As part of this investigation, the Commission directed its Staff to submit a report on or before May 31, 1997, containing, among other things, recommendations regarding regulatory and competitive issues facing the electric industry in Maryland. The Commission also directed the four major electric utilities in Maryland to prepare unbundled cost studies and model unbundled retail service tariffs prior to August 1, 1997. On May 30, 1997, the Commission Staff issued its report, recommending that all Maryland customers be given a choice of electricity suppliers beginning April, 2001. The Staff recommends a three step process for implementing customer choice. Starting in April 1998, all investor-owned utilities in Maryland would begin sending customers bills that itemize the costs of specific services such as generation, transmission and delivery of electricity. Next, up to 20 percent of the utilities' customers would be offered the option of enrolling in one of two pilot customer choice programs starting at the end of 1998 and 1999, respectively. Lastly, all customers of Maryland investor- owned utilities would have the option to choose their supplier of electricity, with service beginning April 2, 2001. Under the plan, one of the choices available to customers would be a regulated power supplier. For now, existing utilities would continue to provide customers with distribution-related services such as billing and metering, at prices regulated by the Maryland Commission. Further unbundling would be considered later. The Staff also recommended that utilities be permitted to recover prudently incurred stranded costs. In comments provided to the Commission on the Staff report, the Company reaffirmed its full support for customer choice for Maryland electric customers and provided key principles that should be used as guidelines for the effective introduction of electric customer choice. The principles include the concept that Maryland companies should not be put at a competitive disadvantage by customer choice, that competition should not be regulated, and that the benefits of customer choice should not be oversold. Hearings are scheduled to begin in August 1997, following which certain actions must be taken by the Maryland legislature and the Public Service Commission before the recommendations can take effect. 42 The District of Columbia Public Service Commission initiated a proceeding to investigate issues regarding electricity industry structure and competition in late 1995. In September 1996, the Commission issued an order designating the issues to be examined in the proceeding. Initial comments regarding the designated issues were filed with the Commission in January 1997, and reply comments were filed in March 1997. PEAK LOAD, SALES, CONSERVATION, AND CONSTRUCTION - ------------------------------------------------ AND GENERATING CAPACITY ----------------------- Peak Load and Sales Data - ------------------------ Kilowatt-hour sales decreased 3.9%, 4.3% and 4.8%, for the three, six and twelve months ended June 30, 1997, respectively, as compared to sales for the corresponding periods in 1996. The decline in sales reflects milder than average weather in each calendar quarter in the twelve months ended June 30, 1997. The weather in the corresponding quarters in the prior twelve months was more severe than average in the third quarter of 1995 as well as the first and second quarters of 1996. Assuming future weather conditions approximate historical averages, the Company expects its compound annual growth in kilowatt-hour sales to range between 1% and 2% over the next decade. Through August 11, 1997, the 1997 summer peak demand was 5,689 megawatts. This compares with the 1996 summer peak demand of 5,288 megawatts, and the all-time summer peak demand of 5,769 megawatts which occurred in July 1991. The Company's present generation capability, including capacity purchase contracts, is 6,706 megawatts. To meet the 1997 summer peak demand, the Company had approximately 265 megawatts available from its dispatchable energy use management programs. Based on average weather conditions, the Company estimates that its peak demand will grow at a compound annual rate of approximately 1.5%, reflecting continuing success with demand side management (DSM) and energy use management (EUM) programs and anticipated service area growth trends. The 1996-1997 winter season peak demand of 4,632 megawatts was 7.5% below the all-time winter peak demand of 5,010 megawatts which was established in January 1994. Conservation - ------------ The Company's DSM and EUM programs are designed to curb growth in demand in order to defer the need for construction of additional generating capacity and to cost-effectively increase the efficiency of energy use. To reduce the near-term upward pressure on customer rates and bills, the Company has, since 1994, phased out several conservation programs and reduced rebate 43 levels for others. By narrowing its conservation offerings and limiting conservation spending, the Company expects to continue to encourage its customers to use energy efficiently without significantly increasing electricity prices. In Maryland, the Company invested approximately $12.8 million and $28.7 million in DSM programs for the six and twelve months ended June 30, 1997, respectively. The Company recovers the costs of Maryland DSM programs through a base rate surcharge which amortizes costs over a five-year period and permits the Company to earn a return on its conservation investment while receiving compensation for lost revenue. In addition, when the Company's performance exceeds its annual goals, the Company earns a performance bonus. The Company was awarded a bonus of $1.6 million in 1997, based on 1996 performance, which followed a bonus of $8.9 million in 1996, based on 1995 performance. As expected, the performance bonus in 1997 was significantly lower than amounts awarded in prior years, reflecting reduced DSM program expenditures. Investment in District of Columbia DSM programs totaled approximately $2.1 million and $9.6 million for the six and twelve months ended June 30, 1997, respectively. These DSM costs are amortized over ten years with an accrued return on unamortized costs. The Company estimates that peak load reductions of over 700 megawatts have been achieved to date from DSM and EUM programs and that additional peak load reductions of approximately 400 megawatts will be achieved in the next five years. The Company also estimates that, in 1996, energy savings of more than 1.6 billion kilowatt-hours were realized through operation of its DSM and EUM programs. See the discussions included in Summary of Significant Accounting Policies, Total Revenue, and Base Rate Proceedings, for additional information. Construction and Generating Capacity - ------------------------------------ Construction expenditures, excluding AFUDC and CCRF, are projected to total $1.2 billion for the five-year period 1997 through 2001, which includes $18 million of estimated Clean Air Act (CAA) expenditures. In 1997, construction expenditures are projected to total $215 million, which includes $4 million of estimated CAA expenditures. The Company plans to finance its construction program primarily through funds provided by operations. Actual construction expenditures during the period 1997 through 2001 may vary from projections once the Merger with BGE becomes effective. The Company has implemented cost-effective plans for complying with Phase I of the Acid Rain portion of the CAA which requires the reduction of sulfur dioxide and nitrogen oxides emissions to achieve prescribed standards. Boiler burner equipment for nitrogen oxides emissions control has been replaced 44 and the use of lower-sulfur coal has been instituted at the Company's Phase I affected stations, Chalk Point and Morgantown. Anticipated capital expenditures for complying with the second phase of the CAA total $18 million over the next five years. Plans for complying with the second phase of the CAA are being reviewed in anticipation of the pending Merger with BGE. If economical, continued use of lower-sulfur coal, cofiring with natural gas and the purchase of sulfur dioxide (SO2) emission allowances is expected. Nitrogen oxides emissions reductions will be achieved by installing control equipment in the most cost-effective manner after considering the characteristics of each of the merged company's boilers. In addition to the Acid Rain portion of the CAA, the State of Maryland and District of Columbia are required, by Title I of the CAA, to achieve compliance with ambient air quality standards for ground-level ozone. This provision is likely to result in further nitrogen oxides emissions reductions from the Company's boilers; however, the extent of reductions and associated cost cannot be estimated at this time. A 32-megawatt municipally financed resource recovery facility in Montgomery County, Maryland, began commercial operation in August 1995. The Company has been purchasing energy under the agreement covering this project without capacity payment obligations, which are not expected to commence until after the year 2000. In addition, the Company has a 25-year agreement with Panda for a 230-megawatt gas-fueled combined-cycle cogeneration project in Prince George's County, Maryland. The Panda facility achieved full commercial operation in October 1996. The Company projects that existing contracts for nonutility generation and the Company's commitment to conservation will provide adequate reserve margins to meet customers' needs well beyond the year 2000. In 1995, the Maryland Public Service Commission issued an order that requires electric utilities to competitively procure future capacity resources. The Company believes that completion of the first combined-cycle unit at its Station H facility in Dickerson, Maryland, currently scheduled for 2004, is likely to be the most cost-effective alternative for the next increment of capacity. This will add a steam cycle to the two existing combustion turbine units. SELECTED NONUTILITY SUBSIDIARY FINANCIAL INFORMATION - ---------------------------------------------------- The Company's wholly owned nonutility subsidiary, Potomac Capital Investment Corporation (PCI), was organized in late 1983 to provide a vehicle to conduct the Company's ongoing nonutility businesses. The principal assets of PCI are portfolios of securities and equipment leases, and to a lesser extent real estate and other investments. The $289.3 million securities portfolio, consisting primarily of investment grade preferred stocks, provides PCI with significant liquidity and flexibility 45 to participate in additional investment opportunities. The Company's equity investment in PCI was $215.2 million, $196.3 million and $183.1 million, at June 30, 1997, December 31, 1996, and June 30, 1996, respectively. On August 6, 1997, PCI announced an agreement with RCN Telecom Services, Inc. (RCN) of Princeton, New Jersey to form a joint venture to provide local and long-distance telephone, cable television, Internet and other telecommunications services to Washington, D.C. area residents and businesses. PCI and RCN each intend to invest up to $150 million to provide these services over an advanced fiber optic network. See Item 2 (Management's Discussion and Analysis of Consolidated Results of Operations) for additional information. 46 Consolidated Statements of Earnings: - -----------------------------------
Three Six Twelve Months Ended Months Ended Months Ended June 30, June 30, June 30, ---------------------- - ---------------------- ---------------------- 1997 1996 1997 1996 1997 1996 -------- --------- -------- - --------- -------- --------- (Thousands of Dollars) Income Leasing activities $ 14,646 $ 23,138 $ 35,761 $ 47,055 $ 80,367 $ 101,764 Marketable securities 6,132 7,466 17,874 17,524 34,040 35,077 Other 7,887 1,179 14,837 (15,483) 19,935 (19,803) -------- --------- -------- - --------- -------- --------- 28,665 31,783 68,472 49,096 134,342 117,038 -------- --------- -------- - --------- -------- --------- Expenses Interest 17,523 20,844 36,549 42,973 77,018 89,491 Administrative and general 2,356 3,677 8,710 9,040 15,199 14,090 Depreciation and operating 15,265 4,781 29,224 18,576 51,630 50,580 Loss on assets held for disposal - - - 12,320 424 12,320 Income tax credit (7,935) (6,566) (20,917) (45,328) (30,214) (56,435) -------- --------- -------- - --------- -------- --------- 27,209 22,736 53,566 37,581 114,057 110,046 -------- --------- -------- - --------- -------- --------- Net earnings from nonutility subsidiary $ 1,456 $ 9,047 $ 14,906 $ 11,515 $ 20,285 $ 6,992 ======== ========= ======== ========= ======== ========= Per share contribution to earnings of the Company $ .01 $ .07 $ .13 $ .10 $ .17 $ .06 ===== ===== ===== ===== ===== ===== Reflects non-recurring, noncash, after-tax charges of $5.2 million ($.04 per share) for the twelve months ended June 30, 1996, related to the 1995 plan with respect to the aircraft equipment leasing business. 47
STATISTICAL DATA - ----------------
Three Months Ended Twelve Months Ended June 30, June 30, --------------------------------- - ------------------------------------- 1997 1996 % Change 1997 1996 % Change -------- -------- -------- - ---------- ---------- -------- Revenue from Sales ------------------ of Electricity -------------- (Thousands of Dollars) Residential $119,812 $131,305 (8.8) $ 524,896 $ 566,870 (7.4) General Service 270,804 282,848 (4.3) 1,068,188 1,089,205 (1.9) Large Power Service 8,990 9,391 (4.3) 35,414 36,431 (2.8) Street Lighting 2,910 2,827 2.9 12,643 12,322 2.6 Rapid Transit 7,038 6,917 1.7 28,690 28,712 (0.1) Wholesale 28,370 27,714 2.4 118,908 123,815 (4.0) -------- -------- - ---------- ---------- System $437,924 $461,002 (5.0) $1,788,739 $1,857,355 (3.7) ======== ======== ========== ========== Energy Sales ------------ (Millions of KWH) Residential 1,390 1,521 (8.6) 6,493 7,121 (8.8) General Service 3,688 3,772 (2.2) 15,100 15,586 (3.1) Large Power Service 160 172 (7.0) 675 716 (5.7) Street Lighting 34 35 (2.9) 164 165 (0.6) Rapid Transit 99 99 - 408 415 (1.7) Wholesale 558 569 (1.9) 2,504 2,609 (4.0) -------- -------- - ---------- ---------- System 5,929 6,168 (3.9) 25,344 26,612 (4.8) ======== ======== ========== ========== Average System Revenue ---------------------- per KWH (cents per KWH) 7.39 7.47 (1.1) 7.06 6.98 1.1 ----------------------- System Peak Demand ------------------ (Thousands of KW) Summer - - 5,689 5,732 Winter - - 4,632 4,831 Net Generation -------------- (Millions of KWH) 4,042 4,146 17,005 20,373 Fuel Mix (% of Btu) ------------------- Coal (%) 86 90 90 86 Oil (%) 5 6 5 7 Gas (%) 9 4 5 7 Fuel Cost per MBtu ------------------ System Average $1.89 $1.78 $1.82 $1.77 Weather Data ------------ Heating Degree Days 462 399 3,871 4,591 20 Year Average 325 4,036 Cooling Degree Hours 1,988 3,446 7,789 13,072 20 Year Average 2,656 11,130 Heating Degree Days - The daily difference in degrees by which the mean temperature is below 65 degrees Fahrenheit (dry bulb). Cooling Degree Hours - The daily sum of the differences, by hours, by which the temperature (effective temperature) for each hour exceeds 71 degrees Fahrenheit (effective temperature). Large Power Service customers are served at a voltage of 66KV or higher. At June 30, 1997, the generation capability, including capacity purchase contracts, was 6,706 MW. 48
UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL INFORMATION - ------------------------------------------------------------ The following unaudited pro forma condensed information combines the historical consolidated balance sheets and statements of income of Potomac Electric Power Company and Baltimore Gas and Electric Company, including their respective subsidiaries, after giving effect to the proposed Merger of the two companies into Constellation Energy Corporation. As previously disclosed, the Merger is expected to close as soon as all necessary regulatory approvals, on terms satisfactory to PEPCO and BGE, are obtained. As of the date of this filing, the Merger has not closed. The unaudited pro forma combined condensed balance sheet at June 30, 1997, gives effect to the Merger as if it had occurred at June 30, 1997. The unaudited pro forma combined condensed statement of income for the six months ended June 30, 1997, gives effect to the Merger as if it had occurred at January 1, 1997. These statements are prepared on the basis of accounting for the Merger as a pooling of interests and are based on the assumptions set forth in the notes thereto. Constellation Energy Corporation was formed September 22, 1995, and has no assets or operations. Therefore, Constellation Energy Corporation has no financial statements and, in turn, there has been no audit of such statements. The following pro forma financial information has been prepared from, and should be read in conjunction with, the historical consolidated financial statements and related notes thereto of PEPCO and BGE, which are contained in their respective 1934 Act reports for prior periods. The following information is not necessarily indicative of the financial position or operating results that would have occurred if the Merger had been consummated on the dates, or at the beginning of the periods, for which the Merger is being given effect nor is it necessarily indicative of future financial position or operating results. The following unaudited pro forma combined condensed financial information of Constellation Energy Corporation is set forth below: Balance Sheet as of June 30, 1997 Income Statement for the Six Months Ended June 30, 1997 Notes to Unaudited Pro Forma Combined Condensed Financial Statements The following PEPCO financial information is also set forth below: Reclassifying Balance Sheet as of June 30, 1997 Reclassifying Income Statement for the Six Months Ended June 30, 1997 49 Other Information - ----------------- Both PEPCO and BGE file annual and quarterly reports with the Securities and Exchange Commission (SEC). These are available at the SEC's public reference rooms in Washington, D.C. and New York, New York (call 1-800-SEC-0330 for more information); and at the SEC's web site at http://www.sec.gov. 50 CONSTELLATION ENERGY CORPORATION UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET JUNE 30, 1997 (IN THOUSANDS) ----------------------------------------------------
PEPCO BGE (As Reclassified) Pro Forma Pro Forma (As Reported) (See Note 1) Adjustments Combined -------------- ----------------- - ------------- ------------- ASSETS Current Assets Cash and Cash Equivalents $ 271,212 $ 26,751 $ - $ 297,963 Accounts Receivable - net 400,483 302,340 - 702,823 Materials and Supplies 166,320 131,765 - 298,085 Prepayments and Other 207,229 6,997 - 214,226 ------------- ---------------- - ------------ ------------ Total Current Assets 1,045,244 467,853 - 1,513,097 ------------- ---------------- - ------------ ------------ Investments and Other Assets Notes Receivable - 34,253 - 34,253 Real Estate Projects 440,846 72,627 - 513,473 Power Generation Systems 404,868 968 - 405,836 Financial Instruments 127,980 - - 127,980 Marketable Securities 40,679 289,293 - 329,972 Investment in Finance Leases 29,378 486,049 - 515,427 Operating Lease Equipment - net - 179,337 - 179,337 Assets Held for Disposal - 3,700 - 3,700 Other Investments 405,327 113,311 - 518,638 ------------- ---------------- - ------------ ------------ Total Investments and Other Assets 1,449,078 1,179,538 - 2,628,616 ------------- ---------------- - ------------ ------------ Utility Plant Plant in Service Electric 6,644,436 6,299,044 - 12,943,480 Gas 813,672 - - 813,672 Common 544,790 - - 544,790 ------------- ---------------- - ------------ ------------ Total Plant in Service 8,002,898 6,299,044 - 14,301,942 Accumulated Depreciation (2,715,425) (1,960,616) - (4,676,041) ------------- ---------------- - ------------ ------------ Net Plant in Service 5,287,473 4,338,428 - 9,625,901 Construction Work in Progress 158,600 78,450 - 237,050 Nuclear Fuel - net 128,427 - - 128,427 Other Plant - net 25,470 26,263 - 51,733 ------------- ---------------- - ------------ ------------ Net Utility Plant 5,599,970 4,443,141 - 10,043,111 ------------- ---------------- - ------------ ------------ Deferred Charges Regulatory Assets 464,514 466,376 - 930,890 Other 108,475 183,123 - 291,598 ------------- ---------------- - ------------ ------------ Total Deferred Charges 572,989 649,499 - 1,222,488 ------------- ---------------- - ------------ ------------ Total Assets $ 8,667,281 $ 6,740,031 $ - $ 15,407,312 ============= ================ ============ ============ LIABILITIES AND CAPITALIZATION Current Liabilities Short-term Borrowings $ 116,900 $ 311,600 $ - $ 428,500 Current Portion of Long-term Debt, Preferred Stock and Preference Stock 324,783 478,485 - 803,268 Accounts Payable 147,536 209,781 - 357,317 Other 223,782 102,482 - 326,264 ------------- ---------------- - ------------ ------------ Total Current Liabilities 813,001 1,102,348 - 1,915,349 ------------- ---------------- - ------------ ------------ Deferred Credits and Other Liabilities Deferred Income Taxes 1,276,242 1,037,690 - 2,313,932 Capital Lease Obligations - 161,702 - 161,702 Pension and Postemployment Benefits 180,530 - - 180,530 Other 103,141 52,604 - 155,745 ------------- ---------------- - ------------ ------------ Total Deferred Credits and Other Liabilities 1,559,913 1,251,996 - 2,811,909 ------------- ---------------- - ------------ ------------ Capitalization Long-term Debt 3,162,147 2,262,274 - 5,424,421 Preferred Stock - 266,293 - 266,293 Preference Stock 323,000 - - 323,000 Common Shareholders' Equity 2,809,220 1,857,120 - 4,666,340 ------------- ---------------- - ------------ ------------ Total Capitalization 6,294,367 4,385,687 - 10,680,054 ------------- ---------------- - ------------ ------------ Total Liabilities and Capitalization $ 8,667,281 $ 6,740,031 $ - $ 15,407,312 ============= ================ ============ ============ See accompanying Notes to Unaudited Pro Forma Combined Condensed Financial Statements. 51
CONSTELLATION ENERGY CORPORATION UNAUDITED PRO FORMA COMBINED CONDENSED INCOME STATEMENT SIX MONTHS ENDED JUNE 30, 1997 (In thousands, except per share amounts) - -------------------------------------------------------
PEPCO BGE (As Reclassified) Pro Forma Pro Forma (As Reported) (See Note 5) Adjustments Combined ------------- ----------------- ------------ ------------- Revenue Electric $ 1,015,362 $ 840,031 $ - $ 1,855,393 Gas 306,046 - - - 306,046 Diversified businesses 312,714 68,472 - 381,186 ------------ ----------------- ----------- ------------ Total Revenue 1,634,122 908,503 - 2,542,625 ------------ ----------------- ----------- ------------ Operating Expenses Electric fuel and purchased energy 248,008 324,877 - 572,885 Gas purchased for resale 181,421 - - - 181,421 Operations 265,031 105,132 - 370,163 Maintenance 102,195 45,080 - 147,275 Diversified business expenses 316,643 37,934 - 354,577 Depreciation and amortization 170,786 114,401 - 285,187 Taxes other than income taxes 107,323 94,641 - 201,964 ------------ ----------------- ----------- ------------ Total Operating Expenses 1,391,407 722,065 - 2,113,472 ------------ ----------------- ----------- ------------ Income from Operations 242,715 186,438 - 429,153 Total Other Income 2,016 5,592 - 7,608 ------------ ----------------- ----------- ------------ Income Before Interest and Income Taxes 244,731 192,030 - 436,761 Net Interest Expense 110,784 106,856 - 217,640 ------------ ----------------- ----------- ------------ Income Before Income Taxes 133,947 85,174 - 219,121 Income Taxes 46,866 12,068 - 58,934 ------------ ----------------- ----------- ------------ Net Income 87,081 73,106 - 160,187 Preferred and Preference Stock Dividends 15,758 8,282 - 24,040 ------------ ----------------- ----------- ------------ Earnings Applicable to Common Stock $ 71,323 $ 64,824 $ - $ 136,147 ============ ================= =========== ============ Average Shares of Common Stock Outstanding 147,667 118,500 265,812 Earnings Per Share of Common Stock $0.48 $0.55 $0.51 See accompanying Notes to Unaudited Pro Forma Combined Condensed Financial Statements. 52
Notes to Unaudited Pro Forma Combined Condensed Financial - --------------------------------------------------------- Statements - ---------- 1. The revenue, expenses, assets, and liabilities of PEPCO's nonregulated subsidiaries have been reclassified to conform with the presentation used by BGE. The effect of accounting policy differences are immaterial and have not been adjusted in the pro forma combined condensed financial statements. 2. Pro forma per common share amounts give effect to the conversion of each share of PEPCO and BGE Common Stock into .997 share and 1 share, respectively, of Constellation Energy Corporation Common Stock. The pro forma combined condensed financial statements are presented as if the companies were combined during all periods included therein. 3. The allocation between PEPCO and BGE and their customers of the estimated cost savings resulting from the Merger, net of the costs incurred to achieve such savings, will be subject to regulatory review and approval. None of these estimated cost savings, the costs to achieve such savings, or transaction costs have been reflected in the pro forma combined condensed financial statements. 4. Intercompany transactions between PEPCO and BGE during the periods presented were not material and, accordingly, no pro forma adjustments were made to eliminate such transactions. 5. The PEPCO reclassifying information reflects the reclassifying entries necessary to adjust PEPCO's consolidated balance sheet and statement of income presentation to be consistent with the presentation expected to be used by Constellation Energy Corporation. 53 POTOMAC ELECTRIC POWER COMPANY RECLASSIFYING BALANCE SHEET JUNE 30, 1997 (In Thousands) ------------------------------
PEPCO PEPCO PEPCO (As Reported) (Reclasses) (As Reclassified) -------------- - -------------- ----------------- ASSETS Current Assets Cash and Cash Equivalents $ 7,640 $ 19,111 $ 26,751 Accounts Receivable - net - 302,340 302,340 Customer Accounts Receivable - net 164,006 (164,006) - Other Accounts Receivable - net 29,633 (29,633) - Accrued Unbilled Revenue 94,973 (94,973) - Materials and Supplies - 131,765 131,765 Fuel 63,834 (63,834) - Construction and Maintenance 67,931 (67,931) - Prepayments and Other - 6,997 6,997 Prepaid Taxes 105 (105) - Other Prepaid Expenses 6,892 (6,892) - ------------- - ------------- ---------------- Total Current Assets 435,014 32,839 467,853 ------------- - ------------- ---------------- Investments and Other Assets Notes Receivable - 34,253 34,253 Real Estate Projects - 72,627 72,627 Power Generation Systems - 968 968 Marketable Securities - 289,293 289,293 Investment in Finance Leases - 486,049 486,049 Operating Lease Equipment - net - 179,337 179,337 Assets Held for Disposal - 3,700 3,700 Other Investments - 113,311 113,311 ------------- - ------------- ---------------- Total Investments and Other Assets - 1,179,538 1,179,538 ------------- - ------------- ---------------- Utility Plant Plant in Service Electric 6,299,044 - 6,299,044 Construction Work in Progress 78,450 (78,450) - Electric Plant Held for Future Use 4,190 (4,190) - Nonoperating Property 22,976 (22,976) - ------------- - ------------- ---------------- Total Plant in Service 6,404,660 (105,616) 6,299,044 Accumulated Depreciation (1,961,519) 903 (1,960,616) Construction Work in Progress - 78,450 78,450 Other Plant - net - 26,263 26,263 ------------- - ------------- ---------------- Net Utility Plant 4,443,141 - 4,443,141 ------------- - ------------- ---------------- Deferred Charges Regulatory Assets - 466,376 466,376 Income Taxes Recoverable through Future Rates, net 239,435 (239,435) - Conservation Costs, net 229,010 (229,010) - Unamortized Debt Reacquisition Costs 54,149 (54,149) - Other 171,758 11,365 183,123 ------------- - ------------- ---------------- Total Deferred Charges 694,352 (44,853) 649,499 ------------- - ------------- ---------------- Nonutility Subsidiary Assets Cash and Cash Equivalents 19,111 (19,111) - Marketable Securities 289,293 (289,293) - Investment in Finance Leases 486,049 (486,049) - Operating Lease Equipment - net 179,337 (179,337) - Assets Held for Disposal 3,700 (3,700) - Receivables - net 47,981 (47,981) - Other Investments 186,906 (186,906) - Other Assets 14,280 (14,280) - ------------- - ------------- ---------------- Total Nonutility Subsidiary Assets 1,226,657 (1,226,657) - ------------- - ------------- ---------------- Total Assets $ 6,799,164 $ (59,133) $ 6,740,031 ============= ============= ================ 54
POTOMAC ELECTRIC POWER COMPANY RECLASSIFYING BALANCE SHEET JUNE 30, 1997 (In Thousands) ------------------------------
PEPCO PEPCO PEPCO (As Reported) (Reclasses) (As Reclassified) -------------- - ------------ ----------------- LIABILITIES AND CAPITALIZATION Current Liabilities Short-term Borrowings $ 311,600 $ - $ 311,600 Current Portion of Long-term Debt and Preferred Stock 100,985 377,500 478,485 Accounts Payable and Accrued Expenses 158,846 50,935 209,781 Capital Lease Obligations Due within One Year 20,772 (20,772) - Other 81,710 20,772 102,482 ------------- - ----------- ---------------- Total Current Liabilities 673,913 428,435 1,102,348 ------------- - ----------- ---------------- Deferred Credits and Other Liabilities Deferred Income Taxes 1,001,460 36,230 1,037,690 Deferred Investment Tax Credits 59,133 (59,133) - Capital Lease Obligations - 161,702 161,702 Other 40,561 12,043 52,604 ------------- - ----------- ---------------- Total Deferred Credits and Other Liabilities 1,101,154 150,842 1,251,996 ------------- - ----------- ---------------- Other Non-Current Liabilities Capital Lease Obligations 161,702 (161,702) - ------------- - ----------- ---------------- Total Other Non-Current Liabilities 161,702 (161,702) - ------------- - ----------- ---------------- Capitalization Long-term Debt 1,727,065 535,209 2,262,274 Preferred Stock - 266,293 266,293 Serial Preferred Stock 125,293 (125,293) - Redeemable Serial Preferred Stock 141,000 (141,000) - Common Shareholders' Equity - 1,857,120 1,857,120 Common Stock 118,501 (118,501) - Other Common Equity 1,738,619 (1,738,619) - ------------- - ----------- ---------------- Total Capitalization 3,850,478 535,209 4,385,687 ------------- - ----------- ---------------- Nonutility Subsidiary Liabilities Long-term Debt 912,709 (912,709) - Deferred Taxes and Other 99,208 (99,208) - ------------- - ----------- ---------------- Total Nonutility Subsidiary Liabilities 1,011,917 (1,011,917) - ------------- - ----------- ---------------- Total Liabilities and Capitalization $ 6,799,164 $ (59,133) $ 6,740,031 ============= =========== ================ 55
POTOMAC ELECTRIC POWER COMPANY RECLASSIFYING STATEMENT OF INCOME SIX MONTHS ENDED JUNE 30, 1997 (In thousands, except per share amounts) ----------------------------------------
PEPCO PEPCO PEPCO (As Reported) (Reclasses) (As Reclassified) ------------- - ------------- ----------------- Electric $ 840,031 $ - $ 840,031 Diversified businesses - 68,472 68,472 ------------ - ------------ ---------------- Total Revenue 840,031 68,472 908,503 ------------ - ------------ ---------------- Operating Expenses Electric fuel and purchased energy - 324,877 324,877 Fuel 156,702 (156,702) - Purchased energy 95,450 (95,450) - Capacity purchase payments 72,725 (72,725) - Operations 105,132 - 105,132 Maintenance 45,080 - 45,080 Diversified business expenses - 37,934 37,934 Depreciation and amortization 114,401 - 114,401 Income taxes 33,058 (33,058) - Taxes other than income taxes 94,641 - 94,641 ------------ - ------------ ---------------- Total Operating Expenses 717,189 4,876 722,065 ------------ - ------------ ---------------- Income from Operations 122,842 63,596 186,438 ------------ - ------------ ---------------- Other Income Nonutility Subsidiary Income 68,472 (68,472) - Expenses, including interest and income taxes (53,566) 53,566 - ------------ - ------------ ---------------- Net earnings from nonutility subsidiary 14,906 (14,906) - Allowance for other funds used during construction and capital cost recovery factor 3,341 - 3,341 Other, net 2,324 (73) 2,251 ------------ - ------------ ---------------- Total Other Income 20,571 (14,979) 5,592 ------------ - ------------ ---------------- Income Before Interest and Income Taxes 143,413 48,617 192,030 ------------ - ------------ ---------------- Interest Expense Interest on debt 68,847 - 68,847 Other 5,505 - 5,505 Subsidiary interest expense - 36,549 36,549 Allowance for borrowed funds used during construction and capital cost recovery factor (4,045) - (4,045) ------------ - ------------ ---------------- Net Interest Expense 70,307 36,549 106,856 ------------ - ------------ ---------------- Income before income taxes 73,106 12,068 85,174 ------------ - ------------ ---------------- Income taxes - Utility - 33,058 33,058 Income taxes - Nonoperating - (73) (73) Income taxes - Subsidiary - (20,917) (20,917) ------------ - ------------ ---------------- Total Income Taxes - 12,068 12,068 ------------ - ------------ ---------------- Net Income 73,106 - 73,106 Preferred Dividends 8,282 - 8,282 ------------ - ------------ ---------------- Earnings Applicable to Common Stock $ 64,824 $ - $ 64,824 ============ ============ ================ Average Shares of Common Stock Outstanding 118,500 118,500 Earnings Per Share of Common Stock $0.55 $0.55 56
Item 6 EXHIBITS AND REPORTS ON FORM 8-K - ------ -------------------------------- (a) Exhibits Exhibit 3 - By-Laws of the Company Exhibit 11 - Computation of Earnings Per Common Share - filed herewith. Exhibit 12 - Computation of ratios - filed herewith. Exhibit 15 - Letter re unaudited interim financial information - filed herewith. Exhibit 27 - Financial data schedule - filed herewith. (b) Reports on Form 8-K A Current Report on Form 8-K was filed by the Company on April 7, 1997, providing unaudited pro forma combined condensed financial information of Baltimore Gas and Electric Company (BGE) and Potomac Electric Power Company (PEPCO), after giving effect to the proposed Merger of the two companies into Constellation Energy Corporation. The item reported on such Form 8-K was Item 5 (Other Events). A Current Report on Form 8-K was filed by the Company on April 17, 1997, providing details on the Federal Energy Regulatory Commission's approval of the proposed Merger between the Company and BGE; and on the plan of the two companies to file a Request for Reconsideration of the Maryland Public Service Commission's Merger Order. The item reported on such Form 8-K was Item 5 (Other Events). A Current Report on Form 8-K was filed by the Company on May 5, 1997, providing details of the Company's and BGE's Application for Rehearing of Maryland Public Service Commission's Merger Order. The item reported on such Form 8-K was Item 5 (Other Events). 57 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Potomac Electric Power Company ------------------------------ Registrant By /s/ D. R. Wraase ------------------------------ (D. R. Wraase) Senior Vice President and Chief Financial Officer August 13, 1997 - --------------- DATE 58 Exhibit 11 Computations of Earnings Per Common Share - ---------- ----------------------------------------- The following is the basis for the computation of primary and fully diluted earnings per common share for the twelve months ended June 30, 1997, and the twelve months ended December 31, 1996 and 1995:
June 30, December 31, December 31, 1997 1996 1995 ------------- ------------ - ------------ Average shares outstanding for computation of primary earnings per common share 118,498,718 118,496,683 118,412,478 ============ ============ ============ Average shares outstanding for fully diluted computation: Average shares outstanding 118,498,718 118,496,683 118,412,478 Additional shares resulting from: Conversion of Serial Preferred Stock, $2.44 Convertible Series of 1966 (the "Convertible Preferred Stock") 34,404 34,986 38,255 Conversion of 7% Convertible Debentures 2,364,559 2,418,579 2,469,639 Conversion of 5% Convertible Debentures 3,392,500 3,392,500 3,392,500 ------------ ------------ - ------------ Average shares outstanding for computation of fully diluted earnings per common share 124,290,181 124,342,748 124,312,872 ============ ============ ============ Earnings applicable to common stock $206,490,000 $220,356,000 $77,540,000 Add: Dividends paid or accrued on Convertible Preferred Stock 14,000 15,000 16,000 Interest paid or accrued on Convertible Debentures, net of related taxes 6,358,000 6,416,000 6,475,000 ------------ ------------ - ------------ Earnings applicable to common stock, assuming conversion of convertible securities $212,862,000 $226,787,000 $84,031,000 ============ ============ ============ Primary earnings per common share $1.74 $1.86 $0.65 Fully diluted earnings per common share $1.71 $1.82 $0.68 The valuation is not required by footnote 2 to paragraph 14 of APB No. 15 for the the twelve months ended June 30, 1997 and December 31, 1996 because it results in dilution of less than 3%. In addition, this calculation is submitted in accordance with Regulation S-K item 601 (b)(11) although it is contrary to paragraph 40 of APB No. 15 because it produces an antidilutive result for the twelve months ended December 31, 1995. 59
Exhibit 12 Computation of Ratios - ---------- --------------------- The computations of the coverage of fixed charges, excluding the cumulative effect of the 1992 accounting change, before income taxes, and the coverage of combined fixed charges and preferred dividends for the twelve months ended June 30, 1997, and for each of the preceeding five years on the basis of parent company operations only, are as follows.
Twelve Months For The Year Ended December 31, Ended - --------------------------------------------------------- June 30, 1997 1996 1995 1994 1993 1992 --------- --------- --------- --------- --------- --------- (Thousands of Dollars) Net income before cumulative effect of accounting change $202,795 $220,066 $218,788 $208,074 $216,478 $172,599 Taxes based on income 120,406 135,011 129,439 116,648 107,223 76,965 --------- --------- --------- --------- --------- --------- Income before taxes and cumulative effect of accounting change 323,201 355,077 348,227 324,722 323,701 249,564 --------- --------- --------- --------- --------- --------- Fixed charges: Interest charges 146,676 146,939 146,558 139,210 141,393 138,097 Interest factor in rentals 23,374 23,560 23,431 6,300 5,859 6,140 --------- --------- --------- --------- --------- --------- Total fixed charges 170,050 170,499 169,989 145,510 147,252 144,237 --------- --------- --------- --------- --------- --------- Income before income taxes, cumulative effect of accounting change and fixed charges $493,251 $525,576 $518,216 $470,232 $470,953 $393,801 ========= ========= ========= ========= ========= ========= Coverage of fixed charges 2.90 3.08 3.05 3.23 3.20 2.73 ==== ==== ==== ==== ==== ==== Preferred dividend requirements $16,590 $16,604 $16,851 $16,437 $16,255 $14,392 --------- --------- --------- --------- --------- --------- Ratio of pre-tax income to net income 1.59 1.61 1.59 1.56 1.50 1.45 --------- --------- --------- --------- --------- --------- Preferred dividend factor $26,378 $26,732 $26,793 $25,642 $24,383 $20,868 --------- --------- --------- --------- --------- --------- Total fixed charges and preferred dividends $196,428 $197,231 $196,782 $171,152 $171,635 $165,105 ========= ========= ========= ========= ========= ========= Coverage of combined fixed charges and preferred dividends 2.51 2.66 2.63 2.75 2.74 2.39 ==== ==== ==== ==== ==== ====
60 Exhibit 12 Computation of Ratios - ---------- --------------------- The computations of the coverage of fixed charges, excluding the cumulative effect of the 1992 accounting change, before income taxes, and the coverage of combined fixed charges and preferred dividends for the twelve months ended June 30, 1997, and for each of the preceding five years on a fully consolidated basis, are as follows.
Twelve Months For The Year Ended December 31, Ended - --------------------------------------------------------- June 30, 1997 1996 1995 1994 1993 1992 --------- --------- --------- --------- --------- --------- (Thousands of Dollars) Net income before cumulative effect of accounting change $223,080 $236,960 $94,391 $227,162 $241,579 $200,760 Taxes based on income 90,192 80,386 43,731 93,953 62,145 79,481 --------- --------- --------- --------- --------- --------- Income before taxes and cumulative effect of accounting change 313,272 317,346 138,122 321,115 303,724 280,241 --------- --------- --------- --------- --------- --------- Fixed charges: Interest charges 224,243 231,029 238,724 224,514 221,312 226,453 Interest factor in rentals 23,515 23,943 26,685 9,938 9,257 6,599 --------- --------- --------- --------- --------- --------- Total fixed charges 247,758 254,972 265,409 234,452 230,569 233,052 --------- --------- --------- --------- --------- --------- Nonutility subsidiary capitalized interest (550) (649) (529) (521) (2,059) (2,200) --------- --------- --------- --------- --------- --------- Income before income taxes, cumulative effect of accounting change and fixed charges $560,480 $571,669 $403,002 $555,046 $532,234 $511,093 ======== ======== ======== ======== ======== ======== Coverage of fixed charges 2.26 2.24 1.52 2.37 2.31 2.19 ==== ==== ==== ==== ==== ==== Preferred dividend requirements $16,590 $16,604 $16,851 $16,437 $16,255 $14,392 --------- --------- --------- --------- --------- --------- Ratio of pre-tax income to net income 1.40 1.34 1.46 1.41 1.26 1.40 --------- --------- --------- --------- --------- --------- Preferred dividend factor $23,226 $22,249 $24,602 $23,176 $20,481 $20,149 --------- --------- --------- --------- --------- --------- Total fixed charges and preferred dividends $270,984 $277,221 $290,011 $257,628 $251,050 $253,201 ======== ======== ======== ======== ======== ======== Coverage of combined fixed charges and preferred dividends 2.07 2.06 1.39 2.15 2.12 2.02 ==== ==== ==== ==== ==== ====
61 Exhibit 15 August 13, 1997 Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 Ladies and Gentlemen: We are aware that Potomac Electric Power Company has incorporated by reference our report dated August 13, 1997, (issued pursuant to the provisions of Statement on Auditing Standards No. 71) in the Prospectuses constituting parts of the Registration Statements (Registration Nos. 33-36798, 33-53685 and 33-54197) on Form S-8 filed on September 12, 1990, May 18, 1994 and June 17, 1994, respectively, and (Registration Nos. 33-58810 and 33-61379) on Form S-3 filed on February 26, 1993 and July 28, 1995, respectively, in the Joint Proxy Statement/Prospectus constituting part of the Registration Statement (Registration No. 33-64799) on Form S-4 of Constellation Energy Corporation filed on December 7, 1995, and in the Prospectuses constituting parts of the Registration Statements on Form S-3 (Registration Nos. 333-24705 and 333-24855) of Constellation Energy Corporation filed on April 7, 1997, and April 9, 1997, respectively. We are also aware of our responsibilities under the Securities Act of 1933. Very truly yours, /s/ Price Waterhouse LLP Price Waterhouse LLP Washington, D.C. 62 EX-3 2 BY-LAWS ======================================== By-Laws of POTOMAC ELECTRIC POWER COMPANY WASHINGTON, D. C. As amended through July 24, 1997 ================================================================= POTOMAC ELECTRIC POWER COMPANY BY-LAWS ______ ARTICLE I SECTION 1. The annual meeting of the stockholders of the Company shall be held on such day, at such time and place within or without the District of Columbia as the Board of Directors or the Executive Committee shall designate for the purpose of electing directors and of transacting such other business as may properly be brought before the meeting. At an annual meeting of the stockholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting, business must be specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board, otherwise properly brought before the meeting by or at the direction of the Board, or otherwise properly brought before the meeting by a stockholder. In addition to any other applicable requirements, for business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the Secretary of Potomac Electric Power Company. To be timely, a stockholder's notice must be received at the principal executive offices of the Company not less than 50 days nor more than 75 days prior to the meeting; provided, however, that in the event that less than 65 days' notice or prior public disclosure of the date of the meeting is given or made to stockholders, notice by the stockholder to be timely must be so received not later than the close of business on the fifteenth day following the day on which such notice of the date of the annual meeting was mailed or such public disclosure was made, whichever first occurs. A stockholder's notice to the Secretary shall set forth (i) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and record address of the stockholder proposing such business, (iii) the class and number of shares of the Company that are beneficially owned by the stockholder, and (iv) any material interest of the stockholder in such business. Notwithstanding anything in the By-Laws to the contrary, no business shall be conducted at the annual meeting except in accordance with the procedures set forth in this Article I, Section 1; provided, however, that nothing in this Article I, Section 1 shall be deemed to preclude discussion by any stockholder of any business properly brought before the annual meeting in accordance with such procedures. The Chairman of an annual meeting shall, if the facts warrant, determine that business was not properly brought before the meeting in accordance with the provisions of this Article I, Section 1, and if he should so determine, he shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted. SECTION 2. Special meetings of the stockholders, when called, shall be held at such time and place within or without the District of Columbia and may be called by the Board of Directors, or the Executive Committee, or the holders of record of not less than one- fifth of all the outstanding shares entitled to vote at the meeting, or, if the meeting is for the purpose of enabling the holders of the Serial Preferred Stock of the Company to elect directors upon the conditions set forth in the Articles of Incorporation of the Company, such meeting shall be called as therein provided. SECTION 3. Written notice stating the place, day and hour of each meeting of the stockholders and the purpose or purposes for which the meeting is called shall be given not less than ten days (or such longer period as may be prescribed by law) and not more than fifty days before the date of the meeting to each stockholder of record entitled to vote at the meeting, by depositing such notice in the United States mail addressed to the respective stockholders at their addresses as they appear on the records of the Company, with postage thereon prepaid. In connection with the first election of a portion of the members of the Board of Directors by the holders of the Serial Preferred Stock upon accrual of such right, as provided in the Articles of Incorporation of the Company, the Company shall prepare and mail to the holders of the Serial Preferred Stock entitled to vote thereon such proxy forms, communications and documents as may be deemed appropriate for the purpose of soliciting proxies for the election of directors by the holders of the Serial Preferred Stock. The Secretary or an Assistant Secretary of the Company shall cause to be made, at least ten days before each meeting of stockholders, a complete list of the stockholders entitled to vote at such meeting or any adjournment thereof, with the address of and the number of shares held by each. Such list, for a period of ten days prior to such meeting, shall be kept on file at the principal place of business of the Company and shall be subject to inspection for any proper purpose by any stockholder at any time during usual business hours. Such list shall also be produced and kept open at the time and place of the meeting and shall be subject to the inspection for any proper purpose of any stockholder during the whole time of the meeting. SECTION 4. At each meeting of stockholders the holders of record of a majority of the outstanding shares entitled to vote at such meeting, represented in person or by proxy, shall constitute a quorum, except as otherwise provided by law or by the Articles of Incorporation of the Company. The affirmative vote of the holders of a majority of the shares represented at a duly organized meeting at which a quorum was present at the time of organization, and entitled to vote on the subject matter, shall be the act of the stockholders, unless the vote of the holders of a greater number, or voting by classes, is required by law or by the Articles of Incorporation of the Company and except that in elections of directors those receiving the greatest numbers of votes shall be deemed elected even though not receiving a majority. If a meeting cannot be organized because a quorum has not attended, the holders of a majority of the shares represented at the meeting may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall have been obtained, when any business may be transacted which might have been transacted at the meeting as first convened had there been a quorum. SECTION 5. Meetings of the stockholders shall be presided over by the Chairman of the Board or, if he is not present, by the President or, if neither is present, by a Vice Chairman or, if no such officer is present, by a chairman to be chosen at the meeting. The Secretary of the Company or, if he is not present, an Assistant Secretary of the Company or, if neither is present, a secretary to be chosen at the meeting, shall act as Secretary of the meeting. SECTION 6. Each stockholder entitled to vote at any meeting may so vote either in person or by proxy executed in writing by the stockholder or by his duly authorized attorney-in-fact and shall be entitled to one vote on each matter submitted to a vote for each share of stock of the Company having voting power thereon registered in his name at the date fixed for the determination of the stockholders entitled to vote at the meeting. SECTION 7. At all elections of directors the voting shall be by ballot. At all such elections, the Chairman of the meeting shall appoint two inspectors of election, unless such appointment shall be unanimously waived by the stockholders present in person or represented by proxy at the meeting and entitled to vote for the election of directors. No director or candidate for the office of director shall be appointed as such inspector. The inspectors, before entering upon the discharge of their duties, shall take and subscribe an oath or affirmation faithfully to execute the duties of inspector at such meeting with strict impartiality and according to the best of their ability, and shall take charge of the polls and after the balloting shall make a certificate of the result of the vote taken. SECTION 8. In order to determine who are stockholders of the Company for any proper purpose, the Board of Directors either may close the stock transfer books or, in lieu thereof, may fix in advance a date as the record date for such determination, such date in any case to be not more than fifty days (and, in the case of a meeting of stockholders, not less than ten days or such longer period as may be required by law) prior to the date on which the particular action, requiring such determination, is to be taken. When such a record date has been so fixed for the determination of stockholders entitled to vote at a meeting, such determination shall apply to any adjournment thereof. ARTICLE II BOARD OF DIRECTORS SECTION 1. The Board of Directors of the Company shall consist of twelve persons, each of whom shall be a stockholder of the Company. The directors shall be divided into three classes, designated Class I, Class II, and Class III. Each of the classes shall have four directors. At the 1987 annual meeting of stockholders, Class I directors shall be elected for a one-year term, Class II directors for a two-year term, and Class III directors for a three-year term. At each succeeding annual meeting of stockholders beginning in 1988, successors to the class of directors whose term expires at that annual meeting shall be elected for a three-year term. Except as otherwise provided in the Articles of Incorporation of the Company and in these By-Laws, the directors shall hold office until the annual meeting of the stockholders for the year in which their respective terms expire and until their respective successors shall have been elected and qualified. No person shall be eligible for election as a director after he shall have attained his seventieth birthday, and no person shall be eligible to serve as a director beyond the next annual meeting after he shall have attained his seventieth birthday. No director who is a full time employee of the Company shall be eligible to serve as a director beyond the next annual meeting after termination of his employment with the Company, provided, that (a) this provision shall not apply to a director who is serving or has served as Chief Executive Officer and (b) a director serving at the time of termination of employment as Vice Chairman shall be permitted to continue as director until the expiration of his three-year term. Seven members of the Board shall constitute a quorum for the transaction of business, but if any meeting of the Board cannot be organized because a quorum has not attended, a majority of those present may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall have been obtained, when any business may be transacted which might have been transacted at the meeting as first convened had there been a quorum. The acts of a majority of the directors present at a meeting at which a quorum is present shall, except as otherwise provided by law, by the Articles of Incorporation of the Company, or by these By-Laws, be the acts of the Board of Directors. Only persons who are nominated in accordance with the following procedures shall be eligible for election as Directors. Nominations of persons for election to the Board of the Company may be made at the annual meeting of stockholders by or at the direction of the Board of Directors, by any nominating committee or person appointed by the Board, or by any stockholder of the Company entitled to vote for the election of Directors at the meeting who complies with the notice procedures set forth in this Article II, Section 1. Such nominations, other than those made by or at the direction of the Board, shall be made pursuant to timely notice in writing to the Secretary of Potomac Electric Power Company. To be timely, a stockholder's notice shall be received at the principal executive offices of the Company not less than 50 days nor more than 75 days prior to the meeting; provided, however, that in the event that less than 65 days' notice or prior public disclosure of the date of the meeting is given or made to stockholders, notice by the stockholder to be timely must be so received not later than the close of business on the fifteenth day following the day on which such notice of the date of the meeting was mailed or such public disclosure was made, whichever first occurs. Such stockholder's notice to the Secretary shall set forth (a) as to each person whom the stockholder proposes to nominate for election or reelection as a Director, (i) the name, age, business address and residence address of the person, (ii) the principal occupation or employment of the person, (iii) the class and number of shares of capital stock of the Company that are beneficially owned by the person and (iv) any other information relating to the person that is required to be disclosed in solicitations for proxies for election of Directors pursuant to Section 14(a) of the Securities Exchange Act of 1934, as amended; and (b) as to the stockholder giving the notice (i) the name and record address of the stockholder and (ii) the class and number of shares of capital stock of the Company that are beneficially owned by the stockholder. The Company may require any proposed nominee to furnish such other information as may reasonably be required by the Company to determine the eligibility of such proposed nominee to serve as Director of the Company. No person shall be eligible for election as a Director of the Company unless nominated in accordance with the procedures set forth herein. The Chairman of the meeting shall, if the facts warrant, determine that a nomination was not made in accordance with the foregoing procedure, and if he should so determine, he shall so declare to the meeting and the defective nomination shall be disregarded. The Board of Directors, as soon as is reasonably practicable after the initial election of Directors by the stockholders in each year, shall elect one of its number Chairman of the Board, who may be, but is not required to be, an officer and employee of the Company. SECTION 2. Any vacancy, from any cause other than an increase in the number of Directors, occurring among the directors shall be filled without undue delay by a majority of the remaining directors who were elected, or whose predecessors in office were elected, by the same class of stockholders as that which elected the last incumbent of the vacant directorship. The term of any director elected by the remaining directors to fill a vacancy (other than one caused by an increase in the number of directors) shall expire at the next stockholders' meeting at which directors are elected. SECTION 3. Regular meetings of the Board of Directors shall be held at the office of the Company in the District of Columbia (unless otherwise fixed by resolution of the Board) at such time as may from time to time be fixed by resolution of the Board. Special meetings of the Board may be held upon call of the Executive Committee, or the Chairman of the Board, or the President, or a Vice Chairman, by oral, telegraphic or written notice, setting forth the time and place (either within or without the District of Columbia) of the meeting, duly served on or sent or mailed to each director not less than two days before the meeting. A meeting of the Board may be held without notice, immediately after, and at the same place as, the annual meeting of the stockholders. A waiver in writing of any notice, signed by a director, whether before or after the time stated therein, shall be deemed equivalent to the giving of such notice to such director. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the Board need be specified in any notice, or waiver of notice, of such meeting. SECTION 4. Meetings of the Board of Directors shall be presided over by the Chairman of the Board or, if he is not present, by the President or, if neither is present, by a Vice Chairman or, if no such officer is present, by a chairman to be chosen at the meeting. The Secretary of the Company or, if he is not present, an Assistant Secretary of the Company or, if neither is present, a secretary to be chosen at the meeting, shall act as secretary of the meeting. SECTION 5. The Board of Directors may, by resolution or resolutions adopted by not less than the number of directors necessary to constitute a quorum of the Board, designate an Executive Committee consisting of not less than three nor more than seven directors. Except as otherwise provided by law, the Executive Committee shall have and may exercise, when the Board is not in session, all of the powers of the Board in the management of the property, business and affairs of the Company; but the Executive Committee shall not have power to fill vacancies in the Board, or to change the membership of, or to fill vacancies in, the Executive Committee, or to adopt, alter, amend, or repeal by-laws of the Company. The Board shall have the power at any time to fill vacancies in, to change the membership of, or to dissolve, the Executive Committee. The Executive Committee may make rules for the conduct of its business and fix the time and place of its meetings, and may appoint such committees and assistants as it shall from time to time deem necessary. A majority of the members of the Executive Committee shall constitute a quorum, and the acts of a majority of the members of the Committee present at a meeting at which a quorum is present shall be the acts of said Committee. All action taken by the Executive Committee shall be reported to the Board at its regular meeting next succeeding the taking of such action. SECTION 6. The Board of Directors may also, by resolution or resolutions adopted by not less than the number of directors necessary to constitute a quorum of the Board, designate one or more other committees, each such committee to consist of such number of directors as the Board may from time to time determine, which, to the extent provided in said resolution or resolutions, shall have and may exercise such limited authority as the Board may authorize. Such committee or committees shall have such name or names as the Board may from time to time determine. The Board shall have the power at any time to fill vacancies in, to change the membership of, or to dissolve, any such committee. A majority, or such other number as the Board may designate, of the members of any such committee shall constitute a quorum. Each such committee may make rules for the conduct of its business and fix the time and place of its meetings unless the Board shall otherwise provide. All action taken by any such committee shall be reported to the Board at its regular meeting next succeeding the taking of such action, unless otherwise directed. SECTION 7. The Board of Directors shall fix the compensation to be paid to each director who is not a salaried employee of the Company for serving as a director and for attendance at meetings of the Board and committees thereof, and may authorize the payment to directors of expenses incurred in attending any such meeting or otherwise incurred in connection with the business of the Company. This By-Law shall not be construed to preclude any Director from serving the Company in any other capacity and receiving compensation therefor. SECTION 8. At a special meeting called expressly for such purpose (i) any director elected by the holders of the Serial Preferred Stock, or elected by directors to fill a vacancy among the directors elected by the holders of such stock, may be removed, only for cause, by a vote of the holders of a majority of the shares of Serial Preferred Stock, and the resulting vacancy may be filled, for the unexpired term of the director so removed, by a vote of the holders of such Stock; and (ii) any director elected by the holders of the Common Stock, or elected by directors to fill a vacancy among the directors elected by the holders of such stock, may be removed, only for cause, by a vote of the holders of a majority of the shares of Common Stock, and the resulting vacancy may be filled, for the unexpired term of the director so removed, by a vote of the holders of such Stock. SECTION 9. With respect to a Company officer, director, or employee, the Company shall indemnify, and with respect to any other individual the Company may indemnify, any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding (an "Action"), whether civil, criminal, administrative, arbitrative or investigative (including an Action by or in the right of the Company) by reason of the fact that he is or was a director, officer, employee or agent of the Company, or is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such Action; except in relation to matters as to which he shall be finally adjudged in such Action to have knowingly violated the criminal law or be liable for willful misconduct in the performance of his duty to the Company. The termination of any Action by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not of itself create a presumption that the person was guilty of willful misconduct. Any indemnification (unless ordered by a court) shall be made by the Company only as authorized in the specific case upon a determination that indemnification of the director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth above. In the case of any director, such determination shall be made: (1) by the Board of Directors by a majority vote of a quorum consisting of directors who were not parties to such Action; or (2) if such a quorum is not obtainable, by majority vote of a committee duly designated by the Board of Directors (in which designation directors who are parties may participate) consisting solely of two or more directors not at the time parties to the proceeding; or (3) by special legal counsel selected by the Board of Directors or its committee in the manner prescribed by clause (1) or (2) of this paragraph, or if such a quorum is not obtainable and such a committee cannot be designated, by majority vote of the Board of Directors, in which selection directors who are parties may participate; or (4) by vote of the shareholders, in which vote shares owned by or voted under the control of directors, officers and employees who are at the time parties to the Action may not be voted. In the case of any officer, employee, or agent other than a director, such determination may be made (i) by the Board of Directors or a committee thereof; (ii) by the Chairman of the Board of the Company or, if the Chairman is a party to such Action, the President of the Company, or (iii) such other officer of the Company, not a party to such Action, as such person specified in clause (i) or (ii) of this paragraph may designate. Authorization of indemnification and evaluation as to reasonableness of expenses shall be made in the same manner as the determination that indemnification is permissible, except that if the determination is made by special legal counsel, authorization of indemnification and evaluation as to reasonableness of expenses shall be made by those entitled hereunder to select such legal counsel. Expenses incurred in defending an Action for which indemnification may be available hereunder shall be paid by the Company in advance of the final disposition of such Action as authorized in the manner provided in the preceding paragraph, subject to execution by the person being indemnified of a written undertaking to repay such amount if and to the extent that it shall ultimately be determined by a court that such indemnification by the Company is not permitted under applicable law. It is the intention of the Company that the indemnification set forth in this Section 9 of Article II, shall be applied to no less extent than the maximum indemnification permitted by law. In the event that any right to indemnification or other right hereunder may be deemed to be unenforceable or invalid, in whole or in part, such unenforceability or invalidity shall not affect any other right hereunder, or any right to the extent that it is not deemed to be unenforceable. The indemnification provided herein shall be in addition to, and not exclusive of, any other rights to which those indemnified may be entitled under any by-law, agreement, vote of stockholders, or otherwise, and shall continue as to a person who has ceased to be a director, officer, employee, or agent and inure to the benefit of such person's heirs, executors, and administrators. SECTION 10. The Board of Directors may, in its discretion, at any time elect one or more persons to the position of Advisory Director, to serve as such during the pleasure of the Board, but no person shall be eligible to serve as an Advisory Director beyond the next annual meeting after he shall have attained his seventy- second birthday. Advisory Directors so elected by the Board shall be entitled to attend, and take part in discussions at, meetings of the Board of Directors, but shall not be considered members of the Board for quorum or voting purposes. Advisory Directors shall receive the same compensation as members of the Board. SECTION 11. In any proceeding brought by a stockholder in the right of the Company or brought by or on behalf of the stockholders of the Company, no monetary damages shall be assessed against an officer or director. The liability of an officer or director shall not be limited as provided in this section if the officer or director engaged in willful misconduct or a knowing violation of the criminal law. ARTICLE III OFFICERS SECTION 1. The Board of Directors, as soon as reasonably practicable after the initial election of directors by stockholders in each year, shall elect a President, may elect one or more Vice Chairmen and shall elect one or more Vice Presidents (who may be given such other descriptive titles as the Board may specify), a Secretary, a Treasurer and a Comptroller, and from time to time may elect such Assistant Secretaries, Assistant Treasurers, Assistant Comptrollers and other officers, and appoint such other agents, as it may deem desirable. Any two or more offices may be held by the same person, except the offices of President and Secretary. The Board of Directors shall elect the Chairman of the Board or one of the above officers Chief Executive Officer of the Company. SECTION 2. The term of office of all officers shall be until the next succeeding annual election of officers and until their respective successors shall have been elected and qualified; but any officer or agent elected or appointed by the Board of Directors may be removed, with or without cause, by the affirmative vote of a majority of the members of the Board whenever in their judgment the best interests of the Company will be served thereby. Such removal shall be without prejudice to contract rights, if any, of the person so removed. Election or appointment of an officer or agent shall not of itself create contract rights. Unless specifically authorized by resolution of the Board of Directors, no agreement for the employment of any officer for a period longer than one year shall be made. SECTION 3. Subject to such limitations as the Board of Directors or the Executive Committee may from time to time prescribe, the officers of the Company shall each have such authority and perform such duties in the management of the property, business and affairs of the Company as by custom generally pertain to their respective offices, as well as such authority and duties as from time to time may be conferred by the Board of Directors, the Executive Committee or the Chief Executive Officer. SECTION 4. The salaries of all officers, employees and agents of the Company shall be determined and fixed by the Board of Directors, or pursuant to such authority as the Board may from time to time prescribe. ARTICLE IV CERTIFICATES OF STOCK SECTION 1. The shares of the capital stock of the Company shall be represented by certificates, provided that the Board of Directors of the Company may provide by resolution that some or all of the shares of any or all of its classes or series of capital stock may be uncertificated shares. Except as otherwise expressly provided by law, the rights and obligations of the holders of uncertificated shares and the rights and obligations of the holders of certificates representing shares of the same class and series shall be identical. Shares of the capital stock of the Company that are evidenced by certificates shall be in such form as the Board of Directors may from time to time prescribe. Such certificates shall be signed by the President or a Vice President and by the Secretary or an Assistant Secretary, shall be sealed with the seal of the Company, or a facsimile thereof, shall be countersigned and registered in such manner, if any, as the Board may by resolution prescribe. Where such a certificate is countersigned by a transfer agent (other than the Company or an employee of the Company), or by a transfer clerk and registered by a registrar, the signatures thereon of the President or Vice President and the Secretary or Assistant Secretary may be facsimiles. In case any officer who has signed or whose facsimile signature has been placed upon any such certificate shall have ceased to be such officer before such certificate is issued, it may be issued by the Company with the same effect as if such officer had not ceased to hold such office at the date of its issue. SECTION 2. The shares of the capital stock of the Company shall be transferable on the books of the Company by the holders thereof in person or by duly authorized attorney, and, if represented by certificates, upon surrender and cancellation of the certificates evidencing such shares, with duly executed assignment and power of transfer endorsed thereon or attached thereto, and with such proof of the authenticity of the signatures as the Company or its agents may reasonably require and, if uncertificated, upon receipt of appropriate instructions. SECTION 3. No certificate evidencing shares of the capital stock of the Company shall be issued in place of any certificate alleged to have been lost, stolen, or destroyed, except upon production of such evidence of the loss, theft or destruction, and upon such indemnification of the Company and its agents by such person or persons and in such manner, as the Board of Directors may from time to time prescribe. ARTICLE V CHECKS, NOTES, CONTRACTS, ETC. All checks and drafts on the Company's bank accounts, bills of exchange, promissory notes, acceptances, obligations, other instruments for the payment of money, and endorsements other than for deposit in a bank account of the Company shall be signed by the Treasurer or an Assistant Treasurer and shall be countersigned by the Chief Executive Officer, the President, a Vice Chairman or a Vice President, unless otherwise authorized by the Board of Directors; provided that checks drawn on the Company's dividend and/or special accounts may bear the manual signature, or the facsimile signature, affixed thereto by a mechanical device, of such officer or agent as the Board of Directors shall authorize. All contracts, bonds and other agreements and undertakings of the Company shall be executed by the Chief Executive Officer, the President, a Vice Chairman or a Vice President and by such other officer or officers, if any, as may be designated, from time to time, by the Board of Directors and, in the case of any such document required to be under seal, the corporate seal shall be affixed thereto and attested by the Secretary or an Assistant Secretary. Whenever any instrument is required by this Article to be signed by more than one officer of the Company, no person shall so sign in more than one capacity. ARTICLE VI FISCAL YEAR The fiscal year of the Company shall begin on the first day of January in each year and shall end on the thirty-first day of December following. ARTICLE VII OFFICES The principal office of the Company shall be situated in the District of Columbia. The registered office of the Company in Virginia shall be situated in the County of Fairfax. The Company may have such other offices at such places, within the District of Columbia, the Commonwealth of Virginia, or elsewhere, as shall be determined from time to time by the Board of Directors or by the Chief Executive Officer. ARTICLE VIII AMENDMENTS Except as otherwise provided by law, the Board of Directors may alter, amend, or repeal the By-Laws of the Company, or adopt new By-Laws, at any meeting of the Board, by the affirmative vote of not less than the number of directors necessary to constitute a quorum of the Board. EX-27 3 FINANCIAL DATA SCHEDULE
UT 1 POTOMAC CAPITAL INVESTMENT CORPORATION 1,000 6-MOS DEC-31-1997 JAN-01-1997 JUN-30-1997 PER-BOOK 4,421,068 0 435,014 694,352 1,248,730 6,799,164 118,501 1,010,378 728,241 1,857,120 141,000 125,293 1,727,065 0 0 311,600 100,000 985 161,702 20,772 2,353,627 6,799,164 840,031 33,058 684,131 717,189 122,842 20,571 143,413 70,307 73,106 8,282 64,824 98,304 126,500 142,038 $.55 0 Included on the Balance Sheet in the caption "Short-term debt." Total annualized interest costs for all utility long-term debt outstanding at June 30, 1997. No material dilution would occur if all the convertible preferred stock and debentures were converted into common stock.
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