(12) STOCK-BASED COMPENSATION, DIVIDEND RESTRICTIONS, AND CALCULATIONS OF EARNINGS PER SHARE OF COMMON STOCK

Stock-Based Compensation

Pepco Holdings maintains the 2012 Long-Term Incentive Plan (2012 LTIP), the successor plan to the Long-Term Incentive Plan (LTIP), the objective of which is to increase shareholder value by providing long-term and equity incentives to reward officers, key employees and non-employee directors of Pepco Holdings and its subsidiaries and to increase the ownership of Pepco Holdings common stock by such individuals. Any officer, key employee or non-employee director of Pepco Holdings or its subsidiaries may be designated as a participant. Under these plans, awards to officers, key employees and non-employee directors may be in the form of restricted stock, restricted stock units, stock options, performance shares and/or units, stock appreciation rights, unrestricted stock and dividend equivalents. At inception, 10 million and 8 million shares of common stock were authorized for issuance under the LTIP and the 2012 LTIP, respectively. The LTIP expired in accordance with its terms in 2012 and no new awards may be granted thereunder.

Total stock-based compensation expense recorded in the consolidated statements of income (loss) for the years ended December 31, 2014, 2013 and 2012 was $18 million, $12 million and $11 million, respectively, all of which was associated with restricted stock, restricted stock unit and unrestricted stock awards.

No material amount of stock compensation expense was capitalized for the years ended December 31, 2014, 2013 and 2012.

Restricted Stock and Restricted Stock Unit Awards

Description of Awards

A number of programs have been established under the LTIP and the 2012 LTIP involving the issuance of restricted stock and restricted stock unit awards, including awards of performance-based restricted stock and restricted stock units, and time-based restricted stock and restricted stock units. A summary of each of these programs is as follows:

•

Under the performance-based program, performance criteria are selected and measured over the specified performance period. Depending on the extent to which the performance criteria are satisfied, the participants are eligible to earn shares of common stock at the end of the performance period, ranging from 25% to 200% of the target award, and dividend equivalents accrued thereon.

•

Generally, time-based restricted stock and restricted stock unit award opportunities have a requisite service period of up to three years and, with respect to restricted stock awards, participants have the right to receive dividends on the shares during the vesting period. Under restricted stock unit awards, dividends are credited quarterly in the form of additional restricted stock units, which are paid when vested at the end of the service period.

•

PHI granted a total of 21,138 and 37,735 restricted stock units in 2014 and 2013, respectively, to its non-employee directors under the 2012 LTIP. These restricted stock units vest over a service period which ends upon the first to occur of (i) one year after the date of grant or (ii) the date of the next annual meeting of stockholders. These awards represent the equity portion of the annual retainer paid to non-employee directors for their service as a director of PHI.

Activity for the year

The 2014 activity for restricted stock, performance-based restricted stock, time-based restricted stock units and performance-based restricted stock unit awards, is summarized in the table below. For performance-based restricted stock and restricted stock unit awards, the table reflects awards projected, for purposes of computing the weighted average grant date fair value, to achieve 100% of targeted performance criteria for each outstanding award cycle.


				Weighted
	Number			Average Grant
	of Shares			Date Fair Value
Balance as of January 1, 2014 (a)
Restricted stock		—		$	—
Performance-based restricted stock		—			—
Time-based restricted stock units		583,554			19.34
Performance-based restricted stock units		1,069,830			19.06

Total		1,653,384
Granted during 2014
Restricted stock		183,486			26.80
Performance-based restricted stock		70,276			27.01
Time-based restricted stock units		222,350			19.77
Performance-based restricted stock units		448,107			18.53

Total		924,219
Vested during 2014
Restricted stock		(129,321	)		26.80
Time-based restricted stock units		(336,946	)		19.25
Performance-based restricted stock units		(349,020	)		21.07

Total		(815,287	)
Forfeited during 2014
Performance-based restricted stock units		(340,936	)		19.54

Total		(340,936	)
Balance as of December 31, 2014 (b)
Restricted stock		54,165			26.80
Performance-based restricted stock		70,276			27.01
Time-based restricted stock units		468,958			19.61
Performance-based restricted stock units		827,981			17.73

Total		1,421,380

(a)	The balance as of January 1, 2014 does not include 59,523 time-based restricted stock units and 31,403 performance-based restricted stock units that were vested but had not yet settled.

(b)	The balance as of December 31, 2014 does not include 36,110 shares of restricted stock, 94,685 time-based restricted stock units and 59,797 performance-based restricted stock units that were vested but had not yet settled.

Grants included in the table above reflect 2014 grants of restricted stock, performance-based restricted stock, time-based restricted stock units and performance-based restricted stock unit awards. PHI recognizes compensation expense related to restricted stock, performance-based restricted stock, time-based restricted stock units and performance-based restricted stock unit awards based on the fair value of the awards at date of grant. The fair value is based on the market value of PHI common stock at the date the award opportunity is granted. The estimated fair value of the performance-based awards is also a function of PHI’s projected future performance relative to established performance criteria and the resulting payout of shares based on the achieved performance levels. PHI employed a Monte Carlo simulation to forecast PHI’s performance relative to the performance criteria and to estimate the potential payout of shares under the performance-based awards.

The following table provides the weighted average grant date fair value per share of those awards granted during each of the years ended December 31, 2014, 2013 and 2012:


	2014		2013		2012
Weighted average grant-date fair value of each restricted stock award granted during the year	$	26.80	$	—	$	—
Weighted average grant-date fair value of each performance-based restricted stock award granted during the year	$	27.01	$	—	$	—
Weighted average grant-date fair value of each unrestricted stock award granted during the year	$	—	$	—	$	18.85
Weighted average grant-date fair value of each time-based restricted stock unit award granted during the year	$	19.77	$	19.70	$	19.69
Weighted average grant-date fair value of each performance-based restricted stock unit award granted during the year	$	18.53	$	17.03	$	21.13

As of December 31, 2014, there was approximately $12 million of future compensation cost (net of estimated forfeitures) related to restricted stock unit awards granted under the LTIP and the 2012 LTIP that PHI expects to recognize over a weighted-average period of approximately two years.

Stock Options

Stock options to purchase shares of PHI’s common stock granted under the LTIP and the 2012 LTIP must have an exercise price at least equal to the fair market value of the underlying stock on the grant date. Stock options generally become exercisable on a specified vesting date or dates. All stock options must have an expiration date of no greater than ten years from the date of grant. No options have been granted under the LTIP or the 2012 LTIP since 2002. As of December 31, 2012, all outstanding stock options under predecessor plans have been exercised or expired. Total intrinsic value and tax benefits recognized for stock options exercised in 2012 were immaterial.

Directors’ Deferred Compensation

Under the Pepco Holdings’ Executive and Director Deferred Compensation Plan, Pepco Holdings non-employee directors may elect to defer all or part of their cash retainer and meeting fees. Deferred retainer or meeting fees, at the election of the director, can be credited with interest at the prime rate or the return on selected investment funds or can be deemed invested in phantom shares of Pepco Holdings common stock on which dividend equivalent accruals are credited when dividends are paid on the common stock (or a combination of these options). All deferrals are settled in cash. The amount deferred by directors for each of the years ended December 31, 2014, 2013 and 2012 was not material.

Compensation expense recognized in respect of dividends and the increase in fair value was $1 million for the year ended December 31, 2014 and not material for each of the years ended December 31, 2013 and 2012. The deferred compensation balances under this program were approximately $2 million at December 31, 2014 and 2013.

A separate deferral option under the 2012 LTIP gives non-employee directors the right to elect to defer the receipt of common stock upon vesting of restricted stock unit awards.

Dividend Restrictions

PHI, on a stand-alone basis, generates no operating income of its own. Accordingly, its ability to pay dividends to its shareholders depends on dividends received from its subsidiaries. In addition to their future financial performance, the ability of PHI’s direct and indirect subsidiaries to pay dividends is subject to limits imposed by: (i) state corporate laws, which impose limitations on the funds that can be used to pay dividends and, in the case of ACE, the regulatory requirement that it obtain the prior approval of the NJBPU before dividends can be paid if its equity as a percent of its total capitalization, excluding securitization debt, falls below 30%; (ii) the prior rights of holders of mortgage bonds and other long-term debt issued by the subsidiaries, and any other restrictions imposed in connection with the incurrence of liabilities; and (iii) certain provisions of ACE’s charter that impose restrictions on payment of common stock dividends for the benefit of preferred stockholders. Pepco, DPL and ACE have no shares of preferred stock outstanding at December 31, 2014. Currently, the capitalization ratio limitation to which ACE is subject and the restriction in the ACE charter do not limit ACE’s ability to pay common stock dividends. As further described in Note (10), “Debt,” PHI, Pepco, DPL and ACE have restrictions on total indebtedness in relation to total capitalization under the credit facility.

PHI had approximately $565 million and $595 million of retained earnings free of restrictions at December 31, 2014 and 2013, respectively. These amounts represent the total retained earnings balances at those dates. The amount of restricted net assets for PHI’s consolidated subsidiaries at December 31, 2014 is $2,547 million.

For the years ended December 31, 2014, 2013 and 2012, dividends paid by PHI’s subsidiaries were as follows:


Subsidiary	2014		2013		2012
	*(millions of dollars)*
Pepco (paid to PHI)	$	86	$	46	$	35
DPL (paid to Conectiv)		100		30		—
ACE (paid to Conectiv)		26		60		35

Total	$	212	$	136	$	70

Calculations of Earnings per Share of Common Stock

The numerator and denominator for basic and diluted earnings per share of common stock calculations are shown below.


	For the Years Ended December 31,
	2014		2013			2012
	*(millions of dollars, except per share data)*
Income (Numerator):
Net income from continuing operations	$	242	$	110		$	218
Net (loss) income from discontinued operations		—		(322	)		67

Net income (loss)	$	242	$	(212	)	$	285

Shares (Denominator) (in millions):
Weighted average shares outstanding for basic computation:
Average shares outstanding		251		246			229
Adjustment to shares outstanding		—		—			—

Weighted Average Shares Outstanding for Computation of Basic Earnings Per Share of Common Stock		251		246			229
Net effect of potentially dilutive shares (a)		1		—			1

Weighted Average Shares Outstanding for Computation of Diluted Earnings Per Share of Common Stock		252		246			230

Basic earnings per share of common stock from continuing operations	$	0.96	$	0.45		$	0.95
Basic (loss) earnings per share of common stock from discontinued operations		—		(1.31	)		0.30

Basic earnings (loss) per share	$	0.96	$	(0.86	)	$	1.25

Diluted earnings per share of common stock from continuing operations	$	0.96	$	0.45		$	0.95
Diluted (loss) earnings per share of common stock from discontinued operations		—		(1.31	)		0.29

Diluted earnings (loss) per share	$	0.96	$	(0.86	)	$	1.24

(a)	There were no options to purchase shares of common stock that were excluded from the calculation of diluted earnings per share for the years ended December 31, 2014, 2013 and 2012.

Equity Forward Transaction

During 2012, PHI entered into an equity forward transaction in connection with a public offering of PHI common stock. Pursuant to the terms of this transaction, a forward counterparty borrowed 17,922,077 shares of PHI’s common stock from third parties and sold them to a group of underwriters for $19.25 per share, less an underwriting discount equal to $0.67375 per share. Under the terms of the equity forward transaction, upon physical settlement thereof, PHI was required to issue and deliver shares of PHI common stock to the forward counterparty at the then applicable forward sale price. The forward sale price was initially determined to be $18.57625 per share at the time the equity forward transaction was entered into and was subject to reduction from time to time in accordance with the terms of the equity forward transaction. PHI believed that the equity forward transaction substantially eliminated future equity price risk because the forward sale price was determinable as of the date that PHI entered into the equity forward transaction and was only reduced pursuant to the contractual terms of the equity forward transaction through the settlement date, which reductions were not affected by a future change in the market price of the PHI common stock. On February 27, 2013, PHI physically settled the equity forward at the then applicable forward sale price of $17.39 per share. The proceeds of approximately $312 million were used to repay outstanding commercial paper, a portion of which had been issued in order to make capital contributions to the utilities, and for general corporate purposes.

Direct Stock Purchase and Dividend Reinvestment Plan

PHI maintains a Direct Stock Purchase and Dividend Reinvestment Plan (DRP) through which participants may reinvest cash dividends. In addition, participants can make purchases of shares of PHI common stock through the investment of not less than $25 per purchase nor more than $300,000 each calendar year. Shares of common stock purchased through the DRP may be new shares, treasury shares held by PHI, or, at the election of PHI, shares purchased in the open market. Approximately 1 million, 2 million and 2 million new shares were issued and sold under the DRP in 2014, 2013 and 2012, respectively.

Pepco Holdings Common Stock Reserved and Unissued

The following table presents Pepco Holdings’ common stock reserved and unissued at December 31, 2014:


Name of Plan	Number of Shares
DRP		4,982,016
Pepco Holdings Long-Term Incentive Plan (a)		6,946,614
Pepco Holdings 2012 Long-Term Incentive Plan		7,746,773
Pepco Holdings Non-Management Directors Compensation Plan (b)		457,211
Pepco Holdings Retirement Savings Plan		4,003,652

Total		24,136,266

(a)	No further awards will be made under this plan.

(b)	This plan expired by its terms on December 31, 2014.