Mergers, Acquisitions and Dispositions (Exelon, Generation, PHI and Pepco)

Merger with Pepco Holdings, Inc. (Exelon)

Description of Transaction

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

Regulatory Matters

Approval of the merger in Delaware, New Jersey, Maryland and the District of Columbia was conditioned upon Exelon and PHI agreeing to certain commitments including where applicable: customer rate credits, funding for energy efficiency and delivery system modernization programs, a green sustainability fund, workforce development initiatives, charitable contributions, renewable generation and other required commitments. In addition, the orders approving the merger in Delaware, New Jersey, and Maryland include a “most favored nation” provision which, generally speaking, requires allocation of merger benefits proportionally across all the jurisdictions. Exelon estimates total commitments of approximately $444 million on a net present value basis (excluding charitable contributions and renewable generation commitments) will be provided. The actual cost of commitments may differ by a material amount depending on the result of final negotiations and application of the most favored nation provision. The following pre-tax costs were recognized, including the estimated impacts of applying the most favored nation provision, after the closing of the merger and are included in Operating and maintenance expense in Exelon's, PHI's, Pepco's, DPL's and ACE's Consolidated Statements of Operations and Comprehensive Income for the six months ended June 30, 2016 and PHI's successor Consolidated Statements of Operations and Comprehensive Income:



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

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

In addition, Exelon is committed to develop or to assist in the commercial development of approximately 37 MWs of new generation in Maryland and the District of Columbia, 27 MWs of which are expected to be completed by 2018. These investments are expected to total approximately $130 million, are expected to be primarily capital in nature, and will generate future earnings at Exelon and Generation. The actual cost of new generation may differ by a material amount depending on the result of final negotiations and application of the most favored nation provision. Investment costs will be recognized as incurred and recorded on Exelon's and Generation's financial statements. Exelon has also committed to purchase 100 MWs of wind energy in PJM, to procure 120 MWs of wind RECs for the purpose of meeting Delaware's renewable portfolio standards, and to maintain and promote energy efficiency and demand response programs in the PHI jurisdictions.

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

Exelon has been named in suits filed in the Delaware Chancery Court alleging that individual directors of PHI breached their fiduciary duties by entering into the merger transaction and Exelon aided and abetted the individual directors’ breaches. The suits seek rescission of the merger. In addition, they also seek unspecified damages and costs. Exelon was also named in a federal court suit making similar claims. On June 1, 2016, the parties executed a settlement to resolve all claims, subject to the approval of the Delaware Court. Exelon does not believe resolution of these suits will have a material impact on Exelon’s results of operations or cash flows.

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

On March 25, 2016, Grid 2.0 filed an application for reconsideration of the DCPSC’s March 23, 2016 order approving the merger. On March 30, 2016, Exelon filed a reply to that application. On April 20, 2016, DC Public Power filed a motion to reconsider the DCPSC's March 23, 2016 order, motion to intervene and motion to consider alternative settlement provisions (namely, that the DCPSC consider requiring the post-merger divestiture of Pepco’s DC-based assets to a not-for-profit independent grid operator). On April 27, 2016, Exelon filed a reply to these motions. On April 22, 2016, (1) the District of Columbia Office of People’s Counsel, (2) the District of Columbia Government, and (3) DC Sun and Public Citizen each filed separate applications for reconsideration of the DCPSC’s March 23, 2016 order. On April 29, 2016, Exelon filed a reply to these applications. These applications for reconsideration generally argue that the DCPSC violated its regulations, utilized improper processes, abused its discretion, acted arbitrarily and capriciously, committed legal error and denied due process in approving the merger under terms that revised the Settlement Agreement offered by the companies and various parties. On June 17, 2016, the DCPSC denied all motions. The parties have until August 16, 2016 to appeal the DCPSC decision.

Accounting for the Merger Transaction

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



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

_____________


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

(b)

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

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

The valuations performed in the first quarter of 2016 to assess the fair value of certain assets acquired and liabilities assumed were considered preliminary as a result of the short time period between the closing of the merger and the end of the first quarter of 2016. Accounting guidance provides that the allocation of the purchase price may be modified up to one year from the date of the merger as more information is obtained about the fair value of assets acquired and liabilities assumed; however, Exelon expects to finalize these amounts by the end of 2016, if not sooner. During the second quarter, certain modifications were made to preliminary valuation amounts for acquired unamortized energy contracts, long-term debt and pension and OPEB liability resulting in an $8 million net increase to goodwill. The preliminary amounts recognized are subject to further revision to the extent that additional information is obtained about the facts and circumstances that existed as of the acquisition date. Any changes to the fair value assessments may affect the purchase price allocation and could potentially impact goodwill.

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



Preliminary Purchase Price Allocation
Current assets	$	1,441
Property, plant and equipment	11,076
Regulatory assets	5,015
Other assets	248
Goodwill	4,024
Total assets	$	21,804

Current liabilities	$	2,763
Unamortized energy contracts	1,515
Regulatory liabilities	297
Long-term debt, including current maturities	5,636
Deferred income taxes	3,443
Pension and OPEB liability	821
Other liabilities	187
Total liabilities	$	14,662
Total purchase price	$	7,142

During preparation of the June 30, 2016 financial statements, an error was identified related to the preliminary purchase price allocation table above as originally reported in the first quarter 2016 Form 10-Q. The error resulted in a gross up of certain assets and liabilities related to legacy PHI intercompany and income tax receivable and payable balances that were not properly reflected in the first quarter 2016 Form 10-Q disclosure, with no impact on reported net assets acquired or goodwill. The correction of the disclosure error has been reflected in the table presented above. As revised, the Current assets, Other assets, Current liabilities, Long-term debt, including current maturities, Deferred income taxes, and Other liabilities would have been disclosed as $1,441 million, $249 million, $2,764 million, $5,661 million, $3,448 million and $187 million, respectively, within the first quarter 2016 Form 10-Q. Management has concluded that the disclosure error is not material to the previously issued financial statements.

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

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

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

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

Exelon’s and PHI’s carrying amount of goodwill for the six months ended June 30, 2016 was as follows:



	PHI		Exelon^(a)
Beginning balance	$	—	$	2,672
Goodwill from business combination	4,016		4,016
Measurement period adjustment	8		8
Ending balance	$	4,024	$	6,696

_____________

(a) As of June 30, 2016, there were no changes to the carrying amount of goodwill for ComEd and Generation, see Note 11— Intangible Assets of the Exelon 2015 Form 10-K for further information.

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

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

Fair value adjustments were recorded at Exelon and PHI for the difference between the contract price and the market price of electricity and gas energy supply contracts of PHI’s wholly-owned rate regulated utility subsidiaries. These adjustments are intangible assets and liabilities classified as unamortized energy contracts on Exelon’s and PHI’s Consolidated Balance Sheets as of June 30, 2016. The difference between the contract price and the market price at the acquisition date of the Merger was recognized for each contract as either an intangible asset or liability. In total, Exelon and PHI recorded a net $1.5 billion liability reflecting out-of-the-money contracts. The valuation of the acquired intangible assets and liabilities was estimated by applying either the market approach or the income approach depending on the nature of the underlying contract. The market approach was utilized when prices and other relevant information generated by market transactions involving comparable transactions were available. Otherwise the income approach, which is based upon discounted projected future cash flows associated with the underlying contracts, was utilized. In certain instances, the valuations were based upon certain unobservable inputs, which are considered Level 3 inputs, pursuant to applicable accounting guidance. Key estimates and inputs include forecasted power prices and the discount rate. The unamortized energy contract fair value adjustment amounts and the corresponding offsetting regulatory asset and liability amounts are amortized through Purchase power and fuel expense or Operating revenues, as applicable, over the life of the applicable contract in relation to the present value of the underlying cash flows as of the merger date.

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

The current impact of PHI, including its unregulated businesses, on Exelon's Consolidated Statements of Operations and Comprehensive Income includes Operating revenues of $1,112 million and Net income of $52 million during the three months ended June 30, 2016, and Operating revenues of $1,219 million and Net loss of $(262) million during the six months ended June 30, 2016

For the three and six months ended June 30, 2016 and 2015, the Registrants have recognized costs to achieve the PHI acquisition as follows:



	Three Months Ended June 30,						Six Months Ended June 30,
Acquisition, Integration and Financing Costs^(a)	2016			2015			2016			2015
Exelon^(b)	$	1		$	(87	)	$	103		$	21
Generation	4			7			20			15
ComEd^(c)	1			3			(7		)	6
PECO	1			1			2			2
BGE^(d)	(5		)	1			(4		)	3
Pepco^(d)	(4		)	1			23			2
DPL^(d)	—			1			16			1
ACE	2			1			15			1



	Successor			Predecessor		Successor		Predecessor
Acquisition, Integration and Financing Costs^(a)	Three Months Ended June 30, 2016			Three Months Ended June 30, 2015		March 24, 2016 to June 30, 2016		January 1, 2016 to March 23, 2016		Six Months Ended June 30, 2015
PHI^(d)	$	(1	)	$	5	$	55	$	29	$	14

______________


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


(b)	Reflects costs (benefits) recorded at Exelon related to financing, including mark-to-market activity on forward-starting interest rate swaps.


(c)	For the six months ended June 30, 2016, includes the reversal of previously incurred acquisition, integration and financing costs of $8 million incurred at ComEd that has been deferred and recorded as a regulatory asset for anticipated recovery. See Note 5—Regulatory Matters for more information.


(d)	For the three and six months ended June 30, 2016, includes the reversal of previously incurred acquisition, integration and financing costs of $6 million, $9 million, $3 million and $12 million incurred at BGE, Pepco, DPL and PHI, respectively, that have been deferred and recorded as a regulatory asset for anticipated recovery. See Note 5—Regulatory Matters for more information.

Pro-forma Impact of the Merger

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

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



	Three Months Ended June 30,				Six Months Ended June 30,				Year Ended December 31,
	2016 (a)		2015 (b)		2016 (a)		2015 (b)		2015 (c)
Total operating revenues	$	6,910	$	7,522	$	15,466	$	17,584	$	33,823
Net income attributable to common shareholders	268		623		845		1,423		2,618

Basic earnings per share	$	0.29	$	0.68	$	0.92	$	1.55	$	2.85
Diluted earnings per share	0.29		0.67		0.91		1.54		2.84

______________


(a)	The amounts above include adjustments for non-recurring costs directly related to the merger of $1 million and $641 million for the three and six months ended June 30, 2016, respectively, and intercompany revenue of $170 million for the six months ended June 30, 2016.


(b)	The amounts above include adjustments for non-recurring costs directly related to the merger of $(82) million and $35 million and intercompany revenue of $111 million and $233 million for the three and six months ended June 30, 2015, respectively.


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

Proposed Acquisition of ConEdison Solutions (Exelon and Generation)

On July 27, 2016, Generation entered into an Asset Purchase Agreement (the Purchase Agreement) with ConEdison Solutions, a subsidiary of Consolidated Edison, Inc. (collectively ConEdison). Pursuant to the Purchase Agreement, ConEdison Solutions agreed to sell its competitive retail electric and natural gas business to Generation for an all cash purchase price of $53 million plus estimated purchase price adjustments, including net working capital, of $130 million. Pursuant to the Purchase Agreement, Generation has agreed to use its commercially reasonable efforts to replace the guarantees and other credit support currently being provided by ConEdison in support of the ongoing competitive retail electric and natural gas business and to reimburse ConEdison for any payments arising pursuant to such arrangements continuing for any post-closing period. The renewable energy, sustainable services and energy efficiency businesses of ConEdison are excluded from the transaction.

The transaction is expected to close in the third or fourth quarter of 2016. The closing of the transaction is subject to certain conditions, including, obtaining the termination or expiration of any applicable waiting period required under the HSR Act for the consummation of the transaction. Either party may terminate the Purchase Agreement if the transaction has not been consummated within six months after the date of the Purchase Agreement. The Purchase Agreement also includes various representations, warranties, covenants, indemnifications and other provisions customary for a transaction of this nature. The total costs directly related to the closing of the transaction are not expected to have a material impact on the financial results of Exelon and Generation.

The transaction is expected to be accounted for as a business combination. Therefore, Generation will record the fair value of the assets acquired and liabilities assumed as of the acquisition date. To the extent the purchase price is greater than the fair value of the net assets acquired, goodwill will be recorded. To the extent the fair value of the net assets acquired is greater than the purchase price, a bargain purchase gain will be recorded.

Proposed Acquisition of James A. FitzPatrick Nuclear Generating Station (Exelon and Generation)

On August 8, 2016, Generation executed a series of agreements with Entergy Nuclear FitzPatrick LLC (Entergy) to acquire the 838MW single-unit James A. FitzPatrick (FitzPatrick) nuclear generating station located in Scriba, New York for a cash purchase price of $110 million. As part of the transaction, Generation would receive the FitzPatrick NDT fund assets and assume the obligation to decommission FitzPatrick. Closing of the transaction is currently anticipated to occur in the second quarter of 2017 and is dependent upon regulatory approval by FERC, NRC and the New York Public Service Commission (NYPSC). The transaction is also subject to the notification and reporting requirements of the HSR Act and other customary closing conditions. The NRC license for FitzPatrick expires in 2034. Entergy had previously announced plans in November 2015 to early retire FitzPatrick at the end of the current fuel cycle in January 2017. Under the terms of the agreements, Generation will reimburse Entergy for approximately $200 million to $250 million of incremental costs to refuel the plant and operate and maintain the plant after the refueling outage, scheduled to end in February 2017, through the closing date. These are costs which otherwise would have been avoided by FitzPatrick’s planned permanent shutdown in January 2017, a portion of which for financial reporting purposes will be evaluated as part of the purchase price consideration. Generation will be entitled to all revenues from FitzPatrick’s electricity and capacity sales for the period commencing upon completion of the refueling outage through the acquisition closing date. The agreements provide for certain termination rights, including the right of either party to terminate if the transaction has not been consummated within 12 months due to failure to obtain the required regulatory approvals.

Asset Divestitures (Exelon, Generation, PHI and Pepco)

On April 21, 2016, Generation completed the sale of the retired New Boston generating site, located in Boston, Massachusetts, resulting in a pre-tax gain of approximately $32 million.

On May 2, 2016, Pepco completed the sale of the New York Avenue land parcel, located in Washington, D.C., resulting in a pre-tax gain of approximately $8 million at Pepco. Due to the fair value adjustments recorded at Exelon and PHI as part of purchase accounting, no gain was recorded in the Exelon and PHI Consolidated Statements of Operations and Comprehensive Income.

On June 16, 2016, Generation initiated the sales process of its Upstream business by executing a forbearance agreement with the lenders of the nonrecourse debt. See Note 10 - Debt and Credit Agreements for more information. As a result, $61 million of Property, plant and equipment and $5 million of Asset retirement obligation were reclassified as held for sale within Other current assets and Other current liabilities on Exelon’s and Generation’s Consolidated Balance Sheets.