Proposed Merger with Pepco Holdings, Inc. (Exelon)

Description of Transaction

On April 29, 2014, Exelon and Pepco Holdings, Inc. (PHI) signed an agreement and plan of merger (as subsequently amended and restated as of July 18, 2014, the Merger Agreement) to combine the two companies in an all cash transaction. The resulting company will retain the Exelon name. Under the Merger Agreement, PHI’s shareholders will receive $27.25 of cash in exchange for each share of PHI common stock. Based on the outstanding shares of PHI’s common stock as of December 31, 2015, PHI shareholders would receive $6.9 billion in total cash. In addition, in connection with the Merger Agreement, Exelon entered into a subscription agreement under which it has purchased $180 million of a class of nonvoting, nonconvertible and nontransferable preferred securities of PHI. The preferred securities are included in Other non-current assets on Exelon’s Consolidated Balance Sheet. PHI has the right to redeem the preferred securities at its option for the purchase price paid plus accrued dividends, if any.

On November 2, 2015, Exelon and PHI each filed a new Notification and Report Form with the DOJ under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (HSR Act) due to the expiration of the original filing. The HSR Act waiting period expired on December 2, 2015, and the HSR Act no longer precludes completion of the merger.

To date, the PHI stockholders, the Virginia State Corporation Commission, the New Jersey Board of Public Utilities (NJBPU), the Delaware Public Service Commission (DPSC), the Maryland Public Service Commission (MDPSC) and the FERC have approved the merger of PHI and Exelon. The Federal Communications Commission has also approved the transfer of certain PHI communications licenses.

On February 11, 2015, the NJBPU approved the proposed merger and the previously filed settlement signed and filed by Exelon, PHI, Atlantic City Electric (ACE), NJBPU staff, and the Independent Energy Coalition. The settlement provides a package of benefits to ACE customers and the state of New Jersey. This package of benefits includes the establishment of customer rate credit programs, with an aggregate value of $62 million for ACE customers and energy efficiency programs that will provide savings for ACE customers of $15 million. The March 6, 2015, order by the NJBPU approving the merger required that the consummation of the merger must take place no later than November 1, 2015 unless otherwise extended by the Board. On October 15, 2015, the NJBPU extended the November 1, 2015 date to June 30, 2016.

On February 13, 2015, Exelon and PHI announced that they had reached a settlement agreement in the proceeding before the DPSC to review the proposed merger. The settlement, which was amended on April 7, 2015, was signed and filed by Exelon, PHI, Delmarva Power & Light Company (DPL), the DPSC Staff, the Delaware Public Advocate, the Delaware Department of Natural Resources and Environmental Control, the Delaware Sustainable Energy Utility, the Mid-Atlantic Renewable Energy Coalition and the Clean Air Council. As part of this settlement, Exelon and PHI proposed a package of benefits to DPL customers and the state of Delaware including the establishment of customer rate credits of $40 million for DPL customers in Delaware, $2 million of funding for energy efficiency programs for DPL low income customers, and $2 million of funding for workforce development. On June 2, 2015, the DPSC issued an order accepting the settlement and approving the merger between Exelon and PHI.

On March 17, 2015, Exelon and PHI announced that they had reached settlements with multiple parties in the Maryland proceeding to review the proposed merger after filing a Request for Adoption of Settlements with the MDPSC. The settlements were signed and filed by Exelon, PHI, Montgomery County, Prince George’s County, the National Consumer Law Center, National Housing Trust, the Maryland Affordable Housing Coalition, the Housing Association of Nonprofit Developers, and a consortium of recreational trail advocacy organizations led by the Mid-Atlantic Off-Road Enthusiasts. Exelon and PHI also announced a settlement with The Alliance for Solar Choice. On May 15, 2015, the MDPSC approved the merger after modifying a number of the conditions in the settlements, resulting in total rate credits of $66 million, funding for energy efficiency programs of $43.2 million, a Green Sustainability Fund of $14.4 million, 20 MWs of renewable generation development and increased penalties related to reliability commitments. On May 18, 2015, Exelon and PHI accepted and committed to fulfill the conditions.

On June 11, 2015, the Maryland Office of People’s Counsel (OPC), the Sierra Club, and the Chesapeake Climate Action Network filed Petitions for Judicial Review of the MDPSC’s approval of the merger with the Circuit Court for Queen Anne’s County. On June 23, 2015, Public Citizen, Inc. filed its Petition for Judicial Review with the Circuit Court for Queen Anne’s County. On July 10, 2015, Exelon and PHI filed a response in opposition to the Petitions for Review.

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 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, the Chesapeake Climate Action Network (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, Sierra Club and CCAN filed a notice of appeal. In the ordinary course this appeal would be resolved no earlier than third quarter 2016.

On August 27, 2015, the District of Columbia Public Service Commission (DCPSC) issued an Opinion and Order denying approval of the merger, concluding that the merger as presented was not in the public interest. Exelon and PHI filed an Application for Reconsideration with the DCPSC on September 28, 2015. On October 6, 2015, Exelon, PHI, the District of Columbia Government, the Office of Peoples Counsel, the District of Columbia Water and Sewer Authority, the National Consumer Law Center, National Housing Trust and National Housing Trust - Enterprise Preservation Corporation, and the Apartment and Office Building Association of Metropolitan Washington (collectively, Settling Parties) entered into a Nonunanimous Full Settlement Agreement and Stipulation (Settlement Agreement) with respect to the merger. Exelon and PHI subsequently filed a motion of joint applicants requesting the DCPSC to reopen the approval application to allow for consideration of the Settlement Agreement and granting additional requested relief. The new package of benefits totals $78 million and includes commitments to provide relief of residential customer base rate increases of $26 million, one-time direct bill credits of $14 million, low-income energy assistance of $16 million, improved reliability, a cleaner and greener D.C. through funding energy efficiency programs and development of renewable energy, and investment in local jobs and the local economy through workforce development of $5 million. It also guarantees charitable contributions totaling $19 million over 10 years.

On October 28, 2015, the DCPSC agreed to reopen the approval application to allow for consideration of the Settlement Agreement. Since then, parties supporting and opposing the Settlement filed testimony, participated in formal hearings and, on December 23, 2015, submitted final briefs to the DCPSC. The parties now await a formal decision from the DCPSC. The Merger Agreement provides that either Exelon or PHI may terminate the Merger Agreement if the merger is not completed by October 28, 2015. Pursuant to a Letter Agreement related to the Settlement Agreement, Exelon and PHI have agreed, among other things, that they will not exercise their rights to terminate the Merger Agreement before March 4, 2016, except under limited circumstances. If the DCPSC does not approve the Settlement Agreement by March 4, 2016, either Exelon or PHI may terminate the Settlement Agreement.

The settlements reached and commission orders received to date in Delaware, Maryland and New Jersey include a “most favored nation” provision which, generally speaking, requires allocation of merger benefits proportionately across all the jurisdictions. When applying the most favored nation provision to the settlement terms and other conditions established in the merger approvals received to date, and as proposed in the Settlement Agreement filed with the DCPSC, Exelon and PHI currently estimate direct benefits of $430 million or more on a net present value basis (excluding charitable contributions and renewable generation commitments) will be provided, including rate credits, funding for energy efficiency programs and other required commitments. Exelon and PHI anticipate substantially all of such amounts will be charged to earnings at the time of merger close and will be paid by the end of 2017. An additional $53 million will be charged to earnings at the time of the merger close for charitable contributions, which are then required to be paid over a period of 10 years. Commitments to develop renewable generation, which are expected to be primarily capital in nature, will be recognized as incurred. Upon completion of the merger, the actual nature, amount, timing and financial reporting treatment for these commitments may be materially different from the current projection.

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 proposed merger transaction and Exelon aided and abetted the individual directors’ breaches. The suits seek to enjoin PHI from completing the merger or seek rescission of the merger if completed. In addition, they also seek unspecified damages and costs. Exelon was also named in a federal court suit making similar claims. In September 2014, the parties reached a proposed settlement that would resolve all claims, which is subject to court approval. Final court approval of the proposed settlement is not anticipated until approximately 90 days after merger close. Exelon does not believe these suits will impact the completion of the transaction, and they are not expected to have a material impact on Exelon’s results of operations.

Including 2014 and through December 31, 2015, Exelon has incurred approximately $259 million of expense associated with the proposed merger. Of the total costs incurred, $121 million is primarily related to acquisition and integration costs and $138 million are for costs incurred to finance the transaction. The financing costs include $22 million of costs associated with the private exchange offer and redemption of certain Senior Unsecured Notes (see Note 14—Debt and Credit Agreements for further information on the exchange), as well as, a net loss of $64 million related to the settlement of forward-starting interest-rate swaps. These swaps were terminated in connection with the $4.2 billion issuance of debt; refer to Note 13—Derivative Financial Instruments for more information. The financing costs exclude costs to issue equity and the initial debt offering which we recorded to Exelon's Consolidated Balance Sheets.



	For the year ended,
Acquisition, Integration and Financing Costs ^(a)	2015		2014
Exelon	$	80	$	179
Generation	25		11
ComEd	10		4
PECO	5		2
BGE	5		2

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(a) The costs incurred are classified primarily within Operating and maintenance expense in the Registrants’ respective Consolidated Statement of Operations and Comprehensive Income, with the exception of the financing costs, which are included within Interest expense.

Under certain circumstances, if the Merger Agreement is terminated, PHI may be required to pay Exelon a termination fee ranging from $259 million to $293 million plus certain expenses. If the Merger Agreement is terminated due to a failure to obtain a required regulatory approval, Exelon may be required to pay PHI a termination fee equal to $180 million through the redemption by PHI of the outstanding nonvoting preferred securities described above for no consideration other than the nominal par value of the stock, plus reimbursement of PHI's documented out-of-pocket expenses up to a maximum of $40 million.

Merger Financing

Exelon has raised cash to fund the all-cash purchase price, acquisition and integration related costs, and merger commitments, through the issuance of $4.2 billion of debt (of which $3.3 billion remains after execution of the exchange offer, see Note 14—Debt and Credit Agreements for further information on the exchange), $1.15 billion of junior subordinated notes in the form of 23 million equity units, the issuance of $1.9 billion of common stock, cash proceeds of $1.8 billion from asset sales primarily at Generation (after-tax proceeds of approximately $1.4 billion) and the remaining balance from cash on hand and/or short-term borrowings available to Exelon. Exelon will have sufficient cash to fund the all-cash purchase price, acquisition and integration related costs, and merger commitments. See Note 14—Debt and Credit Agreements and Note 19—Shareholder's Equity for further information on the debt and equity issuances.

Acquisitions (Exelon and Generation)

Acquisition of Integrys Energy Services, Inc. (Exelon and Generation)

On November 1, 2014, Generation acquired the competitive retail electric and natural gas business activities of Integrys Energy Group, Inc. through the purchase of all of the stock of its wholly owned subsidiary, Integrys Energy Services, Inc. (IES) for a purchase price of $332 million, including net working capital. Generation has elected to account for the transaction as an asset acquisition for federal income tax purposes. The generation and solar asset businesses of Integrys are excluded from the transaction. The Purchase Agreement also includes various representations, warranties, covenants, indemnification and other provisions customary for a transaction of this nature.

Consistent with the applicable accounting guidance, the fair value of the assets acquired and liabilities assumed was determined as of the acquisition date through the use of significant estimates and assumptions that are judgmental in nature. Some of the more significant estimates and assumptions used include: projected future cash flows (including the amount and timing); discount rates reflecting the risk inherent in the future cash flows; and future power and fuel market prices.

The following table summarizes the acquisition-date fair value of the consideration transferred and the assets and liabilities assumed for the Integrys acquisition by Generation:



Total consideration transferred	$	332

Identifiable assets acquired and liabilities assumed
Working capital assets	$	390
Mark-to-market derivative assets	184
Unamortized energy contract assets	115
Customer relationships	50
Working capital liabilities	(196		)
Mark-to-market derivative liabilities	(57		)
Unamortized energy contract liabilities	(110		)
Deferred tax liability	(16		)
Total net identifiable assets, at fair value	$	360
Bargain purchase gain (after-tax)	$	28

The after-tax bargain purchase gain of $28 million is primarily the result of IES executing additional contract volumes between the date the acquisition agreement was signed and the closing of the transaction resulting in an increase in the fair value of the net assets acquired as of the acquisition date. The after-tax gain is included within Gain on consolidation and acquisition of businesses in Exelon's and Generation's Consolidated Statements of Operations and Comprehensive Income.

IES's operating revenues and net loss included in Exelon's and Generation's Consolidated Statements of Operations and Comprehensive Income for the period from November 1, 2014 to December 31, 2014 were $386 million and $(42) million, respectively. The net loss for the period from November 1, 2014 to December 31, 2014 includes pre-tax unrealized losses on derivative contracts of $108 million and the bargain purchase gain of $28 million. It is impracticable to determine the overall financial statement impact of IES for 2015 due to the integration of the business into ongoing operations. For the years ended December 31, 2015 and 2014, Exelon and Generation incurred $5 million and $7 million, respectively, of merger and integration related costs which are included within Operating and maintenance expense in Exelon's and Generation's Consolidated Statements of Operations and Comprehensive Income.

Asset Divestitures (Exelon and Generation)

Including the Quail Run generating facility that was sold on January 21, 2015, Generation has sold certain generating assets with a total net book value of approximately $1.8 billion prior to consideration of asset impairments (See Note 8 — Impairment of Long-Lived Assets for further information), for total pre-tax proceeds of approximately $1.8 billion (after-tax proceeds of approximately $1.4 billion), which resulted in cumulative pre-tax gains on sale of approximately $412 million, which are included in Gain (loss) on sales of assets on Exelon's and Generation's Consolidated Statement of Operations and Comprehensive Income for the year ended December 31, 2014. The proceeds are expected to be used primarily to finance a portion of the merger with PHI.



Station	Net Generation Capacity	Location	Operating Segment	Percent Owned
Fore River	726 MW	North Weymouth, MA	New England	100	%
West Valley	185 MW	Salt Lake City, UT	Other	100	%
Keystone	714 MW	Shelocta, PA	Mid-Atlantic	41.98	%
Conemaugh	532 MW	New Florence, PA	Mid-Atlantic	31.28	%
Safe Harbor	278 MW	Conestoga, PA	Mid-Atlantic	66.7	%
Quail Run	488 MW	Odessa, TX	ERCOT	100	%

At December 31, 2014, the assets and liabilities of the Quail Run generating facility were reported as Assets held for sale and within Other current liabilities on Exelon’s and Generation’s Consolidated Balance Sheets. The table below presents the major classes of assets and liabilities held for sale at December 31, 2014. Assets held for sale at December 31, 2015 are not material.



	December 31, 2014
Assets
Property, plant and equipment, net ^(a)	$	143
Inventory	4
Total assets held for sale	$	147
Liabilities
Accrued expenses	$	1
Asset retirement obligations	4
Total liabilities held for sale^(b)	$	5

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(a) The total aggregate book value of property, plant and equipment is net of a $50 million pre-tax impairment loss recorded within Operating and maintenance expense on Exelon’s and Generation’s Statements of Operations and Comprehensive Income for the year ended December 31, 2014. See Note 8 — Impairment of Long-Lived Assets for further information.

(b) Included within Other current liabilities on Exelon's and Generation's Consolidated Balance Sheets.