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Pepco Holdings DEF 14A 2007
DEFINITIVE NOTICE AND PROXY
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SCHEDULE 14A

(RULE 14a-101)

INFORMATION REQUIRED IN PROXY STATEMENT

 

SCHEDULE 14A INFORMATION

Proxy Statement Pursuant to Section 14(a) of the

Securities Exchange Act of 1934

(Amendment No.     )

 

Filed by the Registrant    x

 

Filed by a Party other than the Registrant    ¨

 

Check the appropriate box:

 

¨    Preliminary Proxy Statement  

¨    Confidential, For Use of the Commission Only

(as permitted by Rule 14a-6(e)(2))

x    Definitive Proxy Statement    
¨    Definitive Additional Materials    
¨    Soliciting Material Under Rule 14a-12    

 

PEPCO HOLDINGS, INC.


(Name of Registrant as Specified in Its Charter)

 


(Name of Person(s) Filing Proxy Statement, if Other Than the Registrant)

 

Payment of Filing Fee (Check the appropriate box):

 

x    No fee required.

 

¨    Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.

 

  1.   Title of each class of securities to which transaction applies:

 

  2.   Aggregate number of securities to which transaction applies:

 

  3.   Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined):

 

  4.   Proposed maximum aggregate value of transaction:

 

  5.   Total fee paid:

 

¨    Fee paid previously with preliminary materials:

 

  ¨   Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the form or schedule and the date of its filing.

 

  1.   Amount previously paid:

 

  2.   Form, Schedule or Registration Statement No.:

 

  3.   Filing Party:

 

  4.   Date Filed:


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LOGO

Proxy Statement and

2006 Annual Report to Shareholders

 

Dear Fellow Shareholders,

 

I am pleased to report that in 2006 Pepco Holdings, Inc. (PHI) applied its extensive experience and leadership abilities to meet significant challenges successfully, while enhancing our focus on growth and the creation of shareholder value.

 

Despite higher energy costs, ever-increasing consumer expectations, unprecedented political involvement in utility affairs and adverse weather, our stock held its value and we finished the year stronger than we started it.

 

As examples of our progress in 2006 we

  ü implemented balanced rate mitigation plans that helped transition customers to higher Standard Offer Service supply rates without unduly affecting shareholders,
  ü filed four distribution rate cases to cover the increased costs of providing service and decouple earnings from kilowatt-hour usage,
  ü proposed a major transmission line to boost reliability throughout our service area,
  ü agreed to sell the last of our regulated generation assets,
  ü negotiated a favorable settlement in the Mirant bankruptcy case,
  ü achieved strong gross margins in our wholesale energy business despite mild weather, and
  ü posted another record year in our retail energy company.

 

This progress was reflected in our financial performance, which included

   

a 4 percent annual increase in the dividend in January 2006,

   

a 52.6 percent total return to shareholders, measured over the past three years, and

   

paying down over $1 billion of debt since 2003.

 

Results of Operations

 

The achievements outlined above are especially noteworthy given the challenging environment in which they were accomplished. Especially mild weather throughout the year, combined with increased energy costs, resulted in reduced electricity sales per customer for the first time since the 1970s, even though we reached all-time summer peak demand in all jurisdictions in 2006.

 

PHI’s consolidated earnings in 2006 were $248.3 million, or $1.30 per share, compared to $371.2 million, or $1.96 per share, in 2005. Excluding special items (which are items not indicative of ongoing performance), earnings for the full year 2006 would have been $254.1 million, or $1.33 per share, compared to $287.8 million, or $1.52 per share, in 2005. Milder weather resulted in a $.17 per share reduction in 2006 compared to 2005.

 

Despite lower earnings, shareholder value continued to grow as indicated by our growth in total return and stock performance. I believe this reflects

 

Letter to Shareholders

   Cover Page

Notice of 2007 Annual Meeting and Proxy Statement

   1

Policy on the Approval of Services Provided by the Independent Auditor

   A-1

2006 Annual Report to Shareholders

   B-1

•   Business of the Company

   B-8

•   Management’s Discussion and Analysis

   B-19  

•   Quantitative and Qualitative Disclosures about Market Risk

   B-78  

•   Consolidated Financial Statements

   B-84 

Board of Directors and Officers

   B-158

Investor Information

   B-159


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continued market recognition of the solid foundation upon which PHI is built—a core power delivery business, supported by earnings from complementary energy companies—as well as opportunities for business growth that now are coming into focus.

 

Focus on Growth

 

   

Rate Case Filings

 

An important milestone was reached when rate caps on delivery service, which had been in place for a number of years, expired in Delaware and Maryland. Late last year, we filed electric distribution rate cases in Maryland and the District of Columbia as well as a gas distribution rate case in Delaware. These cases requested increases in delivery rates to cover the increased costs of providing reliable and safe service. The gas case was recently settled on reasonable terms and included a 10.25 percent return on equity. We expect to receive final orders in the electric cases in the third quarter. We also negotiated balanced mitigation plans in Maryland and Delaware that helped transition customers to higher Standard Offer Service supply rates, while maintaining the financial integrity of the company.

 

In all of our distribution filings, we are requesting approval of a mechanism that would establish approved revenue levels tied to the number of customers, rather than unit sales consumption. This approach would reduce fluctuations in revenue and customer bills due to weather and changes in customer usage. While bill stabilization, sometimes called “revenue decoupling,” is a relatively novel concept for electric utilities, it has been much discussed in regulatory circles throughout the country as an essential regulation, which will unleash the potential for distribution utilities to encourage energy conservation—a crucial element in the nation’s efforts to achieve energy security and respond to environmental concerns.

 

I am pleased that as part of our gas case settlement, the commission agreed to initiate a separate proceeding to consider implementing a decoupling mechanism for electric and gas utilities in Delaware.

 

   

Environmental Leadership

 

Adoption of the decoupling proposal would give us the “green” light to offer a wide range of energy management options to our customers to assist them in controlling their energy costs. Customers have told us in surveys that they want this, and these environmentally friendly programs have the potential of helping to reduce dependence on fossil fuels.

 

In anticipation of the approval of our filings, we have developed a comprehensive “Blueprint for the Future,” which includes advanced technologies to help customers manage energy costs, enhance reliability and protect the environment. I am enthusiastic about our plan, because it will place PHI at the forefront of helping to solve the nation’s energy challenges associated with high energy costs and concerns over climate change.

 

Implementing PHI’s Blueprint will be a long-term process, but we are already taking concrete steps. For example, in 2006, we launched a Web-based “Energy Know How Solutions” campaign, which provides online tools for customers to analyze and reduce their energy usage.

 

   

Investment in Transmission Facilities

 

At the 2006 Annual Meeting of Shareholders, I announced PHI’s proposed Mid-Atlantic Power Pathway (MAPP) project, a new 230-mile high-voltage transmission line that would originate in Virginia, go into Maryland under the Chesapeake Bay and travel up the Delmarva Peninsula and across the Delaware River into southern New Jersey. The PJM Interconnection, which oversees planning and construction of transmission lines in our region, is currently evaluating the project along with other proposals. We expect PJM’s decision in the first half of 2007.

 

In addition to MAPP, over the next five years we plan to continue investing in our infrastructure to meet customer reliability needs, including $450 million in transmission facilities. In 2006, we completed a new transmission line on the Delmarva Peninsula to meet southern peninsula import capability requirements. In 2007, we will complete two additional transmission projects to enhance reliability in the District of Columbia and southern New Jersey.

 

In 2006, the Federal Energy Regulatory Commission (FERC) approved our Transmission Formula Rates settlement, which is structured to provide stable and fair returns on transmission projects. Under Formula Rates, PHI companies will

 

ii


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earn 10.8 percent on existing investments and 11.3 percent on new facilities put into service on or after January 1, 2006, which will provide a steady, predictable revenue stream.

 

   

Improved Wholesale Energy Market

 

PHI’s competitive energy businesses also offer opportunities for growth. In December 2006, FERC approved PJM’s proposed Reliability Pricing Model, which establishes a new process for determining the price of generating capacity. The process is designed to create more stable and uniform pricing and should enhance Conectiv Energy’s returns as supply and demand for generation come into balance in our region. We also expect Conectiv Energy’s favorable location in eastern PJM and flexible, mid-merit plants to help the business capture improved value. Because of our conservative hedge strategy at Conectiv Energy, these improvements will phase in over time.

 

   

Growth in Retail Energy Supply

 

Pepco Energy Services, our retail energy arm, had another record year in 2006 in renewing and acquiring customers for retail electric supply. The business has successfully expanded into Illinois, New York and Massachusetts, and at the end of the year had a contract backlog of 31 million megawatt-hours over the next five years, also a record high and up 105 percent over 2005. Although essentially a regional company, Pepco Energy Services now is the fifth largest commercial and industrial electric retail marketer in the nation. The business also is achieving strong earnings growth in its energy services segment, and we anticipate that Pepco Energy Services will continue to enhance its earnings contributions to PHI.

 

Dedicated and Talented Employees

 

I am proud of PHI’s employees, whose dedication and talent are responsible for the many successes I have discussed in this letter. In 2006, we continued to focus on safety and business performance by launching a comprehensive employee cultural change effort focused on behavioral-based leadership development and field

safety programs. Results have led to greater safety awareness and a decline in serious accidents.

 

Our Investor Relations team continues its focus on communicating with investors openly and through multiple channels to explain PHI value drivers, business strategy and financial performance. I am pleased with their efforts, which have contributed to the steady appreciation of PHI’s stock price throughout 2006.

 

All told, PHI is well managed with a versatile and diverse management team. The strength and breadth of our leadership enabled us to make several seamless executive changes in 2006 that further enhanced our diversity.

 

Outlook for 2007

 

As we look ahead to 2007, I would like to acknowledge your Board of Directors who continue to play a key role in guiding PHI to its current success and future direction. The Board closely monitors your company’s progress, contributing expertise and experience to the corporation’s overall benefit and enhancement of shareholder value.

 

I believe PHI is a very good investment, secured by our low-risk, stable power delivery business and supported by our growing, conservatively managed competitive energy businesses. We have made much financial progress, the dividend is secure and we now are positioned for a sustained period of growth driven by regulatory outcomes, infrastructure investments and improved energy market conditions.

 

I want to thank you for your continued confidence, and look forward to a new period of growth.

 

Sincerely,

 

LOGO

 

Dennis R. Wraase

Chairman of the Board,

President and Chief Executive Officer

March 29, 2007

 

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YOUR VOTE IS IMPORTANT.

PLEASE VOTE YOUR SHARES PROMPTLY.

TO VOTE YOUR SHARES, USE THE INTERNET

OR CALL THE TOLL-FREE TELEPHONE NUMBER

AS DESCRIBED IN THE INSTRUCTIONS ATTACHED TO YOUR PROXY CARD,

OR COMPLETE, SIGN, DATE AND RETURN YOUR PROXY CARD

IN THE ENVELOPE PROVIDED.

 

THANK YOU FOR ACTING PROMPTLY.


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LOGO

 

701 Ninth Street, N.W.

Washington, D.C. 20068

 

Notice of Annual Meeting of Shareholders

 

March 29, 2007

 

NOTICE IS HEREBY GIVEN that the Annual Meeting of Shareholders of Pepco Holdings, Inc. will be held at 10:00 a.m. local time on Friday, May 18, 2007 (the doors will open at 9:00 a.m.), at the Company’s offices located at 701 Ninth Street, N.W., Edison Place Conference Center (second floor), Washington, D.C. for the following purposes:

 

  1. To elect ten directors to serve for a term of one year;

 

  2. To ratify the appointment of PricewaterhouseCoopers LLP as independent registered public accounting firm of the Company for 2007;

 

  3. To transact such other business as may properly be brought before the meeting.

 

All holders of record of the Company’s common stock at the close of business on Monday, March 19, 2007, will be entitled to vote on each matter submitted to a vote of shareholders at the meeting.

 

By order of the Board of Directors,

ELLEN SHERIFF ROGERS

Vice President and Secretary

 


 

IMPORTANT

 

You are cordially invited to attend the meeting in person.

 

Even if you plan to be present, you are urged to vote your shares promptly. To vote your shares, use the Internet or call the toll-free telephone number as described in the instructions attached to your proxy card, or complete, sign, date and return your proxy card in the envelope provided.

 

If you attend the meeting, you may vote either in person or by proxy.


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     PAGE

TABLE OF CONTENTS     

Election of Directors

   4

Nominees for Election as Directors

   5

Directors Continuing in Office

   7

Board Meetings

   10

Board Committees

   10

2006 Director Compensation

   14

Security Ownership of Certain Beneficial Owners and Management

   16

Compensation/Human Resources Committee Report

   18

Compensation Disclosure and Analysis

   18

Executive Compensation

   29

2006 Summary Compensation Table

   29

2006 Grants of Plan-Based Awards

   32

Outstanding Equity Awards at December 31, 2006

   35

2006 Option Exercises and Stock Vested

   36

Pension Benefits at December 31, 2006

   37

Nonqualified Deferred Compensation at December 31, 2006

   42

Board Review of Transactions with Related Parties

   51

Audit Committee Report

   52

Ratification of Independent Registered Public Accounting Firm

   53

Shareholder Proposals and Director Nominations

   54

Other Matters Which May Come Before the Meeting

   57

Policy on the Approval of Services Provided by the Independent Auditor

   A-1

2006 Annual Report to Shareholders

   B-1


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PROXY STATEMENT

 

Annual Meeting of Shareholders

 

Pepco Holdings, Inc.

 

March 29, 2007

 

This Proxy Statement is being furnished by the Board of Directors of Pepco Holdings, Inc. (the “Company,” “Pepco Holdings” or “PHI”) in connection with its solicitation of proxies to vote on the matters to be submitted to a vote of shareholders at the 2007 Annual Meeting. This Proxy Statement, together with the Company’s 2006 Annual Report to Shareholders, which is attached as Annex B to the Proxy Statement, the Notice of Annual Meeting, and a proxy card, is being first mailed to shareholders of record on or about April 3, 2007.

 

The Company is a holding company formed in connection with the merger of Potomac Electric Power Company (“Pepco”) and Conectiv. As a result of the merger, which occurred on August 1, 2002, Pepco and Conectiv became wholly owned subsidiaries of the Company. The address of the Company’s principal executive offices is 701 Ninth Street, N.W., Washington, D.C. 20068.

 

When and where will the Annual Meeting be held?

 

The Annual Meeting will be held at 10:00 a.m. local time on Friday, May 18, 2007 (the doors will open at 9:00 a.m.), at the Company’s offices located at 701 Ninth Street, N.W., Edison Place Conference Center (second floor), Washington, D.C. Admission to the meeting will be limited to Company shareholders or their authorized proxies. Admission tickets are not required.

 

Will the Annual Meeting be Webcast?

 

The live audio and slide presentation of the meeting can be accessed at the Company’s Web site, www.pepcoholdings.com/investors. An audio-only version will also be available. The dial-in information will be announced in a news release at a later date. The Annual Meeting Webcast will be archived and can be found on the Company’s Web site (www.pepcoholdings.com) by first clicking on the link: Investor Relations and then the link: Webcasts and Presentations.

 

What matters will be voted on at the Annual Meeting?

 

1. The election of ten directors, each for a one-year term.

 

The Board recommends a vote FOR each of the ten candidates nominated by the Board of Directors and identified in Item 1 in this Proxy Statement.

 

2. The ratification of the appointment by the Audit Committee of PricewaterhouseCoopers LLP as the Company’s independent registered public accounting firm for 2007.

 

The Board recommends a vote FOR this proposal.

 

How do I vote shares held in my own name?

 

If you own your shares in your own name, you can either attend the Annual Meeting and vote in person or you can vote by proxy without attending the meeting. You can vote by proxy in any of three ways:

 

   

Via Internet: Go to www.voteproxy.com. Have your proxy card in hand when you access the Web site. You will be given simple voting instructions to follow to obtain your records and to create an electronic voting instruction form. At this Web site, you also can elect to receive future proxy statements and annual reports electronically via the Internet, rather than by mail.

 

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By Telephone: Call toll-free 1-800-PROXIES (1-800-776-9437). Have your proxy card in hand when you call, and you will be given simple voting instructions to follow.

 

   

In Writing: Complete, sign, date and return the enclosed proxy card in the postage-paid envelope that has been provided.

 

The Internet and telephone voting facilities for shareholders of record will close at 5:00 p.m. Eastern time on May 17, 2007. Your signed proxy card or the proxy you grant via the Internet or by telephone will be voted in accordance with your instructions. If you return a signed proxy card or grant a proxy via the Internet or by telephone, but do not indicate how you wish your shares to be voted, your shares will be voted FOR the election of each of the Board of Directors’ director nominees and FOR the ratification of PricewaterhouseCoopers LLP as the Company’s independent registered public accounting firm for 2007.

 

How do I vote shares held through a brokerage firm, bank or other financial intermediary?

 

If you hold shares through a brokerage firm, bank or other financial intermediary, you will receive from that intermediary directions on how to direct the voting of your shares by the intermediary, which may include voting instructions given via the Internet or by telephone. If you hold your shares through a brokerage firm, bank or other financial intermediary, you may not vote in person at the Annual Meeting unless you obtain a proxy from the recordholder of the shares.

 

Who is eligible to vote?

 

All shareholders of record at the close of business on Monday, March 19, 2007 (the “record date”) are entitled to vote at the Annual Meeting. As of the close of business on the record date 192,831,641 shares of Pepco Holdings common stock, par value $.01 per share (the “common stock”), were outstanding. Each outstanding share of common stock entitles the holder of record to one vote on each matter submitted to the vote of shareholders at the Annual Meeting.

 

What is the quorum requirement?

 

In order to hold the Annual Meeting, the holders of a majority of the outstanding shares of common stock must be present at the meeting either in person or by proxy.

 

What shares are included on the enclosed proxy card?

 

The number of shares printed on the enclosed proxy card indicates the number of shares of common stock that, as of the record date, you held of record, plus (i) any shares held for your account under the Pepco Holdings Dividend Reinvestment Plan and (ii) if you are a participant in the Pepco Holdings, Inc. Retirement Savings Plan, the shares held for your account under that plan.

 

How is stock in the Pepco Holdings Dividend Reinvestment Plan voted?

 

Shares held by the Pepco Holdings Dividend Reinvestment Plan will be voted by the plan administrator in accordance with your instructions on the proxy card or given via the Internet or by telephone. Any shares held in the Dividend Reinvestment Plan for which no voting instructions are given will not be voted.

 

How is stock in the Company employee 401(k) plans voted?

 

If you are a current or former employee who is a participant in the Pepco Holdings, Inc. Retirement Savings Plan (which is the successor plan to the (i) Potomac Electric Power Company Savings Plan for Bargaining Unit Employees, (ii) Potomac Electric Power Company Retirement Savings Plan for Management Employees (which

 

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itself is the successor to the Potomac Electric Power Company Savings Plan for Non-Exempt, Non-Bargaining Unit Employees; the Potomac Electric Power Company Retirement Savings Plan for Management Employees was formerly known as the Potomac Electric Power Company Savings Plan for Exempt Employees), (iii) Conectiv Savings and Investment Plan and the Conectiv PAYSOP/ESOP and (iv) Atlantic Electric 401(k) Savings and Investment Plan-B), then the number of shares printed on the enclosed proxy card includes shares of common stock held through that plan. By completing, dating, signing and returning this proxy card or granting a proxy via the Internet or by telephone, you will be providing the plan trustee with instructions on how to vote the shares held in your account. If you do not provide voting instructions for your plan shares, the plan trustee will vote your shares on each matter in proportion to the voting instructions given by all of the other participants in the plan.

 

What does it mean if I receive more than one proxy card?

 

If you receive more than one proxy card, it is because your shares are registered in different names or with different addresses. You must sign, date and return each proxy card that you receive (or grant a proxy for the shares represented by each proxy card via the Internet or by telephone) in order for all of your shares to be voted at the Annual Meeting. To enable us to provide better shareholder service, we encourage shareholders to have all their shares registered in the same name with the same address.

 

Can I change my vote after I have returned my proxy card or granted a proxy via the Internet or by telephone?

 

If you own your shares in your own name or through the Dividend Reinvestment Plan or Retirement Savings Plan, you may revoke your proxy, regardless of the manner in which it was submitted, by:

 

   

sending a written statement to that effect to the Secretary of the Company before your proxy is voted;

 

   

submitting a properly signed proxy card dated a later date;

 

   

submitting a later dated proxy via the Internet or by telephone; or

 

   

voting in person at the Annual Meeting.

 

If you hold shares through a brokerage firm, bank or other financial intermediary, you should contact that intermediary for instructions on how to change your vote.

 

How can I obtain more information about the Company?

 

The Company’s 2006 Annual Report to Shareholders is included as Annex B after page A-3 of this Proxy Statement. You may also visit the Company’s Web site at www.pepcoholdings.com.

 

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1. ELECTION OF DIRECTORS

 

Thirteen directors currently constitute the entire Board of Directors of the Company. Immediately prior to the commencement of the 2007 Annual Meeting, the number of directors will be decreased to 12. In 2005, the Company’s Restated Certificate of Incorporation was amended to reinstate the annual election of Board members except that any director who prior to the 2006 Annual Meeting was elected to a term that continues beyond the 2006 Annual Meeting will continue in office for the remainder of his or her elected term or until his or her earlier death, resignation or removal. Accordingly, at the Annual Meeting, ten directors are to be elected, each to hold office for a one-year term that expires at the 2008 Annual Meeting, and until his or her successor is elected and qualified.

 

The Board of Directors, on the recommendation of the Corporate Governance/Nominating Committee, has nominated for election at the 2007 Annual Meeting Jack B. Dunn, IV, Terence C. Golden, Frank O. Heintz, George F. MacCormack, Richard B. McGlynn, Lawrence C. Nussdorf, Frank K. Ross, Lester P. Silverman and William T. Torgerson, each of whom currently is a director, and Barbara J. Krumsiek, who currently does not serve on the Board of Directors. Ms. Krumsiek was identified for consideration as a nominee by one or more non-management directors. Mr. Wraase and Ms. Schneider were elected in 2005 for terms that will expire in 2008.

 

The Board of Directors unanimously recommends a vote FOR each of the nominees listed on pages 5 and 6.

 

What vote is required to elect the directors?

 

Each director shall be elected by a majority of the votes cast “for” his or her election.

 

In January 2006, the Company amended its Bylaws to provide that each director shall be elected by a majority of the votes cast “for” his or her election, except that in a contested election where the number of nominees exceeds the number of directors to be elected, directors shall be elected by a plurality of the votes cast. Accordingly, at the 2007 Annual Meeting, a nominee will be elected as a director only if a majority of the votes present and entitled to vote are cast “for” his or her election. In accordance with the Company’s Bylaws any incumbent nominee who fails to receive a majority of votes cast “for” his or her election is required to resign from the Board no later than 90 days after the date of the certification of the election results.

 

What happens if a nominee is unable to serve as a director?

 

Each nominee identified in this Proxy Statement has confirmed that he or she is willing and able to serve as a director. However, should any of the nominees, prior to the Annual Meeting, become unavailable to serve as a director for any reason, the Board of Directors either may reduce the number of directors to be elected or, on the recommendation of the Corporate Governance/Nominating Committee, select another nominee. If another nominee is selected, all proxies will be voted for that nominee.

 

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NOMINEES FOR ELECTION AS DIRECTORS

 

For Terms Expiring in 2008

 

LOGO    Jack B. Dunn, IV, age 56, since October 1995 has been Chief Executive Officer and since October 2004 has been President of FTI Consulting, Inc., a publicly held multi-disciplined consulting firm with practices in the areas of corporate finance/restructuring, forensic and litigation consulting, economic consulting, and strategic and financial communications, located in Baltimore, Maryland. He has served as a Director of FTI since 1992 and served as Chairman of the Board from December 1998 to October 2004. Mr. Dunn is a limited partner of the Baltimore Orioles and is a director of NexCen Brands, Inc. He has been a director of the Company since May 21, 2004.
LOGO    Terence C. Golden, age 62, since 2000 has been Chairman of Bailey Capital Corporation in Washington, D.C. Bailey Capital Corporation is a private investment company. From 1995 until 2000, Mr. Golden was President, Chief Executive Officer and a director of Host Marriott Corporation. He serves as a director of Host Hotels and Resorts, Inc. and the Morris & Gwendolyn Cafritz Foundation. Mr. Golden also currently serves as Chairman of the Federal City Council. Mr. Golden was a director of Pepco from 1998 until August 1, 2002. He has been a director of the Company since August 1, 2002.
LOGO    Frank O. Heintz, age 63, is retired President and Chief Executive Officer of Baltimore Gas and Electric Company, the gas and electric utility serving central Maryland, a position he held from 2000 through 2004. From 1982 to 1995, Mr. Heintz was Chairman of the Maryland Public Service Commission, the state agency regulating gas, electric, telephone and certain water and sewerage utilities. Previously he served as agency head of the Maryland Employment Security Administration and was an elected member of the Maryland legislature. He has been a director of the Company since May 19, 2006.
LOGO    Barbara J. Krumsiek, age 54, since 1997 has been President and Chief Executive Officer and since 2006 Chair of Calvert Group, Ltd. Calvert is based in Bethesda, Maryland, and offers a range of fixed income, money market and equity mutual funds including a full family of socially responsible mutual funds. She serves as a trustee or director for 40 Calvert-sponsored mutual funds, including serving as Chair of the Calvert Variable Series of funds. Ms. Krumsiek currently does not serve as a director of the Company.
LOGO    George F. MacCormack, age 63, is retired Group Vice President, DuPont, Wilmington, Delaware, a position he held from 1999 through 2003. He was previously Vice President and General Manager (1998), White Pigments & Mineral Products Strategic Business Unit and Vice President and General Manager (1995), Specialty Chemicals Strategic Business Unit for DuPont. Mr. MacCormack was a director of Conectiv from 2000 until August 1, 2002. He has been a director of the Company since August 1, 2002.

 

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LOGO    Richard B. McGlynn, age 68, is an attorney. From 1995-2000, he was Vice President and General Counsel of United Water Resources, Inc., Harrington Park, New Jersey and from 1992-1995, he was a partner in the law firm LeBoeuf, Lamb, Greene & MacRae. He was a director of Atlantic Energy, Inc. from 1986 to 1998. Mr. McGlynn was a director of Conectiv from 1998 until August 1, 2002. He has been a director of the Company since August 1, 2002.
LOGO    Lawrence C. Nussdorf, age 60, since 1998 has been President and Chief Operating Officer of Clark Enterprises, Inc., a privately held investment and real estate company based in Bethesda, Maryland, whose interests include the Clark Construction Group, LLC, a general contracting company, of which Mr. Nussdorf has been Vice President and Treasurer since 1977. He serves as a director of CapitalSource Inc. Mr. Nussdorf was a director of Pepco from 2001 until August 1, 2002. He has been a director of the Company since August 1, 2002 and currently serves as Lead Independent Director.
LOGO    Frank K. Ross, age 63, is retired managing partner for the mid-Atlantic Audit and Risk Advisory Services Practice and managing partner of the Washington, D.C. office of the accounting firm KPMG LLP, positions he held from July 1, 1996 to December 31, 2003. He is currently a Visiting Professor of Accounting at Howard University, Washington, D.C. and the Director of its Center for Accounting Education. He is a director of Cohen & Steers Mutual Funds and serves as a director of 20 of these Funds. Mr. Ross serves on The Greater Washington, D.C. Urban League, Gallaudet University and The Hoop Dreams Scholarship Fund boards. He has been a director of the Company since May 21, 2004.
LOGO    Lester P. Silverman, age 60, is Director Emeritus of McKinsey & Company, Inc., having retired from the international management consulting firm in 2005. Mr. Silverman joined McKinsey in 1982 and was head of the firm’s Electric Power and Natural Gas practice from 1991 to 1999. From 2000 to 2004, Mr. Silverman was the leader of McKinsey’s Global Nonprofit Practice. Previous positions included Principal Deputy Assistant Secretary for Policy and Evaluation in the U.S. Department of Energy from 1980 to 1981 and Director of Policy Analysis in the U.S. Department of the Interior from 1978 to 1980. Mr. Silverman is currently an Adjunct Lecturer at Georgetown University, Washington, D.C., and a trustee of several national and Washington, D.C.-area nonprofit organizations. He has been a director of the Company since May 19, 2006.
LOGO    William T. Torgerson, age 62, has been Vice Chairman of the Company since June 1, 2003 and has been General Counsel of the Company since August 1, 2002. From August 1, 2002 to June 2003, he was also Executive Vice President of the Company. From December 2000 to August 2002, he was Executive Vice President and General Counsel of Pepco. Mr. Torgerson has been a director of Pepco and Conectiv since August 1, 2002. He has been a director of the Company since May 21, 2004.

 

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DIRECTORS CONTINUING IN OFFICE

 

Terms Expiring in 2008

 

LOGO    Pauline A. Schneider, age 63, joined the Washington office of the law firm of Orrick, Herrington & Sutcliffe LLP in September 2006. From 1985 to September 2006, she was with the law firm of Hunton & Williams. From October 2000 to October 2002, Ms. Schneider served as Chair of the Board of MedStar Health, Inc., a community-based healthcare organization that includes seven major hospitals in the Washington, D.C./Baltimore area. From 1998 to 2002, she chaired the Board of The Access Group, Inc., a not-for-profit student loan provider headquartered in Wilmington, Delaware. She continues her service on both boards. She is a director of Diamond Management and Technology Consultants. Ms. Schneider was a director of Pepco from 2001 until August 1, 2002. She has been a director of the Company since August 1, 2002.
LOGO    Dennis R. Wraase, age 63, is Chairman, President and Chief Executive Officer of the Company. Since May 2004 he has been Chairman of Pepco, Atlantic City Electric Company and Delmarva Power & Light Company. He was Chief Executive Officer from August 2002 through October 2005 and President and Chief Operating Officer of Pepco from January 2001 through August 1, 2002. Mr. Wraase became President of the Company in August 2002. From August 2002 through May 2003, Mr. Wraase was Chief Operating Officer of the Company. Mr. Wraase became CEO of the Company in June 2003. He has been a director of the Company since 2001, and has been Chairman since May 2004.

 

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Which directors are “independent”?

 

The listing standards of the New York Stock Exchange (“NYSE”) require that a majority of the Company’s directors be “independent” as defined by the NYSE listing standards. Applying these standards, the Board has determined that ten of the Company’s current 13 directors, consisting of Messrs. Dunn, Golden, Heintz, MacCormack, McGlynn, Nussdorf, O’Malley, Ross and Silverman and Ms. Schneider qualify as independent. The Board also has determined that Ms. Krumsiek, if elected, will qualify as independent. Accordingly, if each of the nominees is elected at the Annual Meeting, ten of the Company’s 12 directors will qualify as independent.

 

For a director to be considered independent under NYSE listing standards, a director cannot have any of the disqualifying relationships enumerated by the NYSE listing standards and the Board must determine that the director does not otherwise have any direct or indirect material relationship with the Company. In accordance with the NYSE listing standards, the Board of Directors has adopted, as part of the Company’s Corporate Governance Guidelines, categorical standards to assist it in determining whether a relationship between a director and the Company is a relationship that would impair the director’s independence. The Company’s Corporate Governance Guidelines can be found on the Company’s Web site (www.pepcoholdings.com) under the link: Corporate Governance. Under these standards, which incorporate the disqualifying relationships enumerated by the NYSE listing standards, a Company director is not “independent” if any of the conditions specified are met.

 

  a. The director is, or has been within the last three years, an employee of the Company, or an immediate family member is, or has been within the last three years, an executive officer of the Company. The executive officers of the Company consist of the president, principal financial officer, controller, any vice-president in charge of a principal business unit, division or function, any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the Company. Officers of the Company’s subsidiaries are deemed to be officers of the Company if they perform such policy-making functions for the Company.

 

  b. The director has received, or has an immediate family member who has received, during any twelve-month period within the last three years, more than $100,000 in direct compensation from the Company, other than director and committee fees and pension or other forms of deferred compensation for prior service (provided such compensation is not contingent in any way on continued service).

 

  c. (A) The director or an immediate family member is a current partner of a firm that is the Company’s internal or external auditor; (B) the director is a current employee of such a firm; (C) the director has an immediate family member who is a current employee of such a firm and who participates in the firm’s audit, assurance or tax compliance (but not tax planning) practice; or (D) the director or an immediate family member was within the last three years (but is no longer) a partner or employee of such a firm and personally worked on the Company’s audit within that time.

 

  d. The director or an immediate family member is, or has been within the last three years, employed as an executive officer of another company where any of the Company’s present executive officers at the same time serves or served on that company’s compensation committee.

 

  e. The director is a current employee, or an immediate family member is a current executive officer, of a company that has made payments to, or received payments from, the Company for property or services in an amount which, in any of the last three fiscal years, exceeds the greater of $1 million or 2% of such other company’s consolidated gross revenues. Contributions to tax exempt organizations shall not be considered “payments” for purposes of this categorical standard, provided, however, that the Company shall disclose in its annual proxy statement any such contributions made by the Company to any tax exempt organization in which any independent director serves as an executive officer if, within the preceding three years, contributions in any single fiscal year from the Company to the tax exempt organization exceed the greater of $1 million, or 2% of such tax exempt organization’s consolidated gross revenues.

 

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  f. For purposes of considering the existence or materiality of a director’s relationship with the Company or the relationship with the Company of an organization with which the director is associated, payments for electricity, gas or other products or services made in the normal course of business at prices generally applicable to similarly situated customers shall not be included.

 

  g. Additional provisions applicable to members of the Audit Committee.

 

  i. A director who is a member of the Audit Committee may not accept directly or indirectly any consulting, advisory, or other compensatory fee from the Company or any subsidiary of the Company, provided that, unless the rules of the NYSE provide otherwise, compensatory fees do not include the receipt of fixed amounts of compensation under a retirement plan (including deferred compensation) for prior service (provided that such compensation is not contingent in any way on continued service). The term “indirect acceptance” by a member of the Audit Committee of any consulting, advisory, or other compensatory fee includes acceptance of such fee by a spouse, a minor child or stepchild or a child or stepchild sharing a home with the member or by an entity in which such member is a partner, member, an officer such as a managing director occupying a comparable position or executive officer, or occupies a similar position (except limited partners, non-managing members and those occupying similar positions who, in each case, have no active role in providing services to the entity) and which provides accounting, consulting, legal, investment banking or financial advisory services to the Company or any subsidiary of the Company.

 

  ii. A director who is an “affiliated person” of the Company or its subsidiaries (other than in his or her capacity as a member of the Board or a Board Committee) as defined by the Securities and Exchange Commission (“SEC”) shall not be considered independent for purposes of Audit Committee membership. A director who beneficially owns more than 3% of the Company’s common stock will be considered to be an “affiliated person.”

 

In making independence determinations, the Board considered the following relationships in accordance with its procedures for evaluating related person transactions described under the heading “Board Review of Transactions with Related Parties.”

 

Pauline Schneider, a director of the Company, was a partner in the law firm of Hunton & Williams until October 2006. Hunton & Williams rendered legal services to the Company and certain Company subsidiaries in 2006 in the areas of environmental, regulatory, tax and administrative law. Ms. Schneider did not work on any of these matters, nor did she direct Hunton & Williams’ work on any of these matters and did not receive any additional compensation as a result of Hunton & Williams’ representation.

 

In October 2006, Ms. Schneider became a partner in the law firm of Orrick, Herrington & Sutcliffe LLP. Orrick, Herrington & Sutcliffe rendered legal services to certain Company subsidiaries in 2006 and is expected to render services to certain Company subsidiaries in 2007 with respect to certain contract and bankruptcy matters. Ms. Schneider did not work on any of these matters, nor did she direct Orrick, Herrington & Sutcliffe’s work on any of these matters and did not receive any additional compensation as a result of Orrick’s representation.

 

In determining that Ms. Schneider is an independent director, the Board examined the specific transactions that the Company and its subsidiaries had with each law firm. The Board determined that (1) the relationship between each law firm and the Company and its subsidiaries was solely a business relationship which did not afford Ms. Schneider any special benefits and (2) the amounts of the transactions with each firm in the last three years were below the numerical threshold set forth in the Corporate Governance Guidelines with respect to payments for property and services between the Company or its subsidiaries and an entity with which the director is affiliated.

 

Mr. Dunn is President and Chief Executive Officer of FTI Consulting, Inc. In 2005, the Company’s subsidiaries, Pepco, Atlantic City Electric Company and Delmarva Power & Light Company retained Lexecon, a subsidiary of FTI Consulting, Inc., to supply an expert witness in a regulatory proceeding. The Board determined

 

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that (1) the relationship between the Company and Lexecon was solely a business relationship which did not afford Mr. Dunn any special benefits and (2) the amount paid to Lexecon in 2005 was below the numerical threshold set forth in the Corporate Governance Guidelines with respect to payments for property and services between the Company or its subsidiaries and an entity with which the director is affiliated. On this basis, the Board determined that this business relationship did not disqualify Mr. Dunn as an independent director.

 

BOARD MEETINGS

 

The Board held seven meetings during 2006 to review significant developments affecting the Company, engage in strategic planning, and act on matters requiring Board approval. In 2006, each director attended at least 75% of the Board meetings and the meetings of the Board committees on which he or she served. The Board has adopted an attendance policy, set forth in the Corporate Governance Guidelines, under which attendance in person is required at all regularly scheduled shareholder, Board and Committee meetings (except where scheduled as a conference call) and is the preferred method of attendance at specially called meetings. The Chairman has the authority to waive the requirement of this policy if, in the Chairman’s opinion, it is in the Company’s best interests to do so. Of the Company’s 12 directors at the time, 11 attended the 2006 Annual Meeting.

 

At each Board meeting, the directors set aside time to meet in executive session without any management director or other management personnel present. The executive session of the Board is convened by the Lead Independent Director.

 

BOARD COMMITTEES

 

The Board has five separately designated standing committees:

 

   

the Audit Committee;

 

   

the Compensation/Human Resources Committee;

 

   

the Corporate Governance/Nominating Committee;

 

   

the Executive Committee; and

 

   

the Finance Committee.

 

Each committee’s charter can be found on the Company’s Web site (www.pepcoholdings.com) under the link: Corporate Governance.

 

Each of the Committees (other than the Executive Committee) sets aside time to meet in executive session without management personnel present. The Compensation/Human Resources Committee meets separately with its compensation consultant. The Audit Committee meets separately with the Vice President, Internal Audit and the independent registered public accounting firm.

 

The Audit Committee held eight meetings in 2006. The Committee represents and assists the Board in discharging its responsibility of oversight with respect to the accounting and control functions and financial statement presentation (but the existence of the Committee does not alter the traditional roles and responsibilities of the Company’s management and its independent registered public accounting firm). The Audit Committee is responsible for, among other things, representing and assisting the Board in oversight of (i) the integrity of the Company’s financial statements, accounting and financial reporting processes and audits of the Company’s consolidated financial statements, (ii) the Company’s compliance with legal and regulatory requirements, (iii) the qualifications, independence and the retention, compensation and performance of the Company’s independent

 

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registered public accounting firm, and (iv) the design and performance of the Company’s internal audit function. The Audit Committee also reviews the Company’s guidelines and policies with respect to risk assessment, and has full power and authority to obtain advice and assistance from independent legal, accounting or other advisors as it may deem appropriate to carry out its duties.

 

Committee members are Directors Golden, Heintz, McGlynn, Nussdorf (Chairman) and Ross. The Board has determined that directors Golden, Heintz, Nussdorf and Ross each is an “audit committee financial expert” as defined by the rules of the SEC. The Board has determined that each member of the Audit Committee is independent as defined by the Company’s Corporate Governance Guidelines and the listing standards of the NYSE.

 

The Compensation/Human Resources Committee held five meetings in 2006. The Committee, together with the other independent members of the Board of Directors, sets the CEO’s compensation level after taking into account the annual evaluation of the CEO’s performance conducted by the Corporate Governance/Nominating Committee and such other factors as the Committee deems appropriate. The Committee reviews the performance of elected officers and other executives in the context of the administration of the Company’s executive compensation programs. The Committee, on the recommendation of the CEO, (i) approves the salaries for the executive officers, the heads of the business units, and all PHI Vice Presidents and any salary that exceeds the approval level of the CEO, (ii) establishes performance guidelines under the Executive Incentive Compensation Plan, and (iii) exercises the powers of the Board with respect to the Company’s annual salary increase for all management employees. The Committee sets target award levels and approves payments for the executive officers and the heads of the business units pursuant to the Executive Incentive Compensation Plan, establishes the structure of compensation and amounts of awards under the shareholder-approved Long-Term Incentive Plan, and reviews other elements of compensation and benefits for management employees and makes recommendations to the Board as appropriate. The Committee makes recommendations to the Board concerning the Company’s retirement and other benefit plans and oversees corporate workforce diversity issues, and also receives input on compensation matters from the Chief Executive Officer and management, as it deems appropriate.

 

In order to assist it in carrying out these responsibilities, the Committee in 2006 employed Buck Consultants as its independent compensation consultant. Pursuant to this engagement, Buck Consultants provided the following services: reviewed the compensation philosophy; advised on construction of and determination of a peer group of companies; reviewed new salary ranges; reviewed the annual incentive plan; reviewed the long-term incentive plan; reviewed proposed compensation plans or amendments to existing plans; reviewed the total executive compensation structure for the coming year; attended the Compensation/Human Resources Committee meetings dealing with executive compensation, as requested; presented comparative information to assist the Compensation/Human Resources Committee in its deliberations and decision-making concerning executive compensation; advised senior management, as requested by the Compensation/Human Resources Committee; and provided various industry performance and other comparative information.

 

Committee members are Directors Dunn, Heintz, MacCormack, McGlynn (Chairman), O’Malley and Ross. The Board has determined that each member of the Compensation/Human Resources Committee is independent as defined by the Company’s Corporate Governance Guidelines and the listing standards of the NYSE.

 

The Corporate Governance/Nominating Committee held five meetings in 2006. The Committee’s duties and responsibilities include making recommendations to the Board regarding the governance of the Company and the Board, and helping ensure that the Company is properly managed to protect and enhance shareholder value and to meet the Company’s obligations to shareholders, customers, the industry and under the law. The Committee makes recommendations to the Board regarding Board structure, practices and policies, including Board committee chairmanships and assignments and the compensation of Board members, evaluates Board performance and effectiveness, and oversees the development of corporate strategy and structure, including management development, management succession, management performance criteria, business plans and

 

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corporate and government affairs. The Committee evaluates annually the performance of the Company’s Chief Executive Officer and reports its appraisal to the Compensation/Human Resources Committee. The Committee also ensures that the technology and systems used by the Company are adequate to properly run the business and for it to remain competitive. The Committee reviews and recommends to the Board candidates for nomination for election as directors.

 

Committee members are Directors Dunn, McGlynn, O’Malley (Chairman), Schneider and Silverman. The Board has determined that each member of the Corporate Governance/Nominating Committee is independent as defined by the Company’s Corporate Governance Guidelines and the listing standards of the NYSE.

 

The Executive Committee held one meeting in 2006. The Committee has, and may exercise when the Board is not in session, all the powers of the Board in the management of the property, business and affairs of the Company, except as otherwise provided by law. The Committee does not hold regularly scheduled meetings. Committee members are Directors Cronin, Golden, MacCormack (Chairman), Nussdorf, Torgerson and Wraase.

 

The Finance Committee held six meetings in 2006. The Committee oversees the financial objectives, policies, procedures and activities of the Company and considers the long- and short-term strategic plans of the Company. The Committee reviews with management the Company’s risk mitigation profile and reviews the Company’s insurance program. Committee members are Directors Cronin, Golden (Chairman), MacCormack, Nussdorf, Schneider and Silverman.

 

How do I send a communication to the Board of Directors or to a specific individual director?

 

The Company’s directors encourage interested parties, including employees and shareholders, to contact them directly and, if desired, confidentially or anonymously regarding matters of concern or interest, including concerns regarding questionable accounting or auditing matters. The names of the Company’s directors can be found on pages 5-7 of this Proxy Statement and on the Company’s Web site (www.pepcoholdings.com) under the link: Corporate Governance. The Company’s directors may be contacted by writing to them either individually or as a group or partial group (such as all non-management directors), c/o Corporate Secretary, Pepco Holdings, Inc., 701 Ninth Street, N.W., Room 1300, Washington, D.C. 20068. If you wish your communication to be treated confidentially, please write the word “CONFIDENTIAL” prominently on the envelope and address it to the director by name so that it can be forwarded without being opened. A communication addressed to multiple recipients (such as to “directors,” “all directors,” “all non-management directors,” “independent directors”) will necessarily have to be opened and copied by the Office of the Corporate Secretary in order to forward it to each director, and hence cannot be transmitted unopened, but will be treated as a confidential communication. If you wish to remain anonymous, do not sign your letter or include a return address on the envelope. Communications from Company employees regarding accounting, internal accounting controls, or auditing matters may be submitted in writing addressed to: Vice President, Internal Audit, Pepco Holdings, Inc., 701 Ninth Street, N.W., Room 8220, Washington, D.C. 20068 or by telephone to 202-872-3524. Such communications will be handled initially by the Internal Audit Group, which reports to the Audit Committee, and will be reported by the Internal Audit Group to the Audit Committee. If for any reason the employee does not wish to submit a communication to the Vice President, Internal Audit, it may be addressed to the Chairman of the Audit Committee using the procedure set forth above, or can be sent via mail, telephone, facsimile or e-mail to the Company’s Ethics Officer. Employees may also leave messages on the Company’s Ethics Officer’s hotline.

 

What are the directors paid for their services?

 

Each of the Company’s non-management directors is paid an annual retainer of $45,000, plus a fee of $2,000 for each Board and Committee meeting attended. The Chairman of the Audit Committee receives an additional retainer of $7,500 and a non-management director who chairs any one of the other standing Committees of the Board receives an additional retainer of $5,000. A director who does not otherwise serve as chairman of a Committee but who serves as Lead Independent Director receives a retainer of $2,500 for service in that capacity.

 

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Each non-management director is required to own at least 7,500 shares of Company common stock or common stock equivalents (“phantom stock”). Non-management directors serving as of January 1, 2005, have until December 31, 2007, to meet this requirement. Newly elected or appointed non-management directors are required to reach this ownership level within three years after the date of their election or appointment.

 

Under the Non-Management Director Compensation Plan, each non-management director is entitled to elect to receive his or her annual retainer, retainer for service as a Committee chairman, if any, retainer for services as the Lead Independent Director, if any, and meeting fees exclusively in or a combination of: (i) cash, (ii) shares of Company common stock, or (iii) a credit to an account for the director established under the PHI Executive and Director Deferred Compensation Plan as described under the heading “Deferred Compensation Plans — PHI Executive and Director Deferred Compensation Plan” below.

 

The following table sets forth, as of March 19, 2007, for each non-management director who has elected to receive all or a portion of his or her annual retainer and meeting fees in phantom stock under the Deferred Compensation Plan, the number of credited phantom stock units (each corresponding to one share of common stock).

 

Name of Director


   Pepco Holdings
Phantom Stock Units


Edmund B. Cronin, Jr.

   29,010

Terence C. Golden

   18,726

George F. MacCormack

   4,420

Richard B. McGlynn

   2,222

Lawrence C. Nussdorf

   3,186

Peter F. O’Malley

   5,297

Pauline A. Schneider

   442

Lester P. Silverman

   2,834

 

Although under the terms of the Company’s Long-Term Incentive Plan, each non-management director is entitled to a grant, on May 1 of each year, of an option to purchase 1,000 shares of common stock, in 2003, the Board of Directors discontinued these grants.

 

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The following table sets forth the compensation paid by the Company to its non-management directors for the year ended December 31, 2006.

 

2006 DIRECTOR COMPENSATION

 

Name


  Fees
Earned or
Paid in
Cash (1)


  Stock
Awards


  Option
Awards (2)


  Non-Equity
Incentive Plan
Compensation


  Changes in
Pension Value
and
Nonqualified
Deferred
Compensation
Earnings (3)


  All Other
Compensation


  Total

Edmund B. Cronin, Jr.

  $ 79,000   $ 0   $ 0   $ 0   $ 0   $ 0   $ 79,000

Jack B. Dunn, IV

    77,000     0     0     0     0     0     77,000

Terence C. Golden

    98,000     0     0     0     0     0     98,000

Frank O. Heintz
(first elected May 19, 2006)

    47,816     0     0     0     0     0     47,816

George F. MacCormack

    90,091     0     0     0     0     0     90,091

Richard B. McGlynn

    108,000     0     0     0     0     0     108,000

Lawrence C. Nussdorf

    104,045     0     0     0     0     0     104,045

Peter F. O’Malley

    84,955     0     0     0     71,576     0     156,531

Frank K. Ross

    89,000     0     0     0     0     0     89,000

Pauline A. Schneider

    85,000     0     0     0     0     0     85,000

Lester P. Silverman
(first elected May 19, 2006)

    45,816     0     0     0     0     0     45,816

Floretta D. McKenzie
(retired May 19, 2006)

    31,231     0     0     0     15,344     0     46,575

(1) Consists of retainer and meeting fees, which the director may elect to receive in cash or Company common stock or to defer under the terms of the PHI Executive and Director Deferred Compensation Plan. The following directors have elected to receive all or a portion of their 2006 retainer and meeting fees in the form of either (i) shares of PHI common stock or (ii) as a credit to the director’s account under the PHI Executive and Director Deferred Compensation Plan.

 

          Amount of Deferred Compensation Plan Credit

Name


   Shares of Common Stock

   Phantom Stock

   Non-Stock Plan Accounts

Edmund B. Cronin, Jr.

   0    $ 79,000    $ 0

Jack B. Dunn, IV

   0      0      77,000

George F. MacCormack

   0      0      45,045

Lawrence C. Nussdorf

   0      0      104,045

Frank K. Ross

   965      0      0

Pauline A. Schneider

   0      0      45,000

Lester P. Silverman

   0      45,816      0

 

(2) At December 31, 2006, the following directors held options to purchase the indicated number of shares of Company common stock: Mr. Cronin — 5,000 shares; Mr. Golden — 4,000 shares; Dr. McKenzie — 5,000 shares; Mr. Nussdorf — 2,000 shares; Mr. O’Malley — 5,000 shares; and Ms. Schneider — 2,000 shares. The Company discontinued the use of stock options as a form of director compensation starting January 1, 2003.

 

(3) Represents “above-market” earnings (as defined by SEC regulations) on director compensation deferred under the Pepco Director and Executive Deferred Compensation Plan. For a description of the terms of this plan, see “Deferred Compensation Plans — Pepco Director and Executive Deferred Compensation Plan” below.

 

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The Company provides directors with travel accident insurance for Company-related travel and directors’ and officers’ liability insurance coverage and reimburses directors for travel, hotel and other out-of-pocket expenses incurred in connection with their performance of their duties as directors.

 

The Company also provides the directors with free parking in the Company’s headquarters building, which is also available for use by the directors other than in connection with the performance of their duties as directors. In addition, in 2006, Company-leased entertainment venues and Company-purchased tickets to sporting and cultural events were made available to one or more directors for personal use when not being used by the Company for business purposes. There was no incremental cost to the Company of providing these benefits.

 

The compensation of the non-management members of the Board of Directors is reviewed periodically by the Corporate Governance/Nominating Committee which makes recommendations for changes, if any, to the Board for its approval. In September 2004, the Company, at the direction of the Corporate Governance/Nominating Committee, retained Towers Perrin to (i) advise the Committee on current trends in director compensation, including stock ownership guidelines, (ii) determine if the Company’s compensation program is competitive, and (iii) evaluate the structure of the compensation program and the relative mix of compensation elements.

 

In December 2004, Towers Perrin delivered its report to the Corporate Governance/Nominating Committee in which it outlined trends in Board of Directors’ compensation, and included a review of director compensation arrangements in the utility industry generally and among companies located in the metropolitan Washington, D.C. area.

 

The report concluded that the Company’s compensation for non-management directors fell below the 25th percentile of the utility group and at the lower end of companies located in the metropolitan Washington, D.C. area.

 

Towers Perrin recommended that the Company align director compensation more closely to those of Washington, D.C companies, place more weight on equity compensation, increase compensation for the members of the Audit Committee and implement stock ownership guidelines. Following a review of the report, the Board of Directors, on the recommendation of the Corporate Governance/Nominating Committee, adopted, effective January 1, 2005, the director compensation arrangements described above.

 

 

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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

The following table sets forth, as of March 19, 2007, for each director, director nominee, each executive officer named in the Summary Compensation Table below and all directors and executive officers as a group (i) the number of shares of common stock beneficially owned, (ii) the number of shares of common stock that could be purchased through the exercise of stock options then-currently exercisable or scheduled to become exercisable within 60 days thereafter, and (iii) total beneficial ownership. Each of the individuals listed, and all directors and executive officers as a group, beneficially owned less than 1% of the outstanding shares of common stock.

 

Name of Beneficial Owner


  

Shares of

Common Stock

Owned(4)


  

Common Stock

Acquirable Within

60 Days


  

Total

Beneficial

Ownership(5)


Edmund B. Cronin, Jr.

   1,425    5,000    6,425

Jack B. Dunn, IV

   10,495    0    10,495

Terence C. Golden (6)

   52,132    4,000    56,132

Frank O. Heintz (7)

   1,500    0    1,500

Barbara J. Krumsiek

   1,000    0    1,000

George F. MacCormack

   11,282    0    11,282

Ed R. Mayberry

   33,486    44,834    78,320

Richard B. McGlynn

   5,765    0    5,765

Lawrence C. Nussdorf

   5,000    2,000    7,000

Peter F. O’Malley (8)

   10,000    5,000    15,000

Joseph M. Rigby

   37,116    0    37,116

Frank K. Ross

   6,693    0    6,693

Pauline A. Schneider

   3,671    2,000    5,671

Thomas S. Shaw

   104,374    68,333    172,707

Lester P. Silverman

   1,000    0    1,000

William J. Sim

   39,603    43,934    83,537

William T. Torgerson

   63,457    51,843    115,300

Dennis R. Wraase

   154,825    69,843    224,668

All Directors and Executive Officers as a Group (21 Individuals)

   577,406    296,787    874,193

(4) Includes shares held under the Company’s Dividend Reinvestment Plan and Retirement Savings Plan. Also includes shares awarded under the Company’s Long-Term Incentive Plan that vest over time if the executive officer has the right to vote the shares. Unless otherwise noted, each beneficial holder has sole voting power and sole dispositive power with respect to the shares shown as beneficially owned.

 

(5) Consists of the sum of the two adjacent columns.

 

(6) Includes 11,600 shares owned by Mr. Golden’s spouse. Mr. Golden disclaims beneficial ownership of these shares.

 

(7) Shares are owned in the Frank O. Heintz Trust of which Mr. Heintz is Trustee.

 

(8) Includes 4,086 shares owned by Aberdeen Creek Corporation, of which Mr. O’Malley is the sole owner.

 

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The following table also sets forth, as of March 19, 2007, the number and percentage of shares of common stock reported as beneficially owned by all persons known by the Company to own beneficially 5% or more of the common stock.

 

Name and Address of Beneficial Owner


   Shares of
Common Stock
Owned


    Percent of
Common Stock
Outstanding


 

Barclays Global Investors, NA

45 Fremont Street, 17th Floor

San Francisco, CA 94105

   9,924,944 (9)   5.18 %

UBS AG

Bahnhofstrasse 45

P.O. Box CH-8021

Zurich, Switzerland

   15,415,862 (10)   8 %

 

(9) This disclosure is based on information furnished in Schedule 13G, filed with the SEC on January 23, 2007, jointly by Barclays Global Investors, NA, Barclays Global Fund Advisors, Barclays Global Investors, Ltd., Barclays Global Investors Japan Trust and Banking Company Limited, and Barclays Global Investors Japan Limited in which Barclays Global Investors, NA reports that it is the beneficial owner with sole dispositive power of 6,597,762 shares of common stock, Barclays Global Fund Advisors reports that it is the beneficial owner with sole dispositive power of 2,665,620 shares of common stock, Barclays Global Investors, Ltd. Reports that it is the beneficial owner with sole dispositive power of 426,855 shares of common stock, Barclays Global Investors Japan Trust and Banking Company Limited reports that it is the beneficial owner with sole dispositive power of 189,246 shares of common stock, and Barclays Global Investors Japan Limited reports that it is the beneficial owner with sole dispositive power of 45,461 shares of common stock.

 

(10) This disclosure is based on information furnished in Schedule 13G/A filed with the SEC on February 20, 2007, by UBS AG (for the benefit and on behalf of the UBS Global Asset Management business group of UBS AG), in which UBS AG reports that it is the beneficial owner of 15,415,862 shares of common stock (consisting of 15,415,862 shares as to which it has shared dispositive power and 13,344,112 shares as to which it has sole voting power).

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) requires the directors and executive officers of a company with a class of equity securities registered under Section 12 of the Exchange Act and any beneficial owner of more than 10% of any class of the company’s equity securities to file with the SEC certain reports of holdings and transactions in the company’s equity securities. Based on a review of the reports filed for 2006 and on written confirmations provided by its directors and executive officers, the Company believes that during 2006 all of its directors and executive officers filed on a timely basis the reports required by Section 16(a), except that Dennis R. Wraase, Chairman, President, Chief Executive Officer and a Director of the Company, and William T. Torgerson, Vice Chairman, General Counsel and a Director of the Company, each filed one day late a report on Form 4 disclosing option exercises that had been inadvertently omitted from a Form 4 filed the previous day to report the acquisition and disposition of common stock received and sold in connection with the exercise of stock options.

 

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COMPENSATION/HUMAN RESOURCES COMMITTEE REPORT

 

Among its duties, the Compensation/Human Resources Committee is responsible for reviewing and discussing with the Company’s management the Compensation Disclosure and Analysis (the “CD&A”) section of the Proxy Statement. Based on its review and discussion with management of the CD&A that follows this Report, the Committee has recommended to the Board of Directors that it be included in this Proxy Statement.

 

Richard B. McGlynn, Chairman

Jack B. Dunn, IV

Frank O. Heintz

George F. MacCormack

Peter F. O’Malley

Frank K. Ross

 

COMPENSATION DISCLOSURE AND ANALYSIS

 

The following is a discussion and analysis of the compensation provided by the Company to its executive officers named in the Summary Compensation Table (the “NEOs”) as detailed in the executive compensation tables that follow. The purpose of this discussion and analysis is to explain the principles underlying the Company’s executive compensation practices and to identify the factors and reasoning on which decisions regarding the compensation of the NEOs in 2006 were based.

 

Compensation Philosophy

 

The objectives of the Company’s executive compensation program are to attract, motivate and retain talented executives and to promote the interests of the Company and its shareholders. To achieve these objectives, the Company’s executive compensation program is designed to:

 

   

provide executives with salaries, incentive compensation opportunities and other benefits that are competitive with comparable companies in the industry;

 

   

reward executives for both the achievement by the Company and its business segments of targeted levels of operational excellence and financial performance and the achievement by the executives of individual performance goals; and

 

   

align the financial interests of the executives with those of the shareholders through equity-based incentive awards and stock ownership requirements.

 

Responsibilities and Resources of the Compensation/Human Resources Committee

 

The Compensation/Human Resources Committee, the composition and responsibilities of which are described more fully above under the heading “Compensation/Human Resources Committee,” is responsible for all executive compensation decisions with respect to each of the NEOs, except that the annual salary of the Chief Executive Officer is set by all of the independent directors. When structuring compensation arrangements for the Company’s NEOs and other executives, the Committee typically receives advice from its independent consultant on the financial costs and the tax consequences to the Company, as well as the accounting treatment, associated with the various elements of compensation.

 

To assist it in carrying out its responsibilities, the Committee requests and receives recommendations from the Chief Executive Officer with respect to the compensation packages of the other NEOs, including the selection and weighting of the specific performance objectives applicable to short-term and long-term incentive awards. The Committee also uses the following resources:

 

Compensation Consultants.    In 2005, the Committee engaged Buck Consultants (the “Consultant”) as an independent compensation consultant to advise the Committee on executive compensation matters. The Consultant continued to serve in this capacity in 2006. Among other matters, the Consultant advises the

 

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Committee on compensation practices generally and on plan and award design matters. The Consultant also provides the Committee with survey data and other comparative information to assist it in its executive compensation decisions. The services provided by the Consultant are described in greater detail above under the heading “Compensation/Human Resources Committee.” While serving as the compensation consultant to the Committee, the Consultant has not had any other relationships with the Company.

 

Peer Group.    In 2005, the Committee, with the assistance of data provided by the Consultant, conducted a review of the composition of the group of companies used by the Committee as a basis to evaluate, relative to other companies, the various elements of the Company’s executive compensation program and individual compensation levels. As a result of this review, the Committee identified a group of 25 U.S. publicly traded electric or gas utilities that have total assets and a market capitalization comparable to those of the Company (the “Peer Group”).* Based on data for the preceding fiscal year, the Company, at that time, ranked relative to the Peer Group at the 58th percentile in total assets and at the 59th percentile in market capitalization. The composition of the Peer Group did not change in 2006.

 

Tally Sheets.    As part of its compensation review process, the Committee reviews annually a tally sheet for each NEO prepared by the Company that identifies the material elements of the executive’s compensation, including salary, short-term and long-term incentive compensation opportunity, pension accruals and other benefits. These sheets also show the severance and other payouts to which the executive would be entitled under various employment termination scenarios.

 

2005 Review of Executive Compensation

 

In 2005, the Committee, with the assistance of the Consultant, undertook an overall review of the Company’s executive compensation practices. The review covered base salary and total cash compensation levels, short-term and long-term incentive program design, employment and severance agreements, retirement benefit plans, deferred compensation plans, and perquisites. The major elements of this review are discussed in this section. Additional findings are noted in the detailed discussion below of the components of the Company’s executive compensation program.

 

Assessment of Salary and Incentive Compensation Levels.    To assess the salary levels and the short-term and long-term incentive compensation opportunities provided by the Company relative to other companies, the Consultant, at the direction of the Committee, prepared an analysis (the “Executive Market Pricing Review”) comparing the Company’s compensation arrangements to those of (a) the companies composing the Peer Group and (b) a broader survey group of companies within the energy industry generally (the “Industry Survey Group”). This analysis compared, for each of the Company’s senior executive positions, the Company’s compensation level to the respective comparison groups using the following measures: (i) salary, (ii) total cash compensation (consisting of salary combined with target annual incentive compensation), and (iii) total direct compensation (consisting of total cash compensation and long-term incentive compensation).

 

This analysis showed that for each of the three measures, the compensation of the executive officers in most cases fell below the median of the competitive ranges as reflected in both the Peer Group data and the Industry Survey Group data. Based on these findings, the Consultant recommended, and the Committee, after a thorough review of the Consultant’s methodology and conclusions, approved, for each executive officer position, including each of the NEOs, (i) a target salary range and a framework for adjusting the salary range in future years, (ii) a target short-term incentive opportunity as a percentage of salary, and (iii) a target long-term incentive opportunity as a percentage of salary, each as more fully described in the discussion below of the components

 

 


*The companies composing the Peer Group are: Allegheny Energy Inc., Alliant Energy Corp., Ameren Corp., Centerpoint Energy Inc., Cinergy Corp., CMS Energy Corp., Consolidated Edison, DQE Inc., DTE Energy Co., Energy East Corp., Hawaiian Electric Co., Keyspan Corp., NiSource Inc., Northeast Utilities, NSTAR, OGE Energy Corp., Pinnacle West Capital Corp., PPL Corp., Puget Energy Inc., SCANA Corp., Sempra Energy, Sierra Pacific Resources, Teco Energy Inc., Wisconsin Energy Corp., and Xcel Energy Corp.

 

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of the Company’s executive compensation program. In each case, the levels were designed to approximate the 50th percentile level within the competitive range.

 

Long-Term Incentive Plan Design.    In 2003, the Company discontinued the use of stock options as a form of long-term incentive compensation for executives. For 2004 and 2005, the Company’s long-term incentive awards for executives consisted solely of performance-based shares of restricted stock that were subject to vesting at the end of a three-year performance period depending on the extent to which pre-established performance objectives were satisfied (“Performance Stock”). To assess the Company’s long-term compensation arrangements relative to other companies, the Committee, as part of the 2005 review of executive compensation, directed the Consultant to review the long-term compensation arrangements of the Peer Group companies.

 

The Consultant found that 79% of the Peer Group companies had multiple long-term incentive plan instruments. The Consultant, in its report to the Committee, recommended use of a combination of Performance Stock and shares of Company common stock that vest solely on the basis of the continued employment of the executive (“Restricted Stock”). The Consultant noted that, whereas Performance Stock is designed to focus the executive on the achievement by the Company or a business segment of specific financial or other performance goals or on the achievement of individual performance goals, the primary objective of the Restricted Stock is executive retention and the alignment of the financial interests of the executives with the interests of the shareholders.

 

On the recommendation of the Consultant, the Committee approved a long-term incentive award program consisting of both (i) Performance Stock, representing two-thirds of the targeted long-term incentive award opportunity (the “Performance Stock Program”), and (ii) Restricted Stock, that vested after three years of service (which the Committee chose rather than pro-rata vesting over the three-year period to maximize the retention value of the award), representing one-third of the targeted long-term incentive award opportunity (the “Restricted Stock Program”). This allocation was selected by the Committee based on its view that the predominant portion of an executive’s long-term incentive award opportunity should be tied to performance. In structuring the Company’s long-term incentive compensation arrangements, the Committee noted that a number of companies in the Peer Group used stock options as a form of long-term incentive compensation in addition to, or in lieu of, Restricted Stock. The Committee concluded, however, that stock options, the value of which is contingent solely on the appreciation of a company’s stock price, are of limited value in measuring the performance of a company that is primarily a public utility where the company’s stock price is significantly affected by the company’s dividend yield relative to prevailing interest rates.

 

With regard to the selection of performance measures for the vesting of shares of Performance Stock, the Committee sought to identify measures that would further the Committee’s goal of ensuring that executives are rewarded only if they deliver results that enhance shareholder value. The Committee determined that this goal could be achieved by selecting performance measures that were closely tied to the achievement of important objectives under the Company’s financial plan. To identify specific measures, a subcommittee of the Committee met with senior management of the Company. Based on these discussions, the subcommittee identified and recommended to the Committee, and the Committee approved, the use of (i) earnings per share or, in the case of business unit performance, earnings (excluding in each instance extraordinary items and other gains and losses relating to matters that are not reflective of the Company’s ongoing business), which serve as a measure of improvements in the Company’s operating results, and (ii) free cash flow, which reflects the generation of the cash available for dividends and debt reduction.

 

The Committee also determined that, to take into account an executive’s specific responsibilities, the selected performance measures would, depending on the executive’s position within the Company, apply in whole or in part to the performance of the Company as a whole or to one or more regulated (consisting of Power Delivery) or unregulated (consisting of Conectiv Energy and Pepco Energy Services) business units and could be weighted differently as between the two performance measures. The Committee further determined that the extent to which Performance Stock awards would be earned would depend on actual performance relative to the target level, with no award or a reduced award to the extent performance fell below the target and an increased

 

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award if the target is exceeded (with awards earned pro-rata for performance between the threshold and maximum levels). The table below shows the relationship between (i) performance relative to the targeted performance level and (ii) the amount of the award earned as a percentage of the target award:

 

Percentage Performance Relative to
Target Level (Company and Power
Delivery)


 

Percentage Performance Relative to
Target Level (unregulated business units)


 

Amount of Award (as a Percentage of
Target Award)


below 90%   below 80%   0%
90%   80%   50%
100%   100%   100%
115%   120%   200%

 

The narrower performance range for the Company and Power Delivery performance targets reflects the historically lower volatility of the results from regulated operations as compared to the Company’s unregulated businesses.

 

The Components of the Executive Compensation Program

 

The compensation program for the Company’s executives, including the NEOs, consists of the following components:

 

   

base salary;

 

   

cash incentive awards under the Executive Incentive Compensation Plan;

 

   

equity incentive awards under the Long-Term Incentive Plan;

 

   

retirement programs;

 

   

health and welfare benefits; and

 

   

other perquisites and personal benefits.

 

The following is a discussion of each of these components of executive compensation.

 

Base Salary.    Each of the NEOs has an employment agreement with the Company, which provides that the executive is entitled to an annual base salary that is not less than his salary on the date he entered into the agreement, and which if increased may not be subsequently decreased during the term of the agreement. The Committee considers salary adjustments annually and also may consider salary adjustments in connection with promotions and in other special circumstances.

 

As part of the 2005 review of executive compensation, the Committee, in order to provide consistency within the Company, developed salary levels for the executives and senior management and assigned a level to each position based primarily on the decision-making responsibility associated with the position. The Committee then assigned to each salary level a salary range, with the midpoint of the range fixed at approximately the median of the competitive range as determined by the Executive Market Pricing Review. Within the range, the salary of the executive is determined based on a combination of factors, including the executive’s level of experience, tenure with the Company and in the position, and performance.

 

The Committee also adopted a framework for the annual consideration by the Committee of adjustments to the salary range for each salary level and to the salaries of the executives at that level. To evaluate the salary ranges, the Committee obtains from the Consultant published data showing projected salary structure adjustments of other companies compiled on the basis of compensation surveys conducted by several executive compensation consultants, including the Consultant, and other compensation information resources. Upon consideration of this data, the Committee determines whether to adjust the Company’s salary range for each level by a percentage selected by the Committee based on the survey data. The first such adjustment to the salary ranges occurred at the beginning of 2007 and is discussed below.

 

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To consider adjustments to executive salaries within the salary ranges, the Committee obtains from the Consultant published data showing projected salary adjustments compiled from the same sources as the salary structure information. If this information shows an increase in salary levels, the Committee may approve a percentage increase in the total salary budget for the Company’s executive employee group (currently consisting of 56 executives) that corresponds to the market increase in salaries as shown by the survey data. This increase, which is referred to as a “merit budget,” is available for allocation among the executive employee group in the form of salary increases based on the Committee’s evaluation of the executive’s performance, length of service and any other factors that the Committee considers relevant. The Committee also may consider whether a further salary adjustment for a particular executive is warranted based on the goal of generally paying an executive at the median of the competitive salary range for the executive’s position.

 

Based on the information provided by the Executive Market Pricing Review, the Committee determined that the salary of Dennis R. Wraase, the Company’s Chairman, President and Chief Executive Officer, of $759,000 for 2004 was below the 50th percentile of the Peer Group and below the 25th percentile of the Industry Survey Group. To bring his salary level more closely in line with the comparison groups, the Committee in 2005 raised the competitive salary range for his position. To place his salary more closely to the midpoint of the competitive range, the Committee approved increases in Mr. Wraase’s salary to $825,000 in 2005 and to $950,000 in 2006. In approving these increases, the Committee also took into account the Company’s successes under Mr. Wraase’s leadership in debt reduction, succession planning and management development, diversity efforts, safety record improvements, emergency response capability improvements, business unit integration, and Sarbanes-Oxley implementation.

 

As part of the Executive Market Pricing Review, the Committee in 2005 also established a salary range for the chief financial officer position, and increased the salary of Joseph M. Rigby, the Company’s Senior Vice President and Chief Financial Officer, from $350,000 to $400,000, which brought his salary within the competitive range. In October 2006, the Committee, effective November 1, 2006, increased Mr. Rigby’s salary to $475,000, slightly below the midpoint of the competitive range. In making this decision, the Committee concluded that Mr. Rigby was performing all components of the position as Chief Financial Officer in a superior manner, noting, in particular, the significant improvement in Sarbanes-Oxley compliance, the improvement in the strategic planning process, and the development of a comprehensive financial communication plan and deployment of the plan under his direction. The Committee also noted that the current employment market for individuals with Mr. Rigby’s experience was very competitive and that the increase reflected the Committee’s desire to ensure his continued development and employment by the Company.

 

With respect to the other NEOs, the Committee determined that the salaries of each of William T. Torgerson, Thomas S. Shaw, William J. Sim and Ed R. Mayberry were close to the midpoint of the competitive salary range for his position as established by the Committee based on the Executive Market Pricing Review, and accordingly each received only modest salary increases in 2005. In 2006, the salaries of these executive officers were increased as follows: Mr. Torgerson from $492,000 to $512,000, Mr. Shaw from $488,000 to $502,000, Mr. Sim from $289,000 to $298,000, and Dr. Mayberry from $271,000 to $280,000, representing percentage increases of between 2.9% to 4.0%, and reflecting allocations by the Committee, based on individual factors referred to above, from a 3.5% merit budget for 2006.

 

In January 2007, the Committee, based on the data furnished by the Consultant, approved a 2.6% increase in the minimum and maximum levels in the competitive salary range for each executive officer salary level. The Committee also approved a merit budget of 3.6%, which was allocated among the executive employee group. As part of this allocation, the Committee approved the following 2007 salary increases for each of the 2006 NEOs whose employment continued into 2007:

 

Name


   2007 Salary

   Percentage Increase
From 2006


 

Dennis R. Wraase

   $ 1,025,000    7.9 %

William T. Torgerson

     537,000    4.88 %

Thomas S. Shaw

     522,000    4 %

 

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In approving the increase for Mr. Wraase, the Committee noted his direction and leadership during 2006 in achieving the Company’s strategic initiatives, including: the successful negotiation of a settlement in the Mirant bankruptcy proceeding, implementation of a succession plan, the re-branding efforts for the Company’s utility subsidiaries, development of comprehensive legislative and regulatory proposals to address rising electricity prices, strengthening the Company’s Sarbanes-Oxley compliance, the three-year total return to shareholders of 52.64%, increasing the Company’s dividend, and resolution of the reliability issues associated with the Potomac River generating plant.

 

In approving the increase for Mr. Torgerson, the Committee took into account his experience and tenure in the position of Vice Chairman and General Counsel and noted the following achievements in 2006: the Mirant bankruptcy settlement, leadership of the Company’s legislative response to rising electricity prices, and contribution to diversity in employment of new staff.

 

As the basis for Mr. Shaw’s increase, the Committee took into account the following accomplishments in 2006: achieving targeted savings levels associated with the Conectiv merger, keeping utility operations and maintenance spending within 1.5% of budget in spite of inflationary pressure on the prices of critical materials, and support of the Company’s safety initiative.

 

No change was made to Mr. Rigby’s salary in view of the November 1, 2006 increase.

 

Annual Cash Incentive Awards.    The Company provides its executives, including its NEOs, with an opportunity to receive annual cash bonuses under the Executive Incentive Compensation Plan. Under this plan, payments are based on the extent to which the Company, one or more business segments, or individual performance meets specified objectives (which can be based on financial or other quantitative criteria). The Committee, however, retains the discretion, whether or not the established performance objectives are achieved, to adjust awards taking into account such factors and circumstances as it determines to be appropriate. As part of the 2005 review of executive compensation, the Committee was advised by the Consultant that the design of the Executive Incentive Compensation Plan was typical of annual incentive compensation plans generally and included “best practice” design elements. As a result, the Committee determined that no design changes to the Executive Incentive Compensation Plan were needed.

 

As part of the Executive Market Pricing Review, the Consultant determined that the total cash compensation (consisting of salary and target annual incentive compensation) opportunity for the Company’s chief executive officer was significantly below, and for other executive officers was somewhat below, the midpoint of the competitive range. As a result, in conjunction with establishing a salary range for each executive officer position, the Consultant recommended, and the Committee adopted, a target short-term incentive opportunity for each executive officer as a percentage of salary that is designed to raise the Company’s total cash compensation opportunity to a level that more closely approximates the midpoint of the comparison groups. The target levels adopted by the Committee for the NEOs are as follows:

 

Name


 

Target as a
Percent of Salary


Dennis R. Wraase

  100%

Joseph M. Rigby

    60%

William T. Torgerson

    60%

Thomas S. Shaw

    60%

William J. Sim

    50%

Ed R. Mayberry

    50%

 

Under the Executive Incentive Compensation Plan, the performance criteria used as the basis for awards and the specific targets can vary from year to year. Generally, the financial targets are based on the Company’s annual financial plan. Other quantitative targets are set at levels that exceed the level of performance in prior years. For a discussion of the 2006 awards under the Executive Incentive Compensation Plan, see the section headed “Executive Incentive Compensation Plan Awards” following the 2006 Grants of Plan-Based Awards table below.

 

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Long-Term Incentive Plan Awards.    Long-term incentive awards are made under the Long-Term Incentive Plan (the “LTIP”). As discussed above, the Committee, as part of the 2005 review of executive compensation, approved design changes to the Company’s long-term incentive award program, with the result that (i) two-thirds of the targeted long-term incentive award opportunity consists of Performance Stock that vests to the extent that established performance objectives are achieved and (ii) the other one-third consists of Restricted Stock that vests on the basis of the executive’s continued employment.

 

In the Executive Market Pricing Review, the Consultant determined that the total direct compensation (consisting of salary, target annual cash incentive compensation, and target long-term incentive compensation) opportunity, like the Company’s total cash compensation opportunity, for the Company’s chief executive officer was significantly below, and for other executive officers was somewhat below, the midpoint of the competitive range. As a result, in conjunction with establishing a competitive salary range and the establishment of annual cash incentive compensation targets for each executive officer position, the Consultant recommended, and the Committee after extensive review adopted, target long-term incentive opportunities for each executive officer as a percentage of salary that are designed to raise the Company’s total direct compensation opportunity to a level that more closely approximates the midpoint of the comparison groups. The target levels adopted by the Committee for the NEOs are as follows:

 

Name


 

Target as a
Percent of Salary


Dennis R. Wraase

  200%

Joseph M. Rigby

  100%

William T. Torgerson

  100%

Thomas S. Shaw

  100%

William J. Sim

    70%

Ed R. Mayberry

    70%

 

Under the terms of the Restricted Stock awards, the executive has all rights of ownership with respect to the shares, including the right to vote the shares and the right to receive dividends on the shares. The executive is entitled to retain these dividends whether or not the shares vest at the end of the employment period.

 

With respect to the Performance Stock awards, the performance targets for each year in the three-year performance period typically are established relative to the performance of the Company in the year immediately preceding the first year of the three-year period, and are set at levels that reflect year-to-year improvement over the three-year period and further the Committee’s goal of rewarding executives only if only they deliver results that enhance shareholder value. The objective of the Committee is to set target levels, which, if achieved, would place the Company’s performance at the 75th percentile within the Peer Group.

 

If during the course of a performance period relating to an award of Performance Stock an extraordinary event occurs that the Committee expects to have a substantial effect on a performance objective during the period, the Committee, in its sole discretion, has the authority under the LTIP to revise the performance objective. Also under the terms of the LTIP, the Committee retains the discretion to adjust a performance award, whether or not the performance objectives are attained, based on such factors as the Committee determines in its sole discretion. If, at the end of the three-year performance period, shares are earned, the executive also will be entitled to receive additional shares of Company common stock equal to the number of shares that the executive would have owned at the end of the performance period had the cash dividends paid during the performance period on a number of shares equal to the number of shares earned been reinvested in additional shares of common stock. For a discussion of the 2006 awards under the LTIP, see the section headed “Long-Term Incentive Plan Awards” following the 2006 Grants of Plan-Based Awards table below and for a discussion of the vesting in 2006 of awards made in prior years under the LTIP, see the 2006 Option Exercises and Stock Vested table and the accompanying narrative.

 

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At-Risk versus Fixed Compensation.    The percentages of each NEO’s short-term and long-term incentive compensation opportunities relative to the executive’s salary as established by the Committee are designed to reflect the Committee’s view that, as the level of an executive’s responsibility increases, the percentage of the executive’s compensation that is at risk and tied to company or individual performance likewise should increase. The following table shows the allocation of each NEO’s total salary and short-term and long-term incentive compensation opportunities between fixed and at-risk compensation:

 

Name


 

Fixed Compensation


 

Target At-Risk
Compensation


Dennis R. Wraase

  25%   75%

Joseph M. Rigby

  38%   62%

William T. Torgerson

  38%   62%

Thomas S. Shaw

  38%   62%

William J. Sim

  45%   55%

Ed R. Mayberry

  45%   55%

 

Short-Term versus Long-Term Incentive Compensation.    The Committee also believes that with increasing seniority, a larger percentage of an executive’s compensation opportunity should be in the form of long-term incentive compensation. This reflects the view of the Committee that the senior executives should have a greater focus on developing and implementing the Company’s long term strategic goals. The following table shows the allocation between each NEO’s target short-term and long-term incentive compensation opportunities:

 

Name


 

Short-Term Incentive
Opportunity


 

Long-Term Incentive
Opportunity


Dennis R. Wraase

  33%   67%

Joseph M. Rigby

  38%   62%

William T. Torgerson

  38%   62%

Thomas S. Shaw

  38%   62%

William J. Sim

  42%   58%

Ed R. Mayberry

  42%   58%

 

Retirement Programs.    The Company’s retirements plans, including both its general employee retirement plan and its supplemental retirement plans, are discussed in detail in the narrative headed “Retirement Plans” following the Pension Benefits at December 31, 2006 table below. Under the Pepco Holdings Retirement Plan, all employees of the Company with at least five years of service are entitled to receive retirement benefits in accordance with the applicable benefit formula up to the maximum level that a qualified pension plan is permitted to provide consistent with Internal Revenue Code regulations.

 

The Company’s supplemental retirement plans (consisting of the Executive Retirement Plan and the Conectiv Supplemental Executive Retirement Plan (“Conectiv SERP”)) provide retirement benefits in addition to the benefits the individual receives under the Pepco Holdings Retirement Plan due to certain benefit calculation features which have the effect of augmenting the individual’s aggregate retirement benefit. If the benefit payment that otherwise would have been available under the applicable benefit formula of the Pepco Holdings Retirement Plan is reduced due to a contribution or benefit limit imposed by law, any participant in the Pepco Holdings Retirement Plan is entitled to a compensating payment under the supplemental retirement plan in which the individual participates. In addition, participants in the Pepco Holdings Retirement Plan, if designated by the Chief Executive Officer, are entitled to one or more of the following enhancements to the calculation of their retirement benefit: (i) the inclusion of compensation deferred under the Company’s deferred compensation plans in calculating retirement benefits, (ii) to the extent not permitted by the Pepco Holdings Retirement Plan, the inclusion of annual cash incentive compensation received by the participant in calculating retirement benefits, or (iii) the crediting of the participant with additional years of service.

 

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The various components of the Company’s supplemental retirement plans have been in effect for many years. The plans were adopted in order to assist the efforts of the Company to attract and retain executives by offering a total compensation package that is competitive with those offered by other companies, particularly other electric and gas utilities. As part of the 2005 review of executive compensation, the Committee directed the Consultant to review the Pepco Holdings Retirement Plan and the Company’s supplemental retirement plans, and was advised by the Consultant that the Company’s plans are fairly typical among the Peer Group companies.

 

All employees of the Company, including the NEOs, are entitled to participate on the same terms in the Company’s 401(k) savings plan (the “Savings Plan”), and as participants receive a 100% Company matching contribution on employee contributions up to 3% of annual salary and a 50% Company matching contribution on employee contributions in excess of 3% of annual salary up to 6% of annual salary. Executives of the Company, including each of the NEOs, also are eligible to participate in the PHI Executive and Director Deferred Compensation Plan which, as discussed below under the heading “Deferred Compensation Plan,” allows for deferrals (and credits corresponding to the Company matching contribution up to the limits described above) of amounts in excess of the limitations imposed on contributions to the Savings Plan by the Internal Revenue Code.

 

Health and Welfare Benefits.    The NEOs participate in the Company’s healthcare, life insurance, and disability insurance plans on the same terms as are made available to Company employees generally. With the exception of Company payment for an annual executive physical, as more fully described in Note 14 to the Summary Compensation Table, the Company has no health or welfare plans, programs, or arrangements that are available only to executives.

 

Other Perquisites and Personal Benefits.    As more fully described in Note 14 to the Summary Compensation Table, the Company provides its NEOs with certain perquisites and other personal benefits, including: (i) a Company car or a car allowance, (ii) Company-paid parking, (iii) tax preparation fees, (iv) certain club dues, and (v) personal use of Company-leased entertainment venues and Company-purchased tickets to sporting and cultural events when not otherwise used for business purposes. As part of the 2005 review of executive compensation, the Committee directed the Consultant to review the Company’s perquisites and other personal benefits provided to executives. As part of the 2005 review of executive compensation, the Consultant advised the Company that such perquisite and personal benefits were conservative and generally in line with those provided by the Peer Group companies.

 

Deferred Compensation Plan

 

Under the terms of the Company’s Executive and Director Deferred Compensation Plan (the “Deferred Compensation Plan”), which is described in greater detail in the narrative headed “Deferred Compensation Plans” following the Nonqualified Deferred Compensation at December 31, 2006 table below, the NEOs and other executives of the Company are permitted to defer the receipt of all or any portion of their compensation, including incentive compensation. In addition, to the extent an executive is prevented from making a contribution to the Savings Plan due to limitations imposed by the Internal Revenue Code, the executive is entitled to defer the excluded amount under the Deferred Compensation Plan and receive an additional credit under the Deferred Compensation Plan equal to the matching contribution, if any, that the Company would have made with respect to the excluded amount under the Savings Plan. Balances under the Deferred Compensation Plan are credited on a monthly basis with an amount corresponding to, as elected by the participant, any or a combination of: (i) interest at the prime rate or (ii) the return that would have been earned had the account balance been invested in any one or a combination of the investment funds selected by the Committee. This Deferred Compensation Plan is designed to allow participating executives to save for retirement in a tax-effective way. The Company funds its future financial obligations under the Deferred Compensation Plan through the purchase of Company-owned life insurance policies.

 

Severance and Change in Control Benefits

 

The employment agreements of each of the NEOs, each entered into at the time of the merger of Pepco and Conectiv, provide for severance payments and other benefits if the employment of the executive is terminated

 

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other than for “cause” or the executive voluntarily terminates his employment for certain specified reasons, whether or not such termination is in connection with a change in control of the Company. These provisions are generally designed to provide assurance to the executive that, if the executive’s employment is actually or constructively terminated by the Company, the executive will receive for a period of time thereafter the compensation and benefits that the executive would have received had the termination not occurred. These benefits also address the concern that the fear of job loss might influence the NEOs when considering strategic opportunities that may include a change of control of the Company.

 

The specific benefits to which the NEOs are entitled are described in detail under the heading “Termination of Employment and Change in Control Benefits” below and include:

 

   

A severance payment equal to three times the executive’s highest annual base salary and annual bonus for the year in which the termination of employment occurs or any of the three preceding years. This provision was customary for a senior executive in agreements of this type at the time the Company entered into the employment agreements with the respective NEOs.

 

   

A lump sum supplemental retirement benefit paid in cash, which represents the net present value of the additional pension benefits that the executive would have earned under the Pepco Holdings Retirement Plan and the supplemental retirement plan had the executive completed a specified additional number of years of service.

 

The other severance benefits, including the payment of a pro-rata portion of the executive’s annual bonus for the year of termination, the accelerated vesting of unvested shares of Restricted Stock and the vesting of unvested shares of Performance Stock to the extent the established performance objectives are achieved, are designed to assure the executive that he will receive the benefits that he otherwise would have received had the termination of employment not occurred.

 

The Company also has a Change in Control Severance Plan in which 53 executives currently participate who do not have employment agreements. Under this plan, if, within one year following a change in control, a participating executive’s employment is terminated by the Company without “cause” or is terminated by the executive for “good reason,” the executive will be entitled to termination benefits similar to those described above for executives with employment agreements, except with a severance payment equal to 1.5, 2 or 3 times the salary of the affected executive depending upon the executive’s position. The receipt of the benefits is contingent upon the execution by the employee of (i) a general release and a non-disparagement agreement and (ii) a covenant against competition with the Company or a solicitation of its employees, each in form and substance satisfactory to the Company.

 

Deductibility of Executive Compensation Expenses

 

Under Section 162(m) of the Internal Revenue Code, a public company is prohibited from deducting for federal income tax purposes compensation in excess of $1 million paid to any of the Company’s five highest paid executive officers, except that this prohibition does not apply to compensation that qualifies as “performance-based compensation.” Under the LTIP, which has been approved by the Company’s shareholders, shares of Performance Stock issued pursuant to the achievement of pre-established performance objectives qualify as performance-based compensation, except if the Committee were to alter the performance objectives after the commencement of the performance period or were to exercise its discretion to pay an award notwithstanding that the specified performance objectives were not satisfied. There may be circumstances where the Committee determines that it is in the best interests of the Company to take either of such actions with respect to one or more awards, even though the result may be a loss of a tax deduction for the compensation.

 

The issuance of shares of Restricted Stock under the LTIP does not qualify as performance-based compensation because the award vests on the basis of continued employment, rather than pre-established performance objectives. Because the Executive Incentive Compensation Plan has not been approved by shareholders, awards under the plan cannot qualify as performance-based compensation even when the payment of awards under the plan is based on the achievement of pre-established performance objectives.

 

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Stock Ownership Requirements

 

To align further the financial interests of the Company’s executives with those of the shareholders, the Board of Directors in 2005 adopted stock ownership requirements for officers of the Company. The requirements, which are expressed as a multiple of salary, are a function of the executive’s seniority:

 

Chief Executive Officer

   5 times salary

Executive Vice President, Vice Chairman

   3 times salary

Senior Vice President

   2 times salary

Vice President

   1 times salary

 

Each officer has until December 31, 2010, or five years from the date of his election as an officer, whichever is later, to achieve the required ownership level. An individual who is appointed as an officer or is promoted to a position with a higher stock ownership requirement has five years from the date of appointment or promotion to achieve the applicable stock ownership level. Shares of Company common stock owned through the Savings Plan, unvested shares of Restricted Stock, and the number of shares of Company common stock corresponding to the target level of the executive’s unearned Performance Stock awards are considered owned by the executive for the purpose of meeting the ownership requirement.

 

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Table of Contents

EXECUTIVE COMPENSATION

 

The following table sets forth compensation information for the Company’s principal executive officer, principal financial officer, and its three other most highly compensated executive officers employed as of December 31, 2006, determined on the basis of their total compensation for 2006, and including Ed R. Mayberry whose 2006 compensation exceeded the 2006 compensation of one or more of the three other most highly compensated executive officers employed at December 31, 2006. The information in this table includes compensation paid by the Company or its subsidiaries.

 

2006 SUMMARY COMPENSATION TABLE

 

Name and Principal Position


  Year

  Salary

  Bonus

 

Stock

Awards (11)


  Option
Awards


 

Non-Equity
Incentive
Plan
Compen-

sation (12)


 

Change in
Pension

Value and
Nonqualified
Deferred
Compen-

sation
Earnings (13)


 

All Other
Compen-

sation (14)


 

Total
Compen-

sation


Dennis R. Wraase

    Chairman, President

    and Chief Executive Officer

  2006   $ 950,000   $ 0   $ 1,280,884   $ 0   $ 0   $ 2,462,563   $ 228,103   $ 4,921,550

Joseph M. Rigby

    Senior Vice President

    and Chief Financial Officer

  2006     412,500     0     288,480     0     0     38,805     76,860     816,645

William T. Torgerson

    Vice Chairman and General Counsel

  2006     512,000     0     478,237     0     0     698,459     128,393     1,817,089

Thomas S. Shaw

    Executive Vice President and Chief Operating Officer

  2006     502,000     0     488,258     0     0     201,174     113,238     1,304,670

William J. Sim (15)

    Senior Vice President

  2006     298,000     0     228,773     0     0     194,515     1,708,466     2,429,754

Ed R. Mayberry

    Senior Vice President (16)

  2006     70,000     0     158,459     0     31,290     336,868     3,166,014     3,762,631

 

(11) Represents the dollar amount of expense recognized by the Company for financial statement reporting purposes in 2006, as determined in accordance with Financial Accounting Standard 123R, with respect to shares of restricted stock and performance share awards made to the executive in 2006 and in prior years under the LTIP. For a further description of these awards, see the discussion under the heading “Long-Term Incentive Plan Awards” below. The amount of the annual expense for the restricted stock awards was determined by dividing the market value of the shares as of the date of the grant by three (representing the number of years of service from the date of the grant required for the vesting of the award). The assumptions used to calculate the expense recognized for the performance share awards are set forth in Note 10 to the Company’s consolidated financial statements, which are included in the Company’s Annual Report to Shareholders attached as Annex B to this Proxy Statement.

 

(12) See the description of the Executive Incentive Compensation Plan following the 2006 Grants of Plan-Based Awards table below.

 

(13) Represents the aggregate increase in the actuarial present value of the executive’s accumulated benefits under all deferred benefit and actuarial pension plans from December 31, 2005, to December 31, 2006. Also includes “above-market earnings” (as defined by SEC regulations) on non-tax-qualified deferred compensation plans of $10,375 for Mr. Torgerson and $12,355 for Mr. Wraase. See discussion under the heading “Deferred Compensation Plans — Pepco Director and Executive Deferred Compensation Plan” below.

 

(14) The totals shown in this column consist of:

 

(a) Dividends paid on unvested shares of restricted stock held by the executive: Mr. Wrasse — $33,477; Mr. Rigby — $8,237; Mr. Torgerson — $7,983; Mr. Shaw — $7,827; Mr. Sim — $3,252; and

 

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Dr. Mayberry — $0. For a further description of these payments, see “Long-Term Incentive Plan Awards — Restricted Stock Program” below.

 

(b) The market value on December 31, 2006, of additional shares of Company common stock (calculated by multiplying the number of shares by the closing market price on December 29, 2006, the last trading day of the year) issued to the executive equal to the number of shares that the executive would have owned on December 31, 2006, (i) had the number of shares earned by the executive for the 2004 - 2006 performance share award cycle under the LTIP been issued to the executive on January 1, 2004, the commencement date of the performance cycle, and (ii) had the dividends on such shares been invested in additional shares of common stock: Mr. Wrasse — $117,905; Mr. Rigby — $29,702; Mr. Torgerson — $59,104; Mr. Shaw — $64,203; Mr. Sim — $31,498; and Dr. Mayberry — $29,400. For a further description of these payments, see “Long-Term Incentive Plan Awards — Performance Stock Program” below.

 

(c) Company-paid premiums on a term life insurance policy: Mr. Wrasse — $4,014; Mr. Rigby — $1,746; Mr. Torgerson — $2,197; Mr. Shaw — $2,159; Mr. Sim — $1,281; and Dr. Mayberry — $296.

 

(d) Company 401(k) matching contributions: Mr. Wrasse — $10,110; Mr. Rigby — $9,900; Mr. Torgerson — $10,006; Mr. Shaw — $9,374; Mr. Sim — $9,956; and Dr. Mayberry — $3,428.

 

(e) Company matching contributions on deferred compensation: Mr. Wrasse — $32,509; Mr. Torgerson — $13,228; and Mr. Sim — $2,772. For a further discussion, see “Deferred Compensation Plans — PHI Executive and Director Deferred Compensation Plan.”

 

(f) The following perquisites and other personal benefits (all amounts shown reflect cash payments made by the Company, except as otherwise stated)

 

Name


   Company
Car(i)


   Auto
Allowance(ii)


   Parking

   Tax
Preparation
Fee


   Financial
Planning
Fee


   Executive
Physical
Fee


   Club
Dues


Dennis R. Wraase

   $ 10,889    $ 0    $ 2,400    $ 3,500    $ 8,875    $ 281    $ 4,143

Joseph M. Rigby

     0      11,700      2,400      3,500      8,875      800      0

William T Torgerson

     11,910      0      2,400      3,500      8,875      720      8,470

Thomas S. Shaw

     0      11,700      2,400      3,500      8,875      800      2,400

William J. Sim

     12,315      0      2,400      3,500      8,875      3,849      0

Ed R. Mayberry

     0      2,925      420      3,500      8,875      0      0

 

  (i) Consists of lease and registration costs paid by the Company and variable costs, including gasoline, service and parts.

 

  (ii) Consists of a nonaccountable expense allowance to compensate executives who are not provided with a Company car.

 

In addition, in 2006, Company-leased entertainment venues and Company-purchased tickets to sporting and cultural events were made available to employees, including the executive officers listed in the Summary Compensation Table, for personal use when not being used by the Company for business purposes. There was no incremental cost to the Company of providing these benefits.

 

(15) Mr. Sim retired on December 31, 2006. The column headed “All Other Compensation” includes (i) a severance payment of $1,341,000, (ii) a payment of $264,523 under the Supplemental Executive Retirement Benefit Structure of the Executive Retirement Plan, and (iii) the fair market value ($23,245) of his Company car on December 31, 2006, which he was permitted to retain. For a further discussion of the payments and benefits received by Mr. Sim in connection with his retirement, see “Termination of Employment and Change in Control Benefits — Sim Retirement Arrangements.”

 

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(16) Dr. Mayberry retired on April 1, 2006. The column headed “All Other Compensation” includes (i) a severance payment of $1,226,076, (ii) a payment of $802,673 under the Supplemental Executive Retirement Benefit Structure of the Executive Retirement Plan, (iii) a payment of $840,526 under the Executive Performance Supplemental Retirement Benefit Structure of the Executive Retirement Plan, (iv) a non-compete payment of $280,000 and (v) a lump-sum supplemental retirement benefit of $247,895. For a further discussion of the payments and benefits received by Dr. Mayberry in connection with his retirement, see “Termination of Employment and Change in Control Benefits — Mayberry Retirement Arrangements.”

 

Employment Agreements

 

Each of the NEOs was an employee of the Company as of December 31, 2006, with the exception of Dr. Mayberry, who retired on April 1, 2006. Mr. Sim retired on December 31, 2006. The Company has employment agreements with each of Messrs. Wraase, Rigby, Torgerson and Shaw, and had employment agreements with each of Mr. Sim and Dr. Mayberry prior to his retirement.

 

   

Mr. Wraase’s agreement provides for his employment until his normal retirement date under the Company’s defined benefit pension plan of April 1, 2009.

 

   

Mr. Torgerson’s agreement provides for his employment until his normal retirement date under the Company’s defined benefit retirement plan of June 1, 2009.

 

   

Mr. Rigby’s agreement provides for his employment through August 1, 2008.

 

   

Mr. Shaw’s agreement provides for his employment through August 1, 2007.

 

   

The agreements of Mr. Sim and Dr. Mayberry each provided for his employment through August 1, 2008.

 

Each executive’s employment agreement provides for (i) an annual salary in an amount not less than his base salary in effect as of August 1, 2002, with the condition that, if at any time during the term of the agreement the annual base salary of the executive is increased, it may not subsequently be decreased during the remainder of the term of the agreement, (ii) incentive compensation as determined by the Board of Directors under plans applicable to senior executives of the Company, (iii) participation, in a manner similar to other senior executives, in retirement plans, fringe benefit plans, supplemental benefit plans and other plans and programs provided by the Company for its executives or employees, and (iv) as more fully described below under the heading “Termination of Employment and Change in Control Benefits,” various payments and other benefits in connection with the termination of the executive’s employment.

 

Relationship of Salary and Bonus to Total Compensation

 

The following table sets forth the 2006 salary of each of the NEOs as a percentage of the executive’s Total Compensation, as set forth in the Summary Compensation Table:

 

Name

  Salary as a Percentage
of Total Compensation


 

Dennis R. Wraase

  19.3 %

Joseph M. Rigby

  50.5 %

William T. Torgerson

  28.2 %

Thomas S. Shaw

  38.5 %

William J. Sim

  12.3 %

Ed R. Mayberry

  1.9 %

 

The percentages for Mr. Sim and Dr. Mayberry reflect that a significant portion of their total 2006 compensation involved payments associated with their retirement. Of the continuing executives, the lower percentage for Mr. Wraase evidences in substantial part the higher at-risk component of his total compensation. For a further discussion see the “Compensation Discussion and Analysis.”

 

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Table of Contents

2006 Incentive Compensation Awards

 

2006 GRANTS OF PLAN-BASED AWARDS

 

Name


 

Grant
Date


  Estimated Future Payouts
Under Non-Equity
Incentive Plan Awards


  Estimated Future Payouts
Under Equity
Incentive Plan Awards


  All
Other
Stock
Awards:
Number
of
Shares
of Stock
or Units


  Grant Date
Fair Value
of Stock
and Option
Awards
(17)


    Threshold

  Target

  Maximum

  Threshold
Number
of Shares


  Target
Number
of
Shares


  Maximum
Number
of Shares


   
        ($)   ($)   ($)                   ($)

Dennis R. Wraase

                                           

Executive Incentive Compensation Plan

  1-26-06   $ 0   $ 950,000   $ 1,710,000                      

LTIP—Restricted Stock Program

  1-26-06                                 28,484   $ 663,108

LTIP—Performance Stock Program

  1-26-06                     0   56,967   113,934         1,326,192

Joseph M. Rigby

                                           

Executive Incentive Compensation Plan

  1-26-06     0     240,000     432,000                      

LTIP—Restricted Stock Program

  1-26-06                                 5,997     139,610

LTIP—Performance Stock Program

  1-26-06                     0   11,993   23,986         279,197

William T. Torgerson

                                           

Executive Incentive Compensation Plan

  1-26-06     0     307,200     552,960                      

LTIP—Restricted Stock Program

  1-26-06                                 7,676     178,697

LTIP—Performance Stock Program

  1-26-06                     0   15,351   30,702         357,371

Thomas S. Shaw

                                           

Executive Incentive Compensation Plan

  1-26-06     0     301,200     542,160                      

LTIP—Restricted Stock Program

  1-26-06                                 7,526     175,205

LTIP—Performance Stock Program

  1-26-06                     0   15,051   30,102         350,387

William J. Sim

                                           

Executive Incentive Compensation Plan

  1-26-06     0     149,000     268,200                      

LTIP—Restricted Stock Program

  1-26-06                                 3,127     72,797

LTIP—Performance Stock Program

  1-26-06                     0   6,255   12,510         145,616

Ed R. Mayberry

                                           

Executive Incentive Compensation Plan

  1-26-06     0     35,000     63,000                      

 

(17) Represents the grant date fair value, as determined in accordance with Financial Accounting Standard 123R, of shares of restricted stock granted under the Restricted Stock Program and performance share awards under the Performance Stock Program. The value of the shares of restricted stock is calculated by multiplying the number of shares granted by the closing price for PHI common stock on January 26, 2006. The value of the performance share awards is calculated by multiplying the target number of shares that the executive is entitled to earn by the closing price for PHI common stock on January 26, 2006.

 

Executive Incentive Compensation Plan Awards

 

Under the Executive Incentive Compensation Plan, participating executives are entitled to receive annual cash bonuses to the extent performance goals established by the Compensation/Human Resources Committee are achieved. The performance goals can consist entirely, or be a combination, of (i) performance objectives for the Company as a whole, (ii) performance objectives for a particular business unit or (iii) individual performance objectives.

 

Under the plan as in effect for 2006, each of the executive officers listed in the Summary Compensation Table had the opportunity to earn a cash bonus of between 0% and 180% of the following percentage of his 2006 base salary: Mr. Wraase: 100%, Messrs. Rigby, Torgerson and Shaw: 60%, and Mr. Sim and Dr. Mayberry: 50% (in the case of Dr. Mayberry pro-rated for the three-month period of his employment in 2006).

 

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The performance goals for Messrs. Wraase, Rigby, Torgerson and Shaw consisted entirely of corporate performance goals, the performance goals for Mr. Sim consisted of 40% corporate performance goals and 60% performance goals related to the Power Delivery business unit, and the performance goals for Dr. Mayberry consisted of 40% corporate performance goals and 60% performance goals related to the Pepco Energy Services business unit.

 

The corporate performance goals for 2006 consisted of: (i) Company net earnings relative to budgeted net earnings of $301.9 million (40%), (ii) Company free cash flow relative to budgeted free cash flow of $9.4 million (25%), (iii) utility customer satisfaction as measured by the results of customer surveys (15%), (iv) diversity as measured by the attainment or good faith efforts toward the attainment of established affirmative action goals (10%), and (v) safety as measured by the absence of fatalities and the number of recordable injuries and fleet accidents (10%). Free cash flow is defined as net income available for common stock dividends, plus depreciation and amortization, plus or minus changes in working capital and minus capital expenditures.

 

The Power Delivery business unit goals for 2006 consisted of: (i) Power Delivery net earnings relative to budgeted net earnings of $34 million (40%), (ii) Power Deliver overhead and maintenance spending relative to a budgeted amount of $153 million (15%), (iii) Power Delivery capital expenditures relative to a budgeted amount of $18.4 million (10%), (iv) utility customer satisfaction as measured by the results of customer surveys (15%), (v) diversity as measured by the attainment or good faith efforts toward the attainment of established affirmative action goals (10%) and (vi) safety as measured by the absence of fatalities and the number of recordable injuries and fleets accidents (10%).

 

The Pepco Energy Services business unit goals for 2006 consisted of: (i) Pepco Energy Services revenues relative to budgeted revenues of $1.7 billion (30%), (ii) Pepco Energy Services earnings, without taking into account earnings attributable to Pepco Energy Services’ power plants, relative to a budgeted amount of $23 million (60%), and (iii) earnings attributable to Pepco Energy Services’ power plants relative to a budget amount of $2.8 million (10%).

 

These 2006 award opportunities are shown in the above table under the heading “Estimated Future Payouts Under Non-Equity Incentive Plan Awards,” with the threshold representing overall performance at the 50% level (meaning no award is made if performance is below the 50% level relative to the target), the target amount representing overall performance at the 100% level, and the maximum amount representing overall performance at or above the 180% level.

 

In 2006, the Corporate and the Power Delivery performance with respect to each of the performance goals was below the target level, and, accordingly, none of Messrs. Wraase, Rigby Torgerson, Shaw or Sim received an award under the Executive Incentive Compensation Plan. For Pepco Energy Services, revenues and earnings attributable to power plants earnings were below the target, whereas earnings (excluding earnings attributable to power plants) substantially exceeded the target, resulting in a payment at the 149% level for Dr. Mayberry.

 

Long-Term Incentive Plan Awards

 

In January 2006, the Compensation/Human Resources Committee established award opportunities pursuant to the Performance Stock Program under the LTIP and made awards of restricted stock pursuant to the Restricted Stock Program under the LTIP to each of the executive officers listed in the Summary Compensation Table (other than Dr. Mayberry, whose retirement on April 1, 2006, was anticipated by the Committee).

 

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Table of Contents

Performance Stock Program

 

The award opportunities established under the Performance Stock Program, which account for two-thirds of each participant’s aggregate 2006 LTIP award opportunity, relate to performance over a three-year period beginning in 2006 and ending in 2008.

 

   

For Messrs. Wraase, Rigby, Torgerson and Shaw, 75% of their award opportunity is based on a Company earnings per share goal and 25% of their award opportunity is based on a Company free cash flow per share goal.

 

   

For Mr. Sim, 37.5% of his award opportunity is based on a Company earnings per share goal, 37.5% is based on a Power Delivery earnings goal, 12.5% is based on a Company free cash flow per share goal and 12.5% is based on a Power Delivery free cash flow goal.

 

The following table sets forth the performance targets for each year in the three-year period:

 

     2006

   2007

   2008

Company

                    

Earnings per share

   $ 1.55    $ 1.61    $ 1.67

Free cash flow per share

   $ .58    $ .95    $ 1.24

Power Delivery Business Unit

                    

Earnings (in millions)

   $ 233.5    $ 244    $ 255

Free cash flow (in millions)

   $ 90.1    $ 176.2    $ 201.5

 

The earnings targets exclude extraordinary items and gains or losses relating to matters that are not reflective of the Company’s ongoing business. The formula used to calculate free cash flow and free cash flow per share is determined in the same manner as described above with respect to the Executive Incentive Compensation Plan.

 

These award opportunities are shown in the above table under the heading “Estimated Future Payouts Under Equity Incentive Plan Awards,” with the threshold number of shares representing performance at 90% of the target level, the target number of shares representing performance at the target level, and the maximum number of shares representing performance at or above 115% of the target level. The award that the executive earns at the end of the three-year performance period is equal to the average of the award percentage for each of the three years, with the award percentage for performance below the threshold target level being zero and the maximum award percentage for performance above the target being 200%. If, however, during the course of the three-year performance period, a significant event occurs, as determined in the discretion of the Compensation/Human Resources Committee, that the Committee expects to have a substantial effect on a performance objective during the period, the Committee may revise performance targets. If at the end of the three-year performance period shares are earned, the executive also will be entitled to receive additional shares of Company common stock equal to the number of shares that the executive would have owned at the end of the performance period had the cash dividends that would have been paid during the performance period on a number of shares equal to the number of shares earned been reinvested in additional shares of common stock.

 

Restricted Stock Program

 

Under the Restricted Stock Program, each of the executive officers listed in the Summary Compensation Table (other than Dr. Mayberry, whose retirement on April 1, 2006, was anticipated by the Committee) received a grant of shares of Restricted Stock, which accounts for one-third of the executive’s aggregate 2006 LTIP award opportunity. The entire awards of shares of Restricted Stock, which are shown in the above table under the heading “All Other Stock Awards: Number of Shares of Stock or Units,” are subject to forfeiture if the employment of the executive terminates before January 26, 2009, except that, unless the Committee determines otherwise, and subject to any contrary provision in the executive officer’s employment agreement (see “Termination of Employment and Change in Control Benefits — Employment Agreements” below), in the event

 

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Table of Contents

of death, disability or retirement of the executive or if the employment of the executive is terminated or the executive terminates his employment for “good reason” following a “change in control” (see “Termination of Employment and Change in Control Benefits — Long-Term Incentive Plan” below), the award is prorated to the date of termination. During the vesting period, the executive has all rights of ownership with respect to the shares, including the right to vote the shares and the right to receive dividends on the shares. The executive is entitled to retain the dividends paid whether or not the shares vest.

 

OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2006

 

     Option Awards

   Stock Awards

Name


  

Number of

Securities

Underlying

Unexercised

Options

(Exercisable)


   Number of
Securities
Underlying
Unexercised
Options
(Unexercisable)


   Equity
Incentive
Plan
Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options


  

Option
Exercise

Price


   Option
Expiration
Date


   Number
of
Shares
or Units
of Stock
That
Have
Not
Vested


   Market
Value of
Shares or
Units of
Stock
That
Have Not
Vested
(18)


  

Equity

Incentive
Plan
Awards:
Number
of
Unearned
Shares,
Units or
Other
Rights
That
Have Not
Vested
(19)


   Equity
Incentive
Plan
Awards:
Market or
Payout
Value of
Unearned
Shares,
Units or
Other
Rights That
Have Not
Vested (18)


Dennis R. Wraase

                                                  

Awarded 1-26-06 (20)

                              28,484    $ 740,869    56,967    $ 1,481,712

Awarded 1-2-05 (21)

                                          45,500      1,183,455

Awarded 1-2-04 (22)

                                          39,300      1,022,193

Awarded 1-1-01

   48,000    0    0    $ 24.5900    12-31-10                        

Awarded 5-1-98

   21,843    0    0      24.3125    4-30-08                        

Joseph M. Rigby

                                                  

Awarded 1-26-06 (20)

                              5,997      155,982    11,993      311,938

Awarded 1-2-05 (21)

                                          11,200      291,312

Awarded 1-2-04 (22)

                                          9,900      257,499

Awarded 1-2-02

                              1,923      50,017            

William T. Torgerson

                                                  

Awarded 1-26-06 (20)

                              7,676      199,653    15,351      399,280

Awarded 1-2-05 (21)

                                          20,200      525,402

Awarded 1-2-04 (22)

                                          19,700      512,397

Awarded 1-1-01

   30,000    0    0      24.5900    12-31-10                        

Awarded 5-1-98

   21,843    0    0      24.3125    4-30-08                        

Thomas S. Shaw

                                                  

Awarded 1-26-06 (20)

                              7,526      195,751    15,051      391,477

Awarded 1-2-05 (21)

                                          20,100      522,801

Awarded 1-2-04 (22)

                                          21,400      556,614

Awarded 1-2-02

   68,333    0    0      22.4375    1-2-12                        

William J. Sim

                                                  

Awarded 1-26-06 (20)

                              3,127      81,333    6,255      162,693

Awarded 1-2-05 (21)

                                          9,800      254,898

Awarded 1-2-04 (22)

                                          10,500      273,105

Awarded 1-1-01

   30,000    0    0      24.5900    12-31-10                        

Awarded 5-1-98

   13,934    0    0      24.3125    4-30-08                        

Ed R. Mayberry

                                                  

Awarded 1-2-05 (21)

                                          9,800      254,898

Awarded 1-2-04 (22)

                                          8,900      231,489

Awarded 1-1-02

   10,300    0    0      22.5700    3-31-11                        

Awarded 1-1-01

   10,300    0    0      24.5900    12-31-10                        

Awarded 1-1-00

   10,300    0    0      22.4375    12-31-09                        

Awarded 5-1-98

   13,934    0    0      24.3125    4-30-08                        

 

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(18) Calculated by multiplying the number of shares shown in the preceding column by $26.01, the closing market price on December 29, 2006, the last trading day of the year.

 

(19) Reflects the number of shares that would be earned if the target level of performance is achieved.

 

(20) For a discussion of the vesting provisions relating to this award, see the description of the Restricted Stock Program under the heading “Long-Term Incentive Plan Awards — Restricted Stock Program” above.

 

(21) These awards, made under the LTIP, entitle the participating executive to earn shares of common stock to the extent the pre-established performance objective for the three-year performance period beginning on January 1, 2005, and ending on December 31, 2007, is satisfied. The performance objective for the 2005 to 2007 performance period is based on the Company’s total shareholder return compared to other companies in a peer group comprised of 20 gas and electric distribution companies. A participant is eligible to earn a number of shares of common stock ranging from 0% to 200% of the target performance award depending on the extent to which the performance objective is achieved. The performance objective was fixed at the time the awards were made; however, if during the course of the performance period, a significant event occurs, as determined in the sole discretion of the Compensation/Human Resources Committee, that the Committee expects to have a substantial effect on total shareholder return during the period, the Committee may revise the targeted performance objective. The shares of common stock earned by a participant will be fully vested on the date the performance award is earned.

 

(22) These awards, made under the LTIP, entitle the participating executive to earn shares of common stock to the extent the pre-established performance objective for the three-year performance period beginning on January 1, 2004, and ending on December 31, 2006, is satisfied. The performance objective for the 2004 to 2006 performance period is based on the Company’s total shareholder return compared to other companies in a peer group comprised of 20 gas and electric distribution companies. A participant is eligible to earn a number of shares of common stock ranging from 0% to 200% of the target performance award depending on the extent to which the performance objective is achieved. The performance objective is fixed at the time the awards are made; however, if during the course of the performance period, a significant event occurs, as determined in the sole discretion of the Compensation/Human Resources Committee, that the Committee expects to have a substantial effect on total shareholder return during the period, the Committee may revise the targeted performance objective. The shares of common stock earned by a participant will be fully vested on the date the performance award is earned.

 

2006 OPTION EXERCISES AND STOCK VESTED

 

     Option Awards

   Stock Awards

Name

   Number of
Shares
Acquired on
Exercise


   Value Realized
on Exercise (23)


   Number of
Shares
Acquired on
Vesting (24)


  

Value Realized

on Vesting (25)


Dennis R. Wraase

   96,000    $ 202,365    87,333    $ 2,174,420

Joseph M. Rigby

   16,025      87,130    19,337      486,611

William T. Torgerson

   69,000      143,463    38,095      959,328

Thomas S. Shaw

   0      0    87,093      2,074,727

William J. Sim

   40,300      103,743    20,503      515,957

Ed R. Mayberry

   0      0    17,975      454,382

 

(23) Calculated by aggregating with respect to all of the options exercised the amount by which the closing market price of the Company common stock on the date of exercise exceeded the option exercise price.

 

(24)

Consisting of (i) shares earned for the 2004 to 2006 performance share award cycle under the LTIP (Mr. Wrasse — 63,090 shares; Mr. Rigby — 15,893 shares; Mr. Torgerson — 31,627 shares;

 

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Mr. Shaw — 34,355 shares; Mr. Sim — 16,853 shares; and Dr. Mayberry — 15,732 shares), as further described below, and (ii) shares earned under the Merger Integration Success Program under the LTIP based on performance criteria for a performance period ended December 31, 2003, which together with reinvested dividends vested in 2006 (Mr. Wrasse — 9,421 shares; Mr. Rigby — 3,444 shares; Mr. Torgerson — 6,468 shares; Mr. Shaw — 7,867 shares; Mr. Sim — 3,650 shares; and Dr. Mayberry — 2,243 shares). Also includes (i) for Mr. Wraase 14,822 shares of restricted stock granted as a retention award in 2003 that vested in 2006 and (ii) for Mr. Shaw 44,871 shares of restricted stock that vested in 2006, which originated as a restricted stock award under the Conectiv Long-Term Incentive Plan and converted into shares of restricted PHI common stock in connection with the merger of Pepco and Conectiv in 2002.

 

(25) Represents the aggregate market value of the vested shares calculated by multiplying the number of shares that vested on a given date by the closing market price of the Company common stock on that date,

 

For the three-year performance cycle ending December 31, 2006, under the LTIP, participating executives, including each of the executive officers listed in the Summary Compensation Table, were entitled to earn shares of common stock based on the Company’s total shareholder return (consisting of stock price appreciation and dividends) compared to that of other companies in a peer group comprised of 21 gas and electric distribution companies (including the Company) over the three-year period. During the three-year period, the Company had a total shareholder return of 52.64%, exceeding the medium total shareholder return among the peer group companies of 50.38% and ranking the Company tenth within the group of 21. This result entitled each of the participating executives to receive an award of shares equal to 140% of the target number of shares.

 

PENSION BENEFITS

AT DECEMBER 31, 2006

 

Name


   Plan Name

   Number of Years
of Credited
Service (26)


   Present
Value
of
Accumulated
Benefits (27)


   Payments
During
Last
Fiscal Year


Dennis R. Wraase

   Pepco General Retirement Subplan    32 yrs. 11 mos.    $ 1,226,434    $ 0
     Executive Retirement Plan    37 yrs. 9 mos.      9,477,726      0

Joseph M. Rigby

   Conectiv Cash Balance Subplan    27 yrs. 11 mos.      616,948      0
     Conectiv SERP    27 yrs. 11 mos.      402,250      0

William T. Torgerson

   Pepco General Retirement Subplan    24 yrs. 2 mos.      740,515      0
     Executive Retirement Plan    37 yrs. 7 mos.      3,742,755      0

Thomas S. Shaw

   Conectiv Cash Balance Subplan    35 yrs. 5 mos.      1,525,831      0
     Conectiv SERP    38 yrs. 5 mos.      5,859,255      0

William J. Sim

   Pepco General Retirement Subplan    29 yrs. 9 mos.      881,306      0
     Executive Retirement Plan    37 yrs. 0 mos.      1,357,629      0

Ed R. Mayberry (28)

   Pepco General Retirement Subplan    25 yrs. 7 mos.      864,282      55,041
     Executive Retirement Plan    27 yrs. 7 mos.      273,524      17,419

 

(26) Number of years of service credited at December 31, 2006.

 

(27)

Represents the actuarial present value, in the case of Messrs. Wraase, Rigby, Torgerson and Shaw, of the executive’s accumulated pension benefit calculated as of December 31, 2006, assuming the executive retires

 

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at the earliest time he may retire under the applicable plan without any benefit reduction due to age and, in the case of Mr. Sim and Dr. Mayberry, of the executive’s actual retirement benefit. The valuation method and all material assumptions applied in calculating the actuarial present value are set forth in Note 6 to the Company’s consolidated financial statements which are included in the Company’s Annual Report to Shareholders attached as Annex B to this Proxy Statement.

 

(28) In April 2006, Dr. Mayberry received lump sum payments of $802,673 under the Supplemental Executive Retirement Benefit Structure and $840,526 under the Executive Performance Supplemental Retirement Benefit Structure of the Executive Retirement Plan, representing payments to which he was entitled by reason of his retirement. See “Termination of Employment and Change in Control Benefits — Mayberry Retirement Arrangements.”

 

Retirement Plans

 

The Company’s retirement plans consist of a tax-qualified defined benefit pension plan and two supplemental executive retirement plans.

 

The Pepco Holdings Retirement Plan

 

The Pepco Holdings Retirement Plan consists of several subplans. Each of the executives listed in the Summary Compensation Table participates in either the Pepco General Retirement Subplan or the Conectiv Cash Balance Subplan.

 

Pepco General Retirement Subplan.    All employees who were employed by Pepco on August 1, 2002, the date of the merger of Pepco and Conectiv, are eligible to participate in the Pepco General Retirement Subplan. The plan provides participating employees who have at least five years of service with retirement benefits based on the participant’s average salary for the final three years of employment and the number of years of credited service under the plan at the time of retirement. Normal retirement age under the Pepco General Retirement Subplan is 65. Participants who have reached age 55 and have at least 30 years of credited service are eligible for early retirement without any reduction in benefits. Participants who have reached age 55 and who have 10 years of credited service are eligible for retirement benefits prior to normal retirement age, at a benefit level that is reduced from the benefit level at normal retirement age by 2% for each year that the early retirement date precedes the normal retirement date. Plan benefits are partially offset by the Social Security benefits received by the participant. Benefits under the plan are paid in the form of a monthly annuity selected by the participant from among several available annuity options. Mr. Wraase and Mr. Torgerson are participants in the Pepco General Retirement Subplan. Mr. Wraase is eligible for retirement under the plan without any reduction in benefits and Mr. Torgerson is eligible for early retirement with reduced benefits. If Mr. Torgerson had retired on December 31, 2006, the actuarial present value of his retirement benefit under the Pepco General Retirement Subplan as of that date would have been $747,102; however, the additional supplemental retirement benefit he would be entitled to receive under the Supplemental Executive Retirement Benefit Structure of the Executive Retirement Plan, as described below, would offset the reduction in benefits that he would have incurred under the Pepco General Retirement Subplan by reason of his early retirement. Mr. Sim and Dr. Mayberry each retired before becoming eligible for early retirement without any reduction in benefits. In each case, however, the supplemental retirement benefits he has received or is entitled to receive under the Supplemental Executive Retirement Benefit Structure of the Executive Retirement Plan, as described below, offset the reduction in benefits that he incurred under the Pepco General Retirement Subplan by reason of his early retirement. See “Termination of Employment and Change in Control Benefits — Sim Retirement Arrangements” and “Termination of Employment and Change in Control Benefits — Mayberry Retirement Arrangements.”

 

Conectiv Cash Balance Subplan.    Most non-unionized employees who were employed by Conectiv on August 1, 2002, are eligible to participate in the Conectiv Cash Balance Subplan, including Messrs. Rigby and Shaw. The Conectiv Cash Balance Subplan is a cash balance pension plan. Under the plan, a record-keeping

 

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account in a participant’s name is credited with an amount equal to a percentage, which varies depending on the participant’s age at the end of the plan year, of the participant’s total pay, consisting of base pay, overtime and bonuses. Also, participants in the Atlantic City Electric Retirement Plan, in which Mr. Rigby participated, and the Delmarva Retirement Plan, in which Mr. Shaw participated, who had at least ten years of credited service as of December 31, 1998, the inception date of the Conectiv Cash Balance Subplan, are eligible to receive additional transition credits until the participant’s combined years of service under the prior plan and the Conectiv Cash Balance subplan total 35.

 

Participants employed on the inception date of the Conectiv Cash Balance Subplan were credited with an initial cash balance equal to the present value of their annuity benefits as of that date earned under the Atlantic City Electric Retirement Plan or the Delmarva Retirement Plan. Each participant’s account balance is supplemented annually with interest credits equal to the prevailing 30-year U.S. Treasury bond rate. Benefits become vested after five years of service. When a participant terminates employment (regardless of age), the amount credited to his or her account, at the election of the participant, is converted into one of several actuarially equivalent annuities selected by the participant or is paid to the participant in a lump sum (which cannot exceed 6.5 times the participant’s final average compensation). For 2006, Mr. Rigby had a Company credit percentage of 9%, and until December 31, 2013, receives an annual transition credit of 4%, of total pay. For 2006, Mr. Shaw had a Company credit percentage of 10%, and until July 26, 2006, received an annual transition credit of 4%, of total pay.

 

The Conectiv Cash Balance Subplan also provides for certain “grandfathered” rights that existed under the Delmarva Retirement Plan and under the Atlantic City Electric Retirement Plan, which apply to employees who had either 20 years of credited service or had attained age 50 on or before January 1, 1999. Under these grandfathering provisions, employees who participated in the Delmarva Retirement Plan or the Atlantic City Electric Retirement Plan are assured a minimum retirement benefit calculated for all years of service up to the earlier of December 31, 2008, or retirement, according to their original benefit formula under the applicable plan. There is no Social Security offset under either the Delmarva Retirement Plan or the Atlantic City Electric Retirement Plan. Normal retirement age under both the Delmarva Retirement Plan and the Atlantic City Electric Retirement Plan is 65. Under the Delmarva Retirement Plan, participants who have reached age 55 and have at least 15 years of continuous service are eligible for retirement benefits prior to normal retirement age, at a reduced level of benefit that is a function of retirement age and years of service. Under the Atlantic City Electric Retirement Plan, participants who have reached age 55 and have at least 5 years of credited service are eligible for retirement without any reduction in the benefits they would be entitled to receive at normal retirement age. Benefits under the Atlantic City Electric Retirement Plan are paid either in the form of a monthly annuity selected by the participant from among several available annuity options or in a lump sum of an actuarial equivalent amount. Benefits under the Delmarva Retirement Plan are payable only in the form of a monthly annuity selected by the participant from several actuarially equivalent annuity options. At the time of an employee’s retirement, the benefit under the Delmarva Retirement Plan or the Atlantic City Electric Retirement Plan is compared to the employee’s cash balance account under the Conectiv Cash Balance Subplan and the employee will receive whichever is greater. On December 31, 2008, the participant’s grandfathered benefit under the Delmarva Retirement Plan or Atlantic City Electric Retirement Plan will be frozen, and all future benefit accruals will be under the cash balance formula of the Conectiv Cash Balance Subplan.

 

Mr. Rigby continues to accrue benefits under the Atlantic City Electric Retirement Plan formula and Mr. Shaw continues to accrue benefits under the Delmarva Retirement Plan formula. In the case of Mr. Rigby, the present value of accumulated benefits under the Conectiv Cash Balance Subplan, as shown in the Pension Benefits at December 31, 2006 table above, reflects the value of his grandfathered benefits under the Atlantic City Electric Retirement Plan, which exceeds the value of his accumulated benefits as otherwise calculated under the Conectiv Cash Balance Subplan. In the case of Mr. Shaw, the present value of accumulated benefits under the Conectiv Cash Balance Subplan, as shown in the Pension Benefits at December 31, 2006 table above, reflects the value of his grandfathered benefits under the Delmarva Retirement Plan, which exceeds the value of his accumulated benefits as otherwise calculated under the Conectiv Cash Balance Subplan.

 

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Mr. Shaw is eligible for early retirement under the terms of the Delmarva Retirement Plan at a reduced benefit level from that to which he would be entitled at normal retirement age. If Mr. Shaw had retired on December 31, 2006, the net present value of his retirement benefits as of that date, calculated using the Delmarva Retirement Plan formula, which would exceed his cash balance under the Conectiv Cash Balance Subplan, would have been $667,019; however, the additional supplemental retirement benefit he would be entitled to receive under the Conectiv SERP, as described below, would offset the reduction in benefits that he would have incurred by reason of his early retirement. Mr. Rigby is not eligible for early retirement under the Atlantic City Electric Retirement Plan formula of the Conectiv Cash Balance Subplan. At December 31, 2006, the amount credited to his account under the Conectiv Cash Balance Subplan was $709,528. Had Mr. Rigby retired on that date, that balance, at his election, would have been converted into one of several actuarially equivalent annuities or would have been paid to him in a lump sum.

 

Executive Retirement Plan

 

The Executive Retirement Plan is a non-tax-qualified supplemental retirement plan. Eligibility to participate in the Executive Retirement Plan is determined by the Company’s Chief Executive Officer (and, in the case of the Chief Executive Officer, by the Board of Directors). Each of Messrs. Wraase and Torgerson is, and each of Mr. Sim and Dr. Mayberry was at the time of his retirement, designated as a participant in each of the benefit structures under the Executive Retirement Plan described below. The following benefit structures make up the Executive Retirement Plan:

 

Supplemental Benefit Structure.    Under provisions of the Internal Revenue Code, the level of a participant’s pension benefit under a tax-qualified pension plan and the amount of compensation that may be taken into account in calculating that benefit are limited (the “Qualified Plan Limitations”). In addition, under the terms of the Pepco Holdings Retirement Plan salary deferrals elected by the participant under the Company’s deferred compensation plans (other than the participant’s pre-tax contributions made under the PHI Retirement Savings Plan) are not taken into account as compensation for purposes of calculating a participant’s retirement benefit. If applicable, these provisions have the effect of reducing the participant’s retirement benefit relative to what the participant otherwise would be entitled to receive under the plan’s benefit formula. If a participant’s retirement benefits under the Pepco Holdings Retirement Plan are reduced by either or both of these limitations, the Company, under the Supplemental Benefit Structure, will pay a supplemental retirement benefit to a participant equal to the difference between (i) the participant’s actual benefit under the Pepco Holdings Retirement Plan and (ii) what the participant would have received under the Pepco Holdings Retirement Plan (A) were the Qualified Plan Limitations not applicable and (B) had the deferred compensation earned by the executive that was excluded from the executive’s compensation base used in determining retirement benefits under the Pepco Holdings Retirement Plan been included in such compensation base. The benefit under the Supplemental Benefit Structure vests under the same terms and conditions as the participant’s retirement benefits under the Pepco Holdings Retirement Plan. Messrs. Wraase, Torgerson and Sim and Dr. Mayberry are participants in the Supplemental Benefit Structure. The purpose of the Supplemental Benefit Structure is to enable participants to receive the full retirement benefits they are entitled to receive under the Pepco Holdings Retirement Plan without reduction due the Internal Revenue Code limits and compensation deferral elections made by the participant.

 

Supplemental Executive Retirement Benefit Structure.    Under the Supplemental Executive Retirement Benefit Structure, a participating executive whose employment by the Company terminates on or after age 59 for any reason other than death (or prior to age 59, if such termination follows a change in control of the Company) is entitled to a supplemental retirement benefit equal to the difference between (i) the executive’s actual benefit under the Pepco Holdings Retirement Plan and his supplemental benefits under the Supplemental Benefit Structure and the Executive Performance Supplemental Retirement Benefit Structure (as described below) and (ii) what the executive would have received had the executive been credited with the additional years of service provided for under the Supplemental Executive Retirement Benefit Structure. As of December 31, 2006, the additional years of service credited under the Supplemental Executive Retirement Benefit Structure to the NEOs

 

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were: Mr. Wraase — 4 years, 10 months, Mr. Torgerson — 13 years, 5 months, and Mr. Sim — 7 years, 3 months. Dr. Mayberry was credited with 7 years, 10 months, of additional service as of the date of his retirement. See “Termination of Employment and Change in Control Benefits — Mayberry Retirement Arrangements.” No years of service credits have been made under the Supplemental Executive Retirement Benefit Structure since 1998. The Company has retained the plan primarily to preserve a mechanism that can be used by the Company, when hiring a new executive, to equate the Company’s pension benefits with those of the executive’s former employer and, if credits are made, to operate as a retention incentive because the benefits under the plan do not vest until age 59.

 

Executive Performance Supplemental Retirement Benefit Structure.    Under the Executive Performance Supplemental Retirement Benefit Structure, a participating executive whose employment by the Company terminates on or after age 59 for any reason other than death (or prior to age 59, if either (i) the executive had been designated as a recipient of this benefit prior to August 1, 2002, or (ii) if such termination follows a change in control of the Company) is entitled to a supplemental retirement benefit equal to the difference between (i) the executive’s actual benefit under the Pepco Holdings Retirement Plan and his supplemental retirements benefits under the Supplemental Benefit Structure and the Supplemental Executive Retirement Benefit Structure and (ii) what the executive would have received (A) had the average of the highest three annual incentive awards in the last five consecutive years been added to the executive’s average salary over the final three years of his employment (without regard to any deferral of the receipt of the award by the executive) in calculating the executive’s retirement benefit under the Pepco Holdings Retirement Plan and under the Supplemental Benefit Structure and the Supplemental Executive Retirement Benefit Structure, (B) had the benefits of the executive under the Pepco Holdings Retirement Plan and under the Supplemental Benefit Structure and the Supplemental Executive Retirement Benefit Structure not been reduced by the Qualified Plan Limitations and (C) had the deferred compensation earned by the executive that was excluded from the executive’s compensation base used in determining retirement benefits under the Pepco Holdings Retirement Plan and under the Supplemental Benefit Structure and the Supplemental Executive Retirement Benefit Structure been included in such compensation base. The supplemental benefits provided by the Executive Performance Supplemental Retirement Benefit Structure allow a greater percentage of a participant’s total compensation to be used in the calculation of the executive’s pension benefit and benefits senior executives who typically receive a larger percentage of their total compensation in the form of incentive compensation. The Executive Performance Supplemental Retirement Benefit Structure also has had the effect of making the retirement benefits for participants in the Pepco General Retirement Subplan more comparable to the retirement benefits received by participants in the Conectiv Cash Balance Subplan, which takes into account bonuses in calculating retirement benefits.

 

The benefits under the Executive Retirement Plan are payable in the form of a monthly annuity, except that if the employment of a participant terminates before age 59 following a “change in control” of the Company (as defined by the plan), the payments due under the Supplemental Executive Retirement Benefit Structure and Executive Performance Supplemental Retirement Benefit Structure will be paid in a lump sum amount equal to the present value of the annuity payments to which the participant otherwise would be entitled. If a participant in the Executive Retirement Plan is discharged by the Company because of misfeasance, malfeasance, dishonestly, fraud, misappropriation of funds, or commission of a felony, the participant’s benefits under the plan will be forfeited.

 

Conectiv Supplemental Executive Retirement Plan

 

Under the Conectiv SERP, a participating executive’s retirement benefit is calculated as it would be under the Conectiv Cash Balance Subplan (i) without giving effect to the Qualified Plan Limitations, (ii) if salary deferrals elected by the participant under the Company’s deferred compensation plans (other than the participant’s pre-tax contributions made under the PHI Retirement Savings Plan) were taken into account as compensation for purposes of calculating a participant’s retirement benefit in the year earned, rather than the year actually paid, and (iii) giving effect to any additional years of service credited to the executive in excess of the executive’s actual years of service. The executive’s benefit under the Conectiv SERP is the amount by which the Conectiv SERP benefit exceeds the executive’s benefit under the Conectiv Cash Balance Subplan, calculated

 

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under the cash balance component or based on the executive’s “grandfathered” benefit under the Atlantic City Electric Retirement Plan or the Delmarva Retirement Plan, as applicable. The benefit under the Conectiv SERP is payable at or beginning at the same time as, and in the same manner as, the benefits payable to the participant under the Conectiv Cash Balance Subplan. Only employees who were employed by Conectiv on August 1, 2002, are eligible to participate in the Conectiv SERP. Messrs. Rigby and Shaw are participants in the Conectiv SERP. The primary purpose of the Conectiv SERP is to enable participating executives to receive the full retirement benefits they are entitled to receive under the Conectiv Cash Balance Plan without reduction due to Internal Revenue Code limits.

 

Under his employment agreement, entered into in 2002, Mr. Shaw has been credited with three additional years of service and is deemed three years older than his actual age for purposes of determining his benefits under the Conectiv SERP. This entitles him to three additional years of credited service and adds three years to his actual age in calculating his retirement benefit under the Conectiv SERP as compared to the calculation of this benefit under the Delmarva Retirement Plan and to three additional years of pay and interest credits in calculating his cash balance under the Conectiv SERP as compared to his cash balance under the Conectiv Cash Balance Subplan. If Mr. Shaw had retired on December 31, 2006, the net present value of his retirement benefits as of that date under the Conectiv SERP would have been $6,194,448. The purpose of the supplement to his retirement benefits was to encourage him to remain employed by the Company following the merger of Pepco and Conectiv. If Mr. Rigby had retired on December 31, 2006, the net present value of his retirement benefits as of that date under the Conectiv SERP would have been $462,612.

 

NONQUALIFIED DEFERRED COMPENSATION

AT DECEMBER 31, 2006

 

Name


   Executive
Contributions
in Last Fiscal
Year (29)


    Registrant
Contributions
in Last Fiscal
Year (30)


   Aggregate
Earnings in
Last Fiscal
Year (31)


   Aggregate
Withdrawals/
Distributions


   Aggregate
Balance at Last
Fiscal Year
End(32)


Dennis R. Wraase

Pepco Director and Executive Deferred Compensation Plan

   $ 0     $ 0    $ 88,432    $ 0    $ 677,911

PHI Executive and Director Deferred Compensation Plan

     43,644       32,509      73,649      0      1,015,058

Joseph M. Rigby

                                   

Conectiv Deferred Compensation Plan

     0       0      198,449      0      1,684,903

PHI Executive and Director Deferred Compensation Plan

     0       0      500      0      6,268

William T. Torgerson

Pepco Director and Executive Deferred Compensation Plan

     0       0      116,796      0      914,595

PHI Executive and Director Deferred Compensation Plan

     17,495       13,228      21,476      0      230,878

Thomas S. Shaw

                                   

Conectiv Deferred Compensation Plan

     0       0      656,781      0      6,008,361

PHI Executive and Director Deferred Compensation Plan

     0       0      103,965      0      1,059,602

William J. Sim

PHI Executive and Director Deferred Compensation Plan

     18,666       2,772      38,137      0      300,416

Ed R. Mayberry

PHI Executive and Director Deferred Compensation Plan

     128,692 (33)     0      26,967      26,429      323,034

 

(29) All amounts shown are included in the “Salary” column of the Summary Compensation Table above.

 

(30) All amounts shown are included in the “All Other Compensation” column of the Summary Compensation Table above.

 

(31) Includes the following amounts previously reported in the Company’s Summary Compensation Table in years prior to 2006 as “above-market” earnings (as defined by SEC regulations) on deferred compensation: Mr. Wraase — $76,256 and Mr. Torgerson — $59,345.

 

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(32) Includes the following amounts reported as compensation in the Company’s Summary Compensation Table in years prior to 2006:

 

The PHI Executive and Director Deferred Compensation Plan: Mr. Wraase — $587,612; Mr. Rigby — $3,135; Mr. Torgerson — $93,236; and Mr. Shaw — $791,245.

 

The Conectiv Deferred Compensation Plan: Mr. Rigby — $21,468 and Mr. Shaw — $180,866.

 

(33) Consists of deferral of 2005 incentive compensation received in 2006.

 

Deferred Compensation Plans

 

The Company maintains the following deferred compensation plans in which one or more of the executive officers listed in the Summary Compensation Table participate.

 

PHI Executive and Director Deferred Compensation Plan

 

Under the PHI Executive and Director Deferred Compensation Plan participating executives and directors are permitted to defer the receipt of all or any portion of the compensation to which they are entitled for services performed, including, in the case of executives, incentive compensation. In addition, to the extent an executive is precluded from making contributions to the PHI Retirement Savings Plan (the “Savings Plan”), a tax-qualified 401(k) plan, due to limitations imposed by the Internal Revenue Code, the executive is entitled to defer under the plan an amount equal to the contribution the executive is prevented from contributing to the Savings Plan and receive an additional credit under the plan equal to the matching contribution, if any, that the Company would have made to the executive’s account under the Savings Plan. Under the terms of the Savings Plan, employees can contribute to the Savings Plan up to 6% of their annual salary, with the Company matching 100% the employee’s contribution up to 3% of salary and 50% of any contributions in excess of 3% of salary up to 6% of salary.

 

Under the plan, the Company also credits to each participant’s account on a monthly basis an amount corresponding to, as elected by the participant, any or a combination of: (i) the interest at the prime rate that would have been paid on an amount equal to the participant’s account balance, or (ii) an amount equal to the return that the participant would have earned had his or her account balance been invested in any one or a combination of the investment funds selected by the Compensation/Human Resources Committee or, in the case of directors only, had the account balance been deemed invested in the Company’s common stock. A participant may reallocate his account balance among these investment choices at any time.

 

The distribution to a participant of accrued balances under the plan commences, at the election of the participant, (i) if an executive, on the date of the commencement of payments under the tax-qualified defined benefit plan in which the executive is a participant, (ii) the calendar year following the year in which the participant reaches retirement age, (iii) when the participant’s employment by the Company or service as a director ceases, (iv) when the participant’s employment by the Company or service as a director ceases and the participant attains an age specified by the participant or (v) the date specified by the participant, which may not be earlier than the second calendar year following the year in which the deferrals occurred to which the distribution relates. Distributions may be made, at the election of the participant, either in a lump sum or in monthly or annual installments over a period of between two and fifteen years.

 

Eligibility of executives to participate in the plan is determined by the Company’s Chief Executive Officer (and, in the case of the Chief Executive Officer, by the Board of Directors). All of the executive officers listed in the Summary Compensation Table are eligible to participate in the plan. All non-management directors also are eligible to participate in the plan.

 

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Conectiv Deferred Compensation Plan

 

Prior to the merger of Pepco and Conectiv, Conectiv maintained the Conectiv Deferred Compensation Plan under which participating executives were permitted to defer the receipt of all or any portion of the compensation to which the executive was entitled for services performed, including incentive compensation, and to receive employer matching credits on deferrals corresponding to contributions the executive was precluded from making to the Conectiv tax-qualified 401(k) plan due to limitations imposed by the Internal Revenue Code. On August 1, 2002, employee deferrals and matching employer credits under the plan were discontinued.

 

Pre-August 1, 2002, participant deferrals and employer matching contributions are credited to a deferred compensation account and are deemed invested, as elected by the executive, in any of the investment options available to participants under the Conectiv tax-qualified 401(k) plan as of August 1, 2002. A participant may reallocate his account balance among these investment choices at any time. Prior to August 1, 2002, employer matching contributions were credited to an employer matching account in the form of Conectiv common stock equivalents, to which additional credits are made when cash dividends are paid on the Company common stock based on the number of shares that could be purchased with the cash dividend. Of the executive officers listed in the Summary Compensation Table, only Messrs. Rigby and Shaw maintain account balances under the plan.

 

Distributions under the plan commence at a time selected by the executive at the time of deferral, provided the date specified by the executive may not be earlier than two years after the year in which a deferral occurs or later than the year in which the executive reaches age 70, and may be made in a lump sum or in equal installment over periods of five, ten or fifteen years, as selected by the executive. In the event of the termination of the executive’s employment following a change in control (as defined by the plan), the committee responsible for the administration of the plan may in its discretion, after consultation with the executive, elect to distribute the executive’s account balances in a lump sum, rather than in accordance with the distribution elections originally selected by the executive.

 

Pepco Director and Executive Deferred Compensation Plan

 

Under the Pepco Director and Executive Deferred Compensation Plan, participating executives were permitted to defer up to 15% of their salary earned between September 1, 1985 and August 31, 1989. Participating directors were permitted to defer all or any portion of their fees for services as a director paid during the same period. In addition, the Board of Directors authorized the deferral by Mr. Wraase in accordance with the terms of the plan of his 1985 annual incentive award in the amount of $9,563 and his target 1986 annual incentive award in the amount of $12,800.

 

Under this plan, participant account balances attributed to salary and director fee deferrals are credited annually with an amount corresponding to a fixed interest rate of 15%, and Mr. Wraase’s incentive deferrals are credited annually with an amount corresponding to a fixed interest rate of 12%, which in each case were established at the time of deferral.

 

Under the terms of the plan, amounts deferred (other than Mr. Wraase’s deferral of his 1985 annual incentive award) by an executive or director who on his nearest birthday to September 1, 1985, was below age 54, but not the interest credits thereon, were distributed to that person in a lump sum on the first day of the eighth plan year following the date of the deferral. The distribution of the remaining balance to which an executive is entitled (including Mr. Wraase’s 1985 annual incentive award deferral) will commence at age 65 and will be paid out over a 15-year period in substantially equal monthly installments, subject to reduction by an adjustment factor if the executive’s employment terminates prior to age 62 for any reason other than death, total or permanent disability or a change in control. In the event of the termination of the executive’s employment before age 62 following a change in control, the executive will receive a lump sum payment equal to the net present value of the expected monthly annuity payments beginning at age 65. The distribution of the remaining balance to which a director is entitled commences at age 65 and is paid out in substantially equal monthly installments until age 80.

 

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Of the executive officers listed in the Summary Compensation Table, only Messrs. Wraase and Torgerson maintain account balances under this plan and of the Company’s directors, only Mr. O’Malley and Dr. McKenzie (who retired in 2006), maintain account balances under this plan.

 

Termination of Employment and Change in Control Benefits

 

The following is a description of the Company’s plans and arrangements that provide for payments to the NEOs following or in connection with the termination of the executive’s employment, a change in control of the Company, or a change in the executive’s responsibilities. Because Mr. Sim and Dr. Mayberry each ceased to be an executive officer of the Company on or before December 31, 2006, the description of such plans and arrangements as they relate to each of them is limited, as permitted by SEC rules, to a discussion of the consequences of the termination of his employment.

 

Employment Agreements

 

The employment agreements of Messrs. Wraase, Rigby, Torgerson, and Shaw each provides the executive with specified benefits if the employment of the executive is terminated under any of the circumstances described below, whether or not such termination is connected with a change in control of the Company:

 

Termination by the Company Other Than for Cause.    If at any time during the term of the executive’s employment the Company terminates the executive’s employment other than for cause (“cause” is defined as (i) intentional fraud or material misappropriation with respect to the business or assets of the Company, (ii) the persistent refusal or willful failure of the executive to perform substantially his duties and responsibilities to the Company after the executive receives notice of such failure, (iii) conduct that constitutes disloyalty to the Company and that materially damages the property, business or reputation of the Company, or (iv) the conviction of a felony involving moral turpitude), the executive will be entitled to:

 

   

A lump sum severance payment equal to three times the sum of (i) the executive’s highest annual base salary in effect at any time during the three-year period preceding the termination of employment and (ii) the higher of (A) the executive’s annual bonus for the year in which the termination of employment occurs or (B) the highest annual bonus received by the executive during the three calendar years preceding the calendar year in which the termination of employment occurs.

 

   

The executive’s annual bonus for the year in which the termination occurs, if the Board of Directors, before the termination date, has made a good faith determination of the executive’s bonus for the year, and otherwise a prorated portion (based on the number of days the executive was employed during the year) of the executive’s target annual bonus for the year.

 

   

Any shares of restricted stock the vesting of which is contingent solely on the continued employment of the executive and that would have become vested had he remained employed for the remainder of the term of his employment agreement will become vested and non-forfeitable on the date the executive’s employment terminates.

 

   

Any shares of restricted stock that are the subject of an award the vesting of which is contingent on the achievement of specified performance goals during a performance period that ends within the term of the executive’s employment agreement will become vested at the end of the performance period if and to the extent the performance goals are achieved.

 

   

In addition to the retirement benefits to which the executive is entitled under the Pepco Holdings Retirement Plan and the Company’s supplemental retirement plans in which he participates, as more fully described under the heading “Retirement Plans” above, a lump sum supplemental retirement benefit paid in cash equal to the difference between (i) the present value of the executive’s vested retirement benefit accrued at the time of termination under the Pepco Holdings Retirement Plan and any excess or supplemental retirement plan in which the executive is a participant and (ii) the benefit the

 

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executive would be entitled to receive under the Pepco Holdings Retirement Plan and such excess and supplemental retirement plans assuming: (A) in the cases of Messrs. Wraase and Torgerson only, the executive’s earnings for the benefit computation are equal to the executive’s annual base salary rate in effect immediately prior to the executive’s termination, plus the highest annual bonus awarded to the executive in any of the three years preceding the executive’s termination of employment or, if higher, the executive’s annual bonus for the year in which the termination occurs and (B) in the cases of Mr. Wraase and Mr. Torgerson, that the executive has reached age 62 and has completed 40 years of service (or, if greater, the age and years of service that the executive would have reached at the end of the term of his employment agreement in effect at the time his employment terminates), and in the cases of Messrs. Rigby and Shaw, that each is three years older than his actual age and is credited with three additional years of service.

 

Voluntary Resignation by the Executive under Specified Circumstances.    If, at any time during the term of the executive’s employment agreement, the executive terminates his employment under any of the following circumstances, he will receive under his employment agreement the same benefits that he would have received had the Company terminated his employment without cause as described above: (i) the base salary of the executive is reduced (other than a reduction consistent and proportional with the overall reduction, due to extraordinary business conditions, in the compensation of all other senior executives of the Company), (ii) the executive is not in good faith considered for incentive awards under the Company’s plans in which senior executives are eligible to participate, (iii) the Company fails to provide the executive with retirement, fringe and supplemental benefits in a manner similar to other senior executives, (iv) the Company relocates the executive’s place of employment to a location further than 50 miles from Washington, D.C. (or, in the case of Mr. Rigby or Mr. Shaw, a location further than 50 miles from Wilmington, Delaware, other than the Washington, D.C. metropolitan area) or (v) the executive is demoted to a position that is not a senior management position (other than due to the executive’s disability).

 

Resignation or Termination Due to Disability or Death.    Upon his resignation (other than under the circumstances specified above) or upon his death or disability (which shall be deemed to have occurred if he becomes entitled to long-term disability benefits under the Company’s disability plan or policy), the employment agreements provide that the executive will not be entitled to any benefits beyond those provided for under the terms of the Company benefit plans in which the executive participates.

 

Gross-up Payments.    Each of the employment agreements also provides that, if any payments or benefits provided to the executive under his employment agreement, or under any other plan, program, agreement or arrangement of the Company, are determined to be payments related to a change in control within the meaning of Section 280G of the Internal Revenue Code, and as a result the executive incurs an excise tax under Section 4999 of the Internal Revenue Code, the executive will be entitled to receive a gross-up payment in an amount equal to the amount of all excise taxes imposed upon compensation payable upon termination of employment and the additional taxes that result from such payment, such that the aggregate net payments received by the executive will be the same as they would have been had such excise tax not been imposed.

 

Long-Term Incentive Plan

 

Under the LTIP, if the employment of a recipient of an award is terminated by the Company or the recipient terminates his or her employment for “good reason” within 12 months following a “change in control,” the recipient’s outstanding awards under the LTIP will be affected as follows:

 

   

A pro-rata portion of any restricted stock or restricted stock unit award that is subject to vesting contingent on the continued employment of the recipient (“service-based vesting”) will become immediately vested based on the number of months of the restricted period that have elapsed as of the termination date.

 

   

A pro-rata portion of any restricted stock or restricted stock unit award that is subject to vesting contingent on the satisfaction of established performance criteria (“performance-based vesting”) will

 

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become immediately vested based on the number of months of the restricted period that have elapsed as of the termination date and on the assumption that the target level of performance has been achieved.

 

   

Any stock option or stock appreciation right not then exercisable will become immediately exercisable.

 

A “change in control” will occur under the terms of the LTIP if generally: (i) any person is or becomes the “beneficial owner” (as defined under SEC rules), directly or indirectly, of securities of the Company (excluding any securities acquired directly from the Company) representing 35% or more of the combined voting power of the Company’s then outstanding securities, (ii) during any period of 12 consecutive months, the individuals who, at the beginning of such period, constitute the Company’s Board of Directors cease for any reason other than death to constitute at least a majority of the Board of Directors, (iii) the consummation of a merger or consolidation of the Company with any other corporation, other than a merger or consolidation that would result in the voting securities of the Company outstanding immediately prior to the merger or consolidation continuing to represent at least 50% of the combined voting power of the voting securities of the Company or the surviving company, or (iv) the stockholders of the Company approve a plan of complete liquidation or dissolution of the Company or there is consummated an agreement for the sale or disposition by the Company of all or substantially all of the Company’s assets.

 

Under the LTIP, a recipient of an award will have “good reason” to terminate his or her employment if, without the written consent of the recipient, any of the following events occurs following a “change in control”: (i) the assignment to the recipient of any duties inconsistent in any materially adverse respect with his or her position, authority, duties or responsibilities in effect immediately prior to the change in control, (ii) there is a reduction in the recipient’s base salary from that in effect immediately before the change in control, (iii) there is a material reduction in the recipient’s aggregate compensation opportunity, consisting of base salary, bonus opportunity, and long-term or other incentive compensation opportunity, (iv) the Company requires the recipient to be based at any office or location more than 50 miles from that location at which he or she performed his or her services immediately prior to the occurrence of the change in control, or (v) any successor company fails to agree to assume the Company’s obligations to the recipient under the LTIP.

 

Under the terms of the LTIP, if a “change in control” of the Company were to occur, and within 12 months thereafter the employment of any of Messrs. Wraase, Rigby, Torgerson or Shaw were to be terminated by the Company or a successor company or such executive were to terminate his employment for “good reason,” the provisions of the LTIP, with respect to the vesting of service-based restricted stock and performance-based restricted stock, would apply only to any such awards with a performance period that ended after the term of the executive’s employment agreement. For those awards with a performance period ending within the executive’s employment agreement, the provisions of the LTIP would be superseded by the terms of each executive’s employment agreement, as more fully described above under the heading “Termination of Employment and Change in Control Benefits — Employment Agreements.”

 

If the employment of a recipient of a restricted stock award terminates because of retirement, early retirement at the Company’s request, death or disability prior to vesting, the payout of the award will be prorated, in the case of an award subject to service-based vesting, for service during the performance period and, in the case of an award subject to performance-based vesting, taking into account factors including, but not limited to, service and the performance of the participant before employment ceases, unless the Compensation/Human Resources Committee determines in either case that special circumstances warrant modification of the payment to which the participant is entitled. If the employment of a recipient of a restricted stock award terminates for any other reason, the award is forfeited, except in the case of early retirement at the request of the participant, in which case the payout or forfeiture is at the discretion of the Compensation/Human Resources Committee.

 

If employment of the holder of a stock option terminates because of retirement, early retirement, death or disability, the option will remain exercisable for the remainder of its term, unless the Compensation/Human Resources Committee determines that special circumstances warrant modification of this result. Otherwise, the option will lapse on the effective date of the holder’s termination of employment.

 

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Executive Incentive Compensation Plan

 

Under the Executive Incentive Compensation Plan, if a participant retires, dies or becomes disabled prior to the to the end of a plan year, the participant is entitled to a pro rated portion of the award to which the participant otherwise would be entitled based on the portion of the year that the participant was employed. If the employment of the participant terminates for any other reason during the plan year, the participant will not be entitled to an award, except in the case of each of the executive officers listed in the Summary Compensation Table to the extent his employment agreement provides otherwise as more fully described above under the heading “Termination of Employment and Change in Control Benefits — Employment Agreements.”

 

Retirement Plan Benefits

 

Messrs. Wraase and Torgerson are participants in the Pepco General Retirement Subplan of the Pepco Holdings Retirement Plan and Messrs. Rigby and Shaw are participants in the Conectiv Cash Balance Subplan of the Pepco Holdings Retirement Plan. For a discussion of their benefits under these defined benefit retirement plans and under the corresponding supplemental retirement plans in the event of a termination of employment, see the discussion under the heading “Retirement Plans” above.

 

Deferred Compensation Plans

 

Messrs. Wraase, Rigby, Torgerson and Shaw each is a participant in one or more Company deferred compensation plans. For a discussion of the payments to which they are entitled to under these plans following a termination of employment, see the discussion under the heading “Deferred Compensation Plans” above.

 

Quantification of Termination of Employment Benefits

 

The following discussion quantifies the benefits that each of Messrs. Wraase, Rigby, Torgerson and Shaw would have been entitled to receive under his employment agreement and the Company’s compensation plans (other than the Company’s retirement plans and deferred compensation plans, the payments under which are described above under the headings “Retirement Plans” and “Deferred Compensation Plans” above) if his employment had terminated on December 31, 2006, under specified circumstances:

 

Termination by the Company Other Than for Cause or Voluntary Resignation By the Executive under Specified Circumstances.    If, as of December 31, 2006, the employment of the executive had been terminated by the Company other than for cause, or the executive had voluntarily terminated his employment for any of the reasons specified in his employment agreement, the executive would have received the benefits shown in the following table. These benefits would have been payable whether or not the termination of the executive’s employment occurred in the context of a change in control, with the exception of the benefits in the last three columns. The benefit in the column headed “Section 280G Gross-up Payment” would have been made only if the payments made to the executive would have caused the executive to incur an excise tax under Section 4999 of the Internal Revenue Code.

 

                        Additional Benefits if Termination
Involves a Change in Control


    Severance
Payment


  Target
2006
Bonus
(34)


  Accelerated
Vesting of
Service-
Based
Restricted
Stock (35)


  Target
Performance
-Based
Restricted
Stock (36)


  Supplemental
Retirement
Benefit
Payment


  Accelerated
Vesting of
Service-
based
Restricted
Stock (37)


  Target
Performance-
Based
Restricted
Stock (38)


  Section
280G
Gross-Up
Payment


Dennis R. Wraase

  $ 5,700,000   $ 0   $ 740,869   $ 2,665,167   $ 6,237,480   $ 0   $ 0   $ 7,062,179

Joseph M. Rigby

    2,280,000     0     0     291,312     2,620,482     51,994     103,962     2,421,255

William T. Torgerson

    2,457,600     0     199,653     924,682     1,209,824     0     0     2,031,224

Thomas S. Shaw

    2,409,600     0     0     0     783,765     65,233     479,026     1,466,217

 

(34) No bonus was paid for 2006 under the Executive Incentive Compensation Plan.

 

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(35) Represents the market value on December 29, 2006, the last trading day of the year, of the shares of restricted Company common stock that would vest and become non-forfeitable under the terms of the executive’s employment agreement whether or not the termination involved a change in control, as calculated by multiplying the number of shares by $26.01, the closing market price on that day.

 

(36) Represents the market value on December 29, 2006, of shares of Company common stock issuable under the LTIP to which the executive would be entitled under the terms of his employment agreement at the end of the performance cycle periods in which he participates, assuming that the targeted level of performance is achieved, whether or not the termination involved a change in control. If performance-based shares are earned, each executive also is entitled under the terms of his award to receive, in addition to the award shares earned, shares of Company common stock equal in number to the shares that the executive would have acquired had the cash dividends paid during the performance period on the number of shares of common stock equal to the number of performance shares earned been reinvested in shares of common stock. The additional number of shares that would be received by the executive is as follows: Mr. Wraase — 13,537 shares; Mr. Rigby — 1,510 shares; and Mr. Torgerson — 4,719 shares.

 

(37) Represents the market value on December 29, 2006, of the additional shares of restricted Company common stock that would vest and become non-forfeitable under the terms of the LTIP if the termination of the executive’s employment occurred within one year following the change in control.

 

(38) Represents the market value on December 29, 2006, of shares of Company common stock issuable under the LTIP to which the executive would be entitled under the terms of the LTIP at the end of the performance cycle periods in which he participates, assuming that the target level of performance is achieved, if the termination of the executive’s employment occurred within one year following the change in control. The additional shares of Company common stock that the executive would receive based on the reinvestment of cash dividends paid during the performance period on the number of performance shares earned is as follows: Mr. Rigby — 521 shares and Mr. Shaw — 2,458 shares.

 

Retirement or Termination of Employment Due to Death or Disability.    If, as of December 31, 2006, the executive had retired (including early retirement) or his employment had terminated because of his death or disability, the executive (or his estate) would have been entitled under the terms of the LTIP, unless otherwise determined by the Compensation/Human Resources Committee, to (i) the accelerated vesting of a pro-rata portion of each outstanding time-based restricted stock award issued to the executive under the Restricted Stock Program and (ii) the accelerated vesting of a pro-rata portion of the performance-based restricted stock awards issuable pursuant to any then-uncompleted performance periods as determined by the Compensation/Human Resources Committee taking into account factors including, but not limited to, the period of the executive’s service prior to termination and the performance of the executive before his employment ceased. The executive would not have been entitled to any severance payment or supplemental retirement benefit payment.

 

Resignation by the Executive (Other than Resignation under Specified Circumstances).    If, as of December 31, 2006, the executive resigned (other than for specified circumstances), the executive would have been entitled to receive his 2006 bonus under the Executive Incentive Compensation Plan, as determined by the Compensation/ Human Resources Committee. However, (i) the executive would not have been entitled to any severance payment or supplemental retirement benefit payment and (ii) all unvested shares of restricted stock issued to the executive under the Restricted Stock Program of the LTIP, and any shares of common stock that the executive had the opportunity to earn under the Performance Stock Program of the LTIP, would have been forfeited.

 

Termination for Cause.    If, as of December 31, 2006, the executive’s employment had been terminated for cause (i) the executive would not have been entitled to any severance payment, a 2006 bonus under the Executive Incentive Compensation Plan or supplemental retirement benefit payment and (ii) all unvested shares of restricted stock issued to the executive under the Restricted Stock Program of the LTIP, and any shares of common stock that the executive had the opportunity to earn under the Performance Stock Program of the LTIP, would have been forfeited.

 

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Sim Retirement Arrangements

 

On December 31, 2006, Mr. Sim retired as an employee of the Company. In connection with his retirement, Mr. Sim has received or will be entitled to receive, in accordance with the terms of his employment agreement, the following benefits based on the agreement of the Company and Mr. Sim reached at the time of his retirement to treat his retirement as a termination of his employment by the Company without cause:

 

   

A lump sum severance payment in the amount $1,341,000, which is equal to three times the sum of (i) his highest annual base salary in effect at any time during the three-year period preceding the termination of his employment and (ii) the higher of (A) his annual bonus for the year in which the termination of employment occurs or (B) the highest annual bonus received by him during the three calendar years preceding the calendar year in which the termination of employment occurs.

 

   

He is eligible to receive up to 19,600 shares of common stock for the 2005-2007 performance cycle and up to 10,772 shares of common stock for the 2006-2008 performance cycle, along with dividend credits on the shares earned, if and to the extent the established performance goals associated with these award opportunities are achieved.

 

   

The vesting of 2,693 shares of restricted stock that were not vested on the date his employment terminated, which on December 31, 2006, had an aggregate fair market value of $81,333, based on the closing market price of the Company’s common stock on December 29, 2006, the last trading day of the year.

 

   

A lump sum supplemental retirement benefit in the amount of $264,523, representing the difference between (i) the present value of his vested retirement benefit accrued at the time of termination under the Pepco General Retirement Subplan and under the Executive Retirement Plan and (ii) the benefit he would be entitled to receive under such plans assuming that he retired at age 65 (rather than his actual retirement age of 62) and is credited with 3 additional years of service (in addition to the 29 years, 9 months of service with which he is credited under Pepco General Retirement Subplan and the 37 years of service with which he is credited under the Executive Retirement Plan).

 

Mr. Sim, by reason of his retirement, also is entitled to receive the future retirement benefits under the plans described under the heading “Retirement Plans” above, which consist of:

 

   

A pension payment under the Pepco General Retirement Subplan in the amount of $84,665 per year.

 

   

A supplemental pension payment under the Supplemental Benefit Structure in the amount of $137,443 per year, representing the incremental payment he would have received under the Pepco General Retirement Subplan (i) but for the Qualified Plan Limitations, (ii) assuming he been credited with 37 years of service (rather than his 29 years, 9 months of actual service) and (iii) assuming his benefit calculation included as compensation the average of the three highest annual awards under the Executive Incentive Compensation Plan for the five years immediately preceding his retirement.

 

In addition, the Company (i) has agreed to provide to Mr. Sim the services of a tax preparer for 2006 on the same terms and conditions as similarly situated active employees of the Company and (ii) has transferred to Mr. Sim the Company car provided to him prior to his retirement with a market value of approximately $23,245.

 

Mayberry Retirement Arrangements

 

On April 1, 2006, Dr. Mayberry retired as an employee of the Company. In connection with his retirement, Dr. Mayberry has received or will be entitled to receive, in accordance with the terms of his employment agreement, the following benefits based on the agreement of the Company and Dr. Mayberry reached at the time of his retirement to treat his retirement as a termination of his employment by the Company without cause:

 

   

A lump sum severance payment in the amount $1,226,076, which is equal to three times the sum of (i) his highest annual base salary in effect at any time during the three-year period preceding the

 

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termination of his employment and (ii) the higher of (A) his annual bonus for the year in which the termination of employment occurs or (B) the highest annual bonus received by him during the three calendar years preceding the calendar year in which the termination of employment occurs.

 

   

An annual bonus for 2006 in the amount of $31,290, representing a prorated portion of his target annual bonus for the year.

 

   

An award of 15,732 shares of common stock for the 2004-2006 performance cycle, which on December 31, 2006, had an aggregate fair market value of $409,189, based on the closing market price of the company common stock on December 29, 2006, the last trading day of the year. In addition, he is eligible to receive up to 17,800 shares of common stock for the 2005-2007 performance cycle, along with dividend credits on the shares earned, if and to the extent the established performance goals associated with this award opportunity are achieved.

 

   

A lump sum supplemental retirement benefit in the amount of $247,895, representing the difference between (i) the present value of his vested retirement benefit accrued at the time of termination under the Pepco General Retirement Subplan and under the Executive Retirement Plan and (ii) the benefit he would be entitled to receive under such plans assuming that he retired at age 61 (rather than his actual retirement age of 58) and is credited with 36 years of service (rather than the 33 years of service with which he is credited under Pepco General Retirement Subplan and under the Executive Retirement Plan).

 

Dr. Mayberry, by reason of his retirement, also has received or is entitled to receive the future retirement benefits under the plans described under the heading “Retirement Plan” above, which consist of:

 

   

A pension payment under the Pepco General Retirement Subplan in the amount of $73,388 per year.

 

   

A supplemental pension payment under the Supplemental Benefit Structure of the Executive Retirement Plan in the amount of $23,226 per year, representing the incremental payment that he would have received under the Pepco General Retirement Subplan but for the Qualified Plan Limitations.

 

   

A lump sum payment in the amount of $1,643,199 under the Executive Retirement Plan, representing the present value of the annual pension benefit he would have received under the Pepco General Retirement Subplan (1) assuming he been credited with 33 years, 5 months of service (rather than his 25 years, 7 months of actual service) and (ii) assuming his benefit calculation included as compensation the average of the three highest annual awards under the Executive Incentive Compensation Plan for the five years immediately preceding his retirement.

 

In connection with his retirement, Dr. Mayberry also entered into an agreement with the Company pursuant to which he, in consideration for a cash payment of $280,000, has agreed that for a period of one year following the termination of his employment he will not, without the prior consent of the Company, (i) engage in, own or become a director, officer, employee or agent of, or consultant to, any competing business or (ii) solicit for employment any employees of the Company. In addition, the Company has agreed to provide to Dr. Mayberry for a period of two years following his retirement the services of a financial advisor and the services of a tax preparer on the same terms and conditions as similarly situated active employees of the Company.

 

BOARD REVIEW OF TRANSACTIONS WITH RELATED PARTIES

 

The Board of Directors has adopted Procedures for Evaluating Related Person Transactions (the “Procedures”) which set forth the procedures followed by the Board in review and approval or ratification of transactions with related persons to ensure compliance with PHI’s Conflicts of Interest Business Policy, Corporate Governance Guidelines, and applicable law. Related persons include directors, nominees for director, certain executives and their immediate family members. The Procedures apply to any situation where a related

 

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person serves as a director, officer or partner of, a consultant to, or in any other key role with respect to, any outside enterprise which does or seeks to do business with, or is a competitor of, the Company or any affiliate of the Company. The Procedures can be found on the Company’s Web site (www.pepcoholdings.com) by first clicking on the link: Corporate Governance and then the link: Business Policies.

 

The Procedures require that each director, nominee for director and certain executives provide to the Corporate Secretary annually a completed questionnaire setting forth all business and other affiliations which relate in any way to the business and other activities of the Company and Company affiliates. Each director and certain executives should also, throughout the year, update the information provided in the questionnaire as necessary.

 

When a related person transaction is contemplated, all of the material facts regarding the substance of the proposed transaction, including the material facts relating to the related person’s or other party’s relationship or interest, shall be fully disclosed to the members of the Corporate Governance/Nominating Committee (excluding any member of the Committee who has an interest in the transaction). The members of the Corporate Governance/Nominating Committee will review the contemplated transaction and will then make a recommendation to the disinterested members of the Board. At a Board meeting, all of the material facts regarding the substance of the proposed transaction, including the facts relating to the related person’s or other party’s relationship or interest and the recommendation of the Corporate Governance/Nominating Committee, shall be fully disclosed to the Board. Approval of the transaction requires the affirmative vote of a majority of the disinterested directors voting.

 

The Procedures generally require that related person transactions be approved in advance. On occasion, however, it may be in the Company’s interest to commence a transaction before the Corporate Governance/Nominating Committee or Board has had an opportunity to meet, or a transaction may commence before it is discovered that a related person is involved with the transaction. In such instances, the Procedures require the director and/or executive to consult with the Chairman of the Corporate Governance/Nominating Committee to determine the appropriate course of action, which may include subsequent ratification by the affirmative vote of a majority of the disinterested directors. If the Chairman of the Corporate Governance/Nominating Committee is an interested director, the Procedures require the director and/or executive to consult with the Lead Independent Director to determine the appropriate course of action.

 

AUDIT COMMITTEE REPORT

 

Among its duties, the Audit Committee is responsible for recommending to the Board of Directors that the Company’s financial statements be included in the Company’s Annual Report on Form 10-K. The Committee took a number of steps as a basis for making this recommendation for 2006. First, the Audit Committee discussed with PricewaterhouseCoopers LLP, the Company’s independent registered public accounting firm for 2006, those matters that PricewaterhouseCoopers LLP is required to communicate to and discuss with the Audit Committee under Statement on Auditing Standards No. 61, as amended (Communication with Audit Committees) as adopted by the Public Company Accounting Oversight Board (the “PCAOB”), which included information regarding the scope and results of the audit. These communications and discussions are intended to assist the Audit Committee in overseeing the financial reporting and disclosure process. Second, the Audit Committee discussed with PricewaterhouseCoopers LLP that firm’s independence and received from PricewaterhouseCoopers LLP a letter concerning independence as required by Independent Standards Board No. 1 (Independence Discussions with Audit Committees) as adopted by the PCAOB. This discussion and disclosure informed the Audit Committee of PricewaterhouseCoopers LLP’s relationships with the Company and was designed to assist the Audit Committee in considering PricewaterhouseCoopers LLP’s independence. Finally, the Audit Committee reviewed and discussed, with the Company’s management and with PricewaterhouseCoopers LLP, the Company’s audited consolidated balance sheets at December 31, 2006 and 2005, and the Company’s consolidated statements of earnings, comprehensive earnings, shareholders’ equity and

 

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cash flows for the three years ended December 31, 2006, including the notes thereto. Management is responsible for the consolidated financial statements and reporting process, including the system of internal controls and disclosure controls. The independent registered public accounting firm is responsible for expressing an opinion on the conformity of these consolidated financial statements with accounting principles generally accepted in the United States. Based on the discussions with management and PricewaterhouseCoopers LLP concerning the audit, the independence discussions, and the financial statement review and discussions, and such other matters deemed relevant and appropriate by the Audit Committee, the Audit Committee recommended to the Board that the consolidated financial statements be included in the Company’s 2006 Annual Report on Form 10-K.

 

The Audit Committee, in accordance with its charter, conducts an annual evaluation of the performance of its duties. Based on this evaluation, the Committee concluded that it performed effectively in 2006.

 

AUDIT COMMITTEE

Lawrence C. Nussdorf, Chairman

Terence C. Golden

Frank O. Heintz

Richard B. McGlynn

Frank K. Ross

 

2. RATIFICATION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Audit Committee of the Board of Directors of the Company appointed PricewaterhouseCoopers LLP as independent registered public accounting firm for the Company for the year 2006. The Audit Committee has reappointed the firm for 2007. A representative of PricewaterhouseCoopers LLP is expected to attend the Annual Meeting and will be given the opportunity to make a statement and to respond to appropriate questions.

 

Although the Company is not required to seek shareholder ratification of this appointment, the Board believes it to be sound corporate governance to do so. If the appointment is not ratified, the Audit Committee will take this fact into consideration when selecting the Company’s independent registered public accounting firm for 2008. Even if the selection is ratified, the Audit Committee may in its discretion direct the appointment of a different independent registered public accounting firm at any time during the year if the Committee determines that a change would be in the best interests of the Company and its shareholders.

 

Audit Fees

 

The aggregate fees billed by PricewaterhouseCoopers LLP for professional services rendered for the audit of the annual financial statements of the Company and its subsidiary reporting companies for the 2006 and 2005 fiscal years and reviews of the financial statements included in the 2006 and 2005 Forms 10-Q of the Company and its subsidiary reporting companies were $5,515,127 and $5,407,413, respectively. The amount for 2005 includes $55,330 for the 2005 audit that was billed after the 2005 amount was disclosed in Pepco Holdings’ proxy statement for the 2006 Annual Meeting.

 

Audit-Related Fees

 

The aggregate fees billed by PricewaterhouseCoopers LLP for audit-related services rendered for the 2006 and 2005 fiscal years were $19,736 and $214,053, respectively. These services consist of employee benefit plan audits, accounting consultations, internal control reviews, computer systems post-implementation reviews and attest services for financial reporting not required by statute or regulation. The amount for 2005 includes $44,000 for the 2005 employee benefit plan audit that was billed after the 2006 Pepco Holdings proxy statement was filed.

 

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Tax Fees

 

The aggregate fees billed by PricewaterhouseCoopers LLP for tax services rendered for the 2006 and 2005 fiscal years were $86,160 and $8,400, respectively. These services consisted of tax compliance, tax advice and tax planning.

 

All Other Fees

 

The aggregate fees billed by PricewaterhouseCoopers LLP for all other services other than those covered under “Audit Fees,” “Audit-Related Fees” and “Tax Fees” for the 2006 and 2005 fiscal years were $20,419 and $3,000, respectively, which represents the costs of training and technical materials provided by PricewaterhouseCoopers LLP.

 

All of the services described in “Audit Fees,” “Audit-Related Fees,” “Tax Fees” and “All Other Fees” were approved in advance by the Audit Committee, in accordance with the Audit Committee Policy on the Approval of Services Provided by the Independent Auditor which is attached to this Proxy Statement as Annex A.

 

What vote is required to ratify the selection of the independent registered public accounting firm?

 

Ratification of the appointment of the independent registered public accounting firm requires the affirmative vote of the holders of a majority of the common stock present and entitled to vote at a meeting of shareholders at which a quorum is present.

 

How are the votes counted?

 

Shares, if any, which are the subject of an abstention with regard to the vote on this proposal, will be considered present and entitled to vote, and accordingly will have the same effect as a vote against the proposal. Any shares that are the subject of a “broker non-vote” will not be considered present and entitled to vote and, therefore, will not be included in the denominator when determining whether the requisite percentage of shares has been voted in favor of this matter.

 

THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE IN FAVOR OF RATIFICATION OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM, WHICH IS SET FORTH AS ITEM 2 ON THE PROXY CARD.

 

SHAREHOLDER PROPOSALS AND DIRECTOR NOMINATIONS

 

What is the deadline for submission of shareholder proposals for inclusion in the Company’s proxy statement for the 2008 Annual Meeting?

 

In order to be considered for inclusion in the proxy statement for the 2008 Annual Meeting, shareholder proposals must be received by the Company on or before November 29, 2007.

 

May a shareholder introduce a resolution for a vote at a future annual meeting?

 

Under the Company’s Bylaws, a shareholder may introduce a resolution for consideration at a future Annual Meeting if the shareholder complies with the advance notice provisions set forth in the Bylaws. These provisions require that for a shareholder to properly bring business before an Annual Meeting, the shareholder must give written notice to the Company’s Secretary at 701 Ninth Street, N.W., Washington, D.C. 20068, not less than 100 days nor more than 120 days prior to the date of the meeting (or if the date of the meeting is more than 30 days before or after the anniversary date of the Annual Meeting in the prior year, then the written notice must be

 

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received no later than the close of business on the tenth day following the earlier of the date on which notice or public announcement of the date of the meeting was given or made by the Company). The shareholder’s notice must set forth a description of the business desired to be brought before the meeting and the reasons for conducting the business at the Annual Meeting, the name and record address of the shareholder, the class and number of shares owned beneficially and of record by the shareholder, and any material interest of the shareholder in the proposed business. The Company will publicly announce the date of its 2008 Annual Meeting at a later date.

 

May a shareholder nominate or recommend an individual for election as a director of the Company?

 

Under the Company’s Bylaws, a shareholder may nominate an individual for election as a director at a future Annual Meeting by giving written notice of the shareholder’s intention to the Company’s Secretary at 701 Ninth Street, N.W., Washington, D.C. 20068, not less than 100 days nor more than 120 days prior to the date of the meeting (or if the date of the meeting is more than 30 days before or after the anniversary date of the Annual Meeting in the prior year, then the written notice must be received no later than the close of business on the tenth day following the earlier of the date on which notice or public announcement of the date of the meeting was first given or made by the Company). The notice provided to the Secretary must set forth the name and record address of the nominating shareholder and the class and number of shares of capital stock of the Company beneficially owned by such shareholder; and, for each nominee, the nominee’s name, age, business address, residence address, principal occupation or employment, the class and number of shares of the Company’s capital stock beneficially owned by the nominee, and any other information concerning the nominee that would be required to be included in a proxy statement. The Company will publicly announce the date of its 2008 Annual Meeting at a later date.

 

A shareholder also may recommend for the consideration of the Corporate Governance/Nominating Committee one or more candidates to serve as a nominee of the Company for election as a director. Any such recommendations for the 2008 Annual Meeting must be submitted in writing to the Secretary of the Company on or before November 29, 2007, accompanied by the information described in the preceding paragraph.

 

What principles has the Board adopted with respect to Board membership? What are the specific qualities or skills that the Corporate Governance/Nominating Committee has determined are necessary for one or more of the directors to possess?

 

The Board has approved the following principles with respect to Board membership. The Board should include an appropriate blend of independent and management directors, which should result in independent directors being predominant and in the views of the Company’s management being effectively represented. Accordingly, the number of independent directors should never be less than seven and the management directors should always include the Chief Executive Officer, there should never be more than three management directors, and any management directors other than the Chief Executive Office should be selected from the Company’s Executive Leadership Team.

 

For independent directors, the Corporate Governance/Nominating Committee seeks the appropriate balance of experience, skills and personal characteristics required of a director. In order to be considered for nomination to the Board, a director candidate should possess most or all of the following attributes: independence, as defined by the NYSE listing standards as currently in effect; integrity; judgment; credibility; collegiality; professional achievement; constructiveness; and public awareness. The independent directors should possess, in aggregate, skill sets that include but are not limited to: financial acumen equivalent to the level of a Chief Financial Officer or senior executive of a capital market, investment or financial services firm; operational or strategic acumen germane to the energy industry, or other industry with similar characteristics (construction, manufacturing, etc.); public and/or government affairs acumen germane to complex enterprises, especially in regulated industries; customer service acumen germane to a service organization with a large customer base; legal acumen in the

 

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field(s) of regulatory or commercial law at the partner or chief legal officer level; salient community ties in areas of operation of Pepco Holdings’ enterprises; and corporate governance acumen, gained through service as a senior officer or director of a large publicly held corporation or through comparable academic or other experience. Independent directors are also selected to ensure diversity, in the aggregate, which diversity should include expertise or experience germane to the Company’s total business needs, in addition to other generally understood aspects of diversity.

 

What is the process for identifying and evaluating nominees for director (including nominees recommended by security holders)?

 

The Corporate Governance/Nominating Committee has developed the following process for the identification and evaluation of director nominees which is contained in the Company’s Corporate Governance Guidelines and can be found on the Company’s Web site (www.pepcoholdings.com) under the link: Corporate Governance:

 

a. List of Potential Candidates.    The Corporate Governance/Nominating Committee develops and maintains a list of potential candidates for Board membership. Potential candidates are recommended by Committee members and other Board members. Shareholders may put forward potential candidates for the Committee’s consideration by following submission requirements published in the Company’s proxy statement for the previous year’s meeting.

 

b. Candidate Attributes, Skill Sets and Other Criteria.    The Committee annually reviews the attributes, skill sets and other qualifications for potential candidates and may modify them from time to time based upon the Committee’s assessment of the needs of the Board and the skill sets required to meet those needs.

 

c. Review of Candidates.    All potential candidates are reviewed by the Committee against the current attributes, skill sets and other qualifications established by the Board to determine if a candidate is suitable for Board membership. If a candidate is deemed suitable based on this review, a more detailed review will be performed through examination of publicly available information. This examination will include consideration of the independence requirement for outside directors, the number of boards on which the candidate serves, the possible applicability of restrictions on director interlocks or other requirements or prohibitions imposed by applicable laws or regulations, proxy disclosure requirements, and any actual or potentially perceived conflicts of interest or other issues raised by applicable laws or regulations or the Company’s policies or practices.

 

d. Prioritization of Candidates.    The Committee then (i) determines whether any candidate needs to be removed from consideration as a result of the detailed review, and (ii) determines a recommended priority among the remaining candidates for recommendation to and final determination by the Board prior to direct discussion with any candidate.

 

e. Candidate Contact.    Following the Board’s determination of a priority-ranked list of approved potential candidates, the Chairman of the Committee or, at his or her discretion, other member(s) of the Board will contact and interview the potential candidates in priority order. When a potential candidate indicates his or her willingness to accept nomination to the Board, no further candidates will be contacted. Subject to a final review of eligibility under the Company’s policies and applicable laws and regulations using information supplied directly by the candidate, the candidate will then be nominated.

 

In 2007, the Committee employed Korn/Ferry International to assist with identifying potential candidates for nomination for election as directors. Pursuant to this engagement, Korn/Ferry International is providing the following services: researching and presenting a list of potential candidates; contacting potential candidates; screening for conflicts; confirming availability; introducing written materials on each candidate; and, scheduling interviews.

 

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3. OTHER MATTERS WHICH MAY COME BEFORE THE MEETING

 

Does the Board of Directors know of any additional matters to be acted upon at the Annual Meeting?

 

The Board of Directors does not know of any other matter to be brought before the meeting.

 

If another matter does come before the meeting, how will my proxy be voted?

 

If any other matter should properly come before the meeting, your signed proxy card, as well as your Internet or telephone proxy, gives the designated proxy holders discretionary authority to vote on such matters in accordance with their best judgment.

 


 

How are proxies being solicited and who pays for the costs involved?

 

The Company will bear the costs of solicitation of proxies, including the reimbursement of banks and brokers for certain costs incurred in forwarding proxy materials to beneficial owners. In addition to the use of the mails, officers, directors and regular employees of the Company may solicit proxies personally, by telephone or facsimile or via the Internet. These individuals will not receive any additional compensation for these activities.

 

Why was only a single Proxy Statement mailed to households that have multiple holders of common stock?

 

Under the rules of the SEC, a company is permitted to deliver a single proxy statement and annual report to any household at which two or more shareholders reside, if the shareholders at the address of the household have the same last name or the company reasonably believes that the shareholders are members of the same family. Accordingly, the Company is sending only one copy of this Proxy Statement and 2006 Annual Report to Shareholders that shared the same last name and address, unless the Company has received instructions to the contrary from one or more of the shareholders.

 

Under these SEC rules, brokers and banks that hold stock for the account of their customers also are permitted to deliver single copies of proxy statements and annual reports to two or more shareholders that share the same address. If you and other residents at your mailing address own shares of common stock through a broker or bank, you may have received a notice notifying you that your household will be sent only one copy of proxy statements and annual reports. If you did not notify your broker or bank of your objection, you may have been deemed to have consented to the arrangement.

 

If, in accordance with these rules, your household received only a single copy of this Proxy Statement and 2006 Annual Report to Shareholders and you would like to receive a separate copy or you would like to receive separate copies of the Company’s proxy statements and annual reports in the future, please contact American Stock Transfer & Trust Company, the Company’s transfer agent:

 

By Telephone:    1-866-254-6502 (toll-free)
In Writing:    American Stock Transfer & Trust Company
     6201 15th Avenue
     Brooklyn, NY 11219-9821

 

If you own your shares through a brokerage firm or a bank, your notification should include the name of your brokerage firm or bank and your account number.

 

If you are a record holder of shares of common stock who is receiving multiple copies of the Company’s shareholder communications at your address and you would like to receive only one copy for your household, please contact American Stock Transfer & Trust Company at the telephone number or address set forth above. If you own your shares through a brokerage firm or a bank, please contact your broker or bank.

 

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Where do I find the Company’s Corporate Business Policies, Corporate Governance Guidelines and Committee Charters?

 

The Company has in place Corporate Business Policies, which in their totality constitute its code of business conduct and ethics. These policies apply to all directors, employees and others working at the Company and its subsidiaries. The Company’s Board of Directors has also adopted Corporate Governance Guidelines and charters for the Company’s Audit Committee, Compensation/Human Resources Committee and Corporate Governance/Nominating Committee which conform to the requirements set forth in the NYSE listing standards. The Board of Directors has also adopted charters for the Company’s Executive Committee and Finance Committee. Copies of these documents are available on the Company Web site at http://www.pepcoholdings.com/governance/index.html and also can be obtained by writing to: Ellen Sheriff Rogers, Vice President, Secretary and Assistant Treasurer, 701 Ninth Street, N.W., Suite 1300, Washington, D.C. 20068.

 

Any amendment to, or waiver of, any provision of the Corporate Business Policies with respect to any director or executive officer of the Company will be promptly reported to shareholders through the filing of a Form 8-K with the SEC.

 


 

The Letter to Shareholders which begins on the cover page of this document, the sections of this Proxy Statement headed “Compensation/Human Resources Committee Report” and “Audit Committee Report” and the 2006 Annual Report to Shareholders, including the “Five-Year Performance Graph 2002-2006,” attached as Annex B to this Proxy Statement are not deemed to be “soliciting material” or to be “filed” with the SEC under or pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934 and shall not be incorporated by reference or deemed to be incorporated by reference into any filing by the Company under either such Act, unless otherwise specifically provided for in such filing.

 

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ANNEX A

 

PEPCO HOLDINGS, INC.

AUDIT COMMITTEE

 


 

Policy on the Approval of Services

Provided By the Independent Auditor

 

I. Overview

 

Under the federal securities laws and the rules of the Securities and Exchange Commission (the “SEC”), the annual consolidated financial statements of Pepco Holdings, Inc. (the “Company”) and each of its subsidiaries that has a reporting obligation (a “Reporting Company”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), must be audited by an “independent” public accountant. Likewise, the quarterly financial statements of the Company and each Reporting Company must be reviewed by an “independent” public accountant.

 

Under SEC regulations, a public accountant is not “independent” if it provides certain specified non-audit services to an audit client. In addition, a public accountant will not qualify as “independent” unless (i) before the accountant is engaged to provide audit or non-audit services, the engagement is approved by the public company’s audit committee or (ii) the engagement to provide audit or non-audit services is pursuant to pre-approved policies and procedures established by the audit committee.

 

Under the Audit Committee Charter, the Audit Committee of the Company has sole authority (i) to retain and terminate the Company’s independent auditors, (ii) to pre-approve all audit engagement fees and terms and (iii) to pre-approve all significant audit-related relationships with the independent auditor. This Policy sets forth the policies and procedures adopted by the Audit Committee with respect to the engagement of the Company’s independent auditor to provide audit and non-audit services to the Company and its subsidiaries (as defined by Rule 1-02 (x) of SEC Regulation S-X).

 

The Audit Committee also serves as the audit committee for each subsidiary of the Company that is a Reporting Company for the purpose of approving audit and non-audit services to be provided by the independent auditor(s) of such Reporting Companies. In this capacity, the Audit Committee has determined that this Policy also shall govern the engagement of the independent auditor for each such Reporting Company.

 

II. Statement of Principles

 

The Audit Committee recognizes the importance of maintaining the independence of its external auditor both in fact and appearance. In order to ensure that the independence of the Company’s external auditor is not, in the judgment of the Audit Committee, impaired by any other services that the external auditor may provide to the Company and its subsidiaries:

 

   

The Audit Committee shall approve in advance all services—both audit and permitted non-audit services—provided to the Company or any of its subsidiaries by the Company’s independent auditor in accordance with the procedures set forth in this Policy.

 

   

The Audit Committee shall not engage the Company’s independent auditor to provide to the Company or any of its subsidiaries any non-audit services that are unlawful under Section 10A of the Exchange Act or that would impair the independence of the Company’s independent auditor under the standards set forth in Rule 2-01 of SEC Regulation S-X (“Prohibited Non-Audit Services”).

 

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III. Approval of Annual Audit Services

 

The annual audit services provided to the Company and its subsidiaries by the Company’s independent auditor shall consist of:

 

   

The audit of the annual consolidated financial statements of the Company and each other Reporting Company and the other procedures required to be performed by the independent auditor to be able to form an opinion on the financial statements.

 

   

Review of the quarterly consolidated financial statements of the Company and each Reporting Company.

 

   

The attestation engagement for the independent auditor’s report on management’s statement on the effectiveness of the Company’s internal control over financial reports.

 

   

Services associated with SEC registration statements, periodic reports and other documents filed with the SEC or issued in connection with securities offerings, including consents and comfort letters provided to underwriters, reviews of registration statements and prospectuses, and assistance in responding to SEC comment letters.

 

All such audit services must be approved annually by the Audit Committee following a review by the Audit Committee of the proposed terms and scope of the engagement and the projected fees. Any subsequent change of a material nature in the terms, scope or fees associated with such annual audit services shall be approved in advance by the Audit Committee.

 

Any additional audit services may be pre-approved annually at the meeting at which the annual audit services are approved. If not pre-approved, each additional annual audit service must be approved by the Audit Committee in advance on a case-by-case basis.

 

IV. Approval of Audit-Related Services

 

Audit-related services consist of assurance and related services that are reasonably related to the performance of the audit or review of the financial statements of the Company and each Reporting Company, other than the annual audit services described in Section III above. Audit-related services may include, but are not limited to:

 

   

Employee benefit plan audits.

 

   

Due diligence related to mergers and acquisitions.

 

   

Accounting consultations and audits in connection with acquisitions.

 

   

Internal control reviews.

 

   

Attest services related to financial reporting that are not required by statute or regulation.

 

Audit-related services may be pre-approved annually at the meeting at which the annual audit services are approved. If not pre-approved, each audit-related service must be approved by the Audit Committee in advance on a case-by-case basis.

 

V. Approval of Tax Services

 

Tax services consist of professional services rendered by the independent auditor to the Company or any of its subsidiaries for tax compliance, tax advice and tax planning. Tax services may be pre-approved annually at the meeting of the Audit Committee at which the annual audit services are approved. If not pre-approved, each tax service must be approved by the Audit Committee in advance on a case-by-case basis.

 

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VI. Approval of All Other Services

 

Any other services to be provided by the Company’s independent auditor, other than Prohibited Non-Audit Services, may be pre-approved annually at the meeting of the Audit Committee at which the annual audit services are approved. If not pre-approved, each such other service must be approved by the Audit Committee in advance on a case-by-case basis.

 

VII. Procedures

 

At the meeting of the Audit Committee to select the independent auditor for the Company and each of the Reporting Companies, the Chief Financial Officer shall submit to the Audit Committee a list of the additional audit services, audit-related services, tax services and other services, if any, that the Company and the Related Companies wish to have pre-approved for the ensuing year. The list shall be accompanied by:

 

   

a written description (which may consist of or include a description furnished to the Company by the independent auditor) of the services to be provided in detail sufficient to enable the Audit Committee to make an informed decision with regard to each proposed service, and, to the extent determinable, an estimate provided by the independent auditor of the fees for each of the services; and

 

   

confirmation of the independent auditor that (i) it would not be unlawful under Section 10A of the Exchange Act for the independent auditor to provide the listed non-audit services to the Company or any of its subsidiaries and (B) none of the services, if provided by the independent auditor to the Company or any of its subsidiaries, would impair the independence of the auditor under the standards set forth in Rule 2-01 of SEC Regulation S-X.

 

If a type of non-audit service is pre-approved by the Audit Committee, and the Company or any of its subsidiaries subsequently engages the independent auditor to provide that service, the Company’s Chief Financial Officer shall report the engagement to the Audit Committee at its next regularly scheduled meeting.

 

VIII. Delegation

 

The Audit Committee hereby delegates to the Chairman of the Audit Committee the authority to approve, upon the receipt of the documentation referred to in Section VII above, on a case-by-case basis any non-audit service of the types referred to in Sections IV, V and VI above (i.e. an audit-related, tax or other service) at any time other than at a meeting of the Audit Committee. The Chairman shall report any services so approved to the Audit Committee at its next regularly scheduled meeting. In no circumstances shall the responsibilities of the Audit Committee under this Policy be delegated to the management of the Company or any of its subsidiaries.

 

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Table of Contents

ANNEX B

 

LOGO

 

2006 Annual Report to Shareholders

 

     PAGE

TABLE OF CONTENTS

    

Glossary of Terms

   B-2

Consolidated Financial Highlights

   B-6

Business of the Company

   B-8

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   B-19

Quantitative and Qualitative Disclosures about Market Risk

   B-78

Management’s Report on Internal Control Over Financial Reporting

   B-82

Report of Independent Registered Public Accounting Firm

   B-82

Consolidated Statements of Earnings

   B-84

Consolidated Statements of Comprehensive Earnings

   B-85

Consolidated Balance Sheets

   B-86

Consolidated Statements of Cash Flows

   B-88

Consolidated Statements of Shareholders’ Equity

   B-89

Notes to Consolidated Financial Statements

   B-90

Quarterly Financial Information (unaudited)

   B-155

Five-Year Performance Graph—2002-2006

   B-157

Board of Directors and Officers

   B-158

Investor Information

   B-159

 

Forward-Looking Statements:    Except for historical statements and discussions, the statements in this annual report constitute “forward-looking statements” within the meaning of federal securities law. These statements contain management’s beliefs based on information currently available to management and on various assumptions concerning future events. Forward-looking statements are not a guarantee of future performance or events. They are subject to a number of uncertainties and other factors, many of which are outside the company’s control. Factors that could cause actual results to differ materially from those in the forward-looking statements herein include general economic, business and financing conditions; availability and cost of capital; changes in laws, regulations or regulatory policies; weather conditions; competition; governmental actions; and other presently unknown or unforeseen factors. These uncertainties and factors could cause actual results to differ materially from such statements. Pepco Holdings disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. This information is presented solely to provide additional information to understand further the results and prospects of Pepco Holdings.

 

B-1


Table of Contents

GLOSSARY OF TERMS

 

Term


  

Definition


2006 Supply Agreement

  

A supply agreement between Conectiv Energy and DPL covering the period June 1, 2006, though May 31, 2007, pursuant to which DPL currently obtains all of the energy and capacity needed to fulfill its Default Service obligations in Virginia

ABO

  

Accumulated benefit obligation

Accounting Hedges

  

Derivatives designated as cash flow and fair value hedges

ACE

  

Atlantic City Electric Company

ACE Funding

  

Atlantic City Electric Transition Funding LLC

ACO

  

Administrative Consent Order

ADFIT

  

Accumulated deferred federal income taxes

ADITC

  

Accumulated deferred investment tax credits

AFUDC

  

Allowance for Funds Used During Construction

Ancillary services

  

Generally, electricity generation reserves and reliability services

APB

  

Accounting Principles Board

APCA

  

Air Pollution Control Act

Appellate Division

  

Appellate Division of the Superior Court of New Jersey

Asset Purchase and Sale Agreement

  

Asset Purchase and Sale Agreement, dated as of June 7, 2000 and subsequently amended, between Pepco and Mirant (formerly Southern Energy, Inc.) relating to the sale of Pepco’s generation assets

Bankruptcy Court

  

Bankruptcy Court for the Northern District of Texas

Bankruptcy Funds

  

$13.25 million in funds from the Bankruptcy Settlement

Bankruptcy Settlement

  

The bankruptcy settlement among the parties concerning the environmental proceedings at the Metal Bank/Cottman Avenue site

Bcf

  

Billion cubic feet

BGS

  

Basic Generation Service (the supply of electricity by ACE to retail customers in New Jersey who have not elected to purchase electricity from a competitive supplier)

BGS-FP

  

BGS-Fixed Price service

BGS-CIEP

  

BGS-Commercial and Industrial Energy Price service

Bondable Transition Property

  

Right to collect a non-bypassable transition bond charge from ACE customers pursuant to bondable stranded costs rate orders issued by the NJBPU

BSA

  

Bill Stabilization Adjustment

CAA

  

Federal Clean Air Act

CAIR

  

EPA’s Clean Air Interstate rule

CAMR

  

EPA’s Clean Air Mercury rule

CERCLA

  

Comprehensive Environmental Response, Compensation, and Liability Act of 1980

CO2

  

Carbon dioxide

Conectiv

  

A wholly owned subsidiary of PHI which is a holding company under PUHCA 2005 and the parent of DPL and ACE

Conectiv Energy

  

Conectiv Energy Holding Company and its subsidiaries

Conectiv Group

  

Conectiv and certain of its subsidiaries that were involved in a like-kind exchange transaction under examination by the IRS

Cooling Degree Days

  

Daily difference in degrees by which the mean (high and low divided by 2) dry bulb temperature is above a base of 65 degrees Fahrenheit

CRMC

  

PHI’s Corporate Risk Management Committee

CWA

  

Federal Clean Water Act

DCPSC

  

District of Columbia Public Service Commission

 

B-2


Table of Contents

Term


  

Definition


Default Electricity Supply

  

The supply of electricity by PHI’s electric utility subsidiaries at regulated rates to retail customers who do not elect to purchase electricity from a competitive supplier, and which, depending on the jurisdiction, is also known as Default Service, SOS, BGS, or POLR service

Default Service

  

The supply of electricity by DPL in Virginia to retail customers who have not elected to purchase electricity from a competitive supplier

Default Supply Revenue

  

Revenue received for Default Electricity Supply

Delaware District Court

  

United States District Court for the District of Delaware

Directors Compensation Plan

  

PHI Non-Management Directors Compensation Plan

District Court

  

United States District Court for the Northern District of Texas

DNREC

  

Delaware Department of Natural Resources and Environmental Control

DPL

  

Delmarva Power & Light Company

DPSC

  

Delaware Public Service Commission

DRP

  

PHI’s Shareholder Dividend Reinvestment Plan

EDECA

  

New Jersey Electric Discount and Energy Competition Act

EDIT

  

Excess Deferred Income Taxes

EITF

  

Emerging Issues Task Force

EPA

  

U.S. Environmental Protection Agency

ERISA

  

Employment Retirement Income Security Act of 1974

Exchange Act

  

Securities Exchange Act of 1934, as amended

FAS

  

Financial Accounting Standards

FASB

  

Financial Accounting Standards Board

FERC

  

Federal Energy Regulatory Commission

Fifth Circuit

  

U.S. Court of Appeals for the Fifth Circuit

FIN

  

FASB Interpretation Number

Financing Order

  

Financing Order of the SEC under PUHCA 1935 dated June 30, 2005, with respect to PHI and its subsidiaries

FSP

  

FASB Staff Position

FSP AUG AIR-1

  

FSP American Institute of Certified Public Accountants Industry Audit Guide, Audits of Airlines—”Accounting for Planned Major Maintenance Activities”

FTB

  

FASB Technical Bulletin

Full Requirements Load Service

  

The supply of energy by Conectiv Energy to utilities to fulfill their Default Electricity Supply obligations

GAAP

  

Accounting principles generally accepted in the United States of America

GCR

  

Gas Cost Recovery

GPC

  

Generation Procurement Credit

Gwh

  

Gigawatt hour

Heating Degree Days

  

Daily difference in degrees by which the mean (high and low divided by 2) dry bulb temperature is below a base of 65 degrees Fahrenheit.

HPS

  

Hourly Priced Service DPL is obligated to provide to its largest customers

IRC

  

Internal Revenue Code

IRS

  

Internal Revenue Service

ITC

  

Investment Tax Credit

LEAC Liability

  

ACE’s $59.3 million deferred energy cost liability existing as of July 31, 1999 related to ACE’s Levelized Energy Adjustment Clause and ACE’s Demand Side Management Programs

LTIP

  

Pepco Holdings’ Long-Term Incentive Plan

Mcf

  

One thousand cubic feet

MDE

  

Maryland Department of the Environment

 

B-3


Table of Contents

Term


  

Definition


Medicare Act

  

Medicare Prescription Drug, Improvement and Modernization Act of 2003

MGP

  

Manufactured gas plant

Mirant

  

Mirant Corporation, its predecessors and its subsidiaries, and the Mirant business that emerged from bankruptcy on January 3, 2006 pursuant to the Reorganization Plan, as a new corporation of the same name

MOA

  

Memorandum of agreement entered into by DPL, the staff of the VSCC and the Virginia Attorney General’s office in the docket approving DPL’s generating asset divestiture in 2000

MPSC

  

Maryland Public Service Commission

NFA

  

No Further Action letter issued by the NJDEP

NJBPU

  

New Jersey Board of Public Utilities

NJDEP

  

New Jersey Department of Environmental Protection

NJPDES

  

New Jersey Pollutant Discharge Elimination System

NOPR

  

Notice of Proposed Rulemaking

Normalization provisions

  

Sections of the IRC and related regulations that dictate how excess deferred income taxes resulting from the corporate income tax rate reduction enacted by the Tax Reform Act of 1986 and accumulated deferred investment tax credits should be treated for ratemaking purposes

Notice

  

Notice 2005-13 issued by the Treasury Department and IRS on February 11, 2005

NOx

  

Nitrogen oxide

NPDES

  

National Pollutant Discharge Elimination System

NSR

  

New Source Review

NUGs

  

Non-utility generators

OCI

  

Other Comprehensive Income

Panda

  

Panda-Brandywine, L.P.

Panda PPA

  

PPA between Pepco and Panda

PARS

  

Performance Accelerated Restricted Stock

PBO

  

Projected benefit obligation

PCI

  

Potomac Capital Investment Corporation and its subsidiaries

Pepco

  

Potomac Electric Power Company

Pepco Distribution

  

The total aggregate distribution to Pepco pursuant to the Settlement Agreement

Pepco Energy Services

  

Pepco Energy Services, Inc. and its subsidiaries

Pepco Holdings or PHI

  

Pepco Holdings, Inc.

Pepco TPA Claim

  

Pepco’s $105 million allowed, pre-petition general unsecured claim against Mirant

PHI Parties

  

The PHI Retirement Plan, PHI and Conectiv, parties to cash balance plan litigation brought by three management employees of PHI Service Company

PHI Retirement Plan

  

PHI’s noncontributory retirement plan

PJM

  

PJM Interconnection, LLC

PLR

  

Private letter ruling from the IRS

POLR

  

Provider of Last Resort service (the supply of electricity by DPL before May 1, 2006 to retail customers in Delaware who did not elect to purchase electricity from a competitive supplier)

POM

  

Pepco Holdings’ NYSE trading symbol

Power Delivery

  

PHI’s Power Delivery Business

PPA

  

Power Purchase Agreement

 

B-4


Table of Contents

Term


  

Definition


PPA-Related Obligations

  

Mirant’s obligations to purchase from Pepco the capacity and energy that Pepco is obligated to purchase under the Panda PPA

PRP

  

Potentially responsible party

PSD

  

Prevention of Significant Deterioration

PUHCA 1935

  

Public Utility Holding Company Act of 1935, which was repealed effective February 8, 2006

PUHCA 2005

  

Public Utility Holding Company Act of 2005, which became effective February 8, 2006

RAR

  

IRS revenue agent’s report

RARM

  

Reasonable Allowance for Retail Margin

RC Cape May

  

RC Cape May Holdings, LLC, an affiliate of Rockland Capital Energy Investments, LLC, and the purchaser of the B.L. England generating facility

Recoverable stranded costs

  

The portion of stranded costs that is recoverable from ratepayers as approved by regulatory authorities

Regulated T&D Electric Revenue

  

Revenue from the transmission and the delivery of electricity to PHI’s customers within its service territories at regulated rates

Reorganization Plan

  

Mirant’s Plan of Reorganization

RGGI

  

Regional Greenhouse Gas Initiative

RI/FS

  

Remedial Investigation/Feasibility Study

ROE

  

Return on equity

SAB

  

SEC Staff Accounting Bulletin

SEC

  

Securities and Exchange Commission

Second Circuit

  

United States Court of Appeals for the Second Circuit

Settlement Agreement

  

Settlement Agreement and Release, dated as of May 30, 2006 between Pepco and Mirant

SFAS

  

Statement of Financial Accounting Standards

SMECO

  

Southern Maryland Electric Cooperative, Inc.

SMECO Agreement

  

Capacity purchase agreement between Pepco and SMECO

SMECO Settlement Agreement

  

Settlement Agreement and Release entered into between Mirant and SMECO

SO2

  

Sulfur dioxide

SOS

  

Standard Offer Service (the supply of electricity by Pepco in the District of Columbia, by Pepco and DPL in Maryland and by DPL in Delaware on and after May 1, 2006, to retail customers who have not elected to purchase electricity from a competitive supplier)

Standard Offer Service revenue or SOS revenue

  

Revenue Pepco and DPL, respectively, receive for the procurement of energy for its SOS customers

Starpower

  

Starpower Communications, LLC

Stranded costs

  

Costs incurred by a utility in connection with providing service which would be unrecoverable in a competitive or restructured market. Such costs may include costs for generation assets, purchased power costs, and regulatory assets and liabilities, such as accumulated deferred income taxes.

Third Circuit

  

United States Court of Appeals for the Third Circuit

Tolling agreement

  

A physical or financial contract where one party delivers fuel to a specific generating station in exchange for the power output

TPA

  

Transition Power Agreements for Maryland and the District of Columbia between Pepco and Mirant

Transition Bonds

  

Transition bonds issued by ACE Funding

Treasury lock

  

A hedging transaction that allows a company to “lock-in” a specific interest rate corresponding to the rate of a designated Treasury bond for a determined period of time

Utility PRPs

  

A group of utility PRPs including Pepco that are parties to a settlement involving the environmental proceedings at the Metal Bank/Cottman Avenue site

VaR

  

Value at Risk

Virginia Restructuring Act

  

Virginia Electric Utility Restructuring Act

VSCC

  

Virginia State Corporation Commission

 

B-5


Table of Contents

CONSOLIDATED FINANCIAL HIGHLIGHTS

 

     2006

    2005

    2004

    2003

    2002

     (Millions of dollars, except share data)

Consolidated Operating Results

                              

Total Operating Revenue

   $ 8,362.9     8,065.5     7,223.1     7,268.7     4,324.5

Total Operating Expenses

   $ 7,669.6 (a)   7,160.1 (c)(d)(e)   6,451.0     6,658.0 (h)(i)   3,778.6

Operating Income

   $ 693.3     905.4     772.1     610.7     545.9

Other Expenses

   $ 282.4 (b)   285.5     341.4     433.3 (j)   191.4

Preferred Stock Dividend Requirements of Subsidiaries

   $ 1.2     2.5     2.8     13.9     20.6

Income Before Income Tax Expense and Extraordinary Item

   $ 409.7     617.4     427.9     163.5     333.9

Income Tax Expense

   $ 161.4     255.2 (f)   167.3 (g)   62.1     124.9

Income Before Extraordinary Item

   $ 248.3     362.2     260.6     101.4     209.0

Extraordinary Item

   $ —       9.0     —       5.9     —  

Net Income

   $ 248.3     371.2     260.6     107.3     209.0

Redemption Premium on Preferred Stock

   $ (.8 )   (.1 )   .5     —       —  

Earnings Available for Common Stock

   $ 247.5     371.1     261.1     107.3     209.0

Common Stock Information

                              

Basic Earnings Per Share of Common Stock Before Extraordinary Item

   $ 1.30     1.91     1.48     .60     1.59

Basic—Extraordinary Item Per Share of Common Stock

   $ —       .05     —       .03     —  

Basic Earnings Per Share of Common Stock

   $ 1.30     1.96     1.48     .63     1.59

Diluted Earnings Per Share of Common Stock Before Extraordinary Item

   $ 1.30     1.91     1.48     .60     1.59

Diluted—Extraordinary Item Per Share of Common Stock

   $ —       .05     —       .03     —  

Diluted Earnings Per Share of Common Stock

   $ 1.30     1.96     1.48     .63     1.59

Weighted Average Shares Outstanding

     190.7     189.0     176.8     170.7     131.1

Cash Dividends Per Share of Common Stock

   $ 1.04     1.00     1.00     1.00     1.00

Year-End Stock Price

   $ 26.01     22.37     21.32     19.54     19.39

Net Book Value per Common Share

   $ 18.82     18.88     17.74     17.31     17.49

Other Information

                              

Investment in Property, Plant and Equipment

   $ 11,819.7     11,441.0     11,109.4     10,815.2     10,699.7

Net Investment in Property, Plant and Equipment

   $ 7,576.6     7,368.8     7,152.2     7,032.9     7,118.0

Total Assets

   $ 14,243.5     14,038.9     13,374.6     13,390.2     13,479.4

Capitalization

                              

Short-term Debt

   $ 349.6     156.4     319.7     518.4     971.1

Long-term Debt

   $ 3,768.6     4,202.9     4,362.1     4,588.9     4,287.5

Current Maturities of Long-Term Debt

   $ 857.5     469.5     516.3     384.9     408.1

Transition Bonds issued by ACE Funding

   $ 464.4     494.3     523.3     551.3     425.3

Capital Lease Obligations due within one year

   $ 5.5     5.3     4.9     4.4     4.1

Capital Lease Obligations

   $ 111.1     116.6     122.1     126.8     131.3

Long-Term Project Funding

   $ 23.3     25.5     65.3     68.6     28.6

Debentures issued to Financing Trust

   $ —       —       —       98.0     —  

Trust Preferred Securities

   $ —       —       —       —       290.0

Minority Interest

   $ 24.4     45.9     54.9     108.2     110.7

Common Shareholders’ Equity

   $ 3,612.2     3,584.1     3,339.0     2,974.1     2,972.8
    


 

 

 

 

Total Capitalization

   $