QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended June 30, 2003

Commission
File Number

Name of Registrant, State of Incorporation, Address of Principal Executive Offices,
    and Telephone Number    

I.R.S. Employer Identification Number

001-31403

PEPCO HOLDINGS, INC.
("Pepco Holdings," a Delaware
  corporation)
701 Ninth Street, N.W.
Washington, D.C. 20068
Telephone: (202)872-2000

52-2297449

001-01072

POTOMAC ELECTRIC POWER COMPANY
("Pepco," a District of
  Columbia and Virginia
  corporation)
701 Ninth Street, N.W.
Washington, D.C. 20068
Telephone: (202)872-2000

53-0127880

001-13895

CONECTIV
("Conectiv," a Delaware
  corporation)
800 King Street, P.O. Box 231
Wilmington, Delaware
Telephone: (202)872-2000

51-0377417

001-01405

DELMARVA POWER & LIGHT COMPANY
("DPL," a Delaware and
  Virginia corporation)
800 King Street, P.O. Box 231
Wilmington, Delaware
Telephone: (202)872-2000

51-0084283

001-03559

ATLANTIC CITY ELECTRIC COMPANY
("ACE," a New Jersey
  corporation)
800 King Street, P.O. Box 231
Wilmington, Delaware
Telephone: (202)872-2000

21-0398280

333-59558

ATLANTIC CITY ELECTRIC
  TRANSITION FUNDING LLC
("ACE Funding," a New Jersey
  limited liability company)
P.O. Box 15597
Wilmington, Delaware
Telephone: (202)872-2000

51-0408521

Continued

Securities registered pursuant to Section 12(b) of the Act:

Registrant

Title of Each Class

Name of Each Exchange on Which Registered  

Pepco Holdings

Common Stock, $.01 par value

   New York Stock
   Exchange

Pepco

Guarantee by Pepco of the 7-3/8% Trust Originated Preferred Securities issued by Potomac Electric Power Company Trust I

   New York Stock    Exchange

DPL

Guarantee by DPL of the 8.125% Cumulative Trust Preferred Capital Securities of Delaware Power Financing I

   New York Stock
   Exchange

ACE

Guarantee by ACE of the 7-3/8% Cumulative Quarterly Income Preferred Securities, issued by Atlantic Capital II

   New York Stock    Exchange

     None.

     Indicate by check mark whether each of the registrants (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes X . No    .

     Indicate by check mark whether Pepco Holdings is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes   X  .    No      .

     Pepco, Conectiv, DPL, ACE, and ACE Funding are not accelerated filers.

     Conectiv, DPL, ACE and ACE Funding meet the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and are therefore filing this Form 10-Q with reduced disclosure format specified in General Instruction H(2) of Form 10-Q.

Registrant

Number of Shares of Common Stock of the Registrant Outstanding at June 30, 2003

Pepco Holdings

170,907,405 ($.01 par value)

Pepco

100 ($.01 par value) (a)

Conectiv

100 ($.01 par value) (a)

DPL

1,000 ($2.25 par value) (b)

ACE

18,320,937 ($3 par value)(b)

ACE Funding

None (c)

(a)

As of August 1, 2002, all voting and non-voting common equity is owned
  by Pepco Holdings.

(b)

All voting and non-voting common equity is owned by Conectiv.

(c)

All voting and non-voting common equity is owned by ACE.

DOCUMENTS INCORPORATED BY REFERENCE

     THIS COMBINED FORM 10-Q IS SEPARATELY FILED BY PEPCO HOLDINGS, PEPCO, CONECTIV, DPL, ACE, AND ACE FUNDING. INFORMATION CONTAINED HEREIN RELATING TO ANY INDIVIDUAL REGISTRANT IS FILED BY SUCH REGISTRANT ON ITS OWN BEHALF. EACH REGISTRANT MAKES NO REPRESENTATION AS TO INFORMATION RELATING TO THE OTHER REGISTRANTS.

TABLE OF CONTENTS

Page

PART I

FINANCIAL INFORMATION

  Item 1.

-

Financial Statements

1

  Item 2.

-

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

89

  Item 3.

-

Quantitative and Qualitative Disclosures
   About Market Risk

153

  Item 4.

-

Controls and Procedures

153

PART II

OTHER INFORMATION

  Item 1.

-

Legal Proceedings

156

  Item 2.

-

Changes in Securities and Use of Proceeds

158

  Item 3.

-

Defaults Upon Senior Securities

159

  Item 4.

-

Submission of Matters to a Vote of Security Holders

159

  Item 5.

-

Other Information

159

  Item 6.

-

Exhibits and Reports on Form 8-K

160

  Signatures

188

  Principal Executive Officer and Principal Financial Officer Certifications
     (Exhibit 31)

169

TABLE OF CONTENTS - EXHIBITS

Exh. No.

Registrant(s)

Description of Exhibit

Page

12.1

PHI

Statements Re: Computation of Ratios

163

12.2

Pepco

Statements Re: Computation of Ratios

164

12.3

Conectiv

Statements Re: Computation of Ratios

165

12.4

DPL

Statements Re: Computation of Ratios

166

12.5

ACE

Statements Re: Computation of Ratios

167

15

PHI

Independent Accountants' Awareness Letter

168

31.1

PHI

Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer

169

31.2

PHI

Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer

170

31.3

Pepco

Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer

171

31.4

Pepco

Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer

172

31.5

Conectiv

Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer

173

31.6

Conectiv

Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer

174

31.7

DPL

Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer

175

31.8

DPL

Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer

176

31.9

ACE

Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer

177

31.10

ACE

Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer

178

31.11

ACEF

Rule 13a-14(a)/15d-14(a) Certificate of Chief Executive Officer

179

31.12

ACEF

Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer

180

32.1

PHI

Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

181

32.2

Pepco

Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

182

32.3

Conectiv

Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

183

32.4

DPL

Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

184

32.5

ACE

Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

185

32.6

ACEF

Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

186

PART I    FINANCIAL INFORMATION

Item 1.   FINANCIAL STATEMENTS

     Listed below is a table that sets forth, for each registrant, the page number where the information is contained herein.

                      Registrants                  

Item

Pepco
Holdings

Pepco

Conectiv

DPL

ACE

ACE
Funding

Report of Independent
  Accountants

3

N/A

N/A

N/A

N/A

N/A

Consolidated Statements
  of Earnings

4

31

48

65

75

85

Consolidated Statements
  of Comprehensive Income

5

32

49

N/A

N/A

N/A

Consolidated Balance
  Sheets

6

33

50

66

76

86

Consolidated Statements
  of Cash Flows

8

35

52

68

78

N/A

Notes to Consolidated
  Financial Statements

9

36

53

69

79

87

THIS PAGE LEFT INTENTIONALLY BLANK.

Report of Independent Accountants

To the Shareholders and Board of Directors
   of Pepco Holdings, Inc.

We have reviewed the accompanying consolidated balance sheet of Pepco Holdings, Inc. and its subsidiaries (the Company) as of June 30, 2003, and the related consolidated statements of earnings and consolidated statements of comprehensive income for each of the three-month and six-month periods ended June 30, 2003 and 2002 and the consolidated statement of cash flows for the six-month periods ended June 30, 2003 and 2002. These interim financial statements are the responsibility of the Company's management.

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We previously audited in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet as of December 31, 2002, and the related consolidated statements of earnings, and the consolidated statements of comprehensive income, and consolidated statements of cash flows for the year then ended (not presented herein), and in our report dated February 10, 2003, except as to Note (a) to Note 11 for which the date is February 28, 2003 and as to the eleventh and twelfth paragraphs of Note 15 for which the date is March 4, 2003, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of June 30, 2003, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.

/s/ PricewaterhouseCoopers LLP
Washington, DC
August 13, 2003

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

PEPCO HOLDINGS, INC.

     For additional information, other than the information disclosed in the Notes to Consolidated Financial Statements section herein, refer to Item 8. Financial Statements and Supplementary Data of the Company's 2002 Form 10-K.

(1)  ORGANIZATION

     Pepco Holdings, Inc. (Pepco Holdings or the Company), a registered holding company under the Public Utility Holding Company Act of 1935 (PUHCA), was incorporated under the laws of Delaware on February 9, 2001 for the purpose of effecting Potomac Electric Power Company's (Pepco) acquisition of Conectiv. In accordance with the terms of the merger agreement, upon the consummation of the merger on August 1, 2002, Pepco and Conectiv became wholly owned subsidiaries of Pepco Holdings. Additionally, Pepco, through a series of transactions, transferred its ownership interests in its pre-merger subsidiaries Potomac Capital Investment Corporation (PCI) and Pepco Energy Services, Inc. (Pepco Energy Services) to Pepco Holdings and PCI transferred its ownership interest in its pre-merger subsidiary Pepco Communications, Inc. (Pepcom) to Pepco Holdings. These transactions resulted in PCI, Pepco Energy Services, and Pepcom becoming wholly owned subsidiar ies of Pepco Holdings. Additionally, PUHCA imposes certain restrictions on the operations of registered holding companies and their subsidiaries; therefore, Pepco Holdings has a subsidiary service company that provides a variety of support services to Pepco Holdings and its subsidiaries. The costs of the service company are directly assigned or allocated to Pepco Holdings and its subsidiaries based on prescribed allocation factors listed in the service agreement filed with, and approved by, the Securities and Exchange Commission (SEC). Pepco Holdings manages its operations as described below.

Power Delivery

     The largest component of Pepco Holdings' business is power delivery, which is conducted through its subsidiaries Pepco, Delmarva Power & Light Company (DPL), and Atlantic City Electric Company (ACE). Pepco, DPL and ACE are all regulated public utilities in the jurisdictions in which they serve customers. The operations of DPL and ACE are collectively referred to herein as "Conectiv Power Delivery."

Pepco

     Pepco is engaged in the transmission and distribution of electricity in Washington, D.C. and major portions of Prince George's and Montgomery Counties in suburban Maryland. Under settlements entered into with regulatory authorities in connection with the divestiture of its generation assets in 2000, Pepco is required to provide default electricity supply (referred to as "standard offer service" or "SOS") at specified rates to customers in Maryland until July 2004 and to customers in Washington, D.C. until February 2005, which supply it purchases from an affiliate of Mirant Corporation ("Mirant"). On July 14, 2003, Mirant and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. For a discussion of Pepco's relationship with Mirant, see Note (5) "Commitments and Contingencies" herein. For the twelve months ended June 30, 2003, Pepco delivered 5.7 million megawatt hours to SOS cus tomers in the District of Columbia and 10.3 million megawatt hours to SOS customers in Maryland. For this period total deliveries were 11.2 million megawatt hours in the District of Columbia and 15.4 million megawatt hours in Maryland.

     On April 29, 2003, the Maryland Public Service Commission approved a settlement in Phase 1 of Maryland Case No. 8908 under which Pepco will supply retail customers with standard offer service electricity at market prices, including a margin, after existing rate caps expire in July 2004. Under this settlement, Pepco will provide standard offer service to its Maryland residential customers from July 2004 through May 2008 and to its non-residential customers for periods of one to four years. Pepco will obtain power for this market rate standard offer service through a competitive wholesale bidding process. In the District of Columbia, under current law, Pepco will not provide standard offer service after the expiration of its current obligations in February 2005, unless the District of Columbia Public Service Commission determines that there are insufficient bids to provide standard offer service, in which case Pepco may be directed to provide suc h service.

Conectiv Power Delivery

     DPL is engaged in the transmission and distribution of electricity in Delaware and portions of Maryland and Virginia and provides gas distribution service in northern Delaware. Under regulatory settlements, DPL is required to provide standard offer electricity service at specified rates to residential customers in Maryland until July 2004 and to non-residential customers in Maryland until June 2004 and to provide default electricity service at specified rates to customers in Delaware until May 2006. It is currently expected that DPL will also provide default electric service at specified rates to customers in Virginia until July 2007. However, the Virginia State Corporation Commission could terminate the obligation for some or all classes of customers sooner if it finds that an effectively competitive market exists. Conectiv Energy (described in the "Competitive Energy" section) supplies all of DPL's standard offer and default service load requ irements under a supply agreement that ends May 31, 2006. The terms of the supply agreement are structured to coincide with DPL's load requirements under each of its regulatory settlements. Conectiv Energy's resources for supplying DPL's standard offer and default service load include electricity generated by Conectiv Energy's plants and electricity purchased under long-term agreements or in the spot market. DPL purchases gas supplies for its customers from marketers and producers in the spot market and under short-term and long-term agreements.

     As discussed above, on April 29, 2003, the Maryland Commission approved a settlement in Phase I of Maryland Case No. 8908 to extend the provision of standard offer service that requires local utilities to continue to supply customers with electricity after existing rate caps/freezes expire in July 2004 at market prices. DPL will provide SOS to its Maryland residential customers from July 1, 2004 through May 31, 2008 and to its non-residential customers for periods of one to four years. DPL will obtain power for the market rate standard offer service through a competitive wholesale bidding process.

     ACE is engaged in the generation, transmission, and distribution of electricity in southern New Jersey. ACE has default service obligations, known as Basic Generation Service (BGS), for approximately 20 percent of the electricity supply to its customers. ACE expects to fulfill these obligations through the generation output from its fossil fuel-fired generating plants and through existing purchase power agreements with non-utility generators (NUG). In January 2003, ACE terminated its competitive bidding process to sell these generation assets.

     ACE formed Atlantic City Electric Transition Funding LLC (ACE Funding) during 2001. ACE Transition Funding is a wholly owned subsidiary of ACE. ACE Funding was organized for the sole purpose of purchasing and owning Bondable Transition Property (BTP), issuing transition bonds (Bonds) to fund the purchasing of BTP, pledging its interest in BTP and other collateral to the Trustee to collateralize the Bonds, and to perform activities that are necessary, suitable or convenient to accomplish these purposes.

Competitive Energy

     The competitive energy component of the Company's business is conducted through subsidiaries of Conectiv Energy Holding Company (collectively referred to herein as "Conectiv Energy") and Pepco Energy Services.

Conectiv Energy

     Conectiv Energy provides wholesale power and ancillary services to the Pennsylvania/New Jersey/Maryland (PJM) power pool and supplies power under contract, to customers including DPL and ACE. Conectiv Energy's generation asset strategy focuses on mid-merit plants with operating flexibility and multi-fuel capability that can quickly change their output level on an economic basis. Mid-merit plants generally are operated during times when demand for electricity rises and prices are higher.

     As of June 30, 2003, Conectiv Energy owned and operated electric generating plants with 3,302 MW of capacity. In January 2002, Conectiv Energy began construction of a 1,100 MW combined cycle plant with six combustion turbines at a site in Bethlehem, Pennsylvania. The plant has become operational in stages that added 306 MW in 2002(resulting from the installation of three CTs), 279 MW in the first quarter of 2003 (resulting from the installation of an additional two CTs and an upgrade of the CTs installed during 2002), 296 MW in the second quarter (resulting from the installation of one additional CT and one waste heat recovery boiler and steam generating unit), and is expected to add an additional 209 MW of capacity by the end of 2003 (resulting from the installation of a second waste heat recovery boiler and steam generating unit and upgrades of the existing CTs).

     On June 25, 2003, Conectiv Energy entered into an agreement consisting of a series of energy contracts with an international investment banking firm with a senior unsecured debt rating of A+ / Stable from Standard & Poors (the "Counterparty"). The agreement is designed to more effectively hedge approximately fifty percent of Conectiv Energy's generation output and approximately fifty percent of its supply obligations, with the intention of providing Conectiv Energy with a more predictable earnings stream during the term of the agreement. For additional information about this agreement and Conectiv Energy, refer to Note 6. Conectiv Energy Events, herein.

Pepco Energy Services

     Pepco Energy Services provides retail electricity and natural gas to residential, commercial, industrial and governmental customers in the mid-Atlantic region. Pepco Energy Services also provides integrated energy management solutions to commercial, industrial and governmental customers, including energy-efficiency contracting, development and construction of "green power" facilities, equipment operation and maintenance, fuel management, and home service agreements. In addition, Pepco Energy Services owns electricity generation plants with approximately 800 MW of peaking capacity, the output of which is sold in the wholesale market. Pepco Energy Services also purchases and sells electricity and natural gas in the wholesale markets to support its commitments to its retail customers.

Other Non-Regulated

     This component of Pepco Holdings' business is conducted through its subsidiaries PCI and Pepcom.

PCI

     PCI manages a portfolio of financial investments. During the second quarter of 2003, Pepco Holdings announced the discontinuation of further new investment activity by PCI. In the future, PCI's existing portfolio of financial investments will be managed at Pepco Holdings. The majority of PCI's investments are focused on investments related to the energy industry, such as energy leveraged leases. These transactions involve PCI's purchase and leaseback of utility assets, located outside of the United States, that provide a long term, stable stream of cash flow and earnings. PCI also owns a ten-story, 360,000 square foot office building in downtown Washington, D.C., known as Edison Place, which is leased to Pepco and serves as Pepco Holdings' and Pepco's corporate headquarters. PCI will continue to pursue opportunities to divest its remaining aircraft assets and plans to sell its final real estate property - Edison Place. The sale of the Edison Pl ace building, which was announced on July 21, 2003, will occur by competitive bid and is expected to close during 2003. PCI's book basis in the building at June 30, 2003, is approximately $79 million.

     At June 30, 2003, PCI's utility industry products and services were provided through various operating companies, including W.A. Chester and Severn Cable, which effective August 1, 2003 were transferred to Pepco Energy Services. W.A. Chester, an underground electric services company, provides high voltage construction and maintenance services to utilities and to other customers throughout the United States. Severn Cable provides low voltage electric and telecommunication construction and maintenance services in the Washington, D.C. area.

Pepcom

     Pepcom owns a 50% interest in Starpower Communications, LLC (Starpower), a joint venture with RCN Corporation, which provides cable and telecommunication services to households in the Washington, D.C. area.

(2)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND IMPACT OF OTHER
       ACCOUNTING STANDARDS

Significant Accounting Policies

Principles of Consolidation

     The accompanying consolidated financial statements include the accounts of Pepco Holdings and its wholly owned subsidiaries. All intercompany balances and transactions between subsidiaries have been eliminated. Investments in entities in which Pepco Holdings has a 20% to 50% interest are accounted for using the equity method of accounting. Under the equity method, investments are initially carried at cost and subsequently adjusted for Pepco Holdings' proportionate share of the investees' undistributed earnings or losses and dividends. Ownership interests in other entities of less than 20% are accounted for using the cost method of accounting.

Consolidated Financial Statement Presentation

     The Company's unaudited consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Pursuant to the rules and regulations of the U.S. Securities and Exchange Commission, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted. Therefore, these financial statements should be read along with our Annual Report on Form 10K for the year ended December 31, 2002. In management's opinion, the consolidated financial statements contain all adjustments (which all are of a normal recurring nature) necessary to present fairly Pepco Holdings' financial position as of June 30, 2003 and 2002, in accordance with GAAP. Interim results for the three-months and six months ended March 31, and June 30, 2003 may not be indicative of results that will be realized for the full year ending Decembe r 31, 2003. Certain prior period amounts have been reclassified in order to conform to current period presentation.

     Pepco Holdings' independent accountants have performed a review of, and issued a report on, these consolidated interim financial statements in accordance with standards established by the American Institute of Certified Public Accountants. Pursuant to Rule 436(c) under the U.S. Securities Act of 1933, this report should not be considered a part of any registration statement prepared or certified within the meanings of Section 7 and 11 of the Securities Act.

     The accompanying consolidated statements of earnings and the consolidated statements of comprehensive income for the three and six months ended June 30, 2003 and the consolidated statements of cash flows for the six months ended June 30, 2003 include Pepco Holdings and its subsidiaries results for the full periods. However, these statements for the corresponding periods in 2002, as previously reported by Pepco, include only the consolidated operations of Pepco and its pre-merger subsidiaries. Accordingly, the consolidated balances included in the statements referred to above for the three and six months ended June 30, 2003 and 2002 are not comparable. The amounts presented in the accompanying consolidated balance sheets as of June 30, 2003 and December 31, 2002, respectively, are comparable as both periods presented reflect the impact of the merger transaction with Conectiv.

Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, such as Statement of Position 94-6 "Disclosure of Certain Significant Risks and Uncertainties," requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Examples of estimates used by Pepco Holdings include the calculation of the allowance for uncollectible accounts, environmental remediation costs and anticipated collections, unbilled revenue, pension assumptions, and fair values used in the purchase method of accounting and the resulting goodwill balance. Although Pepco Holdings believes that its estimates and assumptions are reasonable, they are based upon information presently available. Actual results m ay differ significantly from these estimates.

Impact of Other Accounting Standards

Energy Trading Reclassifications

     In 2002, the Emerging Issues Task Force issued a pronouncement entitled EITF Issue No. 02-3 (EITF 02-3) "Accounting for Contracts Involved in Energy Trading and Risk Management Activities." Beginning with July 2002, all trades were recorded net in accordance with EITF 02-3 and therefore no reclassification was required for activities after July 2002. Accordingly, due to the timing of the August 2002 merger, no revenue or expense reclassifications are required for Conectiv Energy's portion of Pepco Holdings' results. However, Pepco Energy Services' revenues decreased from $183.5 million to $170.9 million for the three months ended June 30, 2002 and from $340.3 million to $317.7 million for the six months ended June 30, 2002. There is no impact on Conectiv Energy's or Pepco Energy Services' overall financial position or net results of operations as a result of the implementation of EITF 02-3.

Severance Costs

     During 2002, Pepco Holdings' management approved initiatives by Pepco and Conectiv to streamline their operating structure by reducing the number of employees at each company. These initiatives met the criteria for the accounting treatment provided under EITF No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." As of December 31, 2002, Pepco Holdings accrued $23.2 million of severance costs in connection with the plan. As of June 30, 2003, the severance liability had a balance of $15.9 million. Based on the number of employees that have or are expected to accept the severance packages, substantially all of the severance liability at June 30, 2003 will be paid through mid 2005. Employees have the option of taking severance payments in a lump sum or over a period of time.

Asset Retirement Obligations

     In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143 entitled "Accounting for Asset Retirement Obligations," which was adopted by Pepco Holdings on January 1, 2003. This Statement establishes the accounting and reporting standards for measuring and recording asset retirement obligations. Based on the implementation of SFAS No. 143, at June 30, 2003, $252.2 million in asset removal costs that are not legal obligations pursuant to the statement ($177.3 million for DPL and $74.9 million for Pepco) and $245.3 million at December 31, 2002 ($173.2 million for DPL and $72.1 million for Pepco) have been accrued and are embedded in accumulated depreciation in the accompanying consolidated balance sheets.

Accounting for Guarantees

     Pepco Holdings and its subsidiaries have applied the provisions of FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," to their agreements that contain guarantee clauses. These provisions expand those required by FASB Statement No. 5, "Accounting for Contingencies," by requiring a guarantor to recognize a liability on its balance sheet for the fair value of obligation it assumes under certain guarantees issued or modified after December 31, 2002 and to disclose certain types of guarantees, even if the likelihood of requiring the guarantor's performance under the guarantee is remote.

     As of June 30, 2003, Pepco Holdings and its subsidiaries did not have material obligations under guarantees issued or modified after December 31, 2002, which are required to be recognized as a liability on the consolidated balance sheets. Refer to Note 5. Commitments and Contingencies, herein, for a summary of Pepco Holdings' guarantees and other commitments.

New Accounting Standards

     In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149 entitled "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement amends and clarifies SFAS No. 133 for certain interpretive guidance issued by the Derivatives Implementation Group. SFAS No. 149 is effective after June 30, 2003, for contracts entered into or modified and for hedges designated after the effective date. The Company is in the process of assessing the provisions of SFAS No. 149 to determine its impact on the Company's financial position and results of operations.

     In May 2003, the FASB issued SFAS No. 150 entitled "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 (the Company's third quarter 2003 financial statements). This Statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity and will result in the Company's reclassification of its "Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Which Holds Solely Parent Junior Subordinated Debentures" on its consolidated balance sheets to a liability classification. There will be no impact on the Company's results of operations from the implementatio n of this Statement.

(3)  DEBT

     During the quarter ended June 30, 2003, and subsequent thereto through August 7, 2003, Pepco Holdings and its subsidiaries engaged in the following capital market transactions:

     On May 1, 2003, DPL redeemed $32 million of 8.15% First Mortgage Bonds due October 1, 2015.

     On May 20, 2003, Pepco purchased on the open market and subsequently redeemed $15 million of 7% Medium Term Notes due January 15, 2024.

     On May 29, 2003, PHI issued $400 million of notes. $200 million were issued at a fixed rate of 4% due May 15, 2010 and $200 million were issued at a floating rate (3 month LIBOR plus 80 basis points) due November 15, 2004. Proceeds were used to pay down PHI commercial paper.

     On June 2, 2003, Conectiv redeemed at maturity $50 million of 6.73% Medium-Term Notes.

     On June 2, 2003, DPL redeemed at maturity $2.2 million of 6.95% First Mortgage Bonds.

     On June 2, 2003, ACE redeemed at maturity $30 million of 6.63% Medium Term Notes.

     On July 1, 2003, DPL redeemed at maturity $85 million of 6.4% First Mortgage Bonds.

     On July 21, 2003, Pepco redeemed the following First Mortgage Bonds: $40 million of 7.5% series due March 15, 2028 and $100 million of 7.25% series due July 1, 2023.

     PCI redeemed the following Medium Term-Notes at maturity: on April 1, 2003, $10 million of its 6.5% Series; on June 2, 2003, $3.5 million of its 7.38% Series; on June 18, 2003, $1 million of its 7.3% Series; on July 15, 2003, $5 million of its 7.04% Series; and on July 28, 2003, $7 million of its 7% Series.

     On July 29, 2003, Pepco Holdings, Pepco, DPL and ACE entered into (i) a three-year working capital credit facility with an aggregate credit limit of $550 million and (ii) a 364-day working capital credit facility with an aggregate credit limit of $550 million. Pepco Holdings' credit limit under these facilities is $700 million, and the credit limit of each of Pepco, DPL and ACE under these facilities is $300 million, except that the aggregate amount of credit utilized by Pepco, DPL and ACE at any given time under these facilities may not exceed $400 million. Funds borrowed under these facilities are available for general corporate purposes. Either credit facility also can be used as credit support for the commercial paper programs of the respective companies. These credit facilities replaced a $1.5 billion 364-day credit facility entered into on August 1, 2002.

     On August 1, 2003 Pepco mailed official notice to the holders of its Serial Preferred Stock, $3.40 Series of 1992 for mandatory sinking fund redemption on September 1, 2003 of 50,000 shares at par value of $50.00 per share.

     In September 2002, Pepco Holdings issued in a private placement $1.5 billion of notes. In connection with the sale of the notes, Pepco Holdings agreed to cause an exchange offer for the notes to be completed no later than June 3, 2003. By May 22, 2003, all of the exchange notes were issued and all of the original notes were tendered.

     On August 7, 2003 on behalf of DPL, the Delaware Economic Development Authority issued $33.2 million of long-term bonds and loaned the proceeds to DPL. The bonds issued included $15.0 million of variable rate Exempt Facilities Refunding Revenue Bonds, Series A due August 1, 2038, and $18.2 million of 3.15% Pollution Control Refunding Revenue Bonds, Series B due February 1, 2023. The Series B bonds are subject to mandatory tender on August 1, 2008. All or a portion of the tendered bonds may be redeemed and/or remarketed. After August 1, 2008, the bonds may bear interest at a variable rate or fixed rate and may be subject to optional redemption prior to maturity, as provided for in the indenture for the bonds. On September 15, 2003, DPL will use the proceeds to redeem $33.2 million of bonds outstanding, as follows: $15.0 million of 6.05% bonds, due June 1, 2032, and $18.2 million of 5.90% bonds, due June 1, 2021.

(4)  SEGMENT INFORMATION

     Pepco Holdings' management has identified the following reportable segments: Pepco, Conectiv Power Delivery, Conectiv Energy, Pepco Energy Services, and Other Non-Regulated. Intercompany (intersegment) revenues and expenses are not eliminated at the segment level for purposes of presenting segment financial results. Elimination of these intercompany amounts is accomplished through the "Corporate and Other" column. Segment financial information for the three and six months ended June 30, 2003 and 2002 is as follows.

(5)   COMMITMENTS AND CONTINGENCIES

Relationship with Mirant Corporation

     In 2000, Pepco sold substantially all of its electricity generation assets to Mirant, formerly Southern Energy, Inc. As part of the asset purchase and sale agreement (the "Asset Purchase and Sale Agreement"), Pepco and Mirant entered into Transition Power Agreements for Maryland and the District of Columbia, respectively (collectively, the "TPAs"). Under these agreements an affiliate of Mirant is obligated to supply Pepco with all of the capacity and energy needed to fulfill its standard offer service obligations in Maryland until July 2004 and in the District of Columbia until February 2005. The prices paid by Pepco under the TPAs consist of a $3.50 per megawatt hour capacity price and a $.50 per megawatt hour charge for certain ancillary services, and an energy payment price of $35.50 per megawatt hour during summer months (May 1 through September 30) and $25.30 per megawatt hour during winter months (October 1 through April 30) in Maryl and and $40.00 per megawatt hour during summer months and $22.20 per megawatt hour during winter months in the District of Columbia. The average purchase price is approximately 3.4 cents per kilowatt hour. These rates result in payments to the Mirant affiliate that are lower than the revenues produced by the currently approved tariff rates that Pepco charges its customers for providing standard offer service, which average 4.1 cents per kilowatt hour. The difference in revenues is shared with customers pursuant to regulatory settlements.

     Under agreements with FirstEnergy Corp., formerly Ohio Edison ("FirstEnergy"), and Allegheny Energy, Inc., Pepco is obligated to purchase from FirstEnergy 450 megawatts of capacity and energy annually through December 2005 (the "FirstEnergy PPA"). Under an agreement with Panda-Brandywine, L.P. ("Panda"), Pepco is obligated to purchase from Panda 230 megawatts of capacity and energy annually through 2021 (the "Panda PPA"). In each case, the purchase price is substantially in excess of current market prices. As a term of the Asset Purchase and Sale Agreement, Pepco, in connection with the sale of substantially all of its electricity generation assets to Mirant, entered into "back-to-back" agreements with Mirant. Under the agreements, Mirant is obligated to purchase from Pepco the capacity and energy that Pepco is obligated to purchase under the FirstEnergy PPA and the Panda PPA at a price equal to the price Pepco is obligated to pay under the PPA s.

     On July 14, 2003, Mirant and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Mirant is continuing to supply power to Pepco under the terms of the TPAs and is performing its contractual obligations to Pepco corresponding to Pepco's obligations under the PPAs (the "PPA-Related Obligations"). Retail prices paid by Pepco's standard offer service customers have not been affected by the bankruptcy filing. These retail prices can be changed only by order of the Maryland and the District of Columbia Public Service Commissions.

     Under bankruptcy law, a debtor may affirm or reject executory contracts. A rejection of an executory contract entitles the counterparty to file a claim as an unsecured creditor against the bankruptcy estate for damages incurred due to the rejection of the contract. Mirant has not informed Pepco and, to the knowledge of Pepco, has not otherwise stated that it intends to reject either of the TPAs or its PPA-Related Obligations. However, there is no assurance that Mirant will not seek to reject the agreements in the course of the bankruptcy proceedings.

     If Mirant were to attempt to reject either of the TPAs or its PPA-Related Obligations, Pepco intends to exercise all available legal remedies and vigorously oppose any actions that could adversely affect Pepco's rights under its agreements with Mirant. While Pepco believes that it has substantial legal bases to oppose any attempt at rejection of the agreements, the outcome of the bankruptcy proceeding cannot be predicted with any degree of certainty. Pepco intends to be actively involved in the bankruptcy proceeding to protect the interests of its customers and shareholders. If Mirant were to fail to fulfill its obligations under the TPAs, Pepco would be required to replace the electricity supply under the TPAs, likely through one or more supply contracts supplemented by spot market purchases. Pepco is confident that it would have alternative sources of supply sufficient to fulfill its standard offer service obligations to customers in Washingt on, D.C. and Maryland.

     To evaluate the potential financial impact of the Mirant bankruptcy, Pepco has prepared the following estimates of its exposure if Mirant successfully rejected the TPAs and its PPA-Related Obligations as of September 1, 2003. These estimates are based on current spot market prices and forward price estimates for energy and capacity, and on current percentages of service territory load served by competitive suppliers and by standard offer service and do not include financing costs, all of which could be subject to significant fluctuation. These estimates do not take into account alternative supply arrangements that might be entered into by Pepco that could mitigate the losses that might otherwise be incurred. They also assume no recovery on either the bankruptcy claims or regulatory recovery of costs, which would also mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recover y. Based on these assumptions, Pepco estimates that its pre-tax exposure, representing the loss of the benefit of the contracts to Pepco is as follows:

·

Pepco estimates that it would cost approximately $45 million for the remainder of 2003, $95 million in 2004 and $10 million in 2005 to replace, at an assumed purchase price of approximately 4.7 cents per kilowatt hour, the electricity required to supply Pepco's standard offer service obligations in Maryland and the District of Columbia for the remainder of the respective terms of the TPAs (until July 2004 in Maryland and until February 2005 in the District of Columbia). These figures reflect that under the terms of its regulatory settlements in Maryland and the District of Columbia the gains that Pepco realizes from the sale of standard offer service are shared with its customers.

·

If Pepco were required to purchase capacity and energy from FirstEnergy at the rates provided in the PPA (with an average price per kilowatt hour of approximately 5.5 cents) and resold the capacity and energy at market rates projected, given the characteristics of the FirstEnergy PPA, to be approximately 3.9 cents per kilowatt hour, Pepco estimates that it would cost approximately $25 million for the remainder of 2003, $75 million in 2004 and $65 million in 2005, the last year of the FirstEnergy PPA.

·

If Pepco were required to purchase capacity and energy from Panda at the rates provided in the PPA (with an average price per kilowatt hour of approximately 12.2 cents), and resold the capacity and energy at market rates projected, given the characteristics of the Panda PPA, to be approximately 6.4 cents per kilowatt hour, Pepco estimates that it would cost approximately $15 million for the remainder of 2003, $40 million in 2004 and $35 million in 2005 and approximately $35 million to $40 million annually thereafter through the 2021 contract termination date. For a discussion of a separate dispute with Panda regarding this agreement, see Part II, Item I, Legal Proceedings. Any potential liability in the Panda litigation would be encompassed within the estimated loss discussed above.

·

In connection with the sale of substantially all of its generation assets to Mirant, Pepco, as a term of the Asset Purchase and Sale Agreement, assigned to Mirant a facility and capacity agreement with Southern Maryland Electric Cooperative, Inc. ("SMECO") under which Pepco was obligated to purchase the capacity of an 84-megawatt combustion turbine installed and owned by SMECO at a former Pepco generating station. In the event Mirant successfully rejects this agreement, Pepco would be responsible to SMECO for the performance of the agreement. The agreement remains in effect through 2015 and the capacity payment to SMECO is approximately $5.5 million annually. The estimated cost to Pepco, net of estimated capacity and energy revenues, would be approximately $1 million for the remainder of 2003, $3 million in 2004 and $2 million annually thereafter through 2015.

     Based on the foregoing assumptions, Pepco estimates that its pre-tax exposure aggregates approximately $700 million on a net present value basis (based on a discount rate of 7.5 percent).

     If Mirant were to successfully reject any or all of the contracts, the ability of Pepco to recover damages from the Mirant bankruptcy estate would depend on the amount of assets available for distribution to creditors and Pepco's priority relative to other creditors. At the current stage of the bankruptcy proceeding, there is insufficient information to make a prediction regarding the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate. However, if Mirant successfully rejects the TPAs and Pepco's full claim is not paid by Mirant's bankruptcy estate, Pepco may seek authority from the Maryland and District of Columbia Public Service Commissions to recover these costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers.

     In view of the foregoing, the consequences of a successful rejection by Mirant of one or more of the TPAs and its PPA-Related Obligations could have a material adverse effect on Pepco Holdings' results of operations. However, Pepco Holdings currently does not believe that a rejection by Mirant of one or more of the contracts would have a material adverse effect on its financial condition.

Rate Changes

     On February 3, 2003, ACE filed a petition with the New Jersey Board of Public Utilities (NJBPU) to increase its electric distribution rates in New Jersey. The petition seeks a rate increase of approximately $68.4 million in electric delivery revenues, which equates to an increase in average total electricity rates of 6.9 percent overall. The filing requests a continuation of the currently authorized 12.5% ROE as well as the recovery of several regulatory assets, including carrying costs, over a four-year period. This is the first increase requested for electric distribution rates since 1991. ACE's Petition requested that this increase be made effective for service rendered on and after August 1, 2003. ACE cannot predict at this time the outcome of this filing, except that any change in rates relating to the filing will occur sometime after August 1, 2003.

     On March 31, 2003, DPL filed with the Delaware Public Service Commission for a gas base rate increase of $16.8 million, or an increase of 12.7% in total operating revenue. The filing includes a request for a ROE of 12.5%. DPL is currently authorized a ROE of 11.5% in Delaware. This is the first increase requested for its gas distribution since 1994. The Commission suspended the requested increase pending evidentiary hearings, so DPL has exercised its statutory right to place an interim base rate increase of 1.9% into effect on May 30, 2003, subject to refund.

Stranded Cost Determination and Securitization

     On January 31, 2003, ACE filed a petition with the NJBPU seeking an administrative determination of stranded costs associated with the B. L. England ("BLE") generating facility. The net after tax stranded costs included in the petition were approximately $151 million. An administrative determination of the stranded costs is needed due to the cancelled sale of the plant. On July 25, 2003 the NJBPU rendered an oral decision approving the administrative determination of stranded costs at a level of $149.5 million. As a result of this order, ACE reversed $10.0 million ($5.9 million after-tax) of previously accrued liability for possible disallowance of stranded costs. This credit to expense is classified as an extraordinary item in the Consolidated Statements of Earnings because the original accrual was part of an extraordinary charge resulting from the discontinuation of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation" in conjunction with the deregulation of ACE's energy business in September 1999. It is anticipated that in the third quarter, the NJBPU will issue a ruling on ACE's request to securitize these stranded costs.

     On February 5, 2003, the NJBPU issued an order on its own initiative seeking input from ACE and the Ratepayer Advocate within 10 days as to whether and by how much to cut the 13% pre-tax return that ACE was then authorized to earn on BLE. ACE responded on February 18 with arguments that: 1) reduced costs to ratepayers could be achieved legally through timely approvals by the NJBPU of the stranded cost filing made by ACE on January 31, 2003, and a securitization filing made the week of February 10; and 2) it would be unlawful, perhaps unconstitutional, and a breach of settlement and prior orders for the NJBPU to deny a fair recovery on prudently incurred investment and to do so without evidentiary hearings or other due process. On April 21, 2003, the NJBPU issued an order making the return previously allowed on BLE interim, as of the date of the order, and directing that the issue of the appropriate return for BLE be included in the stranded cos t proceeding. On July 25, 2003, the NJBPU voted to approve a pre-tax return reflecting a 9.75% Return on Equity for the period April 21, 2003 through August 1, 2003. The rate from August 1, 2003 through such time as ACE securitizes the stranded costs will be 5.25%, which the NJBPU represents as being approximately equivalent to the securitization rate. A written order had not been issued as of August 8, 2003.

     On February 14, 2003, ACE filed a Bondable Stranded Costs Rate Order Petition with the NJBPU. The petition requests authority to issue $160 million of Transition Bonds to finance the recovery of stranded costs associated with BLE and costs of issuances. This proceeding is related to the proceeding seeking an administrative determination of the stranded costs associated with BLE that was the subject of the July 25, 2003 NJBPU vote. The Company cannot predict at this time the outcome of these proceedings.

Restructuring Deferral

     On August 1, 2002, in accordance with the provisions of New Jersey's Electric Discount and Energy Competition Act (EDECA) and the NJBPU Final Decision and Order concerning the restructuring of ACE's electric utility business, ACE petitioned the NJBPU for the recovery of about $176.4 million in actual and projected deferred costs incurred by ACE over the four-year period August 1999 through July 31, 2003. The requested 8.4% increase was to recover those deferred costs over a new four-year period beginning August 1, 2003 and to reset rates so that there would be no under-recovery of costs embedded in ACE's rates on or after that date. ACE's recovery of the deferred costs is subject to review and approval by the NJBPU in accordance with EDECA. An Initial Decision by the Administrative Law Judge was rendered on June 3, 2003. The Initial Decision was consistent with the recommendations of the auditors hired by the NJBPU to audit ACE's deferral balances.

     On July 31, 2003, the NJBPU issued its Summary Order permitting ACE to begin collecting a portion of the deferred costs that were incurred as a result of EDECA and to reset rates to recover on-going costs incurred as a result of EDECA.

     The Summary Order approved the recovery of $125 million of the deferred balance over a ten-year amortization period beginning August 1, 2003. The Summary Order also transferred to ACE's pending base case for further consideration approximately $25.4 million of the deferred balance. The Summary Order estimated the overall deferral balance as of July 31, 2003 at $195 million, of which $44.6 million was disallowed recovery by ACE. Since the amounts included in this decision are based on estimates through July 31, 2003, the actual ending deferred cost balance will be subject to review and finalization by the NJPBU and ACE. The approved rates became effective on August 6, 2003. Based on analysis of the order and in accordance with prevailing accounting rules, ACE recorded a charge of $27.5 million ($16.3 million after-tax) during the second quarter of 2003. This charge is in addition to amounts previously accrued for disallowance. ACE believes the record does not justify the level of disallowance imposed by the NJBPU. ACE is awaiting the final written order from the NJBPU and is evaluating its options related to this decision. The NJBPU's action is not appealable until a final written order has been issued.

Pepco Regulatory Contingencies

     Final briefs on Pepco's District of Columbia divestiture proceeds sharing application were filed on July 31, 2002 following an evidentiary hearing in June 2002. That application was filed to implement a provision of Pepco's D.C. Commission approved divestiture settlement that provided for a sharing of any net proceeds from the sale of its generation related assets. A principal issue in the case is whether a sharing between customers and shareholders of the excess deferred income taxes and accumulated deferred investment tax credits associated with the sold assets would violate the normalization provisions of the Internal Revenue Code and implementing regulations. On March 4, 2003, the Internal Revenue Service (IRS) issued a notice of proposed rulemaking (NOPR) that is relevant to that principal issue. Comments on the NOPR were filed by several parties on June 2, 2003, and the IRS held a public hearing on June 25, 2003. Three of the parties in t he case filed comments urging the D.C. Commission to decide the tax issues now on the basis of the proposed rule. Pepco filed comments in reply to those comments, in which Pepco stated that the courts have held and the IRS has stated that proposed rules are not authoritative and that no decision should be issued on the basis of proposed rules. Instead, Pepco argued that the only prudent course of action is for the D.C. Commission to await the issuance of final regulations relating to the tax issues and then allow the parties to file supplemental briefs on the tax issues. Pepco cannot predict whether the IRS will adopt the regulations as proposed, make changes before issuing final regulations or decide not to adopt regulations. Other issues deal with the inclusion of internal costs and cost allocations. Pepco believes that its calculation of the customers' share of divestiture proceeds is correct. However, the potential exists that Pepco could be required to make additional gain sharing payments to D.C. custo mers. Such additional payments, which cannot be estimated, would be charged to expense and could have a material adverse effect on results of operations in the quarter and year in which a decision is rendered; however, Pepco does not believe that additional payments, if any, will have a material adverse impact on its financial position. It is uncertain when the D.C. Commission will issue a decision.

     Pepco filed its divestiture proceeds plan application in Maryland in April 2001. Reply briefs were filed in May 2002 and Pepco is awaiting a Proposed Order from the Hearing Examiner. The principal issue in the case is the same normalization issue that was raised in the D.C. case. Following the filing of comments by Pepco and two other parties, the Hearing Examiner on April 8, 2003: (1) postponed his earlier decision establishing briefing dates on the question of the impact of the proposed rules on the tax issues until after the June 25, 2003 public hearing on the IRS NOPR;(2) allowed the Staff of the Commission and any other parties to submit motions by April 21, 2003 relating to the interpretation of current tax law as set forth in the preamble to the proposed rules and the effect thereof on the tax issues; and (3) allowed Pepco and any other party to file a response to any motion filed by Staff and other parties by April 30, 2003. Staff filed a motion on April 21, 2003, in which it argued that immediate flow through to customers of a portion of the excess deferred income taxes and accumulated deferred investment tax credits can be authorized now based on the NOPR. Pepco filed a response in opposition to Staff's motion on April 30, 2003, in which, among other things, Pepco argued that no action should be taken on the basis of proposed regulations because, as Pepco stated in a similar pleading in the District of Columbia divestiture proceeds case, proposed regulations are not authoritative. The Hearing Examiner will issue a ruling on Staff's motion, although there is no time within which he must issue a ruling. Pepco cannot predict whether the IRS will adopt the regulations as proposed, make changes before issuing final regulations or decide not to adopt regulations. Other issues deal with the inclusion of internal costs and cost allocations. Pepco believes that its calculation of the customers' share of divestiture proceeds is correct. Howev er, the potential also exists that Pepco would be required to make additional gain sharing payments to Maryland customers. Such additional payments, which cannot be estimated, would be charged to expense and could have a material adverse effect on results of operations in the quarter and year in which a decision is rendered; however, Pepco does not believe that additional payments, if any, will have a material adverse impact on its financial position. It is uncertain when the Hearing Examiner or the Maryland Commission will issue their decisions.

Standard Offer Service (SOS)

District of Columbia

     On February 21, 2003, the D.C. Public Service Commission opened a new proceeding to consider issues relating to (a) the establishment of terms and conditions for providing SOS in the District of Columbia after Pepco's obligation to provide SOS terminates on February 7, 2005, and (b) the selecting of a new SOS provider. Pepco and other parties filed comments on issues identified by the Commission and some parties suggested additional issues. In its comments, Pepco, among other things, suggested that the D.C. law be changed to allow Pepco to continue to be the SOS provider after February 7, 2005. Under existing law, the Commission is to adopt, before January 2, 2004, terms and conditions for SOS and for the selection of a new SOS provider. The Commission is also required, under existing law, to select the new SOS provider before July 2004. Existing law also allows the selection of Pepco as the SOS provider in the event of insufficient bids. By or der issued on June 24, 2003, the Commission decided that all participating parties should individually propose, by August 29, 2003, regulations setting forth such terms and conditions. The Commission will then issue proposed regulations by September 30, 2003 and allow initial and reply comments from interested parties to be filed by October 30 and November 17, 2003, respectively. Pepco continues to pursue legislation that would allow it to remain as the SOS provider after early 2005.

Maryland

     In accordance with the terms of an agreement approved by the Maryland Commission, customers who are unable to receive generation services from another supplier, or who do not select another supplier, are entitled to receive services from Pepco until July 1, 2004. Pepco has entered into a settlement in Phase I of Maryland Case No. 8908 to extend its provision of SOS services in Maryland. The settlement was approved by the Maryland Commission on April 29, 2003. One party has filed for rehearing of the Commission's April 29 order. The Commission subsequently denied that application for rehearing on July 26, 2003. The settlement provides for an extension of SOS for four years for residential and small commercial customers, an extension of two years for medium sized commercial customers, and an extension of one year for large commercial customers. The settlement also provides for a policy review by the Commission to consider how SOS will be provided after the current extension expires. In addition, the settlement provides for SOS to be procured from the wholesale marketplace and that Pepco will be able to recover its costs of procurement and a return. Following months of meetings in Phase II, final settlement documents were filed on July 2, 2003. The Phase II settlement documents include the Phase II settlement agreement, a model request for proposals for wholesale power to be delivered to the utility SOS providers and a full requirements service agreement between the wholesale suppliers and the utility SOS providers. Initial testimony on the settlement was filed by numerous parties on July 18, 2003. No party filed testimony opposing the Phase II settlement, although at least one party has stated that it opposes the Phase II settlement. The Commission will set hearing and briefing dates.

Third Party Guarantees

     As of June 30, 2003, Pepco Holdings and its subsidiaries were parties to a variety of agreements pursuant to which they were guarantors for standby letters of credit, performance residual value, and other commitments and obligations, as follows:

                 Guarantor               

PHI

Pepco

Conectiv

PCI

Total

Energy trading obligations of
  Conectiv Energy (1)

$190.9 

-    

$37.2  

-  

$228.1 

Energy procurement obligations
  of Pepco Energy Services (1)

40.0 

-    

-  

-  

40.0 

Standby letters of credit of
  Pepco Holdings (2)

72.5 

-    

-  

-  

72.5 

Guaranteed lease residual
  values (3)

- 

-    

4.7  

-  

4.7 

Loan agreement (4)

13.1 

-    

-  

-  

13.1 

Construction performance
  guarantees (5)

- 

-    

10.4  

-  

10.4 

Other (6)

    - 

 -    

  4.5  

6.2  

 10.7 

  Total

$316.5 

$ -    

$56.8  

$6.2  

$379.5 

1.

Pepco Holdings and Conectiv have contractual commitments for performance and related payments of Conectiv Energy and Pepco Energy Services to counter parties related to routine energy trading and procurement obligations, including requirements under BGS contracts for ACE.

2.

Pepco Holdings has issued standby letters of credit of $72.5 million on behalf of subsidiaries operations related to Conectiv Energy's competitive energy activities and third party construction performance. These standby letters of credit were put into place in order to allow the subsidiaries flexibility needed to conduct business with counterparties without having to post substantial cash collateral. While the exposure under these standby letters of credit is $72.5 million, Pepco Holdings does not expect to fund the full amount. As of June 30, 2003, the fair value of obligations under these standby letters of credit was not required to be recorded in the Consolidated Balance Sheets.

3.

Subsidiaries of Pepco Holdings have guaranteed residual values in excess of fair value related to certain equipment and fleet vehicles held through lease agreements. As of June 30, 2003, obligations under the guarantees were approximately $4.7 million. Assets leased under agreements subject to residual value guarantees are typically for periods ranging from 2 years to 10 years. Historically, payments under the guarantee have not been made by the company as, under normal conditions, the contract runs to full term at which time the residual value is minimal. As such, Pepco Holdings believes the likelihood of requiring payment under the guarantee is remote.

4.

Pepco Holdings has issued a guarantee on the behalf of a subsidiary's 50% unconsolidated investment in a limited liability company for repayment borrowings under a loan agreement of approximately $13.1 million.

5.

Conectiv has performance obligations of $10.4 million relating to obligations to third party suppliers of equipment.

6.

Other guarantees comprise:

o

PCI has guaranteed facility rental obligations related to contracts entered into by Starpower Communications LLC. In addition, it has agreed to Indemnify RCN for 50% of any payments RCN makes under the Starpower franchise and construction performance bonds.  As of June 30, 2003, the guarantees cover the remaining $4.1 million in rental obligations and $2.1 million in franchise and construction performance bonds issued.

o

Other Conectiv obligations represents a commitment for a subsidiary building lease. Conectiv does not expect to fund the full amount of the exposure under these guarantees.

(6)  CONECTIV ENERGY EVENTS

     On June 25, 2003, Conectiv Energy entered into an agreement consisting of a series of energy contracts with an international investment banking firm with a senior unsecured debt rating of A+ / Stable from Standard & Poors (the "Counterparty"). The agreement is designed to more effectively hedge approximately fifty percent of Conectiv Energy's generation output and approximately fifty percent of its supply obligations, with the intention of providing Conectiv Energy with a more predictable earnings stream during the term of the agreement. The 35-month agreement consists of two major components: a fixed price energy supply hedge and a forward physical energy sale. The fixed price energy supply hedge will be used to reduce Conectiv Energy's financial exposure under its current supply commitment to DPL. Under this commitment, which extends through May 2006, Conectiv Energy is obligated to supply to DPL the electric power necessary to enable DPL to meet its Provider of Last Resort (POLR) load obligations. Under the energy supply hedge, the volume and price risks associated with fifty percent of the POLR load obligation are effectively transferred from Conectiv Energy to the Counterparty through a financial "contract-for-differences." The contract-for-differences establishes a fixed cost for the energy required by Conectiv Energy to satisfy fifty percent of the POLR load, and any deviations of the market price from the fixed price are paid by Conectiv Energy to, or are received by Conectiv Energy from, the Counterparty. The contract does not cover the cost of capacity or ancillary services. Under the forward physical energy sale, Conectiv Energy will receive a fixed monthly payment from the Counterparty. This portion of the agreement is designed to hedge sales of approximately 50% of Conectiv Energy's g eneration output, and under assumed operating parameters and market conditions should effectively transfer this portion of the company's wholesale energy market risk to the Counterparty, while providing a more stable stream of revenues to Conectiv Energy. The 35-month agreement also includes several standard energy price swaps under which Conectiv Energy has locked in a sales price for approximately 50% of the output from its Edge Moor facility and has financially hedged other on-peak and off-peak energy price exposures in its portfolio to further reduce market price exposure. In total, the transaction is expected to improve Conectiv Energy's risk profile by providing hedges that are tailored to the characteristics of its generation fleet and its POLR supply obligation.

     During the first quarter of 2003, Conectiv Energy had a loss of $92.3 million, which includes the unfavorable impact of a $65.7 million loss resulting primarily from the cancellation of a combustion turbine (CT) contract with General Electric. The loss at the Pepco Holdings level is $31.1 million, substantially lower than the Conectiv Energy loss due to the fair market adjustment recognized by Pepco Holdings at the time of the acquisition of Conectiv as further discussed below. The loss also includes the unfavorable impact of net trading losses of $26.6 million that resulted from a dramatic rise in natural gas futures prices during February 2003, net of an after-tax gain of $15 million on the sale of a purchase power contract in February 2003. In response to the trading losses, in early March 2003, Pepco Holdings ceased all proprietary trading activities.

     Conectiv Energy had entered into contracts for the delivery of seven combustion turbines (CTs). These contracts included one with General Electric for the purchase of four CTs (the GE CTs). Through April 25, 2003, payments totaling approximately $131 million had been made for the GE CTs. As part of the acquisition of Conectiv by Pepco Holdings in August of 2002, the book value related to the CTs and associated equipment (including the payments already made as well as the future payments called for under the contracts) was adjusted downward by approximately 35%, to the then-fair market value. Approximately $54 million of the August fair value adjustment was related to the GE CTs, and another $4 million of the adjustment was related to ancillary equipment. The adjustment was recorded by Pepco Holdings and was not pushed down to, and recorded by, Conectiv.

     Because of uncertainty in the energy markets, the decline in the market for CTs and the current high level of capacity reserves within the PJM power pool, Conectiv Energy provided notice to General Electric canceling the contract for delivery of the GE CTs. The net unfavorable impact on Pepco Holdings of this cancellation, recorded in the first quarter 2003, is $31.1 million, comprised of the fees associated with cancellation of the GE CTs, all associated site development and engineering costs and the costs associated with cancellation of ancillary equipment orders. The unfavorable impact of the cancellation specified above is also net of over $51 million in cash as sociated with pre-payments on the GE CT orders, which General Electric is required to refund as a result of the cancellation. There was a positive cash impact in the second quarter related to this refund. The cancellation of the GE CTs and associated equipment is one of the steps being taken by the company to proactively deal with the risks it would otherwise have in the merchant energy sector.

     After the cancellation of the four General Electric CTs discussed above, Conectiv Energy continues to own three CTs which were delivered in 2002. The CTs have a carrying value of $52.5 million when adjusted to reflect the fair market adjustment made at the time Conectiv was acquired by Pepco Holdings. This fair market value adjustment was recorded by Pepco Holdings and was not pushed down to, and recorded by Conectiv. Due to the decline in wholesale energy prices, further analysis of energy markets and projections of future demand for electricity, among other factors, Conectiv delayed the construction and installation of these CTs. Whether these turbines will be installed and the actual location and timing of the construction and installation will be determined by market demand or transmission system needs and requirements.

(7)  PRO FORMA INFORMATION

     Due to the completion of the merger with Conectiv on August 1, 2002, the accompanying consolidated financial statements include Conectiv and its pre merger subsidiaries operating results commencing on August 1, 2002. Accordingly, as discussed in Note (2) Summary of Significant Accounting Policies, herein, Pepco Holdings' consolidated operating results for the three and six-month periods ended June 30, 2003 are not comparable with the corresponding periods in 2002.

     The following pro forma information for Pepco Holdings for the three and six months ended June 30, 2002, which is based on unaudited data, gives effect to the Company's merger with Conectiv as if it had been completed on January 1, 2002. This information does not reflect future revenues or cost savings that may result from the merger and is not indicative of actual results of operations had the merger occurred at the beginning of the period presented or of results that may occur in the future.

Three Months Ended
June 30, 2002

Six Months Ended
June 30, 2002

(In Millions, except Share Data)

Operating Revenue

$1,400.4

$2,673.5

Net Income

    76.6

   117.3

Earnings per Share of Common Stock

    $.47

    $.72

     The primary pro forma adjustments were related to interest expense incurred on acquisition debt and interest income on existing funds used to partially fund the acquisition. Pro forma weighted average shares outstanding for each period were 163.4 million shares.

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POTOMAC ELECTRIC POWER COMPANY
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)

Three Months Ended
June 30,

Six Months Ended
June 30,

   2003   

   2002   

   2003  

   2002  

(Millions of Dollars)

Operating Revenue

   Utility

$370.1 

$390.8 

$703.5 

$  706.9 

   Competitive

- 

190.4 

- 

363.1 

      Total Operating Revenue

370.1 

581.2 

703.5 

1,070.0 

Operating Expenses

   Fuel and purchased energy

164.6 

308.2 

298.8 

563.8 

   Other operation and maintenance

57.9 

84.5 

117.6 

171.9 

   Depreciation and amortization

39.7 

38.0 

79.2 

75.9 

   Other taxes

44.9 

48.7 

89.9 

94.2 

   Impairment loss

- 

2.4 

- 

2.4 

      Total Operating Expenses

307.1 

481.8 

585.5 

908.2 

Operating Income

63.0 

99.4 

118.0 

161.8 

Other Income (Expenses)

   Interest and dividend income

1.8 

8.9 

3.6 

15.6 

   Interest expense

(19.3)

(32.0)

(38.6)

(63.4)

   Loss from Equity Investments, principally
     a Telecommunication Entity

- 

(.9)

- 

(1.2)

   Other expenses

(1.4)

(1.0)

(4.0)

(.5)

      Total Other Expenses

(18.9)

(25.0)

(39.0)

(49.5)

Distributions on Preferred Securities
  of Subsidiary Trust

2.3 

2.3 

4.6 

4.6 

Income Tax Expense

17.2 

25.1 

29.8 

36.2 

Net Income

24.6 

47.0 

44.6 

71.5 

Dividends on Preferred Stock

1.3 

1.3 

2.5 

2.5 

Earnings Available for Common Stock

$ 23.3 

$ 45.7 

$ 42.1 

$   69.0 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

POTOMAC ELECTRIC POWER COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited at June 30, 2003)

June 30,
2003

December 31,
2002

ASSETS

(Millions of Dollars)

CURRENT ASSETS

   Cash and cash equivalents

$   17.3  

$   13.9  

   Accounts receivable, less allowance for
     uncollectible accounts of $3.6 million

321.4  

263.0  

   Note receivable from affiliate

110.4  

110.4  

   Fuel, materials and supplies - at average cost

37.8  

37.8  

   Prepaid expenses and other

15.3  

10.2  

         Total Current Assets

502.2