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

For the quarter ended March 31, 2004

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 or PHI), 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

001-01405

DELMARVA POWER & LIGHT COMPANY
(DPL), a Delaware and
  Virginia corporation
800 King Street, P.O. Box 231
Wilmington, Delaware 19899
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 19899
Telephone: (202)872-2000

21-0398280

333-59558

ATLANTIC CITY ELECTRIC
  TRANSITION FUNDING LLC
(ACE Funding), a Delaware
  limited liability company
P.O. Box 15597
Wilmington, Delaware 19850
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

DPL

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

   New York Stock
   Exchange

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

Pepco

Serial Preferred Stock, $50 par value

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

     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 March 31, 2004

Pepco Holdings

172,171,604 ($.01 par value)

Pepco

100 ($.01 par value) (a)

DPL

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

ACE

12,886,853 ($3 par value)(b)

ACE Funding

None (c)

(a)

All voting and non-voting common equity is owned by Pepco Holdings.

(b)

All voting and non-voting common equity is owned by Conectiv, a wholly owned subsidiary of Pepco Holdings.

(c)

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

     THIS COMBINED FORM 10-Q IS SEPARATELY FILED BY PEPCO HOLDINGS, PEPCO, 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

Glossary of Terms

i

PART I

FINANCIAL INFORMATION

  Item 1.

-

Financial Statements

1

  Item 2.

-

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

67

  Item 3.

-

Quantitative and Qualitative Disclosures
   About Market Risk

109

  Item 4.

-

Controls and Procedures

118

PART II

OTHER INFORMATION

  Item 1.

-

Legal Proceedings

120

  Item 2.

-

Changes in Securities, Use of Proceeds and
  Issuer Purchases of Equity Securities

121

  Item 3.

-

Defaults Upon Senior Securities

121

  Item 4.

-

Submission of Matters to a Vote of Security Holders

121

  Item 5.

-

Other Information

122

  Item 6.

-

Exhibits and Reports on Form 8-K

122

  Signatures

143

__________________________________________________________________________________

TABLE OF CONTENTS - EXHIBITS

Exh. No.

Registrant(s)

Description of Exhibit

Page

12.1

PHI

Statements Re: Computation of Ratios

124

12.2

Pepco

Statements Re: Computation of Ratios

125

12.3

DPL

Statements Re: Computation of Ratios

126

12.4

ACE

Statements Re: Computation of Ratios

127

31.1

PHI

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

128

31.2

PHI

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

129

31.3

Pepco

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

130

31.4

Pepco

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

131

31.5

DPL

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

132

31.6

DPL

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

133

31.7

ACE

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

134

31.8

ACE

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

135

31.9

ACE Funding

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

136

32.1

PHI

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

137

32.2

Pepco

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

138

32.3

DPL

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

139

32.4

ACE

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

140

32.5

ACE Funding

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

141

__________________________________________________________________________________

           GLOSSARY OF TERMS

Term

Definition

ABO

Accumulated benefit obligation

ACE

Atlantic City Electric Company

ACE Funding

Atlantic City Electric Transition Funding LLC

Ancillary services

Generally, electricity generation reserves and reliability services

APCA

New Jersey Air Pollution Control Act

Act

Medicare Prescription Drug, Improvement and Modernization Act of 2003

APB

Accounting Principles Board Opinion

APBO

Accumulated Post-retirement Benefit Obligation

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

BGS

Basic generation service (the supply of energy to customers in New Jersey who have not chosen a competitive supplier)

BTP

Bondable Transition Property

CAA

Clean Air Act

Competitive Energy
  Business

Consists of the business operations of Conectiv Energy and Pepco Energy Services

Conectiv

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

Conectiv Energy

Conectiv Energy Holding Company and its subsidiaries

Conectiv Power
  Delivery (CPD)

The tradename under which DPL and ACE conduct their power delivery operations

CT

Combustion turbine

DCPSC

District of Columbia Public Service Commission

Debentures

Junior Subordinated Debentures

Delivery revenue

Revenue Pepco receives for delivering energy to its customers

District Court

U.S. District Court for the Northern District of Texas

DMEC

Delaware Municipal Electric Corporation

DPL

Delmarva Power & Light Company

DPSC

Delaware Public Service Commission

EDECA

New Jersey Electric Discount and Energy Competition Act

EITF

Emerging Issues Task Force

EITF 03-11

Emerging Issues Task Force 03-11 entitled "Reporting Realized Gains and Losses on Derivative Instruments that are Subject to FASB Statement No. 133, 'Accounting for Derivative Instruments and Hedging Activities,' and not 'Held for Trading Purposes'"

EPA

Environmental Protection Agency

ERISA

Employment Retirement Income Security Act of 1974

Exchange Act

Securities Exchange Act of 1934, as amended

FASB

Financial Accounting Standards Board

FERC

Federal Energy Regulatory Commission

FIN 45

FASB Interpretation No. 45, entitled "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others"

FIN 46

FASB Interpretation No. 46, entitled "Consolidation of Variable Interest Entities"

FIN 46R

FASB Interpretation No. 46 (revised December 2003), entitled "Consolidation of Variable Interest Entities"

FirstEnergy

FirstEnergy Corp., formerly Ohio Edison

i
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Term

Definition

FirstEnergy PPA

PPAs between Pepco and FirstEnergy Corp. and Allegheny Energy, Inc.

FSP

FASB Staff Position

FSP 106-1

FASB Staff Position 106-1, entitled "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003"

GAAP

Accounting principles generally accepted in the United States of America

GCR

Gas Cost Recovery

GPC

Generation Procurement Credit

LTIP

Long-Term Incentive Plan

Mirant

Mirant Corporation and certain of its subsidiaries

Mirant Pre-Petition
  Obligations

Unpaid obligations of Mirant to Pepco existing at the time of filing of Mirant's bankruptcy petition consisting primarily of payments due Pepco in respect of the PPA-Related Obligations

MPSC

Maryland Public Service Commission

NERC

North American Electric Reliability Counsel

NJBPU

New Jersey Board of Public Utilities

NJBPU Financing Orders

Bondable stranded costs rate orders issued by the NJBPU

NJDEP

New Jersey Department of Environmental Protection

NOx

Nitrogen oxide emissions

OCI

Other Comprehensive Income

OPC

Maryland Office of the People's Counsel

Panda

Panda-Brandywine, L.P.

Panda PPA

PPA between Pepco and Panda

PCI

Potomac Capital Investment Corporation and its subsidiaries

Pepco

Potomac Electric Power Company

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

Pepcom

Pepco Communications, Inc.

PJM

PJM Interconnection, LLC

PPA

Power Purchase Agreement

PPA-Related
  Obligations

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

PSD

Prevention of Significant Deterioration provisions of the CAA

PUHCA

Public Utility Holding Company Act of 1935

RARC

Regulatory Asset Recovery Charge

RCN

RCN Corporation

Recoverable stranded
  costs

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

Regulated electric
  revenues

Revenues for delivery (transmission and distribution) service and electricity supply service

SEC

Securities and Exchange Commission

Settlement Agreement

Amended Settlement Agreement and Release, dated as of October 24, 2003 between Pepco and the Mirant Parties

SFAS

Statement of Financial Accounting Standards

SFAS No. 106

Statement of Financial Accounting Standards No. 106, entitled "Employers Accounting for Post-retirement Benefits Other than Pensions"

ii
_________________________________________________________________________________

Term

Definition

SFAS No. 123

Statement of Financial Accounting Standards No. 123, entitled "Accounting for Stock-Based Compensation"

SFAS No. 131

Statement of Financial Accounting Standards No. 131, entitled "Disclosures About Segments of an Enterprise and Related Information"

SFAS No. 132

Statement of Financial Accounting Standards No. 132, entitled "Employers Disclosures about Pensions and Other Post-retirement Benefits"

SFAS No. 133

Statement of Financial Accounting Standards No. 133, entitled "Accounting for Derivative Instruments and Hedging Activities"

SFAS No. 148

Statement of Financial Accounting Standards No. 148 entitled "Accounting For Stock-Based Compensation - Transition and Disclosure"

SFAS No. 150

Statement of Financial Accounting Standards No. 150, entitled "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity"

SMECO

Southern Maryland Electric Cooperative, Inc.

SMECO Agreement

Capacity purchase agreement between Pepco and SMECO

SO2

Sulfur dioxide emissions

SOS

Standard Offer Service (the supply of energy to customers in Maryland and the District of Columbia who have not chosen a competitive supplier)

Standard Offer Service
  revenue or SOS
  revenue

Revenue Pepco receives for the procurement of energy by Pepco for its SOS customers

Starpower

Starpower Communications, LLC

Stranded costs

Costs incurred by a utility in connection with providing service which would otherwise 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.

TBC

Transition bond charge

TPAs

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

VaR

Value at Risk

VSCC

Virginia State Corporation Commission

iii
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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

DPL

ACE

ACE
Funding

Consolidated Statements
  of Earnings

3

28

42

52

63

Consolidated Statements of
  Comprehensive Income

4

N/A

N/A

N/A

N/A

Consolidated Balance Sheets

5

29

43

53

64

Consolidated Statements
  of Cash Flows

7

31

45

55

65

Notes to Consolidated
  Financial Statements

8

32

46

56

66

1
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THIS PAGE INTENTIONALLY LEFT BLANK.

2
_____________________________________________________________________________

3
_____________________________________________________________________________

PEPCO HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)

Three Months Ended
March 31,

2004

2003

(Millions of Dollars)

Net income (loss)

$51.2 

$(24.9)

Other comprehensive income, net of taxes

  Unrealized gains on commodity
    derivatives designated as cash flow hedges

    Unrealized holding gains arising during period

21.9 

20.8 

    Less: reclassification adjustment for
           gains included in net earnings

1.5 

9.9 

    Net unrealized gains on commodity derivatives

20.4 

10.9 

  Realized gain on Treasury lock

2.9 

3.0 

  Unrealized (losses) gain on interest rate swap
    agreements designated as cash flow hedges:

    Unrealized holding losses arising during period

(9.0)

(.4)

    Less: reclassification adjustment for (loss) gain
           included in net earnings

(.4)

1.5 

    Net unrealized (losses) on interest rate swaps

(8.6)

(1.9)

  Unrealized gains on marketable securities:

    Unrealized holding gains arising during period

.3 

.6 

    Less: reclassification adjustment for gains
           included in net earnings

- 

- 

    Net unrealized gains on marketable securities

.3 

.6 

  Other comprehensive income, before taxes

15.0 

12.6 

  Income tax expense

6.6 

6.9 

    Other comprehensive income, net of taxes

8.4 

5.7 

Comprehensive income (loss)

$59.6 

$(19.2)

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

4
_____________________________________________________________________________

5
_____________________________________________________________________________

6
_____________________________________________________________________________

7
_____________________________________________________________________________

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

PEPCO HOLDINGS, INC.

(1)  ORGANIZATION

     Pepco Holdings, Inc. (Pepco Holdings or PHI) is a diversified energy company that, through its operating subsidiaries, is engaged in three principal areas of business operations:

·

regulated power delivery,

·

non-regulated competitive energy generation, marketing and supply, and

·

other non-regulated activities consisting primarily of investments in energy-related assets.

     PHI is a public utility holding company registered under the Public Utility Holding Company Act of 1935 (PUHCA)and is subject to the regulatory oversight of the Securities and Exchange Commission (SEC) under PUHCA. As a registered public utility holding company, PHI requires SEC approval to, among other things, issue securities, acquire or dispose of utility assets or securities of utility companies and acquire other businesses. In addition, under PUHCA, transactions among PHI and its subsidiaries generally must be performed at cost and subsidiaries are prohibited from paying dividends out of an accumulated deficit or paid-in capital without SEC approval.

     PHI was incorporated in Delaware on February 9, 2001, for the purpose of effecting the acquisition of Conectiv by Potomac Electric Power Company (Pepco). The acquisition was completed on August 1, 2002, at which time Pepco and Conectiv became wholly owned subsidiaries of PHI. Conectiv was formed in 1998 to be the holding company for Delmarva Power & Light Company (DPL) and Atlantic City Electric Company (ACE) in connection with a merger between DPL and ACE. As a result, DPL and ACE are wholly owned subsidiaries of Conectiv. Conectiv also is a registered public utility holding company under PUHCA.

     PHI Service Company, a subsidiary service company of PHI, provides a variety of support services, including legal, treasury, accounting, tax, purchasing and information technology services to Pepco Holdings and its operating subsidiaries. These services are provided pursuant to a service agreement among PHI, PHI Service Company, and the participating operating subsidiaries that has been filed with, and approved by, the SEC under PUHCA. The expenses of the service company are charged to PHI and the participating operating subsidiaries in accordance with costing methodologies set forth in the service agreement.

     The following is a description of each of PHI's areas of operation.

     Power Delivery

     The largest component of PHI's business is power delivery, which consists of the transmission and distribution of electricity and the distribution of natural gas. PHI's power delivery business is conducted by its subsidiaries Pepco, DPL and ACE, each of which is a regulated public utility in the jurisdictions in which it serves customers. DPL and ACE conduct their power delivery operations under the trade name Conectiv Power Delivery.

8
_____________________________________________________________________________

     Competitive Energy

     PHI's competitive energy business provides non-regulated generation, marketing and supply of electricity and gas, and related energy management services, in the mid-Atlantic region. PHI's competitive energy operations are conducted through subsidiaries of Conectiv Energy Holding Company (collectively, Conectiv Energy) and Pepco Energy Services, Inc. and its subsidiaries (collectively, Pepco Energy Services).

     Other Non-Regulated

     This component of PHI's business is conducted through its subsidiaries Potomac Capital Investment Corporation (PCI) and Pepco Communications, Inc. (Pepcom). PCI manages a portfolio of financial investments, which primarily includes energy leveraged leases. During the second quarter of 2003, PHI announced the discontinuation of further new investment activity by PCI. Pepcom through a subsidiary currently owns a 50% interest in Starpower Communications, LLC (Starpower), a joint venture with RCN Corporation (RCN), which provides cable and telecommunication services to households in the Washington, D.C. area. As part of PHI's strategy of focusing on energy-related investments, PHI in January 2004 announced that Pepcom intends to sell its interest in Starpower. PHI cannot predict whether Pepcom's efforts to sell its interest in Starpower will be successful or, if successful, when a sale would be completed or what the sale proceeds would be. As of December 31, 2003, PHI determined that its investment in Starpower was impaired and therefore recorded a non-cash charge of $102.6 million during the fourth quarter of 2003.

(2)  ACCOUNTING POLICY AND PRONOUNCEMENTS DISCLOSURES

Financial Statement Presentation

     Pepco Holdings' 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 SEC, 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 the annual financial statements included in PHI's Annual Report on Form 10-K/A for the year ended December 31, 2003. In the opinion of PHI's management, the consolidated financial statements contain all adjustments (which all are of a normal recurring nature) necessary to present fairly Pepco Holdings' financial condition as of March 31, 2004, in accordance with GAAP. Interim results for the three months ended March 31, 2004 may not be indicative of results that will be realized for the full year ending De cember 31, 2004. Additionally, certain prior period balances have been reclassified in order to conform to current period presentation.

FIN 45

     Pepco Holdings applied the provisions of FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45), commencing in 2003 to its agreements that contain guarantee and indemnification 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 obligations it assumes under certain guarantees issued or modified after December 31, 2002 and to disclose certain

9
_____________________________________________________________________________

types of guarantees, even if the likelihood of requiring the guarantor's performance under the guarantee is remote.

     As of March 31, 2004, Pepco Holdings did not have material obligations under guarantees or indemnifications issued or modified after December 31, 2002, which are required to be recognized as a liability on its consolidated balance sheets, however, certain energy marketing obligations of Conectiv Energy were recorded.

FIN 46

     On December 31, 2003, FIN 46 was implemented by Pepco Holdings. FIN 46 was revised and superseded by FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities" (FIN 46R) which clarified some of the provisions of FIN 46 and exempted certain entities from its requirements. FIN 46R is applicable to Pepco Holdings' financial statements for the quarter ended March 31, 2004. The implementation of FIN 46R (including the evaluation of interests in purchase power arrangements) did not impact Pepco Holdings' financial condition or results of operations for the three months ended March 31, 2004.

     As part of the FIN 46R evaluation, Pepco Holdings reviewed its subsidiaries' power purchase agreements (PPAs), including its Non-Utility Generation (NUG) contracts, to determine (i) if the subsidiary's interest in each entity that is a counterparty to a PPA agreement was a variable interest, (ii) whether the entity was a variable interest entity and (iii) if so, whether Pepco Holdings' subsidiary was the primary beneficiary. Due to a variable element in the pricing structure of PPAs with four entities, including Pepco's agreement with Panda-Brandywine, L.P. (Panda), Pepco Holdings' subsidiaries potentially assume the variability in the operations of the plants of these entities and therefore have a variable interest in the entities. However, due to Pepco Holdings' inability to obtain information from certain of these entities considered to be confidential and proprietary by the entities or the certain entities' own determination that they qua lified for exemption as a business, Pepco Holdings was unable to obtain sufficient information to conduct the analysis required under FIN 46R to determine whether these four entities were variable interest entities or if Pepco Holdings' subsidiaries were the primary beneficiary. As a result, Pepco Holdings has applied the scope exemption from the application of FIN 46R for enterprises that have conducted exhaustive efforts to obtain the necessary information.

     Power purchases related to the PPAs with these four entities in the quarters ended March 31, 2004 and 2003 were approximately $77 million and $79 million, respectively. Power purchases related to the PPAs in the years ended December 31, 2003, 2002 and 2001 were approximately $302 million, $295 million and $302 million, respectively. Pepco Holdings' exposure to loss under the Panda PPA is discussed in Note (4) Commitments And Contingencies, under "Relationship with Mirant Corporation." Pepco Holdings does not have loss exposure under the remaining three PPAs since cost recovery will be achieved from its customers through regulated rates.

EITF 03-11

     On January 1, 2004, Pepco Holdings implemented EITF Issue No. 03-11 (EITF 03-11), "Reporting Realized Gains and Losses on Derivative Instruments That Are Subject to FASB Statement No. 133, 'Accounting for Derivative Instruments and Hedging Activities,' and not 'Held for Trading Purposes' as Defined in EITF Issue No. 02-3" "Issues Involved in Accounting for Derivative

10
______________________________________________________________________________

Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities." As a result of the implementation of this EITF, $37.4 million of operating revenues and operating expenses related to certain of Conectiv Energy's energy contracts are reported on a net basis in the accompanying consolidated statements of earnings for the three months ended March 31, 2004, as these energy contracts did not physically settle. Had EITF 03-11 been effective for the first quarter of 2003, Pepco Holdings' operating revenues and operating expenses would have been reduced by $37.1 million. The implementation of EITF 03-11, including the associated reclassification of certain operating revenues and operating expenses, did not have an impact on Pepco Holdings' financial condition or earnings.

Components of Net Periodic Benefit Cost

     The following Pepco Holdings information is for the three months ended March 31,

Pension Benefits

Other Post-Retirement Benefits

2004

2003

2004

2003

(In Millions)

Service cost

$  9.6 

$  8.1 

$ 2.4 

$ 2.3 

Interest cost

23.8 

23.0 

8.3 

7.9 

Expected return on plan assets

(29.8)

(26.1)

(2.8)

(2.0)

Amortization of prior service cost

.3 

.3 

- 

- 

Amortization of net loss

   4.5 

   3.4 

  3.1 

  1.9 

Net periodic benefit cost

$  8.4 

$  8.7 

$11.0 

$10.1 

     The actual components of net periodic benefit cost for the 2003 interim period are not available. The component amounts presented above for the 2003 interim period were calculated in proportion to the annual amounts presented in Pepco Holdings' financial statements for the year ended December 31, 2003. These component amounts are presented for comparison purposes only.

     Pension

     The 2004 pension net periodic benefit cost of $8.4 million includes $3.6 million for Pepco, $2.1 million for ACE, and $(.5) million for DPL. The remaining pension net periodic benefit cost is for other PHI subsidiaries. The 2003 pension net periodic benefit cost of $8.7 million includes $5.2 million for Pepco, $3.2 million for ACE, and $(1.4) million for DPL. The remaining pension net periodic benefit cost is for other PHI subsidiaries.

     Pension Contributions

     Pepco Holdings funding policy with regard to the pension plan is to maintain a funding level in excess of 100% of its accumulated benefit obligation (ABO). PHI's defined benefit plan currently meets the minimum funding requirements of the Employment Retirement Income Security Act of 1974 (ERISA) without any additional funding. In 2003 and 2002 PHI made discretionary tax-deductible cash contributions to the plan of $50 million and $35 million, respectively. Assuming no changes to the current pension plan assumptions, PHI projects no funding will be required in 2004; however PHI may elect to make a discretionary tax-deductible contribution, if required to maintain its assets in excess of its ABO. As of March 31, 2004, no contributions have been made.

11
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     Other Post-Retirement Benefits

     The 2004 Other Post-Retirement net periodic benefit cost of $11.0 million includes $4.5 million for Pepco, $2.5 million for ACE, and $2.3 million for DPL. The remaining Other Post-Retirement net periodic benefit cost is for other PHI subsidiaries. The 2003 Other Post-Retirement net periodic benefit cost of $10.1 million includes $4.2 million for Pepco, $2.6 million for ACE, and $1.7 million for DPL. The remaining Other Post-Retirement net periodic benefit cost is for other PHI subsidiaries.

     FASB Staff Position (FSP 106-1), Accounting and Disclosure
       Requirements Related to the Medicare Prescription Drug, Improvement
       and Modernization Act of 2003 (the Act)

     The Act became effective on December 8, 2003. The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D.

     SFAS No. 106 "Employers Accounting for Post-retirement Benefits Other than Pensions" requires presently enacted changes in relevant laws to be considered in current period measurements of post-retirement benefit costs and the Accumulated Post-Retirement Benefit Obligation (APBO). Therefore, under that guidance, measures of the APBO and net periodic post-retirement benefit costs on or after the date of enactment should reflect the effects of the Act.

     However, due to certain accounting issues raised by the Act that are not explicitly addressed by SFAS No. 106 and uncertainties that may exist as to reliable information available on which to measure the effects of the Act, the FSP 106-1 allows a plan sponsor to elect to defer recognizing the effects of the Act in the accounting for its plan under SFAS No. 106 and in providing disclosures related to the plan required by SFAS No. 132 (revised 2003), "Employers' Disclosures about Pensions and Other Post-retirement Benefits," until authoritative guidance on the accounting for the federal subsidy is issued, or until certain other events occur.

     Pepco Holdings sponsors post-retirement health care plans that provide prescription drug benefits. Pepco Holdings did not elect the deferral provided by the FSP 106-1. The APBO as of December 31, 2003 was reduced by $28 million to reflect the effects of the Act. For the current quarter and all of 2003, Pepco Holdings' net periodic postretirement benefit expense has not been reduced to reflect the Act. It is estimated that the annual postretirement benefit cost will be reduced by approximately $4 million due to effects of the Act. This reduction includes both the decrease in the cost of future benefits being earned and an amortization of the APBO reduction over the future average working lifetime of the participants, or 13.5 years. The anticipated claims costs expected to be incurred have been adjusted to reflect the cost sharing between Medicare and Pepco Holdings. Participation rates have not been changed. In reflecting the effects of the Act, Pepco Holdings has determined which plans are eligible for Medicare cost sharing by analyzing the terms of each of its plans. It has recognized Medicare cost sharing for a plan only if Pepco Holdings' projected prescription drug coverage is expected to be at least as generous as the expected contribution by Medicare to a prescription drug plan not provided by Pepco Holdings.

     Specific authoritative guidance on the accounting for the federal subsidy under the Act is pending and that guidance, when issued, could require Pepco Holdings to change previously reported information. When

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issued, the guidance on accounting for the federal subsidy will include transition guidance, as applicable, for entities that elected to defer accounting for the effects of the Act and those that did not.

     The effect of the subsidy on the current period Other Post-Retirement net periodic benefit cost of $11.0 million would be approximately a $1 million reduction due to the subsidy. Approximately $.5 million would be related to the amortization of the actuarial gain, $.1 million would be a subsidy-related reduction in current period service cost and approximately $.4 million would be a subsidy-related reduction in interest cost on the APBO.

Severance Costs

     During 2002, Pepco Holdings' management approved initiatives by Pepco and Conectiv to streamline their operating structures 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)." A roll forward of the severance accrual balance is as follows. (Amounts in millions)

Balance, December 31, 2003

$  7.9 

  Accrued during 2004

     - 

  Payments during 2004

  (4.3)

Balance, March 31, 2004

$  3.6 

     Substantially all of the severance liability accrued at March 31, 2004 will be paid through mid 2005. Employees have the option of taking severance payments in a lump sum or over a period of time.

Summarized Income Statement Information for Starpower

     Pepco Holdings, through a subsidiary of Pepcom, owns a 50% interest in Starpower. Unaudited summarized financial information for Starpower for the three months ended March 31, 2004, is as follows:

(Millions of Dollars)

Total Revenue

$ 20.5      

Cost of Sales

  5.7      

Gross Margin

14.8      

Operating Expenses

10.6      

Depreciation and Amortization

 6.5      

Loss

$(2.3)     

Stock-Based Compensation

     The objective of Pepco Holdings' Long-Term Incentive Plan (the LTIP) is to increase shareholder value by providing a long-term incentive to reward officers, key employees, and directors of Pepco Holdings and its subsidiaries and to increase the ownership of Pepco Holdings' common stock by such individuals. Any officer or key employee of Pepco Holdings or its subsidiaries may be designated by PHI's Board of Directors as a participant in the LTIP. Under the LTIP, awards to officers and key employees may be in the form of restricted stock, options, performance units, stock appreciation rights, or dividend equivalents. No awards were granted during the quarter ended March 31, 2004.

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     Pepco Holdings recognizes compensation costs for the LTIP based on the provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." In accordance with FASB Statement No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"), as amended by FASB Statement No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure," the following table illustrates the effect on net income and basic and diluted earnings per share if Pepco Holdings had applied the fair value based method of expense recognition and measurement provisions of SFAS No. 123 to stock-based employee compensation.

For the Three Months Ended March 31,

2004    

2003    

(Millions, except Per Share Data)

Net Income (Loss), as reported

$51.2   

$(24.9)

Add: Total stock-based employee compensation cost, net of related tax effects, included in net income as reported

.8   

.1 

Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects

  (1.1)  

  (.4) 

Pro forma net income

$  50.9   

$(25.2) 

Basic and diluted earnings per share as reported

$   .30   

$ (.15) 

Pro forma basic and diluted earnings per share

$   .30   

$ (.15) 

(3)  SEGMENT INFORMATION

     Based on the provisions of Statement of Financial Accounting Standards (SFAS) No. 131 "Disclosures about Segments of an Enterprise and Related Information," Pepco Holdings' management has identified its reportable segments at March 31, 2004 as Power Delivery, Conectiv Energy, Pepco Energy Services, and Other Non-Regulated. Prior to the three months ended March 31, 2004, Pepco Holdings' Power Delivery business consisted of two reportable segments, Pepco and Conectiv Power Delivery. However, with the continued integration of the Power Delivery businesses, effective January 1, 2004 these two businesses represent a single segment. Additionally, during the quarter ended March 31, 2004, Pepco Holdings transferred several operating businesses from one reportable segment to another in order to better align their operations going forward. In accordance with the provisions of SFAS No. 131, results for the quarter ended March 31, 2003 have b een reclassified to conform to the current period segment presentation. 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 for Pepco Holdings' consolidated results through the "Corporate and Other" column. Segment financial information for the three months ended March 31, 2004 and 2003, is as follows.

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                For the Three Months Ended March 31, 2004               
                                 (In Millions)

Competitive
Energy Segments

Power
Delivery

Conectiv
Energy

Pepco
Energy
Services

Other
Non-
Regulated

(a)
Corp.
& Other

PHI
Cons.

Operating Revenue

$1,039.2

$  587.8

(b)

$310.7 

$   21.1 

$ (194.7)

$ 1,764.1

Operating Expense

930.7

(b)

572.3

308.2 

(3.3)

(194.3)

1,613.6

Operating Income
  (loss)

108.5

15.5

2.5 

24.4 

(.4)

150.5

Interest Expense

46.3

6.6

.5 

10.0 

29.2 

92.6

Income Taxes (c)

27.2

3.4

(.6)

(5.8)

(12.8)

11.4

Net Income (loss)

$   40.8

$    5.0

$  3.1 

$   20.1 

$  (17.8)

$    51.2

Total Assets

$8,514.3

$2,048.8

$555.2 

$1,336.2 

$1,095.3 

$13,549.8

(a)

Includes unallocated Pepco Holdings (parent company) capital costs, such as acquisition financing costs, and the depreciation and amortization related to purchase accounting adjustments for the fair value of non-regulated Conectiv assets and liabilities as of August 1, 2002. Intercompany transactions are also included in this line item. Additionally, this line item for "total assets" also includes Pepco Holdings' goodwill balance.

(b)

Power Delivery purchased electric energy, electric capacity and natural gas from Conectiv Energy in the amount of $148.4 million for the three months ended March 31, 2004.

(c)

In February 2004, a local jurisdiction issued final consolidated tax return regulations, which were retroactive to 2001. Under these regulations, Pepco Holdings (parent) and other affiliated companies doing business in this location, now have the necessary guidance to file a consolidated income tax return. This allows Pepco Holdings' subsidiaries with taxable losses to utilize those losses against tax liabilities of Pepco Holdings' companies with taxable income. During the first quarter of 2004, Pepco Holdings and its subsidiaries recorded the impact of the new regulations of $13.1 million for the period of 2001 through 2003.

                For the Three Months Ended March 31, 2003               
                                 (In Millions)

Competitive
Energy Segments

Power
Delivery

Conectiv
Energy

Pepco
Energy
Services

Other
Non-
Regulated

(a)
Corp.
& Other

PHI
Cons.

Operating Revenue

$  969.1 

$  828.2 

(b), (d)

$332.4 

$   26.3 

$(227.3)

$ 1,928.7 

Operating Expense

842.8 

(b)

980.2 

(c)

337.6 

4.1 

(275.1)

(c)

1,889.6 

Operating Income
  (loss)

126.3 

(152.0)

(5.2)

22.2 

47.8 

39.1 

Interest Expense

46.7 

2.9 

2.1 

13.8 

23.6 

89.1 

Income Taxes

34.5 

(63.3)

(2.6)

.7 

8.7 

(22.0)

Net Income (loss)

49.0 

(90.5)

(4.4)

8.4 

12.6 

(24.9)

Total Assets

$8,539.7 

$2,066.4 

$484.5 

$1,611.8 

$892.6 

$13,595.0 

(a)

Includes unallocated Pepco Holdings (parent company) capital costs, such as acquisition financing costs, and the depreciation and amortization related to purchase accounting adjustments for the fair value of non-regulated Conectiv assets and liabilities as of August 1, 2002. Intercompany transactions are also included in this line item. Additionally, this line item for "total assets" also includes Pepco Holdings' goodwill balance.

(b)

Power Delivery purchased electric energy, electric capacity and natural gas from Conectiv Energy in the amount of $158.0 million for the three months ended March 31, 2003.

(c)

Conectiv Energy's results include a charge of $110.7 million related to a combustion turbine (CT) cancellation. This unfavorable impact at Conectiv Energy is partially offset by $57.9 million in Corp. & Other related to the reversal of a purchase accounting fair value adjustment made on the date of the merger.

(d)

This amount includes the unfavorable impact resulting from net trading losses of approximately $44 million incurred prior to the cessation of proprietary trading.

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(4)  COMMITMENTS AND CONTINGENCIES

Relationship with Mirant Corporation

     In 2000, Pepco sold substantially all of its electricity generation assets to Mirant Corporation, formerly Southern Energy, Inc. As part of the sale, Pepco entered into several ongoing contractual arrangements with Mirant and certain of its subsidiaries (collectively, Mirant). On July 14, 2003, Mirant Corporation and most of its subsidiaries filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of Texas (the Bankruptcy Court). Under bankruptcy law, a debtor generally may, with authorization from a bankruptcy court, assume 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. In a bankruptcy proceeding, a debtor can normally restructure some or all of its pre-petition liabilities.< /TD>

     Depending on the outcome of the matters discussed below, the Mirant bankruptcy could have a material adverse effect on the results of operations of Pepco Holdings and Pepco. However, management currently believes that Pepco Holdings and Pepco currently have sufficient cash, cash flow and borrowing capacity under their credit facilities and in the capital markets to be able to satisfy the additional cash requirements that are expected to arise due to the Mirant bankruptcy. Accordingly, management does not anticipate that the Mirant bankruptcy will impair the ability of Pepco Holdings or Pepco to fulfill their contractual obligations or to fund projected capital expenditures. On this basis, management currently does not believe that the Mirant bankruptcy will have a material adverse effect on the financial condition of either company.

     Transition Power Agreements

     As part of the asset purchase and sale agreement for the Pepco generation assets (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, Mirant was obligated to supply Pepco with all of the capacity and energy needed to fulfill its standard offer service obligations in Maryland through June 2004 and its standard offer service obligations in the District of Columbia into January 2005.

     To avoid the potential rejection of the TPAs, Pepco and Mirant entered into an Amended Settlement Agreement and Release dated as of October 24, 2003 (the Settlement Agreement) pursuant to which Mirant has assumed both of the TPAs and the terms of the TPAs were modified. The Settlement Agreement also provides that Pepco has an allowed, pre-petition general unsecured claim against Mirant in the amount of $105 million (the Pepco TPA Claim).

     The amount, if any, that Pepco will be able to recover from the Mirant bankruptcy estate in respect of the Pepco TPA Claim will depend on the amount of assets available for distribution to creditors. At the current stage of the bankruptcy proceeding, there is insufficient information to determine the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate.

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     Power Purchase Agreements

     Under agreements with FirstEnergy Corp., formerly Ohio Edison (FirstEnergy), and Allegheny Energy, Inc., both entered into in 1987, 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), entered into in 1991, 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 part of the Asset Purchase and Sale Agreement, Pepco entered into a "back-to-back" arrangement with Mirant. Under this arrangement, Mirant is obligated, among other things, 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 PPAs (the PPA-Related Obligations).

     Pepco Pre-Petition Claims

     When Mirant filed its bankruptcy petition on July 14, 2003, Mirant had unpaid obligations to Pepco of approximately $29 million, consisting primarily of payments due to Pepco in respect of the PPA-Related Obligations (the Mirant Pre-Petition Obligations). The Mirant Pre-Petition Obligations constitute part of the indebtedness for which Mirant is seeking relief in its bankruptcy proceeding. Pepco has filed Proofs of Claim in the Mirant bankruptcy proceeding in the amount of approximately $26 million to recover this indebtedness; however, the amount of Pepco's recovery, if any, is uncertain. The $3 million difference between Mirant's unpaid obligation to Pepco and the $26 million Proofs of Claim filed by Pepco primarily represents a TPA settlement adjustment which is included in the $105 million Proofs of Claim filed by Pepco against the Mirant debtors in respect of the Pepco TPA Claim. In view of this uncertainty, Pepco, in the third quarter of 2003, expensed $14.5 million to establish a reserve against the $29 million receivable from Mirant. In January 2004, Pepco paid approximately $2.5 million to Panda in settlement of certain billing disputes under the Panda PPA that related to periods after the sale of Pepco's generation assets to Mirant. Pepco believes that under the terms of the Asset Purchase and Sale Agreement, Mirant is obligated to reimburse Pepco for the settlement payment. Accordingly, in the first quarter of 2004 Pepco increased the amount of the receivable due from Mirant by approximately $2.5 million, and Pepco intends to file Proofs of Claim for this amount against Mirant. Pepco currently estimates that the $14.5 million expensed in the third quarter of 2003 represents the portion of the entire $31.5 million receivable unlikely to be recovered in bankruptcy, and no additional reserve has been established for the $2.5 million increase in the receivable. The amount expensed represents Pepco's estimate of the possible outcome in bankruptcy, although the amount ultimately recoverable could be higher or lower.

     Mirant's Attempt to Reject the PPA-Related Obligations

     On August 28, 2003, Mirant filed with the Bankruptcy Court a motion seeking authorization to reject its PPA-Related Obligations.

     Upon motions filed by Pepco and the Federal Energy Regulatory Commission (FERC), on October 9, 2003, the U.S. District Court for the Northern District of Texas (the District Court) withdrew jurisdiction over the rejection proceedings from the Bankruptcy Court. On December 23, 2003, the District Court denied Mirant's motion to reject the PPA-Related Obligations. The District Court's decision is being appealed by Mirant and The Official

17
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Committee of Unsecured Creditors of Mirant Corporation in the U.S. Court of Appeals for the Fifth Circuit. Oral argument on the appeal was heard on May 5, 2004.

     Pepco is exercising all available legal remedies and vigorously opposing Mirant's continued attempts to reject the PPA-Related Obligations in order to protect the interests of its customers and shareholders. While Pepco believes that it has substantial legal bases to oppose the attempt to reject the agreements, the outcome of Mirant's efforts to reject the PPA-Related Obligations is uncertain.

     In accordance with the Bankruptcy Court's order, Mirant is continuing to perform the PPA-Related Obligations pending the resolution of the ongoing proceedings. However, if Mirant ultimately is successful in rejecting, and is otherwise permitted to stop performing the PPA-Related Obligations, Pepco could be required to repay to Mirant, for the period beginning on the effective date of the rejection (which date could be prior to the date of the court's order and possibly as early as September 18, 2003) and ending on the date Mirant is entitled to cease its purchases of energy and capacity from Pepco, all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity. Pepco estimates that the amount it could be required to repay to Mirant in the unlikely event September 18, 2003, is determined to be the effective date of rejection, is approx imately $69.2 million as of May 1, 2004. This repayment would entitle Pepco to file a claim against the bankruptcy estate in an amount equal to the amount repaid. Mirant has also asked the Bankruptcy Court to require Pepco to disgorge all amounts paid by Mirant to Pepco in respect of the PPA-Related Obligations, less an amount equal to the price at which Mirant resold the purchased energy and capacity, for the period July 14, 2003 (the date on which Mirant filed its bankruptcy petition) to September 18, 2003, on the theory that Mirant did not receive value for those payments. Pepco estimates that the amount it would be required to repay to Mirant on the disgorgement theory is approximately $22.5 million. Pepco believes a claim based on this theory should be entitled to administrative expense status for which complete recovery could be expected. If Pepco were required to repay any such amounts for either period, the payment would be expensed at the time the payment is made.

     The following are estimates prepared by Pepco of its potential future exposure if Mirant's motion to reject its PPA-Related Obligations ultimately is successful. These estimates are based in part on current market prices and forward price estimates for energy and capacity, and do not include financing costs, all of which could be subject to significant fluctuation. The estimates assume no recovery from the Mirant bankruptcy estate and no regulatory recovery, either of which would mitigate the effect of the estimated loss. Pepco does not consider it realistic to assume that there will be no such recoveries. Based on these assumptions, Pepco estimates that its pre-tax exposure as of May 1, 2004, representing the loss of the future benefit of the PPA-Related Obligations to Pepco, is as follows:

·

If Pepco were required to purchase capacity and energy from FirstEnergy commencing as of May 1, 2004, at the rates provided in the PPA (with an average price per kilowatt hour of approximately 6.1 cents) and resold the capacity and energy at market rates projected, given the characteristics of the FirstEnergy PPA, to be approximately 4.5 cents per kilowatt hour, Pepco estimates that it would cost approximately $41.0 million for the remainder of 2004, and $57 million in 2005, the last year of the FirstEnergy PPA.

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·

If Pepco were required to purchase capacity and energy from Panda commencing as of May 1, 2004, at the rates provided in the PPA (with an average price per kilowatt hour of approximately 15.6 cents), and resold the capacity and energy at market rates projected, given the characteristics of the Panda PPA, to be approximately 6.9 cents per kilowatt hour, Pepco estimates that it would cost approximately $26 million for the remainder of 2004, $38 million in 2005, and $36 million in 2006 and approximately $35 million to $43 million annually thereafter through the 2021 contract termination date.

     The ability of Pepco to recover from the Mirant bankruptcy estate in respect of the Mirant Pre-Petition Obligations and damages if the PPA-Related Obligations are successfully rejected will depend on whether Pepco's claims are allowed, 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 determine the amount, if any, that Pepco might be able to recover from the Mirant bankruptcy estate, whether the recovery would be in cash or another form of payment, or the timing of any recovery.

     If Mirant ultimately is successful in rejecting the PPA-Related Obligations and Pepco's full claim is not recovered from the Mirant bankruptcy estate, Pepco may seek authority from the Maryland Public Service Commission (MPSC) and the District of Columbia Public Service Commission (DCPSC) to recover its additional costs. Pepco is committed to working with its regulatory authorities to achieve a result that is appropriate for its shareholders and customers. Under the provisions of the settlement agreements approved by the MPSC and the DCPSC in the deregulation proceedings in which Pepco agreed to divest its generation assets under certain conditions, the PPAs were to become assets of Pepco's distribution business if they could not be sold. Pepco believes that, if Mirant ultimately is successful in rejecting the PPA-Related Obligations, these provisions would allow the stranded costs of the PPAs that are not recovered from the Mirant bankruptcy estate to be recovered through Pepco's distribution rates. If Pepco's interpretation of the settlement agreements is confirmed, Pepco expects to be able to establish the amount of its anticipated recovery as a regulatory asset. However, there is no assurance that Pepco's interpretation of the settlement agreements would be confirmed by the respective public service commissions.

     If the PPA-Related Obligations are successfully rejected, and there is no regulatory recovery, Pepco will incur a loss. However, the accounting treatment of such a loss depends on a number of legal and regulatory factors, and is not determinable at this time.

     The SMECO Agreement

     As a term of the Asset Purchase and Sale Agreement, Pepco 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 (the SMECO Agreement). The SMECO Agreement expires in 2015 and contemplates a monthly payment to SMECO of approximately $.5 million. Pepco is responsible to SMECO for the performance of the SMECO Agreement if Mirant fails to perform its obligations thereunder. At this time, Mirant continues to make post-petition payments due to SMECO.

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     However, on March 15, 2004, Mirant filed a complaint with the Bankruptcy Court seeking a declaratory judgment that the facility and capacity credit agreement is an unexpired lease of non-residential real property rather than an executory contract and that if Mirant were to successfully reject the agreement, any claim against the bankruptcy estate for damages made by SMECO (or by Pepco as subrogee) would be subject to the provisions of the Bankruptcy Code that limit the recovery of rejection damages by lessors. Pepco believes that there is no reasonable factual or legal basis to support Mirant's contention that the SMECO Agreement is a lease of real property and has filed a motion to dismiss the complaint. However, the outcome of this proceeding cannot be predicted.

Proposed Federal Tax Legislation Affecting Cross-border=0Leases

     The assets of PCI include a cross-border=0energy lease portfolio with a book value of approximately $1.2 billion at March 31, 2004. Currently, there is pending legislation in the U.S. House of Representatives (HR3967), that would apply new passive loss limitation rules prospectively to any new leases (including cross-border=0leases) entered into on or after February 11, 2004 with tax indifferent parties (i.e., municipalities, tax exempt or governmental entities). Cross-border=0leases are leases by a U.S. taxpayer of property located in a foreign country. All of PCI's cross-border=0leases are with tax indifferent parties but were entered into prior to 2004. Legislation is also pending in the Senate (S1637) that may jeopardize the tax benefits received by leaseholders, including PCI, from existing cross-border=0leases. The legislation, if adopted as proposed, would enact new passive loss limitation rules that would be applied retroactive ly to all existing lease agreements, for taxable years beginning after May 31, 2004, for all cross-border=0leaseholders, including PCI. The outcome of these legislative proposals is unknown at this time. However, if the Senate's version were to be adopted in its current form, the amount of income tax benefits that PHI would receive in connection with PCI's cross-border=0leases could decrease materially. If this occurred, PHI may be required to write down the book value of PCI's portfolio of cross-border=0leases by taking a charge against earnings. Any of these circumstances could have a material adverse effect on PHI's financial condition and results of operations.

Preliminary Settlement Agreement with NJDEP

     On April 26, 2004, PHI, Conectiv and ACE entered into a preliminary settlement agreement with the New Jersey Department of Environmental Protection (NJDEP) and the Attorney General of New Jersey that addresses various environmental issues at ACE and Conectiv Energy facilities in New Jersey. Among other things, the preliminary settlement agreement provides that:

·

contingent upon the receipt of necessary approvals from the New Jersey Board of Public Utilities (NJBPU), PJM Interconnection, LLC (PJM), North American Electric Reliability Council (NERC)/FERC and other regulatory authorities and the receipt of permits to construct certain transmission facilities in southern New Jersey described more fully below, ACE will permanently cease operation of the B.L. England generating facility by December 15, 2007. In the event that ACE is unable to shut down the B.L. England facility by December 15, 2007 through no fault of its own (e.g., because of failure to obtain the required regulatory approvals), B.L. England Unit 1 would be required to comply with stringent sulfur dioxide (SO2), nitrogen oxide (NOx) and particulate matter emissions limits set forth in the preliminary settlement agreement by October 1, 2008, and B.L. England Unit 2 would

20
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be required to comply with the emissions limits by May 1, 2009. If ACE does not either shut down the B.L. England facility by December 15, 2007 or satisfy the emissions limits applicable in the event shut down is not so completed, ACE will be required to pay significant monetary penalties.

·

ACE will be permitted to combust coal with a sulfur content of greater than 1% at the B.L. England facility in compliance with the terms of B.L. England's current permit until December 15, 2007 and NJDEP will not impose new, more stringent short-term SO2 emissions limits on the B.L. England facility.

·

to resolve any possible civil liability (and without admitting liability) for violations of the permit provisions of the New Jersey Air Pollution Control Act (APCA) and the Prevention of Significant Deterioration (PSD) provisions of the federal Clean Air Act (CAA) relating to modifications that may have been undertaken at the B.L. England facility, ACE will pay a $750,000 civil penalty to NJDEP by June 1, 2004.

·

to compensate New Jersey for other alleged violations of the APCA and/or the CAA, ACE will undertake environmental projects beneficial to the state of New Jersey and approved by the NJDEP in a consent order or other final settlement document valued at $2 million.

·

ACE will submit all federally required studies and complete construction of facilities necessary to satisfy the Environmental Protection Agency's (EPA) new cooling water intake structure regulations in accordance with a schedule that NJDEP will establish in the renewal New Jersey Pollutant Discharge Elimination System (NJPDES) permit for the B.L. England facility. The schedule will take into account ACE's agreement, provided that all regulatory approvals are obtained, to shut down the B.L. England facility by December 15, 2007.

·

to resolve any possible civil liability (and without admitting liability) for natural resource damages resulting from groundwater contamination at the B.L. England facility, Conectiv Energy's Deepwater generating facility and ACE's operations center near Pleasantville, New Jersey, ACE and Conectiv will pay NJDEP $647,162 in cash or property and will remediate the groundwater contamination at all three sites. If subsequent data indicate that groundwater contamination is more extensive than indicated in NJDEP's preliminary analysis, NJDEP may seek additional compensation for natural resource damages.

     The preliminary settlement agreement also provides that the parties will work toward a consent order or other final settlement document that reflects the terms of the preliminary settlement agreement.

     Pursuant to a NJBPU order issued on September 25, 2003, ACE on April 30, 2004, filed a report with the NJBPU recommending that the B.L. England facility be shut down in accordance with the terms of the preliminary settlement agreement. The report stated that the operation of the B.L. England facility is necessary at the present time to satisfy reliability standards, but that those reliability standards could also be satisfied in other ways. The report concludes that, based on B.L. England's current and projected operating costs resulting from compliance with more restrictive environmental requirements, the most cost-effective way in which to meet reliability standards is to shut down the B.L. England facility and construct additional transmission lines into southern New Jersey. ACE cannot predict

21
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whether the NJBPU will approve the construction of the additional transmission lines.

Rate Proceedings

     On February 3, 2003, ACE filed a petition with the NJBPU to increase its electric distribution rates and its Regulatory Asset Recovery Charge (RARC) in New Jersey. In its most recent submission, made on February 20, 2004, ACE proposed an overall rate increase of approximately $35.1 million, consisting of a $30.6 million increase in distribution rates and a $4.5 million increase in RARC. Hearings were held before an Administrative Law Judge in late March and early April 2004. At the hearing held on April 6, 2004, the Ratepayer Advocate proposed an annual rate decrease of $4.5 million, modifying its earlier proposal that rates be decreased by $11.7 million annually. The Staff of the NJBPU is expected to submit its recommendations in briefs to be filed in June. ACE cannot predict the outcome of this proceeding.

     In December 2003, the Delaware Public Service Commission (DPSC) approved a settlement agreement that provided for an annual increase of $7.75 million in DPL's gas base rate. In accordance with the terms of the settlement agreement, on February 13, 2004, DPL filed for an Environmental Surcharge of approximately $522,000 amortized over five years to recover out-of-pocket costs associated with gas environmental issues. The DPSC approved this surcharge on April 20, 2004. The surcharge will be adjusted year-to-year to reflect DPL's actual costs.

     DPL filed on February 13, 2004 for a change in electric ancillary service rates that has an aggregate effect of increasing annual revenues by $13.1 million or 2.4%. This filing was prompted by the increasing ancillary service costs charged to DPL by PJM. On February 24, 2004, the DPSC accepted the filing and placed the increase into effect on March 15, 2004, subject to refund. Intervention by another party has been filed. Unless the proceeding is settled, evidentiary hearings will be held in late August with a decision expected before the end of 2004.

     On August 29, 2003, DPL submitted its annual Gas Cost Recovery (GCR) rate filing to the DPSC. In its filing, DPL sought to increase its GCR rate by approximately 15.8% in anticipation of increasing natural gas commodity costs. The GCR rate, which permits DPL to recover its procurement gas costs through customer rates, became effective November 1, 2003 and was subject to refund pending evidentiary hearings that were held on April 19, 2004. No party has proposed to modify DPL's proposed GCR rate, thus no refund is required. However, DPSC Staff has suggested prospective modifications to the program by which DPL hedges price risk for its gas purchases.

     In compliance with the merger settlement approved by the MPSC in connection with the merger of Pepco and Conectiv, on December 4, 2003, DPL and Pepco submitted testimony and supporting schedules to establish electric distribution rates in Maryland effective July 1, 2004, when the current distribution rate freeze/caps end. The filings of each company demonstrate that it is in an under-earning situation. As provided in the terms of the merger settlement, DPL requested it be allowed to put into effect July 1, 2004, a rate increase for non-residential customers to offset the nuclear decommissioning equivalent decrease that was effective July 1, 2003. The merger settlement provides that Pepco's distribution rates can only decrease or remain unchanged after July 1, 2004. With limited exceptions, the merger settlement does not permit either company to increase distribution rates until after December 31, 2006. The MPSC Staff has filed testimony stating that no distribution rate reductions are justified and that DPL should be authorized to

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increase its non-residential customers' distribution rates by approximately $1.1 million. The Office of the People's Counsel (OPC) agrees that no distribution rate reduction is warranted for DPL or Pepco if the respective DPL and Pepco capital structures are used in determining whether existing rates should be reduced. However, OPC argues that the Pepco Holdings' consolidated capital structure and capital costs should be used to determine whether distribution rate reductions for Pepco and DPL are warranted. Based on PHI's consolidated capital structure, OPC recommended that DPL's and Pepco's distribution rates be reduced. Hearings in the Pepco case concluded April 27, 2004. Hearings in the DPL case will be held on May 11 and 12, 2004. Separate MPSC decisions in the DPL and Pepco cases are expected to be issued in early July 2004. Neither Pepco nor DPL can predict the outcome of the proceedings.

SOS and POLR Proceedings

     District of Columbia

     On March 1, 2004, the DCPSC issued an order adopting the "wholesale" model for Standard Offer Service (SOS) in the District of Columbia after fixed rate SOS ends February 7, 2005. Under the wholesale model, Pepco will continue as the SOS provider after February 7, 2005. Several parties have filed applications for reconsideration of the order adopting the wholesale model that are pending before the DCPSC. PHI cannot predict the outcome of this proceeding.

     In December 2003, the DCPSC issued an order adopting terms and conditions that would apply if the wholesale SOS model were adopted. Pepco and most of the other parties in the case filed applications for reconsideration and/or clarification of various parts of this order, and on March 1, 2004, the DCPSC granted in part and denied in part the applications for reconsideration and/or clarification. Because the DCPSC changed certain rules in its order granting in part and denying in part applications for reconsideration of the wholesale SOS terms and conditions, several parties filed for reconsideration of the March 1, 2004 order. Those applications for reconsideration are pending decision by the DCPSC. The DCPSC has also instituted an evidentiary proceeding to consider the amount of the administrative charge which Pepco may collect for providing SOS on and after February 8, 2005. The DCPSC intends to issue a decision by August&n bsp;10, 2004.

     Virginia

     In March 2004, Virginia amended its Electric Utility Restructuring Act to extend the rate freeze provisions applicable to DPL's rates for both provider of last resort (POLR) supply and distribution. The rate freezes, previously scheduled to expire on July 1, 2007, were extended to December 31, 2010, except that one change in base rates can be proposed by DPL prior to July 1, 2007, and one additional change in base rates can be proposed by DPL between that date and December 31, 2010. Additionally, rates may be increased to reflect increased purchased power costs, increased taxes, or increased costs to comply with environmental or reliability requirements.

     The Virginia Electric Utility Restructuring Act obligates DPL to offer POLR service during the period that rates are frozen and thereafter, until relieved of that obligation by the Virginia State Corporation Commission (VSCC).

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     On December 3, 2003, DPL and Conectiv Energy filed with the VSCC an amendment to extend their power supply agreement for one year, i.e., through December 31, 2004, and on a month-to-month basis thereafter, as it applies to power supply for DPL's Virginia POLR customers. The VSCC approved the amendment in an order issued on March 1, 2004. After December 31, 2004 either DPL or Conectiv Energy can terminate Conectiv Energy's obligation to provide supplies to meet DPL's Virginia POLR obligations by giving 30 days written notice to the other party.

Third Party Guarantees, Indemnifications, and Off-Balance Sheet Arrangements

     Pepco Holdings and certain of its subsidiaries have various financial and performance guarantees and indemnification obligations which are entered into in the normal course of business to facilitate commercial transactions with third parties as discussed below.

     As of March 31, 2004, 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. The fair value of these commitments and obligations was not required to be recorded in Pepco Holdings' Consolidated Balance Sheets; however, certain energy marketing obligations of Conectiv Energy were recorded. The commitments and obligations, in millions of dollars, were as follows:

           Guarantor         

PHI

Conectiv

PCI

Total

Energy marketing obligations of
  Conectiv Energy (1)

$119.3 

$12.2  

$  - 

$131.5 

Energy procurement obligations
  of Pepco Energy Services (1)

17.3 

-  

- 

17.3 

Standby letters of credit of
  Pepco Holdings (2)

5.5 

-  

- 

5.5 

Guaranteed lease residual values (3)

- 

5.5  

- 

5.5 

Loan agreement (4)

13.1 

-  

- 

13.1 

Construction performance guarantees (5)

- 

4.2  

- 

4.2 

Other (6)

  14.9 

  4.2  

 5.7 

24.8 

  Total

$170.1 

$26.1  

$5.7 

$201.9 

1.

Pepco Holdings and Conectiv have contractual commitments for performance and related payments of Conectiv Energy and Pepco Energy Services to counterparties related to routine energy sales and procurement obligations, including requirements under Basic Generation Service contracts for ACE.

2.

Pepco Holdings has issued standby letters of credit of $5.5 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 the flexibility needed to conduct business with counterparties without having to post substantial cash collateral. While the exposure under these standby letters of credit is $5.5 million, Pepco Holdings does not expect to fund the full amount.

3.

Subsidiaries of Conectiv have guaranteed residual values in excess of fair value related to certain equipment and fleet vehicles held through lease agreements. As of March 31, 2004, obligations under the guarantees were approximately $5.5 million. Assets leased under

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agreements subject to residual value guarantees are typically for periods ranging from 2 years to 10 years. Historically, payments under the guarantees have not been made by the guarantor 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 $4.2 million relating to obligations to third party suppliers of equipment.

6.

Other guarantees comprise:

·

Pepco Holdings has guaranteed payment of a bond issued by a subsidiary of $14.9 million. Pepco Holdings does not expect to fund the full amount of the exposure under the guarantee.

·

Conectiv has guaranteed a subsidiary building lease of $4.2 million. Pepco Holdings does not expect to fund the full amount of the exposure under the guarantee.

·

PCI has guaranteed facility rental obligations related to contracts entered into by Starpower Communications LLC. In addition, PCI has agreed to indemnify RCN for 50% of any payments RCN makes under the Starpower franchise and construction performance bonds.  As of March 31, 2004, the guarantees cover the remaining $3.6 million in rental obligations and $2.1 million in franchise and construction performance bonds issued.

     In addition, in connection with the Conectiv Bethlehem revolving credit agreement, Conectiv provides a guarantee associated with Conectiv Energy's agreement to purchase energy and capacity from Conectiv Bethlehem and other guarantees related to obligations of Pepco Holdings subsidiaries under agreements related to constructing and operating the Conectiv Bethlehem mid-merit plant. Generally, Conectiv's guarantee obligations do not exceed the amount of the debt outstanding under the credit agreement and do not guarantee Conectiv Bethlehem's obligation to repay the debt. As of March 31, 2004, the outstanding balance under the Conectiv Bethlehem credit facility was $320.6 million.

     Pepco Holdings and certain of its subsidiaries have entered into various indemnification agreements related to purchase and sale agreements and other types of contractual agreements with vendors and other third parties. These indemnification agreements typically cover environmental, tax, litigation and other matters, as well as breaches of representations, warranties and covenants set forth in these agreements. Typically, claims may be made by third parties under these indemnification agreements over various periods of time depending on the nature of the claim. The maximum potential exposure under these indemnification agreements can range from a specified dollar amount to an unlimited amount depending on the nature of the claim and the particular transaction. The total maximum potential amount of future payments under these indemnification agreements is not estimable due to several factors, including uncertainty as to whether or when claims m ay be made under these indemnities.

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Dividends

     On April 22, 2004, Pepco Holdings' Board of Directors declared a dividend on common stock of 25 cents per share payable June 30, 2004, to shareholders of record on June 10, 2004.

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POTOMAC ELECTRIC POWER COMPANY
STATEMENTS OF EARNINGS
(Unaudited)

Three Months Ended
March 31,

   2004  

   2003  

(Millions of Dollars)

Operating Revenue

$369.6 

$333.4 

Operating Expenses

   Fuel and purchased energy

173.7 

134.2 

   Other operation and maintenance

67.1 

59.7 

   Depreciation and amortization

43.9 

41.3 

   Other taxes

56.5 

45.0 

   Gain on sale of asset

(6.6)

- 

      Total Operating Expenses

334.6 

280.2 

Operating Income

35.0 

53.2 

Other Income (Expenses)

   Interest and dividend income

- 

1.2 

   Interest expense

(20.2)

(19.3)

   Other income

1.4 

1.4 

   Other expenses

(.5)

(1.6)

      Total Other Expenses

(19.3)

(18.3)

Distributions on Preferred Securities
  of Subsidiary Trust

- 

2.3 

Income Before Income Tax Expense

15.7 

32.6 

Income Tax Expense

6.2 

12.6 

Net Income

9.5 

20.0 

Dividends on Redeemable Serial Preferred Stock

.4 

1.2 

Earnings Available for Common Stock

9.1 

18.8 

Retained Income at Beginning of Period

505.3 

468.9 

Dividends paid to Pepco Holdings

(11.8)

(15.7)

Retained Income at End of Period

$502.6 

$472.0 

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

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POTOMAC ELECTRIC POWER COMPANY
BALANCE SHEETS
(Unaudited)

March 31,
2004

December 31,
2003

ASSETS

(Millions of Dollars)

CURRENT ASSETS

   Cash and cash equivalents

$209.2 

$    6.8 

   Accounts receivable, less allowance for
     uncollectible accounts of $18.2 million
     and $18.4 million

243.8 

269.8 

   Materials and supplies - at average cost

44.1