(1)     Organization and Segment Information

     On August 1, 2002, Potomac Electric Power Company (Pepco or the Company) closed on its acquisition of Conectiv for a combination of cash and stock valued at approximately $2.2 billion. In accordance with the terms of the merger agreement, both Pepco and Conectiv became subsidiaries of Pepco Holdings, Inc. (Pepco Holdings, formerly New RC, Inc.) a registered holding company under the Public Utility Holding Company Act of 1935. Pepco Holdings was incorporated under the laws of Delaware on February 9, 2001 for the purpose of effecting the merger. As part of the merger transaction, holders of Pepco's common stock immediately prior to the August 1, 2002 merger received in exchange for their Pepco shares approximately 107,125,976 shares of Pepco Holdings common stock, par value $.01 per share. Additionally, Pepco issued 100 shares of common stock, par value $.01, all of which is owned by Pepco Holdings.

     Since August 1, 2002, Pepco is engaged solely in the provision of regulated electric utility transmission and distribution services in the Washington, D.C. (D.C.) metropolitan area (the Utility). Until August 1, 2002, Pepco was also engaged in the management of a diversified financial investments portfolio and the supply of energy products and services in competitive retail markets. These activities were performed through the Company's wholly owned unregulated subsidiary at that time, POM Holdings, Inc. (POM) which until August 1, 2002, was the parent company of two wholly owned subsidiaries, Potomac Capital Investment Corporation (PCI) and Pepco Energy Services, Inc. (Pepco Energy Services). PCI managed the Company's financial investment portfolio and Pepco Energy Services provided competitive energy products and services. PCI's investment in Starpower Communications, LLC, which provides cable and telecommunication services in the Washington, D.C. area, was owned by its wholly owned subsidiary Pepco Communications, Inc. (Pepcom). After the merger, the stock of PCI, Pepco Energy Services, and Pepcom was distributed as a dividend to Pepco Holdings, which resulted in Pepco Holdings becoming the new parent company of PCI, Pepco Energy Services, and Pepcom. Additionally, the Company has a wholly owned Delaware statutory business trust, Potomac Electric Power Company Trust I, and a wholly owned Delaware Investment Holding Company, Edison Capital Reserves Corporation.

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(2)   Summary of Significant Accounting Policies

     The information furnished in the accompanying consolidated financial statements reflects all adjustments (which consist only of normal recurring accruals) which are, in the opinion of management, necessary for a fair presentation of the Company's results of operations for the interim periods presented. The accompanying consolidated financial statements present the financial results of the Company as described above. All intercompany balances and transactions have been eliminated. The accompanying consolidated financial statements and notes thereto should be read in conjunction with the Company's 2001 Form 10-K. Certain prior period amounts have been reclassified in order to conform to the current period presentation.

     As discussed in Note (1) Organization and Segment Information, on August 1, 2002, in accordance with the terms of the merger agreement Pepco transferred its ownership of PCI and Pepco Energy Services to Pepco Holdings. Accordingly, the accompanying unaudited consolidated balance sheet as of September 30, 2002 includes the accounts of Pepco's utility operations only. The consolidated balance sheet as of December 31, 2001 includes the consolidated accounts of Pepco and its pre-merger wholly owned subsidiaries, PCI and Pepco Energy Services.

     The accompanying unaudited consolidated statements of earnings and retained income for the three and nine months ended September 30, 2002 include Pepco's utility operations for the entire periods presented consolidated with its pre-merger subsidiaries operations for July 2002 and the seven months ended July 2002, respectively. The 2001 operating amounts reflect the consolidated operations for Pepco and its pre-merger subsidiaries, for the entire periods presented, as previously reported by Pepco. Accordingly, the 2002 and 2001 balances included in the accompanying unaudited consolidated financial statements are not comparable.

     The Utility's revenue for services rendered but unbilled as of the end of each month is accrued and included in the accounts receivable balance on the accompanying consolidated balance sheets.

     Based on the regulatory framework in which it has operated, the Company has historically applied, and in connection with its transmission and distribution business continues to apply, the provisions of Statement of Financial Accounting Standards No. 71 (SFAS 71) "Accounting for the Effects of Certain Types of Regulation." SFAS 71 allows regulated entities, in appropriate circumstances, to establish regulatory assets and to defer the income statement impact of certain costs that are expected to be recovered in future rates. Management's assessment of the probability of recovery of regulatory assets requires judgment and interpretation of laws, regulatory commission orders, and other factors. Should existing facts or circumstances change in the future to indicate that a regulatory asset is not probable of recovery, then the regulatory asset would be charged to earnings.

     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," which addresses the presentation of revenue and expense associated with "energy trading book" contracts on a gross vs. net basis. Previously, the EITF concluded that gross presentation was acceptable, but with the issuance of EITF 02-3 and the subsequent guidance provided by the EITF, net presentation is required. Pepco does not enter into trading activities that are subject to the provisions of the pronouncement, however, its pre-merger subsidiary Pepco Energy Services did enter into such transactions and historically classified these contracts on a gross basis.

     Pepco Energy Services has completed its evaluation of the extent of the revenue and expense reclassifications required by EITF 02-3. Beginning with July 2002, all trades were recorded net and therefore no reclassification was required for the three months ended September 30, 2002. The impact of the implementation of EITF 02-3, because of financial statement line item changes, decreases Pepco Energy Services gross revenues for the nine months ended September 30, 2002 (consisting of the six months ended June 30, 2002) from approximately $423.6 million to $401 million. For the three and nine months ended September 30, 2001 gross revenues decreased from $212.1 million to $165.6 million and approximately $481.2 million to $400.7 million, respectively. There is no impact on Pepco's overall financial position or net results of operations as a result of the implementation of EITF 02-3.

(3)   Commitments and 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 the Company'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. Other issues deal with the inclusion of internal costs and cost allocations, with respect to which Pepco believes its calculations are correct. Accordingly, Pepco is of the strong belief that its calculation of the customers' share of divestiture proceeds is correct and that its position should p revail before the D.C. Commission or upon judicial review. The potential exists that Pepco could be required to make additional gain sharing payments to D.C. 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 impossible to predict 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. It is a certainty that some party or parties will appeal the Hearing Examiner's Proposed Order to the Maryland Commission. The principal issue in the case is the same normalization issue that was raised in the D.C. case. Other issues deal with the inclusion of internal costs and cost allocations, with respect to which Pepco believes its calculations are correct. Accordingly, Pepco is of the strong belief that its calculation of the customers' share of divestiture proceeds is correct and that its position should prevail before the Maryland Commission or upon judicial review. 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 ha ve 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 impossible to predict when the Hearing Examiner or the Maryland Commission will issue their decisions.

     On April 7, 2000, approximately 139,000 gallons of oil leaked from a pipeline at a generation station which was owned at the time by the Company at Chalk Point in Aquasco, Maryland. As of September 30, 2002, approximately $75 million in clean-up costs had been incurred in connection with the oil spill. For the year ended December 31, 2000, the Company recorded the net amount of $1 million in operating expense as a result of the oil spill, which represents an accrual of $75 million in total estimated oil spill related clean-up costs, net of $5 million in insurance proceeds received through June 30, 2000, (the date the amount was recorded by the Company) and an additional $69 million in probable recoveries (recorded as a receivable) from its insurance carriers. Through September 30, 2002, approximately $56 million has been received from insurance carriers and approximately $3.7 million has been received from other parties. The Company believes that the remainin g receivable balance at September 30, 2002 will be recovered from its insurance carrier or other parties.

     Additionally the State of Maryland Department of Environment executed a settlement agreement that reflects the full and final settlement of all claims and penalties against the Company for its violation of state laws in regards to the oil spill. The settlement agreement resulted in a total expense of $950,000, which was recorded in the third quarter of 2002.

Item 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
           AND RESULTS OF OPERATIONS

     For additional information, other than the information disclosed in the Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition section herein, refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company's 2001 Form 10-K.

     On August 1, 2002, Potomac Electric Power Company (Pepco or the Company) closed on its acquisition of Conectiv for a combination of cash and stock valued at approximately $2.2 billion. In accordance with the terms of the merger agreement, both Pepco and Conectiv became subsidiaries of Pepco Holdings, Inc. (Pepco Holdings, formerly New RC, Inc.) a registered holding company under the Public Utility Holding Company Act of 1935. Pepco Holdings was incorporated under the laws of Delaware on February 9, 2001 for the purpose of effecting the merger. As part of the merger transaction, holders of Pepco's common stock immediately prior to the August 1, 2002 merger received in exchange for their Pepco shares approximately 107,125,976 shares of Pepco Holdings common stock, par value $.01 per share. Additionally, Pepco issued 100 shares of common stock, par value $.01, all of which is owned by Pepco Holdings.

     Since August 1, 2002, Pepco is engaged solely in the provision of regulated electric utility transmission and distribution services in the Washington, D.C. (D.C.) metropolitan area (the Utility). Until August 1, 2002, Pepco was also engaged in the management of a diversified financial investments portfolio and the supply of energy products and services in competitive retail markets. These activities were performed through the Company's wholly owned unregulated subsidiary at that time, POM Holdings, Inc. (POM) which until August 1, 2002, was the parent company of two wholly owned subsidiaries, Potomac Capital Investment Corporation (PCI) and Pepco Energy Services, Inc. (Pepco Energy Services). PCI managed the Company's financial investment portfolio and Pepco Energy Services provided competitive energy products and services. PCI's investment in Starpower Communications, LLC, which provides cable and telecommunication services in the Washington, D.C. area, was owned by its wholly owned subsidiary Pepco Communications, Inc. (Pepcom). After the merger, the stock of PCI, Pepco Energy Services, and Pepcom was distributed as a dividend to Pepco Holdings, which resulted in Pepco Holdings becoming the new parent company of PCI, Pepco Energy Services, and Pepcom. Additionally, the Company has a wholly owned Delaware statutory business trust, Potomac Electric Power Company Trust I, and a wholly owned Delaware Investment Holding Company, Edison Capital Reserves Corporation.

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires estimates and assumptions that affect the reported amounts of assets and liability, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The U.S. Securities and Exchange Commission (SEC) has defined a company's most critical accounting policies as the ones that are most important to the portrayal of the company's financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, Pepco has identified the critical accounting policies and judgments addressed below. Although Pepco's management believes that its estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions or conditions.

     The Utility's revenue for services rendered but unbilled as of the end of each month is accrued and included in the accounts receivable balance on the accompanying consolidated balance sheets.

     Based on the regulatory framework in which it has operated, the Company has historically applied, and in connection with its transmission and distribution business continues to apply, the provisions of Statement of Financial Accounting Standards No. 71 (SFAS 71) "Accounting for the Effects of Certain Types of Regulation." SFAS 71 allows regulated entities, in appropriate circumstances, to establish regulatory assets and to defer the income statement impact of certain costs that are expected to be recovered in future rates. Management's assessment of the probability of recovery of regulatory assets requires judgment and interpretation of laws, regulatory commission orders, and other factors. Should existing facts or circumstances change in the future to indicate that a regulatory asset is not probable of recovery, then the regulatory asset would be charged to earnings.

LACK OF COMPARABILITY OF OPERATING RESULTS WITH PRIOR PERIODS

     As discussed in the "Overview" section herein, on August 1, 2002, in accordance with the terms of the merger agreement, Pepco transferred its ownership of PCI and Pepco Energy Services to Pepco Holdings. Accordingly, the accompanying unaudited consolidated balance sheet as of September 30, 2002 includes the accounts of Pepco's utility operations only. The consolidated balance sheet as of December 31, 2001 includes the consolidated accounts of Pepco and its pre-merger wholly owned subsidiaries, PCI and Pepco Energy Services.

     The accompanying unaudited consolidated statements of earnings and retained income for the three and nine months ended September 30, 2002 include Pepco's utility operations for the entire periods presented consolidated with its pre-merger subsidiaries operations for July 2002 and the seven months ended July 2002, respectively. The 2001 operating amounts reflect the consolidated operations for Pepco and its pre-merger subsidiaries, for the entire periods presented, as previously reported by Pepco. Accordingly, the 2002 and 2001 balances included in the accompanying unaudited consolidated financial statements are not comparable.

OPERATING REVENUE

     Total consolidated operating revenue decreased by $112.4 million ($607.6 million vs. $720 million) for the three months ended September 30, 2002, compared to the corresponding period last year. This decrease consists of a $29.1 million decrease in Utility operating revenue and a $101.7 million decrease in operating revenues for PCI and PES. Additionally, the 2001 quarter included a loss of $18.4 million that resulted from the settlement of certain disputes with Mirant Corporation in connection with the December 2000 sale of Pepco's generating plants.

     The decrease in Utility operating revenue during the 2002 quarter primarily results from a decrease of $43.7 million in standard offer service revenue due to increased migration to alternate suppliers during the 2002 quarter. Retail access to a competitive market for generation services was made available to all Maryland customers on July 1, 2000 and to D.C. customers on January 1, 2001. At September 30, 2002, 14% of the Utility's Maryland customers and 12% of its D.C. customers have chosen alternate suppliers. These customers accounted for 1,134 megawatts of load in Maryland (of our total load of 3,369) and 1,195 megawatts of load in D.C. (of our total load of 2,326). The decrease in standard offer service revenue was partially offset by a $20.5 million increase in delivery revenue due to higher delivered kilowatt hour sales (11% increase) from hotter than normal summer weather. Cooling degree hours were approximately 42% above normal during the 2002 quarter .

     The decrease in PCI and PES' operating revenue during the 2002 quarter results from the fact that Pepco's consolidated three months ended September 30, 2002 results include the operating results from PCI and PES for only the pre-merger month of July 2002, compared to a full three months during the corresponding period last year.

     Total consolidated operating revenue decreased by $241.1 million ($1,677.6 million vs. $1,918.7 million) for the nine months ended September 30, 2002, compared to the corresponding period last year. This decrease consists of a $186.9 million decrease in Utility operating revenue and a $22.4 million decrease in operating revenues for PCI and PES. Additionally, the 2001 year to date period included a gain of $31.8 million that resulted from the sale of the Company's 9.72 percent interest in the Conemaugh Generating Station in January 2001.

     The decrease in Utility operating revenue during the 2002 nine month period primarily results from a decrease of $193.2 million in standard offer service revenue due to increased migration to alternative suppliers, partially offset by a $15.4 million increase in delivery revenue due to hotter than normal weather during the period.

     The decrease in PCI and PES' operating revenue during the 2002 nine month period results from the fact that Pepco's consolidated nine months ended September 30, 2002 results include the operating results from PCI and PES for seven months (January 2002 through July 2002), compared to a full nine months during the corresponding period last year.

OPERATING EXPENSES

     Total consolidated operating expenses decreased by $118.6 million ($468.2 million vs. $586.8 million) for the three months ended September 30, 2002, compared to the corresponding period last year. This decrease consists of a $29.9 million decrease in Utility operating expenses and an $88.7 million decrease in operating expenses for PCI and PES.

     The decrease in Utility operating expenses during the 2002 quarter primarily results from a $44.2 million decrease in fuel and purchased energy expense due to less energy purchased because of increased customer migration. This decrease was partially offset by an increase of $8.3 million in O&M expenses primarily due to severance costs recorded in July 2002 related to the merger ($5.5 million); and an increase of $4.8 million in other taxes due to higher Maryland property taxes ($2.1 million) and higher delivery taxes ($2 million).

     The decrease in PCI and PES' operating expenses during the 2002 quarter results from the fact that Pepco's consolidated three months ended September 30, 2002 results include the operating results from PCI and PES for one month (July 2002), compared to a full three months during the corresponding period last year.

     Total consolidated operating expenses decreased by $168.7 million ($1,376.4 million vs. $1,545.1 million) for the nine months ended September 30, 2002, compared to the corresponding period last year. This decrease consists of a $150 million decrease in Utility operating expenses and a $18.7 million decrease in operating expenses for PCI and PES.

     The decrease in Utility operating expense during the 2002 nine month period results from a $166.3 million decrease in fuel and purchased energy expense due to less energy purchased due to higher customer migration. This decrease was partially offset by an increase of $4.1 million in O&M expenses due to an increase in severance costs recorded compared to the corresponding period last year ($2.3 million) and an increase in general power delivery expenses ($2.7 million); an increase of $4 million in depreciation expense; and an increase of $8.2 million in other taxes due to higher Maryland property taxes ($6.4 million) and higher delivery taxes and Pennsylvania property taxes ($1.8 million).

     The decrease in PCI and PES' operating expense during the 2002 nine month period results from the fact that Pepco's consolidated three months ended September 30, 2002 results include the operating results from PCI and PES for seven months (January 2002 through July 2002), compared to a full nine months during the corresponding period last year.

OTHER INCOME (EXPENSES)

     Total consolidated other expenses decreased by $3.7 million ($21.4 million vs. $25.1 million) for the three months ended September 30, 2002, compared to the corresponding period last year. This decrease consists of a $9.5 million increase in Utility other expenses offset by a $13.2 million decrease in other expenses for PCI and PES.

     The increase in Utility other income (expenses) during the 2002 quarter results from a $4.1 million decrease in interest income earned primarily due to lower proceeds remaining to invest from the Company's generation asset divestitures, and due to an increase of $4.2 million in interest expense due to higher interest incurred on the Company's outstanding debt used to partially fund the merger.

     The decrease in PCI and PES' other expenses during the 2002 quarter results from the fact that Pepco's consolidated three months ended September 30, 2002 results include the operating results from PCI and PES for one month (July 2002), compared to a full three months during the corresponding period last year.

     Total consolidated other income (expenses) decreased by $1.7 million ($70.9 million vs. $72.6 million) for the nine months ended September 30, 2002, compared to the corresponding period last year. This decrease consists of a $20.6 million increase in Utility other expenses and a $22.3 million decrease in other expenses for PCI and PES.

     The increase in Utility other expenses during the 2002 nine month period primarily results from a $33.7 million decrease in interest income primarily due to lower proceeds remaining to invest from the Company's generation asset divestitures, and due to a decrease of $18.5 million in int