AMERICAN ELECTRIC POWER CO INC quarterly report, Q3 FY2010

American Electric Power Company, Inc. — Q3 2010 Form 10-Q

Business context and period. AEP is a regulated electric utility holding company with generation, transmission and distribution operations, plus river transportation and generation/marketing businesses. This combined, unaudited filing covers the quarter and nine months ended September 30, 2010; it also includes separate reports for six utility subsidiaries. Results are not necessarily indicative of full-year performance.

Financial performance and position

Metric	Q3 2010	Q3 2009	Nine months 2010	Nine months 2009
Revenue	$4.064 billion	$3.547 billion	$10.993 billion	$10.207 billion
Net income	$557 million	$446 million	$1.040 billion	$1.126 billion
Earnings attributable to AEP common shareholders	$555 million	$443 million	$1.035 billion	$1.119 billion
Diluted EPS	$1.16	$0.93	$2.16	$2.47
Utility Operations gross margin	$2.480 billion	$2.244 billion	$6.760 billion	$6.375 billion

Quarterly earnings improved primarily on rate increases and favorable weather. Utility retail margins rose $246 million in Q3; increased weather-related usage contributed $131 million. Utility operating income was $1.010 billion, versus $844 million.
Nine-month earnings declined despite higher revenue and utility gross margin. AEP cited $182 million of after-tax cost-reduction charges, partially offset by rate relief and weather. Utility Operations income before extraordinary loss fell to $1.017 billion from $1.121 billion.
Cash flow: For the first nine months, operating cash flow was $1.702 billion, down from $1.871 billion. Investing used $1.575 billion, including $1.629 billion of construction expenditures; financing provided $473 million. Cash increased to $1.090 billion from $490 million at year-end 2009. A $463 million qualified-pension contribution and a $656 million increase in securitized receivables under new accounting guidance affected operating cash flow.
Debt and capitalization: Total debt was $18.747 billion at September 30, including $1.466 billion short-term debt. Debt-to-total capitalization was 57.7%, compared with 57.2% at year-end 2009. Management attributed the increase principally to short-term borrowings and accounting treatment of receivables.
Liquidity: Net available liquidity was approximately $3.207 billion, including $1.090 billion in cash and cash equivalents; AEP reported $3.4 billion of credit-facility commitments. It stated liquidity was adequate and was in compliance with its credit covenants.
The board declared a quarterly dividend of $0.46 per share in October, up $0.04 from the previous quarter. Cash dividends paid in Q3 were $0.42 per share.

Material changes and unusual items

Retail electricity sales volumes improved year over year; industrial sales increased 6% in Q3 and 5% for the first nine months, relative to recession-affected 2009 levels. Favorable weather and rate proceedings also supported margins.
AEP recorded $293 million of cost-reduction initiative expense in 2010, primarily severance; 2,461 positions were eliminated. $265 million had been settled by September 30, leaving a $25 million balance after adjustments.
Effective January 1, 2010, new receivables accounting guidance required AEP to report transferred receivables and related financing on its balance sheet. AEP also deconsolidated SWEPCo’s DHLC mining subsidiary under revised VIE rules.
AEP recorded a $54 million pretax write-off in Q2 after Virginia regulators denied recovery of APCo’s share of the Mountaineer carbon capture project. APCo still reported a $59 million regulatory asset for related amounts, with recovery uncertain.
The October 2010 Bank of America litigation ruling affirmed a $346 million judgment against AEP but revived AEP’s claims in Texas. AEP had recorded a $447 million liability, including interest, as of September 30; management said the ruling would not affect 2010 consolidated net income.

Outlook, management commentary and principal risks

AEP announced planned capital expenditures of $2.6 billion in 2011 and $2.9 billion in 2012. No consolidated earnings guidance is provided in the supplied filing text.
SWEPCo’s 600 MW Turk coal plant was expected to enter service in 2012. SWEPCo estimated its share of plant costs at $1.3 billion, excluding AFUDC, plus $132 million for transmission. In October, a federal court partially enjoined unfinished work affecting wetlands, streams and rivers; SWEPCo appealed. Management expected completion, but failure to complete or recover costs could materially harm future earnings, cash flow and financial condition.
Proposed federal environmental rules could materially increase capital and operating costs. AEP estimated potential coal-combustion residual compliance costs of up to $3.9 billion under the proposed solid-waste alternative; hazardous-waste classification could cost more. Recovery through rates or market prices is not assured.
Ohio customer choice was increasing: about 2,000 retail customers had switched providers and another 1,200 had given notice. AEP forecast incremental lost generation margins of approximately $10 million in Q4 2010 and $53 million in 2011, partly offsettable through off-system sales.
Ohio regulators were reviewing whether CSPCo or OPCo earned significantly excessive 2009 returns. Intervenors recommended CSPCo refund up to $156 million; the outcome was uncertain. Appeals and recovery disputes also put Ohio fuel deferrals and riders at risk.
PSO sought an $82 million annual base-rate increase, including $30 million already recovered through a rider; party recommendations ranged from an $18 million reduction to less than $1 million of increase. A hearing was scheduled for December 2010.
Cook Plant Unit 1 had returned to service in December 2009, but rotor replacement was scheduled for fall 2011. Repair and replacement costs could reach approximately $395 million; insurance, warranty and regulatory recovery remain subject to review and proceedings.
Other notable exposures include the pending SWEPCo fuel-cost reconciliation (management estimated a $7 million impact if the proposal were adopted), possible Ohio rate refunds, the $42 million PSO fuel-recovery dispute, and climate-related litigation for which potential losses could not be estimated. A Fitch downgrade of SWEPCo to BBB in June could raise borrowing costs and affect construction financing.

Important facts for investors to verify

Whether higher rates and favorable weather sustain utility margins, and how industrial demand and Ohio customer switching develop.
Cash-flow quality and financing needs, including the effects of receivables accounting, pension contributions, working-capital changes and planned capital spending.
Turk Plant injunction and permitting developments, construction schedule and cost recovery; also the timing and cost of environmental compliance.
Outcomes of Ohio ESP/earnings-test proceedings, PSO’s rate case, SWEPCo’s fuel reconciliation and Cook Unit 1 insurance and customer-recovery reviews.
Final Bank of America judgment and appeal developments, and any potential impact on liquidity or obligations beyond the recorded $447 million liability.