AMERICAN ELECTRIC POWER CO INC quarterly report, Q2 FY2013

Business context and reporting period

American Electric Power Company, Inc. (AEP) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2013. AEP is an electric utility holding company with regulated generation, transmission and distribution operations, alongside transmission, river and competitive generation and marketing businesses. The combined filing also reports results for five utility subsidiaries; figures below are AEP consolidated unless identified otherwise.

Financial results and liquidity

Metric	Q2 2013	Q2 2012	Six months 2013	Six months 2012
Total revenue	$3.582 billion	$3.551 billion	$7.408 billion	$7.176 billion
Operating income	$547 million	$741 million	$1.302 billion	$1.495 billion
Net income	$339 million	$363 million	$703 million	$753 million
EPS attributable to AEP common shareholders	$0.69	$0.75	$1.44	$1.55

• Revenue increased about 0.9% in Q2 and 3.2% for the first half; net income declined about 6.6% in both comparisons. Operating income fell about 26% in Q2 and 13% for the six months.
• Utility Operations gross margin was $2.148 billion in Q2 versus $2.162 billion, and $4.388 billion for the first half versus $4.278 billion. Gross margin is management’s measure of revenue less fuel and purchased electricity costs; it is not a reported consolidated profit margin.
• Net cash from operations was $1.516 billion for the first six months, down from $1.713 billion. Investing used $1.643 billion, including $1.637 billion of construction expenditures; financing used $35 million. Cash declined from $279 million at year-end to $117 million.
• At June 30, total debt was $19.156 billion, including $17.618 billion of long-term debt and $1.538 billion of short-term debt. Debt was 55.2% of total capitalization, unchanged from year-end. AEP reported $3.447 billion of net available liquidity, including cash, committed facilities and after outstanding commercial paper, letters of credit and a term-facility draw.
• Total assets were $54.979 billion and equity $15.537 billion. AEP reported compliance with credit-facility covenants; its contractually defined debt-to-capitalization ratio was 51.6%, against a 67.5% maximum. The board declared a $0.49-per-share quarterly dividend in July.

Material changes and unusual items

• AEP recognized a $154 million pretax impairment ($99 million after tax) for Ohio Power’s Muskingum River Plant Unit 5, which management expects to retire by 2015. The impairment reflects the conclusion that a proposed natural-gas refueling project was remote.
• A favorable U.S. Supreme Court decision on the U.K. Windfall Tax produced an $80 million tax benefit and $43 million pretax interest income in Q2, increasing net income by $108 million. It did not generate cash in the quarter.
• Utility Operations net income fell to $222 million in Q2 from $365 million and to $571 million for the half from $749 million. Drivers included the impairment, Ohio customer switching, lower capacity and off-system sales margins, outages, storm costs and weaker weather-related usage; rate increases and the tax decision partly offset these pressures.
• Weather-normalized AEP System retail sales declined 2.7% in Q2 and 2.1% for the half. Industrial sales fell 5.3% and 5.7%, respectively, partly reflecting reduced production and bankruptcy proceedings at large Ohio customer Ormet.
• Segment results were mixed: first-half Transmission Operations net income rose to $31 million from $17 million; AEP River Operations swung to an $11 million loss from $12 million income; Generation and Marketing earned $11 million versus a $6 million loss. All Other earned $101 million versus a $19 million loss, largely due to the U.K. tax-related item.

Outlook, management commentary and risks

• The filing provides no clear consolidated earnings guidance. Management cautions that interim results are not necessarily indicative of full-year results.
• Ohio proceedings create material uncertainty. OPCo had $484 million of deferred fuel costs and $171 million of deferred capacity costs at June 30; appeals or regulatory decisions could reduce recovery. Intervenors’ proposals in the competitive-bid proceeding could reduce projected revenues by up to approximately $160 million through May 2015. OPCo also had a $268 million Deferred Asset Recovery Rider balance approved for securitization, with bonds expected in Q3 2013.
• AEP planned a major corporate separation: approximately 9,200 MW of OPCo generation was approved for transfer to AEPGenCo, with specified plant transfers to APCo and KPCo proposed for year-end 2013. Challenges remained pending, as did FERC action on a replacement power-coordination arrangement. AEP warned that market prices and cost recovery could affect future AEPGenCo results.
• Turk Plant cost recovery remains a key exposure. SWEPCo had capitalized approximately $1.8 billion; a Texas administrative recommendation indicated a possible additional $74 million write-off beyond a previously recorded $62 million reserve. The Texas commission’s decision was expected in Q3. Arkansas’s share was not receiving cost-based rate recovery and was being sold into the SPP market.
• Environmental compliance, regulation and potential early retirements may require substantial investment. AEP estimated system-wide environmental investments of $4–$5 billion through 2020; proposed federal requirements, including carbon, air, coal-ash and water rules, could change costs, asset lives and recoverability.
• Other material exposures include recovery of storm, fuel and environmental costs; the Ormet bankruptcy and contract proceedings; nuclear decommissioning and spent-fuel obligations; litigation; commodity, interest-rate and counterparty risks; and possible collateral requirements following credit downgrades. Management reported $4.5 billion of aggregate credit-facility commitments and stated that no downgrade below investment grade had occurred.

Investor facts to verify

• Whether the $154 million Muskingum impairment and the $108 million U.K. tax-related earnings benefit are treated appropriately in evaluating recurring earnings and cash generation.
• Developments in Ohio deferred fuel and capacity recovery, the competitive-bid process, and planned securitization of OPCo’s regulatory asset.
• Final regulatory outcomes for Turk Plant cost recovery and the proposed OPCo generation transfers, including any appeals and the effective timing of separation.
• Actual environmental capital spending, planned unit retirements, and the extent to which those costs and remaining asset values are recoverable in rates.
• Liquidity and debt trends, including the refinancing and allocation of the $1 billion term facility described in the filing, and cash flow relative to capital expenditures and dividends.