Why did AEP report a net loss in 2002 after a strong 2001?

The loss came primarily from roughly $1.4 billion of pre-tax impairments and write-downs tied to deteriorating wholesale energy markets, U.K. generation, Brazilian investments and telecom assets. It also included a $350 million SFAS 142 cumulative-effect charge and $190 million of losses from discontinued operations, including SEEBOARD and CitiPower. Core utility earnings were comparatively stable.

Is the dividend safe after the cut?

The company reduced the quarterly dividend to $0.35 from $0.60, a roughly 40% cut, which management said would generate about $340 million in annual cash savings for debt reduction. The 2002 payout ratio was negative because of the loss, so the new rate is intended to be sustainable from utility cash flows, but future results and credit ratings will determine whether it holds.

How much liquidity does AEP have, and what are the funding risks?

At December 31, 2002, AEP reported about $3.5 billion of available liquidity, including a $1 billion cash reserve and credit facilities. The Moody's downgrade to P-3 limits commercial paper access, so AEP plans to rely more on term debt and other sources. Its debt-to-capitalization ratio rose, and common equity fell to 32% of total capitalization from 36%.

What are the biggest legal and regulatory risks?

Key risks include the Federal EPA Clean Air Act case over plant modifications (penalties and possible pollution control costs cannot be estimated), the Texas 2004 true-up that will determine stranded cost recovery and could be adverse, the Enron bankruptcy claims, shareholder and ERISA class actions, a California suit over reported gas prices, and FERC proceedings on market power, long-term contracts and Standard Market Design. Management says it expects favorable outcomes on the PUHCA merger challenge and believes most matters will not be materially adverse, but several outcomes remain uncertain.

AEP 10-K FY2002 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 20, 2003. Cited figures are marked; the original filing is the authoritative source.

American Electric Power (AEP) filed a combined 2002 Form 10-K on March 20, 2003, covering itself and ten operating subsidiaries.

AEP is a registered PUHCA holding company serving about five million retail customers across eleven states, with roughly 38,000 MW of domestic generation and a large U.S. transmission and distribution network. The headline story is financial distress: AEP reported a 2002 net loss of $519 million^a, or $(1.57) per share, versus $971 million of earnings in 2001. The loss was driven by about $1.4 billion of pre-tax impairments and investment write-downs (including U.K. generation, Brazilian Grupo Rede investments, telecom and Texas gas plants), a $350 million cumulative-effect charge from adopting SFAS 142, and $190 million of losses from discontinued operations (SEEBOARD, CitiPower, Eastex, Pushan).

Income before discontinued operations, extraordinary items and accounting changes fell 98% to just $21 million^b. The balance sheet and dividend policy were reset in response. Credit ratings were downgraded by Moody's (AEP senior unsecured to Baa3, commercial paper to P-3), S&P (to BBB) and Fitch (to BBB), and the company's ability to rely on commercial paper is now constrained.

Management responded with a 40% dividend cut from $0.60 to $0.35^c per quarter starting in the second quarter of 2003 (about $340 million in annual savings), a 2002 common stock issuance and equity units, a February 2003 common stock offering of 50 million shares, asset sales (SEEBOARD, CitiPower, Texas REPs), and a $1 billion cash liquidity reserve. A Sustained Earnings Improvement program eliminated 1,120 positions at a cost of $75.4 million.

Investors should weigh several open risks: pending Texas true-up proceedings (2004) affecting stranded cost recovery, Clean Air Act litigation with potential civil penalties and NOx compliance capex of $1.3 to $2 billion^d, Enron-related claims, shareholder class actions and a California lawsuit tied to alleged false gas price reporting, FERC market power and Standard Market Design rulemakings, and an underfunded qualified pension plan that required a $585 million charge to other comprehensive income. Management is trying to shift the company toward a regulated utility focus and reduce trading exposure, but the filing shows a company in significant financial stress with uncertain recovery of several large investments.

02—Key points

Key Highlights

Net loss of $519 million ($1.57 per share) in 2002 vs. net income of $971 million ($3.01 per share) in 2001, driven by impairments and write-downs.
Income before discontinued operations, extraordinary items and accounting change fell 98% to $21 million; pre-tax asset and investment impairments totaled about $1.43 billion.
Dividend cut of 40%, from $0.60 to $0.35 per quarter beginning Q2 2003, saving roughly $340 million annually to reduce debt.
Credit downgrades in early 2003: AEP senior unsecured debt cut to Baa3 (Moody's), BBB (S&P and Fitch); commercial paper cut to P-3, limiting short-term funding access.
Strategic retreat from energy trading: announced October 2002 plan to downsize wholesale trading and sell non-core assets (SEEBOARD, CitiPower, Texas REPs, telecom, Eastex).
Financing actions: common stock and equity unit issuances in 2002, a February 2003 offering of 50 million common shares, $1 billion cash liquidity reserve at year-end, and a March 2003 $500 million senior note issue.
Legal and regulatory overhang: Clean Air Act enforcement suit, NOx compliance capex of $1.3-$2.0 billion, Texas stranded cost true-up in 2004, shareholder class actions, and FERC market-power and SMD proceedings.

03—Questions

Frequently Asked Questions

Why did AEP report a net loss in 2002 after a strong 2001?
The loss came primarily from roughly $1.4 billion of pre-tax impairments and write-downs tied to deteriorating wholesale energy markets, U.K. generation, Brazilian investments and telecom assets. It also included a $350 million SFAS 142 cumulative-effect charge and $190 million of losses from discontinued operations, including SEEBOARD and CitiPower. Core utility earnings were comparatively stable.
Is the dividend safe after the cut?
The company reduced the quarterly dividend to $0.35 from $0.60, a roughly 40% cut, which management said would generate about $340 million in annual cash savings for debt reduction. The 2002 payout ratio was negative because of the loss, so the new rate is intended to be sustainable from utility cash flows, but future results and credit ratings will determine whether it holds.
How much liquidity does AEP have, and what are the funding risks?
At December 31, 2002, AEP reported about $3.5 billion of available liquidity, including a $1 billion cash reserve and credit facilities. The Moody's downgrade to P-3 limits commercial paper access, so AEP plans to rely more on term debt and other sources. Its debt-to-capitalization ratio rose, and common equity fell to 32% of total capitalization from 36%.
What are the biggest legal and regulatory risks?
Key risks include the Federal EPA Clean Air Act case over plant modifications (penalties and possible pollution control costs cannot be estimated), the Texas 2004 true-up that will determine stranded cost recovery and could be adverse, the Enron bankruptcy claims, shareholder and ERISA class actions, a California suit over reported gas prices, and FERC proceedings on market power, long-term contracts and Standard Market Design. Management says it expects favorable outcomes on the PUHCA merger challenge and believes most matters will not be materially adverse, but several outcomes remain uncertain.

04—Continue

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