Why did AEP's net income and EPS decline in 2005 compared with 2004?

Net income fell from $1,089 million ($2.75 per share) to $814 million ($2.09 per share). The main drivers were a $225 million after-tax extraordinary loss and $17 million cumulative-effect charge tied to TCC's Texas stranded-cost true-up, the non-recurrence of 2004 gains on asset and equity-investment sales (including the UK and IPP sales), and the reversal of most of the $302 million of 2004 TCC carrying-cost income. Operating results in the core utility business were relatively steady.

What is the financial impact of the PUCT's final true-up order for TCC?

The PUCT set TCC's net stranded generation costs and other recoverable true-up items at about $1.475 billion versus the $2.4 billion TCC requested. TCC wrote its net true-up regulatory asset down by $384 million, of which $345 million was an extraordinary pretax loss. Recorded net true-up regulatory asset is about $1.3 billion, and TCC expects to seek roughly $1.8 billion in securitization. TCC intends to seek rehearing and appeal, so the final recovery amount remains uncertain.

How is AEP positioned financially and what are its capital requirements?

At year-end 2005 AEP had about $3.0 billion of net available liquidity, a debt-to-capital ratio of 57.2%, and a covenant limit of 67.5% (actual 54.2%). Moody's upgraded AEP to Baa2. Construction expenditures are forecast at $3.7 billion for 2006 and about $10.9 billion over 2006-2008, of which $4.9 billion is committed and $6.0 billion discretionary, and management expects additional capital market funding will be needed in 2006.

What are the main risks investors should monitor?

Key risks include fuel and coal cost increases, with recovery mechanisms covering only about half of fuel costs and some jurisdictions (Ohio, Indiana, West Virginia) having capped or suspended clauses; pending rate cases in Virginia, West Virginia, Kentucky and Indiana; the outcome of TCC's true-up appeal and securitization; EPA New Source Review litigation over coal-plant modifications; and the $173 million Tractebel/SUEZ judgment being appealed. Expiration of SECA transmission revenues in March 2006 also reduces transmission income unless offset by rate increases or the PJM regional rate proceeding.

What is the outlook for AEP's generation fleet and environmental spending?

AEP plans large environmental investments, including about $1.5 billion in 2006 and roughly $3.6 billion of projected 2006-2008 environmental spending, to meet CAIR and CAMR requirements, including added scrubbers on about 8,700 MW and SCRs on another 1,900 MW. It is also pursuing IGCC coal plants (roughly 600 MW each) in West Virginia and Ohio, subject to regulatory cost recovery approval. Management estimates additional pollution-control retrofit costs of about $1 billion for 2011-2020, with significant operating-cost increases.

AEP 10-K FY2005 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 1, 2006. Cited figures are marked; the original filing is the authoritative source.

American Electric Power (AEP) reported a 2005 year in which Utility Operations, its core business, improved on favorable weather and industrial demand growth.

Consolidated 2005 net income was $814 million^a ($2.09 basic EPS), down from $1,089 million ($2.75) in 2004, primarily because 2004 included large gains on asset and equity-investment sales and $302 million of TCC stranded-cost carrying-cost income that was largely reversed in 2005. Income before discontinued operations, extraordinary items and accounting changes was $1,029 million ($2.64 per share), down from $1,127 million. Revenues fell to $12.1 billion from $14.2 billion, reflecting the divestiture of Texas generation, the HPL gas pipeline sale and the exit from UK and other noncore investments.

The most material negative item was a $225 million^b after-tax extraordinary loss (and $17 million accounting charge) at TCC after the PUCT's February 2006 final true-up order, which set net stranded generation costs at about $1.475 billion versus $2.4 billion requested. TCC has recorded a net true-up regulatory asset of $1.3 billion and plans to appeal and seek roughly $1.8 billion in securitization. Management also flagged rising fuel costs (coal prices up sharply, with a further 11-13% coal cost increase expected in 2006), pending rate cases in Virginia, West Virginia, Kentucky and Indiana, large capital spending (about $3.7 billion in 2006 and $10.9 billion over 2006-2008), and a $3 billion proposed 765kV transmission project.

Balance sheet metrics improved: the debt-to-capital ratio fell to 57.2% from 59.1%, the qualified pension plans were fully funded after a $626 million^c contribution, and Moody's upgraded AEP to Baa2. Liquidity was about $3.0 billion.

The 10-K also discloses significant contingencies, including the EPA/state NSR litigation over coal plant modifications, a $173 million^d judgment owed by Tractebel/SUEZ (under appeal), and various CO2 nuisance and Ontario class-action suits, none of which management expects to be material beyond what is already accrued. Dividends were $1.42 per share in 2005, rising to a $0.37 quarterly rate.

02—Key points

Key Highlights

Net income fell to $814 million ($2.09/share) from $1,089 million ($2.75) in 2004, mainly due to a $225 million after-tax extraordinary loss at TCC and 2004 one-time gains that did not recur.
Utility Operations earnings declined to $1,020 million from $1,175 million, reflecting lower TCC carrying-cost income, offset partly by higher retail margins and off-system sales.
TCC's net true-up regulatory asset was cut by $384 million after the PUCT's final order set stranded costs at about $1.475 billion, versus $2.4 billion requested; TCC plans to appeal.
Debt-to-capital improved to 57.2% from 59.1%, and qualified pension plans were fully funded after a $626 million contribution; Moody's upgraded AEP to Baa2/P-2.
Capital spending is heavy, with $3.7 billion of construction expenditures planned for 2006 (environmental investments $1.5 billion) and $10.9 billion for 2006-2008, plus a proposed $3 billion 765kV transmission line.
Fuel cost pressure persists: spot coal prices rose to $43.75/ton in 2005 and management expects an additional 11-13% coal cost increase in 2006, with fuel recovery mechanisms covering only about 50% of fuel costs.
Ongoing litigation and regulatory risk remains significant, including EPA NSR suits, a $173 million Tractebel/SUEZ judgment on appeal, and pending rate cases in Virginia, West Virginia, Kentucky and Indiana.

03—Questions

Frequently Asked Questions

Why did AEP's net income and EPS decline in 2005 compared with 2004?
Net income fell from $1,089 million ($2.75 per share) to $814 million ($2.09 per share). The main drivers were a $225 million after-tax extraordinary loss and $17 million cumulative-effect charge tied to TCC's Texas stranded-cost true-up, the non-recurrence of 2004 gains on asset and equity-investment sales (including the UK and IPP sales), and the reversal of most of the $302 million of 2004 TCC carrying-cost income. Operating results in the core utility business were relatively steady.
What is the financial impact of the PUCT's final true-up order for TCC?
The PUCT set TCC's net stranded generation costs and other recoverable true-up items at about $1.475 billion versus the $2.4 billion TCC requested. TCC wrote its net true-up regulatory asset down by $384 million, of which $345 million was an extraordinary pretax loss. Recorded net true-up regulatory asset is about $1.3 billion, and TCC expects to seek roughly $1.8 billion in securitization. TCC intends to seek rehearing and appeal, so the final recovery amount remains uncertain.
How is AEP positioned financially and what are its capital requirements?
At year-end 2005 AEP had about $3.0 billion of net available liquidity, a debt-to-capital ratio of 57.2%, and a covenant limit of 67.5% (actual 54.2%). Moody's upgraded AEP to Baa2. Construction expenditures are forecast at $3.7 billion for 2006 and about $10.9 billion over 2006-2008, of which $4.9 billion is committed and $6.0 billion discretionary, and management expects additional capital market funding will be needed in 2006.
What are the main risks investors should monitor?
Key risks include fuel and coal cost increases, with recovery mechanisms covering only about half of fuel costs and some jurisdictions (Ohio, Indiana, West Virginia) having capped or suspended clauses; pending rate cases in Virginia, West Virginia, Kentucky and Indiana; the outcome of TCC's true-up appeal and securitization; EPA New Source Review litigation over coal-plant modifications; and the $173 million Tractebel/SUEZ judgment being appealed. Expiration of SECA transmission revenues in March 2006 also reduces transmission income unless offset by rate increases or the PJM regional rate proceeding.
What is the outlook for AEP's generation fleet and environmental spending?
AEP plans large environmental investments, including about $1.5 billion in 2006 and roughly $3.6 billion of projected 2006-2008 environmental spending, to meet CAIR and CAMR requirements, including added scrubbers on about 8,700 MW and SCRs on another 1,900 MW. It is also pursuing IGCC coal plants (roughly 600 MW each) in West Virginia and Ohio, subject to regulatory cost recovery approval. Management estimates additional pollution-control retrofit costs of about $1 billion for 2011-2020, with significant operating-cost increases.

04—Continue

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