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American Electric Power Company, Inc. (NYSE:AEP)

Q1 2010 Earnings Call Transcript

April 29, 2010 9:00 am ET

Executives

Chuck Zebula – SVP and Treasurer

Mike Morris – Chairman, President and CEO

Brian Tierney – EVP and CFO

Analysts

David Frank – Catapult Capital

Hugh Wynne – Sanford Bernstein

Lucas Leiva [ph] – Deutsche bank

Leslie Rich – Columbia Management

Paul Patterson – Glenrock Associates

Paul Ridzon – Keybanc

Michael Lapides – Goldman Sachs

Anthony Crowdell – Jefferies

Phyllis Gray – Dwight Asset Management

Ali Agha – SunTrust Robinson Humphrey

Daniele Seitz – Dudack Research

Jeff Kersanty [ph] – Millennium

Operator

Ladies and gentlemen, thank you for standing by and welcome to the first quarter 2010 earnings conference call. At this time, all participants are in a listen-only mode, and later, we will conduct a question-and-answer session with instructions being given at that time. (Operator instructions) As a reminder, this conference is being recorded.

I'd now like to turn the conference over to our host, Mr. Chuck Zebula. Please go ahead sir.

Chuck Zebula

Thank you, Kele. Good morning and welcome to the 2010 first quarter earnings web cast of American Electric Power. Our earnings release and related financial information are available on our website aep.com. The presentation slides are also available on our website.

Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of the factors that may cause results to differ from management's forecasts.

Joining me this morning are Mike Morris, our Chairman, President, and CEO; and Brian Tierney, our CFO. We will take your questions following their remarks.

I will now turn the call over to Mike.

Mike Morris

Thanks, Chuck and hello everybody, and thank you for being with us. We appreciate the opportunity to update you on the first quarter performance, and a very interesting year in 2010.

As I know you've already seen from our press release, we did accomplish our ongoing earnings of $0.76 a share, and we had to make a GAAP adjustment thanks to our friends who passed the Patient Protection and Affordable Care Act, which of course is anything but that to reflect the change in the tax treatment for retiree medical benefits under Subpart D.

Having said that, we continue to feel comfortable about reaffirming our guidance of $2.80 to $3.20 a share. We like so many other utilities were treated reasonably well by weather throughout the first quarter. We actually saw some encouraging sales results in our Western footprint, but sales results that were of concern in our Eastern footprint. Revenues were up, earnings were up and our earnings per share, as I said, was $0.76.

We are concerned, however, about activities here in the Eastern footprint and I will address that a little bit later. The overall performance was surely helped by successful rate proceedings through 2009 and early here in 2010, and we did have some very strong sales volumes in the off-system market here in the first quarter. However, we had some concern about that again as we go forward and will address that in a minute.

Moody's finally saw the light and moved us from a negative outlook to a stable outlook and we really appreciate the deep diligence that they went through to come to that conclusion, and we obviously agree with them 100%.

On the corporate actions activity, let me just diverge for a moment because Tuesday of this week at our annual meeting, we did in fact announced to our shareholders the 400th consecutive quarterly dividend. In fact, the board voted to raise that dividend by 2.4%. And that may not seem like a lot to many of you, but when you reflect back on a company that has paid dividends through all of the gyrations that this great country has gone through since 1910, it really is something. In fact Chuck put together some unique factoids for me.

Our first dividend was paid to 35 shareholders, who owned 50,000 shares, and William Howard Taft, a great resident of Cincinnati, Ohio, was in the White House. And when we pay our dividend on the 10th of June this year, of course, Barrack Obama, our 44th president to be in the White House, and we will pay dividends to 350,000 shareholders who hold 478 million shares. Really quite an amazing story when you think about that and something that we are very, very proud of.

We also did something unique this year. We are the first company to combine our sustainability and annual report in a single integrated accountability report, and we hope that you will take full advantage of looking at that. It surely is worth the read. We have as I know most of you know two weeks ago announced an effort here at American Electric Power to take a very serious look at some pretty significant reductions in our overall cost structures here in 2010.

This surely is driven by the comments that I said just a few moments ago. The sales volumes in the Eastern footprint continue to be of some concern, although residential sales were relatively sturdy. The aluminum manufacturers are yet to come back in business in Ohio and West Virginia, and that is obviously a volume metric and a revenue stream issue for us.

And we are seeing, as we had seen before in the 1980s and in some of the other shorter recessions, a real lag in recovery of commercial sales. So with an eye towards that and a commitment to make certain that we stay within our previously announced guidance range and deliver it to our shareholders, we are going through a very significant voluntary and involuntary headcount reduction as well as realignments of O&M expenses, and taking a real hard look at that.

This is the first time we really had the occasion or the need to do this at American Electric Power, and as we have told you many times before, when revenues are down we adjust our spending profile. When revenues are up, we adjust that spending profile in an upward direction.

We are being I think very cautious here. I think we are being very responsible, and I assure you that we will achieve whatever number needs to be achieved so that we can stay well within our guidance. On the regulatory front, we feel very, very comfortable that we will accomplish the remainder of the rate proceedings that are out there to hit our target goal of $320 million that we had talked about before. So we feel comfortable that those will move in the right direction. Obviously there are a couple of unique rate cases and rate proceedings in front of us.

The Ohio [ph] proceeding being the leader in those categories. We await, as do all the other Ohio utilities, and I know many of you for the results out of the PUC. They are very informative and I thought very appropriate open hearing on 1 April, so that all parties could make their comments about significant excess earnings test. And what it might be and where it might lead.

As you can imagine, we came prepared to that open hearing to discuss the fact that we don't believe that any of the Ohio operating companies, particularly in our portfolio, but even our brothers across the state fail the SEET test, and we await the commission's direction so that we can file the required papers. We have sought an extension to that filing for obvious reasons, and I believe that the commission is supportive of that and we look forward to that result.

As I’ve said many times before this is an interesting and a pretty serious look at the performance of all of the utilities here in Ohio, but I doubt very seriously that it will lead to anything of a major consequence for any of us. Clearly, AP [ph] Ohio and its operating companies allow power and Columbus [ph] inside.

Two really important rate cases in Virginia. There has been a bit of a political flap, and we continue to address that issue. We have had a chance to meet with the governor and the leaders of the state, and have promised that we will continue to work diligently towards finding some rational answer to the filings that were made. In fact, pursuant to those discussions we did stop collecting the interim rates; of course under Virginia's statute you are allowed to recover.

We had our hearing back in March, and we will have our final briefs on the 18 May. There are positions taken by various parties in the case, all of them for a rate increase. None of them for the substantial increase that we feel we deserve for the capital that has been invested in Virginia over the 10 full years. We believe that case will come to some recent conclusion as well. The Virginia Corporation Commission has been a very solid and very balanced commission, and we would expect that to be the case.

Another pretty significant case filed in Kentucky, we will have our hearing on 25 May. We again hope that an order will come out about midyear in both of those cases, and we expect that they will come out in a reasonable performance for us.

On the operational side, some really good news that long last in the transmission space. The Southwest Power Pool has come to a very rational conclusion on cost allocation, something that we have been a champion of for a long time. It is called the Highway/Byway approach. It is logical in saying that on the higher voltage transmission system all kilowatt hours that transfer over that system should pay their fair share of the cost, and we think that that is a very appropriate way.

We are equally encouraged by the FERC nominees going in front of the senate and having what appeared to be a pretty safe walk-through and confirmation, because many of them house the same concept of allocating cost throughout the RTOs, and we think that that is an appropriate way to go.

More specifically, and really more importantly, the SPP has announced their priority projects, and I'm happy to tell you that our partnerships at ETA are included in many of those activities, as well as some transmission investment at our Public Service of Oklahoma operating company, which of course will be done through the AEP Transmission Company, which we announced a year or so ago.

Everything in Texas seems to be moving exactly as we hoped that it would. I know that you know, Electric Transmission Texas our partnership with Mid American has been in business for a number of years now, and the fact of the matter is we continue to see capital being deployed and transferred into that operating company, as we had planned it to be. In fact, just a week or two ago we had a very significant public unveiling of the largest battery, a 4 megawatt battery at Presidio, Texas, attended by all kinds of Texas dignitaries.

It is a shame that you didn't have a chance to be there because that is the second creative investment that we have done on the transmission system, something that I know both Chairman Wellinghoff at the FERC is very much encouraged by. So we have the variable frequency transformer at Laredo, and the Presidio battery at 4 megawatts, two creative breakthroughs for American Electric Power in the transmission space as well.

So I really am encouraged by what we see in the transmission plants. It has taken an inordinately long time, but it is now moving forward apace and we are pleased with that. Lastly, and I won't spend too much time on this, because I actually could probably take up the entirety of the call, touching on the federal legislation and the EPA’s approach to the continued discussions on how America will address the issue of global warming and CO2 emissions from the coal fleet.

I know you know that that is a very important subject at American Electric Power since we are the largest consumer of coal and have the largest CO2 footprint of any of the US utilities. The fact of the matter is the Kerry-Graham-Lieberman legislation as it moved towards its final stages a week ago was something that American Electric Power was very, very strongly behind and very much in favor of. Driven almost to 100% by the full allocation of credits, very similar to the Clean Air Act, as it approached the handling of CO2 emissions by the US electric utility fleet, both coal and natural gas fired electrons.

Unfortunately, politics reared its head, as it occasionally does in Washington over the weekend, and a very important Monday unveiling of the law or the bill, I should say, was set aside. As we understand it, the senators continue to work diligently. The leader of the Senate, Harry Reid, mentioned mid-week that he thought we would set the immigration [ph] beside because we don't really have a bill to work with and take up energy, because in fact with Kerry-Graham-Lieberman they have a bill to bring to the floor. But I know most of you know that last night they decided to first debate the financial regulatory approach.

The only thing I can say about Kerry-Graham-Lieberman is it finally set the stage for what is absolutely essential for the United States to go forward, and that is to mirror the undertakings of the Clean Air Act. Utilities like American Electric Power and other carbon intensive utilities are dedicated to the notion of protecting our customers, the economies, and the states that we do business in by seeing to it that there is a full allocation of credits for the entire footprint of the electric utilities.

This is really the only way to start this kind of an undertaking. There were many other pieces in Kerry-Graham-Lieberman that we like to lock, and since it was being sent to the EPA for what they call scoring in Washington, we believe that when we finally get back to this debate, whether it is at this year or next year, this will be the template that we begin with, and we are encouraged by that.

We have said many, many times that we doubted very seriously in a robust economy or a challenged economy as we are seeing in the United States today, the Congress will ultimately have to come to a recent conclusion if it intended to pass a legislation that would approach addressing the issue of global warming.

The Environmental Protection Agency continues to be, we think very reasonable in the way that they approach their obligations under the Massachusetts EPA Supreme Court decision of 2007. All of us, from the administrator of the EPA to the president of the United States are hopeful that a legislative approach is the appropriate way to go rather than an administrative regulatory approach.

Administrator Jackson has said that, the chair of her – the lead of her subgroup has said that and clearly I think every utility has said that. But you are already beginning to see signs that there is a tempering of the approach that EPA might take if in fact we don't reach a legislative resolution. There remains, of course, the challenges of Senator Murkowski and the information of delay request of Senator Rockefeller, and those issues need to be addressed as well.

As we have said to you in many occasions, the AEP regeneration fleet is robust. It will continue to be robust. It is flexible, and it is adjustable and we will adjusted it as we need to do. There is no question that we will be proactive and aggressive in addressing the emissions of our larger already retrofitted facilities. And we will (inaudible) our capital, when it comes to smaller facilities to higher heat rates and capital not invested to address the Clean Air Act requirements, and that is a very familiar tone for us to you, and one that I think you should take full confidence in.

We are capacity strong, we are energy strong, and we will continue to be that way no matter what legislation or regulations come out of Washington.

So with that, I will turn the call over to Brian, and then allow them to give you some granularity about the financial performance, and then we will get to Chuck’s already suggested Q&A undertaking. Brian.

Brian Tierney

Thank you so much Mike. I like to start on page 4, where I will take us through a quarter-on-quarter reconciliation of this year's results to last year's first quarter. As Mike previously stated, ongoing earnings for the quarter was $365 million. That compares favorably by $5 million to last year's $360 million. Last year's results put up an $0.89 per share a number versus this year's $0.76 per share. That full difference could be explained by the dilutive effect of last year's equity offering, but there are some other important ins and outs that I think are worth noting.

Late changes accounted for a positive $0.13 a share and it came from multiple of our operating jurisdictions. As Mike stated, we are on target to meet our annual number for rate relief of about $320 million. Weather normalized load was down 1.6%, and accounted for a negative $0.06 per share versus last year’s number. We will go into some more detail on that in the next two slides.

Weather offset that negative $0.06 per share by being positive $0.06 per share, and resulted from heating degree days being up 4% in the eastern part of our system, and 48% in the western part of our system. Off-system sales accounted for a positive $0.02 variance versus last year and we will talk more about that on slide seven.

Other utility operations net accounted for negative $0.11 a share, and was primarily associated with the absence of the Cook accidental outage insurance, higher interest expense, higher depreciation and amortization and other taxes. Non-utility operations and parent expenses accounted for a negative $0.04 per share, but was mostly associated with reduced deal flow in our Texas marketing business, again resulting in $0.76 per share for the first quarter.

If we turn to slide five, we will look at the normalized load trends, which were positive overall, the most positive overall for the first time in the last four quarters. Starting with residential, we are encouraged by the fact that residential load on a normalized basis was up 2.1%. On the top right-hand side of the slide, you will see the commercial sector continues to struggle. It was down 1.6% versus the prior quarter.

Economists here tell us that the commercial sector lagged going into and out of recessions, and given what we are seeing in the residential and industrial sectors we are anticipating an improvement in that sector shortly. In the bottom left-hand side of the page, you will see that industrial sales were down only 1% versus prior quarter. The decline in this sector is clearly abated somewhat, and it is the best quarterly variance in this category in over a year. We will dig into some more detail on that on the next slide.

Overall, total normalized sales at retail were down 1.6%. In terms of some more color on that, in our Eastern utilities, they all showed declines in the commercial sector, however, on a combined basis our western utilities showed positive in residential, commercial and industrial sectors.

Turning to slide six, we do a little bit of a deeper dive in terms of industrial sales, where you see there the five sectors that accounted for 61% of our industrial sales in the first quarter of 2010. We show trends from March of 2003 through March of 2010. While I think the interest in this is not just the overall trends, but some quarter-on-quarter changes versus the prior year’s first quarter.

Primary metals manufacturing was down 10.5% on an aggregate basis, but if you were to take out the two large aluminum customers in the eastern part of our territory, the sector actually grew by 11%. Chemical manufacturing marked a positive 2.9% growth quarter-on-quarter, and petroleum and coal manufacturing was essentially flat, being down a tenth of a percent.

Mining is off slightly at negative 2.5%, but is not unexpected given the reduced demand that we’ve seen for coal. Paper manufacturing was up 4.3%. Other industrial sectors that I think you will be interested in hearing about are transportation, which was up 6.4% in fabricated metals, which are up 10% quarter-on-quarter.

Turning to slide seven, we will take a little bit of a deeper dive in terms of off system sales. In 2010 we made $74 million in off system sales versus $62 million in 2009. This was despite the fact that wholesale electricity prices liquidated lower in 2010 than they did in 2009. Volumes were up 83%, and this was mostly associated with the return of the Cook unit 1 to service. We experienced continued strong performance by the trading organization.

In the right-hand side of the page, you will see the balance of the prices are above 2009 liquidations, but there are certainly less than they were three and six months ago. This certainly puts pressure on the balance of the year and full-year estimates for off system sales. Ultimately, we expect wholesale prices and demand to improve with an improving economy.

Turning to page 8, we will take a look at what we are seeing overall in summary for the balance of the year. As we stated a couple of times, in terms of regulatory proceedings, we are on track to hit our annual forecasted numbers of $320 million. In terms of retail load, although we are seeing positive indications in both residential and industrial sectors, the commercial and industrial classes are recovering at a slower rate than we had anticipated.

In terms of off system sales, despite the fact that we had a good quarter, given how prices are flagging there that is certainly putting pressure on our year around estimates, and we are concerned about how we will be able to bring in a full-year estimate for off system sales. Given the impacts of retail load recovery lagging anticipation, and off system wholesale prices being down, as Mike stated, we have embarked on a significant O&M cost reduction effort designed to allow us to hit the middle of our earnings guidance range for the year.

It is with those actions that we are reiterating our 2010 earnings guidance of $2.80 per share to $3.20 per share.

With that, I will turn it over to the operator and we will have some questions.

Question-and-Answer Session

Operator

(Operator instructions) We will go the line of David Frank of Catapult Capital. Please go ahead.

David Frank – Catapult Capital

Hi, good morning Mike. How are you?

Mike Morris

Good morning David. Good. How are you doing?

David Frank – Catapult Capital

All right. Question on the regulatory process in Ohio, do you think that there will be a final ruling regarding the SEET by the commission prior to you actually making a filing, or do you think the commission might wait to accept your filing and use that as kind of litmus, and decide on everything in your filing?

Mike Morris

I think that from the hearing on 1 April, we all walked away with the conclusion that the commission would be issuing a road map if you will, kind of here is what we expect you to file. Here is how we like you to file, and here is the schedule that will take up the various utilities’ filings. So we have no reason to believe that that isn’t the case. I guess we're all somewhat surprised that it is now turning to May, and they haven't issued some result of that hearing, but as you know it was very fulsome.

There were lots of folks with lots of ideas, and I think that the PUCO was trying to get a good handle on how they might best go about it. The bottom line of this whole matter, of course, I do believe as you heard us say many times before David is this is an intriguing and interesting event, but I hope and doubt that it will lead to anything of very substantial nature at the end of the day.

It was part of Senate Bill 221. I think the commission rightfully so is struggling with exactly how to go about doing it, and trying to do it in as balanced a fashion as they can and we applaud them for that approach.

David Frank – Catapult Capital

Right, thanks. And just one follow up Mike, on the commission and the ESPs, I mean the ESP has proven to be a really unique process for the utilities in the state to craft constructive rate plans. Are traditional rate cases dead in the state, why would a utility ever file a traditional rate case again? Why wouldn’t you just continue to file ESPs every three years, where you are kind are removed from more of the scrutiny and potentially even a lower ROE that you get as a result of an ESP?

Mike Morris

Well, it is clear that the electric security plan just like its predecessor has proven to be extremely rewarding to all of the economy here in Ohio. There is a certain amount of predictability for our large volume commercial and industrial customers, and it dampens the overall year-to-year volatility in rates to the homeowners, and it allows for a much smoother approach. But recall that inside of the ESP, even as it is functioning year-over-year if inside of your overall operating facilities, for instance, distribution is a perfect example.

As the AEP Ohio companies deploy the grid smart technology that the commission is in full support of as if the DOE, we may need to in fact have a distribution tracker or a distribution rate adjuster. All of those things, we think make a great deal of sense. We also as you know, are in the process of recovering fuel 100% for the dollars expended, and on occasion particularly we hope in the not too distant future we will see fuel prices come down as coal adjusts to the reality of natural gas prices in the marketplace.

We would want to make adjustments to a lower cost there. So I appreciate the notion of not wanting to go through the scrutiny of a full rate review in the more traditional sense, but I think Ohio both from Senate Bill 221, and the way that the commission has decided to in such a balanced fashion employ the ESPs, I think it is working really quite well. I would expect that the Ohio companies at American Electric Power will file yet another ESP to cover another three-year cycle, hopefully sometime in the not too distant future.

I am encouraged by what my friends up in Akron [ph] filed and the commission’s warmth with which they accepted that. So, it is almost a perfect regulatory setup that has been created, save one or two pieces. I think it is going to be very difficult going forward for any of us to build new central generating facilities here in Ohio, with the way the 221 was written. But there is plenty of time to address that before anyone is going to need to build a new central station here in Ohio, and I think it needs to be addressed.

David Frank – Catapult Capital

Thank you.

Mike Morris

You bet.

Operator

Thank you. Next we will go to the line of Hugh Wynne of Sanford Bernstein. Please go ahead.

Mike Morris

Good morning Hugh.

Hugh Wynne – Sanford Bernstein

Good morning. Congratulations on taking these cost-cutting steps. I think that is very important. I had a question regarding environmental developments from Washington, you had spent some time talking about CO2, I was wondering if you might comment on expected upcoming EPA regulations regarding SO2, coal ash, and perhaps most importantly hazardous air pollutants like mercury and acid gases that – could you comment perhaps on the direction of the impact on your off-system sales both volume and price, as well as the direction of the impact on your regulated utilities that will pull these regulations opportunities for investment and rate based growth or there are going to be problematic in terms of base rate increases that could cause any push back?

Mike Morris

Well, again as I mentioned in my comments at the outset here, I think that the EPA under the leadership of administrator Jackson is being very balanced in the way that they are going about this. There are requirements for them to issue those particular adjustments under the care and camera [ph] undertaking, and we expect they will do that in the not too distant future. They have told all of us that they are coming. But again, I think there will be time to react to them in an appropriate way to deal with them.

All of which might call for additional investments in some facilities, which would be logical. I doubt that they would be so massive that it would run into rate pushback as you go forward to continue to produce electricity at very handsome kilowatt-hour costs out of our larger units that have already been retrofitted and may need to be adjusted.

It may lead to, as we have said and I think many of my colleagues have said, some electrical premature shutdown of facilities or at least lay up of facilities that probably still have plenty of electric life, but not enough environmental life to make those kinds of capital investments.

All in all, I think it will be a reasoned approach to the endeavor. The commission, or excuse me the EPA has been very accepting of ideas that our folks and others have given them on all of those issues including the HAPs, including the coal ash handling. So we are kind of encouraged by what we see. No question it will change the profile, but it should. The quality of air in this country continues to improve, the volume of coal based electricity continues to grow, and I don't think that these changes will change that profile.

Hugh Wynne – Sanford Bernstein

Do you see any material impact on your off system sales volumes or prices?

Mike Morris

Well, it clearly will have the effect, but I doubt very much that it will be more so than what we are seeing with the price of natural gas going forward. Obviously that will have an impact as the cost of coal based kilowatt hour might go up some, but don't forget at the end of the day the gas machines are not free of their own emissions, and sooner or later they will be addressing the same issues, and there will be cost increases there as well.

Hugh Wynne – Sanford Bernstein

Great. Thank you very much.

Mike Morris

You bet.

Operator

Thank you. Next we will go to the line of Lucas Leiva [ph] at Deutsche bank. Please go ahead.

Lucas Leiva – Deutsche bank

Good morning.

Mike Morris

Good morning.

Lucas Leiva – Deutsche bank

I was wondering if you could provide us with a bit more color in terms of what drove the 1% decline in industrial sales, is it further plant shutdowns and shift cuts, or is there a shift away from your existing customer base to other providers in your geography.

Brian Tierney

This is Brian. We are not seeing much of a shift at all. In fact, we are seeing almost none in terms of industrial to third-party suppliers. And what really was the main driver in terms of the year-on-year industrial change is what happened in primary metals, and really most of that wasn’t associated with the broad swap of our customer base, but it was associated two large aluminum customers in the eastern part of our system.

Despite those customers in particular that we have talked about, we have seen really some pretty broad based improvement in terms of the industrial sector.

Lucas Leiva – Deutsche bank

That is great. Thanks. And also in terms of the O&M that you have announced between your voluntary and involuntary plan, when do you think you will be able to give us a range in terms of the overall dollar impact?

Mike Morris

Our intent is to have everything fully implemented on the human resources side of it in the very near future. This week is the last week that we do the voluntary acceptance, and that has been very robust. We are quite encouraged by what we see. Middle of next month, we will resolve the rest of the involuntary undertaking, and some of the realignment of facilities. It is clear that service centers might be closed, certain power plants might be laid up. We're looking at all of those opportunities as well.

Our plan of course is to take advantage of all of the cost reductions to the benefit of our investors for the entirety of the second half of 2010, and we will share with you the results of all of those endeavors along those lines, and on that kind of a time cycle.

Lucas Leiva – Deutsche bank

Great. Thank you very much.

Mike Morris

You bet.

Operator

Thank you. And next we will go to the line of Leslie Rich of Columbia Management. Please go ahead.

Leslie Rich – Columbia Management

Hi. I wondered if we could go back to slide seven, and Brian your comments about off system sales and how you saw that there were some headwinds for the rest of the year to hit your target. As I look at the chart on page 7, it looks like 2010 is nicely above 2009, particularly for the summer months and if we get normal weather as opposed to last year abnormally cold weather, potentially some improvement in industrial sales. I'm just not clear why did these percentage changes that you show at the bottom of that table, why you are so bearish on off system sales?

Brian Tierney

Well, I would say, I guess, you know we certainly had positive weather in the first quarter of this year. I would love to bank on that for the balance of the year, but clearly we can't. I think we have to assume that weather will normalize over the course of the year. So, I can't bank on the weather.

In terms of what we have on the slide on page seven, certainly it is above – the balance of the year pricing is certainly above 2009 levels, but when we put our forecast for the year together 5, 6 months ago prices were considerably higher than even that. So given what prices – prices have fallen off, and given our yearly guidance for off system sales, it is on page 14 of our presentation, we don't anticipate being able to hit that $329 million net of sharing number.

I anticipate it will be somewhat higher than the 247 that we had last year, but I think it is going to be bounded in that range somewhere.

Mike Morris

Of course, let us say the salesman in me says there is nothing wrong in praying for one weather in the summer and there is surely nothing wrong with hoping that natural gas prices rebound. The downward pressure on natural gas is really affecting some of the spreads on off system as you know.

Leslie Rich – Columbia Management

Okay. Thank you.

Operator

Thank you. We will go next to the line of Paul Patterson of Glenrock Associates. Please go ahead.

Mike Morris

Good morning Paul.

Paul Patterson – Glenrock Associates

Good morning. I wanted to ask about the cost reduction efforts, are they sustainable past this year. I mean is there anything that is sort of tempering these cost reductions that will have to come back, or are these pretty much permanent cost reduction efforts here that should benefit you in the future as well?

Mike Morris

They are absolutely sustainable, and it will be up to the discipline of this team to see to it that happens. We really, as we said here on the call, are looking at the impacts of what we are seeing in the marketplace, particularly here in the East for 2010. But we really are viewing the recovery as being over a longer period of time. I read like you read all of the economic data, but I also continue to read that the employment numbers simply aren't moving much.

That means that our commercial customer footprint, not big buildings, not the Wal-Marts or hospitals, but things like Mom And Dad, Pizza places, carry out stores and dry cleaners, and those kinds of things are going to continue to be affected. Restaurants, all of which add up to a tremendous amount of demand on our system through the footprint. So we are really adjusting with an eye towards 2011, 2012.

And having said that Paul, I think you can absolutely count on these being a sustainable period. One of the challenges that we will have because of the size of the headcount reduction is for this management team, many of whom you are familiar with to take a hard look at how we operate the various facilities, customer service and employee safety reign tall in the saddle along with performance for the investor, but these reductions will in fact be sustainable and will serve our investors well over the near term years.

Paul Patterson – Glenrock Associates

Okay, great. And then just a quick accounting question on slide 12 in the cash flow, the application of new accounting guidance securitize that receivables, which I guess hits your operating cash flow, but benefits your financing cash flow. If I understand that correctly that is the first question. Then secondly, is it true the short-term debt, is that – I mean is that – do I understand that correctly is that the way to think about this space?

Mike Morris

Yes, first of all you do understand it correctly, and yes that is short-term debt.

Paul Patterson – Glenrock Associates

Okay, great. Thanks a lot.

Mike Morris

So, if you are looking for a job Paul, FASB is looking for some people that understand these rules.

Paul Patterson – Glenrock Associates

I think I will pass, thanks.

Operator

Thank you. And next we will go to the line of Paul Ridzon of Keybanc. Please go ahead.

Mike Morris

Good morning Paul.

Paul Ridzon – Keybanc

How are you?

Mike Morris

Good.

Paul Ridzon – Keybanc

If you strip out the impact of the two smelters that shut down, what happened to industrial sales, maybe I missed that?

Mike Morris

They would be booming.

Paul Ridzon – Keybanc

They would. They will be up as they had been in the…

Mike Morris

Well, let Brian give you the granularity, because he has it, but they would be substantially up. Go ahead Brian.

Brian Tierney

Paul, the number is 11% up.

Paul Ridzon – Keybanc

And then, you indicated you are not seeing any industrial migration. Are you seeing any other migration particularly with First Energy?

Mike Morris

We are seeing a small less than one half of one percent on Columbus Southern in the commercial space. But as I know you all know, we have decided to react to that in a both aggressive – defensive and offensive approach. We have made the requisite filings and have almost in hand the authority to move forward with our own retail activity.

FE isn't having much of an effect than direct energy is, and they continue to pursue a lot of our customers. So we’ll react to that defensively, first through our retail marketing arm and then now we think there are some places here in Ohio in the South and the West where we can do some of our own farming. So it's intriguing, it's exactly what the open market in Ohio was intended to do. Our price structures for the last half decade have been such that we were untouchable, but in the commercial space at Columbus Southern now, there is a margin to be gained by those offering discounts from our current rates and we’ll react to that aggressively.

Paul Ridzon – Keybanc

And then if you look at slide seven, we just wanted to look at gross margin, how far step down below that curve will gross margin be?

Mike Morris

Yes, I know, those are wholesale prices. Paul, I think you would probably need to look at slide 14 to get some sense for gross margin for the balance of the year, and if we were at 1370 before given the falloff in prices, we'd expect it to come in below that as we look at our year-end estimated number.

Paul Ridzon – Keybanc

I guess another way to phrase it is how far has it fallen?

Mike Morris

Yes, it's certainly fallen not all the way to 2009, but well below what we had forecasted for the year.

Paul Ridzon – Keybanc

Okay, thank you.

Operator

Thank you. Next we’ll go to the line of Michael Lapides of Goldman Sachs. Please go ahead.

Michael Lapides – Goldman Sachs

Hi guys, nice quarter.

Mike Morris

Thanks Michael.

Michael Lapides – Goldman Sachs

My question for you, when you think about making significant kind of structural changes to how you get regulated by the various PSCs and PUCs, are there any places you're looking at and saying okay this is a jurisdiction where we think we could go from historical test years to forward test years. Or this is a jurisdiction that doesn't have formula rate plans that we think we might be able to get formula rate plans or one where you would even consider and maybe you wouldn't do it at this point of the economic cycle, but you would consider asking for decoupling, just kind of thinking about the two or three big structural changes in regulation that can improve earnings.

Mike Morris

Well, as I know Michael we’re a big believer in a new approach to the regulatory compact in that sense, and as you also know in many, many jurisdictions we have automatic rate adjustors and trackers for all kinds of expenses that are incurred to ensure greater reliability, greater vegetation management, more aggressive treatment of the meter technology interface with the customer.

Michigan as you know, has gone to a forecasted rate year. We think that is very appropriate and have taken advantage of that at our I&M operating subsidiary, and we will continue to dialog with regulators and legislative bodies. In all of our jurisdictions we've been very, very active in Oklahoma and Kentucky. We of course were instrumental along with Dominion, now we have clearly second share in Virginia to Dominion, but the restructuring that went on a couple of years back.

So we will continue to push the envelope there. Decoupling is still a very intriguing undertaking. We think there are much better ways to go about than a simple decoupling approach. Our favorite approach is to go to a formula-based grade and create a band of returns on equity where one would surcharge customers and a shortfall of the band or in refund to customers and access performance under the band. We think that's a unique approach to take and one that has a lot more stability to it. One of the issues that is difficult in decoupling is for the customers and their legislative representatives to understand why one would raise their prices as their volumes shrink.

And that the simplest phrase for a legislator or to listen to when you are in a declining gigawatt hour sales cycle, which is what decoupling is all about. So we think that band on equity approach is much better because then to the legislature, the legislator who is very unfamiliar with our business, you go in and simply say look if we are in a band, if that is acceptable and maybe 150 basis points up-and-down of a central figure, all things are steady and everyone is in good shape.

If you go above that however, you begin to lower your cost to the customer as you can well imagine an elected official loves that kind of language, and they do understand the balance for the shareholders, and therefore the capital invested in their state for jobs to be created in their state get too low. They can understand the logic for adjusting up. They do that every single day as they try to lever other companies and customers to their jurisdiction for economic development.

And all of us who are in jurisdictions continue to tell our governors and our legislators and this is from General Motors to American Electric Power to you know, the gap and everyone else, it's great to attract new folks but don't forget about those of us who've been here for a long time. So we are very active in that space and continue to try to find exactly the right formula that will yield stability for those who invest in us as well as stability in the price of electricity for the economies that we're trying to serve.

Michael Lapides – Goldman Sachs

Okay. Thank you Mike.

Mike Morris

You bet.

Operator

Thank you. And next, we'll go to the line of Anthony Crowdell of Jefferies. Please go ahead.

Anthony Crowdell – Jefferies

Good morning. I guess my question is focused on the off system sales guidance on page 14, and Brian had said earlier that I think the biggest headwind or maybe Mike said that the biggest headwind facing you guys are going to be the price of natural gas, are you able to tell us when you guys provided 2010 guidance, what gas price you baked in there?

Brian Tierney

I guess, Anthony I am not – it was in the time frame of October when we did back at EEI. So it was some time ago, and you can just pull up the strip and see what the prices were back then and they were certainly higher than what they are balance of the year to date.

Mike Morris

Yes, I think it's important Anthony that Brian’s point is spot on. We, when we do the formulation of off system sales revenues, we really peg that to the strip for natural gas because that's such a determining factor as we put together our budgets, you know, a quarter or more before you get to the actual performance. And we are not aggressive in that sense. So if the strip was $5.02 for all of 2010, we would not – we’d probably put in $4.98 or some conservative number rather than saying let's be bullish and hope that gas gets to six bucks.

I can assure you this with shale gas developing as it is, the Katrina led $14 a MMBTU price of natural gas is in the rearview mirror, not out in our headlights, although I would never want Katrina to happen again. I'd love to have those prices come back for a short period of time, but I don't see that happening.

Brian Tierney

Anthony, it's Brian again. I think the Q2 to Q4 strips that we're looking at that time was about $6.

Anthony Crowdell – Jefferies

Great, thank you very much.

Mike Morris

You bet.

Operator

Thank you. (Operator instructions) And we’ll go next to the line of Phyllis Gray at Dwight Asset Management. Please go ahead.

Phyllis Gray – Dwight Asset Management

Good morning.

Mike Morris

Good morning Phyllis.

Phyllis Gray – Dwight Asset Management

Would you please provide just a little more color on the two aluminum plants decline in energy consumption and whether you think that decline is a permanent reduction by those facilities?

Mike Morris

So, one that which is located here in Ohio is at two-thirds production. It's a six pot-line facility, and they're running four pot lines most typically. Century Aluminum, which is located over in West Virginia near our Mountaineer Station [ph] is off-line and have been since early in 2009. Governor Manchin, Dana Waldo, the president of our Appalachian Power Company, myself and others worked diligently with Century to see if we couldn't find some rate activity that would allow them to continue to produce and fluctuate the cost of their power to the LME numbers on aluminum in the world marketplace.

Unfortunately, we’re not able to do that. Both of them have said LME is north of $2100 a ton would probably encourage them to continue to look at bringing their facilities back online, and those numbers have been there now for a good chunk of calendar year 2010 and they continue to see some potential upside. The LME has fluctuated from about $1900 to $2300, and they're looking for a bit more stability.

So it isn’t as though they're gone, they're clearly there, but every time I go to Mountaineer, I crane my neck to see what's going on at Century, and I'm always happy to see they are cutting the grass and polishing the aluminum sign up front. That tells me that they are eager to get back in business themselves. They have some labor price issues that I know they are working hard on and for jobs in West Virginia and for electric sales. At AEP, we wish them well in that endeavor.

Phyllis Gray – Dwight Asset Management

Thanks very much.

Mike Morris

You bet.

Operator

Thank you. And next we'll go to the line of Ali Agha of SunTrust Robinson Humphrey. Please go ahead.

Ali Agha – SunTrust Robinson Humphrey

Thank you. Good morning.

Mike Morris

Good morning.

Ali Agha – SunTrust Robinson Humphrey

Hey, Michael, Brian, when you had highlighted the remaining rate cases for the year that are important, obviously you highlighted Virginia and Kentucky, and I was just wondering is there any possibility that you may reach settlements in either one or both of those rate cases rather than waiting for the final decision from the commission. Is that a possibility?

Mike Morris

Yes, of course it is. Ali, we constantly work on those approaches. In fact, Monday next week there is a settlement discussion in Kentucky. We have had very serious settlement discussions in Virginia. We offered what we thought was a very, very reasoned approach to touch on the issues that were important to the governor as well as the members of the Senate and House that we had met with.

There are different ways of going about it. In Virginia for instance, the settlement doesn't need to be unanimous and that may lend itself to the more likely approach of settling that case in Kentucky. You do need all parties to join in a settlement, and as you can well imagine there are representatives in the rate case proceedings who are looking out for retired citizens on fixed incomes, and it's very difficult for them to stand behind and support a settlement.

We are encouraged by what we saw in Kentucky, one of the principal interveners has suggested that rates might go up by some $40 odd million. That's not near what we filed for. We are equally encouraged by the positions taking at parties in the Virginia case ranging from rate increases of $30 million, $40 million up to as high as $90 million, which again is a little soft that what we filed for, but we're encouraged by those activities, and I guess if I would have forecast I would argue there is probably higher potential of settling Virginia than there is in Kentucky because of the unanimous requirement, but we'll see. We're always striving to do that.

Ali Agha – SunTrust Robinson Humphrey

Okay, thanks. And separate question, just to be clear Brian on some of your earlier remarks, you know, you highlighted off system sales probably unchallenged versus your original budget, also commercial and industrial load growth is so far somewhat lower than anticipated. So when you look at the cost savings that the two folks have announced on the headcount reduction and you look at the market that has been shaping up right now, did I hear you correctly that you believe the cost savings should be able to offset any lower margins from the businesses, so the midpoint of the range is still where you are comfortable with. Am I hearing that right?

Brian Tierney

That's correct. So we're seeking to offset with off system sales, with O&M savings, what we're not going to be getting in terms of retail sales and off system sales.

Mike Morris

And again I think it's important that we stress to all of you on the phone that this is not different from anything that we've done before except the magnitude of what we feel we need to do now and the sustainability of what we intend to accomplish going forward in answer to Paul’s question earlier on. We have always told you that when revenues begin to get weak, you will see us throttle back on operating and maintenance expenses.

We've done that. You know, if I think back to 2007 we made some major adjustments in our tree trimming programs, followed shortly thereafter by going with tracker adjustments for tree trimming investments in many of our jurisdictions. So this is not uncommon to us. The size of this one and the dedication of the change that will yield by reducing headcount now north of 10% clearly is a challenge, but it's one that this team is more than capable of handling.

Ali Agha – SunTrust Robinson Humphrey

Last question Mike. The Ohio SEET, any sense at all on when you may hear from the commission on the framework?

Mike Morris

No, in conversations with the commission I know they continue to deliberate the issue. The political season in Ohio and throughout the country is beginning to heat up and I doubt very much if the commission wants to get crosswise in the current administration versus the party and the candidates running. So that may say it could come early just to get it behind us or that really could say that it could be delayed substantially later into the year post election cycle.

It's an intriguing issue, but the most important thing here, and you've all had many opportunities to speak with the Chair of the PUCO and other commissioners. This is a very balanced and a very fair group of individuals who see the benefit of strong healthy financial utilities here in Ohio, which enables our manufacturing base and the Ohio economy to continue to recover. This is not Michigan in an economic sense, but Ohio has been hit pretty hard by the economic downturn and you're beginning to see signs of recovery but nothing too dramatic yet. So I think it'll be balanced, it'll be fair, but it's really difficult to forecast when they might move.

Ali Agha – SunTrust Robinson Humphrey

Thank you.

Mike Morris

You bet.

Operator

Thank you. Next we'll go to the line of Daniele Seitz of Dudack Research. Please go ahead.

Daniele Seitz – Dudack Research

Thank you. In the last conference call on the earnings you were mentioning expecting some upside in the industrial sector of about 5%. I know now reality is setting in, it seems that – do you have again some acres from the industrial sector regarding next year and what is expected in terms of growth as well?

Mike Morris

Well, Daniele we’re still as you know in the recovery of sales and industrial volumes in the 2007, 2008 timeline. You will remember that we shared with you before. We didn't see a downturn in industrial demand because many of our large volume customers are exporters until quite honestly December of ’08. So we struggled through quarter after quarter after quarter in ’09, and as Brian said but for the aluminum folks, quarter one was really strong industrially.

We'd love to have the aluminum folks come back. We think again we’re beginning to see good export volumes. You read as I read about the economic recovery in China and India and other Asian nations, where much of the exported products end up going to market or exports parts end up going to the ultimate manufacturing then back to market. So when we look at 2011 and 2012, we're comfortable that we’ll continue to see recovery and then ultimately we hope in the 2012 beyond timeline growth in the industrial sales themselves. Those are many of the reasons why we're taking this what we think to be sustainable reduction in the cost structure and cost profile at American Electric Power.

Daniele Seitz – Dudack Research

Thank you.

Mike Morris

You bet. Thank you.

Operator

Thank you. And we’ll go to the line of Rishi Modi [ph] of Millennium. Please go ahead.

Jeff Kersanty – Millennium

Hi, it’s Jeff Kersanty [ph]. Good morning.

Mike Morris

Hi Jeff.

Jeff Kersanty – Millennium

Sorry if I missed it, but I just want to clarify. On the cost-cutting initiative, basically that start gives you roughly a half year in ’10, so that would be a full year impact in ’11?

Mike Morris

Yes, that’s exactly right.

Jeff Kersanty – Millennium

Okay, so if all the other assumptions for ’11 were flat or equal to you know, previous assumptions, then this would be sort of incremental of that.

Mike Morris

Yes, it would be. So it would again give us more comfort going forward basic growth numbers are in that 2 to 4 range.

Jeff Kersanty – Millennium

Okay, great. Thank you.

Mike Morris

Yes, you bet. You must have been on that other phone call about some pending merger.

Operator

Thank you. And gentlemen, I'll turn it back to you for closing remarks.

Chuck Zebula

Thank you for joining us on today's call. As always, our IR team will be available to answer any additional questions you may have. Operator, you can please give the replay information.

Operator

Thank you. And ladies and gentlemen, today’s conference will be available for replay after 11:00 A.M. Eastern Time today until May 6th at midnight. You may access the AT&T Executive Playback Service at anytime by dialing 1-800-475-6701 and entering the access code of 150111. International participants may dial 1-320-365-3844.

That does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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Source: American Electric Power Company, Inc. Q1 2010 Earnings Call Transcript
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