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

Q1 2006 Earnings Conference Call

April 27th 2006, 11:00 AM.

Executives:

Julie Sloat, Vice President of Investor Relations

Susan Tomasky, Executive Vice President, Chief Financial Officer

Michael Morris, President, Chief Executive Officer

Analysts:

Daniel Eggers, Credit Suisse

Elizabeth Parella, Merrill Lynch

Craig Shere, Calyon Securities

Paul Ridzon, Keybanc

Paul Patterson, Glenrock associates

Ashar Khan, SAC Capital

Greg Gordon, Citigroup

David Frank, Pequot Capital

Daniele Seitz, Dahlman Rose

Michael Lapides, Goldman Sachs

Operator

Ladies and gentlemen, thank you for standing by and welcome to American Electric Power First Quarter 2006 Earnings Conference Call. Operator Instructions As a reminder, today's conference is being recorded. I would now like to turn the call over to our host, VP of Investor Relations, Ms. Julie Sloat. Please go ahead.

Julie Sloat, Vice President of Investor Relations

Thanks Beverly. Good morning and thank you for joining us today to discuss AEP's 2006 first quarter earnings. I expect that you have seen the press release issued earlier today. It's also available on our web page at www.aep.com. In addition to the financial schedules included in the press release package, the web cast of this call will include visuals of charts and graphics referred to by AEP management during the call. An investor information packet will also be available at www.aep.com today at approximately 1 pm that will include the consolidated balance sheet and statement of cash flows, as well as full income statements for our utility operations, GAAP operations, investments, and parent company.

The earnings release and other matters that may be discussed on the call today contain forward-looking statements and estimates that are subject to risks and uncertainties. Please refer to the SEC filings including the most recent annual reports on Form 10-K and quarter reports on Form 10-Q for discussion of factors that may cause results to differ from management projections, forecasts, estimates, and expectations. Also on the call, we will discuss the measures about company performance, that is ongoing earnings versus reported earnings that differ from those recognized by Generally Accepted Accounting Principles or GAAP. You can find the reconciliation of these non-GAAP measures on our Investor Relations website at www.aep.com.

I will turn the proceedings over to Susan Tomasky, EVP and CFO of the company to lead an opening presentation and then there will be time for questions. Susan?

Susan Tomasky, Executive Vice President, Chief Financial Officer

Good morning. Mike Morris is slightly delayed, coming in on an airplane, he'll be joining us for a question and answer session as soon as he possibly can, but let me go forward and give you an overview of our quarter's performance. We're very pleased to announce this quarter's performance. As you see, we had a performance of $0.96 per share on an ongoing basis. We had GAAP earnings of $0.97 per share and we had a very positive performance that had to do with increased commercial industrial usage, the positive impact of rate changes, and a strong performance of our MEMCO Barge Line. This was partially offset by the impact of unfavorable weather in the quarter. We are reaffirming our earnings guidance range of $2.50 to $2.75 per share, and there are couple of other major issues that I wanted to discuss with you before we get into the details on the earnings performance for this quarter.

First of all, I want to mention that we have another asset divestiture. The Bajio assets in Mexico were divested. They were divested at book value so there was no impact on earnings for this quarter, but nevertheless it does represent the last divestiture of our international assets and is noteworthy for that reason. I also want to talk for a minute about regulatory activity, which from our perspective continues to be quite positive. We did have an order out of the Public Utility Commission of Ohio approving the first phase of our IGCC pre-construction costs. We were extremely pleased to see that initial recognition on the State of Ohio that they want to go forward with this. We're going to continue on with our feed study, that's the detailed engineering study of costs. And by October, we should be in a position to put that forward to the commission and that should serve as the basis for subsequent commission approval of the Phase II and ultimately the Phase III costs with respect to the IGCC. We consider this a very significant step forward in our desire to bring this excellent technology, the future of coal for Ohio, to our rate payers and to our customers.

The second, we are also pleased to talk about a rate settlement that we have agreed to in the State of West Virginia. It is, of course, still pending approval with the state commission, but it is an outcome that is very much in line with our plans for rate recovery both with respect to this year and future recovery with respect to fuel and environmental costs. We have already provided some detail with respect to this and will continue to go into greater detail in further investor presentations, but the bottom line is that the agreement provides for an initial $44 million increase in revenues, and it will be effective on July 28, 2006.

We also have the $46 million in fuel recovery that we spoke to you about in the future. And most importantly from our perspective, mechanisms in place for fuel recovery, we have reactivated the fuel costs in West Virginia, and that are $56 million will flow through initially and we will have regular adjustments in order to reflect the ongoing costs of fuel.

In addition to the environmental recovery and the recovery for Wyoming-Jacksons Ferry that we've received, we also find ourselves with a mechanism established in West Virginia to permit us to update environmental costs as they occur with carrying charges, a very significant positive for us in West Virginia. We think this is an absolutely excellent outcome. We very much appreciate the constructive framework in which we went forward. Obviously, in all of these circumstances you do not get everything that you seek in the first instance, we do have a base rate decrease of about $18 million, but overall we think this is an excellent settlement, and we appreciate the effort of all parties to come to a reasonable outcome and certainly are looking forward to approval, we hope from the West Virginia Commission expeditiously so that this can go into effect.

We do, of course, have other items that are still outstanding. We have the stranded cost proceeding which is at issue and continues to be in Texas. We have made our securitization filing and we are expecting an outcome of that in June, as we previously described. The Virginia E&R case continues to remain pending at the commission, although as I think you know we have already notified the commission that we intend to put forward a rate filing and a rate case sometime after May the 1st. And we continue to work with the Indiana commission and interveners there for a resolution of the Indiana and Michigan depreciation filing.

I would like to turn now to the first quarter earnings performance detail. Reported earnings for the first quarter were $0.97 and the ongoing earnings were $0.96. The $0.01 difference is simply a prior period adjustment on discontinued operations. Our ongoing earnings of $0.96 were composed of $0.93 from utility operations, and I'm going to talk in detail about that in a minute. But I also want to highlight a positive in the investment segment.

The investment segment showed a $15 million contribution to earnings, which is a $3 million quarter-to-quarter improvement. Those were the results of a very strong performance from MEMCO Barge Line and that was due to a number of factors; good operating conditions, a strong demand, and improved operations overall. The MEMCO contribution was more than sufficient to offset the loss of earnings that on a quarter-to-quarter basis that we saw from the sale of HPL, of course, occurring early in the quarter of 2005.

We also saw a $12 million improvement at the parent company and that's attributable to interest variance on long-term debt due to a reduction in the quarter-to-quarter basis in debt outstanding. We also had a higher interest income from subsidiary company borrowings.

Let's turn now to the detail on utility operations and there are a number of things here I want to highlight. I think you have a lot of detail there in the margin, but there are couple of things that are significant. I think that we were all anticipating a drag associated with mild weather, and indeed we did see that. Weather contributed a negative impact about $0.04 for the period negative against the first quarter of last year and a negative $0.06 against normal.

But nevertheless across the utility operations we saw very excellent outcome. Ongoing earnings from utility operations increased by about $22 million or $0.06 a share during the first quarter. There were higher gross margins from retail sales, although those were tempered somewhat by increased amortization, interest, and tax expense. You will also see a lower number in the reduced off-system sales line, that was due largely to the sale of the Texas assets that happened between the first quarter of last year and of course this year.

The anticipated drag that we had on mild weather was also more than offset by industrial load from the east regulated utilities. We also saw an east customer count increase of about 29,600 in addition to increases in normal load growth. For the east companies in particular, load grew by about 5% even though the heating degree days were 16% below normal. At the Ohio companies, we had a $49 million improvement year-over-year, that's due primarily to rate relief associated with the rate stabilization plan, as well as the addition of the Mon Power customers. For the west integrated utilities, we saw a $17 million improvement that was driven largely by higher margins for our SWEPCO, Muni/Coop customers, PSO rate increased that we've talked to you about before, and higher fuel margin.

O&M expenses you'll see dropped slightly by about $6 million and that was due primarily to a favorable year-over-year increase, and that had to do with storm restoration expense that we had in the first quarter of last year. We also did offset that to a considerable extent by higher expenses associated with tree trimming, reliability, and other ordinary activities. We do expect our O&M budget to be as forecasted by year-end.

We also saw at the other income and deduction line that it was driven lower, however, that really has largely to do with the lower carrying costs in Ohio, which have now moved into the Ohio lines as those dollars are actually collected. I would note there that the Centrica cost-sharing also occurs on this line and it is the same as it was last year, contributing $70 million to earnings.

Let me turn now to a couple of comments about cash flow. We ended the first quarter of 2006 with a cash balance of $276 million. I remind you that the ending cash balance of the previous year of $1.2 billion was associated, of course, with the cash that came in through the sale of Houston Pipeline.

For year-to-date, the cash flow from operations totaled $590 million and that's $378 million in continuing earnings. We also had various other adjustments. You probably want to know what the $123 million negative is in the change of working capital, and that really is a quarter activity and has to do with increase in fuel inventories as well as counter-party collateral. There is nothing unusual in that working capital number. The investment activities required cash outlays of about $757 million in the first quarter of 2006, and that was driven primarily by our CapEx, which were $772 million in the quarter.

We received $111 million in cash from asset sales and that's mostly the Centrica payment of $70 million plus the sale of Bajio of $29 million. We had financing activity in the first quarter that provided us a net cash increase of $42 million and although we ended 2005 with a minimal short-term debt balance, I think we did tell you that we did expect this year particularly with our ratings improvements with Moody's to begin a more effective use of short-term debt, and we did indeed see that for funding CapEx ahead of long-term financing, and that's why you see the $215 million balance at this point.

You can expect that to be in the range of $215 million to about $400 million or $500 million varying over the course of the year depending upon how we see interest rates. Again, it continues to be an instrument to fund capital activity and other business activity in advance of long-term debt. As a result of all this, our net change in cash was a negative $125 million and that's resulting in an ending cash balance of $276 million. Our year-end guidance is that we expect to see a cash balance of $326 million. Finally, with respect to capitalization, we ended the quarter at 56.7% debt-to-cap on a GAAP basis and 57.5% on a credit-adjusted basis. We continue to remain committed to our debt-to-cap ratio on an adjusted basis of about the 60% range.

With that, I want to turn it over to Mike, who has arrived from his late plane and is ready to provide you some overview comments and then we'll turn to questions.

Michael Morris, President, Chief Executive Officer

I apologize for missing the very start of the meeting. I had an opportunity to be in Detroit at the annual convention of the American Association of Blacks in Energy and share with them a bit of what we as an industry are seeing and I didn't want to miss that opportunity, It really is invigorating to see a room of absolutely diverse employees. In fact, I was the only minority in the room and it felt good to be that way for one time in my career that a very energized group of young people who will add tremendous value to not only our company, but this industry as we go forward.

I was able to catch most of what Susan had to say, and I simply want to add a couple of thoughts. As you know, coming into 2006 we were extremely concerned about rate proceedings that laid in front of us, as you know, from the discussions we've had with you, we've built into our guidance about $500 million worth of success in the regulatory arena in calendar year 2006.

I know that Susan already touched on the figures, but I just want to add some color to say how pleased we are at the end of only the first quarter to be as far along that road as we are today. There are a few matters that are still pending, the West Virginia settlement is an extremely well balanced, well-thought through, and we think meaningful approach forward to address the environmental investments on the significant power production facilities at Appalachian.

Obviously, the Virginia issue remains open. We feel comfortable that at the end of the day we'll be treated as we had hoped that we would in Virginia and then just a few other small items will fill the entirety of that requirement for 2006. The Texas stranded cost activity, terribly important and we at least are in the beginning of some settlement discussions with all parties that may yield an early opportunity to begin the securitization in Texas, we surely hope that to be the case.

And of course, lastly, the other issue that we came into this year with some concern, and you had that concern as well is how will we be able to finance the entirety of the CapEx program that we had in mind? And again, I would tell you at the end of the first quarter we feel very comfortable, not only with the asset sales that came to us to Centrica payment that Susan just spoke of, but in fact the potential for the securitization as we go and what we see as the CapEx forecast for the rest of the year. I just a little different than Susan and little more aggressive than her, believe that we'll finish the year sub 60% debt equity ratio, but we'll be right near that target, and that we feel, again as I've said, extremely gratified as to where we are at the end of the first quarter in 2006.

With that, we'll turn it back over to Julie and move to your questions.

Julie Sloat, Vice President of Investor Relations

Beverly, we're ready for questions.

Question-and-Answer Session

Operator

Thank you. Operator Instructions Our first question will come from Dan Eggers with Credit Suisse. Please go ahead.

Q - Daniel Eggers

Hi, good morning guys.

A – Michael Morris

Good morning, Dan.

Q - Daniel Eggers

First question, I guess Mike, just a little bigger picture, we've seen a lot of folks pile on to the idea of building more coal fire generation as you guys make progress in Ohio with the IGCC, how are you contingent planning I guess one to have -- make sure you have all the coal supply you need three, four, five, ten years down the road and how are you thinking about procuring engineering in a construction resources to proceed with some of these plans you guys have?

A - Michael Morris

Yeah Dan, that's really an excellent question. I know that we always try to forecast for you where we are in the coal supply situation and we feel already, almost with a full book for a calendar year '07 and a very full book for calendar year '08. But as Chuck Sabula and his team go out and buy coal, they do in fact typically sign longer term contracts because we easily become a base purchaser of coal from people who are willing to open up new mines and that we continue to work with Console and Lear and Peabody and others in the major production area to see to it that we can sign longer term coal contracts. They see us as the kind of customer that we're interested in, we see them as the kind of supplier. So, I don't see any longer term worry about coal supply. As you know, the integrated gas activity will open up higher soft for coal opportunities that will take us back into some areas that really haven't been productively mined since the Clean Air Act. We saw the article in a paper a week ago about northern App being $60 to $70 a ton a wheel, and didn't know to whom the author was speaking but I presume it was a coal producer. We don't see those kinds of prices. To the second side of your question, I did have breakfast this morning in Detroit with John Krenicki from General Electric, and we have them and Bechtel already tied up for our activities going forward. So we feel very comfortable about the engineering talents and the physical talent with the ability to do that work. But you know you really are raising an important issue, as you know with our environmental program too. We were clearly ahead of the pack and the engineering and the onsite personnel are typically there for us and that's not been an issue, but it is an issue for the industry.

Q - Daniel Eggers

Great. One other question for you guys on the off system sales. Can you give us a little color on how much of that sale amount from a price perspective is sold forward or hedged for the remainder of this year? And then maybe a little color on what you guys are seeing in the off peak market for PJM?

A - Michael Morris

Well, we just soon not talk a great deal about where we are and how much we've got sold on a going forward basis, that let’s our competitors kind of know what the book looks like and I'd rather have them worry about what our book does look like. I would tell you this though as to the second part of your question. We're seeing some very handsome prices in the off peak market, prices that we really didn't think that we would see and we're encouraged by that because obviously with our availability and then the capacity factor that goes with it, we've got plenty of room to additionally put power into the off peak market. I think, Julie has shared with you all that about 59% or so of the revenues come from on-peak obviously the rest off-peak, we are feeling very good about what we see off-peak.

Q - Daniel Eggers

Great. Thank you guys very much.

A - Michael Morris

Thank you.

Operator

Thank you. Our next question comes from Elizabeth Parella from Merrill Lynch. Please go ahead.

Q - Elizabeth Parella

Thank you. Just a follow-up on the coal supply question for a minute. Could you talk a little bit more specifically on PRB and what you're seeing with delivery situation right now versus say earlier in the year or last year?

A - Michael Morris

Yeah well Elizabeth, I would tell you that we like everyone continue to be concerned with the performance of the Union Pacific as well as B&N out of the Powder River Basin area. We're seeing a bit better performance than the fall of last year, but we're still off as compared to our contractual rights and their contractual obligations, and they continue to hide behind things that simply are not real. This is an issue that we and others will be addressing before the senate sometime in the month of May. My friends in the railroad business are doing all that they can, but quite honestly they are underperforming on their contractual obligations.

Q - Elizabeth Parella

And in terms of inventory levels going into the summer, I realize PRB is not the biggest source of your coal, but just in terms of how you feel about inventory levels going into the summer?

A - Michael Morris

Well, I would tell you that Bob Powers and Bill Sigmund and the folks that run the plants are worried that we don't have enough. I think we've got too much. We're in the 30 plus day range of inventory at most of our facilities and feeling very comfortable about that.

Q - Elizabeth Parella

Okay. Question in a different area. Last call you spent a fair amount of time talking about the CapEx forecast, kind of a three-year outlook. Just maybe focusing on '06 at this point, and I think the total number you were looking at was potentially a little bit less than 3.3 billion. Can you update that for us a little bit in terms of there was a kind of a discretionary piece and a committed piece? Where do you think that you kind of wind up in '06 at this point?

A - Susan Tomasky

Yes, the number for '06 is 3.7, Elizabeth.

A - Michael Morris

And was.

A - Susan Tomasky

It continues to be that. We have not really reallocated among the chunks that you see on that bar graph. As far as we're concerned if you simply multiplied this quarter's total by 4 you would end up, you would see us to be slightly under, but we don't think that's necessarily where we're going to be, we continue to see ourselves at about the 3.7 level. See that as timing. If we see a dramatic difference in that, we'll update you later in the year. Obviously given where the West Virginia outcome, if that's confirmed that gives us reasonably high level of confidence around those numbers at this point. And again there is so much value to us in completing the environmental spend and getting some of this reliability spend done. As long as the numbers continue to work as they appear to be right now we're going to maintain that level of spend.

A - Michael Morris

And I think to your point on the flexibility, part of what Susan and I spend a great deal of time in, you're right as we did our end of year call was that, we had the ability to throttle back if in fact we saw signals from the regulator that they thought we were heading in the wrong direction. The West Virginia settlement that's currently in front of that commission would show that they are very much encouraging as to the capital ads there, however, there was some issue over capital to be spent on the distribution system for reliability will continue to improve reliability but not as aggressively as we intended to because they didn't feel that that was the right number going forward. So that's the kind of flexibility you see us doing. The integrated gas approval in Ohio obviously tells us that all of the money is being spent and capitalized on IGCC up to and through the upcoming filing are recoverable, that's a very encouraging sign. Had that not gone that way we would have probably moved off of that project at that time. So, we are very encouraged Elizabeth by what we're seeing in the regulatory arena as we go forward here.

Q - Elizabeth Parella

Okay, and one last question. On the Ohio margin improvement of, I think it was 49 million in the quarter. Can you talk about how much of that came from the RSP in the quarter?

A - Susan Tomasky

Sure. Basically the rate stabilization plan was itself 49 million. We had an additional positive from the Mon Power customers of about 3.8 million. And there is also in there a booking of a buckeye allowance gain that's worth about 9.4 million. That's something that on a quarter-to-quarter basis you won’t see Elizabeth because we booked that in the second quarter of last year. It was 17 million last year.

Q - Elizabeth Parella

Okay, thank you.

A - Susan Tomasky

Sure.

A - Michael Morris

Thanks for your questions.

A - Susan Tomasky

Beverly, we can take the next question.

Operator

Thank you, we'll go to the line of Craig Shere from Calyon Securities. Please go ahead.

Q – Craig Shere

Hi, good quarter, congratulations.

A - Michael Morris

Thank you very much, Craig.

Q – Craig Shere

Mike, maybe it’s just real early in the year so you’d want to wait and see how things go along here, but is there any reason that the street shouldn't be thinking about narrowing the earnings band to the upside, or are we off in anyway in your view in terms of the allocation quarterly this year?

A - Michael Morris

Well, obviously I'm as bullish on our share price as I hope you all are. The fact of the matter is after only one quarter and coming into our major earning quarters we would rather stay where we are. You'll remember that we spoke about the range and we spoke about the higher end of the range, really only being available to us if we continue to be successful in the regulatory arena. And it’s clear that some good things have happened, but we still feel very comfortable with the guidance that we have to date and depending on how the machines run during the cooling cycles that we hope to see in a significant way this year. Then we might address that issue. But for now, we think it's just appropriate to stay where we are.

Q – Craig Shere

Fair enough. And then on the regulatory area. Susan, do I understand that the 17 million remittance for over collected fuel costs, that's going to be over a one year period, so that will end come July '07, and then you'll have a higher run rate from that rate relief plus any additional relief for future environmental spend?

A - Susan Tomasky

Yeah actually that continues over three years. It's a total of 51 million over each of those three years starting this year.

Q – Craig Shere

Great. And any potential beyond the obvious human issues, any potential ramifications from a couple recent accidents at the primary power plant, anything on the regulatory side or changes in O&M that you're potentially envisioning?

A - Michael Morris

No, but I'm glad you asked that question Craig, because I want you to understand something that we feel is very important here at American Electric Power. That issue is of great concern to us and Bob Powers and the operating side of our generation team took a number of sister plants offline so that we could do some x-ray work on the same kind of pipe and pipe bends to see if we have some kind of a larger problem out there. We found some indications that other plants that are now going to come off line for a short period of time, have that work done and come back on line. Bob assures me as he did the board this week that all that work will be done well inside of his current budget for operating maintenance and capital for the year. And of course that puts us in a very unique position in the commercial upside of scrambling around to try to find some replacement power for power we thought that we would have, and I think that Brian Tierney and his team did an excellent job in that regard, and the April numbers came in just as we had hoped that they would.

Q – Craig Shere

Great. And last question. If I'm not mistaken, I think some rate relief was factored into your numbers along with one IGCC plant for kind of the mid single digit, kind of longer-term EPS growth outlook. Given what you're seeing so far on the regulatory front, if you wound up doing more than one IGCC project, do you think we could start to look at the top end of that mid single digit or earnings growth range or maybe even better?

A - Michael Morris

Well I would love to find ourselves in that position. That's relatively aggressive and I would be overselling and I certainly don't want to under deliver. We feel very good again about the structure of the West Virginia settlement, and if in fact the commission is satisfied with the process and it's not unlike some of the things that they did for Allegheny so we might see, we hope, reasonable support for that. That one could take that process forward on the West Virginia planned integrated project. And if that were the case then you have a more of a current cash flow, cash outflow matching, which would make that kind of activity not so much pressure on the capital structure of the company and we'd be encouraged by that. But again, we'll have to see how all of that unfolds Craig.

Q – Craig Shere

Great. Thank you.

Operator

Thank you. We'll now go to the line of Paul Ridzon from Keybanc. Please go ahead.

Q - Paul Ridzon

Good morning Mike, how are you?

A - Michael Morris

I'm fine Paul.

Q - Paul Ridzon

The 9.4 million gain on allowances, is that a pretax or aftertax number?

A - Susan Tomasky

It's a pretax number.

Q - Paul Ridzon

And then, it looks like things are going pretty well in Ohio, but Mike, in the past you've talked about maybe your second choice for capital deployment would be transmission in Texas. Is that still your thought process?

A - Michael Morris

We continue to be extremely encouraged Paul by what we see in Texas in the transmission side of things and will continue to look at that. Again, the more current opportunity for the return of transmission investments, as you know, ERCOT just went through some rolling blackouts a couple of weeks ago. I think that demonstrates the significant need that they have to increase the ability to flow energy over the magnitude of the size of Texas. So, we're encouraged by that, we'll keep looking at it and do projects with or without partners when they make sense. Lower Colorado River Authority is very aggressive in that regard. We've done a lot of work with them and we'll continue to do that. So we see it still as a pretty good place to invest capital because of the quick turnaround of the return on and on.

Q - Paul Ridzon

Any sense of magnitude and timing?

A - Michael Morris

No, no nothing that would be concrete enough to share with you now.

Q - Paul Ridzon

Okay. Thank you.

A - Michael Morris

You bet.

Operator

Thank you. We'll now go to the line of Paul Patterson with Glenrock Associates. Please go ahead.

Q - Paul Patterson

Hi, how are you?

A - Michael Morris

I'm fine Paul, how are you?

Q - Paul Patterson

Great. First of all wanted to touch base with the gross margins from optimization, which went down. What happened there? And how much are you guys getting from sort of the trading business, from the trading contribution? What do you have, I mean for 2005 what was -- I mean, excuse me for 2006, what was the first quarter here, what was the contribution?

A - Susan Tomasky

Yes Paul, this is Susan. The major effect on the off system sales line was really had to do with the fact that we no longer had the Texas generation. We did have a $13 million contribution from optimization or trading in this quarter of '06.

Q - Paul Patterson

And what was that compared to '05?

A - Susan Tomasky

In '05 it was 48 but we did have a very unusual quarter, the first quarter of last year.

A - Michael Morris

And again, Paul, I just want to add that, we think, as we moved in and out of the optimization particularly as it pertains to credits, we stepped in at exactly the right time and exited at equally the right time. Prices as you know have fallen off and we're standing on the sidelines watching for now.

Q - Paul Patterson

Okay. And then just the weather impact that you guys have there, the negative $0.06 versus normal. Does that include wholesale sales, the impact on wholesale sales?

A - Susan Tomasky

No that's retail.

Q - Paul Patterson

That's completely retail.

A - Susan Tomasky

We don't really know quite how to quantify a weather impact on wholesale sales.

Q - Paul Patterson

Because of the price differential, but you had more volume there to sell in the wholesale market as a result of the lower weather.

A - Susan Tomasky

Absolutely.

Q - Paul Patterson

Okay, so we should that full $0.06 if you had normal weather, it probably wouldn't have been the – the wholesale would have been a little bit less as a result because you've had less volume you think?

A - Susan Tomasky

That's correct.

Q - Paul Patterson

Okay. And then finally, the IGCC and the PUCO ruling, it was -- I hear when you say it’s encouraging, but on the other hand, in terms of getting the full plant in there, I'm wondering what you're seeing in terms of perhaps the need for a legislative change. And just in general, the concerns in Ohio with respect to going to market rates in 2009 or whatever, and the alternatives they might be looking for, and also the alternative desire to have an IGCC. And if you could just sort of elaborate a little bit on what some of the developments have been or what you might be seeing happening in Ohio with respect to these issues?

A - Michael Morris

As usual you ask a multiphase and deep question, but we'll try to give you the best we can on it. First, very importantly in the order that was issued in the current application for the Ohio integrated gas project, the commission laid out a very detailed view of the legislative history, the legislative implementation and their legal authority to approve the ownership and a rate of return type structure for a distribution utility with a provider of last resort obligation. And I think it was well logic and laid out very clearly. I expect, and we have every reason to believe Paul that that will be taken up on appeal by people who had raised different arguments in front of the Ohio Utility Commission as we went through the hearing process. We obviously share their view. We think that the commission's staff and the commission lawyers are exactly right on what their authorities are and what the obligations of a distribution utility in Ohio under restructuring and the provider of last resort obligation are going forward. So, we feel comfortable with where we are, we'll see how that plays out.

We're always encouraged when people challenge the commission and Supreme Court which is as you know the court of first appeal of commission decisions stands behind them. You know that the rate stabilization plans that are currently in place have been challenged. One decision has come out of the Supreme Court that fully supports the RSP, we expect others well as well. The larger question that you're asking is what will we do in Ohio post RSPs? And the way we see that, it can only head in two directions, both of which are very good for a low cost provider like American Electric Power Company and those who own our shares. Because if we do go to market, if that in fact is the answer, we will be a huge beneficiary of the tick-up to market prices when compared to our current fleet. If you simply look at a day-in, day-out average PJM price it's in the $60 $70 range. If you look at, I guess the most recent auction data its north of $100, I don't expect any of that to be the market in Ohio, but that's where the market is today. Our production costs continue even after the environmental investments to be in the $30 to $40 range. So we feel very comfortable about that if that's where we head.

I would expect and I would hope that during the tendency of the next couple of years, others take the position that Dayton Power and Light took most recently when they filed in their current RSP, an augmentation which really was an extension of it for a few more years and we'll see if the commission has an interest in doing those kinds of things. And you've heard me say this many times before, I really don't want to be party to a Maryland type or Illinois type battle. I don't think that that's in anyone's best interest, most importantly, my shareholders and my customers. So I would expect that during the period of time, as we move closer to the end, and the end really is closer than you would think, we'll try to move forward with some kind of extension of RSP and watch how things unfold here in Ohio. But in any event, Paul, I see both of those as substantial upsides for the AEP companies.

Operator

Thank you, we'll now go to the line of Ashar Khan from SAC Capital, please go ahead.

Q - Ashar Khan

Good morning, and congratulations.

A - Susan Tomasky

Thank you, Ashar.

A - Michael Morris

Thank you.

Q - Ashar Khan

Susan, I'm going to do a little bit hopefully, I'm going back and I'm comparing the factors you gave for improvement in gross margin for each of the different categories in your outlook that you gave for the first time at the EI presentation. And I wanted to check I just wanted to share my, I guess my numbers the way I read them and whether you agree or not. You were expecting 142 million increase in gross margin for the east integrated companies and you're already up about 40 million in the first quarter and none of the rate increases have gone in. So that would imply to me that the east companies are running ahead of I guess forecast, or they could do better than the 142 million that was set up at that forecast? That's the first question.

A - Susan Tomasky

Well, Ashar I think your sentence is true, there are other things that can go up or down over the course of the year that would cause me not to speculate including changes in load, we could have increased costs and that sort of thing and that would lead me not to speculate and end up where you are going. But I certainly would agree with your initial proposition.

Q - Ashar Khan

Okay. Then the Ohio companies were to have like a 315 million increase in gross margin, and we are up like 50 million for the first quarter. So I guess the weather is playing a role over there that you might be a little bit behind in that category?

A - Susan Tomasky

Yeah, weather is playing a role, fuel plays a little role there too as well.

Q - Ashar Khan

Okay. At least and then I'm going to off system sales. You were expecting nearly 223 million drop-off. I guess it was because of the Texas system getting out and increased plan outage rates. I guess we haven't had much of a drop-off in the first quarter, is that because the planned outages are in the -- what area? I thought the planned outages would come in the shorter quarters, what was the planned outage rate in the first quarter versus I guess last first quarter?

A - Susan Tomasky

I don't have that last number at the ready. Let me tell you generally, that as we schedule the outages over the course of the year and don't have any specific information about when particular plans are out. What I will share with you is that the off system sales number for the east is running pretty much on track to what we had expected. The issue with respect to the year-to-year drop-off that we projected really had to do partly with our view with respect to prices, our view with respect to availability and also the fact that retail sales absorbed a certain amount of the generation. The other thing again to remember is Texas. Texas is gone. And that affects our year-to-year number. So, that leaves us pretty much on track for off system sales and whether or not we realize a difference in an uptick will depend a lot on how prices materialize over the course of the summer.

Q - Ashar Khan

Okay, and then can I just ask you on the O&M, I guess there was to be a general decrease, I guess we're running flat, so I was just trying to understand the timing of that in the remaining three quarters?

A - Susan Tomasky

We still expect to be basically on budget by year-end, which is the 3 billion plus number that we've given you, 3.45 billion. And that's pretty much where we are. We actually tolerate a fair amount of variance from quarter to quarter because we do expect that some of the activity that we do is seasonal and weather related. So I would not at this point attach a great deal of significance to the O&M under run. Again, we have an incentive, while we have incentives to control costs, we also have incentives to improve reliability; to get the work done at the plants so that they run for the summer, well run all the time, but in particular – in our particularly profitable periods. So, I just wouldn't simply attempt to multiply by four and get to the outcome. You should use the $3 billion number.

Q - Ashar Khan

Okay and if I can end up, could you just remind us how much Centrica you got in '05 versus '06, what's the variance?

A - Susan Tomasky

On an ongoing basis, Centrica was 70 million and it continues to be that this year. And it's all booked in the first quarter.

Operator

Thank you, our next question comes from Greg Gordon with Citigroup. Please go ahead.

Q - Greg Gordon

Two quick questions guys. The first -

A - Susan Tomasky

How are you Greg?

Q - Greg Gordon

Good, how are you doing?

A - Susan Tomasky

Good.

Q - Greg Gordon

We've got a $15 million total contribution from investments versus 12 last year and we know that there is a negative trend from the sale of the asset. That was, I guess completely offset by the barge company. Can we just get sort of a buildup of year-over-year and should we presume that you've locked in contracts at MEMCO so that this looks like this quarter is going to be repeatable over the course of the year or can you give us some guidance on that?

A - Susan Tomasky

MEMCO was $20 million aftertax, net contribution to earnings for this quarter. We do have a lot of this locked into contracts, but we can't really assume the same volume of activity associated with third party activities. So I don't have a good number for you in terms of a projection for this year. There were some other minor negatives, Greg, that are interest in resources and that sort of thing. But the key positive is MEMCO, and while we don't have an individual projection for you on MEMCO, we do expect a good year out of them.

Q - Greg Gordon

And that was $20 million this year versus the contribution. Do you remember the contributions from the first quarter last year?

A - Susan Tomasky

It was just one million.

A - Michael Morris

One million.

Q - Greg Gordon

One million, so that's a huge, huge uptick.

A - Susan Tomasky

It is. We're delighted.

Q - Greg Gordon

And obviously, you're not prepared at this point to give us an update on what your full-year investments, contributions might be versus your prior forecast, but it's going to be significantly better?

A - Susan Tomasky

Not right now, but obviously we'll continue to look at it.

Q - Greg Gordon

Okay, and then the second question was - and you may have answered this indirectly in a prior question. When we look at the CapEx budget over the next three years, not the '06 which we indicated as basically locked in. How much of the budget is the IGCC, which will only get billed if you get recovery? Because there's sort of feedback loop here in terms of cash flow and CapEx, I just want to understand that what portion of your sort of '07 and '08 CapEx budget simply won't happen if you don't get the revenue relief that you need to earn a return on those investments?

A - Susan Tomasky

It would take me a minute to get that because I don't have the chart right in front of me. But your proposition is exactly correct, that if we find ourselves not satisfied with the ultimate outcome, that number would go down. The total amount on the new build generation is 611 million and a portion of that for the IGCC is really not established yet, I'm sorry to say. But we'll get it for you, Greg.

Q - Greg Gordon

You can always follow-up with me.

A - Susan Tomasky

Yeah.

Q - Greg Gordon

But the point is that the cash flows don't get – if the cash flows don't get directed to these investments then there's a big significant portion of the '07 '08 budget which would then not be spent, correct?

A - Susan Tomasky

That's correct and actually my recollection, although I want to check this is a large portion of these dollars in '07 are really in the new build, in the west, and of course we are still subject to the outcome of the RFPs, and that would be another reason if those RFPs were not awarded to the internal bid then that would be another reason that you wouldn't see that capital spent.

A - Michael Morris

But again, Greg, I think you're putting your hand on a very important issue or your finger on that issue, and that is simply this that without the regulatory upfront path that is crystal clear, those projects will lay over for another day, another time. And to Susan's point, the new builds in the west which are part of the '07, '08 even '09 capital forecast, if we aren't the successful bidder to build those facilities and someone else is then that would be a major shift in the capital requirements.

Q - Greg Gordon

Okay thanks guys.

A - Michael Morris

Sure.

Operator

Thank you, we'll now go to the line of David Frank from Pequot Capital. Please go ahead.

Q - David Frank

Yeah hi, good morning.

A - Michael Morris

Good morning, David

A - Susan Tomasky

Good morning, David.

Q - David Frank

Susan, I think Ashar was asking about this before, but I just wanted to go over what exactly was built into your '06 forecast for either margin or prices on wholesale sales made in the east for this year?

A - Susan Tomasky

Well, we haven't really provided information about what we assumed the details on the pricing. What I can tell you that obviously the margin -- the overall gross margins we've provided you, we haven't provided percentage margin numbers if that's what you're asking for. What we have said directionally with respect to our price assumptions is that we did not expect that the prices that the forward prices that you saw in the fourth quarter of last year to prevail over the course of this year. I think Mike told you a little bit that we've seen off system prices a little bit higher than is within our current projections. But overall, we have not seen a wide variance to date from what we pretty much expected. And again if you compared it to the forward prices at the end of the last quarter, our projections are meaningfully lower than that.

Q - David Frank

Okay, so that's but since I really don't know what your assumptions are, I'm still a little cloudy on this. I thought you were assuming something around $18 per megawatt hour realized margins on wholesale in the east, is that for this year, is that not right? Am I not thinking correctly or am I in the ballpark?

A - Susan Tomasky

Yeah, I'm not familiar that we've put out that number. Other than what -- I'm confused. I guess I'm a little confused about what you're asking. If you're talking about the realization number it’s 16.

Q - David Frank

$16 per megawatt hour for 2006 on eastern wholesale?

A - Susan Tomasky

That's on total off systems sales on average, right. We haven't broken that down.

Q - David Frank

I see, $16 on total off systems sales, that's kind of like the average. And that's a blend of the higher priced east generation along with other stuff in the south or in Michigan, I guess?

A - Susan Tomasky

That's correct, it is predominantly the eastern components, the generation that we have in the east that drives that margin.

Q - David Frank

Okay, well I'm just -- now again, trying to do a quick back of the envelope. If I think most of your generation is coal and nuclear driven and your variable cost is somewhere I would guess south of $20, that means that I would assume you were looking for power prices in, fair to say $40 or below average realized, which, am I thinking correctly now?

A - Michael Morris

In general of course you've got other pieces that go into the overall production side with credit allowances and those kinds of things and fluctuating coal prices. But in general, we took what we felt was a realistically achievable power price in the delta between costs and price. I mean, now and again we see prices that are better every now and again, unfortunately we see prices a little bit worse. But on average, we're feeling comfortable again about what we're seeing here.

Q - David Frank

Okay. And Mike, I guess come 2009 for your next potential RSP, I mean we don't know exactly what's going to happen. Is it fair to say that you would demand to be treated at least equally with whatever plan First Energy or one of the other companies in the state might get whether that's going to market or some type of further glide pass of these generation rates?

A - Michael Morris

You know that's an interesting idea, David, if I could sign up for a favorite nations clause with the PUCO, I might do just that. I would tell you though in the last round of rate stabilization plans, I believe that those approved for the four principle operating companies here in the state are Columbus Southern, Ohio Power did better than the others. So I think they would want our favored nations rather than us to take theirs. But to your point, if FE were to go to market, and in fact if that were to be a sustainable, that obviously is something that would surely cause all of us to want to have the same opportunity. And it would be intriguing to see how that would unfold both legislatively, legally and regulatorily here in Ohio. It's not doing well in other jurisdictions as I know you know.

Q - David Frank

Just one other, I hate to bother you so much, but have you ever thought of selectively monetizing some of your non-core distribution properties and maybe using the proceeds to fund some of your CapEx, liquidity or perhaps higher growth transmission type projects you're looking at, or maybe even stock buybacks?

A - Michael Morris

Well we always look at all of the assets that are in the portfolio, and we have what we think is a very reasonable expectation for the rate of return on the capital invested in each of the seven operating companies. And if we really got to the place where we felt there was no near and longer term upside for the shareholder by having those assets as compared to monetizing them, we would do just that. But we don't see that in our near-term forecast. We again, as I think you know, feel very comfortable in the way that things are unfolding, and have every reason to believe that we have very logical and non-risky capital investment opportunities in almost every one of those operating companies.

Operator

Thank you, our next question comes from Daniele Seitz from Dahlman Rose. Please go ahead.

Q - Daniele Seitz

Hi, just a quick question, most of them had been answered. The transmission line that you intend to build in West Virginia, have there been any update on that?

A - Michael Morris

Yeah, Daniele, I would tell you that there is a tremendous amount of excitement over the potential of what we call the I765 project could do. When we first made our filing at the FERC and our public announcements of what it was that we had hoped that we could accomplish by that, we thought that congestion cost in the PJM for calendar year '05 would be on the order of $1 billion. It ended up that they were in the order of $2 billion, which simply says that the bottlenecking, the flow of energy from west to east into the PJM would be to everyone's advantage. We have had an opportunity to meet with all of the governors of the states affected, all of the regulators in the states that are affected. We continue to encourage the DOE to move forward with their designation of that as one of the principle corridors. We continue to encourage the PJM to go through their process of determining the rate structure and approach that one would take as to the broadness of who would pay for the activity. Finding it as an essential facility for the PJM and of course, we continue to encourage the FERC to make the determinations that are important for them. We feel comfortable about where we are. As you know that's again, too many of the questions that have been asked before, that's a capital before steel goes in the ground kind of projects. So we need to follow that as we go. We're finding very little pressure right now from the environmental side. Some are very worried about what the alignment would be, rightfully so. It’s way premature to talk about that, but again as we did with Jackson's Ferry-Wyoming and as we've done before, we will see to it that the alignment is as environmentally responsible as it can be. That it addresses all of the concerns of the citizens along that route. But the ability to flow a relatively cost effective power into the eastern side of this country on a facility like that would simply be a very good thing for the energy consumers in the Eastern United States.

Q - Daniele Seitz

Can you guess at the timing yet, or because it's such a high profile project?

A - Michael Morris

I would expect that the regulatory process both PJM, DOE and the FERC will surely happen sometime this calendar year. So we think again that's encouraging.

Q - Daniele Seitz

Great, thanks.

A - Michael Morris

Sure.

Operator

Thank you. Operator Instructions We'll now go to the line of Michael Lapides from Goldman Sachs. Please go ahead.

Q - Michael Lapides

Hey guys, one easy quick question. Can you give us an update on the -- just kind of the process in calendar for stranded cost in Texas?

A - Michael Morris

Well, the process is well underway. Filings have been made and the testimony and cross examination of that testimony is about to occur. People have taken their positions. All of which are some well thought through and supportable even by us. Others not well thought through and had reached just overreach. We will, as I said, we're in the midst of some potential discussions on the possibility of bringing some early conclusion to that. I'm always encouraged by that, but never overly optimistic that something like that might happen. So the hearing itself will commence soon. The commission has a time line that they have to follow, and it’s well on its way already. So we feel comfortable again, that that's an '06 event, one way shape or form.

Q - Michael Lapides

Any major risks that we should be thinking about?

A - Michael Morris

Not when I see it upfront. There’s a couple of chunks inside of 1.8 billion that we worry about. But none that I think that anyone's on a firm enough footing in arguing that we are wrong in the way that we've approached this that would have a dramatic impact on the number. If it isn't securitized, then it's recovered as a CTC or flow through in another method or recovered in another method. I don't want anyone to lose sight however, of what we feel is one really large error on behalf of the commission as the way they treated ECOM and the way that our Texas companies pursued the process that one needed to follow on that. And that is an issue that's been carved up for appeal and we intend very much to do that. And that is a big number, that’s north of $400 million.

Q - Michael Lapides

Great, thank you.

A - Michael Morris

Yeah.

Operator

And our final question in queue is a follow-up from Paul Ridzon with Keybanc. Please go ahead.

Q - Paul Ridzon

Can you give some flavor as to the drivers behind the meaningful customer growth you saw in the east?

A - Susan Tomasky

Sure, a couple of things. The most significant of course was the addition of the Mon Power customers. That was about 29,600 customers. The rest --

A - Michael Morris

Paul, I don't want anyone to forget that we are in the M&A game here big time at AEP.

A - Susan Tomasky

The rest of the growth in the east was pretty much typical growth about a little over -- about 1.5%.

A - Michael Morris

I would say and I think Susan touched on this in her formal slide presentation, the other thing that we are seeing is substantial uptick in the industrial energy consumption in the east, which we are encouraged by, very much encouraged by it. As you know the economy in the country seems to be booming along, although the country doesn't seem to recognize it, we surely saw that in the first quarter in our industrial sales, which were up compared to what we thought that they would be.

Q - Paul Ridzon

What sectors are you seeing that in?

A - Michael Morris

Well, we saw it in the primary metals and the chemicals and a couple of others. So we were again very much encouraged by what we saw there. We are very sensitive to the autos, but the autos are very, very small part of what we do. Even auto and auto-related all the way down to the rubber as it meets the road is a very small part of the AEP industrial load base.

Q - Paul Ridzon

Okay, thank you.

A - Michael Morris

Sure.

Operator

Thank you, and with that I'll turn the conference back over to you for any closing comment.

Julie Sloat, Vice President of Investor Relations

Thanks for joining us today. The investor relations staff is available for you for any follow-up questions and Beverly will provide you with replay information for those who are interested. Thanks.

Operator

Ladies and gentlemen, this conference will be available for replay after 2:30 P.M. Eastern time today, until May 4th at midnight. You may access the AT&T replay service by dialing 1-800-475-6701 and using the access code 824284. International callers may dial area code 320-365-3844. Once again, those numbers are 1-800-475-6701 and area code 320-365-3844, using the access code 824284. That does conclude our conference for today. Thank you for your participation, as well as for using AT&T's executive teleconference service. You may now disconnect.

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Source: American Electric Power Company, Inc. Q1 2006 Earnings Conference Call Transcript (AEP)
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