American Electric Power Company, Inc. (AEP) Q2 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Second Quarter 2013 Earnings Conference Call. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Ms. Julie Sherwood. Please go ahead.

Thank you, Ernie. Good morning, and welcome to the second quarter 2013 earnings webcast of American Electric Power. Our earnings release, presentation slides and related financial information are available on our website, aep.com. 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 these factors. Joining me this morning for opening remarks are Nick Akins, our President and Chief Executive Officer; and Brian Tierney, our Chief Financial Officer. We will take your questions following their remarks. And now I'd like to turn the call over to Nick.

Thanks, Julie. So thanks to everyone for joining us today. The second quarter, while in space may seem uneventful, there have been some significant developments that warrant further discussion and define the mile post for future action. The challenges we face with the economy, capacity markets and an industry in transition provide the forcing functions for change. That is exactly what our management team and this company intends to do, face these challenges head on and provide the tools for our employees to be agile and adapt to an ever-changing environment. So from the outset, the financial measures for the quarter were on track and respectable and have not changed our plans for the year or our guidance that has been previously provided. Second quarter GAAP earnings per share was $0.69 per share and $0.73 per share from an operating earnings perspective, which was slightly less than the $0.77 per share for second quarter 2012. So year-to-date puts us at $1.44 per share GAAP earnings and $1.53 per share operating, while again, it's slightly less than last year. The difference in GAAP versus operating earnings primarily is the net of an impairment related to Muskingum River 5, which should not clear the PJM capacity market, and the benefit of a Supreme Court ruling regarding the tax benefits related to a U.K. windfall profits tax. Our board yesterday did approve the quarterly payment of a dividend to investors of record of $0.49 per share, which is AEP's 413th consecutive quarter of paying a dividend. So steady as you go is from the board perspective. With the basic financial numbers for the quarter out of the way, I want to give you my perspective on the challenges we face and what we're doing about them. But first, let me cut to the…

Thank you, Nick. And good morning, everyone. I'll start on Slide 6 with the reconciliation of this year's second quarter to last year's. As you can see, American Electric Power's operating earnings were $0.73 per share for the second quarter as compared to $0.77 per share last year. As I will discuss, this decline of $0.04 is explained by the effect of certain Ohio transition items, with our regulated businesses showing a net favorable impact for the period. The largest item adversely affecting the quarter-over-quarter comparison includes a combination of certain Ohio transition items that were unfavorable, $0.09 per share. This effect on earnings included the reversal of a prior period fuel provision last year worth $0.05 per share and lower capacity payments from competitive suppliers totaling $0.04 per share. Operations and maintenance expenses, net of offsets, increased slightly, adversely affecting earnings by $0.05 per share. The higher expense levels were driven primarily by additional spending associated with storm restoration and incremental plant outage work performed in 2013. We continue to focus on controlling our expenses across all functions, particularly overhead costs, and expect to see this impact back-end loaded in 2013. We anticipate that O&M, net of offsets, will be close to flat when compared to 2012 on an annual basis. We will discuss this more later. Weather played an unfavorable role in our quarterly earnings comparison. Temperatures were milder across all of our jurisdictions, adversely affecting results by $0.04 per share. However, weather was $0.02 per share favorable versus normal. Allowance for funds used during construction, or AFUDC, was up $0.03 per share in 2013 versus 2012, due primarily to the startup of the Turk plant in December of 2012. With the inclusion of Turk in Louisiana and FERC wholesale rates currently and with the anticipated rate order…

[Operator Instructions] And we'll go to the line of Greg Gordon with ISI Group.

So I hear your enthusiasm and optimism about the ongoing ability of the company to improve ROEs in states where you're under earning and control costs. But I -- there's still a lot of skepticism about the very significant headwind between 2015 and 2017 coming from the most recent PJM capacity result as it pertains to your ability to sustain your 4% to 6% growth rate. So can you just talk a little bit more about your planning horizon and what you think the tools are in your toolbox to plow through that headwind?

Yes. Greg, I guess we sort of learned this early on in my tenure. We had a $250 million problem with Ohio. And now, this time around, we have 2.5 to 3 years to get this fully resolved from a sustainability fashion. But as I mentioned earlier on the O&M issues and the revenue enhancements that we have going on, we've -- it's crescendo-ing over time. And like -- the plant ideas were an example of that, where you have 6 to 8 plants going through it next year and then the rest of the plants going through the following year. And then we also have the buying measures, the differences in the way they operate the plants. Certainly, the unregulated plants are now looking at -- I mean, they can look across the board at areas of fuel. I mean, fuel is part of the business case for some of the things that they do, which typically is hard to do in a regulated environment because of the different capital versus fuel decisions. But also, Chuck is looking deeply at that team to figure out, okay, what the overhead costs look like. We have to address that because it's in a competitive environment. These plants are focused on making sure they survive. And they intend on doing that. So I think -- and really, I guess, the optimism is coming from the fact that our employees have already come together to find objectives in terms of savings and revenue enhancements for the year that -- or in excess of the targets that we had in place, and that's sort of confirming this year. But also, it's setting the track record for the future years because we're only getting partial benefits of some of these in '13. Some of these…

Next, we'll go to the line of Dan Eggers with Crédit Suisse. Dan Eggers - Crédit Suisse AG, Research Division: Listen, I'm going to maybe carry on with Greg's question. And I know you gave a very thorough answer. But I guess just maybe a little more simply, when you look at the Ohio generation and the uncertainty that RPM has created around economic viability and visibility to the business, how are you guys seeing that fit within AEP? And was RPM kind of a point where you were pushed to make a more drastic decision than maybe you were hoping?

Yes. I think, certainly, if capacity prices had stayed in there at a reasonable level, it probably wouldn't have had everyone questioning the 4% to 6% or the -- or our ability to get the cost savings that we needed to make sure we were sustainable into the future. I think it raises a lot of questions, and we're addressing those questions. It's -- but it also puts us even more focused on how we adjust that particular business. And when we talk about minimum load adjustments, for example, I mean, the Amos plant reduced its minimum load by over 1,000 megawatts, which -- that's a big change. It takes a lot of cost out of the way we operate in relation to the market. Our people have a very -- I'm not going to say what it is. But certainly, they have a very aggressive measure on what they're trying to achieve in terms of a clearing price for capacity that they operate under. And that's -- but we have a lot of work to do, but -- and I can say that, that business, if it remains as volatile as it is, if we don't get this capacity construct working to where it should, where it respects the long-term investments made by steel in the ground investors in the territory, then that's not something we're very interested in. And so I -- it doesn't fit what we believe our investors are looking for, and we'll need to make adjustments.

Dan, I know you've talked about this in the past. We were very aggressive in moving our Muskingum River 5 as we saw the results of this and recognized that the capacity environment didn't lend itself to invest -- further investment in that unit. And we're going to be very disciplined in terms of the capital that we put to work in that regard. And right now, that's not an area that's attracting a lot of capital from us as compared to lower-volatility, higher-growth areas like our transmission business. We're -- we've been disciplined in the past, and we're going to demonstrate that discipline as we work our way through this capacity pricing issue.

And I don't know that the generation function itself can make up that difference. I mean, if you're thinking about what energy prices can be in the future -- well, we don't want to bank on what energy prices are going to be in the future. We just assume they're going to be low. So we have to adjust accordingly. And it's not just a matter of looking at the generation -- the unregulated generation business itself. It's also a matter of looking at the overhead that's charged to that generation business because if there's less units running, if they're running in different ways and you're compartmentalizing the profit-loss picture of each unit, then it drives a very different supporting structure from corporate that supports it. So there's a lot of work to be done, and we'll be doing it. Dan Eggers - Crédit Suisse AG, Research Division: And Nick, I guess one other question is kind of looking at the load trends and, obviously, the bankruptcies to just kind of skew the industrial numbers maybe a little worse than they otherwise would be. But usage trends haven't been great. You've seen unemployment fall. You've seen economic growth in the region. What is the prognosis, do you think, for power demand growth for your territories going forward? And is there something bigger structural happening from usage that's really going to limit the amount of future demand growth?

I think we continue to see probably soft load because -- and it's probably 2 things. I mean, energy efficiency is part of it. Also, it's an area where the economy -- and through the entire country, but certainly in our area as well, there's been a lasting impact of that. And at the first of the year, economists were saying by the third quarter, things would pick up. We were always saying and have been saying for several quarters now, actually since the third quarter of last year, the industrials were tenuous at best. And that continues to be the case. I think there are some structural changes that are occurring. We'll continue to have energy efficiency in play. The question is, can the electrification of the economy outstrip the energy efficiency piece of the business that enables us to continue to grow. But you can't bank on that. And that's why I say our business is going to be more about optimization and providing services to customers as well that provide additional benefits beyond what you see just strictly in the load numbers. But I also believe that, and as Brian pointed out, the oil and gas activity in our footprint is prevalent, whether the Eagle Ford Shale or the Utica Shale and others. Those are wet gas, and we have a lot of dry gas top formations. If we can -- if we ever get to a point where the economy starts to pick up like the economists keep projecting, at some point, we'll benefit probably more than others because of that indigenous growth associated with the shale gas footprint and the production capability associated with it, so -- and that's actually been our saving grace on the other primary metals industrial losses that have occurred. So I'd say, certainly, with the growing economy but also with the intensive focus on energy-related infrastructure, particularly in our service territory, that could be a benefit, so I -- and I'm probably more optimistic. I guess I'm probably -- if there's -- if it's pessimism, it's when is it going to happen. And we've all been waiting for an economic recovery, and you hear a lot about housing construction and I see a lot of commercial and housing construction in our service territory. And I also see the top of the -- all the corn in the fields are still green. So that's a good sign. But we really do need an emphasis placed on how to move this economy forward.

Next we'll go to the line of Anthony Crowdell with Jefferies.

Hopefully, 2 quick questions. One is, it seems everyone's focused on the '16 and beyond. Just wanted -- how could you help us maybe forecast like transmission earnings? I mean, you guys have a great trajectory of transmission earnings, I think roughly $0.35 you're projecting in '15. I mean, what's the best way we could do to forecast that going forward? And the second question is kind of, you mentioned during your opening remarks with RPM and it just seems like it's all over the map. It's just kind of throwing numbers out of a hat. What does AEP think the reserve margin is with actually steel in the ground versus when you're adding in all these demand response and everything else?

Yes. So I guess it's what steel you put in the ground that's important. We've already finished our build cycle-related generations. So Turk went operational. We bought natural gas. That's all done in our Eastern footprint. And so we're at a point where we can decide for the -- probably for the first time in a long time where our capital was deployed. Much of it was driven by environmental spend. It was driven by new generation spend. Now it's driven by block and tackle infrastructure spending that typically commissions don't have an issue with. Matter of fact, they support it. And they should because we are at a stage where there's a rehabilitation of the grid that needs to occur. What we're trying to focus on is whether those no-regrets types of activities and optimization of transmission is no regrets. Infrastructure build-related distribution is no regrets. Certainly, the investment we're making from an environmental standpoint, we have about $4 billion to $5 billion left to spend associated with the particular plants that we have. But we're doing it in very different way. We're not going out and building and then asking for recovery of it. We're going in at the beginning and saying, "Okay, before we start construction on this thing in a big way, we need to know, are we going to be able to recover it?" And in the case of Kentucky, we haven't. In the case of Arkansas, we have, because there's a different set of circumstances and we're more than willing to do that. Matter of fact, we want to move more of our capital to those infrastructure areas. And that's the kind of steel in the ground that makes sense. With demand-side resources, certainly, I'm all for demand-side resources, but not to the point of really jeopardizing the reliability of the grid by depending on those kinds of resources for only a specific set of hours during the year, as opposed to the things that we run into in the real world from an operational perspective. I started out as an electric system dispatcher, and my experience is actually in interconnected power system operations. And I can tell you, what's going on now is wrong and it needs to be fixed. But that said, demand-side resources, certainly, generation with firm transmission coming into the area is a benefit. And we should be mindful of that because we're optimizing resources and we're actually defining a new set of resources that includes new technologies as well. So my view is, we stay with optionality around resource side of things, but we focus on those enabling areas where we can accommodate those resources and provide better services to our customers.

Anthony, we hope to have some more detail for you on the growth trajectory of transmission about the EEI conference timeframe. We're working on that capital rotation now. And one thing that we've never done is showed you earnings that we hope to get or think we might get or projects that may come together. We've really tried to show projects that are either approved or don't need further approval. And that's why we're reluctant to go out too far in terms of the transmission growth rate beyond areas where we've been through the planning process at the RTOs.

And Anthony, I mean, I'll add on to that. We're already looking at additional transmission that can be -- I think like projects that can be put in place and addressed more quickly because, frankly, that's part of the revenue stream and the additional earnings that would partially fill the gap for this capacity issue that we had. So we have every motivation to continue with our transmission investment and every motivation to find and release every bit of capital. And the one thing that gets forgotten in all of this, the performance management side of things also produces capital alleviation benefits that can be -- they can be redeployed to other areas, including transmission. So we're not just about O&M changes, we're about capital changes as well to accommodate that and fuel that future growth. So as Brian said, at EEI, we'll have more information on that.

And next, we'll go to the line of Jonathan Arnold with Deutsche Bank.

Just quick one on -- so on the -- just the quarterly sales in commercial, you mentioned, Brian, I think, that you were strong still in Texas and Ohio, but you didn't really say very much about what had underpinned the big drop. Was it a couple of specific items or something more broad? Can you just give us a bit more color on what certainly turns the negative there?

Sure. It was -- and it was largely broader-based across the area. The place where we saw -- places where we saw the increase was really associated with shale gas plays, where we're seeing the growth in employment. And in the other areas, we just weren't seeing that growth in employment as much as we were. And it was pretty much broad-based across the sector. The one thing, Jonathan, that I'll say, and we look at these monthly. We look at -- we discuss with you quarterly weather-normalized sales. You really need to look at, I think, the trend over time to try and understand what's happening with load and can't just take it quarter-to-quarter. Up modestly in the first quarter of this year, down greater than 2% in the second quarter. You need to kind of look at a trend line for these quarterlies to get some sense for what you think is going on. But with the exception of Texas and Ohio, the decrease was pretty broadly based.

Okay. And secondly, on the -- just to understand this interest income item. So there was like $0.06 of benefit relating to reversing a previous negative related to the U.K. windfall tax. Is that correct?

Yes. So it's separated into 2 categories: one is the interest income component of it, and the other is the tax component of it. Interest income, we always reflect in ongoing earnings. To the point where it's specifically associated with this item, we had a negative in the fourth quarter of last year, as we thought that the case was going against us. And then the PP&L won their case at the U.S. Supreme Court. And since we had previously adjusted for this in operating earnings, the interest income component were just reflecting the same treatment that we always had for interest income.

So it's -- the negative, it was the -- the negative was booked Q4 last year. This reverses that, effectively?

It doesn't entirely reverse it. We took a partial write-down of that in the fourth quarter of last year, where we had previously accounted for the interest income, and then we had the full reversal in this year. But the full treatment of this issue has always been in ongoing earnings.

Okay. Is there any ongoing -- beyond this quarter, do we have any continued impact from this item?

Very little bit.

Okay, so -- and how -- just in Q3 or is that...

It will be true-ups as we work our way through the balance of the year, but very little.

Okay. And then could I just squeeze in one other thing? On the whole -- this conversation going on with the commission and Ormet around trying to reduce tariff, does -- how does -- how should we -- is there any kind of guidance exposure to that? Or how should we be thinking about that as we watch it play out?

We -- so I wouldn't want to talk specifically about the discussions with the commission that we're having. There are issues related to whether or not Ormet stays in business or not altogether. And those items are fairly small for us. If Ormet were to stop operations altogether, the pretax would be about $2.8 million per month, so for the balance of the year, maybe $0.025, and for all of 2014, maybe $0.045 per share.

That would be the -- that would be not -- but the incremental would be the difference?

That would be if they -- that's right. And that would be if they ceased operations altogether. But remember, Jonathan, there will be some offset for that as well in off-system sales as we've had the incremental energy to take out to the market.

Yes. It's a large load, like many of these industrials, but that one in particular. And if you -- we don't hardly make any money off of it to begin with. But then, if it did go away, then we'd be selling it at any off-system [ph] market, so...

And our final question will come from the line of Steven Fleishman with Wolfe Research.

Just on the PJM outcome and implications, does it have any change besides Muskingum 5 to your kind of coal plant shutdown plans or EPA spend? Are those under any kind of review because of that?

I'd say no, not at this point, obviously. We've addressed Muskingum River 5. That was the one issue where we had an incremental investment that would have to be made and was related to natural gas, so -- and if the market didn't support making that investment, then we retire it. The others are either planned to be retired anyway, which we've already written those off in terms of an impairment. So the others are fully controlled units that operate well in the market and -- but we're certainly focused on that year to ensure that we're driving costs out and efficiencies that we can drive through the market and make sure they continue to operate. So we don't see anything else at this point.

Yes. So Steve, we've been proactive in getting out in front of this. As Nick mentioned, we had those units that we knew we were going to retire in 2015, and the Ohio components of them we wrote off late last year. And then we had bubble units, and Muskingum River 5 is one where we thought we were going to be able to retrofit it and run it on gas through 2028, and the capacity results just made that not a prudent investment for us. So it went from being on the bubble to being a unit that makes sense for us to not operate after 2015.

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

Thank you very much. And ladies and gentlemen, this conference will be available for replay after 11:00 A.M. today until August 1, 2013, at midnight. You may access the AT&T Executive Playback Service at any time by dialing 1 (800) 475-6701 and entering the access code 297308. International participants may dial 1 (320) 365-3844 and using that same access code, 297308. This does conclude our conference for today. Thank you again for your participation and for using AT&T Executive TeleConference Service. You may now disconnect.