美國電力 (AEP) 2010 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the second quarter 2010 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Treasurer and Senior Vice President Investor Relations, Mr. Chuck Zebula. Please go ahead, sir.

Thank you, Bob. Good morning, and welcome to the second quarter 2010 earnings webcast 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 forecast. Joining me this morning are Mike Morris, our Chairman, President and Chief Executive Officer and Brian Tierney, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Mike.

Thanks, Chuck, and good morning everyone. Thank you much for joining us for our second quarter update. We had a $0.74 per share quarter on ongoing earnings. Something we're very pleased with, clearly above what appeared to be the consensus forecast of how we would do. There really were some very interesting load issues that were contributors to that, and Brian will give you some granularity about that as we go forward. And like most of the other reporting utilities for the quarter, our best friend has been the weather, and that has been good to us as well. We have talked at length about how we would manage operating and maintenance expenses at American Electric Power over the last handful of years. And as we looked at the results of the first quarter and early into the second quarter, we decided to take relatively dramatic actions on that front which will help us, not only in 2010 to achieve our earnings range targets, but should help us going forward for the next two or four year cycle, and we feel that our team is prepared to continue to demonstrate the discipline that will get us there.

When we looked very closely at 2010, we're confident with our earnings guidance range of $2.80 to $3.20. I'm sure that many of you might like to tip up on that (inaudible), we don't feel that now is the time to do that. If we decide to make an adjustment in that guidance range, it would be after we see the third quarter. Because again, as Brian will share with you, there have been some ups, there have some downs and there has been some flatness in the demand as we look at energy consumption throughout the United States. The macro economic issues that you hear about and we hear about, some say no chance for a second dip, some say for sure. Consumer confidence is low, retail spending is low, and many of the things that we look at and control, those decisions are telling us let's be midwest conservative, and that's exactly what we intend to do.

On the regulatory front, we have $300 million rate adjustments in hand to date of the $320 million target number that we began the year with, and we feel very, very comfortable with a number of pending issues still being reviewed that will meet or exceed that $320 million target that we began 2010 with. That really tells you a great deal about the value of regulatory diversity. We have had some jurisdictions where things have gone surprisingly well and others where they haven't gone as well. In fact, they have been somewhat disappointing. But the diversity surely has proven to be a benefit as I know that many of you realize. In fact, over the last six years, we have either met or exceeded our target because of that regulatory diversity. And I would argue that that shows some of the logic of the scale and size of the footprint that American Electric Power has.

A couple of specific issues on the regulatory update. The Ohio seat activity continues the pace. Duke Energy had sought rehearing on the original order of the seat structure. And the PUCO decided that it would make no sense to begin hearings on something that was already up for rehearing, so they intend to settle the rehearing issue first and then go ahead and process the seat cases as they suggested. They have moved the filing date to September 1. We're prepared to file at that time. I continue to believe that no matter what the outcome is, it will be extremely digestible for us. It will keep us within that [$2.80 to $3.20] range, and it will give us a good path forward so that we can stay within the 2% to 4% growth targets that we have spoken to you about as we look at 2011, 2012 and years beyond. When it comes to the Turk update, we continue to build on time, under budget, and with as much safety focus as I would hope that you would expect that we would have.

And we continue to defend in every court, in every jurisdiction, wherever those who would not like to see this coal plant built, go forward. I know that you all know that we have chosen the merchant approach, or the non-rate treatment approach with the 88 megawatts that are focused for our customers in Arkansas, and so be it. We feel that's a very supportable and in fact, appropriate way to go. We are still going to take the output of the Turk station to our Louisiana customers and Texas customers through the certificates that were issued in those states. As I mentioned, we will continue to defend and continue to build, and we know that an ultra super critical plant is necessary for this country. Necessary for our customers, necessary for our Company, and we will continue to pursue that with all vigor.

The transmission update is actually beginning to show some signs of encouragement. It is clear to us the FERC notice of proposed rule making is nothing but good news. They will attend to the issue of cost allocation and ultimately get to the interstate process of saying that facilities that serve the many should be paid for by the many and in fact, we're comfortable that that's the way that they will go. Their support of the SPP cost allocation method is something that be has been dubbed highway/byway, it is something we believe in very strongly. And we think that and hope that the FERC NOPR lead us to that point on cost allocations. There are many in the utility space who would like to argue that that shouldn't be the way. The driver for them is raising the cost of electricity, the driver for us is lowering the cost electricity throughout the country, and we think we will win that event as we go forward.

As to the ability to plan for and get authority to build facilities, we think the FERC NOPR will also address that in a very strong way. Congress continually suggests to the chair and others of the FERC commissioners that they have this authority to do these issues. The NOPR should put more strength behind that authority and if need be, ultimately legislation will support that as well. The rationalization of the power generation fleet in the United States, the continuing increase with renewable energy will all be served by a more robust transmission grid. Something that American Electric Power has been the champion of for decades and clearly, with a focus in the last handful of years, and we're comfortable that that is all moving in the right direction.

The PJM decision to one more time ratify that path as the best electrical plan as well as economic plan to decongest much of the PJM where power prices are substantially different on the western front versus the eastern front was a good decision. The timeline has been moved up, and we are moving at pace there as well. There are others who are making late in the game filings. Those will all go through the PJM process, and it will get sorted out as one would expect that it should. So, when we look at midterm and long term plans for our transmission proposals that we have been after for a number of years, we see it as nothing but good news.

The federal legislative update is something that I probably could take the rest of the call over. I think it is interesting to see how this unfolds. We were, along with other colleagues, in a number of meetings with members of the United States senate on both sides of the aisle a week ago Tuesday, and there was no consensus among two democrats, let alone 60. There was no consensus among two Republicans, let alone 60. I don't see a horizon where 60 votes come in favor of a carbon proposal in 2010. The White House has suggested through the czar of energy, that if we don't do it in 2010, we probably won't do it until 2013, and I will let that statement stand for itself. It is interesting, as I look back at this industry, I have been at it a long while, as I know many of you know. In the 1990s when I was in New England, it was an assured American gospel that the nuclear fleet would no longer exist by the early 2000s. All were forecasting the demise of the nuclear fleet and I'll be darned, that didn't happen.

So, here we are in 2010, and everyone is forecasting the demise of the coal fleet. And I would argue, as we get to 2015 and 2020 and beyond, the coal fleet too will survive just like the nuclear fleet did. Clearly different, clearly cleaner. A bit more expensive, but nonetheless, coal will continue to be a major player in the base load generation of this country and American Electric Power's fleet will be doing just that. So when we look at these events, we aren't troubled by them. We will react to them. The EPA is moving forward with rules and regulations that they feel are verifiable. All of them are under challenged, all of them will remain under challenged and eventually, Congress will speak to the issue. We are strong supporters of the Rockefeller approach, to say to the EPA, let the legislators, just as the White House has suggested, address all of these issues. Rather than going forward in a non-voted for regulatory scheme that is driven towards the notion of putting this country in a very difficult base load power situation, and I expect all of that will move forward in the next few months and the next few years.

Let me dovetail into something that is important for us, and that is the new operating company model. One of the things that I think our regulatory success has shown over the years, is that the focus of attention on the regulator and the customers in the states that we do business has served us well. And what we intend to do with the reorganization structure and the cost controls that came from that activity is to put more power in the hands of the instate operating company presidents and give them greater line of sight over the capital expenditures. I know that Brian has talked to many of you at length about that, and it is a project and an undertaking that we feel strongly about. We think that it will continue to allow for a much clearer line of sight for states as they look at the environmental challenges going forward and the decisions that need to be made as to whether one would retrofit a plant or replace that plant with combined cycle natural gas facility.

So, we feel very comfortable about the plans that we are pursuing, we feel comfortable about 2010 guidance, we feel comfortable about our 2% to 4% earnings growth strength at American Electric Power as we look at the next few handful of years. And, we feel comfortable that the US Congress will not allow the lights to go out in this great country. With that, I will get off my soap box and turn it over to Brian. Brian?

Thank you, Mike. If we could turn to slide four, we will take a look at the quarter on quarter comparisons. AEP's ongoing earnings for the second quarter of this year were $355 million, an increase of $34 million over the last year's result of $321 million, which was $0.68 per share. This year we are reporting $0.74 per share for the second quarter. Let me take you through the factors that account for the changes.

The share count increase accounted for a negative $0.01 for the quarterly comparison, reflecting 479 million average shares outstanding this year versus 472 million in 2009. Rate changes accounted for a positive $0.03, or $22 million. These rate changes came from multiple of our jurisdictions, reflecting the jurisdictional diversity that Mike referenced. Retail margin, which reflects retail sales at our utilities, net of rate, weather and firm wholesale load effects, accounted for a positive $0.05 per share, or $33 million.

Firm wholesale load, which reflects long term sales to utility and municipal systems accounted for a negative $0.03, or $22 million and reflects the loss of two wholesale customers. Since the economy is not recovering as fast as we would like, weather has been our friend this year, accounting for a positive $0.05 per share, or $34 million versus last year. Off system sales net of sharing accounted for negative $0.02 per share, or $12 million compared to the second quarter of last year. We will discuss these results further on slide eight. O&M expenses net of revenue offsets accounted for a positive comparison in the last year of $0.07 per share, or $51 million. $33 million was associated with underspend at our distribution operations, and $25 million of that was associated with the recent storm costs deferral order. The remaining dollars were associated with lowered expenses in plant maintenance and lower expenses associated with the headcount reduction across all of our companies.

Other utility operations net reflects negative $0.10 per share, or $75 million and primarily reflects the absence of Cook accidental outage insurance for $46 million, higher interest expense of $10 million, higher depreciation and amortization expenses of $6 million and the higher effective tax and other taxes of $13 million. Finally, non-utility operations parent accounted for positive $0.02 per share, or $12 million and primarily reflects the gain on our remaining investment in the intercontinental exchange.

Turning to slide five, you will see that for the year to date, AEP is reporting ongoing earnings of $720 million, an increase of $39 million over last year's result of $681 million, which was $1.55 per share. This year we are reporting $1.50 year to date, and I will take you through the factors that account for that change. We had an increase in shares outstanding which accounted for negative $0.14 per share. This reflects average shares outstanding of 479 million this year versus 440 million last year. Rate changes accounted for a positive $0.17 per share, or $112 million and also came from the multiple jurisdictions as was the case in the quarterly comparison.

Retail margins were up $21 million, or $0.03 per share due to recovery across all customer classes, and I will talk more about load on the next two slides. Firm wholesale margin accounted for negative $0.07 per share, or $46 million in the year to date period. As was the case in the quarterly period, weather was a positive contributor versus last year's results, accounting for $0.11 per share or $71 million. Off system sales net of sharing was flat, and we usually don't have flat comparisons in these waterfall type discussions, but we are going to have some more discussion about that on a later slide. O&M expenses, net of revenue offsets accounted for positive $0.10 per share, or $66 million and is driven primarily by the same factors that I reported in the second quarter reconciliation.

Other utility operations net accounted for a negative $0.24, or $185 million and is comprised of the following contributors -- Cook accidental outage insurance of $99 million, higher depreciation and amortization expenses of $31 million, higher interest expenses of $25 million, a higher effective tax rate of $14 million and higher other taxes of $11 million. Let's turn to slide six and take a look at the normalized load trends. The top left-hand side of the slide, you will see that residential sales on a normalized basis were up 0.3% for the quarter and up 1.1% for the year to date period. Residential customer accounts are improving modestly, and housing starts were actually up 20% versus the second quarter of 2009. AEP commercial normalized -- commercial normalized sales -- the top right-hand side of the slide, were up 2% for the quarter and are now up 0.3% for the year to date period.

They tell us that commercial sales lagged going into and coming out of the recession, and we're encouraged by what we see in the commercial sales category. In the bottom left-hand side of the slide, you will see that industrial normalized sales were up 9.4% for the quarter and are now up 4.2% for the year to date period. Excluding a large -- two large aluminum customers in the east, the quarterly number would have been up 12% and the year to date number would have been up 8%. We will discuss industrial sales more on the next slide.

Finally, in the bottom right-hand side, you will see total normalized sales are up 2.5% for the quarter and up 0.4% for the year to date period. This includes the firm wholesale loads that we have discussed earlier in the call. Finally, unemployment in our service territories continues to struggle. In our east service territories, unemployment stands at 11.2% and in the west portion of our service territory, unemployment stands at 8.3%. This is compared to a national average of 9.5%.

Let's take a deeper dive into some large industrial sectors on page seven. The top five sectors that are listed in this slide account for 60% of our industrial gigawatt sales in the second quarter of 2010. As a group, these five sectors were up 9-point -- were up 9%, versus the second quarter of 2009 and reflect a year to date recovery of 3%. The group also saw a 2.3% sequential improvement versus the first quarter of 2010. AEP's total industrial demand improved 9.6% from the first to second quarter of this year. Notable standouts in these five categories include primary metals, which are up 14.6% in the second quarter of 2010 versus '09, and 0.5% year to date, chemical manufacturing is up 10.8% for the quarter and 6.8% for the year to date period, and paper manufacturing is up 10% for the quarter, and 7.2% for the year to date period. Other notable trends in our top ten industrial classes include plastic and rubber products, which are up 15.2% for the quarter and 10.7% for the year. Transportation is up 10.7% for the quarter, and 8.6% for the year, and oil and gas extraction is up 11% for the quarter and 11.3% for the year.

If you turn to slide eight we will take a look at off system sales gross margin details. You can see that in the top half of the slide, gross margin from physical sales were up $8 million to $45 million from $37 million for the prior period. Volumes were up 10%, largely led by a 37% increase in the June volumes. Pricing was up 13% versus the year prior period to $35.50 a megawatt hour versus $31.44 a megawatt hour, and trading and marketing results were lower by $20 million. Similar results are what we saw in the year to date period where we saw physical off system sales margins up $27 million, volumes were up 40% versus last year, AEP date and hub pricing was up 5% to $37.22 from $35.61, and we also witnessed lower trading and marketing results by $24 million for the year to date period.

Finally, turning to slide nine, if we take a look at what the outlook looks like for the balance of the year period, we continue to see retail load volume and margin recover slower than we had previously anticipated. We're encouraged by what we're seeing in industrial and commercial demand, but it is still trailing our forecast for the year. Year to date, our total load is up, as we saw, 0.4%, but our annual load increases were forecasted to be 1.6%. This would require -- to get to this number -- would require a balance of year load growth of 2.8%, and we're just not seeing that in our service territories. As we have just said, off system sales are flat on a year to date basis versus 2009, but our guidance reflected an $82 million increase to $329 from $247. Prices for the balance of year 2010 are still greater than the liquidations of [29], but they are below our forecast by what we have seen so far in off system sales for the month of July. Rate changes remain on target. As Mike said, we're at about $300 million, on our way to the $320 million that was reflected in guidance, and we expect to be able to close the remaining $20 million or so.

We promised to talk in more detail about the O&M cost reduction and restructuring program, and we will do that in some detail now. This program includes both labor and non-labor components. I will talk a little bit about the labor side of the reductions that we have had. As you can see, we have reduced or severed 2,461 employees, and many of you have asked for details of the severances. The average age of the employee was 57 years. The average years of service was 29 years, the average salary was $74,000, and the O&M to capital split was 75% O&M, and the remainder going to capital. Many of you have you asked about the savings associated with the combination of these labor and non-labor savings. For 2010, we expect to be able to realize $150 million of O&M savings, $70 million of which were labor and $80 million of which we expect to be non-labor. In 2011, we expect to be able to realize $200 million of O&M savings, of which $120 million is labor and $80 million is non-labor. These sustainable O&M savings will help to offset O&M increases in other categories during future periods.

Mike referenced the operating company refinement model -- operating company refinements that the we're going through, clearly placing greater responsibility for the spending investment and the balancing -- for balancing spending and investment with the cash flows and balance sheet strength of the companies, if the operating companies will allow us to change in conditions going forward and will certainly set us up for future success in that model. With that, we are reaffirming our 2010 earnings guidance at $2.80, to $3.20 per share for the factors that we have mentioned and discussed in the earlier portion of this call. With that, I will turn it back over to the operator for questions. Bob?

Thank you. (Operator Instructions) One moment please for the first question. And first question comes from the line of Dan Eggers of Credit Suisse. Please go ahead.

Hello, good morning.

Good morning, Dan.

Mike, I was wondering if you could share maybe some more thoughts on the EPA action around the CAVR rules and the mercury coming in the first quarter. And how are you guys looking at the decision of retirements versus more environmental CapEx upgrades and what kind of conversations you are having with your regulators to prepare them, inevitably for a lot more capital and rate increases that are going to --?

Well, that's a perfect question, Dan. The fact of the matter is, as you know, most of those rules will be challenged. When you look particularly at the transport rule, it affects the states every bit as it affects the operating industrial customers within those states. And we're beginning, through the operating company model, to share some of the impacts that this could mean to the various jurisdictions. Our intent would be to, as you heard us say many times before, retrofit those plants where capital investments have already been made and approach the regulator in a very logical way to say here are the costs associated with that.

To the extent that you go to a regulator and offer that, well, either A, shut down this plant or replace it with combined cycle natural gas plant, they will be partners in those decisions without stepping over their regulatory authority line. And we think that that is an appropriate way to go about it. As you continue to look at the series of events that the EPA has on their plate, to go forward and implement, you really do get to a situation that becomes a bit frightening about the prospects of the coal fleet to continue to operate throughout the country. I know that some of my colleagues have talked about this in their earnings call in forecasting 30,000, 40,000, 50,000 megawatts of coal fire generation going offline. I think that is no different than the forecast of the nuclear facility some years ago, as I said.

The fact of the matter is base load generation will be needed. These existing fleets will be needed, and the EPA's rules will get adjusted to the reality of the economy. I know that some people talk about that as a massive increase in the commodity cost of electricity. In the next two or three years, as the US economy struggles going forward, I can't imagine a scenario where those laws and rules will be implemented to the extent that some think that they might be.

The legislative interference in the ability to slow all of that down, we're seeing it all over the world. The European union, many other countries, all are beginning to look at the economic ramifications of that. So our plan has been consistent. We have a series of stations that we're prepared to lay up, which we have done, and ultimately retire if need be. Those that we are already dedicated to retrofitting and using, we have taken a long hard look. Converting to natural gas isn't the best option for our customers, but replacing generating facilities with combined cycle natural gas at those sites where water and electric ingress and egress are there tells us that that is the approach we ought to take, and we will.

We will work all of that in concert with our regulators, because our goal isn't to raise the cost of commodity energy, which some of my colleagues think is a great place to be. Our goal is to continue to improve the environmental performance of very cost effective power plants, and that is what we're going to continue to pursue. So, this is not some nightmare scenario that you can say good night to king coal. That's not going to happen in the United States. That is not going to happen anywhere in the world.

Okay. So, you -- Mike, your thought process then is that you're going -- this is going to take longer than probably what the EPA and some of us have been thinking toward? How long do you think it is going to take to get implemented, then?

Well, so let's just think about it. So the transport ruled ultimately comes in the first phase in 2012, and the actual implementation date is mid 2011. In six months you can not design, contract and build any of the retrofit facilities you would have to do to get there. So the practical reality of that is we're looking at the mid decade before you really see implementation of any of these events that are going to cause a major, major shift in the generation fleet. And by that time, quite honestly, Dan, if you begin to see the economy recover, which many people think that you will by the mid decade, harken back to 2008 when every power plant that could run was running. Take 10,000, 15,000 megawatts of power off of here, and you're looking at South Africa, Venezuela and South Korea and the United States being without base load generation. That is not going to happen.

Okay. And Mike, I guess just one other question. Can you share with us what you're hearing from your industrial customers as far as the outlook for the second haf of this year? Is the strength of the second quarter going to continue? Or is this more of one of these restocking conversations where they are looking to maybe start slowing down already?

I think it is probably a bit of the latter. As you know, there is a great debate whether we will find a second dip in this recession or whether we will just flatten out for awhile. I think when you speak to many of our larger industrials, particularly the metal melders that Brian gave us some granularity over, they are eager. I know the guys at Century would love to get going again. LMEs at $2,000 plus tells them that the market maybe okay for them. World wide demand for aluminum continues to grow.

But at the same time,their labor costs -- we have offered them energy prices that should clearly bring them back online. They need to address their labor issues. So, it's -- I don't think it is pure restocking. I think they are all being very careful about their inventory levels. Brian said something about the housing starts. But we all know that the minute the government pulled away the first-time buyer incentive, the housing starts crashed in June and the same in July. So I -- that's really why we're keeping our guidance where it is. We see some encouraging signs, but it would be premature to adjust with what we have seen for the first half of the year.

Okay. Thank you.

Yes, you bet, Dan.

And next we go to the line of Jonathan Arnold, Deutsche Bank. Please go ahead.

Good morning, Jonathan.

Good morning. I have a quick question on the operating company management changes. Is that -- how should we think about that in terms of financial impact? Is this something that is incorporated within the savings targets that you gave us on the call this morning? Is it something that is going to in the longer term generate additional efficiencies, or is it more of a kind of a strategic and sort of non-financial shift? A bit more color around that and how to bake it into some of those financial numbers you put out there?

Sure, so let me handle the first side of the strategic, and then I will ask Brian to address the cost containment and discipline that is associated with it. The biggest change here is that the capital utilization model for transmission distribution and generation will be much more in the control of the operating company president. And the logic for that is that it goes back to Dan's question about how we're going to go forward and manage the generation fleet.

In our company, like so many other companies, the generation capital investment dwarfs the transmission investment, and is just a bit north of what is invested in the distribution assets going forward. So the dialogue with the state regulator, again, is going to be -- for instance, we have a coal production facility in the state of X, and we can either retrofit it for Y dollars with this kind of rate impact, or we can replace it with combined cycle natural gas facility for Z dollars, with this kind of costs for the customers all intended to make sure that we have the most cost effective electricity available in your state governor regulator so you can continue to grow jobs inside your footprint. We think that that strategic alignment and that partnership in the regulatory compact with the regulator and the executive officers of our 11 jurisdictions will serve us well, our customers well, the political as well and most importantly, our shareholders well as well. So that's the strategic side of it. On the financial side of it, Brian, why don't you kick in?

Yes, so clearly, the strategic components that Mike referenced are clearly there. There is also tactical financial components of it in that we wouldn't be able to realize the $150 million in savings this year in the $200 million sustainable savings going forward to offset other increases if we didn't have the operating company presidents out there working with their colleagues in the transmission side of the business and the generation side of the business. And clearly, what we're trying to do is to match the cash flow from the operating companies with the balance sheet strength that we're seeing and allow the operating company presidents to pull the levers that they need to optimize the return on equity at those operating companies. So the model definitely gives us the opportunity to do what we've been talking about tactically in terms of savings, and we certainly will be able to reap the investment benefits that Mike laid out for the long term.

Thank you. If I could just follow-up on the -- you talked about the $200 million of sustainable savings to offset other increases. As we think about 2011 and we think about O&M, should we be thinking around the incremental savings, 11 over 10 and then normal inflation on everything else, or how should we be starting to think about modeling that?

That's probably a good start, Jonathan. We're going through that process certainly ourselves right now and have dispatched this new operating company model out there to take care of working through those numbers, but I would think that would be a good place to start. And what I wouldn't want you to do is to take the forecasted O&M that you have in there for 2010 and assume that $200 million is going to come off the top and that's your 2011 number.

That's great. Thank you.

And I would just add to that Jonathan that, keep an eye on the 2% to 4% per year growth rate in earnings. That is what we're managing toward and that is what we will dedicate ourselves towards delivering to our investors.

Thank you.

You bet.

And next we go to Greg Gordon of Morgan Stanley, please go ahead.

Hi, Greg.

How are you doing? If you answered this towards the end of your scripted remarks, I apologize, because my phone cut out for a minute. But, $150 million in cost savings that you have achieved through the headcount reductions this year, is still what you think you need to bring down to the bottom line to offset the sluggishness you're seeing in other areas of your business, vis-a-vis plan, to still sort of target the midpoint of the range for this year in terms of what you're going to deliver to shareholders?

It is, Greg. And as we talked about a little bit in the closing part of the remarks, and I will just fill you in a bit. We're still seeing load recovery below what we had in guidance. We were looking at for the year load recovery of about 1.6% year to date. We're at 0.4%, and we just don't see a 2.8% growth for the balance of the year that is going to get us back up to that number. So, the O&M savings will help to offset that. We're watching off-system sales very closely as we're only at matching last year's number through half the year. We're seeing a good July, but prices for the balance of the year are off what we had in guidance, and we are watching that number very closely.

Right. So the cost-cutting benefits compensate for those two issues?

Yes.

But if we think about the economic recovery being delayed but ultimately, hopefully happening, just not on the schedule that you had anticipated, this does create, doesn't it, some operating leverage that would otherwise not have existed because the cost cuts have now been put in place?

Without question.

Sure.

Alright. Thank you.

You bet, Greg.

Thank you, and next we go to the line of Leslie Rich of JPMorgan. Please go ahead.

Good morning, Leslie.

Good morning. Brian, I wondered if we could go back to off system sales and your comments on slide 8, and I guess I'm just sort of having trouble connecting all the dots. If your volumes are up 10% versus last year and your pricing is up very nicely, could you go into why the trading and marketing results are lower? Is that just that second quarter of 2009 was particularly good or are you seeing any sort of recurring trends? And then I'm sorry if you already answered this, but your forecast of the full year of $329 million, other than the month of July, which you said is shaping up well, why do you still have confidence in that for the full year?

Yes, and that's another piece that -- I wouldn't say we have confidence in that for the full year. I think we will be somewhere in between the $246 million or so from last year and the $329 million that was forecast for the balance of the year. So, I'm not calling for a hit for that number. I think we will be somewhere in between those two numbers. But Leslie, you did point out obviously that the trading and marketing is down. I wouldn't say that is indicative of a greater trend. It is certainly off versus last year, but you will remember last year, a lot of what goes in that business, is both inception gains from long-term transactions that we enter into, as well as some of the mark-to-market activity associated with some of the auctions that we engage in. And there has just been lower deal flow for us around the two components of that business. So it doesn't reflect a stepping away from that business for us or a -- or any longer term trend other than what I would say the deal this year is a little bit less than what we saw last year, particularly in regards to the auction business.

And do you see any impact from the financial reform legislation vis-a-vis derivatives in terms of your hedging or trading in marketing --

At this point Leslie, no. We're waiting to see what happens with the CFTC. As you know, so much of the implementation of thats was punted to the CFTC, and that is where the rule makings are going to be played out. From the way things were left and from some of the letters that we have seen from some of the members of the committee, we believe that there will be end user exemptions, and we don't believe that we will be in the higher category swap dealer. But that we will be in an end user type exemption and think that those exemptions that have been talked about will be available to us in the CFTC rule makings.

Okay great. Thank you.

Next we go to the line of Ali Agha, SunTrust Robinson. Please go ahead.

Good morning, Ali.

Good morning. A couple of questions. One, you pointed out that relative to your $320 million rate increase target, you're at $301 million already. Could you just remind us what is out there for the rest of this year that would help you get there or even cross the line?

Well, I think that most important one would be the self implemented number in Michigan. We don't count those in the $301 million stack because they are subject to refund as we go forward, and a couple of other smaller issues that are still in the process commission that we think will get decided. There are some environmental adjustments in Ohio and other jurisdictions that we think will go through smoothly. So, we, again, feel very comfortable that we will hit or exceed that target for the year.

And Mike (inaudible)the Michigan self implementation, is that already in $301 million or you have not counted on that yet?

Not counted on that yet.

Second question, Mike, the cost savings are coming in, as you point out, you've got more rate increases coming in next year. Hopefully, the forward curves are moving up on all system sales. I just wanted to be clear, the 2% to 4% EPS guidance that you talk about, should we be thinking about that for 2011 and perhaps 2012? Or is that more of a longer term normalized number that you allude to?

Well, I think you would be in the right range if you used that for 2011 and 2012. When you get beyond that and we finally begin to see some of the transmission activities kick in, you would be closer to the upside of that range, and we might expand that as we've chatted about before, that that could put us in the 4% to 6% range. But, as you know and as you have experienced our view from conservative midwest point is to be conservative, and that's what we have done. And fortunately, we have typically over delivered and that we would hope to be our case going forward. I can tell you when I look at some of my colleagues who have very robust numbers, explaining later on how you didn't hit them is much more difficult than explaining that we were able to achieve our goals or do a little bit better than that.

And last question, as I look forward, Mike, if I recall, you also had planned about $320 million for rate increases for 2011. Is that still the target, and how much of that is secure based on activity that has happened so far?

Well, that is the basic target. And I'm sorry, I don't have at top of mind a percent that is already in hand, but it is probably $70 million to $80 million of the $320 million, give or take, so about a third of it.

Okay thank you.

You bet.

Next we go to the line of Hugh Wynne, Stanford Bernstein. Please go ahead.

Good morning, Hugh.

Good morning. I had a question about the drivers of your long term growth forecast of 2% to 4%. What are the key components there? In particular, it seems to that you have curtailed CapEx to a level where net CapEx raising rate base over time will only contribute a portion of the -- is the remainder in your view going to be a function of increasing returns on rate base through rate relief and cost reductions? Maybe you could just help me by breaking out the 2% to 4% growth in terms of your strategy for achieving it.

So, it is interesting. There are probably three components that make most of that up. To your point,as you know, we depreciate about $1.5 billion a year. So, we're looking at capital expenditures that will allow for earnings growth going forward. Rates of return on equity are an issue but we don't build a lot of forecast into that. And the upside, just believe that we will continue, particularly with the new operating company model, to continue to enjoy some success in that space.

Obviously, we believe that along with most others, that all system sales numbers, both volumemetricly and commodity price-wise will grow some going forward. If you look at the 2011 strip for gas, which is the real bellwether of where commodity prices will be, it is a bit stronger than 2010. So, we see some of that as potential. And then of course, even in our footprint, we look at something like 1% going forward. Our western footprint growing more dramatically than our eastern footprint. So when you take those three and add to it the discipline of cost control on the O&M side, we feel pretty comfortable with that 2% to 4% range. As I mentioned at the question Ali asked, as we begin to get into the midterm and see the transmission capital investments starting to impact in a constructive way more so than they have to date, our earnings per share numbers, that also is in the equation. So, again, now, there are many who would argue that gosh, that is not very stretchy, but for a company like ours with a footprint that we have, we think that that's very achievable. And I would argue, if over a handful of years we deliver that kind of growth and couple that with our dividend, this is a pretty good investment strategy for those who are looking for steady solid, low-risk returns compared to other low-risk options that they have.

Excellent, thank you very much. That is quite helpful, actually. Just one quick follow-on question. I noticed when I compare your year to date performance on page 14 of the slide deck, with the earnings guidance on page 17 of the deck, one of the areas where it seems that the company is slightly underperforming its earlier plan is on the Ohio company's margin. The expectation had been for a margin of about $64 per megawatt hour, and it seems in the first half, we're coming in around 58. Is that something you would expect to make up over the remainder of the year? Or has there been a change there relative to expectations, but it is important to be aware of?

It is inside of the $280 million to $320 million guidance that we're giving you. It is a reality of what we have seen so far in Ohio with the mix of industrial/commercial/residential demand. But we have built that into the 2010 plan, and we expect that number to rebound some as we look at 2011 and beyond because of some adjustments that are inside of ESP. So, we continue to feel comfortable with the range that we're in. That is an area, though, as you surely point out, is underperforming, and that is one of the reasons that we aren't robust at the second quarter to say gosh, we really feel great, let's uptick guidance for the year.

Great, thank you very much.

Yes, you bet, Hugh. Thanks.

And next we go to the line of Annie Tsao of AllianceBernstein, please go ahead.

Good morning, Annie.

Good morning can you hear me?

We hear you clearly.

I have a follow-up question regarding to Leslie's question on the off system sale. Can you remind us and walk through the third quarter and fourth quarter of '09 in regarding to your training and marketing. Were there anything that we should be aware of from last year in the third quarter and fourth quarter? And how should we think about that for this share, for the rest of the year?

I think, as Brian said to Leslie's question, we had some auction results that were current in calendar year 2009. And as you know, our tendency is to take those contracts, cover our basic requirements and then continually manage up side potential of fulfilling those requirements in our team as they have been many times before. We're very successful in 2009. They don't have those same auction contracts to deal with in calendar year 2010, because they rolled off at the mid-year point. So that really is what Brian was going to.

There will be auctions in the future and we always participate in them. We are almost always successful for a handful of tranches. We draw a line at what spreads we would like to see from auction successes, and then the charge to the team is, back them up so that there is limited exposure and then manage the upside of the back-up contracts as we go forward. And we have been very successful at that over a long horizon. We are not big home run hitters in our commercial ops group, we are very steady, solid performers and so, 2010 as compared to 2009, that is really the driver.

Thank you.

You bet.

And next we go to the line of Brian Chin of Citigroup, please go ahead.

Good morning, Brian.

Hi good morning. If I remember right, had you placed several thousand megawatts on temporary moth ball status earlier this year? To what extent are the cost containment efforts that you guys have successfully made so far related to those moth ball plants? And then have you had any changes in terms of when you expect those moth balls to come back on line?

So, phraseology, we call -- we laid them up, and it really is part of the generation contribution to the O&M savings that Brian outlined. This is really a great question, Brian, because it demonstrates some of the flexibility that the American Electric Power fleet has. Our plan was to be prepared in a very short period of time, to bring any one of those plants online to satisfy unexpected weather related demand. And in the last 60 days, we have done that a couple of times. What the generation group did was reduce some of the headcounts that would normally be stationed at any one of those facilities. And we have turned them into a roving group of highly experienced folks who can show up at a plant site and augment the skeletal staff that is there and bring the plant online within hours. And we have worked that out with the PJM, and as I said in the last 60 days we have brought some of those plants back online for very important high price opportunities. So, we're pretty comfortable with the way that that is working and again, it just shows the depth and the breadth of the skill sets in the human capital that we have here at American Electric Power.

That's very helpful. And then one other unrelated question. Can you guys comment on distribution, spending? Are you guys expecting distribution spending to start to ramp up a little bit more later this year or maybe the early part of next year? Are your distribution spending forecast largely pretty much set in stone for the time being?

Well, for 2010, we're pretty much set. I would tell you that one of the -- there is upsides and downsides of the new operating company model. We have chosen some very strong operating company presidents, and they could spend $3 billion or $4 billion on distribution every year if we gave them the freedom to do that, but we clearly won't do that. We will continue to manage it as we go forward. But this goes back to the question maybe that you asked. If you look at our concept going forward regulatorily, dollars spent on the energy delivery system, and spent wisely with some early education of the regulator as to the why and the need and the where, usually yields great regulatory success, and will continue to do that.

So far this year, quite honestly, there has been underspend on that side as they used a lot of their dollars to satisfy early storm requirements. As you know, across our entire regulatory portfolio, commissions have been treating storm recovery in a very, very respectful manner. There is nothing more in the political world than getting the lights back on that is important to the political team. And commissions now are being very dutiful, not only in our states, but in other states at allowing for recovery of incurred costs as we go forward. So, we see that, again, as one of the disciplines of the operating company model. Brian and the finance team will see to it that we don't overspend the capital forecast, and that yields our performance in that 2% to 4% range.

Thank you.

You bet.

And next we go to line of Michael Lapides, Goldman Sachs. Please go ahead.

Good morning Michael.

Good morning, Mike. Real quick question on Turk. What's the latest in terms of the last rounds of litigation filed? I think they have now turned to the water permit and the army corps of engineers process for reviewing that permit. Just curious how and when you think this plays out.

Well, actually there are two current events. You're right that the army corps of engineers permit is now under challenge. Most of the effect of the core permit, the work in those areas is already done. So I think that the courts will look at that and say, well, this is interesting, but the thing that you're most trying to protect has already been protected, so what is it that you would seek?

But look, I -- there is no question that the proponents of those kinds of endeavors simply don't want to see any coal plants built anywhere in the United States and obviously, we are 180 degrees from them in that undertaking. They should champion an ultra-super critical coal plant. This is the technology of the Twenty-first Century to continue to have coal burned around the world. So let me set aside my podium for a moment and then get to the second matter.

There was a huge challenge and another seek of a stay of construction on the transmission lines that was handled by the courts in Arkansas this week, and it couldn't have come out better. A, no stay, keep building. B, take these things back to the commission to verify that the certificates that were issued for the transmission build, in fact, is exactly what you intend it to do. To our opponents, I would simply say this. That rest assured, when the Turk plant is ready to run, there will be transmission in and out of the station. Because there are some laws that pertain to the United States, not simply to some very wealthy hunters and environmentalists who God bless them, are dedicated to seeing no coal plant built anywhere in the world.

Got it. Last Mike, in terms of Ohio, when do you expect negotiations for ESP version 2 to really heat up?

I expect you will see that early in 2011. As you know, it is March 11 filing. We will probably have some discussions before we take that approach. In fact, we're in the midst of discussions with many of our customers today. Look, my large industrial customers, they are very desirous of having controlled cost of electricity going forward for the growth in the Ohio economy, and we want the same thing.

So, Michael, I go back to one of my earlier comments. Some of my colleagues think it would be great to see the cost of electricity to go up. We think it would be great to see the cost of electricity be reliable and to be acceptable, and that is what negotiation is for. A three year, maybe even a five year ESP if we could get to that place would make sense. I really do think we need to get some color on seat and again, I have said many a time, I don't think that that is going to be some kind of nightmarish outcome. When we get that color on seat, hopefully, sometime in calendar year 2010, that will let us know how to build that into the 2011 and beyond ESP play.

Got it. Thanks, Mike.

Yes, you bet Michael.

And next we go to the line of Paul Patterson, Glenrock Associates. Please go ahead.

Good morning Paul.

Hi how are you?

Good.

Just to follow-up on Ohio first. The seat filing, the seat order, I guess, that came out in June, Duke is asking for a rehearing. I'm sure you have read it or had it reviewed. What do you think about that as it pertains to you? Are you guys unhappy with the order? Are you thinking of seeking rehearing?

Well, I had a chance to chat with some of the commissioners the other day about that. I'm not sure what Duke sought, but they put it in. And the commission really is doing what you would expect them to do, which is if people are going to petition to rehear, let's get that out of the way before we go forward and actually issue orders on a path that is subject to rehearing. We don't intend to do that. We think that there was plenty of flexibility in their June directions to all of us. We were prepared to file on 15 July , we will be prepared to file on 1 September, and we will proceed with our case. If we seek any review, it would be of some unexpected curve ball in a seat order that affected the AP Ohio companies, and we would take that to the appropriate court of review, which is the Ohio Supreme

Okay. On the O&M reduction, and just to clarify, the earlier projections that you have that are in the slide deck, I guess those are subject to change? These are just your place holders and you guys might be -- you guys don't necessarily feel this is where we're going to be -- do I understand that correctly?

Talking about for 2010 guidance?

Yes, the 2010 slide 17. It seems that you guys have different -- the O&M number will probably be different than what you're thinking?

That's correct.

Okay. With respect to the O&M savings. How much would you say is in the regulated as opposed to the non-regulated areas?

The vast majority of it.

Okay.

I think you know we're like 96% regulated and 4% non, so.

Okay. And then, just finally on the trading and marketing question, what was the total outlook for trading and marketing that you guys had originally for 2010?

Yes, I don't know if we broke that out separately, Paul, for the year.

Yes, I think classically we do not -- when you're in the business of trading and marketing, it probably doesn't make much sense to tell your colleagues what you hope to accomplish.

But when you guys mentioned that you guys won some contracts and some of the bidding, was that because of the accounting associated with that? In other words, if you hit a -- if bid into one of these auctions, you mark-to-market the benefit of that contract over the period of time? Or that is -- because it just seems like a wide variance for the quarter.

Yes, some of those pieces of business we match up against our generating assets and others will hedge out. And we will put those activities that we hedge out in the trading and marketing side rather than in the physical off system sales side.

Okay. Thanks a lot, guys.

Yes, you bet.

Next we go to Andrew Levy, Tudor Pickering. Please go ahead.

Guys, I think most of the questions were asked, but I will put you back on your soap box, Mike.

(laughter) Thanks Andrew.

What are your thoughts on renewables going forward? Obviously, a lot of talk, kind of know where Congress is probably heading, various states have mandates for the next several years that may or may not be able to be made and obviously, there is large cost to renewables as well. Do you think the numbers are -- whether they are going to be met, or do you think state legislators, which probably have a little different opinion than state commissioners at this point, do you think the numbers are toned down a little bit and with maybe the cost being the major hurdle? Or do you think the numbers actually are made and we go ahead and do all this renewable stuff?

Well, I think you really raise an interesting question. When you look at some of the requirements in California for instance going to the 33%, I think that Governor Schwarzeneggar and many of the utilities in California see that as a very, very difficult stretch with substantial impacts on the cost of electricity. But if you look at this in a more macro sense for the conterminous 48 United States, I think things like the Binghamton Murkowski legislation is the way the country will go and should go.

We need to blend some of the requirements for renewable energies into the overall portfolio as we go forward. The price points are still awkward, but they are trending in the right direction. The technology continues to move forward aggressively, and I think that that's helpful. And as you know for us, we believe strongly, in the Binghamton approach to transmission, removing the Corker amendment, the cost allocation that I spoke to at the very beginning of our conversation on the FERC notice of proposed rule making, I think yield's a very logical renewable energy standard for all of us to find a way to satisfy. I know that those who have commodity plays particularly must run nuclear stations hate the notion of renewables, but it is going to happen. And I know this is also heresy, but nuclear power plants can be cycled just like coal power plants can be cycled, and they are going to have to get to that place if we're going to accommodate a large renewable portfolio standard.

We at the Edison Electric Institute, as we have done on many, many other issues, support the Binghamton Murkowski model. We don't think it makes sense to have much larger of a demand than that, but the price points will continue to get better. The combined electrical efficiency of the facilities is what it is but the mayoring capacity of energy storage and supplemental generation will allow us to accommodate those needs as we go forward. So, it would be silly for America to say we don't want to do anything in the renewable space. It would be equally silly to have unachievable numbers with a penalty associated with them. But the fleet can react to it. And again, if you build out the transmission grid as we have been proposing now for a number of decades and years, you can accommodate all this without much of a bump in the highway.

Thanks a lot.

Bob, we have time for one additional question.

Thank you, and that comes the from the line of [Ryan Morning] of Duquesne Capital. Please go ahead.

Hi, good morning. My questions have actually been asked and answered, thank you.

Great, well that gives me one moment to say something. Many of us read each others transcripts and oddly enough, many of us listen into each other's transcripts so we get some flavor for the things that are on the analytical community mind. And I want to take a moment to just say goodbye to my dear friend David, and look forward to continuing to work with Tom and the team at Southern Company. Thanks for joining us for the call. Thanks for your interest in American Electric Power.

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