Following an onslaught of bad news including the announcement of a fourth quarter net loss, American Electric Power Co. (AEP) shares fell more than 5% Friday $25.65. The company reported a fourth quarter net loss of $837 million, or $2.47 a share, compared to net income of $52 million, or 16 cents a share a year earlier.

The net loss included $1 billion in special charges, made up of an unexpected $415 million write down of Columbus, OH-based AEP’s U.K. generation assets, and several additional large charges for telecommunications and various domestic and international power generation assets. The company also reported a change to other comprehensive income of $585 million for pension liability adjustments, which had a negative effect on AEP’s balance sheet. A total of more than $1.6 billion of common equity on its balance sheet was removed in the fourth quarter of 2002.

CEO E. Linn Draper Jr. said the U.K. asset write down was the result of recent analysis that indicates that power prices will not recover to levels required to permit recovery of the original purchase price of the assets. “Continued weakness in the U.K. market coupled with the British government’s intervention in the competitive market, giving advantage to the supplier British Energy, has been particularly troublesome and detrimental to the recovery of generation asset values there.”

In addition to the write downs, the company also announced plans to cut its work force by 1,300 jobs, cut spending, trim its dividend by 40% and sell noncore wholesale assets to strengthen its balance sheet. It also is considering issuing new equity.

Depressed domestic energy market conditions, including surplus generation capacity, low power prices, high gas prices and low liquidity along with financial pressure from credit rating agencies and operational problems at some of its midwestern power plants all contributed to AEP’s severe difficulties.

“Last year was a difficult one for us, especially when compared with 2001, when very favorable market conditions for much of the year boosted our earnings,” said Draper. “Our utility operations did reasonably well in 2002 in the face of escalating costs. But the collapse of wholesale markets hurt our earnings from wholesale operations, an area that had been highly profitable for us in previous years.” Similar to many of its peers, AEP, Draper said, intends to head back to its roots with a focus on its regulated utility operations “with a small commercial group that ensure maximum value for the output of our generation assets.”

“The once flourishing wholesale market is no longer the promising business we contemplated three years ago. We will return to the more traditional model of a regulated utility,” said Draper.

“We’ve taken steps to reduce operating and capital expenses and have made significant improvements in winding down our speculative trading, and therefore, reducing the risk of our business,” he added during a conference call with analysts. “Our gross trading book has dropped to approximately $2.1 billion in assets and $1.9 billion in liabilities at the end of the third quarter. We have done this by carefully managing our counterparty credit exposure and have not incurred significant losses. As we begin a new year we remain focused on our utility operations where the fundamental earnings power of this company remains.”

He said the company intends to “systematically dispose of noncore assets, principally a portfolio of wholesale investments.” Proceeds from the sales will be used to reduce debt. AEP also continues to evaluate the potential for issuing additional equity. “While we don’t like the dilutive impact on earnings and the additional cash required for dividends, incremental equity may be necessary to further strengthen our balance sheet and maintain credit quality… I believe that ultimately a strong BBB credit rating for the company is in the best interests of all investors.”

AEP will cut 5% of its work force, and will urge its board to cut its quarterly dividend to 35 cents a share from 60 cents. The dividend cut beginning in the second quarter would result in annual cash savings of $340 million, immediately improving retained earnings and creating free cash flow that can be used to pay down debt, Draper said.

For the fourth quarter, AEP recorded write-offs of $1 billion to reduce the valuation of underperforming assets, including overseas holdings and other investments. Excluding special items, the company said “ongoing” earnings were $177 million, or 52 cents a share, compared to $114 million, or 35 cents a share, a year earlier. Wall Street had projected earnings of 55 cents a share. Revenue increased 31% to $3.8 billion from $2.9 billion.

AEP cut its 2003 earnings outlook to $2.50 to $2.70 a share, based on assumptions that earnings from utility operations will be flat from the previous year, and amid expectations of further erosion in nonutility investments. The company previously projected 2003 results in line with those of 2002. Wall Street’s current estimate is for 2003 earnings of $2.81 a share.

For the full year 2002, AEP posted a net loss of $519 million, or $1.57 a share, from net income of $971 million, or $3.01 a share, the previous year. The company said it had “ongoing” earnings of $957 million, or $2.89 a share, in 2002, down 12% from $1.09 billion, or $3.01 a share, in 2001. Revenue rose 14% to $14.5 billion from $12.7 billion.

Standard and Poors Ratings Services placed the ratings of AEP (BBB+/A-2) and its subsidiaries on CreditWatch with negative implications following the large write-offs reported by the company. S&P noted that about $12 billion of total debt is outstanding for the company. However, S&P expressed some confidence that AEP’s balance sheet strengthening program would resolve the CreditWatch listing “within a short time.”

“AEP’s proposed outline to address the effect of the write-offs on its balance sheet appears to be a sound and achievable plan for continuing its path toward improved credit quality,” noted S&P credit analyst Todd Shipman. “However, management must be able to show its ability to accomplish the plan and that it is sufficient to produce a credit profile that is consistent with a ‘BBB+’ rating. Until greater clarity is demonstrated on those points, the possibility remains that ratings will settle at a lower level.”

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