OGE Energy Corp. (OGE) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the First Quarter 2016 OGE Energy Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today’s conference, Mr. Todd Tidwell. Sir, please begin.

Thank you, operator. Good morning, everyone and welcome to OGE Energy Corp’s first quarter 2016 earnings call. I am Todd Tidwell, Director of Investor Relations. And with me today I have Sean Trauschke, Chairman, President and CEO of OGE Energy Corp; and Steve Merrill, CFO of OGE Energy Corp. In terms of the call today, we will first hear from Sean followed by an explanation from Steve of first quarter results. And finally, as always, we will answer your questions. I would like to remind you that this conference is being webcast and you may follow along on our website at oge.com. In addition, the conference call and accompanying slides will be archived following the call on that same website. Before we begin the presentation, I would like to direct your attention to the Safe Harbor statement regarding forward-looking statements. This is an SEC requirement for financial statements and simply states that we cannot guarantee forward-looking financial results, but this is our best estimate today. I would also like to remind you that there is Regulation G reconciliation for gross margin in the appendix along with projected capital expenditures. I will now turn the call over to Sean for his opening comments. Sean?

Thank you, Todd. Good morning, everyone and thank you for joining us on the call this morning. This morning, we reported first quarter consolidated earnings of $0.13 per share [Technical Difficulty]. We have received approximately $35 million in distributions from Enable year-to-date and I will speak more about Enable a bit later. And then Steve will provide a little more detail on our financial results for the quarter. Quickly turning to the utility, we continue to see our historical growth rate of 1% as we have added an additional 10,000 customers compared to the first quarter of 2015. The majority of these customers are in the residential and commercial sectors. As you know, Oklahoma has been impacted by the downturn in energy prices, which contributed to a moderate decrease in oilfield sales. The latest economic statistics put Oklahoma’s unemployment rate at 4.4% with Oklahoma City just under 4%. Both of these compare to 5% nationally. The new customer gross margin was just under $1 million for the quarter. It is consistent with our projections. We will continue to monitor the impact of low energy prices on the state economy and we will keep you updated if and when we begin to see a significant change in our sales growth. Our operations team continued a great job of maintaining the fleet and the grid this quarter and this quarter was no exception. We have already had two significant storms with tornadoes this year and the majority of outages were returned to service within 24 hours. Our combined cycle plants performed well and with the continued record low natural gas prices, our capacity factors were exceedingly high. In fact, our McClain power plant reached record production levels in the first quarter. It is really important I should say to note that these achievements were made while achieving best-in-class safety performance. For the first quarter, the utility was number two in the Southeast Electric Exchange for safety performance. I am proud of our members for working safely watching out for themselves and others day in and day out. On the cost side, we continue to focus on controlling costs and increasing efficiency. And as a point of reference and I know I have said this before, but I think it’s worth noting, our O&M costs per customer today – are lower today than it was in 2011. We have remained focused on enhancing the value of our product for the benefit of our customers. And our smart grid deployment was just the beginning of the transformation of our grid enabling customer-facing products and services, but also operational efficiencies. We believe that enhanced products and services along with our low rates are the best way to attract new businesses to our service territory. Two recent examples of new loads are the Commercial Metals Company, which will build a 40 megawatt micromill in Durant, Oklahoma. The mill is expected to be commissioned by the fall of 2017. We actually had the groundbreaking just last week on this facility. The second is a 15 megawatt specialty paper mill being constructed by Glatfelter in Fort Smith, Arkansas and this project should be completed by early in 2018. All-in-all, a solid start to the year. Turning to the regulatory events in Oklahoma and Arkansas, we were pleased that the Oklahoma Commission has approved our application seeking approval to install the scrubbers at the Sooner plant. This support allows us to move forward with our environmental compliance plan with much more certainty. We believe and I firmly believe this is the right decision for not only our customers and our state and our company, but also provides the fuel diversity for our fleet for many years to come. Project construction on the scrubbers has resumed. And despite the delays, we are confident the project will be completed by our compliance deadline. I want to thank all the parties including the OGE members, the OCC staff, commissioners, the Attorney General’s office, and the Oklahoma Industrial Group for working diligently to bring this cause to a conclusion. We have received approval for a solar tariff making our solar farm the first one available to Oklahoma customers. As you may recall, we filed a general rate case in December with the test year ending June 30, 2015 and those hearings have started this week. I will tell you I think this case is as straightforward as they come. We have invested $1.6 billion in the system to improve reliability, to drive more functionality to our customers and to ensure long lasting service to our customers. And this is all since our last rate case and there has not been any opposition to this plan and service. I believe this is a testament to our planning process that delivers low cost energy to our customers. Our rates are more than 20% below the national average and we have extremely high customer satisfaction ratings. The real issues in the case have really been around ROE and depreciation. ROE is always up for debate and we will work through that issue. Some of the interveners are proposing extending depreciable life of assets. The issue with this idea is that when you kick the can down the road, you are really burdening future generations for assets beyond their useful life. I believe we will be able to work through both these items for a positive resolution. Overall, I believe we have a good working relationship with the Oklahoma Commissioners and the Commission as a whole. I firmly believe it’s in the best interest of our customers, our company and the state as a whole that we have a strong working relationship with the Commission. That’s why I am committed to always working to continually improve that. I want that relationship to be based on credibility and trust backed up by our performance. And as I stated earlier, we have low rates. Our reliability is extremely high. Our customer satisfaction is extremely high as evidenced by our numerous J.D. Power awards, our community involvement, our engagement in making our community stronger is second to none, and our environmental record is strong. So, if we are judged by that performance, I believe we will always come out on the right side and these principles apply to Arkansas as well. In Arkansas, we do plan to file a general rate case this summer. We intend to utilize the recently passed legislation in the state allowing formula rates. Our dialog with the Commission in Arkansas has been positive and we believe our filing will be a major step towards future investments in Arkansas. Moving on to Enable’s financial results, on their earnings call yesterday, they reported strong results for the first quarter considering current commodity price environment. Processing volumes were up 6% and crude gathering volumes in the Bakken were high as well. They also announced two additional rigs have been moved into the SCOOP STACK play reinforcing the significant acreage dedications Enable possesses in that prolific basin. Another key item was lower O&M costs, which decreased 12%. So, as the sponsor of Enable, I was very pleased with that. And clearly, they are focused on the right issues. We were very pleased with the first quarter and I have to tell you I am excited about the significant upside for that business as commodity cycle continues to improve. Before closing, I did want to speak for a moment regarding our investment in Enable. While we are disappointed with Enable’s current trading price although improving, we are still not satisfied. Remember, our investment provides OGE with strong cash flow that helps support our dividend, capital needs, balance sheet and credit profile. It is doing exactly what we designed it to do when we established Enable a few years ago. Enable is a much larger and more resilient company today compared to when we owned 100% of Enogex a few years ago and it is strong enough to manage through the cycle. As you know, CenterPoint has announced they are reviewing strategic alternatives as it pertains to their interest in Enable. Their review does not pertain to Enable or OGE’s interest in Enable. We are committed to our investment in Enable and are focused on helping to position the partnership for growth as the MLP sector emerges from the current commodity cycle. We believe the value associated with our investment in Enable including our 60% share in the IDRs will be realized in the market as commodity prices continue to improve. We are focused on creating that long-term value for all of our shareholders. So in summary, we continue to believe our businesses are strong and well positioned for long-term growth and value creation. We are on a plan to achieve our utility long-term growth rate of 3% to 5% and continue to grow our dividend at an industry leading rate of 10% through 2019. So now, I will turn it over to Steve to review the financial results.

Thank you, Sean and good morning everyone. For the first quarter, we reported net income of $25 million or $0.13 per share as compared to net income of $43 million or $0.22 per share in 2015. The contribution by business unit on a comparative basis is listed on the slide. At OG&E, net income for the quarter was $6 million or $0.03 per share as compared to net income of $17 million or $0.09 per share in 2015. First quarter gross margin at the utility decreased approximately $13 million, which I will discuss on the next slide. Now, looking at other key drivers, first quarter O&M had a variance of – it was $2 million higher, just a modest increase over 2015 and is consistent with our focused efforts on controlling our costs. Depreciation increased $3 million primarily due to additional plant in service, including the low-NOx and ACI environmental compliance assets. Other income increased $2 million primarily due to increased margin from the Guaranteed Flat Bill program. Income tax expense decreased $4 million due to lower earnings. Turning to the first quarter gross margin, utility margins decreased approximately $13 million in the first quarter of 2016 compared to 2015. The primary drivers for the reduction in gross margin were as follows. The expiration of our wholesale contract last summer has reduced margin this quarter by approximately $5 million. As we have said before, this item has been included in the current Oklahoma general rate case. Weather translated into $2 million of lower gross margin as compared to the first quarter of 2015. Weather for the quarter was flat compared to normal. Finally, lower demand revenues and lower wholesale transmission revenues combined to reduce margin $3 million as compared to the first quarter of 2015. Partially offsetting those reductions was growth from new customers contributing $1 million in gross margin. We added nearly 10,000 new customers to the system compared to the first quarter 2015. Moving on to the environmental and Mustang Modernization investments, investments for 2016 are largely comprised of the Sooner scrubbers in the Mustang CTs. There is a small amount of low-NOx as five of the seven of those units are being completed today and are now in service. The Muskogee Natural Gas Conversion project spending will begin in 2017. As we have said before, we plan to run those coal units as long as we can for the benefit of our customers. Turning to our investment in Enable, for the first quarter of 2016, Enable made cash distributions of approximately $35 million to OGE compared to $34 million in the first quarter of 2015 and contributed earnings of $18 million or $0.09 per share compared to $23 million or $0.11 per share last year. The decrease reflects lower commodity prices in addition to higher depreciation and interest expense offset by lower O&M expense. Turning to the 2016 outlook, as you know, the majority of utility earnings occur in the second and third quarters and assuming normal weather, we are comfortable with our current guidance. That concludes our prepared remarks this morning and we will now answer your questions.

[Operator Instructions] Our first question will come from the line of Anthony Crowdell from Jefferies. Your line is open.

Hi good morning Sean.

Hi good morning. Anthony, how are you doing?

Not bad, never been better, how about yourself.

We are doing well, good to hear from you.

So I have – first question is just more on congratulations you finally or the commission in OGE finally got together on the scrubbers. What’s the rate case filing schedule look like for the next couple of years now?

Well, Steve, do you want to kind of run through the schedule there?

Sure. Anthony, what we are looking at, as you know we are currently in a rate case with Oklahoma. We will file sometime in August an Arkansas general rate case and that will take a little bit of time. And then we will time our next Oklahoma general rate case associated with when the Mustang plant goes into service the CTs. And we will use our six-month forward look to really minimize any impact of that going into service. So look for that towards the end of 2017. And then there would be a follow-on Oklahoma general rate case towards the end of ‘18 which would pick up the scrubbers when they finally go into service.

So in Oklahoma you currently have a case going on now and that should get you new rates I guess in 2016, then another filing for Mustang CT end of ‘17 and then another filing end of ’18?

That’s correct, Anthony.

Okay. And just – and I don’t want to take too much time on the call, I think there is an issue going on in the case right now of how the PTC, whether the PTC is putting base rates or the PTC gets put through the fuel adjustment clause, could you just walk us through, I am just struggling to understand the differences there like what’s one side versus the other?

Yes. I think Anthony, so the issue there is when we commissioned that first wind farm, we had PTCs and we flowed all that back to customers. And so now as the PTCs are expiring, there is an increase in the revenue requirement. And what we recommended was really flowing all those through the fuel clause, but if you want to put in base rates, that’s fine too. I don’t think there is an issue, I think the better issue was let’s capture all of the energy costs – the variable cost components around energy in the fuel clause. It just seems to make more sense that will be an annual review. I am not sure what the real distinction is.

So now these assets are – now that the PTC has expired, these assets are going to earn a regulated return off them and that regulated return because you were previously refunding customers through the fuel clause, the utility’s filing was to get this return via the fuel clause?

Yes. It’s just a – it’s a recovery. Just there is a return of that component. It’s more of an expense.

Okay, great. Thank you so much.

Alright. Thanks. Have a great day Anthony.

Thank you. Our next question will come from the line of Charles Fishman from Morningstar. Your line is open.

Thank you. The only question I had was I just wanted to confirm the movement in capital expenditures between ‘16 and ‘17 from the fourth quarter is just the Sooner, the delay in the Sooner project or more capital being pushed into ‘17 and ‘16, is that correct?

Yes, that’s correct. It’s really because we suspended that project for the first quarter while we tried to get this resolved at the commission. That effectively is going to push about $50 million out of ‘16 and into ’17.

Everything else stayed the same?

That’s correct.

Okay. And tell you what, can I ask the second question, I was looking at the CapEx chart when you were talking about guidance, you reaffirmed ‘16, now that the Sooner scrubber issue is behind you, did you give a long-term earnings growth for OG&E beyond ‘16, anything?

Yes, 3% to 5%.

Okay. I missed that. Thank you very much. That was it.

Thanks Charles. Have a great day.

Thank you.

Thank you. Our next question will come from the line of Sarah Akers of Wells Fargo. Your line is open.

Hi, good morning.

Hi, good morning Sarah.

So now that there is clarity on the CapEx outlook, can you just comment on the parent credit metrics and any opportunities you are seeing to utilize the balance sheet after the two big spending yeas here?

Sure, I mean obviously our credit metrics. We go into this very strong. We are in a good position with regard to free cash flow to debt. And it’s something that we certainly are always looking at as far as deploying capital. We will be firming those plans up over the coming months and we certainly have some work to do on the back half of our 5-year outlook. If you recall, our cash taxes will ultimately increase, not in the near-term with bonus appreciation, but we do become a full cash taxpayer in 2021 at this point.

Got it. And then on rate case, are there any formal settlement conferences scheduled or what are the next key milestones in the process there?

Yes. As part of the procedural schedule, there was a – there will be preliminary settlement discussions like I mentioned in my comments, Sarah. There is really not a lot of disagreement when you look at the intervener testimony on the plant service, kind of the two gating items really seem to be around ROE and kind of the depreciable life of assets. And so we will continue to have discussions, but there is no scheduled settlement proceeding from this point forward.

Got it. Thank you.

Okay. Thanks. Have a great day.

You too.

Thank you. Our next question will come from the line of Paul Griffin of KeyBanc. Your line is open.

Good morning. How are you?

Hi, good, Paul how are you doing?

I am fine. Thank you. Just I think you already answered this in Charles’ question, but did the delay at Sooner affect costs at all?

No, we don’t believe so. That was an important point that we made when we made this filing with the commission. We negotiated with all of our suppliers for a delay that would not impact schedule or cost. And so we don’t believe there will be any cost impact to this.

Okay. Thank you very much.

Thanks.

Thank you. Our next question will come from the line of Brian Russo of Ladenburg Thalmann. Your line is open.

Hi, good morning.

Hi, good morning Brian.

Just on the Sooner environmental CapEx just in terms of kind of the trend in quarter, should we just kind of assume that you will spend an equal amount in the next – in 2Qs through 4Q or is it – does this kind of ramp up as we move through the year?

It will ramp up a little bit, I would say the largest part would be third quarter and fourth quarter as we kind of get cranked back up and then the majority of our spend will be in 2017 associated with the scrubbers.

Okay, great. And then just on the 3% to 5% utility EPS, CAGR, are we now kind of at the high end of that range given the scrubber installation?

We are pretty comfortable with the 3% to 5%, Brian, and we have got a few years left to go, but we are very confident in both that and the dividend growth.

Okay, great. And then just lastly, you guys have witnessed some pretty good customer growth for the last several years despite the commodity cycle, what’s driving the residential and commercial customer growth?

Brian, could you repeat that, I didn’t get that?

The 1% customer growth that you have been experiencing in the last 3 years, what’s driving the residential compared to the commercial side?

I think it’s – there is a lot more to the Oklahoma economy than oilfield. That’s a big component. But there is a lot more to that. And we are seeing a lot of growth at the Tinker Air Force Base. And so Boeing has relocated a number of people here. And those are high paying jobs that have come into the service territory. I think we just announced these two other developments are going to bring multiples hundreds of jobs to the area. So I think it’s a combination probably of we have a workforce here that’s available and so it’s unfortunate that there has been a downturn in commodity cycles and there has been maybe a pullback in the oilfield sector, but it’s created an opportunity for others looking to relocate here because of our low energy rates to utilize that workforce, that skilled workforce. And so that’s really probably why we haven’t seen a decrease because while we have seen some companies pull back, unemployment hasn’t really changed. So people have been able to find jobs. And I think that’s been a real testament to the economy. And I think it’s prime for when the market does – commodity cycle does turn and we know it will. The state and the city are really primed for a lot of growth.

Okay, great. Thank you very much.

Thanks Brian. Have a great day.

Thank you. At this time, I am showing no further questions. I would like to turn the call back over to Sean Trauschke for any closing remarks.

Thank you. Thank you, everyone for joining us today and for your continued support of the company. We appreciate it and we look forward to visiting with you soon. Have a great day.

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program. You may now disconnect. Everyone have a great day.