OGE Energy Corp. (OGE) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q2 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 be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I'd now like to introduce your host for today's conference, Mr. Todd Tidwell, you may begin.

Thank you, operator. Good morning, everyone, and welcome to OGE Energy Corp's second quarter 2016 earnings call. I'm 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 second 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 a 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 remarks. Sean?

Thank you, Todd. Good morning everyone and thank you for joining us on today's call. This morning, we reported second quarter consolidated earnings of $0.35 per share; our utility OG&E contributed $0.36 per share. We received approximately $70 million in distributions from Enable year-to-date and I'll speak more about Enable a bit later followed by Steve to provide greater detail on our financial results. As a company, OGE is doing quite well and has accomplished a great deal this year. I've been pleased and actually very pleased with our members’ commitment to continually moving the company forward and remaining focused on the day-to-day operations of the company. For environmental compliance, we've now completed the construction of our ACI systems as well as six of the seven low NOx burners. They were all completed on time and budget. We've managed the restoration efforts of several major storms and connected thousands of new customers all in a safe manner. On the regulatory front in Oklahoma, we gained approval of our scrubbers and successfully completed our annual fuel cost review. In Arkansas, we completed our second 310 filing to recovering rates, another low NOx burner as well as all of the ACI systems. The utility had a solid quarter with many accomplishments. On the operations front, the team did a great job of maintaining the fleet and the grid this quarter. Last month, we had two rounds of destructive wind and lightning storms that moved through our service territory. The storms resulted in more than 120,000 unique outages, the majority of which were restored within 24 hours and I should say without injury. This is significant because more than 800 personnel were involved in the restoration efforts. This is just another example of the dedication and performance that recently earned OG&E the EEI Emergency Recovery Award. The award was for the outstanding restoration efforts after Oklahoma was struck by back-to-back severe winter storms in November and December of last year. This actually marks the 11th time since 1999 that OG&E has won from EII the highest national distinction for emergency service restoration. Another area of focus is that we continue to look for ways in which technology will improve our capabilities and efficiency. As an example, this year we are deploying a new fault location technology. This technology will enable distribution operators and engineers to identify the location of faults using information gathered from automated devices on our lines and in our substations, which will actually save time and money in getting customers back online. This technology also will provide us with the ability to proactively identify and repair transient or blink outages before they cause service interruptions. We're continually looking to find these efficiencies that will help increase our reliability and contribute to future benefits for our customers. Our combined cycle natural gas plants delivered outstanding reliability and performance once again. Our McClain and Redbud power plants had availability of 87% for the first half of the year. This is top quartile reliability performance and it is important to note that these achievements – all of these achievements were made while achieving best-in-class safety performance. For the first half of this year, the utility is Number 2 in the Southeast Electric Exchange for safety performance. And I'm really proud, I'm proud of everyone here at the company for not only their execution, but their dedication and commitment and for working safely day in and day out. Briefly looking at our service territory, we continue to see our historical customer growth rate of 1% as we added an additional 10,000 customers compared to the second quarter of 2015. Now the majority of these new 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 decrease in oil field sales. The latest economic statistics put Oklahoma's unemployment rate at 4.7%, roughly on par with the national rate. However, we remain focused on keeping our rates low, our service high, and actively working to attract new loads to our system. Quickly turning to our regulatory events, we will be filing general rate cases in Oklahoma in each of the next few years. We will file another case in the fourth quarter of 2017. This will have a June 30 test year and the principal items will be the recovery of Mustang and the last low NOx burner. In the fourth quarter of 2018, we will file another case to recover the scrubbers at our Sooner plant and conversion to natural gas of the two coal-fired units at our Muskogee station. I recognize this is certainly a full schedule, but we're determined and committed to make this a success. I believe that overall, we have a good working relationship with the commissioners and the staffs in both Oklahoma and Arkansas. I believe it is in the best interest of our customers, our company, and both states if we have a strong working relationship and that is why we remain committed to always working to improve it. We want our regulatory relationships to be based on credibility and trust and backed up by our own performance. We have low rates, high reliability, strong customer satisfaction, strong community involvement, and a strong environmental record. So if we are judged by that performance, I believe we'll come out on the right side. In Oklahoma, we successfully completed the annual review of our fuel adjustment clause in May, the hearings for our general rate case also concluded in May, and we implemented interim rates on July 1. The interim rate increase was offset by lowering our fuel adjustment charges that are passed along to customers. So at the end of the day when you combine all of these factors, the average residential customers actually will save approximately $7.73 per month compared to last summer. We expect to receive the ALJ report on our general rate case sometime this quarter followed by an order in the fourth quarter. Finally in Arkansas, we will file a general rate case later this month. We also anticipate incorporating a Formula Rates Tariff as well. Our dialog with the Arkansas Commission has been positive and we believe our filing will be a major step towards future investments in Arkansas. Now let me provide you with an update on the implementation of our projects and our plans around environmental compliance in Mustang. So just to recap, six of the seven low NOx burners are in service. The final one will be completed in the spring of 2017 to meet the compliance deadline. The sixth in service were on time and under budget and our expectations are that the seventh one will be also. Construction resumed in early June on the scrubbers at our Sooner plant following the approval by the Oklahoma Commission of our decision to install these scrubbers. The project remains on schedule and cost continued to trend under budget despite the two-month suspension. Site prep at the Mustang plant for the new CTs is approximately 90% complete and an RFP has been issued for the general contractor on the mechanical side. The Mustang CTs will be in service by December of 2017, the Sooner scrubbers will be in service by November of 2018, and we expect to have the Muskogee gas conversion completed by December of 2018. The important point regarding all of these projects is that they are all on time and under budget, which is something we're very proud of considering the complexity and size of these projects. I did want to provide briefly my thoughts on our capital expenditures. As indicated in our capital expenditure forecast and some of you've asked, why do our capital expenditures drop in 2019 and 2020 compared to previous years? So let me provide a few data points and provide a little more perspective on this. First, 2018 concludes our major environmental investments. So you would expect some drop there going into 2019. Second, we accelerated. We brought forward the $190 million Windspeed 2 line from a 2021 in service date to a 2018 service date to meet the increasing demands on the system. This further adds to some of this drop. And lastly, I want you to understand that we have many opportunities under consideration. They range from distribution infrastructure, lower voltage transmission, and smart grid technology and investments in both Oklahoma and Arkansas and we're going to update our CapEx numbers as the economy improves and we have clear line of sight to those benefits. We also want to be able to evaluate our options from a return perspective. We have an active regulatory agenda in both states and regulatory outcomes are very important regarding capital deployment. We will continue to be prudent allocators of capital and we will continue to deploy capital wisely to meet our customers' needs. At the end of the day, I do expect our investments in 2019 and 2020 to look a lot like historical levels. So more to come and we will update you as we move forward. Turning to Enable, they continue to perform well in a very difficult commodity environment. As I previously mentioned, OGE has received $70 million in cash distributions year-to-date. Producers remain active on Enable's gathering and processing footprint, now with 29 rigs currently active that are contractually dedicated to Enable. Enable saw increased process volumes in the Anadarko Basin in the second quarter of 2016, compared to last year. Enable completed the 200 a day Bradley 2 Plant. Enable now has 14 major processing plants with approximately 2.5 Bcf a day of processing capacity. And last but not least, Enable's just done a great job of managing their expenses, controlling their costs and as a result O&M was 8% lower quarter-over-quarter. So as a sponsor of Enable, we are pleased with their progress in this very tough environment. If you recall, when we reviewed our strategic opportunities for our legacy Enogex business, we had three main criteria and the first was to create an entity that was large enough to stand on its own and survive downturns and commodities. We've been in the business long enough to understand commodity cycles come and go. Secondly, we wanted the business to be self-funding. Stated differently, we wanted to flip the cash flow statement from a use of cash to a source of cash. And finally, we wanted the new entity to be investment grade. Financial flexibility, strong ratings, and ample liquidity were critical to the long-term success of the enterprise. It's in times like these that you're glad you have this balance sheet. So, even though I would like Enable's valuation to be much better, looking back over the past three years, the business is actually satisfying those criteria we laid out, which brings me to my next point. On July 18, CenterPoint provided OGE with our right to first offer notice as they will seek offers to sell their interest in Enable. We have 30 days from the notice date to make an offer. Understandably, we're not going to discuss our intentions on this matter. With that said, we look forward to the eventual closure of this process as it should remove some of the uncertainty concerning Enable. I would like to reiterate that we are committed to our investment in Enable. We are focused on helping position the partnership for growth as the MLP sector emerges from our current downturn. We believe the value associated with our investment in Enable, including our 60% share of IDRs will be realized in the market as these commodity prices improve. So, in closing, I'm proud of the continued accomplishments in execution to move our company forward. We're on plan to achieve our long-term growth rate at utility of 3% to 5% and continue to grow our dividend at an industry-leading rate of 10% a year through 2019. We are committed to executing on our strategies to continue growing our business, growing our communities, and to create long-term shareholder value for all of our shareholders. So, thank you for your time and now I'll turn the call over to Steve. Steve?

Thank you, Sean and good morning everyone. For the second quarter, we reported net income of $72 million or $0.35 per share, as compared to net income of $88 million or $0.44 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 $72 million or $0.36 per share, as compared to net income of $69 million or $0.34 per share in 2015. Second quarter gross margin at the utility increased approximately $15 million, which I will discuss on the next slide. O&M is on plan for the year, the increase of $9 million is due in part to the timing of both plant maintenance and vegetation management. Our goal is to keep O&M growth no higher than the rate of inflation. Depreciation increased $4 million, due to additional assets being placed into service. AFUDC has increased $2 million due to higher construction work-in-progress related to our environmental compliance projects. And finally, income tax expense increased $6 million on higher pre-tax income and lower production tax credits from decreased wind production. Turning to the second quarter gross margin, utility margins increased approximately $15 million for the second quarter of 2016, compared to 2015. There were a few primary drivers for the change in gross margin. First, wholesale transmission revenues increased $7 million compared to the second quarter of 2015. Second, warmer weather translated into $2 million of higher gross margin as cooling degree days were 2% higher compared to the second quarter of 2015. While gross margin for weather was slightly higher than last quarter, compared to normal, weather has reduced gross margin by approximately $4 million for the quarter. Finally, the expiration of our wholesale contract last summer has reduced margin this quarter by approximately $4 million. As we've said before, this item has been included in the current Oklahoma general rate case filing. Moving on to the environmental and Mustang Modernization investments. I'm not really going to go into much detail on this slide, I just want to point out that our CapEx has shifted to coincide with the major in service dates in 2017 and 2018. We anticipate the Mustang CT's will be in service by the end of 2017 and we also expect the scrubbers and the Muskogee conversion to be in service by the end of 2018. We have also added AFUDC and property taxes associated with the above projects. In addition, we have included the rate case timing schedule in our appendix. Turning to our investment in Enable, for both the second quarters of 2015 and 2016, Enable Midstream made cash distributions of approximately $35 million to OGE. Enable posted breakeven results this quarter compared to earnings of $18 million or $0.10 per share last year. There were two primary contributors to the lower results. The first was mark-to-market losses on natural gas and natural gas liquid hedges reducing our earnings by $0.03. The hedging adjustment is an indication of the strengthening of commodity prices since the time in which the hedges were put in to place and will unwind throughout 2016 and some in 2017. Secondly, at the OGE Enogex Holdings level, there was a $6 million increase in deferred state tax liabilities, which impacted our earnings by $0.03. The increase was largely due to a change in state tax law and will not be an ongoing expense. Turning to the 2016 outlook, the utility is on plan. I would like to remind you that approximately two-thirds of our projected utility earnings occur in the third quarter and assuming normal weather, we're comfortable with our current guidance. Before we take your questions, I wanted to address a couple of additional items. We made a $20 million contribution to our pension plan in July and have reduced our discount rate to 3.25% bringing our funded status to 87%. I would like to remind you that the pension plan is closed and we have a pension expense tracker in Oklahoma. The second item I would like to mention is that we anticipate we'll be filing in the next few days a shelf registration in preparation for debt issuances planned in 2017 and beyond. I'll remind you that we do not have any equity needs in the foreseeable future. This concludes our prepared remarks and we'll now answer your questions. Operator?

Thank you. [Operator Instructions] And our first question comes from Paul Ridzon, you may proceed.

Good morning.

Hi, good morning Paul.

So Midstream was down $0.10, $0.06 is explained by hedge timing and the tax item at Enogex. What were the drivers on the other $0.04.

It's really just the downturn in commodity prices and just operating results from Enable for the most part.

Can you just give more detail on this tax item?

It's really a change in the tax law in Louisiana and its taxes that flow through from Enable. If you recall, back in 2013, we setup an employment company and we booked, we increased what we booked, a deferred tax liability of about $17 million and this really just brings that down and it's just a change that they made in their apportionment calculation.

And this is kind of a one-time event?

Yes, until some other change would be made in the tax code, but yes, one-time.

And we’re not going to see this come back after we're going to probably, eventually the head will unwind, but this is permanent.

That's correct.

Okay, thank you.

Thanks Paul.

And our next question comes from Charles Fishman. You may proceed.

Assuming normal weather, you said OG&E was on track, but July was pretty good, wasn't it in Oklahoma?

July weather was slightly above normal, it was pretty humid. So yes, it helped us get back on track. If you recall from the first quarter, we were down a little more on weather and we made up some of that or we will make up more of that in July, it was pretty good.

Okay. And then my second question is, Sean on your comments on CapEx for 2019 and 2020, I sense that you feel the total CapEx at OG&E is likely to go up, but unlikely to go down. Is that a fair assessment of what you said?

Yes, I think that's accurate.

Okay and then I guess a follow-up would be a tougher question is does the fact that your CapEx is likely to go down with the completion of the environmental expenditures? Would that enter into the Board's thinking with respect to other investments i.e., increasing your investment in Enable?

No, I think we look at those independent and so that's not going to factor into that. My comments around the CapEx were really focused on what value we could bring to those communities and those customers. I want to see that customer benefit and then I want to make sure that we have clear line of sight of how we're going to recover that. And that's how we think about that piece of the business and again Enable is a separate discussion and as we've talked about, we like the way this is working where they're actually flowing cash to us.

Okay. That’s very helpful. Thank you. That’s all I had.

Take Care. Have a great day.

And our next question comes from Anthony Crowdell. You may proceed.

Good morning, John. Good morning, Steve.

Hi, how you’re doing.

Just another day in sell side paradise?

All right. Good to hear you. One question first on page 13, the CapEx slide, it looks like you've added another line item, the AFUDC and the Ad Valorem I'm not familiar with that.

The Ad Valorem is really property taxes. That's just what they call it in Oklahoma. So we just added that. If you recall, when we were in the rate case, we were looking for [Seawip]. We're just adding in the AFUDC and the property taxes now given how we'll be recovering that going forward.

But do you get recovery of that or you get a return on?

We get both. We get a return on and we anticipate we'll get recovery as well. We just haven't included that in our CapEx up to this point.

Okay, and now if I just to make sure my math is correct, if I added up the first quarter CapEx each year versus now, actually there's been a slight increase, is that accurate?

That's correct.

Okay and Sean, I guess more of a bigger picture question is we view OGE Energy as a utility. I'm curious on how you view it and what you think the right mix of regulated utility earnings to commodity earnings is acceptable or reasonable for OGE and its shareholder base?

Sure, thanks Anthony. I think your description, we are utility, we've got that and we've actually removed a lot of that commodity exposure. Recall, we used to have 25% of our business was Enogex. Now, it's a much smaller piece, but we positioned Enogex not for earnings, but for cash – I mean Enable, not for earnings, but for cash. And that's how we're thinking about Enable. So OGE is a utility. It just has a cash flow stream coming out of Enable.

And in CenterPoint and I don't know if you could talk about it. If CenterPoint, the right of first refusal, is that for [their] LP and GP shares or one of the two, is there any like clarity on what you have the right of first refusal on?

Yes. So, generally speaking, they are ROFO and ROFR rights, okay, and it's for any of the pieces, meaning the GP or the LP individually or combined for both. That's just how it works.

Okay and it's 30 days and so I think they had approached you, you had said sometime in July or July 18 I guess. When it's get to August 18, do you put out an 8-K or how do we know what OGE decided?

Yes, we'll cross that bridge when we get there. I'm not exactly sure how we're going to handle all that as far as what ultimate decision we make, but obviously we'll address that in some way.

Great. Thanks for taking my question guys.

Take care.

And our next question comes from Greg Reese. You may proceed.

Hey, guys. How are you?

Great. How are you?

I have follow-up question on the ROFO, kind of a two-part question. First, I guess, what exactly prompted CenterPoint at this point to ask on the ROFO. Was it that they had something inbound that basically resulted in them having to present you with the ROFO and then the second part of the question is what happens after the 30-day period, if after that period, there is some sort of inbound on Enable. Do you still have a ROFO to kind of match whatever that inbound would be?

Yes, so let me – Greg, the first question I think to be perfectly honest, you need to address that with CenterPoint. Their decision criteria is something that they ought to speak to, but as far as the way this works is on August 17. That is the date when the 30 days is up. If we make an offer for any or a piece of this or whatever it is, CenterPoint will have 30 days to respond. If it's not accepted, they will have 120 days to sell that interest for a value not less than 105% of what we offered. Then again, if we don't make an offer, that's a different issue. They have 120 days to go pursue their transactions. Okay?

Got you and if they find a superior transaction, can you still match that down the road?

Yes, the ROFR provisions, they work kind of mirror of each other. So, if they were to receive an unsolicited offer, we have a ROFR right on that as well.

And that doesn't expire within 30 days.

Right.

[Operator Instructions] And our next question comes from Brian Russo. You may proceed.

Good. Can you hear me?

Yes.

Just curious, I'm wondering how does the GAAP accounting work for the interim rates that you implemented July 1. Are you able to book that revenue or do you have to wait for a commission decision?

Yes, what we're really doing is we're deferring recording any income off of that. So we're effectively setting up a regulatory liability. We are receiving the cash, but we will wait until an order before we book any earnings associated with that.

Okay, great. And then also did staff make a recommendation in the Oklahoma GRC?

Yes, they did.

Okay, all right, I will check that filing. And then lastly, are there any regional haze legacy legal issues? Any appeals et cetera like we saw in Texas?

No, we've exhausted those outcomes and we have the compliance deadline of January of 2019 and unfortunately we have to meet those deadlines.

Okay, thank you.

Thanks, Brian.

Next question comes from Paul Ridzon. You may proceed.

Was there first quarter hedge impact at midstream? A mark-to-market impact?

No, I do not believe there was.

And you said you expect most of this to reverse by year-end, but some could bleed into 2017 obviously depending on what prices do?

Yes, Enable's hedges are really for the balance of 2016 and they do have some for 2017. They're significantly hedged as it relates to 2016 and rough numbers, about half of that amount would be in 2017.

Half of the $0.03?

Yes, they don't say specifically how would unwinds, I don't necessarily want to comment on that. I'm just saying of their hedge position, they are about half as much hedged in 2017 as they are in 2016. It all depends on when they put the hedges on and what month they were specifically hedging at what prices.

Got it. Thank you again.

You are welcome.

I would now like to turn the call back to Sean Trauschke for further remarks.

Well, just in closing, I want to thank you for your time this morning. Thank you for your interest and support in OGE. We're excited about the future and really pleased with the progress we're making today. So have a great day and we will speak to you soon.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.