OGE Energy Corp. (OGE) Q2 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the OGE Energy Corp.'s Second Quarter 2018 Earnings Call. [Operator Instructions]. As a reminder, today's conference is being recorded. I would now like to turn the call over to Mr. Todd Tidwell. Sir, you may begin.

Thank you, Chelsea. Good morning, everyone, and welcome to OGE Energy Corp.'s Second Quarter 2018 Earnings Call. I'm Todd Tidwell, Director of Investor Relations. 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 ogeenergy.com. In addition, the conference call and accompanying slides will be archived following the call on that same website. Before we begin this morning's 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 statements, but this is our best estimate to date. I would also like to remind you that there is a Regulation G reconciliation for gross margin in the Appendix. I will now turn the call over to Sean Trauschke for his opening comments. Sean?

Hi, thank you, Todd, and good morning, everyone, and thank you for joining us on today's call. Earlier this morning, we reported second quarter consolidated earnings of $0.55 per share compared to $0.52 per share in 2017. The utility reported earnings of $0.46 per share and our portion of Enable earnings were $0.11 per share. Both businesses continued to perform well and accomplished a great deal. Steve will discuss the details in a moment, but right now I want to highlight our second quarter achievements. Our service territory continues to grow. With 7,000 new customers over the last year, we're growing near the historical average of 1%. The latest economic statistics put Oklahoma's unemployment rate below 4%, which is on par with the national average. In addition, our largest load center, Oklahoma City, unemployment is below pre-2008 levels at 3.3% and employment and tax revenues are now growing solidly again, signifying a strong economic outlook. Across our service territory, leadership in economic development is an important part of our company strategy. From data centers to steel mills to the oil and gas sector, we are seeing growth on our system driven by our low rates and quality service. I'm very proud of our team's work to deliver this competitive advantage to the communities we serve. On the operations front, our success has continued through the first half of 2018, transmission and distribution reliability has seen a 15% improvement over this same period last year. Our generation fleet continued to perform well with the combined cycle units performing among the best in the country. The Mustang Energy Center combustion turbines have approximately 1,200 starts across the 7 units already this year, demonstrating their value to the market and our customers. For many years now, we've been talking about Mustang and the other large projects. These projects are now complete or are nearing completion and beginning to bear the positive results we predicted. Just to recap, we began with more than $1 billion of investments, covering 2 scrubbers, 7 low-NOx burners, 2 coal-to-gas conversions, 5 ACI installations, 126 miles of 345-KV transmission line, and of course, the new Mustang plan. All completed projects were under budget and on schedule and being recovered in Oklahoma rates. The unit 1 scrubber at Sooner is complete and going through final testing. Unit 2 in the Muskogee conversions will be completed by January of 2019, and we expect these to be under budget as well. Highlighting our members' dedication, and as we've talked previously, this year our crew spent 40 days in Puerto Rico, helping to restore power to thousands of citizens. In June, OG&E was honored with yet another EEI Emergency Assistance Award for those efforts. I point this out because it is important to note that these achievements were made while achieving best-in-class safety performance. Year-to-date, I'm pleased to report the utility has the top safety performance in the Southeast Electric Exchange. Today marks record performance in safety excellence for our company, going 307 days without an incident or injury. I could not be prouder of the total team effort here at the company. As we mentioned previously, this year we resumed our focus on grid modernization, starting in Arkansas. This investment program is a focused deployment of both integrity and technology assets in the Fort Smith area. The project will reach approximately 1/3 of our Arkansas customers and enable benefit from streamlined operations and reliability improvements. This means they will see integration with the benefit from distribution management systems, integration benefits with existing smart grid investments, decreased annual truck rolls, faster outage response times and improved storm resiliency. We expect the saving improvement in Arkansas greater than 10%. Customers will also benefit from nearly 500,000 of avoided annual O&M in capital maintenance cost. This investment will give us meaningful experience as we move into deployment in Oklahoma, and it will better enable us to meet customer demands and position our infrastructure for the future. Turning to regulatory, as you know, we reached a settlement in our most recent Oklahoma rate review that provides for full recovery of our investment in the Mustang Energy Center. We're pleased the various parties recognize the value and strategic importance of Mustang to our customers, communities and the state. The agreement supports regional energy grid reliability and resiliency. It also ensured that Oklahoma customers receive the timely benefit of the tax savings resulting from the Tax Cuts and Jobs Act of 2017. The new rates took effect July 1, with customers beginning to receive the tax savings at the same time. We'll file another rate review in Oklahoma at the end of 2018 for the recovery of the Sooner Scrubbers, and we will make our first Arkansas Formula Rate filing in October of this year. Turning to Enable, on their call last week, they reported another quarter of strong results. During the second quarter, per day natural gas gathered volumes grew for the 10th consecutive quarter, as a result of strong rig activity across Enable's footprint. They also achieved the highest per day crude gathered volumes since the partnership's formation in May of 2013. Enable also commissioned project Wildcat, bringing critical processing capacity and market access to Anadarko Basin suppliers. They also signed several key transportation contracts in the second quarter, further demonstrating market demand for their transportation systems. As a sponsor of Enable, we continue to be pleased with their performance and what the Enable team is building. Last but not least, the Enable board approved quarterly distributions last week, of which $35 million will be distributed to OGE. Before turning the call over to Steve, I do want to acknowledge the growth and accomplishments of the company. We have a lot of momentum here and it originates from a solid core. I mentioned previously the world-class safety performance. Our customers are enjoying even higher levels of reliability. We've added state-of-the-art generation and even stronger performance on our existing fleet. Our environmental investments have made significant strides in emission reductions. By the close of '19, we expect SO2 to be lower by 86%, NOx to be lower by 74% and CO2 to be lower by 40%. Our J.D. Power results for the residential customer satisfaction continue to improve. Each year, we consistently rank among the leaders in the highly competitive South region, and we're doing all of this keeping retail rates 29% below the national average, but we're not satisfied and I think that's the key to our success. We know we must continually strive to get even better. So in closing, I want to reiterate how pleased I am with the performance of both businesses. We're committed to executing our strategy, to continuing to growing our business, growing our communities and creating long-term shareholder value. So thank you, and I'll turn the call over to Steve to review our financial results for the quarter. Steve?

Thank you, Sean, and good morning, everyone. For the second quarter, we reported net income of $111 million or $0.55 per share as compared to net income of $105 million or $0.52 per share in 2017. The contribution by business unit on a comparative basis is listed on the slide. At OG&E, net income for the quarter was $92 million or $0.46 per share as compared to net income of $86 million or $0.43 per share in 2017. Second quarter gross margin at the utility increased approximately $4 million, which I will discuss on the next slide. The following 4 expenses are on plan and in our guidance. O&M increased approximately $9 million due to increased employee and vegetation management costs. We remain focused on cost control and are on plan for the year. Depreciation increased approximately $7 million due to additional assets placed into service, including the Mustang CTs and the Covington solar farm. AFUDC has decreased $2 million due to lower construction work in progress, following the completion of the Mustang CTs. And finally, income taxing decreased $27 million primarily due to the decrease in the federal tax rate. As I mentioned earlier, utility margins were up $4 million for the second quarter. The primary driver for the increase was warmer weather compared to 2017. Looking closer at weather, cooling degree days were 24% above normal and 37% above last year for the second quarter. This translated into $13 million in higher margin compared to normal and $21 million in higher gross margin compared to last year. Higher demand prices, new customer growth, industrial and oilfield sales and wholesale transmission combined to increase margin by approximately $8 million. Partially offsetting these increases is $26 million to be returned to customers due to the lowering of the corporate tax rates. Turning to our investment in Enable. For the second quarter of 2018, Enable Midstream made cash distributions of approximately $35 million, the same amount received in the second quarter of 2017. Enable also contributed earnings of $22 million or $0.11 per share compared to $18 million or $0.09 per share in 2017. Enable continues to perform very well and their financial metrics are strong. Enable set all-time quarterly records for gathering and processing volumes, natural gas liquids and crude oil gathered volumes. Adjusted EBITDA increased by $30 million and DCF increased $15 million compared to the second quarter of 2017. They ended the quarter with a distribution coverage ratio of 1.24x. Turning to the 2018 outlook. At the utility and assuming normal weather for the balance of the year, we project earnings per share to be at the high end of the earnings range of $1.43 to $1.53 per average diluted share. As you know, over half of our earnings will occur in the third quarter. This concludes our prepared remarks. We'll now answer your questions.

[Operator Instructions]. And our first question will come from the line of Julien Dumoulin-Smith with Bank of America, Merrill Lynch.

Would love to hear a little bit of your thoughts on how the next case here coming up might be structured given some of the resolution, shall we say, that you've already been able to bring to this next case. Might it be abbreviated? I just want to try to understand some of the other parameters that might be resolved ahead of time here and how that might impact it. And then, maybe in parallel with that, can you give us a little bit of an update on the process at the Oklahoma level on any kind of reform?

Sure. So maybe take it in two steps there. I think this upcoming case, just like the previous case, is going to be very straightforward. It is about the recovery of the Sooner investments and to a smaller degree the conversion of the two Muskogee units to natural gas. And again, a very straightforward case. And the merits of that case have been heard previously. Previously, all three commissioners supported the plan of scrubbing those units and converting the Muskogee unit. So we feel very good about this case going forward. As far as the Governor's task force looking at the structure of the commission and the mission of the commission, they still are on schedule to present their final recommendations in early November, after the November elections. And again, Julian, I think we've always said, we're not expecting -- I think it would be unrealistic to expect some big, great change or anything to happen immediately with those recommendations. But I think those are ideas that you have somebody look at on how things work, it's always good in business to have someone come in and evaluate how you can do things better, and so we're interested in that feedback that we get and hopefully, that'll create some momentum for us all.

Got it. And then I suppose, just thinking more conceptually about the company's finances. How are you thinking about capital allocation, sort of at a higher level, right? You've got some latitude here. You've made commitments on dividend already. How do you think about extending those out and/or evaluating other alternatives, be it strategic or additional capital investments? Because we've seen you make moves on, frankly, at least a couple of those year-to-date. How do you think about it into the future at this point? Are there further CapEx levers that were waiting here? Or do you think a dividend extension or acceleration, et cetera is the more likely angle?

Sure. So good question and something that we spend a lot of time evaluating here at the company. And recall we committed to a 10% dividend increase through 2019. And so I think your first question's there, what are you going to do after that in terms of the dividend? I think first and foremost, we think about this in terms of long-term shareholder value creation. I mean, that's how we've looked at this, and we have numerous opportunities for capital investment. We've talked about that before. Our first foray is going to be really into Arkansas. We have clear line of sight there to the recovery mechanisms. Regulatory outcomes are very important to our investment decisions and so therefore, that line of sight recovery is key, so to the extent that we have better line of sight, and I'm confident we will in Oklahoma, we could see capital expenditures increase. As it relates to the dividend, I think that's a -- also something that we consider in conjunction with that. So we've not made any commitments beyond 2019 for the dividend, but we recognize that growing our earnings of the company and growing the dividends of the company are important investment criteria, and we're going to continue to be prudent allocators of capital and to the extent that we have opportunities to invest, we want to invest. We want to grow our company.

Right. But strategically it seems like you're focused internally rather than externally.

Yes, we appreciate the comment, Julian. We -- not really going to comment on externally, and I'm not sure there's really any upside to that and -- but I understand your point, and I think what I'd want you to take away from this is, we're focused on creating long-term shareholder value, and we will be prudent allocators of capital. I think we've proven that over the years, and I see no reason that won't continue.

Our next question comes from the line of Paul Ridzon with KeyBanc.

Just a quick question. New rates kicked in July 1, and that includes the benefit of lower taxes. What happened to that benefit in the first half of the year?

We had reserved that -- we began reserving that giveback to customers or that benefit starting in January. So basically, the first half, we reserved and I mentioned that in my comments that, that was an offset to our margin growth, and that's all been -- we've started giving that back already and actually, that first six months has been returned in July.

That first six months have been full -- been fully returned. Okay.

It has been fully returned in Oklahoma. We'll start giving that back in Arkansas in October.

And how's July weather been? Is that baked into your updated forecast through the top ends?

It's been okay. Not great, not bad, just okay.

[Operator Instructions]. Our next question comes from the line of Vedula Murti with Avon Capital.

I wanted to follow up a little bit on what Julian was talking about, but first thing, assuming the case you'll be filing here for the final environmental investments and everything like that kind of go the way you're anticipating, should we -- do you believe you'll be able to then basically manage within the existing rate structure? And be able to not be in the rate arena for a while?

Yes, I think there's two components to that question. Good question. Certainly, as we look at some of these grid-modernization investments, you want to make sure you have a line of sight so does that -- do we pursue some sort of Rider Formula Rate mechanism for those. We'll certainly consider those. I think first things first, we're focused on getting all of these environmental compliance projects behind us soon. Sooner will be the last -- Sooner and Muskogee will be the last ones in that suite. And so that would be our expectation, of not going in every year for rate actions. And so to the extent that we could secure some sort of rider or something like that, that could keep us out even longer, but I think your thesis is exactly right. We're not going to have to go in every year but the better regulatory, more constructive regulatory mechanism we have, we can stay out for additional years.

Well -- because given your cash flow profile as well as your balance sheet, and everything like that, frankly, you have an opportunity if you wanted to potentially consider an equity buyback or that type of thing as a part of capital allocation as opposed to incremental capital investments such as grid mods. So how do you think about those -- how do you think about compare and contrasting those?

Yes, well, I think it goes back to what's going to create the most long-term shareholder value, and we've been rather bullish in terms of the investment opportunities we have in our service territories. When we had deferred a lot of those great modernization things as we were going through this environmental program and so we're -- we've got a lot there that is teed up and ready to go. That's really going to create a lot of value for our customers as well. So assuming that we have the right regulatory construct, I think those are going to be really valuable investments and can create a lot of value for not just our shareholders, but more importantly, probably our customers going forward.

Okay. And I guess one last thing, is there any type of update in terms of management structure? Or thoughts about any, I guess, realignment? Or clarity in terms of Enable other than just the status quo?

I think that's something -- we always look at different things around Enable. I think that’s just -- I think good management practice. But we have nothing to update as far as any pending actions or any change of thinking around how Enable is organized.

Are there any milestones in terms of just the way the partnership agreements work, where that type of valuation would be considered and just re-looked at on a formal basis?

No. Nothing like that.

And I'm showing no further questions at this time. I would now like to turn the call back to Mr. Sean Trauschke for closing remarks.

Thank you, Chelsea. This concludes our call. I want to thank all of you for joining us today. Thank you for your interest in OGE. And all of you -- I hope all of you have a safe and wonderful day. Thank you.

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