OGE Energy Corp. (OGE) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2018 OGE Energy Earnings Conference Call. [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 go ahead.

Thank you, Michelle, and good morning, everyone, and welcome to OGE Energy Corp.'s third quarter 2018 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 third 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 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 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?

Thank you, Todd, and good morning, everyone, and thank you for joining us on today's call. Earlier this morning, we reported third quarter consolidated earnings of $1.02 per share compared to $0.92 per share in 2017. The utility, reported earnings of $0.92 per share and our portion of Enable earnings was $0.14 per share. I'm pleased with the operational and financial performance of both businesses. Steve will discuss the financial results in a moment, but first, I'd like to discuss the key events and accomplishments. You know, OG&E's has had a remarkable year. It seems each quarter we are achieving a new milestone on our journey to continually getting better to improve the customer experience with safe, reliable and low-cost energy. But then, again, it should be better. That's what good operating companies do, they get better, they grow. And that's clearly what we are doing. We continued our strong record-setting safety performance and year-to-date are the safest company in our industry and we expect the same of our contractors. Illustrative of this is the Sooner scrubber project that has seen 2.8 million hours work with no loss-time accidents. Speaking of the generating fleet. I'm pleased to announce that our fleet continues to build upon last year's performance. The Mustang Energy Centers have approximately 1,800 starts across the seven units since inception earlier this year, demonstrating their value to the market and our customers. Generation reliability has also improved by an additional 4% over 2017. Distribution reliability has improved approximately 10% over 2017, as our deployment of technology and the hardening of assets is showing real value for our customers. This year, we also completed and placed into service the Windspeed II transmission line, the Covington solar farm. We settled our last rate case in a constructive manner passing through to our customers the benefits of tax reform in a timely fashion. The Sooner scrubber project is on time and on budget. Unit 1 has been commissioned, Unit 2 is on schedule and slated for completion next month. And finally, we once again answer the call to assist with recent hurricane restoration efforts. And while the year's in complete, I couldn't be more proud of our performance. We are in a fortunate position as having continued customer and sales growth in our service territory. We added over 6,000 new customers since last year and sales growth is steady at about 1%. The economies of our two largest load centers are robust. Oklahoma City's unemployment rate sits at 2.8% and Fort Smith is at 3.6%. You'll recall at the height of the 2008 recession the unemployment rate in Fort Smith was well over 10%. Truly a remarkable turnaround story in Western Arkansas. Leadership and economic development is an important part of our company's strategy. We continue to be on the front line working with stakeholders to attract new and diverse businesses to our service territory as well as playing a key role in the expansion of current businesses. For example in the third quarter we saw the expansion of a large customer in Init, Oklahoma. This successful expansion was instrumental in not only protecting the existing jobs in the area, but also adding new jobs. We successfully partnered with our customers and communities to find solutions for their business and economic needs. Furthermore on the commercial front, our footprint continues to expand in the data center sector. Another area of focus that is gaining traction is the electrification of compressors and processors in the prolific SCOOP and STACK midstream space. There is a strong business case for conversion and we are at the forefront of this transition. Clearly, Oklahoma and Arkansas are open for business and we're proud to be playing an active and supportive role in this endeavor. Turning to the regulatory front. We submitted our final integrated resource plan to the OCC in September and at the same time, we had the opportunity to end a costly contract, which necessitates the need for replacement capacity. For reference, our capacity needs are 168 megawatts by the summer of 2019 and 305 megawatts by the summer of 2020, in order to maintain our capacity reserve margin requirements in the SPP. We issued an RFP for these capacity needs. We expect to make approval filing with the OCC in December and a similar filing in Arkansas. We have been impressed with the proposals and although we can't discuss the specifics. We are pleased that customers will see reduced cost as a result of our actions. We've mentioned many times that a cornerstone of our strategy is to actively manage cost to customers, so new investments can be made to protect the customers bill. This is a prime example of this strategy in action. Since 2011, we've invested over $5 billion at the utility and customer bills have grown less than 1%. In Arkansas, we filed a new rate request under the Formula Rate plan and requested a $6.4 million increase with new rates in place by April 1, 2019. We are excited about this streamlined process in Arkansas that expedites recovery, increases transparency and enhances the utility planning process. Continuing on with the regulatory update, we will file a general rate case in Oklahoma for the recovery of the Sooner scrubbers by year-end. Before moving on to Enable, I did want to briefly discuss our financial position as it relates to capital expenditures and dividend growth. At the end of September, the OGE Board approved another 10% increase in the dividend. This was the fifth consecutive year of a 10% increase. We announced our dividend policy back in 2014 with the formation of Enable and the flipping cash position from the midstream business. As investors, you rightfully inquire if we will continue with the increase and at what percentage. I can tell you this is an area where we are strongly focused. We are in a favorable position of having many options because of our healthy balance sheet, which provides significant financial flexibility. Our objective has always been and continues to be value creation. We can increase capital investment, increase the dividend or both. Regardless, you should expect us to continue to be prudent allocators of capital. I do want to be very clear here that we will not sit on excess cash, nor will we allow the balance sheet to become lazy. Embedded in this is our commitment to protecting our strong credit profile. We will continue to update investments as we see clarity in the recovery and you should not expect a big multi-year capital announcement, but rather a value-creation strategy based on financial flexibility. What we will do is deploy capital in the most efficient manner that benefits customers and shareholders alike. We have a large backlog of projects that have not been reflected in our capital expenditure forecast. If the regulatory environment is constructive, you can expect to see increased investments that benefit customers. If not, cash will be deployed through dividends or other means to increase shareholder value. In other words, we will always look to optimize our capital allocation strategy with a goal to maximize shareholder value. Now to Enable. They continue to produce stellar results. Natural gas gathered, natural gas process, natural gas liquids produced and crude oil gathered, all hit record highs once again in the third quarter. Distributable cash flow and net income also were at record levels. Enable's ability to maintain strong financial metrics through trying times is a testament to their leadership and focus. They continue to tie in assets to expand their existing footprint in some of the most prolific oil and gas basis in the U.S. The recently announced acquisition of Velocity Holdings greatly enhances their position in the crude gathering business. In this quarter they also announced the development of a Gulf Run Pipeline, an interstate natural gas transportation project that is designed to connect abundant U.S. natural gas supplies to growing LNG export markets in the Gulf Coast. This is another example of Enable leveraging its existing assets to provide customers with cost-effective market solutions. Before turning the call over to Steve, I did want to reiterate how pleased I'm with our position as a Company. These results just don't happen overnight, but as a result of hard work and focus by everyone here. You know a key part of our strategy and culture is to never settle, but to strive to get better each and every day. It's not just a motto, it's not just a slogan, but something to which we are all committed. We believe this creates the proverbial win-win for customers and shareholders and I couldn't be prouder of performance of our dedicated members in delivering outstanding results. So thank you. And now, I'll turn the call over to Steve to review the financial results. Steve?

Thank you, Sean, and good morning, everyone. For the third quarter, we reported net income of $205 million or $1.02 per share as compared to net income of $183 million or $0.92 per share in 2017. The contribution by business unit on a comparative basis is listed on the slide. As you know, we implemented rates in July that include tax reform. And this adds complexity to quarter-over-quarter comparisons. I'll do my best to simplify this in my remarks. Turning to gross margin. Gross margin at the utility was higher for the quarter excluding the impacts from tax reform that resulted in lower customer rates, which were offset by lower income tax expense. Margin was higher due to the following; weather contributed approximately $5 million of margin as cooling degree days increased 3% compared to the third quarter of 2017. However, compared to normal, weather reduced margin approximately $12 million for the quarter. New customer growth contributed approximately $3 million. We added nearly 6,300 new customers to the system as compared to the third quarter of 2017 supported by our commercial and industrial sectors. Higher demand revenue and industrial oilfield sales increased margin by approximately $6 million. Offsetting these increases were the impact of lower tax rates on margin as a result of the Tax Cuts and Jobs Act. At OG&E net income for the quarter was $184 million or $0.92 per share in 2018, as compared to net income of $162 million or $0.81 per share in 2017. O&M increased approximately $6 million due in part to the timing of plant maintenance and increased employee costs and we are on plan for the year. Depreciation increased approximately $5 million primarily due to the Mustang CT as being placed in the service. AFUDC also decreased $5 million as we are seeing lower construction work in progress balances with projects being completed. Likewise other income was approximately $10 million lower due in part to a decrease in the tax gross up related to lower AFUDC and a decrease in Guaranteed Flat Bill margins, which are now included in gross margin. This trend of lower AFUDC and higher depreciation expense will continue as our projects are placed into service. Margin will increase once we receive recovery. Placing these major projects into service creates the lumpiness in earnings we've mentioned in the past. Finally, income tax expenses decreased $53 million, primarily due to the reduction in the corporate federal tax rate. Turning to our investment in Enable. For the third quarter of 2018, Enable Midstream made cash distributions of approximately $35 million, the same amount received in the third quarter of 2017. Enable also contributed earnings of $28 million or $0.14 per share compared to $21 million or $0.10 per share in 2017. The increase in earnings was primarily due to record volumes in the gathering and processing segment partially offset by higher operating and interest expenses. Enable continues to perform very well. This quarter they achieved record financial results that included the highest quarterly results for net income, adjusted EBITDA and distributable cash flow since their formation in 2013. They ended the quarter with a distribution coverage ratio of 1.6x. We were pleased with the 2019 outlook Enable provided on their call, comparing their 2018 guidance with the newly issued 2019 guidance, they are expecting growth in adjusted EBITDA of 12% and growth and distributable cash flow of 9%, while maintaining a strong coverage ratio of 1.38 times at the midpoint of the range. We look forward to Enable's continued growth. Turning to the 2018 outlook. We're increasing our utility guidance to $1.59 to $1.61 per share. There's a few reasons for the increase; utility experienced a one-time $0.04 per share benefit from the timing of rate implementation and rate design; weather was approximately $0.04 above normal year-to-date; depreciation expenses lower due to the timing of plant placed into service; and the utility had stronger nonresidential growth than expected. Excluding the one-time items, we had an outstanding year and would have been toward the top end of our guidance. The earnings contributions from OGE Energy Holdings ownership interest in Enable midstream is projected to be between $0.50 and $0.52 per share. The consolidated guidance projects net increase to between $2.05 and $2.09 per share -- per average diluted share and includes a projected $0.04 loss at the holding company. This is an increase from the previously issued guidance of between $1.90 and $2.05 for average diluted share and is primarily due to higher projected earnings at the utility. This concludes our prepared remarks today and we will now answer your questions.

[Operator Instructions] Our first question comes from the line of Paul Ridzon with KeyBanc. Your line is open. Please go ahead.

A couple of questions. What drove the lower holdco results in the quarter? I think would stick at one at a time I guess?

Yes on the holding company, there's a little bit of interest expense that's there as we kind of manage short-term debt or cash. So that happens from time to time. And then there's also a little bit of a timing on taxes there that were reversed in the fourth quarter, but we do expect the holding company to be around $0.04 for the year. We also have a deferred compensation plan that when the stock over performs actually causes us to have a charge at the holding company and that's the remaining portion.

You mentioned 305 megawatt short by 2020. You've got an RFP out. I assume you bid into that?

Well, we're running an RFP and there are available options out there in the marketplace. We certainly will compare that to our own internal options and we'll see where that takes us. I think to your question I guess is how does this impact our capital expenditure sides or forecast for 2019. That's all the comp -- we incorporated that into those numbers.

Okay. And then in the quarter was tax reform neutral?

No, there was a little bit of a pickup. Well actually there was about $0.08 of a pickup due to tax reform. and that's really just a timing issue. When tax reform was put into base rates that gives money back to customers ratably throughout the year. And as you know, our margin is seasonal, our revenues are seasonal. So there's a pickup when our revenues were high and we'll be giving that back over the next two quarters where customers -- it is neutral overall, but just the timing of our revenue stream creates a bit of a disconnect.

Is it neutral within 2018 or does it get into multiple years?

It crosses over into the first quarter of 2019.

So where are we year-to-date?

Will be a $0. 04 pickup this year.

And then you kind of gave some reasons for the increase guidance. Do any of these bleed into 2019 or are they all kind of one-timing -- well just one-timing issues?

Well, $0.08 is one-time. $0. 04 from the timing of tax reform and then $0.04 due to weather.

Thank you. And our next question comes from the line of Julien Dumoulin-Smith with Bank of America Merrill Lynch. Your line is open. Please go ahead.

Hey. Good morning. This is actually [indiscernible] here for Julian. Yes, I just had a question regarding your great modernization plan. Have you been deploying that in Arkansas? And when can we kind of expect you to display the benefits in Oklahoma for the regulators there?

I'm sorry, I didn't catch the last part of your question.

Yes, I was just wondering, if you started deploying grid mod in Arkansas. And if you have? When can we expect you to begin educating stakeholders in Oklahoma of the benefits there and potentially pursue a rider in Oklahoma?

So yes, we are under way in Arkansas. We're addressing about 1/3 of the circuits in Arkansas. We think we're expecting to see 10% improvement in saving in Arkansas. Some significant savings in terms of O&M expenses in Arkansas, but just by looking at this first wave of 1/3 of the circuits in Arkansas. The idea would be -- we want to get past the Sooner scrubber project, this RFP project. And then we will begin having dialogue with some sort of rider tracker for grid mod in Oklahoma. But first things first, we want to get the current regulatory calendar behind us. I think the other benefit that occurs there is because we have the Formula Rate in Arkansas, we will have a track record there of what investments we made and to realize customer benefits that have been achieved and I think we'll have a good story there to share that with Oklahoma.

And then just you alluded to having a large backlog of projects not in your forecast. I just want outside of grid mod, what other opportunities are you seeing?

Well, I think it's primarily around the grid mod and that's become a big word that encompasses a lot of elements. But we've said for a number of years, when -- before we had the Formula Rate structure in Arkansas, we didn't -- we did not invest as heavily as we had been in years past. We've got some catch up work to do in Arkansas. In addition to that, we are installing a lot of this new technology there in Arkansas. So we've got two components going on in Arkansas. And then quite frankly even in Oklahoma because we were forced to do these environmental compliance projects, we deferred some of the investments in grid modernization, some of those in emerging technologies to kind of ease the customer impacts. We've even got some catch up to do in Oklahoma too. So it's primarily going to be around the wireless side of the business. We've invested significantly on the generation side here in the last couple of years. But we're always looking for creative ways to make investments and really improve the reliability to customers and not impact their bills.

[Operator Instructions] Our next question comes from the line of Andrew Levi with ExodusPoint. Your line is open. Please go ahead.

Hey, guys. How are you?

Hey, good, Andy. How you doing?

I am doing really well.

Are you already out in California for EEI or?

No, actually I have a pot midst on Saturday. So I'm actually get the steaming.

Are you not coming out next week at all?

I am not, it will be kind of volatile too. But, whatever, I'll ask my question here and I'll see you in December I guess, when you come to the conference.

Okay. All right.

So anyway just two questions and I apologize because I did jump on like five minutes late and I kind of heard the tail end. Could you just repeat, I hate to make you repeat, but just what you were saying about the dividend longer term? And then the second question is also, what you were saying longer term about potential CapEx raises?

Yes, our intent is to continue to invest organically and grow the earnings of the Company and grow the dividends of the Company. And we're going to be prudent allocators of that. We've worked hard to create our balance sheet. We were fortunate to have that flexibility. What I was referring to is, I want to get there in particular in Oklahoma through these environmental projects. The one lesson we learned out of some of our previous cases is we've got to keep these simple stay focused on the task at hand and not get too far out in front. I do believe things are continuing to improve in Oklahoma and as things continue, we will begin highlighting more capital investment opportunities kind of as we go. I'm not sure that in particular in Oklahoma for us to announce a multi-year, multi-billion dollar investment program is productive to the regulatory outcome. So we're going to be very thoughtful about growing our dividend and making investments. But the ultimate goal is to really grow both and meeting the earnings of the Company and the dividends and we've done that over the last couple of years and we think that's going to continue. We expect it to continue.

And then as far as the dividend?

We're going to grow that too. We're going to grow at 10% this year like we...

I know, but then in the longer term when do we find out kind of that was like through this year and then after that we were going to do...

Yes, I think we're going to get through this regulatory cycle in Oklahoma and that will be a very good data point for us to identify a longer-term dividend growth rate.

Thank you. And I'm showing no further questions at this time. And I'd like to turn the conference back over to Sean Trauschke for any closing remarks.

Well, thank you, Michelle, and thank you all for joining us today and thank you for your interest in the Company. And I look forward to seeing many of you next week. Have a great day.

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.