OGE Energy Corp (OGE) 2003 Q2 法說會逐字稿

Good day. I would like to turn the program over to your host, Mr. Jim Hatfield. Go ahead, please.

Thank you and good morning and welcome to OGE Energy Corp.'s second-quarter 2003 conference call. I am Jim Hatfield, Senior Vice President and Chief Financial Officer. I have with me today Steve Moore, Chairman, President, and CEO; Al Strecker, Executive Vice President and Chief Operating Officer; Pete Delaney, Executive Vice President; Don Rowlett, Vice President and Controller; and Todd Tidwell, Manager of Financial Planning and Investor Relations; all with OGE Energy Corp.

In terms of the call today, we're going to hear some opening remarks from Steve Moore. I'll review second quarter, talk about 2003 outlook, and then we will turn it over for Q&A. Before we get started, this is webcast today; I want to refer everybody to the link in our earnings release. And also remind everybody today that we have prepared slides to accompany our webcast, and so it will be easy to follow along in the numbers as we get into the presentation. Also before we began, I want to point everybody to the Safe Harbor statement that is contained at the end of the earnings release.

With that caveat, I will turn it over to Steve.

Thank you, Jim. I would like to also welcome you to the call, and we appreciate your continued interest in OG&E. Well, this is an exciting time for the company and we have got a lot to cover today. I want to address three areas. Firs, our second-quarter earnings; second, progress towards our powerplant acquisition; and third, OG&E's new wind-power program.

First, we announced this morning that second-quarter earnings for OGE Energy Corp. were 41 cents a share, up from 36 cents a share last year. I feel this improvement is noteworthy because second=quarter results are traditionally driven by utility earnings and summer weather. But this year, a rate reduction for our utility OG&E, compounded by cooler weather in the second quarter, resulted in lower net income for the utility.

So at a time when improved performance at Enogex is what we need, that is exactly what we're getting. We are very pleased to report that Enogex contributed 10 cents a share to our consolidated earnings in the second quarter. In fact, the performance by Enogex has enabled us to increase our full-year earnings projection. Previously we had said we expected OGE Energy Corp. to earn between $1.35 and $1.45 a share this year.

Now we expect earnings between $1.40 and $1.50 a share for 2003, due almost entirely to the improved financial performance at Enogex. And I would note that we've had some hot weather to start the third quarter. Our customers set new daily records for system megawatt hours and peak demands three times in July.

Jim will discuss the second quarter on our outlook for the rest of the year in greater detail in just a moment. As you know, one of our most important goals in 2003 is to acquire at least 400 megawatts of new electric generating capacity. In late June, you might remember, we announced our decision to move our general rate filing to later in the year to coincide with that acquisition. We had pursued our options carefully, and we believe we are on track to acquire that new plant.

We expect to announce that we have entered into a purchase agreement soon. Such an acquisition would put us in a fairly unique position, with a clear path for growth in our regulated utility. Once we have a purchase agreement, we will file requests with state regulators in Oklahoma and Arkansas to have the plant included in our regulated rate base. In our rate case settlement agreement last year, we agreed to provide to our customers that the new plant, when added to our fleet, will make possible those savings. It will enable us to provide cost savings for customers, at the same time increasing earnings for our shareowners.

Also here in Oklahoma we are proposing, and the commission is considering, another kind of addition to our generating capacity. We have an agreement to purchase 50 megawatts of electrical output from a new wind farm under construction in northwestern Oklahoma. Yesterday a law judge here in Oklahoma approved our proposal. If the commission approves the proposal on a hearing scheduled for August 12th, we will begin offering our customers the option to choose wind-power for all or part of their electric service.

We are excited to take this first step and see how wind-power works in our system in an environment of real supply and demand. It is a voluntary program with no governmental mandates, which is the way it should be. We expect to begin delivering wind-power by the end of the year to our customers who sign up for it this fall.

Before I turn it back over to Jim, I would just like to thank you again for your interest in the company. As you know, we have come through a very difficult period in the energy industry. Plenty of challenges remain in front of us, we know; but I think today's news indicates our company is faring very well. We hear a lot about companies talking about going back to their basics or back to their core strengths, and we don't have to do that.

We've been focused on our core strengths in electricity and natural gas all along. I think our conservative business strategy is the right one for us, and it has brought us to an important point. For our shareholders, we have a clear path for earnings growth, and we continue to provide award-winning service to our customers.

As one example of the latter, I would point to a new J.D. Powers study of electric utilities, which ranks OG&E first in customer satisfaction in 15 southern states. Customer satisfaction is our goal. It is very important, so we do appreciate that recognition. J.D. Powers' southern region, by the way, is the region with the highest overall customer satisfaction in the United States. So we are particularly pleased to be first within the region.

So the people at OG&E, I feel, are regarded as the very best of the best as they strive to deliver value to customers and shareowners every day. There is a real sense of momentum around OG&E right now. I hope you see us as a company moving in the right direction; and certainly we appreciate your continued support. Thanks again for your interest. I will turn it back over to Jim.

Thank you, Steve. I will now cover the earnings results of OGE Energy Corp. First, I will start with a discussion of the second quarter. Second, discuss the contributions of the business units in the quarter. And third, comment on the 2003 outlook. Now for a discussion of the second quarter, we reported net income of $32.2 million or 41 cents per share, as compared to net income of 28.4 million or 36 cents per share in the second quarter of 2002.

The contributions by business unit on a comparative basis are as follows. Energy Corp., loss of 4 cents compared to 5 cents in 2002; OG&E, 35 cents as compared to 40 cents in 2002; and Enogex, contribution of 10 cents versus 1 cent in 2002; 41 versus 36. In terms of drivers of the contributions, starting at OGE Energy Corp., the holding company, a loss of 3.4 million or 4 cents per share, as compared to loss of 3.4 million or 5 cents per share in the second quarter of 2002.

Average shares outstanding increased from 79.2 million, from 78 million in the second quarter of 2002. So even though Energy Corp. was flat quarter to quarter on a net income basis, more shares outstanding reduced the per-share loss. For OG&E, net income was 27.9 million or 35 cents per share, as compared to net income of 30.8 million or 40 cents per share in the second quarter of 2002.

The components of operating results are as follows. Gross margin was 171 million, as compared to 174 million in 2002. The reconciliation to 2002 consists of growth, a positive contribution of 4.9 million or 4 cents a share; the ECR, 2.6 million or 2 cents a share; those were offset by weather, negative contribution of 4.8 million or 4 cents a share; the rate reduction, 3.4 million or 3 cents a share; the GEP, 1.1 million or 1 cent a share; and off systems sales, 1.1 million or 1 cent a share. We continue to experience a solid growth in electric sales in the second quarter.

I mentioned the positive benefit from the ECR. The ECR is a fuel recovery mechanism in Arkansas. In the fourth quarter of 2002 the accounting for this rider was changed so that fuel recover going forward will neither positively nor negatively impact the earnings of OG&E, which is consistent with our Oklahoma treatment. However, prior to the fourth quarter we had the potential to over or under collect fuel, as the base was reset every April 1st. The positive contribution of 2.6 million represents under collection in last year's second quarter. This is a timing issue. For the remainder of 2003, we will see negative variance in the second quarter, but no financial impact for 2003 as a whole.

The benefit of growth and the ECR was offset by unfavorable weather in the quarter, as cooling degree days were 13 percent below normal and 8 percent below the 2002 quarter, resulting in a negative variance. Additionally, the rate reduction, which took effect in January, the loss of the GEP rider as of June 30, 2002, and no benefit from off systems sales also negatively impacted the second quarter.

We will now discuss O&M expenses, which demonstrated a slightly positive trend of 74.9 million in the quarter. The reconciliation to 2002 consists of a positive variance of uncollectibles, 1.7 million or 1 cent a share; miscellaneous other expenses, a positive variance of 1.9 million or 1 cent a share; and pensions and negative variance of 3 million or 2 cents a share. Lower levels of uncollectible and miscellaneous other expenses were mostly offset by higher pension expense. The lower levels of uncollectible accounts is a result of process improvements made in our collection practices. Rising pension expense is a result of general upward trend in pension cost, as seen throughout our industry.

Depreciation expense decreased about 1.1 million or 1 cent a share. This is the result of changes to our depreciation schedules as a result of our 2002 rate case. The increased number of shares outstanding reduced the per-share contribution of the utility by about 1 cent a share.

Now for Enogex. Net income of 7.7 million or 10 cents a share, as compared to net income of 1 million or 1 cent a share in 2002. As Steve pointed out in his opening comments, we are pleased with the improving operating results at Enogex in the second quarter. The components of net income at Enogex are as follows. Gross margins increased 22 percent, from 48.6 million in 2002 to 59.6 million in 2003.

The gross margin contribution by business unit is as follows. Transportation storage, 35.3 million in this year's quarter as compared to 25.7 million in the 2002 quarter. Gathering and processing, 21.3, as compared to 17.5 in 2002. Marketing and trading, 3 million, down from 5.4 million in 2002; 59.6 compared to 48.6.

The increase in transportation and storage gross margin was driven primarily by improved pipeline system fuel usage, higher levels of firm transportation revenues, and storage margins on an asset acquired in the second half of 2002. The improved fuel usage is a result of collection of under-recovered fuel from prior periods and more efficient operation of the pipeline system. Improvement in firm transportation is a result of a collectibility reserve taken in 2002. Storage results benefited from OG&E contracting for higher levels of storage service for its utility needs at market base rates. As you know, Enogex provides OG&E with transportation and storage services under a contract that is subject to approval by the Oklahoma Corporation Commission.

The increase in gathering and processing gross margin was a result of better performance in both businesses as compared to 2002. Processing gross margin was 6.7 million in 2003, compared to 5.7 million in 2002. The major factors in increased gross margin were the optimization of the plants and higher prices. Although volumes were down, due to bypass of gas on uneconomics (ph) , average realized NGL prices were up. Average gross margin per gallon of NGL was 7.9 cents in 2003, compared to 6.6 cents in 2002. Treating fees, which we have spoken about in the past, helped to minimize downside exposure under certain market conditions. Gathering gross margins were 14.6 million as compared to 11.8 million in 2002.

The major factors in improved gross margins were our ability to improve rates through renegotiation of expiring contracts; volumes; well connects in the quarter were 65 as compared to 22 in last year's quarter. The decrease in gross margins in marketing and trading were the result of lower volumes and realized prices in natural gas marketing, partially offset by profitable use of storage contracts.

Overall expenses at Enogex were lower, resulting in operating income of 21.6 million, as compared to 7.5 million in 2002. O&M expenses were lower by 1.3 million. Depreciation expense was lower by 2.1 million; and net interest expense was lower by 2.1 million. These lower expenses contributed in the aggregate 5 cents a share in the quarter. There were no discontinued operations this year's quarter. So in summary, we are seeing the benefit of our optimization strategy and process improvement efforts, through the realization of higher gross margins and lower expenses at Enogex.

In terms of 2003 outlook, as Steve mentioned at the outset we now see 2003 net income of between $1.40 to $1.50 per share. We now expect lower average shares outstanding from our previous guidance, based on the timing of the share issuances and assumed net proceeds per-share. We still project OG&E to earn between 112 and 118 million, based on normal weather in the second half of the year. As Steve pointed out earlier, it has been a hot July. Cooling degree days, according to the NOAA website, were 14 percent higher in July than normal. Holding company, lose $14 million.

However, we have raised the projection for Enogex to (multiple speakers) 18 to 20 million, up from our 16 to 12 in our first-quarter call. The increase in guidance at Enogex is due primarily to stronger operating results through the second quarter as we continue to perform above plan. Also like to point out that the range of 18 to 20 million would be normalized net income; it would not include gain on the sale of assets, discontinued operations, further impairment charges, and so on.

I want to emphasize that our change in guidance is driven by two factors. Primarily the improvement in expectation of net income at Enogex, 18 to 20 million from our 14 to 16 million guidance provided in our January call. And to a smaller degree an assumption of lower average shares outstanding. So that concludes our prepared remarks. I will now turn over the program to Q&A.

Douglas Fischer of A. G. Edwards.

Congratulations on a good quarter. Just a couple of things. I noticed in the release that Enogex net cash provided from operations declined quite a bit in the second quarter, even though it is not down that much for the six months. Could you explain to us what is happening? And then I have another question.

Really the cash decline really relates to the injection of gas in the storage and the use of cash in the quarter. That is really, as you know, a timing issue.

Okay, and then what is the risk that some of the improvement at Enogex is due to a different rate agreement with the utility? Is it just more volumes? Or is it higher prices? And what kind of issues might there be in '04 in the general rate case, with regard to this?

You asked two questions. The contracts, as you recall, we talked in the last quarter's call I believe; there are two parts to that contract. There is transportation service, and there is storage services. Transportation services being provided under this contract, which is 10 to 7 years, is at the same rate as was agreed to under a letter agreement that existed prior to this contract. As you may recall and notice in Jim's remarks that last year we acquired the Stuart Storage facility. So that we are in fact providing more storage services to utility than we have had in the past. So the contract reflects those two services.

On the regulated front, there is a separate transportation storage proceeding, that I believe is scheduled in October of this year, under which the Commission will evaluate and take into consideration this contract. It will not be a part, at this point in time, that I anticipate; it will be part of the rate filing that will occur hopefully later in this year.

I will just add to that two things. Again, those are market base rates. And the commission will look at not only the rate and the level of service, but look at the process that the utility went about in contracting for those services. So it will be fully debted (ph) in 2003.

And when would you expect a decision? If it is taken up by the Commission in October, how long does that take? Or is it open-ended?

(multiple speakers) October, early November; it should be am order within 30 days or so of the time you go through the process.

I have some others, but I'll give others a chance to ask.

Nick Basalocos (ph), Eaton Vance.

Quick fixed income question here. Can you guys give us the balances for debt and cash, the consolidated level at quarter end? Thanks.

Yes, the balance of long-term debt on a consolidated basis at quarter end is $1.5 billion. And cash at quarter end was $22.5 million.

Douglas Fischer, AG Edwards.

There was a $1 million impairment charge, a small item. What was that?

We had a company airplane at the holding company level. We sold that during the -- well, we are in the process of selling it and expect it to close Friday at the holding company level.

And to understand your guidance, is your guidance GAAP guidance? Because there are several somewhat unusual items that happened in the first quarter, plus this item, which is admittedly small, in the second quarter? Does it incorporate the 7 cent cumulative accounting change? And then there were two offsetting items, which I think probably netted to 4 cents in the first quarter. Plus this probably 1 cent item. Or 3 cents in the first quarter, plus this 1 cent item here in the second quarter. Is it a GAAP guidance?

Yes, the $1.40, $1.50 would be reported net income.

And that would include the cumulative effect of accounting change, Jim?

Yes.

So on an operating basis, one could argue that it is a little bit high? The ongoing number is a little bit higher than that?

Yes, but you have gain on sale of assets and there. You have the $1 million charge. You have your cumulative effect. I guess all those things we see being incorporated in these numbers from a consolidated respect. And remember in the first quarter we talked about the cumulative change, which was an accounting principle change in the first quarter. We more than offset that with gross margin in the first quarter, based on the physical (ph) delivery of gas.

Yes, thank you.

Doug, on the discussion on the contract, I think you need to understand, I think it may be unclear, that the Commission approves the contract from the standpoint of recovery by the utility card (ph) . And so I think the direction of your question was whether there would be a substantial financial (inaudible) in 2004; and that would not be the case.

I understand. I misspoke there.

All right.

David Grimhouse (ph), Kopia Capitol.

Good morning and congrats on a very nice quarter. With regards to the Enogex business, what effect do the gas prices have on that business? As gas has trended down here, and if that continues, is that a positive? Is that a negative? Or does it really not have a big effect going forward?

We try to minimize that impact of commodity prices in our businesses. And I guess there's various impacts. One, obviously, we have our gathering business. And as we've seen and Jim mentioned, our well connects are up dramatically from what we planned. Again, we did not plan for gas prices to be at this high level. So that from a lower gas standpoint, there is a correlation we see between connects and gas prices. So that if gas prices were to fall low enough, we would expect to see lower amounts of activity. And then our well connects would drop, and it would flow through to lower gathering volume. However, we do believe that that drop in gas would have to be probably further than it has dropped to today in order to have any chilling effect on drilling.

The other part of that is, as you know, in our processing business, traditionally higher gas prices are not followed by higher natural gas liquids prices. Our financial performance is impacted historically -- the fact that our margin on our keyhole contracts either is narrowed or historically could turn into a log (ph). We have instituted a treating fee that detects the downsize on our margin on our keyhole contracts. So that while we would lose margin from higher gas prices, it is not offset by the higher liquids prices. We would be protected from a negative margin.

And then we do have some benefit also on higher gas prices from the gas that we do purchase on a percentage of index basis. So at higher gas prices, we make more margin on those acquisitions. So it is a more complicated answer, unfortunately, but we feel that the steps we've taken really help minimize our volatility in our earnings to commodity prices. But again, the discussion of the factors show that we do have some impact. But it's hard to say that if it goes up a couple of pennies what the impact on us is; or if it goes down what the impact is on us. It is mixed.

That is helpful; thanks. Can you also talk a little bit about the marketing end trading? Obviously that was down a little. But how you sort of see that play out going forward?

Basically we've seen differences in terms of injection and withdrawal, timing, on a seasonal basis than we normally see. But in terms of where we expect our business to come in, we expect that it will basically come in, at this point in time, on plan. As what we had planned for the year, in our projection. So we don't see any difference at this point in time. We expect them to make the numbers.

Last quick question for you. On this ETR fuel rider, you mentioned that last year you had undercollection in Q2. When we look ahead to Q3 and Q4, you may have covered this but I didn't quite follow what you said in the prepared remarks. Is their undercollection in Q3 and Q4 last year? Was their overcollection? Is it flat? What does the comparable look like?

Let me explain that a little bit better. Oklahoma, we have fuel pass-throughs that really are balance-sheet items; they are not P&L items. So in Oklahoma we have about a two-month lag between actual fuel used and billing to customers. Arkansas was set up a little bit differently. Every April 1st the fuel rate was reset. We tended to over or undercollect over the course of the year, and then reset that again every April 1. It was never really much of an issue. It's all the volatility in gas prices.

We changed the way we account for that at the end of the third quarter last year. So going forward it is booked just like Oklahoma. It is an over or under-collection on the balance sheet. And as of June 30, we were under-collected fuel about $38 million due to the price of natural gas and collection. We see a negative variance in the third quarter, which means we over-collected, and that was really the accounting charge to true it up and get it back to the spot where it didn't affect P&L. So over the course of the year it is going to have no P&L impact. It is just really a timing quarter to quarter. And really it is just the first three quarters. Is that helpful?

Yes, that is helpful. So there will be a negative variance versus last year in the last quarter; and then we will be done with it, basically, beyond that? Great. That is helpful. Thanks for the time this morning.

It appears we have no further questions. I will turn it back over to our hosts for any concluding remarks.

Before I turn it back to Steve, I just want to remind everybody you can replay the call with the slides by going to (technical difficulty). And the multimedia section on the right side of the screen has the actual slide presentation. Steve?

I want to thank you for your interest in the company. It's great to be with you. Have a good day.

This concludes our conference call for this morning. You may now disconnect your lines, and thank you for participating.