OGE Energy Corp (OGE) 2004 Q3 法說會逐字稿

Mr. Hatfield you may begin your conference.

Thank you.

Good morning and welcome to OGE Energy Corp's Third Quarter 2004 Conference Call. I'm Jim Hatfield, Senior Vice President and Chief Financial Officer of OGE Energy Corp. I have with me today Steve Moore, Chairman, President and CEO of OGE Energy Corp, Pete Delaney, Executive Vice President and Chief Operating Officer of OGE Energy Corp, and Howard Motley, Director of Regulatory Strategies for Oklahoma Gas and Electric. We also have several other members of the management team here available to address questions.

In terms of the call today we'll hear first comments from Steve Moore. I'll review the third quarter results and talk briefly about 2004 and 2005 outlook. Howard Motley is going to give us an update on regulatory proceedings. We'll have a summary from Steve Moore and then we'll be available for q-and-a at that point.

But before we begin I want to remind everybody that we've prepared slides to accompany our web cast, which would be the following numbers when we get to those numbers.

Slide 2 is the Safe Harbor Statement if I could just point everybody to that as a backdrop to this presentation. And onto slide 3, I'll turn it over to Steve Moore. Steve.

Thank you Jim. I'd like to also welcome you to the call and as always, I appreciate your interest in OGE Energy.

Today we're going to tell you about our third quarter results and update you on some of the other important issues that we're working on. And as usual we'll answer your questions.

OGE Energy today reported a third quarter net income of $95 million compared with $100 million a year ago. That translates to $1.07 per diluted share in the third quarter of this year compared to $1.20 per diluted share a year ago, a pretty solid result when you consider 2 factors. First, we had a summer that was 14 percent cooler than normal and 15 percent cooler than last year. And second, the number of shares that we have outstanding has grown since last year by more than 5 million shares.

For the year-to-date earnings are $1.53 per diluted share. So as you can see, even when the weather works so strongly against us, our asset diversity can help us achieve solid financial performance. We feel we have a strong position in our region, not just with our electric utility Oklahoma Gas and Electric Company but also with our natural gas pipeline, Enogex.

Looking ahead, we're investing in our infrastructure primarily in regulated assets in our utility business. We have increased our capital spending on infrastructure projects to more than $200 million this year to strengthen the reliability of our electric system.

In addition, we have completed the McClain Power Plant acquisition, the cornerstone of what we call our customer savings and reliability plan. Oklahoma Gas and Electric Company expects to file a rate case next year to include these major system investments in our regulated rate base.

In our unregulated business, the operational improvements continue and the financial performance also continues to improve. Enogex is capturing value from the positive impact that higher commodity prices have had on drilling and well connections and gas processing. Again, this asset diversity can help to cushion the impact of unfavorable weather in our utility business.

The third quarter results were reduced by about 6 cents per share however, with the write-down of more than $8 million of Enogex pipeline assets. These assets serve other utilities power plants in West Texas that are being taken out of operation by that utility.

In the financial markets, we sold $140 million of 30-year senior notes in the third quarter and we arranged for 16 different banks to participate in 2 new revolving-credit programs, which give us up to $550 million of liquidity.

On the immediate horizon, we have some regulatory matters that are nearing completion. Howard Motley is here with us to provide an update on our natural gas transportation and storage case and our separate security case, both pending before the Oklahoma Corporation Commission. We were pleased that the Administrative Law Judge at the Oklahoma Corporation Commission found that OG&E's contract with Enogex, or what we call no-notice load following natural gas delivery service, is in the best interest of our electric customers.

In the security case last week we reached an agreement that would enable us in the future to recover about $5 million annually for security improvements and investments. As always, we're focused on creating long-term value.

At OG&E the major investments we're making in our electric system will help us to improve service and provide savings to our customers and increase the long-term earning power of the business.

In 2005 we will initiate a rate case to enable our shareowners to earn on these important investments. But until we receive a new rate order, the expenses associated with the new assets will affect OG&E's earnings.

At Enogex our outlook remains and contains conservative assumptions about future commodity prices. We believe it's a prudent stance to take at this time, and it's good for a reminder that the Enogex business model does not require the current high price environments for profitability.

As always, we're focused on the details of our business and the challenges ahead. Again, I thank you for your interest in the Company and I'll turn the program back over to Jim for some more detail. Jim.

Thank you Steve.

I would now like to cover the earnings of OGE Energy Corp on slide 4. And I'll start with a discussion of the third quarter and discuss the contributions of the business units in the quarter, as well as the 2004 outlook and provide 2005 guidance.

Now for discussion of the third quarter, as Steve mentioned we reported net income of $94.6 million or $1.07 per share in 2004 as compared to net income of $99.5 million or $1.20 per share in the third quarter of 2003. The contribution by business unit on a comparative basis is as follows. OG&E $1.03 in 2004 as compared to $1.15 in 2003, Enogex 7 cents versus 10 cents in 2003, The Holding Company a loss of 3 cents versus a loss of 5 cents in 2003, Consolidated $1.07 as compared to $1.20.

The decrease in our earnings per share for the third quarter in 2004 was also impacted by higher average common stock outstanding pursuant to the equity issuance in 2003 and the issuance of direct shares in 2004.

On slide 5 looking specifically at OG&E net income was $91.3 million or $1.03 per share in 2004 as compared to $95.1 million or $1.15 per share in the third quarter of 2003. Gross margin on revenues was down $19.2 million or 14 cents per share to $255 million from $274.2 million in the third quarter of 2003. The major factors impacting the decreased gross margins were weather, $21.9 million due to cooler weather when compared to the third quarter of 2003. As Steve alluded to, we were 14 percent below normal and 15 percent on a comparative basis at the third quarter of last year.

We also had a reduction of $1.1 million, which is reduced sales of power under a new contract with an existing customer where they're just taking less power partially offset by growth of about $2.2 million in the quarter and $1.9 million due to recovery of some (indiscernible) timing.

On slide 6 in terms of expenses O&M expense decreased by $5.8 million or 4 cents per share to $65.7 million in 2004 from $71.5 million in the third quarter of 2003. O&M expenses were lower due to payroll-related expenses, wages, and benefits partially offset by an increase in outside services. Other income was up $4.3 million or 3 cents per share primarily due to the sales from natural gas producing properties at OG&E and net interest expense was down about $800,000 or 1 cent.

On slide 7, we'll talk about Enogex third quarter results. Net income was $6.3 million or 7 cents per share in 2004 as compared to $8.4 million or 10 cents per share in the third quarter of 2003. Gross margin on revenues were $65.4 million, up $1.2 million or 1 cent per share as compared to $64.2 million in the third quarter of 2003. And you can see that the gathering and processing posted a large increase in margin in the third quarter.

On slide 8 talking specifically about transportation and storage, we saw in the prior slide that they were down on a comparative basis of $5.7 million. If you really look at the numbers that are here on the screen, you would have the $3.5 million of negative comparison. It's really a reclassification of margins that are now being reported on gathering and processing. We also had the $2.3 million settlement last year, the Calpine energy issue which increased net income last year. If you take those out, the quarter is really flat, which would be our expectation of the steady nature of this business which are under fee-based long-term contracts.

On slide 9 we have gathering and processing margins were up $15.2 million, $38.7 million for the quarter or up 64.7 percent. Gathering was $6.8 million higher compared to the third quarter of last year. We talked about the shift of $3.5 million from transportation to gathering, also up due to a favorable overall business environment. And we continue to increase our margins under gathering contracts. We talked about the business environment, volumes were up 7 percent quarter-over-quarter, which is reflecting the business environment.

Processing gross margins were $8.4 million higher in 2004 as compared to the third quarter of 2003 really driven by higher NGL prices, average sales prices per gallon of 73 cents in the 2004 quarter as compared to 58 cents in the third quarter of 2003.

Marketing margins were down $8.3 million really due to 2 factors, the largest factor being mark-to-market timing on gas storage inventory of about $5.2 million. And again, that's timing. We would see that those margins come back in the fourth quarter of 2004 or the first quarter of 2005. The other is $3.1 million of lower gross margins on origination and trading on a comparative basis quarter-over-quarter.

On slide 10 we talk about expenses for Enogex going in, expense increased by $3.3 million over the third quarter of 2003. Really what was driving that are outside services, as well as increases in materials and payroll and benefits. Steve alluded to the impairment, we did have an impairment of an asset, $8.6 million in the quarter, which really relates to 4 high fine asset segments that we had in what sectors they were originally built for the purpose of providing gas transportation to customers for power plants. The customer notified us that they are going to shut down those plants. And we've done an evaluation of the assets and other alternative commercial uses are considered unlikely at this time. That's the reason for the impairment.

Net other income increased about $2.1 million. We had a settlement of an uncollectible account as well as gain on some sale of assets. Discontinued operations was a positive variance of $1.8 million or 2 cents per share. We had no discontinued operations in this year's quarter versus the lost posted (indiscernible) in the third quarter of 2003. An income tax adjustment of $1.7 million or 2 cents per share, which is really just a true-up to match the tax expense with a tax liability.

On slide 11 we talk about our non-recurring items. For 2003's quarter we had a positive contribution of $1.5 million. It's really fuel recoveries from prior periods as well as the offset of discontinued ops paid up to $1.5 million in the 2004 quarter driven largely by the impairment after-tax of $5.1 million. We talked about the tax adjustments. We did have some positive fuel recoveries this year as well as small gain on asset sales. So we continue to look at non-recurring items and think about those when we think about Enogex earnings power going forward.

On slide 12 again just to re-emphasize the 2004 outlook, we are projected to be near $1.60 per share. This estimate recognizes the impact that mild weather has had at OG&E when we talked about the 14 percent cooler than normal during the third quarter. That impact on the revenue was approximately $20 million or 14 cents per share as compared to normal, and so we see OG&E’s earnings now expected to be between $111 million and $115 million or $1.26 to $1.30.

In addition, Enogex recorded the impairment of $8.6 million in the third quarter and as we said in conjunction with the preparation of the third quarter financial statements, we performed an evaluation on these assets and included that it needed to be recorded in the third quarter. However, Enogex still expects to meet its previous guidance of between $40 and $44 million or 45 to 50 cents per share.

In the 2004 guidance for the Holding Company remains unchanged, a projected loss of $13 to $14 million for 2004 or 15 to 16 cents per share.

In terms of 2005 guidance on slide 13 we expect Consolidated earnings to be between $136 million and $145 million or $1.50 to $1.60 per share assuming approximately 90.4 million average diluted shares outstanding. We expect OG&E's earnings to be between $108 million and $112 million or $1.19 to $1.23 per share. Within that, we have assumed margin growth of approximately 2 percent will be more than offset by increased operating expenses and higher costs associated with the acquisition of the McClain plant and capital expenditures for investments in OG&E's generation transmission and distribution system.

As Steve mentioned we expect to file a rate case in mid-year 2005 to recover among other the things the investment in the operating expenses of the McClain plant and expect new rates to be in effect prior to the first quarter of 2006.

For 2005 Enogex projects earnings between $39 million and $43 million or 43 to 48 cents per share, forecasting slightly lower margins due to assumed lower commodity spreads of $1.53 for MMBtu in 2005 as compared to $2.21 per MMBtu in 2004. These lower margins assume lower average natural gas liquids prices of 71 cents per gallon in 2005 as compared to 78 cents per gallon in 2004.

These lower commodity prices are primarily offset by lower operating expenses. We do not have an impairment within this number and lower interest expenses due to the retirement of long-term debt.

For 2005 the Holding Company, which primarily has interest expense but no operating revenue projects a loss of between $6 million and $8 million or 7 to 9 cents per share. The decrease in projected loss as compared to 2004 is primarily due to lower interest expense associated with the retirement of $200 million of trust deferred securities which happened on October 15, 2004.

And now I'd like to turn the program over to Howard Motley to provide a regulatory update. Howard.

Thanks Jim.

The Company's most significant proceeding in the Oklahoma jurisdiction at this time is the $47 million gas transportation and storage case. The Administrative Law Judge issued a report on October 22 recommending a $41.9 million annual payment to Enogex as payer-adjusted reasonable, and that should be recovered from the Oklahoma customers. On November 19, the commission will consider appeals to the ALJ recommendations. And we expect a decision before the end of this year in that case.

The second case that's been going on for quite some time is our security rider case, and on October 28 all of the parties in that case signed a stipulation. The Company will have a one-time expenditure of about $19 million for capital investments and security projects and will have an ongoing $2.5 million annually O&M expense for securities. The stipulation the parties signed contains an adjustable rider that will recover about $5 million a year that will be the annual revenue requirement for the O&M expense and for the $19 million capital expense.

As far as the rate case for the McClain plant, the 2002 settlement agreement requires OG&E to file within 12 months of the acquisition. The settlement also allows the capitalization of the costs related to McClain for a period of up to 12 months after the purchase. The Company is planning to file a rate case by mid-year and expect to get a commission order by the end of 2005.

I'll turn it back to Steve Moore for a summary.

Well, before we go to the q-and-a I just want to summarize by reminding you of our strong operating results that we had in this quarter despite the cool summer and the asset impairment at Enogex.

I also want to remind you that we began this year with a great deal of regulatory uncertainty, but now we have gained FERC approval for the McClain acquisition and it is completed. And we are nearing the completion of the Enogex gas transportation and storage in the separate security cases. Obviously, we've had a very busy and I feel a very successful year on the regulatory front.

Our focus for 2005 also begins on the regulatory front as we seek to recover the costs in Oklahoma associated with the McClain acquisition and other investments in our reliability and savings plan. And as always, we continue to focus on operational excellence and the details of our business. We know they must go very well.

And now we'll turn to your questions.

(OPERATOR INSTRUCTIONS).

Paul Patterson, Glenrock Associates.

I wanted to ask you just a couple of questions. I was wondering why you're waiting until the middle of the year to do the McClain filing.

When we say mid-year it's really a planning assumption. We must file by July 8, 2005 and of course, we will file as quickly as possible as we evaluate all of the information in front of us. So when we say mid-year, it's really a planning assumption.

How much sooner could it be done?

Well, you need to accumulate data. Probably April would probably be about as early as you could do it, maybe March. But we have to close the books and go through the audit process, which would be a one-time constraint.

Okay, so if it were to happen in April or March then we would consequently think that the commission order would happen a little bit earlier. Is that correct?

Yes, 180 days is the statute in Oklahoma.

Okay, and is that pretty much what they file? I mean sometimes you find these statutory things are often delayed. Is that pretty much how it goes in Oklahoma?

Yes, we try to stick very close to that time table.

Okay, and then the second thing I wanted to ask you. I'm not completely clear on the November 19 date. What exactly happens there? I mean, you said there's a commission appeal and then there's a commission order. If you could clarify what happens on November 19 exactly, with the specific gas transportation sources (ph).

Yes, several parties have appealed the ALJ's recommendation, the industrial group and the Attorney General. OG&E also has appealed the ALJ's report in the area of the value set for gas storage. And the commission will hear those appeals on the 19th and then make a decision whether to modify the ALJ's report or adopt the ALJ's report in total.

Okay so those are pretty much just hearings that are going to happen on the 19th.

Yes.

Okay, and then finally in terms of NGL prices, could you tell us, you pretty much said it was like 78 cents that you got for the quarter. What is your outlook, I mean what are you actually seeing in terms of the mark out there? I know that you guys are using 71 cents for '05, but is there any hedge number in there? Do you guys hedge any of that? Could you just remind us a little bit about that?

Well, there's no hedge assumption in our guidance for 2005. It's difficult to hedge out for any length in the liquids market. We do have targets and those targets for the most part on hedging are set above our budget assumptions. And we have been successful with it this year and some time past. But it usually would be within a 90-day, usually within a 3-month sort of rolling time horizon. And after that the forward-market discounts significantly did not appear to be economic to us because of the illiquidity of that market. It really helps us to manage once we're in the year. We're not able to lock it up for the entire year for a larger volume.

What are you guys seeing in the marketplace right now in terms of just what are you experiencing right now with NGL prices? What is the market price out there?

Well, the NGL market price continues to be strong, and the quarter really reflects the current marketplace. We're currently 80 cents or above on the NGL, would be sort of the current stock price. And when we look at thinking about what pricing assumptions to do, we take a lot of factors into account. And if 80 cents is near a high, will that continue? It may or may not, but we sort of put a probability around it to try to get a number we think is certainly achievable over that time horizon.

Okay, thank you very much.

Jeff Corvello, Duquesne Capital.

I just was wondering if you could give us any sort of sensitivity whether it be EPS or gross margin around what, how the Company reacts to changes in the NGL price?

We're very hesitant to provide absolute sensitivity because you have so many other factors that come into play, what's the change in gas prices relative to NGL. But assuming that you see no other change in any other factors and based on volumes you'd see a penny increase in NGL would equate to net income of about $1.7 million. That's about a 10 cent frac spread if you think about it.

Okay, so that's a dollar per MMBtu's.

But you've got to keep in mind that assumes no change in gas prices, which both of those are always moving.

Jeff Corvello, Of course, and I guess you said that you'd hedge given the opportunity 90 days before if it looks like the price is attractive, that's been the policy in the past and through '05 is that sort of the way you envision to continue it?

Well, the hedge policy is not an official 90-day policy. They're out looking at the marketplace. We have budget targets, and they will hedge and execute in the market when they can achieve above budget targets. We have found that much beyond 90 days it is very difficult to enter into these hedges because as Steve alluded to earlier, you just get such a big ASP(ph) spread in there that it doesn't make it economic for us to do that.

Okay, and then I guess looking at the NGL sensitivity if gas prices stayed the same, then '05 looks like it would be about, if prices are where they are now, it would be about 20 cents higher. Is that sort of roughly -- I'm still talking about your EPS.

Right, based on the math, that would be pretty much correct.

Okay great, and as far as the utility goes, I think if I remember correctly that the McClain rate base was about $230 million. Is that right?

It's about $160 million.

That's the equity portion?

That's the total portion.

Oh total, okay, and you've got the additional CapEx as well, right?

CapEx and O&M will go into the regulatory action.

Okay, and I know there's some additional CapEx spending. How much was that over the last time you had a rate case, the last time you had rates set on that.

Well, our last cost of service rate base was set on calendar year of 2001, and we in 2002 and 2003 our CapEx was at $160 million. This year it's over $200 million, so our depreciation is $130 million, so we are adding over $70 million a year. So our rate base over the last 3 years, plus McClain, which would be on top.

So $210 plus McClain.

Over that time frame. And of course, we'll continue the CapEx program in the beginning of 2005 as well.

Jeff Corvello, Great, okay guys, that sounds good. Thank you very much.

(OPERATOR INSTRUCTIONS).

Doug Fischer, A.G. Edwards.

What kind of rough regulatory lag does, say you filed 6 months, I don't know how you’d quantify it. Maybe per month, what's the regulatory lag once the accounting order expires on McClain?

Well, for '05 McClain expenses are around $9 million. If you think about O&M and depreciation and ad valorem and salaries and so on, that would be after the regulatory order expires. I'll point out though, Doug, if we have a test(ph) year for 2004 we have labor increases and increases in other operating costs, we will also try to pro forma these costs into our cost of service. But one of the impacts that is impacting OG&E in '05 is obviously the additional costs associated with McClain after the expiration of the regulatory order.

So it's $9 million for what period Jim?

Basically the last half of the year.

So that's for 6 months?

Yes and that's just cost of service. That's not return on the $160 million of initial investment.

And don't you have to give a notice, I forget the time period, I want to say 30 days, but maybe its 60 days before you file?

Yes, we have to provide 45-day notice of our intent to file for an increase in rates.

Does that have to have an amount? Is that something, are you talking about just in response to Paul's question, are you talking about giving a notice say in the first quarter, or do you need firmer numbers before you give a notice?

No, the notice says you're intention to file for increased rates of more than 1 percent. And typically we'll lay out what the issues of the case will be. It will be recover McClain, recover additional investments increase in costs, things of that nature. So part of what we will do will be look at a schedule and see how quick we can file and work our way back and file that notice.

The primary reason for the notice is for the commission staff to be able to schedule their staffing requirements and to also determine if they will need any consultants, experts in certain areas so they can start retaining those. So it's more of a management of time and resources for the commission, not really a notice of how much the rate request could be.

Okay, thank you.

Mike Werner, Kennedy Capital.

Good results here, even with the cooler weather. Congratulations on that. I just wanted to ask, you probably already answered this with the prior questioners, but if you could explain to me with Enogex the reason for the flat earnings, the flat year-over-year earnings guidance, is that just because conservatism on pricing again, or is there something else that I missed?

Well, we are looking at slightly lower gross margins just based on the commodity components of the forecast. We will have a little higher expenses, we won't have an impairment charge that's embedded in that number, and we will have lower interest expense. So when we offset all those factors, we're down slightly from '04.

Okay, and one other thing about your dividend level. At what point would you say you were better growing that dividend from its current rate?

Well, we are setting out to achieve earnings growth of 4 to 5 percent on a growth rate going forward. And once we have a clear path to achieve the 4 to 5 percent growth rate, we'll look at the payout ratio and we'll look at the business environment. We would have to take all those factors into account. For example, right now our payout is 83 percent based on '04 guidance. We need rate relief so we would take all of those factors into account.

Okay, thanks.

Steve Fleishman, Merrill Lynch.

Based on your utility projections for either '04 or '05, what would the earned ROE be at the utility?

The '04 earned ROE is going to be in the low-10s.

And then how about updates on the '05 projection given the additional rate base?

It's going to be slightly under 10 based on additional investment regulatory (indiscernible).

And can you just recall us in the last rate case, I think you settled it without an allowed return. Is that right?

No, we have an allowed return at OG&E of 11.55 based on a 56 percent equity component of cash reduction.

Okay, and is the equity still out around that 56 percent?

Yes, pretty much. I think it was 56.8 percent at the end of the quarter, but we expect to be at 56 percent.

And what's the rough total rate base in '05, or year-end '04 or whatever data point you have?

The rough rate base is about 1.8 billion.

Okay, thank you.

Doug Fischer, A.G. Edwards.

Just to clarify on the commodity assumptions in your '05 versus '04 guidance, on slide 13 are these numbers for '04 the third quarter numbers or the current numbers or the full-year '04 expectation?

What slide?

The 221 per MMbtu?

That would be '04 full-year.

That's the estimate or the realized '04 numbers, yes, that would be in the $40 to $44 million.

And the current is above those levels?

Yes I think for the third quarter on average the, well it's about 72.7 cents realized in the third quarter per NGL.

72 point what?

Seven.

And did that reflect some hedging or something like that? Because I think you said the current was about 80-something, right?

No, this is taken over the 3 months as a whole, so the 80 was more reflective of current market conditions. (Multiple Speakers)

And the commodity spread, what was that in the third quarter, and what is it currently?

If you hold on a second, in the quarter I don't have that number in front of me Doug from a spread perspective.

You don't have either the third quarter or the current?

No not in front of me. I apologize for that.

That's okay, I'll follow up with you later. Thank you Jim.

James Alacker (ph), Highbridge Capital Management.

Just a real quick question. I'm not as familiar with the rate-making process in Oklahoma. When you file for rate relief potentially before mid-next year, are you allowed to put rates in subject to refund? Or can you actually apply for interim relief, or is it just as of the final order?

In Oklahoma, they really haven't granted interim relief. Sometimes they have granted emergency relief if your return on equity was really at such a level that was harmful to the Company. The Company does have the capability under the statutes though, at the end of the 6-month period after you file the case, if the commission has not issued an order we do have the ability to implement our rate increase at the end of that 6 months.

Okay great, thank you.

At this time, there are no further questions.

We'd like to thank you very much for your interest in the Company and we will continue to focus on the details on this end. Thank you for joining us. Good day.

This concludes today's OGE Energy Corp Conference Call. You may now disconnect.