OGE Energy Corp (OGE) 2007 Q2 法說會逐字稿

Good morning. My name is Candace, and I'll be your conference operator today. At this time, I want to welcome everyone to the OGE Energy second quarter earnings call. (OPERATOR INSTRUCTIONS)

Thank you. Mr. Hatfield, you may begin your conference.

Thank you. Good morning and welcome to OGE Energy Corp second quarter 2007 conference call. I'm Jim Hatfield, Senior Vice President and Chief Financial Officer. And I have with me today Steve Moore, Chairman and CEO of OGE Energy Corp; Pete Delaney, President and Chief Operating Officer of OGE Energy Corp; Howard Motley, Vice President Regulatory Affairs OG&E; and Danny Harris, who's Senior VP of OGE Energy Corp, as well as President and Chief Operating Officer of Enogex.

In terms of the call today, we'll start with comments from Steve Moore. I'll then cover second quarter results 2007 outlook. Howard will give us an update on regulatory activities, and then we'll end with a Q&A.

And before we begin, I want to remind everyone that we have prepared slides to accompany our web cast so it will be easier to follow the numbers when we get to that point.

Also, before we begin, I'd 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.

And with that, I'll now turn the call over to Steve Morris. Steve.

Thank you, Jim. Pardon my voice this morning. It got a little froggy. I want to thank everyone here that's joining us on the call today.

We're going to talk about our second quarter results and our outlook for the rest of the year. We are very pleased to report that even in one of the coolest, rainiest stinking quarters on record here in our part of the country, our income from (inaudible) prices was higher than it was a year ago. Jim will have all the details in a moment to show us that it is working well.

We have excellent regulated utility prices balanced by excellent unregulated mid-stream pipe business -- pipeline business. (inaudible) has had a very bad impact on (inaudible) revenues. While the impacts continues to (inaudible) environment in natural gas.

You are probably aware that we have announced plans to create a national limited partnership business structure for Enogex and we will file (inaudible) statement with the SSA in (inaudible) By the SSA rules, we are not permitted to comment on the filing at this time. In the meanwhile, as (inaudible) put it and seeing before how (inaudible) on the Red Rock cattle plant proposal. We believe very strong that our progress with ASO and OMJI is the right (inaudible). We will have a detailed impact on our regulatory (inaudible) in a moment. But it all comes down to one simple fact as far as demand is going and we must have the capacity to meet it. We hope to have a commission order and put it in our plan this fall.

And again, thank you for your interest. Pardon my husky voice. We appreciate your confidence in OG&E. And I'll turn the program back to Jim.

Thank you, Steve. For the second quarter, we reported net income of $62.6 million, or $0.68 per diluted share, as compared to net income of $93.7 million, or $1.02 per diluted share in 2006.

On a continuing operations basis, we earned $0.68 per share, compared to $0.63 per share in 2006. Throughout the presentation, earnings comparisons are based on income from continuing operations.

The contribution by business unit, on a comparative basis is as follows: OG&E, $0.38 in 2007, as compared to $0.48 in 2006; Enogex, $0.30 in 2007, as compared to $0.17 in 2006; holding company was flat compared to a $0.02 loss in 2006; continuing operations $0.68 versus $0.63 on a consolidated basis.

At OG&E, the net income was $35.1 million, or $0.38 per share, as compared to net income of $44 million, or $0.48 per share in 2006. Some of the primary drivers are as follows: gross margin on revenues decreased $22.5 million, or 10.5%, to $192.6 million, from $215.1 million. I'll review gross margin in detail in a moment.

Operation and maintenance expense decreased $1.9 million, or 2.4%. The lower O&M costs were primarily due to lower professional services and employee costs, partially offset by higher outside services and marketing and advertising costs. Depreciation expense increased $1.4 million, or 4.2%, primarily due to the Centennial wind farm, which was put in service in January 2007. Net other income increased $8 million in 2007, primarily due to a loss on the retirement of the fixed asset in 2006, and higher participation in the company's guaranteed flat bill program in 2007.

Interest expense increased $5 million to $16.5 million, primarily due to interest owed customers as a result of over-recovered fuel, interest associated with an IRS audit, lower ASCDC, and higher levels of short-term debt.

The effective tax rate for the (inaudible) declined 17%, from 37.1% 2006, to 30.8% 2007, primarily due to state and federal tax credits associated with the Centennial wind farm.

Looking at gross margin, $192.6 million during the three months ended June 30, 2007, as compared to $215.1 million during the same period in 2006, a decrease of approximately $22.5 million, or 10.5%. Gross margin decreased primarily due to cooler weather in OG&E service territory, which resulted in an approximate 29% decrease in cooling degree days, as compared to the second quarter of 2006. The impact of cooler weather decreased gross margin by $18 million.

OG&E's filing of amended tariffs with the OCC in January of 2007, which caused the gross margin to be approximately $7.7 million lower than the second quarter 2006. Price variance, due to sales and customer mix, which decreased gross margin by approximately $2.5 million, and various miscellaneous items decreased gross margin by $600,000. These decreases were partially offset by higher rates, the result of the Centennial wind farm rider, security rider, Arkansas rate case. And these increased gross margin by approximately $6.3 million.

At Enogex, income from continuing operations was $28.1 million, or $0.30 per share, as compared to income from continuing operations of $15.5 million, or $0.17 per share in 2006. Some of the primary drivers are as follows: gross margin increased $26.3 million, from $69.6 million in 2006, to $95.9 million in 2007. And I'll discuss the details of gross margin on the next slide.

Operation and maintenance expense increased $5 million, or 19.7%. The increase was primarily due to higher outside service costs associated with pipeline integrity programs, higher employee costs, and a sales and use tax refund, which occurred in May of 2006. Depreciation expense increased $900,000 from 2006, primarily due to higher levels of depreciable plants. And net other income decreased $600,000, primarily due to lower interest income.

Now looking at gross margin. Gross margin increased 37.8%, from $69.6 million to $95.9 million in 2007. Marketing margins increased $14.9 million, primarily due to our position on the Cheyenne Plains pipeline. Gross margin increased by $12.6 million due to physical deliveries of gas during the quarter. And in addition to physical deliveries, gross margin increased by $3.5 million due to gains on hedges, as we marked these hedges to market value on June 30, 2007.

Transportation and storage business contributed approximately $40.2 million of Enogex's consolidated gross margin during the three months ended June 30, as compared to approximately $27.2 million during the same period in 2006, an increase of approximately $13 million, or 47.8%.

Gross margin increased primarily due to fuel recoveries in the E-zone under its [perked] approved fuel tracker, as compared to the same period 2006, which increased the gross margin by approximately $5.1 million. A reduction in the net in-balance liability, as compared to the three months ended June 30, 2006, increased the gross margin by approximately $4.8 million.

Increased demand fees due to entering into new contracts with higher rates increased gross margin by approximately $2.7 million during the three months ended June 30th, 2007. And then the liability for the settlement of a throughput contract was transferred to the gathering and processing segment in the second quarter of 2007, which increased the gross margin by approximately $2.4 million.

The gathering and processing business contributed approximately $40.6 million of Enogex's consolidated gross margin during the three months ended June 30th, 2007, as compared to approximately $42.2 million during the same period in 2006, a decrease of approximately $1.6 million dollars, or 3.8%. The gathering and processing gross margin decreased primarily to a reduction in fuel recoveries during the three months ended, which decreased the gross margin by approximately $2.9 million. Lower net keep-whole margins, primarily due to lower commodity spreads in 2007, as compared to 2006, which decreased the gross margin by approximately $2.1 million. In the 2007 quarter, processing spreads realized were $4.62 per mnbtu, as compared to $4.92 per mnbtu in last year's quarter.

The settlement on a throughput contract during the three months ended June 30, 2007, decreased gross margin by approximately $1.9 million. These decreases were partially offset by gathered volumes, which were up 4% in this year's quarter. Reduced net in-balance liability as compared to 2006, increased gross margin by approximately $3.5 million. A new [PLO] contract entered into during 2007, increased gross margin by approximately $1.

I'd like to point out that even though we benefited this quarter and will throughout the remainder of 2007, we do not anticipate that our position on the Cheyenne Plains pipeline will provide a material contribution beyond 2007.

For the second quarter 2007, Enogex did not have any significant non-recurring items. And you can see the $37.1 million in non-recurring items which occurred in the second quarter of 2006, primarily the gain on the sale of the [Kenta] assets.

Looking at the effects of timing, for the three months ended June 30th, 2007, Enogex has consolidated net income of approximately $28.1 million, and included a gain of approximately $2.2 million in marketing, resulting from recording the economic hedges associated with the Cheyenne Plains transportation contract at market value. The offsetting losses from fiscal utilization of the transportation capacity are expected to be realized in the remainder of 2007.

Additionally, marketing recorded a gain of approximately $700,000 from economic storage hedges at market value, compared to $1.3 million of hedge gains in 2006. The offsetting losses from the sale of withdraws from inventory are expected to be realized during the remainder of 2007 and the first quarter of 2008.

For 2007, we are reiterating the company's previously stated consolidated earning's guidance of $213 to $231 million of income from continuing operations, or $2.30 to $2.50 per diluted share. However, we have changed the guidance for our individual businesses. The utility earnings guidance has declined, primarily due to mild weather for the first six months of 2007, which has decreased gross margin by over $13 million. The Enogex guidance has increased as a result of continued high commodity prices. The holding company loss has decreased slightly due to lower projected interest costs. And the key assumptions can be found in the company's second quarter 10-Q.

In reviewing assumptions, I would point out that we have approximately 78% of our keep-whole and PLO exposure hedge through the rest of 2007, and the hedge processing spread at approximately $3.89 per mnbtu.

Now I'd like to turn the presentation over to Howard Motley for a regulatory update. Howard.

Hey. Thanks, Jim. Today the rates we update will cover the company's activities in the Oklahoma jurisdiction. The Homeland Security Rider application and the application regarding the 2002 settlement agreement will be discussed. I will also provide a status of the timing for decision in OG&E's Red Rock proceeding.

In December 2006, OG&E filed an application with the Oklahoma Commission updating its security plan, and we requested approval of $18.5 million of capital expenditures, an additional $2.7 million recovery through the security rider. A settlement was reached in May this year, May 16th, that would authorize $17.6 of the $18.5 million capital expenditures, and $2.6 million of the $2.7 million requested for increased revenues through our rider. On June 26, the Commission issued an order approving that settlement.

The next item is the 2002 settlement compliance. It resulted from the 2002 rate case, where OG&E entered into a settlement agreement that resulted in the purchase of the McClain generation facility. As part of the settlement, the company also agreed to provide $75 million of customer savings over the 36-month period, January 2004 through December 2006. On June 7th of this year, OG&E filed a compliance application with testimony showing $177 million dollars of customer savings, which doubled the $75 million targeted amount from the settlement in 2002. And we expect a commission order by the end of this year.

Finally, the major application or major activity we have going on in Oklahoma right now is our Red Rock proceeding. In January of this year, we filed for pre-approval to build the Red Rock coal plant under commission rules that are based on a new Oklahoma law. The company also requested a rider similar to our Centennial rider and our security rider, to recover the financing cost on the construction expenditures, up to a cap level of $790 million, which is OG&E's portion of the overall cost of the power plant. On July 31st, Tuesday of this week, the hearing was concluded, and the Administrative Law Judge will issue her report on August 21st, and then any appeals must be filed by August 28th. We expect a commission order in September of this year.

Back to you, Jim.

Thanks, Howard. In summary, our higher second quarter results highlight the benefits of asset diversity. In a quarter with mild weather resulting in lower earnings at the utility, Enogex posted a strong quarter. We have reaffirmed our 2007 guidance of $2.30 to $2.50 per share, through -- though the utility guidance has been lowered and Enogex's guidance has increased.

As Howard said, we completed the Red Rock hearing and expect the ALJ report on August 21st, and hope to have the commission order in September and begin construction soon after.

And although not discussed, because we are in the quiet period, we did, in June file to create an MLP at Enogex.

We continue to execute our original utility plus strategy through increased capital spending at the utility and investing in growth opportunities at the unregulated business, in pursuit of achieving our financial objectives.

That concludes our prepared remarks, and we'll be glad to answer any questions you have at this time.

(OPERATOR INSTRUCTIONS) And your first question comes from the line of Doug Fischer.

Good morning.

Good morning, Doug.

Jim, a couple things. First of all, the frac spread that you realized were, I think, well below those available in the market, certainly they were favorable on a historic basis, though.

Yeah.

Did you -- Is that a result of hedging and then things improved throughout the quarter? And maybe you can discuss that a little bit --

Sure.

-- and the philosophy around that.

Yeah. That's a great observation, Doug. You know, our -- And what we did in 2007 is, we will buy gas and sell liquids, physical at [Comway] so we have a perfect hedge. And as we go forward throughout the year, we look at the marketplace and we look at budget, and the marketing group will make those trades as they see appropriate based on guidance that's provided. And you're -- Exactly what happened, we've seen a real run-up in spreads here in the last 30 days or two months. And but we were just trying to protect the downside and taking the market opportunities when we saw it.

What -- Can you remind us how much you were hedged for the quarter going into the quarter? Do you have that number?

I don't have that number, Doug. I know where we are today, about 78%. We did a lot -- We started to lay in a lot of hedges in the April and first part of May time frame, so.

Okay. And then is that 78% for the whole year or for the balance of the year now?

That's what -- the balance of the year based on expected volumes.

And then is it, according to my numbers on cooling degree days, while the quarter was much cooler than last year, it was still somewhat hotter than normal. Does that jive with your numbers? And if --

Well, Doug --

-- so, what was the margin impact versus normal?

You know, Doug, I have a saying, and that is, not all cooling degree days are created equal. Because if you look at the absolute number for the quarter, you'll see that it would tell you that it was above normal. But I can tell you, in the months of May and June, if you look at the average high and average low, we were running 10, 12% below normal on average high, but 10, 12% above normal on average low. And that, obviously, isn't the same thing as being, you know, above normal on the high. And we think the impact to us was about $13 million.

Versus what? Versus --

Normal.

A negative?

Yes.

Okay. And that's gross margin?

Yes.

Okay. And then one last question. Can you give us a little bit of an update on the legal proceeding related to Red Rock?

You talking about the spring court case?

Yes.

Well, briefs were filed and I guess there was a, you know, appearance in front of the referee. The referee provides a report to the Supreme Court Justice. August is pretty much a recess. So at this point, we wouldn't expect anything until after the end of this month.

Okay. Thanks.

Yeah.

Your next question comes from the line of Steve [Schelzman].

I think that might be me. It's Steve Fleishman at Catapult.

Hey, Steve.

Can you hear me, Jim?

Yes.

How are you?

Good. How are you?

Good. Couple questions. First, on the -- where do you guys see the frac spreads today?

We're seeing spreads near $7, as of last Friday.

Okay. And in your guidance, are you -- what are you assuming for the unhedged piece?

For the unhedged piece, that's ---

Yes --

You're talking about the 22%?

Right. Are you assuming that --

We're --

Yes.

Yes, we're seeing around in the $6 range. That's what we're assuming within the guidance. Keep in mind that what we've seen historically as, as we get into the end of the third quarter, you'll see -- you'll traditionally see spreads narrow.

Right. And then -- Okay. And then could you -- You mention on the call that the Enogex upside, that a lot of that was due to higher commodity prices, I think.

I'm --

Yes, the Enogex increased guidance for the year.

Oh, so just based on where we are and what we expect for the rest of the year, yes.

Okay.

And you also have -- we've had a significant Cheyenne Plains contribution as well.

Right.

Yes.

And could you just go through what -- how you benefited there?

Cheyenne Plains?

Yes.

We have a contract. Basically, we have a transportation position on the Cheyenne Plains pipeline. We've had it since the inception of the pipeline. And what we saw in -- and we're seeing in 2007, but so far in the second quarter is just a basis widen between the Cheyenne hub and Greensburg, Kansas. And since we have a position on that, we're able to transport gas and lock in those margins.

We see that really throughout the rest of the 2007. What we see in 2008 is, with the expectation that the Rocky Mountains Express will be in service, that those -- the basis spread will go away.

So is it -- I wouldn't classify it as a one-time, but, certainly, we think it's just an opportunity in the marketplace that, you know, with competition with Rocky Mountain -- or Rocky's Express, we don't see that continuing.

Yes. And then the utility reduction was all just below normal weather?

Correct.

Nothing else? Okay.

Yes, nothing else.

So it's kind of utility, one-time, or in a way, and then also Enogex one-time or in a way, and you're still pretty much where you are?

Correct. Again --

Okay.

-- we see that, the value of having the [diversant] assets.

Okay. And then finally, could you just give us some color on how the Red Rock hearings have proceeded relative to your expectations and --

Well, the hearing goes into two pieces, really. The first piece of it was the need and did we -- was there a need for Red Rock. And then the second piece was our request for recovery, and we requested the rider.

And I'll tell you, I was out there for one day on the stand. So I don't -- I don't have a biased view of how they went. I'll let Howard talk about that. You spent some time out there --

Yes.

-- with the regulatory --

Yes. I reviewed or participate in a lot of hearings out at the Commission over the last 30 years. And at the end of the hearing, I believe we made a very could record for the need, especially for PSO and OG&E's need and OMPA. So the whole need is not just OG&E; it's 95% of the customers in the State of Oklahoma.

And so I think the commissioners are taking this very serious. And it's probably the biggest decision they've had to make in many, many years, probably in decades. But I think there was a lot of testimony on customer paying construction costs upfront. There's a good record that we -- we did a customer survey, and 54% of our customers versus 26% are willing to pay upfront for a construction plant like this.

And reliability came out a lot in the survey and in the testimony. So the Commission will really have to look at the reliability of the system, the lowest reasonable cost over the long term. And I believe that we made a very good record and the judge and the commissioners were very interested in all the testimony. So I think we did as well as we could. I think there's a good record. And I believe the three commissioners will be very thoughtful in their decision about delivering what the customers in Oklahoma need.

Thank you.

Your next question comes from the line of Jeff Coviello.

Morning. How are you?

Good, Jeff. How are you?

Pretty good. I just wanted to see, on a similar topic, if you could give an update of where we are in the Supreme Court challenge that Chesapeake filed for the commissions.

Yes. I think Doug may have asked this question earlier. But briefs were filed and appearances were made, the -- before the referee. The referee provides a report to the Supreme Court Justice. August is sort of a down month in terms of recess for the Supreme Court. So at this point, we're just waiting for the decision. There's, as you know, there's no time frame for a decision.

Right.

But everything's been done at this point. We're just in a waiting game.

Right. Great. Thank you very much.

Your next question comes from the line of David Reynolds.

Yes, gentlemen. Good morning.

Good morning.

Really quick question. There's been talk about Enogex, there's a little money left on the table, obviously, through the hedging process, probably going to do that again in the third quarter. Can you discuss just a little bit the philosophy that you use going in here, vis--vis, gas-oil?

Our philosophy really is to -- and we have a market risk committee and they're sort of handed by management some parameters around hedging. And what they do, really, is try to find opportunities to lock in above operating plans, which is what they, you know, really what they did. And what we've seen, of course, is a significant movement in the market over the last 30, 45 days.

We know these things are volatile. We've sat here before and saw high spreads that collapse down to into the $1 range, $1.50 range in the fourth quarter. So we're not -- it's really just a philosophy of trying to lock in operating margins when we see the opportunity to do so.

So you essentially work off of what your operating margin is? You pick kind of a level that feels like it's -- you know, that it -- whatever level of return there is, but you're not really looking at the commodity itself directly?

Well, what -- Maybe to just clarify a couple things. We look at what our required return on assets are and we look at sort of the market expectation at the time. And any time we're able to sort of bring those two together, we think we can lock in value better than staying on hedge, we'll try to do that.

Obviously, if we'd have predicted that the spreads would have gone to $7, we wouldn't have hedged this much. But we've been here before, 2005, $1.88 spreads in the fourth quarter. So we know these things will go up and down over the course of the year.

Understood. Thanks.

Yes.

I was just trying to get into the thought process.

Yes.

Thank you very much.

Thanks.

Your next question comes from the line of [Roenson].

Hi, guys. Actually, I was with Dave. So sorry about this. It's fine. I think he answered -- he asked the question that I had in mind. Thank you.

Thank you.

Your next question comes from the line of Scott Engstrom.

Good morning, Jim.

Hey, Scott. How are you?

Good. Thank you. Sorry. I'm trying to listen to about three calls at the same time here. So I apologize in advance if you've covered some of this. I think you mentioned 78% hedged at Enogex for the end of the year -- for the rest of the year; is that right?

Yes.

Did you say at what level that is, or --

Yes. Approximately $3.89 of mnbtu.

Okay. And what is beyond '07 then? I heard you just talk about kind of the philosophy of hedging. But can you talk about what you -- what could you, if you wanted to do a lot of hedging in '08, I mean, given liquidity and your outlook on the markets, what -- how much could you do there? How much would you want to do? At what levels do your marketing guys see the ability to hedge in '08 right now?

I'm going to give you a broad answer on that, which is, in the S-1, we talk about what we've hedged for '08 and beyond. So I would -- I'm going to be cautious here and just refer you to the S-1 --

Okay.

-- which I think gives you some detail around what we've done in '08.

Okay. I'll do that. Then on Red Rock, big picture-wise, what, from your point of view, and maybe it's a -- I hate you to -- I hate to have you speak for all of the interveners and the other side. But what is the fallback plan if Red Rock is -- does not go through?

Well, if the Red Rock does not go through, we'll have to go back to step one, looking at the bidding process and probably go out for another bid for the future to determine what the alternative is, which we believe will be a more costly alternative to our customers. But that's a decision that the Commission will make. And then we'll have to start the process all over again.

All right. Great. Thanks, guys.

And there are no further questions at this time.

Great. Well, we appreciate your participation in the call this morning in support of OGE. Thank you.

This concludes today's conference call. You may now disconnect.