OGE Energy Corp (OGE) 2010 Q2 法說會逐字稿

Good morning. My name is Caroline and I will be your conference operator today. At this time I would like to welcome everyone to the OGE Energy second quarter earnings call. All line have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question and answer session. (Operator Instructions). Todd Tidwell, you may begin your conference.

Thank you. Good morning everyone and welcome to OGE Energy Corp's. second quarter 2010 earnings call. I am Todd Tidwell, Director of Investor Relations and with me today I have Pete Delaney, Chairman, President and CEO of OGE Energy Corp., Sean Trauschke, Vice- President & CFO of OGE Energy Corp. and several other members of the management team to address any questions you may have.

In terms of the call today, we will first hear from Pete followed by an explanation of second quarter results from Sean, 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 www.oge.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 too date.

In addition, there is a regulation G reconciliation for on-going earnings guidance in the appendix along with projected capital expenditures. I will now turn the call over to Pete Delaney for his opening comments. Pete?

Thank you, Todd. Good morning and welcome to our second quarter earnings call. This morning I will discuss our recent accomplishments, important initiatives and outlook for our businesses and Sean will review in more detail financial results. Our second quarter results from operations were $0.78 a share up from $0.72 compared to the second quarter of last year. And I'm pleased to report increased earnings at both utility and mid-stream businesses.

Utility earnings increased primarily due to prior approved rates associated with the significant capital invested to maintain system reliability and to be able to provide additional renewable energy resources to our customers. However, the earnings impact was tempered by higher operating expenses primarily resulting from plant maintenance. You may remember on the first quarter earnings call, we projected higher O&M expenses for the remainder of the year.

At Enogex, earnings increased 44% as we experienced record Volumes in the gathering business, record volumes in the processing business, as well as higher natural gas liquid prices compared to the second quarter of last year. Gathering volumes increased more than 6% and processing volumes grew nearly 19% compared to last year. However, natural gas liquids sold and produced, increased by almost 50% from 120 million gallons to 179 million gallons during that same time.

Processing margins were up 21 million including a doubling of the fixed fee volumes, further reducing the volatility of that contribution looking forward. These results demonstrate the continuation of robust drilling activity in the very liquids rich basins of western Oklahoma, where we are very competitively positioned. Producers have indicated that these basins are their most profitable drilling areas, including the shale plates.

Moving on in the Oklahoma economy, it continues to remain stronger than most of the country. The Oklahoma City and State unemployment rates 6.7% and 6.9% respectively, both well below the national average. However, like most of the country, state and local governments are under spending pressure as tax revenues have declined.

Year-to-date, we have added over 2800 customers to the system. Which is an annualized growth rate of 0.7% per year, slightly below our historical average of just under 1% per year. We have also added about five mega watts of new industrial loads this year, and projecting an additional 12 mega watts during the second half.

Our Industrial load increased for the fourth consecutive quarter and industrial sales were up 9% since June of last year. And while not official, we believe a new peak, substantially above our previous last peak that occurred in 2006 was met this week. We are very encouraged by this recovery in sales, but remain cautious regarding the overall economic outlook.

Since our last call, we have executed several significant milestones in progressing forward our Smart Grid, our Transmission, and Wind Generation portfolio initiatives. First our 366 million system-wide Smart Grid roll out, which included $127 million of federal stimulus funds, was approved by the Oklahoma Corporation Commission on July 1. As you know, the implementation of Smart Grid is a critical component of our strategy to reach our demand response goals to advance our customer relationships and improve operations. Through improved reliability, yet providing for $22 million reduction in O&M when implementation is complete. We expect this improved program will be full implemented by the end of 2013.

Second, the $450 million Crossroads Wind Farm was approved just last week and should be operational in late 2011. As in the Smart Grid case, we were very pleased to have reached another settlement for the OCC to approve. The project was upsized from 190 mega watts to 228 mega watts following the Southwest Power Pool's approval over inter-connection request last Friday. Like our Smart Grid program, Crossroads provides significant savings projected to start in 2013 to our customers over the life of the project. Once all of our wind projects are complete, which would be by the end of 2011, our renewable portfolio will be at about 10% of our generation mix , which is slightly above our near term goal of 750 mega watts.

This month in Arkansas, we will file for recovery of the OU Spirit Wind Farm and separately we plan on filing a general rate case related to our infrastructure investments. Our transmission program continues to advance with the FERC approving in June, the SPP allocation methodology for high voltage transmission projects, prompting the Southwest Power Pool to issue notices for OG&E to construct portions of two transmission lines for operation in 2014. We have 90 days to notify the Southwest Power Pool of our intention to build these lines.

One of these lines is the Woodward to Hitchland line, which was a key part of our Tallgrass transmission joint venture created to construct only 765 kV lines. The notice to construct was for 345 kV line which will be built by OG&E. While we have written off $1.3 million of expenses related to the Hitchland line in the Tallgrass joint venture, we remain interested in building 765 kV lines under that joint venture.

We are confident that all of these projects will be accretive to the bottom line, and at the same time they collectively produce savings to mitigate the rate impact on our customers. We remain focused on the value for the customer, not only investing to meet business initiatives, but by finding ways to reduce the impact on customers as well.

Turning to Enogex, I mentioned in prior calls, that Enogex was evaluating many projects and the capital expenditures were expected to increase this year and next, as we have only included committed projects in our past projections. Since the last call, our capital expenditure projections have increased by $140 million through 2011.

The biggest driver of the increase is the construction of a $200 million a day processing facility located in Canadian County, Oklahoma. It is a $124 million project, it is expected to be operational by July of 2012, and will increase processing capacity by over 20%. We have also invested in gathering system and compression expansions, driven again by the robust drilling activity in western Oklahoma and the Texas panhandle.

We continue to see ample opportunities available for continued growth and intend to continue to vigorously pursue them. The addition of the Crossroads project will lead us to raise equity, most likely in 2011, to support our balance sheet as we are committed to maintaining strong credit ratings. As I discussed in the first quarter earnings call we continue to assess various alternatives for raising equity and with a primary consideration being the cost of capital.

In any event, whichever route we take, it will be to support projects that we believe are in the best long-term interest of our stock holders. Today, we are reaffirming our 2010 ongoing earnings guidance, assuming normal weather, with expectations that EPS will come in toward the high end of the range.

There is still a lot of the year left, but we are comfortable regarding our earnings outlook given year-to-date results. We continue to hit the milestones on our key business initiatives at both OG&E and Enogex. At the same time, remain focused on (inaudible) associated with our day-to-day operation. We have a lot going on and once again, I would like to recognize our members who are stepping up and delivering these results. Now, I would like to turn it over to Sean to discuss the details of our financial results.

Thank you, Pete. For the second quarter our net income was $77.3 million or $0.78 per average diluted share, as compared to net income of $70.5 million or $0.72 per average diluted share in 2009.

The contribution by business unit, on a comparative basis, is listed on the slide. Before moving on to the business unit results, let me address the results at the holding company. As Pete mentioned we wrote-off expenses of $1.3 million in the Tallgrass joint venture, as it is no longer probable that the line to Hitchland will be built to 765, based on the recent notices to construct we received from the SPP to build that line as 345. That being said, we are still interested in pursuing the construction of the 765 line within the Tallgrass joint venture, when and if, 765 is approved.

Turning to our marketing business, we have a few remaining transportation agreements in our business which thy to the lack due to the lack of favorable spreads, we were unable to recover the demand fees in the second quarter. The total transportation demand fees for the quarter was $2.8 million.

At OG&E, net income for the quarter was $60 million or $0.61 per share compared to net income of $56.4 million or $0.58 per share in 2009.

Some of the primary factors are as follows. Gross margin increased $45 million or 19%. I will touch on gross margin on the next slide. Operation and maintenance expense increased by $23.3 million, primarily due to higher power plant maintenance expenses and higher pension, post-retirement, and medical expenses. Also included in the increased O&M are $4.5 million of expenses that also have revenue offsets in the form of riders.

On last earnings call we mentioned that operation and maintenance expenses would trend higher, primarily due to planned power plant maintenance and tree trimming activities, and that has occurred as we have planned. Depreciation and amortization expense increased $4.6 million primarily due to additional assets being placed into service including the OU Spirit Wind Farm and wind speed Transmission line. Net other income and expense was lower by $5 million, primarily due to lower amounts of ASPD equity and lower margins associated with the guaranteed flat build program based on normal weather. Finally, interest expense increased $2 million in part due to higher long-term debt balances.

Now turning to gross margin. You can see the drivers on the slide for the $45 million increase in gross margin at the utility for the second quarter compared to 2009. The various riders including the OU Spirit Wind Farm increased gross margin by $26.7 million and the Oklahoma rate increase, implemented in August of 2009, added $14.9 million of gross margin.

You can also see on this slide, the other drivers for the quarter including the Arkansas rate increase and the benefit of new customer growth. Weather was slightly more favorable compared to last year which increased gross margin by $1.8 million. Compared to normal weather, gross margin increased $4.7 million.

Megawatt hour sales were up nearly 3% for the quarter. Industrial sales were up 12% and our overall customer growth rate year-to-date was seven-tenths of 1% with the majority of customer growth occurring in the residential sector. For the year, mega watt hour sales are up 4% compared to 2009.

Now turning to Enogex, net income for the quarter was $22.3 million or $0.23 per share as compared to net income of $16 million or $0.16 per share in 2009.

The largest variance was the gross margin which increased by $19.1 million or 23%, which I will discuss in just a moment. The other primary driver was operation and maintenance expenses, which increased $6.5 million, in part due to higher employee costs and increased third-party engineering and inspection services.

Now turning to gross margin. The vast majority of the increase in gross margin came from the gathering and processing businesses. Volumes increased 6% and 19% respectively, and realized commodity spreads increased from $3.50 per MMBtu in 2009 to $4.74 per MMBtu in 2010.

Natural gas liquids prices also saw a significant increase from $0.66 per gallon in 2009 to $0.86 per gallon in 2010. Condensate volumns were up 14%, due primarily to a richer natural gas strain, cooler spring weather, and increased operating efficiencies at our processing plant plants. Condensate contributed $7.5 million of gross margin, compared to $4.9 million in the second quarter of 2009.

Gather volumes for the month of June in the second quarter set all-time records. 40 million MMBtu's were gathered in June, and 117 million MMBtu's were gathered in the second quarter. Not only are our volumes increasing, but we are also increasing our fixed fee percentage in the processing business, as our fixed fee contract mix grew from 17% to 28% quarter-over-quarter. Transportation gross margins fell primarily due to lower cross held volumes, as the basis differential for moving gas from the western Oklahoma, to the eastern part of the state, declined compared to the second quarter of 2009. For a more detailed explanation of these financial results, I would refer you to the Company's second quarter 10-Q filed with the SEC this morning.

Before turning to your questions, I would like to address some of the changes we have made to our 2010 guidance. As Pete mentioned, we are reiterating that projected ongoing earnings for 2010 will be at the upper end of the $2.70 to $2.95 range. However, some of our key assumptions have changed from our previous guidance.

At the utility, we are projecting an increase in the effective tax rate for on-going earnings, driven by lower than expected production and investment tax credits, and the on-going impact of losing the tax deduction on the Medicare Part D subsidy. Also, the approval of the Crossroads wind farm is expected to increase pre-tax equity FUDC by $10 million. At Enogex , volumes for both gathering and processing, are expected to increase more than previously forecast, as producers continue to expand in the Granite and Colony Washes in the Cana area.

We also are projecting Ethane to be in rejection for the remainder of 2010. Full Ethane rejection began in late June and depressed prices make full recovery uneconomical. Finally, we expect higher operating expenses as a result of pipeline integrity projects we are likely to pursue.

And, at the holding Company a projected loss of $0.11 to $0.13 per share, up from the previous projected loss of $0.07 to $0.09 per share, as a result of the lower marketing revenues in the second quarter associated with the transportation contract, and the Tallgrass write-off I mentioned earlier in the discussion. This concludes our prepared remarks and now we will turn it over to

(Operator Instructions). Your first question comes from the line of David Frank. Your line is now open.

Hi, good morning, guys.

Good morning, David.

Question, I mean it looks like you have a pretty large bump up in your CapEx forecast, and I guess what every investor is going to wonder is, will the increase in CapEx, net of any financing expenses to support it, will this be additive to your previous forecasted growth outlook for the Company?

Sure. David, this is Sean. If you are referring to our growth rate of 5% to 7% , we are still good with that 5% to 7%. Recall that when we originally set that 5% to 7%, we set that off a base of $2.45 and then we updated that off a base of $2.60, so we have increased that because of the base.

The second point I would make is that 5% to 7% is a long-term growth rate, so you are exactly right. The CapEx has increased, but as you look at the CapEx schedule we have provided you, not all of this CapEx is occurring in the first couple of years. Crossroads is, but as you look at the priority projects and some of the other projects, they are layering in over time, so you are going to see more of a steady

Right. I guess, is it safe to assume that you are better off with it than without it?

That is absolutely, correct.

Absolutely.

Absolutely. Okay. Great. Thanks, guys.

Thank you.

Your next question comes from the line of Brian Russo. Your line is now open.

Just a follow-up on the previous question and answer on the 5% to 7% growth rate. It just seems that the CapEx on the utility side sets you up for some nice growth just on the utility side, independent of where Enogex performs. Would you say there is a bias towards the top end of that 5% to 7% range?

Again, Brian, that is a long-term growth rate and we are going to stick with that as a long-term growth rate. And so some years it is going be at the high end, some years at the low end but we are comfortable with the range there.

Okay. You mentioned the possibility of raising equity to finance some of these incremental utility projects. Can you quantify the amount that you are considering?

Sure. So, you know, Pete mentioned that with the Crossroads investment of $450 million, I think you ought to think about that in terms of kind of a fifty-fifty cap structure. That is in incremental to our plan, so we would finance that roughly fifty-fifty, so $200 million to $250 million of equity would be a good range of number there.

And what about the longer term transmission related projects? I realize it as 2014 timeline but when would construction start on that? And would you need in incremental external financing for it?

We will begin deploying some more and investing some capital next year, a pretty nominal amount for those two priority projects, but we really don't get into the heavy lifting there until 2012 and 2013. Hopefully with retained earnings we will address that funding. But to reiterate what Pete said, we are going to protect the balance sheet but we don't envision significant equity needs for that.

Okay. And could you just comment on what you are seeing in NGL pricing? Clearly year-over-year it has been up, but I have just heard that there is a lot of NGL in the surrounding basins and I'm just wondering, you know, kind of what you see for kind of the remainder of the year.

Keith, would you take that call question.

Sure. Yes, certainly with all of the producers focusing on the rich plates, NGL production is increasing in a lot of areas, but we believe that, our projections that we have, have some of those considerations in there and certainly forward market would represent that. So we think that we are okay with our projections.

Can you we mind remind me of the sensitivity that you guys have previously outlined in terms of changes in commodity spreads and what the annualized net impact that has?

Yes, so what we have said, Brian, was for a 10% move for the entire year, in commodity spreads, was about $4 million of net income.

Okay, and I would imagine given your migration towards more fixed fee business, will that sensitivity decrease in 2011 versus 2010?

It should. The offset there would be, is you recall in 2010, we had roughly 75% of our key pole volumes were hedged. Next year it is closer to 50%. But directionally you're, correct.

Okay. And then lastly there was some recent activity in the midstream M&A environment or specifically I think there was a deal announced in Oklahoma and I was just wondering if you could just comment on your on-going, initiatives to pursue strategic alternatives for Enogex?

We are very much aware that, I think you are talking about the ATLAS transaction that you are referring to?

Yes.

Enbridge and the Western parts. You know, we operate in that area so we are much aware of that. We are aware of it. So we are anticipating that particularly given ATLAS' situation, that may be an eventuality. But we are very well competitively positioned, remain so. We are fortunate and we look organically at our position. We have significant opportunities.

I mentioned in the call that these areas where we operate, and Robert McClendon just this week was quoted as saying, and we heard that from Chesapeake, as well as other producers, that this is their most profitable in the Granite Wash area because of the rich natural gas liquid production from all their positions. And you know, Chesapeake as , an example, are in all the basins, probably in all the shale plates in the country so that is quite a statement. So we do see substantial organic growth opportunities.

As I said in earlier calls we only are projecting known and committed projects that we do, so we do expect that our forward CapEx will be increasing as we have this quarter. We have the Enogex folks are very busy and working very hard because of all the opportunities we have. So we, again, have a lot of organic opportunities if there is an acquisition potential that has the right value for us and works, and is complementary to our system and can produce synergies and a higher return for our assets we will take a look at it. We still like how we are positioned in the Mid-continent and really excited about our potential growth opportunities that we

Great. Thank you very much.

(Operator Instructions). Your next question comes from the line of Jay Dobson. Your line is now open.

Hey, good morning.

Hey, good morning, Jay.

Question, Sean, on the guidance. Sort of understand the puts and takes as far as why it remains where it is. But I do note in the press release you exclusively indicate it is based on normal weather, and took note of Pete's comment that I think last week you hit a new peak, and certainly understanding weather can change a lot between here and year end, but I'm just wondering how you think about what is happening right now and what that could do to earnings?

Good question. So the issue there, is you're right, we are counting on normal weather. It has been very warm here. I think it is a different type of warm, just because it is in the 90's in Oklahoma, doesn't mean it is above normal. That is kind of expected.

It has been very warm here the last couple of weeks, the first part of July it was in the 80's and we had a lot of rain. So the third quarter, Jay, just to put it in perspective , is between 60% and 70% of the earnings contribution for the utility, for the year. So it is a big quarter and that is the important point to take there.

From a weather stand point, it looks like it has been good for July. June was a good month. May and April were so-so. So on balance, we were a little bit ahead for the quarter, but certainly the third quarter will turn that around either

Okay. Fair enough. And then on Enogex, wanted a little more detail on the O&M. You indicated it was sort of third-party expenses and then later on in the comments talked about the pipeline integrity initiatives that you had. Dig down a little bit for me and tell me what is going on there sort of the trends this year and next.

I think just to be perfectly clear, what we are doing there is, we saw the opportunity that we could do some of this integrity work and some of this maintenance now, actually earlier in the year and maybe not accelerate it in from 2011, to minimize the business interruption and that for our customers.

Fair enough. Pete, back to the equity question. I know you get asked this all the time but just your latest thoughts.

Obviously you have a number of different alternatives to consider when you think about raising $200 million or $250 million of equity. So how you think about it straight common versus MLP versus any other alternatives and understanding it is an on going process so you're not giving your final answer here..

I would like to reiterate what we said before about the commitment to long-term value creation for shareholders and to us, that obviously translates into a lowest cost of capital. Again, that alternatives have to be consistent with our long-term business and financial strategies.

We are not in a position to really discuss or comment on the process at this time. Just to say that we remain committed to value accretion, and again, because of where the stock, I have said consistently over time we don't believe our OG stock reflects the full value of Enogex. And so given that view, alternative transaction may well involve Enogex, but in the event that at the time if we do come to a point in the position to comment further I just assure you that we will communicate with you as soon as we can.

No, that's great. Thanks a lot. Sean, just one more. On the hold Co expenses, I appreciate that those expenses are going up and so on your Slide 9, I guess it is shows the difference there but that does include the write-off of $1.3 million and then the un-recovered demand fees?

Yes, it does.

Go ahead, I'm sorry. Go ahead.

No, it absolutely does. And, you know, certainly we weren't anticipating that in the second quarter and that is why the guidance is essentially moved up $0.04.

Perfect. Can you remind me the sort of longer term range on hold co expenses and if we are looking out at 11, should it remain at the 11 to 13 level or is this something that reverts back to a number sub 10?

We obviously haven't given 11 guidance, but I think we are focused on kind of that historical range of that $0.07 to $0.09 isprobably a good way to think about it. We don't anticipate obviously to write-off the expenses associated with Tallgrass. We are done with that. We don't anticipate another quarter where there is just actually no basis opportunity for us to recover the demand fees.

That's great. Thanks very much for the time.

Okay. Good luck.

And there are no further questions at this time , and so I will turn the call back over to the

Thank you, operator. In closing, I would say we just remain very excited about our plans for continued growth in both businesses. We remain on track. I think as evidenced by the accomplishments of this quarter. We are on track executing the strategy we laid out several years ago. I thank you for your continued interest in OGE Energy and have a great day.

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