OGE Energy Corp (OGE) 2011 Q1 法說會逐字稿

Good morning. My name is Krista and I'll be your conference operator today. At this time I would like to welcome everyone to the OGE Energy first-quarter 2011 earnings conference call. (Operator Instructions). Mr. Todd Tidwell, you may begin the conference.

Thank you Krista. Good morning everyone and welcome to OGE Energy Corp.'s first quarter 2011 earnings call. I'm Todd Tidwell, Director of Investor Relations and with me today I have Pete Delaney, Chairman and CEO of OGE Energy, Sean Trauschke, Vice President and CFO of OGE Energy and several other members of the management team to address any questions that you may have.

In terms of the call today, we will first hear from Pete followed by an explanation of first 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 web site.

Before we begin the presentation I would like to direct your attention to the Safe Harbor statement regarding forward-looking statements. This is an SEC requirement for financial statements and simply states that we cannot guarantee forward-looking financial results, but this is our best estimate to date. In addition, there is a Regulation G reconciliation for ongoing earnings in the appendix. I will now turn the call over to Pete Delaney for his opening comments. Pete.

Thank you, Todd. Good morning everyone and welcome to our first-quarter earnings call. We had a good quarter. Our key capital projects are moving ahead as expected. First-quarter earnings are in line with our financial plan, and we continue to make progress on the regulatory front.

For the first quarter we reported earnings of $0.25 per share flat to the first quarter of 2010, although ongoing earnings were $0.36 last year. As Sean will explain later in more detail, we remain on track to meet our financial targets.

Utility gross margins were higher primarily for the quarter due to regulatory riders associated with preapproved utility investments and new customer growth, partially offset by milder winter weather. However, utility operating income was down slightly as the increase in gross margin was offset by a higher level of operating expenses including costs associated with our generation mechanical integrity plan.

You may recall these expenses were not incurred until later in 2010. Last year we increased O&M by $21 million to meet our integrity objectives and this work continues. As I've mentioned before our generation fleet provides great value to our customers with an embedded cost of just over $150 per KW.

And we continue to evaluate investments in our older gas- and coal-fired units to determine the best options, again, given the potential for incremental investments associated with environmental regulations currently being proposed.

As you are also aware, the EPA did not approve the State Implementation Plan followed by the Oklahoma's Department of Environmental Quality regarding regional haze. Instead, the EPA proposed a Federal Implementation Plan that we believe, in comparison, unnecessarily burdens our customers with additional costs.

Many parties in Oklahoma, including the governor and the attorney general, are in opposition to the EPA's regional haze proposal. We expect a final rule later this year at which time we will review our options, including litigation, as we believe we have a strong case by correctly applying the regional haze regulations.

We are also analyzing the preliminary maximum achievable control technology rules which relates to hazardous air pollutants, as well as a recent EPA Notice of Violation received related to new source review. Determining our ultimate path forward on regional haze requires an understanding of our obligations under the other rules.

Our goal is one investment strategy that addresses all these regulations while mitigating, to the extent possible, the impact on our customers. I'll remind you that we do have a state law that allows for the recovery of prudently incurred investments in response to environmental mandates.

In reviewing 2011 on the last call, I referred to this year as a building year with a record $1.4 billion capital plan and one in which management is very focused on executing our operational capital programs that are positioning us for the future.

Our transmission projects are progressing at various stages of planning and design with over $200 million of investment expected this year. We recently received FERC approval for CWIP recovery on all of our key SBP projects.

In addition, the Oklahoma Corporation Commission has approved the SBP tracker which allows for recovery of transmission costs billed to OG&E from other SBP member utilities. These orders will lower the ultimate cost to customers and mitigate the regulatory lag normally associated with large capital plans.

Our smartgrid implementation continues on plan with over 275,000 meters installed, part of our three-year deployment, guaranteeing customers cumulative O&M savings of $22 million through 2013. These meters and our communication network are also already allowing us to remotely read meters for billing, remotely connect and disconnect, identify theft and provide real-time consumption data to our customers among other things. And we're on track to complete that system-wide deployment by 2013.

The Crossroads Wind Farm is proceeding with the turbines expected to come online beginning with the third quarter of this year. And with the majority of the turbines to be on line by December.

On the regulatory front, we are pleased that the Arkansas Public Service Commission staff adjusted their initial rate increase recommendation from $5.6 million to $9.6 million which included a SBP tracker similar to that approved in Oklahoma. While less than our request, it better positions us for the rate hearing.

We're also in the process of preparing the Oklahoma general rate case, which is scheduled to be filed in early summer with new rates projected for January of 2012.

We are keeping a focus on costs and laying the groundwork to mitigate future cost pressures. Some elements are the recent modification of our retiree medical plan that reduces volatility of those expenses and related OCC filings to recover those expenses under a tracker.

It involves also moving our pension fund to a fully funded status with a more conservative allocation and continuing to rework our processes to capture opportunities associated with the ongoing automation of our system.

Our expectation remains for significantly less cost increases going forward than experienced last year. Looking at the economy here, our economy in our service area is much the same as the past quarters with continued strength. With the Oklahoma City and state unemployment rates both continue to be well below the national average in the low 6% range. Customer growth continues. We've added 6,000 customers to the system compared to the first quarter of 2010 with residential customers up a little less than 1%.

Megawatt hour sales continue to grow with industrial sales up again this quarter but still below pre-recession levels. The oil field sector on the other hand is about 5% above 2008. Turning to Enogex, the midstream business continues to perform well with continued gathering and processing volume growth on the system.

Our processing plant expansions are on plan and we are capturing a larger market share of new gathering and processing volumes in the mid-continent. Our gathering volume increase of 2% over last quarter of the prior year does not reflect the full extent of our growth potential as we are in the early stages of some recently contracted growth areas.

Processing volumes up 3% compared to last year were also negatively impacted by the loss of one of the units at Cox City processing facility until the third quarter this year. Adjusting for that plan outage volumes would have been up 6%. Though volume growth for the quarter was below guidance for the year we still expect to meet our volume growth targets.

We continue to see multiple opportunities for Enogex. The Granite Wash and Cana regions continue to show robust drilling activity, and we believe we are well positioned in those areas. That said, longer term geographic diversity remains a part of our expansion strategy for Enogex.

Looking at natural gas liquid prices they were again higher compared to last year as prices averaged $1.11 per gallon compared to $1.05 per gallon. Condensate provided record margins of $13 million as we've seen oil above $100 since the end of February. The recent run up in commodity spreads improves our gross margin, but that impacts us less than it used to as we have increased the fixed fee portion of our processing business.

The keep-whole portion is expected to continue to decline as we expect the vast majority of producers, particularly those in the liquid-rich areas, will favor fixed fee or percentage of proceeds processing for new volume commitments or as existing processing agreements expire.

We are in discussions with converting an agreement for an extension of term and expansion of dedication. The lower risk associated with fixed fee pricing combined with the value of an extended term and expanded dedication is in the best interests of our shareholders after taking in to consideration any short-term margin reduction. Of course, our ability to mitigate the loss of short-term margin through higher fixed fees is dependent upon our relative competitive position in an area as well as the producer's own value proposition from self construction.

As I mentioned earlier our planned $1.4 billion investment program is the largest in our history. Accordingly we are focused on executing our capital projects, the processing plants, transmission lines, the wind farm, our smartgrid deployment, as well as managing our costs, executing against customer expectations and processing our rate cases. My many thanks to our members who are working hard to execute our many projects on time and on budget.

And now, Sean is here to discuss the details. Sean?

Thank you, Pete. Good morning. For the first quarter our net income was $24.8 million, or $0.25 per average diluted share, as compared to ongoing net income of $35.6 million, or $0.36 per share, for the first quarter of 2010. Recall the 2010 ongoing results excluded the charge for the Medicare Part D subsidy. The contribution by business unit on a comparative basis for both ongoing and as-reported earnings per share is listed on the slide.

Now turning to OG&E, net income for the quarter was $6.4 million, or $0.06 per share, as compared to ongoing net income of $8.2 million, or $0.08 per share, in 2010. Some of the primary drivers are as follows.

Gross margin increased $9.5 million or 5%, and I'll touch on gross margin on the next slide. Operation and maintenance expense increased by $11.9 million, of which $3.3 million was associated with riders that have a revenue offset. The remaining drivers include higher payroll and benefits expense and the increased plant expenses Pete mentioned earlier.

Depreciation and amortization expense increased $2.1 million primarily due to the additional assets being placed into service including the Windspeed transmission line.

Taxes other than income increased $1.4 million, primarily as a result of higher property taxes. Net other income increased by $4.7 million, primarily due to an increase in AFUDC equity and net gains in the Guaranteed Flat Bill program which didn't make as much in 2010 due to the strong winter weather in the first quarter of last year.

And finally, interest expense increased $1.9 million, primarily due to an increase in interest on long-term debt we issued last summer.

Gross margin increased $9.5 million compared to the same period in 2010. The various riders increased the gross margin by $11.3 million in addition to higher demand fees and new customer growth which contributed $4 million of the increase.

Mild weather compared to last year reduced gross margin by $3.4 million, as heating degree days were 15% below 2010. Although heating degree days were 7% below normal, weather did contribute $5.5 million of gross margin for the first quarter of 2011, due to the intensity and duration of some tight cold spells in late January and early February. Customer growth continued at just below 1%, compared to 2010, as over 6,000 new customers were added to the system.

Now turning to Enogex, net income to OGE for the quarter was $18.8 million, or $0.19 per share, as compared to ongoing net income of $29.4 million, or $0.30 per share, in 2010. Some of the primary drivers are as follows.

Gross margin decreased by $10.5 million, and I will discuss the drivers in a moment. Operation and maintenance expenses increased by $3.4 million in 2011, primarily due to the site remediation projects and higher salary and wages.

Interest expense was $2.1 million lower compared to 2010, in part due to lower debt levels. And finally, ArcLight's 13% ownership reduced earnings $3.8 million or about $0.04 per share.

Now looking at gross margin, gross margins decreased $10.5 million in the first quarter of 2011 compared to 2010. Although gross margins were lower, they were in line with our expectations and our guidance. Volumes increased in both the gathering and processing businesses by 2% and 3% respectively, and commodity prices continued to strengthen.

The Cox City plant won't be online until the third quarter of this year, and we have not received the insurance proceeds yet, which is expected to offset the processing gross margin loss of approximately $2 million a month.

When looking at the decrease in gross margin quarter-over-quarter, there are two main business drivers in addition to the Cox City outage, both of which we expected. First, in the gathering business, we have contractual gains and as natural gas prices were lower in 2011 compared to 2010.

Second, we had storage hedges in place for the first quarter of 2010 and those are not in place for 2011 due to the lack of spreads. For a more detailed explanation of the earnings drivers for OGE, I would refer you to the Company's first quarter 10-Q filed with the SEC this morning.

Before discussing our outlook for the remainder of 2011, I did want to provide a quick update on key regulatory events for the next eight months. We will file a rate case next month in Oklahoma with new rates expected to take effect in January of 2012. The Arkansas rate case hearing is later this month, and we expect new rates to be in place during the third quarter of this year.

Regarding our 2011 outlook for earnings guidance of $3 to $3.20 per share, it is unchanged and based on the assumptions set forth in our 10-K. After the first quarter results, we are right on plan. Please keep in mind, the first quarter results represent less than 10% of our projected full-year 2011 earnings.

Before moving on to Q&A, let me provide some additional color around a few factors, which in addition to the weather and the other assumptions, could impact 2011.

First, as all of you are aware, commodity prices have strengthened significantly since we released guidance in February. If this trend were to continue for the remainder of the year, we would expect Enogex to exceed the upper end of the earnings range of $0.90 to $1.05, with no other changes to the Enogex assumptions previously provided.

On the other hand, as Pete mentioned, we are in discussions with a large customer for a long-term gathering and processing deal which would include a much larger acreage dedication and therefore increased volumes. This agreement would contain a fixed fee processing arrangement. And we like these agreements because they increase our volumes, grow our business without increasing the earnings volatility. If we execute this agreement, earnings could be at the lower end of the Enogex range of $0.90 to $1.05.

And lastly, for those of you updating your models, I would like to point out a change in geography for our guidance. As Pete mentioned, we will be receiving CWIP for our FERC transmission projects. As a result, our credit metrics and quality of earnings improve as AFUDC will now be $13 million lower and gross margin will increase by the same $13 million.

So this concludes our prepared remarks, and we will now open it up for your questions.

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

Good morning. I just wanted to follow up on some of the comments you just made. I may have mixed things up. If you sign this large acreage deal for fixed fee, you're guiding to the low end of Enogex guidance at $0.90 and if you don't sign it, you'd be more at the higher end? Is that accurate?

Yes. Anthony, this is Sean. Let me try to clarify that. What we were trying to say is the first point is is we're exactly right on plan, right where we thought we would be for the year. And we've been -- there's a lot of interest. Because of commodity prices, people are wondering if we're going to increase our guidance for the year. And recognize, as I said, this is less than 10% of the full-year earnings for the year so we're not going to do that.

But what I did want to make sure was very clear that if these commodity prices continued for the year, there's nothing to prevent us from exceeding our guidance at Enogex, all else being equal. But I wanted to keep it in balance because we've said many times we are also looking at increasing our acreage dedication and therefore increasing our volumes for a much longer period of time. And if we were able to do some of those transactions, we would -- we certainly wouldn't do those agreements at the current spread levels. And so we would see some short-term earnings drop. But I wanted to confirm for you that we still expect to be within that guidance range.

Is it right for me to think of this spread for fixed fee a ballpark roughly like $0.14, $0.15 per MMBtu and a keep-whole of like $1.20, $1.30? Is that reasonable?

I think, Anthony, if you look at Todd's processing supplement he's put out there, the probably correct number there is probably about $0.32 per MMBtu on a fixed fee basis.

And the keep-whole?

All right. We'll have to have Todd get back to you on that.

Okay, great. Thank you, guys.

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

Hi. Good morning.

Hey, good morning, Brian.

Could you just talk a little bit more about the growth opportunities at Enogex? I'm sorry. I don't have access to all of the slides. If you could just kind of update us on what the CapEx profile is at Enogex? And then just talk about kind of the longer-term strategy with ArcLight. I think you said they're at 13% as of the first quarter of '11. I think their ownership is projected to grow to 16% to 17% by year-end. Just wanted to get a better feel for the growth outlook post-2011.

Okay, well let me address the first issues there as far as the ArcLight percentage and our current growth opportunities and then maybe have Keith talk about where he's seeing activity and where some opportunities may be.

As far as growth opportunities, Brian, you're well aware that we have the South Canadian plant coming online in the fourth quarter of this year. That's a 200-a-day processing facility. We also expect the Cox City plant to return to service in the third quarter of this year. And then we have the Wheeler processing facility which will be coming online in the second quarter of 2012.

So if you think about just South Canadian and the Wheeler, we're increasing our processing capacity by about a third, pretty significant. The Enogex team is also spending -- or investing a great deal of capital expanding their gathering infrastructure. So that's kind of the lineup there.

Based on where our CapEx schedule sits right now, we would expect ArcLight to be at about 17% ownership by the end of the year. But again, we're continuing to look for opportunities, and Keith and his team are constantly having discussions with customers. And Keith?

Sure. We still see continued activity and increased activity in the Granite Wash areas in Oklahoma and the Texas Panhandle, as well as in the Cana-Woodford Shale. And so we are continuing to build infrastructure and we continue to see our volumes grow there and are projected to continue to grow. And so we continue to look at these new packages of gas as well, as acreage comes up needing infrastructure.

And I guess where Enogex sits now it's currently less than two times debt-to-EBITDA. What would the strategy be to utilize ArcLight's equity contribution and also leverage it up a little bit on your end to grow that business?

Brian, this is Sean. Certainly we'll utilize ArcLight and OGE to fund the Enogex business. It's not our intent at this time to really lever up Enogex. I actually like the metrics there. You shouldn't expect that to get too far north of two to three times EBITDA -- I mean, that debt-to-EBITDA to be more than two or three times.

The other point that I would make to you is our partnership here with ArcLight is all about growth. We want to grow the business, and we think if we're successful in growing it and then also come out of this with a much stronger balance sheet, and we really like that investment grade rating, we think that's a key competitive advantage. So it's not our plan at this time to begin levering up Enogex.

Okay. And just to confirm on your guidance, all of your Enogex commodity assumptions that you laid out initially in the '11 guidance, all of that's intact?

Yes.

Okay, so you're assuming for the full year average weight in natural gas liquids of $0.90 a gallon?

That is correct. And then what I was -- what we're trying to convey there, Brian, is NGL prices are a lot higher now. I mean, if that was going to continue for the year, we would expect the corresponding impact to Enogex to go up as well. But again, it's still the first quarter, and we've got a long way to go.

Given your experience at Enogex and with NGL pricing, is there any reason to believe that these NGL prices would reverse trend and drop off significantly or are you comfortable with where they stand today?

I don't know what the future holds for NGL prices, Brian, but what I would tell you is that's why we put our NGL assumption at $0.90. And what I wanted to assure is if NGL prices end up being higher than $0.90 for the year, you should expect earnings to be higher for Enogex all else being equal. And if they come in lower than $0.90, earnings will be lower for Enogex. And that's why we put the number out there for you.

Okay. And then just lastly, if I could, just the general, upcoming general rate case in Oklahoma, any major projects that you're looking to layer in rates or is this kind of a traditional rate case with no major big ticket items?

It will be just, I think if you want to use that term traditional rate case, that's what it'll be. Because we do have riders for OU Spirit and the other activities, this will be, as you say, a traditional rate case.

Okay. Thank you very much.

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

Hi. Just a follow-up I guess on Enogex, it appears that you're seeing a lot of the contracts going from keep-whole to fixed fee or percent of proceeds. I mean, when we look at 2012 or 2013, I mean, is the right way to look at it is a split 50/50 between fixed fee and percent of proceeds? Or do you end up where you get to a point where Enogex has very little, if any, commodity sensitivity other than just volumes being processed?

Yes, Anthony, this is Sean. Obviously we haven't put any guidance out there for 2012 and 2013. We've made considerable progress converting our keep-whole volumes to fixed fee. We would expect that to continue.

I don't believe we will ever get to the point where 100% of the processing business will be fixed fee. As Pete said in his comments, what we are seeing is a lot of the new contracts that previously might have been keep-whole are actually being fixed fee. So you're going to see less keep-whole contracts in the future. But you're still going to have POL and POP contracts so there will still be some commodity exposure. But we would say that you should expect to see less of it going forward.

Do the fixed fee margins decline also in time from, I guess, $0.32 going down? I mean, at what point do they reach a point of where there's just -- so much processing capacity out there that those margins keep getting thinner?

Well, I think that probably has more to do with the competitive dynamics in those marketplaces. But the other point that I would make to you, Anthony, is we look at those processing fees in terms of making sure that we're able to build infrastructure and capacity and earn good, solid double-digit returns.

And so we're looking at the economics there, and I think the underlying fundamental that we're focused on is we're talking about the price in this discussion. But what these fixed fee agreements are bringing to us are future growth in the form of increased volumes. And that's the real key piece of these contracts.

Great. And just lastly, I believe the last quarter you guys had reiterated a compound annual growth rate. I want to say I believe it was like 10% to 12%?

5% to 7%.

5% to 7% -- sorry. I mean, you guys are still standing by the 5% to 7%? There's no change in that at all?

We're not changing, no. We're not changing our outlook for long-term earnings growth rate.

Great. Thank you very much, guys.

Your next question comes from the line of Greg Reese. Your line is now open.

Hi, guys. How are you?

Good.

Hi, Greg.

I'm having a little trouble with getting the slides so I'm not able to flip through them. Have you guys made any changes to that CapEx slide all the way at the end?

We didn't post the CapEx slide. It is in our Q that we filed this morning but there aren't material changes to the CapEx slide from what we posted in the K.

Okay, got it. Thanks, guys.

Okay.

(Operator Instructions). There are no further questions in queue at this time.

Thank you, operator. Thank you, everyone for joining us for our first quarter earnings call. Thank you for your continued interest in OGE Energy and have a great day.

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