OGE Energy Corp (OGE) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, welcome to Q2 2012 OGE Energy earnings conference call. My name is Sandra and I'm your operator. (Operator Instructions).

Mr. Todd Tidwell, please go ahead, sir.

Thank you, Sandra. Good morning, and welcome to OGE Energy Corp. second quarter 2012 earnings call. I'm Todd Tidwell, director of Investor Relations, and with me today I have Pete Delaney, Chairman, President, and CEO, of OGE Energy Corp., Sean Trauschke, VP and CFO of OGE Energy Corp., and Keith Mitchell, President of Enogex.

In terms of the call today, we'll first hear from Pete, followed by an explanation from Sean of second quarter results, Keith will review the and the Chesapeake announcement, and finally as always, we will answer your questions. I would like to remind you that this conference is being web cast and you may follow along on our website at 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 can't guarantee forward looking financial results but this our best estimate to date. In addition, there is a regulation G reconciliation forEBITDA in the appendix along with our projected capital expenditures. I will now turn the call over to Pete Delaney for his opening remarks. Pete?

Thank you, Todd. Good morning and welcome to our call, second quarter 2012. We reported earnings of $0.95 per share compared to $1.04 in 2011. Year to date earnings of $1.33 per share are slightly ahead of last years earnings per share of $1.29 for the same period. Consolidated earnings guidance is unchanged for 2012. We're comfortable with our $3.40 to $3.60 per average dividend share estimate. Sean will discuss our guidance in more detail later in the call.

Regarding the second quarter both businesses delivered solid results compared with last year considering weather, benefited the utility $0.15 last year and considering the 33% drop in natural gas liquids prices and the 50% decline of natural gas prices quarter over quarter. Despite the head winds, gross margins improved in OGE and Enogex.

On the utility side, primary earnings drivers were sales growth, recovery of transmission investments and various other utility investments including the Crossroads wind farm. Enogex gathering and processing volumes were up 3% to 29% respectively. These higher volumes more than offset the decline in margins, resulting from lower commodity prices.

For the second quarter Enogex process therecord amount of natural gas, nearly 1 trillion BTU's per day. However, higher expenses primary depreciation caused overall earnings to decline. While posting solid second quarter results we continued to move key initiatives forward.

Growing both businesses but keeping our utility and midstream asset earnings mix in approximately 70% for utility and 30% for mid-stream businesses and we continue to expect to grow earnings at 5% to 7% annually and grow our dividend along the way as well. We are on plan to complete our Smart Meter deployment this year and are primarily focused in that regard will shift to extracting value for our customers. A large part of that value proposition is demand and response, providing customers hourly energy usage information and products with which to control their usage.

We have about 30,000 customers signed up on the program on track with our expectations and we expect several hundred megawatt's demand response for the next several years. Again, which should set us up to defer the need for the increase in generation capacity past 2020.

Meanwhile, a billion plus transmission build is under way, two of the lines completed in May, and we filed an application this week for recovery under the writer approved as part of the Oklahoma rate case settlement. The subject of the rate settlement will remain on plan overall but our initial expectation was for a larger rate increase. However, as the first quarter ground on with that decision, we began to plan for a potential modest increase. We lowered our base capital spending and operating plans that quarter to mitigate future regulatory lag.

We were reluctant to accept the settlement, we believe that accepting the 10.2 ROE, and getting a writer for SVP transmission projects positions us for the future. The future including escalating environmental spend and continued transmission expansion. Given the circumstances, we believe that settlement was in the best interest of the company. We are committed to achieve the same high level of customer satisfaction and reliability, despite the modest increase, as we continue to drive for efficiencies.

We will work with the commission staff, as always, to build a framework of our timely recovery of our future environmental expenditures. On the last call, we indicated our current estimate of environmental compliance cost could be well over $1 billion depending on the outcome of various legal proceedings. The tenth circuit court appeals granted a stay in the implementation of the EPA's reasonable haze federal implementation plan, and we expect the final decision by court in the first half of 2013. Under that time frame, a new compliance state would be in the first half. 2018.

Regional haze will by far have the largest impact on our customers and we hope this stay will enable OG&E and the state to reach an accommodation with the EPA. If our legal and settlement efforts are not successful, we're ready to comply with regulations.

This quarter we've included $120 million of projected cost for low knox burners on seven units to be spent in the 2012 and 2016 time frame. We've also indicated that compliance with utility map would most likely require DSI and activate carbon injections at an estimated cost of a $310 million. Compliance with the rules for OGE primarily relates to mercury and acid gases. However, an extra year may be needed to required to complete installation in the to 2015-2016 time frame after our testing is completed by this year.

As known on the last call, a well positioned portfolio at Enogex help us stay with our game plan although the operating environment continues to change around us. Our large dedications in the most profitable wet gas spaces in the US provide a degree of protection from decline of natural gas prices. We continue to experience robust drilling activity in these regions despite lower gas prices. Our original 2012 guidance was for processing volumes to grow 15% for the year and now we're projecting growth of 20%.

As of today we have brought on line 320 of the 600 [inaudible] per day plant expansion with the re-remaining capacity to be available by the end of 2013. While we have a much larger portion of fixed fee contracts, lower liquids prices have reduced our profitability. We have not experienced a reduction in drilling associated with lower natural gas liquid prices in these regions and our volume gains were able to offset the impact of lower prices year over year.

We are pleased to announce today the acquisition of some of Chesapeake's gathering assets in the prolific greater Granite Wash area. Along with these assets we received a significant acreage dedication of approximately 500,000 net acres for 15 years under a fee based arrangement. This is a significant step towards our objectives in regard to scale, diversity, and long-term growth.

Keith will discuss this acquisition in a few moments. Before turning it over to Sean, a final note about the health of our service area of the economy. June unemployment rates for the state were 4.7% and Oklahoma City's unemployment rate of 4.5% was the lowest in the nation for large metro areas. Like other parts in the nation, Oklahoma is in the middle of the robust gas and oil environment which is driving the low unemployment rates. This is good for both Enogex, and for the utility. We are now adding almost 8,000 customers a year, and total customer count should eclipse 800,000 sometime in 2013. Now, I would like to turn the call over to Sean to review our financial performance in more detail.

Thank you, Pete. Good morning. For the second quarter we reported net income of $94 million or $0.95 per share as compared to net income of $103 million or $1.04 in 2011. Year to date consolidated earnings per share were $1.33 in 2012 compared to $1.29 last year.

The contribution by business unit, on a comparative basis is listed on the slide. At OGE, net income was $73 million or $0.74 per share as compared to net income of $79 million or $0.79 per share in 2011.

Looking at some of the key drivers, second quarter gross margin came in stronger as we saw an increase in $9 million or 3%, despite weather which was milder than last years record setting summer. I will discuss the drivers for the increase on the next slide. O&M and depreciation were $15 million higher for the quarter. The increase was due to additional assets being placed into service including the Crossroads wind farm and various other investments. I would like to point out that $8 million dollars of the increase had a revenue offset for the recovery of various utility investments.

Net other income decreased over $4 million due to lower [inaudible] equity resulting from the completion of the Crossroads wind farm. Interest expense was $4 million higher due to the long-term debt issuance we completed in May of 2011 and the associated lower debt. Utility earnings were lower for the quarter but year to date we're a penny ahead from last year.

Turning to the second quarter gross margin. As I mentioned earlier, utility margins were up for the second quarter despite the impact of weather compared to 2011. There were three primary drivers for the increase in gross margin. First, was the recovery of various utility investments including Crossroads and Smart Grid. These increased gross margin by $11 million. Second, our SPP transmission projects increased gross margin by $6 million. And lastly, growth from new and existing customers increased gross margin by $4 million. Partially offsetting these increases was mild weather compared to 2011.

Looking closer at weather, cooling degree days were 27% above normal yet 10% below the second quarter last year. This translated into $14 million lower gross margin compared to last year but $6 million in higher gross margins compared to normal for the quarter.

The weather impact year to date on gross margin was $25 million lower than 2011 but a positive $2 million for the year compared to normal. We added nearly 8,000 new customers to the system compared to the second quarter of 2011. On a weather normalized basis, residential mega watt hour sales grew just under 1%, while oil field sales were up 9%, and industrial sales grew 4%.

Turning to the second quarter of Enogex earnings, although gross margin did grow by $8 million or 7%, OGE's portion of Enogex earnings per share decreased from $0.25 in 2011 to $0.21 in 2012. I'll discuss gross margin on the next slide, but first I'd like to review some additional drivers for the quarter.

Operating expenses increased $7 million primarily as a result of higher depreciation expense due to higher levels of plant and service. Net other income fell nearly $4 million partially due to the recognition of the $2 million gain for the sale of certain gathering of processing assets in 2011. Lastly, the impact of ArcLight's change in ownership resulted in a $1.1 million variance quarter over quarter. Year to date, OGE's portion of Enogex earnings was $0.46 per share compared to $0.44 per share in 2011.

Turning to gross margin for the second quarter, Enogex increase in gross margin came from the gathering of processing businesses as they continued to show solid growth. Gathering volumes were up 3%, process volumes, 29%, and condensate volumes increased 35%, compared to 2011. As Pete mentioned earlier, volume growth offset most of the impact from lower NGL prices.

NGL prices declined from $1.24 per gallon in 2011 to $0.83 per gallon in 2012. In additions, ethane volumes dedicated to Conway were in rejection for much of the quarter. While natural gas prices declined from $4.36 per mmbtuto $2.23 per mmbtu. Enogex volumes continued to grow.

Finally condensate contributed nearly $15 million to gross margin on a 9 million gallons of production compared to 11 million of gross margin on nearly 7 million gallons of production in the second quarter of 2011. Year to date condensate margins were $33 million compared with $24 million in 2011 and gallons produced were $19 million compared to $15 million for the same period last year.

Before addressing guidance and moving on to your questions, I would like to address a few different topics. You will notice that our capital expenditure forecast has increased. At the utility we included $120 million dollars for low knox burners. Recall the low knox burners were part of the state implementation plan in response to the regional haze requirements. Regarding the utility match rule, our compliance date is 2015 with a possibility of a one year extension to 2016. A plan for [inaudible] is [inaudible] injection, an activated carbon injection, at a cost of approximately $300 million.

We hope to complete our testing of DSI and ACI by the end of the year at which time we will provide our CAPEX plans to comply with utility match rules. The two controls that we will need under regional haze are being litigated as Pete mentioned earlier and accordingly the timing and cost of the compliance expenditures is unknown at this time. We were very pleased that the tenth circuit granted a stay of the EPA's federal implementation plan under regional haze hat would have required by 2017 scrubber's or fuel switching at four of our coal units. We now will have five years from the effective date of the final rule to be in compliance.

Turning to Enogex, you'll hear from Keith Mitchell, President of Enogex, in just a moment, but I did want to speak to their capital expenditures. We have included additional $320 million of capital expenditures for 2012 and 2013 associated with infrastructure build-out of this acreage dedication and asset purchase. We anticipate ArcLight contributing approximately $60 million in 2012 as a result of this announcement and their ownership percentage is expected to be near 20% by year end and average ownership for 2012 should be just over 19%.

In addition, we also are closing today on a three year $250 million term loan at Enogex, at liable plus 150, which will be used to finance system expansion. We're mindful of our credit metrics and this deal priced inside of our revolver. We found a cheaper source of short-term borrowing and created more liquidity. We expect to term this out with long term debt issuance in the future as these significant acreage dedications begin generating more EBITDA.

I would like to mention that our 2012 outlook is unchanged with consolidated earnings projected to be between $3.40 to $3.60per average share. You can see the guidance ranges for each business on the slide. We did tweak some of the price and volume assumptions we discussed earlier and I would refer you to the second quarter 10-Q filed this morning with the SEC for additional information.

Overall, we feel comfortable where your today relative to our guidance. Looking forward at the utility, July weather has been 23% above normal but still well below the 2011 when July was 44% above normal. We still have August and September left regarding third quarter earnings and as you know the bulk of utility earnings comes from the second and third quarters. At Enogex, we are maintaining our guidance despite a significant drop in commodity prices which has been offset by strong volume growth. With that, I'll turn the call over to Keith to discuss the acreage dedication. Keith?

Thank you, Sean. Enogex is pleased to announce this morning a 15 year acreage dedication with Chesapeake in the greater Granite Wash area. This is dedication of approximately 500,000 net acres, nearly 800 square miles. In addition to the acres dedication, we will be purchasing approximately $70 million of gathering assets, the acquired pipelines are shown on the map that we've provided in dark blue. We hope to close the deal in early September after the customary closing conditions and the HSRprocess has been satisfied.

This agreement is significant for a number of reasons. Enogex will now have acreage dedications of over two million net acres primarily within the greater Granite Wash and the Cana Woodford plays which we've also outlined on the map and located within the counties highlighted in yellow. This transaction further expands our footprint to the northwest and to the liquid rich areas of northwestern Oklahoma and the Texas panhandle. The fee based arrangement reduces our exposure to commodity price volatility and at the same time should allow for steady and consistent volume growth. One important feature to emphasize about the greater Granite Wash is the number of pay zones in the underlying geology which are also noted on the map. These multiple layers provide a number of opportunities for producers to exploit high levels of drilling density which provides support for our volume growth.

We believe this deal, when combined with our existing position, will provide long-term volume growth for years to come. Thank you and I'll now turn the call back over to Pete.

Operator, I think we're ready to open up the lines for questions.

Certainly. (Operator Instructions). Please stand by for your first question. Your first question is from Anthony Crowd from Jeffries. Please go ahead.

Good morning. Some questions on the acquisition. In the press release you mentioned that the acquisition would be accretive to 2012 earnings. Could you give us a range of what we should estimate from that acquisition and also, maybe in 2013-2014, what type of EBITDA, or contribution, you expect from these two acquisitions?

Sure, Anthony, then this is Sean. For 2012 you should just bottle that we're going to get a couple pennies out of that this year. For 2013 we noted what capital we will be deploying next year for that. Not in the position to give you an EBITDA forecast for next yearat this point, but we would expect it to be greater than it is this year.

What about if you can't give an EBITDA, what is your expected return on the acquisition if we know how much you are deploying next year?

Yeah, I don't think we're going to give that number. Obviously, it's accretive and we're very excited about it.

Great, thank you, guys.

Thanks, Anthony.

Thank you. Your next question is from Jay Dobson from Wunderlich Securities. Apologizes for the pronunciation.

No worries. Following up on the last question. Can we talk a little bit about volumes and just what the new acreage might do to volumes looking forward into 2013-2014? Sess interested in 2012. If you have comments there, that'd be great.

Jay, how are you, this is Sean.

Great.

You noticed that we also increased our processing volumes and guidance this year in anticipation of the performance we've seen year to date but also in anticipation of increased drilling in this area. So when we moved our processing volumes up from 15% to now 20% to 25%, that reflects some of this activity.

Okay. So, but I guess I'm looking out to sort of 2013-2014, it will be sort of a partial year which actually is also another question, when will this actually close, but what would you think the volume additions would be in 2013-2014, more on a run rate basis?

We haven't given that number for 2013-2014 yet. We hope to close within the third quarter. Certainly we'll be active in building out this infrastructure. And we'll certainly update, like we did this year, we'll provide the 2013 and 2014 volume next year. I think where you're headed, your thesis is correct, this should be incremental to the 15% volume growth we originally had out there for 2013.

Okay. Great. I'll throw this out to you Sean, but maybe this goes to Keith. You guys have done a great job of moving the Enogex business to a higher percentage of fixed fee revenues. As we look to these additions, and 500,000 net acres is big,but maybe not as big from a volume perspective. Put into context what that will do to the fixed fee portion of revenues as percent of total of revenues when I look out to 2013 or 2014?

Certainly, it should increase it. I don't think it's going to increase it materially, Jay, only because a lot of the contract mix depends on the contracts we have with certain producers. But this is a fee based contract. So you should expect, to the extent that drilling ramps up, that our fee-based percentages will increase as well.

Nope. That's great. Shifting to the utility with the rate case behind us, what is the outlook for the next rate case appreciating you did get out of this one with some riders that maybe can extend that runway a little bit?

Sure. So, as I think about Oklahoma, you should expect as we've already filed this week for the retail transmission recovery, you're going to see us continue to do that as those plans come into service, those lines come into service. Additionally, you'll probably see us file for a recovery of some as we begin the environmental compliance plan. As we think about Arkansas, you should think we're going to be filing for the recovery of the Crossroads wind farm there.

And in Arkansas we have a hypothetical capital structure there. We're not earning close to our allowed return there. We will continue to evaluate the timing of the rate cases there. We've got to get that return up. It's higher than it has been historically but still not high enough. We're earning roughly 6.5% in Arkansason an allowed return of 9.95%. So, you should expect us to be working hard in Arkansas. As it relates to Oklahoma, Pete mentioned that we have adjusted our capital spending plans to better align with depreciation and amortization so we don't incur regulatory lag.

We're adjusting our operating plans with the eye toward seeing increasing costs coming down the path as a result of environmental spending. So we really want to ease that impact to customers. Our goal in Oklahoma is really to file for these transmission environmental recoveries and try to minimize the rate impact to customers going forward.

Hey, that's great. Thanks a lot.

Thanks, Jay.

Thank you, your next question is from Chris Shelton from Millennium. Please go ahead.

Good morning, guys.

Good morning.

Quick follow up. I know you mentioned that the volume growth for 2012 you're now expecting 20%, versus the previous guidance, is that correct?

Yes, it is.

Do we think of that as organic or does that include the acquisition?

The large portion of it is organic but certainly if we close at the end of the third quarter, we'll get some benefit from this recent deal.

Okay. So I guess, is the right way to think about it that the increase in that projected growth for this year is from the acquisition or are we actually ahead of schedule on where you thought you'd be on volume growth even without the acquisition?

This is Keith, we have seen continued activities in the rich areas where we already exist despite the acquisition and we have seen growth continue in these areas. The growth is attributable to organic growth within our current area and we'll get a bit of a bump on the acquisition.

Okay. Great. As far as organically, is the 2013, 15% process volume growth, is that still valid or is that under review, I guess?

Yeah, Chris, this is Sean. For right now that is. We'll certainly update that in the future, but for right now it is 15%. But keep in mind that's also off a higher base.

Right. Right. And then switching to utility quick, now that we're through the rate case, where do you expect in the Oklahoma jurisdiction to earn on earned ROE? Is there regulatory lag or would you expect to get pretty close to your authorized ROE?

Yeah, for the trailing 12 months, assuming some pretty significant weather last year, we're probably earning close to 10% right now year, Chris. As Pete mentioned we did adjust our base capital expenditures to better align it with depreciation and amortization so we shouldn't see significant lag on the capital side, and we're focused on keeping our costs low and not letting them get outside of inflation.

So we are focused on earning close to our allowed return. Outside of the riders, we do not have any growth projects that we're not recovering right now. As I mentioned before, you're going to see us make filings for the recovery of the retail portion of transmission and likewise we'll do something similar to relative to environmental. So I think we will be focused on earning close to that 10% as we go forward.

Understood. And then, at [firk?], can you remind me the allowed?

It's 11.1%. With the formula rate and the CWIP, we're going to earn right on top of that.

Understood. Thanks a lot, guys.

Thanks, Chris.

Thank you. Your next question is from Brian Russo from Ladenburg Thalmann.

Good morning.

Good morning, Brian.

Just curious, what's your NGL assumption for the remainder of the year?

From a price per gallon standpoint?

Yes.

$1.04.

Is that consistent or are you comfortable with that given that where spot NGL prices are today?

YesWe are. And, Brian, that's are really good question. Originally we put $1.04 per gallonNGL price out back in February. That assumed ethane recovery. This $1.04 assumes rejection of Conway. Todd has explained many times that ethane on a volumetric basis is the largest partial portion of our barrel. It's just by coincidence the price per gallon is the same. But we're assuming rejection of Conway.

Understood. Can you give us an idea of the mix of the volumes that go to Conway versus Mount Bellevue?

Brian, we haven't disclosed a precise percentage, but our expectation is by towards the end of the year we ought to be close to 40% going to Bellevue.

Okay. Great. And on the CAPEX additions and ArcLight's contribution, $60 million, does that imply that they are only funding 19% of these projects?

No, remember, we're not necessarily looking at this on a project by project basis. We look at it in the aggregate. And so the $60 million is really representative of what we need to maintain our own credit metrics and maintaining our earning guidance.

Okay. What is ArcLight's full year equity contribution?

This year?

Yeah.

Up to 60. That was an approximate number. We started the year. We did not anticipate any contributions from ArcLight. With this recent acquisition we think it could be as high as $60 million.

Understood. Just the 5% to 7%, [caker?] remind us, what's the base year to use for that?

2010, $3.10.

2010, $3.10?

Yeah. We set that on a weather normalized basis. $3.10.

Okay. Lastly, the environmental cost recovery that you mentioned earlier, are you going to just file for a rider or will that have to be filed for in the context of a rate case?

What we've committed to date is the $120 million with regard to the low knox burners. If you look in the CAPEX table, Brian, that is spread over five years. It's not a big number in any individual year. I think our expectation is that we would complete those projects and then go seek recovery. It's something similar to what we're doing on the transmission as it relates to low knox burners. If we need to go down the path on scrubbers, I think that's a different animal.

Right.

Maybe just one more question on a long-term strategy. Just given where the stock is trading and implied value of Enogex is well below some of the other publicly traded comps, I'm wondering what your thoughts are on the longer term strategy to realize fair value for that subsidiary either as a part of OGE or maybe as a separate entity?

Brian, as we set out several years ago with the ArcLight transaction, one of the issues and objectives was to help improve the valuation we were getting at that time to be able to expand Enogex and invest in Enogex to a magnitude much higher than we had been able to do historically and minimize dilution to our consolidated shareholders while we continue to grow and expand the scale diversity and to lock in long-term growth for Enogex.

We feel that we're making great progress with the ArcLight partnership with the objectives we set forward. At the same time I think we've shown with ArcLight that we do keep an eye on creating value for shareholders. To the extent that we feel that we're not getting the value we need, we will do what we think we need to close the valuation gap. You know we do have a long-term focus, and I think we're excited, as Sean said and Keith, about this opportunity we have now with Chesapeake with the net 500,000 acres, to really execute and provide some long-term growth.

So we're moving in that direction, we're keeping an eye on valuation and we're committed if we need to do something to close that gap, we're going to close that gap. Directionally we haven't changed. We're just trying to position ourselves. You talk about MLP to improve our optionally, if you want to think about the way and position ourselves to be able to do that and if that's the right thing to do for our shareholders.

Okay. Thank you very much.

Sure.

Thank you. You have no more questions. I'll now turn the call over to Pete Delaney.

Thank you, operator. Thank you everyone for joining us this morning. In closing, I would like to say our management team remains very excited about the opportunity for us here at OGE Energy to continue to deliver great service to our customers and to build shareholder value and as always I want to recognize our members for their hard work, commitment, thoughtfulness, and capitalizing on those opportunities and executing our plans. I hope you all have a great day. Thank you all for joining us again this morning.

Thank you for your participation in today's conference call. That concludes the presentation. You may now disconnect.