歐尼克 (OKE) 2005 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the ONEOK first-quarter 2005 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. I would now like to your host for today's conference, Mr. Weldon Watson.

Good morning and welcome. As we begin this morning's conference call, I remind you that any statements that might include Company expectations or predictions should be considered forward-looking statements and as such are covered by the Safe Harbor provision of the Securities Acts of 1933 and 1934. It is important to note that actual results could differ materially from those projected in such forward-looking statements. For a discussion of factors that could cause actual results to differ, please refer to the MD&A sections of ONEOK's filings with the Securities and Exchange Commission.

And now David Kyle, ONEOK's Chairman, President, and CEO, will moderate this morning's conference call.

Thank you, Weldon. Good morning, everyone, and thank you for joining us to discuss ONEOK's first-quarter results. We had a strong quarter, with our net income for the quarter higher than the first quarter of last year. Our production segment delivered stronger results this quarter compared with last quarter based on the higher prices we experienced for both natural gas and oil. While we are seeing stronger pricing, rig availability and other well services are in high demand and may affect our ability to add volumes over the course of the year.

I am pleased to report, however, that during the quarter we also completed several successful wells and anticipate that production from those wells will have a positive impact on production volumes for the remainder of the year.

ONEOK's Gathering and Processing segment continued to do well during the first quarter, again largely due to wider processing spreads and a favorable commodity pricing environment. The Translation and Storage segment continued its consistent earnings stream during the quarter, while Energy Services experienced a decrease for the first quarter, mostly resulting from lower intramonth price volatility, lower spreads, and reduced overall sales from inventory because of warmer weather.

John Gibson is here and in a few moments I will ask him to expand the discussion on both the Gathering and Processing and the Energy Services segments.

Our Distribution segment experienced a decrease during the quarter compared last year, again primarily because of warmer weather and increased labor and benefit costs. As you know, Oklahoma Natural Gas Company filed a $99.4 million rate increase at the beginning of the quarter, which included a $10.7 million interim increase granted last year. Again, we expect to get a decision by the Oklahoma Corporation Commission in July of this year and are currently going through the discovery phase of the case with the Commission staff, the Attorney General's office, and the few interveners. Our expectation, consistent with past practice at the Commission, is that the issues will be fully and fairly vetted and that the process will conclude in a timely but reasonable fashion.

As has been our practice, we revisit each quarter our published guidance, and once again, we reaffirm our earnings guidance for the year in the range of $2.22 to $2.28 per diluted share of common stock. The individual components may move up or down, and I want to remind you that this does not include earnings from potential trading opportunities within the Energy Services segment.

I am also pleased to remind you that during this quarter, the Board of Directors increased the dividend by 12% to $1.12 per diluted share or $0.28 per quarter. This will bring our payout near the 50% level and raise our yield to about 3.8%. We also repurchased about 2.1 million shares during the quarter, and you will recall that the Board approved a 7.5 million share repurchase earlier this year.

While this is not the conference call to discuss the specifics of Northern Border partners, we have received a number of questions regarding the potential sale of one of the assets to the partnership. To begin, let me remind everyone that we purchased our interest in the general partner last fall and have been very focused on the many transition issues since then. That is not to say that we have been idle on other fronts. While we have been working and expect to continue to work with the leadership at Northern Border to identify acquisition opportunities for the partnership, those may include certain ONEOK assets, such as transportation and/or storage assets. I do want to emphasize that remain very excited about the potential for the partnership.

At this time, I would like to call upon Jim Kneale, Executive Vice President and Chief Financial Officer, to review some of the financial highlights for the first quarter.

Thank you, David, and good morning. For the first quarter, our net income increased to $107.7 million from last year's $105.2 million. Earnings per share were $0.97, which is $0.01 over our quarterly guidance of $0.96. That compares to $1.04 last year. This quarter had about 10 million more shares included in the fully diluted earnings per share calculation, which caused the decrease in reported earnings per share. As the ONEOK stock price has continued to increase, the dilution from the equity units, which will convert to common stock in February of 2006, increased to 6.3 million shares. The remainder of the share dilution resulted primarily from the equity issuance during the first quarter of 2003.

Although David already covered the business segments, the one thing I would add is that we recorded $2.5 million in other income, not operating income, related to our ownership in Northern Border Partners. About 65% of that amount is related to the general partner incentive distribution, which is tied to the cash distribution made by Northern Border. The other 35% is related to the equity pickup of our share of their net income.

For the quarter, our cash flow from operations before changes in working capital was 179 million, which exceeded capital expenditures and dividends by $94 million. Although higher oil and gas prices and the cost of carrying more gas in storage from the winter are putting pressure on our working capital, our cash flows continue to be strong. Within the last five months, we issued $574 million of commercial paper to acquire our interest in Northern Border, retire a 7 3/4% long-term debt issue and acquire stock under our repurchase plan.

In addition to that $574 million, we still have $300 million of natural gas and natural gas liquids in storage. Although those total $874 million, at March 31, we only have $653 million of net commercial paper outstanding.

During the quarter, based on the change in short-term interest rates and forecast of future levels, we have terminated floating interest rate swaps on 400 million of our long-term debt and paid $19.4 million. This amount will be offset against a termination gain we recorded last year that is being amortized as of reduction in interest expense over the next several years. We still have $340 million of long-term debt with an average fixed rate of 6.44% swap to floating. Including commercial paper, approximately 46% of our debt has floating rates.

Our debt to equity ratio at March 31, including commercial paper, net of natural gas and NGLs in storage, is 55% debt and 45% equity. Using the Moody's methodology of treating 75% of the equity units as equity, we are 46% debt.

David mentioned that we reaffirmed our 2005 earnings guidance, but noted that the individual components may move around. We have not adjusted our guidance for the impact of the 2.1 million shares repurchased. Because of the timing of these purchases, they had minimal impact on the first quarter; however, they will positively impact future quarters. Potentially offsetting some of that impact are higher interest rates and the carrying costs related to working capital.

David also mentioned that as a result of warmer weather in the first quarter, the margins from our Physical Marketing business and Energy Services were down. Consequently, we lowered the annualized estimate for the Physical Marketing business from $131 million to $123 million. However, we left the yearly estimate for Energy Services at 131 million because of the $7.8 million in trading margins that we generated in the first quarter.

David, that concludes my remarks.

Thanks, Jim. Also joining us this morning are John Gibson, who is President of ONEOK Energy Companies, and Sam Combs, President, ONEOK Distribution. Let me to call over to John for a few comments and then we will be available for questions.

Thanks, David. The Gathering and Processing segment experienced another good quarter. Higher natural gas liquids, condensate, and natural gas prices resulted in an increase in operating income, which were primarily recognized through our percent of proceeds contracts. Wider processing spreads contributed to increased margins through our keep whole contracts.

Within our NGL Marketing effort, the addition of several new NGLs storage and transportation agreements also contributed to the segment's increased operating income.

Industry pricing projections seem to all point to continued strong pricing as well as attractive processing spreads for the balance of this year. As shown in our release, we continued to hedge some of our percent of proceeds production for the balance of 2005 and have hedged some of our 2006 volumes through the use of costless collars. Our reasoning is not that we believe pricing has significant downside risk, as much as we see this as an opportunity to lock in attractive prices and margins, helping us reduce the volatility of the segment's earnings.

I would like to also point out that in the release we again have provided data in two tables, margin information and information at a glance, which when used with the formula available on our Website, enables you to estimate the margin generated from our Keep Whole percent of proceeds and fee-based contracts. Again, keep in mind that these are estimates and the actual margins can be affected by operating mode, producer elections, and our hedging activities.

The Energy Services segment was affected by decreased storage activity. Heating degree days, one measure of demand, were some 4.5% lower across the United States and almost 12% lower in our core market area of Texas, Oklahoma, Kansas, and Nebraska. That means less demand for gas and, correspondingly, lower sales for storage. Also margins from storage spreads, or the relative value of gas from one period of time to another, were lower, due in part to lower natural gas price volatility.

Offsetting these lower-than-expected margins was an increase in our transportation margins, primarily due to an increase in the basis between the Rocky Mountains and the midcontinent, where we have about 300 million cubic feet per day of transportation capacity under lease.

Compared to the same quarter last year, we had approximately 7 Bcf more gas in storage due to decreased demand, due to the previously mentioned warmer weather. At the end of the quarter, we had 40 billion cubic feet of storage in the ground as compared to the 87 Bcf we have under lease. And our weighted average cost of inventory as of March 31 of this year was in the neighborhood of something south of $6.20.

Current pricing projections confirm the value of maintaining our storage position with the current May to winter spreads ranging from $0.75 to $1.35. As of the quarter's end, we had approximately 52 Bcf of inventory hedged at an average spread of $0.54. These hedges were put into place in the prior year to help offset our storage costs and also at a time when spreads were significantly lower. We still have the ability to cycle most of our storage to capture incremental margins as well as capture the value of our unused or open storage capacity.

On a more positive note, our sales volumes increased approximately 15%, a historic level for the segment. This is primarily due to the addition of term contracts, such as the previously announced People's agreement and other sales from our Canadian operation. Also, the new capacity we have out of the Rockies on Cheyenne Plains Pipeline has given us access to additional gas supplies, which we have moved into our core Midwest markets.

Within Energy Services, we have spent time fine-tuning our existing strategies while looking for opportunities where we can solidify our existing business and profitably expand. We remain focused on enhancing our ability to combine physical supply with Transportation and Storage to meet the needs of our customers and produce significant margins for the segment.

Thank you all for your continued interest in ONEOK. And David, that concludes my remarks.

Thanks, John, and at this point, we are ready for questions.

(OPERATOR INSTRUCTIONS) (indiscernible) from W.H. Reed (ph).

Good morning. First of all, thanks for the dividend increase. It was wonderful.

I was wondering if you could talk to me -- maybe John could -- about the carrying costs of storage. You have clearly made the decision to carry some storage over for next winter's season. Do you know what the unit cost of making that decision was and what kind of margin differential you're looking at that would justify carrying storage over? I'm just trying to understand the economics.

This is John. Let me try to answer that question. The economics for us boil down to decision of whether or not we would monetize those dollars now or whether we would see an opportunity to continue to carry the inventory and monetize it against a sale in the future. When you look at what the market was telling you, the market was telling you you could buy cheaper supply now and in the first quarter, put it into inventory, and the opportunity exists in the future to sell those at greater value.

So what we do is we look for two things. One is we look for those opportunities to sell current inventory against future sales, and by future, say, winter sales. But we also look to monetize in the near-term, where we sell gas into the next month or maybe a couple months forward and then turn around and look for another buying opportunity to put more gas in the inventory and then apply that to a winter sale.

I understand the theory, John, but I was wondering if you could give us some idea of what the specifics might be -- what kind of spreads you're looking at, what kind of carrying costs you're contemplating. I'm just trying to get a sense of what the current market dynamics look like. Am I making any sense to you at all?

Kathleen, let me see if I can -- you know, a lot of the storage costs are sub (ph) costs, if you will. And so you really only have a cost for going in and then coming out. In terms of the carrying cost, basically it's a cost of capital kind of carrying cost, the time value of money between spring and winter, whenever you may take it out.

So, David, would you say that's like less than a penny, $0.05, $0.02? And what can of margins are you looking at in the future that gave you an idea to keep gas in storage? I'm trying to get some quantification.

I think a rough number -- John, do you have a rough number?

I would say it is something less than $0.02 per Mcf per month.

So it $0.02 per Mcf per month for carrying cost? And what kind of spread do you see between now and next winter, if you could take the gas you now have and sell it into the winter?

Again, probably anywhere between $0.75 and $1.35.

Depending upon which month you took it out.

Sure. And that would compare to what kind of spread would you get if you sold it into the current market? What is the differential between the $0.75 and $1.35 to the current market? That would be much less, correct?

It would be much less, maybe $0.15 or $0.20.

Excellent. Thank you so much.

Kathleen, what the market is telling us is that where you were incentivized to put gas in, now build inventories and sell (indiscernible).

I can see that. If you only have $0.02 a month carrying cost, with that kind of spread versus what you could do now, it makes a lot of sense. Thank you so much.

Mike Heim from A.G. Edwards.

Can I get you to repeat some of the segment changes in your forecast? It went a little quick for me.

Yes. Mike, what I was talking about was specifically in Energy Services, we left our guidance at $131 million, but what we did was we lowered -- when we gave the guidance, that $131 million was our forecast of what the physical business would produce. Well, with the warmer weather, we came up short a little bit in the first quarter in the physical business, but fortunately, we had some about $7.8 million of trading margins. So we still believe we're going to be at 131 million by the end of the year, but instead of it all being physical, it is going to be about 123 million physical and that $8 million from trading that we recognized in the first quarter.

So roughly an 8 million shortfall in the physical. And again, you're not including any trading going forward, just what you have accomplished in the first quarter.

That is correct, Mike.

Were there changes to the other segments?

No, there were not any changes to the other segments. David mentioned that we saw some very good drilling results in the Production unit late in the first quarter, and those potentially could increase those volumes somewhat. I mentioned that we had bought back 2.1 million shares of stock. We had not factored that in our forecast. On an annual basis, after the carrying cost of that stock, if we had bought back January 1, that would add maybe $0.03 a share to earnings. But then what I said on the flip side, you have higher interest costs and maybe higher working capital, so net-net-net we still feel like we are in our range that we have given for guidance. There's just a lot of pieces moving in the middle.

Is somebody there prepared to address some of the concerns at Northern Borders, specifically the unsold capacity concerns they talked about a couple weeks ago?

Mike, I will tell you I serve on management committee, policy committee for the partnership, and my preference really is to let Bill Cordes, who is CEO, to let him address those. I think their call is scheduled next week, and I know they have had a number of calls and a number of inquiries. But I would really prefer to let you deal with Bill on that.

Okay, that's fine. And finally, not looking for specifics here, but just in a general sense, can you talk about what the environment for acquisitions is? Is there a hidden read we could make that the raising of the dividend and the buying back shares is a sign that we are not seeing as good an acquisition environment as we would like?

No, I don't think that should be an inference that you should draw. As we looked at our yield, as we looked at our payout, and all of the factors relative to our aggregate peer group, the Board concluded that it would be appropriate obviously to increase the dividend.

As you know, there are demands on capital. Dividends is one of those. You can repurchase shares and we're doing some of that. Or you can, as I have said many times, you can use your capital to go add to your earnings base by acquiring assets that fit your strategic footprint. We're seeing a lot of activity out there. Primarily, obviously, the producing segment continues to have a high amount of activity. I will tell you that we are not very actively involved in that activity currently, but there is a fair amount of activity in the midstream segment, what we would call the Gathering and Processing part of our business and then attendant pipeline type projects.

You have seen recent announcements with some major transactions over the last quarter and the previous quarter, and I think that trend continues. So I would not necessarily jump to the conclusion that we have concluded that we are out of the acquisition market. We just believe that we are taking sort of a three-pronged approach to it -- dividend return, return through repurchase, and then continued acquisition opportunity.

Okay, very good. That's my questions.

(OPERATOR INSTRUCTIONS) Devin Geoghegan from Zimmer Lucas Partners.

I appreciate the time this morning. Just a couple of quick questions. I forget -- I'm sure I have been told before -- when you talk about hedges that are basis adjusted, is that to get it back to NYMEX equivalent or is that net to the wellhead? I just forget.

Devin, this is Jim. The hedging information that we are disclosing is the price net to ONEOK. So for instance for the Production segment, we use the NYMEX strip to put them on but then we adjust this for the basis that we would realize -- incur, I guess.

So the hedges are net to the well after transport fees and the basis fee?

Yes.

That's helpful. And just that you mentioned a formula for your Gathering and Processing business online. Was that separate from the press release or --?

Devin, this is John. It was in the press release, maybe in the last quarter meeting. We put it on the Website, on the ONEOK website.

It should be in the attendant presentation materials on the Website.

I will look for that. Thank you very much. I appreciate it.

If you can't find it, give Weldon a holler, will you?

I appreciate it. Thank you.

Yves Siegel from Wachovia.

Good morning. A couple of questions. And first is, in terms of the trading profits, in the Energy Services business, can you just speak about the environment in Q1 that presented the opportunity to make $8 million? And I know it is not in your guidance, but how should we think about the opportunity going forward throughout the year?

This is John. Primarily it was activities to capture changes in volatility that occurred within the quarter, where there might be a small uptick in pricing followed by a drop. And they capture that primarily through the use of options.

Is it unreasonable for me to think that you want to have some trading profits going forward?

I don't think that is unreasonable for you to think that.

Let me -- I know that this has been a point of concern, and as we have said many times, it is very difficult to predict margins from trading. And because of that, we have concluded that it is best for us in terms of our guidance to not include those on a prospective basis. We believe that the market from time to time will give us opportunities to capture some of that inefficiency that occurs in pricing. And the primary tool that we use is this option strategy. As John said, I think it is reasonable to assume that there will be those opportunities prospectively. We just have not included those in our guidance.

Thanks. And just to turn to the Gathering and Processing side, John, where are you in terms of the contract renegotiations?

We're still actively engaged in them. We have several what I will call key contracts under negotiation right now with two big producers and they are (ph) both set to expire by natural terms and we look to roll those over. But we continue to make more than satisfactory progress in our renegotiations. We have got our portfolio about where we think it needs to be, particularly given that we are now about 27% of our volume in our Keep Whole with conditioning language and that continues to work its way up and really played into the marketplace here recently, fortunately.

But we continue to improve and increase our fees as we have an opportunity to renegotiate a contract when it expires. So I would say that we are in a maintenance mode on renegotiating our contracts and increasing margin, with the exception of these two larger contracts that we are working on.

Let me emphasize a point I think that John was making there, and that is that we have a mix among those three basically types of contracts and we are pretty pleased with where that mix is. It gives us obviously upside potential when prices run. It also gives us potential when there are increases in spread, and it gives us some comfort when those turn the opposite direction when we have a fair amount under fee. So we are pretty pleased with the mix where we are. Obviously, when John said he is happy with the portfolio, they are always looking to add volumes and bring additional volumes to the plants.

David, thanks. Can I just push on here, too? In terms of the competitive landscape and I think in the prepared remarks, John, you might have spoken about -- or maybe David you did -- the acquisition activity in this segment. How has the competitive landscape perhaps impacted your business, number one? Number two, as you look at the Gathering and Processing segment and you look at the Transportation and Storage segment and you think about Northern Border and you think about how you have hedged and have done such a good job in terms of providing a nice underpinning of cash flow, try to tie all that together, how should we think about the appropriateness of these assets in an MLP? And how should we think about transactions in this sector that are going for maybe ten times EBITDA? So it's a long-winded way of me asking the question of what is the competitive landscape given the sale or the transfer of assets, number one? And number two, what is the appropriateness of these assets going into an MLP?

Let me take it from sort of a 10,000-foot level and say that I think the competitive environment for gathering and processing assets is hotter than I think I have ever seen it. Candidly, that challenges us to examine the assets that we own and those that we may have attraction for to determine whether or not it makes sense for us to continue to hold or whether it makes sense for us to reap some of that benefit and redeploy that cash in other alternatives. We continually go through that process.

A lot of the new entrants into the market are, as you know, the MLPs, and they are having to adding to their portfolios with gathering and processing type assets. As we have visited with the management at Northern Border, we have concluded that while we do have some commodity sensitive assets within the partnership, as we look at ONEOK, the assets that we own that we believe best fit -- if we choose to do so -- that best fit within that partnership, as I said, are the transportation and/or storage assets.

We obviously have not announced the deal, and as I indicated in my prepared remarks, that is something we may do prospectively. But we have owned this GP for six months and we have been pretty busy on transition and also looking at potential deals. We think that there is going to be opportunities to grow both sides of the equation, if you will, to grow within ONEOK and to grow within the partnership. Having that partnership capital tool available to us, I think, will give us an opportunity to remain competitive with other players in this market.

So that is about the 10,000-foot level. I think I will let John speaks to the competitiveness and the geographic footprint and what we see going on. I can tell you that we get calls frequently for gathering systems, processing plants, and the combination. So, John?

One of the things we have talked about, one of our key strategies in G&P has been through backyard acquisition. We are always looking for opportunities where we can acquire more gathering systems and plants to either add supply or shut down capacity. And so what is occurring is this activity that David refers to -- and I agree with David -- I have never seen this much activity in the G&P segment as it relates to the changing hands of assets -- so we look at these opportunities.

For us, it is a way for us to enhance our competitive position, but it is very competitive and there are a lot of people out there looking at assets on the buy side. So it is a very competitive landscape from the standpoint of assets in play, deal flow, and we try to look at everything that makes sense for us in our core area.

John, what about trying to go after production and just hooking up new wells? Is it becoming more difficult or is that an issue at all right now?

It depends. And it is more a function of where the new production is relative to your assets and whether or not that new production is under a contract with you -- is dedicated to you under a contract. When I mean by that is a producer can drill a well, and if the gas is not dedicated to anybody, in most cases it's a very competitive landscape. And so that producer may have two, three, maybe even more options to look at from the standpoint of gathering and processing.

But if when you negotiate your contracts, you enter into a lease dedication or an area dedication where you have a right, a first look if you will, a first option to connect a well if it is within so many miles of your existing system, that gas is dedicated to you. Over the last four years, as we have looked at our contract mix, that's one of the things that we have been trying to get, is more acreage dedication. So to the extent you can get that, you have an advantage.

The second advantage of course is that you have systems where the new production is. In Oklahoma, where we are located, which is central and the southern part of Oklahoma, we have got some great producers -- all of our producers are great -- but I should say we have had very successful producers in finding new wells in Arbuckle, and we have actually experienced growth and we are close to capacity in Oklahoma.

In Texas, there continues to be a lot of activity, but the size of the wells coming onstream relative to the decline we are experiencing from the existing wells is not keeping that area flat. And the same is true for Kansas. So we feel like the key to the G&P business is supplies, supply or die, and our supply group has been doing an outstanding job connecting new wells. To the extent we can get favorable contract language that gets us acreage dedication, we definitely have an advantage.

Thank you.

There are no further questions at this time.

This concludes ONEOK's first-quarter 2005 conference call. As a reminder, our quiet period for the second quarter will start when we close our books in early July, 2005 and will extend until earnings are released. We will provide a reporting date and conference call information for second-quarter results at a later date.

This is Weldon Watson, and I will be available throughout the day for follow-up questions. You may contact me at 918-588-7158 or through e-mail at wwatson@ONEOK.com. On behalf of the Company, thank you for joining us and good day.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect.