歐尼克 (OKE) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the ONEOK second-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 introduce your host for today's conference, Mr. Weldon Watson. Please begin, sir.

Good morning and welcome. As we begin this morning's conference call, I'll 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's 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.

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

Thank you, Weldon. Good morning, everyone, and thank you for joining us to discuss our second-quarter results. We had a very good quarter, with net income for the quarter 40% higher than the second-quarter results one year ago. I am very proud of our employee group and the hard work they have accomplished during this very busy quarter.

As you know, on May 9th, we announced the acquisition of Koch's natural gas liquids businesses for about $1.35 billion. We successfully closed that acquisition on July 1st and will begin reporting results for a new natural gas liquids business segment for our next quarter.

We also announced that we plan to sell our production segment. If example successful, we expect that divestiture to be completed sometime in the third quarter.

We announced last week that the Administrative Law Judge at the Oklahoma Corporation Commission has recommended a rate increase of $58 million for Oklahoma Natural Gas Company. The case has been appealed to the three-person Commission, but in the meantime, rates were implemented last Thursday at the level recommended by the Administrative Law Judge. Sam Combs, President of ONEOK's distribution segment, will have more to say about that in a few moments.

During the quarter, several of our business segments saw some very positive results, driven primarily by higher commodity prices, volumes and margins. We will be making some adjustments in our Gathering and Processing segment as we start the new Natural Gas Liquids segment next quarter, and we will rename the Transportation and Storage segment to Pipelines and Storage because it will include some of the acquired natural gas liquids pipelines. Jim Kneale and John Gibson will have more to say about that later in the call.

The result of all of this activity is revised guidance. At this time, I would like to ask Jim Kneale, ONEOK's Executive Vice President and Chief Financial Officer, to review the financial highlights for the quarter and provide some detail on the changes and their effects on guidance. Jim?

Thank you, David, and good morning. As David mentioned, we had strong results in the second quarter. Net income was $24.9 million, or 23 cents per share, compared to 17.9 million, or $0.17, last year. For the six months, net income increased to $132.5 million compared to 122.9 million last year.

Earnings per share were flat at $1.20 per share due to additional shares used in the calculation, which resulted from an equity issuance in 2004 and the increased dilution from the mandatory convertible equity unit that issue in February of 2006. Also for the six months, cash flow from operations before changes in working capital was $262.7 million, which exceeded capital expenditures and dividends by $85.4 million.

In June, we issued $400 million of 10-year notes with a coupon of 5.2% and $400 million of 30-year notes with a coupon of 6%. Proceeds were used primarily to repay commercial paper borrowings. As of June 30th, our long-term debt was $2.3 billion. Using Moody's methodology, our capitalization ratio is 53% long-term debt and 47% equity.

On July 1st, we borrowed $1 billion under a short-term bridge financing facility and issued $351 million of commercial paper to finance the Koch acquisition. The current interest rate on the bridge financing is 3.92%.

We anticipate permanent financing of the acquisition to come from a combination of proceeds from the settlement of our mandatory convertible equity units in February, 2006, proceeds from the sale of certain assets and our free cash flow.

The last thing I want to cover is our revised 2005 earnings guidance. We anticipate that net earnings per share will be in a range of $2.56 to $2.62 per share, and we expect net income from continuing operations will be $1.92 to $1.98 per share.

This revision is a result of several factors that David already mentioned. First is the potential sale of our oil and gas production operations. Our revised guidance reflects this segment's 2005 operating results as discontinued operations. We also made some conservative assumptions about the potential gain on the sale, which is also reflected as discontinued operations.

Next is the acquisition of the natural gas liquids businesses from Koch and the related integration of those assets, which results in the creation of a new segment, Natural Gas Liquids, and some shifting of income between our existing segments. John Gibson will go into more detail on those revisions.

Another factor that impacted our guidance was the implementation of a $58 million increase in customer rates for Oklahoma Natural Gas on July 28th. As a result, we increased distribution operating income by $3.7 million, which brings the 2005 operating income impact from the rate increase to $21.7 million. However, this increase was partially offset by higher employee costs.

Last, we increased interest expense as a result of the long-term financing I mentioned earlier, higher levels of working capital, along with higher short-term interest rates and the financing of the acquisition of the Koch businesses. This was offset by a reduction in interest expense resulting from the use of proceeds from the production sale, which were used to reduce short-term debt.

David, that concludes my remarks.

Thanks, Jim. I will now turn the call over to John Gibson. John?

Thanks, David, and good morning. As you pointed out, the Gathering and Processing segment experienced another good quarter. High NGL, condensate and natural gas prices, as well as wider processing spreads, contributed to increased operating income. For the remainder of the year, it appears energy prices will remain strong. Processing margins are anticipated to decline from their current levels, as natural gas prices are forecasted to be higher than both crude and NGLs on a MMBtu basis. We do that the processing spread will remain above our five-year average of $1.78 per MMBtu.

We have renamed our Transportation and Storage segment Pipelines and Storage, to more accurately reflect the assets contained in the segment. This segment continues to produce consistent earnings and has experienced some modest growth through the renewal and addition of several gas transportation and storage contracts. During the second quarter, this segment also benefited from hotter weather, as our power plant customers transported more natural gas on our pipelines to their facilities.

We experienced a good first month with the Koch assets. Through the efforts of many, the transition from Koch to ONEOK is progressing smoothly. As stated in the earnings release, we expect the EBITDA contributions for the second half of this year to be in the 59 to $62 million range.

Also as indicated in the release, we are forming a new operating segment called Natural Gas Liquids. Its focus is to gather raw NGLs from gas plants and redeliver them as finished products to market for our customers, who are primarily gas processing plant owners. If the customers prefer, we will buy the raw NGLs and market the finished products through our own marketing efforts.

Some of the NGL gathering and distribution pipelines acquired from Koch are regulated by the FERC. We have chosen to place these FERC regulated assets into our Pipeline and Storage segment. This allows us to keep the commercial activities of those FERC regulated pipelines, together with the other parts of our company that are engaged in regulated transportation activity.

The remaining Koch gathering, fractionation and storage assets will be combined with our existing NGL business, which was formerly a part of our Gathering and Processing segment, to become the core of the new Natural Gas Liquids segment.

As indicated in our release, for 2005, we are projecting this new segment's operating income to be $43 million, $22 million associated with the assets acquired from Koch and $21 million from the legacy ONEOK NGL activity, which, for the most part, are derived from fee-based storage and transportation agreements.

With the addition of the FERC regulated natural gas liquids pipelines to the Pipelines and Storage segment, we estimate the 2005 operating income for this segment to be $65 million, 50 million from our legacy assets and 15 million from the Koch FERC regulated NGL pipes. Most of the earnings generated by this segment will be fee-based, with all of the Koch revenues generated through tariffs.

For the remainder of 2005, we anticipate operating income from Gathering and Processing to be $130 million, which is the previous guidance of 150 million, less the 21 million attributable to our legacy NGL activity, plus about $1.5 million from VESCO, the gas processing plant located near Venice, Louisiana, that was also acquired as part of the Koch acquisition.

In the second quarter, the Energy Services segment was affected by lower retail and trading margins. Most of the decline in retail margins is attributable to lower demand from irrigation customers due to a wetter than normal spring, primarily in Kansas. Our trading loss was due to rising gas prices relative to our gas price positions.

On the positive side, widening basis differentials, particularly in the Rockies and the midcontinent regions, more than covered our transportation costs. Our guidance for 2005 in Energy Services has not changed; it remains at $131 million.

For the remainder of the year, we are encouraged by several things in the Energy Services segment. The storage spreads have widened and now range from a low of $0.68 for the August to November timeframe to a high of $1.55 for the August to February time period.

Next, at the end of the quarter, of the 86 Bcf of storage we have at leased, we have about 59 Bcf of gas in inventory at a weighted average cost somewhat less than $6.20. Our current carrying cost of inventory is 1.8 cents per Mcf per month.

And finally for the year, we are projecting an increase in our demand revenues due to several new or renegotiated contracts. These are revenues paid by customers, such as local distribution companies, to provide them with a bundled natural gas service. These growing demand revenues are consistent with the segment's focus, which is to provide customers with the combination of physical supply, transportation, storage and risk management services.

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

Thanks, John. As I mentioned, I've asked Sam Combs to provide more detail on the Oklahoma rate case. Sam?

Thank you, David, and good morning. As it relates to our Distribution segment, we filed for a $99 million rate increase in Oklahoma in January of 2005. The administrative law judge issued an order recommending an increase of approximately $58 million. However, the full commission has yet to rule on the order.

The order is currently going through the appeals process, and the commissioners heard the appeal arguments on August 1st and agreed to take the issues under advisement. We hope to have a final order sometime within the next three to four weeks.

As statutorily allowed, Oklahoma Natural implemented the recommended $58 million rate increase on July 28th, subject to refund. While we were disappointed in the recommended return on equity, we were encouraged by the ALJ's decision to accept a new two-tier rate plan that offers customers greater choice and features a front-loaded rate design that should improve cash flow, a gas and storage rider that will allow a return on our annual storage investment, and an integrity management plan rider, which will allow for the faster recovery of costs related to federally mandated pipeline integrity rules. These represent concepts that we believe we can build on in the future.

In our Kansas operation, we are planning on filing for a rate increase in May of 2006, and we were very pleased by the Kansas Corporation Commission's recent decision to allow Kansas Gas Service to begin recovering the fuel-related portion of bad debts through our cost of gas rider. This should improve annual cash flows and earning prospects, and we estimate the impact on operating income to be 1.5 to $2 million on an annualized basis.

In Texas, we just received a $1 million cost of service adjustment for El Paso and are planning to file a rate case in several other jurisdictions prior to the end of 2005.

We will continue our efforts to improve returns by focusing on growth through extensions to new customers, retention of existing customers, system acquisitions and strategic investments in new technology and service-related infrastructure. Finally, we are ever mindful of our cost structure and committed to reducing cost while improving the quality of our service delivery system.

Thanks, Sam. before we take questions, I would like to thank the employees for their continued hard work and their contributions to these results. We are excited to add the natural gas liquids employees to that team, but it is difficult to begin a process to sell our production segment knowing that many of those employees will be leaving the team.

The decision to sell was a difficult one, but as I told the employees, I do believe it is the right decision for our shareholders. To their credit, they have stepped up to the challenge and I have the highest respect and appreciation for them.

At this point, we will open the call up to questions.

(OPERATOR INSTRUCTIONS) Kathleen (indiscernible) of W.H. Reeves.

Good morning, guys. I have a couple of questions. First of all, on the two-tier rates, how does that structure work exactly? And for the distribution system, what kind of growth in customers are you estimating for the year?

And what kind of aggregate operating income are you getting from Koch? You have broken it up in a number of segments, so either for the six months or what you expect for a year.

Then, what kind of ROE are you getting on the FERC regulated businesses, now that you have lumped them together? And what kind of free flow are you expecting annually? Sorry about this.

And I don't really understand why Gathering and Processing went from 150 to 130 on the new forecast. John Gibson mentioned that it was related to the legacy assets. Are you looking at selling those assets? I really just don't understand why those numbers are going down. Sorry for all the questions.

I was trying to keep count, Kathleen. I lost count.

I'm so sorry.

That is okay, not a problem. Let me address partially the last question and then I'll turn the rate case questions over to Sam and some of the other questions over to John.

As John described in his comments, part of what we are doing with this new segment is readjusting the business lines to segments where they better fit. And with the addition of the NGL, Natural Gas Liquids segment, we are going to pull out of the Gathering and Processing segment those activities that are more closely related to natural gas liquids. And so that segment now will include about $21 million worth of operating income on an annual basis that was previously carried in Gathering and Processing.

So they are not being sold; they are just being shifted to another segment?

Exactly.

Okay, okay.

Readjusting to more properly fit --.

Makes sense.

You'll also see the Transportation and Storage segment increase in terms of guidance. That is also reflective of the placing of those FERC regulated natural gas liquids pipelines into that segment.

Sure. That makes sense.

So with that, let me ask Sam to address the two-tier rates and the other question.

Okay, thanks.

Kathleen, what I heard was two questions for distribution, one related to the two-tier rate plan and the second about customer growth.

Yes.

The two-tier rate plan we believe is fairly innovative in that it offers customers two options. One, they can choose a plan that has -- Plan A, if you will -- that has a higher service charge accompanied by a lower delivery charge. And Plan B would offer a lower customer charge coupled with a higher delivery charge --.

One is more volume sensitive than the other.

Exactly.

Okay. I understand.

And then secondly, with respect to customer growth, we project in Oklahoma and Kansas our growth to be in the 1, 1.5% range; Texas it may get around 2%. But overall, we generally say for all three about 1 to 1.5% annual growth.

Sam, are you also seeing lower usage per customer?

We are experiencing the same phenomena that most LDCs across the country are seeing.

Thank you so much.

Sam, you might also quantify the first rate step in both of those rates.

The higher service charge is $20. And for the Plan B, if you will, that has a lower service charge, it is $9 compared to $6.50 previously.

All right, great.

The point I wanted to make there, Kathleen, is that the improved cash flow, by pushing more of the margin into the first rate step, is a benefit. And in either case, whether it is $9 or $20, that is a significant benefit from where we were.

It sounds like a lot more stable earnings flow then too.

That is right. Now let me turn the other questions over to John.

Thank you.

Kathleen, I think according to my tally, I've got one question I need to answer for you and that is combining all these pieces together to represent the earnings from the Koch assets --.

Yes, and what is the ROE on the FERC regulated group of business?

Let me go ahead and just share with you the earnings operating income. The natural gas liquids assets, which would be the gathering, the fractionators, the storage, those are going to be about $22 million of operating income for the remainder of the year, for the six months that we will be owning the assets. And as I mentioned in my comments, $15.5 million of operating income associated with the Koch distribution FERC regulated pipelines -- those are both distribution as well as a small amount of the gathering. And then the $1.5 million operating income associated with the VESCO gas processing plant located near Venice, Louisiana.

So 1.5 that goes into Gathering and Processing, 15.5 that goes into Pipelines and Storage, and 22 million in the Natural Gas Liquids segment. So the total number for the Koch assets for a half a year of operating income is $39 million.

And I'm sorry, I don't have the return on equity number with me.

We can provide that at a later point, Kathleen, if that is all right.

Great, that is perfect. Does Jim know the new forecast, what would that relate to on free cash flow on an annualized basis?

Kathleen, we projected initially when we announced the Koch acquisition that just that acquisition would increase our free cash flow by about $90 million a year. And if you look at our historical free cash flow -- I'm talking cash flow from operations over interest and dividends --- it has been in the $180 million range. So I think go-forward we are looking at something around 250 to $275 million.

Holy moly. Great, great, great. Thank you so much, guys. I appreciate your patience with all the questions.

Thank you, Kathleen.

Rebecca Followill of Howard Weil.

Hi. I have several questions. Not as many as Kathleen, but I do have several.

Good morning, Becky.

Good morning. On the LDC, can you talk about -- I'm surprised at the impact on the rate case is not greater -- and I don't remember the exact number -- I think you said around 3 to $4 million for the second half of the year. Why is it not higher? And I understand you are looking at filing some rate cases in other places. But with this rate case, what does it do to your ROE in Oklahoma? And once this one gets approved, what is the timing to file another one to pull that are ROE up to a more reasonable level?

Rebecca, this is Jim. I'll answer part of that and then maybe Sam wants to talk about the ROE. The impact of the rate case on 2005 from July 28 forward is about 21 -- I think it's $21.7 million. We already had in our forecast for the year an $18 million estimate of the rate case impact. It was included in that distribution guidance. So this settlement, or what looks like -- or this decision just increases that again 3.7 million to the 21.7.

Okay. And the ROE.

The ROE the ALJ recommended was 9.9%.

We had asked for a little over 11, Rebecca, and obviously, we are a little disappointed, as Sam indicated in his comments, with the recommended ROE level. There is, importantly, as a result of this case no moratorium. Candidly, we have not talked about the timing of when we might go back, but we do believe that we do have the opportunity to improve margins in this segment.

And I might mention the ROE is part of our appeal.

Okay. On the trading business, the loss for the quarter you said was related to the price of natural gas relative to your positions. Does that come back later in the year or is that just lost here? And is there upside in the second half of the year?

It is lost.

It is lost trading opportunities.

Are there similar hedges still in effect that we could see losses in the second half of the year then?

No.

Okay. And then finally on the E&P, you talked about built into your gain is $2 an M. Does that mean you have you are fairly close to a transaction or you're just looking at comparative transactions. How do you get to the $2 an M?

No, we do not have a transaction in the pocket. We will begin the process very soon. Jim and I talk about how we should reflect the results from that segment in terms of the year-end guidance. Between us, we concluded that looking at a number of transactions we've seen, that $2 for in-the-ground reserves was a fairly conservative number.

And so in order to provide some range for you all as analysts and shareholders, we chose to use the $2 as an estimate. The actual results, of course, will depend upon the results of the sale.

One last one. Are you guys going to give restated numbers for prior periods so that we can look on a comparative basis this new breakout of numbers, or just on a go-forward basis, that is how it is?

When we file our 10 Quarter -- the first time we -- I assume you are talking about Koch. And when we file our third quarter Q, the comparative quarters and year-to-date information will be reflective of -- I guess we'd call it restated. There will be pro forma information in the Q to get you back to those numbers.

Okay, thank you.

Mike Heim of A.G. Edwards.

Good morning. I will continue the trend of getting fewer and fewer questions and just ask one. Just want to run through the math on the new Natural Gas Liquids division. If I remember right, the Koch acquisition was approximately 140 million in EBITDA, or 70 million for a half a year. And we're saying there's about 20 million in depreciation. So talking operating income of roughly 50 million for half a year?

To that, we add 21 million from the Gathering and Processing and take away 15 million that goes to the Pipe and Storage. That would leave me with a number more like 56 instead of the 43. Where am I missing something?

I think first, the annualized basis you are thinking about is our '06 estimate. Because -- and John can get into more detail -- there is a number of contracts that have been restructured, there is some new volume's been added to that system, some that start later this year but more that start in early '06. So in our press release, we estimated the EBITDA for the second half of '05 to be 59 to 62. And then, as you said, we estimated a half year's depreciation would be 20 million. So that gets you kind of into that 39 to $42 million EBIT range.

And I think we took -- I can't remember John's numbers -- how much of that is in each segment, but it should come up to that 39 to 42 million.

Mike, the important takeaway is that the numbers you started with were based upon the '06 numbers.

That makes sense, if I use the 59 to 62 million, that gets made a lot closer to the 43 million.

Right.

All right, thank you.

(OPERATOR INSTRUCTIONS) Sam Brothwell of Wachovia.

Hi, can you hear me?

Yes, we can, Sam. Good morning.

Sorry -- I have to use the speaker phone; I can't get this thing to switch over to the handset. Eight years at another firm, I've got to learn a new phone. On the planned sale, can you give us any color on your assumptions with respect to your guidance this year and next and your thoughts about next year with respect to the timing of that?

And you indicated, as was discussed earlier, $2 an M and a base of 228 Bcf. Can you give us some thoughts on the tax ramifications of that and the timing that you take into your guidance with respect to applying those proceeds to the debt that you took on?

I'll start by saying that we expect the process to conclude by the end of the third quarter. We have timelines in place we believe that are reasonable that can get us to a close on or before the end of the third quarter.

With respect to the other parts of your question, I'll let Jim take that.

Sam, this is Jim. Just to your question, you know the 228 Bcfe are crude reserves at December 31st. And I guess one point when David said we tried to be -- we think we are being conservative on our gain estimate, because you noticed in the attachment to the press release, at the end of this quarter proved reserves are now about 233, 234 Bcfe, and that doesn't include the possible and probables.

Now, that said, we expect our tax basis in those assets is about $314 million. So we factored in the proceeds from the sale, net of taxes, paying off short-term debt effective September 30th. Did I answer your question?

Yes, you did. Thank you.

Thanks, Sam.

Nicholas (indiscernible) of Ritchie Capital Management.

Good morning, guys. I just had a quick question on your February 2006, your mandatory convertibles. Can you elaborate what you meant by settlements on those?

Jim.

Those are mandatorily convertible equity units that we issued in February of 2003. So the holders of those in February of '06 -- I mean, we will remarket some debt behind those in November, that funds get placed in a trust and then the holders of the per equity purchase contract will effectively turn that in, along with the Note, and receive a share of ONEOK stock -- actually, it's a little more than a share because they were $25 units. But they will receive from stock from ONEOK and we'll receive $402 million worth of cash.

Okay, thank you.

Thank you.

(OPERATOR INSTRUCTIONS) It appears there are no more questions at this time.

This concludes ONEOK's second-quarter 2005 conference call. As a reminder, our quiet period for the third quarter will start when we close our books in early October, 2005, and will extend until our earnings are released. We will provide a reporting date with conference call information for third-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 today and good day.

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