歐尼克 (OKE) 2005 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the ONEOK, Inc. Third Quarter 2005 Earnings Audio Conference Call.

[Operator Instructions].

I would now like to introduce your host for today's conference, Mr. Dan Harrison. Mr. Harrison, you may begin.

Thank you. Good morning, and welcome everyone. As we begin this morning's conference call, I want to 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 Act of 1933 and 1934. It's also 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 I'd like to turn it over to David Kyle, ONEOK's Chairman, President and CEO. David.

Thank you Dan, and welcome to you -- to your first conference call. Good morning everyone, and thank you for joining us to discuss our third quarter results. We had a very busy quarter. This is our first quarter with our new natural gas liquids segment. We closed on the sale of our production assets and announced the sale of the Texas gathering and processing assets and our Spring Creek power generation asset.

And in addition to that activity each of our operating units turned in a strong performance. All of our businesses improved in the quarter. Gas processing spreads positively affected our gathering processing segment, and our energy services segment posted gains related to increased natural gas marketing and storage activity, and from wider transportation and storage basis spreads.

The new natural gas liquid segments results were right in line with our expectations when we bought the business back in July. And as you will hear in a moment from John Gibson, President of our Energy Company, we continue to see additional opportunities with that business. In addition, he will talk in more detail about each of these business segments including the pipelines and storage business.

Our distribution segments performance improved as well, primarily because of the implementation of new rates in Oklahoma. You will recall we implemented the new rates in late July, as we were allowed to do by statute. And the Oklahoma Corporation Commission issued a final order in early October. Sam Combs, President of our Distribution Companies will talk more about that later, as well as additional activities for his segment.

We also updated our 2005 guidance and issued preliminary 2006 guidance a week and a half ago. Jim Kneale, our Executive Vice President and Chief Financial Officer will explain our guidance for the next year was intended to provide some clarity around the changes from our announced transactions, and will be further refined as we progress. At this time, let me ask Jim to highlight the third quarter financial results and other financial items. Jim?

Thank you David, and good morning everyone. David mentioned that we had very positive results for the third quarter. Our net income was $1.70 per diluted share compared with $0.19 last year. Our earnings from continuing operations were up over 200% to $52.7 million or $0.49 per diluted share. Our free cash flow remains strong. For the nine months cash flow from continuing operations before changes in working capital, exceeded capital expenditures and dividends by $137 million.

On October 21st we issued a press release that updated our 2005 guidance. It takes into account our strong performance, the sale of our production business, the anticipated closing on the sale of our Texas gathering and processing assets in December of this year, and the impairment of the Spring Creek Power Plant as a result of that pending sale. We also issued preliminary 2006 guidance. For 2005 we estimated net earnings to be in the range of $4.92 to $4.96 a share, and earnings per share from continuing operations to be in the range of $3.59 to $3.63. Both include the gain on the sale of the Texas gathering and processing assets.

Our preliminary 2006 earnings guidance is a range of $1.97 to $2.03 per share. It reflects our current view of 2006, and includes a full year results from the natural gas liquid assets we acquired in July 2005, a full year of the margins from the recent rate case in Oklahoma, conversion of the equity units in February 2006 and estimated increase in employee benefit costs. It does not include any margin for trading activities in the energy services segment.

Both 2005 and 2006 guidance, treat the proceeds from the sale of the Texas gathering and processing assets as being used to reduce short-term debt. However, we do have other potential uses which include purchasing assets or re-repurchasing ONEOK shares, either of which would increase earnings per share for 2006.

During the quarter Moody's reduced our credit rating to BAA-2 from BAA-1, and last week Standard & Poor's reduced our rating one notch to BBB from BBB+. Obviously, we're disappointed with those actions. We sold some of our production business and some of our gathering and processing assets, both of which the rating agencies considered high business risk. We replaced them with steady earning primarily fee-based assets. The transactions improve our earnings and cash flow stability, so I'm sure you can see why we're disappointed with those outcomes.

Also during the quarter we increased our short-term liquidity in view of higher natural gas prices and their potential impact on our working capital. We exercised the accordion feature in our five-year credit agreement to increase the facility $200 million up to $1.2 billion. At September 30th, we had $900 million outstanding under our bridge financing facility used to purchase the natural gas liquid assets in July. We also had $385 million of letters of credit and commercial paper issued net of cash on hand under our $1.2 billion five year facility. At the same time, we had $880 million of natural gas and natural gas liquids in storage.

The last item I want to mention is that we began re-marketing the senior note component of the February 2003 equity unit offering earlier this week. Ultimately, on February 16, 2006, we will receive proceeds from the re-marketing of approximately $402.5 million, we will continue to have $402.5 million of senior debt due February 2008 outstanding, and we will issue ONEOK common stock currently estimated to be 19.5 million shares; 6.9 million of those shares are already reflected in the calculation of our 2005 earnings per share guidance. David, that concludes my remarks.

Thanks Jim. Now we'll turn the call over to John Gibson who will discuss our energy company's performance. John.

Thanks David and good morning. We're very pleased with the financial results of our new segment, natural gas liquids, which was created at the time we purchase the natural gas liquids assets from Koch on July 1. We anticipate that at year end this segment will contribute $43 million of operating income which for a large part, is derived from fee-based arrangements.

We continue to search for and connect new NGL supplies to our system. Increased drilling activity has resulted in the need for new gas processing plants, as well as increased production of incremental NGL supplies from existing plants. The 15,000 barrels a day of incremental NGLs anticipated prior to the acquisition are now flowing, and we are in negotiations with several plant operators which could add as much as another 20,000 barrels per day to our system during 2006, which have not been reflected in our 2006 guidance.

During the third quarter, the natural gas liquid segment did experience some lost revenue, less than $100,000 due to the shutdown of our Texas Gulf Coast fractionator MB1 which was out of service for a few days due to Hurricane Rita. However, these lost revenues were more than offset by gains from our optimization efforts along with increased margins from our isomerization operations. Our volumes, margins and costs continue to track closely with our projections and we remain confident in our 2006 operating income guidance for this segment of $93 million.

Our gathering and processing segment posted another solid quarter. Continued higher prices for natural gas, condensate and natural gas liquids have worked favorably to increase gross margins on our percent of proceeds contracts. We also saw wider processing spreads on our keep-whole contracts. The increases in gross margin would have been even higher if it were not for the affects of hedging, as well as the affects of natural production declines and contract expirations that lowered volumes.

For the remainder of 2005 energy prices are expected to remain at these high levels, but processing spreads are expected to weaken to the three year average of $1.78 per MMBtu level due primarily to higher natural has prices in comparison with the natural gas liquid equivalents. Based on current market pricing the $1.78 per MMBtu three year average processing margin and excluding earnings from our Texas assets, we estimate operating income for 2006 to be $88 million.

As part of our Koch acquisition, we obtained a 10.2% interest in the Venice Energy Services Company or VESCO a processing complex located near Venice, Louisiana. That facility took a direct hit from Hurricane Katrina and is currently out of service. The operator Targa is taking the steps necessary to return it to service, which we now understand will be phased in starting in mid-February and fully operational by late May of 2006. Obviously we are earning no revenue from this entity and will not do until it returns to service. However, the impact on our operating income is minimal.

We expect to close on our sale of our Texas gathering and processing assets in December. As we have previously stated, we consider these assets less strategic. Compared with our remaining gathering and processing assets, the Texas assets have the least amount of synergies with our other ONEOK entities. Furthermore, the Texas assets represent our smallest region in terms of natural gas throughput, NGL production and margin. The sale also provides us an opportunity to reconfigure our contract mix which in turn will serve to better stabilize the segments earnings. The Texas assets represent our greatest exposure to keep-whole contracts without conditioning language.

We believe the sale combined with our acquisition of the Koch natural gas liquids assets will result in more stable earnings in the future. Selling the Texas assets does not diminish our commitment to our gathering and processing segment. We will continue to look for opportunities to expand this segment when the timing and strategic opportunity is right.

Our pipeline and storage segment continues to be a steady performer enhanced by the new natural gas liquids assets acquired from Koch. For year-end 2005, we estimate operating income for this segment to be $75 million. Operating income growth for the quarter was due to the addition of the Koch assets, and an increase in throughput on our natural gas pipelines, primarily as a result of the greater natural gas demand from power plants due to warmer weather experienced over the quarter.

Throughput on our liquids pipelines was down relative to forecast, due primarily to power outages along the Texas Gulf Coast associated with Hurricane Rita which affected some our pumping stations in the Houston area for a few days. This resulted in approximately $750,000 of lower margin from the liquids pipelines, but as I mentioned earlier these were more than offset by the increased throughput on our natural gas pipelines. We anticipate 2006 will be another good year for the pipeline and storage segment, and expect $85 million in 2006 operating income.

And finally, shifting to energy services. They had a strong third quarter performance, primarily due to margins generated through our storage and marketing efforts. Most of these margins resulted from the optimization of our supply, transportation and storage contracts key components of our energy services business in which we provide customers with no notice premium service. During the quarter we experienced extreme price volatility coupled with rising natural gas prices, which allowed us to sell our monthly index price gas, which was slotted for storage injection into the daily market to capture the margins provided by the difference in the daily price relative to the first of the month index.

Also during the quarter we were able to cycle our storage inventories at certain locations, selling inventory into a rising market, while replenishing inventories when the price pulled back. And finally, basis differentials between physical locations widened significantly throughout the quarter, allowing us to capture additional margins. As we head into the heating season ,of our 86 Bcf of contracted natural gas storage capacity, we have slightly more than 75 Bcf in inventory at a weighted average cost of less than $7.55 per MMBtu.

We anticipate that both daily and month to month price volatility will continue to provide us with additional storage, transportation and marketing margins throughout the fourth quarter of this year and in the next year. These strong third quarter results in energy service prompted us to adjust our full year 2005 guidance to $145 million for this segment. We also announced 2006 guidance of $125 million. From an operating income perspective, we see 2006 fairly flat compared with 2005 when you back out earnings from trading and power marketing activities.

As we have stated before, we do not include any trading earnings in our guidance. However through the end of our third quarter, we have captured a little over $11 million of trading earnings, again primarily attributable to the volatility in the natural gas market. Thank you for your continued interest in ONEOK. And David, that concludes my remarks.

Thanks John. I will now ask Sam Combs to discuss our distribution businesses. Sam?

Thank you David. As we mentioned in our press release we received a final order from Oklahoma Corporation Commission and concluded our rate case in Oklahoma. The order, based on a stipulated agreement between all parties, awarded us annual revenue increase of $57.5 million. Although we were disappointed in the return on equity allowed we recognize the sheer amount of the request may have played a part in the return on equity awarded.

As highlights we note the Commission also accepted our new two tier rate plan, that offers greater customer choice and features front loaded rate structures, designed to recover a greater percentage of our fixed costs through the demand charge and improved cash flow, an increased level of bad debt recovery in our base breaks. The positive treatment of recoveries related to our annual gas and storage investments and approval of a new and updated service charge fees.

In Kansas, we continue to prepare for our next rate case that we anticipate filing in May 2006. In Texas, we plan to file full rate cases in our Port Arthur and North Texas jurisdictions before the end of the year. In 2006, we anticipate a full rate case filing in the Rio Grade Valley and a gas reliability infrastructure program, which is a capital recovery mechanism filing in El Paso. Finally, we plan on filing for six cost of service adjustments in other jurisdictions. Collectively, these rate proceedings in Texas should add some $2 to $2.5 million in margins for 2006, which have been included in our guidance.

Employment costs related to pensions and post-retirement benefits were up for the quarter. Additional increases have been factored into our 2006 guidance. We believe escalating employee-related costs are not exclusive to our company or industry, and we plan to address these through cost-control measures and in subsequent rate proceedings.

Also in the quarter in Kansas, we experienced increased property tax amortizations that were offset by an increase in revenue resulting from an approved property tax rate adjustment mechanism. Our natural gas system in Port Arthur, Texas is now fully operational after Hurricane Rita. We continue to reconnect the remaining affected customers as people reestablish their residences.

Our third quarter numbers also included an expense of $500,000 to cover our insurance deductible. But the cost effect to our overall business will be minor, and is reflected in our 2005 forecast and 2006 guidance. We are mindful of concerns related to higher natural gas prices and their effect on our bad debt expense. We are working to minimize the effects -- and Kansas, our coldest region and the second largest of our distribution units by customer count, poses the greatest challenge for us, with the most adverse cold weather collections rules.

But the Kansas Corporation Commission recently accepted our proposal to allow for recovery of fuel-related portion of the bad debt through a monthly check or mechanism. Oklahoma, our second-coldest service area and the largest of our distribution units by customer count, enjoys the best collection history of the three units, with bad debt levels well below the industry average for the previous 12 months, and three of the last four years.

And as mentioned earlier, a higher level of bad debt recovery allowance has been included in our base rates through the recent rates case in Oklahoma. Oklahoma also has a unique customer choice program titled the Voluntary Fixed Price Program, that allows consumers to individually lock in their fuel costs for a 12 month period. This year that special program has a gas price of $8.39 per decotherm, a very attractive rate and we received very good response to the program with some 10% of the customer base signing up. In conclusion, we continue to execute on our strategies of improving the timing of our rate cases, growing rate base appropriately, and controlling expenses.

Thanks, Sam. Before we open the lines up for questions, I'd like to make some additional comments about the number of questions we continue to receive about Northern Border Partners. As I am sure many of you know, but let me remind you, we own 82.5% of the general partner interest. And TransCanada owns the remaining interest. We have received a number of questions about our commitment to continuing to own the general partner interest. Let me address that issue directly.

We believe our ownership position of the general partner interest still makes sense for us and we expect to cooperate with them in growing the partnership. We have stated on a number of occasions that we have assets that we believe would fit nicely in the partnership. The pipeline and storage segment assets clearly fit. We now believe, in addition to those assets, we have gathering and processing assets that fit. Cash flows for those assets are now more stable, due to recontracting efforts and reduced exposure to keep-whole spreads from the recently announced sale of the Texas assets.

Finally, the natural gas liquid assets whose cash flows are predominantly fee-based, certainly would fit into the partnership. We continue to evaluate our opportunities with Northern Border. We won't speculate as to the extent or the timing of any potential asset sales to the partnership. But I did want to spend a few moments talking about the relationship due to the many questions we continue to receive. Now we will open the call up for your questions.

[Operator Instructions].

Our first question comes from Mike Heim of A.G. Edwards.

Good morning Mike.

Hi. Good morning. Question on the guidance for '06 distribution results -- 119, not very much higher than your '05 guidance, despite the fact that we've got only a mid-year contribution from Oklahoma in '05. One is, does that include any assumption regarding Kansas rate case, and if not, is it just a reflection of your assumptions regarding much higher operating costs?

I'll let Jim take this, and if need be I'll let Sam supplement.

Mike, good morning. It's a combination of those. First, there is no assumption for increased rate relief in Kansas built into the '06 numbers. I think because of the allowed time schedule at the Kansas commission it's not likely we'll see any effect of that in 2006.

As to the kind of flat results a little bit with '05, we have added in the additional revenue from Oklahoma, but with increased benefit cost coming from really two things. One is, we're projecting to have a lower discount rate, and then just experience in part of our benefit cost. They tend to offset a pretty fair portion of that additional revenue coming from Oklahoma. So that's why I think Sam was mentioning that one of the things that we've talked about before, one of the things we are going to have to do is to file for rate relief quicker as these costs continue to increase.

On the other side of that, we have implemented a number of programs and changes here that will cap some of those increase in the future, but they take a while to roll in. I mean, for instance, new employees aren't eligible for our retirement plan and level -- Part D of Medicare will be implemented next year and that could lower some of our cost.

And the other factor, I guess to throw a little more into this, with the changing and selling of assets and buying of assets, our overheads are allocated under what's called the Distrigas Method and that can cause shifting of overheads, too. So you put all those in a basket and what we gave was, I hope, a conservative view of the cost increases for '06. But those -- we're in the process of finalizing those with our actuaries and things like that.

Okay. And second, on energy services, you mentioned the widened basis spread; I assume you're kind of talking Rocky Mountain, Mid-Continent again. Would you just give us some general comments about where you hold pipeline capacity and which spreads we're talking about?

Well, Mike, this is John. We hold capacity across a lot of the United States. I mean, if you will, from Texas on up north to the Canadian border. So what we've experienced, obviously, is a widening in basis from the Rockies to the tea (ph) pipes over to the Northeast. What has been unique is that at any given point in time, basis has blown out or widened across almost all of the pipelines in which we hold transportation. I think the Rockies to the Gulf has certainly widened, that's one area. But it's been pretty much across all of our pipes.

Okay. All right. Thank you.

Thanks, Mike.

Our next question comes from Kathleen Vuchetich of WH Reaves & Company.

Hi Kathleen.

Good morning, guys. I was wondering, first of all, if you have a cash flow -- a free cash flow forecast for 2006, and a Capital Expenditure forecast for 2006?

Jim?

Hi Kathleen, good morning.

Hi Jim.

Yes, yes we do. We included it in our earnings guidance release, but I have those numbers here. We believe that we'll have what we call surplus free cash flow over dividends in CapEx of around $188 million, and capital expenditures we estimate it at $207 million.

Jim, how much of that 207 is environmental? Is any of that environmental spending?

Kathleen, I don't believe any of it is.

Okay, great, great. The other question I wanted to ask is, do you guys always make the decision on the year going in on how much storage you're going to lease or acquire for next year? And I was wondering if the Koch acquisition is going to change the amount of storage that you guys look at or whether or not just market conditions are going to have you at or subtract to your storage capacity?

Kathleen, this is John. We're looking at the amount of capacity in our energy services segment that we have under lease right now, and trying to determine where we're going to end up as we go into '06, but I would anticipate we'll be close to where we are today, which is around the 86 million. The acquisition of the Koch assets does not really -- I wouldn't say enter into our thinking, but will not cause us to change that as most of all that product is natural gas liquids.

Okay, thanks so much guys. I appreciate it very much.

You're welcome, Kathleen. One thing I'd like to add to John's comments, and we've had a fair amount of discussion within that segment about getting the most out of our storage space. We have a number of storage facilities that really allow multiple turns, and we have some who are really -- which are more one or two-turn type service. And so, there's been a fair amount of work done to try and optimize our storage activity as we go forward.

Great. Thanks.

[Operator Instructions].

Our next question comes from Faisel Khan of Citigroup.

Hi, good morning guys, it's Sebastian. First question, if we look at your business image going forward following the non-core divestures and the NGL asset acquisitions, do you think you have the right strategic mix of assets? Or would you like to see higher earnings from regulated ops and included in there are there other assets that you still consider to be non-core?

Let me address that. I think we would like to add to the more stable type assets. Those would include potential natural gas pipelines, NGL pipelines or NGL storage activities, natural gas storage, and of course distribution.

If we can strategically add to our gathering processing, keeping in mind our mix, we would like to do that, particularly if we could move into an area where we're seeing increased activity. But generally, I think we're pretty pleased with our current asset mix and I think we're very pleased with the assets that we own.

Okay, thanks. And second, if we kind of look at industry-wide frac spreads for right now, they've been negative for the month of October, I know you guys have kind of mitigated your exposure there with some of the contracts you've transferred over to POP and fee-based, et cetera. On your realized price are you seeing these negative frac spreads or is it different than what we're seeing in the market?

John?

What you're seeing in the market -- well, let me answer your question. We are seeing days where the ethane spread, the relative value of ethane to natural gas, is negative. We are seeing some of those days, but let me give you an -- and the way we look at that is that's a daily trade. It's the value of ethane versus the value of gas on that day. It's an opportunity to convert the ethane molecule into natural gas and then put it into daily markets. So what we look at is we compare the daily price to the ethane price.

I'll give you an example. Last week on Monday, that spread was a negative $0.65 and by Thursday of last week it was a positive $0.75. So what -- as we've said before, what tends to happen, is we'll have an extreme rise in natural gas and that spread will turn negative. And then, the ethane market will react to that, and they will increase the value they'll pay for the ethane to keep the ethane flowing and the spread will turn positive. And then, you'll see a day like we did last week and like we've seen so far this week, when the daily gas price drops significantly, and then that spread is back positive.

As it relates to us as an operator of gathering and processing assets, we don't make and we don't react to the day-to-day positive and negatives. We look for the longer-term trend, and we believe in the longer-term trend that processing margins are going to narrow relative to what we've seen over the last couple of years, but we do believe that they're going to level out in that $1.78 area, as opposed to some we've seen like $3.20. Sebastian, did that answer your question?

Yes, that was fine. And now one more. On the demand side, are you guys seeing any type of demand destruction from, for example Petchem guys? Has that played into effect at all?

Demand destruction for natural gas?

For the NGLs.

For the NGLs. I think we're seeing it both for natural gas and for natural gas liquids. The difficulty is determining how much, because the lack of information available just hasn't been put together. It's not for a lack of trying, but I believe clearly in both gas and in the NGL business that there's been some demand destruction, but there's also been some supply constraints as well.

Okay, great. Thanks a lot guys.

Thank you.

Our next question comes from Yves Siegel of Wachovia Securities.

Good morning, Yves. Hello?

Maybe they don't have a question. I'm showing no further questions at this time.

Okay. That concludes our third quarter conference call. As a reminder, our quiet period for the fourth quarter will start when we close the books in early January, and will extend until our earnings are released. We will be providing a reporting date and conference call information for the fourth quarter and year end results at a later date. I'll be available throughout the day for follow-up questions. You can contact me at 918-588-7950. Thanks for joining us, and have a good day.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect.