OGE Energy Corp. (OGE) Q2 2008 Earnings Report, Transcript and Summary

Good morning. My name is Kathleen, and I will be your conference operator today. At this time, I would like to welcome everyone to the earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. [Operator Instructions]. Thank you. It is now my pleasure to turn it over to our host, Mr. Todd Tidwell.

Good morning, everyone, and welcome to OGE Energy Corp.'s second quarter 2008 earnings call. I am Todd Tidwell, Director of Investor Relations and with me today I have Pete Delaney, Chairman, President and CEO of OGE Energy Corp, Dan Harris, Senior Vice President and COO of OGE Energy Corp and President of Enogex; Scott Forbes, Interim CFO of OEG Energy Corp, Mel Perkins, Vice President of Power Delivery; Howard Motley, Vice President of Regulatory Affairs, Steve Merrill, Vice President and CFO of Enogex and several other members of the management team to address any questions that you may have. In terms of the call today, we will first hear an explanation of second quarter results from Scott Forbes, then an overview of regulatory issues from Howard Motley. Pete Delaney will then follow up with closing remarks and finally, as always, we will answer your questions. I would like to remind you that this conference is being webcast and you may follow along on our Web site at www.oge.com. In addition, the conference call and accompanying slides, including required non-GAAP reconciliation information, will be archived following the call on that same Web site. Before we begin the presentation, I would like to direct your attention to the Safe Harbor statement regarding forward looking statements. This is an SEC requirement for financial statements and simply states that we cannot guarantee forward looking financial results, but this is our best estimate to date. I will now turn the call over to Scott Forbes to discuss second quarter results. Scott?

Thank you, Todd, and good morning. For the second quarter, we reported net income of $57.1 million or $0.62 per average diluted share. As compared to net income of $62.6 million or $0.68 per average diluted share in 2007. The contribution by business unit on a comparative basis is as follows. For the second quarter of 2008, OG&E earned $0.33. Enogex also earned $0.33, and the holding company had a $0.04 loss for a total of $0.62. For the second quarter of 2007, OG&E earned $0.38 and Enogex earned $0.30, for a total of $0.68. Please keep in mind that in 2008, the marketing business is included with the holding company results, while in 2007, it was included in Enogex. Over the next few slides, I will go into more detail regarding the results of our businesses. For the second quarter of 2008 and 2007, the Company had certain write downs and timing items which we do not consider representative of our ongoing business. You can see that these items reduced earnings by $0.11 per share in 2008 and increased earnings by $0.07 per share in 2007. In OG&E, the net income for the second quarter was $30.9 million or $0.33 per share, as compared to net income of $35.1 million, or $0.38 per share, in 2007. Some of the primary drivers were as follows. Gross marginal revenues increased 8% from $192.6 million to $208 million. I'll provide details of gross margin on the next slide. Operating and maintenance expenses increased $7.7 million, or 9.9%, primarily due to higher employee costs, higher contract services due to an overhaul at one of OG&E's power plants, higher professional service costs and higher fleet costs associated with increased fuel costs. These increases were partially offset by a lower provision for uncollectible accounts receivable. I would like to add that the majority of these increases for the second quarter were expected and included in our second quarter budget. Depreciation expense increased $2.3 million or 6.6% primarily due to additional assets being placed in service. Other income decreased $10.6 million, primarily due to a $7.5 million net write down of deferred costs associated with the Red Rock power plant and a write down of approximately $1.5 million associated with storm costs related to an expected settlement regarding the recovery of these calls with the Oklahoma commission. Howard Motley will provide more details on the settlement in the regulatory update. Now, looking at gross margin. Gross margin was $208 million during the three months ended June 30, 2008, as compared to $192.6 million during the same period in 2007, an increase of $15.4 million or 8%. The gross margin increases were due to warmer weather in OG&E's service territory, resulting in an approximately 20% increase in cooling degree days compared to the same period in 2007, which increased gross margin by approximately $12.3 million. New customer growth in the service territory increased gross margin by approximately $2 million. Also, increased peak demand and related revenues by non-residential customers increased gross margin by approximately $1.6 million. At Enogex, net income was $30.9 million or $0.33 per share, as compared to net income of $28.1 million or $0.30 per share in 2007. Some of the primary drivers were as follows. Gross margin was the largest variance, as margins increased from $95.9 million to $111.7 million in 2008. That represents an increase of over 16%. I will discuss the details of the changing gross margin on the next slide. Operating and maintenance expense increased $3.9 million, primarily due to an increase in employee cost as part of the results of the system growth and overhead allocations from the parent. Depreciation expense increased $2.3 million, primarily due to higher levels of depreciable plant and other income decreased $3.8 million from 2007, primarily due to lower interest income and the minority interest associated with the Atoka joint venture, which began operations in August of 2007. Gross margin at Enogex increased from $95.9 million in 2007 to $111.7 million in 2008, an increase of over 16%. Gathering and processing margins increased $36.5 million, an increase of nearly 90%, primarily due to higher commodity prices and increased volumes. Gathering contributed $27.2 million of gross margin for the current quarter, compared to $16 million last year and processing contributed $49.9 million of gross margin for the current quarter compared to $24.6 million last year. Gathering and process volumes both increased nearly 9% as Enogex continues to see strong growth on its system. Transportation and storage margins decreased $5.6 million, a decrease of 13.9%. Transportation contributed $27.7 million of gross margin for the current quarter, compared to $32.5 million in the same period last year and storage contributed $6.9 million of gross margin in the current quarter, compared to $7.7 million last year. The decrease in gross margin was primarily due to an increased imbalance liability. Marketing and other contributed $15.1 million in gross margin in Enogex in the second quarter of last year. Effective January 1st of this year, Enogex distributed the stock of the marketing company to OGE. You will recall the increase in margins for the second quarter in 2007 in the marketing business was primarily due to the Cheyenne Plains contract. I'll remind everyone that more detailed explanations are included in our second quarter Form 10-Q that we filed this morning with the SEC. This slide illustrates the tremendous growth Enogex has experienced since 2005 and the projected growth for 2008. You can see that our investments are paying off. EBITDA has grown 98% since 2005 when you take into account the midpoint of the 2008 guidance. Not only are we experiencing favorable commodity prices, but increased volumes on the system as a result of our growth initiatives. Enogex plans on spending $370 million in 2008, which is a 123% increase above 2007 levels. The bottom line is Enogex continues to see multiple growth opportunities within the region and is clearly investing for the future. The Company has increased its 2008 earnings guidance to $234 million to $253 million, or $2.50 to $2.70 per diluted share, based on 93.5 million average diluted shares outstanding. You can see the guidance for each business and I'll discuss the key earnings assumptions over the next slides. OG&E's revised earnings guidance is between $128 million and $138 million or $1.37 to $1.47 per diluted share. The primary drivers for the decreased earnings of OG&E are higher operating expenses totaling $565 million, up from the previous guidance of $545 million. The increase in OG&E's operating expenses is attributable to higher O&M expenses of $17 million and higher depreciation expense of $3 million. These increases are primarily due to the timing of costs and savings associated with performance improvement plans; the acceleration of a planned outage for the McLean power plant into 2008 from 2009. Overtime expenses in the transmission and distribution business primarily associated with storms; higher employee costs associated with incentive performance plans driven largely by Enogex's expected net income; higher vehicle fuel costs, both gasoline and diesel and also depreciation expenses is expected to be up $3 million primarily as a result of the acceleration of plant being placed in service. The revised guidance for OG&E does include the pre-tax $9 million write down for the Red Rock plant and storm related costs as part of the settlement agreement for the recovery of those items. Enogex's earnings guidance has been increased to $105 million to $120 million or $1.12 to $1.30 per diluted share. EBITDA at the midpoint of the range is $273 million. You can see the assumptions for the 2008 earnings above. The key change is in the gathering and processing segment, where we continue to see stronger than previously anticipated commodity prices, which I will discuss on the next slide. Our previous 2008 guidance projected gathering and processing gross margins to be between $247 million to $268 million. The 2008 gross margin has been revised upward for gathering and processing to be between $283 million to $311 million. Volume and hedging assumptions remain unchanged. The increase in Enogex guidance is primarily driven by an increase in commodity prices. You can see the commodity price assumptions on the slide. Regarding commodity price sensitivity, for every 10% change in commodity spreads from a $5.90 base; gross margin changes approximately $14.5 million. We also have 66% of processing volumes subject to commodity prices hedged for 2008. The projected net income at the holding company is between $0 and $2 million. We're up to $0.02 per diluted share, primarily due to better than previously forecasted spreads in the transportation area, specifically the Cheyenne Plains pipeline. Enogex distributed the stock to the marketing company to OG&E at the beginning of 2008. So their results are now included in the holding company. Next, Howard Motley will provide the regulatory update.

Thanks, Scott. Slide 14 is an illustration of our regulatory plan and expected timing and our regulatory plan is to seek approval for riders and regulatory assets to reduce regulatory lag between rate cases. The Company has implemented recovery riders for our Centennial wind farm and our enhanced security projects in the Oklahoma jurisdiction. As illustrated in the chart, we have added a Redbud rider for 2009. Yesterday, a settlement agreement in the Redbud pre-approval case was filed with the Oklahoma commission which includes a recovery rider. I will discuss the Redbud settlement in a moment. OG&E has also requested a renewable rider in the Oklahoma jurisdiction to be effective in 2010 to recover the revenue requirement associated with the transmission line that will promote wind energy development in the state of Oklahoma. In our last Oklahoma rate case, the Company was authorized a regulatory asset for excess storm damage costs above $3.5 million, which proved to be a definite benefit in 2007 because of our ice storm in December. I will also discuss the storm recovery in a moment. Finally, OG&E will be filing an Arkansas rate case in August and plans to file frequent rate applications in both retail jurisdictions in the future. Slide 15 is the Redbud acquisition and on July 30th, the settlement agreement was signed yesterday in the pre-approval application. The settlement provides that the acquisition of a 51% interest in Redbud at the agreed upon $434.5 million purchase price plus transaction costs is prudent, and the facility is found to be used and useful. A rider will be implemented upon closing of the purchase and the integration of the Redbud facility into OG&E's generation portfolio. The rider will recover the Oklahoma jurisdiction revenue requirement until new rates are implemented that include Redbud's net investment, O&M expense, depreciation and ad valorem taxes. OG&E will be filing a motion to accelerate the hearing for final commission approval. On Slide 15, we discuss the Red Rock and storm cost settlement, but in December, OG&E filed an application in the Oklahoma jurisdiction requesting recovery of its $14.7 million Red Rock cancellation cost by selling excess SO2 allowances. On June 27th, OG&E filed an application requesting a storm cost recovery rider for the years 2007 through 2009 and approval of a $35.3 million storm cost regulatory asset for 2007. The authority for the $35.3 million regulatory asset was established in OG&E's last rate case when the commission authorized the Company to approve a regulatory asset for storm costs that exceed $3.5 million for any calendar year and it was expected to recover that cost in future rate cases. At the same time OG&E filed the storm rider application, the company also filed a motion to consolidate for hearing the storm cost and the Red Rock cases, and the commission granted that motion. On July 24th, the parties to the Red Rock and the storm cost cases signed a settlement agreement to resolve both cases. If approved by the commission, OG&E will be authorized to recover $7.2 million of the Red Rock cancellation cost over a 27-year amortization period. We will also receive the debt curing cost in the $7.2 million Red Rock regulatory asset beginning October 1, 2007 until the regulatory asset is earning the rate of return in the next rate case. The Company will also recover the $304,000 paid to the staff and AG consultant in the Red Rock pre-approval cost. As for the storm cost, the settlement agreement authorizes 100% recovery of OG&E's actual storm costs for the years 2006 to 2009 where a storm cost recovery rider and approves a $33.7 million storm cost regulatory asset for 2007. The rider also provides for a 10.75% return on equity on the unrecovered storm costs which is the $33.7 million that's in the settlement agreement. The rider's designed to recover the 2006 to 2009 storm costs over a five-year period. The Company will also retain the first $3.4 million of the profits resulting from selling excess SO2 allowances. And finally, 100% of the SO2 allowances above OG&E's retention amount will offset storm costs. The hearing on the settlement agreement is next Monday, August 4th. One of our other activities in Oklahoma is a renewable plant that we filed an application on May the 19th, requesting approval of this plan. The Company's requesting pre-approval to construct a transmission line between Oklahoma City and Woodward to facilitate wind energy development. Additional, a rider's been requested to recover the revenue requirement when the transmission line is completed and in service during 2010. Renewable tariff offerings will also be available to our Oklahoma customers. The staff is recommending approval of OG&E's renewable plan, and the Oklahoma Industrial Energy Consumers Group are opposed. The settlement conference is scheduled for later this morning, today and a hearing is scheduled for next week, August the 7th. In the Arkansas jurisdiction, we filed on June 2nd a rate application notice that we would be filing this summer. We are currently preparing the financial package based on a 2007 test year and plan to file a rate increase application in late August. The testing will be December 31, 2007. However, the pro forma adjustments will include the revenue requirement for the Redbud power plant. In the Arkansas jurisdiction, there's a 10-month statutory timing for processing a rate case. Therefore, we expect a commission decision in June of 2009 and new rates implemented in July of 2009, next year. Pete?

Thank you, Howard. Good morning, everyone. The increased earning guidance for 2008 and our progress on the recovery of our utility investments reflect the positive business fundamentals of both the electric utility and natural gas midstream business. That said, our work to position OGE Energy to be able to continue to capture opportunities for our customers and shareholders continues. My remarks today will follow closely the themes in the last quarter. We continue to experience higher profitability and increased capital investment at Enogex, reflecting greater investment opportunities in Enogex's natural gas midstream. At OG&E, we continue to pursue investments in wind- and renewable-related transmission projects. The acquisition of the natural gas-fired Redbud plant and a host of regulatory filings for the recovery are under way. On the regulatory front, we have made significant progress since the last call, negotiating settlements for the Redbud acquisition, which we announced this morning, the 2007 ice storm and Red Rock cost recovery cases. From a financial standpoint, we're increasing our 2008 earnings guidance to $2.50 to $2.70 per share despite a $0.06 per share charge to OG&E in the second quarter for the costs associated with the canceled Red Rock plan and the 2007 ice storm recovery cases. At the end of the first quarter, our expectations of increased profits at Enogex put us towards the high end of our previously announced guidance of $2.40 to $2.60. It is our continuing expectation of higher profits at Enogex that's the driver for the increase in our earnings guidance at this time. Assuming the midpoint of $2.60 per share of our guidance, such results would compare very favorably to our reported earnings of $2.64 per share in 2007, which included approximately $20 million, or $0.22 per share, of unusual products or items. OG&E continues to make steady progress on important initiatives positioning us to meet our business objectives over the coming years. Our economy in Oklahoma has not been negatively impacted to the same extent as many areas of the nation. Oklahoma's economy created about 3,900 jobs in the April to May timeframe of this year, ranking the state sixth in terms of monthly job creation, and as of the end of July, and our yearly employment growth of 1.4% compares favorably to the 0.1% growth rate for the nation. To us, this means expectations of continued load growth, and to meet that growth, our Redbud plant acquisition of 600 megawatts at $695 per kW, or about 75% of the cost of construction, will provide additional capacity required to meet our load growth for five years, assuming no plant retirements. We believe this plant at this price, and given its capabilities and location, is the right choice for our customers, as do others, as evidenced by the settlement. However, we're not relying just on supply options. We also plan on delaying the date at which additional capacity will be needed by stepping up energy efficiency and demand-side management effort. I've asked our team to develop and implement options to defer the need for any additional follow-up of fuel generation plant until 2020. In addition, we are investing in the development of wind resources in Oklahoma. The foundation of our wind initiative is a new 345 kV transmission line from our Woodward substation in northwest Oklahoma to Oklahoma City. This new line provides the capacity to support our efforts to purchase or own at least an additional 600 megawatts of wind production. In fact, we received approval on Tuesday from the Southwest power pool to construct this critical piece of renewable transmission infrastructure. We also recently announced our partnership with AEP and MidAmerican Energy to build a 765 kV transmission line to provide for the transport of large amounts of wind energy generation from the remote locations that wind farms are typically located to other parts of the region. Our goal would be to have the new line in place by 2013. In addition to promoting investment in our state and providing clean energy, we believe that wind energy will provide our customers significant value in the future as a hedge against natural gas price volatility and CO2 legislation. And in other parts of the country, our customers are experiencing increases in prices for food, fuel and other items. In this environment, we remain vigilant over the magnitude of our price increases. Our investments in Redbud and wind will provide fuel savings that will mitigate the pricing impact on our customers. We expect and project that our prices will increase by about 7.5% to 7% by 2011 from today's level, assuming current fuel prices. At Enogex, the board just recently approved a $50 million increase in 2008 capital expenditures to $270 million, reflecting the opportunities associated with natural gas production in our region. We expect the 2008 EBITDA for Enogex to now be $270 million, with continued growth in the coming years expected as many of our capital projects are completed in 2009 and began generating positive cash flow. On the transportation side of Enogex's business, both the Gulf Crossing and Midcontinent Express Pipeline projects recently received approval from the FERC and are proceeding to construction. As always, we remain committed to a strong financial position and credit rating. At the present time, we expect to issue around $75 million of OG&E common equity in 2008 to finance our capital program. The last significant public offering by OGE Energy was in the amount of $115 million in August of 2003, and since 2003, we've invested over $2 billion in our businesses, and our book value per share has grown from $13.75 per share to $18.41 per share. We believe our low payout ratio combined with strong cash flow production from Enogex positions us to continue to increase the earnings power of our stock. Additional equity capital needs beyond 2008 could be met through the IPO of the Enogex MLP, which is currently sidelined awaiting a more constructive market environment. We do not believe that OG&E stock price fully reflects the inherent value of Enogex and that the Enogex story is even more compelling given the increase in the capital program and growing EBITDA growth. Accordingly, we remain committed to taking steps toward realizing the value of Enogex and the OG&E stock price. At our current stock price, we estimate that Enogex is valued at less than four times EBTIDA, a heavy discount to comparables in the market. While we are making great progress, much work remains. Our renewable program's moving ahead with multi-year implementation plans if approved by the OCC, but the opportunities for the renewable program are clear, and actions for capturing value are underway. We recently launched our Quick Start initiative to help our customers use energy more wisely and are very focused on the development of a business plan for investment in or recovery of energy efficiency and demand side management programs. Our intent is to make a regulatory filing by the first half of 2009 outlining these plans. In summary, we are pleased with the progress made at both OG&E and Enogex. The settlement of the Oklahoma proceedings for the approval of the Redbud plant and recovery of the cost for the cancelled Red Rock plan 2000 ice storm should significantly clear up the regulatory docket and increase OG&E earnings in 2009. On the renewables filing, we are encourage by the SBP approval of the transmission line from Oklahoma City to Woodward, and considering the other testimony filed in that case, we look forward to a satisfactory resolution to that case as well. Overall, we like our progress and are working hard to keep our momentum. Thank you for your interest in OG&E, and now, let's hear your questions. Question and Answer

[Operator Instructions] And your first question comes from the line of David Frank with Catapult Capital.

Yeah, Hi. Good morning, guys

Good morning, David.

I just had a question, I want to clarify something. It looks like your revised guidance, you said in the press release, now includes a $0.06 one-time hit at the utility?

That's correct. That is the $9 million pre-tax charge for Red Rock, which was $7.5 million, and $1.5 million towards the storm.

And then, in the first quarter, you also had another $0.06 one-time hit when you reiterated your '08 guidance. So I guess my question to you is does your revised guidance... if I'm understanding this correctly, your revised guidance for 2008 now includes $0.12 of nonrecurring items, of hits.

Yes, it does.

Okay. All right. I just wanted to clarify that. Thank you.

Your next question comes from the line of Brian Russo with Ladenburg Thalmann.

Good morning, guys.

Good morning, Brian.

On the Redbud settlement, can you quantify the rider that you expect and when that might be implemented?

Yes, the recovery rider would recover the rate of return on Redbud, operating expenses, depreciation, ad valorem taxes. We're estimating that the annual revenue requirement that we would recover through the rider would be about $75.4 million from our Oklahoma customers, and that's about 85% of our jurisdiction of cost. The rider would be implemented, let's just say if the commission approved this in August or September, and we owned this September 1 or owned it October 1, whenever we do own it, the day that we integrate Redbud into our generation fleet and start generating with it, that will trigger the rider to start recovering the $75 million a year.

Okay, so it's possible for this rider to be implemented in early fourth quarter, and the contribution of that would be incremental to your revised guidance.

Brian, this is Todd. No, that incremental amount is included in the guidance.

Okay. And also, what is the unhedged frac spread that you're assuming in your guidance, the 40% that's unhedged?

The market spread that is in our guidance is between... well, the realized spread is $7.03 to $8.32. I believe the market spread is right around $8.00 to $9.00.

Okay. And I think for the month of July it looks like a frac spread was a little... close to $11. Are you just assuming maybe that for the full year it's $8.00 to $10.00? It looks like second half is fairly strong.

That's correct.

Okay. And then I think I missed your comment on the issuance of common equity in 2008. Could you just repeat that please?

Yeah, I'd be happy to, Brian. We filed the continuous offering program. We have not issued anything under that in terms of equity, but our plans would be to issue around $75 million of common stock this year under the continuous offering program starting sometime in the next few months.

Okay. Thank you very much.

You're welcome.

[Operator Instructions] At this time, there are no further questions.

No other questions? I'd like to close the call. Thank you for your time this morning and your continued interest in OGE Energy. Have a nice day. Thank you.