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OGE Energy Corp. (NYSE:OGE)

Q4 2013 Earnings Conference Call

February 25, 2014 09:00 AM ET

Executives

Todd Tidwell - Director, IR

Pete Delaney - President and CEO

Sean Trauschke - CFO

Analysts

Matt Tucker - KeyBanc Capital Markets

Brian Russo - Ladenburg Thalmann

Andy Bischof - Morningstar

Anthony Crowdell - Jefferies

Operator

Good day ladies and gentlemen and welcome to the Q4, 2013 OGE Energy Earnings Conference Call. My name is Mark and I'll be your operator for today. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Todd Tidwell. Please proceed sir.

Todd Tidwell

Thank you, Mark and good morning everyone and welcome to OGE Energy Corp’s fourth quarter 2013 earnings call. I’m Todd Tidwell, Director of Investor Relations and with me today I have Pete Delaney, Chairman, President and CEO of OGE Energy Corp.; and Sean Trauschke, President of OG&E and CFO of OGE Energy Corp.

In terms of the call today, we will first hear from Pete, followed by an explanation from Sean of fourth quarter results and year-to-date results 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 website at oge.com. In addition, the conference call and accompanying slides will be archived following the call on that same website.

Before we begin the presentation, I would like to direct your attention to the Safe Harbor statement regarding forward-looking statements. This is an SEC requirement for financial statements and simply states that we cannot guarantee forward-looking financial results, but this is our best estimate to date. I would also like to remind you that the presentation of our results reflect the 2-for-1 stock split which was effected July 1, 2013. In addition because Enable Midstream is in the process of an Initial Public Offering, we will not be discussing or answering any questions regarding the guidance for Enable or the S-1 filing. Once the IPO is complete, Enable will be able to provide you additional information.

I will now turn the call over to Pete Delaney for his opening comments. Pete?

Pete Delaney

Thank you, Todd. Good morning everyone and thank you for joining us this morning. This morning we reported full year 2013 earnings of a $1.94 per share, compared to $1.79 per share in 2012 and are pleased to report that both of our businesses reported higher earnings for the year, as well as in the fourth quarter, reporting earnings per share for the quarter of $0.29 compared to $0.19 in 2012. Our primary driver, as in past periods, for increased consolidated earnings was due to our interest in Enable partnership and transmission earnings at the utility. Our 2014 consolidated earnings guidance is a $1.94 to $2.06 per average share, in line with our long-term growth rate of 5% to 7%.

From 2010 to the midpoint of our 2014 guidance, we will have achieved just over 7% annual growth rate, which is at the top of our long-term growth targets. Sean will discuss the guidance for each of our businesses later in the call. Earnings at the utility continue to be driven by our FERC jurisdictional transmission projects and secondly by customer growth. As expected, operation and maintenance costs in the last quarter were higher as we completed generating plant maintenance deferred earlier in the year. However, for the full year O&M expenses were 2% lower, due primarily to attrition associated with retirements.

As we have said for some time, the Company continues to focus on productivity and operational efficiencies in order to mitigate the impact of environmental compliance costs on the customer’s bill. As you know we are concerned about the substantial rate increase to customers due to Regional Haze compliance. We originally planned to provide details on this call about our compliance plan but we do not anticipate that a stay of the federal implementation plan would be in place at this time. The 10th Circuit Court ruled that the stay of the EPA’s [SIP] [ph] is in place until the process at the Supreme Court appeal has run its course. Once the stay is lifted we will have 55 months to comply with the Regional Haze order.

On January 30th, we joined the Oklahoma Attorney General in asking for the U.S. Supreme Court to review the ruling issued by the 10th Circuit Court rejecting Oklahoma’s authority to implement a state plan, versus the more costly EPA federal implementation plan. We will wait for the Supreme Court decision before providing further guidance on our compliance plan. Counsel has indicated that we should expect a decision on whether the Supreme Court will hear our case by the beginning of the second quarter. If we aren’t successful before the Supreme Court, we will promptly file for recovery of associated environmental costs under House Bill 1910.

Passed in 2005, the law allows utilities in the state to recover mandated environmental expenditures. Regardless of the outcome, we will be compliant under the 55 month timeline. Our plan will represent based on our analysis the best option for customers using a lowest risk adjusted approach across a range of future scenarios. As stated before, we are a big believer in fuel diversity, as part of addressing the future risk to our customers associated with fuel price volatility and operational reliability. Our compliance strategy will also contemplate our generation portfolio operating in the SPP Day 2 markets, with ever-increasing amounts of intermittent energy.

Turning to health of our service territory, the Oklahoma economy continues to sustain its first quartile of economic performance. Oklahoma City continues to have one of the lowest unemployment rates for large metropolitan areas at about 4.8% and the state as a whole is just over 5%. New customer growth continues. As in the past, we added nearly 9,000 customers in 2013.

At the utility we continue to focus on the customer through a number of initiatives geared towards improving the value of our service. Our rates are currently more than 20% below the national average and we intend to keep that advantage. It is an important component of attracting businesses too and retaining businesses in our service territory.

I mentioned earlier tight management of utility O&M is a part of these efforts as 2013's expenses were down compared to ‘12. While we expect next year we’ll require higher expenses to deal with planned power plant outages, long-term cost performance remains a key part of management’s focus. Our members are fully engaged in driving productivity improvement and I appreciate their great work for our customers.

In the area of improving our customer experience, we now have over 81,000 or about 10% of our customer base enrolled in our Smart Hours program, which provides real time price signals to our customer's thermostats. It is important for a couple of reasons. First it’s critical to our plan of not adding base load fossil fuel and increasing our capacity until after 2020, helping to keep our rates low. And secondly it allows our customers more control over their bill and their usage, which creates additional cost savings for them and of course improved customer satisfaction.

The last of our large transmission projects was completed by the end of this year. These investments have been one of the largest drivers of our utility earnings with $81 million of margin in 2013, compared to $39 million the prior year and we are projecting a $115 million of margin in 2014. We have some smaller projects scheduled in 2016 and beyond for approximately $230 million. These investments will allow us to operationally integrate, win more effectively and realize the benefits from the SPP Day 2 market. With the advent of FERC Order 1000 implemented in 2015, we will continue to work to position ourselves for additional transmission opportunities.

Additionally, we expect to receive smaller [scene] [ph] projects in our service territory that will be below the 300 KV level. Oklahoma law provides the right of first refusal for transmission owners on projects of 300 KV and below. Our focus will be in the SPP territory, partnering with transmission owners and others to bid for additional projects in the Southwest Power Pool.

Turning to Enable Midstream Partners, as you know, in January the Enable Board named Lynn Bourdon as President and CEO of the partnership. Under his leadership his team has focused on integration of legacy operations, optimization of the system and growth of the business. Of course all of this, while moving forward with an IPO target for the end of this quarter. Enable’s amended S-1 was filed on February 21st incorporating 12 months ended March 31, 2015 forecast. Compared to the previous forecasted period volumes and distributable cash flow have increased primarily due to continued volume growth in wet gas basins, higher commodity prices and the realization of operation synergies.

Performance of the business in 2013 was in line with our expectations. Volumes continue to grow in the Granite Wash and SCOOP plays, while volumes declined in the drier gas basins. Volume [identification] [ph] for the majority of gathering volumes in the dry gas basins help offset the financial impact of much of the volume decline.

In the transportation store segment, margin was down to the lower basis differentials in storage spreads decreasing revenues of the interstate pipelines. The 200 million a day -- the McClure facility became fully operational in January and the 200 million a day Bradley plant is on schedule for completion early 2015. The partnership’s first Bakken project is operational with over 1,000 barrels per day, flowing and ramping up to 9,500 barrels per day by the end of the year. Also Enable has a second Bakken crude gathering project in development, with an open season continuing through early March.

A lot of hard and good work is going on at Enable. Without a doubt 2013 was another year of accomplishments at OGE Energy for our shareholders and customers. Enable transaction at the top of the list was a major platform item, positioning OGE Energy for future earnings growth and cash flow accretion. Another favorable outcome of the transaction was the upgrade in the ratings of both OGE Energy and OG&E by S&P and Moody’s. OG&E also won the EEI Edison award, our industry’s highest award for its work in improving customer experience with the Smart Hours program. JD Power recognized us once again for being tops in residential customer satisfaction among large southern utilities. And the pension fund is now virtually fully funded. In December furthermore the Board increased the annual dividend by nearly 8%, and that marked four consecutive years the dividend growth rate has been increased.

Of course we would like to put in the win column the success in our legal appeal the EPA Regional Haze federal implementation plan. However as opposed to the alternative, appealing was the best option for our customers and ultimately will be for our shareholders.

With that I would like to turn the call over to Sean, who will review our financial results for the fourth quarter and the full year 2013 in greater detail. Sean?

Sean Trauschke

Thank you Pete and good morning. For the fourth quarter we reported net income of $58 million or $0.29 per share as compared to net income of $39 million or $0.19 per share in 2012. The contribution by business unit on a comparative basis is listed on the slide.

And for the full-year 2013, we reported net income of $388 million $1.94 per share, as compared to net income of $355 million or $1.79 per share in 2012. I would like to point out that the loss of the holding company is primarily due to the costs associated with the formation of the Enable Midstream Partnership.

At OG&E, net income for the quarter was $29 million or $0.15 per share, as compared to net income of $28 million or $0.14 per share in 2012. For the quarter gross margin came in stronger as we saw an increase of $18 million or 7%, primarily due to transmission revenues and positive weather. Heating degree days were 25% above last year and 13% above normal.

Now looking at some of the other key drivers, O&M increased $8 million primarily due to the timing of planned power plant maintenance for the quarter as compared to last year. Interest expense increased $2 million primarily due to the additional long-term debt issued in May of 2013. And finally, income tax expense increased $4 million, due to our higher tax rate and a higher pre-tax net income. Our tax rate was 28% in the fourth quarter, compared to 22% in 2012.

Now turning to the full year at OG&E, net income for the year was $293 million or $1.47 per share, as compared to net income of $280 million or $1.41 per share in 2012. Gross margin for 2013 came in stronger as we saw an increase of $34 million or 3%. Weather though positive compared to normal was less of a factor compared to 2012. I’ll discuss gross margin on the next slide. Though looking at some of the key drivers, our operating expenses decreased $8 million or 2% for the year and was lower, primarily due to lower employ costs.

Taxes, other than income increased by $6 million, attributable to higher property taxes. Interest expense increased by $5 million due to the additional long-term debt issued in May 2013 and again finally, income tax expense increased $19 million or 20%, primarily due to higher pre-tax income and a reserve related to a portion of the Oklahoma investment tax credits we discussed earlier this year. The effective income tax rate increased to 28% from 25%.

Utility margins were up for 2013, therefore its primary drivers impacting gross margins. First our SPP transmission projects increased gross margin by $45 million. Second, growth from new customers added an additional $11 million in gross margin. We added nearly 9000 new customers to the system, compared to 2012. These were partially offset by lower average prices due to changing sales and customer mix as well as milder weather compared to 2012.

Looking closer at weather, cooling degree days were 1% above normal, compared to 2012 which was 22% above normal. The margin impact from fewer cooling degree days in 2013 compared to 2012 was approximately $6 million. Compared to normal weather contributed $4 million of gross margin for 2013. Overall utility margins were up for 2013 despite the weather impact that was lower than 2012.

For 2013, natural gas midstream operations reported equity income to OGE Energy Corp of $100 million or $0.50 per share in 2013, compared to $74 million or $0.38 per share in 2012. The increase was primarily due to accretion and positive accounting adjustments resulting from the formation of the Enable Midstream Partnership.

Enable Midstream Partners' results for 2013 were consistent with management’s expectations in light of lower natural gas liquids prices and low seasonal geographic price differentials. Enable Midstream continued to increase processing volumes through system expansions. As we mentioned on the third quarter call, the formation of the Enable Partnership created a re-measurement of deferred state tax liabilities.

Basically the new partnership operates in several states and when you take into account the various state income tax rates, the impact is our deferred state tax liabilities decreased 21 million. This is a one-time non-recurring adjustment. And finally looking at distributable cash flow, for the eight months Enable Midstream made distributions of approximately $52 million to OGE.

Before answering your questions, I did want to discuss our guidance for 2014 which on a consolidated basis is between $1.94 and $2.06 per share. Looking at the utility and assuming normal weather, we project earnings per share to be between $1.46 and $1.52 per share. For the Midstream business, our equity earnings are projected to be between $0.49 and $0.55 per share.

And at the holding company we are projecting a loss of one penny. I do want to point out that our equity earnings from Enable does not include any dilution from the issuance of new units, nor does it include any gains recognized each time Enable sales units represent a difference between our book value and the unit sales price. Once the IPO occurs, we will update you with those impacts.

Now I want to look closer at some of the key assumptions for the utility. Primary drivers for the earnings growth at the utility are going to come from the investment in the SPP projects and the 1.2% projected sales growth. On an incremental basis, the transmission projects and sales growth are projected to increase gross margin by approximately $33 million and $16 million respectively.

As you know, we’ve disclosed our Regional Haze compliance plan due to the proceedings at the U.S. Supreme Court. We expect to hear something regarding our petition in the second quarter of this year and we’ll disclose our plan and any impacts to our forecast once we have resolution on this issue. Our current financing plan is to issue $250 million of long term debt at the utility in the first half of the year and to retire $100 million of debt at the holding company that matures November of this year.

This concludes our prepared remarks. We’ll now open it up for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Matt Tucker from KeyBanc Capital Markets. Please proceed.

Matt Tucker - KeyBanc Capital Markets

First question, does your Enable guidance reflect the forecast that were provided in the S-1 yesterday or something different?

Sean Trauschke

It does represent what was submitted in the S-1 yesterday. And keep in mind that forecast in the S-1 that went out yesterday is for -- basically from March 31 of this -- it’s first quarter to first quarter. It’s not a full calendar’14. So there are some adjustments there, but it does reflect an updated S-1 filing.

Matt Tucker - KeyBanc Capital Markets

The amortization of the basis difference, that you recorded in 2013 if we annualize that, is that like a good annual run rate going forward?

Sean Trauschke

Yes, it is and so I think we’ve said on our last call that’s roughly $2.5 million a month or something like that.

Matt Tucker - KeyBanc Capital Markets

And does that get re-measured when the IPO occurs or was that kind of locked in when the MLP was formed?

Sean Trauschke

No, that’s kind of locked in.

Matt Tucker - KeyBanc Capital Markets

And then the $10.4 million fair value adjustment, does that recur at all?

Sean Trauschke

Yes.

Matt Tucker - KeyBanc Capital Markets

That does. Is it the same level this year?

Sean Trauschke

Matt, just let me make sure we say this correctly. So both of those items combined are just shy of $2.5 million a month, okay. And those go on for 30 years. And those will be recurring.

Matt Tucker - KeyBanc Capital Markets

And what tax rate are you assuming on equity earnings for ’14?

Sean Trauschke

38%.

Matt Tucker - KeyBanc Capital Markets

38%. And then, of the state deferred tax benefit that you recorded in 2013, how much of that hit the fourth quarter?

Sean Trauschke

Very little. Most of it was in the third quarter. I think we indicated there was $17 million adjustment in the third quarter and I think yearend was $21 million and that’s a pre-tax number, I mean -- yes, after tax number.

Operator

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

Brian Russo - Ladenburg Thalmann

Just on the CapEx at the utility in the slide presentation. Just on the environment CapEx, I realize you’ll update that after the Regional Haze conclusion, but don’t you also have MACT-related spending?

Sean Trauschke

Yes.

Brian Russo - Ladenburg Thalmann

And how much is that and why isn’t it in the CapEx table?

Sean Trauschke

Well, it is in the CapEx table there. If you look at our CapEx table there, down under other projects, we have activated carbon injection, do you see that?

Brian Russo - Ladenburg Thalmann

Yes.

Sean Trauschke

Yes, okay, we do have some capital in there for activated carbon injection. We -- we're -- obviously with our Regional Haze process, the opportunity we have on the utility MATS for a particular matter is we’re certainly looking at DSI, but that also is impacted by what we ultimately decide to do relative to our Regional Haze strategy. And so that’s why it’s not in there. Is that fair enough?

Brian Russo - Ladenburg Thalmann

Yes. And just in terms of the House Bill that allows for recovery of environmental compliance costs, would you seek a tracker for recovery rather than file a general rate case and then also could you get cash recovery on that tracker or was it just AEFUDC.

Pete Delaney

Brian, it’s pretty wide open, the statutes I recall don’t provide for cash earnings. In other words it allows the Commission to grant CIP and rate base. It does not mandate that. So it’s actually pretty open in terms of how that recovery would go. We are -- of course we all know that either we’re concerned about the impact on the customers and that the greater the cash earnings on our construction, the lower ultimate cost to customers. So we will strongly make that argument. We would think that was in the best interest of our customers, but it can take a lot of different forms, whether it’s a tracker or we do a separate rate case filing. So it’s pretty far -- it’s open and as you said, when we find out what the Supreme Court does in the United States, we will announce our plan and then provide greater details on our filing strategy.

Brian Russo - Ladenburg Thalmann

Okay, so to clarify, you can, you’re allowed to do like a single issue filing for a tracker. It doesn’t have to be in the context of the general rate case?

Pete Delaney

That’s correct.

Brian Russo - Ladenburg Thalmann

And in that context, the filing for a tracker, are the return parameters consistent with the last general rate case or can the OCC adjust the returns?

Pete Delaney

They could do either.

Brian Russo - Ladenburg Thalmann

And then just, the Bradley processing plant at Enable, can you just kind of talk about what be the ramp up period on the utilization, or generally speaking, how long does it take from when the plant becomes operational and how long does it take to ramp up to full capacity.

Sean Trauschke

Brian, this is Sean. Just so we can be very careful here, I think our expectation is it’s going to ramp up just like the previous plants have done, like McClure has done, like the others have done. We’ve typically said it’s roughly an 18 month process from beginning to end to get it started; those it's typically the most efficient unit so they run first.

Brian Russo - Ladenburg Thalmann

Okay so maybe, could you talk a little bit more about the McClure plant, when was construction completed and when did it become at the optimal utilization?

Sean Trauschke

So it began in kind of the end of this year, beginning of 2014. So kind of December ‘13 - January ’14 and we’ve talked before as far as the processing capacity since we’ve been adding new units, those obviously are the most efficient. So those typically are full first and maybe some of our less efficient units aren’t as full.

Brian Russo - Ladenburg Thalmann

And then lastly any commentary on the common dividend policy?

Pete Delaney

Well I think -- as I mentioned in my comments, we increased the growth rate again to 8% in December. We, as you know the environmental compliance plan is a pretty big item for us -- we would -- in terms of impacting our cash flow going forward and we are looking to get resolution, to provide some clarity. As you do know, as I've talked about, our earnings growth rate since ’10 has been about 7%. We just increased it to 8%. We do know our payout ratio is below 50% and we do have obviously financial flexibility and we’ll be taking a hard look at that after we get clarity on our environmental plan. As well as, we’d like to get this IPO done, we will get the IPO done and that’s on track and so all that’s pretty important in terms of its financial impact on us and what the forecast looks like longer term and we think it’s prudent to get that behind us and then see what we want to do from a dividend perspective.

Brian Russo - Ladenburg Thalmann

Okay, so it seems that if all goes according to plan you’ll probably be in a position to discuss the dividend and the environmental CapEx in more detail on say your second quarter conference call?

Pete Delaney

We're particularly going to talk about our environmental compliance plan. As you know we typically use our practices through December to review those with the board and whether we would depart from our practice I can’t say at this point in time, but I think we’re going to focus really on discussing what our plans are on the compliance and we’ll hopefully -- obviously have the IPO behind us and we can talk about that but it may be premature at the same call to talk about dividend policy. So that’s sort of the time frame I guess. If you want to think about it we may stick with December and that’s obviously a board discussion, a very important one and we’ll have those discussions with the board throughout the year.

Operator

Your next question comes from the line of Andy Bischof from Morningstar. Please proceed.

Andy Bischof - Morningstar

I was hoping you could provide a little more clarity on the 1.2% sales growth in your 2014 guidance. How much of that is attributed to new customers versus base level growth?

Pete Delaney

Andy could you say that, did I understand….

Andy Bischof - Morningstar

Sure -- your 1.2% sales growth guidance, how much of that is attributed to new customers?

Pete Delaney

Most of it is.

Andy Bischof - Morningstar

Okay, so and then in terms of the material or the hours affecting on them, can you provide a little more clarity on that.

Pete Delaney

Yes, so kind of two things are going on here and we made two references to that in our comments. We had had said during the course of 2013 we were under running kind of our operating expense targets relative to our initial guidance, but we’ve said all along that we had some planned outages for the fourth quarter and we've proceeded with those and completed those and so that’s what was the driver for quarter-over-quarter variances. As I look forward to 2014, we have more planned work at our plants than we did in 2013 in total and so that’s what’s going on and this is just, as you go through your maintenance cycle, we have more this year than we did last year. Okay?

Operator

[Operator Instructions] Your next question comes from the line of Anthony Crowdell from Jefferies. Please proceed.

Anthony Crowdell - Jefferies

Just wanted to look at the guidance that you have for utility for 2014. What ROE are you assuming if I just take the midpoint there? What ROE are you assuming and I guess on what rate base?

Pete Delaney

Yes, so we’re assuming in Oklahoma -- we’re earning close to our live return there. Arkansas is obviously below the 9.95 we’re allowed. It’s probably closer to 7 and obviously on the FERC Jurisdictional rate base we’re earning -- it would be 11.1. As far as the rate base goes, Oklahoma’s by yearend will be roughly $4.1 billion. Arkansas, Antony is $370 million and I expect FERC will be close to about $700 million.

Anthony Crowdell - Jefferies

And Oklahoma, the allowed returns are 10 and an eight or 10.2; something like that?

Pete Delaney

Yes.

Anthony Crowdell - Jefferies

10.2, great.

Operator

There are no more questions in the queue.

Pete Delaney

Thank you, operator. I’d like once again to recognize our members for their focus on safety and for all their hard work that led to the accomplishments that I mentioned earlier in the call. I’d like to thank you for your continued interest in the company. Please have a safe day. We’re adjourned. Thank you.

Operator

Thank you very much. This concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day

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