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OGE Energy Corp. (NYSE:OGE)

Q1 2012 Earnings Conference Call

May 3, 2012 09:00 AM ET

Executives

Peter Delaney - Chairman and Chief Executive Officer

Sean Trauschke - Vice President and Chief Financial Officer

Keith Mitchell - President, Enogex

Todd Tidwell - Director of Investor Relations

Analysts

Brian Russo - Ladenburg Thalmann & Co.

Andrew Bischof - Morningstar, Inc

David Frank - Catapult Capital Management

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2012 OGE Energy Earnings Conference Call. My name is Kisha, I will 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’d now like to hand the conference over to Mr. Todd Tidwell, Director of Investor Relations. Please proceed.

Todd Tidwell

Thank you, Kisha. Good morning, everyone, and welcome to OGE Energy Corp’s first quarter 2012 earnings call. I’m Todd Tidwell, Director of Investor Relations. And with me today, I had Pete Delaney, Chairman, President and CEO of OGE Energy Corp.; Sean Trauschke, Vice President and CFO of OGE Energy Corp.; and Keith Mitchell, President of Enogex.

In terms of the call today, we will first hear from Pete, followed by an explanation from Sean of first quarter results and finally as always we will answer your questions. I’d 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’d 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. In addition, there is a Regulation G reconciliation for EBITDA in the appendix along with projected capital expenditures.

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

Peter Delaney

Thank you, Todd. Good morning, everyone, and welcome to our call. For the first quarter of 2012 we reported earnings of $0.38 per share compared to $0.25. In 2011 with higher margins and earnings at utility end Enogex. The increase of Enogex was driven by the investments associated with volume growth, particularly in the processing business.

Processing volumes grew 20% quarter-over-quarter highlighting Enogex expansion liquids rich basins of Western Oklahoma and the Texas Panhandle. Enogex also benefited from insurance proceeds associated with the Cox City plant fire discussed on previous call.

On the utility side, primary earnings drivers are investments in the Crossroads wind farm and transmission that benefits both customers and shareholders. While the first quarter results show continued progress in several fronts, the pending Oklahoma rate case is one of those. As you recall, key differences between our request and the interveners are the ROE requested and the recovery of O&M expenses outside the test year.

We’re still waiting on the ALJ decision that while not binding on the Oklahoma Commission, does in our opinion influence decision making. We had expected that report would have been issued by this time. We may have underestimated however, the impact of the States cut backs to the Commissions’ budget. Meanwhile, we’re hopeful that within a short period of time an ALJ report will be issued. We will be working to bring this case to a conclusion and we will keep you posted as events unfold.

This uncertainty around the rate case continues to overhang the markets view of our future earnings, so today we’re providing 2012 earnings guidance without the impact of the Oklahoma rate case. With the expectations of an order earlier in the quarter, we had previously declined to issue 2012 guidance for the utility.

Our consolidated earnings guidance for 2012 is $3.40 and $3.60 per average diluted share. Utility outlook is between $2.60 and $2.70 per share and as you will hear transmission is a big driver. The previously issued Enogex guidance is unchanged. While natural gas price is at a 10-year low and generate a significant investor attention, our plans as outlined on the last call remain the same.

We took prudent action earlier this year to adjust the Enogex 2012 capital expenditure and volume growth projections reflect the expected lower volume growth rate associated with the low price. Our continued growth reflects that the majority of our assets are located in rich natural gas liquids basins. In fact our 2012 capital plant at Enogex was recently increased by $55 million as our management team secured meaningful dedications additive to our already well positioned portfolio. That improves our relative wide earnings growth and additional value for shareholders.

As always, the commodity cycle moves through its paces and the operating environment continually changes around us. But a well positioned portfolio provides the ability to respond by shifting tactics, but not requiring us to change our long-term strategy. Our utility plans remain on track apart from the pending rate case. Our transmission reliability expansion continues with additional $700 million, in Southwest Power Pool projects over the next three years. This does not include the conditional notice to construct [recently] for $250 million to $300 million of additional projects scheduled to be complete in the 2018-2021 timeframe.

Over the past week we’ve completed two projects on time and on plan, the Sunnyside-Hugo line and the Sooner-Rose Hill line. Total costs of these projects was approximately $200 million. We are now beginning to realize meaningful earnings from our transmission investment with projected 2012 transmission gross margin, up $30 million over last year. By the end of 2016 we’re projecting 1.5 billion of transmission rate base with over 800 million under FERC jurisdiction.

On the environmental side, we’re moving forward with plans for low NOx burners with seven generating units, Dry Sorbent and Activated Carbon injection add up to 5 coal units to comply with Casper and Mac and to comply with the NOx provisions of regional haze that we agree to. This will require approximately $450 million to be invested by the year 2017.

Of course the timing is dependent upon ultimate resolution of various legal proceedings underway. If no changes are granted by the courts associated with current appeals, OG&E will have till May of 2013 to being compliance with the Casper rule. Our short-term compliance plans could include re-dispatch low NOx burners, purchasing credits, purchasing power or a combination of these.

Subject to challenge the Mac rules have gone to effect and require compliance in three years with a possible one-year extension. Compliance with the Mac rules for OG&E primarily relates to mercury and acid gases. As I mentioned, activated carbon injection in the use of Dry Sorbent Injection on a limited basis are expected to allow us to comply.

However, next two year maybe required to complete testing and installation. As you all know, regional haze has the largest potential regarding investment and impact on our customers. Meeting the EPI’s five-year federal implementation plan with forced-scrubbers would require more than a $1 billion of investment as oppose to the state implementation plan, which found low sulfur coal to be BART.

On April 4, the Oklahoma Attorney General and the OG&E requested a stay with the Tenth Circuit Court of Appeals. We believe the legal briefs filed with the petition provide compelling legal and technical reasons to satisfy the requirements first day. Based on previous timeline for similar issues, we would expect a decision this summer. And we’re proceeding with our initial engineering design plans for scrubbers in order to comply with the [flip] should our legal efforts not to be successful.

The recent announced PSO settlement and principal shows that the only low cost option for our customers to regional haze is for the federal implementation plan to be returned and the Oklahoma State plan to go forward.

Phase II of our smart grid deployment, as it relates to the installation of smart meters, and targeted distribution automation investment is in its third and final year. At this juncture almost 625,000 of approximately 800,000 meters on our system had been replaced, including 33,000 in Arkansas.

These investments are part of a second Phase covering the years 2010 to 2012, during which investment and operating expenses net of guaranteed savings are covered under regulatory rider. Part of our deployment we’ve embarked on a ambitious volunteer demand response program seeking to enroll 40,000 customers, with a goal of saving about 70 megawatts of our peak demand this year. We currently have over 12,000 customers enrolled. Success of this program is a critical component of our plan of not adding additional base load capacity until 2020. We are currently reviewing plans for our Phase III starting in 2013, which will include an expansion of the voluntary demand response program.

At Enogex, in the current price environment, the economics are difficult for producers in the leaner gas regions. Enogex has long-term dedications in some of the leaner areas that extend for several years into the future when drilling will likely return.

Enogex is also well positioned with large portion of our assets in the richer areas of the Woodford Shale and Granite Wash areas. These highly-profitable and highly-competitive areas are driving the growth in Enogex. While these liquids rich areas are very competitive Enogex continues to win new business and increase market share and in our 10-Q we announced a new long-term acreage dedication in our rich natural gas liquids plant in six counties of Southern and Central Oklahoma which will require new gathering and compression investment.

At the $200 million a day Wheeler, the McClure plants are on schedule for completion in 2012 and ’13 respectively as the gas wells in Western Oklahoma and the Panhandle are proven to be in high liquids content. We experienced 2% gathering and 20% processing volume growth quarter-over-quarter and anticipate reaching our volume growth targets this year of 6% to 10% for gathering, at least 15% for processing. Enogex pool of acres dedication is expanding and we look forward to adding more opportunities for growth in the near future.

Before turning it over to Sean, I want to mention that the economic health of our service territory remains strong. The March unemployment rates for the state are now 5.3% for the lowest in the nation and Oklahoma City’s employment rate is 4.4%, the lowest in the nation for large metro areas even significantly ahead of that economic engine that we know is Washington DC that has an unemployment rate of 5.5%. Utility customer growth continues at 1% or 7000 new customer’s pre year and oil field and industrial sales are showing steady growth. However low natural gas prices are impacting the states tax receipts and hopefully oil production tax receipts will ramp-up to mitigate that impact.

Overall we reign on sound footing with transmission expansion and smart grid implementation on track. Technically our environmental compliance plants are in place and the cost estimates for various alternatives are known. With the timing the expenditures continues to be in flux with legal proceedings pending. I discussed several calls ago, tight control of utility cost remain a priority to mitigate customer impact from future environmental compliance costs. We expect to be announcing on the second quarter call more specific timing of spending on low NOx burners as well as complying with Mac and Casper.

Enogex continues to grow in terms of the market share; gathering and processing volumes and acreage dedications in key areas would provide the basis for future growth. Our ArcLight partnership provides us capital as needed to execute on our objective, are positioning Enogex for significant growth and as a more substantial competitor with more base and diversity. This provides OGE Energy with more options in the future as we seek to maximize value. We continue to look at ways to produce sustainable value creation that withstands the test of time as opposed to short-term, but less sustainable gains.

Now I’d like to turn the call over to Sean, to review our financial performance in more detail.

Sean Trauschke

Thank you, Pete, and good morning. For the first quarter, we reported net income of $37 million or $0.38 per share as compared to net income of $25 million or $0.25 per share in 2011. The contribution by business unit on a comparative basis is listed on the slide. At OG&E net income for the quarter was $12 million or $0.13 per share as compared to net income of $6 million or $0.06 per share in 2011.

Now looking at some of the key drivers. First quarter gross margin came in stronger as we saw an increase of $29 million or 14%, and I’ll discuss those drivers on the next slide. O&M and depreciation were higher for the quarter; the increase was due to additional assets being placed in the service such as Crossroads and smart grid. We do have revenue offsets for both of these. Net other income decreased nearly $3 million due to lower AFUDC equity resulting from the completion of the Crossroads Wind Farm.

Interest expense was $5 million higher mainly due to the long-term debt issuance we completed in May of 2011. I would like to remind you that although earnings are up for the quarter compared to last year, the first quarter comprises less than 5% of the utilities earnings for the year.

Now turning to first quarter gross margin. The utility performed well despite warmer than normal weather. There were two primary drivers for the increase in gross margin. First, was the recovery of various utility investments as I mentioned previously. This accounted for $24 million of the increased margin.

Second, was the recovery of transmission investments primarily from SPP customers which increased gross margin by $9 million, major offset to these gains was the weather which lowered gross margin by $12 million, and if I look at that compared to normal, weather had a $5 million impact.

Like much of the country the winner of 2012 was one of the warmest on record, as heating degree days were 27% below last year and 23% below normal. On a weather normalized basis, residential megawatt hour sales grew just over 1% while oilfield sales were up 9%, public authority was up 5% and industrial sales grew 4%.

Now turning to first quarter Enogex earnings, OGE’s portion of Enogex’s earnings per share increased from $0.19 in 2011 to $0.25 in 2012. Gross margin grew by $20 million or 19%. On the next slide we’ll look at the gross margin growth in more detail.

O&M and depreciation increased $10 million due to higher cost to support system expansion and higher levels of plant and service. I did want to touch on the gain on insurance proceeds from the Cox City plant fire which occurred in December 2010. We recognized $7.5 million of the gains from insurance proceeds and this final $7.5 million resolves the claim with our insurers. Lastly the impact of ArcLight’s change in ownership resulted in $1.5 million variance quarter-over-quarter.

Now turning to gross margin for Enogex during the quarter. Gross margin increased in all of Enogex’s businesses with the exception of storage. The largest increase came from the processing business, while processing volumes increased 20% quarter-over-quarter. Commodity prices were mixed for the quarter, as natural gas prices declined from $4.13 per MMBtu to $2.80 per MMBtu. Natural gas liquids prices remained strong although the average prices per gallon declined from $1.11 in 2011 to $0.99 per gallon in 2012.

We saw record volumes in gross margins for condensate. Volumes increased 25% to 10 million gallons in the first quarter of 2012 compared to 8 million gallons in 2011. Condensate margins were $18 million for the quarter up $5 million or 38% compared to 2011. Gathering volumes increased 2% quarter-over-quarter and finally transportation margins also increased but were offset by $4 million lower cost to market adjustment in the storage business.

Consistent with what we saw with the Clinton plant, I would also like to point out that the new South Canadian plant and the replacement of the damaged portion of the Cox City plant has increased system efficiencies and therefore resulted in higher recoveries of liquids. These new plants can recover nearly 100% of the heavier liquids and 90% of the ethane compared to our older vintage plants in which ethane recovery was approximately 65%.

Before moving on to your questions, I would like to discuss our consolidated and utility earnings guidance that Pete, mentioned in his opening remarks. On a consolidated basis we are projecting earnings of $3.40 to $3.60 per average diluted share. The utility is forecasted to earn $2.60 to $2.70 per share and the holding company loss of $0.01 to $0.02 per share. The outlook for OGE’s portion of Enogex’s earnings remains unchanged at $0.80 to $0.95 per share.

Before going through the key details of the utility outlook, I did want to point out that the guidance does not include any impacts regarding the pending Oklahoma rate case. As Pete, mentioned we are well passed the 180 day statutory timeline and we felt it was important for us to provide investors with more clarity concerning 2012 earnings.

As a reminder, for every $5 million change in rates, earnings are impacted $0.03 per share on an annualized basis and every 10 basis point change in ROE impacts the requested rate increase by $3 million. Looking closer at the utility guidance of $2.60 to $2.70 per average share, one of the main drivers for higher gross margin in 2012 compared to 2011 is the recovery of our investments for the regionally allocated transmission projects from the SPP.

We are projecting $40 million of gross margin from these projects of which approximately $30 million is incremental compared to 2011. Under the FERC incentive rate plan we’re allowed recovery off and on our [Z-width] balances. All of the revenues forecasted for 2012 are from SPP customers outside of Oklahoma and Arkansas. We did ask for recovery of the Oklahoma jurisdictional portion in our Oklahoma rate case; that equates to approximately $3 million of the revenue requirement. I would also like to point out that we have held O&M flat year-over-year with the exception of investments with direct revenue offsets, and as you would expect depreciation expense will be higher as we place additional assets into service.

Finally if you look at the capital expenditure table in our 10-Q filed this morning, you’ll notice the capital expenditure estimates for 2012 to 2016 have been reduced at the utility by $285 million including $80 million in 2012. By lowering our capital spending we are hoping to mitigate future rate increases to customers especially in light of pinning the environmental regulations. Once we have a final rate order, we will update our guidance.

So this concludes our prepared remarks, and now we’ll open it up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Brian Russo with Ladenburg Thalmann. Please proceed.

Brian Russo - Ladenburg Thalmann & Co.

Hi. Good morning.

Peter Delaney

Hi. Good morning, Brian.

Sean Trauschke

Hi, Brian.

Brian Russo - Ladenburg Thalmann & Co.

Hey, just on the utility guidance of 260 to 270, and based on your sensitivities, you guys asked for roughly $70 million, the staff came in flat, let’s just assume on a more normalized ROE and to get most of your coarse-textured plant additions, say, $30 million of additional revenue. That equates to $0.18 of upside to your current guidance. There are no offsets there, a few more increase to your O&M or reposition the utility once you receive rate belief?

Sean Trauschke

Brian, this is Sean. The guidance excludes any impact of the rate order. And so, our plan is something that we view the utility that we – that’s sustainable. So, I want to avoid speculating what we would and wouldn’t do, but I think it’s safe to say that the impact of the rate outcome would be additive to the – to our guidance.

Brian Russo - Ladenburg Thalmann & Co.

Okay. So, I guess my math is in line.

Sean Trauschke

Yeah. If your math was, you said $30 million is roughly $0.18, yes.

Brian Russo - Ladenburg Thalmann & Co.

Yeah. Okay. And you mentioned you cut back on your CapEx at the utility, where are those cutbacks coming from? And why exactly – are you pulling back on that?

Sean Trauschke

Well, this is something we’ve been looking at for quite some time. And we’ve been investing a lot of money, improving the reliability of our system across our footprint. And we recognized that we’re going to have increased environmental expenditures coming down the road, and we’re balancing, we’re trying to minimize the impact on reliability and customer impact with these future environmental expenditures. So this is not in any one particular area, but this is more efficiencies and rationalization of some of the investments we’re making.

Brian Russo - Ladenburg Thalmann & Co.

Okay, great. And just switching gears to Enogex, you got about $0.15 range in your guidance assumption even after what appears to be a fairly strong first quarter ’12, is there any bias towards the upside of that range or the mid end of the range?

Sean Trauschke

It’s the first quarter. I think we’re comfortable right where we’re right now, Brian. No bias at this time one way or the other.

Brian Russo - Ladenburg Thalmann & Co.

Okay. And the CapEx profile at Enogex, have there been any additional projects identified or is the CapEx similar to what we see – what we saw last quarter?

Sean Trauschke

It’s actually increased by $55 million. And I think in Pete’s remarks, he talked about an additional acreage dedication for that, but the CapEx has increased by $55 million. And maybe Keith can talk a little bit about that dedication.

Keith Mitchell

Sure. There is a lot of activity going on in the rich areas around our system, and we were successful with bidding on one package. There are other packages, but at this point in time, we added in the CapEx for what we were awarded.

Brian Russo - Ladenburg Thalmann & Co.

Okay. And remind me – I think you got over a million dedicated acreages, is that accurate?

Keith Mitchell

Over the last year and a half, yes, there has been over a million acres that we’ve had awarded to us in dedications across our system.

Brian Russo - Ladenburg Thalmann & Co.

Okay. Is there any – could you break that down by region?

Keith Mitchell

Well, not to get too specific, but it’s definitely Western Oklahoma, Texas, that’s where there has been a lot of development, the Granite Wash areas and the Cana-Woodford areas, is where most of this activity has been occurring.

Brian Russo - Ladenburg Thalmann & Co.

Okay. And then lastly, we’ve seen a lot of we’ve seen a lot of activity in the MLP space and just in the midstream sector, particularly in your mid-continent region, you guys have got a lot of dedicated acreage, you got a very good partner in ArcLight, and what’s the long-term strategy for Enogex and is NMLP arrangement something to be considered?

Sean Trauschke

Well, Brian our strategy really hasn’t changed from the outset when we did the partnership. It was – our strategy is to, again as you noted, we’re grateful to be successful and the dedications that we’re undertaking. The Cordillera acquisition, the $200 million acquisition, we view it as important for us to help position in a great area.

Of course ArcLight Capital was helpful in that regard, but – and so, we continue with our plans to continue to build that portfolio of acres dedications, which is I pointed out as the basis for the future growth of that company. We’ve expanded the leadership team and we’re doing everything to strengthen that company more and more as a standalone entity.

And so as you know, that provides us greater flexibility with which to – with our partner go down different roads in the future, which one is under consideration would be a nice little partnership, and obviously I talked a little bit in my comments about we’re looking for -- to produce long-term sustainable value for our shareholders. And so, we’re – that’s what our goal is and it remains our goal.

Brian Russo - Ladenburg Thalmann & Co.

Okay, great. Thank you. One last quick question, are you guys involved in the Mississippian Oil Play at all?

Peter Delaney

We’ve been involved in – I’d say more of the eastern portion of that. That’s a pretty large area, northwest Oklahoma, northern Oklahoma into the Kansas. But we’ve been talking to some of the producers in the area, and we certainly think we’ll be successful in certain parts of that play.

Brian Russo - Ladenburg Thalmann & Co.

Okay, thank you very much.

Operator

(Operator Instructions) Your next question comes from the line of Andy Bischof with Morningstar. Please proceed.

Andrew Bischof - Morningstar, Inc

Hi, good morning. Just one quick question for you. If you could – once the decision is hand down by the ALJ, if you could kind of revive the regulatory timeframe, which we could expect decision on the rate case decision as you can?

Peter Delaney

Well, after the ALJ, there is probably – in the earliest, would be after that period of time I think would be three weeks or so period …

Andrew Bischof - Morningstar, Inc

Okay.

Peter Delaney

… about 30 days. There is the two-week period for appeal, but that’s – again, that’s probably the minimum. There is no – on the other side, it could go on longer than that.

Andrew Bischof - Morningstar, Inc

Okay. And there is really no indication of when the ALJ decision will come down?

Peter Delaney

We haven’t been very good at predicting that over the last couple of months. So – but we do believe that, we do have indications that it is in the near-future.

Andrew Bischof - Morningstar, Inc

Okay, great. Thank you.

Operator

Your next question comes from the line of Greg Reiss with Catapult. Please proceed.

David Frank - Catapult Capital Management

Hi. Good morning. It’s actually David Frank.

Peter Delaney

Hi, Dave. Good morning.

David Frank - Catapult Capital Management

Hey, good morning. Question for you guys on the PSO’s original Haze Settlement …

Sean Trauschke

Yeah.

David Frank - Catapult Capital Management

… and I was little unclear from your comments earlier on, but I mean, is there road for you to settle for some kind of similar compliance level, that’s more economic to the State or this does not have much application – applicability toward your fleet?

Sean Trauschke

I think it’s the latter, which doesn’t have much applicability to us.

David Frank - Catapult Capital Management

Okay. So there is not really like a cheaper option, if you were to really comply with?

Peter Delaney

Well, there is cheaper options, and we’ve evaluated exhaustibly a lot of those, and – but unfortunately, we don’t believe that the EPA will entertain any of those cheaper options in terms of the settlement.

As we – and again, we don’t have – I think PSO’s agreement and principle, those are the basic terms, but always a lot of details are important to work things out. But again, we – any type of settlement like that for us would again put a lot of economic – big increase in rates on our customers.

David Frank - Catapult Capital Management

Okay. And was I correct to understand that you would expect some kind of decision on this, potentially the summer kind of court ruling?

Peter Delaney

Well on the stay, yeah. Well, let me walk through that a minute, it’s worthwhile to do that. In my remarks I talked about couple of things. One that – so the low NOx portion of the Federal Implementation Plan we agreed with, and so when you look at the low NOx that we – that’s part of our Mac compliance and Casper. And Casper, I mean, Mac is more DSI and ACI that looks to us to about a $450 million investment. And so we’re moving ahead with our planning and in the next call, we will lay out more specifically the timing of expenditures for that $450 million.

Now with regional haze, which is a much bigger number potentially we believe that –again our estimate would be that we would get a stay from the Tenth. The stay decision would be made by the Tenth Circuit Court of Appeals in July around and so depending on what that decision is, obviously will have an impact on what we do.

David Frank - Catapult Capital Management

Okay. And if they grant a stay then …

Peter Delaney

Yeah, they grant a stay, David that starts the – actually the five-year period then would start at the end of the litigation when the case is decided. So, that could – decision could, be in – would probably be in 2013. Various people tell you whether its middle of ’13 or end of ’13, and so your compliance then would be pushed back to 18.

David Frank - Catapult Capital Management

Okay. And if they don’t grant a stay, then you …

Peter Delaney

Then the …

David Frank - Catapult Capital Management

… should have to make some decision on compliant by the normal time?

Peter Delaney

Yes. We are already – January 27, so we’re already couple of months into that time. The clock is ticking, and will continue to tick.

David Frank - Catapult Capital Management

Okay. All right, great. Thank you very much.

Peter Delaney

You’re welcome.

Operator

There are no further questions in queue at this time. I’d now like to hand the conference over to Mr. Pete Delaney for any closing remarks.

Pete Delaney

Thank you, operator. As always, I’d like to acknowledge our Company’s members continued hard work to make this quarter success. And I’d thank you for your continued interest in OGE Energy. Have a great day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect your lines. Good day.

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