Good day, ladies and gentlemen, and welcome to the third quarter 2018 OGE Energy Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require operator's assistance during today's conference, please press star then zero on your touch-tone telephone. As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Mr. Todd Tidwell. Sir, please go ahead.
Thank you, Michelle. Good morning, everyone, and welcome to OGE Energy Corp's third quarter 2018 earnings call. I'm Todd Tidwell, Director of Investor Relations, and with me today, I have Sean Trauschke , Chairman, President, and CEO of OGE Energy Corp, and Steve Merrill, CFO of OGE Energy Corp. In terms of the call today, we will first hear from Sean, followed by an explanation from Steve of third quarter 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 ogeenergy.com. 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 there is a Regulation G reconciliation for gross margin in the appendix. I will now turn the call over to Sean Trauschke for his opening comments. Sean?
Thank you, Todd. Good morning, everyone, and thank you for joining us on today's call. Earlier this morning, we reported third-quarter consolidated earnings of $1.02 per share compared to $0.92 per share in 2017. The utility reported earnings of $0.92 per share and our portion of Enable earnings was $0.14 per share. I'm pleased with the operational and financial performance of both businesses. Steve will discuss the financial results in a moment, but first, I'd like to discuss the key events and accomplishments. OGE's had a remarkable year. It seems each quarter we are achieving a new milestone on our journey to continually getting better to improve the customer experience with safe, reliable, and low-cost energy. It should be better. That's what good operating companies do. They get better. They grow. That's clearly what we are doing.
We continued our strong record-setting safety performance and year-to-date are the safest company in our industry, and we expect the same of our contractors. Illustrative of this is the Sooner Scrubber project that has seen 2.8 million hours worked with no lost time accidents. Speaking of the generating fleet, I'm pleased to announce that our fleet continues to build upon last year's performance. The Mustang Energy Center has had approximately 1,800 starts across the 7 units since inception earlier this year, demonstrating their value to the market and our customers. Generation reliability has also improved by an additional 4% over 2017. Distribution reliability has improved approximately 10% over 2017 as our deployment of technology and the hardening of assets is showing real value for our customers. This year, we also completed and placed into service the Windspeed II transmission line, the Covington Solar Farm.
We settled our last rate case in a constructive manner, passing through to our customers the benefits of Tax Reform in a timely fashion. The Sooner Scrubber project is on time and on budget. Unit 1 has been commissioned, Unit 2's on schedule and slated for completion next month. Finally, we once again answered the call to assist with recent hurricane restoration efforts. While the year isn't complete, I couldn't be more proud of our performance. We are in the fortunate position of having continued customer and sales growth in our service territory. We added over 6,000 new customers since last year, and sales growth is steady at about 1%. The economies of our two largest load centers are robust. Oklahoma City's unemployment rate sits at 2.8%, and Fort Smith is at 3.6%.
You will recall at the height of the 2008 recession, the unemployment rate in Fort Smith was well over 10%. Truly a remarkable turnaround story in Western Arkansas. Leadership and economic development is an important part of our company strategy. We continue to be on the front line working with stakeholders to attract new and diverse businesses to our service territory, as well as playing a key role in the expansion of current businesses. For example, in the third quarter, we saw the expansion of a large customer in Enid, Oklahoma. This successful expansion was instrumental in not only protecting existing jobs in the area, but also adding new jobs. We successfully partner with our customers and communities to find solutions for their business and economic needs. Furthermore, on the commercial front, our footprint continues to expand in the data center sector.
Another area of focus that is gaining traction is the electrification of compressors and processors in the prolific SCOOP and STACK midstream space. There is a strong business case for conversion, and we're at the forefront of this transition. Clearly, Oklahoma and Arkansas are open for business, and we're proud to be playing an active and supportive role in this endeavor. Turning to the regulatory front, we submitted our final integrated resource plan to the OCC in September. At the same time, we had the opportunity to end a costly contract which necessitates the need for replacement capacity. For reference, our capacity needs are 168 MW by the summer of 2019, and 305 MW by the summer of 2020, in order to maintain our capacity reserve margin requirements in the SPP. We issued an RFP for these capacity needs.
We expect to make a pre-approval filing with the OCC in December, and a similar filing in Arkansas. We have been impressed with the proposals, and although we can't discuss the specifics, we are pleased that customers will see reduced costs as a result of our actions. We've mentioned many times that a cornerstone of our strategy is to actively manage cost to customers, so that new investments can be made to protect the customer's bill. This is a prime example of this strategy in action. Since 2011, we have invested over $5 billion at the utility, and customer bills have grown less than 1%. In Arkansas, we filed a new rate request under the formula rate plan and requested a $6.4 million increase, with new rates in place by April 1st of 2019.
We are excited about this streamlined process in Arkansas that expedites recovery, increases transparency, and enhances the utility planning process. Continuing on with the regulatory update, we will file a general rate case in Oklahoma for the recovery of the Sooner Scrubbers by year-end. Before moving on to Enable, I did want to briefly discuss our financial position as it relates to capital expenditures and dividend growth. At the end of September, the OGE board approved another 10% increase in the dividend. This was the fifth consecutive year of a 10% increase. We announced our dividend policy back in 2014 with the formation of Enable and the flip in cash position from the midstream business. As investors, you rightfully inquire if we will continue with the increase and at what percentage. I can tell you this is an area where we are strongly focused.
We are in the favorable position of having many options because of our healthy balance sheet, which provides significant financial flexibility. Our objective has always been, and continues to be, value creation. We can increase the capital investment, increase the dividend, or both. Regardless, you should expect us to continue to be prudent allocators of capital. I do want to be very clear here that we will not sit on excess cash, nor will we allow the balance sheet to become lazy. Embedded in this is our commitment to protecting our strong credit profile. We will continue to update investments as we see clarity in the recovery, and you should not expect a big multi-year capital announcement, but rather a value creation strategy based on financial flexibility. What we will do is deploy capital in the most efficient manner that benefits customers and shareholders alike.
We have a large backlog of projects that have not been reflected in our capital expenditure forecast. If the regulatory environment is constructive, you can expect to see increased investments that benefit customers. If not, cash will be deployed through dividends or other means to increase shareholder value. In other words, we will always look to optimize our capital allocation strategy with a goal to maximize shareholder value. Now to Enable. They continue to produce stellar results. Natural gas gathered, natural gas processed, natural gas liquids produced, and crude oil gathered all hit record highs once again in the third quarter. Distributable cash flow and net income also were at record levels. Enable's ability to maintain strong financial metrics through trying times is a testament to their leadership and focus.
They continue to tie in assets to expand their existing footprint in some of the most prolific oil and gas spaces in the U.S. The recently announced acquisition of Velocity Holdings greatly enhances their position in the crude gathering business. In this quarter, they also announced the development of a Gulf Run pipeline, an interstate natural gas transportation project that is designed to connect abundant U.S. natural gas supplies to growing LNG export markets in the Gulf Coast. This is another example of Enable leveraging its existing assets to provide customers with cost-effective market solutions. Before turning the call over to Steve, I did want to reiterate how pleased I am with our position as a company. These results just don't happen overnight, but are the result of hard work and focus by everyone here.
You know, a key part of our strategy and culture is to never settle, but to strive to get better each and every day. It's not just a motto, it's not just a slogan, but something in which we are all committed. We believe this creates the proverbial win-win for customers and shareholders. Thank you. Now I'll turn the call over to Steve to review the financial results. Steve?
Thank you, Sean. Good morning, everyone. For the third quarter, we reported net income of $205 million, or $1.02 per share, as compared to net income of $183 million, or $0.92 per share in 2017. The contribution by business unit on a comparative basis is listed on the slide. As you know, we implemented rates in July that include tax reform, and this adds complexity to quarter-over-quarter comparisons. I will do my best to simplify this in my remarks. Turning to gross margin. Gross margin at the utility was higher for the quarter, excluding the impacts from tax reform that resulted in lower customer rates, which were offset by lower income tax expense. Margin was higher due to the following.
Weather contributed approximately $5 million in margin as cooling degree days increased 3% compared to the third quarter of 2017. However, compared to normal, weather reduced margin approximately $12 million for the quarter. New customer growth contributed approximately $3 million. We added nearly 6,300 new customers to the system as compared to the third quarter of 2017, supported by our commercial industrial sectors. Higher demand revenue and industrial oil field sales increased margin by approximately $6 million. Offsetting these increases were the impact of lower tax rates on margin as a result of the Tax Cuts and Jobs Act. At OG&E, net income for the quarter was $184 million, or $0.92 per share in 2018 as compared to net income of $162 million, or $0.81 per share in 2017.
O&M increased approximately $6 million due in part to the timing of plant maintenance and increased employee costs, and we are on plan for the year. Depreciation increased approximately $5 million, primarily due to the Mustang CTs being placed into service. AFUDC also decreased $5 million as we are seeing lower construction work and progress balances with projects being completed. Likewise, other income was approximately $10 million lower, due in part to a decrease in the tax gross-up related to lower AFUDC and a decrease in Guaranteed Flat Bill margins, which are now included in gross margin. This trend of lower AFUDC and higher depreciation expense will continue as our projects are placed into service. Margin will increase once we receive recovery. Placing these major projects into service creates the lumpiness in earnings we've mentioned in the past.
Income tax expenses decreased $53 million, primarily due to the reduction in the corporate federal tax rate. Turning to our investment Enable. For the third quarter of 2018, Enable Midstream made cash distributions of approximately $35 million, the same amount received in the third quarter of 2017. Enable also contributed earnings of $28 million, or $0.14 per share, compared to $21 million or $0.10 per share in 2017. The increase in earnings was primarily due to record volumes in the gathering and processing segment, partially offset by higher operating and interest expenses. Enable continues to perform very well. This quarter, they achieved record financial results that included the highest quarterly results for net income, adjusted EBITDA, and distributable cash flow since their formation in 2013. They ended the quarter with a distribution coverage ratio of 1.6 times.
We were pleased with the 2019 outlook Enable provided on their call. Comparing their 2018 guidance with the newly issued 2019 guidance, they are expecting growth in adjusted EBITDA of 12% and growth in distributable cash flow of 9%, while maintaining a strong coverage ratio of 1.38 times at the midpoint of their range. We look forward to Enable's continued growth. Turning to the 2018 outlook, we're increasing our utility guidance to $1.59-$1.61 per share. There's a few reasons for the increase. The utility experienced a one-time $0.04 per share benefit from the timing of rate implementation and rate design. Weather was approximately $0.04 above normal year to date. Depreciation expense is lower due to the timing of plant placed into service, and the utility had stronger non-residential growth than expected.
Excluding the one-time items, we had an outstanding year and would have been towards the top end of our guidance. The earnings contributions from OGE Energy Holdings' ownership interest in Enable Midstream is projected to be between $0.50 and $0.52 per share. The consolidated guidance projection has increased to between $2.05-$2.09 per average diluted share and includes a projected $0.04 loss at the holding company. This is an increase from the previously issued guidance of between $1.90-$2.05 per average diluted share and is primarily due to higher projected earnings at the utility. This concludes our prepared remarks today, and we will now answer your questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star, then the number 1 on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from the line of Paul Ridzon with KeyBank. Your line is open. Please go ahead.
Morning, Steve. Morning, Sean. How are you?
Hey, good morning, Paul.
A couple questions. What drove the lower holdco results in the quarter? I guess we'll just take them one at a time, I guess.
Yeah. On the holding company, there's a little bit of interest expense that's there as we kind of manage short-term debt or cash. That happens from time to time. There's also a little bit of a timing on taxes there that will reverse in the fourth quarter, but we do expect the holding company to be around $0.04 for the year. We also have a deferred compensation plan that when the stock overperforms, actually causes us to have a charge at the holding company, and that's the remaining portion.
You mentioned 305 megawatts short by 2020. You've got an RFP out. I assume you've bid into that?
Well, we're running an RFP, and there are available options out there in the marketplace. We certainly will compare that to our own internal options, and we'll see where that takes us. I think to your question, I guess, is how does this impact our capital expenditure slides or forecast for 2019? We
We incorporated that into those numbers.
Okay. Then in the quarters, was tax reform neutral?
No. There was a little bit of a pickup. Well, actually, there was about $0.08 of a pickup, due to tax reform. That's really just a timing issue. When tax reform was put into base rates, that gives money back to customers ratably throughout the year. As you know, our margin is seasonal. Our revenues are seasonal. There's a pickup when our revenues were high, and we'll be giving that back over the next two quarters, where customers and us, it is neutral overall, but just the timing of our revenue stream creates a bit of a disconnect.
Is it neutral within 2018, or does it get into multiple years?
It crosses over into the first quarter of 2019.
Where are we year to date?
We'll be a $0.04 pickup this year.
You kind of gave some reasons for the increased guidance. Do any of these bleed through to 2019, or are they all kind of one-time or just timing issues?
Eight cents is one-time. $0.04 from the timing of Tax Reform and $0.04 due to weather.
Okay. All right. Thank you very much.
You're welcome.
Thanks, Paul.
Thank you. Our next question comes from the line of Julien Dumoulin-Smith with Bank of America, Merrill Lynch. Your line is open. Please go ahead.
Hey, good morning. This is actually Richard Ciciarelli here for Julian.
Okay. Good morning.
Morning. Yeah, I just had a question, regarding the grid modernization plan. Have you been deploying that in Arkansas? When can we kind of expect you to display the benefits in Oklahoma to the regulators there?
I'm sorry. I didn't catch the last part of your question.
Yeah, I was just wondering if you've started deploying grid mod in Arkansas. If you have, when can we expect you to begin educating stakeholders in Oklahoma of the benefits there and potentially-
Okay.
-pursue a rider in Oklahoma?
Yeah. Great question. Yes, we are underway in Arkansas. We're addressing about a third of the circuits in Arkansas. We think we're expecting to see a 10% improvement in saving Arkansas, some significant savings in terms of O&M expenses in Arkansas just by looking at this first wave of a third of the circuits there in Arkansas. The idea would be, we want to get past the Sooner Scrubber project, this RFP project, then we will begin having dialogue with some sort of rider or tracker for grid mod in Oklahoma. First things first, we want to get the current regulatory calendar behind us. I think the other benefit that occurs there is because we have the formula rate in Arkansas, we will have a track record there of what investments we made and the realized customer benefits that have been achieved.
I think we'll have a good story there to share that with Oklahoma.
Got you. Thank you. That's very helpful. Just, you alluded to having a large backlog of projects not in your forecast.
Yeah.
I'm just wondering, outside of grid mod, what other opportunities are you seeing?
I think it's primarily around the grid mod, That's become a big word that encompasses a lot of elements. We've said for a number of years when before we had the formula rate structure in Arkansas, we did not invest as heavily as we had been in years past. We've got some catch-up work to do in Arkansas. In addition to that, we are installing a lot of this new technology there in Arkansas. We've got two components going on in Arkansas. Quite frankly, even in Oklahoma, because we were forced to do these environmental compliance projects, we deferred some of the investments in grid modernization, some of those emerging technologies to kind of ease the customer impacts. We've even got some catch up to do in Oklahoma too. It's primarily going to be around the wires side of the business.
We've invested significantly in on the generation side here in the last couple of years. We're always looking for creative ways to make investments and really improve the reliability to customers and not impact their bills.
Okay. Thank you. That's very helpful. That's all I have.
Okay. Have a great day. Thank you.
All right. You too.
Thank you. Again, ladies and gentlemen, if you have a question at this time, please press star then one on your touch tone telephone. Our next question comes from the line of Andrew Levy with ExodusPoint. Your line is open. Please go ahead.
Hey, guys. How are you?
Hey, good, Andy. How are you doing?
I'm doing really well.
Are you already out in California for EEI or?
No, actually, I have a bat mitzvah on Saturday. You're not going to get to see me.
Are you not coming out next week at all?
I'm not.
Oh.
Markets are kind of volatile too. Whatever.
All right.
I'll ask my question here, and I'll see you in December, I guess, when you come to California.
Okay. All right.
Anyway, just two questions, and I apologize because I did jump on five minutes late, and I heard the tail end. Could you just repeat, I hate to make you repeat, but just what you were saying about the dividend longer term?
Yeah.
I'm sorry. The second question is also what you were saying longer term about potential CapEx raises.
Our intent is to continue to invest organically and grow the earnings of the company and grow the dividends of the company. We're going to be prudent allocators of that. We've worked hard to create our balance sheet. We're fortunate to have that flexibility. What I was referring to is, I want to get through, in particular in Oklahoma, through these environmental projects. The one lesson we learned out of some of our previous cases is we've got to keep these simple, stay focused on the task at hand, and not get too far out in front. I do believe things are continuing to improve in Oklahoma, and as things continue, we will begin highlighting more capital investment opportunities as we go. I'm not sure that, in particular in Oklahoma, for us to announce a multi-year, multi-billion-dollar investment program is productive to the regulatory outcome.
We're going to be very thoughtful about growing our dividend and making investments, but the ultimate goal is to really grow both, meaning the earnings of the company and dividends. We've done that over the last couple of years, and we think that's going to continue. We expect it to continue.
As far as the dividend?
We're going to grow that, too. We're going to grow it 10% this year.
Right. No, I know. Longer term, when do we find out? Because that was through this year, and then after that, we were going to get a new dividend.
Yeah, I think we're going to get through this regulatory cycle in Oklahoma, and that'll be a very good data point for us to identify a longer-term dividend growth rate.
Okay. I got it. Okay. Thank you very much. Great quarter.
Hey, thanks, Andy. Take care, and good luck Saturday. All the best.
It's fun. It's not. Don't need luck.
All right.
Thank you. I'm showing no further questions at this time, and I'd like to turn the conference back over to Sean Trauschke for any closing remarks.
Well, thank you, Michelle. Thank you all for joining us today, and thank you for your interest in the company. I look forward to seeing many of you next week. Have a great day.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.