OGE ENERGY CORP. quarterly report, Q2 FY2018

OGE Energy Corp. — Q2 2018 Form 10-Q

Business context and reporting period. This unaudited quarterly report covers the three and six months ended June 30, 2018. OGE operates a regulated electric utility in Oklahoma and western Arkansas through OG&E, and holds a 25.6% equity-method interest in Enable Midstream Partners, a natural-gas and crude-oil midstream business. Results are seasonal and are not necessarily indicative of full-year performance.

Financial results and liquidity

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Operating revenue	$567.0 million	$586.4 million	$1,059.7 million	$1,042.4 million
Operating income	$131.7 million	$145.8 million	$192.2 million	$191.5 million
Net income	$110.7 million	$104.8 million	$165.7 million	$140.8 million
Diluted EPS	$0.55	$0.52	$0.83	$0.70
Dividends declared per share	$0.33250	$0.30250	$0.66500	$0.60500

• OG&E’s gross margin, a company-defined non-GAAP measure, was $358.3 million in Q2, up 1.1%, and $640.5 million for the first half, up 6.5% year over year. Consolidated operating revenue declined in Q2 despite higher system sales revenue, principally reflecting a $16.5 million rate-refund provision versus $16.6 million of provision reversal in Q2 2017.
• Income tax expense fell to $17.9 million in Q2 from $46.6 million, and to $28.0 million for the first half from $66.6 million, primarily reflecting the lower federal corporate tax rate and other tax effects.
• First-half operating cash flow was $354.2 million, compared with $197.4 million. Investing cash outflow was $266.9 million, versus $490.3 million, largely due to lower capital expenditures. Financing cash outflow was $101.7 million; the prior-year period included long-term debt issuance and revolver borrowings. Cash was nil at June 30.
• At June 30, total debt was approximately $3.20 billion, including $200.1 million of short-term debt, $499.9 million of long-term debt due within one year, and $2.50 billion of long-term debt. The current portion increased mainly because debt maturing in January 2019 was reclassified. The company reported $699.6 million of net available liquidity under its revolving facilities, which total $900 million.
• Current assets of $560.8 million were below current liabilities of $1.25 billion. OGE reported compliance with its debt agreements. It expected to issue up to $400 million of long-term debt in the second half of 2018, subject to market conditions.

Material changes and management commentary

• Net income increased 5.6% in Q2 and 17.7% for the first half. Management attributed the gains mainly to higher OG&E gross margin and lower income tax expense; higher operating and maintenance, depreciation and interest expense partly offset these benefits.
• OG&E’s Oklahoma settlement, approved June 19, reduced annual rates by a net $64 million, including the effects of the Mustang modernization investment and lower taxes under the 2017 Tax Act. New rates took effect July 1. The tax reserve for January–June was refunded to Oklahoma customers in July.
• OG&E’s seven Mustang combustion turbines were in service, with minor project work remaining. The company’s long-term financial objectives include 3%–5% annual weather-normalized OG&E earnings growth and dividend increases of approximately 10% annually through 2019.
• OGE Energy’s 2018 earnings guidance was projected at the top end of its previously issued range: net income of approximately $380–$410 million, or $1.90–$2.05 per diluted share. This assumes normal weather for the remainder of the year and about 200 million diluted shares; favorable Q2 weather supported the updated expectation.

Risks, contingencies, and unusual items

• Credit ratings weakened: S&P lowered OGE Energy and OG&E to BBB+ in June and assigned stable outlooks; Moody’s lowered ratings in July and assigned negative outlooks; Fitch lowered ratings in August and assigned stable outlooks. Management said the borrowing-cost impact under credit agreements would be immaterial. Rating agencies cited regulatory outcomes, capital spending, tax changes, and, for the parent, Enable-related risks.
• OG&E’s Sooner Dry Scrubber project was expected to cost $542.4 million, with $451.6 million invested by June 30, and completion expected in late 2018 to early 2019. The Oklahoma Supreme Court ruled that the OCC lacked authority to pre-approve the project outside the applicable statutory process. OG&E intends to seek recovery in a future general rate review; cost recovery remains subject to review and uncertainty.
• A municipal power authority’s FERC complaint seeks to reduce OG&E’s transmission return on equity from 10.60% to 7.85%. OGE estimated that each 25-basis-point reduction could lower annual transmission revenue by about $1.5 million; a reduction or retroactive refunds could materially affect results. The outcome and timing were uncertain.
• OG&E had recorded $32.8 million of reserves at June 30 for tax-related customer refunds and adjustments across jurisdictions. Arkansas and FERC-related refund amounts were still being reserved pending updated rates or riders.
• Environmental rules, litigation, and permitting may require additional costs, although management reported substantial compliance with current standards and could not quantify certain future costs. Fuel-adjustment reviews and regulatory proceedings are additional contingencies; management did not expect reasonably possible legal losses above accruals to be quantitatively material.
• Enable’s earnings and distributions are exposed to commodity prices, drilling and production activity, contract renewals, competition, and regulatory changes. Its quarterly distribution announced August 1 was $0.318 per unit, unchanged from the prior quarter.

Important facts for investors to verify

• Whether the $64 million annual Oklahoma rate reduction, refund requirements, and subsequent Arkansas and FERC tax riders affect realized utility earnings and cash flows as expected.
• OG&E’s recovery prospects and final cost for the Sooner Dry Scrubbers, including the outcome of prudence and used-and-useful reviews.
• The resolution and potential refund exposure from the FERC return-on-equity complaint and the 2017 fuel-adjustment review.
• Whether the company can refinance the January 2019 debt maturity and fund capital spending while maintaining liquidity, credit quality, and dividend growth targets.
• Whether Enable sustains distributions and earnings amid midstream regulatory, volume, commodity, and contract-renewal risks.