ONE Gas, Inc. — Q1 2017 Form 10-Q
Business and period: Regulated natural gas distribution utility serving more than 2 million customers in Oklahoma, Kansas and Texas. Results cover the three months ended March 31, 2017; comparisons are with Q1 2016 unless noted. The company cautions that its business is seasonal and quarterly results are not necessarily indicative of full-year performance.
Financial results and position
| Metric | Q1 2017 | Q1 2016 / prior date |
|---|---|---|
| Revenue | $550.4 million | $508.4 million |
| Net margin | $287.3 million | $272.6 million |
| Operating income | $125.1 million | $116.1 million |
| Net income | $76.5 million | $64.7 million |
| Diluted EPS | $1.44 | $1.22 |
| Cash provided by operations | $162.2 million | $188.9 million |
| Capital expenditures | $70.5 million | $75.3 million |
| Cash and cash equivalents | $13.2 million | $14.7 million at Dec. 31, 2016 |
| Long-term debt, net of issuance costs | $1,192.6 million | $1,192.4 million at Dec. 31, 2016 |
| Short-term borrowings | $85.4 million | $145.0 million at Dec. 31, 2016 |
Operating expenses were $162.1 million, including $109.4 million of operations and maintenance and $37.0 million of depreciation and amortization. Interest expense, net, was $11.5 million. The filing does not report a specific margin percentage.
At March 31, 2017, total assets were $4.89 billion, total equity was $1.94 billion, and total current liabilities were $307.9 million. The company had $612.8 million of remaining availability under its $700 million revolving credit agreement, after short-term borrowings and letters of credit. Its debt-to-capital ratio was 40%, within the 70% covenant limit. Credit ratings were Moody’s A2, stable, and S&P A-, positive.
Changes versus the prior comparable period
- Revenue rose $42.0 million, while net margin increased $14.6 million (5%) and operating income rose $9.0 million (8%). Net income increased $11.7 million (18%); diluted EPS rose from $1.22 to $1.44.
- Management attributed higher net margin mainly to new Texas and Kansas rates (+$9.8 million), weather-normalization mechanisms (+$2.7 million), residential customer growth (+$0.8 million) and higher Kansas transportation volumes (+$0.7 million).
- Operating costs increased $3.3 million, reflecting prior-year deferral of certain IT costs, pipeline maintenance, higher IT costs and bad debt expense, partly offset by lower legal and employee-related costs. Depreciation and amortization rose $2.3 million as capital investments entered service.
- Operating cash flow declined $26.7 million, chiefly because working-capital changes more than offset higher net income and noncash expenses. Cash used in financing increased $29.5 million, mainly due to larger repayments of notes payable and higher dividends; fewer share repurchases partly offset this.
- Volumes sold fell from 67,117 to 64,947 MMcf, primarily due to warmer weather; weather-normalization mechanisms mitigated the margin impact. Total volumes delivered were nearly flat.
Outlook, commentary, risks and unusual items
- Outlook and liquidity: No specific earnings or financial guidance is provided in the filing. Management expects operating cash flow and short- and long-term financing arrangements to support planned operations and infrastructure investment, and describes its residential customer base, fixed charges and regulatory mechanisms as supporting relatively stable cash flows. It intends to maintain strong credit metrics and a competitive dividend.
- Dividend: In May 2017, the company declared $0.42 per share, or $1.68 annualized, payable June 1 to shareholders of record May 15.
- Accounting item: Adoption of ASU 2016-09 resulted in a $5.2 million reduction in Q1 income tax expense from excess tax benefits, increasing reported net income. The company also recorded an $11.0 million noncash opening retained-earnings increase for previously earned excess tax benefits.
- Regulatory matters: Oklahoma Natural Gas reported earnings within its allowed 9.0%–10.0% return-on-equity range and sought no base-rate change, while requesting an approximately $1.9 million program true-up and incentive adjustment. Texas GRIP filings requested $4.5 million for West Texas and $4.9 million for Central Texas; approval and effective rates remained pending.
- Environmental exposure: ONE Gas is responsible for 12 former manufactured-gas sites in Kansas. At one site, estimated investigation and remediation costs were $4.0–$7.0 million; a $4.0 million reserve was recorded in Q4 2016. Further testing and regulatory approval could change the estimate. Management says broader environmental costs are not expected to have a material adverse effect, but recovery through insurance or rates is not assured.
- Pipeline safety: Proposed PHMSA transmission and gathering pipeline rules could require significant capital and operating expenditures, depending on final regulations.
- Other risks: Results depend on rate recovery, regulation, weather, customer demand, operating and pipeline integrity, access to capital, interest rates, environmental compliance, and litigation or regulatory outcomes. The company reported no material expected adverse effect from ordinary-course litigation.
- Controls: Management concluded disclosure controls were effective at quarter-end and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of Q1 earnings growth is repeatable, given the $5.2 million tax benefit and seasonal weather effects?
- Whether pending rate and GRIP filings are approved, and the resulting timing and amount of customer revenue recovery.
- Whether regulatory authorities continue to permit recovery of the company’s substantial regulatory assets, including pension and postemployment benefit costs.
- Final remediation requirements and cost exposure at the Kansas manufactured-gas sites, including whether costs are recoverable from customers or insurance.
- The eventual cost and compliance impact of PHMSA pipeline-safety rulemaking, and capital-spending and cash-flow needs relative to financing capacity.