ONE Gas, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with Q1 2017 unless otherwise noted. ONE Gas is a regulated natural-gas distributor serving more than 2 million customers in Oklahoma, Kansas and Texas. Results are seasonal and the company cautions that this quarter is not necessarily indicative of full-year results. Amounts below are in U.S. dollars.
Financial results and key metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenue | $638.5 million | $550.4 million | +16.0% |
| Net margin | $288.0 million | $287.3 million | +$0.8 million |
| Operating income | $130.3 million | $129.4 million | +$0.9 million |
| Net income | $90.8 million | $76.5 million | +18.8% |
| Diluted EPS | $1.72 | $1.44 | +$0.28 |
| Cash from operations | $223.3 million | $162.2 million | +$61.1 million |
| Capital expenditures | $86.6 million | $70.5 million | +$16.1 million |
- Cost of natural gas rose to $350.4 million from $263.2 million. Because these costs are generally recovered through regulatory mechanisms, net margin is a more useful performance measure than revenue alone.
- Operating expenses were $157.8 million, essentially unchanged; depreciation and amortization increased 5% to $38.9 million. Net margin was nearly flat, with higher rates, transportation activity and customer growth largely offset by a $12.3 million tax-related revenue deferral.
- Net income increased chiefly because income tax expense fell to $24.9 million from $38.1 million, including a $16.2 million benefit associated primarily with the federal tax-rate reduction.
- Operating cash flow improved partly due to working-capital movements, including natural gas in storage and purchased-gas cost balances, as colder weather increased deliveries. Investing cash use was $86.6 million; financing cash use was $106.6 million. Cash increased to $44.5 million from $14.4 million at year-end.
- At March 31, total assets were $5.16 billion and equity was $2.02 billion. Debt included $893.5 million of long-term debt, $300.0 million of current maturities and $282.6 million of commercial paper. The $300 million notes due in 2019 were classified as current maturities.
- Liquidity included $44.5 million cash and $415.3 million of remaining availability under the $700 million revolving credit facility. Total debt-to-capital was 42%, against a 70% covenant maximum; the company reported compliance with covenants. Moody’s rating was A2 with a negative outlook; S&P’s was A with a stable outlook.
- Quarterly dividends declared were $0.46 per share, versus $0.42 in Q1 2017. The company also declared a $0.46-per-share dividend in April, payable June 1, 2018.
Material changes and management commentary
- Delivered volumes rose to 144,758 MMcf from 118,818 MMcf, mainly because Q1 2018 was colder. Heating degree days were above normal in Oklahoma, near normal in Kansas and below normal in Texas. Weather-normalization mechanisms mitigate much of the impact on residential and commercial margins.
- Net margin increased $0.8 million. Contributions from new rates, weather-normalization mechanisms, higher transportation volumes and customer growth were offset principally by the $12.3 million deferral for potential customer refunds following tax reform.
- Capital expenditures increased 23%, primarily for system integrity work and service extensions. Management describes ongoing infrastructure investment as necessary to maintain safe, reliable and efficient operations.
- Management says operating cash flow and expected financing arrangements should support planned operations and infrastructure investment, while noting that tax reform is expected to reduce operating cash flow over time. No company-wide earnings or EPS guidance is provided in the supplied filing text.
Outlook, regulation, risks and unusual items
- Tax reform and rates: The federal corporate tax rate fell from 35% to 21%. At quarter-end, the company had a $518.1 million regulatory liability related to remeasured accumulated deferred income taxes, subject to regulatory decisions on customer refunds. The timing and amount of refunds remain to be determined by regulators. The company also recorded a $12.3 million Q1 revenue reduction for the lower tax rate. Management expects tax reform to reduce cash flow through lower tax recovery in rates, customer refunds and loss of bonus depreciation; it believes available liquidity and capital structure can accommodate the effects.
- Pending rate matters: Oklahoma’s annual PBRC filing identified a proposed $5.6 million customer rate credit, primarily reflecting tax reform, and requested approximately $2.1 million for program true-ups and incentives; an order was expected in Q3 2018. Texas rate filings included requested increases and tax-related decreases/refunds, many subject to approval. In Kansas, a settlement contemplated a general rate case filing no later than 150 days after KCC approval.
- Safety and environmental exposure: Potential capital and operating costs under proposed PHMSA pipeline rules could be significant, depending on final regulations. The company has responsibilities at 12 former manufactured-gas-plant sites in Kansas. It recorded a $4.0 million reserve for one site against an estimated investigation/remediation range of $4.0–$7.0 million; recovery of eligible costs at the sites is subject to a $15.0 million cap absent further KCC approval.
- Other contingencies: Management believes probable outcomes of ordinary-course litigation and claims will not materially adversely affect results, financial position or cash flows. Environmental compliance costs, changing regulation and unrecovered remediation costs remain risks.
- Accounting and reporting: ASC 606 revenue guidance was adopted in Q1 2018 with no opening retained-earnings adjustment; certain regulatory-mechanism revenues were reclassified as other revenues. Adoption of pension-cost presentation guidance changed operating-income and other-expense classification, not previously reported net income. Management reported disclosure controls were effective.
Important facts for investors to verify
- Regulatory orders and the eventual amount, timing and method of customer refunds related to the $518.1 million tax-reform regulatory liability.
- Whether the pending Oklahoma and Texas rate filings are approved as requested, and the resulting effects on margins and customer refunds.
- Commercial-paper balances, credit-facility availability, refinancing of the $300 million 2019 maturity, and credit-rating outlooks.
- Whether higher infrastructure spending and any final pipeline-safety rules affect future cash flow, financing needs or allowed recovery through rates.
- Environmental remediation developments, including costs beyond recorded reserves and the Kansas recovery cap.
- How much of the Q1 operating-cash-flow increase reflects seasonal and working-capital timing rather than recurring cash generation.