ONE Gas, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. ONE Gas is a regulated natural-gas utility serving more than 2 million customers in Oklahoma, Kansas and Texas. Results are seasonal and interim performance is not necessarily indicative of a full year.
Financial performance
Amounts below are in millions, except per-share data. Comparative periods are the corresponding 2017 periods.
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Total revenue | $292.5 vs. $279.7 | $931.0 vs. $830.1 |
| Net margin | $198.4 vs. $197.1 | $486.4 vs. $484.4 |
| Operating income | $41.0 vs. $48.4 | $171.3 vs. $177.8 |
| Net income | $20.4 vs. $20.6 | $111.3 vs. $97.1 |
| Diluted EPS | $0.39 vs. $0.39 | $2.10 vs. $1.83 |
| Capital expenditures | $89.2 vs. $84.2 | $175.8 vs. $154.7 |
In Q2, revenue increased about 5%, but operating income fell about 15% and net income was nearly flat. For the first half, revenue increased about 12% and net income about 15%, while operating income declined about 4%. Revenue growth largely reflects higher natural-gas sales and transportation activity; natural-gas commodity costs are generally recovered through regulatory mechanisms. Net margin, which management considers a more relevant performance measure than revenue, increased only $1.2 million in Q2 and $2.0 million for the six-month period.
Q2 net margin benefited from new Texas and Kansas rates, higher volumes and customer growth, partly offset by a $9.2 million revenue deferral associated with potential customer refunds following federal tax reform. The corresponding six-month deferral was $21.5 million. Operating expenses rose, particularly employee-related costs; depreciation also increased as capital projects entered service.
Cash flow, debt and liquidity
- Operating cash flow: $400.0 million for the first half, up from $279.3 million, primarily reflecting working-capital movements, including purchased-gas costs, gas storage and weather-related regulatory adjustments.
- Investing cash flow: $175.8 million used, mainly for capital expenditures. Financing cash flow: $226.0 million used, including $172.2 million of net note-payable repayments and $48.3 million of dividends paid. Cash ended the period at $12.6 million.
- Debt and liquidity: Long-term debt, including current maturities, was approximately $1.2 billion; commercial paper outstanding was $185.0 million. The company had $514.2 million of available capacity under its $700 million revolving credit facility. The $300 million of 2.07% notes due in 2019 was classified as current maturities.
- Leverage and credit: Total debt-to-capital was 41%, versus a 70% covenant limit; the company reported compliance with covenants. Long-term debt-to-capital was 37%. Moody’s rated the company A2 with a negative outlook; S&P rated it A with a stable outlook. Moody’s outlook change reflected potential tax-reform impacts.
- Dividend: The company declared a Q3 dividend of $0.46 per share, or $1.84 annualized, payable September 4, 2018.
Material changes, outlook and risks
- Tax reform: The federal corporate tax rate fell from 35% to 21%. At June 30, the company recorded a $521.7 million regulatory liability related to remeasured accumulated deferred income taxes, subject to regulatory determination and customer refunds. Regulators in the three states are addressing the timing and method of rate changes and refunds. Management expects tax reform to reduce operating cash flow over time, but believes available liquidity and its capital structure are adequate to adjust.
- Rate proceedings: Kansas Gas Service filed for a $42.7 million net base-rate increase, in addition to $2.9 million already recovered through its surcharge, citing system investment and operating costs. Oklahoma’s pending annual rate filing included a $5.6 million credit to customers, primarily reflecting tax-rate reductions, and a requested approximately $2.1 million energy-efficiency and incentive adjustment. Texas rate and surcharge decisions included both increases for system investment and tax-related rate reductions/refunds.
- Investment and safety: First-half capital expenditures rose 14% to $175.8 million, primarily for system integrity and service expansion. Proposed federal pipeline-safety rules could require significant capital and operating spending; final-rule timing and impact were uncertain.
- Environmental and legal contingencies: At one former Kansas manufactured-gas-plant site, the estimated investigation and remediation range was revised to $5.6–$7.0 million; a $1.6 million reserve adjustment was recorded in Q2, with a corresponding regulatory asset. A Kansas order allows qualifying site costs to be deferred up to a $15 million cap, subject to recovery approval. Management said other ordinary-course litigation losses are not expected to be material.
- Other considerations: Management cited weather, regulatory recovery, operating costs, pipeline integrity, environmental requirements, financing access and credit ratings among factors that could affect results. No specific company-wide earnings or full-year capital-expenditure guidance is provided in the filing. Management describes cash generation as historically stable, supported by residential customers, fixed charges and regulatory mechanisms.
Important facts for investors to verify
- Regulatory decisions on tax-related customer refunds, the $521.7 million deferred-tax regulatory liability and pending state rate cases.
- Refinancing or repayment plans for the $300 million of notes due in 2019, and the company’s continuing access to commercial-paper and bank-credit markets.
- Whether operating cash flow remains sufficient to fund infrastructure investment and dividends as tax reform affects cash taxes and customer refunds.
- Final pipeline-safety requirements and resulting compliance costs, together with remediation estimates and recoverability for Kansas MGP sites.
- Whether reported first-half earnings and cash flows are representative, given seasonal utility demand and significant working-capital effects.