ONE Gas, Inc. — Q3 2017 Form 10-Q
Business and period: ONE Gas is a regulated natural-gas distributor serving more than 2 million customers in Oklahoma, Kansas and Texas. This unaudited report covers the three and nine months ended September 30, 2017; results are seasonal and may not indicate full-year performance.
Financial results and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $247.1 million | $232.2 million | $1,077.2 million | $986.5 million |
| Net margin | $188.4 million | $179.9 million | $672.7 million | $642.0 million |
| Operating income | $40.8 million | $30.9 million | $210.0 million | $190.6 million |
| Net income | $18.8 million | $12.7 million | $115.9 million | $97.8 million |
| Diluted EPS | $0.36 | $0.24 | $2.19 | $1.85 |
| Operating cash flow | — | — | $302.4 million | $290.4 million |
| Capital expenditures | — | — | $249.1 million | $231.3 million |
Revenue growth primarily reflected higher natural-gas sales; commodity costs are generally recovered through regulatory mechanisms, so net margin is a more informative measure of underlying revenue contribution. Q3 operating income rose 32%, and nine-month operating income rose 10%. Net income benefited from a $5.2 million excess share-based compensation tax benefit recorded in Q1.
At September 30, cash was $6.9 million, short-term borrowings were $174.0 million, and long-term debt was $1,193.1 million. The company reported a 41% total debt-to-capital ratio, compliance with credit-facility covenants, and $524.2 million of remaining credit availability. Nine-month cash used in investing was $248.4 million; cash used in financing was $61.8 million. Cash declined $7.8 million from year-end 2016 to $6.9 million.
Equity was $1,932.0 million at September 30, compared with $1,888.3 million at December 31, 2016. Dividends declared were $0.42 per share in Q3 and $1.26 per share year to date. In October, the company declared a $0.42-per-share dividend, or $1.68 annualized.
Material changes and management commentary
- Nine-month net margin increased $30.7 million, mainly from $20.0 million of new rates in Texas and Kansas, $5.5 million from weather-normalization mechanisms, customer growth and higher transportation volumes.
- Q3 net margin increased $8.4 million, primarily due to new rates, residential customer growth and the modified Kansas weather-normalization mechanism.
- Capital expenditures rose 8% year over year for the first nine months, largely reflecting system-integrity work and service extensions. Management described infrastructure investment as focused on safe, reliable operations.
- In October, ONE Gas amended and restated its $700 million unsecured revolving credit facility, which expires in October 2022 and may be increased by up to $500 million subject to customary conditions. Management expects operating cash flow and financing arrangements to support current operations and planned infrastructure investment.
Outlook, risks and unusual items
- The filing provides no specific earnings or EPS guidance. Management emphasizes the stable cash-flow profile it associates with residential customers, fixed charges and regulatory mechanisms.
- Key exposures include regulatory recovery and rate proceedings, weather and demand, natural-gas supply and transportation, interest rates and access to capital, pipeline integrity and safety requirements, environmental compliance, cybersecurity, and pension obligations.
- For 12 former manufactured-gas-plant sites in Kansas, a proposed settlement would allow deferral of eligible costs incurred after January 1, 2017, up to $15 million net of insurance, subject to KCC approval. A $4 million reserve had been recorded for one site; management estimated potential investigation and remediation costs there at $4 million to $7 million. Future costs and recoverability remain uncertain.
- Proposed PHMSA transmission-pipeline rules could require significant capital and operating expenditures depending on final requirements. The company said ordinary-course litigation losses were not expected to be material.
- The company adopted new share-based-payment accounting in 2017, recording the $5.2 million tax benefit in income tax expense and an $11.0 million cumulative-effect increase to opening retained earnings. It also early-adopted the simplified goodwill impairment test without financial-statement impact.
- Disclosure controls were assessed as effective, and the company reported no materially affecting changes in internal control over financial reporting during Q3.
Important facts for investors to verify
- How much of the year-to-date earnings increase is sustainable apart from the $5.2 million tax benefit and regulatory rate changes?
- Whether the KCC approves the MGP settlement, and how actual remediation costs and customer recoveries compare with the stated estimates and cap.
- Progress on rate proceedings and the timing and amount of approved recovery for infrastructure investment and operating costs.
- Whether final pipeline-safety rules create material additional spending, and whether operating cash flow and available credit remain adequate for planned capital expenditures and dividends.
- Seasonality and weather-normalization effects when assessing full-year performance; nine-month results are not necessarily indicative of annual results.