OGE ENERGY CORP. quarterly report, Q1 FY2016

OGE Energy Corp. — Q1 2016 Form 10-Q

Business context and reporting period. The unaudited quarter ended March 31, 2016. OGE operates a regulated electric utility, OG&E, serving Oklahoma and western Arkansas, and holds a 26.3% equity-method investment in natural-gas midstream partnership Enable. Enable’s revenues are not consolidated into OGE’s operating revenues; OGE records its share of Enable’s earnings.

Key financial metrics

Metric	Q1 2016	Q1 2015
Operating revenues	$433.1 million	$480.1 million
Operating income	$37.9 million	$56.4 million
Net income	$25.2 million	$43.2 million
Diluted EPS	$0.13	$0.22
Operating cash flow	$73.4 million	$139.6 million
Capital expenditures	$177.7 million	$108.8 million
Dividends declared per share	$0.275	$0.25

OG&E gross margin, a company-defined non-GAAP measure, was $255.2 million versus $268.5 million. Consolidated operating margin was approximately 8.7% versus 11.7%, and net margin approximately 5.8% versus 9.0% (calculated from reported revenue and income). OGE’s equity earnings from unconsolidated affiliates were $28.3 million, down from $31.7 million.

At March 31, 2016, total debt was approximately $2.82 billion, comprising $2.63 billion of long-term debt and $187.5 million of short-term debt; cash was zero. The company reported $960.8 million of net available liquidity under revolving credit agreements totaling $1.15 billion. Total assets were $9.52 billion and stockholders’ equity $3.30 billion.

Material changes versus the prior comparable period

• Net income fell $18.0 million, or 41.7%, and diluted EPS declined from $0.22 to $0.13. OG&E net income fell $11.0 million, primarily on lower usage amid milder weather, expiration of the AVEC wholesale contract, and higher depreciation and operating costs. OGE Holdings’ net income declined $4.8 million, mainly with lower Enable earnings and a prior-year tax benefit.
• OG&E gross margin decreased $13.3 million. Management attributed the decline principally to weather-related volume reductions ($8.8 million) and the AVEC contract expiration ($5.2 million), partly offset by price and customer mix.
• Operating cash flow decreased $66.2 million, primarily due to increased vendor payments and higher fuel refunds; investing cash use increased with environmental-project spending. Capital expenditures were substantially higher year over year.
• Cash declined from $75.2 million at year-end to zero, following use of cash and repayment of $110.0 million of long-term debt that matured in January. Short-term debt rose from zero to $187.5 million.

Outlook, management commentary, risks and contingencies

• 2016 guidance: Net income of approximately $344 million–$366 million, or $1.72–$1.83 per diluted share. Assumptions include normal weather, approximately 200 million diluted shares, and full recovery of SmartHours lost revenues.
• Longer-term objectives: OG&E weather-normalized earnings growth of 3%–5% annually and dividend increases of approximately 10% annually through 2019. Management expects operating cash, debt financing and Enable distributions to cover anticipated cash needs and growth over the next three years.
• Rate matters: OG&E requested a $92.5 million annual Oklahoma rate increase and a 10.25% return on equity. Intervenors recommended materially lower outcomes, including a $47.9 million rate decrease from industrial consumers. The proceeding was ongoing. OG&E also intended to file an Arkansas rate case by August 15, 2016.
• SmartHours recovery: The Oklahoma ALJ recommended using the PUD staff’s lower lost-revenue methodology. The OCC had not ruled, and the filing says an adverse decision could require impairment of recorded amounts. OG&E’s guidance assumes full recovery.
• Environmental investment: OG&E estimated approximately $1.1 billion of capital costs for its environmental compliance plan, including Sooner dry scrubbers and conversion of Muskogee units to natural gas, as well as the Mustang modernization proposal. The OCC had denied the broader plan and cost-recovery requests. After quarter-end, on April 28, 2016, the OCC approved the dry scrubber project, but not its costs; the filing reported $107.3 million incurred on the project through March 31.
• Regulatory and legal uncertainty: Potential environmental requirements include possible non-attainment designation affecting Muskogee County under the SO₂ standard and the Clean Power Plan, whose implementation was stayed pending litigation. OG&E said it could not reliably quantify several possible compliance costs. The Sierra Club’s request for rehearing in a Clean Air Act case was denied April 13, 2016; further review remained uncertain.
• Enable exposure: OGE’s cash generation depends partly on Enable distributions and midstream conditions. Enable issued 10% Series A preferred units that rank senior to common and subordinated units for distributions and liquidation, potentially limiting cash available to OGE and increasing financing constraints.
• The company stated it was in compliance with debt agreements, believed reasonably possible losses beyond accrued amounts would not be quantitatively material, and reported effective disclosure controls. It cautioned that first-quarter results are not necessarily indicative of full-year results because of seasonality.

Important facts for investors to verify

• Whether the OCC’s final SmartHours decision permits recovery of the remaining recorded lost revenues and supports the full-recovery assumption in 2016 guidance.
• The final Oklahoma rate-case outcome, including allowed return on equity, depreciation treatment and timing of any rate changes.
• Dry scrubber project costs, schedule, future cost-recovery treatment and any appeals of the OCC’s post-quarter approval.
• OG&E’s ability to fund elevated capital spending while cash is zero, short-term debt is higher, and operating cash flow has declined.
• Enable’s distribution capacity and the effects of its preferred-unit obligations, commodity conditions and midstream operating results on OGE’s cash receipts.
• Whether environmental rules or litigation lead to additional compliance costs or affect the recoverability of utility investment.