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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, ladies and gentlemen, and welcome to the First Quarter 2019 OGE Energy Corp.'s Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded.
I would now like to introduce your host for today's conference, Mr. Todd Tidwell. Please begin, sir.
Thank you, Norma. Good morning, everyone, and welcome to OGE Energy Corp.'s First Quarter 2019 Earnings Call. I'm Todd Tidwell, Director of Investor Relations. And with me today, I have Sean Trauschke, Chairman, President and CEO of OGE Energy Corp.; and Steve Merrill, CFO. In terms of the call today, we will first hear from Sean, followed by an explanation from Steve of first quarter results and finally, as always, we will answer your questions. I would like to remind you that this conference is being webcast, and you may follow along on our website at ogeenergy.com. In addition, the conference call and accompanying slides will be archived following the call on that same website.
Before we begin the presentation, I would like to direct your attention to the safe harbor statement regarding forward-looking statements. This is an SEC requirement for financial statements and simply states that we cannot guarantee forward-looking financial results, but this is our best estimate to date. I would also like to remind you that there is a Regulation G reconciliation for gross margin along with other information in the appendix.
I will now turn this call over to Sean for his opening comments. Sean?
Thank you, Todd. Good morning, everyone, and thank you for joining us on today's call. Earlier this morning, we reported first quarter consolidated earnings of $0.24 per share compared to $0.27 for the first quarter of 2018. As I reflect on the first quarter, I am pleased with the progress our members have made regarding the execution of our plan.
On our last call, I noted 2018 was one of the most accomplished years in our 117-year history. It is now the benchmark for us as we look to build on that success in 2019 and beyond. Steve will discuss the details of the first quarter in a moment, but I'd like to give you a few updates on the first quarter. Our service territory is strong. Quarter-over-quarter, we saw new customer growth of nearly 9,000 customers, which is above our historical growth rate of 1%.
As I mentioned last quarter, we're closely watching population growth, economic development successes and other positive trends, which could push our load growth even higher. Obviously, this is good for our communities and good for our company. Oklahoma as a state is performing well, with a low unemployment rate of 3.3%. Oklahoma saw a 5.5% increase in GDP. Fort Smith continues to see positive economic growth with an unemployment rate now at 3.5%, and over the last few years, Fort Smith has secured over $700 million in capital investment and created over 6,000 new jobs, and we're certainly pleased to be part of that growth.
Our economic development efforts continue to pay dividends. New manufacturing facilities and expansions occurred during the first quarter in the southeast part of our service territory. Oklahoma City also was selected for a new aircraft production center and a new maintenance facility as our aerospace segment of the economy continues to expand. Electricity cost and reliability continue to be important criteria for these site selections.
Grid modernization has become a catch-all phrase in our industry, so let me define what it means to us. These are primarily investments in our distribution system that includes hardening the circuits and leveraging our smart meters and investments in technology to increase reliability and reduce outage response and restoration times. These investments ultimately enhance the customer's experience. The first phase of our distribution investments, which we made in Arkansas, is complete and is actually exceeding our expectations. Through April of 2019 compared to the same period last year, we've seen a 19% improvement in SAIDI and a 58% reduction in momentaries. The Formula Rate mechanism in Arkansas allows customers to see the benefits of these investments and for us to receive recovery in a timely fashion. Based on this success, we're moving forward with the second phase there in Arkansas.
We are embracing technology to improve the efficiency of operations. In March, we opened a new state-of-the-art operating center, which will support the ongoing digital transformation of our business. Data-driven analytics is integral to our next-generation distribution management system. This new system will better enable technology deployment and further improve service quality.
In addition, we realigned our operations organization to focus on grid innovation and advanced analytics. More and more customers want enhanced solutions, and these new systems and tools will help us partner with them to provide just that. On the regulatory front, we made preapproval filings in Oklahoma and Arkansas for the 2 plant purchases. In late March, we reached a nonunanimous settlement in Oklahoma for the recovery of the 2 plants. The administrative law judge report recommends approval, and the hearing is scheduled for next Wednesday.
Late last year, we filed our latest rate review in Oklahoma to recover investments in Sooner and Muskogee projects. Each of these projects came in significantly under budget and are operating as we designed. As a result of these investments, our overall plant emissions are significantly lower from 2005 levels. Sulfur dioxide emissions are nearly 90% lower, nitrogen oxide emissions are 75% lower, and CO2 is down by 40%, and we're not done. We fully expect our CO2 reduction to be at 50% by 2030. We have received intervener testimony last week, and almost all the parties recommended approval of our environmental investments. We look forward to bringing this case to a favorable conclusion. After more than 10 years of court cases and regulatory filings, it will be nice to have this one behind us.
In Arkansas, we concluded our first Formula Rate filing with rates taking effect on April 1st of this year, and we'll make our second filing in October of this year. Before moving to Enable, I would like to discuss our total return proposition. Over the past 5 years, we've delivered an average annual total return near 9%. In fact, over this time frame customer rates have not increased, even though we've invested over $3 billion into our system. In fact, our rates today are lower than they were 8 years ago. Going forward, our investment thesis will not change. We plan to invest approximately $600 million per year, and these investments will be committed to the continued improvement in the customer experience, maintaining the competitive advantage of our rates, which are 31% below the national average, and continuing to attract businesses to our service territory. We project this will deliver a long-term earnings growth rate at Utility of 4% to 6% and when combined with our dividend yield, produce an average annual total return of 8% to 10% to shareholders.
As a result of our balance sheet strength and the Enable cash flow, we do not foresee any requirements for equity. We will continue to focus on economic development and service territory growth by providing highly reliable service combined with low rates. Given our track record, I firmly believe that our long-term investment thesis is realistic, achievable and sustainable. We are creating shareholder value and growing our communities.
Turning to Enable, the natural gas midstream business posted another solid quarter of operational and financial results and distributed $35 million in cash to OGE during the quarter. Volumes were up across all business segments; most pronounced were processing volumes and natural gas liquids produced. They were up 14% and 25%, respectively. There were 52 rigs operating across Enable's footprint. These higher volumes drove an increase in distributable cash flow. In addition, the FERC recently approved Enable's request to initiate the commission's prefiling process for the Gulf Run Pipeline project, and this was an important milestone for the project. The Midstream business continues to perform well by expanding its footprint, maintaining a strong balance sheet and providing unencumbered cash to OGE.
Before turning the call over to Steve, I want to reiterate that our businesses are on plan through the first quarter. We will continue to invest in our system, stay involved with our communities and create values - value for customers and shareholders alike.
Thank you, and I'll now turn the call over to Steve to review our financial results for the quarter. Steve?
Thank you, Sean, and good morning, everyone. For the first quarter, we reported net income of $47 million or $.0.24 per share as compared to net income of $55 million or $0.27 per share in 2018. The contribution by business unit on a comparative basis is listed on the slide. The holding company had earnings of $0.03 per share. This is primarily due to an income tax benefit prevalent in the first quarter because it is a low revenue quarter and will levelize throughout the year. We project holding company results to be in line with guidance.
At OG&E, net income for the quarter was $20 million or $0.10 per share as compared to net income of $31 million or $0.16 per share in 2018. First quarter gross margin at the utility decreased approximately $5 million, which I'll discuss on the next slide. Looking at other key drivers, first quarter O&M increased approximately $7 million, primarily due to the timing of work performed when compared to last year. O&M expense for the year is on plan. Depreciation increased $4 million, as additional assets were placed into service. Equity AFUDC also decreased approximately $6 million due to the completion of certain environmental projects.
Interest expense decreased $5 million, primarily due to less long-term debt resulting from the maturity of $250 million senior notes in January. Overall, we're on plan and off to a good start.
Turning to the first quarter gross margin, utility margins decreased approximately $5 million in the first quarter of 2019 compared to 2018. The change was primarily driven by the implementation of new rate design. Partially offsetting the changes in rates was weather, which contributed $3 million of margin, as heating degree days were 11% above last year. Compared to normal, weather contributed $9 million to margin. New customer growth also contributed $2 million to margin.
Before we move on to Enable, I want to touch on this year's regulatory schedule. For the capacity acquisition, we have filed for preapproval in Oklahoma, Arkansas and with FERC. We received a positive ALJ recommendation in Oklahoma and expect decisions in all jurisdictions this month.
For the recovery of the scrubbers in the gas conversion, the hearing in the Oklahoma General Rate Case in May - is May 29, and we expect a decision this summer. We will make our 310 filing in Arkansas by June 1, recall that this is the rider mechanism for recovery of environmental compliance investments. As you can see, there will be a lot of activity over the next couple of months as we bring many of our proceedings to a conclusion.
Turning to our investment in Enable. Enable had a solid first quarter and their financial metrics are strong. Their revenues, gross margin, adjusted EBITDA and distributable cash flows were higher compared to the first quarter of 2018. In addition, Enable Midstream made cash distributions of approximately $35 million, the same amount received in the first quarter of 2018.
Turning to our 2019 guidance. Both businesses are off to a good start, and assuming normal weather, we affirm our current guidance.
This concludes our prepared remarks. And we will now answer your questions.
[Operator Instructions]. Our first question comes from Julien Dumoulin-Smith of Bank of America Merrill Lynch.
This is actually Richie here for Julien. Can you hear me? All right, just curious how settlement negotiations are going in the scrubber rate case following the positive intervener testimony?
Yes, I think discussions are ongoing all the time. And there's really nothing more to add to that other than to comment on what Steve said earlier. We expect a positive resolution of these cases by the summer.
Okay. Got it. And just wondering, if you do receive a constructive outcome there, when we can expect a decision around capital allocation opportunities given the excess cash on the balance sheet?
Yes. So as we've mentioned at the beginning of the year, I want to make sure that we get through these two Oklahoma filings, these two Arkansas filings, continue to receive the distributions from Enable, and as we - as these outcomes are realized, we'll further refine our capital allocation and investment thesis for you towards the end of the year.
And our next question comes from Charles Fishman of Morningstar Research.
Sean, you indicated in your service territory, growth is - the economic growth is solid. Have you given any indications of what load growth and customer growth are recently?
Yes, so we've been tracking that growth some - really close to 1%. We've been watching it very closely, Charles. The last couple of quarters, we are seeing some increases there. A lot of our economic development efforts have produced a lot of results. So we're cautiously watching this to make sure it's a sustainable increase in load growth, but 1% is where we're at today, but we're paying very close attention to it, and we're optimistic.
So 1% is the load growth?
Yes.
Okay, and customer growth is roughly the same or a little higher?
Yes. A little higher but load is important.
Okay. And then, one other question for Steve. Steve, you indicated on, when you were talking about Slide 6, the gross margin variance, the price variance due to rate design. Will that normalize over the rest of the year?
Yes, it does. Yes, just with new rates in place, it basically squeezes everything to the summer months. There are some other issues that go on as it relates with Tax Reform. We actually recover less from customers in the first and fourth quarters due to the seasonality of our revenues, and we recover more in the second and third quarters.
[Operator Instructions]. Our next question comes from Phil Covello of ExodusPoint.
Just a couple of quick questions - and I apologize if this was already asked, I was juggling a couple calls - but can you just comment on the prospects for successfully reaching a settlement in this Oklahoma Rate Case?
Well, I think the prospects for a good outcome are really good, and we expect to get that done this summer. Whether it comes about as part of a settlement or comes about just from a commission ruling, we do expect a positive outcome here.
Okay. Great. And then just on the scrubber investments, can you kind of frame for us the impact of regulatory lag to date on those investments, not having it in the rate base through Q1 I guess?
Right. So recalling the last rate case we had, the commission ordered us to - when those came into service, we were put that on the balance sheet as a regulatory asset. So we're not really incurring lag on those investments from a depreciation standpoint. Recognizing we're not earning a return on those yet, but nevertheless we're not depreciating those assets. And Steve?
Yes, if you wanted to quantify the impact of that equity return for 2019, it's about $0.06.
And our next question comes from Vedula Murti of Avon Capital.
If we get an outcome in the case that you - that's within your expectations and everything like that, would you foresee being able to then avoid the rate arena for a few years under - based on the current CapEx plan and given the various mechanisms you may have available to you? When you update the capital program as part of capital allocation like this year for next year, can you give us a sense as to if you're running, I think, numbers like $500 million or something like that. I think it is the run rate right now that if - at what level do you think that if you were to alleviate capital program that that may require kind of going to the commission? And as part of all this, have you kind of telegraphed to them in some fashion post this case kind of beyond what you have out there, potential incremental capital?
Yes, so I think first things first. We're focused on these cases at hand. We have had some discussions trying to begin thinking longer term as we close the book on a lot of these environmental projects. The $600 million of CapEx that we have in our budget, we can certainly move that around. We're really focused on that customer benefit. We've historically, and we expect to continue to be, prudent allocators of capital. But the recovery mechanism's important, and so as we work through that with the commission and staff, if we were to have some sort of rider mechanism, that certainly allows you to stay out a lot longer. And - but if you didn't have a rider mechanism, we would proceed very cautiously and probably go through the traditional regulatory arena. But there again, Vedula, I appreciate the question, but we want to make - stay focused on the current case at hand and get those behind us.
Okay. And then, I guess, perhaps one other thing. Enable, are - do you foresee any opportunities or milestones where perhaps the existing relationships and structures could be altered?
Yes, I don't see any milestones. Enable's done a great job strengthening that balance sheet. We're proud of what they've accomplished over there and, like we've talked about, we're really focused on the cash flow that comes into us, and we want to see that grow. And we like that business over there.
Okay. I just want to make sure I also understand from your previous answer, but with your commentary earlier about load growth and economic growth, is it reasonable to think though that if we kept - if we just looked at the existing capital program that of - an acceptable outcome in the rate case would support that CapEx on a go-forward basis without necessarily returning to - back to the rate arena?
Yes, I mean, you'll have to get there eventually. But I think that's - I think directionally you're right.
And our next question comes from Gregg Orrill of UBS.
What drove the change in the amortization of the basis adjustment related to Enable?
Yes, they issued some shares earlier this year, and it's just a dilution loss that offsets that.
Is that a onetime difference?
I mean, it is as it relates - it's coincident with any shares that they potentially issue, that would be there, but I don't see anything in the foreseeable future this year that would cause that to occur again.
You can annualize that impact?
Well, it was a charge in the first quarter. But yes - I mean, yes, that would levelize out over the year.
Okay. What - I didn't quite get, what was the $0.06 that you referred to with Phil's question?
Yes, that's just the lack of equity return on the Sooner Scrubbers. We have a regulatory asset, so we're picking up the O&M and depreciation but we are not currently getting an equity return on that investment. And those units have been in service for quite some time. The first unit went in service in the second quarter last year.
Okay. And then the environmental rider filing, June 1. What's involved there?
That's the Act 310 filing in Arkansas, which is a rider mechanism to recover our investments for environmental compliance, so that's really the Sooner Scrubbers and the Muskogee gas conversion, and we can begin collecting on those when we make that filing.
And our last question comes from David Peters of Wolfe Research.
Just wondering if you also had any initial conversations with the new CFO at CenterPoint and kind of how those discussions have gone with respect to the shared investment in Enable? Specifically, if she has any differing views from the prior CFO?
Well, yes, we've met her last week, and it was good to meet her and look forward to working with her. I think it's way too early to identify if there's any difference of opinion. But I do look forward to working with Xia.
And I have no further questions at this time. I'd like to turn the call back over to Mr. Sean Trauschke for further comments.
Thank you, Norma, and thank you, all, for joining us this morning. Thank you for the interest in our company. We're off to a great start, and we're working hard. So everyone have a great day.
Ladies and gentlemen, thank you for your participation in today's conference. You may disconnect. Everyone have a wonderful day.