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OGE Energy (OGE) CEO Sean Trauschke on Q3 2015 Results – Earnings Call Transcript

OGE Energy Corp. (NYSE: OGE ) Q3 2015 Earnings Conference Call November 5, 2015 09:00 a.m. ET Executives Sean Trauschke – President, Chief Executive Officer Steve Merrill – Chief Financial Officer Todd Tidwell – Director of Investor Relations Analysts Anthony Crowdell – Jefferies Matt Tucker – KeyBanc Capital Bryan Russo – Ladenburg Thalmann Jay Dobson – Wunderlich Paul Patterson – Glenrock Associates Operator Good day ladies and gentlemen and welcome to the Third Quarter OGE Energy Earnings Conference Call. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call will be recorded. I would now like to introduce your host for today’s conference, Mr. Todd Tidwell, please go ahead. Todd Tidwell Thank you, Katherine. Good morning everyone and welcome to OGE Energy Corp’s third quarter 2015 earnings call. I’m Todd Tidwell, Director of Investor Relations and with me today, I have Sean Trauschke, President and CEO of OGE Energy Corp; and Steve Merrill, CFO of OGE Energy Corp. In terms of the call today we will first hear from Sean, followed by an explanation from Steve of third 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 oge.com. In addition, the conference call and the 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 and ongoing earnings in the appendix along with projected capital expenditures. I will now turn the call over to Sean for his opening remarks. Sean? Sean Trauschke Thank you, Todd. Good morning everyone and thank you for joining us on today’s call. This morning we reported third quarter results and our utility OGE contributed $0.82 per share compared to $0.79 per share last year. Looking forward to the full year, the company projects 2015 utility earnings to be at the low end of the earnings range of $1.41 to $1.49 per average diluted share. This is primarily due to mild summer weather as compared to normal and environmental compliance assets placed in this service that have not yet been included in rates. Earnings from the Enable Midstream for the third quarter of 2015 include a pension settlement and the good will impairment charges of $0.35 per share. Ongoing earnings on a consolidated basis which exclude these non-cash charges were $0.90 for the third quarter compared to $0.94 per share for the same period in 2014. Steven will discuss the financial results and impairment in more detail in just a moment. That being said, the Enable impairment does not change our plans for OGE. We are on plan to achieve our utility long term growth rate of 3% to 5% and to continue to grow our dividend through 2019. We continue to believe our businesses are strong and well positioned for the long term growth and value creation. In September the Board of Directors proved a 10% increase in the quarterly dividend, bringing the dividend to $1.10 per share annually. This was the 10 th consecutive year of dividend growth. It reaffirms our commitment to growing the dividend 10% a year through 2019. We have received approximately $104 million of distributions from Enable year-to-date. With the quarterly distribution they’ve just announced, distributions to OGE will be approximately $140 million for the year. As we said before, cash distributions received is the key metric we are using for Enable. Distributions from Enable will continue to help fund our dividend and utility investments. Turning to the utility, our service territory remains strong despite the continued pressure from the current commodity cycle. The latest economic statistics with Oklahoma’s unemployment rate at 4.5%, with Oklahoma City just under 4%. Although these rates have increased, we are still well below the national average. As expected, we are seeing pull backs in the industrial and oil field sector, but growth from the commercial sector, particularly chain accounts has offset those loses. This is a testament to our region’s growing economic diversity. Our operations team did a great job of maintaining the fleet in the grid this summary. Our combined cycle plants achieved best in class for liability of nearly 99% and capitalize on lower gas pricing to bring the best value to our customers. Our coal units demonstrated a liability of 91% and during the summer months 9% of our total generation came from renewable resources. On the cost side we continue to focus on controlling costs and increasing efficiency and productivity. As a point of reference, our O&M cost per customer is lower today than it was in 2011. This is really good news for our customs. Attracting customers with not only competitive rates, but additional products and services is a key component of our strategy. Last month our customers saw improved functionality with the implementation of our estimated time of restoration project. This technology allows customers access to outage issues, and estimates for when they can expect service restoration. We continue to look for ways in which technology will improve our customer experience. Next I would like to provide an update on our regulatory events in Oklahoma and Arkansas. In Oklahoma we are still waiting on a order for our environmental case. We plan to file a general rate case in Oklahoma later this month, with a test year ending June 30, 2015. The case as we have said previously will focus on two main issues. First, we have terminated a large wholesale contract and several smaller contracts and will now seek to place in the rates approximately 300 megawatts of that capacity previously used to meet those obligations. The second focus will be to recover the retail portion of several in-service transmission lines that OG&E has constructed at SPP’s direction over the last few years. Also in Oklahoma we’ve filed a distributed generation tariff with the commission. Oklahoma’s Senate Bill 1456 was signed into law last year, requiring us to have a tariff by the end of 2015. This tariff is to ensure that distributed generation customers are not being subsidized by other customers. Our proposed tariff enables an individual adding distributed generation to expense reductions in their utility bills, while ensuring that they pay for their fair share for the grid as the law requires. While the number of DG customers of our system is very small today, this prepares us for accurate cost recovery in the future, should the adoption of DG devices become more prevalent. Moving to Arkansas, we have filed under Act 310, which provides a constructive way to file and begin the recovery of environmental expenditures for assets placed in the service. We made our first filing in May, and put the rates into effect in June. The settlement hearing was in October and we are waiting the commission’s final order. We anticipate making our second filing later this month and we will update the filing every six months as additional compliance investments are placed into service. We are very pleased with this process in Arkansas. We also plan to file a general rate case in Arkansas in early 2016. We intend to utilize the formula rate provision in the recently passed legislation, and our biggest issue in Arkansas continues to be the imputed capital structure utilized. We are planning to work with the Arkansas Public Service Commission on this issue. Proper resolution of this issue will improve our ability to enhance the customer experience in Arkansas and to make investments that will help attract new businesses to this day. Turning to the environmental compliance plan, regardless of the delays we experienced on the regulatory side, we must move forward to meet our compliance deadlines. Regarding the activated carbon systems from MATS compliance, we are on budget and construction has begun to meet the April 2016 compliance deadline. Looking at the regional haze compliance plan, four of the seven low NOx burners are complete and in service and installation will begin on the remaining units this winter and will be completed by the spring of 2017. The equipment and installation vendors for the two dry scrubbers at Sooner have been selected and schedules and budgets are on plan. For the Mustang plants, full notice to proceed has been issued to the turbine manufacturer. Permanent applications have been filed with the Oklahoma Department of Environmental quality and we anticipate the final permit will be issued by the end of the month. Engineering studies for the conversion of the two coal units in Miscurgie have been completed and we’ve issued an RFP for gas supply, and recall our plan is to continue to run these coal units as long as possible to maximize the benefit to our customers. Finally the EPA issued its clean power plant in August and the plan seeks to reduce CO2 emissions in Oklahoma from 24% to 32% depending on the format of the compliance plan, the mass versus rate base plan by 2030. As you know Oklahoma’s Attorney General has begun the legal proceedings against the EPA in regard to the clean power plant, stating that it threatens the reliability and affordability of power generation across the nation. Similar to regional haze litigation, we will be support of the AGs efforts on behalf of the State of Oklahoma. In the meantime we are in process of reconfiguring our fleet with the addition of Mustang and the conversion of the Miscurgie units. In addition, we are we are 18 months into the SPP day head market and the decisions other generators and other states make could impact our fleet. As a result we will continue the evaluation of our units, our role in the state and our role in the broader southwest carpool, while continuing our active discussion with the state regarding various options of compliance. Finally, last week Rod Sailor was announced the CEO of Enable. As you know Rod joined us in April of 2014 and has been an instrumental part of the company. Since June, Rod has been leading the development and execution of the business strategy, and I’m comfortable that Rod brings familiarity to the company, customers and the market, providing that stability and consistency we are looking for. I’m confident that he is the right person to lead Enable’s growth strategy going forward. So in summary, this is an exciting time for us at OGE. As a management team we are committed to executing on our strategy to continue growing our business. I’ll now turn the call over to Steve to review our financial results. Steve. Steve Merrill Thanks Sean and good morning everyone. For the third quarter we reported net income of $111 million or $0.55 per share as compared to net income of $187 million or $0.94 per share in 2014. The contribution by business unit on a comparative basis is listed on the slide. I would like to point out that the loss from Enable is due in part to a $0.35 per share write down of good will and a pension charge. Excluding the impact of these charges, third quarter 2015 earnings would have $0.90 per share as compared to $0.94 per share for 2014. I will discuss the good will impairment on a later slide. The holding company loss is primarily attributable to changes in our differed compensation plan. The holding company is on plan, and is expected to be flat for the year. At OG&E net income for the quarter was $163 million or $0.82 per share as compared to net income of $157 million or $0.79 per share in 2014. Third quarter gross margin at the utility increased approximately $11 million, which I’ll discuss on the next slide. O&M is on plan for the year. The decrease of $4 million is primarily due to the lower maintenance cost at our power plant and our continual focus to control cost. Depreciation increased $7 million, primarily due to the large transmission lines that were added in the last 12 months, part of the over $800 million of plant placed in service in 2014. Income tax expense also increased approximately $4 million due to higher pre-tax net income and a reduction of federal tax credits recognized. Turning to the third quarter gross margin, utility margins increased approximately $11 million for the third quarter of 2015 compared to 2014. The primary drivers for gross margin were new customer growth, which contributed $9 million. We added over 9,000 new customers to the system as compared to the third quarter of 2014. We continue to see about 1% growth supported by the commercial sector. Weather contributed nearly $9 million of margin as cooling degree days increased 6% compared to the third quarter of 2014. However, compared to normal, weather decreased for us the margin, approximately $11 million for the quarter. Partially offsetting this growth was wholesales transmission revenues which decreased $4 million compared to the third quarter of 2014, primarily due to an adjustment of the SPP formula rate to reflect the continuation of bonus depreciation. Finally, on June 30 we had a wholesale power contract that expired, reducing margin by nearly $8 million for the quarter. As we’ve said before, this is an item that will be included in the general rate case we are filing this month in Oklahoma. For the third quarter of 2015, Enable Midstream contributed ongoing earnings of $0.10 per share compared to $0.14 per share in 2014. Cash distributions increased by 6% to $35 million from $33 million in 2014. Year-to-date OG&E has received approximately $104 million of distributions from Enable. Before I explain the impairment charge, I would like to point out that cash flow in the form of distributions, not the earnings from Enable of what is important to OGE. Though commodity prices are low, Enable is performing as planned in regards to allowing us to fund environmental CapEx and to grow our dividend by 10% per year through 2019. Turning to the impairment, Enable Midstream recorded a goodwill impairment of approximately $1.1 billion in the third quarter of 2015. OGE’s portion of Enable’s good will impairment is approximately $108 million. The reason our shares left within the pro rata share is because of the formation of Enable. We received a higher level of LT [ph] interest just compared to the assets that were contributed. However, we were required to record our investment of historical costs, thus creating a basis difference. Turning to 2015 outlook, the company projects 2015 utility earnings to be at the low end of the earnings range with $1.41 to $1.49 per average diluted share, primarily due to mild summer weather as compared to normal and environmental compliance assets placed into service that have not been included in rates. For the Midstream business we are projecting to receive approximately $140 million in cash distributions. Utility is on track to achieve its long term growth rate of 3% to 5%. Our cash flow position for 2015 remains strong and is key to our value proposition, which is growing utility UPS and utilizing our cash flow from Enable to fund our capital investments and grow our dividend at 10% annually. This concludes our prepared remarks and we’ll now answer your questions. Question-and-Answer Session Operator Thank you. [Operator Instructions] Our first question comes from Anthony Crowdell with Jefferies. Your line is open. Anthony Crowdell Good morning. Sean Trauschke Hey, good morning Anthony. How are you doing? Anthony Crowdell Just crushing it. How about yourself? Sean Trauschke Just crushing it. Well, I’m going to use that line. Anthony Crowdell No worries. Just two questions, the first question is related to I guess the delay in the approval of your regional haze CapEx. Do you think that the clean power plant or the Oklahoma Attorney General fighting the clean power plant is what’s causing the delay of the regional haze approval? Sean Trauschke No, I don’t. I think those are totally independent issues and the ruling on the regional haze is with the three commissioners right now. So the AG is not part of that. Anthony Crowdell If I remember correctly, you guys said I think a 55 month window to comply. Is this eating into the time of that 55 month window to comply? Like it’s a clock running and you are just waiting to start executing once you get approval on it. Sean Trauschke Yes, no very good question Anthony. You’re exactly right. We have a deadline to comply. By law we have to comply. So we are actually in that process of complying. I mentioned in my comments, we’ve got four of the seven low NOx burners already in service. We’re well down the path that Sooner on the scrubbers. We’ve made the commitment; we’re doing an RFP right now for the gas supply, the stogie for the conversion. So we’ve got to move ahead. We could not wait for commission approval to begin this. I mean we have to comply and so that’s what’s going on, we’re moving forward. Let me say it differently; non-compliance is not really an option. Anthony Crowdell Right, but I guess I’m just thinking out loud if you did not get approval for regional haze, does that create a more challenging regulatory environment? Sean Trauschke Yes, while we’re surprised or disappointed that it’s taken this long to get the order; we do believe that we’re going to receive approval for these required expenditures. Anthony Crowdell Great. And moving to the easy part of the business Enable, I think on Enable’s second quarter call or whatever they spoke about when they thought they’d hit maybe the Tier 2 distributions, which that also I think it begins with GP just like getting some distributions. When does OGE forecast that they start receiving some of the GP distributions? Steve Merrill Sure. At the present time with the guidance that Enable put out yesterday, we would anticipate starting to receive those in 2017. Anthony Crowdell And is it like a – I don’t want to use the word trickle, but a small amount and then 18 to get a gradual step up or… Steve Merrill That’s correct. I mean at the current growth that’s out there right now, it would be a gradual step up. Anthony Crowdell Great. Guys, thanks for taking my questions. I’ll see you at EEI. Sean Trauschke All right, see you Anthony. Operator Thank you. Our next question comes from Matt Tucker with KeyBanc Capital. Your line is open. Matt Tucker Hey guys, good morning and thanks for taking my question. Sean Trauschke Good morning Matt. Matt Tucker I was hoping you could elaborate a little bit on what’s changed in terms of the utility outlook. If you could maybe quantify how much of the headwind is weather versus the recovery of environmental investments and is that Writer drag just related to the delay in the environmental case approval? Steve Merrill Yes, that’s correct. If you look at weather, it’s about $0.03 and then the environmental drag is a couple of cents at this point and yes, it’s just timing of the Writer. That will go away as soon as we get the Writer. Matt Tucker Got it, thanks. And then thinking about, you’ve maintained the long term outlook despite Enable kind of reducing its distribution growth guidance for the next couple of years and I know that you built a lot of cushion into your longer term assumptions. Could you talk a little bit about how stress tested those are if Enable were to hypothetically hold its distributions flat for the next couple of years or beyond. Would you still be okay in terms of the dividend growth guidance and lack of equity needs? Sean Trauschke Yes, we would. Matt Tucker Okay, great. That’s all I had guys, thanks. Sean Trauschke Thanks Matt. Operator Thank you. Our next question comes from Bryan Russo with Ladenburg Thalmann. Your line is opened. Bryan Russo Good morning. Sean Trauschke Hey, good morning Bryan. Bryan Russo Just curious. How much environmental spend is not in base rates. Steve Merrill Right now that’s about $39 million. Bryan Russo Okay, great. I realized the delay in the OCC order. I think previously you had conveyed that they indicated they were going to try to make a decision by September and we’re probably six weeks past September; any reason for the delay? Sean Trauschke None that we’re aware of Bryan to be perfectly blunt. There was that public hearing they did allude to. They thought they were going to try to get an order out within 30 days. We’ve not seen the order and we’re talking to them and anxious to receive the orders as quickly as you are. Bryan Russo Okay, so it’s basically any day is how we should look at it? Sean Trauschke Yes, but I wouldn’t characterize that any day any differently from September. Bryan Russo Understood. And if you don’t get the ECP for the tracker order by the end of the month and you file your rate case, does not having that tracker or a decision on the order, does that complicate this rate case at all or is it because your environment, the spin is so back end loaded that your able to manage it? Sean Trauschke Yes, you’re correct in your assumption there. I think the complication that arises with this filing is that under 1910 there is a provision there that you file a rate case every two years after the Writer goes in place and our goal and objective was we wanted to run our business and we didn’t want to get tangled up in rate cases every couple of years and just because of the time, energy and money you spend going through that process. In your scenario there we would file and not have – file a rate case and we potentially could not have rates, the Writer in place and so that may give rise to another rate case. I believe we’ll cross that bridge when we get there. I think the thinking thereby and just to be perfectly honest, we said all along we were going to file this rate case this year and this is to recover those items that Steve’s mentioned to that are not being recovered today. There would be good value for customers, the transmission lines are in service and we are going to bring 300 megawatts there back to our utility customers around 230 a KW. So that’s good value for the customers and we ought to be doing it, but we’ve got to kind of run our business for our customers and not get bogged down with kind of the regulatory timeline. Bryan Russo Okay, and the June 2015 test here. What’s like the true-up here or a known and measurable date? Sean Trauschke Six months. Bryan Russo Okay, and what’s the statutory deadline for the commission to issue a final order in a rate case? Sean Trauschke Well, after 180 days from that filing in the rate case, we can implement rates. Bryan Russo Okay, got it. So we should feel rest assured or comfortable that new rates are going to affect prior to near your summer third quarter peak period. Sean Trauschke Yes sir. Bryan Russo Okay, great. Thank you. Sean Trauschke Thank you. Operator Thank you. Our next question comes from Jay Dobson with Wunderlich. Your line is open. Jay Dobson Hey, good morning Sean. Sean Trauschke Hey, good morning Jay. Jay Dobson Hey, a couple of questions if I can. Operating cost trends obviously have been moving in the right direction and you spend a little time highlighting them. Can you talk a little bit about what’s going on there and sort of the durability of those controls or reductions? Sean Trauschke Yes, I think – good question. So we’re actually quite proud of this and philosophically this is not a one-time project that we have these initiatives or teams out there; this is every day. This is just grinding away, looking for opportunities. We’ve seized opportunities around supply chain recently, around our maintenance of our facilities, our engineering systems. We’ve had a number of opportunities as people have retired. How we re-tool the workforce and brought new people into the company. So there’s no singular item Jay is what I would tell you and I think that speaks to the durability or the sustainability of what we’re doing here and it’s just a daily effort and we’re keenly focused on keeping our own costs low. In this case actually reducing them, but I expect that to continue. Jay Dobson Is that something we’d measure in quarters or years? Sean Trauschke I think it’s probably something that you do on an annual basis. A lot of things going at your own expense, but I think that’s more of an annual trend and we’ve been trending that. We’ve been watching that since 2011 and I’m really proud of the effort the entire company has put forth on this. I don’t expect it to seize. The expectation is we’ll continue going forward. Jay Dobson No, that’s great. So the reduction sort of to-date or whenever the rate case is filed, you’ll be sort of handing those back in a rate proceeding, but looking forward sort of post rate case we should assume that costs could continue to decline in a measurable pace. Sean Trauschke Well, let me clarify that a bit. So we are very fortunate to see low growth on our system and so we’re adding customers and so what we’ve been able to do is absorb that and not see incremental costs go out, okay. So I don’t think you’re going to see O&M reductions go down if you’re thinking in terms of rate case activity or anything like that. What we’re saying is that we’re absorbing this additional low with productivity and efficiency gain in our system. Jay Dobson Nope, that’s perfect. It’s like you read my mind. So commercial trends you indicated, what exactly is going on there? Is there new customers coming in? Is this expansion sort of economically related? What’s going on there? Sean Trauschke Yes and yes and so we’re seeing a number of the chain account kind of builds, box stores and restaurants and things like that coming in. We are beginning to see a bit of a slowdown in the oil field sector as you would expect, but it does not seem to be slowing down on the commercial side or the retail side. Jay Dobson Got you, that’s great. And then Enable, I assumed they’d be in the running to serve the Miscurgie conversion and Mustang gas needs. Sean Trauschke Yes, I think we’ll conduct a competitive bid process like we do with everything we procure in this company and if they are successful they’ll get it, if they are not, somebody else will get it. But yes, they would certainly be a viable candidate, but they will not receive any kind of special treatment. Jay Dobson Do they serve other facilities on your system currently? Sean Trauschke Yes, they do. So Enable serves the Mustang plant currently and Horseshoe Lake and Seminole and then some other suppliers serve Redbud and McClain. Jay Dobson Got you. And then two last ones; tax rate with the write down maybe more for Steve. I imagine not that you’re a big tax payer, but that it would do Steve, actual taxes paid, so cash flow benefit. Am I thinking about that right from the good will impairment you recorded? Steve Merrill Yes, you are. We won’t be a full tax payer until 2018. Jay Dobson Perfect. And then last one, just to tag on to the – I think it was the last question Sean. So you can implement rates, 120 days if you don’t have a decision, but am I remembering historically you haven’t actually done that. Sean Trauschke Yes, so it’s actually 180 days and so have we done that? I believe we’ve done it way, way back in the past, but not in recent history. Jay Dobson Okay, got you. Awesome! Thank you so much. Look forward to seeing you in a couple of days. Sean Trauschke All right, thanks Jay. Take care. Operator Thank you. Our next question comes from Paul Patterson with Glenrock Associates. Your line is open. Paul Patterson Hi, how are you doing? Sean Trauschke Hey, good Paul. How are you? Paul Patterson I’m managing. With respect to the, back to this regional haze thing, I mean I guess it was asked and I guess if you could just elaborate a little bit. I mean there’s no sense as to why this is being delayed. Sean Trauschke Well, they are deliberating right now. This is I think the top item on their play. In fairness to the commission, they’ve got a heavy case load. They’ve been very involved in some of the – there’s been a lot of earthquakes here. So they’ve been involved in that analysis and in fairness to commissioner Hye [ph], he walked into this. He didn’t have the benefit of the history that had gone on the previous four years with this. So he is quickly getting up to speed as well. So I don’t really have any, Paul any more insight than that and we’re as anxious as you are to get this resolved. We’ll tell you that we have had some discussions, not complaining or anything about this case, but more about prospectively we’ve got to come up with solutions. What can we do on our side to make this process faster in the future. So we are looking forward in terms of how we can improve this process to make it more timely. Paul Patterson But the record has been closed for some time. There was a deliberation statement from Anthony right. I mean so isn’t like – it seems like it’s got nothing to do with you guys at this point, correct. I mean you guys can’t do anything to – so generally your really… Steve Merrill I think your thesis is exactly right. I mean we have asked if they are looking for any more information or they need anything from us. I think your thesis is right. Its sitting there on their desk. They are deliberating right now. Paul Patterson So we are really not going to be in a situation where you are going to be doing things to address the regional haze issue before we get this; at least nothing that would be controversial potentially. Correct? Sean Trauschke Are you talking about as far as taking access to comply? Paul Patterson Yes. Sean Trauschke No Paul, we are taking actions to comply. We have a deadline, we have a compliance date between regional haze and MATS and we are taking actions – go ahead. Paul Patterson But is there anything that like I guess in terms of – is there any risk that you’ll be taking action that these guys might say, ‘hey, well that’s not what we really thought you were going to do.’ Sean Trauschke No, no the actions we are taking is exactly what we spelled out in our testimony, exactly what we communicated well in advance of our filing and our plan of attack is exactly what we’ve been communicating for a couple of years now. Paul Patterson Okay and so if these guys come up with a decision that’s different than that? Sean Trauschke When you say a decision different than that, what do you mean? Paul Patterson I mean if they go with the ALJ recommendation, right. Would that… Sean Trauschke The ALJ, I think the ALJ was primarily speaking about various components of how you’d recover that, but the commission is not – it’s our job to kind of design and operate this system and make these decisions on how the business is going to operate, and aside I don’t believe that they are going to get into making decisions about what asset we should be utilizing. And besides remember, the ALJ did indicate all of this was prudent, and the legislation provides for that as well and that this was a mandate, a requirement and that’s what this legislation that was put in place was to address, was timely recovery for environmental mandate and this is the mandate. Paul Patterson But the Mustang monetization plan and stuff like that, I mean how do we think about that I guess. Do you follow what I’m saying? Sean Trauschke Yes, so on Mustang, our point there on Mustang was we wanted to be upfront and transparent with the commission. Let them know where we are going with how we are going to reconfigure our fleet. We had a window of opportunity there to be able to site new generation closest to the largest load center. It serves a very critical piece of our 345 transmission loop around the city and we made that case to the committee, to the commission and whether they account for that and the writer or whether they want to do deal with that later in a rate case, that’s fine, we’ll deal with that. Paul Patterson Okay. And then just in terms of good will, I’m sorry to be a little so on. Just with the account and back to Jay’s question, what was the tax impact? I apologize, it’s been a busy morning, associated with our write-off. Steve Merrill I mean it’s really just a timing issue as it relates to a tax impact. That write-off will actually flow through our corporate tax calculation and impact our effective rate accordingly. Paul Patterson As opposed to being amortized, is that how we should think about it. Steve Merrill That’s correct. It accelerates in the amortization, and you don’t really amortize good will anyway. It just sits there until… Paul Patterson Not on a GAAP basis, but on the tax basis, was there any amortization on that. Steve Merrill No. Paul Patterson Okay, I just wanted to check on that. Steve Merrill Okay. Paul Patterson Thank you. Sean Trauschke Thanks Paul. Operator Thank you. And I am showing no further questions at this time. I would like to turn the call back to Sean Trauschke for any closing remarks. Sean Trauschke Well, once again I want to thank our members for their hard work and dedication and commitment to safety and thank all of you for joining us on this call today and have a great day. Operator Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude today’s program. You may all disconnect. Everyone have a great day.

Is It Time To Buy Convertible Bond CEFs?

Summary Convertible bond CEFs have been hit hard lately, resulting in historically large discounts. Convertible bond CEFs offer enticing income while you wait for the sector to recover. My pick is NCZ, which is currently selling at a large discount and provides a distribution of 12%. In February of this year, I wrote an article advising investors to beware of convertible bond closed end funds (CEFs). At that time, I cautioned that premiums could disappear. As it turned out, my fears was well founded. In July of this year, the premiums morphed into large discounts. After the selloff, I now believe some of these CEFs are selling at bargain levels. Part of my reasoning is based on the currently large negative Z-scores associated with these CEFs. Z-score is a metric popularized by Morningstar and is a measures how far a discount (or premium) is from the mean discount (or premium). The Z-score is computed in terms of standard deviations from the mean so it can be used to rank CEFs. A negative Z-score indicates that the current discount is larger than the average discount over the past year. A Z-score more negative than minus 2 is relatively rare, occurring less than 2.25% of the time. A good source for reviewing Z-scores is the CEFAnalyzer website. Most of the convertible CEFs currently have Z-scores more negative than minus 2. Before jumping into analysis of the risk versus rewards of convertible CEFs, I will recap some of the characteristics of this asset class. A “convertible security” is an investment that can be converted into a company’s common stocks. A company will typically issue a convertible security to lower the cost of raising money. For example, many investors are willing to accept a lower payout because of the conversion feature. The conversion formula is fixed and specifies the conditions that will allow the holder to convert into common stock. Therefore the performance of a convertible is heavily influenced by the price action of the underlying stock. As the stock prices approaches or exceeds the “conversion price” the convertible tends to act more like an equity. If the stock price is far below the conversion price, the convertible acts more like a bond or preferred share. Convertible bond CEFs usually contain a mixture of convertible securities and high yield bonds. The attraction of convertible CEFs is that they offer upside potential with some protection on the downside. Granted that with a portfolio of high yield bonds and convertibles the downside protection is limited. However, over the long run, the fund manager seeks to obtain the “sweet spot” between fixed income and equity that will enable him to outperform his peers. The funds that were analyzed in my previous article are summarized below. AGIC Convertible and Income (NYSE: NCV ). Over the past 5 years, this CEF has sold mostly at a premium, sometimes as high as 14%. It was not until the second half of 2015 that the fund began selling at a discount. The five year average has been a premium of 7.5% and the 1 year average was still a premium of 5.7%. The fund is now selling at a discount of over 10% and has a Z-score of negative 2.55. The portfolio consists of a combination of convertible bonds (58%) and high yield bonds (41%). Less than 10% of the holdings are investment grade. The fund utilizes 33% leverage and has an expense ratio of 1.2%. The distribution is 12.5%, funded by income with no return of capital (NYSE: ROC ). AGIC Convertible and Income II (NYSE: NCZ ). This is a sister fund to NCV and over the past 5 years, the prices of these two funds have been 90% correlated. So if you invest in one of these funds, you gain virtually no diversification from investing in the other. Over the past 5 years, this CEF has sold mostly at a premium, sometimes as high as 17%. It was not until the second half of 2015 that the fund began selling at a discount. The five year average has been a premium of 10.4% and the 1 year average was a premium of 9.4%. The fund currently sells for a discount 9.4% and has a Z-score of negative 2.4. The portfolio consists of a combination of convertible bonds (57%) and high yield bonds (42%). Less than 10% of the holdings are investment grade. The fund utilizes 33% leverage and has an expense ratio of 1.2%. The distribution is 12.4%, funded by income with no ROC. Calamos Convertible and High Yield (NASDAQ: CHY ). Over the past 5 years this CEF has sold for a both a discount and a premium. The premium was as high as 5% in early 2015 but by late 2015 the fund sold at a discount. The 5 year average discount has been 2.9% but over the past year, the fund averaged a slight premium of 0.3%. The current discount is 8.6%. The portfolio consists of a combination of convertible bonds (55%) and high yield bonds (40%). Less than 15% of the holdings are investment grade. The fund utilizes 29% leverage and has an expense ratio of 1.5%. The distribution is 10.6%, funded by income with only a small amount of ROC. The UNII is negative and quite large when compared with the distribution, which may be a concern for maintaining future distributions. Calamos Convertible Opportunities and Income (NASDAQ: CHI ). Over the past 5 years this CEF has sold for a both a discount and a premium, alternating frequently between discount and premium. The premium was as high as 4% in 2011 but by late 2015 the fund sold at a large discount approaching 14%. The 5 year average discount has been less than 1% and over the past year, the fund’s average a discount has been 1.8%. The fund is currently selling at an 11% discount and has a Z-score of negative 2.05. The portfolio consists of a combination of convertible bonds (56%) and high yield bonds (39%). Less than 15% of the holdings are investment grade. The fund utilizes 28% leverage and has an expense ratio of 1.5%. The distribution is 10.9%, funded by income with only a very small amount of ROC. The UNII is negative and quite large when compared with the distribution, which is red flag for future distributions. This is a sister fund to CHY but over the past 5 years these two funds have only been 80% correlated so you receive a small amount diversification if you own both of these CEFs. Advent Claymore Convertible and Income (NYSE: AVK ). Over the past 5 years, this CEF has always sold at a discount. The five year average has been a discount over 8% and the 1 year average is an even higher discount of 10.5%. The current discount is a large 16.8%, which translates into a Z-score negative 2.78. The portfolio consists of a combination of convertible bonds (64%) and high yield bonds (31%). About 10% of the holdings are investment grade. The fund utilizes 37% leverage and has an expense ratio of 2%. The distribution is 8.1%, funded by income with a substantial (40%) ROC component. UNII is negative and large compared with the distribution. Advent Claymore Convertible Securities and Income (NYSE: AGC ). Over the past 5 years, this CEF has usually sold at a discount. The only premium was for a short time in 2010 and was less than a 5% premium. The five year average has been a discount of 8.7% and the 1 year average is an even higher discount of 13.8%. The current discount is over 17%, which translates into a Z-score of negative 1.95. The portfolio consists of a combination of convertible bonds (63%) and high yield bonds (28%). The portfolio also has a small (5%) equity component. About 10% of the holdings are investment grade. The fund utilizes 40% leverage and has an expense ratio of 3.1%. The distribution is 10.1%, funded by income with a substantial (70%) ROC component. UNII is negative and large compared with the distribution. Even though AGC is in the same family as AVK, the prices of these CEFs have been less than 60% correlated over the past 5 years. As a reference, I compared the performance of the convertible CEFs to the following exchange traded fund (ETF). SPDR Barclays Convertible Securities (NYSEARCA: CWB ) . This is the largest and most liquid convertible bond ETF. The fund was launched in 2009 and holds about 100 convertible bonds. ETFs are constructed so that they typically sell very near NAV, so there is no discount or premium. ETF has an expense ratio of 0.4% and yielded 4.5% over the past year. To assess the performance of the selected CEFs, I plotted the annualized rate of return in excess of the risk free rate (called Excess Mu in the charts) versus the volatility of each of the component funds over the past 5 years (from August, 2010 to August, 2015). The risk free rate was set at 0% so that performance could be easily assessed. This plot is shown in Figure 1. Note that the rate of return is based on price, not Net Asset Value (NAV). (click to enlarge) Figure 1: Reward versus risk over past 5 years The figure indicates that there has been a wide range of returns and volatilities associated with convertibles CEFs. For example, NCV had a high return but also a high volatility. Was the return worth the increased volatility? To answer this question, I calculated the Sharpe Ratio for each fund. The Sharpe Ratio is a metric, developed by Nobel laureate William Sharpe that measures risk-adjusted performance. It is calculated as the ratio of the excess return over the volatility. This reward-to-risk ratio (assuming that risk is measured by volatility) is a good way to compare peers to assess if higher returns are due to superior investment performance or from taking additional risk. On the figure, I also plotted a red line that represents the Sharpe Ratio of NCV. If an asset is above the line, it has a higher Sharpe Ratio than NCV, which means it has a higher risk-adjusted return. Conversely, if an asset is below the line, the reward-to-risk is worse than NCV. Some interesting observations are apparent from the plot. With the exception of AGC, the convertible CEFs had a respectable return over the past 5 years even though they recently sold off. Since CWB did not sell at a premium or a discount, it is not surprising that it had the best risk-adjusted performance over the period of the analysis. Looking at only CEFs, CHY, CHI, and NCV had nearly the same risk-adjusted performance. NCZ was close behind. AGC was the worst performer and only barely stayed in positive territory. The volatility of convertible CEFs ranged from about 15% to 17% (this is similar to the volatility of the S&P 500 over the same period) The 5 year look-back data shows how these funds have performed in the past. However, the real question is how they will perform in the future when the bull market in convertibles returns. Of course, no one knows, but we can obtain some insight by looking at the most recent bull market period from June, 2012 to September, 2014. Figure 2 plots the risk versus reward for the funds over this bull market time frame. As expected, all the funds did well. The performance of the CEFs were tightly bunched but NCZ was the clear leader among the CEFs. Somewhat surprisingly, CWB still turned in the best risk-adjusted performance. However, NCZ had the best return on an absolute basis. (click to enlarge) Figure 2 Risk versus reward over a convertible bull market Bottom Line Convertible bond CEFs have taken it on the chin lately and the discounts have widened to historic proportions. Is it time to buy these CEFs? To my mind, the answer is yes, especially NCZ. NCZ is currently selling at a discount, which is rare. If the discount reverts back to the mean, you will receive a capital gain along with collecting 12% in distributions. Not a bad combination! Of course, the discount could widen and it may time a long time for this CEF to recover, but I am willing to wait. CHY has had exceptional performance in the past and is also selling at steep discounts. This would be another alternative but I am a little worried about the large UNII and ROC. If you are risk adverse, you may want to consider CWB. There is no doubt this is the best in terms of risk-adjusted performance. However, you will not receive any “reversion to the mean” benefits. I normally choose asset with the best risk-adjusted returns but in this case, I am willing to take a slight gamble and go with NCZ. This is a special situation where I think I can capitalize on the selloff in CEFs and hope for that the large discount associated with this CEF will revert back to the mean.

Investors Have Been Selling But Haven’t Yet Decided What To Buy

“The stock market is almost magical because it always leads the economy. It goes down long before the economy drops and then heads higher long before the economy rebounds. It always has.” -Kenneth L. Fisher If you look at the details of fund flows during the last several months, then you will discover that there have been net outflows from many funds of U.S. risk assets. This includes most U.S. equity and U.S. bond funds. As more and more time passes from the all-time peaks for many U.S. equity indices, investors are progressively realizing that the likelihood for additional gains is less than the probability that we have begun what could eventually become a full-fledged bear market. The S&P 500 reached its highest point of 2134.72 on May 20, 2015, which was more than five months ago. Investors hate to tamper with the status quo if they are comfortable with it, so very few people sold near the spring highs. In recent weeks, there have been notable outflows especially on days when U.S. equities have been declining. The more that time passes and additional lower highs are registered for the S&P 500, the Nasdaq, the Russell 2000, and similar indices, the more that people will realize that their portfolios are losing money rather than making money. Since the losses have been modest overall, these outflows haven’t nearly approached the record withdrawals which were made during the first quarter of 2009. However, there has been a notable total decline in the money committed to U.S. risk assets, while the amount of money in safe deposits including money market funds has surged in recent months. One interesting observation is that, prior to the recent climb in the popularity of safe time deposits, these had reached all-time low levels relative to the amount of money invested in riskier assets. It is likely that, obtaining only around one percent interest or less on their bank accounts and near zero in their money market funds, many investors were encouraged to shift into far more speculative alternatives. They convinced themselves, with the able assistance of financial advisors, that they were nearly as safe in high-dividend blue chip U.S. stocks or high-yield corporate bonds as they were in the bank. In reality, they have been taking enormously greater risk, because most of these assets lost more than half their value during their respective bear markets of 2007-2009. However, most advisors politely didn’t bring up this inconvenient fact, and most people would rather not think about what is possible while focusing instead on what is ideal. Now that reality has slowly begun to reassert itself, investors have been moving back into time deposits-but haven’t yet taken more than a tiny percentage of this money and invested it in other assets. Historically, whenever there is a recent surge in safe time deposits, most of the money ends up being reallocated into securities which are perceived to contain greater upside potential. The only exception tends to be near the very end of a bear market, when risk assets are plummeting and investors are frightened into safety at any cost. Since we are far from such a situation today, asset reallocation usually means chasing after whatever has recently been climbing the most in percentage terms. If 2015 ends with a net loss for most U.S. equity and bond funds, then those funds which have enjoyed net gains will stand out noticeably among a sea of red. Other investors look for whatever has rebounded the most from its recent bottom, or for various kinds of moving average crosses and other signals. Therefore, whichever assets outperform from now through the end of 2015 are likely to be especially visible and to receive increasingly positive media, analyst, and advisor coverage. The persistence of such upbeat discussion will be accompanied by strong inflows. So far, there haven’t been any sectors which have featured many such standout assets. However, this could change soon, because there is such a huge disparity between the world’s most overpriced assets and the most undervalued ones. The list of overvalued securities includes many U.S. stocks and bonds and global real estate. The most compelling bargains can generally be found among commodity-related and emerging-market assets which in many cases have been trading at lower prices than during their worst levels of 2008-2009. Because they are so inexpensive, they can gain enormously in percentage terms and yet remain far below their respective peaks from the first half of 2008 or in many cases from April 2011. If this happens, then they will be able to continue to gain dramatically until the final months of 2016 or the early months of 2017. It is too early to say whether this kind of activity will occur or not, although historically most U.S. bull markets end with a period of rising inflationary expectations. It is rare for the economy to go into a recession without first experiencing an inflationary binge. During the most recent bear market of 2007-2009, we had a sharp and unexpected inflationary climb for roughly one year from the summer of 2007 through the summer of 2008. Since literally a hundred central banks worldwide including the U.S. Federal Reserve are eager for higher inflation, we are likely to get exactly what they want. Wage inflation has been moderately accelerating in the U.S., while prices have been generally slower to follow suit. Most investors are continuing to moderately sell their previous favorites, while sitting on the fence in indecision about what to do with the money. If you follow the fund flows during the next few months, you are likely to learn a lot about what will happen for another year or more. There are supporting clues from the media, which have become less enthusiastic about U.S. assets but continue to generally favor them because they appear to many to be the only game in town. Most news articles regarding commodities or emerging markets are gloomy, especially when there have been recent price declines for anything in these sectors. It appears that precious metals and the shares of their producers may already have bottomed, while energy producers are possibly following suit while emerging markets are mostly bringing up the rear. If all of these are able to outperform, then especially with the best-known U.S. benchmark indices continuing to struggle, investors will begin to take notice of the top-performing securities and will become increasingly eager to own them. The financial markets have always been a paradox, in which more people are eager to buy something after it has doubled than before it has done so. It is surely the same this time, so most people won’t actually participate until it is too late to enjoy the lion’s share of the potential percentage gains. If an asset goes from 10 to 50, then buying it at 20 might seem to surrender only one fourth of the profit since 20 is one fourth of the way from 10 to 50. However, the gain from 10 to 50 is 400% while the increase from 20 to 50 is 150%, so you actually give up 5/8 of the total profit instead of just 1/4. The financial markets are inherently geometric rather than arithmetic, which is why it works out this way. The key is that those who buy before a rally end up gaining far more than those who wait until a rebound has been “confirmed”. Also, there is really no such thing as confirmation; whenever something has allegedly established a new uptrend, it often first suffers a sharp short-term correction to punish those who were tardy in jumping aboard the bandwagon. Tax tip: If you own shares or funds which are trading near multi-year bottoms and you are a U.S. resident, you can take advantage of their currently depressed prices if these assets are in your 401(k), 403(b), SEP-IRA, Keogh, traditional IRA, or other non-Roth retirement account. You can convert these shares from your account to a Roth IRA and pay taxes based upon their present low valuations. As these eventually rebound, all future gains will be completely tax free. In the event that these shares don’t recover but end up retreating further in price, you can choose to undo your conversion, which is known as a recharacterization. You can then wait at least 30 days, or until the following calendar year-whichever is later-and then convert them again. There is no limit to how many times you can repeat this process and there are no income or other restrictions in making such conversions and recharacterizations, as long as each recharacterization is done on or before October 15 of the year following the date when the conversion had been done. It’s like being able to go back in time and “unbuy” something which doesn’t go up in price. It’s heads you win, and tails you also win. Unfortunately, I do not know of an equivalent strategy which is permitted in any other country besides the United States. Disclosure: In August-September 2013, and at various points during 2014-2015, I have been buying the shares of emerging-market country funds whenever they have appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares-and more recently energy shares-especially following their most extended pullbacks. I have also been accumulating HDGE whenever U.S. equity indices are near their peaks; HDGE is an actively-managed fund that sells short U.S. equities. I believe that U.S. assets of almost all kinds have become dangerously overvalued. From my largest to my smallest position, I currently own (NYSEARCA: GDXJ ), (NYSEARCA: KOL ), (NYSEARCA: XME ), (NYSEARCA: COPX ), (NYSEARCA: SIL ), (NYSEARCA: HDGE ), (NYSEARCA: GDX ), (NYSEARCA: REMX ), (NYSEARCA: EWZ ), (NYSEARCA: RSX ), (NYSEARCA: GLDX ), (NYSEARCA: URA ), (NYSEARCA: IDX ), (NYSEARCA: GXG ), (MUTF: VGPMX ), (NYSEARCA: ECH ), (NYSEARCA: FCG ), (NYSEARCA: VNM ), (MUTF: BGEIX ), (NYSEARCA: NGE ), (NASDAQ: PLTM ), (NYSEARCA: EPU ), (NYSEARCA: TUR ), (NYSEARCA: SILJ ), (NYSEARCA: SOIL ), (NYSEARCA: EPHE ), and (NYSEARCA: THD ). In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled. I have reduced my total cash position to roughly 3% of my total liquid net worth in order to increase my holdings in the above assets. I sold all of my SLX by acting whenever steel insiders were doing likewise. I also sold all of my FCG but I have been repurchasing it following its recent collapse because there has been intense buying by top corporate insiders of companies which produce natural gas. I expect the S&P 500 to eventually lose about two thirds of its recent peak value, with its next bear-market bottom occurring within several months of October 2017. The Russell 2000 Index and its funds including IWM have only modestly surpassed their highs from the first week of March 2014, while the Russell Microcap Index (NYSEARCA: IWC ) marginally surpassed its zenith from March 6, 2014. The S&P 500 Index set a new all-time high on numerous occasions during the same period, and may have completed its final top for the cycle at 2134.72 on May 20, 2015. This marks a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have “forgotten” or never learned the lessons of previous bear markets are doomed to repeat their mistakes.