Brandon Lohse - IR Curtis Dinan - SVP & CFO Pierce Norton - President & CEO.

Chris Sighinolfi - Jefferies Aga Zmigrodzka - UBS Dennis Coleman - Bank of America.

Good day and welcome to the ONE Gas Third Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Brandon Lohse. Sir, please go ahead..

Good morning and thank you for joining us on our third quarter 2018 earnings conference call. This call is being webcast live and a replay will be made available. After our prepared remarks, we will be happy to take your questions.

A reminder, that statements made during this call that might include ONE Gas expectations or predictions should be considered forward-looking statements and are covered by the safe harbor provision of the Securities Acts of 1933 and '34. Actual results could differ materially from those projected in any forward-looking statements.

For discussion of factors that could cause actual results to differ, please refer to our SEC filings. Our first speaker, this morning, is Curtis Dinan, Senior Vice President and Chief Financial Officer of ONE Gas.

Curtis?.

Thanks, Brandon. Good morning everyone and thank you for joining us today. Beginning with our third quarter results, net income for the third quarter 2018 was $16.3 million or $0.31 per diluted share, compared with $18.8 million or $0.36 per diluted share for the same period last year.

The largest impact to our results was the timing of income tax deferrals and related rate adjustment which was partially offset by increases from new rates in Texas and Kansas and residential customer growth in Oklahoma and Texas. I'll comment more as to the ongoing effects of tax reform in a minute.

Operating cost for the third quarter were 110.5 million compared with 104.8 million in the same period last year due to an increase in employee related cost and bad debt expense. Capital expenditures for the third quarter increased $9 million to $103.5 million compared with $94.4 million for the same period last year.

We are still expecting full year capital expenditures to be in the range of $375 million to $390 million with approximately 70% targeted towards system integrity and replacement project. Now for a quick update on tax reform.

In compliance with the accounting authority orders in each of our jurisdictions, we have established a regulatory liability for the difference in federal taxes resulting from the recent drops in statutory income tax rates.

The establishment of this regulatory liability and related rate adjustments from completed filings resulted in a $6 million reduction to our revenues in the third quarter 2018, or $4.6 million, net of tax. This was partially offset by $2.6 million reduction in our income tax expense.

Recall from our two previous earnings calls that this timing difference between the revenue deferral and the reduction in our income tax expense created a positive $0.13 impact on earnings in the first quarter and a negative $0.06 impact in the second quarter.

We saw another $0.4 reversal in the third quarter and expect the remaining $0.03 to reverse in the fourth quarter. The effect from the change in tax rate has now been reflected in regulatory filings across all of our jurisdictions including our pending filings in Oklahoma and Kansas.

The timing and process for returning excess accumulated deferred income taxes to our customers and most of our jurisdictions is still to be determined. Yesterday, the ONE Gas Board of Directors declared a dividend of $0.46 per share, unchanged from the previous quarter. This dividend is consistent with the Company's guidance for 2018.

As we've indicated previously, we expect the average annual dividend increase to be 7% to 9% between 2017 and 2022 with a targeted dividend payout ratio of 55% to 65% of net income. We affirmed our 2018 net income guidance range of $167 million to $178 million or $3.15 to $3.35 per diluted share.

Historically, during our earnings calls, we have provided two different rate base calculations. The first is authorized rate base defined as the rate base reflected in our latest regulatory proceedings including full rate cases and interim rate filings. At September 30, 2018, authorized rate base was approximately $3 billion.

The second is estimated average rate base which is defined as authorized rate base plus additional investments in our system, and other changes in the components of our rate base that are not yet reflected in approved regulatory filings.

We project that for year-end 2018 our estimated average rate base will be approximately 3.36 billion with 42% in Oklahoma, 30% in Kansas and 28% in Texas. In August, the IRS issued guidance that utility assets placed in service during the fourth quarter of 2017 are eligible for 100% bonus depreciation.

We have previously assumed that these assets would not be eligible. This additional bonus depreciation had the effect of increasing deferred taxes, thereby slightly reducing estimated average rate base from our prior estimates. And now, I'll turn it over to Pierce Norton, ONE Gas President and Chief Executive Officer.

Pierce?.

Thanks, Curtis, and good morning everyone. I would like to by giving you an update on the recent regulatory activity throughout our service areas, so I want to begin in Oklahoma. In September, the administrative law judge issued his report regarding our performance-based rate change application.

The ALJ recommended the commission approved the non-unanimous consent agreement between the staff and the Company except for the amortization period for unprotected excise accumulated deferred income taxes for which he recommended a 10-year amortization period.

A hearing is scheduled before the Oklahoma Corporation Commission for November 28 and a final order is anticipated by the end of this year. So onto Texas.

New rates went into effect in August for the incorporated customers in the Rio Grande Valley service area after we received approval by 1.1 million increase pursuant to the cost of service adjustment filing.

Finally, in Kansas in August, Kansas Gas Service requested an increase of approximately 2.4 million related to its gas system reliability surcharge and order from the Kansas Corporation Commission is expected in December, 2018 with new rates expected to be an effect January 1st of 2019.

In the pending Kansas Gas Service Rate request, the procedural schedule was approved on August 2nd, evidentiary hearings are scheduled for December 11th through the 13th, and a final order from the KCC is due February 25 2019. New rates are expected to be effective before the end of the first quarter of 2019.

As a reminder, this file request with the KCC is for a net increase in rates of 42.7 million, reflecting investments in the system and changes in operating cost necessary to maintain the safety and reliability of its natural gas distribution system.

The requested net increase in rates would be an increase in the operating income of approximately 31 million. The following is based on a 10% return on equity and 62.2% common equity ratio. For every 25 basis point change in our requested ROE, the impact on the operating income is approximately 2.2 million.

For every 1% change in our requested equity ratio, the impact on the operating income is approximately 1.4 million. On October 8th, Kansas Gas Service announced it has been selected by the U.S. government to own, operate and maintain the natural gas distribution facilities at Fort Riley under a 50-year contract. Fort Riley is the U.S.

Army installation in Kansas and has more than 15,000 active military, 5,600 civilian workers and supports over 5,000 retirees, 24,000 veterans and more than 18,000 family members living both owned and off the post. The terms of the privatization contract will be reviewed by the KCC.

If approved, Kansas Gas Service will start the transition process with an intent to take over the gas system operations in April of 2020. At closing, the Fort Riley contract will add approximately 5.8 million to the rate base.

In closing, I would like to express my gratitude to our 3,500 hard-working employees, their focus and commitment to provide safe and reliable natural gas service every day by more than 2.2 million customers is to be commended. Operator, we are now ready for questions..

[Operator Instructions] And our first question will come from Chris Sighinolfi with Jefferies..

Pierce, just had a question on I guess, the follow-up on your description Fort Riley, I guess we have talked previously about some municipal systems that may kind of available, but haven’t thought about U.S. government installations.

Is that a one-off opportunity? Or is that an effort by the armed services to move more of that I guess their gas infrastructure into more private professional hands?.

They actually started this in motion Chris years ago. We actually own and operate some assets, natural gas assets in other areas of our service territory like Fort Bliss, and they have been moving toward this privatization type effort even prior to the President Trump Administration.

So, this is something I think that they have had ongoing for a while. It just takes a while to run to go through the process..

I guess the fact that you've done previously, the experience in overtaking formally federally run assets.

What -- can you say anything about the state of those systems relative to your own systems and any associated upgrading or I guess, if there's a standardization that's required in terms of how you guys operate or some of the hardware you use versus what's been used by the government? Is there anything to be expected in that regard?.

Well, it's the same thing that we do in every other place. As far as your question, Chris, it really comes down to that’s part of the due diligence and that's part of what takes as long as it does is there's already been a significant amount of due diligence already done on those systems. So, we know who built them.

We know who maintained them at some of the same contractors that we use on our system. So, we have confidence that the systems were put in correctly and it is routine maintenance from here on out just like we would do on our systems..

And the contracts 50-year life I think I heard you mentioned in your prepared remarks that was just to inoculate risk in case there is a base closure some point in the future?.

That's exactly right. Yes, there are some things in there that allow us to do some different things and for some reason there was a base closure whatever, so we can grow level of that contract..

Okay, that was really impromptu on my part. I didn’t -- it was just born based on the prepared remarks, I appreciate the color. I was interested, Pierce, in terms I guess as I look forward into future periods and more I think of that next year, the maturing that you have in February.

Just curious your thoughts on refinancing that and with the capital program, if you thought you do it at the same size and what duration you thought would be appropriate given what the flattening of the curve yield deals do at this point, just curious thoughts on that?.

You referring to as the 300 million of bond maturity that we have at the end of January next year. We haven't made final determinations as to how will refinance that or what that tenure may look like when we do or even what the timing of it will be.

What they had said as at the end of the third quarter, we had under 300 million outstanding under our $700 million revolver. So our liquidity position is really strong at this point. And so, that gives us options as to how we think about what that refinancing and what the timing of that may look like..

Okay, so something just you'll evaluate as we grind closer to it, but capacity put down on the revolver, if markets aren’t super attractive at that point.

Is that how we think about it? Or are you just -- do you think it will be not that way that you will actually term it out before it comes to maturity, but you just haven't decided on what the structure exactly look like?.

Yes, we haven't decided exactly what that's going to look like or what that timing would be, so sort of a little bit of both of your assumptions..

Our next question will come from Aga with UBS..

Could you please discuss the customers' growth around your footprint? And how do you think about the customers' growth going forward? Looks like the third quarter, customers growth was down to 4.4% from 4.7% in 17. Thank you..

So, Aga, those growth numbers are net numbers. So, you have customers that exit the system and customers they come, so from -- if you look in from quarter to quarter, you do find some movement in that the best time to Mark that in the year is during the middle of the winter.

So, in the January timeframe, so when we get the annualized numbers, those of the best one to compare year-over-year. But if you look at year to date numbers, it's about 0.3% in Kansas about 0.5% in Oklahoma about 0.8% in Texas, which is very similar to what we've been experience over the past several years..

I have one follow-up question. Fully year O&M expenses guidance implies roughly 18 million quarter-over-quarter increase.

Typically, O&M is higher than 4Q, but do you see in potential room for incremental efficiencies to get the full year O&M guidance below of what you provided or the number before the guidance, below the guidance?.

We still believe that our O&M step and overall guidance numbers are right and they are definitely within our range that we given you guys earlier..

Our next question comes from Dennis Coleman with Bank of America..

Just a couple of quick ones.

Pierce, can I just ask you to repeat the numbers on the Fort Riley? How many people in total is it, if I can just get a single number there? And so, how many customers would it be?.

Well, in total there's about 15,000 active military on that base. Now that can ebb and flow because they could be deployed or whatever then you get about 5,600 civilian workers.

The important number that was disclosed on that is the 5.8 million of rate base because their meters and stuffer configured sometimes differently than what you might see in the civilian market.

So, the thing they are focused on there is the 5.8 million of rate base and then I would remind you that it's about 3.36 billion overall of the entire company. So, it's important to us, but it's not -- it's just routine business for us..

And so, is it -- does it have a different regulatory authority? Is it just the federal government or the military or does it….

No, it all falls under the Kansas Corporation Commission. So it's all rolled into the whole rate base of Kansas..

And you mentioned that the 3.36 billion of rate base and I should know this, but just to make sure I do understand that.

So, you said it was 3 billion of authorized rate base at the end of September and estimated average rate base of 3.36 billion which would be at the end of 2018?.

Yes..

And but it's -- so, the difference between 360 million has been filed for?.

No, what that represents is the capital expenditures primarily that have been made since the last rate filings. So what established the 3 billion that was our authorized rate base so the last Oklahoma PBR filing the last GSRS filing in Kansas, all those different things establish that 3 billion.

But we continue to spend money and so average the 3.36 billion that’s not yet fully reflected in those rate filings..

The reason we reported that way is because we think that's the most accurate. We as the Company know all the components to those rate bases in every single state. And so to be able to give you all guidance as to what those numbers are going to be, we feel like that's the most accurate reflection in real time..

But just for example, if I make sure I understand.

So, the Kansas rate case when it presumably is approved at some level next year that will change the authorized rate base?.

That’s correct..

Yes, that 3 million the first number I gave you would increase following that..

And so, presumably narrow into that 3.36..

Yes..

All right, thank you. [Operator Instructions] And all right gentlemen, we currently have no questions in the queue at this time..

Thank you for joining us this morning. Our quiet period for the fourth quarter starts when we close our books in early January and extends until we release earnings in February. We'll provide details on the conference call at a later date and have a great rest of your day. Thank you everybody..

Thank you, ladies and gentlemen. This concludes today teleconference and you may now disconnect..