Atmos Energy Corporation (ATO) Q2 2008 Earnings Report, Transcript and Summary

Good morning ladies and gentlemen, thank you for standing by. Welcome to the Atmos Energy fiscal 2008 second quarter earnings conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. [Operator Instructions]. I would now like to turn the conference over to Susan Giles, Vice President of Investor Relations. Please go ahead, ma’am.

Good morning everyone and thank you for joining us. This call, as you know is open to the general public and media, but designed for financial analyst. It is being webcast live over the internet. We’ve placed slides on our website that summarize our financial results. We will not review those in detail, but we will be happy to take any questions at the end of our prepared remarks. If you would like to access the webcast and slides, please visit our website at atmosenergy.com and click on the conference call link. Also we plan to file the company’s Form 10-Q later today. With me today are Bob Best, Chairman, President and CEO; and Pat Reddy, Senior Vice President and CFO. There are also other members of our leadership team with us here to assist with questions as needed. As we review these financial results and discuss future expectations, please keep in mind that some of our discussion might contain forward-looking statements within the meaning of the Securities Act and the Securities Exchange Act. Any forward-looking statements are intended to fall within the Safe Harbor rules of the Private Securities Litigation Reform Act of 1995. With that I’ll turn the call now over to Bob Best.

Thank you Susan and good morning everyone, and as always we appreciate you joining us and thank you for your interest in Atmos Energy. As Susan mentioned, Pat Reddy will review the financial result in a greater detail in just a moment. But before he does, I want to talk about our business and recent developments regarding the company. Yesterday, we reported second quarter consolidated net income of $112 million in earnings per diluted share of $1.24 per share. In the regulated businesses made up of our gas distribution operations and our intrastate pipeline in Texas, we experienced a 13% increase in our quarterly net income year-over-year. Distribution business continues to benefit from regulatory enhancements at further stabilized margins, and our pipeline in Texas benefited from the recovery of prior year capital expenditures through the GRIP mechanism, as well as higher transportation volumes generated from increased natural gas drilling in our state. And as expected year-over-year results in our non-regulated businesses declined this quarter as lower gas price volatility continued to limit our arbitrage opportunities in the marketplace. But our strategy of combining complimentary regulated and non-regulated operations continues to yield positive results. Our earnings contribution is projected to return to a more historical mix at about 70% coming from the regulated business and the other 30% coming from the non-regulated businesses in 2008. Also our Board declared our 98th consecutive cash dividend. Our indicated annual dividend rate for fiscal 2008 is $1.30 per share. I want to now about the Mid-Tex rate case, and the status of that case that we filed last September. That case now has been settled with all cities except Dallas, which accounts for about 15% of our customers. It is very significant that not only have we settled at about 70% of our customers, half of the commission is also supporting the settlement for what we call our advanced [ph] customers, which represents another 15%. As part of the continuing efforts to settle with the City of Dallas, the rail road commission of Texas order mediation which the first day of mediation occurred yesterday and we continue to talk to Dallas, and we are going to have follow-up meetings in an attempt to reach a settlement that’s fair to both parties. The next milestone in the rate case occurs May 16 when the proposal for a decision is due. And then we would expect accent a settlement, a final decision at the end of June. But I want to say this, that the settlement represents a dramatic paradox shift in how we do business in the Mid-Tex Division. It encourages and facilitates a collaborative and even cooperative partnership with our customers. Traditional rate filings are going to be replaced by a mechanism which streamlines the rate review process and annually updates capital expenditures and expenses. In addition, to establishing the foundation to improve and strengthen customer relationships, the review mechanism incorporates agreement on traditional divisive rate issues including ROE, capital structure, depreciation rates and allocation of shared service cost, which should significantly improve the stability, reliability and predictability of revenues and margins during the term of the agreement. The opportunity to review, challenge and better understand the content of these annual filings is presented during quarterly meetings that will be held to review and discuss expense budgets, operational plans and capital projects. And these meetings should provide the oversight that the cities desire, while giving them an opportunity to better understand our rates, our service and the value that Atmos brings to all of its customers in the State Of Texas. Now I want to turn to several important projects that we have been working on and have mentioned in previous calls. Our Park City Gathering project in Kentucky is nearing completion. This is a 23 mile low-pressure, gas gathering system and treating facility. Construction is completed and testing is currently being conducted, and we expect to be fully operational later this month. Total project cost for the Park City project was $10 million with $7 million of the capital spend in fiscal 2008. In the first full year of operation, pre-tax returns were expected to be about 20%. But the longer term value of this project is that it should give us a foothold in a much larger regional strategy. Now turning to our salt-dome storage project in Louisiana. In early, February we announced, we had submitted a pre filing request with the FERC to construct and operate a salt-cavern gas storage project in Franklin Parish located in North Eastern, Louisiana. Because the facility will store and facilitate transportation and natural gas between states, the FERC will have regulatory oversight, over this project. Potentially this is for an initial build out of three 5 Bcf caverns for a total of 15 Bcf of working gas storage with six-turn injection and withdrawal capabilities. The structure could accommodate an additional four caverns depending on market demand. The first cavern is projected to be operational in 2011 and other two caverns in 2012 and 2014. We have now secured a contractor to drill the test well and drilling is expected to begin some time next week. This well will be configured to serve as a cavern well upon FERC 7(c) certification. We expect to announce a non-binding open season in our fiscal third quarter. Our fiscal 2008 capital budget includes about $15 million for this project. With any project of this scale and scope, there exists a long destination period. At this time with the project being in it’s infancy, it will take some time before we can develop or disclose any meaningful related financial metrics. I’m now going to turn program over to Pat Reddy to review our financial results and then I’ll return for closing remarks and then Pat and I as well as the rest of the team will be glad to take any questions from you, Pat?

Thank you Bob and good morning every one. We are looking forward to seeing many of you at the AGA Financial Forum. I’ll speak to the more significant items in this quarter and our six months period, and then discuss our outlook for the remainder of our fiscal year. As we stated in the earnings release, our consolidated net income for the quarter climbed 5% to about a $112 million or $1.24 per diluted share and for the six months ended net income dip slightly to $185 million or $2.06 per diluted share. The main drivers of our earnings results were the following. Our regulated natural gas distribution segment grew net income 12% in the quarter to about $86 million. Net income grew 16% to $126 million for the current six month period. For both current periods; the National Gas Distribution business continued to benefit from cumulative effect of rate design improvements. We experienced a net increase in gross profit of over $13 million in the quarter and about $23 million for the six month period generated primarily from rate adjustments in several of our areas. The Regulated Transmission and Storage segment experienced remarkable growth. Net income grew 15% to $15 million in the quarter and increased 9% to $25 million in the current six months. This segment continues to benefit from increased transportation in the Barnett Shale and Carthage gas producing regions in Texas, as well as some GRIP recovery at the annual capital investments in Texas. Our nonregulated operations contributed net income of almost $11 million in the quarter, which was down about $7 million from the prior year’s quarter. Year-to-date, the nonregulated operations posted over $34 million of net income, down about $22 million from the same period one year ago. Earnings were lower mainly due to a decrease in realized margins on asset optimization activities resulting from reduced gas price volatility. This decrease is consistent with our view at the beginning of our fiscal year that we express here regarding marketing margin that they would decline as a result of reduced price volatility. Although both nonregulated segments of our business were affected by the lack of natural gas price volatility, my remarks today will focus on gross profit in the natural gas marketing segment and you can follow on if you’d like by turning to slide 6 and 13 in our deck. Natural gas marketing gross profit was down about $7 million for the quarter and $24 million for the six months, as compared to the same period one year ago. Unrealized margin losses decreased about $31 million in the quarter and $11 million for the six months, mainly as a result of smaller changes in the spreads between the forward prices that are used to value the financial hedges and the market price used to value physical storage. Operationally, we experienced an increase in our delivered gas margins of almost $12 million in the current quarter and $10 million for the current six months, as compared to a year ago. This was largely due to the ongoing successful execution of our marketing strategy, which generated incremental sales volumes of about 19 Bcf in the current quarter and 37 Bcf for the six months along with capturing favorable basis gains in both periods. Our asset optimization margins declined $15 million in the quarter and $45 million in the six months as compared to last year. This decrease was due to smaller gains realized from the settlement of financial positions, lower margins earned from cycling gas in a less volatile gas market, and increased fees paid to third-parties for storage. You may recall that during last quarter, natural gas fundamentals were less than favorable with warm weather and national gas inventory levels nearly full. At that time, the marketing company elected to inject gas into storage and roll its financial positions forward, primarily to this fiscal second quarter, in order to take advantage of the favorable spreads that existed at that time. During our fiscal second quarter, Atmos energy market essentially executed on its December 31, 2007 planned injection and withdrawal schedule by cycling gas from storage and settling the associated financial contracts. During the process, the marketing increased its net physical position by 3 Bcf. However, the captured spreads were lower than in prior periods. Information concerning the marketing company’s storage book is shown the appendix to our slide presentation and it begins on slide 38. It shows the difference between, what we call, economic value and the GAAP reported value at the end of the reporting period. At the end of March, the excess value of our gas and storage was about $11 million, which we expect to realize primarily in the second quarter of next fiscal year that would be fiscal 2009. Spreads fell to about $0.52 per Mcf at March 31, 2008 compared to $2.49 per Mcf at the end of December 2007. Now, let’s turn to the expense side of our income statement. Our consolidated operation and maintenance expense increased about $8 million for the second quarter and about $14 million during the first six months of our fiscal year. The primary drivers of the increase were: higher labor and benefits costs associated with annual wage increases and higher contract labor, which increased almost $2 million in the quarter and nearly $5 million in the current six month period. In the current quarter, there was also a reduction and the accrual for incentive compensation at the nonregulated business segment as a result of lower earnings this year. Other administrative costs as well as pipeline odorization and vehicle fuel cost increased O&M by about $5 million for the quarter and $6 million for the current six months. We also had an absence of about $4 million in both the current quarter in six months from the deferral of 2005 and 2006 Hurricane Katrina related expenses allowed by Louisiana regulators in the prior year quarter. We also experienced a rise in outside legal fees of about $3 million for the current six months. As a special offset to these increases, our bad debt expense declined about $2 million in the quarter and by over $4 million in the six months as compared to same period a year ago, mainly due to a relentless and continued focus on collection of customer accounts. Year-to-date our bad debt expenses running about three-tenths of 1% of residential and commercial revenues, and we anticipated no more than $15 million of bad debt expense this fiscal year, down from prior estimates of $20 million. Looking at our capital expenditures. For the current six months, they rose about $26 million to $199 million. Primarily, reflecting cost associated with pilot programs for our automated metering initiative in the gas distribution segment, pipeline main replacement activity in our Mid-Tex Division and the Park City gathering project that Bob talked about in Kentucky. Turning now to our earnings guidance for fiscal 2008. Despite the changes in the composition of our earnings this year, we are maintaining our previously announced earnings estimate in the range of $0.95 to $2.05 per diluted share of common stock. Earlier, Bob discussed the rate case settlement in the Mid-Tex Division and it’s a reminder. We’re not assuming any material impact on earnings in fiscal 2008 from its final outcome. And that’s primarily because of the increase we put in affect last April is recovered volume metrically. So of rather heating season and we will be into our summer and fall months. However, our assumptions for the 2008 fiscal year do include total expected gross margin contribution from the marketing segment in the range of $19 million to a $100 million, excluding any material mark-to-market impact continues successful execution of the rate strategy in collection efforts and our distribution utility, bad debt expense of no more than $15 million, average interest rates on our short-term debt about 6.5% and no material acquisitions in the balance of the year. On a consolidated basis, we remain within our original guidance range. But now that we are halfway through the year, we are better able to refine the split between our business segments. So let me draw your attention to slide 29, where we have project an increased contribution for the regulated transmission and storage segment and decreased contributions from nonregulated segments. We are projecting between $450 million and $465 million of capital expenditures for fiscal 2008. We have a breakdown in our slide deck. Of that $325 million to $335 million will be maintenance CapEx and about a $125 million to $130 million will be growth capital. And with that I’d like to turn it back to Bob.

Thanks Pat. And I’ll make a few closing comments and then we’ll be very happy to take questions. We don’t talk a lot about our solid investment credit. I’d like to remind you that maintaining our credit rate is extremely important to us and it’s certainly essential for financing growth and operating our businesses more efficiently. Our debt capitalization ratio at March 31st was 50% compared to 52% one year ago. We worked hard to return to our traditional 50% to 55% range after integrating the TXU gas assets and operations and feel good about where our balance sheet stands today. Additionally, we have no short-term debt outstanding at the end of March, which is where we want to be as we head into the storage injection season. Operationally, we continue to realize progress and are very focused on our regulated operations and particularly, the rate activity that goes on in our states. In the gas distribution business, we currently have rate actions filed and pending in Kansas, Mid-Tex, Louisiana, Virginia and Georgia service areas. We certainly, as I said, remain focused on effective rate making and effective rate design. We talked earlier about the settlement in Mid-Tex, but let me give you a few more details as we close. Settlement includes initial rate increase to revenues on a systemwide basis of $10 million, which was implemented April 1st. This is being recovered as past debt [ph] through the volumetric piece of the rate, so it will have no sizeable impact, on our 2008 earnings. Settlement also includes an annual Rate Review Mechanism or an RRM as we call it, effective for a three-year trial period that provides for annual adjustments to rates including both a true up to revenues for the prior rate period and the setting of prospective rates to include known and measurable costs for the next year. Beginning October 1, we will lower the base customer charge to $7 from $10.69 for the residential customers. We will adjust billing determinants and consumption to the previous year’s actual throughput experience. The gas cost portion of uncollectibles will be recovered through the purchased gas cost adjustment. Conservation program has also been approved to be funded equally by customers and the company. The first RRM filing was made April 14 requesting an adjustment to rates of $19 million and a true up to rates of $13.8 million for a total requested increase to rates of $33.5 million. (Inaudible) are currently reviewing the filing and after negotiation and agreement, implementation is scheduled for October 1, 2008. As I said earlier, we hope this marks the beginning of a new collaborative and cooperative rate making environment for Atmos and its customers in the state of Texas. In the regulated transmission and storage segment, the through-system business continues to be strong. Atmos Pipeline-Texas is uniquely positioned in the Barnett Shale production basin, which obviously is one of the hottest onshore supply basins in the country. Pipeline traverses and feeds our Mid-Texas utility, which in turn serves sprawling DFW Metroplex. Its capital investment is recoverable through the annual rate mechanism in Texas and it benefits from market based tariffs earned, and transportation gas from producers drilling in the Barnett Shale field. 2007 GRIP filing for revenue increase of approximately $7 million was implemented on April 15th of this year. Pipeline also provides reliability for the Mid-Tex Division distribution customers, yet is strategically positioned to serve the growing producer needs in Texas. Our non-regulated operations continue to complement the gas distribution business. As we have said on this call, we anticipated some pullback in our gas marketing and storage income from the lack of gas price volatility. But the marketing group is increasing sales volumes and continues to evaluate expanding into new market areas. The non-regulated natural gas marketing segment should provide solid earnings through its more predictable delivered gas service revenues with some upside from the storage optimization business. Non-regulated business development strategy is pretty simple. Stick to areas in which we are confident and in which we have a lot of expertise. The Park City Gathering system in Kentucky gives us a foothold into a much larger regional strategy. And as I talked earlier, the fourth necessity salt-dome storage project in Louisiana is still in its infancy. There are a lot of unknowns at this time which make it extremely difficult to model that project at this time with any amount of precision. To get closer to the startup date, we will give you better idea of the financial metrics associated with this project. And finally, I would like to add that assuming we achieve the middle of our earnings guidance of $0.95 to $2.05 for fiscal 2008 on a fully diluted earnings per share on a consolidated basis, we will have grown 6% over the past five years, which is at the upper end of our stated annual earnings range, of 4% to 6% on average. This earnings growth coupled with our dividend yield of 4.5% gives us the opportunity to provide our shareholders with exceptional value. We will continue to do that as we continue to grow our earnings in that 4% to 6% range. We appreciate you taking time to be with us and we will now open it up for any questions. Question and Answer

Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. [Operator Instructions]. And our first question comes from Ted Durban [ph] with Goldman Sachs. Please go ahead.

Hi guys. Question for you on the Mid-Tex case? I am trying to understand the adjustment of the $33.5 million that you are talking about for the next phase. How much of that is… I understand that part of that will be your CapEx recovery? Submit [ph], what you have as a GRIP filing, but now you are going to be getting O&M and what not. How much of that 33.5 would have been CapEx including GRIP and how much of it is more in the expense side and things like that?

Good morning, Ted. This is Kim Cocklin. The GRIP bounced to about $10.2 million or that part of the filing that would have been associated with GRIP is about $10.2 million, and the $13.8 million represents the true up of the revenues that were generated during the period compared to the 9.6 ROE and the capital structure that was agreed to, and remainder is principally expensed.

And he has dropped out of the queue. [Operator Instructions]. And we’ll put Ted Durban back in the queue. Please go ahead, sir.

Yeah, sorry about that.

Welcome back Ted.

Hey I don’t know what happened there. Just wanted to know the forward… it sounds like it’s forward-looking for O&M, that’s as of… is it of fiscal 2009 or is it of sort of when you filed it in April 14?

We utilized the period ending December of last year as the base period.

And Kim, when we make that filing can we take into… It will be non-measurable going forward.

Yes.

Yes. Okay. So can you give an estimate of sort of what do you think you’ll earn ROE basis for 2008 and then presumably you’ll earn your 9.6% ROE in 2009 if you get the full filing requirement?

If we would get the full filing requirement, that would be the outcome. We expect to have a process of negotiation and compromise any other case. So I mean, this is the first step of a three year trial period and obviously we want everybody to have a good understanding of where we are going and there will probably be give and take associated with this initial filing for sure.

Okay.

I don’t know what the returns are going to be in next year. If you know that, that would be helpful for us.

Okay. And then if I could ask a question just on the Fort Necessity Storage Project, what kind of interest are you seeing and what sort of commerciality are you seeing, given where the project is? Have you had to kind of… and not in an open season, obviously but just kind of spoken to producers and what not?

Well, we are very encouraged by the interest in the project. The location in Louisiana is downstream of some bottlenecks and a lot of other projects. So the location is good. It’s very proximal to a handful of interstates, which brings in more players that are interested in participating. The interest has been very encouraging. It gives us a lot of options because the interstates that we have an opportunity to tie to a couple of different regions, which also add to the attractiveness of a storage facility of this make, of this size and in this location. So far so good, as far as all the steps that have taken place to date and the open season should be forthcoming here shortly. Not binding open season.

Okay. And if I just could… one more question, probably for Kim, how far along are you in terms of getting regulatory approval for the AMI spending in the various jurisdictions?

We have sought recovery of those amounts in both of the jurisdictions where we have begun the pilot program, Ted. So, they are included in filings that are before commissions.

So, you’ll do a pilot of...

We are doing a pilot of 70,000 customers right now. We did it in the McKinney, Texas area which is part of the Mid-Tex [Utility] Division. And then we also did it in the Louisiana, part of the Louisiana Division.

And this will be reviewed and accessed in the next year so or?

I think the timing on Louisiana is around June, our recollection and then the Mid-Tex will be part of the process that we’re undergoing right now.

Okay. Great. Thanks for your time.

Thank you, Ted.

Thank you, sir. Our next question comes from the line of Eric Beaumont with Copia Capital. Please go ahead.

Good morning. A couple of quick clarifications on something set me on most meeting. One in particular, is you had the expectation of increased LNG shipments and that that those were going to be positive, I guess, just seeing some structural things, do you still feel that maybe the case for this summer?

This is Mark. At this point, it’s pretty hard to predict LNG shipments coming in this summer. We don’t see a lot of LNG terminal operators locking up lot of supplies. But it is a function of what the market drivers are and what’s happening in Europe, main is competition for LNG. More LNG arrivals on our shores would probably increase the volatility in the gas market, with gas prices jumping up around $11, and continue to rise. We’re in the world market, so we think that there is an opportunity for LNG to come but obviously it’s hard to predict its arrival.

Okay. Thanks. And I guess, its on bad debt you guys have done an extraordinary job keeping it down. I know you’ve had increased collection activities. Just given where most of the utilities are seeing in problems, do you expect to see a lower increased understanding you’ve given not more than $15 million for the year. But just given we’ve come through the heating season and so (inaudible) past due or what have you in given housing markets another residential issues, do you expect to see an increase there?

Well, we’ve been working on our uncollectibles really with a tremendous focus on that since 2000 when gas prices spiked in. I think our goal has always been to be at one half of 1% of commercial residential revenues or less. I think we’re seeing our good work this year, but that good work has almost been a cumulative affect because as I say we’re very focused on making sure we stay on top of our own collectibles. So there are obviously higher gas prices do put pressures on uncollectibles and we do other things nationally such as push for more dollars for live heat, which is a [low in term] housing allowance. And we work closely with agencies to help people that cannot pay their bills. So we’ll just continue to be very focused on and as I say we know that some other things that are going on the housing market and the -- and also with their gas prices will put -- it’s going to put increased emphasis on it. But it’s something that we really work hard at staying on top of it. And our people are very passionate about it. It takes a lot of labor to be able to reach the marks that we have and we’re very appreciative with the good job that our people do.

And one last thing in Texas obviously we had some warmer than normal weather. It was pretty normal last year. Is the weather norm mechanism Mid-Tex working? How do you expect?

Eric this is Pat, it actually worked very well, as part of the ongoing sort of fine tuning and negotiation of this RRM. We are making some technical changes and really it doesn’t change the total amount we collect, it just changes how it falls among our various classes of customers. But overall, it really has helped us remarkably. And as we come out of the heating season, Bob mentioned the fact that we don’t have any short term debt. Part of that has to do with rate increases that we put into effect, but a big part of it relates to this better rate design that we had at Mid-Tex and in Louisiana and in Mississippi, that’s about 75% of our customer margins that are now effectively normalized for weather, and we’ve got a second winter under our development, it’s working very well, really as intended.

Great. I appreciate the time when we see you guys in Miami.

Thank you.

Thank you, sir. Our next question comes from the line of Brooke Glenn Mullin with JPMorgan. Please go ahead.

You mentioned that you were seeing higher storage costs. Can you give us a sense of whether your storage portfolio is close to market or should we see continued cost pressure on that side going forward?

This is Rick Alford, Brooke. We are currently experiencing probably about $1.8 million a month in storage demand charges. As you can see from our table in the appendix, we have about $0.52 per Mcf in our economic value. At this point we feel like we are positioned well for the remainder of the year, because we have in excess of 20 Bcf in the ground, and if there is some kind of weather advent or our curtailment of production in the Gulf, we are again in a good position to realize some benefit from that.

Okay. Thank you.

[Operator Instructions]. And at this time there are no further questions. I would like to turn the conference back to Susan Giles for any closing remarks.

Thank you. Just as a reminder, a recording of this call is available for replay on the website through August the 5th. If you have any additional questions, please call me or visit us at the upcoming AGA Financial Forum. We appreciate your interest in Atmos Energy and thank you again for joining us. Good bye.

Thank you, ladies and gentlemen