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Executives

Susan Giles - VP, IR

Robert W. Best - Chairman and CEO

J. Patrick Reddy - Sr. VP and CFO

Kim R. Cocklin - President and COO

Richard A. Erskine - President, Atmos Pipeline - Texas

Analysts

Schneer Kruschuni - UBS

Barry Klein - Citigroup

Ted Turbin - Goldman Sachs

Atmos Energy Corporation (ATO) Q4 FY08 Earnings Call November 12, 2008 8:00 AM ET

Operator

Good morning ladies and gentlemen, and thank you for standing by. Welcome to Atmos Energy's 2008 Fiscal Year and Fourth Quarter 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.

Susan Giles - Vice President, Investor Relations

Good morning everyone, and thank you for joining us. This call is open to the general public and media, but designed for financial analysts, and it is being webcast live over the internet.

We have placed slides on our website to summarize our financial results. We will not review them in detail, but we will be happy to take any questions at the end of our 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.

With me this morning are Bob Best, Chairman and CEO; and Pat Reddy, Senior Vice President and CFO. There are also other members of our leadership team 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 discussions 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 will turn the call over to Bob.

Robert W. Best - Chairman and Chief Executive Officer

Thank you, Susan and good morning everyone. And as always we appreciate you joining us this morning for our call.

Our Chief Financial Officer, Pat Reddy is going to review our financial results in greater details in just a few minute, but before he does that I'd just like to start up by saying we're extremely pleased with our performance in fiscal year 2008. We were able to earn $2 per diluted share, an increase of 4.2% from last year, again meeting our commitment to deliver average annual earnings growth in the 4% to 6% range on a per share basis.

In fiscal 2008, our regulated operations contributed 74% of the total net income, while the non- regulated operations contributed the remaining 26%. It truly reflects a return to our more historic earnings composition.

Also, we are extremely proud of achieving a significant milestone for our company despite the uncertainty in the financial markets in our economy. Yesterday, our board of directors declared our 100th consecutive cash dividend, which was also our 21st annual dividend increase. Annual dividend was raised $0.02 bringing our indicated annual dividend rate for fiscal 2009 to $1.32 per share.

Our debt capitalization was 54.6% at the end of fiscal 2008. We keep this ratio on our list of top priorities and stand committed to preserving a debt capitalization range of 50% to 55% and maintaining solid investment grade credit ratings. These fundamental business principals have served us well during this time of disruption in the credit markets.

On October 29th, we secured a $212 million 364 days committed revolving credit facility. This facility replaced the $300 million facility that expired October 29th, 2008 and includes two new participating banks. But also like to make some observations about our credit liquidity before turning the call over to Pat.

Our credit capacity and the amount of unused borrowing capacity are affected by the seasonal nature of the natural gas business and our working capital requirements ratchet up as we head into the winter heating season. We typically access the short-term commercial paper market to finance purchases of natural gas to fill our winter storage.

Because of the freezing, the CP market beginning in mid-September, we drew down $331 million under our five-year revolver to fund these working capital needs. Our short-term debt outstanding is about $200 million greater at September 30th, 2008 compared to the same period in 2007 primarily driven by a reduction in operating cash flows in fiscal 2008, largely due to the rise in gas prices experienced during the summer injection period.

At a consolidated level, our weighted average cost of gas and storage was $8.40 at September 2008 compared to $6.78 the same time a year ago. Our debt level is expected to peak by the end of January and then start to decline as our customers begin paying their winter heating bills.

Our liquidity position remains very strong. We have credit facilities in place to meet our working capital needs and as of last Friday November 7th, our total credit capacity included $168 million of available capacity on the $600 million five-year revolver. All of the $212 million of capacity on the new 364 day facility and 213 million on Atmos Energy's 580 million uncommitted facility.

In addition, the company has 171 million of outstanding commercial paper with some maturities that extend into late January. And we also have $97 million of short-term investments and cash on hand. We could potentially experience some near term earnings pressure as a result of these challenging conditions.

As a result, we are reviewing our capital and expense budget to determine what steps there need to be taken to conserve cash and avoid reliance on credit facilities. We would not, however, jeopardize safety or reliability on our distribution in Pipeline systems.

I will now ask Pat Reddy to review our financial results and then I will return for few closing comments and we will take your questions. Pat?

J. Patrick Reddy - Senior Vice President and Chief Financial Officer

Well, thank you, Bob and good morning everyone. My remarks will primarily focus on the fiscal year and at the end of that I will touch on our earnings guidance for fiscal 2009.

I'll begin with the regulated operations. Our natural gas distribution in Texas intrastate Pipeline businesses combined the regulated operations experienced 24% growth in net income that's compared to a year ago.

Continued execution of our rates strategy coupled with higher throughput in per unit margins that Atmos Pipeline, Texas where the primary drivers of the growth and income. Our non-regulated operations experienced a drop in net income of about 25% from one year ago.

If you turn to slide number 7 in the slide there, you can see the earnings decline because of reduced realized margins on asset optimization activities mainly due to lower natural gas price spread volatility, which we have witnessed for sometime now.

The natural gas marketing segment experienced the declining gross profit for the year of about $11 million as compared to last year, mainly due to continued compression of market spreads as I just mentioned. The largest driver of this segment's decrease was the result of AEM' s decision to defer storage withdrawals and reset the corresponding financial instruments, which should enhance the potential gross profit in future periods.

This caused financial hedge settlement losses without the corresponding storage withdrawal gains, resulting in lower gross profit from realized asset optimization activities of about $35 million. Additionally, AEM experienced year-over-year increases in storage demand fees charged by third parties.

The decrease in asset optimization was partially offset by a year-over-year increase in delivered gas margin of over $16 million, which was driven by an increase in consolidated gas sales volumes of about 18 Bcf or 5% compared to last year and an increase in per unit margins due to favorable basis gains and improved marketing efforts.

And finally, unrealized gains increased $7 million mainly as a result of the narrowing of the spreads between current cash prices and forward natural gas prices.

Additional information concerning AEM storage book is shown on the appendix to the slide presentation beginning on slide number 51. This shows the difference between our economic value, which is what we use to manage the business and our GAAP reported value at the end of the reporting period.

At the end of September, the excess value of our gas and storage was about $12 million, which we expect to realize primarily in the first half of fiscal 2009 based on our current injection withdrawal setup. There is a more detailed discussion of economic gross profit and potential gross profit in the MD&A section of our 10-K, which should be filed by the end of next week.

As a reminder, Atmos Energy marketing endeavors to keep a flat trading book and does not engage in speculative trading.

Now, I will turn to the expense side of our income statement. For the year, our operation and maintenance expenses rose about $37 million mainly due to the following factors: first, higher employee and benefit cost increased O&M expenses by about $7 million largely due to salary and headcount increases across all operations.

Our contract labor rose about $8 million primarily due to project spending at Atmos Pipeline-Texas. Other administrative cost rose over $6 million for the year and authorization and vehicle fuel cost increased O&M by almost $6 million in fiscal 2008.

We also experienced a rise in outside legal fees of about $9 million year-over-year due primarily to an increase in both litigation, and rate and regulatory activity. Our bad debt expense in a regulated gas distribution business decreased about $4 million compared to last year mainly due to continued focus on collection.

In fiscal 2007, operating expense included charges of about $6 million, which did not recur this year. Our capital expenditures for fiscal 2008 rose about $80 million to $472 million. This mainly reflects cost associated with the automated metering initiative in the gas distribution segment, main replacement activity in our Mid-Tex division, and capital to the non-regulated Park City gathering project. Please refer to our conference call slides for more detail on our capital expenditures.

Moving now to our earnings guidance for fiscal 2009, we have affirmed our fiscal 2009 earnings per share guidance of $2.05 to $2.15 per diluted share. Our guidance range assumes no material mark-to-market impact at September 30, 2009. And, as you can understand we have no way of determining what the mark will be until the end of our fiscal year.

So, let me draw your attention to slides 37 and 38, where we have outlined our budget assumptions and net income by segment for fiscal 2009. This has not changed since we provided it originally during our Analyst Meeting on October 1st.

Some of the assumptions that underlie our budget include continued successful execution of our rate strategy and collection efforts. No material impact from mark-to-market of our physical storage and offsetting financial hedges; short-term interest rates is well above three and three quarters percent; no material acquisitions; normal weather conditions, which is less impactful for our distribution operations now, but can affect our regulated pipeline and limiting our bad debt expense to no more than $12 million.

It's important to note that as a result of the rate, where we accomplished in fiscal 2008, we're heading into this 2009 winter heating season with the ability to recover the fuel related portion of bad debt cost to purchase gas adjustment mechanism in Amarillo, West Texas Cities, Lebec, Tennessee, Virginia, Kansas and our Mid-Tex jurisdiction, which all when combined account for approximately 67% of the total budgeted cost to gas and a regulated distribution businesses.

This means we can now defer the gas cut portion of bad debt cost above the amount included in base rates in the above mentioned jurisdictions.

I'd like to spend just a minute on our defined benefit pension plan, given what is occurring in the markets. Despite the recent decline in the tier value of the plant assets, we were now required to make a minimum funding contribution to our pension plan during fiscal 2008. However, we will monitor this situation in light of market conditions to determine if any contributions are required in 2009. Our next measurement date is January 1 of 2009.

We are projecting between $510 million and $525 million in capital expenditures in fiscal 2009, of that $310 million to $338 million will be maintenance capital and about a $180 million to $187 million will be growth capital. The growth capital includes $50 million to $55 million for a regulated project close to Austin, Texas on the Atmos Pipeline-Texas system.

As an update on this project, it is proceeding with preconstruction work and includes acquisition of writes away; permitting et cetera and a pipe has been ordered with delivery expected in early February. And we have another $50 million targeted for non-regulated projects including $30 million for identified that is yet unnamed project.

As Bob said earlier, we are reviewing our capital and expense budget to determine what steps can be taken to conserve cash and avoid reliance on credit facilities. Therefore, some of these projects may be delayed until after the 1st of the year, but we are committed to ensuring Atmos will continue to deliver the guide in investors expect even in these difficult markets.

And that concludes my remarks and now once again here is Bob.

Robert W. Best - Chairman and Chief Executive Officer

Thanks, Pat. I will make a few final comments and then we will be glad to take your questions.

As we have outlined today, we feel very good about our achievements that we accomplished this past year. We increased our earnings, preserved our debt capitalization target, received possibly positive outcomes in the regulatory arena and completed the non-regulated Park City gas gathering project in Kentucky.

Additionally, our proposed non-regulated Fort Necessity stall salt-cavern gas storage project in Louisiana is progressing.

In July, we completed a non-binding open season, which reflected significant interest in the project. Drilling of the test well is now complete. The core sample has been extracted and is currently being analyzed and as we indicated at our October 1 Analyst Meeting, we have engaged these services of an investment banker to help us determine the most optimal ownership development mix for this project.

We work to mitigate the market risk associated with the project of this scale and scope. As well as gained assurance on the availability of capital as we move forward. We will continue to update you as milestones or math for this long-term project.

Our regulated pipeline, Atmos Pipeline-Texas, continues to perform well. There are a few projects under review that would increase capacity to meet potential demands associated with the continued development of production in Texas as well as capacity enhancements in the growing areas of our service territory.

As you know, the foundation of our business lies in the regulated distribution business. Execution of our rate strategy is paramount to achieving our financial objectives. This past year we made considerable progress in the Mid-Tex division. We reached settlements with 438 of 439 cities served by Mid-Tex on terms that everyone felt good about. That settlement is for three years and includes the mechanism, which provides us the ability to refresh rates annually to reflect changes in cost, revenues and capital.

In April, we made the initial RRM filing with the settling cities for 33.5 million on a system wide basis. We negotiated with these cities and reached agreement on 20 million, which went into effect on November the 1st.

Last week, we filed a rate case with the City of Dallas, the only city in the Mid-Tex division not to agree to the settlement earlier this year. The rate case for Dallas is approximately $9 million. We have proposed that these rates become effective on December 11.

If Dallas chooses to suspend the case, the statutory deadline will be March 11 of next year. We requested a return on equity of 11.7%. This filing affects over 220,000 customers. We have several other cases currently pending with plans to file others in fiscal 2009. Over the five-year budgeting horizon, we project normalized revenue increases of about $50 million to $60 million annually from our rate outcomes.

We recognized consistency, predictability and growth report, and all of these attributes will be our focus as we move forward. We appreciate you taking time with us this morning and now we will open it up for questions.

Question And Answer

Operator

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions]. And our first question comes from Schneer Kruschuni with UBS. Go ahead please.

Schneer Kruschuni - UBS

Hi, good morning.

Robert W. Best - Chairman and Chief Executive Officer

Good morning, Schneer.

Schneer Kruschuni - UBS

Guys, can you hear me now?

Susan Giles - Vice President, Investor Relations

Now, we can.

Schneer Kruschuni - UBS

Perfect. Sorry about that, we had some phone difficulties. Just wanted to ask a couple of quick questions, just with respect to the utility, I know that you have made significant amount of progress with respect to immunizing yourself from weather exposure and so forth and what not. I was wondering if you can talk to the effects of conservation, I know that you got something in Mid-Texas and so forth but if you can sort of give us some color with respect to your exposure to conservation in this type of environment?

Robert W. Best - Chairman and Chief Executive Officer

I'm going to let Kim Cocklin, who is here with us and is our President of our company answers that question.

Kim R. Cocklin - President and Chief Operating Officer

Good morning, Schneer. Well, as you know conservation tariffs are very popular discussion topic with regulators today and it's pretty similar to the demand despite management that goes on as one on the electric side. We do have conservation programs. We have one in the Mid-Tex division and we are adopting one in West Texas and essentially, it encourages our customers to conserve and it rewards us with joining with them in these efforts to have them conserved and then our margins are not high essentially to throughput.

Robert W. Best - Chairman and Chief Executive Officer

And Schneer, another thing that we benefit from it about 75% of our margins today are reviewed in annual rate filing mechanisms like we have in Texas, the other jurisdictions Louisiana and Mississippi, so that to the extent that conservation could accelerate we wouldn't have to... it wouldn't be a significant lag between the time that develop and the time that we could reflect the declining volumes and rates.

Schneer Kruschuni - UBS

Okay. That makes sense. Can you also give us some color with respect to your historical experience with bad debt expense, I mean, going back let's say at '91 or some more severe recession scenarios than we've seen recently?

Robert W. Best - Chairman and Chief Executive Officer

We had kind of high water mark for bad debt expense in the winter of 2000-2001, where at we hit...we were approaching about 2%. And since then, we have worked hard to reduce our bad debt expense by taking maximum deposits, by charging reconnection fees to customers and cutting off customers for non-payment before they have burned through their deposit.

And as a result, we're running at less than one half of 1% today. Now of course we're all concerned with the current economic conditions that our customers may have more difficulty in paying all of their bills, credit cards and utility bills and we're certainly in the middle of all of that. But we have a very effective collections team in place and good trackers in our terrace.

We also talked in our release about the effect that we have made significant progress and being able to recover the fuel cost portion of bad debt expense in our terrace, which for us 85% of our bill.

Schneer Kruschuni - UBS

Okay. Two last questions here, one is you brought up the pension plan until foot in the 2009 or what not. Is there some sense or some thought process out there to potentially make a total contribution at this point right now, just given the fact that assets are down and obviously the market is down in it, and that it may potentially recover before you make the contribution so forth and can you take advantage of that?

Robert W. Best - Chairman and Chief Executive Officer

Well, we took our snap shot at September 30th and we were 98% front at that point. Obviously since then the markets trailed-off in October. And as we looked at early numbers as of October 31st, we are about 89% funded and under the Pension Protection Act, you don't want to be really below 94% funded on a measurement date.

Our next measurement period is January 1 and we will take a look at that point to see if we are below the 94% level and think about whether we want to make a contribution to the plan, the concern you have is if and when the market does come back, it puts you in an over-funded position that we will certainly look at that.

Based on the snapshot at October 31, the amount of under-funding to get to 94% will be about $16 million. So, it's not an over whelming amount, it is just that the current liquidity situation we prefer not to be making voluntary contributions. We do have all the way until I think October 1st of 2009 to make additional funding. So, we will watch it during the year and watch the markets and make decisions as we go.

Schneer Kruschuni - UBS

And the final question more housekeeping, if you can just give us here for the fourth quarter the mark-to-markets that you have effectively burned the margin on or not, earned the margin on and so forth that would in theory can be reversed with the non-cash impact rather?

Robert W. Best - Chairman and Chief Executive Officer

At the impact on an earnings per share basis for the quarter was $0.11 compared to $0.12 last year and for the full-year, the mark-to-market impact between the marketing segment pipeline storage was $0.20 compared to $0.14 last year.

Schneer Kruschuni - UBS

Is the $0.11 broken up between the pipeline and the trading business?

Robert W. Best - Chairman and Chief Executive Officer

Yes, $0.03 for pipeline and $0.08 for natural gas marketing.

Schneer Kruschuni - UBS

Perfect. Thank you very much.

Unidentified Company Representative

Welcome.

Operator

Thank you. And our next question comes from Barry Klein with Citigroup. Go ahead please.

Barry Klein - Citigroup

How is it going, guys?

Unidentified Company Representative

Good morning.

Barry Klein - Citigroup

Schneer asked a few of my questions, but staying on the topic of the pension expense, does that annual review that you have with I think you said it was Louisiana, Texas and Mississippi. Does it include an annual review for any increases in the pension expense or funding necessary?

Robert W. Best - Chairman and Chief Executive Officer

That's an element of our overall cost to service, and so pension expenses included in the review.

Barry Klein - Citigroup

Okay. How much would 1% change in the discount rate effect your expense... your pension expense?

Robert W. Best - Chairman and Chief Executive Officer

That's a good question. I don't have that on my finger tips, but let me think about that well around the call here.

Barry Klein - Citigroup

Okay. And that's it. Thanks a lot.

Operator

Thank you. And our next question comes from Ted Durbin from Goldman Sachs. Go ahead, please.

Ted Turbin - Goldman Sachs

Hey guys, just coming back to the net non-regulated the marketing margins and what not, I am trying to figure out, if I back out the $0.20 of benefit that you got from non realized margins this year, its at $0.14. It looks like that sort of core operations are down pretty significantly. But you have said I think in the past that you don't really budget for unrealized margins. Can you just give us a sense where you see that coming on 2009, just given the weak trends you had in 2008?

And then the other question on that is I just noticed that your net acquisition of down to 8 Bcf, which looks like its pretty low versus where you've been over the last many quarters. Maybe just talk about what is the commercial activity you're seeing? Is that being reflected in the physical position or not?

Robert W. Best - Chairman and Chief Executive Officer

Rick, would you like to address that?

Richard A. Erskine - President, Atmos Pipeline - Texas

Absolutely. We are at 8 Bcf as you pointed out at the end of fiscal 2008, but we are re-injecting in order to sit our economic values for next year. We have recognized $36.4 million of our economic value of $48.5 leaving us $12.1 million. As Ted pointed out in his remarks, we expect that $48.5 million based on our current sit-up to be realized in primarily in the first quarter of 2009. And the remainder of that in the second quarter of 2009.

And its rally, not unusual for us to have these unrealized gains as we set our positions for the following periods and then we are re-injecting as I mentioned, so that we can have additional economic value. And again, it's not unusual to recognize those in income before we actually get the cash.

Ted Turbin - Goldman Sachs

Okay. Thank you. And then just a question on CapEx and thinking about the pipeline business, you have seen a lot of E&P companies like [indiscernible] and what not flashing their CapEx budgets and I'm just wondering how that might translate for you in terms your growth projects on pipeline and storage, something like that?

Kim R. Cocklin - President and Chief Operating Officer

Ted, this is Kim. Obviously, as Pat and Bob indicated in their opening remarks, both capital and expense budgets are being reviewed almost on a daily basis right now to keep in contact with the economic climate. And we have had conversations with several folks in the Barnett Shale and the producers that we do business with.

And, while we are still having a very, very good...we have a good situation with our throughput, they are backing away from certain projects in the very near term related to expansion of capacity right now and further development given where prices are. So, some of those things have been deferred and delayed. They're not totally shelved, but they are deferred and delayed.

Robert W. Best - Chairman and Chief Executive Officer

And interestingly, in our fiscal 2009, few of our capital projects are earmarked for additional throughput across our Atmos Pipeline-Texas system. We have got some reinforcements that we are doing at the southern end of our system down near Austin, Austin lateral to beat up our ability to deliver gas down to that portion of our system.

And that's not really dependent on the producers drilling program. We have identified as Kim said, probably something on their order of $30 million to $40 million of CapEx that could be slipped beyond January 1 without really hurting the effectiveness of those programs. So, as Kim said those are things that we are looking at pretty closely.

Ted Turbin - Goldman Sachs

Okay. Thanks a lot.

Operator

Thank you. [Operator Instructions]. And we have no further audio questions at this time. I would like to turn the conference back over to Susan Giles for any closing statements.

Susan Giles - Vice President, Investor Relations

Well, thank you all. Just as a reminder, recording of this call is available for replay on the website through February, the 4. We appreciate your interest and thank you again for joining us. Good day.

Operator

Ladies and gentlemen, you may now disconnect. .

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Source: Atmos Energy Corp. F4Q08 (Qtr. End 09/30/08) Earnings Call Transcript
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