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Executives

Susan Giles – VP, IR

Bob Best – Chairman and CEO

Fred Meisenheimer – SVP, CFO, and Controller

Kim Cocklin – President and COO

Analysts

Ted Durban – Goldman Sachs

Barry Kline – Citi

Atmos Energy Corporation (ATO) F1Q09 (Qtr End 12/31/08) Earnings Call Transcript February 4, 2009 8:00 AM ET

Operator

Good morning, ladies and gentlemen, and welcome to the 2009 first quarter earnings conference call on the fourth of February, 2009. Throughout today’s recorded presentation, all parties will be in listen-only mode. Following the presentation there will be an opportunity to ask questions. (Operator instructions) I’d now like to turn the conference over to Miss Susan Giles, President of Investor Relations. Please go ahead, ma’am.

Susan Giles

Good morning, everyone, and thank you for joining us. This call is open to the general public and media, but designed for financial analysts. It is being webcast live over the internet. We have placed slides on the Web site that summarized our financial results. And although we will not review those on detail, 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 go to our Web site at atmosenergy.com and click on the conference call link. Additionally, we plan to file the company’s Form 10-Q later today.

With me today are Bob Best, Chairman and CEO; and Fred Meisenheimer, Senior VP, CFO, and Controller. There are also other members of our leadership team here to discuss your questions as needed. And as we review this financial result sand 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 now turn the call over to Bob.

Bob Best

Thank you, Susan. Before I begin my remarks, I’d like to just say that yesterday, our Board of Directors appointed Fred Meisenheimer as our Senior Vice President, Chief Financial Officer, and Controller. As most of you know, Pat Reddy left our company on December 31st to become CFO of Spectra Energy. Although we are very glad and excited to have Fred as our CFO, and Fred has tremendous experience in the energy business. And all of us here in the company have terrific confidence in him as we move into the future. So he’ll be giving the financial report this morning as soon as I finish my remarks. And then I’ll conclude with a few remarks at the end.

But yesterday, we were pleased to report our first quarter consolidated net income of $76 million, the regulated businesses contributing 76% of that total net income. We’re very pleased with the 25% rise in net income from the regulated gas distribution business from a year ago. The work that we’re doing in a regulatory arena is certainly yielding the results that we have desired, and those results have become more stable and predictable. The regulated pipeline continues to perform very well. The pipeline experienced a 21% rise in gross profits from higher spreads of the through system deliveries.

Our non-regulated operations contributed 24% of our net income. Their results include non-cash unrealized mark-to-market net losses of $0.16 per diluted shares this quarter, which Fred will explain in detail in just a moment. But as you know, unrealized margins are temporary and should reverse in future periods. Our strategy of operating efficient and effective regulated assets and offering non-regulated services remains very, very sound.

Our earnings contribution had settled in to its more historical mix with about 70% to 75% coming from our regulated business and about 25% or 30% from our non-regulated business. Our operations also generated significantly stronger cash flow than a year ago across all lines of businesses. Also our Board yesterday declared our one hundred-and-first consecutive quarterly cash dividend. Our indicated annual dividend rate for fiscal 2009 is $1.32 per share.

I’d like now to comment on our credit and liquidity before turning over the call over to Fred. I’ll remind you that the amount of unused borrowing capacity is affected by the seasonal nature of the natural gas business. Our working capital requirements increase as we begin the winter heating season.

Traditionally, we access a short term commercial paper market to finance purchases of natural gas to fill our storage fields. As we stated last quarter, because of the unavailability of commercial paper, we borrowed funds from our five-year revolver to meet these working capital needs. However, we have seen improvement in the commercial paper markets recently. At December 31st, the total amount directly borrowed against our line of credit dropped $203 million, compared with $351 million at September 30th. And our commercial paper borrowings increased to $158 million, compared with just $20 million at September 30th.

Additionally, during the first quarter of fiscal 2009, we strengthened the sources of our liquidity with the execution of two new committed credit facilities. Our liquidity position is strong. As of last Friday, our total available credit capacity included $247 million of available capacity on the $567 million five-year revolver, all of the $212.5 million of capacity on the new 364-day facility, and $287 million on Atmos Energy’s marketing’s $375 million committed facility. In addition, the company has $319 million of outstanding commercial paper with some maturities extend into mid February. And finally, $43 million of cash on hand.

Finally, our focus on strengthening our balance sheet and preserving our debt capitalization range of 50% to 55% has been rewarded. Recently, Moody’s revised its outlook on Atmos Energy to positive. And Standard & Poor’s raised its corporate credit rating to BBB+. It is very gratifying for us to receive these positive changes to our ratings, particularly during this time of tremendous disruption in the credit market.

It’s now my pleasure to turn the program over to Fred Meisenheimer to review our financial results. And then I’ll return for some closing comments, and we’ll take questions at that time. Fred?

Fred Meisenheimer

Thanks, Bob, and good morning, everyone. Our first quarter fiscal 2009 consolidated net income was about $76 million or $ 0.83 per diluted share. This compares to about $74 million or $0.82 a share a year ago. As Bob stated, our regulated natural gas distribution segment reported over $57 million of net income a 25% increase from a year ago. This business benefited from the cumulative effective of rate design improvements and rate increases. An additional $25 million gross profit was generated as a result of rate adjustments primarily in Texas and Louisiana.

The Mid-Tex division experienced an $11 million increase in gross profit as a result of the three-year rate settlement reached in 2008 of all the cities other than the city of Dallas. Additionally, natural gas distribution gross profit benefited by about $8 million from a non-recurring update to our estimate for unbilled revenues as a result of base rate changes in several of our jurisdictions.

The regulated transmission and storage segment did about $8 million of net income, down about $2 million from the same period a year ago. Gross profit increased by almost $10 million due to increased through deliveries as well as improved margins. During the quarter, we were able to take advantage of spreads between our interconnects at the Waha and Katy hubs despite the over $3, compared to about $0.50 the same period one year ago. Higher position increase was more than offset by planned maintenance expense. The non-regulated pipelines, storage, and other segment posted almost $6 million of net income, up about $4 million from this time a year ago.

Earnings were higher mainly due to increased transportation margins and utilization of excess transportation capacity available under asset management agreements. Non-regulated natural gas markings segment experienced a decline in reported net income of about $11 million or about 49% from the same period a year ago. This was primarily due to the negative mark in our storage book at the end of the current period.

Such are many moving parts to the marketing business, let’s look at gross profits for this segment. If you turn to slide number eight in the slide deck, you can see that gross profit margins declined quarter-over-quarter by almost $16 million. That’s comprised by a $54 million decrease in unrealized margins, offset by $37 million increase in realized storage and trading margins. $37 million improvement in our realized asset optimization margins in the current quarter is a result of realizing net gains from settling financial contracts and withdrawing storage during the quarter. These gains were captured as unrealized in prior periods.

As we discussed on our year-end conference call in November, AEM had been deferring storage withdrawals and resetting their financial instruments in the last half of fiscal 2008. And hence, the potential realized gross profit in future periods. As a result of unfavorable natural gas fundamentals this period, it was economically advantageous to settle financial contracts and cycle gas from storage to realize the economic value at the current quarter.

This contrasts to the prior year quarter where it was advantageous to leave the gas in storage and roll the financial pages forward, which were ultimately cycled into the second quarter of fiscal 2008. This $37 million improvement in the realized asset optimization margin was offset by $54 million decrease in unrealized margins. First, the decrease reflects movement from unrealized margin in the prior year into realized margins of about $37 million in the current quarter. Secondly, market spreads, that is cash versus floor prices on AEM’s positions, decreased by almost $0.54 per MCF in this year’s first fiscal quarter, compared to a decrease of about $1.81 per MCF in the same period last year.

Let me remind you that the mark-to-market impact in this GAAP financial values are temporary and should reverse in future periods as fiscal gas is again cycled from storage and the related financial hitches are settled. Information concerning AEM storage book is shown and appendixed [ph] to the slide presentation on slides 32 to 34. These slides show the difference between the economic value, it is the cash, which is what we use to manage the business and the GAAP reported value at the end of our reported period.

Primarily as a result of realizing the economic value in the first quarter, AEM’s economic value associated with the storage book decreased from $48.5 million at the beginning of the current quarter to $20.7 million at the end of December. Based on the current setup at December 31st, we expect to realize about $10 million of this economic value in fiscal 2009, primarily in the second quarter, then the remainder in fiscal 2010. Spreads were about $0.97 per MCF at December 31, 2008, compared with about $0.64 per MCF at December 31, 2007. As a reminder Atmos Energy Marketing maintains a flat trading book and does not engage with speculative trading.

Looking at our expense side of our income statement for the quarter, consolidated OEM expense rose $13 million. Primary drivers in the increase include about $9 million due to hired contract labor, largely related to a planned maintenance of Atmos pipeline in Texas. About $6 million in increased employee and administrative costs and as a partial offset to these increases, bad debts expense decreased about $1.3 million, compared to the same period a year ago.

Also of great work in fiscal 2008, we entered the 2009 with our heating season with the ability to recover the fuel related portion of bad debt expense through gas cost tractors. This accounts for about 64% of the total budgeted gas costs at the regulated distribution business. This means we could collect the gas cost portion of bad debts or gas costs recovery tractor avoid incurring it as an expense. As a result, our projected bad debt expense for fiscal 2009 has been reduced to $12 million, which is considerably lower than the $16 million experienced in 2008.

Interest charges in the current quarter rose about $ 2 million, compared to one year ago. We had higher average short term debt balances. But moreover, we experienced a higher average commercial rates of about 7.25%, compared to a lower 5.5% of the same quarter one year ago. Also commitment fees for our lines of credit increased. Current commitment fees range from 7 to 50 basis points, compared with eight to nine basis points last year on our short term credit facilities.

Capital expenditures for the quarter were $107 million, up $13 million from the same period a year ago. This increase reflects spinning from non-regulated growth projects and increase regulatory compliance spending in the Mid-Tex division. We have affirmed our fiscal 2009 earnings per share guidance of $2.05 to $2.15 per diluted share, and have updated the expected contribution by business segment.

So let me draw your attention to slides 23 and 24 where we have outlined our budget assumptions of net income by segment for fiscal 2009. Our projections there included $ 8 million increase to net income in the regulated gas distribution segment, with an equal and offsetting decrease in the non-regulated marketing business. Distribution business continues to perform very well. We believe outcomes from our rate design work should provide stronger earnings power in this segment. Additionally, the distribution business has benefitted from a one time $8 million increase of margin, which is about $5 million after tax. That’s from our refining our estimates for our unbilled revenue.

We continue to expect lower margins in the non-regulated marketing business based on our viewpoint of relatively low volatility in the natural gas market in fiscal 2009. Marketing margins will likely fall at the lower end of the estimated range.

As a reminder, the guidance range assumes no material mark-to-market impact at September 30th, 2009. As you can understand, we have no way of determining what that mark will be until the end of our fiscal year.

I’d like to take a minute to review our defined benefit pension plan given what has transpired in the financial markets. Despite the recent decline in fair value of plans assets, we were not required to make a minimum funding contribution to our pension plan during fiscal 2008. However, based on the January 1st measurement date, we expect to fund at the 94% level as permitted by the new ERISA funding requirements. This would require a contribution of less than $25 million to our plans by September 15th, 2009. We’re projecting between $500 million and $515 million in capital expenditures in fiscal 2009. Of that, $345 million to $355 million will be maintenance capital, and about $155 million to $160 million will be growth capital.

As we said last quarter, in our effort to conserve cash and avoid a reliance on credit facilities, some of these projects could be delayed. In response to this action, we’ve modified our CapEx for fiscal 2009. Growth capital has been revised downward from our original projections. You can refer to slide 28 for the current breakdown.

Major growth CapEx requirements now include about $73 million to $75 million in regulated distribution growth projects throughout our service territory. $50 million to $55 million from the project closed to Austin, Texas on the regulated Atmos Pipeline Texas system. And $20 million to $22 million in non-regulated projects, which include $6 million for the Shrewsbury acquisition we announced back in October, and $15 million to $16 million for Fort Necessity.

With respect to Fort Necessity, in January we executed an option to purchase 240 acres and lease 320 acres putting our total investment at about $12 million at the end of December. Drilling of the test well is complete, and evaluation of salt cores is in progress. We’ll be configured to service a cavern well up on FERC 7C certification. In November, we filed a FERC 7C application, and anticipate the certificate by May of 2009.

As we’ve previously indicated, we’ve engaged the services of an investment bank to help us determine our optimal ownership development mix for this project. We want to mitigate the market risk associated with the project of this scale and scope as well as gain assurance on the availability of capital as we move forward. We’ll continue to provide updates on this long term project in the future. That concludes my remarks so I’ll turn this over to you, Bob.

Robert Best

Thanks, Fred. I’ll take a few – make a few closing comments, and then we’ll take questions. As we’ve just said – Fred and I have just reported, we’re off to a good start this year and are encouraged by our earnings report for the first quarter of fiscal 2009. We realized considerable progress in our distribution operations and have rate cases pending.

In October, we filed a rate case in Tennessee seeking an increase of $6 million. In November, we filed a $9 million rate case with the city of Dallas, which is the only city in the Mid-Tex Division not to agree to the settlement we’ve reached in 2008 with 438 other cities served by the Mid-Tex Division. And in December, we filed a TransLa annual rate stabilization clause for $1 million in Louisiana. This ongoing rate work is critical to the future financial performance of our gas distribution segment.

In the regulated transmission and storage segment, the through system business continues to be very strong. There are a few small projects under review to add capacity enhancements in the growing areas of our service territory. This month, we expect also to make a filing under Texas Script legislation to recover 2008 capital expenditures on the Atmos Pipeline Texas system.

Our non-regulated operations will continue to complement the regulated businesses through the marketing segment’s more predictable delivered gas services revenues. The pipeline, storage, and other business should provide additional income from its storage and transportation activities. We continue to review our capital and expense budgets to determine what steps may be taken to conserve cash. We certainly believe that we can balance the need to providing our shareholders with stated earnings growth without jeopardizing the safety or reliability on the distribution and pipeline systems.

We’re off to a great start with solid first quarter earnings, ample credit to operate our business, and improved credit ratings. We’re certainly pleased with the start to 2009, and I appreciate you taking time to be with us this morning. That concludes our prepared remarks and we’ll be glad now to take your questions.

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, at this time we will begin the question and answer session. (Operator instructions) One moment please for our first question. And our first question is from Ted Durban with Goldman Sachs. Please go ahead, sir.

Ted Durban – Goldman Sachs

Hey, guys. Congrats on a good quarter. Question on the O&M side up $13 million or $14 million. I’m trying to get a sense of how much of that is expected to be recurring? It seems like a lot less is on the pipeline and how much money will be more one time?

Fred Meisenheimer

O&M is one time in that we did a lot of maintenance type work on the pipeline in the first quarter. We had opportunities to do that. And so a lot of that spending we accelerated into the first quarter on the pipeline operations. And so we believe that will level back out more in line with our budget for the year.

Ted Durban – Goldman Sachs

So it’s related to the expansion or is just an ongoing maintenance that needed to catch up on?

Fred Meisenheimer

Ongoing maintenance that we needed to catch up on.

Ted Durban – Goldman Sachs

Okay. That’s fine. On the non-regulated growth CapEx coming down just from your – it looked like $25 million or $30 million. Is that mostly coming out of Fort Necessity or are there other projects that you took out of the budget?

Robert Best

That is a – it’s a combination of both, Ted, and looking for the highest and best use of our capital. So we’ve reduced what we’re going to be putting in Fort Necessity plus put some other projects potentially on hold.

Ted Durban – Goldman Sachs

Okay. Can I ask about then just about volume growth? It looks like the distribution companies and volumes were up 6%. How much of that was due to weather? And maybe can you give a little color on what you’re seeing on different segments like industrial demand? A lot of folks talk about industrial demand being off.

Kim Cocklin

Good morning, Ted. This is Kim.

Ted Durban – Goldman Sachs

Hi, Kim.

Kim Cocklin

Yes. A lot of that is related to weather. As we take – obviously experienced some weather patterns in our service territory early in the heating season, and obviously December and January. That’s simply what we’re seeing. Obviously, you’re seeing some contraction in the commercial, industrial sector right now. And that may continue as this economy continues its course.

Ted Durban – Goldman Sachs

So when you talk to your customers do they give you a sense that you’d come out of this in the second half of the year or – where are they talking to you about that?

Kim Cocklin

Depends if you’re watching CNBC or Fox or anybody in New York. Really, on the residential side, which is the lion’s share of our service and associated volume, we have weather normalization that covers about 97% of that stuff. The commercial side, I mean it really isn’t that much of a big part of our business; most of it obviously in the Kentucky mid-states area. And those folks they’re looking very optimistically at the second half.

Ted Durban – Goldman Sachs

Okay. And then if I could just ask one more on rate cases? Can you remind us what the rate increase that you actually have in ’09 rates are in Mid-Tex? And then also in west Texas I thought you’d filed for a $9 million or $10 million rate increase there?

Kim Cocklin

Well, the best way to look at that probably is we keep a running total of the revenue additions that are associated with actual rate outcomes. And if you look at 2008 we added about $54 million of additional revenue from cases that we successfully concluded during that period. So far in ’09, we have brought in about $23 million of additional revenue. And we have cases on file seeking amounts of $16 million. And then we have another – planned filings that we will make during calendar ’09 amount right now to about $61 million. That we’ve got, obviously, a very aggressive approach to our rates and trying to keep our expenses in line with our filings and keeping everything current so we can address and reduce as much lag as possible.

Ted Durban – Goldman Sachs

I’m sorry. The $61 million that you’re planning to file, that’s system wide? Not just Texas?

Kim Cocklin

All those things are system wide.

Ted Durban – Goldman Sachs

All of it. Okay. That’s great. And then if I could just – one last question in terms of the short-term debt balances. They picked up $150 million versus where you were at this time last year. Is there a plan to be out there more in the debt markets of longer-term debt? Or how are you thinking about the mix of short and long term debt and other financing (inaudible)?

Fred Meisenheimer

We’re looking at options as you are well aware. We have the $400 million that comes due October ’09 and we’re looking at activity out in the market now. Rates are continuing to improve from what we’re seeing and we’re looking at our options as to what we have available to us and what we will do during the year. And so that will – time – we’ll come to conclusions on that as we go through the year. But as of now we don’t have – haven’t finalized those plans.

Ted Durban – Goldman Sachs

And would you need any equity at all beyond a standard trip that you do every year?

Robert Best

No. Ted, this is Bob. No, that’s not in our plans at the moment. We’re really – we’ve gotten all of our credit facilities in place and, as Fred said, we’re looking at the timing of this $400 million. But no, we’re not – our balance sheet’s pretty much where we want it to be. And so we wouldn’t be looking at any equity.

Ted Durban – Goldman Sachs

Okay. I appreciate the time. Thanks, guys.

Operator

Thank you. (Operator instructions). Our next question is from Barry Kline with Citi.

Barry Kline – Citi

Hey. Just piggy-backing off one of the last speaker’s questions, you were talking about planned filings of $61 million system wide. Over what territories would that be?

Robert Best

I guess you’re talking about the rate case filings this year. Okay.

Kim Cocklin

That’s over everything, Barry. We got some actions we got to pursue in Missouri, the pipeline grip. Mid-Tex obviously won the settlement. We have further discussions to go there. Down in Louisiana, west Texas, Kentucky, Mississippi, Georgia, Illinois, Colorado and Kansas.

Barry Kline – Citi

Okay. That basically–

Kim Cocklin

How about that?

Barry Kline – Citi

Also, gas is probably put into the ground at pretty high prices compared to historical numbers. What type of working capital cash flow should we see for the rest of the year? Or at least going into the summer – or going through the rest of the heating season versus previous years?

Robert Best

Our cash flows have been very strong as you’ll see in our numbers for the quarter. We have been pulling a good bit of gas out of storage and cycling that gas. And we are – debt balances are in good shape. And we have done things within the company in improving our cash flows just from daily operations and the way we bill and collect our monies. And so our working capital funds are in good condition at this time and believe that we’ll continue with that throughout the year.

Barry Kline – Citi

What I was getting at is that they should improve because you’re taking out some high cost gas that you’re passing on to customers.

Robert Best

That’s correct.

Barry Kline – Citi

How much of an improvement in working capital could we see in the next three to six months compared to other years because of this turnaround? And should that impact – and how much should that impact the short term debt balances that people have been talking about that are pretty high now?

Robert Best

Our short term debt balances are going down and will continue to go down. We anticipate they will be substantially reduced in the next very few months, and largely due or in part due to cycling the gas out of storage and recouping that money from the customers.

Barry Kline – Citi

Okay. Thanks a lot. Thank you.

Operator

Thank you. (Operator instructions). And as there are no further questions, I’d like to turn the call back to Management for any additional remarks.

Susan Giles

Thank you all for joining us this morning. As a reminder, a recording of the call is available for replay on our Web site through April the 30th. If you have any additional questions please call me. Again, thank you. We appreciate your interest in Atmos Energy. Good day.

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