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Executives

Susan Giles - VP, IR

Kim Cocklin - President and CEO

Fred Meisenheimer - SVP and CFO

Atmos Energy Corporation (ATO) F3Q2011 Earnings Call August 4, 2011 8:30 AM ET

Operator

Greetings and welcome to the Atmos Energy’s fiscal 2011 third quarter conference call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. (Operator instructions) as a reminder this conference is being recorded. It is now my pleasure to introduce to your host, Ms. Susan Giles, VP; Investor Relations for Atmos Energy Corporation.

Thank you Mrs. Giles you may begin.

Susan Giles

Thanks Jenny, good morning everyone. Thank you all 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 our website that summarize our financial results. We will refer to just a few of the slides during the call, but of course we are happy to take any questions online at the end of our prepared remark.

If you would like to access the webcast for slides, please visit our website at atlasenergy.com and click on the conference call link. Additionally, we plan to file the Company’s Form 10-Q later today this afternoon.

Our speakers today are Kim Cocklin, President, and CEO, and Fred Meisenheimer, Senior Vice President and CFO. There are 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 and are intended to fall within the Safe Harbor rules of the Private Securities Litigation Reform Act of 1995.

And now, I would like to turn the call over to Kim Cocklin. Kim.

Kim Cocklin

Thank you very much Susan and good morning everyone. We certainly appreciate you joining us and thank you for your interest in Atmos Energy. It looks like the market is in for a wild rise as we begin our call too but yesterday we did report a third quarter consolidated net loss of $600,000 a negative $0.01 per diluted share.

For the current nine month period, reported net income was almost $206 million or $2.25 per diluted share. There were lot of moving parts which are going to be addressed by Fred Meisenheimer. During the quarter, we did announce the sale of our distribution assets in Missouri, Illinois and Iowa which comprised about 84,000 meters at a price of approximately $124 million and the purchase through Liberty Energy, a sub-city area of Algonquin Power & Utilities Corp.

From a geographical standpoint, this is a very rational decision; we have had a limited presence in these jurisdictions and we did not proceed growing our market share or expanding our foot print in these areas and these transactions will allow us to better focus on the remaining jurisdictions where we operate. Applications with the Illinois and Missouri agencies, commission were filed on Monday August 1, and we do anticipate the transaction to close in the latter half of our fiscal in 2012.

Currently we expect the use of proceeds to fund capital programs but looking further out, we could also redeploy the proceeds to fund or partially fund an acquisition if a worthwhile asset presents itself. Also this quarter we recognized a partial impairment of our non-regulated segments gathering facilities in Kentucky, which we call the Shrewsbury Park City Systems. Taking this action was the result of examining our capabilities and recognizing that we simply do not have the depth of expertise that is needed to pursue and develop Greenfield projects such as this.

We are also going to talk about the financial implications of this action. We do continue to focus on enhancing our financial profile and as part of our strategy this year; we have reduced the number of credit facilities, extended the length of their terms and reduced financing cost. Most recently on June 10, we issued $400 million of third year senior notes at a rate of 5.5%, which replaced the $350 million note which had matured in May and carry a 7 and 3A [ph] interest rate.

Taking into account the effective of our Treasury locks, the effect new issue is 5.38%. Refinancing the $350 million note and even adding an incremental $50 million in debt will generate interest savings of over $4 million per year for the next 30 years and as a result of our precedential [ph] demand for our paper coupled with a greater appetite for capital dollars this year for pipeline integrity projects, we outsized the debt offering to $400 million from the originally anticipated $300 million dollars.

Of course throughout the year we have been in step with the rating agencies on all of our actions. Overall our strategy was viewed quite favourably by the agencies and were warranted the following rating A upgrades. On May 11, Moody’s raised its corporate credit rating on Atmos Energy to Baa1 from Baa2 and on June 2, Fitch raised its corporate rating on us to A- from BBB+, both agencies indicated a stable outlook for the company.

The upgrades will allow us to continue to access the capital markets on more economically favourable terms. As of last night, we had about $56 million of commercial paper outstanding at about 30 basis points and as the end of June, our net capital ratio was 48.6% compared with 51.3% at September 30, and 48.4% a year ago.

Our board of directors yesterday declared the 111 consecutive quarterly cased dividends. The indicated annual dividend ratio for fiscal 2011 is $1.36. Now, Fred Meisenheimer our CFO will review our financial results in greater detail and then we will return for posing comments and questions, Fred.

Fred Meisenheimer

Thanks Kim, good morning everyone. I will speak to the more significant items in the quarter and nine months and then discuss the outlook for the reminder of our fiscal year. As a result of the agreement to sell our distribution assets in Missouri, Illinois, and Iowa we just now combined in report to financial results for these assets, a one line item on the income statement entitled discontinued operations for all periods presented.

Therefore, the corresponding detail by line item will be excluded from my comparative discussions. In accordance with accounting pronouncements, the discontinued operation results do not receive allocated corporate overhead or interest expense. Of course until we close the sale of these properties they will remain a part of our total consolidated results and contribute to our overall earnings.

As we stated in the earnings release; the current quarter and year-to-date results were impacted by several onetime items. In the current quarter, the impairment of our non-regulated segments gathering facilities as Kim just mentioned; acquainted to a negative $6 million or $0.06 per diluted share. We still have a balance $6 million on the books for these assets. Revenues are currently sufficient to support this level of investment.

For the current nine months, onetime items equalled almost a positive $7 million or $0.07 per diluted share. These items included the impairment I just mentioned as well as the earlier impairment of the Ft. Necessity storage project, the benefit from unwinding Treasury locks and a tax benefit from settling various income tax positions. By eliminating the onetime items in all periods and the mark to market accounting treatment required, by GAAP and our non-regulated operations which we have done for you on slides 44 and 45.

The company earned $0.05 per share for the current quarter versus $0.09 per share for the prior year quarter and $ 2.20 per share for both nine month periods. Now let’s take a closer look at the major driver’s by segment. Rate relief remains primary ground of our success in the distribution business. Rate increases generate almost $8 million of incremental margin, quarter-over-quarter an almost $36 million of incremental margin for the nine months.

Mainly from the Mid-Tex, Louisiana, Kentucky and Kansas service areas. For the nine months consolidated distribution throughput was 8% lower which decreased gross profit by about $11 million as the unseasonably cold weather experienced last year did not reoccur this year. Atmos Pipeline of Texas gross profit increased; by almost $9 million for the quarter and almost $ 11 million for the nine months. Like the distribution segment, rate relief is also the main driver of our success at the regulated pipeline.

The quarter-over-quarter increase is primarily the result of the Texas Railroad Commission order granting annual operating increases of about $20 million which became effective on our May 1, bills. The current nine months also been accretive from the roughly $9 million or incremental rent relief from the last rate case, but in addition the pipeline experienced a $6 million increase, as a result of the annual grip recovery period-over-period.

Partially offsetting the positive impacts from rate actions was almost a $3 million decline in throughput to our Mid-Tex utility Division as a result of warmer winter weather. Remember the pipeline deliver gas to our mid-Tex utility division and is not weather normalized. The rights to the utility customers are established by the Texas Railroad Commission and are higher than the rates for other APT customer classes to ensure long transportation storage service to these customers.

Additionally, the pipeline experienced about $2 million decline in third party market base per unit transportation margins. Looking ahead, we expect to be insulated on about 81% of our fiscal 2011 through system transportation revenues under the demand based contracts executed with producers and marketers. We are continuing to seek replacement contracts when they expire. Turning now to the non-regulation operations and you may want to turn to slides eight and 16.

Period over period, gross profit increased for almost $2 million for the quarter and declined about $37 million for the nine months. Margins from gas deliveries decreased about $1 million quarter-over-quarter due to $0.03 decrease in unit margins. Overall, we experienced an 18% rise in sales volumes, largely due to increased power generation demand. Our market areas continue to experience strong competition, which serves to drive per unit margin lower.

For the nine months delivered gas margins increased $1 million year-over-year due to a 9% increase in sales volume with comparable average margins of about $0.14 for both periods. Industrial volumes for the nine months rose 18% year-over-year. The most significant driver in the non-regulated business in the quarter in here to date has been the lack of natural gas price volatility, yielding smaller captured spread values, which is translated into sizable reductions and we realized asset optimization margins.

In the prior year periods, we were able to take advantage of more favourable trading opportunities in the daily cash market. Quarter-over-quarter, our last asset optimization margin declined $13 million and $47 million from the comparable nine month period.

Additionally, during the prior year quarter, we were able to recognize higher spread values that were captured from rolling positions. Quarter-over-quarter decrease from the last asset optimization market was more of an offset about a $15 million increase in unrealised margins. That reflects a quarter-over-quarter timing of our last margins coupled with lowered natural gas price volatility. For the current nine months, unrealized margins increased to about $8 million.

Consolidated operation and maintenance expense for the nine months decreased about $7 million compared to the same period one year ago. Our employee-related costs decreased about an $11 million and bad debt expense decreased about $2 million. This expense reduction from partially offset of the absence of about $7 million state sales tax received in the prior year.

Quarter-over-quarter, operating expense increased primarily as a result of $11 million non-cash impairment charge of the Park City and Shrewsbury gathering assets in Kentucky. Operating expense increased for the nine months primarily to $30 million of asset impairments which includes that $11 million of gathering assets I just mentioned was the $19 million non-cash impairment charge of the Fort Necessity that we announced last quarter.

Income tax expense was favourably impacted in the current nine month from a $5 million income tax benefit related to the administrative settlement of various income tax positions recognized earlier this year. Now that we have completed three quarters of our fiscal year; we expect that fiscal 2011 earnings per share guidance in the lower-end of the range of the $2.25 to $2.35 per diluted share.

As you know, with the seasonality of our business we often experience breakeven or even negative financial results during our fourth quarter. We have updated the expected contribution of our business segment and this range assumes no material mark-to-market impact at September 30, 2011.

Let me draw your attention to slide 36 where we have outlined our re-projected income statement. The increase in projected net income of about $4 million for the regulatory distribution segment, this result by continued focus from expense management and higher than plenty of capitalization from our increased capital spending.

The increase in projected net income of about $6 million for the regulated transmission and storage segment is due to the favourable outcome of the APT rate case that went in to effect on May 1, 2011. An increase of about $400 million to the rate base and an ROE increased to an 11.8% from 10% are the main factors driving the uptick in APTs re-projections. The non-regulated segment, net income projection decreased about $10 million since the last quarter, $6 million of which reflects a partial impairment of the gathering assets.

The remaining decrease is due to lower asset optimization margins, resulting from the continued weak market fundamentals and erosion in spread values. We have more limited opportunities to capture economic value and lowered expectations for asset optimization markets to between $1 million and $3 million. Total non-regulated margins now assume to be between $75 million and $85 million, again with no material impact from mark to market of physical storage and offsetting financial agents.

Capital expenditures for fiscal 2011 have been revised upward by about $30 million and are now expected to range between $610 million and $625 million. The increase is largely the result of additional pipeline upgrades and replacements from the aging Atoms Pipeline Texas infrastructure. Thank you for your time and I will hand the call back over to Kim.

Kim Cocklin

Thank you very much Fred. I will make a few closing comments and I will take your questions and you can see from hearing Fred, we had a busy third quarter. In spite of the few speed bumps, we had a very good run in the first nine months of our fiscal 2011. We have taken measure to clean up our balance sheet, we have eliminated under earning assets, which will ultimately removed more risk from the business going forward, although there is no market sense of improvement in the economy, our business continues to perform steadily.

We have done a very good job of managing expense and we will continue that focus going forward. Our O&M expense is down this year without reducing complement. We were also able to provide annual wage increases to our employees while observing government mandated cost and our uncollectable expense is currently less than one quarter or 1% of total revenues despite the current economic conditions.

Our fundamental business is delivering safe and reliable natural gas. We continued this extensively to execute our rate strategy, focusing on reducing our lag, improving our return on our return on equity and increasing the recovery of fixed cost. The stability and predictability of our margins remain vital to our growth.

Today, rate outcomes that provided an increased operating income of about $70 million; which exceeds our original target of between $50 and $60 million of approved annual operating income increases from rate actions [ph] in fiscal 2011. On June 22, a rate settlement, a very important rate settlement was reached with the City of Dallas. This allows an annual increase in operating income to take effect of about $2 million, July 1.

The settlement provides also for an annual rate review process which is patterned after our other rate structures in Texas. The Dallas annual rate review allows an ROE of 10.1% and a 13 month average capital structure. Rate base was established at $1.27 billion and the first filing under this annual rate review will be made by next January 15 on a September 30 ending test year.

We have also talked previously about the final order issued in April on the Atmos Pipeline Texas rate case. It is very important to know that not only where we granted over a $20 million increased to operating income and an ROE of 11.8% as well as the rate based increase from $417 million to $808 million, but this case does lessen our exposure to the market based contract revenues.

The Rider Rev mechanism in that case establishes a represented level of revenues for third party services of $84 million and at the end of each year, either a credit or surcharge will be rendered after calculating whether we fell above or below the $84 million threshold. The company retains or refunds 25% of any increase or decrease from that representative level. Additionally, on July 26, APT received approval for a $12.6 million increase in operating income from their most recent GRIP filing.

Our focus in the non-regulated operation remains in the deliberate gas business. We are on target to sell 440 to 450 BCF in fiscal 2011 at somewhat lower unit margins of between $0.13 and $0.014 per MCF. The non-regulated business continues to experience downward pressure and lower margins in a very highly competitive market.

Especially electric generation to man for power feeding plants this summer, there are some lost later deals that we are mining for the future to pickup more market share. Low gas prices continue as well as little to no spread values and we do expect optimization revenues to make a negligible contribution to earnings going forward. We are lowering our exposure to non-regulated risk.

We found that the market simply does not reward us for our non-regulated earnings. We're principally a utility and we expect the earnings contribution for our regulated operations to remains at about 90% or greater going forward. We are going to continue that to focus on the fundamentals get singles and double in our business and remain focused on enhancing shareholder values. We very much appreciate in taking time with us this morning and now we will take your questions, Jen?

Operator

Thank you. (Operator instructions)

Kim Cocklin

Should we sing happy birthday to the President?

Operator

It appears that there are no questions at this time.

Kim Cocklin

Okay.

Susan Giles

Okay Jen, and thank you everyone and as a reminder a recording of this call is available for replay on our website through November 9. Again we appreciate you interest in Atmos Energy and thank you for joining us. Good day.

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