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Executives

Susan Kappes Giles - VP, IR

Robert W. Best - Chairman, President and CEO

J. Patrick Reddy - Sr. VP and CFO

Kim R. Cocklin - Sr. VP of Utility Operations

Analysts

Barry Klein - Citigroup Investment Research

Atmos Energy Corp. (ATO) Q1 FY08 Earnings Call February 6, 2008 8:00 AM ET

Operator

Good morning ladies and gentlemen. Thank you for standing by and welcome to the Atmos Energy Fiscal 2008 First Quarter Earnings Conference Call. During today's presentation all parties will be in a listen-only mode. And following the presentation the conference will be open for questions. [Operator Instructions].

Now I would like to turn the conference over to Susan Giles, Vice President of Investor Relations. Please go ahead.

Susan Kappes Giles - Vice President, Investor Relations

Good morning everyone. Thank you for joining us today. This call is open to the general public and media but designed for financial analysts, and its being webcast live over the Internet. We've placed slides on our website that summarize our financial results. We will now review those in detail but we will be happy to take any questions about them 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. Also we plan to file the company's Form 10-Q later today.

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

Robert W. Best - Chairman, President and Chief Executive Officer

Thank you Susan and good morning everyone. As always we appreciate you joining us this morning and thank you for your interest in Atmos Energy. Today we are coming to your from Fort Worth, Texas where in a few hours we will hold our Annual Shareholders Meeting. I am very pleased to report to our investors listening on those calls and to those who would join us in our annual meeting and our financial results for the first quarter of fiscal 2008.

As Susan mentioned, Pat Reddy, our Chief Financial Officer will review the financial result in greater detail in just a moment. But before he does I want to make a few observations about the quarter and also about recent developments regarding our company.

Yesterday, we reported first quarter consolidated net income of $73.8 million, with our regulated businesses contributing 68% of that total net income. We are particularly pleased with the 26% increase in net income from the regulated gas distribution business from a year ago. The work done in our regulatory arena is yielding desired results, more stable and predictable earnings.

Results from the non-regulated businesses were lower this quarter compared to a year ago, due to decline in volatility in the natural gas market. This has created fewer profit opportunities in our natural gas marketing segment, which is consistent, frankly with our view that gas margins would decline because of the gas market conditions.

Also yesterday, our Board declared our 97th consecutive cash dividend. Our indicated annual dividend rate for fiscal 2008 is a $1.30 per share. And finally, yesterday we announced that we had submitted a pre-filing request with the Federal Energy Regulatory Commission to construct and operate a salt-cavern gas storage project in Franklin Parish, located in Northeastern Louisiana. Because the facility will store and facilitate transportation of natural gas between states, the FERC will have regulatory oversight for the project. Project is within close proximity to 4 major pipelines, Tennessee Gas, Columbia Gulf, Regency and ANR. This is a multi-turn, high delivery... high deliverability salt-storage project, and is one of the 15 potential projects we mentioned in our December Analyst Conference.

We would intend to initially create 3 Bcf caverns... three 5 Bcf caverns for a total of 15 Bcf of working gas storage with six-turn injection and withdrawal capabilities. We could potentially develop an additional 4 caverns, depending upon the market demand. We have acquired, and/or leased all necessary land at the 500-acre site. In December, we filed for an exemption from FERC to allow for the drilling of a convertible test well or re-entry of a plugged and abandoned well in order to test the salt quality as Fort Necessity.

We anticipate FERC approval for this exemption at any time which will clear the way for the testing of the salt zones. The first cavern is projected to be operational by early 2011 and the other two caverns by 2012 and 2014. Our fiscal 2008 capital budget includes $50 million for this project. This storage project is in its infancy but as we get closer to the start-up date more financial metrics will be provided.

I would like now to turn to the progress that we are making in Texas. In early January, we announced a tentative settlement with cities representing about half of our customer base in the Mid-Tex division. The settlement provides for the implementation of a rate review mechanism on a three-year trial basis. The rate making process established by this mechanism is essentially the same as that describe with the current GRIP program.

The mechanism requires a comprehensive review of the entirety of the company's cost, revenues and investment and enables rates to be established reflecting the company's demonstrated cost of service on a prospective basis. It allows for an annual resetting of both consumption and meters. The RRM is preferable to the current truncated mechanism for revising rates because all costs and revenues are considered, not just increases in capital investment. It then should provide us with more stable and predictable revenues.

The traditional truncated rate filings which are time consuming and expensive and also lethargic are all avoided. Rate adjustments occur in a comprehensive proceeding and we are annually... and are annually adjusted providing right-size adjustments rather than sticker shock amounts. The review process should also facilitate frequent collaborative meetings with customers... with our customers to discuss and describe the cost and revenue structure and capital investment to continue safe and reliable service and to encourage and support economic growth in the many communities that we serve.

Other provisions of the settlement includes, moving uncollectible gas cost to the gas cost recovery mechanism in the tariff and reducing the monthly residential customer charge from $10.69 to $7 beginning October 1, 2008. The settlement also establishes a new program designed to encourage gas conservation. Each year the company and customers will each fund $1 million to the program. Funds collected from customers will be through a new customer tariff. The company is currently in discussions with the other parties in the case to try to reach a settlement. The docket pending before the Railroad Commission of Texas is scheduled to go to hearing in February 25th, for the cities that have not reached a settlement by that date.

I'll now turn the program over to Pat Reddy, to review our financial results and then I'll return for some closing comments and then we'll be glad to take any of your questions that you may have. Pat?

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

Well, thank you Bob and good morning every one. For the first quarter of fiscal 2008, our consolidated net income was about $74 million, or $0.82 per diluted share compared to about $81 million or $0.97 a year ago. Our regulated natural gas distribution segment reported over $40 million of net income, or a 26% increase from a year ago. This business benefited from the cumulative effect of rate design improvements and much needed rates increases as Bob mentioned. An additional $9 million of gross profit was generated as a result of rate adjustments in Texas, Kentucky, Louisiana and Tennessee.

Our weather sensitive margin is been reduced to about 3%, resulting in more predictable earnings during our heating season. Gross profit for meter continues to grow from $82 per meter in the first quarter a year ago to $85 per meter in the current quarter.

Our Regulated Transmission and Storage segment contributed almost $10 million of net income, up about 2% from the same period a year ago. This segment continues to benefit from the increased transportation in the Barnett Shale and Carthage gas producing regions of Texas.

The non-regulated pipeline storage and other segments posted $3 million of net income down about 34% from this time a year ago. Earnings were... are lower mainly due to an expected decrease in unrealized margins on asset optimization activities, resulting from reduced gas price volatility that Bob mentioned.

The non-regulated natural gas marketing segment reported net income of about $21 million, declining about 41% from the same period a year ago. This decline is consistent with our view at the beginning of our fiscal year that gas margins would decline along with our expectation of reduced price volatility. Since there are many components to the marketing business, let's look at gross profit for this segment.

Natural gas marketing gross profit was down about $17 million from the same period a year ago, mainly due to lower volatility experienced in the gas market. Unrealized margins decreased by about $20 million mainly as a result of a smaller change in the spreads between the forward prices that are used to value our financial hedges and the market or spot price used to value our physical storage. Of course as you know these unrealized margins are temporary and should reverse in future periods as the physical gas is cycled from storage and the related financial hedges are settled.

Operationally, we experienced a decrease in our delivered gas margins of almost $2 million in the current quarter compared to year ago. This was largely due to realizing lower unit margins and less volatile market compared to the prior year, offsetting this somewhat though were higher sales volumes of about 19 Bcf, reflecting the ongoing execution of our marketing strategy. We also experienced a $5 million improvement in our asset optimization margins in the current quarter.

During the quarter natural gas fundamentals were less than favorable with warm weather and national gas inventory levels were nearly full. Therefore the marketing company elected to inject gas into storage and roll its financial positions forward, primarily in the second quarter of fiscal 2008, in order to take advantage of more favorable spreads. The losses incurred to settle the financial positions were smaller than in the prior year period. This positive impact was partially offset by increased storage demand fees and cycling gas in a less volatile gas market.

In the process of rolling forward its storaging booking, the marketing company was able to increase the economic value associated with its storage book by almost $4 million dollars. Information concerning Atmos Energy Marketing storage book is shown in the appendix to our slide representation on slide 41 to 42. What shows the difference between the economic value which is what we use to manage the business and our GAAP reported value at the end of reporting period. As you can see there, at the end of December the excess value of our gas and storage was about $11 billion which we expect to realize primarily in our fiscal 2008 second quarter.

Spreads fell to about $0.64 per Mcf at December 31, 2007 compared to a $1.32 per Mcf at the end of December 2006. As you all know Atmos Energy Marketing maintains a flat trading book and we do not engage in speculative trading.

Now focusing on the expense side of our income statement, for the quarter our consolidated operation and maintenance expense rose almost $6 million. The primary drivers of the increase... increase include about $3 million due to higher labor and benefits cost, associated with annual wage increases and higher contract labor, other administrative cost as well as pipeline odorization and vehicle fuel costs, increased O&M by about $4 million. As a special offset to these increases our bad debt expense decreased to about $2 million compared to the same period a year ago, mainly due to reduce receivables resulting from lower natural gas prices in the current quarter. And interest charges in this quarter dropped about $3 million in connection with lower average short-term debt balances, versus last year.

Looking at our cash flows for the quarter, we generated operating cash of about $61 million, compared with a $165 million, the same time a year ago and this difference reflects changes in various working capital items, primarily in our natural gas marketing business, along with the timing of various tax payments and receivable.

Capital expenditures for the quarter were about $94 million, up $7 million from the same period a year ago, reflecting costs associated with our investment in pilot programs for automated... our automated metering initiatives in the gas distribution segment.

Turning now to our earnings guidance for fiscal 2008, we are maintaining our previously announced earnings estimate for the fiscal year 2008 in the range of a $1.95 to $2.05 per diluted share of common stock. Earlier Bob discussed the tentative settlement was about half of our residential and commercial customers in the Mid-Tex division. While we are very pleased with that achievement we continue negotiations with the remaining cities, and since we are uncertain of the final outcome and timing of these negotiations, and then the timing of when we might implement the new rates, we are not assuming any material impact on our earnings in fiscal 2008.

Let me discuss with you our December conference... some of our significant assumptions surrounding the guidance include normal weather, it's prescribed by the regulators in our states, while we operate without W&A or margin decoupling, continued the successful execution of our rate strategy and bad debt collection efforts, no material impact from mark-to-market of physical storage and offsetting financial hedges and those are relative to principle assumptions.

We are projecting between $450 million and $465 million in capital expenditures in fiscal 2008 of that $305 million to $315 million will be maintenance capital, and about $145 to $150 million will be gross capital. The $15 million earmarked for the gas storage project in Louisiana is already included in this estimate and there is more detail and more breakdown in our slides around our CapEx.

So with that I'll turn it back to Bob.

Robert W. Best - Chairman, President and Chief Executive Officer

Thanks Pat. We'll make a few closing comments and then we will be glad to, to take your questions. As Pat just reported, we are off to very good start this year and we are encouraged by our earnings report for the first quarter fiscal 2008. Our debt-to-capitalization ratio at December 31, 2007 was 53.4% compared with 54.9% a year ago. We remain in our targeted range of 50% to 55% and we stand committed to maintaining this range.

One thing we feel really good about we have realized enormous progress in our regulated operations. The gas distribution business grew as a result of effective rate making and we will continue to work on rate design to stabilize our margins, decouple recovery of margin from throughput and recover the gas costs portion of bad debt expense. This continues to be critical to the financial performance of our gas distribution segment.

In the gas distribution business, we currently have rate actions filed and pending in our Kansas, Mid-Tex and Louisiana service areas and we intend to file additional cases in Virginia and Georgia in the coming months. We've talked about the proposed settlement in the Mid-Tex rate division and it's ensured in the long term smooth rate increases and avoid wild fluctuations in customer bills. While removing risk and uncertainty for the company and we think the settlements strikes a good balance between fair and acquittal treatment for our customers to company and our investors.

In the regulated transmission and storage segment, the thorough system business continues to be strong with robust production continuing in the Barnett Shale and Carthage regions. In the coming months, we will be filing for 2007 capital expenditures on the Atmos pipeline Texas system through the annual GRIP filing.

Our non-regulated operations will continue and have continued to complement our gas distribution business. The non-regulated natural gas marketing segment is... will provide and has provided solid earnings through more than predictable delivered gas services revenues, with some upside from the storage optimization process and business.

Again as we've said in this call with lower natural gas price volatility expected for the foreseeable future, the marketing's group ability to lock-in large arbitrage spreads is going to be limited and as we also mentioned we have predicted and really have plan for that. At a consolidated level our earnings goal remains and has been in the past several years. And that is to grow our earnings per share at a rate of 4% to 6% a year on average. Through this earnings growth coupled with our dividend yield of around 4.5%, we think we offer excellent value to our shareholders.

Again we are very pleased with the start of fiscal 2008, and I appreciate you taking time to be with us this morning and this concludes our prepared remarks. And now we'll be glad to field any questions that you may have.

Question And Answer

Operator

Thank you sir. We will now begin the question-and-answer session. [Operator Instructions]. And we have no audio questions at this time. Actually, we just had one pop-in, it's from Ted Durban [ph] Goldman Technologies. Please go ahead.

Unidentified Analyst

Hey, it's Ted Durban with Goldman Sachs. A question for you on the storage project. Maybe you just talk about when do you think you might know if it is actually a feasible project what you are drilling and what not, what the timing would be like? And then in terms of the overall supply and demand balances for gas storage in the Gulf region and may be even specifically to the geography where you are on sort of, off of the coast up in Northeastern Louisiana versus on the Coast?

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

Well as far as the economic or when we will be able to determine if we have a project or not, the next eight months would be critical to that. We will have all kinds of activity, power market studies, and we will have test wells further geophysical staff activity. So that should, we should have a decision whether we are going move forward because we'll also have a non-binding open season, and all those will give us indications as to... as to the viability of the project.

As for the need for storage in that area, our studies have indicated that there is still... although there have been some other projects announced, there is a very large need for storage because of the... a lot of the gas production coming out of Barnett Shale, Bossier Sand is going to be moving in that directions. We will be able to support some of the operations that allow those pipelines. It's very near to Perryville Hub, a lot of pipeline networks as Bob mentioned earlier and the proliferation of LNG is expected to be coming into that region will also be advantaged by additional storage. So our study seem to indicate that it is... there is a quite a bit of need at this time for that matter of that project.

Unidentified Analyst

Okay, great. And then just couple of other questions on that, what are the steps in terms of getting permitting at the Federal level and the local level? How long do you think that will take? And then what kind of... just high level returns, might you be looking for on return-on-capital or what not?

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

Well I can speak to the timing of the permitting and there is quite a few milestones that will take place, I guess. But we just received word that we did, get the FERC... did give us an exemption to proceed with a test well that will be number one. We will be performing that and aligning the drilling of that well so that we can have a core sample submitted to the Department of Natural Resources in Louisiana. But I guess longer term with a lot of... we'll have a lot of interim milestones. But we expect that we would be able to receive a FERC approval to develop this project probably, January, February, timeframe of 09. As far as economics I don't believe we are at that stage where we can begin to start putting those out.

Unidentified Analyst

Okay good. And then just last question actually on the Mid-Tex settlement. Is there any concern of that your increasing your volume metric risk at all, since your reducing, I guess usually customer charges going from $10.69 to $7 is that... is there any sort of offset in terms of decoupling or you actually increasing your volumetric crisis there?

Robert W. Best - Chairman, President and Chief Executive Officer

Ted, well I think, Kim Cocklin is here who runs our regulated business we will let him address that.

Kim R. Cocklin - Senior Vice President of Utility Operations

There is no risk economically to the recovery, because we have reset the charges based on the consumption and the meter counts in each, each year that we established new rate with the RRM mechanism.

Unidentified Analyst

[Multiple Speakers]

Kim R. Cocklin - Senior Vice President of Utility Operations

But it's a bonus to the customer, because they are paying a lot of base charge but we will continue to collect the same revenue.

Unidentified Analyst

Okay, great, thank you.

Robert W. Best - Chairman, President and Chief Executive Officer

Thanks Ted.

Operator

Thank you. [Operator Instructions]. And we do have question from the line of Faisel Khan, with Citigroup, please go ahead.

Barry Klein - Citigroup Investment Research

It is actually Barry Klein.

Susan Kappes Giles - Vice President, Investor Relations

Hi Barry.

Barry Klein - Citigroup Investment Research

Hey, how is it going.

Susan Kappes Giles - Vice President, Investor Relations

Great.

Barry Klein - Citigroup Investment Research

Two questions, one was with regards to regulated transmission and storage, the increase was about $5 million from the last quarter. I guess relating primarily to the GRIP filing associated. Can you remind us how much that will be for the year?

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

On an annualized basis?

Barry Klein - Citigroup Investment Research

Yes. Is that just... is it $5 million a quarter, for the four quarters.

Kim R. Cocklin - Senior Vice President of Utility Operations

I think last year's filing was $13.2 million.

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

And of course its kind of front loaded in the heating season but...

Barry Klein - Citigroup Investment Research

So we shouldn't see much of this over the rest of the year.

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

In the second quarter you will see probably the bulk of the balance.

Barry Klein - Citigroup Investment Research

Okay. So about $5 million to $10 million... about $8 million you are saying in the second quarter?

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

$8 million in the balance of the year and a good portion of that in the second quarter. And again of course that depends on the pipelines throughput in the summer, whether it's a hot summer or cooler summer and they have probably five or six other ways to collect revenues for things like park and loan. And so it's not as simple as just the heating season that I would say at least half of that would be in the second quarter.

Barry Klein - Citigroup Investment Research

Okay, thanks. And can you just give us a little bit more color surrounding the FERC investigation and I guess what are the potential outcomes?

Robert W. Best - Chairman, President and Chief Executive Officer

Well, the FERC of course is as we have mentioned in our filings, we have submitted data to the FERC and we are still waiting. We haven't really at this point, no idea exactly, when they will get back to us. Also they are all looking at a notice of proposed rule making which we think would help clarify some of the rules around issues relating to the matters that they had submitted data to us or so. We are somewhat uncertain at this point about when any action we would be taken and we will just keep you posted as we know something.

Barry Klein - Citigroup Investment Research

Okay, thanks a lot.

Robert W. Best - Chairman, President and Chief Executive Officer

Thank you.

Operator

Thank you. And at this time there are no additional questions. I will turn it back to management for any closing remarks.

Susan Kappes Giles - Vice President, Investor Relations

Well, thank you all, this is Susan. Just as a reminder, a recording of this call is available for replay on our website till May the 2nd and if you have any additional questions of course you can always call me. We appreciate your interest in Atmos and thank you for joining us. Bye, bye.

Operator

You may now disconnect.

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Source: Atmos Energy Corp. F1Q08 (Qtr. End 12/31/07) Earnings Call Transcript
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