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Atmos Energy Corp. (NYSE:ATO)

F3Q2012 Earnings Call

August 9, 2011 10:00 am ET

Executives

Susan Giles - VP, IR

Kim Cocklin - President and CEO

Fred Meisenheimer - SVP and CFO

Analysts

Ted Durbin - Goldman Sachs

Andrew Bischof - Morningstar

Amit Marwaha - Citigroup

Jeff Healy - AIG

Operator

Welcome to the Atmos Energy's Fiscal 2012 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 your host, Ms. Susan Giles, VP, Investor Relations for Atmos Energy Corporation. Thank you. You may begin.

Susan Giles

Thank you, [Danielle]. Good morning, everyone and 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 this live call, but we will be happy to take questions on any of them at the end of our prepared remarks. If you would like to access the webcast and slides, please visit our website at atmosenergy.com and click on the conference call link. Additionally, we plan to file the company's Form 10-Q later this morning.

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 expectation, 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. Please see slide two for more information regarding the assumptions and factors that we consider in making these forward-looking statements and where to go to get more information on our risk factors.

Now, I'd like to turn the call over to Kim Cocklin. Kim?

Kim Cocklin

Thank you, Susan, and good morning everyone. We certainly appreciate you joining us and your interest in Atmos Energy.

Yesterday, we reported third quarter consolidated net income of $31 million or $0.34 per diluted share compared to a net loss of about $1 million or a negative $0.01 per share one year ago.

Our Non-Regulated Operations executed on their strategy and delivered positive results this quarter. I'll remind you that in the first half of our fiscal year our Non-Regulated Group took advantage of falling gas prices by buying and injecting gas into storage. As a result, there were no realized storage withdrawal gains to offset realized losses taken when we settled the financial instruments used to hedge the natural gas purchases. However, that strategy paid off in the fiscal third quarter.

Realized asset optimization margin increased $18 million as the financial position settled as anticipated from the trading approach employed earlier this year. For the current nine months, reported net income was $209 million or $2.28 per diluted share, compared to $206 million or $2.26 for the nine months last year.

Last week, we also announced the closing of the sale of our distribution asset in Missouri, Illinois, and Iowa to Liberty Energy for approximately $129 million. About 84,000 distribution meters were transferred. We expect to record a net of tax gain on the sale in the fourth quarter of fiscal '12 of approximately $6 million or $0.06 per diluted share subject to final purchase price adjustments.

The net proceeds of $129 million have been used to pay down commercial paper.

We also announced, yesterday, an agreement to sell our Georgia utility assets to Liberty for approximately $141 million. Included in that transaction are about 64,000 distribution meters and a rate base estimate of some $96 million. We are estimating a $6 million after-tax gain on the sale and expect that transaction to close in fiscal '13.

Net proceeds will be redeployed to help finance rate-based investment in our remaining jurisdiction.

Our liquidity and financial position remained strong and we benefit from solid investment grade credit ratings. Our debt-capital ratio is 50.7% at June 30, compared with 48.6% one year ago.

On July 27, we issued a notice of full redemption of our $250 million, 5-1/8% senior notes which are due January 2013. That redemption will occur on August 28, 2012. We will initially utilize commercial paper to redeem the notes and shortly thereafter enter into a short-term financing facility to repay the commercial paper. We will then issue new unsecured long-term notes probably in January 13 and use those proceeds to repay the borrowings on the short-term facility.

Yesterday, our board of directors declared the 115th consecutive quarterly cash dividend. The indicated annual dividend rate for fiscal '12 is $1.38.

Fred Meisenheimer, our CFO, will review our financial results in greater detail and we'll come back for some closing comments and open the call up for questions. Fred?

Fred Meisenheimer

Thanks Kim and good morning everyone. I'll review the more significant items in the quarter and nine months and discuss the outlook for the remainder of our fiscal year.

As Kim mentioned, reported consolidated net income was $31 million or $0.34 per diluted share for the quarter, and $209 million or $2.28 per diluted share for the current nine months.

If you'll turn to slide three, it compares quarters. And when you exclude the unrealized gains, net income was $29 million or $0.32 this quarter, compared to a loss of about $1 million or $0.01 per share last year. Last year's quarter has a one-time charge of $6 million or $0.06 per share.

After eliminating both the one-time item and the unrealized net gains, net income was $0.05 per share last year versus $0.32 per diluted share at this quarter, an increase of $0.27 per share.

When comparing the nine-months, slide 10 shows that after eliminating the one-time items last year and the unrealized gains and losses in both years, adjusted earnings per share were $2.20 for both periods.

As a reminder, we combined and reported the financial results for Missouri, Illinois and Iowa on the income statement as discontinued operations for the periods presented. Therefore, the corresponding detail by line item will be excluded from our comparative discussions.

Let's drill down into our Regulated business. Rate relief remains a primary driver of our success in the regulated operations. Rate increases for distribution at Atmos Pipeline -Texas combined generated almost $14 million of incremental margin quarter-over-quarter and about $48 million for the current nine months compared to the same period last year.

Consolidated distribution throughput decreased 5% in the quarter and 9% for the nine months compared to the same periods last year, mainly due to lower consumption primarily from warm weather.

With WNA mechanisms protecting about 94% of our utility margins, we've largely mitigated the negative effects of a warm winter and, in fact, we've received over $50 million of WNA relief to underpin the loss throughput.

The Texas intrastate pipeline continued to experience an increase in its consolidated throughput, which was 5% higher quarter-over-quarter and 9% higher in the nine months. This increase was primarily from incremental through system demand resulting from the execution of new transportation agreements with local producers to Howard and [Kaye], albeit at a lower transportation rates.

Additionally, we saw electric generation load increase during the current quarter. Low natural gas prices displaced part of the load that would normally be generated by coal plants.

Turning now to our Non-Regulated Operations, you might want to turn to slides 8 and 15. At a macro level, we anticipate natural gas storage levels will remain high, gas prices to remain relatively low with little volatility and spot to forward spread values and basis differentials to remain compressed. Pressure on margins from weak natural gas market conditions is a resonating issue throughout the industry for those with non-regulated gas marketing and trading operations.

That said, our realized non-regulated asset optimization margins increased $18 million in the current quarter from the trading strategy executed earlier this year. As Kim mentioned our non-regulated group took advantage of falling gas prices by buying and injecting gas into storage and capturing incremental physical foreign spread values.

This quarter we've realized an increase of $18 million of asset optimization margins as a result. Of the $22 million of economic value at June 30, we expect to recognize about $18 million of that in the fourth quarter of fiscal 2012.

Realized delivered gas margins decreased about $2 million quarter-over-quarter and almost $12 million year-over-year due to, first, a 10% increase the quarter recorded primarily from lower industrial and power generation demand and a 7% decrease year-over-year in consolidated sales volumes mainly due to less consumption by weather sensitive customers due to warmer weather. And second, gas delivery per unit margins were about flat at $0.11 in both quarters, but decreased from $0.14 per Mcf in the prior nine-month period to $0.11 per Mcf in current nine months, primarily due to lower basis differentials resulting from increased natural gas supply and increases transportation costs.

Realized asset optimization margins increased about $18 million quarter-over-quarter, as I mentioned, but for the current nine months asset optimization margin decreased $17 million as a result of flat gas market with little gas price volatility and compressed spot to forward spread values.

Turning now to the expense side of the income statement. As we stated last quarter, the mild weather allowed our crews to focus on capital projects which reduced O&M expenses by about $2 million for the quarter and $6 million for the current nine months compared to last year. Also we implemented regulatory asset treatment in Texas for our pension and post-retirement bond holders which allows us to defer the difference between our actual cost and what we currently recover in rates. These calls will become eligible for recovery in our next rate proceeding. In the current quarter, we deferred about $1.4 million and $3 million of expense year-to-date.

Partially offsetting these postures was an increase in depreciation and amortization in the quarter of about $3 million and $12 million from current nine months due to an increase in net plant as a result of our ramped up capital spending.

Legal and other administrative costs decreased about $1 million quarter-over-quarter or rose over $2 million year-over-year primarily as a result of higher settlements and increased outside attorney's fees.

Operating expense in our non-regulated operations decreased by about $11 million quarter-over-quarter and $36 million for the nine months primarily due to the absence of the current periods of asset impairment charges related to gas gathering assets for necessity that we recognized last year.

Moving to our earnings guidance for fiscal 2012. We have reaffirmed our fiscal 2012 earnings per share guidance of $2.30 to $2.40 per diluted share and have updated the expected contribution by business segment. This range assumes no mark-to-market impact at September 30, 2012, but does include the after-tax gain on the Liberty sale.

Let me draw your attention to slides 36 through 40 where we've outlined our budget assumptions and earnings re-projections. We expect the regulated businesses to generate over 90% of total net income for fiscal 2012. The distribution segment is now expected to achieve net income in the range of $135 million to $139 million, and the regulated pipeline Texas should earn between $61 million and $65 million.

We expect to record an after-tax gain of about $6 million or $0.06 per share on the sale of the distribution properties in Missouri, Illinois and Iowa. These numbers are subject to final purchase price adjustments.

The non-regulated business is re-projected to generate net income in the range of $14 million to $16 million. We anticipate delivery gas volumes of 395 Bcf to 405 Bcf at a per unit rate of $0.09 to $0.11. Our expectations for asset optimization margins continue to remain in the range of breakeven to $2 million. For the near term, we're expecting asset optimization activities to at least offset the contracted storage demand phase.

Keep in mind that the storage is essential for the 1,000 customers to which our AEH provides services such as distribution divisions, utilities and other regulated municipalities contracting for firm natural gas supply. We're working to shorten the lease terms for the contracted storage to one year to better manage our storage cost.

Our capital budget range remains between $690 million to $710 million for fiscal 2012. Year-to-date, we have contributed $56 million to our pension and postretirement plans. The pension obligation is driven by both the reduction in the discount rate and a decline in the fair value of the plant assets compared to last year. We expect to contribute an additional $11 million to $16 million to the plants before the end of the fiscal year. And as a reminder, most of our pension and postretirement expenses are typically recoverable in general rate crisis in our jurisdictions.

Thank you for your time, and I'll hand the call back over to Kim. Kim?

Kim Cocklin

Thank you very much, Fred. We certainly had an unprecedented third quarter with sets us up well for delivering our stated earnings objective of $2.30 to $2.40 per diluted share for fiscal '12. Our business performs steadily year-to-date despite a very mild heating season and the economic obstacles that continue to challenge everyone in our nation.

In our non-regulated business, the prolonged low gas price environment has entirely suppressed spread values and our asset optimization resource will be a very, very negligible contributor going forward. The non-regulated marketing group will focus on its core business, which is delivered gas sales by increasing annual sales and improving margins particularly to those 1,000 customers who rely on and pay a premium for our bundled energy management services.

Throughout the industry a paradigm shift has clearly emerged in the non-regulated gas marketing and trading operations. While we're still trying to determine the new floor for our non-regulated business, we do expect less than 10% of consolidated earnings and revenues to be generated from this unit going forward.

In our regulated operations, we continue to execute our rate strategy to reduce lag, improve returns and increase recovery of fixed cost. Fiscal year-to-date, we have received increases to operating income of about $37 million from rate outcomes. In total, we have about $70 million in rate request currently outstanding and pending and anticipate filing a case in Mississippi before the end of our fiscal year in September. Investing in our regulated asset base will provide the avenue for growth in the coming years.

At Atmos Pipeline Texas, our intrastate pipeline we're investing significant capital to increase capacity to secure new long-term gas supply on a firm reliable basis, and also to enhance the reliability of our service in certain critical locations along the mid-Tex system with our Line W Looping Project and the Line X project. Total capital for these is expected to range between $160 million and $170 million, and these capital expenses are DRIP eligible with obviously the 11.8% return on equity awarded to the pipeline.

As we previously discussed, we're targeting significant capital investment over the next five years to fortify, strengthen and replace our infrastructure.

The Kentucky Pipeline Replacement Program encourages capital spending related to safety by allowing carrying cost and return to be collected in advance through a customer surcharge. Coupled with similar projects in Georgia and Kansas, we expect to spend almost $40 million of capital in these three states in fiscal '12.

In Texas, Rule 8.209 is a risk-based program that encourages spending for system safety and reliability. The program is reviewed in advance and received regulatory asset treatment for carrying costs. We expect Rule 8 spending to be about $100 million in fiscal '12 and increase rapidly to more than double by fiscal 2016.

Also in Texas, the steel service line replacement program is a risk-based program with a carrying cost and return are collected in advance of the spend through a customer surcharge. By the end of September, we will have replaced 100,000 steel service lines in the Mid-Tex division. That program is set to expire September 30, 2012, and we expect to have spent almost $70 million by that time.

We also expect to spend over $200 million on enhanced infrastructure replacement programs in fiscal '12 compared to about $65 million spent on similar programs last year. And over the five years we expect this type of spending to grow at a compounded annual rate of about 27%.

We plan to increase our regulated rate base from about $4 billion at the beginning of fiscal '12 to between $5.8 billion and $6 billion by the end of fiscal 2016 which equates to a compounded annual growth rate in rate base of 8% to 8.5% over that timeframe.

The enhanced value of the rate base is expected to generate earnings growth in the range of 6% to 8% on a compounded annual basis by 2016.

We will focus on the earnings growth potential from our accelerated rate base investment over the next five years and, as always, we do remain committed to delivering dependable, consistent, long-term financial success.

We very much appreciate your time this morning and we'll now open it up for questions. Danielle?

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Ted Durbin of Goldman Sachs & Company. Please proceed with your question.

Ted Durbin - Goldman Sachs

Just starting off with the sale, the Georgia sale, I guess, maybe can you back up and talk about what's the end game here in terms of how many jurisdictions you want to be in? What comes into the decision-making process in terms of exiting a certain jurisdiction, is it scale, is it the returns, some of the underlying growth, maybe just walk us through the overall vision here?

Kim Cocklin

I think the overriding driver obviously is first interest or an appetite from a prospective buyer in that marketplace and, more importantly, it has to be focused in a jurisdiction where we really are growth constrained and that was the real -- I mean, now that we have exited Missouri, Illinois and Iowa. And Georgia, we were obviously kind of fenced in by AGL there. We didn't have a lot of growth prospects.

Georgia is a very, very good jurisdiction. We had received very favorable regulatory treatment there. We had very good relations and we have good investments, and we were of course completing the replacement of all pipes down there.

So long-term, we just looked at it as probably some place that we're going to be constrained going forward, and we felt that we had much better opportunities to take proceeds from an attractive offer and redeploy them into our remaining jurisdictions where we do have an opportunity to expand our footprint very significantly. And we're also getting extremely favorable rate treatment, regulatory treatment with the reduction in lag on particularly on infrastructure investment. So, I think where we're at on the end-game, I mean, I think we're very happy with where we're situated right now.

Ted Durbin - Goldman Sachs

Next one from me is we're coming up on the time here, I think, you've traditionally have increased the dividend. How are you thinking about the payout ratio? You mentioned in your comments you're reducing some of the non-regulated business impact on the earnings you're getting there as you just said lot more of the automatic trackers, how are you thinking about the dividend and payout?

Fred Meisenheimer

Well, the dividend policy hasn't changed. I mean, we still think our highest and best use for capital and the most value of the shareholder is investing in the rate base in Texas, Louisiana, Mississippi, Colorado, Kansas, Kentucky, Tennessee, Virginia where we are situated right now and because of that rate treatment we are getting very favorable treatment and good returns. So we think -- the dividend policy we obviously have increased our dividend every year for the last 28 years or whatever and we are added to the S&P 1500 dividend Aristocrat, identified as one of those for increasing it every year for 20 years. We don't want -- we don’t want to break that track record for sure.

Ted Durbin - Goldman Sachs

And then, the last one for me is just kind of update you can give us on the mid-Tex filing here. Are you getting any closer to any kind of settlement? How are the negotiations going? Are we still thinking this is going to be a fully litigated case, and kind of update on timing of decision?

Fred Meisenheimer

We do assume that it'd probably be a fully litigated case. I mean, the parties that -- I mean, there is good relations going on but I think both sides have reached a position where there is quite a gap between the expectations on both sides and is situation in front of the commission right now. We do expect an outcome and a decision in the November, December timeframe of -- that will be in the fiscal '13 period as we continue to talk about.

Operator

Now, our next question comes from Andrew Bischof of Morningstar.

Andrew Bischof - Morningstar

Looking at your Atmos Energy Holdings, you've been very successful there in your optimization strategy. Am I correct in assuming or understanding that there is a minimum amount of additional benefit in the future quarters from that?

Kim Cocklin

Yes.

Andrew Bischof - Morningstar

And then looking at your --

Fred Meisenheimer

In the fourth quarter, we will realize about $18 million that will come in as realized. And then after that point in time we have about $22 million of economic value at June 30, $18 million of which roughly will be recognized in the fourth quarter. So, that leaves very little for the following year at this point in time.

Andrew Bischof - Morningstar

And looking to the sale of the Georgia distribution assets, in terms of O&M, can you kind of break that out for us?

Fred Meisenheimer

O&M? What kind of breakdown are you wanting on O&M there?

Andrew Bischof - Morningstar

Just how much is related to that business and when you'll expect that transaction to close?

Fred Meisenheimer

We expect it to close in fiscal 2013. The direct operating O&M on Georgia runs in the neighborhood of $16 million to $17 million.

Operator

Your next question comes from Faisel Khan of Citigroup. Please proceed with your question.

Amit Marwaha - Citigroup

It's actually Amit filling in for Faisel.

Kim Cocklin

Amit, you got to be happy about geographic efficiency then.

Amit Marwaha - Citigroup

Yeah, a good deal, good deal. Good quarter guys. Most of my questions have been asked. I just wanted to ask a couple of follow-up questions. Are you guys seeing any pressures on the ROEs at this point across any of your jurisdictions given where rates are?

Kim Cocklin

No, none whatsoever. We -- obviously there's a -- the outstanding mark in fact is with the cases there. But we think that the elections that occurred in the -- the folks that were elected to the Labor Commission continue to believe that the road to a healthy economy is through energy and Texas leads the way on that road. And they are very, very balanced in their approach between the utility and the consumer.

Amit Marwaha - Citigroup

Second question, just wondering the last couple of quarters been seen industrial volumes coming off. I'm wondering if you guys have any color around what's driving that? Is it the weather or what's exactly causing those volumes to kind of shed each quarter over the last couple of quarters?

Fred Meisenheimer

I think more of that has been weather related here recently and the economy still is not picking up dramatically. But I think the warm weather has impacted it more than anything else somewhat offset by the volumes we've been delivering to the power generation too, Amit, but that's really not a big driver in the overall scheme of our revenue structure.

Operator

(Operator Instructions) Now, our next question comes from Jeff Healy of AIG. Please proceed with your question.

Jeff Healy - AIG

I had a question on the takeout of the '13, I guess, you guys have done a bridge from the September to January. Any particular reason why you guys would do that as opposed to just hit the long-term market in September?

Fred Meisenheimer

It will reduce our interest cost both this year and next year. We see some benefits in doing that.

Jeff Healy - AIG

Fred, particularly I just want to say kind of on behalf of all the bondholders and sure other folks (inaudible), but you guys have a great reputation for disclosure and really making things easy for us on the bondholder side. I want to express our appreciation. Thanks for a job, great job well done.

Fred Meisenheimer

Well, good. We appreciate your interest and hope that we can continue to provide useful information to you.

Operator

Thank you. There are no further questions in the queue at this time. I'd like to turn the floor back over to Ms. Giles.

Susan Giles

Thank you, Danielle. And as a reminder, a recording of the call is available for replay on our website through November 7th. And if you have any additional questions, please call me. We appreciate your interest in Atmos Energy and thank you for joining us today. Good bye.

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