Atmos Energy Corporation

Greetings, and welcome to the Atmos Energy second quarter fiscal 2019 earnings conference call. At this time, all participants are in listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jennifer Hills, Vice President of Investor Relations. Please go ahead.

Thank you, Kevin, and good morning, everyone. This is Jennifer Hiltz, Vice President of Investor Relations, and thank you for joining us. This morning, I am joined by Mike Hafner, President and CEO, and Chris Forsythe, Senior Vice President and CFO. This call is being webcast live on the Internet, and our earnings release and conference call slide presentation are available on our website at atmosenergy.com under Company and Investor Relations. 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. Our forward-looking statements and projections could differ materially from actual results. The factors that could cause such material differences are outlined on slide 27 and are more fully described in our SEC filings. Our first speaker is Chris Forsyth, Senior Vice President and CFO of Atmos Energy. Chris.

Thank you, Jennifer, and good morning, everyone. We appreciate your interest in Atmos Energy. Last night, we reported fiscal 2019 second quarter earnings of $215 million, or $1.82 per diluted share, compared with adjusted earnings of $135 million, or $1.57 per diluted share in the prior year quarter. Adjusted earnings excluded $4 million benefit related to the implementation of tax reform. Year-to-date, earnings were $373 million, or $3.21 per diluted share, compared with adjusted earnings of $327 million, or $2.97 per diluted share. And adjusted earnings excluded a $166 million benefit related to the implementation of tax reform. Also yesterday, the Board of Directors approved a 142nd consecutive quarterly cash dividend of 52.5 cents, which represents an indicated annual dividend of $2.10 per share in fiscal 2019, an 8.2% increase over fiscal 2018. Our second quarter results were in line with our expectations. The recovery of the capital spending required to modernize our natural gas delivery network, continued customer growth, and a planned increase in safety-related operating expenses were the primary drivers of the quarter's results. Slides five and six provide details of the period-over-period changes to operating income for each of our segments. I will touch on a few highlights. In the second quarter, operating income in our distribution segment increased 8% to $229 million. Recovery provided by recent regulatory actions increased contribution margin by $24 million. Additionally, we continue to experience solid customer growth. Over the last 12 months, we added a net 37,000 new customers, which represents 1.2% growth. We continue to experience strong customer growth in several of our service areas, including the DFW Metroplex, the suburbs of Nashville and to the north of Austin, and the left of Kansas to the west of Kansas City. This growth added $4 million in contribution margin for the quarter and almost $8 million year-to-date. However, despite weather that was 9% colder than the prior year quarter, customer consumption declined due to varying weather patterns quarter over quarter, which reduced contribution margin by about $9 million. Operating expenses decreased by about 1%. In the prior year quarter, we incurred $23 million related to customer assistance and other non-recurring expenses related to the outage in Northwest Dallas. After adjusting for these expenses, operating expenses increased approximately 9%. More than half of this increase reflects higher depreciation and ad valorem taxes driven by last year's capital spending. The remaining increase related to a planned increase in system integrity and maintenance work, such as digital mapping of legacy assets, and work to mitigate and reduce third-party damage to our system. Additionally, we experience higher labor and training costs as we have added service technicians and leak survey specialists to support our mid-tech operations in the DFW Metroplex. Operating income in our pipeline and storage segment increased about 16% to $69 million during the second quarter. New rates from last year's grid filing contributed $12 million of this growth. Additionally, APT continues to benefit from the supply and demand dynamics in the Permian Basin. APT's through-system revenue increased about $1 million quarter-over-quarter and about $4.5 million year-to-date, net of the Rider-Rev mechanism. APT's tariff customers continue to benefit from this mechanism, while our distribution customers in Texas receive the benefit of low costs of gas produced in this region. Operating expenses increased $6 million, or about 9%. About half of this increase reflects higher depreciation expense as a result of last year's capital spending. Additionally, we planned for incremental pipeline integrity work, which was the primary driver for the remainder of the increase in operating expenses. Consolidated capital spending increased 12% to $778 million year-to-date. About 84% of this spending was dedicated to safety and reliability projects. We remain on track to achieve our capital spending target of $1.65 billion to $1.75 billion for the fiscal year. From a financing perspective, we had another busy quarter as we completed over $600 million of financing. We refinanced our $450 million 8.5% 10-year notes with a 4.125% 30-year notes. As a result of the financing, our overall cost of debt decreased to 4.6% and our weighted average maturities increased to 22 years. Additionally, as most of you are aware, we moved to the S&P 500 from the S&P mid-cap 400 in mid-February. We took advantage of this unplanned and unique liquidity event to issue 1.1 million shares through forward sales arrangements executed under our ACM program. The net proceeds of $159 million from these forward sales arrangements were used towards our equity needs for fiscal 2020 and will not be fully diluted until issued in fiscal 2020. These net proceeds combined with the $245 million in net proceeds issued under forward sales arrangements during our November equity issuance leaves us with just over $400 million to help fund our capital spending through March 31, 2020, when all of these forward sales arrangements mature. Based on the execution of these forward arrangements, the remaining availability under our ATM program, and our current capital spending outlook, we do not foresee the need for discrete equity issuance through the end of fiscal 2020. As a result of our financing activities this year, our equity total capitalization was 60%, and our short-term debt balance was zero at quarter end. including the $108 million in cash on hand at the end of March and the $404 million in net proceeds available under the forward sales arrangements, we have approximately $2.1 billion of total available liquidity. After resetting most of our regulatory mechanisms last year, our fiscal 2019 regulatory calendar has returned to a more traditional cadence. To date, we have implemented $86 million of annualized regulatory outcomes and have about $90 million in progress. Annual filings in Texas, Louisiana, and Mississippi are among the most significant of these filings. Before I turn the call over to Mike, I wanted to comment on our fiscal 2019 earnings per share guidance. Yesterday, we narrowed our guidance to a range of $4.25 to $4.35 per diluted share. Slides 12 and 13 provide additional details of our updated guidance. Earnings for the first half of fiscal year were in line with our expectations. We see potential for a modest uptick in APT contribution margins as a result of the supply and demand dynamics affecting the Permian Basin. However, as we've communicated before, seven months are focused on preparing APT for winter operations for the next fiscal year, and we do not expect the impact to be material. Additionally, we have completed our fiscal 2019 financing program, and we now have clarity on how that financing will impact fiscal 2019 results. Finally, during the first half of the fiscal year, we initiated several efforts that will further mitigate long-term risk. Following the incident in New England last fall, we are now assessing our low-pressure systems and implementing additional procedures to continue to safely manage these systems. Additionally, during the first half of the fiscal year, we initiated a multi-year effort to implement new leak detection technology. The preliminary results from the initial pilot efforts have been encouraging, and we will continue to methodically implement this technology in certain of our jurisdictions during the second half of the fiscal year. And in the second half of the fiscal year, we are planning to run additional inline inspections in our pipeline and storage segment to facilitate capital allocation decisions for fiscal 2020 and beyond. Our performance for the first half of the fiscal year and the additional clarity we have for the second half of the fiscal year leaves us well positioned to meet our 6% to 8% earnings for sure growth target for fiscal 2019. I will now turn the call over to Mike for some closing remarks. Mike.

Thank you, Chris, for that great update on the quarter. Our results for the first half of the fiscal year reflect the ongoing disciplined execution of the investments we're making in safety and reliability of our system while continuing to mitigate long-term risk. Capital spending increased 12% during the first six months of the fiscal year, which demonstrates our commitment to modernizing our system. As we plan to increase our spending 9% to 10% per year through fiscal 2023, we're also investing in our people and technology to support these higher spending levels. Last fall, we started to implement new technology that will digitally capture all the data we're required to collect and retain for compliance purposes. We've completed the rollout to about 20% of the nearly 1,000 company and contractor crews working on our system. We're on track to expand the rollout to about 50% of these crews by fiscal year end. This is just one example of the various initiatives we have underway to build scale and efficiency to sustain our ability to invest in safety and reliability. During the first half of the fiscal year, we also continued to find ways to mitigate risk for the long term. The increased O&M spending that Chris referred to in the second half of the fiscal year for low pressure system assessment Systematic rollout of new leak survey technology and inline inspections on our transmission system will help us implement new procedures and technology that will enhance our ability to safely operate our system and support our risk-based capital allocation program. This spending does not affect our anticipated 6% to 8% annual earnings per share and dividend per share growth through fiscal 2023. Additionally, as Chris mentioned, our move to the S&P 500 created an unplanned and unique liquidity event to issue equity under forward sales arrangements through our ATM that will be used toward our fiscal 2020 equity needs. These are just a couple of examples of how we remain agile when conditions evolve to mitigate operational and execution risk for the long term. These equity forward arrangements combined with the additional $1.8 billion of debt and equity financing further strengthen our balance sheet and provide the capacity necessary to finance our capital spending plans over the next five years. As we look toward the back half of the fiscal year, we have more clarity around our regulatory outcomes, our O&M spending, and our financing costs. This clarity gives us the confidence to tighten our EPS guidance range to $4.25 to $4.35, which leaves us well positioned to meet our earnings per share growth targets for fiscal 2019. In closing, I'd like to thank our employees for their continued outstanding efforts. Our highly qualified gas professionals come to work every day, laser-focused on safety while providing excellent customer service, closely monitoring and maintaining our system, and executing our capital spending program. They are accomplishing these critical services while striving to improve every day as we deliver safe, reliable, and affordable natural gas service to the nearly 3.3 million customers we serve in over 1,400 communities in our eight-state footprint. We certainly appreciate your time this morning, and we'll take any questions you may have. Kevin?

Thank you. We'll now be conducting a question-and-answer session. If you'd like to be placed into question queue, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing star one. One moment, please, while we poll for questions. Our first question today is coming from Christopher Turner from JP Morgan. Your line is now live.

Good morning, Chris. Hey, Mike. Hey, Chris. So I wanted to make sure we were understanding kind of the equity situation correctly and Going back to last fall, my understanding was you guys priced around $750 million of equity, 150 of which had a forward component to it that your message was you would pull down before, I think, the first half of fiscal 20. And then separately, you had a forward component to a $500 million ATM. So what exactly occurred this quarter and kind of when is that going to hit your share count?

Right. So, Chris, backing up to November, it was a $748 million total equity issuance of which $500 million before costs were taken into the first quarter. $245 million was allocated to forward sales arrangements that expire in March of 2020. And our plan was to draw down the 245 between January of 2019 and March 31 of 2020. When we had the opportunity presented to us that was unplanned when we moved to the S&P 500 in February, we issued $160 million under our ATM under forward sales arrangements. So we have a total of $404 million in total forward arrangements available to us through the end of March of 2020. And we'll take that down over that next, basically over the next 11 to 12 months. based on our cash needs. But again, all of this has been contemplated in our 6% to 8% earnings per share growth target for fiscal 19 and in the five-year plan. And the net forward arrangements that we took out in February are going to be applied against our fiscal 2020 equity needs and will not be dilutive to fiscal 19.

Okay, good. I think I understand now, but there's still a lot in there. So the amount that you did in February was simply priced under the forward ATM, and you do not intend to pull that down during fiscal 2019? Correct. Okay. you are still kind of leaving the forward component of the 750 from November as loose. You're not specifying when you'll pull that down. That's correct.

We'll certainly start towards the end of fiscal 19. The exact amount will be to be determined based upon our cash flow projections and cash needs. Okay. We have to utilize all of that equity by the end of March of 2020 because the four sales arrangements expire March 31st of 2020.

And then your comment on these actions covering you through fiscal 2020 to make sure that I'm understanding properly, you're committing that there will be no more equity issuances in the kind of normal course of business?

I'm committing that we will not have a discrete equity need such as a large-scale block trade that we've done the last couple of years. The ATM remains available to us and we intend to consider using that as we go forward as part of our overall financing strategy and needs, honestly. You think back to our five-year plan that we rolled out last fall, we had $5 to $6 billion of incremental financing needs, and we intend to satisfy those needs through a balance of long-term debt and equity. And so we're still executing towards that plan.

Okay. That's pretty clear. And then I guess just as a second question, you mentioned gas basis in Texas is helping you guys at least a little bit here. Can you give us more detail on how you're thinking about that over the next six or 12 months? I think you said that you were making some preparations there in some way.

Yeah, that's correct. In the summer months, as you know, Chris, we have to reduce pressure on the pipeline for maintenance work to get ready for winter operations. So we don't have as much opportunity to take advantage of those spreads. We do see some modest uptick, but between the fact that the pressures are going to be coming down on the system for maintenance work and the fact that we have ride or rev in place where we only share in 25% of that upside, We do, like I said, anticipate a modest uptick that we've contemplated in our guidance, but we don't anticipate that to be all that material in the grand scheme of things.

Chris, as you look into 2020, the expectation is the Gulf Coast Express is expected to be in service in the October-November timeframe, so we expect that to begin affecting spreads in the 2020 timeframe? And the key is that our customers are benefiting from lower-cost gas and then also through the Rider-Rev mechanism in terms of their transport costs and gas costs.

That makes sense. All right, thank you, guys. Thank you, Chris.

Thank you. Our next question today is coming from Charles Fishman from Morningstar. Your line is now live. Hi.

Good morning. Just going back to the equity issue. Your guidance, the average diluted shares, goes down a little bit. The net income guidance for 19, it went down a little bit on the upper end. But correct me if I'm wrong, what happened basically was you went out for the equity you needed and were able to get it at a little better pricing, and then that drove your diluted shares down? Or is it just a later thing? Are you issuing them at a later date? What basically drove the average diluted share quantity down?

Generally pricing. Generally pricing.

Okay. That's what I would have assumed. Okay. Second question, operational. Certainly a tragic event in Boston in the fall. Final report isn't in, but it sounds like a low-pressure event. That utility is putting in low-pressure sensing equipment. devices through their whole system. Is that something you already have? Is that something you're doing? Is that something you will be doing? Or what's the status as far as the Atmos system with respect to low pressure sensing?

It's a good question, Charles. We've operated our low pressure systems for a long time and we're constantly working on them. As Chris mentioned, we have been pretty proactive in terms of doing a full system evaluation, design evaluation, and we've kind of reaffirmed and reviewed all of our procedures, re-communicated them. We've created geofencing in our GIS systems, so when there are line locates called that are anywhere near a low-pressure system, we'll have individuals from the company there to monitor any construction or digging near our assets. And then this review of our system design will then guide our next set of actions, which may involve bifurcating those systems or putting other kind of technical solutions like slam shut devices or additional releases based on the need. So we're well along that process. You know, we expect that, you know, we haven't seen anything that concerns us at this time.

But I suspect that technology is rapidly changing on this stuff. But do you have some device or some way of sensing a low-pressure event that has occurred? Or excuse me, I guess it was a high-pressure event in Boston. I had it backwards. Do you have the capability of sensing that now in most of your systems?

Yeah, since the designs were put in, or the systems were put in over a longer period of time, there are various solutions to that. But yes, we have pressure sensors. We have pressure release devices as well. So we've got that type of protection in the system. And what we're doing now is just going back through and doing a comprehensive review and seeing if there are other steps we should take

you know, as it relates to low pressure. Yeah, I guess the events that really drive you nuts is a contractor doing work, you know, that has nothing to do with your people, but obviously that contractor could do something stupid that creates a problem for you. And that's, I would assume, is an ongoing issue that you have to address.

Yeah, certainly 70% of our hazardous leaks are caused by third-party damage. It's a very significant focus of our efforts and advocacy, and it'll continue to be. And as I mentioned for the low-pressure systems, we've taken the steps to geofence them electronically within our GIS system so that as line locates come in, if we have anybody working near those systems, we're going to have somebody monitoring it

Okay. Thank you very much. That's all I had.

Thank you, Charles.

Thank you. Our next question today is coming from Steven Bird from Morgan Stanley. Your line is now live.

Steven, good morning. Hey, Steven.

Mr. Bird, perhaps your phone is on mute. Please pick up your hand.

Oh, sorry about that. Hi, this is Dave Arcaro on for Steven Bird. Thanks for taking my question. Good morning. What are your latest thoughts following some of the commentary coming out of the Dallas City Council over the last couple of days with the rate request there? Does that change your views of the overall process for that rate request? Sure.

I think what we're seeing is a normal part of the process, Dave. Earlier this year, we filed a 10.1 million rate increase request in accordance with the annual mechanism we agreed to early in 2017. That request is on the City Council agenda today. City staff, we've been working with them. and their consultants and representatives, and they've acknowledged the efforts on both sides to try to reach an agreement. However, we haven't been able to do so in time for their needed approval. So the staffs recommended that the city council deny the request. Now that denial would trigger an appeal process to the Railroad Commission, which we've been down that path before, and our plans to continue to work with the city, share common interests certainly in replacing aging infrastructure, and we've been investing for many, many years in Dallas, and we expect to reach agreement at some point in time in the future. Our company's made $119 million of infrastructure improvements in the city of Dallas during that test year, and we also agreed to accelerate our cast iron replacement at the city's request. to 2021, getting the last of that removed in 2021 versus 2023. So maybe a longer answer than you were looking for, but it's, you know, I think we're continuing to have discussions and we'll continue to move down the path to try to find a win-win solution.

Okay, great. That's helpful. And I was just wondering your latest thoughts on expectations for the NTSB process.

Sure. We don't have much of an update. The Corps of Engineers completed soil samples in the area. They were requested to do that by the NTSB. And in a public release in late February or early March, the NTSB indicated that their finding of fact or factual report would be expected in June. So that's the next step that would come from them. And that would not at that time include any probable cause or safety recommendations. Those will be some time later and there's no timeframe on them. In the meantime, we continue to work with the NTSB and we continue to move forward on improvements in our processes around safety and in our safety investment in our system.

Okay, got it. That's helpful. And then maybe one last question. I wanted to clarify on the increased O&M expected this year for some of the low-pressure system investments. I was wondering how you anticipated getting recovery of those investments. It seems like that's anticipated, but does that flow through mechanisms, or how do you think about that?

Yeah, we will seek to recover those costs through the annual mechanisms that we have in the various jurisdictions. Again, it's safety-safety related, and I think everyone has got a and what happened last fall, and all of our regulators have a commitment to safety, and we would seek to recover those costs in our next round of filings.

Okay, great. Thanks very much. Thank you.

Thank you. Our next question is coming from Brian Levine from Citi. Your line is now live.

Good morning.

Brian, good morning.

Hey, Brian, how you doing?

Good, and how are you guys? Good. Just to follow up on the Permian-Waha-Kiti basis movements, is there a way to quantify exactly what the impact was for the first quarter, or for the first calendar quarter, given your sharing mechanism?

In the first calendar quarter, so year over year, we were up about $4.5 million. Quarter over quarter, we were up about $1 million. So it was about $3.5 million in the first quarter, or quarter over quarter, last fiscal year. Or, sorry, last quarter.

Okay, great. And then in terms of going into the second quarter, are you seeing that directionally move up relative to this past quarter?

Yeah, as we look into our third and fourth fiscal quarters, we do see the opportunity for a modest uptick in those spreads. But as I indicated, with the maintenance work that we have planned for the pipe this summer, combined with the effect of the Rider-Rev mechanism and how we share 75% of that upside benefit flows back to the tariff customers on APT, We expect that impact to be modest for us.

Okay. And then last question, to the extent that you're able to comment, is there any update on the Georgetown incident?

Sure. And let me, for others on the call, the Georgetown situation is pretty much behind us right now. It goes back to February 20th, and there was a leak reported. We responded, identified two leaks and repaired those leaks. And then what we identified was residual gas in the soil that had migrated. And that led us to evacuate up to, at a peak, 85 structures that affected approximately 140 combined businesses and residents. And then we worked on getting that residual gas out of the soil. So all the evacuations have been lifted except for one business. And during this process, we provided financial support, and we've been processing any claims for affected businesses and residences. We've got business interruption insurance. We believe they'll cover any costs that get into that territory, and we don't expect the impact. So we don't expect the impact to be material on the year. But it's largely behind us, and I'll tell you what our team did. Just an absolutely phenomenal job responding to the situation there, working with the community and with all the regulators and city and state leaders.

Okay, great. That's all from me.

Thank you, Ryan.

Thanks, Ryan.

Thank you. As a reminder, that's star one to be placed in the question queue. Our next question is coming from Dennis Coleman from Bank of America. Your line is now live.

Dennis, good morning.

Good morning. Good morning, everyone. This may be a question that is a little more detailed than this, and I'm happy to take it offline if you would like. But I'm wondering, there's quite a big swing in cash flow, and I'm sort of working through the various statements trying to figure out where this is coming from. But is there a simple explanation, you know, there's a drop of close to $200 million in cash flow for the six months?

Virtually all of that is the timing of our deferred cast cost recoveries. We were somewhat over-recovered last year, and we began working that balance down, returning those monies back to customers through the PGA, and that continued into this year. So that's virtually all of the decrease. And that was planned as we moved into fiscal 19.

Okay. So that's all encompassed in the financing plans and whatnot. Okay. And so that will sort of this, the 2019 run rate is more of what we should expect?

Yeah, it should level out now that after we kind of got in a situation where last year we just moved a lot of volumes because it was cold. And this happens to us from time to time under those PGA mechanisms. And every jurisdiction's got a different time period in which those rates are reset and And so we're just working through that standard process. So we should be back to more of a, I'm going to call it a quote unquote normal run rate going forward.

Okay. Thanks. And then just to make sure I understand the equity forwards, are you able to do sort of fives and tens on this? Does it have to be discrete draws? Is there a one-time mechanism? And are there any differences in that regard for the 160 related to the S&P 500 move versus the prior forward?

Well, a couple of things. We issued the forwards in February under the ATM program. So you can go out and issue shares on a daily basis if you want. In the past, we've executed what I would call more of a regular weight issuance where we would take in those shares and they would become diluted daily as we move forward. The ATM program that we set up last fall, we added a forward feature to it that gives us the ability to access the market on a daily basis and then basically allocate those shares under forward arrangements. So it could be a daily, it can be around an unplanned liquidity event like we did in February. It's all subject to the average daily trading volumes and kind of how ATM programs generally work. So we don't have any specifics around, you know, we have to target this, we have to target that. We look at the market conditions and we'll take advantage of pricing as we see it.

But when you actually call for the cash, are there any limits in that regard?

No, no.

Now, the only limit we have is that we have to utilize all of the forwards, all that cash, those net proceeds under those arrangements by March 31 of 2020 when those arrangements expire.

Okay. That's it for me. Thanks.

All right. Thanks, Dennis.

Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over to management for any further or closing comments.

Thank you for joining us today. A recording of this call is available for replay on our website through August 8, 2019. We appreciate your interest in Atmos Energy, and again, thank you for joining us. Goodbye.