Atmos Energy Corporation

Greetings and welcome to the Atmos Energy third quarter earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Jennifer Hills, Vice President of Investor Relations. Thank you. You may begin.

Thank you, Diego. Good morning, everyone. This is Jennifer Hills, Vice President, Investor Relations, and thank you for joining us. This morning, I'm joined by Mike Hafner, President and CEO, Kevin Akers, Executive Vice President, Chris Forsythe, Senior Vice President and CFO, and Kim Coughlin, Executive Chairman. 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 Mike Hagener, President and CEO of Atmos Energy. Mike.

Thank you, Jennifer, and good morning, everyone. And happy birthday, Jennifer. In investor relations, nothing says happy birthday more than hosting an earnings call, so congratulations. Yesterday we reported our fiscal 2019 third quarter results, and I'm pleased to report that we're on track to meet our fiscal 2019 earnings per share guidance. of $4.25 to $4.35, and increased earnings per share for the 17th consecutive year. Capital spending increased 10% during the first nine months of the fiscal year, which demonstrates our commitment to modernizing our system. Approximately 87% of this spending was focused on safety and reliability investment, as we continue to execute a risk-based capital spending program to modernize our distribution and transmission systems. For June 30, 2019, we completed $2.1 billion of financing, which has supported our fiscal 2019 capital spending, further strengthened our balance sheet, lowered the cost of financing for our customers, and leaves us very well positioned to maintain our credit ratings for the long term. We continue to invest in technology, our people, and processes to achieve operating excellence and scale our capabilities to sustain our safety-driven strategies. With the team we have in place, we're extremely well positioned for continued success into the future. Yesterday we announced that I'll step down from my role as President and Chief Executive Officer effective September 30th to focus on my health. I'll remain with the company through the end of the calendar year to support the transition, and I'll retire from the company and plan to step down for the bullet effective January 1, 2020. Also announced yesterday is that Kevin Akers, currently Executive Vice President, has been appointed by the board to succeed me as president and CEO and become a member of the board effective October 1 of this year. Kim Coughlin will continue as executive chairman. This was a very difficult decision for me, but it's the right decision for the company, for me, and for my family. I've been facing a recent health issue that to this point has eluded a definitive diagnosis. I'm extremely optimistic this will resolve itself favorably in the long run, However, it's requiring an increasing amount of my time, and it necessitates me pulling back on my commitment. This decision was made much, much easier for me by the fact that Kevin Akers is ready to assume the role of President and Chief Executive Officer. Kevin's a proven leader with broad company and industry experience. A majority of his nearly 29 years with the company have been in senior leadership positions. He has deep operating experience, having previously served for over nine years as president of our Kentucky Mid-States Division, five years as president of our Mississippi Division, and more recently took on responsibility for the company's pipeline and storage operations. For the past several years, Kevin also oversaw our pipeline safety, supply chain, and customer service functions. And he's been instrumental in driving the process improvement and technology initiatives that have enabled the company to scale its operations to sustain our success. Many of you already know Kevin from our analyst days the past two years, as well as the AGA Financial Forum and other investor conferences this year. Kevin is surrounded by a very seasoned senior leadership team. Chris and the rest of our management committee will continue in their current roles. They've worked closely together for many, many years, and even prior to being on the management committee. Not only are they respected colleagues, but they're also friends. and Kevin has the full support of our 4,700 employees. One of our board's most important responsibilities is succession planning, and they've done that masterfully over our 36 years as an independent public company. This succession plan has been in place for several years, and just as with prior transitions from our founder, Charlie Vaughn, to Bob Best, to Kim Coughlin, to me, the transition to Kevin will be completely seamless. As I mentioned earlier, Kim will continue in the role of executive chairman. I'll be forever grateful to him as a great leader, as a mentor, and a friend. His continued involvement in the company as chairman, as well as advisor to Kevin and the rest of the management committee, will provide further assurance of the company's continued success. And lastly, before I turn the call over to Chris for the financial update, I'd like to thank the investors and analysts I've had the distinct pleasure to get to know over the past four years. Your support and investment of time and capital has been so critical to the success of our safety investment strategy. Your insights and challenging questions have made us a better company and have made me a better leader. I'd also like to thank our 4,700 employees for their continued outstanding efforts to improve every day to deliver safe, reliable, affordable, and exceptional natural gas service to the 3.3 million customers we serve in over 1,400 communities and our eight-state footprint. They come to work every single day focused on safety, while providing excellent customer service and executing our capital spending program focused on modernizing our system. It's been my greatest honor to serve alongside them for the past 11 years. They are the reason that Atmos Energy will continue to be successful for the long term.

Chris, over to you. Thank you, Mike, and good morning, everyone. Yesterday, we reported 2019 third quarter net income of $80 million, or $0.68 per diluted share, compared with $71 million, or $0.64 per diluted share in the prior year third quarter. Year-to-date, net income was $453 million, or $3.88 per diluted share, compared with $564 million, or $5.09 per diluted share in the prior year period. Fiscal 2018 year-to-date results included $166 million of $1.49 per diluted share, non-recurring income tax benefit from tax reform. Excluding the tax benefit, adjusted net income was $398 million, or $3.60 per diluted share. Our third quarter results were in line with our expectations, with many of the drivers underlying our performance during the first half of the year continuing into the third quarter. Slides 5 and 6 provide details for our quarter and year-to-date results. I will touch on a few of the highlights. In our distribution segment, operating income increased $14.4 million to $48.7 million in the third quarter, as the last increase in contribution margin was offset by higher operating expenses. Contribution margin increased about $1 million quarter to quarter. We experienced a $7 million increase in new rates and a nearly $3 million increase in customer growth. From 12 months into June 30, 2019, We added a net 35,000 customers, which represents 1.1% net customer growth. We are on track to exceed 1% net customer growth for the third consecutive year. These increases were offset by a $4 million decrease in customer consumption, primarily due to warmer weather in the third quarter compared to the prior year. As a reminder, most of our weather normalization mechanisms end in April, so our contribution margin is not covered for most of the quarter. Operating expenses rose approximately 6% quarter-over-quarter, reflecting higher depreciation expense associated with increased capital spending and planned 10% increase in O&M expense. As we discussed last quarter, we increased service-related headcount in our mid-tech division to support the growth in our DFW market. Additionally, we experienced a 7% quarter-over-quarter increase in line locates, as many of our communities in which we operate continue to experience strong growth. We continue to roll out new leak survey technology into our operations. This technology is 1,000 times more expensive than traditional leak survey technology. Therefore, we are finding more potential leak indications, which drives the need to hire or contract with people to evaluate and assess these indications. While the deployment of this technology will increase O&M expense in the near term, it plays an important role in our ability to identify and mitigate risk. For example, during the quarter, we had to use this technology in several of our jurisdictions that were hit by heavy storms to assess their system for damage. The performance of our pipeline and storage segments substantially offset the operating income decrease in our distribution segment. Operating income increased $12 million, driven by strong growth in contribution margin, partially offset by higher operating expenses. Contribution margin increased $22 million as a result of APT's grid filings in 2018 and 2019, combined with a $4.5 million quarter-over-quarter rise in APT's through-system revenue as a result of the ongoing supply and demand dynamics affecting the Permian Basin. The activity we experienced in the quarter was higher than anticipated due to two unexpected force majeure events on other pipelines, which drove higher than expected volumes into our system. However, as a new partnership pipeline comes online starting late this summer, we expect the Waha-Ducati spread to narrow. Offsetting the growth and contribution margin was a $10 million increase in operating expenses as a result of higher depreciation related to increased capital expenditures and a planned increase in pipeline integrity work. Year-to-date consolidated capital spending increased 10% to $1.2 billion, which is in line with our plan. We continue to focus our spending and improving the safety and reliability of our system spending with 87% focused on safety and reliability. Based on work completed year-to-date and planned spending for the remainder of the fiscal year, We continue to expect our fiscal 2019 capital spending to be between $1.65 billion and $1.75 billion. From a regulatory perspective, to date, we have completed 21 filings, which should add approximately $110 million in annualized operating income over fiscal 2019 and fiscal 2020. And we have six filings pending seeking about $87 million in annualized operating income. We're on track to complete several of these filings during the fourth quarter, with rates taking effect in the first quarter of fiscal 2020. Assuming these proceedings are resolved in line with our expectations, we remain on track to meet our target of completing $160 million to $180 million in annualized operating outcomes. Our balance sheet continues to remain strong and supports our capital spending program. As of June 30th, equity total capitalization was 60%, and we had approximately $2 billion of equity under our credit facilities and through our equity forward agreements. Slide 9 summarizes our fiscal 2019 financing activities. Year-to-date, we have completed $2.1 billion of financing, including the issuance of $1.1 billion in long-term debt and $1 billion of equity. During the quarter, we continue to utilize forward agreements under our ATM to help meet our fiscal 2020 needs. We issued 1.1 billion shares at an average price of $101.41. Additionally, we settled the forward agreements for 1.1 million shares for net proceeds of approximately $100 million. As of June 30th, we had about $410 million remaining under our forward agreements. Details of equity forward activities can also be found on slide 9. As Mike mentioned in his opening remarks, we are well positioned to meet our fiscal 2019 earnings guidance range of $4.25 to $4.35 per diluted share. However, given the higher than expected premium-based activity we saw during the third quarter, We now expect to be at the higher end of this range. Slides 12 and 13 provide selected information underlying our fiscal 2019 guidance. And we are well positioned to meet our five-year annual EPS growth target of 6% to 8% through fiscal 2023. We'll be rolling forward our five-year plan through fiscal 2024 on our fiscal year-end earnings call in November. Thank you for your time this morning. I will now turn the call over to Kevin for some closing remarks. Kevin?

Thank you, Chris, and good morning, everyone. Mike, thank you for those kind remarks. We are deeply indebted to you for your leadership, your vision, and unwavering dedication and support for Atmos Energy and every one of our 4,700 employees. I'm very excited about the future of Atmos Energy, and I look forward to continuing the execution of the successful strategy that Kim and Mike have put in place as we maintain our focus on our vision of being the nation's safest provider of natural gas services. A key to achieving that vision is to continue the evolution and refinement of our strategy by making investments in safety and reliability while modernizing our business to sustain our company for the long term. This straightforward focus and proven strategy benefits all stakeholders as we strive to safely provide excellent customer service in an environmentally responsible manner. As we've discussed before, increasing our spending 9% to 10% per year through fiscal 2023, requires that we also invest in our people and technology. I'm proud to report that during the third quarter, we crossed over the one million hour mark for total cumulative hours of training provided at our state-of-the-art Charles K. Vaughan Center, which opened in 2010. This training is essential for our employees to become highly qualified gas professionals. We continue to roll out our locus map digital asset data collection solution. Through the first nine months of this fiscal year, we've had approximately 35% of our company and contract construction crews trained on using this important technology. And we continue to systematically roll out our advanced mobile leak detection technology that will enhance our ability to safely operate our system, as Chris mentioned earlier. Implementing a safety management system is another strategic focus. While we have had components of a safety management system, including procedures, policies, and practices for many years, a safety management system formalizes what we are doing and is an integral part supporting our vision of being the safest provider of natural gas services. We've completed our pipeline safety management system assessment and plan to have our high-level roadmap developed for addressing gaps later this fall. These are just a few of the examples of how our investments in training and technology position us for sustained success in the future. In closing, I would like to thank our 47 employees, their dedication to safely operating our system while providing excellent customer service and giving back to the communities where they work and live. That is the biggest reason Atmos Energy will be successful for the long term. We appreciate your time this morning, and now we'll take any questions you may have.

Thank you. Operator? Thank you. At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. It's the star key followed by the 1 key on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. or participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys. Our first question comes from Christopher Turnier with JP Morgan. Please state your question.

Good morning, everyone. Very sorry to hear the news, Mike. Best wishes to you and your family. Thank you, Chris. As we look forward to fourth quarter earnings and potentially an analyst day again this year, how can we think about the outlook for beyond the current plan, kind of 2024, and beyond anything potentially changing there, especially given the acceleration of CapEx that we saw out of you guys last year?

Chris, this is Chris Forsyth, and good morning. Our intent this fall is to not have an analyst day, but we'll have an extended fiscal year-end earnings call. We'll cover off the remainder of fiscal 19 and really focus on where we're going to be going in fiscal 2020. And really, the story and the strategy remains the same. As we've talked about with you and others on the call, we have a long backlog of work to do, if you will. Just a lot of work to get done in terms of pipe replacement. So we will be just rolling it forward another year. You'll expect to see just an increase in line with the increases in capital spending that you've seen from us over the last several years. Financing strategy is going to be pretty consistent with what you've seen as well. We'll update and question those numbers on that call. But I think the key takeaway today is is that the strategy is the same, and it will just be a roll forward of what we've demonstrated in 2023 at this point.

Okay. And, Chris, that kind of all sounds great, obviously, and you feel like there's no customer bill pressures or even kind of balance sheet constraints, despite the strength of your balance sheet right now, that would come into play in that timeframe that would perhaps slow the rate-based growth trend.

We're not seeing anything from a customer bill perspective. You can go back to our charts that we've shown. Our bill is by far the lowest bill in the household from a utility perspective. And you know the strength of our balance sheet, and we're committed to maintain the strength of that balance sheet going forward.

Okay, great. And then my second question is around near-term financing. As you mentioned in the remarks, and I think the Q as well, You priced around a million shares this quarter, and then you also pulled down around a million shares as well from, I guess, one of the earlier ATMs. So given your prior commentary on not I think it was not needing any more equity this year from the ATM programs. Was there something that changed there or caused you to tap that equity during the quarter?

No, no. I think what we were indicating is that we didn't have any discrete equity needs. In our last court call, we said we had no discrete equity issuances planned through the end of fiscal 2020. We did have the proceeds available to us under the forward arrangements. which, as you know, expire. Most of the proceeds right now expire at the end of March, with a little over $100 million expiring at the end of September. So we're needing to utilize those proceeds. So we had intended all along to draw down on those proceeds as capital needs arise or cash needs arise in that period. So all of that, again, is baked into our fiscal 19 guidance. It's baked into our five-year plan. $5.40, $5.80. And as we look forward, we stated in the current five-year plan we have published a $5 to $6 billion incremental financing need, and we intend to finance that in a balanced fashion using both long-term debt and equity. So, again, that strategy is going to look very similar when we roll that forward in November. But, again, the financing that we did in the third quarter is not to satisfy FY19 equity needs. It will satisfy our FY2020 needs and beyond.

Okay, that's clear. Thank you, Chris.

Thank you. Our next question comes from Dennis Coleman with Bank of America. Please state your question.

Yes, good morning, and let me add my thoughts, Mike. Never news that anyone likes to get, so certainly best wishes as you pursue your health and thoughts with your family as well. Thank you so much, Dennis.

I certainly will miss all the opportunities. We've had to talk in the past, and I'll miss seeing all you guys in the future, but again, As I mentioned in my comments, I'm very optimistic that if I gear down a gear or two, I have the opportunity to find a good solution for this.

Great. I hope that's the case. Congratulations also to you, Kevin. Best of luck with the new role and responsibilities. Big shoes to fill, but great company to work with. Absolutely. Thank you. A couple questions for me. I guess first on the expense side, expenses did run up certainly a little more than we thought. Can you talk about sort of, I guess, the roll forward on the expense side? Some of it seems a bit transient, but any help you can give there, Chris, would certainly be appreciated.

Yeah, sure, Dennis. I mean, like I mentioned in the prepared remarks, it's really a continuation of what we've been experiencing and what we've been trying to accomplish from a risk-based perspective. And when we talked about in the second quarter, rolling into the third quarter. So that was, you know, continuing to roll out the AMLB technology that Kevin commented on. You know, we are, because it's new to us, you know, the indications that come in just require a little bit more assessment. A lot of that work is O&M. But over time, we expect as we gain proficiency that that should come back into line with the the 2.5% to 3.5% guidelines that we established for the five-year plan last fall. Additionally, you know, we talked about low-pressure assessments. And when you get an opportunity with, you know, increases in margins, you know, we're always looking to take risk off the table from an O&M perspective. So we've been increasing our, I guess, risk-based O&M work. So that's in-line inspections, that's right-of-way maintenance, that's low-pressure system assessments. anything we can do to reduce risk in the current period that will benefit for future periods. So that's the type of work that you're seeing in the O&M line item, and we'll just continue to manage that going forward as needs arise and as opportunities arise as well.

Okay. Okay. Thanks for that. And then I guess on the leak detection technology, obviously Fairmont said there, I guess, I thought I heard you say you've rolled it out to additional markets. I think last quarter it was just mostly Texas-based, but can you talk about have you rolled it out in all markets now?

This is Kevin. Not in all of our markets. We currently had 11 units here. We rolled an additional one out here with plans the next fiscal year to roll some additional units out to our West Texas area. We have an existing unit in Louisiana. and one in Mississippi as well. So those are the markets that we're talking about there.

Okay. All right. That's it for me. Thank you. Thank you, Dennis.

Our next question comes from Ryan Levine with Citi. Please state your question.

Good morning. I wanted to also echo some of the previous comments about Mike. Sorry to hear about this development, but best of luck. to you and your family. And then I guess in that lies a question. Can you just speak to the transition process and if this was sudden and what are the steps over the next few quarters as Kevin takes the CEO seat?

Sure. This is Mike, Brian. As I mentioned in my comments, This succession plan has been in place for quite a while. And even prior to that, the way we operate, I've worked very closely with Kevin and the entire leadership team works very closely together. Over the last two and a half years, our management committee meets for a half a day and then informally several days a week. So we're completely in lockstep. Kevin and I have worked side by side on all of the initiatives that he's been driving for Scalenscope. In a nutshell, the transition is going to be extremely smooth and uneventful internally since we've been working so closely together all along. As was mentioned, and he and I are working even more closely now, but as I mentioned earlier, he'll assume the President and CEO position on October 1 I will be still around and available to him and meet with him on a regular basis through the end of the calendar year. And also, as I mentioned, Kim will continue as executive chairman, and he's always been tremendously helpful to all of us as an advisor. So I know it's not similar to many other companies, but, you know, at Atmos, everybody's in the same – you know, we're – We're in the same bullpen and dugout every single day of the week. And the strategy, as Chris said, is not going to change. It's a matter of scaling, sustaining our success, and just executing well, taking care of our employees in the process, making sure they've got development opportunities, the training they need, we remain in compliance, and all the things that we talk about regularly, Kevin's had the responsibility for for the last couple years, obviously executed by our division leadership and shared services leadership, but he's got a firm hand on the, on the tiller right now. So it'll be a non-event.

Okay. Thanks for the color. And then a couple more specific questions, um, in terms of the O and M costs inflation over what period of time did you think there'll be some type of elevated level as, uh, the more sensitive, uh, sensors detect additional opportunity for safety improvement?

I think, you know, we were already seeing some, you know, improvements in the productivity of the crews, and I would just say that we're going to be back in line with the 2.5% to 3.5% O&M, target O&M increase over the five-year plan through 2023, and then we'll roll that forward in November through 2024.

Okay, and what was the impact of the Waha basis differentials to your business this past quarter? I think you disclosed some numbers in previous quarters, so I'm curious what the update is.

It was the impact quarter over quarter is about $4.5 million.

In income?

In the third quarter, quarter over quarter in revenue. It's that contribution margin, which is effectively revenue for us.

Okay. Okay. Okay. That's helpful. Appreciate it. Thank you.

Just a reminder to ask a question at this time, press the star key followed by the one key on your telephone keypad. Star one to ask a question. Press star two to remove yourself from the queue. Our next question comes from Steven Bird with Morgan Stanley. Please state your question.

Good morning. Good morning. Good morning. Mike, I just want to say you'll be dearly missed. You're a great executive and a great person, just great to interact with. So we're all rooting for you to address this health issue successfully, and we really wish you and your family all the best. I can't thank you enough for all your help over the years. You will be missed.

Well, thanks so much for everything you've done as well, Stephen. Appreciate it.

Kevin, I look forward to working with you in your new role. Most of my questions have been addressed. I thought I'd just check really on the financing plan. I think your financing plan is very clear. But just given just the very low interest rate environment that we're in, I just thought I'd double check in terms of just additional opportunistic ways to kind of lock in lower cost of debt over a long period of time. I think your average duration is already pretty long at 22 years, but I just thought I'd check if there's just anything else that might be possible.

Yeah, that's a good question, Stephen. That's something that we're evaluating right now. We're mindful of where the markets have gone, certainly here in the last week or so. You pointed out our mature average duration is about 22 years. We're all in average, weighted average cost of debt right now is 4.55%. after we effectuated the two debt offerings that we've done in this fiscal year. So as we look forward, we're certainly evaluating opportunities to further drive that overall cost of debt down, but nothing specific that I can comment on at this point. Understood. That's all I have. Thank you. Okay. Thank you.

Thank you. There are no further questions at this time. I'll turn it back to Jennifer Hill for closing remarks next.

Thank you for joining us today. As a reminder, a recording of this call is available for replay on our website through November 6, 2019. We appreciate your interest in Atmos Energy, and thank you for joining us. Goodbye.

Thank you. This concludes today's conference. All parties may disconnect. Have a great day.