Atmos Energy Corporation

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

Thank you, Diego. Good morning, everyone, and thank you for joining our fiscal 2022 second quarter earnings call. With me today are Kevin Akers, President and Chief Executive Officer, and Chris Forsythe, Senior Vice President and Chief Financial Officer. Our earnings release and conference call slide presentation, which we will reference in our prepared remarks, are available at atmosenergy.com under the Investor Relations tab. 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 33 and are more fully described in our SEC filings. With that, I will turn the call over to Chris Forsyth, our Senior VP and CFO. Chris?

Thank you, Dan, and good morning, everyone. We appreciate you joining us and your interest in Atmos Energy. Last night, we reported fiscal 22 second quarter net income of $325 million, or $2.37 per diluted share, compared to $297 million, or $2.30 per diluted share in the prior year quarter. Year-to-date, earnings were $574 million, or $4.24 per diluted share. compared with earnings of $514 million, or $4.01 per diluted share in the prior year period. Consolidated operating income decreased to $661 million from the six months ended March 31st. As a reminder, beginning the second quarter of fiscal 21 and through the end of last fiscal year, we reached agreement with regulators in various states to begin refunding excess deferred tax liabilities, generally over a three- to five-year period. These refunds reduce revenues throughout the fiscal year when those revenues are billed. The corresponding reduction in our interim annual effective income tax rate was recognized in the prior year when those agreements were completed. In fiscal 22, the corresponding reduction in the effective tax rate was recognized at the beginning of the fiscal year. Therefore, period-over-period changes in revenues and income tax expense may not offset within minimum periods. However, they will substantially offset by the end of the fiscal year. Excluding the impact of these refunds, operating income for the six months ended March 31st increased $62 million, or 9%, to $743 million. Slides four and five summarize the key performance drivers for each of our operating segments that three and six months ended March 31st. I will focus on some of the key drivers underlying our year-to-day performance. Rate increases in both of our operating segments, driven by increased safety and reliability capital spending, totaled $120 million, with approximately 77% coming from our distribution segment. Continued robust customer growth in our distribution segment increased operating income by an additional $11 million. These increases were partially offset by a $17 million decrease in consumption. Most of this decrease occurred during the second quarter, where we observed that residential consumption on a per heating degree day basis was approximately 6% lower than the prior year quarter. We attribute this decrease primarily to customer conservation in response to the current inflationary environment, including the increased cost of natural gas included in customer bills. As a reminder, our weather normalization mechanisms substantially offset changes in weather as measured on a heating degree day basis. However, they do not adjust for changes in customer behavior. Additionally, we experienced a $27 million increase in consolidated O&M expense. $20 million of this increase occurred during the first fiscal quarter as we performed more pipeline maintenance activities in this year's first fiscal quarter compared to prior year. Consolidated capital spending increased 41%, or $344 million, to $1.2 billion, with 87% dedicated to improving the safety and reliability of our system while reducing methane emissions. This increase primarily reflects the increased system modernization, system integrity, and system expansion spending to meet the growing natural gas demand in our service territories. We remain on track to spend $2.4 to $2.5 billion in capital expenditures this fiscal year. We are also on track with our regulatory filings. To date, we have completed $74 million in annualized regulatory outcomes, excluding refunds of excess deferred tax liabilities. And we currently have about $270 million in progress. Slides 23-32 summarize those outcomes. and slide 17 outlines our planned filings for the remainder of the fiscal year. During the second quarter, we completed our planned financing activities for fiscal 22. In January, we issued $200 million in long-term debt through a cap of our existing 10-year 2.625% notes due September 2029. The net proceeds were used to pay off our $200 million term loan that was scheduled to mature in April. Additionally, we fully priced our remaining equity needs for fiscal 22 and a significant portion of our fiscal 23 equity needs. During the second quarter, we executed forward sales agreements under our ATM program for approximately 4.7 million shares for $500 million, and we settled forward agreements on 3.5 million shares for approximately $322 million in net proceeds. As of March 31st, we have approximately $450 million in net proceeds available under existing forward sales agreements. Our second quarter activities exhausted our $1 billion ATM program we established in June of 2021, and we established a new $1 billion ATM program at the end of March. We finished the second quarter with an equity capitalization ratio of 61%, excluding the $2.2 billion of interim winter storm financing, and total liquidity of approximately $3.5 billion. Additional details of our financing activities, including our equity forward arrangements, as well as our financial profile can be found on slides eight through 11. During the second quarter, we continue to make progress in securitization. In March, the Kansas Corporation Commission approved our gas and other related costs incurred during winter storm URI with no disallowances. We plan to file our application for a financing order during our third fiscal quarter. And in Texas, the Texas Public Financing Authority continues its work on the statewide securitization program and we still anticipate the securitization transaction will be completed by the end of our fiscal year. I'll close my portion of our prepared remarks with a few comments on our fiscal 22 earnings per share guidance, which we tightened to a range of $5.50 to $5.60 per diluted share. Earnings for the first half of the fiscal year were in line with our expectations. With approximately 70% of our distribution revenues earned for the fiscal year and the fact we're heading into the summer months, we believe any potential change in customer behavior in the second half of the fiscal year will not have a material impact on revenue. Additionally, customer growth for the first six months of the fiscal year was stronger than we had planned, and we expect that trend to continue into the second half of the fiscal year. In our pipeline and storage segment, our straight fixed variable rate design for substantially all of the segment's revenues provides clarity into the second half of the fiscal year. Additionally, we're seeing spreads widen which is expected to provide a modest increase in APTs through system revenue. Finally, we have completed our fiscal 22 financing program, including pricing all of our equity needs for the remainder of the fiscal year, which removes one more variable. Slides 13 through 14 provide additional details around our guidance. Thank you for your time today. I will now turn the call over to Kevin Akers for his update and some closing remarks. Kevin?

Thank you, Chris, and good morning, everyone. As you heard, the first six months of the fiscal year were in line with our expectations, which leaves us well positioned for another successful fiscal year. This performance reflects the commitment, dedication, focus, and effort of all 4,700 Atmos Energy employees. As we continue to successfully modernize our natural gas distribution, transmission, and storage systems, while safely providing reliable natural gas service to our 3.4 million customers across 1,400 communities in eight states. During the first half of the fiscal year, we continue to experience strong customer growth as you just heard from Chris. For example, for the 12 months ended March 31st, 2022, we added over 57,000 new customers, which represents a 1.8% increase. We added nearly 1,800 commercial customers during the first six months of this fiscal year, And we added 15 new industrial customers that we anticipate using nearly 5 BCF of natural gas annually when at full capacity. On a volumetric basis, that 5 BCF of annual industrial customer usage is equivalent to adding nearly 85,000 residential customers to our system. We're very proud of our efforts for these new customers coming on our systems. As Chris mentioned, our capital spending has increased about $344 million over the prior year period, and we remain on track to achieve our capital spending target of $2.4 to $2.5 billion. Through our system modernization efforts, we are on track to replace 800 to 1,000 miles of pipe and 20,000 to 30,000 steel service lines, all of which supports our goal of reducing methane emissions 50% by 2035 from 2017 levels for EPA reported distribution main services. That also includes APT's integrity work on projects like our Line X Phase II replacement, which is under construction and includes 63 miles of 36-inch pipeline anticipated to be completed later this calendar year. As a reminder, we placed Phase 1 into service in Q1 of this fiscal year. That phase replaced 64 miles of 36-inch pipeline. Additionally, construction has begun on Phase 2 of our Line S2 replacement project. This 18-mile, 36-inch project is expected to be completed late this calendar year. Again, as a reminder, we placed the 22 miles of 36 inch completed in phase one into service in Q1 of this fiscal year. This modernization work is a significant component of our comprehensive environmental strategy that focuses on reducing our scope one, two, and three emissions and environmental impact from operations in the five key areas of operations, fleet, facilities, gas supply, and customers. During the second quarter, we added another RNG facility that will provide renewable natural gas for transportation across our system. That facility has the potential to flow up to a half a BCF a year. As you know, we are currently transporting approximately eight BCF a year, and we are evaluating nearly 30 opportunities that could further expand these transportation opportunities. As I mentioned on previous calls, we completed our first zero net energy home in partnership with the Greeley Weld Habitat for Humanity in Evans, Colorado. Zero net energy homes use high efficiency natural gas appliances, rooftop solar panels, and insulation to produce more energy than it consumes at a very affordable cost. Approximately $50 per month for the combined gas and electric bill for the Evans, Colorado home. We are now partnering with local Habitat for Humanity organizations in each of our eight states to construct additional zero net energy homes. Currently, our home in Dallas is under construction, and on April 27th, we held the dedication for our zero net energy home in Taylor, Texas. Additionally, in Jackson, Mississippi, on April 28th, Atmos Energy and Habitat for Humanity Capital Area held a groundbreaking ceremony for Mississippi's first zero net energy home. And in Lubbock, three homes are scheduled to begin construction in early September of this year. These zero net energy homes demonstrate the value and vital role natural gas plays in helping customers reduce their carbon footprint in an affordable manner. Providing these families with a natural gas home that is environmentally friendly and cost efficient is just one way Atmos Energy fuels safe and thriving communities. Our customer support organization and technology support team continue to innovate and look for ways to improve our customer service and offer convenient channels for our customers to communicate with us as well as to make payments. For example, Over 31% of our customers are enrolled in recurring auto draft, which is about 8% higher than industry average. We also see continuous growth in our electronic bill delivery channels, with nearly 50% of our customers enrolled in e-bill. We continue our outreach to customers to make them aware of our flexible payment plans, as well as provide contact information for local, state, and federal energy assistance programs. For the first six months of this fiscal year, our customer support associates, our energy assistance specialist and coordinator through our customer advocacy team helped nearly 44,000 customers receive $15 million in energy assistance. It is through heartfelt caring efforts like that and exceptional customer service that provide the satisfaction ratings for these employees that exceed 97%. These activities and initiatives reflect how we are focused on the long-term sustainability of Atmos Energy as we serve a very vital role in every community by delivering reliable, efficient and abundant natural gas to homes, businesses and industries to fuel our energy needs now and into the future. We believe our focus on long-term sustainability combined with executing our proven investment, regulatory, and financial strategies, continues to support our ability to grow earnings per share and dividends 6% to 8% annually through fiscal 2026. We appreciate your time and interest in Atmos Energy this morning, and we'll now open the call for questions.

Thank you. And at this time, we'll conduct our question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press the star key followed by the number 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from Nicholas Campanella with Credit Suisse. Please state your question.

Hey, everyone. Good morning. Thanks for taking the question.

Good morning, Nick.

Good morning, Nick. Hey. So, hey, a lot of detail. Thanks for the update. You know, just on the financing side of things, you know, your cost of equity has improved since the start of your fiscal year. And, you know, I know you're largely set on 22 equity needs now, and you gave us a lot of detail around the forward program, but just Any thoughts on why not do more now and take this off the table for future years? Is it just that you guys are being fairly formulaic in how you execute here? Any thoughts on out-year equity? Thank you.

A couple things there, Nick. First, we are under our ATM program for a number of quarters now, have been executing forward arrangements. We may very well take advantage of the current pricing environment to establish pricing for our fiscal 23 and beyond. As I indicated, fiscal 22 is fully priced for the remainder of our fiscal year. So that's an opportunity that we'll take a look at here in the third and the fourth quarter to take advantage of the current pricing environment to build on what we've already established with our fiscal 23 work that we executed through the end of March.

All right, great. No, that's helpful. And then I guess just broader question on inflation. Everyone's dealing with it. Just on the gas side, every day we look at the strip, it's up. And how is that kind of translating to broader customer bills? Do you kind of feel comfortable if we remain at these levels? And if we're at a structurally higher kind of commodity environment through your five-year plan, just confidence level on executing on this rate-based trajectory?

Yeah, Nick, it's Kevin. There's a couple things in your question there. Let me first start with, as you heard in my opening comments there, our team has and continues to stay very attuned to and keep affordability at the top of the mind and focused on how we can help. You heard the things that our customer service organization, our customer advocacy team are doing. with outreach to energy assistance organizations, trying to find funds, get customers connected to that, find ways we can communicate proactively with customers. For example, during the last winter period, we sent out I think about 1.5 million notices, whether those were phone calls, whether those were texts, whether those were emails, those sort of things, trying to alert customers to pending colder-than-normal situations moving into their area. We're also sending them through those various channels, including social media as well, information on weather tips, energy efficiency, conservation, gas cost pricing, all those sort of things. So we're trying to stay very active with our customers, very up-to-date with our customers on the calls, but also find ways where we can – help through our energy assistance, LIHEAP programs, point them to the locations where they can receive assistance. But also, as you know, we're a very efficient operator. We work very hard at that. You've seen the things we've done over the last couple of years through URI, those sort of things. We'll continue those efforts as we monitor the gas price over the next few months and will continue to communicate with our customers where we can. And to the second part of your question there, I think where you were heading regarding our customers, capital investment program over the five-year horizon. I think as you can see in our slide deck right now, we run somewhere between 85 to 90% of our capital investments focused on safety and reliability. That needs to continue and will continue as we continue our strategy to modernize our system for safe delivery of natural gas, as well as, as you just heard me mention, that growth out there to support that high growth rate, particularly when we're adding 12 months ending March, 57,000 new customers out there and 15 new industrials. So we've got to continue to meet that growing positive and strong demand for natural gas across our service territory that we anticipate will continue going forward as we talk to our builders and developers out there. Even with interest rates at 5% right now, they're continuing to see strong demand as well. So You know, that's what we're going to focus on, how we help the customer, how we can connect the customer to the right assistance organization, maintain our focus on O&M where we can, and then continue to invest in our system.

Hey, thanks a lot for that. We'll see you at AGA. Thank you. Thank you, Nick.

Our next question comes from Insoo Kim with Goldman Sachs. Please state your question.

Thank you. First, just more on detail for the quarter, I saw on the pipeline side the O&M year-over-year was up a decent bit on the distribution side down year-over-year. Is this just more timing between the quarters? And I know from a guidance perspective for the year, it doesn't seem like much has changed, but I'm just curious on some clarity there.

Hey, this is Chris. Yeah, certainly it's timing on some of the just the timing of the work on the pipeline. Those are longer lead time projects that need to be planned further out in advance. So just timing around that. And on the distribution side, it's down a little bit. We had a slightly lower baguette expense in our current year's fiscal second quarter compared to the prior year. So those are really kind of the two key drivers for those variances that you just described.

Okay, got it. Second question, just more curious on your observations. You know, we've talked probably over the past couple of years just about the different changing narratives on the future of gas, and it seems like the latest narrative has changed maybe more to a positive for the sector, just on energy security and all that stuff. Have you seen that play out at all on the ground, whether it's customer growth or just demand for gas in your various jurisdictions, if there was ever really an impact from, you know, this narrative on, you know, on the negative side over the past couple years, just seeing, I know you had mentioned customer growth or demand being stronger than expected, so didn't know if that was tied to any of that in your thoughts.

Yeah, thank you, Ian, for your question, and As you know, we've continued to have strong growth. We're very proud of our service territories. We believe they are the best in the country. We're fortunate with the states and support politically, the economic development chambers and their hard work that bring these sort of customers into the communities we serve today. But we've seen strong support for natural gas companies. for a long time throughout our history. And I think you can also see that through the customer advocacy, customer choice bills that we have in six or eight states out there. We get very good support from the regulatory perspective, the political perspective, the community perspective. So I think we've always been in strong supporting natural gas environments. I think the thing that, to get to the crux of your question, that's probably changed here lately, is the conversation that the general public is now seeing and wanting to feel around energy security. Natural gas in our industry has always been there behind the scenes, delivering, transporting, storing natural gas to meet those winter demands, especially as you go back to Yuri and how well some of our distribution transmission systems performed during that piece of it. We've always kind of been out of sight, out of mind, but with the unfortunate geopolitics are going on now, the war in Ukraine, energy's been thrust to the forefront. And I think those are things we're hearing is people, people are wanting to know that natural gas is going to be there. It's a viable choice for them. It's abundant. And they're talking to us about national energy security and how they can have that in their community. So those are the sort of things we're hearing now. And as I said, we're, We're very fortunate and blessed and appreciative of our jurisdictions and their support for natural gas.

That makes a lot of sense, especially given the territories you're in. Thank you for that, Culler.

Thank you. And just a reminder to ask a question, press star 1. Our next question comes from Julian Dumoulin-Smith with Bank of America. Please state your question.

Hey, good morning, team. Thanks for the opportunity. Maybe just staying with this inflationary focus, what's your view on inflation's impact on your CapEx budgets? How are you thinking about that just vis-a-vis some of the latest pressures we're seeing across the industry? What percentage of your CapEx is exposed to material labor, for instance, obviously that are perhaps disproportionately inflationary? And what's locked in, you know, contracted labor, you know, where perhaps you may not see that. But on balance, is there an upward bias in your CapEx budget on that alone effectively?

Yeah, Julian, let me start here. Chris certainly can add some color if he wants to get into percentages or not. But, you know, as we've talked about this before, couldn't be any prouder of our procurement team, our operations team, our engineering teams, all working collectively together. As we were coming through the last year or so of the pandemic, inflationary discussions were picking up. We were seeing some of the signs out there. They were very active. You heard us talk about going from a three-month to a six-month inventory of materials and pipes. You've also heard us continue to talk about that we have 95% to 100% of our pipe on the ground. for the remainder of this fiscal year's steel needs, and that we are already beginning identification and getting steel pipe to the mills for 23 and a debentifying cost as far out as 24 in those project needs. So all to say for us, our team's been very proactive about identifying the types of materials, whether it's pipe, valves, fittings, those sort of things, plastic, steel, increasing our inventory, increasing our lead time on that so we're not just in time. And yes, we've seen some increases in pipe, steel pipe, especially from a couple years ago or three years ago. But we think we're doing everything we can to take advantage of current pricing now to lock that in, as I said, as we buy out into the future for those sort of things. Really, the only pressures we've seen right now from a supply chain perspective We've seen a little bit on the technology side and occasionally on some meters, but it corrects itself over time as our team continues to work through our vendors and suppliers to get additional supplies into our warehouses. So I hope that helps answer your question. Chris, anything additional you'd like to add?

Yeah, I think the same, just really, Kevin and Julian, the other point to make is with our contract laborers that they're executing on the capital projects, you know, we've got contracts with them. We're currently, we're in constant communication with them. Many of these contractors go back many, many years with us. So over the years, we have worked with them to manage their cost pressures and needs. And so we've been able to do this at a in a bite-sized increment, if you will, rather than having to, you know, holding costs really low for a long period of time and having to rush now to catch up to market. So those are long-term relationships that those contractors have given us the ability to, you know, bleed in any higher cost over an extended period of time so as to mute the inflationary pressure on our capital spendings.

Got it, but not ready to quantify an aggregate, but maybe you do see some of these inflationary pressures that could follow through. And maybe to clarify that further, even to the extent to which you do, would you perhaps defer some of these investments in order to keep your budget flat, or is there an argument that would just be made you move forward with the projects despite the modest inflation?

We haven't seen anything right now, Julian, that hadn't already been contemplated in the numbers that we've discussed here today. Okay.

All right, excellent. Sorry, just one other – oh, please go for it.

No, that's all I had.

Okay, excellent. And then just on the transportation and RNG front, you made some comments here. You talked about 30 projects here. It seems like – or 30 opportunities, to use your verbiage. Can you expand a little bit more about what that could amount to, just from sort of a capital opportunity perspective, if you will?

Yeah, Julian, as you've heard us say before, we're not in the upstream side of that. We're not investing capital upstream of the meter right now. So truly, all of our investment would be the sales meter. Whether they're digesters, they're landfills, biomass, sewer gas capture, those sort of things. We're really receiving the process gas and transporting on behalf of our customers. And right now, Those evaluations are truly what is near system, what is close to system. So any capital investment at this time would be modest, and it would be to maybe extend a short distance to a facility. But really, we're not investing upstream at this point. We're really transporting that R&G on behalf of others.

Got it. Lots of projects lingering there, but largely, you know, sales elements.

Correct, helping our customers where we can reduce their carbon footprint and be the conduit. That's why we have the 72,000 miles of pipeline system we have today is to move that gas around and be part of that environmental equation to get that gas to the burner tip.

Excellent, guys. Thank you so much.

Thank you. Appreciate it.

Thank you, and there are no further questions at this time. I'll turn the floor back to Dan Mazur for closing remarks.

We appreciate your interest in Atmos Energy, and thank you all for joining us. A recording of this call is available for replay on our website through June 30th. Have a good day.