Atmos Energy Corp (ATO) — Q1 2019 Earnings Call Transcript

Thank you, and good morning, everyone, and thank you for joining us for. This call is being webcast live on the internet. Our earnings release and conference call slide presentation are available on our website at atmosenergy.com. As we review these financial results and discuss future expectations, please keep in mind that some of our discussions 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 21 and are more fully described in our SEC filings. Our first speaker is Chris Forsythe, Senior Vice President and CFO at Atmos Energy. Chris?

Thank you, Jennifer, and good morning, everyone. We appreciate your interest in Atmos Energy. Yesterday, we reported fiscal 2019 first quarter earnings of $158 million, a $1.38 per diluted share, compared with adjusted earnings of $152 million or $1.40 per diluted share in the prior-year quarter. Fiscal 2018 adjusted earnings and diluted earnings per share, excluding $152 million, a $1.49 per diluted share benefit as a result of implementing tax reform last year. Also, yesterday, the board of directors approved the 141st consecutive quarterly cash dividend of $0.525, which represents an indicated annual dividend of $2.10 per share for fiscal 2019, an 8.3% increase over fiscal 2018. Slides 4 and 5 provided details of the quarter-over-quarter changes to operating income for our distribution and pipeline storage segments. I'll touch on a few of the highlights. Contribution margin in our distribution segment grows a net 1% or about $4 million, strong consumption driven by colder weather in October and November when most of the weather normalization mechanisms were not yet in effect, contributing an incremental $7.7 million. Weather was 20% colder quarter-over-quarter, with most of our service areas experiencing colder-than-normal conditions. Solid customer growth continued, primarily in our Mid-Tex Division, although in the last 12 months, our distribution segment added a net 36,000 customers, which represents a 1.1% net customer growth. This growth contributed an incremental $3.7 million of contribution margin. The implementation of tax reform into customer bills more than offset rate increases that were implemented in the prior fiscal year and the first quarter, resulting in a net $7.3 million decrease in customer rates. However, this had no material impact on the segment's net income as a result of the corresponding reduction in our effective income tax rate. Operating expenses rose 3.5%. Higher employee-related costs, depreciation, and ad valorem tax expenses drove this increase. In our pipeline and storage segment, contribution margin increased about $9 million. About two-thirds of this increase relates to new rates that were approved in the prior fiscal year through APT's GRIP filings. Additionally, stronger transportation margins contributed incremental $3.1 million, net of the impact of our Rider REV mechanism as APT continues to benefit from wider spreads. The supply and demand dynamics in the Permian Basin combined with colder weather drove a 12% increase in transportation volumes. Operating expenses for this segment increased $11 million or almost 20%. This increase is focused on pipeline integrity work and reflects the timing of these activities. In the current year quarter, APT accelerated some hydrostatic testing that new client provided this fiscal year. In the prior year quarter, pipeline integrity work that had been planned for the first quarter was deferred later into fiscal 2018, resulting in a lower-than-normal expense for that quarter. Additionally, depreciation and ad valorem taxes grow year-over-year due to last year's capital spending. Consolidated capital spending increased 8.7% to $416 million, about 82% of the spending was dedicated to safety and reliability projects. Colder wet weather in some of our service areas created challenging conditions, which delayed some projects. However, we benefit from having over 6,000 relatively small projects each year that allow us to quickly reallocate our spending when we face these types of challenges. We remain on track to achieve our capital spending target of $1.65 billion to $1.75 billion for the year. From a financing perspective, we had a very busy quarter, as we completed $1.35 billion in debt and equity financing. In early October, we completed a successful $600 million, 30-year public debt issuance at an interest of 4.3%. The net proceeds were used to pay down outstanding commercial paper. In late November, we issued approximately $750 million of equity. The offering included an equity forward arrangement that will remain in place through March of 2020. At contemplation of the offering, we've received approximately $495 million in net proceeds and allocated the remaining $245 million to the forward. As of December 31, 2018, we had not accessed the net proceeds allocated to forward. At this time, we anticipate the net proceeds from this issuance will satisfy our equity needs for fiscal 2019. Additionally, in November, we filed a new $500 million at-the-market equity issuance program that will support our equity needs beyond fiscal 2019. As a result of these financing activities, our equity to total capitalization was 59%, and we had no short-term debt at quarter-end. When considering the $218 million in cash on hand at the end of December, we have approximately $1.8 billion in total equity available to support our capital spending program. After an exceptionally busy year in fiscal 2018, we expect our fiscal 2019 regulatory calendar to return to a more traditional cadence. To date, we've implemented $21 million in annualized regulatory outcomes and have about $38 million in progress. General rate cases in Kentucky and for about 15% of our Texas customers and annual filings for TransLa service area in Louisiana, the City of Dallas, and Tennessee highlight the key filings that are currently in progress. We continue to implement tax reform into customer bills with completion of our Mississippi and Tennessee annual filings during the first quarter. Virginia, as of the last date, we have not yet incorporated the effects of tax reform into our rates, but our general rate case currently in progress will address tax reform. We're now focused on finalizing the refund periods for our excess deferred taxes. Slide 20 details the progress we have made on tax reform to date. In summary, we're off to a solid start to the fiscal year. We remain on track to meet our 6% to 8% earnings per share growth target. And yesterday, we reaffirmed our fiscal 2019 earnings per share guidance range of $4.20 to $4.35 per diluted share. I will now turn the call over to Mike for some closing remarks.

Well, thank you, Chris, for the update on the quarter. And it was a very good quarter, and thank you for those of you who are joining us this morning. As you can see from our fiscal first quarter results, we're off to a very good start to the year. We remain on track to meet our investment spending goals and our earnings growth targets. The 8.7% increase in capital spending during the first quarter demonstrates our team's consistent, predictable execution of our safety investment strategy. In order to sustain this strategy for the long term, which includes increasing our capital spending from $9 billion, over the past 10 years, to go in $9 billion to $10 billion over the next 5 years, our team is constantly looking for ways to improve. In the first quarter, we began rolling out new advanced asset data collection technology to field employees and contractors. During construction, crews will collect GPS locations, material, construction methods, operator qualification data for newly constructed pipeline. This will transform the process of asset data collection, data verification, project closings, and the transfer of that key data to back-end systems that are used to support operations, maintenance, damage prevention, integrity management, and our compliance programs. With thousands of capital projects completed each year, innovations like this that lie at the intersection of emerging technology, business process change, and most importantly, our employees are certainly game-changers on our safety journey. This rollout will continue through this year 2019 and also through 2020. This transformational technology is the one example of the many initiatives underway inside the company to scale our capabilities, capture efficiencies, and enable our very talented employees to do what they do best, which is investing in safety and serving our customers and members of the community exceptionally well. We're also taking huge steps forward in methods of communicating with key stakeholders. In the first quarter, we implemented interactive project maps for all of our service areas that are displayed on our company's website and show current and recently completed pipe replacement projects, giving our customers and other stakeholders access to status updates about projects in their communities right down to the street level. For larger projects, we now develop customized websites, conduct door-to-door visits, send out mailings, and use other channels, as needed, to most effectively reach our customers. And we're beginning to publish annual operating reports for our regulators and also community leaders. And we meet with officials in the cities we serve to keep them informed of our pipe replacement activity. In December, we issued our first corporate responsibility report under the title of an Integrated Annual Report. We also published our first methane emissions report. Keeping key stakeholders informed, the company actions supporting our long-term commitments to good governance, our employees, customers, the 1,400 communities we serve, and the environment. I want to share some of the highlights from these reports. We adhere to strong corporate governance practices including a focus on thought diversity at the board. Women now hold more than 20% of our board seats, and three or four directors who joined the board since 2016 are female or minorities. And this year, the board will further strengthen corporate governance by forming a new board committee to oversee the company's corporate responsibility and sustainability. In our pursuit to be the safest provider of natural gas services, we know that equipping employees with the training tools and support they need to operate safely and contribute at the highest level is essential to our success. Employees received more than 53,000 hours of safety training last year and more than 73,000 hours of hands-on technical training in the state-of-the-art Charles K. Vaughan training center in Plano, which is a site of more than 850,000 hours of training since its opening. In part due to this training, the OSHA rate of recordable employee injuries has decreased by 23% since 2013. Over the past five years, employees also benefited from more than $1 million in higher education assistance received through the company's Robert W. Best Education Assistance Program. Employees continue to reach new heights in delivering exceptional customer service, giving customers more options and convenience when initiating service, calling about a bill, or making a payment arrangement. A new Spanish language account center was implemented in the past quarter as well as intelligent call routing technology that anticipates customers' needs and connects them with the most qualified agents. And our customers tell us they like what they see. 96% of our customers are satisfied or very satisfied with their interactions with our contact center agents, and 97% are satisfied or very satisfied with our on-site technicians. The company contributed $6.1 million to charitable organizations last year, and that includes $2.7 million that went to help customers in need through our Energy Assistance Program. We're also working with 400 community support organizations to give low-income families access to federal home energy assistance funds. But I am particularly proud of the contributions our Atmos Energy employees make in the communities in which they operate. Last year, employees contributed $700,000 during our week of giving campaign and volunteered more than 35,000 hours of their own time to help their community. Also highlighted in the report is the work our team does to protect the environment, which has always been important to our company, our employees, our customers, and the communities. As a founding member of the EPA's Natural Gas STAR Methane Challenge Program, we work proactively to improve efficiency and reduce methane emissions. Since 2012, we've replaced over 3,500 miles of pipe, and we've decreased total emissions due to the use and loss with natural gas by 13.7% in our system. Over the next 5 years, we plan to replace between 5,000 and 6,000 miles of pipeline, including all remaining cast iron by 2021, two years earlier than originally planned and between 200,000 and 300,000 field service lines. This will reduce methane emissions by another 10% to 15%. As we continue to replace infrastructure, we set a goal to reduce our system's methane emissions by 50% by 2035. In addition to pipeline replacement, we're protecting the environment in other ways. In 2018, we completed our 9th LEED-certified service center and we have four more underway. Over 40% of our customers have signed up for electronic billing, one of the highest percentages in the industry, resulting in savings of approximately 152,000 pounds of paper every year. And we partner with municipal solid waste landfill gas producers to transport renewable natural gas to market. And for safety and to best serve our customers, we review and incorporate state-of-the-art equipment for leak detection, monitoring, and leak repair prioritization, including the use of 11 advanced mobile leak production technology units that are 1,000 times more sensitive than traditional technologies. In closing, as always, I'd like to thank our employees for their outstanding efforts. They strive to find ways to improve every day to deliver safe, reliable, affordable, and exceptional natural gas service for the nearly 3.3 million customers we serve in over 1,400 communities in our 8-state footprint. They come to work every day focused on safety while providing excellent customer service, closely monitoring and maintaining our system, and executing our capital spending program. We appreciate your time this morning. We're off to a good start for the year. And now we'll take any questions you may have.

It was helpful that you quantify the impact of wider basis spreads at APT on the quarter. Certainly, good to see that number. It's difficult to do, but could you maybe take a crack at talking about how sustainable that might be throughout 2019 and maybe into 2020?

Chris, good morning, by the way, and thanks for being on and for your question. As we've said in the past, it's difficult to predict really beyond the current quarter. We do know that there is additional pipeline capacity expected to come on into service at the end of the calendar year. And so we would expect that to normalize pricing a little bit. And as you know and a lot of our transport opportunities are opportunistic, as we serve primarily our firm supply customers, which would be the LDCs in our system industrials. And as we get into the summer months, as we saw last summer, we do an awful lot of maintenance on the pipeline when we're in the off-peak season. So we're not going to get into predicting the rest of the year. We're happy we've gotten off to a good start and had this opportunity. And again, as you know and others know, that three-quarters of any benefits beyond the Rider REV benchmark flow back to our care of customers, which creates yet another opportunity to keep customers' bills low.

Okay. So at least for the first quarter, fair to say that you're running a little bit ahead of maybe the plan that you had introduced back in November?

Yes.

Yes.

Okay. And then switching gears. I believe legislation was introduced or at least was being discussed in Texas, to increase oversight of the Railroad Commission. Could you give us any thoughts you have on that, maybe the probability of success there, what that might entail or any other legislation that you're keeping your eyes on this session?

Yes, Chris, each legislative session brings forward new legislation, and we engage with legislators, as we are currently doing in Texas. This time in Texas, it has received a bit more attention. Our main goal is to ensure pipeline safety while also promoting the modernization of our infrastructure and the replacement of aging systems. We are currently in discussions to identify solutions that align with our strategy and address the interests of all stakeholders. The overall focus is on the accelerated replacement of infrastructure, which we have been actively pursuing and will continue to do. There is also a push for greater visibility and transparency regarding leaks, along with mapping those leaks in Texas. We submit a leak report to the Railroad Commission every six months, which contains a wealth of information on this topic. That said, it is still early in the legislative session, and we are optimistic that progress will proceed at a typical pace without any major disruptions.

I have two questions. First, I may be misunderstanding, but I thought that in the Dallas settlement, you agreed to a 50% equity cap. However, I see on Slide 12 that you are requesting 60%. Is that just applicable to the one settlement from last year? I was under the impression that this would be your standard going forward, but it seems that's not the case. Can you clarify this?

Sure, Charles. This is Chris. Yes. When we reached a settlement with the City of Dallas last February, we agreed to lower our return on equity to 9.8% and increase the equity cap to 58%. That's our current situation. We also set a similar cap with our Mid-Tex and West Texas RRM mechanisms in Texas around the same time last year. Currently, we have about 15% of our customers where we have a stated intent in progress, and they're at 10.5% return on equity and a 55% cap. We are preparing to go to Austin in early March to have that case heard. Settlement discussions are ongoing, but the majority of the state is at 9.8% return on equity and an equity cap of 58%.

Okay. But maybe I'm still misunderstanding this. On Slide 12, if I look at the first two filings, one, the filings you intend to file, you show an authorized capital structure on the third bullet point on each one of 60% equity. So how is that 60%? And then it was 58% before.

The requested capital structure is based on where we concluded the test year-end. We finished at 59.7% after accounting for all the financing activities in the quarter. This will be discussed as we proceed. We are currently starting to finalize the discovery process.

So it sounds like the 58% is not really a hard cap; it's subject to discussion at each round?

Generally, we try to understand the terms, but given our position at the end of the test year, we had to file based on our equity capitalization. It's important to note that the City of Dallas also operates on a 13-month average, which affects how we view the test year-end of September 30. We will address this during the negotiations.

Okay. Second question, I noticed on the queue that regulatory excess deferred taxes, let's say, they were $740 million at the end of your '18 fiscal year. They are now at about $718 million, so a $22 million drop during the quarter. I realize Virginia is not in there yet and I realize every jurisdiction has a little different amortization schedule. But is that, from a modeling standpoint, as an analyst, that was $22 million, maybe $25 million per quarter is how we'll see that liability going down over the next few years? Is that reasonable?

Yes, that sounds about right. If you refer to Slide 20, we have outlined the provisional amortization periods for each jurisdiction to provide more detail for modeling. You can approximate the excess deferred taxes by jurisdiction on a pro rata basis using our rate base, and then apply the amortization periods from Slide 20 for your calculations. It is indeed challenging at the moment, as the changes are being implemented one jurisdiction at a time. For instance, Mississippi and Tennessee just began their processes—Tennessee in mid-October and Mississippi at the start of November. West Texas and Mid-Tex RRMs started in October, which adds to the complexity of the modeling. However, the information on Slide 20 should give you a reliable indication of how these changes will be phased in. Ultimately, once fully implemented, we expect our customers to gain more than $125 million annually, which includes the 21% rate and the flow-back of the excess deferred taxes.

I'm probably too lazy to do it jurisdiction by jurisdiction. I guess I was looking for an easy way out. But it sounds like if I do like $100 million per year realizing that once we get Virginia in there, that's probably close?

And Virginia is very small. So if you do the $740 million, it's about $25 million. That may be a good way to start, if you're doing some high-level modeling.

Can you provide insights on the current availability of labor in your service area and how it has changed over the past few quarters? Also, is there any limitation affecting the acceleration of your capital expenditure programs?

Yes, that's a good question and something we've addressed in the past. We haven't observed any changes in the labor market over the past year. However, it's a limitation for us as we grow and collaborate with our contractors to expand their teams. A significant challenge is not only finding workers but also ensuring they have the right qualifications to operate safely on our system. We've considered their capabilities in our estimates regarding the amount of pipe replacement we can accomplish each year, and we monitor this closely. Nonetheless, we haven't seen a change in those market conditions from year to year, so we're currently quite comfortable with what we're experiencing.

Okay. And then second question, is there any update that you're able to communicate around the NTSB investigations and the timeline for any type of conclusion?

There is really nothing new for us. We initially anticipated that the factual report, which would be the first piece to be released, would come out around the end of this first calendar quarter or the second calendar quarter. However, with the government shutdown, we are uncertain about the impact it may have on that timeline. I know they became quite backed up and started several other investigations once they resumed. Therefore, we don’t have any information either way. Typically, a factual report is released first, followed by safety recommendations at some point after.

Okay. So this is considered a nonessential government agency. So is it safe to assume that no work was done during the shutdown?

Yes.

Thank you, everyone, for joining us this morning. A recording of this call is available for a replay on our website through May 9, 2019. We appreciate your interest in Atmos Energy, and thank you for joining us. Goodbye.