Jennifer Hills - Vice President of Investor Relations Mike Haefner - President and Chief Executive Officer Chris Forsythe - Senior Vice President and Chief Financial Officer.

Chris Turnure - JPMorgan Charles Fishman - Morningstar.

Greetings, and welcome to the Atmos Energy 2018 Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jennifer Hills, Vice President of Investor Relations. Thank you, Ms. Hills, you may begin..

Good morning, everyone, and thank you for joining us. 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 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 some material differences are outlined on Slide 29 and are more fully described in our SEC filings. Our President and CEO, Mike Haefner, will begin our call with some opening comments.

Mike?.

Thank you, Jennifer, and good morning, everyone. We appreciate you joining us and your interest in Atmos Energy. During the quarter, we continued to successfully execute our investment and regulatory strategy focused on becoming the safest and most reliable natural gas utility in the country.

This strategy, along with the exceptional dedication and effort on the part of our 4,600 employees, continues to benefit our customers in the form of improved reliability and service. We remain very well positioned for the future as we move through the seventh consecutive year of our journey to become the safest natural gas utility.

Nothing is more important to our employees than the safety of our customers and communities. In late February, there were three gas-related incidents in Northwest Dallas, one of which resulted in the tragic death of a 12-year-old child.

We're in direct contact with the National Transportation Safety Board and the Railroad Commission of Texas and are supporting a coordinated investigation into the incident. Soon after that and in the days leading up to March 1, we experienced a sudden and unexplained increase in leaks in a 1.5 square-mile area of our system in Northwest Dallas.

To understand why a system that had been performing normally was suddenly performing in this way, we hired a geotechnical, engineering and forensics firm to assess the system.

Their preliminary assessment indicated an extraordinary combination of unique conditions, including geology, hydrology, soil conditions and record rainfall in this concentrated area caused differential ground movement that damaged our pipeline system.

Their report further stated that this could not have been readily modeled, predicted, anticipated or foreseen. On March 1, we acted with the utmost of caution, made the decision to undertake a planned outage to accelerate the replacement of all mains, service lines and meters for approximately 2,400 customers in this area.

We moved approximately 700 contractors temporarily from other pipe replacement projects and replaced all service lines in 124,000 feet of mains. This project, which would normally take a year, was completed in just over three weeks.

While the system was being replaced, we provided financial assistance to the affected customers and incurred other project-related expenses totaling approximately $23 million.

We're very grateful for the more than 500 of our employees, representing every department and division in our company, who worked selflessly around the clock on the accelerated replacement and customer assistance efforts and for all of our other employees, who provided back-office support to the effort while continuing to serve our other customers.

The organization's rapid response and mobilization demonstrates the dedication of our employees and our commitment to safety and to our customers.

We're also grateful for the tremendous support we received from the City of Dallas, Dallas Fire and Rescue, Dallas Police, the Office of Emergency Management and many other city services, as well as the affected customers, who were patient during this difficult time and were very welcoming to our employees and contractors working in their streets, alleys and homes.

We remain committed to our pipeline integrity investment strategy across all jurisdictions in which we operate. Since 2011, we've invested approximately $6 billion on replacing aging infrastructure and modernizing our system. Our current capital investment plans are for an additional $8 billion to be invested over the next 5 years across our company.

We've been growing our capital investment at a 10.5% compound annual growth rate, which is approximately 3.5x our depreciation rate. And we have plans to continue investing at that rate.

Based on work completed in the first two quarters, as well as the planned projects for the remainder of the year, we now expect our fiscal 2018 capital spending to be approximately $1.4 billion. I'll now turn the call over to Chris Forsythe, Senior Vice President and Chief Financial Officer, who will now provide a financial update.

Chris?.

Thank you, Mike, and good morning, everybody. Yesterday, we reported fiscal 2018 second quarter earnings from continuing operations of $179 million or $1.60 per diluted share, compared with $162 million or $1.52 per diluted share in the prior year second quarter.

Results from continuing operations included $4 million or $0.03 per diluted share noncash income tax benefit related to tax reform. Earnings from continuing operations for the six months ending March 31 were $493 million or $4.7 [ph] per diluted share compared to $276 million or $2.61 per diluted share in the prior year period.

Results for the current six-month period included $166 million or $1.50 per diluted share nonrecurring income tax benefit from tax reform.

Our second quarter results were driven by the contribution from recent rate activity due to continued increase in pipe replacement and other system modernization spending, strong consumption trends and higher operating expenses.

Operating income in our distribution segment increased 7.5% to $210 million in the current quarter, due to a number of drivers. Recovery from recent regulatory actions provided an incremental $28 million of contribution margin.

Additionally, we experienced a more normal winter heating season this year, compared to last year's unseasonably warm weather. As a result, we experienced a $9 million quarter-over-quarter increase in residential and commercial consumption and a $15 million increase year-to-date.

Additionally, weather-driven demand drove a $2 million increase in transportation revenues in our tax provisions. Finally, we continue to experience solid customer growth. Over the last 12 months, our distribution segment added net 36,000 customers, which represents 1.1% net customer growth.

Additionally, we continue to add transportation customers to the system, primarily in our Kentucky/Mid-States Division. Combined, this growth added over $4 million in contribution margin for the quarter and up $7 million year-to-date.

This growth in our contribution margin was partially offset by a $26 million decrease as we reflected a 21% statutory tax rate in our revenues beginning January 1, 2018.

Additionally, we experienced an 18% increase in operating expenses due to the planned outage in Northwest Dallas, a planned increase in pipeline integrity activities and higher depreciation in property tax expense resulting from our capital spending. Moving to the pipeline and storage segment. Operating income increased about $1 million.

Contribution margin increased about $9 million due to $17 million of incremental margin from APT's recent rate case and approval of a GRIP filing in December, partially offset by an $8 million reduction in revenues due to the implementation of tax reform.

Additionally, during the quarter, APT continued to benefit from wider spreads between the Katy and Waha hubs. As a result, contribution margin increased $2 million for the quarter and approximately $3 million year-to-date net of the Rider REV adjustment.

Given the supply and demand dynamics impacting the Permian Basin combined with stronger demand in the Barnett, Katy and Houston ship channel areas, we expect these trends to continue for the remainder of the fiscal year.

Offsetting this growth in contribution margin was an $8 million increase in operating expenses as a result of higher depreciation related to capital expenditures and the planned increase in pipeline integrity work. Consolidated capital spending increased almost 25% period-over-period to $694 million and was in line with our expectations.

Over 80% of the spending was focused on improving the safety and reliability of our system. At this time, I'd like to highlight the progress we've made to implement tax reform. As a reminder, because of fiscal year starting October 1, 2017, our blended federal statutory income tax rate for fiscal 2018 will be 24.5%.

It will decline to 21% beginning in fiscal 2019. As a result, our effective tax rate for the six months ending March 31 was 27.1%, excluding the one-time benefit and is expected to be the range of 26% to 28% for the fiscal year.

During the second quarter, we continue to find the impact of tax reform in our balance sheet, and we recorded an additional $4 million income tax benefit. This brings the total nonrecurring income tax benefit from implementing tax reform to $166 million or $1.50 per diluted share.

Additionally, we reduced the amount of excess deferred taxes that we've returned to customers by about $8 million. Our total excess deferred tax liability is now $738 million. During the quarter, we worked with the regulators to ensure that our utility customers receive the full benefit of tax reform in their gas bills.

We have reached agreement with our regulators in Colorado, Kansas, Kentucky and Texas to reduce customer bills going forward to reflect the lower statutory federal rate. In Colorado and Kansas, new rates were implemented effective April 15 and April 1. And in Kentucky, customer bills were adjusted effective March 20.

In Texas, we began phasing in the impact of lower taxes in customer bills in February and all customer bills reduced by April 1. Through the end of March, we've returned $5 million to customers, and we anticipate customers will realize annual savings of over $100 million from the lower federal tax rates.

In our other four jurisdictions, tax reform is being addressed in connection with regulatory proceedings are currently in progress. Slides 22 and 23 provide additional detail on our progress towards implementing tax reform.

Additionally, regulators in all of our jurisdictions have ordered us to record liabilities for the difference in our rates based in the form of 35% statutory federal income tax rate and the new 21% rate beginning January 1, 2018, until customer bills are adjusted. At the end of March, these liabilities approximated $29 million.

Finally, with respect to the refund of excess deferred taxes, we have reached an agreement in Colorado to begin returning those liabilities on a conditional basis beginning June 1, 2018. In our other jurisdictions, we expect to address the treatment of this liability in our next annual or other future regulatory proceedings.

As we discussed last quarter, we expect that the reduction in operating cash flow from fully implementing tax reform will increase our estimated financing needs for fiscal 2022 by $500 million to $600 million. Our balance sheet as of March 31 is strong and can support this incremental financing need.

The total capitalization was 60%, and we had approximately $1.5 billion of borrowing capacity available under our credit facility. In closing, yesterday we reaffirmed our fiscal 2018 earnings guidance of $3.85 to $4.05 per diluted share, excluding the nonrecurring benefit recognized for the implementation of tax reform.

Stronger-than-planned customer consumption in our distribution segment and transportation revenue trend in both the distribution and pipeline storage segments have increased our outlook for our contribution margins.

And the associated cash flow has reduced our anticipated short-term borrowing needs in addition to an anticipated interest expense for the year. However, we're anticipating higher levels of O&M as a result of the planned outage in northwest Dallas and an anticipated increase in system monitoring and maintenance activities.

Slide 25 provides additional detail related to our fiscal 2018 EPS guidance. Thank you for your time this morning, and I'll turn the call back over to Mike for his closing remarks..

Thank you, Chris, for that update on the quarter. As you can see from our second quarter results, we remain focused and are on track to meet our fiscal 2018 targets, driven by our proactive pipe replacement and system modernization investments.

In the second quarter, we continued to benefit from recent regulatory outcomes, colder weather compared to the prior year and customer growth. We continue to invest in our infrastructure and are on track to spend approximately $1.4 billion this year.

Our spending will continue to accelerate annually over the next four years with approximately 80% of that spending focused on safety and reliability. On the regulatory front, we've completed 11 filings, which should add approximately $47 million in annualized operating income over fiscal 2018 and fiscal 2019.

And we have 11 filings pending, seeking over $91 million in annualized operating income, inclusive of the impact of tax reform. We remain well on our way to meet our targets for annual increases from implemented rate activity in fiscal 2018, including the impact of tax reform.

In fact, the tax changes due to the Tax Cuts and Jobs Act will lower the annual ratemaking results, but that impact will not affect the overall results of ratemaking on Atmos Energy's earnings. Slides 8 through 20 provide details about the progress we've made during fiscal 2018 and pursuing our regulatory strategy.

Our key regulatory accomplishment during the second quarter was the renewal of several annual rate review mechanisms in Texas with constructive terms. These mechanisms cover approximately 80% of our distribution customers in Texas. In February, we successfully settled the outstanding statement of intent with the City of Dallas.

As part of the settlement, we were able to begin reflecting the benefits of tax reform in customers' rates. We were also able to update the Dallas Annual Rate Review or DARR. Additionally, we refreshed the terms of the annual rate review mechanism or RRM for the largest coalition of cities in Mid-Texas [ph] and for the RRM cities in West Texas.

The renewal of these Annual Rate Review Mechanisms underscores our regulator support for us to continue to replace pipe at an increasing pace.

And these mechanisms provide transparency for regulators to annually review the progress we're making to modernize our system, while also providing the opportunity to earn the reasonable returns that our investors require to provide the financial resources we need to sustain our efforts.

They have a long-time horizon of infrastructure investment needs ahead. The low natural gas price environment and now lower tax environment supports our continued investment in the safety and reliability of our system, while keeping customers' bills very affordable.

We remain confident that our pipe replacement programs will continue to provide a reasonable return to our investors through earnings per share and dividend growth in the 6% to 8% range each year.

We appreciate your time this morning and look forward to meeting with those of you who will be joining us later this month at the AGA Financial Forum in Phoenix. And now, we'll take any questions you may have..

Thank you. [Operator Instructions] Our first question comes from the line of Chris Turnure with JPMorgan. Please proceed with your question..

Good morning Mike and Chris.

I wanted to get an understanding of the NTSB investigation, the potential timing of an outcome now that we have the preliminary reports and any other open investigations that might be out there or your knowledge of any of those that might be forthcoming?.

Yes, good morning Chris. As you know, the NTSB issued a preliminary report on March 23, confirming that they've done site inspections, collected records and materials. They also interviewed our personnel and other first responders.

And we understand it could be months before a factual report is issued, and we expect a final report from them in the 2019 calendar year time frame. There are no other investigations underway from the NTSB at this time..

Okay.

And from the NTSB report that would be upcoming here in months, and then I guess, the final one, at some point next year, would you expect a determination of cause and any determination of fault within that?.

That's a good question, Chris. First of all, just I want to remind everyone that NTSB is an independent agency and the board has no regulatory authority. Its whole focus is on improving safety of the industry.

And so, their focus is on identifying probable cause and then they'll make safety recommendations aimed at preventing any similar future accidents..

Okay. Got it. That's helpful context.

And then, can you maybe give us a little bit of color on your dialogue, if any, with the Railroad Commission since the incidence and maybe some color on how that's going, if they intend to look into the incident further?.

Yes. Yes, absolutely. We've been communicating openly and regularly with them. They're conducting their own investigation, which is standard practice. And the focus there is on whether we complied with regulations in our own procedures. So, we've been in continuing contact with them as well as the City of Dallas and Dallas County.

And so far, I mean the regulators have been supportive of the planned outage that we undertook and all of our response efforts to date. And you may have seen in the paper Railroad Commissioner, Ryan Sitton, confirmed in an interview that their view is that we're doing everything that we can and did everything that we could to keep the area safe..

Got it. And just one last question on that topic.

Do you have a sense as to when the RRC would complete that investigation and make the findings public?.

No, I don't have a time line on that. And I also want to remind you that the Railroad Commission – we fall under very strict guidelines, both federally and at the state level, and the Railroad Commission has auditors in working with our employees on auditing our practices and our system almost on a daily basis, I think almost every week of the year.

So, it's very standard practice. It's not unusual for them to be involved because we all share the same objective, which is safety. So, there's nothing out of the ordinary, unusual here. It's just an extremely unfortunate and tragic event that there was an explosion and a child's death.

I mean, just nothing we can say or do that's going to diminish that tragedy..

Got it. Thank you, Mike. I appreciate the color..

Thanks, Chris..

Our next question comes from the line of Charles Fishman from Morningstar. Please proceed with your question..

I'm comparing Slide 7 to some past Slide 7s, and the percentage of the mix of capital spending has gone up materially since last year, 87% for safety and reliability, 80% last year. Is that just a timing thing as you accelerate – I mean, your planned acceleration of CapEx, which is more focused on the safety and reliability.

I mean, I wouldn't think it has anything to do with these incidents because just hasn't been enough time to react to it..

No, Charles, good question. It really is timing and where our projects are falling out. For example, over the last 3 years to 4 years, 2 years to 4 years, we've invested very significantly in kind of our storage and compression capabilities, as well as other system fortification projects.

So, I think it just varies, but our target is to be 80% or greater in safety and reliability. We also have timing of public works projects, and you've got varying demand in terms of system extension spending for customer growth..

So, in terms of your annual CapEx, I think at your Analyst Day, you were talking $1.3 billion to $1.9 billion per year, accelerating over the next – or through 2022. Is that – you're confirming that and reaffirming that, and I mean, you still see yourself in that range.

In other words, you're going to be $1.4 billion this year and then accelerating to $1.9 billion over the next 5?.

Correct. Yes, $1.4 billion, approximately $1.4 billion this year. $1.4 billion to $1.9 million each year going forward, accelerating gradually, and we put out there the expectation of about approximately $8 billion through 2022..

Okay, thank you very much. That’s all I had..

Thanks Charles..

[Operator Instructions] There are no further questions in the queue. I'd like to hand the call back over to management for closing comments..

Thank you, Doug, and thank you, everyone, for joining us today. Just as a reminder, a recording of this call is available for replay on our website, through August 8, 2018. We appreciate your interest in Atmos Energy and thank you for joining us. Good bye..