埃特莫斯能源 (ATO) 2007 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Atmos Energy Corporation second quarter conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions) This conference is being recorded today, Thursday, May 3rd of 2007.

I would now like to turn the conference over to Susan Files, the Vice President of Investor Relations. Please go ahead.

Good morning, everyone, and thank you for joining us. This call is open to the general public and media, but designed for financial analysts. It is being webcast live over the Internet. We have placed slides on our website that summarize our financial results. We will not review those in detail but we will be happy to take any questions about them at the end of our remarks. If you would like to access the web cast and slides, please visit our web site at atmosenergy.com and click on the conference call link.

Also, we plans to file the Company's Form 10-Q later today. With me are Bob Best, Chairman, President and CEO, and Pat Reddy, Senior Vice President and CFO. There are other members of our leadership team to assist with questions as needed.

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. Any forward-looking statements are intended to fall within the Safe Harbor rules of the Private Securities Litigation Reform Act of 1995.

With that, I'll turn the call over to Bob Best. Bob?

Thank you, Susan, and good morning, everyone. As always, we appreciate your interest in Atmos and for being on this call. As Susan said, Pat Reddy, our Chief Financial Officer, will review the financial results in just a few moments, and before he does, I'm going to just make comments about our quarter's performance overall.

Yesterday, after the market closed, we reported double-digit net income growth in both our second quarter and for the six months of fiscal 2007. We are gratified that the core operations of Atmos are performing very well. At the utility, we have effectively stabilized the majority of our utility margins from the negative impact of weather. The Mid-Tex and the Louisiana divisions delivered better results in the current year due to implementing WNA in both of those service territories this winter. With margins now decoupled from weather at our largest division, Mid-Tex, we can focus our efforts on full decoupling our margins from the effects of conservation. We are determined to achieve further stability in our utility earnings in order to realize the full potential of the Mid-Tex utility franchise.

The non-utility businesses continue to execute as planned with solid marketing and storage performance, despite the non-cash unrealized losses, which arise only because of the mark-to-market accounting treatment required on those activities. Our pipeline operations continue to experience the incremental financial benefits of the four projects that we placed in service on the intrastate pipeline in Texas last year.

We also announced our 94th consecutive cash dividend. Our indicated annual dividend rate for fiscal 2007 is $1.28 per share. As you know, and as we've talked about before, we used 192 million in net proceeds from our December equity offering to reduce our short-term debt. This action, coupled with strong operating cash flow, facilitated the repayment of all our outstanding short-term debt. Our debt to total capitalization ratio was reduced to 51.9% at March 31 from about 61% at September 30th. We're very pleased to be back in our comfort zone and stand committed to maintaining our ratio in the 50% to 55% range.

I also want to address the recent and sizable regulatory decision made in our Mid-Tex rate case, because it's been our focus for the past year. As you know, in late March, we received a rate order from the Railroad Commission of Texas on the Mid-Tex division rate case filed in May of last year affecting our 1.5 million customers in central Texas. While the final result was less than we had hoped for, there were some favorable pronouncements in the rate order. The order included a determination that the acquisition of the Mid-Tex assets was in the public interest and this was an extremely positive pronouncement. It established the fact that the acquisition was prudent, that Atmos has all the necessary authority to operate the acquired facilities, and rendered jurisdictional services, and prevents any further second-guessing of this merger.

We also received permanent WNA using 10-year weather history. We were able to implement WNA months before the rate case was decided, which was indicative to us that the regulators grasped the magnitude of unseasonably warm weather and its effects on both the customer and our customers.

Our capital structure was set at 52% debt and 48% equity, and the allowed return, or the authorized return on equity, was kept at 10%. We were authorized to increase our rate base to reflect [PX] user repayment of previously recorded deferred income taxes.

We received an annual revenue increase of $4.5 million. We can demonstrate that our revenue remains significantly deficient in the Mid-Tex division, and accordingly, we expect to file another rate case later this year. Our returns that we've been earning are not where we want them and our long-term goal, as it is in all of our divisions, is to be able to earn a reasonable rate of return on a consistent basis, and that remains our goal in the Mid-Tex division, and it also remains our goal throughout our company.

We have other rate cases planned or pending and I'll talk a bit about those after Pat Reddy, our Chief Financial Officer, reviews the quarter and year-to-date financial results. Pat?

Thanks, Bob, and good morning, everyone. I'll speak to the more significant items in the quarter and six-month period and then discuss the outlook for the remainder of our fiscal year. We're very pleased to report these quarterly and six-month-ended results. As we stated in the earnings release, consolidated net income for the quarter increased 20% to over $106 million, or $1.20 per diluted share, and for the six months ended, net income climbed 17% to about $188 million, or $2.18 per diluted share.

The most significant drivers of our earnings results for the quarter were positive results at the utility due to increased throughput from weather that was 22% colder than a year ago, coupled with weather normalization adjustments in the Mid-Tex and Louisiana divisions that were not in effect last year, and incremental rate increases that we received and implemented in the current quarter. You may recall that it was during the second fiscal quarter of last year that our exposure to weather negatively impacted our gross profit margin by about $26 million. At that time, roughly 17% of our utility margin was weather sensitive. [Contrast that] with the current quarter, where only 5% of our margins are exposed to weather, and we saw a negligible impact on our utility margins.

The pipeline and storage segment experienced significantly higher throughput, again, largely due to colder weather and greater asset management fees. These positive drivers were partially offset by a decrease in the natural gas marketing segment contribution, primarily due to the reversal of a portion of the mark-to-market gains recorded in the fiscal first quarter.

For the full six months, the principal drivers of earnings results include increased throughput at the utility due to colder weather than a year ago, the positive effects of WNA, and rate increases, combined with higher net income at the non-utility, reflecting positive results in the pipeline and storage segment from higher throughput and demand for storage services, higher asset management fees, and GRIP-related rate increases at Atmos Pipeline Texas, plus greater results at the marketing business from significantly improved realized storage margins, partially offset by lower period-over-period realized marketing margins.

Consolidated gross profit improved in both periods, reaching over $428 million in the quarter and $804 million for the six months. Utility gross profit saw significant improvement in the quarter, rising over $30 million as compared to the second quarter last year, and almost $13 million for the six month, as compared to the same period a year ago. Quarter over quarter, utility gross profit grew by about $26 million, reflecting increased throughput of 31 Bcf, due to whether that was 22% colder than last year. And the six-month period experienced about 15 million from increased throughput of 24 Bcf due to whether that was 10% colder than the prior-year period.

The impact of WNA in the Mid-Tex and Louisiana divisions favorably impacted gross profit by over $4 million for the quarter and about $12 million for the six months ended, as compared to the same periods a year ago. The remaining jurisdictions experienced a negative WNA effect of almost $4 million in the quarter and $2 million for the fiscal year-to-date, as compared to the prior-year period.

Additionally, we experienced incremental margin from net rate increases of about $3 million in the quarter and almost $10 million for the six months as compared to a year ago.

Our natural gas marketing gross profit for the quarter decreased by about $21 million, but climbed almost $16 million for the fiscal six months. For the current quarter, natural gas marketing's gross profit reflects an $81 million decrease in unrealized margin. The storage and marketing margin includes an unrealized mark-to-market loss of $69 million compared with unrealized gains of $12 million in the prior year, creating the negative swing of $81 million quarter over quarter.

As you know, these unrealized gains and losses are primarily caused by differences in NYMEX future prices used to value the financial derivatives which hedge the physical inventory and the spot prices used to value the physical inventory. We expect that these unrealized gains and losses will reverse at the time of delivery and sale of the inventory.

Operationally, we experienced a decrease in our realized marketing margins of almost $7 million quarter over quarter. This was largely due to realizing lower margins in a less volatile market, compared to the prior-year quarter, partially offset by increased sales volumes of 32 Bcf in the current quarter attributable to colder weather.

However, we experienced an increase in our realized storage margins of $67 million quarter over quarter. This was the result of capturing more favorable arbitrage spreads related to our storage optimization efforts in the current-year quarter, again due to greater market volatility, coupled with our ability to cycle more storage in the current quarter and realize previously captured spread opportunities due to colder weather.

If you recall, the storage contribution was accelerated in our fiscal first quarter due to the compression of market spreads during that period. Now, in the fiscal second quarter, we settled our storage financials and a portion of the physical storage was cycled, which resulted in realized gains during the second quarter and the reversal of unrealized gains recorded in the first quarter of this year.

For the current six months, natural gas marketing gross profit rose $16 million, as compared to the prior-year period. Gross profit reflects about a $19 million increase in realized storage and marketing margins, partially offset by a $3 million reduction in unrealized storage and marketing margins. The storage and marketing margin includes an unrealized mark-to-market loss of $10 million, compared with unrealized losses of $17 million in the prior year, creating the $3 million reduction in unrealized margin compared to the prior-year period.

The mark-to-market impact was lessened in the current six months, since we had 4 Bcf less of physical gas and storage compared to same period a year ago. Again, we believe over time that these unrealized gains and losses should reverse at the time of delivery and sale of our inventory.

Operationally, we experienced a decrease in our realized marketing margins of about $16 million in the current six months, compared with a year ago. This was largely due to realizing lower margins in a less volatile market compared to the prior-year period, partially offset by higher sales volume of 38 Bcf in the current period, largely due to colder weather. However, we experienced an increase in our realized storage margins of $35 million in the current six-month period as compared to the prior year. This was the result of capturing more favorable arbitrage spreads related to our storage optimization efforts in the current period due to greater market volatility, coupled with our ability to cycle more physical storage in the current period and realize previously captured spread opportunities due to colder weather.

The embedded value of our storage book is shown in the appendix to our slide presentation on Pages 61 and 62. Those charts show the difference between the economic value, which is what we use to manage the business, and reflects the margins that we initially capture and the GAAP reported value at the end of a reporting period. At the end of March, the economic value of our gas and storage was about $11 million, which we expect to realize in fiscal 2008.

Of note, we have experienced record volatility in the past 18 months, with market spreads reaching greater than $5 at September 30th. Since then, we've seen spreads compress. Looking ahead, we would expect volatility to continue to flatness, barring a major weather event.

Our pipeline and storage gross profit for the current quarter rose about $14 million and increased by about $24 million for the six months, as compared to the same period one year ago. The improvement in both periods was largely due to favorable arbitrage spreads in the Atmos pipeline and storage asset management contracts, yielding an increase of about $7 million for the quarter and $9 million year to date as compared to last year. Increased throughput due to colder weather positively affected pipeline and storage gross profit by about $4 million for the quarter and almost $6 million for the six months ended.

And the North Side Loop and other various completed compression projects on the Atmos Pipeline Texas system had an incremental margin of about $3 million for the current quarter and about $6 million for the six months as compared to a year ago.

As we've discussed, we are continuing to evaluate the scale, scope and timing of the midstream gathering project in Kentucky. We are currently redesigning the original project to better serve the needs of the local producers, as well as to meet the company's economic requirement. The redesigned project will likely be marginally smaller in both size and scope, and we expect the in-service date to be delayed into the second half of fiscal 2008. We hope to announce some details of the gathering project in the near future, but we remain very optimistic that we have a project and that it will go forward.

Taking a look now at the expense side of the income statement, consolidated operation and maintenance expense for the second quarter decreased about $1 million and increased about $6 million in the current six months, due to higher employee costs and benefit costs, which increased O&M by about $7 million and almost $18 million for the six-month period, as compared to a year ago.

These increases were partially offset by a $4 million decrease in both the quarter and six months from the deferral of 2005 and 2006 Katrina-related expenses. Which were subsequently approved for recovery by the Louisiana regulators.

The provision for doubtful accounts decreased by about $3 million in the current quarter and $5 million for the six months, mainly due to declining collection risks caused by lower gas prices period over period. Our current run rate on bad debt expense equates to less than 0.5% of residential and commercial revenues. However, in April and May, as we exit the heating season, we typically see our uncollectibles spike upward and we begin to take bad debt write offs, so we'll be better able to assess the bad debt impact in the next quarter and can talk about it on our next call.

As a reminder, our O&M expense increases about $20 million annually, and it's typically front-loaded in the first two quarters of our fiscal year.

Taxes other than income taxes decreased by $8 million in the current quarter and about $13 million for the six months ended, as compared to prior-year periods. The decrease in both periods is mainly due to lower franchise fees and state gross receipts taxes resulting from lower revenues tied to lower gas prices, and we have more detail on this topic on our Slide 59, in case you want more detail.

Our interest charges were basically flat in the current quarter and increased by $3 million in the six-month period, as compared to prior periods. The six-month period increase is due to a rise in the three-month LIBOR rate, which translated into a 76-basis-point increase in the interest rate on our $300 million floating-rate senior note. However, interest expense was reduced somewhat as a result of lower average short-term debt balances compared with last year.

Turning to cash flow for the first six months, we generated operating cash of about $512 million compared with $148 million in the same period a year ago. Period over period, this reflects the favorable impact of higher net income, higher sales volumes due to colder weather, and lower natural gas prices, all of which we've touched on during this call.

We experienced the following increases in cash flow. $79 million from accounts receivables changes and gas storage balances, $93 million from improved management of our deferred gas balances, $142 million caused by favorable timing and collection of other current assets payables and other liabilities, and changes in working capital increased operating cash flow by about $49 million, of which $28 million relates to increased net income.

Capital expenditures for the six months were about $173 million, down from $213 million last year, basically reflecting the absence of capital expenses related to the North Side Loop and completed pipeline compression projects. We continue to pay close attention to our capital spending, not just in the aggregate, but distinguishing between gross capital and maintenance capital, and targeting our investing in jurisdictions where we experience timely recovery on that investment.

Moving now to our earnings guidance and outlook for the remainder of fiscal 2007, because of the seasonal nature of the Company's utility operations, the Company typically reports a net loss in the remainder of our fiscal year. The heating season's over and natural gas usage is lowest in the summer months. However, despite the expectation for losses for the remainder of the year, we believe that the Company can still achieve a level of earnings this fiscal year within the previously announced range of $1.90 to $2.00 per diluted share. And as Bob discussed, we received a much lower rate increase than we filed for in the Mid-Tex division, but we do believe that the trough performance this year from the marketing business will offset a shortfall expected as a result of that rate case decision.

As we have seen, volatility in natural gas prices can provide positive opportunities for our marketing operations. However, that also means that the impact for mark-to-market accounting on that business can cause unforeseen swings in the trading margins of that business. So our updated guidance assumes no material mark-to-market at the end of our fiscal year in September. We project between $365 million and $385 million in CapEx for fiscal 2007, down from our original range or $425 million to $440 million, as we don't foresee spending as much capital on the gathering project in Kentucky in the current fiscal year as was originally budgeted.

Breaking that down for you, about $255 million to $265 million will be in maintenance capital, and about $110 million to $120 million will be devoted to gross capital. We have slides that break that down, I believe, between utility and non-utility.

Now once again, here's Bob.

Thanks, Pat, and I'll make a few closing comments and then we'll be happy to answer any questions that you may have. As you've heard today, we've achieved, and are gratified to achieve, solid year-to-date results and we remain on track to achieve our earnings target this year. The utility reported marked improvement with higher throughput in a colder quarter compared to a year ago, plus we had the benefit of the WNA mechanisms -- rate mechanisms in our largest divisions, Mid-Tex and Louisiana.

The non-utility segment remains very solid. The natural gas marketing business continues to deliver noticeable results with their dual sources of margin. The strength of combining the stable marketing margins with the upside from optimizing our storage and transportation assets has yielded unprecedented financial results for a number of consecutive quarters.

For Atmos Pipeline Texas, the four projects that we undertook in fiscal 2005 and 2006 are now placed in service and generating annual revenues in excess of $10 million. We continue to see robust demand for system capacity, associated with new production being developed near our system, primarily the Barnett Shale in the Fort Worth area. As you know, this pipeline is connected to the Waha Hub on the west side of the system and the Katy Hub on the south side and to the Carthage Hub on the east. This pipeline is a flourishing asset and complements our existing utility distribution and non-utility businesses.

With respect to other rate cases, besides our anticipated filing in Mid-Tex, in late February we received a final decision in the Missouri rate case and we were able to achieve margin decoupling through a straight fixed-variable customer charge. This is the Third Atmos Energy jurisdiction to achieve decoupling in their rate design. As I mentioned earlier, we already have decoupling in Louisiana and Mississippi. There's also a conservation program tied to this rate case outcome, which we support. It is funded with a 1% of gross annual revenues, or about $165,000 annually.

We anticipate rate filings in Tennessee and Georgia in the near term and we have an existing case in Kentucky, which we believe will be resolved by late this summer.

In Texas, we're utilizing the GRIP mechanism to implement rate increases for our capital expenses. In the coming months, we plan to file for recovery of our 2006 capital expenditures for each of our Texas utility jurisdictions, as well as Atmos Pipeline Texas. These revenue increases are recovered through a surcharge to the monthly fixed-customer charge. There's been a great deal of interest in GRIP during this current session of the Texas Legislature. At this stage, we believe they are fine-tuning the GRIP legislation originally passed in 2003. The legislation's intent was to encourage infrastructure investment and enable more timely returns on new investment.

There are varying bills before the House and Senate, and the most likely outcome would be enhancements to the current law, which better defines the roles and responsibilities of all parties involved in the GRIP filings. You can continue to see us concentrate on rate design, which fundamentally drives the performance of our utility divisions.

At a consolidated level, our goal remains as it has the past six or seven years, and that is to maintain a 4% to 6% growth rate -- earnings per share growth rate and if we meet our guidance this year, then this will be the seventh consecutive year that we have done that. This earnings growth, coupled with our dividend yield of 4%, we continue to enhance value to our shareholders.

This concludes our prepared remarks and we'll be glad to take any questions at this point now.

Thank you, sir. (Operator Instructions) Our first question is from Faisel Khan with Citi. Please go ahead.

Hello, Mr. Khan? Your line is open.

Quick question on the marketing and trading side. If I'm looking at the realized margin, that's cash that you guys bring to your bottom line today -- is that fair to say?

Correct.

And so if I'm looking at the unrealized losses, you're talking about how those will unwind over the next couple of quarters. For all intents and purposes, the economic value you created was your realized portion; the mark-to-market losses are really just accounting discrepancies that unwind over the time.

Yes, it's a snapshot in time that reflects the movement between current cash physical prices and futures prices.

And if I look at that over the next two quarters, you're not going to -- your realized margins going forward for the next couple of quarters, you're not going to lose money, so in theory, that would be -- I'm just trying to think of it from a guidance perspective and what your real earnings power is for that business. I mean, this year it seems like you did really well for that business if I exclude all these mark-to-market losses. Is that a fair statement?

We did. We pulled some income into the first quarter by cycling physical gas from storage and selling derivatives, and that basically swaps out realized income for previously recorded unrealized marks. But what we don't know and don't control is the relative movement between fiscal and financial indexes. And if we have something like 15 Bcf of gas and storage, as we did at September 30 last year, that could be a pretty significant mark, as you point out, [although] it's not cash. And we look at economic value to manage the business and try, based on the setup of our storage book and our derivatives, to forecast as accurately as we can, when that realized cash will come in, particularly after the hurricanes. We saw some very unusual volatility, as much as $5 difference between physical and financial prices, and that can create, at the end of each quarter, some pretty significant unrealized non-cash timing effects.

Is it fair to say that, for the quarter, you guys were able to generate a large realized income from -- mostly because your positions moved over the last couple of quarters and you guys were able to take advantage of the situation and make more on the realized side. Is that fair to say? More than you would in the past?

I'll that Rick Alford elaborate a little bit on the dynamics of the quarter to give you a little bit more color. Rick?

Thank you, Pat. I think what we need to do, probably, to clarify this a little bit is to look at where we were at the end of the first quarter. We had significant unrealized gains in the first quarter, and so if you'll notice on the slide on Page 62, we had $60.6 million of economic value and we had $32.8 million of unrealized gains sitting on the books. And as you pointed out, during the second quarter, we saw those unrealized gains flip back into realized gains and that's what generated the $67 million of realized margin in the storage activities for the second quarter.

But also, as you alluded to, we have $10.8 million of economic value, and that's the cash value that we can expect in the future from the storage operations.

Okay, but going forward for the next two quarters, you're not expecting any realized losses, are you?

We, as a matter of fact, do have some realized losses that, based on the current setup, will hit the books in the second -- in the third and fourth quarters of this fiscal year. The $10.8 million straddles the remainder of fiscal '07 and primarily the first two quarters of fiscal '08.

Okay, so you are expecting some -- because of the way you realized income in this quarter, you are expecting some realized losses over the next two quarters from the position that you put on?

Based on the setup that we had at the end of March, we are expecting realized losses in the last two quarters of the year. However, as market conditions change and the market allows us the opportunity to move in and out of those positions, it's possible that we will reduce those realized losses during that period.

Okay, and that's when you're keeping your guidance where it is?

That's correct.

Okay. Thanks for clearing that up, guys. I appreciate it.

(Operator Instructions) Thank you. Our next question is from Josh Golden with JPMorgan. Please go ahead with your question.

Hi, good morning. I just, first of all, would like to congratulate you on the management of the balance sheet. My next question sort of centers around the $300 million maturity that you have in October. Would you be looking to refinance that in the debt market? If so, how soon? And second of all, do you have any aspirations to improve your credit rating beyond a mid BBB, potentially to a high BBB or low AA credit rating?

We're currently evaluating our options for refinancing the $300 million of floating-rate notes, probably in the July timeframe. That's our next coupon interest date. And so we'll have more to say about that on our next call. Laurie Sherwood, our treasurer, and I have had frequent conversations with the rating agencies, and in particular Moody's, that took us down an additional notch at the announcement of the TXU gas transaction, and we've been diligently pursuing the things that we know will increase our credit metrics and our coverage ratios, including reducing leverage. That's one obvious element of it, and getting better rate designs to improve our cash flow. You saw the benefit of that, or we saw the benefit of that in our second quarter year over year.

So we consider it kind of blocking and tackling, and what we'd like to do is go back and visit with the agencies now that we have our second quarter results. We'll be filing our Q later today. I think what they wanted to confirm is that the weather normalization mechanisms that we got in Louisiana and Texas are working the way we expect them to work and having the desired impact on improving cash flow. And I think we can certainly demonstrate that, so we hope that that would be the process of sort of re-evaluating our meetings.

I think, from a cost-of-capital standpoint, that being a solid BBB is probably the sweet spot for us. We really wouldn't get rewarded for trying to go up much above that, but I would like to have the additional flexibility by having all three agencies at that level. Fitch, of course, has us at BBB+ so I think that would really be -- given the mix of our businesses, that would be our objective.

The other thing that we're very focused on, on the non-utility side, about half of our marketing company income comes from the base business, which is margin times the volume. The other half comes from optimization, which is more volatile. But the projects that we're looking at, like this gathering project in Kentucky and, longer term, perhaps some [greenfield] storage opportunities. We want to emphasize fee-based business with credit-worthy parties. Being a dividend paying company, we think that's very important for us and for our investor base.

Okay. Thank you. Excellent work. Keep it up. Thank you very much.

Thank you. Our next question is from Adar Zango with Zimmer Lucas Capital. Please go ahead.

Hi, good morning. Congratulations on the quarter. I just wanted to know what will be the test year you plan to file on at Mid-Tex on your GRC later this year, and can you tell us what your [rate base] as of year end '06 at that jurisdiction?

I don't think we've set a date yet, Adar, for filing and so you back up from that look at look at test year. It could be, for example, March 30th or second quarter. One of the things, frankly, that will influence the timing of the filing -- and Kim Cocklin, our Senior VP of Utility Operations is here on the call with us, but one of the objectives we have is to be sure that we have time to touch base and visit with key decision-makers and people that have influence on our regulatory outcomes here in the state of Texas.

You know, it will be a very important filing that we make, but when you come up a few thousand feet from that, we really have to work longer term on the regulatory climate and the processes here in Texas that, in our experience, are a little bit dysfunctional and a little bit out of the ordinary, compared to our other states.

We have very good relationships with our cities and the mayors, but when we get into a contested rate case, sometimes it's difficult to sit down and settle and collaborate in that kind of an environment. We want to go down and visit with commission staff and others to make sure that they understand that we're only earning about 50% of our authorized rate of return in Texas and that mechanisms like GRIP are not a windfall for the utility. The merely give us a better shot at earning our authorized rate of return; not exceeding it. And somehow I think we need to get that message out there.

As you all recall, the reason that we had a rate case filing was not of our own choosing. We received show-cause orders from the cities that have initial jurisdiction over us on their presumption that we were over earning because we'd talked on calls like this about accelerating (inaudible). What they failed to appreciate was that the rates that were recovering were set based on a 2002 test period, meaning that the Company had absorbed about five years of inflation without a rate increase.

So I think we have some basic work to do to communicate our position and our story, and hopefully get a better result and a fairer result the next time that we go in. So that will bear on our thinking about timing and when we can get back before the commission.

And then on your other question, we had $1.044 billion in rate base at the end of last year.

But you don't know yet if you'd be going in and filing on an '06 test year or if you're going and filing later this year, would you just file on '07?

If the trailing 12-month period ends -- you know, financials now that we've filed through the second quarter of our fiscal '07, so I mean, potentially it could be a 12 months ended March 30.

I think that's something that Kim and our team will be exploring and considering and talking with our interveners and our interested parties before we file to talk about the elements of the case. We just need some time to be ready for that.

Okay, thank you. And I just have a few more quick questions. The $6.8 million increase in asset management fees that you recognized this quarter, is this an ongoing benefit?

Rick, you want to answer that?

It is an ongoing set of asset management plans. However, the volatility that we experienced during this current period may not exist in the future and that opportunity may not be there to make as much from the asset management plans.

Great. And in terms of O&M, it looks like you modestly raised O&M guidance for the full year, and it looks like, as of now, year over year, the increase will be somewhat greater than $10 million. I just wanted to know what's driving the increase and is that range that you provided an ongoing number?

Adar, I'll call you back on that later. I don't have the details behind all that with me.

Okay. Thank you.

You're welcome, Adar. Thank you.

Thank you. Our next question is from Ted Durbin with Goldman Sachs. Please go ahead.

Hi, guys. Actually, most of my questions have been asked. I guess the one question would be if you think about the gathering project in Kentucky, what are the next milestones or decision plants? What do you have on the radar right now?

Ted, we have several people here that could talk to that. I think, you know, last year we had to file with the FERC to get a declaration that the project was gathering and not interstate transmission, and that filing by itself probably gave the project a higher profile than it warranted because we never thought of this project as make-or-break. To the contrary, it's really our entrée and a step out into a new, but closely related, business -- gathering natural gas.

And the reason, frankly, that we started down the path is that we have a utility in Kentucky, we have the marketing company that serves industrial customers behind the city gate and buys gas from local producers, and we were approached by a subset of those producers and asked to consider sponsoring a project that would give them an alternative to traditional gatherers in the area, and that hasn't changed. But what we intend to do is to finalize long-term contracts with a group of producers to be at a position to order pipe, to have agreements with an interstate transmission pipeline company to put that gas into their system after it's treated. And so we've been a little bit perplexed at the skepticism out there around do we have a project and are we going to go forward.

I think what we're experiencing is a natural kind of progression, where you go from letters of intent or memorandums of understanding to signed contracts. As we've looked at it, we've determined that a different routing and a different sizing really makes more sense and provides close to, or about the same, economic value to it.

So we're moving down that road. This is the first project of its kind for us. We want to do it very well and we're kind of doing it on our time frame. Again, we've been, like I say, a little surprised at the rumors or the positions out there. I'm not sure where people are getting their information, but all we can tell you is that we are very confident that we still have a project and we'll be talking about it when we -- we don't want to get ahead of ourselves and be talking in detail about something until we get those basic agreements flanged up and are ready to (inaudible) and order pipe, so we don't think that's very far away -- ideally, within the next month. But like I said, we don't want to get ahead of ourselves and we'll talk more about that on our next call.

Okay, great. And then just the other question is on Kentucky, have there been filings made by opposing parties?

Yes. The attorney general has filed their recommendation and I might ask Kim Cocklin to comment on that because we're now seeing the range, I guess, of projected outcomes. Kim?

Thank you, Pat. The information that we received from the attorney general in response to our filing, which were seeking an increase of about 10.4 million. I think the latest analysis we have is that they have made an offer for a revenue increase in the neighborhood of about $3.3 million and are proposing a 9% turn on equity, which obviously (inaudible) dismally below where we would accept or end up. But the range, they're at 3.3; we're at 10.4, and obviously we'd leave room for movement on ROE, so it's in very good shape.

Okay, great. Thank you.

(Operator Instructions) And our next question is a follow up from Adar Zango. Please go ahead.

Just one more question. Can you at all guide us on how we should think about a normalized level of marketing in '08, at least in terms of the more volatile part driven by asset optimization?

If we could do that, Adar, I'd be running a hedge fund. I mean, I wish I could do that that. We would like to answer that for ourselves and for our board. And I don't mean to be flippant because really, when you think about it, we've got physical gas, and we're going to have different levels of gas and storage, depending on weather. If we have a very hot summer, it'll affect storage balances as peaking plants that are gas-fired start up.

And then we have weather-related things that cause volatility to be greater or less. We certainly saw that with Hurricane Katrina and the other hurricanes. Typically, in years -- if you look back maybe five years ago, the difference between physical prices today and future prices might have been $0.50 or $.075, or a $1.00, and we've seen that widen out to $4 to $5. And if we could predict what it would be during '08, at the end of each quarter, it sure would make our life easier, and I know from a modeling standpoint, it would make your job easier, but we just can't know that.

Thank you.

Thank you. Ms. Giles, there are no further questions at this time. Please continue with any closing remarks you may have.

Great, thank you. I just want to remind you that there will be a recording of this call available for replay on our website through August the 9th. And again, we appreciate the interest and thank you for joining us.

Thank you. You may now disconnect.