UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Fee Required) For the fiscal year ended September 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (No Fee Required) For the transition period from __________ to ____________ Commission File Number 1-10042 ATMOS ENERGY CORPORATION (Exact name of registrant as specified in its charter) TEXAS AND VIRGINIA 75-1743247 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) Three Lincoln Centre, Suite 1800 5430 LBJ Freeway, Dallas, Texas 75240 (Address of principal executive offices (Zip code) Registrant's telephone number, including area code: (972) 934-9227 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- --------------------- Common stock, No Par Value New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X]. No [ ]. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant was $738,585,541 as of November 25, 1997. On November 25, 1997 the registrant had 29,770,088 shares of common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement filed for the annual meeting of shareholders on February 11, 1998 are incorporated by reference into Part III. Cautionary Statement under the Private Securities Litigation Reform Act of 1995 The matters discussed or incorporated by reference in this Annual Report on Form 10-K contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 or Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical facts included in this Report including, but not limited to, those contained in the following sections, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", and Notes 2, 5, and 11 of notes to consolidated financial statements, regarding the Company's financial position, business strategy and plans and objectives of management of the Company for future operations, are forward-looking statements made in good faith by the Company. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the statements relating to the Company's operations, markets, services, rates, recovery of costs, availability of gas supply, and other factors. These risks and uncertainties include, but are not limited to, economic, competitive, governmental, weather, technological and other factors. PART I ITEM 1. BUSINESS Atmos Energy Corporation (the "Company") was organized under the laws of the State of Texas in 1983 as a subsidiary of Pioneer Corporation ("Pioneer") for the purposes of owning and operating Pioneer's natural gas distribution business in Texas. Immediate ly following the transfer of such business, which had been opera ted by Pioneer and its predecessors since 1906, Pioneer distrib uted the outstanding stock of the Company, then known as Energas Company, to Pioneer shareholders. In September 1988, the Company changed its name from Energas Company to Atmos Energy Corporation. As a result of its merger with United Cities Gas Company in July 1997, the Company became incorporated in the Commonwealth of Virginia as well as the State of Texas. The Company distributes and sells natural gas and propane to approximately 1.02 million residential, commercial, industrial, agricultural, and other customers. The Company distributes and sells natural gas to approximately 985,000 customers in 802 cities, towns, and communities in service areas located in Texas, Louisiana, Kentucky, Colorado, Kansas, Illinois, Tennessee, Iowa, Virginia, Georgia, South Carolina and Missouri. The Company also transports gas for others through parts of its distribution system. It also distributes propane to approximately 29,000 customers in Kentucky, North Carolina, Tennessee and Virginia. The Company's Texas distribution system is operated through its Energas Company division (the "Energas Division") and covers an area having a population of approximately 950,000 people. The economy of the area is based primarily on oil and gas production and agriculture. The principal cities served by the Energas Division include Amarillo, Lubbock, Midland, and Odessa. At September 30, 1997, the Company served 311,571 customers in Texas. The Company's Louisiana distribution system is operated through its Trans Louisiana Gas Company division (the "Trans La Division") and covers an area having a population of approximately 250,000 people. The economy of the area is based primarily on oil and gas production, agriculture, and food processing. The principal cities served by the Trans La Division are Lafayette, Pineville, and Natchitoches. At September 30, 1997, the Company served 80,053 customers in Louisiana. The Company's Kentucky distribution system is operated through its Western Kentucky Gas Company division (the "Western Kentucky Division") and covers an area having a population of approximately 680,000 people. The economy of the area is based primarily on industry and agriculture. The principal cities served by the Western Kentucky Division include Bowling Green, Owensboro, and Paducah. At September 30, 1997, the Company served 173,958 customers in Kentucky. The Company's distribution systems in Colorado and parts of Kansas and Missouri are operated through its Greeley Gas Company division (the "Greeley Gas Division") and covers an area having a combined population of approximately 228,000 people. The economies of the areas served are based on oil and gas production, agriculture and resort business. The principal cities served by the Greeley Gas Division include Greeley, Durango and Lamar, Colorado and Bonner Springs, Herington and Ulysses, Kansas. At September 30, 1997 the Greeley Gas Division served 113,185 customers. The Company operates natural gas distribution systems in Georgia, Illinois, Iowa, South Carolina, Tennessee, Virginia, Kansas and Missouri through its United Cities Gas Company division (the "United Cities Division") and covers an area having a combined population of approximately 6,695,000 people. The economies of the areas served include customers engaged in the manufacture of asphalt, automobiles, auto parts, chemicals, electronics, food products, metals, textiles and wire, among others. The division also serves several colleges and a major army base. The principal cities and counties served by the United Cities Division include Franklin and Murfreesboro, Tennessee; Wyandotte and Johnson Counties in Kansas; Hannibal, Missouri; and Gainesville and Columbus, Georgia. At September 30, 1997, the United Cities Division served 306,681 natural gas customers. 2 The Company also operates certain non-utility businesses through various wholly-owned subsidiaries. One subsidiary, United Cities Gas Storage Company ("UCG Storage"), provides natural gas storage services. It owns natural gas storage fields in Kentucky and Kansas to supplement natural gas used by customers in those states. Another subsidiary, UCG Energy Corporation ("UCG Energy"), leases appliances, real estate and equipment, and vehicles to the United Cities Division and others, and owns a small interest in a partnership engaged in exploration and production activities. UCG Energy also owns a 45% interest in Woodward Marketing, L.L.C. ("WMLLC"), a gas marketing business incorporated in Texas. WMLLC provides gas marketing services to industrial customers, municipalities and local distribution companies, including the United Cities Division. UCG Energy utilized equity accounting, effective January 1, 1995, for this acquisition. The excess of the purchase price over the value of the net tangible assets, amounting to approximately $5,400,000, was allocated to intangible assets consisting of customer contracts and goodwill, which are being amortized over ten and twenty years, respectively. In accordance with the purchase agreement, if certain earnings targets are met, an additional payment of up to $1,000,000 may be paid over a five-year period. UCG Energy also owns United Cities Propane Gas of Tennessee, Inc. (the "Propane Division"), which is engaged in the retail distribution of propane (LP) gas, the wholesale supply and transportation of LP gas, the transportation of certain products for other companies and the direct merchandising and repair of propane gas appliances. Each of approximately 15 town operations has its own storage facility with a total company storage capacity of 2,119,000 gallons. As of September 30, 1997, the Propane Division served 29,097 customers in Tennessee, Kentucky, North Carolina and Virginia. During the three-year period ended September 30, 1997, the Propane Division added approximately 8,000 customers through acquisitions of four propane distribution companies and a propane transport company. The natural gas and propane distribution industries are subject to a number of factors, many of which affect the Company from time to time. These include (i) the ongoing need to obtain adequate and timely rate relief from regulatory authorities to recover costs of service and earn a fair return on invested capital; (ii) inherent seasonality of the business; (iii) competition with alternate fuels; (iv) competition with other gas sources for industrial customers, including the ability of some customers to bypass the Company's facilities, which could result in loss of revenues and reduction in the Company's net income; and (v) possible volatility in the supply and price of natural gas and propane. 3 ACQUISITIONS AND MERGERS Since its organization in 1983, the Company has sought to expand its customer base and to diversify the weather patterns, local economic conditions, and regulatory environments to which its operations are subject. As part of this strategy, the Company acquired Trans Louisiana Gas Company, Inc. ("TLG") in January 1986, Western Kentucky Gas Utility Corporation in December 1987, Greeley Gas Company ("GGC") in December 1993, Oceana Heights Gas Company of Thibodaux, Louisiana in November 1995 and United Cities Gas Company ("UCGC") in July 1997. The Company continues to consider and pursue, where appropriate, additional acquisitions of natural gas distribution properties and other business opportunities. For further information regarding the UCGC merger, see Note 2 of notes to consolidated financial statements. UTILITY AND NON-UTILITY DATA The following table summarizes certain information regarding the operation of the utility and non-utility businesses of the Company for each of the three years in the period ended September 30, 1997. Prior periods have been restated to reflect the pooling of interests with UCGC on July 31, 1997. Utility Non-utility Total ---------- ----------- ---------- (In thousands) 1997 Operating revenues $ 864,720 $42,115 $ 906,835 Net income 20,463 3,375 23,838 Identifiable assets 1,015,818 72,493 1,088,311 1996 Operating revenues $ 837,125 $49,566 $ 886,691 Net income 36,740 4,411 41,151 Identifiable assets 926,935 83,675 1,010,610 1995 Operating revenues $ 707,680 $41,875 $ 749,555 Net income 24,618 4,190 28,808 Identifiable assets 829,849 71,099 900,948 The utility business is comprised of the Company's five utility divisions: Energas Division, Greeley Gas Division, Trans La Division, United Cities Division and Western Kentucky Division. It includes regulated as well as certain nonregulated utility businesses such as irrigation, transportation and gas marketing activities in the utility divisions' respective service areas. 4 The non-utility business includes the operations of UCG Storage and UCG Energy, which includes a 45% interest in WMLLC (a gas marketer), the propane business and leasing of real estate, vehicles and appliances. OPERATING STATISTICS The table on the following page reflects the pooled operating statistics of Atmos and the United Cities Division for fiscal 1997 and the restated operating statistics for the previous four years on a pooled basis. It is followed by two tables of utility sales and operating statistics by business unit for 1997 and 1996, respectively. These two tables are followed by tables of non-utility net income and propane statistics for 1997, 1996 and 1995. 5 ATMOS ENERGY CORPORATION FIVE-YEAR OPERATING STATISTICS Year ended September 30, 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ NUMBER OF CUSTOMERS, at end of year Residential 870,747 860,229 834,376 825,310 789,360 Commercial 92,703 91,960 90,093 93,250 86,124 Industrial (including agricultural) 17,217 19,403 19,762 20,219 9,564 Public authority and other 4,781 4,716 4,982 4,949 3,267 ---------- -------- -------- -------- ---------- Total natural gas customers 985,448 976,308 949,213 943,728 888,315 Propane 29,097 26,108 23,359 21,693 20,498 ---------- --------- -------- -------- ---------- Total Customers 1,014,545 1,002,416 972,572 965,421 908,813 ========== ========= ======== ======== ========== HEATING DEGREE DAYS, (2) Actual 3,909 4,043 3,706 3,855 4,080 Percent of normal 98% 101% 93% 97% 102% SALES VOLUMES - MMcf (3) Residential 75,214 77,001 69,666 72,561 74,818 Commercial 37,382 38,247 34,921 35,250 36,307 Industrial (including agricultural) 46,417 57,863 57,290 57,638 50,537 Public authority and other 5,195 5,182 4,779 5,242 4,403 ---------- --------- -------- -------- ---------- Total 164,208 178,293 166,656 170,691 166,065 TRANSPORTATION VOLUMES - MMcf (3) 48,800 44,146 47,647 47,882 51,665 ---------- --------- -------- -------- ---------- TOTAL VOLUMES DELIVERED - MMcf (3) 213,008 222,439 214,303 218,573 217,730 ========== ========= ======== ======== ========== PROPANE - Gallons (000's) 32,975 40,723 28,854 23,175 20,180 ========== ========= ======== ======== ========== OPERATING REVENUES (000's) Gas Revenues Residential $ 452,864 $ 409,039 $337,768 $375,450 $ 372,770 Commercial 193,302 186,032 150,949 165,883 165,611 Industrial (including agricultural) 168,386 187,693 171,591 188,791 160,410 Public authority and other 23,898 21,738 18,185 22,463 18,315 ---------- --------- -------- -------- ---------- Total gas revenues 838,450 804,502 678,493 752,587 717,106 Transportation Revenues 19,885 18,872 19,813 21,325 21,937 Other Revenue 6,385 13,751 9,374 6,879 8,014 ---------- --------- -------- -------- ---------- Total utility revenues 864,720 837,125 707,680 780,791 747,057 Non-utility revenues Propane revenues 33,194 34,730 22,124 18,510 16,506 Other revenues 8,921 14,836 19,751 27,001 31,330 ---------- --------- -------- -------- ---------- Total non-utility revenues 42,115 49,566 41,875 45,511 47,836 ---------- --------- -------- -------- ---------- Total operating revenues $ 906,835 $ 886,691 $749,555 $826,302 $ 794,893 ========== ========= ======== ======== ========== AVERAGE SALES PRICE/Mcf Residential $ 6.02 $ 5.31 $ 4.85 $ 5.17 $ 4.98 Commercial 5.17 4.86 4.32 4.71 4.56 Industrial (including agricultural) 3.63 3.24 3.00 3.28 3.17 Public authority and other 4.60 4.19 3.81 4.29 4.16 Total 5.11 4.51 4.07 4.41 4.32 AVERAGE COST OF GAS/Mcf SOLD 3.51 3.15 2.70 3.10 3.04 AVERAGE TRANSPORTATION REVENUES/Mcf .41 .43 .42 .45 .42 See footnotes on page 7. 6 UTILITY SALES AND STATISTICAL DATA BY BUSINESS UNIT - 1997(1) Year ended September 30, 1997 -------------------------------------------------------------------- Western Greeley United Total Energas Trans La Kentucky Gas Cities Utility --------- --------- -------- -------- ------- --------- UTILITY CUSTOMERS, at end of year Residential 268,518 73,546 154,219 99,472 274,992 870,747 Commercial 25,234 5,409 17,706 13,328 31,026 92,703 Industrial (including agricultural) 15,589 120 460 385 663 17,217 Public authority and other 2,230 978 1,573 - - 4,781 -------- -------- -------- -------- -------- ---------- Total 311,571 80,053 173,958 113,185 306,681 985,448 ======== ======== ======== ======== ======== ========== HEATING DEGREE DAYS, (2) Actual 3,553 1,523 4,178 6,195 3,980 3,909 Normal 3,531 1,771 4,333 6,274 4,070 3,990 Percent of normal 100% 86% 96% 99% 98% 98% SALES VOLUMES - MMcf (3) Residential 24,292 3,558 13,543 10,227 23,595 75,215 Commercial 7,912 1,383 6,070 6,731 15,286 37,382 Industrial (including agricultural) 19,084 1,872 6,128 1,907 17,425 46,416 Public authority and other 2,689 951 1,555 - - 5,195 -------- -------- -------- -------- -------- ---------- Total 53,977 7,764 27,296 18,865 56,306 164,208 TRANSPORTATION VOLUMES - MMcf (3) 4,479 624 22,398 3,275 18,024 48,800 -------- -------- -------- -------- -------- ---------- TOTAL VOLUMES HANDLED - MMcf (3) 58,456 8,388 49,694 22,140 74,330 213,008 ======== ======== ======== ======== ======== ========== OTHER STATISTICS Operating revenues (000's) $234,310 $ 51,866 $144,139 $ 91,341 $343,064 $ 864,720 Gross plant (000's) $322,774 $108,822 $175,793 $137,489 $501,972 $1,246,850 Net plant (000's) $208,289 $ 78,354 $105,393 $ 83,371 $314,591 $ 789,998 Miles of pipe 13,214 2,241 3,638 3,864 7,945 30,902 Employees (4) 534 154 330 250 1,031 2,299 Communities served 92 41 163 123 383 802 (1) Atmos' utility business is comprised of the five utility divisions listed in the table above. Their operations include the regulated local distribution companies and certain unregulated gas marketing subsidiaries located in their respective service areas. The Energas plant balances include certain shared services utilty amounts. (2) A heating degree day is equivalent to each degree that the average of the high and the low temperatures for a day is below 65 degrees. The greater the number of heating degree days, the colder the climate. Heating degree days are used in the natural gas industry to measure the relative coldness of weather experienced and to compare relative temperatures between one geographic area and another. Normal degree days is based on 30-year average National Weather Service data for selected locations. (3) Volumes are reported as metered in million cubic feet ("MMcf"). (4) This excludes 218 and 235 Atmos shared services employees and 162 and 143 non-utility employees in United Cities in 1997 and 1996, respectively. 7 UTILITY SALES AND STATISTICAL DATA BY BUSINESS UNIT - 1996 (1) Year ended September 30, 1996 -------------------------------------------------------------------- Western Greeley United Total Energas Trans La Kentucky Gas Cities Utility --------- --------- -------- -------- ------- --------- UTILITY CUSTOMERS, at end of year Residential 266,805 73,414 151,798 97,653 270,559 860,229 Commercial 24,950 5,392 17,334 13,230 31,054 91,960 Industrial (including agricultural) 17,780 118 467 401 637 19,403 Public authority and other 2,219 956 1,541 - - 4,716 -------- -------- -------- -------- -------- ---------- Total 311,754 79,880 171,140 111,284 302,250 976,308 ======== ======== ======== ======== ======== ========== HEATING DEGREE DAYS, system average (2) Actual 3,331 1,980 4,610 5,912 4,322 4,043 Normal 3,528 1,760 4,376 6,234 4,070 3,990 Percent of normal 94% 113% 105% 95% 106% 101% SALES VOLUMES (2) Residential 22,842 4,205 14,694 9,829 25,458 77,028 Commercial 7,426 1,490 6,351 6,252 16,706 38,225 Industrial (including agricultural) 24,978 1,707 10,726 1,028 18,207 56,646 Public authority and other 2,529 962 1,685 1,218 - 6,394 -------- -------- -------- -------- -------- ---------- Total 57,775 8,364 33,456 18,327 60,371 178,293 TRANSPORTATION VOLUMES (3) 5,694 562 16,936 3,342 17,612 44,146 -------- -------- -------- -------- -------- ---------- TOTAL VOLUMES HANDLED (3) 63,469 8,926 50,392 21,669 77,983 222,439 ======== ======== ======== ======== ======== ========== OTHER STATISTICS Operating revenues (000's) $203,409 $ 53,288 $153,203 $ 73,844 $353,381 $ 837,125 Gross plant (000's) $278,180 $103,809 $158,918 $125,531 $476,855 $1,143,293 Net plant (000's) $168,014 $ 74,816 $ 96,252 $ 74,485 $301,699 $ 715,266 Miles of pipe 13,163 2,090 3,570 3,817 7,523 30,163 Employees (4) 609 167 373 268 1,068 2,485 Communities served 92 41 163 123 383 802 See footnotes on page 7. 8 The non-utility business is comprised of the operations of UCG Storage and UCG Energy. Their net income for 1997, 1996 and 1995 is recapped below: 1997 1996 1995 ------- ------ ------ (In thousands) Non-utility net income: Propane $ (89) $1,276 $1,123 Rental 1,109 1,237 1,693 Interest in WMLLC and other 1,616 1,092 634 Storage 739 806 740 ------ ------ ------ Total $3,375 $4,411 $4,190 ====== ====== ====== The Company's Propane Division sells and transports propane to both wholesale and retail customers. Propane statistics for 1997, 1996 and 1995 are shown below. The division sold 33 million gallons of propane in 1997 as compared with 41 million gallons in 1996. The decrease in volume was the result of winter weather that was 7% warmer than normal in 1997. PROPANE STATISTICS: 1997 1996 1995 ------- ------- ------- (In thousands) Sales Retail $19,201 $21,434 $15,932 Wholesale 10,349 13,296 6,192 ------- ------- ------- 29,550 34,730 22,124 Cost of sales 20,084 23,832 13,038 ------- ------- ------- Gross profit $ 9,466 $10,898 $ 9,086 ======= ======= ======= Gross margin % of sales 32.0% 31.4% 41.1% Gallons 32,975 40,723 28,854 GAS SALES The Company's natural gas distribution business is seasonal and highly dependent on weather conditions in the Company's service areas. Gas sales to residential and commercial customers are greater during the winter months than during the remainder of the year. The volumes of such sales during the winter months will vary with the temperatures during such months. The seasonal nature of the Company's sales to residential and commercial customers is offset partially by the Company's sales in the 9 spring and summer months to its agricultural customers in Texas, Colorado and Kansas who utilize natural gas to operate irrigation equipment. The Company also has weather normalization adjustments in its rate jurisdictions in Tennessee and Georgia, which serve approximately 170,000 customers. The Company's management believes that the Company has lessened its sensitivity to weather risk by diversifying its operations into geographic areas having different weather patterns. In addition to weather, the Company's revenues are affected by the cost of natural gas and economic conditions in the areas that the Company serves. Higher gas costs, which the Company is generally able to pass through to its customers under purchased gas adjustment clauses, may cause customers to conserve, or, in the case of industrial customers, to use alternative energy sources. In recent years, natural gas market conditions have changed. Natural gas prices to distributors have become more volatile and the number of competing marketers of natural gas has increased. The Company's gas marketing subsidiaries purchase gas to address requirements for large volume customers in certain highly competitive markets. In certain instances, customers purchase gas directly from others instead of from the Company and the Company transports such gas through its distribution systems to the customers' facilities for a fee. Although transportation of customer-owned gas reduces the Company's operating revenues and corresponding purchased gas cost, the transportation revenues received by the Company may offset the loss to gross profit. The Company's distribution systems have experienced aggregate peak day deliveries of approximately 1.5 billion cubic feet ("Bcf") per day. The Company has the ability to curtail deliveries to certain customers under the terms of interruptible contracts and applicable state statutes or regulations which enables it to maintain its deliveries to high priority customers. The Company has not imposed curtailment in its Energas Division since the Company began independent operations in 1983 or in its Trans La Division since the Company acquired TLG in 1986. The Western Kentucky Division curtailed deliveries to certain interruptible customers during exceptionally cold periods in December 1989, January 1994 and during the winter of 1996. Neither the Greeley Gas Division nor its predecessor, GGC, have curtailed deliveries to its sales customers since prior to 1980. The United Cities Division curtails interruptible service customers from time to time each year in accordance with the interruptible contracts and tariffs. 10 GAS SUPPLY The Western Kentucky Division's gas supply is delivered by the following pipelines: Texas Gas, Tennessee Gas, Trunkline and ANR, except that a small percentage of the requirements are being purchased directly from intrastate producers that are connected directly to its distribution system. During 1997, the Western Kentucky Division purchased its supply from various producers and marketers including Texaco Gas Marketing, Union Pacific Fuels, Vastar Gas Marketing, Duke Energy, LG&E Natural and Natural Gas Clearinghouse. The United Cities Division is served by thirteen interstate pipelines. The majority of the volumes are transported through East Tennessee Pipeline, Southern Natural Gas and Williams Natural Gas. During 1997, the United Cities Division purchased its supply from various producers and marketers including TransCanada, Texaco Gas Marketing, Woodward Gas Marketing, and Williams Energy Service Company. Colorado Interstate Gas Company, Williams Natural Gas, Public Service Company of Colorado, and Northwest Pipeline are the principal transporters of the Greeley Gas Division's requirements. Additionally, the Greeley Gas Division purchased substantial volumes from producers that are connected directly to its distribution system. During 1997, the Greeley Gas Division's primary suppliers were Union Pacific Fuels, Williams Energy Service Company, Duke Energy, Interenergy and WESTAR. The Energas Division receives sales and transportation service from various KN affiliates. Also, the Company purchases a significant portion of its supply from Pioneer Natural Resources (formerly Mesa) which is connected directly to the Company's Amarillo, Texas distribution system. During 1997, other major suppliers included Texaco Gas Marketing, Enron, and Natural Gas Clearinghouse. Louisiana Intrastate Gas Company ("LIG"), Acadian Pipeline, Koch Gateway and Texas Gas Transmission Company pipelines delivered most of the Trans La Division's requirements. The Trans La Division purchased its supply from various producers and marketers including Acadiana Gas Marketing, Koch Gas Marketing, LL&E and Engage Energy. The Company owns and operates numerous natural gas storage facilities in Kentucky and Kansas which are used to help meet customer requirements during peak demand periods and to reduce the need to contract for additional pipeline capacity to meet such peak demand periods. Additionally, the Company operates various propane plants and a liquid natural gas ("LNG") plant for peak shaving purposes. The Company also contracts for storage service in underground storage facilities of many of the interstate pipelines serving it. See "Item 2. Properties" for further information regarding the peak shaving facilities. 11 The United Cities Division normally injects gas into pipeline storage systems and UCG Storage's storage system during the summer months and withdraws it in the winter months. At the present time, the underground storage facilities of UCG Storage have a maximum daily output capability of approximately 45,000 Mcf. The United Cities Division has the ability to serve approximately 60% of its peak day load through the use of company owned storage facilities, storage contracts with its suppliers and peaking facilities throughout the system. This ability provides the operational flexibility and security of supply required to meet the needs of the highly weather sensitive residential and commercial market. REGULATION AND RATES Regulation. In the Energas Division, the governing body of each municipality served by the Company has original jurisdiction over all utility rates, operations, and services within its city limits except with respect to sales of natural gas for vehicle fuel and agricultural use. The Company operates pursuant to non-exclusive franchises granted by the municipalities it serves, which franchises are subject to renewal from time to time. The franchises granted to the Company permit it to conduct natural gas distribution within the municipalities' incorporated limits. The Railroad Commission of Texas ("Railroad Commission") has exclusive appellate jurisdiction over all rate and regulatory orders and ordinances of the municipalities and exclusive original jurisdiction over rates and services to customers not located within the limits of a municipality. In Texas, rates for large industrial customers are routinely set by contract negotiation between the Company and its customers pursuant to statutory standards and are filed with and subject to the governmental authority of the municipalities or the Railroad Commission, depending on whether the customer is located inside or outside the limits of a municipality. Historically, the Company's rates for large industrial customers have been accepted as filed. Agricultural sales in Texas are not regulated, except that prices for agricultural sales cannot exceed the prices the Company charges the majority of its commercial or other similar large-volume users in Texas. The Trans La Division is regulated by the Louisiana Public Service Commission ("Louisiana Commission"), which regulates utility services, rates, and other matters. In most of the parishes and incorporated areas in which the Company operates in Louisiana, it does so pursuant to a non-exclusive franchise granted by the governing authority of each parish or incorporated area. The franchise gives the Company the general privilege to operate its gas distribution business in, as well as the right to install its distribution lines along the roadways of, the parish or the incorporated area. Direct sales of natural gas to industrial customers in Louisiana who utilize the gas for fuel or 12 in manufacturing processes and sales of natural gas for vehicle fuel are exempt from regulation. The Western Kentucky Division is regulated by the Kentucky Public Service Commission ("Kentucky Commission"), which regulates utility services, rates, issuances of securities, and other matters. The Company operates in the various incorporated cities served by it in Kentucky pursuant to non-exclusive franchises granted by such cities. The franchises grant to the Company the right to operate its gas distribution business in the city and to install its distribution lines and related equipment in and along the city's public rights- of-way. Sales of natural gas for use as vehicle fuel in Kentucky are not subject to regulation. The Greeley Gas Division is regulated by the Colorado Public Utilities Commission ("Colorado Commission"), the Kansas Corporation Commission, and the Missouri Public Service Commis sion with respect to accounting, rates and charges, operating matters, and the issuance of securities. The Company operates in the various incorporated cities served by it in the states of Colorado, Kansas and Missouri under terms of non-exclusive franchises granted by the various cities. The franchises grant to the Company, among other things, the right to install and operate its gas distribution system within the city limits. Most of the Greeley Gas Division's wholesale gas suppliers are regulated by various federal and state commissions. In each state in which the United Cities Division operates, its rates, services and operations as a natural gas distribution company are subject to general regulation by the state public service commission. Its pipeline suppliers, but not the United Cities Division or the other utility divisions, are subject to regulation by the Federal Energy Regulatory Commission ("FERC"). The United Cities Division's rates, which vary in its different regulatory jurisdictions, are determined by its cost of purchased gas, rate of return, type of service and volume of use by the customer. In addition, the issuance of securities by the Company is subject to approval by the state commissions, except in South Carolina and Iowa. Missouri only regulates the issuance of secured debt. The United Cities Division operates in each community, where necessary, under a franchise granted by the municipality for a fixed term of years. To date it has been able to renew franchises and expects to continue to do so in the future. The Company is also subject to regulation by the United States Department of Transportation with respect to safety requirements in the operation and maintenance of its gas distribution facilities. The Company's distribution operations are also subject to various state and federal laws regulating environmental matters. From time to time the Company receives inquiries regarding various environmental matters. The Company believes that its properties and operations substantially comply with and are operated in substantial conformity with applicable 13 safety and environmental statutes and regulations. There are no administrative or judicial proceedings arising under environmental quality statutes pending or known to be contemplated by governmental agencies which, if adversely determined, would have a material adverse effect on the Company. Rates. Approximately 89% of the Company's revenues in fis cal 1997 was derived from sales at rates set by or subject to approval by local or state authorities. The method of determin ing regulated rates varies among the twelve states in which the Company has utility operations. As a general rule, the regulatory authority reviews the Company's rate request and establishes a rate structure intended to generate revenue sufficient to cover the Company's costs of doing business and provide a reasonable return on invested capital. Substantially all of the sales rates charged by the Company to its customers fluctuate with the cost of gas purchased by the Company. Rates established by regulatory authorities are adjusted for increases and decreases in the Company's purchased gas cost through automatic purchased gas adjustment mechanisms. Therefore, while the Company's operating revenues may fluctuate, gross profit (which is defined as operating revenues less purchased gas cost) is generally not eroded or enhanced because of gas cost increases or decreases. The Georgia Commission and Tennessee Regulatory Authority have approved Weather Normalization Adjustments ("WNAs") that allow the United Cities Division to increase the base rate portion of customers' bills when weather is warmer than normal and decrease the base rate when weather is colder than normal. The net effect of the WNAs was an increase (decrease) in revenues of $2,643,000, $(2,612,000) and $1,030,000 in 1997, 1996 and 1995, respectively. 14 The following table sets forth the major rate requests made by the Company during the most recent five years and the action taken on such requests: Effective Amount Amount Jurisdiction Date Requested Received ------------ ------------ ----------- ---------- Texas West Texas System 11/18/94 $2,581,000 $1,702,000(a) 11/01/96 7,676,000 5,800,000(a) Amarillo 11/25/92 4,398,000 2,130,000 Louisiana 03/01/93 (b) 730,000(b) 03/01/94 (b) 1,058,000(b) 03/01/95 (b) 1,071,000(b) Kentucky 11/01/95 7,665,000 2,300,000(c) 03/01/96 1,000,000(c) Colorado 05/01/94 4,527,000 3,246,000 Kansas 12/01/93 2,604,000 2,088,000(d) 09/01/95 4,230,000 2,700,000(e) Missouri 10/14/95 1,100,000 903,000 South Carolina 02/07/95 341,000 253,000 Tennessee 11/15/95 3,951,000 2,227,000 Iowa 05/17/96 750,000 410,000 Georgia 12/02/96 5,003,000 3,160,000 Illinois 07/09/97 1,234,000 428,000 Virginia 09/29/95 810,000 103,000 (a) These increases include $200,000 and $500,000 applicable to areas outside the city limits which became effective in January 1995 and April 1997, respectively. (b) A September 1992 rate order approved a Rate Stabilization Clause ("RSC") for three years which provided for an annual adjustment of rates to reflect changes in expenses and investment. The RSC provided the Company the opportunity to earn a return on common equity between 11.75% and 12.25%. (c) The Kentucky rate order provided an increase of $2,300,000, lowered depreciation rates effective November 1, 1995 and provided an additional $1,000,000 beginning March 1, 1996. The order also included a provision for a pilot demand side management program which could cost up to $450,000 annually. (d) This increase is applicable to the service area of the Greeley Gas Division. (e) This increase is applicable to the service area of the United Cities Division. 15 COMPETITION The Company is not currently in significant direct competition with any other distributors of natural gas to residential and commercial customers within its service areas. However, the Company does compete with other natural gas suppliers and suppliers of alternate fuels for sales to industrial and agricultural customers. The Company competes in all aspects of its business with alternative energy sources, including, in particular, electrici ty. Competition for the residential and commercial customers is increasing. Promotional incentives, improved equipment efficien cies, and promotional rates all contribute to the acceptability of electric equipment. In the United Cities Division, #2 and #6 fuel oil are the primary competition for industrial customers. In addition, certain customers, primarily industrial, may have the ability to by-pass the Company's distribution system by connecting directly with a pipeline. Beginning in 1985, changes in the federal regulatory environment through FERC orders and conditions related to markets and gas supply in the United States have brought increased competition into the natural gas industry. In 1993, FERC Order 636 was implemented by the interstate pipelines that serve the United Cities and Western Kentucky Divisions, but FERC policies have not had a direct impact upon the Company's Energas, Greeley Gas and Trans La Divisions which are primarily supplied by intrastate pipelines. However, competition for large volume customers in the United Cities and Western Kentucky Divisions and other service areas has increased as a result of FERC Order 636. The Company has sought regulatory approvals for competitive pricing on a case by case basis. The Company participates in the operation of public refueling facilities for the sale of compressed natural gas ("CNG") for vehicular use. The most recent of these were opened in Greeley, Colorado in September 1996, at West Texas A&M University in Canyon, Texas in August 1995, and in Owensboro, Kentucky in April 1995. Prior to that time, the Company provided CNG for vehicular use only in limited situations (such as for school buses in certain school districts and for the fleet vehicles of certain businesses). With the opening of these public refueling stations the Company began competing with gasoline for vehicular fuel sales. All of these facilities, except those in Greeley, Colorado and at West Texas A&M, are located at existing local gasoline stations. The United Cities Division has received approval from all the regulatory authorities in the states in which it operates, except Iowa, to place into effect a negotiated tariff rate which allows the United Cities Division to maintain industrial loads at lower margin rates. Iowa has rules which allow for flexible rates. These rates are competitive with the price of alternative fuels. In addition, certain industrial customers have changed 16 from firm to interruptible rate schedules in order to obtain natural gas at a lower cost. Additionally, the United Cities Division has received approval from all state regulatory authorities to provide transportation service of customer- owned gas. UCG Energy's propane subsidiary is in competition with other suppliers of propane, natural gas and electricity. Competition exists in the areas of price and service. The wholesale cost of propane is subject to fluctuations primarily based on demand, availability of supply and product transportation costs. UCG Energy, through its 45% interest in WMLLC, competes with other natural gas brokers in obtaining natural gas supplies for customers. UCG Energy also competes with other rental companies. UCG Storage charges rates to the United Cities Division that are subject to review by the various commissions in the states within which the storage service is provided. Therefore, UCG Storage's rates must be competitive with other storage facilities. UCG Storage also stores natural gas for WMLLC. As a result, UCG Storage is in competition with other companies that store natural gas as to rates charged and deliverability of natural gas. Storage agreements between UCG Storage and the United Cities Division give it first priority to any storage services. Employees At September 30, 1997, the Company employed 2,679 persons. See "Utility Sales and Statistical Data by Business Unit - 1997" for the number of employees by business unit. As discussed in Management's Discussion and Analysis, the Company is in the process of downsizing and restructuring in connection with the integration of UCGC and its Customer Service Initiative. The projected complement at the end of fiscal 1998 is currently estimated at 2,223 persons. ITEM 2. PROPERTIES The Company owns an aggregate of 30,902 miles of underground distribution and transmission mains throughout its gas distribution systems. These mains are located on easements or right-of-ways granted to the Company, which generally provide for perpetual use. The Company maintains its pipelines through a program of continuous inspection and repair and believes that its pipeline system is in good condition. The Company also owns and operates nine peak shaving plants with a total capacity of approximately 1,050,000 gallons that can produce an equivalent of 19,459 Mcf daily and an LNG storage facility with a capacity of 500,000 Mcf which can inject a daily volume of 30,000 Mcf in the system, as well as underground storage fields which are used to supplement the supply of natural gas in periods of peak demand. It has seven underground gas storage facilities in Kentucky and four in Kansas that have a total storage capacity of 17 approximately 21.1 Bcf. However, approximately 10.0 Bcf of gas in the storage facilities must be retained as cushion gas to maintain reservoir pressure. The maximum daily delivery capability of the storage facilities is approximately 154 MMcf. Substantially all of the Company's properties in its Greeley Gas Division and United Cities Division with recorded values of approximately $83.4 million and $314.6 million, respectively, are subject to liens under First Mortgage Bonds assumed by the Company in its mergers with GGC and UCGC. At September 30, 1997, the liens secured $17.0 million of outstanding 9.4% Series J First Mortgage Bonds due May 1, 2021, and $113.0 million of outstanding Series N, P, Q, R, S, T, U and V First Mortgage Bonds due at various dates from 2004 through 2022. In 1996 the Company consolidated its administrative offices in Dallas, Texas under one lease. The Company also maintains field offices throughout its distribution system, substantially all of which are located in leased premises. Net non-utility property at September 30, 1997 amounted to approximately $19.5 million for propane equipment, $17.4 million for underground storage facilities, and $19.7 million for rental buildings and equipment. The Company holds franchises granted by the incorporated cities and towns that it serves. At September 30, 1997, the Company held 413 such franchises having terms generally ranging from five to 25 years. The Company believes that each of its franchises will be renewed. ITEM 3. LEGAL PROCEEDINGS See Note 5 of notes to consolidated financial statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of fiscal 1997. 18 EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information as of September 30, 1997, regarding the executive officers of the Company. It is followed by a brief description of the business experience of each executive officer during the past five years. Years of Name Age Service Office Currently Held ---- --- -------- --------------------- Robert W. Best 50 - Chairman, President and Chief Executive Officer Larry J. Dagley 49 - Executive Vice President and Chief Financial Officer J. Charles Goodman 36 13 Executive Vice President of Operations Donald E. James 50 16 Senior Vice President of Public Affairs Mary S. Lovell 46 9 Senior Vice President of Utility Services Glen A. Blanscet 40 12 Vice President, General Counsel and Corporate Secretary Wynn D. McGregor 44 9 Vice President, Human Resources Robert W. Best was named Chairman, President and Chief Executive Officer and was appointed to the Board of Directors in March 1997. He previously served as Senior Vice President -regulated businesses, for Consolidated Natural Gas Company of Pittsburgh, Pennsylvania, since January 1996, responsible for its transmission and distribution companies. He previously served as President of Texas Gas Transmission Company of Owensboro, Kentucky, and Houston, Texas, from 1985 to 1995, and from 1992 to 1995 he was President of Transco Gas Pipeline. Larry J. Dagley was named Executive Vice President and Chief Financial Officer effective May 1, 1997. From August 1995 to May 1997, he served as Senior Vice President and Chief Financial Officer of Pacific Enterprises, a Los Angeles, California based utility holding company whose principal subsidiary is Southern California Gas Co., the nation's largest gas distribution utility. From 1985 until joining Pacific Enterprises, he served as Senior Vice President and Controller (1985-1993) and Senior Vice President and Chief Financial Officer (1993-1995) of Transco Energy Company, a Houston, Texas based natural gas pipeline company. Prior to joining Transco, Mr. Dagley was an audit partner with Arthur Andersen & Co., where he supervised audits and financial consulting engagements in the energy industry. J. Charles Goodman was named Executive Vice President, Operations in April 1995. He previously served as President of the Company's Trans La Gas Division from February 1993 until April 1995 and as Chief Engineer from February 1989 until February 1993. 19 Donald E. James was named Senior Vice President - Public Affairs in May 1995. He previously served as Senior Vice President and General Counsel from January 1994 to May 1995, Senior Vice President - General Counsel and Corporate Secretary from May 1993 until August 1993, and Senior Vice President and General Counsel from May 1989 until May 1993. Mary S. Lovell was named Senior Vice President, Utility Services in May 1995. She previously served as Vice President, Rates and Regulatory Affairs from August 1990 to May 1995. Glen A. Blanscet was named Vice President, General Counsel and Corporate Secretary in May 1995. He previously served as Assistant General Counsel and Corporate Secretary from January 1994 to May 1995, and Assistant General Counsel from July 1988 to December 1993. Wynn D. McGregor was named Vice President, Human Resources in January 1994. He previously served the Company as Director of Human Resources from February 1991 to December 1993 and as Manager, Compensation and Employment from December 1987 to January 1991. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's stock trades on the New York Stock Exchange under the trading symbol "ATO". The high and low sale prices and dividends paid per share of the Company's common stock for fiscal 1997 and 1996 are listed below. Dividends paid for 1997 and 1996 have been restated to reflect the merger of Atmos and UCGC accounted for as a pooling of interests. Atmos' actual dividends paid in fiscal 1997 were $.25 for each of the first three quarters and $.255 for the fourth quarter, and $.24 per quarter for each quarter of fiscal 1996. The high and low prices listed are the actual closing NYSE quotes for Atmos shares. 1997 1996 ----------------------------- -------------------------- Dividends Dividends High Low paid High Low paid Quarter ended: -------- ----- ---- ------ ------ ----- December 31 $ 24 3/4 $ 22 5/8 $.251 $23 $18 $.245 March 31 26 1/4 22 1/8 .252 23 21 .245 June 30 25 1/2 22 1/2 .252 31 22 3/4 .245 September 30 27 7/8 24 1/2 .255 30 5/8 20 7/8 .245 ----- ----- $1.01 $ .98 ===== ===== See Note 7 of notes to consolidated financial statements for restriction on payment of dividends. The number of record holders of the Company's common stock on September 30, 1997 was 29,867. 20 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected financial data of the Company and should be read in conjunction with the consolidated financial statements included herein. Amounts for 1997 reflect the pooled operations of Atmos and the United Cities Division. Prior year amounts have been restated for the pooling. Year ended September 30, ---------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- -------- -------- ------- (In thousands, except per share data) Operating revenues $ 906,835 $ 886,691 $749,555 $826,302 $794,893 ========== ========== ======== ======== ======== Net income $ 23,838 $ 41,151 $ 28,808 $ 26,772 $ 29,694 ========== ========== ======== ======== ======== Net income per share $ .81 $ 1.42 $ 1.06 $ 1.05 $ 1.21 ========== ========== ======== ======== ======== Cash dividends per share $ 1.01 $ .98 $ .96 $ .91 $ .82 ========== ========== ======== ======== ======== Total assets at end of year $1,088,311 $1,010,610 $900,948 $829,385 $786,739 ========== ========== ======== ======== ======== Long-term debt at end of year $ 302,981 $ 276,162 $294,463 $282,647 $257,696 ========== ========== ======== ======== ======== 21 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION This section provides management's discussion of Atmos Energy Corporation's ("the Company" or "Atmos") financial condition, cash flows and results of operations with specific information on liquidity, capital resources and results of operations. It includes management's interpretation of such financial results, the major factors expected to affect future operating results, and future investment and financing plans. This discussion should be read in conjunction with the Company's consolidated financial statements and notes thereto. For financial and operating statistics, please see the tables of restated and pooled data included herein. Cautionary Statement under the Private Securities Litigation Reform Act of 1995 The matters discussed or incorporated by reference in this Annual Report on Form 10-K contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 or Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical facts included in this Report including, but not limited to, those contained in this Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", regarding the Company's financial position, business strategy and plans and objectives of management of the Company for future operations, are forward-looking statements made in good faith by the Company. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the statements relating to the Company's operations, markets, services, rates, recovery of costs, availability of gas supply, and other factors. These risks and uncertainties include, but are not limited to, economic, competitive, governmental, weather, technological and other factors. Organization The Company distributes, sells and transports natural gas and propane to residential, commercial, industrial and agricultural customers in thirteen states. The natural gas distribution business is operated through its five utility divisions, rather than as a holding company. Such utility business is subject to regulation by state and/or local authorities in each of the states in which the Company operates. In addition, the Company's business is affected by seasonal weather patterns, competition within the energy industry, and economic conditions in the areas that the Company serves. 22 With the completion of the merger with United Cities Gas Company this year, Atmos is the 12th largest natural gas distribution utility company in terms of total customers in the country, and the fifth largest pure natural gas utility. Since its organization in 1983, the Company has sought to expand its customer base and to diversify the weather patterns, local economic conditions, and regulatory environments in which it operates. As part of this strategy, the Company has completed major acquisitions in 1986, 1987, 1993 and 1997. In addition to growing through acquisitions, the Company's strategy includes building the Atmos team, running the utility operations exceptionally well, increasing the size and market share of the non-utility operations (gas marketing and propane), and developing plans to participate in retail energy services behind the meter. In connection with its merger with United Cities Gas Company, as discussed in Note 2 of notes to consolidated financial statements, the Company acquired certain non-utility subsidiaries which contributed approximately 14% of 1997 net income and offer potential growth opportunities. One non-utility subsidiary, UCG Storage, was formed in 1989 to provide natural gas storage services. In 1989, a natural gas storage field was purchased in Kentucky to supplement natural gas used by customers in Tennessee. In addition, natural gas storage fields located in Kansas were sold to UCG Storage and are used to supplement natural gas requirements of Kansas customers. The other non-utility subsidiary, UCG Energy, incorporated in 1965, leases appliances, real estate and equipment, and vehicles to the United Cities Division and others. UCG Energy also owns a 45% interest in WMLLC of Houston, Texas, which provides natural gas services to industrial customers, municipalities and local distribution companies in the Southeast and Midwest, including the United Cities Division. Management services include contract negotiation and administration, load forecasting, nominations and scheduling, storage acquisition, capacity utilization and pricing/risk management. WMLLC was formed in 1995. UCG Energy has two wholly-owned subsidiaries, United Cities Propane Gas of Tennessee, Inc. and UCG Leasing, Inc. United Cities Propane Gas of Tennessee, Inc. is engaged in the retail and wholesale distribution and transportation of propane (LP) gas. As of September 30, 1997, the propane operation served 29,097 customers in Kentucky, North Carolina, Tennessee and Virginia. UCG Leasing, Inc. was incorporated under the laws of Georgia in 1987 and leases vehicles, equipment and real estate to the United Cities Division. A table of non-utility net income for 1997, 1996 and 1995 appears on page 9 herein. 23 Acquisitions and Mergers The Company has expanded its customer base and sought to diversify the regulations, weather patterns and local economic conditions to which it is subject through acquisitions in fiscal years 1997, 1994, 1987, and 1986. The Company plans to continue its acquisition strategy to add new customers and service areas for both natural gas and propane. It has an excellent track record of acquiring LDC operations that provide diversity in weather, regulatory patterns, economies and markets. It has achieved synergies and benefits quickly, while preserving brand equity. Ratemaking Activity Rates and regulatory initiatives are at the heart of Atmos' utility operations and are important to both shareholders and customers. Atmos' objective is to achieve rates that provide for fair returns for its shareholders while having these rates at low, competitive levels for its customers. As the energy environment and industry change, the process for setting rates in the future may also need to change. In that regard, the Company is participating in a performance-based rates experimental program in Tennessee, which is designed to reward the Company for performing better than certain benchmarks relating to purchased gas cost. A similar program is underway in Georgia. Atmos believes that performance-based rate programs benefit customers and reward efficient service providers like Atmos, and Atmos intends to seek gas cost incentive arrangements and incentive rates in every jurisdiction possible. The Company received rate increases totaling $9.4 million, $6.8 million, and $5.8 million effective in fiscal 1997, 1996 and 1995, respectively. For further information regarding these rate increases please see Note 3 "Rates" in notes to consolidated financial statements. Weather and Seasonality The Company's natural gas and propane distribution businesses are seasonal due to weather conditions in the Company's service areas. Sales are affected by winter heating season requirements. Sales to agricultural customers (who use natural gas as fuel in the operation of irrigation pumps) during the period from April through September are affected by rainfall amounts. These factors generally result in higher operating revenues and net income during the period from October through March of each year and lower operating revenues and either net losses or lower net income during the period from April through September of each year. For further seasonality information, please see the Supplementary Quarterly Financial Data following the notes to consolidated financial statements herein. 24 The Georgia Public Service Commission and the Tennessee Regulatory Authority have approved Weather Normalization Adjustments ("WNAs"). The WNAs, effective October through May each year in Georgia and November through April each year in Tennessee, allow the United Cities Division to increase the base rate portion of customers' bills when weather is warmer than normal and decrease the base rate when weather is colder than normal. The net effect of the WNAs was an increase/(decrease) in revenues of $2,643,000, ($2,612,000) and $1,030,000 in 1997, 1996 and 1995, respectively. The Company has not sought weather normalization clauses in its other rate jurisdictions because of the effect of its geographical diversification strategy and the potential for increased profits in unusually cold years. Environmental Matters The Company is involved in certain environmental matters as discussed in Note 5 "Contingencies" of notes to consolidated financial statements. RESULTS OF OPERATIONS YEAR ENDED SEPTEMBER 30, 1997 COMPARED WITH YEAR ENDED SEPTEMBER 30, 1996 To assist in management's discussion of results of operations, the following table presents the effects for fiscal years 1997, 1996 and 1995 of certain non-recurring charges as well as weather which affected reported results. 1997 1996 1995 -------------- --------------- -------------- Per Per Per Amount Share Amount Share Amount Share ------ ----- ------ ----- ------ ----- (In thousands, except per share data) Net income as reported $23,838 $ .81 $41,151 $1.42 $28,808 $1.06 Non-recurring charges: Management reorganization 2,800 .10 - - - - Reserve for potential sharing of merger and integration costs 12,630 .43 - - - - ------- ----- ------- ----- ------- ----- Normalized net income except for effects of weather 39,268 1.34 41,151 1.42 28,808 1.06 Effects of weather 3,571 .12 (1,838) (.06) 5,000 .18 ------- ----- ------- ----- ------- ----- Normalized net income $42,839 $1.46 $39,313 $1.36 $33,808 $1.24 ======= ===== ======= ===== ======= ===== 25 Net income as reported The Company reported net income of $23.8 million, or $.81 per share, on operating revenues of $906.8 million for the fiscal year ended September 30, 1997. The 1997 net income includes the effects of non-recurring after-tax charges related to management reorganization ($2.8 million or $.10 per share) and reserves related to the UCGC merger and integration ($12.6 million or $.43 per share). Excluding the effect of these charges, the Company's net income would have been $39.3 million or $1.34 per share in 1997, compared with $41.2 million, or $1.42 per share for 1996. The 1997 results include United Cities Gas Company, which merged with Atmos effective July 31, 1997, and prior year operating results have been restated to reflect the pooling of interests accounting which was used for the merger. Non-recurring charges The Company completed a management reorganization in 1997 and recorded a charge of $4.4 million ($2.8 million after-tax) in related costs. The cost of the UCGC merger and integration totaled approximately $17 million for the transaction costs and $32 million for the separation and other costs. There are substantial longer term benefits to the Company's customers and shareholders from the merger of the two companies, which the Company expects to result in cost savings over the next 10 years totaling about $375 million. The Company believes a significant amount of the costs to achieve these benefits will be recovered through rates and future operating efficiencies of the combined operations. Therefore, the Company recorded as regulatory assets the costs of the merger and integration of UCGC. However, the Company has established a reserve of approximately $20 million ($12.6 million after-tax), to account for costs that may not be recovered. The Company recorded these costs in the fourth quarter of fiscal year 1997 when the merger was completed, separation plans were approved by the board of directors and announcements were made to employees. For further information regarding the merger please see Note 2 of notes to consolidated financial statements. Effects of weather Annual sales volumes and revenues vary in relation to winter heating degree days and summer irrigation demand. The Company has weather normalization adjustments in its rates in Georgia and Tennessee, but not in the other 10 states in which it has natural gas distribution operations. The estimated effect on net income of weather different from 30-year normals is included in the previous table. The decline in net income, excluding the charges and reserves, was the result of the effects of warmer than normal weather during the winter months, which negatively impacted gas throughput and sales as well as propane sales. In addition, the spring months were wetter than normal, which adversely impacted 26 irrigation gas utilization. Normal weather conditions would have added $.12 per share to net income. Rates The negative effects of weather were partially offset by rate increases implemented in fiscal 1996 and 1997 in jurisdictions in Texas, Kentucky, Illinois, Georgia, Iowa, Tennessee, Missouri and Virginia. Rate increases contributed approximately $8 million to gross profit in 1997. The following table summarizes heating degree days and volumes delivered for 1997, 1996 and 1995. Year ended September 30, -------------------------- 1997 1996 1995 ---- ---- ---- HEATING DEGREE DAYS Actual 3,909 4,043 3,706 Percent of normal 98% 101% 93% SALES VOLUMES - MMcf Residential 75,214 77,001 69,666 Commercial 37,382 38,247 34,921 Industrial (including agricultural) 46,417 57,863 57,290 Public authority and other 5,195 5,182 4,779 -------- -------- -------- Total 164,208 178,293 166,656 TRANSPORTATION VOLUMES - MMcf 48,800 44,146 47,647 -------- -------- -------- TOTAL VOLUMES DELIVERED - MMcf 213,008 222,439 214,303 ======== ======== ======== PROPANE - Gallons (000's) 32,975 40,723 28,854 ======== ======== ======== Total operating revenues (000's) $906,835 $886,691 $749,555 ======== ======== ======== Operating revenues increased approximately 2% to $906.8 million in 1997 from $886.7 million in 1996 due to an increase of 13% in the average sales price per thousand cubic feet ("Mcf") of gas sold, which more than offset a 4% decrease in total volumes delivered. The increase in sales price reflects an increase in the commodity cost of gas which is passed through to end users and rate increases implemented in 1996 and 1997. Average gas sales revenues per Mcf increased by $.60 to $5.11 in 1997, while the average cost of gas per Mcf sold increased $.36 to $3.51 in 1997. The number of meters in service increased to 985,448 at September 30, 1997 compared with 976,308 at September 30, 1996. Sales to weather sensitive residential, commercial and public authority customers decreased approximately 2.6 billion cubic feet ("Bcf") in 1997 while sales and transportation volumes delivered to industrial and agricultural customers decreased approximately 6.8 Bcf. Total sales and transportation volumes delivered decreased 4.2% to 213.0 Bcf in 1997, as compared with 222.4 Bcf in 1996. The decrease was primarily due to lower 27 irrigation demand as a result of cooler, wetter summer weather in West Texas. Gross profit increased by approximately 2% to $329.7 million in 1997 from $324.4 million in 1996. The primary factor contributing to the higher gross profit was annual rate increases totalling approximately $16.2 million implemented in fiscal 1997 and 1996 in Texas, Kentucky, Tennessee, Iowa, Missouri, Georgia, and Illinois. This was partially offset by a decrease of 9.4 Bcf or 4.2% due to the effect of warmer than normal weather and decreased irrigation demand as a result of cooler, wetter summer weather in 1997. Operating expenses, excluding income taxes, increased $31.2 million or 13% to $263.0 million in 1997. The $25.5 million increase in operation expense was due primarily to the non-recurring $20.0 million reserve for potential sharing of merger and integration costs, and the $4.4 million charge for management reorganization. The $3.6 million increase in depreciation was due to utility plant additions placed in service in 1996 and 1997. Income taxes decreased to $14.3 million for 1997 from $23.3 million for 1996. The primary reason for the decrease was lower pre-tax profits. The effective tax rate increased slightly to 37.5% in 1997 from 36.2% in 1996. This was primarily due to increased state income tax rates in 1997. Also, prior to the merger in 1997, UCGC's income was subject to a slightly lower federal tax rate because of the graduated rate structure. Operating income decreased in 1997 by approximately $17.0 million or 24% to $52.3 million. The decrease in operating income resulted primarily from the non-recurring charges included in 1997 operating expenses as discussed above. Net income decreased in 1997 by approximately 42% to $23.8 million from $41.2 million in the prior year. This $17.3 million decrease in net income resulted from the $17.0 million decrease in operating income and a $1.9 million increase in interest expense, which were partially offset by a $1.6 million increase in other income. The increase in interest expense was due to higher average debt outstanding in 1997 than in 1996. The $1.6 million increase in other income for 1997 was primarily due to a $1.1 million increase in income from the Company's investment in Woodward Marketing LLC, a Houston gas marketing company. Net income per share decreased to $.81 for 1997 from $1.42 for 1996. Average shares outstanding increased 1% to 29,409,000 shares in 1997 from 1996. YEAR ENDED SEPTEMBER 30, 1996 COMPARED WITH YEAR ENDED SEPTEMBER 30, 1995 Operating revenues increased 18% to $886.7 million in 1996 from $749.6 million in 1995 due to weather that was 9% colder than in 1995 and an 11% increase in the average sales price per Mcf sold. Average gas sales revenues per Mcf increased from 1995 by $.44 to $4.51 in 1996, while the average cost of gas per Mcf sold increased $.45 to $3.15 in 1996. The total number of natural gas and propane customers increased to 1,002,416 at September 30, 1996 compared with 972,572 at September 30, 1995. 28 Sales to weather sensitive residential, commercial and public authority customers increased approximately 11.0 Bcf in 1996 while sales and transportation volumes delivered to industrial and agricultural customers decreased 2.9 Bcf. Total volumes delivered increased 4% to 222.4 Bcf in 1996, as compared with 214.3 Bcf in 1995. Revenues from gas sales to weather sensitive customers increased $109.9 million to $616.8 million in fiscal 1996 due to an 11% increase in average sales price and a 10% increase in volumes sold in 1996. The increase in volumes sold was due to weather 1% colder than normal in 1996, as compared with 7% warmer than normal weather in 1995. Revenues from gas sold and transported to industrial and agricultural customers increased $15.2 million due to a $.24 per Mcf or 8% increase in sales price, despite a slight decrease in volumes delivered. Gross profit increased by approximately 8% to $324.4 million in 1996 from $300.2 million in 1995. The primary factor contributing to the higher gross profit in 1996 was higher volumes sold to weather-sensitive customers due to colder weather. The companywide average margin (sales price per Mcf less cost of gas per Mcf) did not change significantly in 1996. Operating expenses, excluding income taxes, increased only slightly to $231.8 million in 1996 from $228.2 million in 1995. Income taxes increased to $23.3 million in 1996 from $16.5 million in 1995. The primary reason for the increase was higher pre-tax profits. The effective tax rate decreased slightly to 36.2% in 1996 from 36.5% in 1995. Operating income increased in 1996 by approximately 25% to $69.3 million from $55.4 million in 1995. The increase in operating income resulted primarily from the increase in 1996 gross profit, partially offset by increases in operating expenses, primarily income taxes, as discussed above. Net income increased in 1996 from 1995 by approximately 43% to $41.2 million from $28.8 million in the prior year. This increase in net income resulted primarily from the increase in operating income, which was partially offset by a $1.5 million increase in interest expense. This increase in interest expense was caused by an increase in weighted average short-term debt outstanding in 1996. Net income per share increased to $1.42 for 1996 from $1.06 for 1995. Average shares outstanding increased 7% to 28,978,000 in 1996. CAPITAL RESOURCES AND LIQUIDITY (See "Consolidated Statements of Cash Flows") Because of the pooling of interests of Atmos, which has a September 30 fiscal year end, with UCGC, which had a December 31 year end, the activities of UCGC for the quarter ended December 31, 1996 are included in the restated 1996 consolidated statement of cash flows and not the 1997 consolidated statement of cash flows. As a result, amounts in the 1997 consolidated statement of cash flows as reported are different than they would have been, had they included a full 12 month's activity for UCGC. 29 The following pro forma condensed consolidated statement of cash flows reflects activities of both Atmos and UCGC for the full 12 months ended September 30, 1997. (In thousands) Cash flows from operating activities: Net income $ 23,838 Depreciation 47,494 Other (11,054) --------- Net cash provided by operating activities 60,278 Net cash used in investing activities (131,286) Cash flows from financing activities: Increase in notes payable, net 63,600 Issuance of long-term debt 40,000 Repayment of long-term debt (16,037) Issuance of common stock 10,482 Cash dividends paid (29,778) --------- Net cash provided by financing activities 68,267 --------- Decrease in cash (2,741) Cash at beginning of year 8,757 --------- Cash at end of year $ 6,016 ========= Cash Flows from Operating Activities Cash flows from operating activities as reported in the consolidated statement of cash flows totaled $68.7 million for 1997 compared with $91.7 million for 1996 and $79.1 million for 1995. Due to non-recurring charges recorded in 1997 and deducting UCGC's net income for the quarter ended December 31, 1996, the Company reported lower net income for the 1997 Statement of Cash Flows as compared with 1996 and 1995. Depreciation for the full 12 months of fiscal 1997 was $2.2 million higher than for 1996 because of increasing utility plant in service. Using 1997 beginning balances for UCGC as of December 31, 1996 resulted in large swings in certain seasonal asset and liability accounts like accounts receivable and accounts payable. Gas stored underground increased in 1996 because of higher gas cost, but was lower in 1997 and 1995 because of substantially lower gas prices during the summers of 1997 and 1995 when the storage reservoirs were being refilled. The changes in deferred charges and other assets and other current liabilities in 1997 were related to merger and integration costs accrued and the related regulatory assets recorded in the fourth quarter of 1997. See "Consolidated 30 Statements of Cash Flows" for other changes in assets and liabilities. Cash Flows from Investing Activities A substantial portion of the Company's cash resources is used to fund its ongoing construction program in order to provide natural gas services to a growing customer base. Net cash used in investing activities totaled $121.1 million in 1997 compared with $111.9 million in 1996 and $101.4 million in 1995. During 1995, UCGC completed construction of a twenty-eight mile main which connects two of its fastest growing distribution systems located in Middle Tennessee and is designed to provide the Company's current customers with the lowest possible priced gas through increased gas supply flexibility. Included in the 1995 capital expenditures stated above is $5.7 million related to this project. Capital expenditures in fiscal 1997 amounted to $122.3 million (including $26.0 million for the Customer Service Initiative ("CSI")) compared with $117.6 million in 1996 and $103.9 million in 1995. Currently budgeted capital expenditures for 1998 total $109.1 million and include approximately $41.5 million for completing CSI, as well as funds for additional mains, services, meters, and vehicles. The CSI project includes application software, related technology infrastructure and business process changes. Benefits related to the CSI project include enabling the Company's ability to deliver its vision by positioning for the future, using best practices in the industry, timely integration of new acquisitions and resolution of Year 2000 issues. Capital expenditures for fiscal 1998 are planned to be financed from internally generated funds and financing activities, as discussed below. 31 The following table reflects the Company's capitalization, including short-term debt except for the portion related to current storage gas. 1997 1996 --------------- --------------- (In thousands) Working capital Short-term debt(1) $ 48,122 $ 43,350 ======== ======== Short-term debt 119,178 15.6% 85,138 12.0% Long-term debt 318,182 41.6% 292,841 41.4% Shareholders' equity 327,260 42.8% 329,582 46.6% -------- ---- -------- ---- Total capitalization $764,620 100% $707,561 100% ======== ==== ======== ==== (1) Includes short-term borrowings associated with working gas inventories. As of the end of fiscal 1997, the debt to capitalization ratio had increased to 57.2% from 53.4% in 1996. The increase was primarily due to increased cash requirements related to merger and integration costs and CSI investments in 1997, as well as the effects of the charges and reserves previously discussed. The Company plans to decrease the debt to capitalization ratio to nearer its target of 50% over the next three years through cash flow generated from operations, issuance of new common stock under its Direct Stock Purchase Plan and ESOP, recovery of CSI and merger/integration costs and possibly from the sale of certain real estate assets. Future capital requirements Short-term borrowings are expected to continue to increase somewhat in fiscal 1998 due to budgeted capital expenditures discussed above and scheduled maturities of long-term debt of $15.2 million. The Company has access to $35.0 million available under its committed lines of credit and $159.9 million available under its uncommitted lines. Forward looking cash requirements beyond fiscal 1998 include capital expenditures and possible contingencies and environmental matters as discussed in the notes to consolidated financial statements. The Company plans to fund future requirements through internally generated cash flows, credit facilities and its access to the public debt and equity capital markets. Cash Flows from Financing Activities Net cash provided by financing activities totaled $47.3 million for 1997 compared with $22.0 million for 1996 and $26.1 million for 1995. Financing activities during these periods included issuance of common stock, dividend payments, short-term 32 borrowings from banks under the Company's credit lines, and issuance and repayments of long-term debt. Cash dividends paid. The Company paid $26.4 million in cash dividends during 1997 (excluding dividends of $3.4 million paid by UCGC in the quarter ended December 31, 1996) compared with $28.5 million in 1996 and $26.2 million in 1995. Prior to the UCGC merger in July 1997, Atmos increased its actual annual dividend rate by $.04 in each of the 3 years presented. Including fiscal 1998, the Company has increased its dividend rate for ten consecutive years. Short-term financing activities. At September 30, 1997, the Company had committed lines of credit totaling $187.0 million, $35.0 million of which was unused, in order to provide for short-term cash requirements. These credit facilities are negotiated at least annually. At September 30, 1997, the Company also had uncommitted short-term credit lines of $170.0 million, of which $159.9 million was unused. During 1997, notes payable increased $38.8 million, after the application of $40.0 million proceeds from the issuance of long-term debt to reduce notes payable, compared with an increase of $62.7 million during 1996 and a decrease of $38.5 million in 1995. The decrease in fiscal 1995 was primarily due to repayment of short-term debt with most of the proceeds from the issuance of $67.0 million of long-term debt. Long-term financing activities. In November 1996, the Company issued $40.0 million of 6.09% unsecured notes due in November 1998 to a bank. The proceeds were used to refinance short-term debt. Long-term debt payments totaled $14.7 million, $20.7 million, and $10.3 million for the years ended September 30, 1997, 1996 and 1995, respectively. The amount for 1997 excludes repayments of $1.4 million by UCGC in the quarter ended December 31, 1996. Payments of long- term debt in 1997 consisted of $9.0 million of installments on the Company's various unsecured Senior Notes, a $2.0 million installment on the 8.69% Series N First Mortgage Bonds, and installments on various term notes and other long-term obligations totaling $3.7 million. Payments of long-term debt in 1996 and 1995 likewise consisted of annual installments under the various loan documents. No long-term debt was issued in 1996. In the first quarter of 1995, the Company entered into note purchase agreements totaling $40.0 million with two insurance companies and issued $20.0 million of unsecured Senior Notes at 8.07% payable in annual installments of $4.0 million beginning October 31, 2002 through October 31, 2006 with semiannual interest payments and $20.0 million of unsecured Senior Notes at 8.26% payable in annual installments of $1,818,182 beginning October 31, 2004 through October 31, 2014 with semiannual interest payments. In 1995 UCGC issued $22.0 million of medium-term notes under a shelf registration statement and a $5.0 million term note for its propane company. The $27.0 million proceeds of these notes were used by UCGC to repay short-term borrowings, retire long-term debt, finance the Company's construction program and for other corporate purposes. 33 The loan agreements pursuant to which the Company's Senior Notes and First Mortgage Bonds have been issued contain covenants by the Company with respect to the maintenance of certain debt-to-equity ratios and cash flows, and restrictions on the payment of dividends. Also see Note 7 of the accompanying notes to consolidated financial statements. UCG Energy and Woodward Marketing, Inc. ("WMI"), sole shareholders of WMLLC, act as guarantors of a $12,500,000 credit facility for WMLLC with a bank. No balance was outstanding on this credit facility at September 30, 1997. UCG Energy and WMI also act as joint and several guarantors on certain purchases of natural gas and transportation services from suppliers by WMLLC. These outstanding obligations amounted to $12.2 million at September 30, 1997. Issuance of common stock. The Company issued 400,578, 995,467 and 2,335,785 shares of common stock in 1997, 1996 and 1995, respectively, for its Direct Stock Purchase Plan, Employee Stock Ownership Plans, Restricted Stock Grant Plan, Outside Directors Stock-for-Fee Plan, a public offering in 1995, acquisitions of Oceana Heights and Monarch Gas Company and an interest in Woodward Marketing LLC. See the Consolidated Statements of Shareholders' Equity for the number of shares issued under each of the plans and for other transactions. Please see Note 9 of the accompanying notes to consolidated financial statements for the number of shares registered and available for future issuance under each of the Company's plans. In November 1995 the Company exchanged 313,411 shares of its common stock valued at approximately $6.4 million in exchange for privately held Oceana Heights Gas Company of Thibodaux, Louisiana. In June 1996, in connection with the acquisition of Monarch Gas Company ("Monarch"), 207,366 shares of UCGC's common stock were exchanged for the common stock of Monarch. The merger added approximately 2,900 natural gas customers in the Vandalia, Illinois area. In May 1995, 320,512 shares of UCGC's common stock valued at $5,000,000 were issued in connection with the purchase of a 45% interest in Woodward Marketing, LLC ("WMLLC") by UCG Energy. In June 1995 UCGC issued 1,380,000 shares of common stock under a shelf registration statement in an underwritten public offering with net proceeds from the sale amounting to approximately $18.9 million. The Company believes that internally generated funds, its credit facilities and access to the public debt and equity capital markets will provide necessary working capital and liquidity for capital expenditures and other cash needs for 1998. 34 Inflation The Company believes that inflation has caused and will continue to cause increases in certain operating expenses and has required and will continue to require assets to be replaced at higher costs. The Company continually reviews the adequacy of its gas rates in relation to the increasing cost of providing service and the inherent regulatory lag in adjusting those gas rates. 35 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page no. Reports of independent auditors 37 Consolidated balance sheets 39 Consolidated statements of income 40 Consolidated statements of shareholders' equity 41 Consolidated statements of cash flows 43 Notes to consolidated financial statements 45 Supplementary data (unaudited) 74 36 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Board of Directors Atmos Energy Corporation We have audited the accompanying consolidated balance sheets of Atmos Energy Corporation at September 30, 1997 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended September 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of United Cities Gas Company, wholly owned by Atmos Energy Corporation (see Note 2), which statements reflect total assets of $513,649,000 as of December 31, 1996 and total revenues of $402,947,000 and $313,735,000 for the years ended December 31, 1996 and 1995. Those statements were audited by other auditors whose report has been furnished to us and our opinion, insofar as it relates to data included for United Cities Gas Company is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Atmos Energy Corporation at September 30, 1997 and 1996, and its consolidated results of operations and its cash flows for each of the three years in the period ended September 30, 1997 in conformity with generally accepted accounting principles. Ernst & Young LLP Dallas, Texas November 11, 1997 37 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To United Cities Gas Company: We have audited the accompanying consolidated balance sheet and consolidated statements of capitalization of United Cities Gas Company (an Illinois corporation) and subsidiaries as of December 31, 1996, and the related consolidated statements of income, retained earnings, capital surplus and common stock and cash flows for each of the two years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Cities Gas Company and subsidiaries as of December 31, 1996, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. Arthur Andersen LLP Nashville, Tennessee February 14, 1997 38 ATMOS ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS September 30, 1997 1996 ---------- ---------- ASSETS (In thousands, except share data) Property, plant and equipment $1,301,004 $1,198,557 Construction in progress 31,668 21,217 ---------- ---------- 1,332,672 1,219,774 Less accumulated depreciation and amort. 483,545 449,563 ---------- ---------- Net property, plant and equipment 849,127 770,211 Current assets Cash and cash equivalents 6,016 11,134 Accounts receivable, less allowance for doubtful accounts of $2,188 in 1997 and $2,462 in 1996 71,217 103,415 Inventories 12,333 13,895 Gas stored underground 48,122 43,350 Prepayments 6,017 2,809 ---------- ---------- Total current assets 143,705 174,603 Deferred charges and other assets 95,479 65,796 ---------- ---------- $1,088,311 $1,010,610 ========== ========== CAPITALIZATION AND LIABILITIES Shareholders' equity Common stock, no par value (stated at $.005 per share); authorized 75,000,000 shares; issued and outstanding 1997 - 29,642,437 shares, 1996 - 29,241,859 shares $ 148 $ 146 Additional paid-in capital 251,174 241,658 Retained earnings 75,938 87,778 ---------- ---------- Total shareholders' equity 327,260 329,582 Long-term debt 302,981 276,162 ---------- ---------- Total capitalization 630,241 605,744 Current liabilities Current maturities of long-term debt 15,201 16,679 Notes payable to banks 167,300 128,488 Accounts payable 62,626 80,321 Taxes payable 416 11,201 Customers' deposits 15,098 16,812 Other current liabilities 52,582 23,866 ---------- ---------- Total current liabilities 313,223 277,367 Deferred income taxes 87,828 72,073 Deferred credits and other liabilities 57,019 55,426 ---------- ---------- $1,088,311 $1,010,610 ========== ========== See accompanying notes to consolidated financial statements. 39 ATMOS ENERGY CORPORATION CONSOLIDATED STATEMENTS OF INCOME Year ended September 30, --------------------------------- 1997 1996 1995 ----------- ---------- -------- (In thousands, except per share data) Operating revenues $906,835 $886,691 $749,555 Purchased gas cost 577,181 562,279 449,397 -------- -------- -------- Gross profit 329,654 324,412 300,158 Operating expenses Operation 173,683 148,196 146,624 Maintenance 11,974 11,719 11,350 Depreciation and amortization 45,257 41,666 40,597 Taxes, other than income 32,131 30,254 29,626 Income taxes 14,298 23,316 16,544 -------- -------- -------- Total operating expenses 277,343 255,151 244,741 -------- -------- -------- Operating income 52,311 69,261 55,417 Other income (expense) Interest and investment income 5,410 3,867 3,290 Other, net (288) (300) 287 -------- -------- -------- Total other income (expense) 5,122 3,567 3,577 Interest charges 33,595 31,677 30,186 -------- -------- -------- Net income $ 23,838 $ 41,151 $ 28,808 ======== ======== ======== Net income per share $.81 $1.42 $1.06 ======== ======== ======== Cash dividends per share $1.01 $.98 $.96 ======== ======== ======== Average shares outstanding 29,409 28,978 27,208 ======== ======== ======== See accompanying notes to consolidated financial statements. 40 ATMOS ENERGY CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Common stock ------------------- Additional Number of Stated paid-in Retained shares value capital earnings ---------- ------- -------- -------- (In thousands, except share data) Balance, September 30, 1994 25,910,607 $130 $196,487 $ 70,967 Net income - - - 28,808 Cash dividends ($.96 per share) - - - (26,197) Common stock issued: Restricted stock grant plan 13,000 - 202 - Direct stock purchase plans 388,484 2 5,832 - ESOP/401(k) plans 233,789 1 4,173 - Woodward Marketing acq. 320,512 2 4,998 - Public offering 1,380,000 6 18,893 - Other - - 45 - ---------- ---- -------- -------- Balance, September 30, 1995 28,246,392 141 230,630 73,578 Net income - - - 41,151 Cash dividends ($.98 per share) - - - (28,478) Common stock issued: Restricted stock grant plan 41,700 1 733 - Direct stock purchase plans 268,124 1 4,563 - Outside directors stock-for-fee plan 3,389 - 76 - ESOP 161,477 1 3,641 - Monarch Gas Co acq. 207,366 1 1,499 933 Oceana Heights acq. 313,411 1 304 594 Other - - 212 - ---------- ---- -------- -------- Balance, September 30, 1996 29,241,859 146 241,658 87,778 (continued) 41 ATMOS ENERGY CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (continued) Common stock ------------------- Additional Number of Stated paid-in Retained shares value capital earnings ---------- ------- -------- -------- (In thousands, except share data) Balance, September 30, 1996 29,241,859 $146 $241,658 $ 87,778 Net income - - - 23,838 Cash dividends ($1.01 per share) - - - (26,415) Common stock issued: Restricted stock grant plan 100,000 1 2,443 - Direct stock purchase plans 85,243 - 1,888 - Outside directors stock-for-fee plan 3,008 - 72 - ESOP/401(k) plans 212,327 1 5,113 - Less: UCGC net income for the quarter ended December 31, 1996 - - - (9,263) ---------- ------- -------- -------- Balance, September 30, 1997 29,642,437 $148 $251,174 $ 75,938 ========== ======= ======== ======== See accompanying notes to consolidated financial statements. 42 ATMOS ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended September 30, -------------------------------- 1997 1996 1995 -------- ---------- ---------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 14,575 $ 41,151 $ 28,808 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization: Charged to depreciation and amortization 39,970 41,666 40,597 Charged to other accounts 2,237 3,580 3,601 Deferred income taxes 5,807 7,585 4,652 Other - (1,866) 293 Change in assets and liabilities: (Increase) decrease in accounts receivable 32,198 (12,697) (9,199) (Increase) decrease in inventories 1,562 (1,238) (827) (Increase) decrease in gas stored underground (4,772) (15,949) 11,707 (Increase) decrease in prepayments (3,208) 1,966 (419) Increase in deferred charges and other assets (29,683) (4,623) (10,832) Increase (decrease) in accounts payable (17,695) 23,796 3,415 Increase (decrease) in taxes payable (837) 7,099 162 Increase (decrease) in customers' deposits (1,714) 592 1,235 Increase (decrease) in other current liabilities 28,716 (4,165) 5,096 Increase in deferred credits and other liabilities 1,593 4,836 854 --------- --------- --------- Net cash provided by operating activities 68,749 91,733 79,143 CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (122,312) (117,589) (103,904) Retirements of property, plant and equipment 1,189 5,708 2,456 --------- --------- --------- Net cash used in investing activities (121,123) (111,881) (101,448) - Continued - 43 ATMOS ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) Year ended September 30, -------------------------------- 1997 1996 1995 -------- ---------- ---------- (In thousands) CASH FLOWS FROM FINANCING ACTIVITIES Net increase (decrease) in notes payable $ 38,812 $ 62,675 $(38,475) Proceeds from issuance of long-term debt 40,000 - 67,000 Repayment of long-term debt (14,659) (20,734) (10,347) Cash dividends paid (26,415) (28,478) (26,197) Issuance of common stock 9,518 8,523 34,109 -------- -------- -------- Net cash provided by financing activities 47,256 21,986 26,090 -------- -------- -------- Net increase (decrease) in cash and cash equivalents (5,118) 1,838 3,785 Cash and cash equivalents at beginning of year 11,134 9,296 5,511 -------- -------- -------- Cash and cash equivalents at end of year $ 6,016 $ 11,134 $ 9,296 ======== ======== ======== See accompanying notes to consolidated financial statements. 44 ATMOS ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Contents of Notes to Consolidated Financial Statements 1. Summary of significant accounting policies 45 2. Business combinations 48 3. Rates 50 4. Income taxes 52 5. Contingencies 54 6. Leases 59 7. Long-term debt and notes payable 60 8. Statement of cash flows supplemental disclosures 62 9. Common stock and stock options 62 10. Employee retirement and stock ownership plans 64 11. Other postretirement benefits 69 Supplementary Data - Quarterly Financial Data (Unaudited) 74 1. Summary of significant accounting policies Description of business - Atmos Energy Corporation and its subsidiaries ("Atmos" or the "Company") are in the business of distributing natural gas to residential, commercial, industrial and agricultural customers within service areas located in Texas, Louisiana, Kentucky, Colorado, Kansas, Illinois, Tennessee, Iowa, Virginia, Georgia, South Carolina and Missouri. Such business is subject to federal and state regulation and/or regulation by local authorities in each of the twelve states in which the Company operates. In connection with the acquisition of United Cities Gas Company (See Note 2), the Company also acquired non-utility businesses operated through UCG Energy Corporation ("UCG Energy") and United Cities Gas Storage Company ("UCG Storage"). They are involved in propane sales and distribution, gas marketing, rental of real estate, equipment and appliances, and natural gas storage services. None of the non-utility operations constitute a material business segment. Principles of consolidation - The accompanying consolidated financial statements include the accounts of Atmos Energy Corporation and its subsidiaries. Each subsidiary is wholly- 45 owned and all material intercompany items have been eliminated. Investments in 50%-or-less owned joint ventures or partnerships are accounted for by the equity method or the cost method, as appropriate. Restatement for pooling of interests - The consolidated financial statements for all prior periods presented have been restated for the pooling of interests of the Company with United Cities Gas Company in July 1997. Certain changes in account classifications have been made to conform United Cities Gas Company's classifications to Atmos' presentation. Regulation - The Company's utility operations are subject to regulation with respect to rates, service, maintenance of accounting records and various other matters by the respective regulatory authorities in the states in which it operates. The consolidated financial statements are based on generally accepted accounting principles. Atmos' accounting policies recognize the financial effects of the ratemaking and accounting practices and policies of the various regulatory commissions.