10-Q 1 d10q.htm FORM 10-Q Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 


FORM 10-Q

 


 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006

OR

 

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM              TO             

 


 

Commission

File

Number

 

Registrant

 

State of

Incorporation

 

IRS Employer

Identification

Number

1-7810   Energen Corporation   Alabama   63-0757759
2-38960   Alabama Gas Corporation   Alabama   63-0022000

 


605 Richard Arrington Jr. Boulevard North

Birmingham, Alabama 35203-2707

Telephone Number 205/326-2700

http://www.energen.com

 


Alabama Gas Corporation, a wholly owned subsidiary of Energen Corporation, meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form with reduced disclosure format pursuant to General Instruction H(2).

Indicate by a check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Act).

 

Energen Corporation

 

Large accelerated filer x

 

Accelerated filer ¨

 

Non-accelerated filer ¨

Alabama Gas Corporation

 

Large accelerated filer ¨

 

Accelerated filer ¨

 

Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Energen Corporation

  

YES  ¨    NO  x

Alabama Gas Corporation    

  

YES  ¨    NO  x

Indicate the number of shares outstanding of each of the issuers’ classes of common stock, as of August 1, 2006.

 

Energen Corporation

  $0.01 par value   72,490,337 shares

Alabama Gas Corporation

  $0.01 par value   1,972,052 shares

 



Table of Contents

ENERGEN CORPORATION AND ALABAMA GAS CORPORATION

FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2006

TABLE OF CONTENTS

 

          Page
   PART I: FINANCIAL INFORMATION   

Item 1.    

  

Financial Statements (Unaudited)

  
  

(a) Consolidated Condensed Statements of Income of Energen Corporation

   3
  

(b) Consolidated Condensed Balance Sheets of Energen Corporation

   4
  

(c) Consolidated Condensed Statements of Cash Flows of Energen Corporation

   6
  

(d) Condensed Statements of Income of Alabama Gas Corporation

   7
  

(e) Condensed Balance Sheets of Alabama Gas Corporation

   8
  

(f) Condensed Statements of Cash Flows of Alabama Gas Corporation

   10
  

(g) Notes to Unaudited Condensed Financial Statements

   11

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   24
  

Selected Business Segment Data of Energen Corporation

   32

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

   33

Item 4.

  

Controls and Procedures

   34
   PART II: OTHER INFORMATION   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   35

Item 6.

  

Exhibits

   35

SIGNATURES

   36

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

ENERGEN CORPORATION

(Unaudited)

 

     Three months ended
June 30,
    Six months ended
June 30,
 

(in thousands, except per share data)

   2006     2005     2006     2005  

Operating Revenues

        

Oil and gas operations

   $ 169,178     $ 134,428     $ 338,697     $ 237,308  

Natural gas distribution

     113,196       107,197       431,819       365,325  
                                

Total operating revenues

     282,374       241,625       770,516       602,633  
                                

Operating Expenses

        

Cost of gas

     57,831       50,424       251,881       187,279  

Operations and maintenance

     78,401       66,904       152,884       127,309  

Depreciation, depletion and amortization

     34,499       33,101       68,796       64,526  

Taxes, other than income taxes

     21,433       19,794       54,112       46,344  

Accretion expense

     912       654       1,810       1,297  
                                

Total operating expenses

     193,076       170,877       529,483       426,755  
                                

Operating Income

     89,298       70,748       241,033       175,878  
                                

Other Income (Expense)

        

Interest expense

     (12,366 )     (11,524 )     (25,543 )     (23,194 )

Other income

     255       517       962       870  

Other expense

     (272 )     (268 )     (501 )     (536 )
                                

Total other expense

     (12,383 )     (11,275 )     (25,082 )     (22,860 )
                                

Income From Continuing Operations Before Income Taxes

     76,915       59,473       215,951       153,018  

Income tax expense

     27,313       21,900       78,848       56,503  
                                

Income From Continuing Operations

     49,602       37,573       137,103       96,515  
                                

Discontinued Operations, net of taxes

        

Income (loss) from discontinued operations

     (1 )     13       (8 )     (6 )

Gain (loss) on disposal of discontinued operations

     —         (13 )     —         110  
                                

Income (Loss) From Discontinued Operations

     (1 )     —         (8 )     104  
                                

Net Income

   $ 49,601     $ 37,573     $ 137,095     $ 96,619  
                                

Diluted Earnings Per Average Common Share

        

Continuing operations

   $ 0.67     $ 0.51     $ 1.85     $ 1.31  

Discontinued operations

     —         —         —         —    
                                

Net Income

   $ 0.67     $ 0.51     $ 1.85     $ 1.31  
                                

Basic Earnings Per Average Common Share

        

Continuing operations

   $ 0.68     $ 0.51     $ 1.87     $ 1.32  

Discontinued operations

     —         —         —         —    
                                

Net Income

   $ 0.68     $ 0.51     $ 1.87     $ 1.32  
                                

Dividends Per Common Share

   $ 0.11     $ 0.10     $ 0.22     $ 0.20  
                                

Diluted Average Common Shares Outstanding

     73,902       73,782       73,978       73,726  
                                

Basic Average Common Shares Outstanding

     73,028       73,017       73,148       72,985  
                                

The accompanying notes are an integral part of these condensed financial statements.

 

3


Table of Contents

CONSOLIDATED CONDENSED BALANCE SHEETS

ENERGEN CORPORATION

(Unaudited)

 

(in thousands)

   June 30,
2006
   December 31,
2005

ASSETS

     

Current Assets

     

Cash and cash equivalents

   $ 11,551    $ 8,714

Accounts receivable, net of allowance for doubtful accounts of $14,970 at June 30, 2006, and $11,573 at December 31, 2005

     132,990      285,765

Inventories, at average cost

     

Storage gas inventory

     72,069      71,179

Materials and supplies

     8,703      7,926

Liquified natural gas in storage

     3,548      3,795

Regulatory asset

     10,352      6,633

Deferred income taxes

     36,565      72,113

Prepayments and other

     27,098      22,366
             

Total current assets

     302,876      478,491
             

Property, Plant and Equipment

     

Oil and gas properties, successful efforts method

     2,021,905      1,930,291

Less accumulated depreciation, depletion and amortization

     512,226      466,643
             

Oil and gas properties, net

     1,509,679      1,463,648
             

Utility plant

     1,034,451      999,011

Less accumulated depreciation

     413,347      401,232
             

Utility plant, net

     621,104      597,779
             

Other property, net

     9,118      6,584
             

Total property, plant and equipment, net

     2,139,901      2,068,011
             

Other Assets

     

Regulatory asset

     33,756      33,436

Deferred charges and other

     38,133      38,288
             

Total other assets

     71,889      71,724
             

TOTAL ASSETS

   $ 2,514,666    $ 2,618,226
             

The accompanying notes are an integral part of these condensed financial statements.

 

4


Table of Contents

CONSOLIDATED CONDENSED BALANCE SHEETS

ENERGEN CORPORATION

(Unaudited)

 

(in thousands, except share and per share data)

   June 30,
2006
    December 31,
2005
 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Current Liabilities

    

Long-term debt due within one year

   $ 15,000     $ 15,000  

Notes payable to banks

     54,000       153,000  

Accounts payable

     136,618       306,618  

Accrued taxes

     65,044       44,324  

Customers’ deposits

     19,543       20,767  

Amounts due customers

     2,150       6,181  

Accrued wages and benefits

     22,234       33,634  

Regulatory liability

     9,380       53,496  

Other

     54,170       55,289  
                

Total current liabilities

     378,139       688,309  
                

Long-term debt

     682,981       683,236  
                

Deferred Credits and Other Liabilities

    

Asset retirement obligation

     51,522       50,270  

Accrued benefit liability

     18,038       15,739  

Regulatory liability

     124,427       119,808  

Deferred income taxes

     174,800       148,040  

Other

     40,664       20,146  
                

Total deferred credits and other liabilities

     409,451       354,003  
                

Commitments and Contingencies

    
                

Shareholders’ equity

    

Preferred stock, $0.01 par value, 5,000,000 shares authorized

     —         —    

Common shareholders’ equity

    

Common stock, $0.01 par value; 150,000,000 shares authorized, 73,543,205 shares issued at June 30, 2006, and 73,493,337 shares issued at December 31, 2005

     735       735  

Premium on capital stock

     407,191       394,861  

Capital surplus

     2,802       2,802  

Retained earnings

     724,245       603,314  

Accumulated other comprehensive loss, net of tax

    

Unrealized loss on hedges

     (40,052 )     (92,112 )

Minimum pension liability

     (13,707 )     (13,707 )

Deferred compensation on restricted stock

     (1,925 )     (2,123 )

Deferred compensation plan

     11,601       11,907  

Treasury stock, at cost (2,012,032 shares at June 30, 2006, and 1,066,935 shares at December 31, 2005)

     (46,795 )     (12,999 )
                

Total shareholders’ equity

     1,044,095       892,678  
                

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 2,514,666     $ 2,618,226  
                

The accompanying notes are an integral part of these condensed financial statements.

 

5


Table of Contents

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

ENERGEN CORPORATION

(Unaudited)

 

Six months ended June 30, (in thousands)

   2006     2005  

Operating Activities

    

Net income

   $ 137,095     $ 96,619  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation, depletion and amortization

     68,796       64,554  

Deferred income taxes

     30,390       30,356  

Change in derivative fair value

     841       8,702  

Gain on sale of assets

     (60 )     (1,455 )

Other, net

     9,025       3,572  

Net change in:

    

Accounts receivable, net

     133,120       65,861  

Inventories

     (1,420 )     (984 )

Accounts payable

     (66,014 )     (25,131 )

Amounts due customers

     (28,492 )     1,271  

Other current assets and liabilities

     1,381       9,927  
                

Net cash provided by operating activities

     284,662       253,292  
                

Investing Activities

    

Additions to property, plant and equipment

     (129,369 )     (116,475 )

Acquisitions, net of cash acquired

     (3,942 )     (5,820 )

Proceeds from sale of assets

     76       10,187  

Other, net

     (1,077 )     (484 )
                

Net cash used in investing activities

     (134,312 )     (112,592 )
                

Financing Activities

    

Payment of dividends on common stock

     (16,164 )     (14,650 )

Issuance of common stock

     130       2,880  

Purchase of treasury stock

     (33,050 )     (1,128 )

Reduction of long-term debt

     (330 )     (35 )

Proceeds from issuance of long-term debt

     —         80,000  

Debt issuance costs

     —         (1,858 )

Net change in short-term debt

     (99,000 )     (135,000 )

Other

     901       —    
                

Net cash used in financing activities

     (147,513 )     (69,791 )
                

Net change in cash and cash equivalents

     2,837       70,909  

Cash and cash equivalents at beginning of period

     8,714       4,489  
                

Cash and Cash Equivalents at End of Period

   $ 11,551     $ 75,398  
                

The accompanying notes are an integral part of these condensed financial statements.

 

6


Table of Contents

CONDENSED STATEMENTS OF INCOME

ALABAMA GAS CORPORATION

(Unaudited)

 

     Three months ended
June 30,
    Six months ended
June 30,
 

(in thousands)

   2006     2005     2006     2005  

Operating Revenues

   $ 113,196     $ 107,197     $ 431,819     $ 365,325  
                                

Operating Expenses

        

Cost of gas

     57,831       50,937       251,881       188,313  

Operations and maintenance

     33,387       32,262       64,266       60,088  

Depreciation

     10,933       10,643       21,679       21,056  

Income taxes

        

Current

     1,670       1,900       25,833       27,166  

Deferred, net

     (2,047 )     (703 )     (3,491 )     (2,170 )

Taxes, other than income taxes

     8,334       7,725       27,555       23,834  
                                

Total operating expenses

     110,108       102,764       387,723       318,287  
                                

Operating Income

     3,088       4,433       44,096       47,038  
                                

Other Income (Expense)

        

Allowance for funds used during construction

     255       188       478       373  

Other income

     198       476       671       697  

Other expense

     (265 )     (260 )     (494 )     (525 )
                                

Total other income

     188       404       655       545  
                                

Interest Charges

        

Interest on long-term debt

     3,246       3,559       6,483       6,972  

Other interest expense

     561       205       1,430       534  
                                

Total interest charges

     3,807       3,764       7,913       7,506  
                                

Net Income (Loss)

   $ (531 )   $ 1,073     $ 36,838     $ 40,077  
                                

The accompanying notes are an integral part of these condensed financial statements.

 

7


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CONDENSED BALANCE SHEETS

ALABAMA GAS CORPORATION

(Unaudited)

 

(in thousands)

   June 30,
2006
    December 31,
2005
 

ASSETS

    

Property, Plant and Equipment

    

Utility plant

   $ 1,034,451     $ 999,011  

Less accumulated depreciation

     413,347       401,232  
                

Utility plant, net

     621,104       597,779  
                

Other property, net

     166       169  
                

Current Assets

    

Cash and cash equivalents

     3,592       7,169  

Accounts receivable

    

Gas

     73,421       194,447  

Other

     4,837       7,524  

Affiliated companies

     2,293       3,215  

Allowance for doubtful accounts

     (14,200 )     (10,800 )

Inventories, at average cost

    

Storage gas inventory

     72,069       71,179  

Materials and supplies

     4,191       4,144  

Liquified natural gas in storage

     3,548       3,795  

Deferred income taxes

     15,917       13,284  

Regulatory asset

     10,352       6,633  

Prepayments and other

     13,258       11,203  
                

Total current assets

     189,278       311,793  
                

Other Assets

    

Regulatory asset

     33,756       33,436  

Deferred charges and other

     6,761       6,857  
                

Total other assets

     40,517       40,293  
                

TOTAL ASSETS

   $ 851,065     $ 950,034  
                

The accompanying notes are an integral part of these condensed financial statements.

 

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CONDENSED BALANCE SHEETS

ALABAMA GAS CORPORATION

(Unaudited)

 

(in thousands, except share data)

   June 30,
2006
   December 31,
2005

LIABILITIES AND CAPITALIZATION

     

Capitalization

     

Preferred stock, $0.01 par value, 120,000 shares authorized

   $ —      $ —  

Common shareholder’s equity

     

Common stock, $0.01 par value; 3,000,000 shares authorized, 1,972,052 shares issued at June 30, 2006 and December 31, 2005

     20      20

Premium on capital stock

     31,682      31,682

Capital surplus

     2,802      2,802

Retained earnings

     258,547      236,957
             

Total common shareholder’s equity

     293,051      271,461

Long-term debt

     209,324      209,654
             

Total capitalization

     502,375      481,115
             

Current Liabilities

     

Long-term debt due within one year

     5,000      5,000

Notes payable to banks

     25,000      55,000

Accounts payable

     53,607      112,443

Accrued taxes

     46,229      32,770

Customers’ deposits

     19,543      20,767

Amounts due customers

     2,150      6,181

Accrued wages and benefits

     8,115      11,449

Regulatory liability

     9,380      53,496

Other

     11,076      8,694
             

Total current liabilities

     180,100      305,800
             

Deferred Credits and Other Liabilities

     

Deferred income taxes

     39,102      39,949

Accrued benefit liability

     1,658      —  

Regulatory liability

     124,427      119,808

Other

     3,403      3,362
             

Total deferred credits and other liabilities

     168,590      163,119
             

Commitments and Contingencies

     
             

TOTAL LIABILITIES AND CAPITALIZATION

   $ 851,065    $ 950,034
             

The accompanying notes are an integral part of these condensed financial statements.

 

9


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CONDENSED STATEMENTS OF CASH FLOWS

ALABAMA GAS CORPORATION

(Unaudited)

 

Six months ended June 30, (in thousands)

   2006     2005  

Operating Activities

    

Net income

   $ 36,838     $ 40,077  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     21,679       21,056  

Deferred income taxes

     (3,491 )     (2,170 )

Other, net

     3,208       2,061  

Net change in:

    

Accounts receivable

     107,459       64,580  

Inventories

     (691 )     (1,125 )

Accounts payable

     (62,555 )     (34,286 )

Amounts due customers

     (28,492 )     1,271  

Other current assets and liabilities

     7,971       17,446  
                

Net cash provided by operating activities

     81,926       108,910  
                

Investing Activities

    

Additions to property, plant and equipment

     (39,911 )     (35,484 )

Other, net

     (936 )     (520 )
                

Net cash used in investing activities

     (40,847 )     (36,004 )
                

Financing Activities

    

Dividends

     (15,248 )     (14,642 )

Reduction of long-term debt

     (330 )     (35 )

Proceeds from issuance of long-term debt

     —         80,000  

Debt issuance costs

     —         (1,708 )

Net advances to affiliates

     922       498  

Net change in short-term debt

     (30,000 )     (82,000 )
                

Net cash used in financing activities

     (44,656 )     (17,887 )
                

Net change in cash and cash equivalents

     (3,577 )     55,019  

Cash and cash equivalents at beginning of period

     7,169       3,467  
                

Cash and Cash Equivalents at End of Period

   $ 3,592     $ 58,486  
                

The accompanying notes are an integral part of these condensed financial statements.

 

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NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS ENERGEN CORPORATION AND ALABAMA GAS CORPORATION

1. BASIS OF PRESENTATION

The unaudited condensed financial statements and notes should be read in conjunction with the financial statements and notes thereto for the years ended December 31, 2005, 2004 and 2003 included in the 2005 Annual Report of Energen Corporation (the Company) and Alabama Gas Corporation (Alagasco) on Form 10-K. Alagasco has a September 30 fiscal year for rate-setting purposes (rate year) and reports on a calendar year for the Securities and Exchange Commission and all other financial accounting reporting purposes. The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the disclosures required for complete financial statements. The Company’s natural gas distribution business is seasonal in character and influenced by weather conditions. Results of operations for interim periods are not necessarily indicative of the results that may be expected for the year.

The quarterly information reflects the application of Statement of Financial Accounting Standard (SFAS) No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 requires that gains and losses from the sale of certain oil and gas properties and writedowns of certain properties held-for-sale be reported as discontinued operations, with income or loss from operations of the associated properties reported as income or loss from discontinued operations in the current and prior periods. All other adjustments to the unaudited financial statements that are, in the opinion of management, necessary for a fair statement of the results for the interim periods have been recorded. Such adjustments consisted of normal recurring items. Certain reclassifications were made to conform prior years’ financial statements to the current-quarter presentation.

2. STOCK-BASED COMPENSATION

The Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R), using the modified prospective application method for new awards effective January 1, 2006. The Company previously adopted the fair value recognition provisions of SFAS No. 123 as amended, “Accounting for Stock-Based Compensation,” prospectively for stock-based compensation effective January 1, 2003. As a result, the adoption of SFAS No. 123R did not have a significant impact to the Company since the expensing provisions were voluntarily adopted in 2003.

SFAS No. 123R requires that all share-based compensation awards be measured at fair value at the date of grant and expensed over the requisite vesting period. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if the actual forfeitures differ from those estimates. Prior to the adoption of SFAS No. 123R, the Company accounted for forfeitures upon occurrence. This change in method did not have a significant impact to the Company upon adoption of SFAS No. 123R.

The Company previously recognized all stock-based employee compensation expense over the stated vesting periods for each award. For awards granted prior to January 1, 2006, the Company recorded any unrecognized expense on the date of an employee’s retirement. For new awards granted to retirement eligible employees effective January 1, 2006, the Company began recognizing the entire compensation expense in the period of grant. If this method of expense recognition had been applied to all awards, compensation expense would have been reduced during the three months ended June 30, 2006 and 2005, by approximately $0.9 million and $0.3 million, respectively. For the year-to-date ended June 30, 2006 and 2005, compensation expense recognized by this method would have been reduced by $1.8 million and $0.7 million, respectively. The Company utilized the long-form method of calculating the available pool of windfall tax benefit. For the three months and six months ended June 30, 2006, the Company recognized a tax benefit of $0.1 million and $0.9 million, respectively, related to its stock-based compensation.

The following table illustrates the effect on net income and diluted and basic earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123, superseded by SFAS No. 123R, for the three months and six months ended June 30, 2005, to all outstanding and unvested employee share-based awards:

 

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(in thousands, except per share data)

  

Three months ended

June 30, 2005

   

Six months ended

June 30, 2005

 

Net income

   $ 37,573     $ 96,619  

As reported

    

Stock-based compensation expense included in reported net income, net of tax

     1,924       3,692  

Stock-based compensation expense determined under the fair value based method, net of tax

     (1,546 )     (3,002 )
                

Pro forma

   $ 37,951     $ 97,309  
                

Diluted earnings per average common share

    

As reported

   $ 0.51     $ 1.31  

Pro forma

   $ 0.51     $ 1.32  

Basic earnings per average common share

    

As reported

   $ 0.51     $ 1.32  

Pro forma

   $ 0.52     $ 1.33  

1997 Stock Incentive Plan and 1988 Stock Option Plan:

Performance Share Awards: The Energen 1997 Stock Incentive Plan provided for the grant of performance share awards, with each unit equal to the market value of one share of common stock, to eligible employees based on predetermined Company performance criteria at the end of a four-year award period. This criteria is considered a market condition as defined by SFAS No. 123R. On January 25, 2006, the Company amended its 1997 Stock Incentive Plan to provide that payment of earned performance share awards be made in the form of Company common stock, with no portion of an award paid in cash. This amendment affected 29 participants. Prior to the amendment, payment of performance awards could be made in cash or in a combination of Company common stock or cash. The impact of this modification was not significant to the Company.

1997 Stock Incentive Plan performance share awards granted or modified after the adoption of SFAS No. 123R have been valued in a Monte Carlo model. The Monte Carol model uses historical volatility and other variables to estimate the probability of satisfying the market condition of the award. For performance share awards granted prior to the adoption of SFAS No. 123R, the Company estimated fair value based on the quoted market price of the Company’s common stock and adjusted each period for the expected payout ratio.

A summary of performance share award activity as of June 30, 2006, and transactions during the six months then ended, is presented below:

 

     1997 Stock Incentive Plan
     Shares     Weighted Average
Price

Nonvested at December 31, 2005

   477,720     $ 40.26

Granted

   111,990       43.81

Forfeitures

   (847 )     43.81
            

Nonvested at June 30, 2006

   588,863     $ 40.27
            

The Company recorded expense of $2,179,000 and $2,150,000 for the three months ended June 30, 2006 and 2005, respectively, for performance share awards with a related deferred income tax benefit of $824,000 and $813,000, respectively. For the year-to-date ended June 30, 2006 and 2005, the Company recorded $4,246,000 and $4,125,000, respectively, for performance share awards with a related deferred income tax benefit of $1,605,000 and $1,560,000, respectively. As of June 30, 2006, there was $4.3 million of total unrecognized compensation cost related to performance share awards. These awards have a weighted average requisite service period of 1.19 years from the date of grant.

Stock Options: The 1997 Stock Incentive Plan and the Energen 1988 Stock Option Plan provided for the grant of incentive stock options, non-qualified stock options, or a combination thereof to officers and key employees. Options granted under the Plans provide for the purchase of Company common stock at not less than the fair market value on the date the option is granted. The sale or transfer of the shares is limited during certain periods.

 

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Under the 1988 Stock Option Plan, 1,080,000 shares of Company common stock reserved for issuance have been granted. Under the 1997 Stock Incentive Plan, 5,600,000 shares of Company common stock were reserved for issuance with 2,006,055 remaining for issuance as of June 30, 2006. All outstanding options are incentive or non-qualified, vest within three years from date of grant, and expire 10 years from the grant date.

A summary of stock option activity as of June 30, 2006, and transactions during the six months then ended, is presented below:

 

     1997 Stock Incentive Plan    1988 Stock Option Plan
     Shares     Weighted Average
Exercise Price
   Shares     Weighted Average
Exercise Price

Outstanding at December 31, 2005

   613,400     $ 14.04    28,000     $ 9.13

Exercised

   (24,440 )     13.08    (6,000 )     9.13
                         

Outstanding at June 30, 2006

   588,960     $ 14.08    22,000     $ 9.13
                         

Exercisable at June 30, 2006

   506,200     $ 12.78    22,000     $ 9.13
                         

The Company used the Black-Scholes pricing model to calculate the fair values of the options awarded. Option awards were granted with an exercise price equal to the market price of the Company’s stock on the date of grant. For purposes of this valuation the following assumptions were used to derive the fair values: a seven-year option life based on historical experience; an annualized volatility rate, based on historical volatility, of 32.72 percent and 34.67 percent for the years ended December 31, 2004 and 2003, respectively; a risk-free interest rate of 3.64 percent and 2.36 percent for the years ended December 31, 2004 and 2003, respectively; and a dividend yield of 1.81 percent on options without dividend equivalents for the year ended December 31, 2004. Options with dividend equivalents assume no dividend yield for all periods presented. The weighted-average grant-date fair value for options granted without dividend equivalents during the year ended December 31, 2004 was $7.11. The weighted-average grant-date fair value for options granted with dividend equivalents during the year ended December 31, 2003 was $6.05. There were no options granted during 2006 or 2005. The Company recorded expense of $49,000 and $116,000 during the three months ended June 30, 2006 and 2005, respectively, for options with a related deferred income tax benefit of $10,000 and $26,000, respectively. For the year-to-date ended June 30, 2006 and 2005, the Company recorded expense of $98,000 and $233,000, respectively, for options with a related deferred income tax benefit of $20,000 and $53,000, respectively.

The total intrinsic value of stock options exercised during the three months and the six months ended June 30, 2006, was $237,000 and $250,000, respectively. During the three months and the six months ended June 30, 2006, the total intrinsic value of stock appreciation rights exercised was $146,000 and $462,000, respectively. During the six months ended June 30, 2006, the Company received cash of $102,000 from the exercise of stock options and paid $462,000 in settlement of stock appreciation rights. Total intrinsic value for outstanding options as of June 30, 2006, was $14.9 million and $13.5 million for exercisable options. The fair value of options vested during the year-to-date ended June 30, 2006 was $3.3 million. As of June 30, 2006, there was $98,000 of unrecognized compensation cost related to outstanding nonvested stock options, all of which will be recognized during 2006.

The following table summarizes options outstanding as of June 30, 2006:

 

1997 Stock Incentive Plan

  

1988 Stock Option Plan

Range of

Exercise Prices

   Shares   

Weighted Average
Remaining

Contractual Life

  

Range of
Exercise Prices

   Shares   

Weighted Average
Remaining

Contractual Life

$9.13-$9.41

                       96,224                    2.49 years    $9.13                        22,000                    1.42 years

$13.72

   122,000    4.33 years    —      —      —  

$11.32

   69,516    5.33 years    —      —      —  

$14.86

   218,460    6.58 years    —      —      —  

$21.38

   82,760    7.58 years    —      —      —  
                          

$9.13-$21.38

   588,960    5.44 years    $9.13    22,000    1.42 years
                          

The weighted average remaining contractual life of currently exercisable stock options is 4.94 years as of June 30, 2006.

 

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Restricted Stock: In addition, the 1997 Stock Incentive Plan provided for the grant of restricted stock which have been valued based on the quoted market price of the Company’s common stock at the date of grant. A summary of restricted stock activity as of June 30, 2006, and transactions during the six months then ended is presented below:

 

     1997 Stock Incentive Plan
     Shares    

Weighted Average

Price

Nonvested at December 31, 2005

   242,444     $ 20.48

Granted

   23,500       38.11

Vested

   (69,764 )     18.30
            

Nonvested at June 30, 2006

   196,180     $ 23.36
            

The Company recorded expense of $357,000 and $452,000 for the three months ended June 30, 2006 and 2005, respectively, related to restricted stock, with a related deferred income tax benefit of $135,000 and $171,000, respectively. For the year-to-date ended June 30, 2006 and 2005, the Company recorded expense of $1,094,000 and $903,000, respectively, related to restricted stock, with a related deferred income tax benefit of $414,000 and $341,000, respectively. As of June 30, 2006, there was $1.9 million of total unrecognized compensation cost related to nonvested restricted stock awards. These awards have a requisite service period of 1.41 years from the date of grant. The Company has typically funded options, restricted stock obligations and performance share obligations through original issue shares.

2004 Stock Appreciation Rights Plan: The Energen 2004 Stock Appreciation Rights Plan provided for the payment of cash incentives measured by the long-term appreciation of Company stock. These awards are liability awards which settle in cash and are re-measured each reporting period until settlement. These awards have a three year requisite service period. Awards granted prior to January 1, 2006 were valued using the intrinsic value method. There were no awards granted in 2006 or 2005. For the three months ended June 30, 2006 and 2005, the Company recorded expense of $123,000 and $341,000, respectively, associated with stock appreciation rights. For the year-to-date ended June 30, 2006 and 2005, the Company recorded expense of $117,000 and $609,000, respectively, associated with stock appreciation rights.

2005 Petrotech Incentive Plan: The Energen Resources’ 2005 Petrotech Incentive Plan provided for the grant of restricted stock units which may include market conditions. These awards are liability awards which settle in cash and are re-measured each reporting period until settlement. Effective January 1, 2006, the fair value of the restricted stock units with a market condition was calculated using a Monte Carlo approach. Restricted stock units with service conditions were valued based on the Company’s stock price at the end of the period adjusted to remove the present value of future dividends. Prior to the implementation of SFAS 123R, these awards were valued using the Company’s common stock price at each period end.

During 2006, Energen Resources awarded 26,440 performance units of which 22,905 included a market condition. Energen Resources awarded 23,460 performance units in 2005 of which 11,730 included a market condition. The Company recognized expense of $25,000 and $270,000 during the three months and six months ended June 30, 2006, respectively, related to these performance units.

1997 Deferred Compensation Plan: The 1997 Deferred Compensation Plan allowed officers and non-employee directors to defer certain compensation. Amounts deferred by a participant under the 1997 Deferred Compensation Plan are credited to accounts maintained for a participant in either a stock account or an investment account. The stock account tracks the performance of the Company’s common stock, including reinvestment of dividends. The investment account tracks the performance of certain mutual funds. The Company has funded, and presently plans to continue funding, a trust in a manner that generally tracks participants’ accounts under the 1997 Deferred Compensation Plan. While intended for payment of benefits under the 1997 Deferred Compensation Plan, the trust’s assets remain subject to the claims of the Company’s creditors. Amounts earned under the Deferred Compensation Plan and invested in Company common stock held by the trust have been recorded as treasury stock, along with the related deferred compensation obligation in the Consolidated Statements of Shareholders’ Equity.

Shareholder Rights Plan: On June 24, 1998, the Company adopted a Shareholder Rights Plan (the 1998 Plan) designed to protect shareholders from coercive or unfair takeover tactics. Under certain circumstances, the 1998

 

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Plan provides shareholders with the right to acquire the Company’s Series 1998 Junior Participating Preferred Stock (or, in certain cases, securities of an acquiring person) at a significant discount. Terms and conditions are set forth in a Rights Agreement between the Company and its Rights Agent. Under the 1998 Plan, one half of a right is associated with each outstanding share of common stock. Rights outstanding under the 1998 Plan at December 31, 2005, were convertible into 734,933 shares of Series 1998 Junior Participating Preferred Stock (1/100 share of preferred stock for each full right) subject to adjustment upon occurrence of certain take-over related events. No rights were exercised or exercisable during the period. The price at which the rights would be exercised is $35 per right, subject to adjustment upon occurrence of certain take-over related events. In general, absent certain take-over related events as described in the Plan, the rights may be redeemed prior to the July 27, 2008 expiration for $0.01 per right.

3. REGULATORY

All of Alagasco’s utility operations are conducted in the state of Alabama. Alagasco is subject to regulation by the Alabama Public Service Commission (APSC) which established the Rate Stabilization and Equalization (RSE) rate-setting process in 1983. RSE was extended with modifications in 2002, 1996, 1990, 1987 and 1985. On June 10, 2002, the APSC extended Alagasco’s rate-setting methodology, RSE, without change, for a six-year period through January 1, 2008. Under the terms of that extension, RSE will continue after January 1, 2008, unless, after notice to the Company and a hearing, the Commission votes to either modify or discontinue its operations. Alagasco is on a September 30 fiscal year for rate-setting purposes (rate year) and reports on a calendar year for the Securities and Exchange Commission and all other financial accounting reporting purposes. Alagasco’s allowed range of return on average equity remains 13.15 percent to 13.65 percent throughout the term of the order, subject to change in the event that the Commission, following a generic rate of return hearing, adjusts the equity returns of all major energy utilities operating under a similar methodology. Under RSE, the APSC conducts quarterly reviews to determine, based on Alagasco’s projections and year-to-date performance, whether Alagasco’s return on average equity at the end of the rate year will be within the allowed range of return. Reductions in rates can be made quarterly to bring the projected return within the allowed range; increases, however, are allowed only once each rate year, effective December 1, and cannot exceed 4 percent of prior-year revenues. As of September 30, 2005, Alagasco had a $3.3 million reduction in revenues to bring the return on average equity to midpoint within the allowed range of return. A $15.8 million and a $12.3 million annual increase in revenues became effective December 1, 2005 and 2004, respectively. RSE limits the utility’s equity upon which a return is permitted to 60 percent of total capitalization and provides for certain cost control measures designed to monitor Alagasco’s operations and maintenance (O&M) expense. Under the inflation-based cost control measurement established by the APSC, if the percentage change in O&M expense per customer falls within a range of 1.25 points above or below the percentage change in the Consumer Price Index For All Urban Consumers (index range), no adjustment is required. If the change in O&M expense per customer exceeds the index range, three-quarters of the difference is returned to customers. To the extent the change is less than the index range, the utility benefits by one-half of the difference through future rate adjustments. Alagasco’s O&M expense fell within the index range for the rate year ended September 30, 2005.

Alagasco calculates a temperature adjustment to customers’ monthly bills to substantially remove the effect of departures from normal temperatures on Alagasco’s earnings. Adjustments to customers’ bills are made in the same billing cycle in which the weather variation occurs. The temperature adjustment applies primarily to residential, small commercial and small industrial customers. This adjustment, however, is subject to certain limitations including regulatory limits on adjustments to increase customers’ bills, the impact of non-temperature weather conditions such as wind velocity or cloud cover and the impact of any elasticity of demand as a result of high commodity prices. Alagasco’s rate schedules for natural gas distribution charges contain a Gas Supply Adjustment (GSA) rider, established in 1993, which permits the pass-through to customers of changes in the cost of gas supply.

4. DERIVATIVE COMMODITY INSTRUMENTS

Energen Resources Corporation, Energen’s oil and gas subsidiary, periodically enters into derivative commodity instruments that qualify as cash flow hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” to hedge its exposure to price fluctuations on oil, natural gas and natural gas liquids production. In addition, Alagasco periodically enters into cash flow derivative commodity instruments to hedge its exposure to price fluctuations on its gas supply. Such instruments may include regulated natural gas and crude oil

 

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futures contracts traded on the New York Mercantile Exchange (NYMEX) and over-the-counter swaps, collars and basis hedges with major energy derivative product specialists. The counterparties to the commodity instruments are investment banks and energy-trading firms. In some contracts, the amount of credit allowed before collateral must be posted for out-of-the-money hedges varies depending on the credit rating of the Company or Alagasco. In cases where this arrangement exists, generally the credit ratings must be maintained at investment grade status to have any available counterparty credit. Adverse changes to the Company’s or Alagasco’s credit rating results in decreasing amounts of credit available under these contracts. The counterparties for these contracts do not extend credit to the Company or Alagasco in the event credit ratings are below investment grade. At June 30, 2006, Energen Resources was in a net loss position with all counterparties but was not required to post collateral. Energen Resources used various counterparties for its over-the-counter derivatives as of June 30, 2006. The Company believes the creditworthiness of these counterparties is satisfactory.

Energen Resources applies SFAS No. 133 which requires all derivatives to be recognized on the balance sheet and measured at fair value. If a derivative is designated as a cash flow hedge, the effectiveness of the hedge, or the degree that the gain (loss) for the hedging instrument offsets the loss (gain) on the hedged item is measured at each reporting period. The effective portion of the gain or loss on the derivative instrument is recognized in other comprehensive income (OCI) as a component of equity and subsequently reclassified into earnings as operating revenues when the forecasted transaction affects earnings. The ineffective portion of a derivative’s change in fair value is required to be recognized in operating revenues immediately. Derivatives that do not qualify for hedge treatment under SFAS No. 133 must be recorded at fair value with gains or losses recognized in operating revenues in the period of change.

As of June 30, 2006, $20 million, net of tax, of deferred net losses on derivative instruments recorded in accumulated other comprehensive income are expected to be reclassified to operating revenues during the next 12-month period. The actual amount that will be reclassified to earnings over the next year could vary materially from this amount due to changes in market conditions. Gains and losses on derivative instruments that are not accounted for as cash flow hedge transactions, as well as the ineffective portion of the change in fair value of derivatives accounted for as cash flow hedges, are included in operating revenues in the consolidated financial statements. For the ineffective portion of the change in fair value of derivatives accounted for as cash flow hedges, Energen Resources recorded a $0.4 million after-tax gain for the three months ended June 30, 2006, and a $1.3 million after-tax loss year-to-date. As of June 30, 2006, all of the Company’s hedges met the definition of a cash flow hedge. The Company had $24.5 million and $56.5 million included in current and noncurrent deferred income taxes on the consolidated balance sheets related to derivative items included in OCI as of June 30, 2006 and December 31, 2005, respectively. At June 30, 2006, and December 31, 2005, the Company had $39.8 million and $145.9 million, respectively, of current losses recorded in accounts payable and $32.6 million and $11.9 million, respectively, of non-current losses recorded in deferred credits and other liabilities related to derivative contracts. The Company also had $1.6 million of current gains recorded in prepayments and other related to derivative contracts as of June 30, 2006.

Energen Resources entered into the following transactions for the remainder of 2006 and subsequent years:

 

Production

Period

  

Total Hedged

Volumes

  

Average Contract

Price

  

Description

Natural Gas

2006

     8.0 Bcf    $8.05 Mcf    NYMEX Swaps
   10.8 Bcf    $6.46 Mcf    Basin Specific Swaps

2007

     8.0 Bcf    $9.48 Mcf    NYMEX Swaps
   22.1 Bcf    $8.11 Mcf    Basin Specific Swaps

Oil

2006

   1,395 MBbl    $52.68 Bbl    NYMEX Swaps

2007

   2,716 MBbl    $70.01 Bbl    NYMEX Swaps

2008

   1,500 MBbl    $63.86 Bbl    NYMEX Swaps

2009

      900 MBbl    $56.25 Bbl    NYMEX Swaps

Oil Basis Differential

2006

      946 MBbl    *    Basis Swaps

2007

   1,768 MBbl    *    Basis Swaps

2008

      600 MBbl    *    Basis Swaps

Natural Gas Liquids

2006

         15.1 MMGal    $0.56 Gal    Liquids Swaps

2007

         10.1 MMGal    $0.80 Gal    Liquids Swaps

*

Average contract prices are not meaningful due to the varying nature of each contract.

 

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All hedge transactions are subject to the Company’s risk management policy, approved by the Board of Directors, which does not permit speculative positions. The Company formally documents all relationships between hedging instruments and hedged items at the inception of the hedge, as well as its risk management objective and strategy for undertaking the hedge. This process includes specific identification of the hedging instrument and the hedge transaction, the nature of the risk being hedged and how the hedging instrument’s effectiveness in hedging the exposure to the hedged transaction’s variability in cash flows attributable to the hedged risk will be assessed and measured. Both at the inception of the hedge and on an ongoing basis, the Company assesses whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. The Company discontinues hedge accounting if a derivative has ceased to be a highly effective hedge. The maximum term over which Energen Resources has hedged exposures to the variability of cash flows is through December 31, 2009.

On December 4, 2000, the APSC authorized Alagasco to engage in energy risk-management activities to manage the utility’s cost of gas supply. As required by SFAS No. 133, Alagasco recognizes all derivatives as either assets or liabilities on the balance sheet with a corresponding regulatory asset or liability. Any gains or losses are passed through to customers using the mechanisms of the GSA in compliance with Alagasco’s APSC-approved tariff. In accordance with SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation,” at June 30, 2006, Alagasco recognized a $6.1 million loss as a liability in accounts payable with a corresponding current regulatory asset of $6.1 million representing the fair value of derivatives. At December 31, 2005, Alagasco recognized a $6.3 million loss as a liability in accounts payable with a corresponding current regulatory asset of $6.3 million representing the fair value of derivatives.

5. RECONCILIATION OF EARNINGS PER SHARE

 

(in thousands, except per share amounts)

  

Three months ended

June 30, 2006

  

Three months ended

June 30, 2005

     Income    Shares    Per Share
Amount
   Income    Shares    Per Share
Amount

Basic EPS

   $ 49,601    73,028    $ 0.68    $ 37,573    73,017    $ 0.51

Effect of Dilutive Securities

                 

Performance share awards

      426          331   

Stock options

      340          376   

Restricted stock

      108          58   
                                     

Diluted EPS

   $ 49,601    73,902    $ 0.67    $ 37,573    73,782    $ 0.51
                                     

(in thousands, except per share amounts)

  

Six months ended

June 30, 2006

  

Six months ended

June 30, 2005

     Income    Shares    Per Share
Amount
   Income    Shares    Per Share
Amount

Basic EPS

   $ 137,095    73,148    $ 1.87    $ 96,619    72,985    $ 1.32

Effect of Dilutive Securities

                 

Performance share awards

      382          320   

Stock options

      344          366   

Restricted stock

      104          55   
                                     

Diluted EPS

   $ 137,095    73,978    $ 1.85    $ 96,619    73,726    $ 1.31
                                     

 

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For the three months and six months ended June 30, 2006 and 2005, the Company had no options that were excluded from the computation of diluted EPS. For the three months ended June 30, 2006 and 2005, the Company had no shares of non-vested restricted stock that were excluded from the computation of diluted EPS. For the six months ended June 30, 2006, the Company had 13,500 shares of non-vested restricted stock that were excluded from the computation of diluted EPS, as their effect were non-dilutive. There were no shares of non-vested restricted stock excluded from the computation of diluted EPS for the year-to-date ended June 30, 2005.

6. SEGMENT INFORMATION

The Company principally is engaged in two business segments: the purchase, distribution and sale of natural gas in central and north Alabama (natural gas distribution) and the acquisition, development, exploration and production of oil and gas in the continental United States (oil and gas operations).

 

     Three months ended
June 30,
    Six months ended
June 30,
 

(in thousands)

   2006     2005     2006     2005  

Operating revenues from continuing operations

        

Oil and gas operations

   $ 169,178     $ 134,941     $ 338,697     $ 238,342  

Natural gas distribution

     113,196       107,197       431,819       365,325  

Eliminations and other

     —         (513 )     —         (1,034 )
                                

Total

   $ 282,374     $ 241,625     $ 770,516     $ 602,633  
                                

Operating income (loss) from continuing operations

        

Oil and gas operations

   $ 87,138     $ 65,369     $ 175,677     $ 104,346  

Natural gas distribution

     2,711       5,630       66,438       72,034  

Eliminations and corporate expenses

     (551 )     (251 )     (1,082 )     (502 )
                                

Total

   $ 89,298     $ 70,748     $ 241,033     $ 175,878  
                                

Other income (expense)

        

Oil and gas operations

   $ (8,723 )   $ (8,052 )   $ (18,010 )   $ (16,148 )

Natural gas distribution

     (3,619 )     (3,360 )     (7,258 )     (6,961 )

Eliminations and other

     (41 )     137       186       249  
                                

Total

   $ (12,383 )   $ (11,275 )   $ (25,082 )   $ (22,860 )
                                

Income from continuing operations before income taxes

   $ 76,915     $ 59,473     $ 215,951     $ 153,018  
                                

 

(in thousands)

   June 30,
2006
   December 31,
2005

Identifiable assets

     

Oil and gas operations

   $ 1,631,675    $ 1,637,244

Natural gas distribution

     848,772      946,819
             

Subtotal

     2,480,447      2,584,063

Eliminations and other

     34,219      34,163
             

Total

   $ 2,514,666    $ 2,618,226
             

7. COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) consisted of the following:

 

(in thousands)

   Three months ended
June 30, 2006
   Three months ended
June 30, 2005

Net Income

   $ 49,601    $ 37,573

Other comprehensive income (loss):

     

Current period change in fair value of derivative instruments, net of tax of $1.7 million and $4 million

     2,694      6,506

Reclassification adjustment, net of tax of $1 million and $8.6 million

     1,679      14,108
             

Comprehensive Income

   $ 53,974    $ 58,187
             

 

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(in thousands)

   Six months ended
June 30, 2006
   Six months ended
June 30, 2005
 

Net Income

   $ 137,095    $ 96,619  

Other comprehensive income (loss):

     

Current period change in fair value of derivative instruments, net of tax of $23.9 million and ($39.6) million

     38,937      (64,565 )

Reclassification adjustment, net of tax of $8 million and $15.2 million

     13,123      24,736  
               

Comprehensive Income

   $ 189,155    $ 56,790  
               

Accumulated other comprehensive loss consisted of the following:

 

(in thousands)

   June 30,
2006
    December 31,
2005
 

Unrealized loss on hedges, net of tax of ($24.5) million and ($56.5) million

   $ (40,052 )   $ (92,112 )

Minimum pension liability, net of tax of ($7.4) million and ($7.4) million

     (13,707 )     (13,707 )
                

Accumulated Other Comprehensive Loss

   $ (53,759 )   $ (105,819 )
                

8. LONG-LIVED ASSETS AND DISCONTINUED OPERATIONS

The Company applies SFAS No. 144, which retains the previous asset impairment requirements of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” for loss recognition when the carrying value of an asset exceeds the sum of the undiscounted estimated future cash flows of the asset. In addition, SFAS No. 144 requires that gains and losses on the sale of certain oil and gas properties and write-downs of certain properties held-for-sale be reported as discontinued operations, with income or loss from operations of the associated properties reported as income or loss from discontinued operations. The results of operations for held-for-sale properties are reclassified and reported as discontinued operations for prior periods in accordance with SFAS No. 144. Energen Resources may, in the ordinary course of business, be involved in the sale of developed or undeveloped properties. All assets held-for-sale must be reported at the lower of the carrying amount or fair value. Energen Resources had no property sales during the three months ended June 30, 2006 and 2005 or the year-to-date ended June 30, 2006. In the six months ended June 30, 2005, Energen Resources recorded a pre-tax gain of $178,000 primarily from a property sale located in the Permian Basin.

The following are the results of operations from discontinued operations:

 

     Three months ended
June 30,
    Six months ended
June 30,
 

(in thousands, except per share data)

   2006     2005     2006     2005  

Oil and gas revenues (expenses)

   $ (2 )   $ 35     $ (2 )   $ 71  
                                

Pretax income (loss) from discontinued operations

   $ (1 )   $ 22     $ (12 )   $ (9 )

Income tax expense (benefit)

     —         9       (4 )     (3 )
                                

Income (Loss) From Discontinued Operations

     (1 )     13       (8 )     (6 )
                                

Gain (loss) on disposal of discontinued operations

     —         (20 )     —         178  

Income tax expense (benefit)

     —         (7 )     —         68  
                                

Gain (Loss) on Disposal of Discontinued Operations

     —         (13 )     —         110  
                                

Total Income (Loss) From Discontinued Operations

   $ (1 )   $ —       $ (8 )   $ 104  
                                

Diluted Earnings Per Average Common Share

        

Income (Loss) from Discontinued Operations

   $ —       $ —       $ —       $ —    

Gain (Loss) on Disposal of Discontinued Operations

     —         —         —         —    
                                

Total Income (Loss) from Discontinued Operations

   $ —       $ —       $ —       $ —    
                                

Basic Earnings Per Average Common Share

        

Income (Loss) from Discontinued Operations

   $ —       $ —       $ —       $ —    

Gain (Loss) on Disposal of Discontinued Operations

     —         —         —         —    
                                

Total Income (Loss) from Discontinued Operations

   $ —       $ —       $ —       $ —    
                                

 

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9. EMPLOYEE BENEFIT PLANS

The components of net pension expense for the Company’s two defined benefit non-contributory pension plans were:

 

(in thousands)

   Plan A     Plan B  
  

Three Months Ended

June 30,

   

Three Months Ended

June 30,

 
   2006     2005     2006     2005  

Components of net periodic benefit cost:

        

Service cost

   $ 1,562     $ 1,544     $ 157     $ 155  

Interest cost

     1,934       1,886       355       351  

Expected long-term return on assets

     (2,432 )     (2,199 )     (565 )     (540 )

Actuarial loss

     815       687       47       31  

Prior service cost amortization

     11       59       94       94  
                                

Net periodic expense

   $ 1,890     $ 1,977     $ 88     $ 91  
                                

 

(in thousands)

   Plan A     Plan B  
  

Six Months Ended

June 30,

   

Six Months Ended

June 30,

 
   2006     2005     2006     2005  

Components of net periodic benefit cost:

        

Service cost

   $ 3,124     $ 3,089     $ 313     $ 309  

Interest cost

     3,869       3,772       710       703  

Expected long-term return on assets

     (4,865 )     (4,398 )     (1,129 )     (1,079 )

Actuarial loss

     1,631       1,374       93       61  

Prior service cost amortization

     22       117       189       189  
                                

Net periodic expense

   $ 3,781     $ 3,954     $ 176     $ 183  
                                

The Company is not required to make pension contributions in 2006. The Company will reevaluate discretionary contributions during 2006 in light of the Pension Protection Act of 2006 that is currently awaiting the signature of President Bush.

The components of net periodic post-retirement benefit expense for the Company’s post-retirement benefit plans were:

 

(in thousands)

   Salaried Employees     Union Employees  
  

Three Months Ended

June 30,

   

Three Months Ended

June 30,

 
   2006     2005     2006     2005  

Components of net periodic benefit cost:

        

Service cost

   $ 145     $ 231     $ 150     $ 124  

Interest cost

     394       492       508       515  

Expected long-term return on assets

     (485 )     (425 )     (740 )     (658 )

Actuarial gain

     (204 )     (32 )     (69 )     (36 )

Prior service cost amortization

     —         —         —         1  

Transition amortization

     171       171       309       321  
                                

Net periodic expense

   $ 21     $ 437     $ 158     $ 267  
                                

 

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(in thousands)

   Salaried Employees     Union Employees  
  

Six Months Ended

June 30,

   

Six Months Ended

June 30,

 
   2006     2005     2006     2005  

Components of net periodic benefit cost:

        

Service cost

   $ 304     $ 462     $ 304     $ 249  

Interest cost

     813       985       1,029       1,030  

Expected long-term return on assets

     (961 )     (851 )     (1,468 )     (1,317 )

Actuarial gain

     (345 )     (64 )     (96 )     (73 )

Prior service cost amortization

     —         —         —         2  

Transition amortization

     341       341       617       643  
                                

Net periodic expense

   $ 152     $ 873     $ 386     $ 534  
                                

For the three months and six months ended June 30, 2006, the Company made contributions aggregating $0.3 million and $1 million, respectively, to the post-retirement benefit plan assets. The Company expects to make additional discretionary contributions of approximately $1 million through the remainder of 2006.

10. COMMITMENTS AND CONTINGENCIES

Commitments and Agreements: Certain of Alagasco’s long-term gas procurement contracts for the supply, storage and delivery of natural gas include fixed charges of approximately $219 million through October 2015. Alagasco also is committed to purchase minimum quantities of gas at market-related prices or to pay certain costs in the event the minimum quantities are not taken. These purchase commitments are 156.5 Bcf through April 2015.

Alagasco purchases gas as an agent for certain of its large commercial and industrial customers. Alagasco has in certain instances provided commodity-related guarantees to the counterparties in order to facilitate these agency purchases. Liabilities existing for gas delivered to customers subject to these guarantees are included in the consolidated balance sheet. In the event the customer for whom the guarantee was entered fails to take delivery of the gas, Alagasco can sell such gas for the customer, with the customer liable for any resulting loss. Although the substantial majority of purchases under these guarantees are for the customers’ current monthly consumption and are at current market prices, in some instances, the purchases are for an extended term at a fixed price. At June 30, 2006, the fixed price purchases under these guarantees had a maximum term outstanding through May 2007 and an aggregate purchase price of $10.6 million with a market value of $9.3 million.

Legal Matters: Energen and its affiliates are, from time to time, parties to various pending or threatened legal proceedings. Certain of these lawsuits include claims for punitive damages in addition to other specified relief. Based upon information presently available, and in light of available legal and other defenses, contingent liabilities arising from threatened and pending litigation are not considered material in relation to the respective financial positions of Energen and its affiliates. It should be noted, however, that Energen and its affiliates conduct business in Alabama and other jurisdictions in which the magnitude and frequency of punitive and other damage awards may bear little or no relation to culpability or actual damages, thus making it difficult to predict litigation results.

Cochran County, Texas

In January 2005, a lawsuit was tried in Cochran County, Texas in which the plaintiff alleged preferential purchase right claims against Energen Resources with respect to certain properties acquired by Energen Resources in 2002. The jury rendered a verdict in Energen Resources’ favor on all counts. Subsequently, in March 2005, the Judge issued a decision overruling the jury verdict. Energen Resources’ appealed the Judge’s order to the Court of Appeals for the Seventh District of Texas. In May 2006, the Court of Appeals reversed the Judge’s decision and entered a judgment in favor of Energen Resources. The Company has been advised that the plaintiff will appeal this decision to the Texas Supreme Court.

 

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Jefferson County, Alabama

In January 2006, RGGS Land and Minerals LTD, L.P. (RGGS) filed a lawsuit in Jefferson County, Alabama, alleging breach of contract with respect to Energen Resources’ calculation of certain allowed costs and failure to pay in a timely manner certain amounts due RGGS under a mineral lease. RGGS seeks a declaratory judgment with respect to the parties’ rights under the lease, reformation of the lease, monetary damages and termination of Energen Resources’ rights under the lease. The Occluded Gas Lease dated January 1, 1986 was originally between Energen Resources and United States Steel Corporation (U.S. Steel) as lessor. RGGS became the lessor under the lease as a result of a 2004 conveyance from U.S. Steel to RGGS. Approximately 120,000 acres in Jefferson and Tuscaloosa counties, Alabama, are subject to the lease. Separately on February 6, 2006, Energen Resources received notice of immediate lease termination from RGGS. As of December 31, 2005, Energen’s consolidated balance sheet included approximately $96 million in net oil and gas properties associated with the lease. During 2005, Energen Resources’ production associated with the lease was approximately 11 Bcf.

RGGS has adopted positions contrary to the seventeen years of course of dealing between Energen Resources and its original contracting partner, U.S. Steel. The Company believes that RGGS’ assertions are without merit and that the notice of lease termination is ineffective. Energen Resources intends to vigorously defend its rights under the lease. The Company remains in possession of the lease, believes that the likelihood of a judgment in favor of RGGS is remote, and has made no accrual with respect to the litigation or purported lease termination.

Other

Various other pending or threatened legal proceedings are in progress currently, and the Company has accrued a provision for estimated liability.

Environmental Matters: Various environmental laws and regulations apply to the operations of Energen Resources and Alagasco. Historically, the cost of environmental compliance has not materially affected the Company’s financial position, results of operations or cash flows and is not expected to do so in the future; however, new regulations, enforcement policies, claims for damages or other events could result in significant unanticipated costs.

Environmental compliance costs, including ongoing maintenance, monitoring and similar costs, are expensed as incurred. Environmental remediation costs are accrued when remedial efforts are probable and the cost can be reasonably estimated.

Alagasco is in the chain of title of nine former manufactured gas plant sites (four of which it still owns) and five manufactured gas distribution sites (one of which it still owns). An investigation of the sites does not indicate the present need for remediation activities. Management expects that, should remediation of any such sites be required in the future, Alagasco’s share, if any, of such costs will not materially affect the financial position, results of operations or cash flows of Alagasco.

11. REGULATORY ASSETS AND LIABILITIES

The following table details regulatory assets and liabilities on the balance sheets:

 

(in thousands)

   June 30, 2006    December 31, 2005
   Current    Noncurrent    Current    Noncurrent

Regulatory assets:

           

Pension asset

   $ —      $ 22,807    $ —      $ 22,807

Accretion and depreciation for asset retirement obligation

     —        10,674      —        10,183

Gas supply adjustment

     3,875      —        —        —  

Risk management activities

     6,135      —        6,291      —  

Other

     342      275      342      446
                           

Total regulatory assets

   $ 10,352    $ 33,756    $ 6,633    $ 33,436
                           

Regulatory liabilities:

           

Enhanced stability reserve

   $ 3,910    $ —      $ 3,690    $ —  

Gas supply adjustment

     —        —        22,326      —  

RSE adjustment

     587      —        2,943      —  

Unbilled service margin

     4,883      —        24,537      —  

Asset removal costs, net

     —        109,666      —        105,404

Asset retirement obligation

     —        13,838      —        13,451

Other

     —        923      —        953
                           

Total regulatory liabilities

   $ 9,380    $ 124,427    $ 53,496    $ 119,808
                           

 

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12. ACQUISITION OF OIL AND GAS PROPERTIES

On December 15, 2005, Energen Resources completed a purchase of Permian Basin oil properties from a private company. The contract purchase price was approximately $168 million with an effective date of November 1, 2005. Approximately 80 percent of the 21.9 million barrels of proved oil reserves are undeveloped. More than 90 percent of the estimated proved reserves are oil. Energen used its available cash and existing lines of credit to finance the acquisition.

13. RECENT PRONOUNCEMENTS OF THE FINANCIAL ACCOUNTING STANDARDS BOARD (FASB)

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 (FIN 48).” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition, measurement and disclosure of a tax position taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. The cumulative effect of applying this Interpretation will be recorded as an adjustment to retained earnings as of the beginning of the period of adoption. The impact of this Interpretation on the Company is currently being evaluated.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Energen’s net income totaled $49.6 million ($0.67 per diluted share) for the three months ended June 30, 2006 and compared favorably with net income of $37.6 million ($0.51 per diluted share) for the same period in the prior year. Energen Resources Corporation, Energen’s oil and gas subsidiary, had net income and net income from continuing operations for the three months ended June 30, 2006, of $50.4 million compared with $36.4 million in the same quarter in the previous year. Significantly higher commodity prices (approximately $18 million after-tax) and increased production volumes (approximately $4 million after-tax) were partially offset by increased lease operating expenses (approximately $4 million after-tax) and increased administrative expenses (approximately $2 million after-tax). Energen’s natural gas utility, Alagasco, reported a net loss of $0.5 million in the second quarter of 2006 compared to net income of $1.1 million in the same period last year primarily reflecting a decrease in customer usage driven by the high price of natural gas and warmer weather partially offset by the utility’s ability to earn on a higher level of equity.

For the 2006 year-to-date, Energen’s net income totaled $137.1 million ($1.85 per diluted share) and compared favorably to net income of $96.6 million ($1.31 per diluted share) for the same period in the prior year. Energen Resources had net income for the six months ended June 30, 2006, of $100.2 million as compared with $56 million in the previous period. Energen Resources generated income from continuing operations of $100.2 million in the current year-to-date as compared with $55.9 million in the same period last year primarily as a result of higher commodity prices (approximately $55 million after-tax) and increased production volumes (approximately $8 million after-tax) partially offset by the impact of increased lease operating expenses (approximately $11 million after-tax), higher production taxes (approximately $2 million after-tax), increased DD&A expense (approximately $2 million after-tax) and increased administrative expenses (approximately $2 million after-tax). Alagasco’s net income of $36.8 million in the current year-to-date compared to net income of $40.1 million in the same period in the previous year largely for the same reasons affecting the second quarter results.

Oil and Gas Operations

Revenues from oil and gas operations rose 25.9 percent to $169.2 million for the three months ended June 30, 2006 and 42.7 percent to $338.7 million in the year-to-date largely as a result of increased commodity prices as well as the impact of higher production volumes. During the current quarter, revenue per unit of production for natural gas rose 8.5 percent to $6.75 per thousand cubic feet (Mcf), while oil revenue per unit of production increased 54.4 percent to $51.92 per barrel. Natural gas liquids revenue per unit of production increased 32.7 percent to an average price of $0.69 per gallon. In the year-to-date, revenue per unit of production for natural gas increased 31.9 percent to $7.16 per Mcf, oil revenue per unit of production increased 48.8 percent to $48.93 per barrel and natural gas liquids revenue per unit of production rose 23.1 percent to $0.64 per gallon.

Production increased primarily due to additional development activities in the San Juan Basin, accelerated workovers due to milder winter weather and increased volumes related to the prior year purchase of Permian Basin oil properties. Energen Resources acquired an estimated 21.9 million barrels of proved oil reserves in the Permian Basin in the fourth quarter of 2005. Negatively affecting production were normal production declines. Natural gas production from continuing operations in the second quarter rose 3.6 percent to 15.7 billion cubic feet (Bcf), while oil volumes increased 7.8 percent to 914 thousand barrels (MBbl) and natural gas liquids production increased 8.1 percent to 20.1 million gallons (MMgal). For the year-to-date, natural gas production from continuing operations increased 4 percent to 31.1 Bcf, oil volumes rose 10 percent to 1,832 MBbl and natural gas liquids production increased 6.7 percent to 36.7 MMgal. Natural gas comprised approximately 65 percent of Energen Resources’ production for the current quarter and the year-to-date.

Energen Resources periodically enters into derivative commodity instruments that qualify as cash flow hedges under Statement of Financial Accounting Standard (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” to hedge its exposure to price fluctuations to its estimated oil, natural gas and natural gas liquids production. Energen Resources applies SFAS No. 133 which requires all derivatives to be recognized on the balance sheet and measured at fair value. If a derivative is designated as a cash flow hedge, the effectiveness of the hedge, or the degree that the gain (loss) for the hedging instrument offsets the loss (gain) on the hedged item is measured at each reporting period. The effective portion of the gain or loss on the derivative instrument is

 

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recognized in other comprehensive income (OCI) as a component of equity and subsequently reclassified into earnings as operating revenues when the forecasted transaction affects earnings. The ineffective portion of a derivative’s change in fair value is required to be recognized in operating revenues immediately. Derivatives that do not qualify for hedge treatment under SFAS No. 133 must be recorded at fair value with gains or losses recognized in operating revenues in the period of change. For the three months and six months ended June 30, 2006, the Company recorded a $0.4 million after-tax gain and a $1.3 million after-tax loss, respectively, on open and closed contracts for the ineffective portion of the change in fair value of derivatives accounted for as cash flow hedges.

Operations and maintenance (O&M) expense increased $10.1 million for the quarter and $20.8 million in the year-to-date. Lease operating expenses (excluding production taxes) increased by $6.3 million for the quarter and $17.4 million year-to-date primarily due to accelerated maintenance expenses in the San Juan Basin, higher transportation costs, overall price increases related to higher commodity prices and the December 2005 acquisition of Permian Basin oil properties. Administrative expense increased $2.6 million for the three months ended June 30, 2006 and $2.4 million year-to-date largely due labor-related costs. Exploration expense rose $1.2 million in the second quarter and $1 million in the year-to-date primarily due to increased exploratory efforts.

Energen Resources’ DD&A expense for the quarter increased $1.1 million and rose $3.6 million year-to-date. The average depletion rate for the current quarter and the same period a year ago was $0.96 per Mcfe. For the six months ended June 30, 2006, the average depletion rate was $0.97 per Mcfe as compared to $0.95 per Mcfe in the previous period. The increase in the year-to-date rate was largely due to a higher depletion rate on oil properties purchased in the Permian Basin in December 2005 partially offset by increased production in lower rate areas.

Energen Resources’ expense for taxes other than income taxes primarily reflected production-related taxes that were $0.9 million higher this quarter and $3.8 million higher year-to-date largely due to increased commodity prices and production.

Energen Resources may, in the ordinary course of business, be involved in the sale of developed or undeveloped properties. With respect to developed properties, sales may occur as a result of, but not limited to, disposing of non-strategic or marginal assets and accepting offers where the buyer gives greater value to a property than does Energen Resources. The Company is required to reflect gains and losses on the dispositions of these assets, the writedown of certain properties held-for-sale, and income or loss from the operations of the associated held-for-sale properties as discontinued operations under the provisions of SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.” Energen Resources had no property sales during the three months ended June 30, 2006 and 2005 or the year-to-date ended June 30, 2006. In the six months ended June 30, 2005, Energen Resources recorded a pre-tax gain of $178,000 primarily from a property sale located in the Permian Basin.

Natural Gas Distribution

Natural gas distribution revenues increased $6 million for the quarter largely due to an increase in commodity gas costs partially offset by a decrease in weather related usage. Weather that was 24.7 percent warmer than the same period last year contributed to a 21 percent decline in residential sales volumes and a 13.6 percent decrease in commercial and industrial customer sales volumes. Transportation volumes decreased 3 percent in period comparisons. Revenues for the year-to-date rose $66.5 million primarily due to an increase in the commodity cost of gas partially offset by a decrease in usage. Weather that was 4.9 percent warmer than in the previous period along with customer conservation related to higher gas costs contributed to a 12.8 percent decrease in residential sales volumes. Commercial and industrial customer sales volumes decreased 8.8 percent while transportation volumes decreased 2.9 percent in period comparisons. An increase in gas costs partially offset by a decline in gas purchase volumes resulted in a 13.5 percent increase in cost of gas for the quarter and a 33.8 percent increase in the year-to-date. Utility gas costs include commodity cost, risk management gains and losses and the provisions of the GSA rider. The GSA rider in Alagasco’s rate schedule provides for a pass-through of gas price fluctuations to customers without markup. Alagasco’s tariff provides a temperature adjustment to certain customers’ bills designed to substantially remove the effect of departures from normal temperatures. The temperature adjustment applies primarily to residential, small commercial and small industrial customers.

 

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As discussed more fully in Note 3 to the Unaudited Condensed Financial Statements, Alagasco is subject to regulation by the Alabama Public Service Commission (APSC). On June 10, 2002, the APSC issued an order to extend Alagasco’s rate-setting mechanism. Under the terms of that extension, RSE will continue after January 1, 2008, unless, after notice to Alagasco and a hearing, the Commission votes to either modify or discontinue its operation.

O&M expense increased 3.5 percent in the current quarter and 7 percent in the six months ended June 30, 2006 primarily due to increased bad debt expense and distribution maintenance expenses partially offset by decreased labor-related expenses. A 2.7 percent increase in depreciation expense in the current quarter and a 3 percent increase in the year-to-date was primarily due to normal replacement of the utility’s distribution and support systems. Taxes other than income taxes primarily reflected various state and local business taxes as well as payroll-related taxes. State and local business taxes generally are based on gross receipts and fluctuate accordingly.

Non-Operating Items

Interest expense for the Company increased $0.8 million in the second quarter and $2.3 million year-to-date primarily due to an increase in short-term borrowings related to the December 2005 purchase of Permian Basin oil properties at Energen Resources and an increase in storage inventory at Alagasco. Also influencing interest expense was an increase in interest rates associated with Energen’s $100 million Floating Rate Senior Notes issued in November 2004. An increase in interest expense related to Alagasco’s issuance of $80 million of long-term debt in November 2005 was largely offset by the redemption of $56.7 million and $18 million of long-term debt by Alagasco in December 2005 and August 2005, respectively. Income tax expense for the Company increased $5.4 million in the current quarter and $22.3 million in the year-to-date largely due to higher pre-tax income.

Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R), which requires a fair value based method of accounting using pricing models that reflect the specific economics of a company’s transactions. This statement was effective for the first annual reporting period beginning after June 15, 2005. The Company prospectively adopted the fair value recognition provisions of SFAS No. 123 as amended, which provided methods of transition for a voluntary change to the fair value base method of accounting for stock-based employee compensation effective January 1, 2003. The Company adopted SFAS No. 123R using the modified prospective application method for new awards effective January 1, 2006. The adoption of SFAS No. 123R did not have a significant impact on the financial condition or results of operations of the Company (See Note 2, Stock-Based Compensation, in the Notes to Unaudited Condensed Financial Statements).

FINANCIAL POSITION AND LIQUIDITY

Cash flows from operations for the year-to-date were $283.3 million as compared to $253.3 million in the prior period. Operating cash flow benefited from higher realized commodity prices and production volumes at Energen Resources. The Company’s working capital needs were also highly influenced by throughput, changes in weather, and timing of payments. Working capital needs at Alagasco were primarily affected by increased gas costs and storage gas inventory compared to the prior period.

The Company had a net outflow of cash from investing activities of $134.3 million for the six months ended June 30, 2006 primarily due to additions of property, plant and equipment. Energen Resources invested $95.6 million in capital expenditures primarily related to the development of oil and gas properties. Utility capital expenditures totaled $39.9 million in the year-to-date and primarily represented expansion and replacement of its distribution system and support facilities.

The Company used $146.1 million for financing activities in the year-to-date primarily due to the repayment of short-term borrowings, dividends paid to common shareholders, the buy-back of Energen common stock under its stock repurchase plan and the issuance of common stock through stock-based compensation plans and through the dividend reinvestment and direct stock purchase plan.

 

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FUTURE CAPITAL RESOURCES AND LIQUIDITY

The Company plans to continue to implement its diversified growth strategy that focuses on expanding Energen Resources’ oil and gas operations through the acquisition of producing properties with developmental potential while maintaining the strength of the Company’s utility foundation. For the five years ended December 31, 2005, Energen’s diluted EPS grew at an average compound rate of 19.8 percent a year. Over the long-term, Energen is targeting an average diluted EPS growth rate over each rolling five-year period of approximately 7 to 8 percent a year.

In May 2006, Energen began buying-back shares of Energen common stock under its existing stock repurchase plan. Energen announced in June 2006, that the Board of Directors authorized an additional 9 million shares of Energen common stock for repurchase. Through July 2006, the Company purchased 1,018,000 shares of Energen common stock at an average price of $34.35 per share. To finance the stock buy-back, the Company expects to use internally generated cash flow.

Over the five-year planning period ending December 31, 2010, Energen Resources plans to spend approximately $395 million for development of existing properties and $50 million for exploratory and other activities. In 2006, Energen Resources plans to invest approximately $177 million in capital expenditures primarily for development and exploratory activities. As of December 31, 2005, the estimated amount of 2006 development of previously identified proved undeveloped reserves was approximately $87 million. Approximately $9 million is estimated for 2006 exploratory exposure. Capital investment at Energen Resources in 2007 is currently expected to approximate $98 million for development and exploration. Of this $98 million, development of previously identified proved undeveloped reserves is estimated to be $71 million and exploratory exposure is estimated to be $6 million. The Company is also considering additional development capital investments relative to current estimates of $55 million to $75 million for 2007 to accelerate development of its proved undeveloped reserves.

Notwithstanding the estimated expenditures mentioned above, as an acquisition oriented company, Energen Resources continually evaluates acquisition opportunities which arise in the marketplace and from time to time will pursue acquisitions that meet Energen’s acquisition criteria which could result in capital expenditures different than those outlined above. The Company is prepared to invest up to $1 billion over the next five years in addition to the estimates given above for property acquisitions that meet Energen’s acquisition criteria. In addition, Energen Resources may conduct limited exploration activities primarily in areas in which it has operations and remains open to considering exploration activities which complement its core expertise and meet its investment requirements. To finance Energen Resources’ investment program, the Company expects primarily to utilize its short-term credit facilities to supplement internally generated cash flow. The Company may also periodically issue long-term debt and equity to replace short-term obligations, enhance liquidity and provide for permanent financing. Energen currently has available short-term credit facilities aggregating $410 million to help finance its growth plans and operating needs. Energen Resources’ continued ability to invest in property acquisitions is subject to market conditions and industry trends.

Energen Resources has raised production estimates from proved reserves for 2006 to approximately 94 Bcfe and currently expects 2007 production to approximate 89 Bcfe. The Company expects to increase current 2007 production estimates by 2.5 Bcfe to 3.5 Bcfe if the aforementioned increase to development capital spending in 2007 occurs.

As of July 2006, Energen Resources had leased approximately 151,000 acres in order to pursue the exploration and development of various shale formations across north-central Alabama. The Company plans to drill additional wells on the acreage over the next 24 months and will be applying various drilling, completions and stimulation techniques in order to ascertain the optimum combination for production. The Company considers reserves and associated production related to shale to be a potential resource; as such, neither production amounts or reserve amounts associated with shale potential are included in the estimates above.

Energen Resources has experienced various market driven conditions generally caused by the increased commodity price environment including, but not limited to, higher workover and maintenance expenses, increased taxes and

 

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other field-service-related expenses. The Company anticipates influences such as weather, natural disasters, changes in global economics and political unrest will continue to contribute to increased price volatility in the near term.

Energen Resources hedges its exposure to estimated commodity production. In addition, Alagasco periodically enters into cash flow derivative commodity instruments to hedge its exposure to price fluctuations on its gas supply. Such instruments may include regulated natural gas and crude oil futures contracts traded on the New York Mercantile Exchange (NYMEX) and over-the-counter swaps, collars and basis hedges with major energy derivative product specialists. The counterparties to the commodity instruments are investment banks and energy-trading firms. In some contracts, the amount of credit allowed before collateral must be posted for out-of-the-money hedges varies depending on the credit rating of the Company or Alagasco. In cases where this arrangement exists, generally the credit ratings must be maintained at investment grade status to have any available counterparty credit. Adverse changes to the Company’s credit rating will result in decreasing amounts of credit available under these contracts. The counterparties for these contracts do not extend credit to the Company in the event credit ratings are below investment grade. At June 30, 2006, Energen Resources was in a net loss position with all counterparties but was not required to post collateral. Energen Resources used various counterparties for its over-the-counter derivatives as of June 30, 2006. The Company believes the creditworthiness of these counterparties is satisfactory. These hedge transactions are pursuant to standing authorizations by the Board of Directors, which do not permit speculative positions.

Energen Resources entered into the following transactions for the remainder of 2006 and subsequent years:

 

Production

Period

  

Total Hedged

Volumes

  

Average Contract

Price

  

Description

Natural Gas

        

2006

     8.0 Bcf    $8.05 Mcf    NYMEX Swaps
   10.8 Bcf    $6.46 Mcf    Basin Specific Swaps

2007

     8.0 Bcf    $9.48 Mcf    NYMEX Swaps
   22.1 Bcf    $8.11 Mcf    Basin Specific Swaps
   *3.4 Bcf    $9.32 Mcf    NYMEX Swaps
   *0.6 Bcf    $9.08 Mcf    Basin Specific Swaps

Oil

        

2006

     1,395 MBbl    $52.68 Bbl    NYMEX Swaps

2007

     2,716 MBbl    $70.01 Bbl    NYMEX Swaps

2008

     1,500 MBbl    $63.86 Bbl    NYMEX Swaps
      *420 MBbl    $77.70 Bbl    NYMEX Swaps

2009

        900 MBbl    $56.25 Bbl    NYMEX Swaps

Oil Basis Differential

        

2006

        946 MBbl    **    Basis Swaps

2007

     1,768 MBbl    **    Basis Swaps

2008

        600 MBbl    **    Basis Swaps
      *420 MBbl    **    Basis Swaps

Natural Gas Liquids

        

2006

           15.1 MMGal    $0.56 Gal    Liquids Swaps

2007

           10.1 MMGal    $0.80 Gal    Liquids Swaps
         *31.8 MMGal    $0.98 Gal    Liquids Swaps

*

Contracts entered into subsequent to June 30, 2006.

**

Average contract prices are not meaningful due to the varying nature of each contract.

Realized prices are anticipated to be lower than NYMEX prices due to basis differences and other factors.

The Company’s efforts to minimize commodity price volatility through hedging is reflected in Alagasco’s current rates. Alagasco’s rate schedules for natural gas distribution charges contain a Gas Supply Adjustment (GSA) rider which permits the pass-through to customers for changes in the cost of gas supply. The GSA rider is designed to capture the Company’s cost of natural gas and provides for a pass-through of gas cost fluctuations to customers

 

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without markup; the cost of gas includes the commodity cost, pipeline capacity, transportation and fuel costs, and risk management gains and losses. Sustained high prices may decrease Alagasco’s customer base and could result in a decline of per customer use and number of customers. The utility will continue to monitor its bad debt reserve and will make adjustments as required based on the evaluation of its receivables which are impacted by natural gas prices.

Alagasco maintains an investment in storage gas that is expected to average approximately $73 million in 2006 but will vary depending upon the price of natural gas. During 2006 and 2007, Alagasco plans to invest $71 million and $65 million, respectively, in utility capital expenditures for normal distribution and support systems. Over the Company’s five-year planning period ending December 31, 2010, Alagasco anticipates capital investments of approximately $331 million. The utility anticipates funding these capital requirements through internally generated capital and the utilization of short-term credit facilities. In January 2005, Alagasco issued $80 million in long-term debt to repay amounts drawn on short-term credit facilities for capital expenditures and to refinance $30 million of Medium-Term Notes recalled by Alagasco in April 2004. In November 2005, Alagasco issued an additional $80 million of long-term debt. This debt largely refinanced $18 million of Medium-Term Notes maturing June 27, 2007 to July 5, 2022 and $56.7 million of long-term debt maturing June 15, 2015 to June 27, 2025 recalled by Alagasco in August 2005 and December 2005, respectively.

Access to capital is an integral part of the Company’s business plan. The Company regularly provides information to corporate rating agencies related to current business activities and future performance expectations. While the Company expects to have ongoing access to its short-term credit facilities and the broader long-term markets, continued access could be adversely affected by future economic and business conditions and credit rating downgrades.

Dividends

Energen expects to pay annual cash dividends of $0.44 per share on the Company’s common stock in 2006. The amount and timing of all dividend payments is subject to the discretion of the Board of Directors and is based upon business conditions, results of operations, financial conditions and other factors.

On April 27, 2005, Energen’s shareholders approved a 2-for-1 split of the Company’s common stock. The split was effected in the form of a 100 percent stock dividend and was effective on June 1, 2005, to shareholders of record on May 13, 2005. All share and per share amounts of capital stock outstanding have been adjusted to reflect the stock split.

Contractual Cash Obligations and Other Commitments

In the course of ordinary business activities, Energen enters into a variety of contractual cash obligations and other commitments. The following table summarizes the Company’s significant contractual cash obligations, other than hedging contracts, as of June 30, 2006.

 

     Payments Due before December 31,

(in thousands)

   Total    2006   

2007 &

2008

  

2009 &

2010

   2011 &
Thereafter

Short-term debt

   $ 54,000    $ 54,000    $ —      $ —      $ —  

Long-term debt (1)

     699,324      15,000      110,000      150,000      424,324

Interest payments on debt (2)

     545,372      44,898      82,039      76,139      342,296

Purchase obligations (3)

     218,809      23,765      95,622      70,218      29,204

Capital lease obligations

     —        —        —        —        —  

Operating leases

     48,151      1,993      7,093      6,355      32,710
                                  

Total contractual cash obligations

   $ 1,565,656    $ 139,656    $ 294,754    $ 302,712    $ 828,534
                                  

(1)

Long-term cash obligations include $1.3 million of unamortized debt discounts as of June 30, 2006.

(2)

Includes interest on fixed rate debt and an estimate of adjustable rate debt. The adjustable rate interest is calculated based on the indexed rate in effect at June 30, 2006.

(3)

Certain of the Company’s long-term gas procurement contracts for the supply, storage and delivery of natural gas include fixed charges of approximately $219 million through October 2015. The Company also is committed to purchase minimum quantities of gas at market-related prices or to pay certain costs in the event the minimum quantities are not taken. These purchase commitments are 156.5 Bcf through April 2015.

 

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Energen Resources operates in certain instances through joint ventures under joint operating agreements. Typically, the operator under a joint operating agreement enters into contracts, such as drilling contracts, for the benefit of all joint venture partners. Through the joint operating agreement, the non-operators reimburse, and in some cases advance, the funds necessary to meet the contractual obligations entered into by the operator. These obligations are typically shared on a working interest basis as defined in the joint operating contractual agreement.

The Company has two defined non-contributory pension plans and provides certain post-retirement healthcare and life insurance benefits. The Company is not required to make any funding payments during 2006. The Company will reevaluate discretionary payments to its pension plans during 2006 in light of the Pension Protection Act of 2006 that is currently awaiting the signature of President Bush. The Company expects to make discretionary payments of approximately $1 million to post-retirement benefit program assets during the remainder of 2006.

Recent Pronouncements of the Financial Accounting Standards Board (FASB)

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 (FIN 48).” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition, measurement and disclosure of a tax position taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. The cumulative effect of applying this Interpretation will be recorded as an adjustment to retained earnings as of the beginning of the period of adoption. The impact of this Interpretation on the Company is currently being evaluated.

FORWARD LOOKING STATEMENTS

Certain statements in this report express expectations of future plans, objectives and performance of the Company and its subsidiaries and constitute forward-looking statements made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Except as otherwise disclosed, the forward-looking statements do not reflect the impact of possible or pending acquisitions, divestitures or restructurings. The absence of errors in input data, calculations and formulas used in estimates, assumptions and forecasts cannot be guaranteed. Neither the Company nor Alagasco undertakes any obligation to correct or update any forward-looking statements whether as a result of new information, future events or otherwise.

All statements based on future expectations rather than on historical facts are forward-looking statements that are dependent on certain events, risks and uncertainties that could cause actual results to differ materially from those anticipated. Some of these include, but are not limited to, economic and competitive conditions, inflation rates, legislative and regulatory changes, financial market conditions, our ability to access the capital markets, future business decisions, utility customer growth and retention and usage per customer, litigation results and other uncertainties, all of which are difficult to predict.

Third Party Facilities: The forward-looking statements assume generally uninterrupted access to third party oil and gas gathering, transportation, processing and storage facilities. Energen Resources relies upon such facilities for access to markets for its production. Alagasco relies upon such facilities for access to natural gas supplies. Such facilities are typically limited in number and geographically concentrated. An extended interruption of access to or service from these facilities, whether caused by weather events, natural disaster, accident, mechanical failure, criminal act or otherwise could result in material adverse financial consequences to Alagasco, Energen Resources and/or the Company.

Energen Resources Production: There are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves and in projecting future rates of production and timing of development expenditures. The total amount or timing of actual future production may vary significantly from reserve and production estimates. In the event Energen Resources is unable to fully invest its planned acquisition, development and exploratory expenditures, future operating revenues, production, and proved reserves could be negatively affected. The drilling of development and exploratory wells can involve significant risks, including those related to timing, success rates and cost overruns, and these risks can be affected by lease and rig availability, complex geology and other factors.

 

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Energen Resources Hedging: Although Energen Resources makes use of futures, swaps, options and fixed-price contracts to mitigate price risk, fluctuations in future commodity prices could materially affect the Company’s financial position, results of operations and cash flows; furthermore, such risk mitigation activities may cause the Company’s financial position and results of operations to be materially different from results that would have been obtained had such risk mitigation activities not occurred. The effectiveness of such risk-mitigation assumes that counterparties maintain satisfactory credit quality. The effectiveness of such risk mitigation also assumes that actual sales volumes will generally meet or exceed the volumes subject to the futures, swaps, options and fixed-price contracts. A substantial failure to meet sales volume targets, whether caused by miscalculations, weather events, natural disaster, accident, criminal act or otherwise, could leave Energen Resources financially exposed to its counterparties and result in material adverse financial consequences to Energen Resources and the Company. The adverse effect could be increased if the adverse event was widespread enough to move market prices against Energen Resources’ position.

Alagasco Hedging: Similarly, although Alagasco makes use of futures, swaps and fixed-price contracts to mitigate gas supply cost risk, fluctuations in future gas supply costs could materially affect its financial position and rates to customers. The effectiveness of Alagasco’s risk mitigation assumes that its counterparties in such activities maintain satisfactory credit quality. The effectiveness of such risk mitigation also assumes that Alagasco’s actual gas supply needs will generally meet or exceed the volumes subject to the futures, swaps and fixed-price contracts. A substantial failure to experience projected gas supply needs, whether caused by miscalculations, weather events, natural disaster, accident, mechanical failure, criminal act or otherwise, could leave Alagasco financially exposed to its counterparties and result in material adverse financial consequences to Alagasco and the Company. The adverse effect could be increased if the adverse event was widespread enough to move market prices against Alagasco’s position.

Operations: Inherent in the gas distribution activities of Alagasco and the oil and gas production activities of Energen Resources are a variety of hazards and operation risks, such as leaks, explosions and mechanical problems. These risks or other risks such as weather events, natural disasters, accidents and criminal acts could result in loss of human life, significant damage to property, environmental pollution, impairment of our operations and substantial financial losses to the Company. In accordance with customary industry practices, the Company maintains insurance against some, but not all, of these risks and losses. The location of pipeline and storage facilities near populated areas, including residential areas, commercial business centers and industrial sites, could increase the level of damages resulting from these risks. The occurrence of any of these events could adversely affect Alagasco’s, Energen Resources’ and/or the Company’s financial position, results of operations and cash flows.

Alagasco Service Territory: Alagasco’s utility customers are geographically concentrated in central and north Alabama. Significant economic, weather, natural disaster, criminal act or other events that adversely affect this region could adversely affect Alagasco and the Company.

 

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SELECTED BUSINESS SEGMENT DATA

ENERGEN CORPORATION

(Unaudited)

 

     Three months ended
June 30,
   Six months ended
June 30,

(in thousands, except sales price data)

   2006    2005    2006    2005

Oil and Gas Operations

           

Operating revenues from continuing operations

           

Natural gas

   $ 106,194    $ 94,401    $ 222,278    $ 162,001

Oil

     47,475      28,499      89,617      54,804

Natural gas liquids

     13,807      9,653      23,484      17,798

Other

     1,702      1,875      3,318      2,705
                           

Total

   $ 169,178    $ 134,428    $ 338,697    $ 237,308
                           

Production volumes from continuing operations

           

Natural gas (MMcf)

     15,725      15,176      31,052      29,858

Oil (MBbl)

     914      848      1,832      1,666

Natural gas liquids (MMgal)

     20.1      18.6      36.7      34.4

Production volumes from continuing operations (MMcfe)

     24,076      22,911      47,285      44,767

Total production volumes (MMcfe)

     24,075      22,919      47,284      44,825

Revenue per unit of production including effects of all derivative instruments

     

Natural gas (Mcf)

   $ 6.75    $ 6.22    $ 7.16    $ 5.43

Oil (barrel)

   $ 51.92    $ 33.63    $ 48.93    $ 32.89

Natural gas liquids (gallon)

   $ 0.69    $ 0.52    $ 0.64    $ 0.52

Revenue per unit of production including effects of qualifying cash flow hedges

     

Natural gas (Mcf)

   $ 6.75    $ 5.79    $ 7.16    $ 5.73

Oil (barrel)

   $ 51.92    $ 33.63    $ 48.93    $ 32.89

Natural gas liquids (gallon)

   $ 0.69    $ 0.52    $ 0.64    $ 0.52

Revenue per unit of production excluding effects of all derivative instruments

     

Natural gas (Mcf)

   $ 6.02    $ 6.36    $ 7.00    $ 6.16

Oil (barrel)

   $ 64.29    $ 47.65    $ 60.41    $ 46.55

Natural gas liquids (gallon)

   $ 0.83    $ 0.64    $ 0.78    $ 0.64

Other data from continuing operations

           

Lease operating expense (LOE)

           

LOE and other

   $ 31,622    $ 25,366    $ 65,484    $ 48,115

Production taxes

   $ 12,759    $ 11,869    $ 25,852    $ 22,073
                           

Total

   $ 44,381    $ 37,235    $ 91,336    $ 70,188
                           

Depreciation, depletion and amortization

   $ 23,566    $ 22,458    $ 47,117    $ 43,470

Capital expenditures

   $ 50,652    $ 48,024    $ 95,557    $ 88,509

Exploration expenditures

   $ 1,417    $ 170    $ 1,526    $ 494

Operating income

   $ 87,138    $ 65,369    $ 175,677    $ 104,346

Natural Gas Distribution

           

Operating revenues

           

Residential

   $ 67,495    $ 64,778    $ 286,001    $ 242,932

Commercial and industrial

     32,856      29,580      117,413      94,880

Transportation

     10,261      10,245      22,996      23,274

Other

     2,584      2,594      5,409      4,239
                           

Total

   $ 113,196    $ 107,197    $ 431,819    $ 365,325
                           

Gas delivery volumes (MMcf)

           

Residential

     3,295      4,170      14,980      17,183

Commercial and industrial

     2,084      2,411      7,025      7,706

Transportation

     11,589      11,942      24,948      25,683
                           

Total

     16,968      18,523      46,953      50,572
                           

Other data

           

Depreciation and amortization

   $ 10,933    $ 10,643    $ 21,679    $ 21,056

Capital expenditures

   $ 21,590    $ 20,897    $ 40,435    $ 35,699

Operating income

   $ 2,711    $ 5,630    $ 66,438    $ 72,034

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Energen Resources’ major market risk exposure is in the pricing applicable to its oil and gas production. Historically, prices received for oil and gas production have been volatile because of seasonal weather patterns, world and national supply-and-demand factors and general economic conditions. Crude oil prices also are affected by quality differentials, by worldwide political developments and by actions of the Organization of Petroleum Exporting Countries. Basis differentials, like the underlying commodity prices, can be volatile because of regional supply-and-demand factors, including seasonal factors and the availability and price of transportation to consuming areas.

Energen Resources periodically enters into derivative commodity instruments that qualify as cash flow hedges under Statement of Financial Accounting Standard (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” to hedge its exposure to price fluctuations to its estimated oil, natural gas and natural gas liquids production. In addition, Alagasco periodically enters into cash flow derivative commodity instruments to hedge its gas supply exposure. Such instruments may include regulated natural gas and crude oil futures contracts traded on the New York Mercantile Exchange (NYMEX) and over-the-counter swaps, collars and basis hedges with major energy derivative product specialists. The counterparties to the commodity instruments are investment banks and energy-trading firms. These counterparties have been deemed creditworthy by the Company and have agreed in certain instances to post collateral with the Company when unrealized gains on hedges exceed certain specified contractual amounts. Notwithstanding these agreements, the Company is at risk for economic loss based upon the creditworthiness of its counterparties. In some contracts, the amount of credit allowed before Energen Resources and Alagasco must post collateral for out-of-the-money hedges varies depending on the credit rating of the Company or Alagasco. All hedge transactions are subject to the Company’s risk management policy, approved by the Board of Directors, which does not permit speculative positions. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking the hedge. The maximum term over which Energen Resources has hedged exposures to the variability of cash flows is through December 31, 2009.

A failure to meet sales volume targets at Energen Resources or gas supply targets at Alagasco due to miscalculations, weather events, natural disasters, accidents, mechanical failure, criminal act or otherwise could leave the Company or Alagasco exposed to its counterparties in commodity hedging contracts and result in material adverse financial losses.

See Note 4, Derivative Commodity Instruments, in the Notes to the Unaudited Condensed Financial Statements for details related to the Company’s hedging activities.

The Company’s interest rate exposure as of June 30, 2006, was minimal since approximately 85 percent of long-term debt obligations were at fixed rates.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

(a)

Our chief executive officer and chief financial officer have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation they have concluded that our disclosure controls and procedures are effective at a reasonable assurance level.

 

(b)

Our chief executive officer and chief financial officer have concluded that during the period covered by this report there were no changes in our internal controls that materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS*

 

Period

   Total Number of
Shares Purchased
    Average
Price Paid
per Share
  

Total Number of
Shares Purchased
as Part of Publicly
Announced Plans

or Programs

   Maximum
Number of Shares
that May Yet Be
Purchased Under
the Plans or
Programs**

April 1, 2006 through
April 30, 2006

   707 *   $ 35.45    —      2,150,700

May 1, 2006 through
May 31, 2006

   701
257,100
*
 
  $
$
35.37
32.92
   —  
257,100
   —  
1,893,600

June 1, 2006 through
June 30, 2006

   420
711,900
*
 
  $
$
34.81
34.54
   —  
711,900
   —  
10,181,700
                      

Total

   970,828     $ 34.11    969,000    10,181,700
                      

*

Acquired in connection with tax withholdings and payment of exercise price on stock compensation plans.

**

By resolution adopted May 24, 1994, and supplemented by resolutions adopted April 26, 2000 and June 24, 2006, the Board of Directors authorized the Company to repurchase up to 12,564,400 shares of the Company’s common stock. The resolutions do not have an expiration date.

ITEM 6. EXHIBITS

 

31 (a)  

- Section 302 Certificate required by Rule 13a-14(a) or Rule 15d-14(a)

31 (b)  

- Section 302 Certificate required by Rule 13a-14(a) or Rule 15d-14(a)

32    

- Section 906 Certificate pursuant to 18 U.S.C. Section 1350

 

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

ENERGEN CORPORATION
ALABAMA GAS CORPORATION

August 7, 2006

 

By

 

/s/ Wm. Michael Warren, Jr.

   

Wm. Michael Warren, Jr.

   

Chairman and Chief Executive Officer

   

of Energen Corporation, Chairman and Chief Executive Officer of Alabama Gas Corporation

August 7, 2006

 

By

 

/s/ G. C. Ketcham

   

G. C. Ketcham

   

Executive Vice President, Chief

   

Financial Officer and Treasurer of

   

Energen Corporation and Alabama Gas

   

Corporation

August 7, 2006

 

By

 

/s/ Grace B. Carr

   

Grace B. Carr

   

Vice President and Controller of Energen

   

Corporation

August 7, 2006

 

By

 

/s/ Paula H. Rushing

   

Paula H. Rushing

   

Vice President-Finance of Alabama Gas

   

Corporation

 

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