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Executives

Jack Walsh - VP of IR

George Lindemann - Chairman and CEO

Eric Herschmann - President and COO

Rick Marshall - SVP and CFO

Rob Bond - SVP, Pipeline Operations

Roger Farrell - SVP, Midstream Operations

Analysts

Carl Kirst - BMO Capital

Mark Caruso - Millennium Partners

Gordon Howald - Calyon Securities

James Heckler - Levin Capital Strategies

Southern Union Company (SUG) Q4 2008 Earnings Call February 26, 2009 9:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter fiscal 2008 Southern Union Company Earnings Call. (Operator Instructions).

I would now like to turn the presentation over to your host for today's call, Mr. Jack Walsh, VP of Investor Relations. Please proceed, Sir.

Jack Walsh

Thank you, Francine, and welcome to Southern Union's fourth quarter and fiscal 2008 earnings call and webcast.

Presenting on today's call will be George Lindemann, CEO; Eric Herschmann, President and COO; Rick Marshall, Senior Vice President and CFO; Rob Bond, Senior Vice President of our Pipeline Operations; and Roger Farrell; Senior Vice President of our Midstream Operations.

A replay of this call will be available for one week by dialing 888-286-8010 and entering passcode 69185508. A replay of the webcast will be accessible through our website at www.sug.com.

Today, we will be discussing our results for 2008, significant events and 2009 financial outlook. This morning, we issued a press release announcing our results, which is available on our website. We have also posted to our website a presentation that contains our financial outlook and guidance for 2009.

Following our prepared remarks, we will be happy to address your questions. If you have further questions after the call, please contact me at 212-659-3208.

Before beginning, I would like to remind everyone that the information discussed on today's call pertains to the financial result of Southern Union Company. Certain amounts and variance explanations for the transportation and storage segment may vary compared to Panhandle Eastern Pipe Line Company's standalone financial statements due to consolidating adjustments.

I would also like to caution you that many of the statements contained in our call may be based on management's current expectations, estimates and projections about the industry in which the company operates. These statements are not guarantees of future performance and involve risks.

The company undertakes no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise. Such statements are intended to be covered by the Safe Harbor provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934.

I would also refer you to the cautionary statement regarding forward-looking information in our earnings release.

I would now like to turn the call over to Mr. George Lindemann. Mr. Lindemann?

George Lindemann

Thank you and good morning. I am pleased to report adjusted 2008 earnings of $1.81 per share. This amount includes the negative impact from hurricanes Gustav and Ike of $0.14 per share.

As will you recall, our original guidance for 2008 was $1.80 to $1.90 per share. Excluding the impact of the hurricanes, our adjusted earnings would have nicely exceeded that range. I am pleased to report that our adjusted earnings guidance for 2009 is $1.75 to $1.90 per share. Rick Marshall will elaborate more on our 2009 outlook in a few moments.

We are happy that 82% of the cash flow of our company is derived from our low-risk regulated business segments. This high level of stability allows us to post strong results for 2008 and gives us a high degree of confidence in our 2009 guidance, in spite of the currently low commodity prices. When we have completed our prepared remarks, we will take your questions.

I would now like to turn the call over to Eric Herschmann to comment further on the quarter. Eric?

Eric Herschmann

Thank you, George, and good morning to everyone. To reiterate George's comments, 2008 was an outstanding year for Southern Union. At Trunkline Gas Company, we placed Field Zone expansion (technical difficult) in early 2008, which helped drive strong results in transportation and storage segment.

During the year, we continue to move forward with our infrastructure enhancement projects at Trunkline LNG and our Phase VIII expansion at Florida Gas Transmission. Rob bond will provide a more detailed update on these projects in a few moments.

Our gathering and processing segment produced improved results for 2008 in spite of the impacts from Hurricane Ike. We expect the stability of our system volumes in our existing hedge portfolio for 2009 will help minimize some of the weakness that is currently seen throughout the commodities markets. Roger Farrell will go into greater detail on gathering and processing later on this call.

At our distribution segment, we recently received a $3.7 million increase in base rates at our Massachusetts operations. The new rates went into effect earlier this month. We currently expect to file the rate case in Missouri in April 2009.

With that, I would now like to turn the call over to Rick Marshall, our CFO, to give an overview of our results and 2009 guidance. Rick?

Rick Marshall

Thank you, Eric, and good morning. Before I begin, I would like to point out that our discussions today will focus on adjusted net earnings, adjusted EBIT and adjusted EBITDA, all non-GAAP measures. In accordance with Reg G, our press release and 2009 financial outlook, both issued this morning, contain reconciliations of the adjusted metrics as well as EBIT to net earnings.

For the year that ended December 31, 2008, Southern Union had adjusted EBIT of $548 million compared with adjusted EBIT of $519 million in the prior year. The increase is due to improvements in our transportation and storage and gathering and processing segments.

Our distribution segment produced stable results year-over-year. We estimate that the hurricanes negatively impacted EBIT by approximately $29 million during the year.

For fiscal 2008, adjusted net earnings were $223 million or $1.81 per share. This compares to adjusted net earnings of $206 million or $1.70 per share in 2007. Reported earnings for the year were $2.26 per share compared with $1.75 per share last year. For the three-month period that ended December 31, 2008, adjusted net earnings were $59 million or $0.47 per share compared with net earnings of $49 million or $0.41 per share in the prior period.

Reported earnings were $0.97 per share for the current quarter. As George mentioned earlier, we estimate that the hurricanes impacted the year by $0.14 per share and the quarter by $0.03 per share.

In terms of segment results, transportation and storage, including our investment in Citrus, had EBIT of $405 million for the year compared with adjusted EBIT of $392 million during the prior year. The current year's results include expenses of $14 million related to damages our facilities sustained during the hurricanes. The results also include approximately $4 million of lower revenues as a result of reduced volumes following the hurricanes.

Panhandle's operating revenue increased by $63 million during the year largely due to the inclusion of Trunkline Field Zone project which went into service in early 2008.

Operating expenses, including expenses associated with the hurricanes, were up $22 million during the year. Depreciation expense increased $18 million year-over-year due to a $388 million increase in property, plant and equipment.

Our gathering and processing segment generated $86 million in adjusted EBIT for the year compared with EBIT of $65 million in the prior year. The increase was largely driven by higher realized natural gas and natural gas liquids’ prices. We estimate Hurricane Ike negatively impacted gross margin by approximately 11 million during the year as it led to the unavailability of third-party fractionation capacity at Mont Belvieu.

Unusual items during the year also included a $3 million bad debt reserve for a customer that filed bankruptcy, plus $2 million related to the settlement of litigation.

Our distribution business generated EBIT of $61 million for the year compared with $62 million in the prior year. Our New England Gas Company division recently received a $3.7 million increase in its base rates. The new rates were effective earlier this month.

During the year, we invested approximately $552 million in our operations. Growth capital accounted for $338 million, and maintenance capital was $214 million.

Broken down by segment, our transportation and storage segment invested $434 million; $284 million for growth and $150 million for maintenance. Our gathering and processing segment invested $68 million; $36 million for growth and $32 million for maintenance. And our distribution segment invested a total of $41 million; $9 million for growth and $32 million for maintenance. Our corporate and other segment invested $9 million of growth capital.

As of February 24, the company had $420 million in revolving credit facilities. Of that amount, approximately $170 million was outstanding, leaving an available balance of $250 million. During 2009, we have $61 million of senior notes maturing at Panhandle, which we expect to pay through cash flow. We also have a $150 million short-term facility at Southern Union Company that we expect to refinance in the bank markets.

As Jack mentioned earlier, we posted our 2009 financial outlook presentation to our website this morning. I would like to take a few moments to walk through those slides.

As you can see on Slide 5, we expect adjusted earnings for 2009 to be in the range of $1.75 to $1.90 per share. This compares to adjusted earnings per share of $1.81 for 2008 and $1.70 for 2007. We expect reported earnings for 2009 to be in the range of $1.45 to $1.60 per share. Again, adjusted earnings reflect the cash impact of mark-to-market accounting treatment on economic hedges.

We expect consolidated adjusted EBITDA for 2009 to be in the range of $860 million to $920 million. This amount includes our 50% interest in the EBITDA of Citrus Corp. This compares to EBITDA of $861 million in 2008 and $831 million in 2007.

Consolidated EBITDA and EBITDA by business segment are shown on Slides 7 and 8. From a net capital expenditure standpoint, we expect to spend a total of $345 million to $370 million in 2009. Of this, approximately $205 million is for maintenance and $140 million to $165 million is for growth with approximately $90 million dedicated to the LNG Infrastructure Enhancement Project.

Capital expenditure guidance is shown on Slide 10 of the outlook. For your review, Slides 11 and 12 depict our corporate and gathering and processing (technical difficulty).

I will now turn the call over to Rob Bond who will discuss our transportation and storage segment.

Rob Bond

Thank you, Rick, and good morning. Our transportation and storage businesses performed well in 2008. Even with the hurricanes, which negatively impacted our segment margin by approximately 18 million, Panhandle Energy set new records for operating income and net income. Our organic growth projects that are currently underway will allow us to continue that upward trajectory into the future.

At this point, I would like to spend a few minutes updating you on these key projects. First, we continue to make excellent progress on our Trunkline LNG Infrastructure Enhancement Project. The project, which is fully subscribed by our customer, BG LNG Services, for years is nearing completion.

Due to the complicated nature of the engineering and construction associated with this project, our current construction schedule now anticipates the project will be complete and in service in either late July or August. The capital cost of the project on which we will earn a fixed return is expected to be $430 million. We expect EBITDA to now been in the range of $67 million to $72 million.

Our other major project underway is the Florida Gas Transmission Phase VIII project. We have a 50% equity interest in and serve as the operator of Florida Gas Transmission through our investment in Citrus Corp. Phase VIII project is designed to add approximately 820 million cubic feet per day of incremental delivery capacity into Florida through the addition of 500 miles of pipe and over 200,000 horsepower of compression.

As you all know, there has been a slow down in growth in Florida due to the current economic conditions. As a result, we have restructured a contract with one of our shippers. They have reduced their contracted capacity, while the transport rates have increased. As a result, we now have 74% of the capacity contracted under a 25-year contract. The restructured agreement provides for an election for the shipper to increase its capacity which would take us up to 83% contracted.

We continue to estimate that the project will cost approximately $2.4 billion and will generate operating income of $240 million to $260 million and EBITDA of $290 million to $310 million when fully contracted.

At this point, we have locked in the cost of our pipe. We have ordered our compression, begun procuring valves, regulators and other necessary equipment; and lastly, have signed agreements with our pipeline contractors. We expect to receive our FERC certificate sometime late summer or early fall. And at that time, we will begin construction with a targeted in-service date of spring 2011.

With that, I will turn the call over to Roger. Roger?

Roger Farrell

Thank you, Rob, and good morning, everyone. The end of 2008 and the beginning of 2009 have been difficult times for the midstream industry to say the least. To date, we have seen a small decline in overall system volumes, but have been fortunate that most of the decline is associated with low margin, fee-based volumes that will not have a meaningful financial impact on our business.

We are seeing relative stability in our high margin, high-BTU volumes largely due to the fact that a significant portion of our processed gas is associated with oil production. Although there has been a decline in a number of active drilling rigs operating in our area, we have not seen a significant decline in the overall pace of the oil related drilling activity.

For 2008, excluding the month of September which was significantly impacted by Hurricane Ike, we averaged just over 40,000 MMBtu per day of equity natural gas liquids. During that same time period, we also averaged approximately 6,000 MMBtu per day of equity natural gas.

For 2009, we expect our equity NGL volumes to be in the range of 40,000 to 45,000 MMBtu per day, consistent with our volumes from 2008. We also expect our equity natural gas to be in a range of 2,500 to 7,500 MMBtu per day. We are cautiously optimistic, given some of the activity that we have seen in our operating area that we will be able to maintain our equity volume projections.

For 2009, we are hedged on 20,000 MMBtu per day of NGLs at a realized price of $16.40. This was accomplished through a combination of swap contracts on natural gas and processing spreads. We have also entered into an additional processing spread hedge on 10,000 MMBtu per day at $8.37. As it relates to the processing spread hedge, you need to add to the spread value the then current natural gas price to arrive at the total net price at which we would be selling our product.

We remain open on the remainder of our equity volumes, but continue to monitor the markets frequently and would look to add additional hedges to our portfolio for 2009 and beyond if and when opportunities present themselves.

I would now like to turn the call back over to George.

George Lindemann

Thank you, Roger. At this point, we would like to open the meeting up to questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Carl of BMO Capital. Please proceed.

Carl Kirst - BMO Capital

Good morning. If I could start maybe, Rob, the update on Citrus, so it looks like we have dropped roughly 125 million a day. You said that was going to be at higher rates. Can you say what the increment is? I do not think you guys have ever sort of published what the actual average negotiated rate is. We have sort of backed into $1.12.

But is there a way to kind of give us what the increment is on, so that we can kind of run our economics?

Rob Bond

Carl, I think we are under confidentiality agreement with the various customers at this stage. So I do not think I can give you too much more clarity on that. But I think it is safe to say, that based on the increase in rate and the reduced [CQ] together with what we think we can sell, the remaining capacity in the project; for that we are still looking to maintain the same EBITDA guidance that we had previously provided.

Carl Kirst - BMO Capital

Okay. And maybe switching over to the financing of Citrus for a second, Rick, if you want to take this. I guess the two questions there are: one, I was just curious how you see sort of the state of the project finance market right now. But now that we might have a little bit less volumes contracted, even if at a bit higher rates, does that change the ultimate level of project finance, which was expected to be fairly high on this pipeline; does that take that down at all?

Rick Marshall

Well, first of all, we were not looking to the project finance markets to finance the Phase VIII expansion, and as Rob mentioned, I think we still have a high degree of confidence that we can guide the lenders to the same level of EBITDA that we were assuming prior to this change of the contract that was recently announced.

So I do not think that that is going to be a major hurdle, as it relates to financing the project. We have been, as I think we have announced; at sometime this year we will be in the market for a debt financing at the FGT level. We have been obviously watching the markets of late and seen a nice rally, as it relates to corporate issuances in our space and are pleasantly surprised.

Because of that, I think we will try to be ready and nimble with respect to accessing the market in 2009 and in order to take advantage of this rally, and I do think that there will be a lot of appetite for this type of paper given the long-term nature of the contract and the asset itself.

Carl Kirst - BMO Capital

Okay. I appreciate the color. And then just one other question, if I could, on the pipeline side.

Rob, when we look at – sort of guidance over on the adjusted EBITDA pre-Citrus and what was sort of achieved very nicely in 2008, recognizing that we are going to get at least one quarter of the IEP; if not another two months in addition to that, but also the hurricane Ike costs and revenues presumably coming in, is there something else that is creating a drag such that the low end of the guidance, for instance, the 430 is actually under the 434 that was achieved in 2008, should we be thinking of that as kind of a retained fuel exposure or any color there?

Rob Bond

I do not think so. I mean I think it is just LNG expense creek. I think some of it may be a little bit of incremental storage expense, but in large part, as you aptly point out, it is going to be largely driven by the timing of getting the IEP project online.

Carl Kirst - BMO Capital

Okay. Thank you all. I will jump back in queue.

Operator

Our next question comes from the line of Mark Caruso of Millennium Partners. Please proceed.

Mark Caruso - Millennium Partners

Good morning, guys. I just had a few clarification questions on guidance. As far as distribution goes, I saw a nice uptick year-over-year in EBITDA, so I was trying to make sure that was just Massachusetts increase. Are you guys assuming successful Missouri or any weather on that?

Eric Herschmann

No, there is no weather. It is a part of the uptick, as you mentioned, in the (technical difficulty) New England gas rate increase. We may have a slight increase in capacity release in off systems' net sales. But there is really no real weather (technical difficulty).

Mark Caruso - Millennium Partners

Okay. And then on gathering and processing, I think you guys are still looking for flat volumes. Is that just a function of carryover barrels and a backup of inventory because I know you had mentioned you are not seeing that much of a drop-off in rigs for oil related? But I know with commodity prices where they are, there are more and more producers in the region talking about cutting rigs, so I just want to try to reconcile the numbers there as well.

Roger Farrell

What we have seen is that there is a pretty good pace of activity on the shallower oil plays around our system. In fact, some producers actually have ratcheted up their other plans. And as I said in my statements that oil related drilling is very good because it is very, very rich gas and good for our processing business.

We have seen the fall-off in some gas rigs, but once again, typically a lot of the areas where we are high focused are quite low margin type of volume. So even if we do have some fall-off there, it will not be particularly meaningful.

I will say also that Grey Ranch facility, which was offline for a good portion of the second and third quarter and fourth; I guess it is back up and running nicely, so that will be a very positive thing for 2009.

Mark Caruso - Millennium Partners

And then, Rick, going back on the financing, I think you guys had a few credit facilities that expired this year, and I just want to see if you can kind of give us updated thoughts there as far as extending those or addressing that?

Rick Marshall

We have a $150 million term loan at the Southern Union Company level that expires in August of this year. We have had discussions with a number of our banks as to the best way to refinance that loan. I believe that I am optimistic that given the relationships that we have with our banks and our overall credit profile that we will be successful in renegotiating that loan and possibly the revolving credit facility that we have coming due in May of 2010.

Mark Caruso - Millennium Partners

Okay. And just one last question. I am sorry. Go ahead.

Rick Marshall

What I was going to say is that that is the only short-term obligation that is coming due. We have got $60 million coming due at the Panhandle level, but we have adequate cash flows to pay that off.

Mark Caruso - Millennium Partners

Got you. And then one last question. It seemed like the corporate and other is a new breakout. I apologize if I missed it. What is in that number?

Rick Marshall

That includes our PEI Power facility as well as our Fall River Appliance facility or segment. They are relatively small. And then it also takes into consideration intercompany allocations that accrue to the benefit of corporate.

Mark Caruso - Millennium Partners

Okay, great. Thank you.

Operator

Our next question comes from the line of Gordon Howald of Calyon Securities. Please proceed.

Gordon Howald - Calyon Securities

Good morning. Two questions if I could. What sensitivity is there at midstream? I was kind of looking at your stock, saying, okay, well, the stock is implying 6.5 times EPS multiple in 2009. And investors may be saying, well, the problem could be at midstream.

If we were to take midstream, what is the worst case scenario that you could get at midstream? Could you see potentially an EBITDA loss coming from that business, assuming no hedges and commodity strip prices stay the same as they are now in 2010? I mean what was the worst case scenario at midstream?

Roger Farrell

Well, we are not going to give 2010 guidance, but --.

Gordon Howald - Calyon Securities

Just a scenario. On 2009, everything stays real bad, hedges go away, what could that business potentially do? Is there an ability to offset any potential losses?

Roger Farrell

Well, we are going to take steps to reduce costs throughout our business, not just at the Southern Union Gas Services level, but that is certainly one of the challenges that management has ahead of it for this year and beyond, especially given the drop-off in commodity prices at the Southern Union Gas Services level.

But as far as just generally to answer your question, I do not see the business producing negative EBITDA on a go forward basis, given today's commodity environment.

Gordon Howald - Calyon Securities

Got you. Okay. And on the Trunkline LNG expansion, I just want to make sure I got this right. I guess the costs increased, but you were able to earn at a higher level. I think the cost was 365. You now are talking 430 and the EBITDA expectations are up from 67 to 72. That is on an annualized basis. Are those numbers correct?

Rick Marshall

That is correct.

Gordon Howald - Calyon Securities

Okay. So, I guess in the contract with BG, the total costs ultimately are earned upon and there was a bit of a change in what you were able to earn as a result of just the higher cost that resulted over the course of the construction period? Is that right?

Rick Marshall

Yes, I think that is right. And I think, Gordon, we said that we estimated that last quarter we were projecting that the costs were right around $400 million. So it is up a little bit from quarter-over-quarter.

Gordon Howald - Calyon Securities

Got you. All right, great. Thanks, guys.

Operator

Our next question comes from the line of James Heckler of Levin Capital Strategies. Please proceed.

James Heckler - Levin Capital Strategies

Hi, good morning.

Eric Herschmann

Good morning, Jim.

Rick Marshall

Good morning.

James Heckler - Levin Capital Strategies

I just wanted to follow up on a couple of the other questions that were asked. At distribution, I was looking at what was happening from 2008 to 2009, the midpoint of 2009 guidance on an EBITDA basis. And it looks like it is about an $18 million increase. And I understand you had a rate increase in Massachusetts. What was the size of that rate increase? I do not recall. Did you say $3.7 million?

Rick Marshall

7 million.

James Heckler - Levin Capital Strategies

And I am just trying to reconcile what the remaining portion of that roughly $14 million increase year-over-year is attributed to. That is the first question.

Rick Marshall

Okay. Why don't you give me your second question? I will see if I can find something here.

James Heckler - Levin Capital Strategies

Okay. It is similar to the distribution question. At corporate and other, from 2008 to 2009, the midpoint of 2009 guidance, that also seems to imply roughly $15 million increase in EBITDA year-over-year, and I was trying to understand what that might be. And I have one more question, Rick.

Rick Marshall

Okay. And the next question, James?

James Heckler - Levin Capital Strategies

Another prior question. I was wondering if you could describe in some way what the impact of the hedges in 2009 are to your EBITDA?

Rick Marshall

With respect to the hedges, it would be about $60 million.

James Heckler - Levin Capital Strategies

Okay.

Rick Marshall

That is basically the unrealized gain that was recorded at the end of 2008, approximately $60 million.

James Heckler - Levin Capital Strategies

Got it. So if I were to think about beyond 2009, would I just subtract that $60 million from the EBITDA at gathering and processing in 2009 to think about what an unhedged number might be?

Rick Marshall

That certainly would be something you would do to disregard the processing spread hedges that we had in place for 2009. That is correct.

George Lindemann

Assuming commodity prices stayed at the exact same level.

James Heckler - Levin Capital Strategies

I understand. Got it. Okay. Those are my other questions. And if you do not have the distribution and corporate and other answers handy, I can follow up afterwards.

Rick Marshall

Yes, let's follow up on that one because we don't have them handy.

James Heckler - Levin Capital Strategies

Thank you.

Operator

That concludes the Q&A portion of the presentation.

George Lindemann

Well, I would like to thank everyone for attending the meeting, and we will look forward to seeing you all in the next quarterly meeting. Thank you very much. Bye.

Operator

Thank you for your participation in today's conference. That concludes the presentation. You may now disconnect. Have a good day.

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