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Executives

Steve Cave – Vice President, Finance

John W. Somerhalder II – Chairman, President and Chief Executive Officer

Andrew W. Evans – Executive Vice President and Chief Financial Officer

Douglas N. Schantz – President of Sequent Energy Management

Analysts

Ryan Rosenthal – Sidoti & Company

Ted Durbin – Goldman Sachs

Barry Kline – Citi

AGL Resources Inc. (AGL) Q3 2009 Earnings Call Transcript October 29, 2009 9:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the AGL Resources Third Quarter 2009 Earning Conference Call. My name is Gina and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a Q&A session. (Operator Instructions) I would now like to turn the presentation over to your host for today's, Mr. Steve Cave, Vice President of Finance. Please proceed.

Steve Cave

Okay. Thanks Gina and good morning everyone. Thanks for joining us today to review our third quarter 2009 earnings results. The speakers on the call today will be John Somerhalder, our Chairman, President and CEO; Andrew Evans, our Executive Vice President and CFO. As always, we have several other members of our management team here with us today to answer questions following the prepared remarks.

As you know, we issued our earnings release and filed our Form 10-Q this morning, before the market opens. If you don't have copies of those documents, you can find those on our website.

And before we move to the prepared remarks, let me just remind you that our discussions today may contain forward-looking statements and that our actual results could differ materially from those projected in those forward-looking statements. The factors that could cause such a material difference are included in our press release, in our 10-Q, and are more fully described in our most recent 10-K filing.

We also used some non-GAAP measures in describing our business and a reconciliation of those measures to the GAAP financials available in our earnings release and our SEC filings on our web site. We will begin today's call with some prepared remarks, and then we will open the lines to take your questions.

And with that let me turn it over to John.

John W. Somerhalder II

Thanks Steve and good morning. As you know, today we reported earnings of $0.16 per diluted share for the third quarter. Last year at the third quarter, we reported $0.85 per diluted share.

Last year's third quarter was a period in which we reported significant gains on storage hedges at Sequent, as a result of gas price movements in that quarter. Gas price volatility was much lower this year, and hedge moments were significantly lower for the second and third quarters this year. Movement between quarters is going to occur based on the way we are required to account for hedges.

So, we will focus on full year-to-date reserves for a more meaningful comparison. Through the first three quarters of this year, we reported $1.97 per diluted share, which is $0.10 ahead of last year's results for the same period. We previously had provided earnings guidance for this year in the range of $2.65 to $2.75 per share. Based on our results year-to-date and some of the future economic value created by Sequent that Drew will discuss, we are on track to achieve earning results at the high end of that range or possibly slightly higher.

These solid financial results reflect good performance from each of our business units this year relative to our expectations. Drew will walk you through some of the major drivers for our results in each business unit in a few minutes. But first, I'd like to briefly provide an update of our progress this quarter on several major initiatives.

On regulatory front, we received approval from the Georgia PSC and early October for our STRIDE program, which is an infrastructure program, primarily in the Metro Atlanta region. We submitted plans for a ten-year program that would cost approximately $400 million. The commission approved the first face of that program, which is a three-year investment of about $176 million.

The STRIDE program is an important part of our long-term utility infrastructure plan, as it will enable us to improve system performance and reliability in several areas of the Metro Atlanta region that have been strained by rapid growth and development. From a cost recovery standpoint, it was important to us to put in place a plan that would support infrastructure development, while minimizing regulatory lag.

Also on the regulatory front, our rate case in New Jersey is ongoing and we continue to expect a resolution in the fourth quarter of this year. We have now received approval from the Georgia Public Service Commission to purchase the 15% additional ownership interest in the SouthStar joint venture. The PSC approval was the only regulatory approval we needed. So, we are now on track to close the $58 million transaction with Piedmont on January on January 1, 2010.

Turning to our major capital projects, we continue to make good progress on both our regulated and our unregulated pipeline in storage projects. Our Hampton Roads Crossing, or what we call our HRX project, in Virginia, continues to go well with only a few minor construction delays.

We anticipate putting that project into commercial operations in December. Construction on our Golden Triangle storage facility in Texas also continues to go well and we are expecting to have the first cavern of that project online in the third quarter of 2010.

The Magnolia Project in Georgia is on schedule to close and begin service at the end of this week. You may recall that this project is about $46 million investment, which includes the purchase of an undivided interest in some of Southern Natural Gas assets that we are combining with existing Atlanta Gaslight distribution pipeline to create a firm transportation path into the Atlanta market from the Elba Island LMG facility.

The result will be that we will have an additional 84,000 [deca-thermos] per day of capacity available to serve our customers. I think those are the major highlights for the quarter. So with that I will turn it over to Drew for the financial review.

Andrew W. Evans

Thanks John. And good morning everyone. I will cover a few of the major earnings drivers for the quarter and the year with a bias toward more of the year-to-date results for the reasons that John described. Being sensitive to the fact that there are a number of earnings calls going on in the utilities space today, I will try to keep my comments brief, so we can get to your questions.

As Steve mentioned we've put out 10-Q in conjunction with our earnings release, which is our normal practice and you should be able to find most of the quarterly details in there if you need them. Also, I will cover each of the business segments, as I cover each of the segments, I will discuss the major drivers, but not all of the reconciling items. You can find some very good schedules in the results of operation segment of our MD&A that reconcile you back to reported EBIT for each business unit.

In both the distribution and retail segments, keep in mind the third quarter is typically a shoulder period for us, representing only about 15% of our earnings in that period. The real story year-to-date is in distribution, is that operating margin is up $16 million, primarily as a result of carrying higher priced inventory on behalf of the marketers in Georgia and higher revenue from our pipeline improvement project in Atlanta Gas Light.

If you recall, when we store gas in our system on behalf of the marketers in Georgia, we collect carrying charges on that inventory and since inventory levels and costs have been higher this year, our margins from that activity are higher than last year. We've also incurred higher cost of carrying it on their behalf. Further, we have seen margin benefit from our regulatory efforts in Virginia that's the decoupling measure that was passed this year.

We've also seen an increase in utility operations expensed year-to-date, primarily as a result of higher depreciation expense, as well as higher pension post retirement expenses. Hank and his team have done a great job of holding in line on discretionary operating costs, particularly during a time when we were challenged by the market impacts of flat-to-negative customer growth, but clearly these two items have had the largest impact on us from an expense standpoint.

In the retail business, which is SouthStar, our EBIT year-to-date is up $19 million, compared to last year, about 12 million of that increase reflects lower-of-cost-or-market or low-COM adjustments year-over-year. The remainder is due primarily to higher contribution from the Ohio market, as well as an increase in the average customer usage. John mentioned the continued aggressive competition we've seen in the Georgia market and we don't see that abating any time soon.

One impact is, we continue to see changes in the mix of retail customers with respect to fixed price plans versus variable price plans and that has impacted our margins as has a slightly lower customer count year-over-year.

Mike Braswell's here today and his team has made some investments in more aggressive marketing this year in an effort to minimize the market share impact and will continue to monitor these impacts of those initiatives through the winter heating season. Let's turn to wholesale, that's clearly the largest driver for quarterly results and here I will focus on some of the reconciling items for the quarter as well as the year. As you know, we have to record changes in fair value of hedges that we use to lock in profits for gas-stored underground. We're required to mark those hedges without regard to the underlying gas.

And in general, as prices rise, we will record losses and if they fall, we'll record gains. Regardless of these price movements, the initial profit we locked in at injection is never at risk. Sequent EBIT loss of $2 million during the third quarter obviously is a dramatic change in reported results from the $86 million EBIT contribution during the third quarter of 2008. So it's very consistent with these concepts. Because of the price movements I just described and their impact on reported earnings, last year we had substantial reported losses in the second quarter, which were essentially offset by substantial gains in the third quarter.

This year, the effect was opposite, but with a much milder change. This year we had higher second quarter earnings followed by lower third quarter results. And let me just describe a few of the reconciling items for the year's third quarter results. First, we recognized commercial activity for the quarter was down $17 million relative to last year. That's the result of lower market volatility and milder weather during the quarter. I'll talk about future profit from gas delivery in a minute.

Second, increasing gas prices during this year's third quarter resulted in a loss of $5 million on our storage hedges, compared to $105 million gain on storage hedges during the third quarter last year as prices declined significantly throughout the quarter. The last reconciling item is the low comp adjustments, we were not required to record an adjustment in this year's third quarter, but last year we recorded a $34 million adjustment.

All of these items net to $10 million in operating margin for the third quarter of 2009 versus a $101 million in the third quarter of 2008. Importantly, though year-to-date Sequent is contributed EBIT of $25 million up $3 million over last year's results. As John pointed out, Sequent has been enable to take advantage of market opportunities to generate significant future economic value in its storage portfolio and you can see that in the storage rollout schedule we provide on page -- I think it's 29 in the 10-Q.

In addition to the income we have already reported we have 26 million cubic feet of salt dome and reservoir storage at a weighted average in the $3.40 range, with 14 billion cubic feet schedule to be withdrawn in the first quarter of this year, I'm sorry in the fourth quarter of this year. This withdraw will generate operating margin of $23 million. We also have 10 billion cubic feet we expect to withdraw in the first quarter of 2010, which will produce an operating margin of $18 million.

In total, we have $45 million embedded in the current rollout schedule over the next four quarters. Obviously, market conditions could cause us to change this withdraw schedule which would impact our expected earnings results. Based on our current projection for the year-end storage positions, a $1 increase in the first quarter 2010 forward NYMEX gas prices would result in a $9 million reduction to reported operating revenue for the year. Conversely, a $1 decrease in prices would result in a $9 million positive impact. Although keep in mind that a portion of this positive impact maybe offset by low-COM adjustments in that particular scenario.

Our base earnings meter exceed our internal estimates in this business, but large changes in gas price could have a significant impact on what we report at year-end, but will be made up or taken in the subsequent quarter. These movements are unrelated to when we generate the value.

Turning to energy investments, we have recorded year-to-date EBIT of $7 million, which is down $11 million relative to last year. That's largely a function of $8 million in reduced margins, with $5 million of that associated with a network expansion project we completed and sold to a customer in 2008. And most of remainder is associated with lower interruptible margin opportunities at Jefferson Island. Also, expenses were up $3 million year-over-year related to legal and outside service costs for Jefferson Island and depreciation expense at Golden Triangle Storage.

Year-to-date income taxes were up $6 million relative to the prior year period, mainly a function of higher consolidated earnings. Interest expense is down $10 million and that's largely a function of lower average rates this year. We continue to have good access to the commercial paper markets. We have no outstanding borrowings under our $1 billion credit facility. Our liquidity position is strong, particularly given lower working capital requirements this year resulting from lower gas prices as we have built inventories throughout the injection season.

And clearly, we continue to have good access to the capital markets as evidenced by our $300 million ten-year senior note issuance in August at a very favorable rate of 5.25%. Those are the highlights, so let's go ahead and take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Ryan Rosenthal with Sidoti & Company please proceed.

Ryan Rosenthal – Sidoti & Company

Good morning everyone.

Unidentified company representatives

Hey Ryan, how are you?

Ryan Rosenthal – Sidoti & Company

Good, Wanted to catch up - questions here on the wholesale storage business, specifically if you could discuss the improvement in year-over-year storage operating revenue that the company forecasts for the '09, 2010 winter season. Reviewing the NYMEX futures curve, it appears that it did improve for the storage curve later in the cycle. I was wondering if you held off on locking in some of your gains until later on than usual?

Douglas N. Schantz

Ryan, this is Doug Schantz, and obviously the spread did move out as we kind of got into the third quarter and there was kind of some storage box dynamics. We did capture- again our salt, we kind of delayed injection on which had higher spreads. The reservoir, because of the limits on the ratchets and injections, we had to kind of space over the summer. So we didn't appreciate as much margin gain as we did on our salt storage. But, yes, no doubt the storage spreads are materially above last year at this time and, of course, that's what's behind the $35 million roll out schedule.

Ryan Rosenthal – Sidoti & Company

Okay, thanks. In terms of thinking about it – in terms of the future, would you suggest that you can wait later in the cycle to, if margins are improving over time or is there a certain amount you look to lock in up front in terms of percentage of your raw storage?

Douglas N. Schantz

Ryan, I would pay attention again to the split between our salt and reservoir because our salt we can wait on, because you can fill the capacity of salt storage typically in 20 days versus reservoir which has to be spread over4 or 5 months so, clearly, we're going to hold back on our salt as we look at the dynamics on the storage box, but the reservoir we have to earlier and spread it out evenly. And then the same thing when you come out, we'll take advantage of salt opportunities based on real time dynamics, while the reservoir storage has to come out evenly. And most of all I'm sure you're looking out in the first quarter part of the roll out schedule for 2010 is reservoir. We just can't come out as quickly as we can on the salt.

Ryan Rosenthal – Sidoti & Company

Okay. And if you could, could you familiarize me with essentially the break down between the reservoir storage and the salt storage in terms of each as a percentage of your business?

Douglas N. Schantz

Well, we carry, I think we have 25, 26 BCF right now. And actually we still have a couple BCF on top of that in salt capacity. But we carry; we have capacity rights to about 28 BCF right now. Six of that, salt, the remainder is reservoir.

Ryan Rosenthal – Sidoti & Company

Okay. And then one further question regarding the wholesale business. In terms of the weak energy demand we've seen over the last year and a half or so, and also relatively low natural gas prices, what's your outlook for the transportation spread business and do you see that recovering with an economic boost into 2010?

Douglas N. Schantz

Ryan, obviously, without weather and storms and other activity that kind of drive volatility, we've seen lower transportation spreads and we expect that to continue to a certain degree through next year. But, obviously, the same thing that impacts transportation margins impacted forward margins. So, reduced demand, no supply disruptions create a better environment for storage. So, they are kind of counter-balancing at times. But, clearly we expect transportation spreads to be relatively tight. They may get modestly better as drilling recovers and the economy comes back. But I wouldn't expect a dramatic reversal.

Ryan Rosenthal – Sidoti & Company

Okay, thanks for your insight on that. And I just want to jump to one more question on the utility side in terms of pension and OPEP expense year-to-date. Trying to get a feel for what that it – what the impact of that is year-to-date versus last year and also looking forward what we can anticipate for the trend line for both ad expense as well as your other operating expenses.

Andrew W. Evans

Ryan, this is Drew. I think as it relates to pension, financials today represent about a $12 million increase year-over-year in pension.

Unidentified Company Representative

It's 9 per year-to-date.

Andrew W. Evans

Not 9 year-to-date, but our budget for the year is about $12 million full year. I'm sorry your other question was related to other operating expenses there?

Ryan Rosenthal – Sidoti & Company

Right. And also your outlook for pension expense moving into next year in terms of your funding status, and kind of how the plan has performed this year?

Andrew W. Evans

In general we target 80% funding in the pension. We try to minimize our insurance premiums and make sure we've got a path to fully funding the pension. It was certainly much closer a year and a half ago. And when we had to set our funding expectations at the beginning of this year, I think our total expectation over a five-year period was about $180 million. We would certainly expect, given the performance of the pension, that we'd see some improvement in the funding requirement. But really it's going to come down to where discount rates land at year-end when we have to discount the liability to recalculate what our funding requirements are.

Ryan Rosenthal – Sidoti & Company

Okay.

Andrew W. Evans

I think you know, today we haven’t seen much movement in that discount rate. We don't expect, certainly not a significant increase year-over-year as we saw this year, but we might see some improvement as the asset continues to accrete and we might get some relief related to long-term rates.

Ryan Rosenthal – Sidoti & Company

So, just on a relative basis year-over-year, will you expect that pension expense will be about the same as this year given that we have seen market benefit with returns in all likelihood?

Andrew W. Evans

I would think that – I think if you don’t change any of our assumption today, our base expectations that we'll be slightly higher next year. But, given performance of the fund, that might be an offset that brings it down, but it's going to be in the couple of million dollar range suppose to the 12 million swing we would anticipate year-over-year.

Ryan Rosenthal – Sidoti & Company

Okay thanks for your time Drew.

Operator

Your next question comes from the line of Ted Durbin with Goldman Sachs. Please proceed.

Ted Durbin – Goldman Sachs

Hi guys. Couple more questions on the regulatory side. The STRIDE program, you sort of stepped into the rate increases. Can you match that with your capital spending or is the capital spending going to come all in the next three years, $176 million divided by 3? How do we think about that?

Henry P. Linginfelter

It doesn’t match the capital spending exactly. It is -- this is Hank by the way…

Ted Durbin – Goldman Sachs

Hi.

Henry P. Linginfelter

The – we start actually collecting the fee in November and the capital spending starts after that or right almost simultaneous to it. But the $176 million will be recovered over a period of several years. I think it's 2020. But it does have sharing cost attached to it.

Andrew W. Evans

I think what it removes from normal capital spend in the utility is the regulatory lag associated with our normal spends. And so what we get is sort of near instantaneous rate making related to the spend as it's spent.

Ted Durbin – Goldman Sachs

Okay. That make sense. And then were are you thinking then, now that you've gotten this behind you, in terms of just the general rate case at Atlanta Gas Light, timing and whatnot?

Henry P. Linginfelter

We still think we'll file second quarter for Atlanta Gas Light rate case. Now that the STRIDE is been decided by the commission. We deferred that filing. We were going to do it originally this year, we deferred it until next year so they could deal with the complexity of the STRIDE outcome and they've done that. So, we had told them and they agreed that some time second quarter was appropriate based on the timing the commission has to deal with the case.

Ted Durbin – Goldman Sachs

And then from a statutory standpoint when would you expect a decision?

Henry P. Linginfelter

Before the end of the year, next year.

Ted Durbin – Goldman Sachs

Okay great. In terms of the – I guess the spending on litigation around Jefferson Island, how do you balance the higher expenses there with the potential upside if you do get that project to go forward? How are you thinking about that?

John W. Somerhalder II

This is John Somerhalder again. That expansion, because the costs are lower for the next two caverns and we have existing surface infrastructure and because we're at the, roughly, at the Henry Hub and have good access there, very liquid point. Those set of expansions really have very favorable economics. And when you compare those very favorable economics to the cost of that litigation that favorable set of economics far outweigh the litigation cost. However, we still believe that a settlement is in everyone's best interest. So we're clearly pursuing the path that would avoid future litigation cost and attempt to settle this sooner rather than later. But we always would use our options related to litigation if we can't settle this in a way that allows us to get that project back on track. So we'll always keep the litigation option open until we have resolved a path towards that allows to expand the facility.

Ted Durbin – Goldman Sachs

Okay. That makes sense. Can you talk a little bit about – how do you think about contracting Golden Triangle, given that you're getting pretty close to bringing the first cavern on line.

John W. Somerhalder II

Yeah, for Golden Triangle the first cavern as you know, it's about 6 BCF, well it is 6 BCF capacity. We were able to sell one third of that capacity very early on at a very good rate we believe. So we did lock up that one-third of the capacity. Normally for these facilities the best time to contract for that capacity is closer to the in service date and so we have been actively working that right now. So we do anticipate that between now and the time it goes in service we will contract the additional 4 BCF of capacity. That's our base plan and so we're actively working that right now, but sometime between now and the in service date we'll lock up that last 4 BCF of capacity.

Ted Durbin – Goldman Sachs

Okay, great. And then one more if I could, just on SouthStar more strategically now that you've got sort of the ownership issue behind you are you going to do anything different with the business or do you sort of see it running the same way, anything that we should expect to change there?

John W. Somerhalder II

Yeah, I think generally we'll continue with business as usual.

Ted Durbin – Goldman Sachs

Okay. That's all of my questions. Thanks.

Operator

Your next question comes from the line of Barry Kline with Citi. Please proceed.

Barry Kline – Citi

Hey guys. Most of my questions were answered. Just had a followup on the pension questions, in the back of your queue you talked about year-to-date changes in pensions that utility, 9 million year-to-date and I think you also mentioned that on the call, but for the quarter it’s the change quarter-over-quarter is 6 million. Aren't those expenses typically spread over the year? Why was there $6 million in expense this quarter?

John W. Somerhalder II

It's 6 million relative to third quarter last year. In third quarter of last year, we resolved an issue related to pension in Florida, which caused that expense to be lower, just in that period, by $2 million than it would have been on the normal run rate.

Barry Kline – Citi

Okay.

John W. Somerhalder II

It really – single item that made that difference.

Barry Kline – Citi

Okay, that makes sense. All right, thanks.

Operator

That concludes the Q&A session. And now I will like to turn it over to management for any closing remarks.

Steve Cave

Okay. Well, thank you very much for joining us today and certainly give us a call for any followup question. Have a good day.

Operator

Thank you, ladies and gentlemen for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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