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Nicor Inc. (NYSE:GAS)

Q4 2010 Earnings Call

February 23, 2011 9:30 am ET

Executives

Russ M. Strobel - Chairman, President and Chief Executive Officer

Kary D. Brunner - Director Investor Relations

Richard L. Hawley - Executive Vice President and Chief Financial Officer

Analysts

Mark Barnett - Morningstar

Edward Calkins - Great Lakes Advisors

Craig Shere - Tuohy Brothers Investment

Matthew Ligas - Copia Capital

Christopher Bassett - Decade Capital

Operator

Good day, ladies and gentlemen, and welcome to the Nicor Forth Quarter 2010 Earnings Call. My name is Crystal and I’ll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, today’s conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Russ Strobel, Chairman, President and CEO of Nicor. Please proceed.

Russ M. Strobel

Crystal, thank you, and good morning, all, and thank you for joining us. With me today are Rick Hawley, our CFO, and Kary Brunner, our Director of Investor Relations. This morning we’re going to discuss our 2010 financial results and our annual earnings outlook for 2011. When we finish. we’ll be happy to take your questions.

Before we get into the numbers, let me touch briefly on our merger with AGL Resources. As you all know, in December of 2010, we entered into a merger agreement with AGL Resources. This merger will combine two great companies. We believe the merger will establish a platform for growth that is superior to what either company could achieve on its own. I am pleased that this transaction provides our shareholders with a significant upfront premium for their shares and an ownership interest in a combined company that we believe provides real upside potential for future growth.

In addition, AGL Resources will establish its national gas distribution headquarters in Illinois and has also agreed to maintain for a period of at least three years a comparable headcount of full-time equivalent employees at Nicor Gas’ distribution business. AGL Resources has also agreed to continue Nicor’s long-standing record of support for philanthropic and civic causes in the communities that we serve.

Most importantly, our $2.2 million natural gas utility customers will be able to continue to rely on the same local gas company with a well-deserved reputation for providing safe, reliable, cost-effective service and the same people whom they have come to know and to trust. The completion of the transaction is subject to the customary conditions including, among others, regulatory and shareholder approvals by both companies.

In January 2011, we and AGL Resources filed a joint application with the Illinois Commerce Commission for approval of the merger. The ICC has 11 months to act upon the application, which would take us to mid-December 2011. You can find additional information relating to the proposed merger and the joint proxy statement and prospectus contained in the S-4 registration statement filed by AGL Resources on February 4, 2011.

With that, let me now turn things over to Kary as we begin to get into the numbers.

Kary D. Brunner

Thanks, Russ, and good morning, everyone. First, I’d like to remind you that this call includes certain forward-looking statements about the operations and expectations of our company, subsidiaries, and affiliates. Although we believe our representations are based on reasonable assumptions, actual results may vary materially from stated expectations. Information concerning the factors that could cause materially different results can be found in our periodic filings with the Securities and Exchange Commission and in this morning’s press release.

As we reported in our press release this morning, preliminary 12 months ended December 31, 2010, diluted earnings per share were $3.02, compared to $2.98 per share for the same period in 2009. 2010 results included the positive effects of a reserve adjustment of approximately $1.3 million pretax related to our mercury inspection and repair program.

Let me now turn things over to Rick for the discussion of our 2010 results and our annual outlook for 2011.

Richard L. Hawley

Thanks, Kary. Good morning, everyone. Excluding the mercury item that Kary just mentioned, 12 months ended 2010 diluted earnings per share compared to 2009 reflected higher operating income at our gas distribution business, partially offset by lower operating income at our shipping and our other energy-related businesses and lower corporate operating results.

The full-year comparisons also reflected lower pretax equity investment income and a higher effective income tax rate in 2010. Reported earnings included a reduction of approximately $0.06 for merger-related costs incurred in the fourth quarter. Without those costs, earnings for the year would have been $3.08 and earnings for the quarter around $0.93.

Our 2010 gas distribution operating income was up compared to 2009. Full-year comparisons reflected the 2010 benefit of a full year of rate relief approved in 2009, partially offset by decreased natural gas deliveries due to a 6% warmer weather in 2010 compared to 2009, lower interest on customer balances, and lower demand unrelated to weather. Regarding the weather variance, while both years were colder than normal, 2009 was just more so.

2010 gas distribution operating results were also impacted by lower operating and maintenance costs, including lower company use and storage-related gas costs, lower pension expense, lower billing and call center related costs, and lower costs on legal matters, partially offset by higher bad debt expense related to 2010 operations.

As we have mentioned in previous calls, a bad debt tracker was approved in February 2010 allowing Nicor Gas to recognize a $31.7 million pretax benefit in the first quarter of 2010 attributable to 2008 and 2009’s net under-recovery of bad debt expense. The benchmark against which 2010 actual bad debt expense was compared is approximately $63 million.

The key takeaway from this is that we have a rider, the objective of which is that on an ongoing basis we ultimately recover in rates our actual bad debt costs. Finally, 2010 gas distribution operating income compared to 2009 reflected higher depreciation expense.

Moving to our shipping segment, Tropical’s 2010 operating income was lower than 2009 due to the adverse impacts on our volumes and rates of the challenging market economics and competition in the Caribbean and Bahamas. Tropical’s fourth quarter 2010 results were lower than we had expected at the time of our third quarter earnings call on November 3, due primarily to higher operating expense and lower than anticipated volume and rates in the fourth quarter.

We’ve mentioned in previous calls that Tropical’s management implemented a number of initiatives in 2010 focused on revenue enhancement, asset utilization, and reduction of controllable costs to mitigate the negative impact of lower than anticipated revenue. We believe that these initiatives have positioned Tropical to begin growing its earnings starting in 2011.

Our Other Energy Ventures’ 2010 operating income finished the year ahead of budget. It was down compared to last year due to lower income at our wholesale natural gas marketing business, partially offset by higher operating income at our retail products and services businesses.

Full-year 2010 corporate operating results compared to 2009 were down due primarily to costs associated with our proposed merger transaction with AGL Resources, partially offset by the weather-related impact associated with certain of our retail bill management products.

Finally, 2010 comparisons reflected the absence of the gain recorded in the first quarter of 2009 on the sale of the company’s equity stake in a joint venture, EN Engineering, of approximately $10 million pretax or $6 million after-tax.

Turning to our 2011 earnings guidance, we estimate that 2011 diluted earnings per common share will be in the range of $2.30 to $2.50. The annual outlook excludes, among other things, the impact, including any merger and integration costs incurred in 2011, of the proposed merger with AGL Resources and any future impacts associated with the ICC’s Performance-Based Rate plan and Purchased Gas Adjustment reviews, other contingencies, or future changes in tax law.

Our estimate also does not reflect the additional variability in earnings due to fair value accounting adjustments and other impacts that could occur because of future volatility in natural gas markets. Our estimate for Nicor Gas is based on historical weather patterns.

Compared to 2010 results, excluding the $31.7 million net recovery of 2008 and 2009 bad debt expense, our 2011 earnings outlook reflects lower expected results from Nicor Gas, higher expected results from Tropical Shipping, and comparable results from our OEV businesses. As a reminder, we will provide updates to our annual earnings outlook only as part of our quarterly and annual earnings releases.

With that, let me now turn things back to Russ for a wrap up.

Russ M. Strobel

Thanks, Rick. I’d like to close with several points. First, our consolidated financial results for 2010 were good in spite of the current challenging economic environment, especially in the markets that Tropical serves. In 2010, our consolidated earnings per share were the second highest in company history. We continued to generate strong cash flow and we maintained our historically high returns on equity.

At Nicor Gas the impact of our 2009 rate relief, together with our focus on cost containment and operational excellence, contributed to our ability to deliver better than expected results in 2010. Tropical Shipping faced challenging conditions throughout 2010. We reacted appropriately and promptly to those conditions by taking actions regarding rates, cost structure, and asset utilization. We believe that those steps will position Tropical to enhance its overall long-term value.

The purchase of V.I. Cargo Services in the third quarter, though small, was a helpful addition to our less than containerload business line and underscored our ability to capitalize on opportunities that the current downturn presents.

Looking to 2011, Tropical is expected to provide improved results due in part to the full-year realization of the actions that we took in 2010. Our other energy-related businesses reported solid results in 2010 and we expect similar results in 2011. An important step in the long-term growth of these businesses will be the continued development of our Central Valley Gas Storage project in northern California.

The most significant event for 2011 is of course the anticipated closing of our merger with AGL Resources. As I mentioned, we’re focused on obtaining the necessary regulatory and shareholder approvals so that this merger can be completed as expeditiously as possible.

In closing, let me reiterate that Nicor remains very strong financially with credit ratings that are the highest in the industry. Our cash flows remain strong and enable us to continue to pay a solid dividend to our shareholders, something that we’ve done now for 57 consecutive years.

And with that, we’d be happy to take your questions.

Questions-and-Answers Session

Operator

(Operator Instructions) Thank you. Our first question comes from the line of Mark Barnett with Morningstar. Please proceed.

Mark Barnett - Morningstar

Hi, good morning guys.

Russ M. Strobel

Good morning.

Mark Barnett - Morningstar

A quick question and apologies if you have made some commentary on this Q elsewhere, but is the merger going to affect your schedule, I know this is obviously be up to AGL, but your schedule for filing the next rate case in Illinois?

Russ M. Strobel

We don’t currently have any plans for filing another rate case. And I think you are right, if the transaction closes those decisions will be made at the AGL level. But I would be surprised if this transaction would have any impact on future rate case decisions.

Mark Barnett - Morningstar

Okay. And with the merger discussions that you have been having, what sort of feedback have you been getting so far from the Commission?

Russ M. Strobel

Well, the process is just beginning and I don’t want to prejudge what the Commission will do or the time schedule that it will do it on. We respect the Commission. They have been eminently fair. They have an obligation to review this transaction under Illinois law and that’s what they are going to do.

We believe that the Commission is going to be favorably impressed. This is a transaction that provides real benefits to the state of Illinois and to our customers. AGL Resources is going to be moving their national natural gas utility distribution headquarters to Illinois. They are going to maintain the FTE levels at Nicor Gas for least three years. They’re going to maintain our philanthropic and civic commitments for a similar period.

And this is a transaction that’s going to be combining us with a very strong company with a long record like ours of providing safe, reliable, cost-effective service to its customers. So we think that when the Commission has an opportunity to look at this, they are going to see it just the way we do, as a real win-win for everybody.

Mark Barnett - Morningstar

Okay. And the general timeline again, is that still the same, or are we...?

Russ M. Strobel

Yeah, it’s the same timeline. Under the statute, the Commission has 11 months to decide this, which would take us to December of 2011. There may or may not be opportunities to shorten that period, but as I say the process is just getting started.

Mark Barnett - Morningstar

Great. Thanks. That’s all I have.

Russ M. Strobel

Thanks, Mark.

Operator

Our next question comes from the line of Ed Calkins with Great Lakes Advisors. Please proceed.

Edward Calkins - Great Lakes Advisors

Could you talk about the assumptions underlying your assessment of a lower income in 2011 in the gas distribution area? What would you be looking at in terms of volumes, O&M cost, depreciation, and bad debt expense to lead to an estimate of lower profits in 2011 than in 2010?

Richard L. Hawley

Sure. If you – this is Rick Hawley. I’ll give you what we have on that. If you look at the – comparing the 2010, the biggest single item obviously is the lack of the $31.7 million or about 19 – a little over $19 million after-tax of bad debt recovery that we booked in the first quarter. That’s the single largest item.

Then if you look, we’re looking for O&M expenses to be up about $5 million, depreciation with our level of capital additions, we depreciate by a formula basis, so when we add plant we automatically add depreciation; and you obviously don’t recover that additional depreciation expense until the next rate case. Has no impact on cash flow, but it lowers net income. That’s going to be about $5 million pretax.

Illinois just raised their individual and corporate income tax rates. That’s going to cost us about $2.5 million after-tax. And there is a bunch of miscellaneous cats and dogs; that’s another couple million dollars. That will take you from the gas reported results in 2010 down to what our estimate is for 2011.

Edward Calkins - Great Lakes Advisors

Good. Thank you. On the Tropical Shipping part of the business, in 2011 can you have higher profitability if volume does not increase over 2010 levels? If so, how would that come about?

Richard L. Hawley

Sure. Actually you read our budgets; we are actually anticipating slightly lower volume in 2011 and we’re expecting a relatively modest increase in our base rates. We have seen our competitors go up about $150 a TEU in the first part of the year. We’re not anticipating that level of rate increases, but we are assuming a modest level.

The combination of the additional revenue we will get out of slightly higher base rates, slightly lower volume, and the annualized benefit of cost initiatives taken in 2010 would get us to our estimate for Tropical for the year. And it would be a higher number. And as you can appreciate in what is now, you are down to, with this footprint, essentially a fixed-cost business, about everything we add at the revenue line will drop to the bottom line, so that’s the basis for our estimate for Tropical going into 2011.

Edward Calkins - Great Lakes Advisors

Good, thank you.

Russ M. Strobel

You’re welcome.

Operator

Our next question comes from the line of Craig Shere with Tuohy Brothers Investment. Please proceed.

Craig Shere - Tuohy Brothers Investment

Hi. Thanks for the call. I am sorry, I didn’t quite catch; were there some merger-related costs in the fourth quarter?

Richard L. Hawley

Yes. There is about $4.6 million pretax. That’s about $0.06 a share for us. So like I had mentioned, without those costs, our reported annual results would have been around $3.08 and the quarterly results instead of $0.87 would have been whatever it is, $0.93.

Craig Shere - Tuohy Brothers Investment

Sure. I appreciate that. I know it’s hard to forecast the future. With respect to Tropical Shipping, it sounds like your expectations for total volumes are still somewhat soft. Are you seeing any glimmers of hope that into 2012 that economic recovery can really allow some traction in that business?

Russ M. Strobel

The answer to that is yes. As you look out, there is no question the economy is down. They are not what they have been in the past. Historically, while there have been dips, the overall trend for the Caribbean and the Bahamas is upwards. Tropical is the major player in most of the ports that we serve. As I said, with our footprint to a large degree, particularly for quite a bit of the upside, it’s pretty much a fixed-cost business. So our expectations is if you get to a normal economy down there, however you would define that, Tropical’s results will go back to the kinds of levels that we’ve seen before the drop started in 2009/2010.

Craig Shere - Tuohy Brothers Investment

The earnings have fluctuated a fair amount through the years. Is there a particular year that you’d kind of call the middle of the road in terms of performance in the cycle?

Richard L. Hawley

I don’t have the list of years in front of me to pick one out for you. But structurally the years in which the bottom line of Tropical, under all of the tax assumptions et cetera that we have, Tropical business that’s around $30 million mark is not a huge stretch.

Craig Shere - Tuohy Brothers Investment

Sure. Last question on storage. What are you all seeing, everybody is talking about the challenges in that market for contracting these days. Are you seeing similar experiences with your storage development in terms of the earlier stage development in Louisiana? What are the prospects for that really moving forward at any point?

Russ M. Strobel

Craig, this is Russ. That is a wonderful question but it’s a very complicated question. It would take a very long time to answer. I don’t – there is no doubt that market volatility is down, which as a general proposition is going to reduce the value of storage, which is really a physical option. But there are countervailing considerations to that depending upon the particular markets you’re in and the particular kind of storage market versus field storage. California project versus Louisiana, the degrees of constraints.

We remain very bullish on storage as a long-term value generator. And there are enormous fundamental reasons for that. Natural gas is a very clean fuel. It’s abundant, it’s American. There is just no reason to believe that natural gas and the infrastructure necessary to produce, store, and deliver natural gas is not going to be a long-term value provider. The current market is soft; there is no question about it. It’s bearish, but we see that as purely cyclical.

Craig Shere - Tuohy Brothers Investment

Sounds like you are quite happy with the California project. Do you have a time frame for when you might think the Sawgrass project might be a go or not?

Russ M. Strobel

We’re looking at that very hard right now. It’s under active consideration. We continue to develop the project. The project remains under development. We’re continuing to work on engineering, design, and also testing the market. But it’s a big project; it’s expensive. We are going to be systematic. We are going to be thoughtful about it. And obviously, it’s a project that AGL, which also is in the storage business, is going to inherit when the merger closes. So we are going to be keeping our eye on that as well. But as I said, we remain bullish on storage. Now you’ve got to have the right project at the right cost in the right location, but we think we have got those.

Craig Shere - Tuohy Brothers Investment

Understood, thank you very much.

Russ M. Strobel

You’re welcome, Craig.

Operator

Our next question comes from the line of Matthew Ligas with Copia Capital. Please proceed.

Matthew Ligas - Copia Capital

Hi, good morning.

Russ M. Strobel

Good morning.

Matthew Ligas - Copia Capital

I was wondering if you could give an update on how much cash there is offshare at Tropical Shipping at the end of the year.

Richard L. Hawley

About $80 million.

Matthew Ligas - Copia Capital

All right. Thanks. Is there any schedule or timing update for the ICC to finish up their PBR review?

Russ M. Strobel

There really is not anything to add. I think our next hearing may be in March or April, April.

Richard L. Hawley

But that’s just hearing.

Matthew Ligas - Copia Capital

All right, that’s it. Thanks.

Operator

Our next question comes from the line of Chris Bassett with Decade Capital. Please proceed.

Christopher Bassett - Decade Capital

Hi there. Wondering if you guys could provide me with your expected earned ROE at Nicor Gas in 2011.

Richard L. Hawley

You know, I don’t – I think you have got the estimate of the earnings and I think Nicor Gas has about $650 million worth of equity. So we’re right around our authorized ROE. And that authorized ROE is (inaudible).

Christopher Bassett - Decade Capital

Excellent. Thank you. That’s all.

Operator

That concludes today’s question-and-answer session. I would like to hand the call back to Mr. Russ Strobel for closing remarks.

Russ M. Strobel

Great. Thank you all for joining us and we will talk to you soon. Thanks very much.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you so much for your participation. You may now disconnect and have a great day.

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