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Executives

Sarah Stashak – Director, IR

John Somerhalder – Chairman, President and CEO

Andrew Evans – EVP and CFO

Analysts

Stephen Huang – Carlson Capital

Mark Barnett – Morningstar Financial

AGL Resources Inc. (AGL) Q3 2011 Earnings Call November 2, 2011 9:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 AGL Resources Earnings Conference Call. My name is Keishall, and I’ll be your coordinator for today’s call. As a reminder this conference is being recorded for replay purposes. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session following the presentation. (Operator Instructions)

I would now like to turn the presentation over to Ms. Sarah Stashak, Director of Investor Relations. Please proceed.

Sarah Stashak

Thank you, Keishall. Thanks to everyone for joining us this morning to review our third quarter 2011 results. With me on the call today are John Somerhalder, our Chairman, President and CEO; Andrew Evans, our Executive Vice President and CFO. We also have several members of our management team here to answer your questions following our prepared remarks. Our earnings release, earnings presentation and Form 10-Q filing are available on our website. To access these materials, please visit aglresources.com.

Let me remind you today that we will be making some forward-looking statements and projections and our actual results could differ materially from those forward-looking statements. The factors that could cause such material differences are included in our earnings release and our 10-Q and 10-K.

We also describe our business using some non-GAAP measures, such as operating margin, EBIT, adjusted net income and adjusted EPS. A reconciliation of those measures to the GAAP financials is available on the appendix of our company’s presentation, as well as on our website.

We’ll begin the call with some prepared remarks before taking your questions.

Drew, I’ll turn it over to you to begin.

Unidentified Company Representative

Thanks, Sarah and good morning, everyone. Starting on slide 3 of our company presentation, you can see that we reported third quarter 2011 earnings loss of $0.04 per diluted share, excluding $5 million of cost incurred during the quarter related to the Nicor merger, earnings per share were $0.02. The decline in year-over-year earnings is largely reflective of a significant negative variance in our Wholesale services segment related to lower natural gas price spreads, lower volatility of takeaway capacity constraints in the Marcellus shale production region.

However we continue to see strong performance in our utility business resulting from a combination of reasonable rate case outcomes and infrastructure investments we’ve made to maintain and enhance the safety and reliability of our system. For the first nine months of the year we’ve reported diluted GAAP EPS of $1.78 or $1.98 including Nicor related expenses, $0.21 lower than the first nine months of 2010.

In the press release we issued on October 17th we reduced our 2011 EPS guidance to $2.90 to $3 per share. – from our original guidance of $3.10 to $3.20 per share and is due to primarily to the degradation of earnings at Sequent. You can see the guidance range in our long term EPS and dividend track record on slide 4 of the presentation.

Moving onto slide five you’ll find a snapshot of EBIT by segment on the top left you can see our results across the business looking back to 2006 and underneath that chart is a quarterly look at EBIT, which gives you a good sense of the seasonality of our business. You’ll note that our wholesale and retail businesses which are more weather dependent tend to have muted earnings in the second and third quarters of the year and that we are heading into our seasonally stronger quarters when we benefit from higher heating demand.

On the right note that our distribution business continues to be the largest operating segment contributor to EBIT representing approximately 81% of the total positive EBIT contributions in the first nine months of 2011, retail accounted for 18%, energy investments for 1% and you’ll notice the absence of positive EBIT contribution from Sequent year-to-date due to the issue that I just mentioned.

I’ll cover some of the major segment variances starting with our distribution business on slide six, primarily as a result of rate decisions and infrastructure programs at Atlanta Gas Light and Elizabethtown Gas, EBIT was up $15million or 27% compared to last year.

New rates for Atlanta Gas Light were effective in the fourth quarter of 2010 and we have infrastructure improvement riders in place in both Georgia and New Jersey. The combination of these two factors drove the $10 million of operating margin improvement year-over-year.

Operating expenses in the distribution segment decreased by 2% driven mainly by lower incentive compensation approvals. Excluding this issue operating expenses were up $6 million or 5% due to increased depreciation for more assets in service, higher legal expenses, and higher payroll and benefit cost.

You can see that our average customer count for the third quarter was up just slightly from this time last year and remain stable. Year-to-date our distribution business reported EBIT of $287 million up 10% versus last year. The same major drivers we saw in the quarter also are the factors driving good performance for the first nine months of the year and these results for our utility business on track to have a strong year in 2011.

Turning to the retail segment SouthStar on slide seven, we recorded an EBIT loss of $5 million for the third quarter of 2011 up $4 million improvement over our $9 million EBIT loss for last year’s third quarter. Due to reduced transportation and gas cost we experienced increased margins but that was partially offset by the continued competitive environment in Georgia including lower retail price growth.

SouthStar’s market share in Georgia is 32% relatively flat quarter-over-quarter. Year-to-date EBIT at SouthStar is down 3% compared to 2010 due mainly to warmer weather in the first nine months of 2011 versus 2010 and the migration of customers to lower margin price plans.

You’ll find third quarter 2011 results for our wholesale service segment on slide eight. John will provide additional detail on the circumstances surrounding the losses in the quarter, so for now I’ll focus on the financial results in the business.

As expected Sequent continues to face the challenges in lower market volatility and lower price differentials for storage and transportation. This is reflected in our EBIT loss of $37 million, a decline of $52 million compared to third quarter 2010.

The largest component of EBIT decline came from $35 million reduction in commercial activity versus last year giving you a breakdown of commercial activity during the quarter $18 million of the year-over-year decline was related to general poor wholesale market conditions including low price volatility for natural gas and tight transportation and storage.

Transportation spreads between the Gulf Coast and Northeast essentially collapsed for much of the summer significantly hampering our ability to earn margins on gas transportation. Further price differentials between the summer to winter seasons have been driven down in the past few years, do not see near term catalyst that will change these dynamics and we’re working to adapt our business to better weather the circumstances.

We also recognized losses of $15 million related to transportation constraints in the Marcellus Shale region. In addition we took a charge of $2 million related to a customer bankruptcy during the third quarter. We took a similar charge, we took charge for a similar amount in the second quarter and any remaining credit exposure associated with this customer is now fully behind us.

Looking at other factors aside from commercial activity that impacted us during the quarter, as I mentioned in our last earnings call during the third quarter of 2010 we had unusually large storage and transportation hedge gains of $30 million. This compares to $14 million of gains in the third quarter of 2011 translating into $16 million accounting loss year-over-year. We also recorded lower-of-cost-or-market known as LOCOM during the quarter of $9 million compared to $5 million last year resulting in another accounting loss of $4 million more than last year.

Looking briefly at expenses for the quarter they were down $4 million compared to last year due mainly to a reduction in the annual incentive accruals. Year-to-date wholesale services posted an EBIT loss of $9 million, $47 million decrease over the first nine months of 2010, operating margin was lower by $47 million largely driven by the same issues affecting the third quarter with $30 million of the decrease coming from lower hedge gains, higher LOCOM and the remainder due to a transportation constraint in customer credit losses.

Looking to our current storage rollout schedule at the end of the third quarter, Sequent has $6 million of economic value which is equivalent to last year at the same time. From our vantage point today we expect positive EBIT for this segment in the fourth quarter.

Moving onto slide nine, you can see that our energy investments segment had slight improvement during the quarter as compared to last year. The improvement was due to increased revenue at Golden Triangle Storage which we put into commercial operation in the third quarter of last year.

Some balance sheet highlights are noted on slide 10. The main thing I want to point out here is that we have effectively completed the financing of the cash consideration of the Nicor transaction. Interest expense for the transaction is better than our expectation but we pre-funded our requirements to reduce our exposure to interest rates. Because of this interest expense was up $4 million for the third quarter and $11 million for the first nine months versus last year.

As a reminder our full year 2011 guidance is now $2.90 to $3 per share excluding Nicor related merger cost. We anticipate providing combined company guidance when we file our 10-K next year and host our fourth quarter and yearend earnings calls.

Thanks for your time today and now I’ll turn the call over to John.

John Somerhalder

Thank you, Drew and good morning. I want to provide some additional context to the information that Drew just reviewed with you related to wholesale services results during the quarter.

The fundamentals of the natural gas wholesale business continue to face extreme pressure. In most geographic locations in the U.S. the wholesale natural gas industry and Sequent are experiencing continued declining values for pipeline transportation and storage. This fundamental weakening of transportation and storage asset values in the third quarter has been caused by two major factors, third quarter weather dynamics and continued increases in natural gas production.

Starting with third quarter weather, you can see on slide 11 that while there was warmer than usual weather in parts of the country in July and August the primary areas served by Sequent the Northeast and the Midwest experienced cooler temperatures and reduced gas by our power supply relative to 2010.

However Texas and the Mid-Continent experienced record setting temperatures. As a result of this disparity between the Texas region and the Northeast natural gas prices in the producing regions in the Gulf and Mid-Continent increased while prices in the Midwest and Northeast decreased resulting in a negative impact on pipeline transportation values.

Unlike weather which is transitory we continue to see significant increases in shale gas production. U.S. total gas production grew to over 63 billion cubic foot per day in the third quarter with production increasing by almost 5 Bcf per day in the past year, much of this due to the shale gas.

Shale production increases are focused in the Northeast market areas particularly in the Marcellus shale in Pennsylvania. Excess gas supply in this region caused severe compression of the price spread differential from the Gulf Coast to the Northeast and significantly eroded third quarter pipeline optimization values.

Such large increases in production coupled with a growing supply of storage capacity have also had a negative impact on storage optimization values. On slide 12 you can see that price differentials between summer to winter seasons have been driven down by approximately 50% in the past few years.

Sequent has about 30 Bcf of storage that is impacted by the change in price spreads over the summer to winter seasons. So a 50% decline in spreads can obviously have a meaningful impact on our business.

Shifting now to the Marcellus constraint issue that we experienced during the third quarter, over the last two years Sequent executed forward purchases of gas supply in the Marcellus, by purchasing gas supply in Pennsylvania and closer to our asset management customer City Gate our view is that Sequent would save money on transportation charges as that is less expensive to transport gas supply from Pennsylvania to the customers than from Texas and Louisiana to those customers.

In securing this forward gas supply Sequent was relying on historical pipeline operations that would allow such gas supply purchases to flow on a secondary basis on the pipeline. These volumes flowed reliably using secondary transportation service until late July at which time Sequent started experiencing curtailments of a portion of secondary transportation due to extreme supply growth in the region.

Curtailments increased as the third quarter progressed and by September the vast majority of secondary flow was curtailed. Sequent and others were relying on this historical secondary flow we’re unable to transport Marcellus gas to market and were forced to either secure a higher price transportation capacity or sell out volumes at lower market prices.

As a result of this issue Sequent experienced losses of $15 million during the third quarter and that includes $7 million associated with re-negotiation – we’re renegotiating certain of its producer agreements. We expect additional losses in the fourth quarter of this year and based on preliminary results we expect the impact in the month of October to be approximately $2 million. Importantly we now have balanced our position with transportation capacity that came online November 1st and expect the impact to further diminish in magnitude going forward.

So what does this all mean for 2012 and beyond? We do expect the low volatility and low spread environment to persist and we’re continuing to modify Sequent’s portfolio accordingly. For example, we are analyzing the fixed cost in the business, reevaluating the types of contracts we pursued going forward and repositioning the company to be successful in a potentially prolong period of reduced volatility.

Assuming that we stay in this low volatility environment for 2012, we may be looking at EBIT for the wholesale segment that is half or potentially a little less than half of our original EBIT projection of $53 million for the business in 2011. There are some possible upside scenarios and we’ll be well positioned if volatility returns to the market sooner than we expect, however at this time we are providing a view that is consistent with the current challenging market conditions in that business.

Moving on to our distribution segment I’ll just reiterate what Drew said in that we are having a very solid year. Our rate cases last year and ongoing infrastructure investment programs are providing support and we have maintained our track record of controlling costs in that business.

Our customer count has remained stable throughout the course of the year and was even up a little under third quarter. At this point we expect to be well ahead of our 2011 EBIT guidance of $374 million for the distribution segment by the time we close out the year.

The only rate case activity on our agenda currently is for Virginia Natural Gas. We filed our rate case in February of this year and consistent with regulations in Virginia, we put rates into effect on October 1st subject to refund. Written testimony has been filed and a hearing is scheduled for this Friday.

As a reminder rate cases typically take 12 to 18 months to prosecute in Virginia. SouthStar is having another good year and is on track to meet full year EBIT in line with our guidance of $97 million. They’ve done a good job managing that business in a very competitive Georgia environment and successfully maintaining a leading market share position. And similar to our distribution business Mike and his team have effectively controlled their costs.

In our storage business we’re still reaching Cavern 2 at Golden Triangle and expect that facility will come on line late in the first quarter of 2012. We initially planned for the facility to have 6 Bcf of working gas capacity. But we’ve extended leaching period and we think we’ll be a little closer to 7 Bcf by the time we begin commercial operation.

We also continue to make permitting progress for expansions at Jefferson Island. Before we conclude today’s call, I want to give you a quick update on the Nicor merger approval process which is outlined on slide 13. With the exception of Illinois Commerce Commission, we have secured all major approvals we need to close the Nicor transaction. At the end of the September, we received a proposed order from the Administrative Law Judge hearing the case in Illinois.

He accepted all of the issues we previously settled with the staff and ruled in a balanced way on the outstanding issues allowing us to move forward. We have been placed on today’s Illinois Commerce Commission Agenda for discussion and a possible look. However, the statutory deadline for decision remains December 16. If we receive approval from the commission we will be prepared to close within 7 to 10 days.

Wrapping up our prepared remarks today that we experienced challenges in our wholesales services business during the third quarter. Our distribution business performed particularly well. SouthStar is on track for another good year and we continue to make progress on our storage assets.

2012 will be a transformational year for us we integrate Nicor’s businesses and welcome their employees and shareholders. We look forward to speaking with you next quarter as we wrap up the year and provide our outlook for the combined company. On behalf of the employees of AGL Resources, we would like to thank each of you for your continued interest and support of our company.

Operator, I’ll now turn the call back over to you to begin the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Stephen Huang with Carlson Capital. Please proceed.

Stephen Huang – Carlson Capital

Hi, good morning guys.

John Somerhalder

Good morning, Steve.

Stephen Huang – Carlson Capital

I was just had a question here related to the Sequent business here. So in the Marcellus you guys said – you guys basically cost $15 million I think to fix the Marcellus issue. When we look into 2012 how should we think about what’s going to continue carrying forward into that other losses?

John Somerhalder

Yeah, I will start out and then let Pete add to that. The issue that we faced as we’ve laid out the result in the quarter of $15 million was broken up into several pieces. A part of that was simply the higher cost to move gas out of the region for the quarter or the lower prices that we sold the gas for in that time period. That was the largest piece of the 15, but 7 of the 15 was really rebalancing our portfolio, so we did not have a mismatch between our obligations to take gas and our ability to transport the gas out on a firm basis. So that helped balance our position.

Further we entered into pipeline transformation that went online November 1st which helps to balance our position. So we are now not in a position where we need to settle and rebalance this and we’re in a position where we have the pipeline transportation to move gas out. So the challenge we face moving forward and it’s much diminished from what we’ve faced in this time period even in the October time period is that we have pipeline transportation firm capacity with a cost that will need to move these volumes and capture our margin on that. We expect that will be able to largely cover the cost of that transportation moving forward. But that is the remaining issue that we face.

Stephen Huang – Carlson Capital

Okay. So basically what happen, was you guys were buying on the spot transport market and didn’t, when the volume is spiked, you’ll have capacity to transport your volumes. But now you have firm capacity going forward?

John Somerhalder

That’s close. What we were doing, we had capacity, firm capacity in the region but we were using it on a secondary basis out of the path which meant that you have priority rights but not as higher rights as primary firm. So that capacity that we had started to get curtailed.

Stephen Huang – Carlson Capital

Okay.

John Somerhalder

Now we make sure that we have capacity that we can use on a primary in the past firm basis to get out of the – this point where we are seeing these rapid increases in supply. So that gives us opportunity moving forward with the firm capacity. But just like with other positions in the portfolio, we still need to make sure we can cover the cost on that.

Stephen Huang – Carlson Capital

And when you...

John Somerhalder

Some issues we will manage moving forward but they are much diminished from what we had in the third quarter and what we saw in October.

Stephen Huang – Carlson Capital

Okay. And then John, for Sequent as a whole when you look at this year versus next year with the spreads and the like coming at 50% down. When we look into ‘12, I don’t think that’s that much better how should we think about that business, I know we can probably think that Marcellus is a onetime item. But should we anticipate that Sequent as a whole, it’s going to be a tough year again next year?

John Somerhalder

If the fundamentals continue the way that we have seen this last year and I think that’s a reasonable expectation.

Stephen Huang – Carlson Capital

Okay.

John Somerhalder

We would expect that Sequent’s business next year would be in that range of one half of what our expectations were this year. That’s our best analysis based on the way the market performed and that what we are able to do this year.

Stephen Huang – Carlson Capital

Okay. And the last question I have here is regarding the Nicor transaction I think that for them Tropical Shipping continues to be weak and they also have like a Sequent Light business not as much I think much more than yours but that’s also suffering from storage spread issues. When we look at that and also netting the positive benefits of lower interest rates than you guys originally anticipated, do you guys still foresee the deal being accretive at this time?

Sarah Stashak

What we do see is that on the distribution businesses very good results out of our distribution businesses, very good results out of Nicor’s distribution businesses is I think you’ve seen from their release. We’ve seen as you said interest cost move in a positive direction. So in total we see all the positive benefits we wanted to achieve out of the combination. But as you mentioned the unregulated businesses and that includes our Sequent business, Nicor’s.

John Somerhalder

Interchange.

Sarah Stashak

Interchange business and their Tropical Shipping are challenged, all of those challenged at the same time. At the same time our SouthStar retail business, Nicor National’s business selling warranty and other products continue to be more stable. So in total we like that balance in this difficult environment. We think we’re getting the benefits, we still see that will be accretive moving forward, but clearly were impacted in the short term with the fact that those three businesses the interchange business, the Sequent business and Tropical Shipping are impacted by the environment each of those businesses face. And I’ll let Drew add to that.

Andrew Evans

I mean I think if you look at the projections for the two businesses a lot of – any discomfort we have is probably associated with the businesses that we currently own today. Interchange as John described it is about a tenth of size of the Sequent business that we operate and Tropical Shipping will be less than 4% of our total EBIT. So I think generally we’re still comfortable on the variances kind of fall within the margin of error in the (inaudible) category we think about the total combined enterprise.

Stephen Huang – Carlson Capital

Okay great. Thank you.

Operator

(Operator Instructions). Your next question comes from the line of Mark Barnett with Morningstar Financial. Please proceed.

Mark Barnett – Morningstar Financial

Good morning guys.

John Somerhalder

Good morning.

Andrew Evans

Good morning.

Mark Barnett – Morningstar Financial

Thanks for the detail on the wholesale side actually this one is another quick question on the Nicor merger regarding the ALJ’s proposed ruling. They had approved everything that you had negotiated with the caveat that – you think that the new Nicor business stopped selling that ComfortGuard service which had been somewhat of a controversial product. And I’m wondering you’re obviously talking about probably on the accretion side you’re still expecting those results maybe it’s the timeline is pushing back does that incorporating lost revenue that you might lose if you can’t sell those products anymore on the non-regulated side there?

Andrew Evans

No – Nicor National’s warranty business is pretty broad scope business it includes services deep into the home like warranty of appliance. It’s also in other states and what we’re losing is the ability to increase the customer count under line guard and we don’t really expect a large deep attrition rate against that product in general and so what it hampers is our ability to grow that base.

We’re really going to focus that business in other jurisdictions and try to find a good way to modulate around the ruling from the or the opinion of the ALJ, we’ll see how it actually comes out and affect when the ICC completes its deliberations today around the, I guess their next opportunity would be that eight. But it’s a material factor in the way that, that business operates in some regard but it’s not unanticipated and I think what we saw was consistent with what our expectation was which is that we’re going to have to make some modifications the way that products delivered in that market.

John Somerhalder

And I’ll probably just end up saying the same thing Drew did, but we had – this had been a long-standing issue with Nicor National and we would characterize just the way you did which – it does change the business, it is a negative but it was anticipated that this was a likely outcome and related to other issues of how we can sell services there the results came out in a way that will work for us.

But on that one issue you are right there is a negative but when you look at the other states we do business, the other products even on the commodity side it’s a reasonably small part of that business and therefore we still feel good about our ability to maintain earnings and have the chance to grow earnings in that business.

Mark Barnett – Morningstar Financial

Okay. Thanks for that. I guess one more question on the infrastructure side, the energy investments side I should say with that just permitting it’s fairly normal to have some kind of delays I suppose, but are you now projecting any kind of delay in your expected and start a construction there and how is that shifted your timeframe?

Andrew Evans

As we’ve kind of walked through over the last several years it has been a slow process for us to achieve permitting at both Cavern 3 and 4 Jefferson Island. But at this time even though that process has moved slowly it’s also moved in a positive direction we still feel good about our ability to get those permits.

I think that the issue that we’re dealing with is given the situation I laid out in the prepared text with the fact that new capacities come online and so much shale gas and other gas is available, we’ve seen low enough spreads and values for storage that we’re going to be disciplined. So it is possible that when we get those permits next year that the environment will say it’s time to immediately move to construction and it’s very possible as well that we’ll say we want to wait and evaluate the market for this.

So, the timing issue is probably more making sure that we move forward when the commercial value support those expansions saying that these are very good expansions and very liquid locations. So we do think we have a better chance for this to match up and for commercial values to come back in this location there at Henry Hub. So we’re still optimistic about it, but at this point we’re going to be very disciplined about that.

Mark Barnett – Morningstar Financial

Okay. Thanks for that and good luck with the closing this quarter.

Sarah Stashak

Thanks.

Andrew Evans

Thank you.

Operator

There are no further questions in queue at this time. I’ll now like to hand the conference back over to Ms. Sarah Stashak for any closing remarks.

Sarah Stashak

Thank you for joining us today. We filed our 10-Q this morning that’s available on our website and we will be around today and the rest of the week if you have any additional questions.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect your lines. Good day.

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