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AGL Resources Inc. (NYSE:GAS)

Q4 2011 Earnings Call

February 22, 2012 09:00 am ET

Executives

John Somerhalder – Chairman, President and CEO

Andrew Evans – EVP and Chief Financial Officer

Peter Tumminello – EVP Wholesale Services & President Sequent Energy Management

Bryan Batson – Senior Vice President, Commercial Operations

Hank Linginfelter – EVP Distribution Operations

Michael Braswell – President of Retail Energy and President and CEO, SouthStar Energy Services

Sarah Stashak – Director, IR

Analysts

Craig Shere - Tuohy Brothers Investment Research, Inc

Ted Durbin - Goldman Sachs & Co

Carl Kirst - BMO Capital Markets

Mark Barnett – Morningstar, Inc

Josh Golden – JPMorgan

Daniel Fidell - U.S. Capital Advisors, LLC

Operator

Good day ladies and gentlemen and welcome to the Fourth Quarter and Year-End 2011 AGL Resources Incorporated Earnings Conference Call. My name is [Shanell] and I’ll be your operator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I’d now like to turn the conference over to the host for today, to Ms. Sarah Stashak, Director of Investor Relations.

Sarah Stashak

Thank you, Shanell. Thanks to everyone for joining us this morning to review our fourth quarter and year-end 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 our Form 10-K for both AGL Resources and Nicor Gas 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-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 presentation, as well as on our website.

Also you will note that we have modified our reporting segments to better reflect our operation post merger. We now have five operating segments. Distribution operations include the legacy AGL Resources utilities plus Nicor Gas. Retail operations include SouthStar plus Nicor’s Retail Energy and Services businesses. Wholesale operations include Sequent and Nicor Interchange. Midstream operations, includes our non-utility storage assets with the addition of Nicor Central Valley Gas Storage project and Cargo Shipping reflects the addition of Nicor’s Tropical Shipping units. Finally, for the segment called other, which including our non-operating business units and corporate expenses.

We will begin the call with some prepared remarks before taking your questions. Drew, I’ll turn it over to you to begin.

Andrew Evans

Thanks, Sarah and good morning, everyone. Starting on slide 3 of our presentation, we reported 2011 GAAP earning per share of $2.12 per diluted share. On an adjusted basis, which exclude $64 million of after-tax costs incurred during fee related to the Nicor merger, earnings per share were $2.92 which compares to $3.05 in 2010. The decline in year-over-year earnings is largely driven by several factors impacting our Wholesale Services business, including lower natural gas price spreads, lower volatility and takeaway capacity constraints that affected us, particularly, in the third quarter.

However, we saw strong performance in our utility business in 2011 resulting from new rate and infrastructure programs. Our results in total also reflect lower year-over-year incentive compensation due to not meeting our corporate earnings thresholds under our plans.

Our 2011 GAAP results included 22 days of operations from Nicor as a result of our merger closing on December 9. We’ve detailed our results here, so you can see the standalone legacy AGL Resource businesses as well as the contribution from Nicor for those 22 days. Note that the Nicor EBIT loss of $90 million includes $34 million of change in control payments that were triggered when the merger closed. Also our weighted average share count increased to 80.9 million diluted shares for the year due to the merger. For 2012, our diluted EPS guidance range is $2.80 to $2.95 and we will discuss the assumptions underlying our guidance in a few minutes.

Now let’s go to slide 4. In the fourth quarter of 2011, our diluted GAAP EPS was $0.37. On an adjusted basis excluding Nicor related expenses, it was $0.87 per share or $0.01 higher than the fourth quarter of 2010. Again, you can see the break out of our legacy businesses separate from the Nicor contribution.

On slide 5, you’ll find a reconciliation of annual 2011 EBIT, the initial segment guidance we’ve provided at our Analyst Meeting in May of last year. We included this slide to emphasize that the primary degradation earnings came from the Wholesale segment as we’ve discussed over the last several – couple of quarters.

Our performance at distribution operations was $38 million favorable to our guidance, but Wholesale was $48 million unfavorable to guidance. We did better than expected in the Midstream segment, but saw slight weakness at the retail segment relative to our expectations.

I’d also note here that the higher interest expense we incurred relative to our expectations really reflects our pre-funding of the Nicor merger to various debt issuances throughout the year and the fees associated with the bridge facility.

You can see the guidance range in our long-term EPS and dividend track record on slide 6 of the presentation. Our Board of Directors approved another 2% increase in our dividend earlier this month and our indicated annual dividend rate is now $1.84. At the mid-point of our 2012 guidance range, this would yield a payout ratio of approximately 64%.

Moving on to slide 7, 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 the quarterly look at EBIT, which gives you a good sense of the seasonality of the – of our business.

On the right you can see that our distribution business continues to be the largest operating segment contributed to EBIT representing approximately 79% of total operating EBIT contributions in 2011. This percentage is up significantly relative to prior years in large part to the reduced earnings contribution from Wholesale services. Retail operations accounted for 18%, Midstream operations for 2% and Wholesale services 1%. There were no material earnings contributions from the Cargo Shipping segment for the 22 days that we owned it in 2011.

I’ll cover some of the major segment variances starting with our distribution business on slide 8. EBIT was up $60 million for the year or 17% compared to last year including an EBIT contribution of $15 million from the 22 days that Nicor Gas was included in our distribution results.

The primary drivers of operating margin improvement were new rate and infrastructure programs at the legacy AGL Resources utilities and the addition of Nicor Gas in the fourth quarter. Operating expenses were up 5% year-over-year, due primarily to the addition of Nicor Gas offset by lower incentive compensation accruals.

EBIT in the fourth quarter was slightly higher by – was higher by 35% year-over-year with similar drivers to our full-year performance. You can see that our average customer count for the year for the legacy AGLR utilities was up slightly from 2010 and remains stable. The customer count at Nicor Gas was just under $2.2 million for 2011 also stable relative to 2010.

Turning to the retail segment on slide 9, we recorded EBIT for 2011 of $93 million, a $10 million decline compared to 2010. Results were down in part due to weather that was 23% warmer than in 2010, resulting in lower customer usage. In addition, as gas prices declined during the fourth quarter of 2011 we recorded a lower-of-cost or market, or LOCOM adjustment that was $5 million higher than in the prior-year.

Operating expenses were lower by $5 million for the full-year due mainly to lower legal expense. You can see that the fourth quarter of 2011 results were also down year-over-year due primarily to the same factors I’ve just described. At the end of the year SouthStar’s market share was 33% in Georgia which equals our market share position at the end of both 2010 and 2009. So you can see that our customer count for 2001 declined slightly compared to the prior-year.

You will find 2011 results for our Wholesale Services segment on slide 10. As expected Sequent continues to face the challenges of lower market volatility and lower price spreads for storage and transportation. This is reflected in our EBIT contribution of just $5 million for 2011, a decline of $44 million from 2010.

The largest component of the EBIT decline came from $45 million reduction in commercial activity versus last year. Of this $45 million, $23 million was due to ongoing low volatility conditions and tight storage and transportation spreads. $18 million was related to the Marcellus takeaway issue that we detailed for you last quarter and $4 million was related to a customer bankruptcy which was also previously described.

We anticipate remaining in a low volatility environment for the foreseeable future and we've made a number of changes to better adapt our business to this new operating environment.

In addition to the impact of lower commercial activity during 2011, we had storage and transportation hedge gains that were $21 million higher than the prior-year, but we also recorded LOCOM in 2011 that was $24 million higher than in 2010 reflecting the decline in natural gas prices during the latter half of the year. Just to remind you, transportation storage hedge gains or losses and LOCOM or non-cash items, but impact the timing of reported income.

Sequent enters 2012 with a $3 million rollout schedule which compares to a rollout schedule of $16 million at the same time last year. You will recall that the rollout schedule was at $6 million at the end of the third quarter in 2011 and 2010. The rollout schedule year-over-year is lower primarily due to lower seasonal spreads resulting from lower volatility associated with robust natural gas supply and ample storage as well as warmer weather versus the prior-year.

Looking briefly at expenses for 2011 on our Wholesale business, they were down $5 million compared to the prior-year due mainly to a reduction in annual incentive compensation. Fourth quarter 2011 EBIT results for Wholesale were up $3 million compared to the fourth quarter of 2010 with primarily the same drivers as the full-year.

Now let’s move to slide 11, EBIT in our Midstream operation segment improved by $3 million in 2011 compared to 2010.The improvement was due to increased revenue at Golden Triangle Storage, which we put into commercial operation in the third quarter of last year. For the fourth quarter of 2011, EBIT improved by $1 million mainly due to slightly higher operating margin.

We've not included a slide here for our new Cargo Shipping segment as there was no material EBIT contribution from the segment for the 22 days that we owned the business since 2011. For the full-year the business was also breakeven on an EBIT basis. The downward trend in earnings at Cargo Shipping since 2007 coincides with the global economic recession, which has had significant impact on tourism in the overall economic conditions in the Caribbean region.

In the past two years, the earnings decline in shipping has resulted from a combination of fewer TEUs or twenty-foot equivalent units being shipped and higher fuel costs that cannot always be easily passed along to customers. As with our Wholesale and Midstream businesses we do not anticipate a change in the market conditions in 2012, but we’ll be focused on controlling fixed-cost in the business and evaluating new customer opportunities.

Some balance sheet highlights were noted on slide 12. Our balance sheet now includes full funding of a Nicor merger with our long term debt now $3.6 billion and short-term debt at $1.3 billion. As I noted earlier our interest expenses was up $27 million for 2011 as compared to 2010. That increase was mainly driven by the pre-funding for the cash portion of the Nicor merger as well as fees associated with the bridge facility we put in place when we announced the merger.

On slide 12, I’d also highlight our capital expenditures for 2011 and expectations for 2012. Utility CapEx including a full-year for Nicor Gas was $604 million in 2011. We anticipate spending about $725 million of utility CapEx in 2012, more than $300 million or over 40% of those expenditures are on writer base programs with minimal regulatory lag compared to about $200 million of writers related to spending in 2011.

Our non-utility capital spending will be around $100 million primarily reflecting the build-out of the second cavern Golden Triangle Storage and the completion of Central Valley Gas storage projects, both of which we expect to be completed in the first half of this year.

I won't go into detail on slide 13, but for reference you can see what our debt maturity schedule looks like following the merger closing. Relative to post merge size of our balance sheet we've no significant maturities until 2016 and even then at very manageable levels.

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

John Somerhalder

Thanks, Drew and good morning. I’ll start by recapping what I believe was by most measures a solid year for the company in 2011. As Drew mentioned, we saw very strong performance in our utility business. And that is the result of a number of things we said in notion over the past couple of years on the regulatory front. To achieve reasonable rate outcomes and to pursue innovative programs such as our infrastructure investment programs where we deploy capital and see returns very quickly rather than waiting on traditional rate based adjustments.

Our retail business continues to generate stable earnings results despite some of the competitive pressures we face, particularly in the Georgia market. In a year where we had significant financing needs related to the Nicor merger we benefited from historically low interest rates. So while we have interest expense that is higher year-over-year because of the merger, we were able to finance the transaction at levels far below what we – what have expected in a more normal rate environment.

We add to these successes the fact that we closed the Nicor merger, the most transformational event in the company’s long history and made substantial progress in the integration of our two companies.

All of those things were positive for us in 2011 and set us up for well for achieving results in 2012. However, as we discussed with you on previous occasions, we clearly have challenges in certain of our businesses, which we saw on 2011, and we expect will continue in 2012.

We’ve three non-utility businesses that face significant headwinds, our Wholesale Services business, our Natural Gas Storage business and the Cargo Shipping unit that we acquired as part of the Nicor merger. Each of these businesses operates in a market, or in markets where the fundamentals have changed dramatically over the past couple of years, and those fundamental shifts in the market and economic forces meaning those businesses have seen and will likely continue to see weaker results than we expected. Those weaker results impacted our earnings in 2011 and resulted in the revised guidance range we issued during the third quarter of the year.

Unfortunately, market fundamentals have degraded even further in those businesses since our last call in October, as a result of mild weather and seasonably high storage levels and other factors. These circumstances have impacted the guidance range we established for 2012 relative to our long-term plan.

I do want to note that we still do the Nicor transaction as neutral to earnings for 2012 and accretive thereafter. Admittedly our forecast for the business has changed in response to market fundamentals. But the negative impacts are proportional across both AGL’s and Nicor’s legacy non-utility businesses.

And importantly, at our regulated businesses, we continue to operate with a backdrop of fair rate case outcomes from recent years over 40% of regulated capital expenditures underwriter programs, constructive regulatory relationships in all of our jurisdictions and the recent approval of Illinois Commerce Commission for this transformative merger.

Turning to slide 14, as Drew mentioned, we expect to earn within the range of $2.80, $2.95 per diluted share in 2012, excluding mark-to-market impacts and any additional Nicor merger-related costs.

Our guidance assumes several factors that we achieved appropriate progress towards 2012 or during 2012 towards the run-rate efficiencies we expect from the Nicor merger, that we’ve no rate case activity in 2012 from our regulated utilities that we experienced minimal growth in our retail businesses and at the challenging market conditions I described for our Wholesale, Midstream, and Cargo Shipping businesses persist throughout the year.

Specifically our guidance includes achievement of anticipated efficiencies related to corporate overhead and non-utility businesses as a result of the Nicor merger, the persistence of a low natural gas price and volatility environment for the foreseeable future, pension expense for 2012 that is expected to be significantly higher than 2011 due to lower discount rates. This issue alone is expected to impact earnings by about $0.07 per share, increased expenses related to pipeline integrity and maintenance and an outstanding diluted share count of approximately 117.5 million reflecting the full effect of the shares we issued as part of the Nicor purchase price. We plan to provide greater detail related to these issues as well as segments specific guidance at our Analyst Day in March.

From a regulatory perspective, as I mentioned, we’ve no pending rate cases and do not expect to file for new rate – case rates in any our jurisdictions this year. However, we’ll be working to put new writer-based capital expenditure programs in place as well as to extend some of the existing programs. For example, earlier this year, we filed for a new pipeline replacement program in Virginia under the State’s Save Program. We’re proposing a five-year modernization plan under which we plan to replace over 200 miles of aging pipeline.

This would be a $100 million program aimed at enhancing the reliability and integrity of the natural gas distribution system in Virginia, while supporting the local economy by providing jobs. Our filing has been deemed complete and we expect to begin the program in August. We also are evaluating options to extend our existing program in New Jersey and may file with the New Jersey Board of Public Utilities later this year. On the regulatory front, I also want to mention a recent development in the long running performance-based rates or PBR case in Illinois.

Turning to slide 15, we’ve highlighted key aspects of the stipulation resolution that we reached with the Illinois Commerce Commission staff. Under this stipulation, Nicor Gas would credit $64 million to customers. The stipulation must still be approved by the ICC, and I’d note that other parties in the case such as The Illinois Attorney General’s Office and The Citizens Utility Board have not signed on to the stipulation at this point.

Some of the accounting impacts are listed here, but on the whole the settlement is consisted with what we’ve reserved for this issue. We anticipate a ruling from the ICC later this year, and we’ll keep you apprised of any substantial developments in the case.

Turning to slide 16, you’ll find our priorities and objectives for 2012. In many ways, our objectives remain the same as they’ve over the past few years. For our utility businesses, we’ll continue to prudently invest in our operating infrastructure, so that we continue to provide safe and reliable systems to our customers at the lowest possible rates.

For retail and Wholesale, we’ll focus on maintaining market share in our core service territories and expand into new markets. For storage, our primary goal is to bring our storage facilities online that the ones that are currently under construction and contract them at the best – the combination of the best available rates and duration to optimize a portfolio in a very challenging market. At Cargo shipping, we’ll continue to focus on managing costs and maintaining a strong brand in the region and across all of our businesses we’ll focus on effectively controlling expenses.

Importantly, in 2012 we’ll continue to build on the work we began in 2011 to integrate the legacy AGL Resources businesses with Nicor across each segment and to generate the efficiencies we‘ve discussed that are central to the success of the transaction. We’re excited to bring so many talented employees from Nicor into the AGL family and look forward to continuing strong tradition of safety, reliability and customer service that both companies have built for decades.

On behalf of the employees of AGL Resources, we also welcome our new shareholders and we’d like to thank each of you for your continued interest and support of our company.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And your first question comes from the line of Craig Shere of Tuohy Brothers.

Craig Shere - Tuohy Brothers Investment Research, Inc

Hi, guys. Congratulations on finishing the merger.

John Somerhalder

Thanks, Craig.

Craig Shere - Tuohy Brothers Investment Research, Inc

So, I’ve got a couple of questions here. First, expense you were talking about for the pension expense, maybe Drew, you want to respond more to this, but I’m assuming that since that’s kind of a retail operation that’s kind of one-time down draft that wouldn’t necessarily carry through in ensuing years predominantly, is there – can you confirm that, can you also advice if there is any potential to recover some of that through utility rates over time and can you outline the new actuarial assumptions?

Andrew Evans

Sure, Craig. This is Drew. The main adjustment is related to the discount rate of the liability. The last three weeks of the year saw pretty decent depression of long-term treasury rates, which is the principal benchmark – the principal underlying benchmark. What that does is just increase the size of the liability. And so this is something that actually – it’s about $13 million increase and that expense moves it out over a period of time. It’s a prudently incurred expense. It is related principally to distribution operations. We don’t anticipate going into a rate case to seek recovery of it because generally it’s like any other expense that we battle.

And so, the goal really is to just remain as efficient and combat the inflations that we’ve in the business. This is sort of a typical corporate issue with the extend that the discount rates starts to move back out if we saw increases in rates over the next couple of years. It actually would start to produce – we’ll see a reduction in the expense naturally, ultimately a generation of income.

We don’t have a real material change in sort of our unfunded status. I mean, the discount rate does in fact influence that, but it doesn’t really change our requirements for investment materially from what we’d have expected normally and our goal there is just to make sure that the plans are healthy and funded to reasonable levels in the short-term.

It’s a headwind, its – this is different than what you’re seeing reported by most other companies, principally the ones that reported in the September year-end because they didn’t have the sort of the detriment of the rate reductions that we saw through the fourth quarter.

Craig Shere - Tuohy Brothers Investment Research, Inc

Okay. So that $13 million cost headwind would be ongoing into the ensuing year like 2013?

Andrew Evans

Without a change in rates, we didn’t really make large scale changes to our return assumptions and there wasn’t any real activity in the plans. It really was a discounting of the liability that produced those results.

John Somerhalder

Yeah, it was almost entirely tied to the discount rate. So, it will depend if that discount rate moves back up and it was somewhere in the range of more than 50 basis points, I’d say.

Craig Shere - Tuohy Brothers Investment Research, Inc

Year-over-year, it’s about 80 basis points?

John Somerhalder

About 80, so it was a big move when you look at year-over-year. So, if that moves back, then this expense would not be there in future. If it stays the same, it would be there, but as you pointed out this is a prudently incurred expense, and in future years and future rate cases if this expense stays, it would be something that we could include in our cost of service and our base rate request from the jurisdictions.

Andrew Evans

It went from 5.4% to 4.6%.

Craig Shere - Tuohy Brothers Investment Research, Inc

Okay.

Andrew Evans

And the asset returns obviously weren’t what we’ve expected for 2011, and that does have an impact, that goes forward for a period of time because you amortize that difference over about five-year period, but it was predominantly the discount rate return.

Craig Shere - Tuohy Brothers Investment Research, Inc

Understood. What if any merger savings were included in the 2012 guidance or you guys kind of just holding that back to talk more about at your conference, Analyst Day?

John Somerhalder

Craig, we’ll talk about that in more detail in March when we get together for the Analyst Day. But as we’ve indicated earlier, we did look to have anticipated savings kind of on a run-rate basis and a high percentage of those we think we can accomplish in 2012. And that was in the range of approaching $60 million. So, we do look to have those types of savings to achieve the results we’ve talked about, which includes making the transaction neutral to earnings in 2012.

Craig Shere - Tuohy Brothers Investment Research, Inc

And you included that because you left out the cost achieved, right? But you included whatever you thought you might get out of the $60 million eventual run-rate in 2012 in your guidance?

John Somerhalder

Correct. That’s correct, Craig.

Craig Shere - Tuohy Brothers Investment Research, Inc

Okay. And what are the net effects of all the non-cash LOCOM and mark-to-market changes in ’11 and 2012 recognition of economic income?

John Somerhalder

Yeah, I’ll start out and then Pete and Drew can add to it, but exceptionally what happened was as you saw mark-to-market was up by 21. I think that was right, and LOCOM was up by 24 year-over-year. But I think the real important issue to us was the fact that the rollout schedule was $3 million, and last year it was $16 million.

So, when we established guidance for the Wholesale business unit for 2012, we took into account the fact that we had a rollout schedule that was $13 million less than it was at the previous year.

So, we not only had the impact of lower volatility in our business, but we’ve a smaller rollout schedule because we were really to create less rollout from 2011 because of the lack of volatility in that time period. I’ll let Pete or Drew add to that.

Peter Tumminello

Yeah. Craig, John spoke to through the impact of the accelerating hedge gains on storage and the resulting lower rollout schedule on storage going into ’12, which certainly came into our guidance calculations. The other aspect is transportation. We accelerated some transportation hedge gains in the fourth quarter of 2011. Similarly, those were taken into account with a lesser expectation from transportation into 2012, so all of that was retail-operated into our ’12 guidance.

Andrew Evans

The only other thing I’d add is there was a LOCOM adjustment taken in Mike Braswell’s business in SouthStar and we’ve factored – it was about $4 million for the year and we factored that into our guidance for 2012.

Craig Shere - Tuohy Brothers Investment Research, Inc

Right.

John Somerhalder

And that will be positive for 2012.

Peter Tumminello

The storage contribution will be up ’12 versus ’11.

Craig Shere - Tuohy Brothers Investment Research, Inc

Right, right, right. Okay. Okay and then I appreciate all these answers. Last question, one of your peers out there, specifically one doing well in some other areas just like you guys are, but having some trouble if the storage and transportation leases and announcing additional right sizing of that business, contraction of obligations over time to new targeted levels. Is Sequent in the position that it’s thinking about what is the right-size and downsizing?

John Somerhalder

Yeah, I’ll start out and let Pete add to that. But we view this business as very important to our overall business mix. Sequent has achieved results from asset management arrangements with our regulated utilities and was returned – approaching $200 million to our regulated customers.

At the same time, we’ve had the benefit from the other side of it, their earnings on the other side of the sharing on that. It also provides us an insight into natural gas prices and storage and values in all of those areas. So we do view the Sequent business as an important part of our business moving forward for those and other reasons. But Craig, you’re right; we’ve looked at the right cost structure moving forward. We looked that as part of the integration, we looked at that separately given the change in volatility. And then, we always look at that related to re-contracting for capacity in all of those areas, both integration separately looking at our operations related to lower our opportunities and then with re-contracting. We’ve been to lower cost in each of those areas. So, we’ll see some benefit over time from that, and I’ll let Pete add more detail to that.

Peter Tumminello

Yeah, Craig, we did reduce our cost structure in late 2012 with some staff reductions and O&M reductions or …

Andrew Evans

In ’11.

Peter Tumminello

In ’11, right, last quarter of ’11. Thank you, Drew. We do see as our asset cost roll off in 2013 and ’14, some material benefits of those higher costs rolling off and then we’ll be re-contracting similar transactions or those identical transactions at much lower market rates. So we do see some benefits in the ’13 and ’14 timeframe coming from those activities and then we’re also seeing significant volume increases from our gas-fired PowerGen customers. The margins are still constrained due to the lower volatility, but we’re seeing the utilization of gas by that market share increase in the services we’re providing there. And you couple that with John’s comment of us rolling and extending all of our six affiliated asset ramp management agreements for longer terms and I believe that’s the core of our business. So that’s kind of how we’re looking at the next couple of years.

Craig Shere - Tuohy Brothers Investment Research, Inc

Thanks. Pete, can you quantify in anyway if you maintained the total capacity exposures, what assuming current market pricing, the cost savings would be if you reset the 2013 and 2014 expiring contracts down?

Peter Tumminello

Yeah, Craig, we’ll be prepared to talk in some more detail about that in the March Analyst Meeting.

Craig Shere - Tuohy Brothers Investment Research, Inc

Fair enough. Thanks, guys.

John Somerhalder

Okay. Thanks, Craig.

Operator

Your next question comes from Ted Durbin, Goldman Sachs.

Ted Durbin - Goldman Sachs & Co

Hey, guys.

John Somerhalder

Good morning, Ted.

Ted Durbin - Goldman Sachs & Co

Hey, first question is just on the PVR settlement with the staff, I guess; do you think you need to have the other intervenors on board, the COB and the AG, or can you go forward within SEC rolling [without] and with just the staff on your side?

Bryan Batson

Ted, this is Bryan Batson. We don’t have to have the other intervenors onboard to proceed forward. The hearings will begin next week, before the ALJ’s and since we and staff have reached a stipulation they’ve actually reduced some of the hearing days because some of the contentions issues have been narrowed. It does not prohibit the COB and AG from taking whatever position they would like, much as in during the merger we stipulated several issues with staff that we didn’t necessarily – weren’t able to stipulate with the AG or COB and then its up to ALJ after hearing all the facts and the information presented to them to recommend forward to the commission their answer. But they can't recommend forward the agreement of the stipulation as part of their resolution or their total resolution and then it’s up to the commission to vote it or to vote for it or against it or amend it in a way they see fit.

Ted Durbin - Goldman Sachs & Co

Okay, that’s helpful. My next question is on, just on weather. Can you give a quantification how much weather impacted the quarter itself? You talked about lower usage in retail and then how you’re seeing it check out here for the first quarters, you had a pretty warm winter?

John Somerhalder

Yes, by our measures, it looks like – overall weather in both late last year and then early this year is one of the warmest, if not the warmest in 80 years, so it’s been remarkably moderate. And that does impact us primarily in two of our businesses obviously it impacts us in our utility business although we have some pretty good weather on normalization programs in many of the jurisdictions. But we did see some impact of that in Nicor Gas and we’ll give you, I’ll have Hank, give you a little bit more precise numbers. Then our SouthStar business also saw a little impact from the milder weather and continues to see that, but we have some ability to have weather hedges on that as well. So I'll let Hank, talk first about how it impacted last year and this year in the utilities and then Mike talk about how it impacts SouthStar.

Hank Linginfelter

Okay. Thanks, John. Good morning Ted. Good morning, everyone. This is Hank. For Nicor Gas all in last year, they actually had a net positive due to weather, but the fourth quarter leaked that out some numbers of millions, a few million, I think, and then 6 or 5 of the 7 utilities in the family have normalization or straight-fixed-variable for Atlanta Gas Light. The 6 of the 7 is Nicor Gas, which is roughly 80% non-weather sensitive. So we do have some weather risk and there’s some round numbers around what a 100 degree days means to net income, it’s a little over $1 million per 100 degree days to net income at Nicor.

And then the last was Florida which doesn’t depend on weather much to begin with. So just broadly speaking the utilities are fairly well normalized against weather and obviously this warm start to the winter affects Nicor, particularly, the rest of the utilities are fairly solid.

John Somerhalder

But just to put that in perspective, so far this year and Hank talked about that metric of about $1 million of net income. We've seen a couple of 100 heating degree – several 100 heating degree day impact in our Illinois territory, kind of so far this year. So we are seeing some impact, its limited as Hank, talked about, but there is some impact, and then I’ll let Mike talk about last year and this year related to SouthStar.

Michael Braswell

Good morning, this is Michael Braswell. In terms of retail year-over-year the primary variants is actually upside for 2010, as opposed to degradation for 2011. Typically how we hedge? We hedge with puts. And what it allows us to do is capture the upside of the colder weather and then prevents a lot of the degradation on the downside. So really a lot of what you’re looking at in terms of the variants is the significantly colder than normal weather in 2010, which gave us uplift and then in 2011, it was actually relatively flat. We may have been down about $1 million on weather, so it’s roughly flat for 2011.

For 2012, the vast majority of our weather exposure is hedged, and but its not 100% due to some usage, if you want to call it impacts on weather. So I’d say, for 2012 there is certainly some headwinds in our business, but the vast majority of our weather exposure is hedged.

Ted Durbin - Goldman Sachs & Co

That is very helpful. Thanks for the detail. And then just last question for me on – both on Golden Triangle and Central Valley, you’re probably in the process of trying to [subscribe] this, can you give us a sense what the rates you were looking at for both?

John Somerhalder

Yeah, I’ll answer the question. You did not ask first, but construction and heading towards options were going very well on both of those facilities …

Ted Durbin - Goldman Sachs & Co

Yeah.

John Somerhalder

… as far as schedules we see, we’ve just now, we’re in the process of converting Cavern 2 from the leach mode to now the – where we’re going to dewater. So that looks very good, Central Valley schedule looks good there. So we feel very good about the facilities, but that sets up the tougher answer which is, we’re seeing continued compression on storage rates and Pete can give you more detail on that.

Peter Tumminello

Yeah, John. Thanks. We're getting set up to go out for some open seasons later in the year on Golden Triangle, Cavern 2 and on the additional unsold capacity at Central Valley. And the market certainly is not improving in that area, and I think you’re going to see rates certainly probably half or less than – marginally less than half than what we’ve experienced in the last several years for those facilities.

So we’re getting prepared for that and we’re making sure our cost structure is inline to support that level of activity, but that’s kind of the market assessment. But given that, there is some benefit to the single cycle levels for storage now, with this warmer weather and really compressed short-term gas pricing that’s expanded the seasonal one turn spread that we’re seeing in the market. So there’s some better intrinsic value, but net total values we’re seeing in that level that I just mentioned.

John Somerhalder

And Ted, it’s somewhat interesting that we're seeing that one turn cycle move out as we’ve seen lower gas prices that have impacted current prices more than they’ve impacted next winter’s prices. So that has been a positive, but since these facilities are higher turn facilities and a lot of the value in these facilities counts on the volatility or intraday and in shorter time periods, we just have not seen that simple cycle spread moving out materially, which in fact we’ve seen further compression of the value.

And then also with Central Valley with last year we saw fairly robust hydroelectric generation. Now that’s, it’s a little drier now, so we at least have that working in our direction, but we saw that compress as well. So we continue to see at least a challenge in the conditions around contracting those facilities as we talked to you about a quarter ago.

Ted Durbin - Goldman Sachs & Co

Yes. I think you had said somewhere around $0.14 for Golden Triangle and maybe I don’t know $0.19 for Jefferson, is that directionally still – are you seeing down from there or that’s kind of where you’re thinking you’re going to end up?

John Somerhalder

Well, that was closer to kind of what our averages were in the last several years for contracting? No we’re …

Ted Durbin - Goldman Sachs & Co

Yeah, okay.

John Somerhalder

… seeing rates that are below that right now.

Ted Durbin - Goldman Sachs & Co

Got it, got it. Okay, great.

John Somerhalder

Yeah, materially below that.

Ted Durbin - Goldman Sachs & Co

Yeah. That’s it for me. Thank a lot.

John Somerhalder

Thanks, Ted.

Operator

Your next question comes from Carl Kirst, BMO Capital.

Carl Kirst - BMO Capital Markets

Thanks, good morning everybody. I appreciate all the color, actually my question has really have been hit, maybe just one sort of follow-up because Pete, you had talked about the rebasing if you will the cost structure in 2013 and 2014. Can u give us a sense of how much of the storage and transport capacity comes off in those years or maybe another way to ask it is; what's the average duration of those storage and pipeline contracts?

Peter Tumminello

Sure. So this is just going to be cost related, so don’t take this to be an EBIT impact yet. But we’re seeing from 2012 to 2013 roughly 50% of our fixed cost at Sequent rolling off. So we’ll be re-contracting roughly half of our portfolio in that one-year time horizon. So that’s a fairly, a very significant piece that will now go to more market based rates. And then from ’13 to ’14 somewhere about 30% to 50% from that level will be also re-contracting at lower rates. So we see some extremely significant roll off, of this overhang of cost structure that was put in place over the last several years and will be opportunistic for us to re-contract at lower market rates.

Carl Kirst - BMO Capital Markets

Great, so that mean really by year-end 2014, 75% of capacity today is pretty much rebased?

Peter Tumminello

I think that’s a good number.

Carl Kirst - BMO Capital Markets

Okay. And then maybe just one other question in understanding really not giving any segment guidance here until next month, but perhaps just looking from fourth quarter, sorry this is also on Sequent, the downdraft in commercial activity excluding of course the Marcellus issue, it seems to be pretty concentrated here in the fourth quarter, and I guess maybe the simple question is, is there any reason to believe that’s changed for the first quarter?

Peter Tumminello

Weather certainly it’s rolling into the first quarter like we saw in the end of the fourth quarter. What you see at Sequent is, two main category of earning’s drivers. One is the cash activity that you generate when its cold, and that is significantly down in Q4 and you would obviously expect to see that down in Q1 given the warm weather.

What happens during that time period though is that it again accelerates forward hedge gains, because we were very well hedged on our storage and transportation portfolio. So as the market weakens those spreads collapse and we take accelerated hedge gains. So I think that trend would continue into Q1, if that price environment continues.

John Somerhalder

Yeah, I think you’re exactly right, Carl. We're seeing the same fundamentals that make it hard for the first quarter, but as Pete indicated we have a couple of positive things, and one is that, we proactively put on hedges on, as Pete said storage and transportation had a very good time, which means that even in an environment where we can't capture that value on a real time basis, the hedge allows us to get that value and we’ve seen that.

And then Pete also talked earlier about that simple cycle spread moving out. We do hold enough capacity and manage enough capacity under asset management agreement, storage capacity that, that gives us some help too. So it is challenging conditions with lack of weather and lack of volatility, but we at least have those, two or three mitigating factors that make us feel okay about where we are right now.

Carl Kirst - BMO Capital Markets

Okay, now that’s very helpful. And then, one last question if I could. Can you remind me what perhaps storage is held by affiliates between Sequent and Wholesale or Midstream, I guess now, just trying to kind of get a sense of how much of Sequent is contracted for perhaps Jefferson Island or something that just as we rebase everything we’ve got all the moving parts correct?

John Somerhalder

Right. At GTS of the 6 Bcf we have under contract, there two is with Sequent.

Carl Kirst - BMO Capital Markets

Okay.

John Somerhalder

And then at Jefferson Island of the 7.1 Bcf that we have there, I believe two is with Sequent, but that happens to be two of the four that are – that expire this year, that we’ll have to re-contract. So even though it’s two at both facilities, two of those are at Jefferson Island where Sequent will make decisions about whether to re-contract or whether we’ll place that with the third party.

Carl Kirst - BMO Capital Markets

Great, that’s extremely helpful. Thank you, guys.

John Somerhalder

Thanks, Carl.

Operator

And your next question comes from Mark Barnett, Morningstar Financial Firm.

Mark Barnett – Morningstar, Inc

Hey, good morning guys.

John Somerhalder

Hi, Mark.

Andrew Evans

Good morning.

Mark Barnett – Morningstar, Inc

That was pretty thorough, but just a couple of other quick questions. You talked about in the third quarter especially that you’ve managed to shift away from your secondary transportation rights, I guess mostly by September. I’m just wondering if you’re looking at 2012, have you been able to kind of transform the way that you contracted capacity in that business, and have you been able to move towards primary firm?

John Somerhalder

And it really speaks to one, a narrow area of our business which is arrangements to move gas away from the Marcellus. In a big part of our business, we hold firm transportation. And at times, we used that on a secondary basis. And that is a good way to optimize it. We do that in shorter time period. So, that continues to be a part of the way we run our business and other energy marketing trading companies run their business. What we’ve done is exactly what you’ve indicated in the Marcellus though, instead of using firm transportation on a secondary basement – excuse me, a secondary basis for long-term commitments to move gas out of the Marcellus, we’ve shifted that to firm transportation and Pete can talk a little bit about several arrangements we put in place so that we now can match-up those firm transportation with those firm obligations.

And so, what we saw on Marcellus, the impact in the third quarter and then a little bit additional impact in the fourth quarter, very consistent with what we talked to you about, and we see that because we’ve now rebalanced the portfolio that we’ve done a good job of mitigating this impact moving forward.

Peter Tumminello

Yeah, and specifically we’ve accounted for firm primary capacity to take care of all of our needs out of that one specific area that John mentioned in the Marcellus. We’ve also contracted for firm storage in that area as well.

So, in this environment not only can we move and transport all of those the gas that we’ve purchased in that area, but we now can be in a mode to be opportunistic. We’ve actually more transportation and more storage capacity than we’ve obligations to move. So on a day-to-day basis and in the future we’re be – able to be more opportunistic if constraints come back into that area.

John Somerhalder

But recognize – I mean, we’re in a good situation where we got firm capacity both on the transportation and storage side. That does give us an opportunity, but also that capacity came at a higher cost. So, it is an opportunity for us, but it’s an opportunity with the higher cost. So, we’ll have to manage that carefully moving forward.

Mark Barnett – Morningstar, Inc

Okay. And second, you had mentioned a little bit earlier about kind of the merger-related savings in 2012. Can you quantify maybe the level of costs that you expect just kind of lingering as you consolidate the businesses?

Andrew Evans

Yeah, so these are sort of integration or transition expenses, the [lion] share of those costs were incurred in 2011 and a large bulk of those were related to change in control agreements, banker fees and bridge facilities. I’d expect – and this will be in our presentations, but it’s going to be much less than $20 million in total for the year to continue to integrate. Think about our principal focus, we’ve only owned the businesses for 22 days as of the reporting date. We’re focused today or have over the last 60 days on things like staffing, but really principally, our focus has been getting consolidated financial statements out and we’re very pleased with the way that we are able to close the books in an accurate and timely fashion.

Our biggest issue there will be the consolidation of our financial systems through the middle of this year, and then sort of longer term will be the consolidation of our IT systems that will take couple of years to fully handle, but we just don’t see much – many tail integration expenses much past the first quarter.

John Somerhalder

And I’d point out when you look at the impact of the transaction, transition, integration costs and change in control type payments, both for last year and this year, but those costs in total are very consistent with what we had anticipated. We’ve been able to manage those right inline with what we had anticipated when we entered into the merger. And we’ve line of sight to run-rate on cost savings that are again inline with what we had anticipated when we entered into the transaction.

So as Drew said, we’ve had some very smooth processes going through this late year close, and going through all these other issues. So, we feel good about where we think all of that’s in a reasonably solid place.

Mark Barnett – Morningstar, Inc

Okay. Thanks for all the comments today, and congratulations on the close, guys.

John Somerhalder

Thanks.

Andrew Evans

Thanks, Mark.

Operator

Your next question comes from Josh Golden of JPMorgan.

Josh Golden – JPMorgan

Yes, good morning.

John Somerhalder

Hi, Josh.

Josh Golden – JPMorgan

When you lookout 2013, 2014, can you talk a little bit about the balance sheet post the merger, what level you’d like to see the debt-to-capital ratio? You have some maturities in 2013, do you plan to pay those down, do you plan to do any deleveraging as time progresses post merger? Thank you.

Andrew Evans

Sure, that’s a great question. Our debt-to-capitalization does not change materially pre and post. The same is true, generally of our credit metrics that we’re reviewing with rating agencies. There is – what you see also though is a lot of capital expenditure in 2012 related principally to the infrastructure programs that we’ve talked about and while we’re in a mode of bonus depreciation, writer-based programs and things that really accelerate the return of capital we’ll continue to make those investments. Until that environment changes we won’t see a material reduction in our debt-to-total capitalization.

We’re seeing some pretty decent relief related to our working capital requirements because of continued low gas prices, and so those have positive implications. But until we see – until we complete out those – the writer-based programs, until bonus depreciation goes away, we really have to focus our – we’ve to really let our business continue to make investments and until we’re complete with those, we just can’t bring debt-to-cap down.

Josh Golden – JPMorgan

Let me ask – let me a follow-up and ask this question, would it be fair to say though that you still maintain a high BBB type of credit rating target?

Andrew Evans

Yeah, absolutely, it’s our goal.

Josh Golden – JPMorgan

Okay.

Andrew Evans

We’ve to focus on that because it’s a requirement. I think of operating good, healthy utilities and it’s important for those trading business in terms of its assurances particularly. If anything we’ve a bias towards strengthening ratings as approved – as opposed to the opposite.

Josh Golden – JPMorgan

Excellent. Thank you very much.

John Somerhalder

Thanks, Josh.

Operator

And your next question comes from Dan Fidell of U.S. Capital Advisors.

Daniel Fidell - U.S. Capital Advisors, LLC

Good morning.

John Somerhalder

Good morning, Dan.

Daniel Fidell - U.S. Capital Advisors, LLC

Just a quick follow-up question on the infrastructure writers, you’ve mentioned moving forward with Virginia, potentially, and New Jersey in the – later this year, can you give us maybe kind of a status update in terms of where you’re at in Georgia and Illinois? And then, I guess as a second and unrelated question, just in terms of weather, your assumptions are for overall for normal weather for the year in total, is that correct?

John Somerhalder

Yes, I’ll answer the last question first, and then turn it to Hank for some of the writer surcharge infrastructure program. Yes, when we put together the guidance, we did have the benefit of looking at how mild the fourth quarter had been and what that had done to lower volatility and gas prices and those types.

So we did factor that into our assumptions around our Wholesale business and some of those things. But when we established the midpoint of the guidance range, we do establish that on the basis of a normal weathered year. So we've had some negative impact already this year from the midpoint of that range because of the milder weather. We've had some offsets as we’ve talked about, storage spreads have moved up a little bit in SouthStar’s business that helps a little bit in some other areas from a lag other example, and they do have some high percentage weather hedged. But we've had some negative impact from the midpoint of that range because of mid weather so far this year. Then I’ll let Hank talk about the surcharge and writer program.

Hank Linginfelter

All right, sure. Thanks Dan and John. We will continue to rollout what now has been more than a decade long pipeline replacement program in Georgia and that program is coming to, it’s at the final stages, the next year or two we’ll largely have finished our program of replacement of pipe, but you recall we did expand into other infrastructure enhancements more than a year-ago with our STRIDE program, that took the PRP and added to that system reliability enhancement and expansion into new communities and towns.

And we have expanded into some new areas of the state where we see opportunity over time to grow our service territory and add to our customer base and we're seeing significant improvements in our reliability where we’ve had growth outside the – or urban core to improve our deliverability of natural gas to our increasing customer base over a period of many year. Those will continue.

We're on a cycle to review with the Georgia Public Service Commission the next stage of those infrastructure enhancement programs later this year probably, towards the end of the year and we’ll propose to them what we think is appropriate for infrastructure for the next few years. And our commitments around those programs have gone very well, the commission is I think fairly well satisfied that the program is delivering what they envisioned and shared.

In Illinois, we really do like the idea of deploying capital as appropriate in that area. There are some areas we could expand infrastructure to sort of new markets in the Illinois area. There are some infrastructure needs for replacement of not only the traditional utility pipeline infrastructure, but some gathering lines in the storage field that the utility owns there. And that will be a normal course of capital deployment, but we think that will be recognized and valued by the regulators in Illinois over time. We [released] that right now, but we think those investments will pay-off in system enhancement and reliability that we’ll get recovery of in a future case.

Daniel Fidell - U.S. Capital Advisors, LLC

Thanks for your comments, very helpful.

John Somerhalder

Thanks, Dan.

Operator

Ladies and gentlemen that concludes the Q&A session. I’d now like to turn the call back over to Sarah Stashak.

Sarah Stashak

Thanks everyone for joining us today. We’ll be available after the call to take any additional questions you may have. And as a reminder, we filed the 10-K for AGL Resources as well as a separate one for Nicor Gas earlier today. So once you have the chance to wade through those over the next few days, we will be around to address any questions you have on those as well.

Operator

Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.

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