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Executives

Stephen H. Clark - Vice President of Treasury & Finance

David A. Kindlick - Chief Financial Officer and Senior Vice President

Edward J. Graham - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Analysts

Spencer E. Joyce - Hilliard Lyons, Research Division

South Jersey Industries (SJI) Q3 2013 Earnings Call November 12, 2013 2:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2013 South Jersey Industries Earnings Conference Call. My name is Celia, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Steve Clark, Vice President of Finance. Please proceed, sir.

Stephen H. Clark

Thank you, Celia, and good afternoon, everyone, and I'd like to welcome you to the South Jersey Industries Third Quarter 2013 Earnings Conference Call and Webcast.

Joining me on the call today are Ed Graham, our CEO; Dave Kindlick, our CFO; Mike Renna, President of our Nonregulated Businesses; Jeffrey DuBois, President of the Utility; Ann Anthony, our Director of Finance and Investor Relations; and Marissa Travaline, our General Manager of Investor Relations.

Before we get started today, I'd like to remind you that during the course of this call, we may make various remarks about future expectations, plans and opportunities for South Jersey Industries. These remarks constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these statements as a result of various important factors, including those discussed in the company's Form 10-Q on file with the SEC.

Further, we assume no duty to update these statements should actual events differ from expectations.

As usual, we'll be discussing SJI's results in the context of its 3 major business lines: the regulated utility, Retail Energy and Wholesale Energy.

Before we begin our discussion, I'd like to refer you to our third quarter 2013 earnings release, which was issued this morning, for an in-depth discussion of our results on both a GAAP and Economics Earnings basis.

The measure we use to asses SJI's performance is Economic Earnings. This measure eliminates all unrealized gains and losses on commodity and on the ineffective portion of interest rate derivative transactions, adjusts for realized gains and losses attributed to hedges on inventory transactions and the impact of transactions or contractual arrangements, where the true economic impact will be realized in a future period.

Now I'll turn the call over to David Kindlick to review the financial results for the third quarter, as well as year-to-date 2013. Dave?

David A. Kindlick

Thanks, Steve. The third quarter income from continuing operations on an Economic Earnings basis reflects a loss of $1.1 million or $0.04 per share as compared with income of $4.1 million or $0.13 per share for the same period last year.

The first 9 months of 2013, SJI posted income from continuing operations on an Economic Earnings basis of $57.2 million, or $1.79 per share, as compared with $62.7 million, or $2.05 per share, for the first 9 months of 2012.

Our utility continues to grow at an annual rate that surpasses national peer averages, and our nonutility on-site energy projects continue to be profitable. However, our Wholesale business saw significant impacts from pipeline capacity constraints, which included margins on certain gas supply and delivery contracts. These impacts were the main contributor to the loss posted for the third quarter. We will discuss this situation in greater detail during this call. But first, let's look at the details related to South Jersey Gas.

Third quarter of 2013, SJG grew its bottom line, posting net income of $900,000 compared to $500,000 in the third quarter of last year. On a year-to-date basis, the utility posted net income of $40.3 million as compared with $38.8 million last year. Third quarter saw an incremental $500,000 net income benefit from investments under our accelerated infrastructure programs versus the same period in 2012. The income benefit of these programs was recognized as AFUDC for the first 9 months of 2013. However, all investments made under our previous accelerated infrastructure programs were completely rolled into rate base as of October 1, and will be reflected as operating margin going forward.

Accelerated infrastructure investments made this year through our current air program will continue to be reflected as AFUDC until rolled into base rates as part of a base rate case.

During the first 9 months of 2013, we invested approximately $30 million under our Accelerated Infrastructure Replacement Program. We anticipate spending an incremental $5.2 million under the program by the end of this year. Investment from all of our accelerated infrastructure investment programs is expected to produce an incremental net income of $2.3 million over the prior year. Gas company has continued to focus on system safety and reliability in the years since Super Storm Sandy hit New Jersey.

In September, at the request of the BPU, we filed a petition for a program that will complement our existing Accelerated Infrastructure Replacement plan. A new Storm Hardening and Reliability Program, or SHARP, proposes a $280 million investment over 7 years. The program will replace the lower operating pressure distribution system along the barrier islands with higher pressure systems, which are less susceptible to water and sand intrusion. If approved as proposed, the program will extend our ability to make and earn on system reliability investments through 2021.

Moving on to customer additions. For the 12-month period ended September 2013, utility added over 4,800 net customers. This increase of nearly 1.4% to over 359,000 customers outpaces the national average of our peers as most recently reported by the American Gas Association.

In total, our projected net customer growth for 2013 adds roughly $1.7 million in incremental net margin on an annualized basis. Going forward, we expect to continue adding customers at a brisk pace, as costs for heating with natural gas remain $0.60 to $0.70 below the cost of heating with propane, oil or electric.

Now let's review the details of our nonutility businesses. These businesses posted a combined Economic Earnings loss of $2.1 million in the third quarter of 2013, as compared with Economic Earnings of $3.5 million in the third quarter of 2012. The year-to-date basis in nonutility operations produced $16.9 million in Economic Earnings versus $23.9 million in the first 9 months of 2012.

We [ph] group our nonutility activities in 2 business segments: Retail Energy, which includes our end user-focused businesses, including primarily Marina Energy and South Jersey Energy; and Wholesale Energy comprised primarily of South Jersey Resources Group.

Retail Energy segment contributed $2.8 million of Economic Earnings for the third quarter of 2013, $2.7 million of which came from our energy project activities at Marina Energy and Energenic.

That $2.7 million included $2.5 million of investment tax credits, which we continue to strategically expand our Retail project's portfolio with development of solar and on-site energy projects. In 2012, income from the Retail segment in the third quarter was $3.9 million including $3.5 million from Marina Energy and Energenic combined, with $2.2 million coming from investment tax credits. A closer look at the project business development and earnings can better illustrate performance from different areas of this business.

Third quarter of 2013, our on-site energy projects contributed $2.1 million of Economic Earnings for Marina. This project, which includes CHP, thermal and distributed generation technology, remained solidly profitable and are performing as expected.

Pacific projects including the new Montclair State University facility, which came online September 1, as well as the on-site energy projects at Borgata and Revel in Atlantic City.

As we continue to pursue the development of these types of projects, the earnings potential and annuity income streams from the long-term contracts that accompany them serve as the foundation of our project portfolio.

In addition, our solar project contributed $2 million of Economic Earnings for Marina, driven by investment tax credits from project development. Operating performance for solar had been negatively impacted by solar energy credit prices. However, we are seeing continuing SREC pricing improvement due to the effects of 2012 legislation in New Jersey that boosted SREC demand.

During the third quarter, landfill suffered negative impacts from downtime associated with repairs and operating inefficiencies resulting in a $700,000 loss. We continue to take corrective actions to ensure that parts are more readily available to help limit downtime and expect that performance should improve on these projects going forward.

The other components of our Retail business segment were generally flat, which combined $200,000 contributions to Economic Earnings for these entities for the third quarter of 2013, as compared with $400,000 combined for the third quarter of 2012.

Switching gears to our Wholesale Energy business. Economic Earnings for the third quarter of 2013 reflected a loss of $4.9 million as compared with a loss of $300,000 in 2012. Our Wholesale group faced significantly eroded natural gas margin due to capacity constraints that limited the ability to move natural gas. However, a series of expansion projects on several pipelines have brought on incremental capacity to alleviate some of the constraints. In addition, we have taken action to alleviate the pressure these conditions have put on our earnings by purchasing additional capacity on 3 different pipelines effective November 1, and renegotiating some contracts to improve pricing features.

Looking forward, one of the most promising opportunities for this business remains as a fuel supplier and manager for natural gas-fired merchant generation plants being developed to take advantage of lower-cost natural gas.

Recently announced projects with Panda Energy to supply fuel to the Moxie Liberty project, an 829-megawatt combined-cycle generating facility in Bradford County, PA, reflects our commitment to reinforce the foundation of our Wholesale business with a model for sustainable earnings growth.

In addition to Moxie Liberty, and the LS Power fuel management contract we mentioned in earlier updates, we are in active negotiations to sign as fuel manager for 2 more comparable facilities in upcoming months. These efforts will begin contributing to our Wholesale group's results in the first quarter of 2015.

Finally, before I turn the call over to Ed, I would like to address our balance sheet. As of September 30, SJI's equity-to-capitalization ratio improved to 45.4% as compared to 44.8% at the end of the third quarter of 2012.

During the first 9 months of 2013, collections on under-recovered utility regulatory clauses, net cash proceeds from the sale of LVE and the proceeds from refinancing of our Hartford energy facility with project financing were used to reduce debt.

Our goal remains for SJI's equity-to-capitalization ratio to average 50% on an average basis. Between dividend, reinvestment and the optional cash purchases made through our DRiP, SJI raised equity capital of $13.9 million through the first 9 months of 2013 and added an additional $12.5 million in October. We do expect to raise additional funds through the DRiP during the fourth quarter.

Now I'd like to turn the call over to Ed to talk about what's ahead of us.

Edward J. Graham

Thanks, Dave. As we look toward the future for SJI, we remain very confident in the framework we've developed for the success of each of our business lines.

At our utility, we have made significant investments over the last 3 years in our gas distribution system that will enhance our ability to serve our territory, and technology improvements that will only increase the efficiency of our businesses going forward.

On the nonutility side, as Dave noted previously, our Retail Energy project business continues to drive earnings as we develop and bring online additional on-site energy and solar generation projects.

While our Wholesale commodity business has encountered some challenges this year, we expect to begin capitalizing on the additional capacity we procured as of November 1 and seeing improvements from some of the restructuring of contracts we have renegotiated to better protect margins.

As we realign the future focus of this business away from capturing spreads on natural gas purchase and sales prices toward our growth as a leading provider of fuel management and supply services, we are confident in the long-term contributions this business can make to SJI. However, due to the challenges that we have seen year-to-date, we are guiding to the low end of our previously issued guidance range of 4% to 8%. We continue to pursue the opportunities that will propel our future earnings growth, and I'd like to take a few minutes to discuss those opportunities.

Beginning with utility, which remains the core of our business, we expect to continue making and earning on system and infrastructure improvements for the foreseeable future.

As we observed the 1-year anniversary of Super Storm Sandy just a few weeks ago, we were reminded of the state's continuing focus on ensuring that we are better prepared for and protected from future severe weather threats.

For South Jersey Gas, the opportunities are twofold: from reinforcing our gas distribution system to supporting efforts to increase gas-fired generation that will allow critical facilities to operate independent of the grid.

On September 3, South Jersey Gas filed our SHARP proposal with the BPU, which if approved, will allow investments totaling $280 million over 7 years to upgrade our distribution system along the barrier islands from low pressure to high pressure.

These improvements, which would be incremental to our existing Accelerated Infrastructure Replacement Programs would make these lines less susceptible to water and sand intrusion.

We also anticipate an opportunity for South Jersey Gas to serve new generation, such as CHP projects, to be developed at the designated critical facilities around the state.

Presently, the state is working to secure federal funding that will allow state-owned facilities to begin these projects. However, through our continuing discussions with the BPU and legislative leaders, South Jersey Gas is pursuing an additional proposal that would bring private critical facilities along on the same timeline, providing much needed support to entities like hospitals, private colleges, universities and nursing homes.

As we mentioned in our second quarter update, such a proposal will allow us to not only provide natural gas to facilities within our service territory, but also to potentially provide financial support in the form of loans to these entities, on which the utility would earn a return as a regulatory asset.

Beyond Storm Hardening, we continue to make a substantial system improvement. While we have discussed previously the investments made under the accelerated infrastructure tracker that was approved earlier this year, we've been making much more significant investments outside that tracker. And as a result, we expect to be filing a rate case shortly to begin earning on those investments.

Based upon our experience with our last base rate case, which was settled in 2010, we would expect to settle this case by the fourth quarter of 2014. We'll announce the details of the case when we complete the filing.

Moving on to customer growth. Interest in conversions to clean-burning natural gas remains very strong as we enter this winter heating season. As our investments in infrastructure have helped on our distribution system, we gain greater access to customers on and near main.

At the same time, the up-to-70% price advantage natural gas has over alternative fuels and available incentive programs such as those available through our energy efficiency tracker for the purchase of high-efficiency heaters, support continued success in our conversion activity.

Through October, we have added over 4,100 conversions and are on track to meet our target of 5,500 for 2013. We also remain cautiously optimistic about the potential for new home construction to complement our growth.

We expect utility to continue contributing the majority of SJI's earnings growth for the foreseeable future as infrastructure spending, customer growth and the impact of a rate case benefit the bottom line both near and long term.

Now let's move to a discussion of our nonregulated businesses. As Dave previously discussed, our Wholesale commodity business encountered challenges that, in turn, negatively impacted third quarter earnings. The inability to move large volumes of low-priced gas to higher-indexed areas due to pipeline capacity constraints in the Marcellus eroded margins. In addressing these specific challenges directly, we have taken steps to mitigate future impacts by securing additional pipeline capacity and restructuring contracts where possible.

While the short-term cost for these measures is not insignificant, we expect the long-term positive return to be more apparent in future earnings.

In the meantime, we look forward to positive impacts from our refocus of this business towards fuel supply and management contracts that we continue to pursue and secure, like the Moxie Liberty and LS Power contracts.

As noted, the solid profitability of our on-site energy generation projects keeps this technology positioned as a cornerstone of our Retail Energy business. The reputation that we've earned from successful projects that we have already brought online, including the recently operational Montclair State University plant, affords us a steady queue of retail project prospects. As a result, we remain confident in our ability to grow this business, particularly in light of the state's continuing pursuit of electric generation capabilities.

We also intend to continue selectively adding solar projects that make sense for our overall portfolio.

On the solar front, we brought on 1 project this quarter and expect 13 more to come online by the end of the year. As the cost of installations have fallen significantly, new and future projects are even more profitable. We are well positioned to capitalize on the SREC market that continues to improve with values moving from $95 in January to as high as $157 in early October.

To reiterate my opening sentiment, we remain confident in the future of our businesses. We continue to position ourselves with the resources needed to capitalize on the opportunities that will be fueled by natural gas. Building on the solid foundation provided by our utility in the form of infrastructure investment, customer growth and a rate case, we also see many opportunities across our business lines to complement the successes we've had to date.

Strategically pursuing energy project opportunities, aggressively growing our retail commodity marketing business and adding valuable wholesale fuel management contracts will reinforce the contributions our nonutilities can make to earnings.

Last, as is historically the case, our Board of Directors will meet in November to review its decisions on dividend growth and take again a look at the continuing policy of growing dividends by at least 6% to 7% a year.

Thank you for your time today. Now I'd like to turn the call back over to the operator for the question-and-answer portion of the call.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from the line of Spencer Joyce, Hilliard Lyons.

Spencer E. Joyce - Hilliard Lyons, Research Division

Just one quick point, I wanted to touch on guidance first. Should we be thinking about the lower end, 4%, as still a lower bound on what we will see this year? Or should we be thinking of that as more of a midpoint at this point?

David A. Kindlick

I guess, in terms of guidance, we really hadn't thought about constructing a range around that number. And I think based on our current best information, we think we're in that ballpark right now, around 4%. So I hadn't really thought of establishing a new range in any way.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay, fair enough. On the Wholesale side, it looks like this quarter was somewhat weak, but you all have made some managerial changes around that or some moves there. Potentially looking out to next year, should the environment stay the same, the low/nonvolatile gas cost, how much rebound should we be thinking about next year, sort of giving those macro parameters unchanged?

Edward J. Graham

As we look at Wholesale next year, we haven't really provided guidance as far as how we expect SJI or its companies to perform. We feel confident in the steps we've taken that are positioning us better, but still, it's a changing environment. So I don't want to speculate on what might happen next year, but I can tell you that we've taken some great steps in terms of adding capacity or changing some of our contractual arrangements. And the other positive effect that's happened as of this -- or this November is some significant capacity coming online on multiple pipes that are bringing gas to where the demand is, where in the past, even where there was adequate capacity, it wasn't necessarily getting to demand pockets in the shoulder months. So at this point, we don't have new guidance as to what next year will look like, but I think we've taken some great steps. In the long run, the capacity we've added will be invaluable, I think, down the road.

Operator

[Operator Instructions] With no further questions at this time, we'll turn the call over to Mr. Ed Graham for closing remarks. Please proceed, sir.

Edward J. Graham

Well, thank you. And at this point, if there's no other questions, I still want to refer to you the opportunity to send questions or call us after the call. And so if anything arises, please contact Marissa Travaline, our General Manager of Investor Relations, or Ann Anthony, our Director of Finance and Investor Relations. Marissa can be reached at area code (609) 561-9000 extension 4227, or by email at mtravaline@sjindustries.com. Ann can be reached at extension 4143, or by email at aanthony@sjindustries.com.

Again, thank you for joining us on the call today, and have a nice day.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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