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Executives

Edward Graham – Chairman, CEO

David Kindlick – Chief Financial Officer

Stephen Clark – Treasurer

Analysts

Dan Fidell - Brean Murray, Carret & Co.

Darren Conti - Wachovia Securities

South Jersey Industries (SJI) Q4 2007 Earnings Call February 28, 2008 2:00 PM ET

Operator

Good day Ladies and Gentleman, and welcome to the Fourth Quarter and Year-End 2007 South Jersey Industries Earnings Conference Call. My name is Grace, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference. If at any time during the call you require assistance, please press * followed by 0, and a coordinator will be happy to assist you. I would now like to turn the presentation over to host of today’s conference, Mr. Edward Graham, Chairman and CEO of South Jersey Industries. Please proceed, sir.

Edward Graham

Thank you and good afternoon. I would like to welcome you to South Jersey Industries year end 2007 Earnings Conference Call and webcast. Joining today on the call are David Kindlick, our Chief Financial Officer, and Stephen Clark, our treasurer. During the course of this call, we may make various remarks about future expectations, plans, and prospects for South Jersey Industries. These remarks constitute forward-looking statements for the purposes of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these statements as a results of various important factors including those discussed in our Company’s Form 10-K and 10-Q on file with the SEC. Further, we see no duty to update these statements should actual events differ from expectations.

Now, let’s start to review our performance. Earnings from continuing operations for 2007 were $62.7 million or $2.12 per share compared with $72.3 million or $2.47 per share for the period 2006. Earnings totaled $16.1 million and $20.3 million for the fourth quarters of 2007 and 2006 respectively. Earnings per share from continuing operations totaled 54 cents and 59 cents per share for those same quarters. GAAP numbers for the full year 2006 received a much larger benefit from unrealized mark-to-market gains from gas sales hedged than did in 2007 results, and remember GAAP does not reflect the changes in value of the gas that we have in storage to satisfy those sales contracts.

As we discussed previously, when managing the company, we measure our performance based upon economic earnings. Economic earnings eliminate all unrealized gains and losses of commodity derivative transactions and adjust the realized gains and losses attributed to hedges on inventory transactions. We do not believe that the mark-to-market accounting reflected in our GAAP earnings provides a clear picture of how we are actually performing. The underlying economic value as opposed to the mark-to-market value of all energy derivative transactions is better reflected in a non-GAAP financial measure that we call economic earnings. For 2007, South Jersey Industries’ economic earnings were $61.8 million, up 14% compared with the $54 million earned during 2006. Economic earnings per share were $2.09 per share for 2007 up 13 cents from $1.85 per share in the prior period. For the fourth quarter of 2007, economic earnings totaled $18.8 million, compared with income of $20.2 million for the fourth quarter of 2006. Economic earnings per share were $0.63 and $0.69 respectively for the same period.

Now, I will review some of the drivers of our performance. Looking first at the utility business, South Jersey Gas posted net income of $38 million for 2007, a 6% improvement over the $35.8 million reported for 2006. Our utilities reported net income of $11.6 million for the fourth quarter of 2007 compared with $12.2 million for the same period in 2006. Customer margin growth, the implementation of our decoupling tariff in the beginning of the fourth quarter of 2006, and lower interest expense were the primary drivers behind the strong 2007 performance. The year and the quarter were both impacted by an increase in our reserve for uncollectible accounts that is tied to a formula to the level of our receivable balance at the end of each period measure. The decoupling tariff noted the Conservation Incentive Program or CIP eliminates the link between volumetric throughput and our profitability. The CIP adjusts our results for any reduction in the actual utilization back to the higher levels contained in our 2004 rate case. The CIP protected $7.5 million of South Jersey Gas net income in 2007.

Strong margin growth attributable to residential and small commercial/industrial customers added significantly to the 2007 utility performance and is expected to contribute $1.9 million in net income on an annual basis. Despite the well-publicized slowdown in new housing construction, our utility increased customers by 5600 customers or 1.7% over the last 12 months. The continuing strong profitability from our commercial markets has more than offset the lower residential growth rate.

Natural gas remains a fuel of choice within our territory, and consequently, we expect to continue to capture over 95% of new housing developed in southern New Jersey. Further, the significant price advantage being enjoyed by natural gas over competing fuels and increasing amount of publicity about that fact is going to bolster our conversion effort in the coming months and years in fact. Currently, natural gas heating provides about 44% cost savings compared to oil and even more significant versus other fuels. Consequently, the incentive to convert to natural gas has really become compelling. At the point that a housing market recovery occurs, the combination of stronger commercial profits and greater conversion activity should leave South Jersey Gas well positioned for additional growth.

One of the factors that should expedite the recovery of housing market in southern New Jersey is the planned growth of the casino industry. For long an important driver in the state’s economy, it appears that the state is looking for it to be even more expansive and supportive of the revenue growth for the state itself. As an example, discussions are being held to ensure that infrastructure improvements necessary to support substantial new development ranging from transportation to utilities does not impede the growth within our territory. This has the potential to produce multiple wins for South Jersey Industries. The utility should benefit from additional residential and commercial customers resulting from new jobs. The state estimates that the planned development will add 40,000 new jobs in the casino market over the next 10 years. Then, there are also opportunities that arise on the energy production side. This is an important basis for our optimism regarding the prospects for SJI.

Moving to the nonutility side of our business, net income contribution on a GAAP basis for 2007 and 2006 was $24.6 million and $36.4 million respectively. The 2006 GAAP results were bolstered by $18.2 million of unrealized mark-to-market gains compared with only $900,000 included in the 2007 results. GAAP net income was $4.5 million in the fourth quarter of 2007 compared with $8.1 million for the fourth quarter of 2006. Economic earnings for 2007 were $23.7 million compared with $18.2 million for the same period of 2006. Economic earnings were $7.2 million and $7.9 million for the fourth quarter of 2007 and 2006 respectively.

For 2007, commodity marketing produced economic earnings of $18.9 million, a 50% increase over the $12.6 million earned in 2006. For the fourth quarter of 2007, we recorded economic earnings of $6 million compared with $6.3 million for the prior year. On the wholesale side of our gas marketing business, we hedge an initial profit margin on each storage transaction we enter into and then we seek to build upon those margins by taking advantage of favorable market conditions.

Storage capacity creates opportunities to lock in attractive margins resulting from volatility in the gas market. Our gas storage capacity under management total 10 BCF at the end of 2007, and our wholesale business is working very hard to add to that storage capacity. We also look at innovative ways to add value to our storage assets; for an example, late in 2006, South Jersey Resources Group purchased a small book of retail business adjacent to the storage assets we leased from National Fuel in Western Pennsylvania. That business is attractive to us for a number of reasons; first, it expanded our retail marketing business; second, it gave us relationship with producers that have enabled us to purchase attractively priced gas from area near our storages; third, it better positions us to take advantage of opportunities associated with the development of a [__________] that extend in that area.

Also, as part of the purchase of that marketing book, we acquired a small interest in a few producing natural gas wells - shallow wells - that are in close proximity to our storage facilities. The location enables us to use output from the wells to better optimize those storage facilities.

Marina Energy, one of our onsite energy production subsidiaries, delivered income of $3.6 million for 2007 compared with $3.4 million for 2006. For the quarter, Marina contributed $700,000 in net income compared with $900,000 for the same period last year. Performance benefited from the operation of additional projects. In the fourth quarter, we began operations at our Burlington County landfill facility and added a third turbine at our Atlantic County Facility. Development continues on our 2 megawatt landfill gas electricity facility in Salem County, New Jersey, that we announced in July. Upon completion, this will be our fourth landfill project in operation producing a total of 18.2 megawatts of electricity. At a time when the State of New Jersey and the country as a whole are quite concerned about the impact to greenhouse gases, we are operating and growing a business that offers tangible solutions and attractive returns.

When complete, the carbon capture from our landfill energy business will be the equivalent of eliminating 152,000 cars from the road. Regarding our Las Vegas project, we expect our plant to begin providing construction cooling to the Echelon Place casinos and resort by summer 2009. Full energy services are to begin in the third quarter of 2010 with the opening of the resort. Construction of the facility is slightly ahead of schedule. We closed on $243 million of project financing for that facility in December. We utilized project financing as a risk management tool because it limits SJI’s financial exposure to the project. SJI’s partner arrangement on the project in which we have a 50% equity ownership interest in the facility serves as another important risk mitigator. That attention to risk is an important consideration as we pursue other opportunities to serve the energy needs of a large number of announced casino projects in Atlantic City, Las Vegas, and tribal gaming areas. Projects which we believe present the most immediate and attractive opportunities are Revel and MGM in Atlantic City. These projects are projected to total over $8 billion in new investment, and we can provide the energy solution for each of these resorts. However, rest assured that before we proceed on any new project, that project will have to conform to our internal risk management guidelines.

On our retail services business, which includes appliance warranty and repair, HVAC installation, meter reading, and now plumbing services, produced $1.3 million in 2007 compared with $2.1 million in 2006. Net income for this business line totaled 500,000 for the fourth quarter of 2007 and 700,000 for the same period in 2006. Product line expansion into commercial HVAC and a broader array of plumbing services were initiated this year and are expected to benefit the performance of this business line going forward.

Moving to the balance sheet, South Jersey Industries’ equity to total capitalization ratio of 50.3% as of December 2007 compares favorably to the 44.4% at the same point in time in 2006. Additions to SJI’s common equity account from our earnings performance were the primary driver for this improvement, but we also benefited from lower working capital requirements of both our utility and nonutility businesses. Utility working capital position benefited from weather conditions that approach normal in the fourth quarter as compared to the very warm 2006 fourth quarter. On the nonutility side, low requirements for long-term capital combined with strong earnings particularly in our commodity marketing business helped us produce a strong cash flow. Just to illustrate, wholesale commodity marketing has produced over $29 million of economic earnings in the last 2 years alone. As we said before, our goal is for South Jersey Industries equity-to-total cap ratio to average 50% on an annualized basis. We should exceed that target in 2008. Our financing strategy combined with earnings growth is designed to ensure we achieve our goal.

In conclusion, we continued to be very pleased about the direction and the progress of our business. Our utility operates within a vibrant geographic area that is being targeted by the state for addition economic development. Our energy project business serves as an attractive niche in the market, and we are positioned as an industry leader. Our commodity marketing business benefits from volatile gas prices, and we don’t see any reason why that volatility will disappear going forward, and finally, our balance sheet has never been stronger. All the factors that I just mentioned provide support for our strategy of delivering long-term average annual economic earnings growth per share of at least 6% to 7% on a forward-looking basis to our shareholders.

Thank you for your time today, and I will turn the call back over to our operator for the question-and-answer portion of this call.

Question-and-Answer Session

Operator

Ladies and gentleman, if you wish to ask a question please press * followed by 1 on your touchtone telephone. If your question has been answered or you wish to withdraw your question, press *2. Press *1 to begin, and please stand by for your first question.

Your first question comes in the line of Dan Fidell of Brean Murray.

Dan Fidell - Brean Murray

Good afternoon, gentleman. Thanks for the call.

Edward Graham

Hi Dan. How are you?

Dan Fidell - Brean Murray

Fine, thanks. Just a couple of questions—one is on utility and the other on the nonutility. First on the utility, can you give us some direction on what you expect out of new customer adds in the next year or two. We’ve got a lot of gas utilities this period reporting slowing customer growth. Can you just touch on that a little?

Edward Graham

Sure. We have slowed I guess to 1.7% to 2% growth level this year. I really believe that we will at least stay in that if not improve upon that in the coming year, largely driven by the conversion opportunities. We are having a lot of activity on the conversion front particularly from oil right now.

Dan Fidell - Brean Murray

The conversion opportunities are enough to at least offset the decline from the new customer. Is that what you are saying?

Edward Graham

Absolutely, we are finding, I think, there is a still a remainder of about 200,000 households that are heating with other than natural gas in southern New Jersey, many of them very close to our facilities, and the other thing that is not helping in terms significantly at the customer count but in terms of margin is we really have not had a slowing of the commercial market in terms of new additions, and in fact our experience has been in 2007 that that will more than offset the shortfall in residential customer addition.

Stephen Clark

Dan, this is Steve Clark. The margins on that commercial business have also been higher than we have enjoyed in the past, so we are getting a benefit there to help offset the lower overall number.

Dan Fidell - Brean Murray

That’s good news. You are actually in better shape than some others. Turning just quickly to the nonregulated side, can you talk a little bit more in terms of some of those additional projects you were mentioning in Atlantic City, MGM, and the other and just talk maybe a little bit about timing, what your outlook is for those and other opportunities on the onsite for Atlantic City and Las Vegas going forward?

Edward Graham

Sure, I will start on Las Vegas quickly since there isn’t many to name at this point, but we pointed out Echelon is moving on track to come on line in 2010. There is a project right next door to Echelon that is still on track as a great opportunity referred to as the Plaza. In terms of Atlantic City though, the fact that the state has really started to focus on Atlantic City, and they are projecting that there is in excess of $20 billion of projects over the next 5 to 10 years at a minimum ranging from the projects that are most immediate which are Revel planning to come online in the next 3 or 4 years as well as MGM—in terms of MGM, a $5 billion project and Revel, a $3 billion—they are our most immediate projects. Revel is already driving pilings and clearing the site, and MGM is well into their design phase, so in terms of Atlantic City, they seem to be clearly out in front in timing.

Other projects that have been named are Gateway, a $5-billion project, and they are buying up additional parcels. Pinnacle also probably trailing the group in terms of timing, but still something that we see in the next 5 years and probably the most significant project area is Bader Field. In fact at a recent meeting in the Governor’s office, they estimate the value of that parcel alone at $1.5 billion, and they plan that growth for at least 2 major casino projects among other facilities, so over the next 5 to 10 years, there is a significant growth plan. Where we see great interest is besides being a solution on the nonregulated side, the state is showing great interest in making sure that the energy infrastructure is in place to serve it. In fact, we really are starting to believe as is the state that really a mini-natural gas gradient may be the best fit for Atlantic City with a series of distributed gen projects connected to it, so serving both gas and electric needs within the city, which again we see that to be great boost for the utility side and serving a great opportunity on a nonregulated side.

Dan Fidell - Brean Murray

Great! I appreciate the detail. Thanks very much.

Edward Graham

Thank you Dan.

Operator

As a reminder, that’s *1 to ask a question. Your next question comes in the line of Darren Conti of Wachovia Securities

Darren Conti - Wachovia Securities

Good afternoon.

Edward Graham

Good afternoon, Darren.

Darren Conti - Wachovia Securities

I apologize if I missed this, but could you talk about how much of your 2008 and 2009 storage capacity is hedged, and then along the same lines, how much of your pretax profit is hedged?

Edward Graham

In 2008 and 2009, somewhere between 60% and 70% has been hedged for the next winter season. In terms of profits, I don’t recall the number off the top of my head quite frankly, but this usually maybe in total represent a quarter to a third of what we might realize from the storage, and as we have pointed out in the past, as we start to optimize over the next 12 months, we would expect to add substantially. Our experience has been consistent over the last 2 years that we are actually growing the value of storage.

Darren Conti - Wachovia Securities

Okay, so the 60 to 70 number - that range is good for both ‘08 and ‘09?

Edward Graham

That’s the ‘08 and ‘09 winter season. I don’t have a number for ‘09 and ‘10 season right now.

Darren Conti - Wachovia Securities

Okay, and you just found out that this is kind of an optimal range to hedge, I guess?

Edward Graham

Yes, I think, again, as we see spread opportunities present themselves, we’ve got time to continue to work at it, and we have, and of course some of the activities that we are doing now for this winter season, and it’s been a great opportunity so far this year to optimize, will also dictate what step to take next winter.

Darren Conti - Wachovia Securities

Alright, thanks guys.

Stephen Clark

Darren, just to go back to your question, we had at the end of the third quarter, we reported that we had a little bit over $10 million locked in, but that was kind of where we were.

Darren Conti - Wachovia Securities

Okay, great! Thank you.

Operator

And you have no further questions, and I would now like to turn the call back over to Mr. Ed Graham for closing remarks.

Edward Graham

Well, thank you. Thank you for questions, and again I welcome any further questions you may have. If further questions arise, please contact Steve Clark, our treasurer, and he can be reached at 609-561-9000, extension 4260, or by e-mail at sclark@sjindustries.com. Again, thank you for your interest in the company and have a nice day!

Operator

Thank you for your participation in today’s conference. This concludes the presentation, and you may now disconnect.

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Source: South Jersey Industries, Inc. Q4 2007 Earnings Call Transcript
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