South Jersey Industries, Inc.
Q3 2017 Earnings Call Transcript

Published: 3 Nov 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the Q3 2017 South Jersey Industries Earnings Conference Call. My name is Lauren, and I will 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] I would now like to hand the conference over to Marissa Travaline, Director of Investor Relations. Please proceed.

[Marissa Travaline:]

Thank you, Lauren. Good morning, and thank you for joining us as we review South Jersey Industries third quarter results for fiscal year 2017 and provide an update on our business. Joining me today to present on our call are Mike Renna, President and CEO of SJI; and Steve Clark, our CFO. We also have several additional members of our senior management team available to help address your questions following our prepared comments. Our earnings release was issued to the media yesterday after market close and is available on our website at www.sjindustries.com. The release and the associated 10-Q provide an in-depth review of earnings on both a GAAP and non-GAAP basis using our non-GAAP measure of economic earnings. Reconciliations of economic earnings to the comparable GAAP measures appear in both documents. Also on our website are slides designed to support the discussion on today's call. Let me note that throughout our call, we will be making references to future expectations, plans and opportunities for SJI. 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 Forms 10-K and 10-Q on file with the SEC. With that said, I'll turn the call over to our CEO, Mike Renna, to discuss both current performance and future initiatives in the context of our strategic plan.

[Mike Renna:]

Thanks, Marissa. Good morning everyone. The third quarter was an eventful one for South Jersey Industries as we made significant strides in support of our strategic objectives. As many of you heard on our last – on our call last month, we announced an agreement with Southern Company Gas to purchase the assets in Elizabethtown Gas and Elkton Gas, an opportunity for us to strengthen and expand our business by adding another strong, efficient, well-run utility to our SJI family and reinforcing the foundation long-term growth. Through this acquisition, SJI will become the second largest natural gas provider in New Jersey with service to approximately 675,000 customers. But most importantly, it supports our principal strategy of focusing on high-quality earnings growth, while expanding utility rate base by about 50%, increasing our customer base by roughly 77% and bringing our utilities earnings contribution from the lower 70% range today to more than 80% upon transaction approval. In another significant October event, South Jersey Gas settled a base rate case with the New Jersey Board of Public Utility. As approved, rate base will increase by $230 million since our last case to $1.6 billion, reflecting the significant infrastructure investments made to improve and expand our utility distribution system and enhance our customer service. The resulting $39.5 million increase in base revenue represents an improved rate of return of 6.8% and ROE of 9.6%, and an equity-to-cap ratio of 52.5%. These changes went into effect November 1st. Work to advance the PennEast Pipeline continues as well. We remain optimistic that FERC approval will occur before year-end. This project, which brings over 1 Bcf of affordable clean burning natural gas from the Marcellus to New Jersey will fuel the region's homes and businesses safely, reliably and cost effectively for years to come. The same growth in our regulated businesses requires substantial investments in the people and infrastructure that are at the core of our operations. Efforts to upgrade our distribution system help to ensure greater access, safety and reliability, while also putting us on a more sustainable growth trajectory going forward. Currently, we are in the second phase of our Accelerated Infrastructure Replacement Program, which will result in more than $300 million of investment by 2021. After replacing all the aging bare steel and cast iron pipe in our system, we will have one of the most modern distribution system, not only in the state but in the entire country. The second phase of our Storm Hardening and Reliability Plan, or SHARP, filed earlier this week proposes a $110 million, 3-year investment to further strengthen the resiliency of the barrier island communities that we serve. And it's the investments that we've made over the past decade to expand and strengthen our system that have us well positioned to tackle the challenge of bringing gas to unserved and underserved communities in our service area. Within our nonutility businesses, finding innovative solutions to drive growth has resulted in strong recurring contributions from contracted assets like those within our fuel supply management portfolio. We now have six active fuel supply management contracts online. And we executed our seventh – our 11th contract in August. Before I turn the call over to Steve, I want to clarify also that we remain fully committed to achieving SJI's 2020 target of $150 million of economic earnings, but that is the baseline. And earnings related to Elizabethtown and Elkton will be additive, strongly additive. We plan to provide a more specific target after the transaction is approved. Let me, once again, emphasize that we are confident in our ability to deliver on the $150 million and that the addition of Elizabethtown and Elkton will deliver significant incremental earnings to our baseline 2020 plan. With that I will turn the call over to Steve to detail our year-to-date and third quarter results.

[Steve Clark:]

Thanks, Mike, and good morning, everyone. As Marissa mentioned earlier, both the earnings release and the slide deck released earlier provide detailed information regarding GAAP earnings. For purposes of this call, as we normally do, we'll focus on discussion on our non-GAAP measures of economic earnings, as management believes this measure provides valuable insights into the performance of our business. I do want to note that GAAP results from the quarter were impacted by a $27 million after-tax impairment charge taken in our solar business, stemming from the extremely weak Maryland SREC market. Consistent with past practice, we exclude impairments from economic earnings. The impairment amount is determined by comparing up current book value to the discounted net present value of projected future cash flows. While the impairment reflects a write-down of our two Maryland solar projects, it is a non-cash event and we will recognize performance of those projects via economic earnings in future periods as it actually occurs. It does not reflect any change in the cash flow produced by the projects currently. Now turning to performance. SJI's year-to-date economic earnings were $58.1 million as compared with $69.6 million for the same period in 2016. Economic EPS for the year-to-date period ending September 30, 2017 were $0.73, as compared with economic EPS of $0.92 for the same period of 2016. For the third quarter of 2017, SJI reported an economic earnings loss of $4 million with an economic EPS loss of $0.05, as compared with economic earnings of $3.9 million and $0.05, respectively, with the third quarter of 2016. Now we'll take a closer look at the items that impacted performance within our individual business lines. Beginning in our utility, South Jersey Gas contributed $43 million of economic earnings year-to-date in 2017, as compared with $46.1 million in the same period last year. In the third quarter, the utility saw a loss of $5.8 million of economic earnings as compared with a loss of $3.3 million in the prior year period. The year-over-year variance in both periods is attributable to several factors. Substantial investments in our utility infrastructure drive depreciation and interest expense higher and reserves taken for uncollectible accounts also increased. Investments in the people and systems needed to support our future growth also contribute to the variance. These items were addressed in SJG's rates through the resolution of the base rate case settled in October. Two months of new rates will be reflected in 2017 results, with 2018 receiving a full year impact. Quarter was further impacted by the reduced benefit from AFUDC recorded from our infrastructure investments in 2017, as compared with the third quarter of 2016. As noted in recent calls, the way we earn under our Accelerated Infrastructure Replacement Program has changed, with investments made through this program rolling into base rates in October of each year based on the new AFUDC recognition methodology. We expected this change to negatively impact 2017, but positively impact future periods. These changes make AIRP consistent with our hardening system and reliability program, or SHARP. Investments we made through these programs for the 12 months ended September 30, 2017, were included in rates as of October 1. For the first nine months of 2017, we have invested $82 million towards improving our gas distribution system under our Accelerated Infrastructure programs, producing an incremental net income contribution of $2.8 million. Another key component of utility earnings for the year and quarter is customer additions. For the 12 months ended September 30, 2017, we continued to post a 1.5% growth rate, with our total number of customers served at approximately 380,000. Conversion activity continues to be the main driver of customer additions throughout our service territory, both conversion and new construction, residential customer additions for the first nine months of 2017 are up significantly over the same period last year. Turning to Midstream. We're still waiting on FERC approval. In the interim, while we're waiting, our investment in PennEast project reflected an earnings contribution from AFUDC totaling $3.7 million year-to-date in 2017, with $1.3 million added in the third quarter. Now turning to our non-utility businesses. They contributed a total of $9.6 million in economic earnings year-to-date in 2017, as compared with $23.7 million for the same period in 2016. For the third quarter, our non-utility businesses provided aggregate economic earnings of $500,000 in 2017 compared to $7.3 million in the third quarter of 2016. I’ll address the significant factors that impacted these results, as I discuss our two primary non-utility business lines. Our wholesale and retail commodity businesses housed within South Jersey Energy Group contributed $9.6 million for the year-to-date in 2017, as compared with $10.4 million for the same period in 2016. Performance for the quarter reflected an economic earnings loss of $800,000 in 2017 versus a loss of $1.4 million in the third quarter of 2016. Year-to-date economic earnings at South Jersey Energy Group were significantly impacted by the record-setting warm weather our region experienced this winter, which limited the ability to optimize capacity and significantly reduce spreads. Since the winter, SJEG has closed the performance gap between 2016 and 2017. We do anticipate that full year 2017 results will exceed those achieved in 2016 in this business, despite the difficult start to the year. Our fuel supply management business continues to positively impact Energy Group results. In May 2017, our sixth contract came online at the Panda Stonewall facility, which would allow for sustained improvement for the balance of the year. As Mike noted, we announced our 11th fuel supply management contract last quarter, and continue to actively seek additional opportunities. Our energy projects business, South Jersey Energy Services, provided no contribution to economic earnings -to-date for 2017, as compared with $13.3 million of economic earnings for the same period in 2016. For the quarter, Energy Services produced economic earnings of $1.3 million in 2017, versus $8.7 million in the same period of 2016. Comparative results for Energy Services were heavily impacted by two significant factors. Strategic elimination of investment tax credits from earnings, which added $4.6 million in the year-to-date period of 2016 and a $4.3 million settlement related to our former energy facility at the Revel casino, which also impacted the full year period. Operational production from our existing solar assets remained strong, producing a lot of solar production and SRECs associated with it. However, market conditions in Maryland resulted in weakened SREC prices there. As such, the year-to-date solar contribution is lower in 2017 at $2.5 million of economic earnings versus $3.8 million in the same period in 2016. Results in Q3 2017 totaled $2.4 million as compared with $3.5 million in Q3 2016. That concludes our prepared remarks. At this time we’d be happy to answer any questions you may have.

[Operator:]

[Operator Instructions] Our first question comes from the line of Chris. Please proceed.

[Unidentified Analyst:]

Hey guys good morning.

[Mike Renna:]

Good morning Chris.

[Unidentified Analyst:]

Mike you said you don’t expect to revise the 2020 target until you get approval on Elizabethtown. But do you intend to extend to 2021 at some point, sort of, the core earnings target?

[Mike Renna:]

Yes we do.

[Steve Clark:]

Not too distant future, Chris.

[Unidentified Analyst:]

Okay.

[Mike Renna:]

I would expect that to – we will be looking at putting out a longer-term projection again, upon approval.

[Unidentified Analyst:]

Okay. Steve, could you talk about – have you spoken to the rating agencies yet about Elizabethtown? And can you tell us what kind of response you got?

[Steve Clark:]

We’ve had very preliminary conversations. We're due to be up there later on in this month. And those conversations will directly guide the specifics associated with our financing plan. So we're still a little bit ways from that, Chris.

[Unidentified Analyst:]

Okay.

[Steve Clark:]

I'd point out, though, that we've specifically looked at our financing plan. And I guess, what we announced when we announced the original transaction was with an eye towards defending the current ratings.

[Unidentified Analyst:]

Right. Okay. Have you got any thoughts on Elizabethtown's SMART program that's currently in the docket? Are you thinking of inning that at this point? It's a this point? It's a little different than what you described as your expectations, but do you feel maintaining that docket is a good idea, maybe more expedient than a new docket? And what are your general thoughts in they already have filed?

[Steve Cocchi:]

This is Steve Cocchi. Those are discussions that we're having with the Elizabethtown folks. That's something that we're going to take a hard look at. Clearly, primary driver behind our decision to pursue this business is the infrastructure replacement need. The timing of when a program may ultimately come into effect is still to be determined. Our primary focus right now is on obtaining the regulatory approval to close the deal.

[Unidentified Analyst:]

Okay. And one last thing, have you got any more revised or refined idea of what your filing timetable might look like?

[Steve Cocchi:]

We are working through that now diligently. I can't give you an exact date, but you should certainly expect something before year end it’s not [indiscernible] before that.

[Unidentified Analyst:]

Okay, great. Thanks a lot guys.

[Steve Cocchi:]

Thanks Chris.

[Operator:]

Our next question comes from the line of Spencer [Hilliard Lyons]. Please proceed.

[Spencer Everett:]

Hey guys good morning. Spencer Everett on line.

[Steve Clark:]

How are you?

[Spencer Everett:]

Doing well, okay. Steve, quick question for you perhaps first on the write-down in Maryland. Obviously, the SREC markets are very state by state, but is there any sort of extrapolation from the write-downs in Maryland that could creep in to what we have in New Jersey? Obviously, with the acquisitions out there, it's not a great time to be impairing capital here. And if the question is – or excuse me, if the answer is no, there are no extrapolations, just what is kind of the remaining asset base of solar in each of those states?

[Steve Clark:]

Spencer, you're actually right. The markets are very individualized. So really what you are looking at in Maryland is a situation where the market – frankly, there's been a lot of overbuilt down there and we're actually seeing people, from our perspective, building at a time where it's not – current SREC values aren't justifying the values of what people are building new. So it doesn't make a lot of sense right now. I would expect that some actions will have to be taken to normalize the market. That being said, those prices are specific to that Maryland market. When you look at New Jersey, and then – let me just back up for a second – the impairment, we had about $55 million worth of asset value there. The impairment takes it down to about $11 million worth of asset value. And that's based upon a discounted set of cash flows that project in the future off of current curves for SREC values. So really what you're dealing with there is kind of – it's a formulaic move with regard to how the EBIT model is done, but it's also pretty draconian. That being said, for Maryland, when you look at New Jersey, our New Jersey's values are considerably better than that. There is a little bit of – values in New Jersey are a little bit lower in the 2019 time period. But that's typically something that has been looked at and addressed in New Jersey by the powers that be from a regulatory standpoint and from a legislative standpoint. We think that New Jersey is in a position to – or has demonstrated in the past that they properly manage that market to encourage future development in the solar field. So you don't expect anything – any creep in from a different market into a particular market. Each market stands on its own.

[Spencer Everett:]

Okay, thanks. That's helpful. Mike, maybe to you for the second. The terminology in the press release looking for guidance to be – or for earnings to be solidly in the guidance range. Is that implying kind of a tightening, if you will? I mean, you see that the range is more resilient or perhaps with the rate case now settled, is solidly implying it could skew a little towards the higher end?

[Mike Renna:]

Solidly is a reflection of my confidence that we will fall solidly inside the range. I'm not at a point right now where I want to start to quantify whether we're going to be at the higher or lower end. But I think solidly is a pretty strong, strong word.

[Spencer Everett:]

Fair enough. Sticking with guidance, kind of, to piggyback off of Chris' question a little bit, just pertaining to what you all may come out with as far as guidance over the next couple of years. Is it possible, we see guidance for 2018 a little earlier than the typical March time frame? Or would you all be looking to guide that year along the normal time line, despite whatever else you might come out with?

[Mike Renna:]

I would – I don't really want to be – get committal on this, but I would think at this point in time, just given the efforts that are going into getting approval and what that approval looks like. It would probably be in everyone's best interest if we kind of stayed in the May time frame. Because we should have a really good indication of what the approval is going to look like at that point in time and whatever the financial impacts of that approval are.

[Spencer Everett:]

Okay. Yes, and sorry, I misspoke. I meant May, not March there. Finally, one here. Good to see the second phase of the Storm Hardening plan be filed there. I would assume you all have had some preliminary discussions with the PUC about some of the items that you would like to spend there. Would that be a fair assessment? Or are you pretty comfortable with that filing, kind of, as is?

[Mike Renna:]

Yes, we've had prefiling conversations with Board of Public Utilities. I would say, overall, there is still a very strong focus in SJI on the need for resiliency in the utility infrastructure. I don't anticipate any negative response or reaction to this filing.

[Spencer Everett:]

Okay, thanks for the color there, and looks like a pretty good quarter operationally. Thanks for taking the call.

[Mike Renna:]

Great, thanks Spencer.

[Operator:]

Our next question comes from line of Michael [Janney Montgomery Scott]. Please proceed.

[Michael Gaugler:]

Good morning, everyone.

[Steve Clark:]

Good morning.

[Mike Renna:]

Good morning, Mike.

[Michael Gaugler:]

Just one housekeeping question. I noticed the operations expense ticked up pretty nicely this quarter. Just wondering what was behind that.

[Steve Clark:]

Mike, I believe that’s the impairment number.

[Michael Gaugler:]

Okay. Thought as much, but just wanted to get a clarification.

[Steve Clark:]

Yes, that’s the big jump.

[Michael Gaugler:]

Okay. Thanks guys.

[Steve Clark:]

Thanks, Mike.

[Operator:]

Our next question comes from the line of Dan [U.S. Capital Advisors]. Please proceed.

[Dan Fidell:]

Good morning, guys.

[Mike Renna:]

Hi, Dan.

[Dan Fidell:]

Most of my questions have been asked and answered at this point, but one final one just from me. Can you give us some color on the Antero contract dispute, sort of where the legal process currently stands, the next steps to resolve this item? WGL has a similar dispute, as you know, ongoing with Antero. So I would just appreciate any thoughts you have on this and how we ought to be thinking about it. Thanks.

[Steve Clark:]

Dan, it’s Steve. When you think about Antero, there’s still some outstanding motions. It is our intent to appeal those motions once they’re ruled upon. If they necessitate us, it must be reversed I think. Once they necessitate us to change that, we will follow. So it’s our intent to follow up on that. As we look at Antero overall, the real impacts of that dispute were experienced a couple of years ago. Contract runs out to, I believe, October of 2019. So we’ve got about 18 months left on that, or actually a little bit more than that. Our exposure because of – basically, that spread has become dramatically thinner and some actions we have taken to protect our positions. We wouldn’t expect to see much more than a few million dollars pretax as a potential impact on that, even if we don’t get a favorable response to our appeal.

[Dan Fidell:]

Okay, great. And is this something that – I guess, how do I ask this. So is this something that you see proceeding on for a period of time kind of a lingering issue or is this something that you sort of hope to put to bed even before we move forward with the Etown and Elkton transaction?

[Steve Clark:]

Frankly, that’s driven by the courts. Their – they set the time frame as to when they choose to rule on different items. So it’s – I’d love to be able to give you a set time frame. But quite frankly, it’s not within our control.

[Dan Fidell:]

Got it. All right, thanks. I appreciate your comments as always guys. Thanks for the color and go Eagles.

[Steve Clark:]

Thank you.

[Operator:]

Our next question comes from the line of Chris [Williams Capital]. Please proceed.

[Chris Ellinghaus:]

Hey, it’s me again, guys.

[Mike Renna:]

Hi, Chris.

[Chris Ellinghaus:]

Mike, I looked it up on dictionary.com just to see if I would get any better sense of what solidly means. There’s plenty – solidly. Maybe a different word for next quarter. Steve, Elizabethtown’s growth, can you give us a little sense of how you see their growth or how does it compare to yours? And what’s their conversions look like?

[Mike Renna:]

I’m happy to talk about that. Their convergence – their customer growth is – I guess, historically, they’ve been around 1%. They do not have a decoupling mechanism in place, so their sales strategy is a little different than ours. They’re still focused on throughput. I think that there’s probably some opportunities on the conversion side, particularly in the Western part of the service territory. They’re pretty heavily saturated in the eastern area. Their growth is – it’s going to be very similar to what ours has been over the – or I think the growth opportunities are very similar to what ours have been over the last seven years. So if you kind of take the previous seven years and project it out through the duration of trackers that we have in place, I think it’s fair to say that this is a long-term, 12- to 15-year type of solid growth opportunity on the infrastructure side at Elizabethtown.

[Chris Ellinghaus:]

It is fair to say…

[Steve Clark:]

I would add that when you look – they did their filing a few years ago for a very large infrastructure program, and that got put to side a little bit because of the Southern acquisition. So basically, from our prospective, all that bare steel and cast iron work that needs to be done is still ahead of them. So we see significant opportunity there, stretching well over that.

[Chris Ellinghaus:]

Yes, it’s pretty obvious that a big piece of the economic value that you saw in the acquisition came from those programs, right?

[Steve Clark:]

Yes. And they’re the same types of programs that we’ve already successful deployed and have made our system what it is today.

[Chris Ellinghaus:]

And the BPUs made it pretty clear that they were supporting their programs up to the point where they sort of got put aside, right?

[Steve Clark:]

That’s correct.

[Chris Ellinghaus:]

And Mike, the reason I asked Steve is I didn’t want you to just say solidly. I thought I’d get a little more out of Steve.

[Mike Renna:]

I can’t believe the amount of heat that I’m getting over situation of a word.

[Chris Ellinghaus:]

All right. Thanks a lot guys.

[Mike Renna:]

But I feel really good. How about that?

[Chris Ellinghaus:]

Really good. That’d be better. I get good.

[Mike Renna:]

All right.

[Steve Clark:]

Thanks.

[Operator:]

There are no additional questions at this time. I would now like to hand the call back over to Marissa. Please proceed.

[Marissa Travaline:]

Thank you. Before we wrap up, as always, please feel free to contact me at your convenience with any questions; or our Treasurer, Ann Anthony. I can be reached at 609-561-9000, extension 4227 or via email at [e-mail]. Ann can be reached at extension 4143 or by email [e-mail]. Thank you again for joining us today and for your continued interest and investment in SJI. Have a great day.

[Operator:]

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