South Jersey Industries, Inc.
Q3 2008 Earnings Call Transcript

Published: 7 Nov 2008

[Operator:]

Good day, ladies and gentlemen, and welcome to the third quarter 2008 South Jersey Industries earnings conference call. My name is [Francine] and I will be your coordinator for today. (Operator Instructions) I would now like to turn the presentation over to your host for today's conference, Ed Graham, Chairman and Chief Executive Officer. Please proceed, sir.

[Ed Graham:]

Thank you and good afternoon. I would like to welcome you to South Jersey Industries third quarter 2008 earnings conference call and webcast. Joining me today on the call are Dave Kindlick, our Chief Financial Officer, and Steve Clark, our Treasurer. During the course of this call we'll make many 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 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-K on file with the SEC. Further, we assume no duty to update these statements should actual events differ from expectations. Now let's review the third quarter. GAAP consolidated earnings from continuing operations reflected income of $43.9 million or $1.47 per share compared with earnings of $8.6 million or $0.29 per share for the third quarter of 2008 and 2007, respectively. For the nine month period on a GAAP basis, South Jersey Industries produced income from continuing operations of $55.3 million or $1.85 per share in 2008 compared with $46.5 million or $1.58 per share for the comparable 2007 period. GAAP results reflect the impact of unrealized gains from marked-to-market accounting at our commodity asset management and marketing business. As discussed previously, when managing the company we measure our performance based upon economic earnings. Economic earnings, which eliminates all unrealized gains and losses on commodity derivative transactions and adjusts for realized gains and losses attributed to hedges on inventory transactions was $1.1 million or $0.04 per share in the third quarter of 2008 as compared to a loss of $1.5 million or a loss of $0.05 per share during the third quarter of 2007. Third quarter economic earnings were lower than they otherwise would have been due to the timing of settlement of certain commodity transactions that were pushed into the fourth quarter, so we'll see the benefit of these transactions next quarter. For the nine months, South Jersey Industries' 2008 economic earnings totaled $47.9 million or $1.60 per share, up over 11% from the $43 million or $1.46 per share in 2007. We'd previously given guidance for economic earnings that will grow between 6% and 10% over the $2.09 per share delivered in 2007. That equates to a range of $2.22 per share and $2.30 per share. The solid year-to-date results that I've described, combined with opportunities ahead of us, leave South Jersey Industries well positioned to deliver economic earnings per share growth towards the higher end of the range. Further, we also remain committed to delivering on our long-term average annual economic earnings per share growth target of at least 6% to 7%. Our Board will be meeting over the coming weeks and as a part of their strategic review they will certainly consider these results as well as our future prospects as they discuss increasing the dividend. Looking at the performance of our non-utility businesses in total, GAAP results for 2008 reflected income of $45.7 million for the third quarter of 2008 and $28.5 million for the year-to-date. For the same period in 2007, GAAP net income from our non-utility businesses were $10.3 million and $20.1 million, respectively. As I've mentioned previously, 2008 GAAP results were positively impacted by gains related to marking-to-market changes in commodity prices. On an economic earnings basis, non-utility income from continuing operations for the third quarter of 2008 was $2.9 million, an increase of $2.7 million from $200,000 in the same quarter of 2007. The increase in economic earnings was due primarily to strong performance at our asset management and marketing business as well as our on-site energy production and appliance service businesses. For the nine months, economic earnings grew to $21.1 million in 2008 from $16.6 million in 2007. Looking at our key non-utility businesses, economic earnings in the third quarter in our asset management and marketing business rose to $200,000 compared to a loss of $1.6 million for the third quarter of 2007. The income contribution for the first nine months of 2008 was $15.1 million compared to $12.9 million for the same period of 2007, an increase of over 17%. Results for 2008 have benefited significantly from the increased value of pipeline capacity, which served to offset market conditions that produced tighter margins for storage capacity. We hedge our initial product margin on each transaction we enter into and then keep the build on those margins by taking advantage of favorable market conditions. As we look at the 2008-2009 winter season, this business is well positioned to continue its strong performance. Over the past year we've increased our storage from 10 billion cubic feet to actually 12.1 billion cubic feet. We have also significantly increased our pipeline capacity from 65,000 decatherms per day to 122,500 decatherms per day. These increases in storage and pipeline capacity create opportunities for this business to lock in attractive margins resulting from volatility and market pricing. For the upcoming winter season we have already hedged 100% of our storage capacity and 100% of our transportation capacity. Those hedges have locked in a minimum of $29 million of pre-tax income for this business, with the potential to opportunistically trade around those assets to further improve earnings. As I mentioned earlier, certain hedge transactions which we expected to settle in the third quarter are now going to settle in the fourth. As a result, we saw negative impact on third quarter earnings, but we'll see the benefit of these transactions in the fourth quarter. We also recently announced that we have a 30% ownership interest in the deep mineral rights on 21,000 acres in the Marcellus Shale. While the company has no plans to drill itself [inaudible] own in the Marcellus Shale, we envision monetizing the value of this asset as a long-term lease of mineral rights to an established E&P company with an upfront payment and ongoing royalties. This represents an exciting opportunity for SJI, and I look forward to sharing more details with you as this develops. On-site energy production also has performed very well in 2008. Our subsidiary, Marina Energy, contributed income of $2.1 million for the third quarter of 2008 compared with $1.3 million for 2007. Results year-to-date were up 52% to $4.4 million as compared to $2.9 million in 2007. Improved operating performance and higher chilled water throughput on a year-over-year basis at the existing Atlantic City thermal plant were driven by increased pulling demand and the opening of the Borgata new Water Club Tower in June. While we don't yet have a firm date when Boyd Gaming will resume construction of its Echelon Resort in Las Vegas due to uncertainties in market conditions, we do remain confident that both Boyd's facility and our thermal energy plant that will serve the facility will be completed not far down the road. As we've told you before, it's important to keep in mind that we have several key protections that are structured in this deal, first, that it's project financed; SJI does not have any liability for the project debt incurred. And second, contractual commitments to the project provided by both Echelon and Boyd should deliver payment streams to us as early as November of 2010 regardless of Echelon's operational status. SJI's is the industry's fourth landfill of gas to electric project, a joint venture to develop a 2 megawatt facility in Salem County, New Jersey. It's on target to be operational in December of 2008. We are also developing a multimillion dollar solar project for an educational facility, which we anticipate to be operational in early 2009. And as you may have known, the State of New Jersey released its energy master plan at the beginning of October. A cornerstone of the plan is combined heat and power, also known as CHP or co-generation. We continue to pursue energy project opportunities similar to those I described earlier that support the concepts laid out in the energy master plan. Marina develops, owns and operates on-site energy plants. These projects are especially attractive to us as the provide an annuity-like income stream under long-term contracts. The contribution from our Retail Services business, which includes appliance repair and warranty, HVAC installation, and meter reading, was $600,000 for the third quarter of 2008 compared to $500,000 for the same period in 2007. For the year-to-date in 2008, retail services produced $1.5 million of net income compared with $800,000 for the first nine months of 2007. As reported previously, a combination of new sales campaigns and realized operational efficiencies drove the improved performance. This business continues to provide a nice income to SJI and positions us well for opportunities that may arise as a result of the State of New Jersey's energy master plan. Changing our focus over to our utility business, South Jersey Gas posted a loss of $1.9 million for the third quarter of 2008 compared with a loss of $1.7 million for the same period in 2007. Traditionally, the third quarter is a loss quarter due to lack of heating demand. Year-to-date, South Jersey Gas reported net income of $26.6 million, up from $26.4 million posted for the same period in 2007. Performance drivers for the quarter and for the nine months were customer growth and lower interest charges, offset by lower margins on gas sales to electronic utilities and higher depreciation expense. South Jersey Gas Company [break in audio] noticed a conservation incentive plan or CIP, eliminate the link between volume metric throughput and our profitability. The CIP adjusts our results for any reduction in actual utilization back to the higher rate levels contained in our 2004 rate case. For the year-to-date, the CIP protected a total of $9 million of South Jersey Gas Company's net income. With the CIP, the gas company's primary profit drivers are customer growth and our ability to control expenses. The gas company's customer base grew by over 4,200 customers in the 12 months ended September of 2008, a 1.3% increase. In terms of financial impact, new customers added over last year are projected to contribute about $1.5 million to the bottom line per year. While the new housing market slump continues, we are encouraged by the tremendous amount of interest in converting to natural gas. We continue to experience a significant increase in the number of conversion requests due to natural gas's competitive advantage over other fuels. Also, our reserve for uncollectible accounts was up slightly, but the increase was formulaic and not tied to any uncollectible concerns. In fact, we have not seen any change in our historical patterns of bad debt. We continue to remain focused on improving operational efficiency, with a goal of controlling expenses or holding them flat. South Jersey Industries' equity-to-capitalization ratio, up 50% as of September 30, 2008, compares favorably to the 48% at the end of September 2007. On a year-to-date basis, the equity-to-capitalization ratio averaged 53%. Strong profitability that reduced the need for borrowings to support working capital needs was the primary driver for this improvement. Our goal has been for South Jersey Industries equity-to-capital ratio to average 50% on an annualized basis. We are committed to maintaining a strong balance sheet to take advantage of future business opportunities as they arise. In September, we announced that our Board of Directors had authorized a share repurchase program. This program authorizes the company to buy back up to 5% or approximately 1.5 million shares over the next four years. While we have not yet repurchased any SJI shares, this program provides management with a tool to optimize the company's capital structure, demonstrating our commitment to increased shareholder value over the long-term as well as our belief in future prospects. I'd also like to emphasize that SJI has more than adequate access to liquidity across all of our businesses. The turmoil that we have seen in the market at no time has interrupted or affected our ability to fund our operations. In conclusion, I want to stress that we believe the future of SJI is very bright based upon the progress of and the prospects for both our utility and non-utility businesses. A reaffirmation of our 2008 and long-term targets for economic earnings per share growth should serve to reflect our confidence in that future. I thank you for your time today. Now I'll turn the call back over to the operator for the question-and-answer portion of this call.

[Operator:]

(Operator Instructions) Your first question comes from James Lykins - Hilliard Lyons.

[James Lykins:]

First of all, you mentioned Echelon a bit. I was wondering if we could also get an update on what's happening with Revel and also MGM?

[Ed Graham:]

Sure. In terms of Revel, it's still heavily under construction. There's a number of cranes working. In fact, I just went by the site last week. The parking garage is pretty much complete and the towers are up a number of floors. We still are operating under a letter of intent that we help to design and do some of the basic layout of the energy plant while we continue to negotiate a contract. And, of course, us proceeding with any agreement there, there are a number of things that have to be in place and certainly the largest is financing in place and dedicated to the project on both Revel's part as well as ours. In terms of MGM, pretty recently they've announced that they are delaying breaking ground next year on the Atlantic City project, although they still are very high on a future development there. But they're not going to start right away in '09 like they intended.

[James Lykins:]

Have they given any kind of timeframe like Echelon did?

[Ed Graham:]

No, they haven't put out a future timeframe yet that I recall. But their commitment, because of some of the attractive nature, taxes, and tax treatment in particular in New Jersey, they're really something they want to do. But they haven't committed to when they break ground and how that alters at all their completion time. I know they are putting a lot of effort in design and engineering work that probably their construction time might be expedited once they start.

[James Lykins:]

And I've got a question about guidance. You reiterated your prior range, but I was wondering if you can tell us if the high end of that range does or does not include any kind of assumption for trading around these hedges that will reverse in Q4?

[Ed Graham:]

No, it doesn't include any new assumption. I think at this point there's no need to update it any further. I thought where we are at the upper end of the 6 to 10 - of course, if things prove up, there's an opportunity, in fact, to increase overall profits further and it affects timing on the storage activity, we'll consider that. But yes, I don't think there's any other specific item that is changing our thinking.

[James Lykins:]

You mentioned a solar project in your press release. I was just wondering if you could tell us what the impact could be or what kind of timeframe you're looking at, just anything at all about that project?

[Ed Graham:]

The solar project at an educational institution is well under way. The expectation is it probably will be fully up and running early 2009. One of the real attractive features with solar is the federal tax credit that you receive so, although very profitable over the life of the project, it should really be profitable in the front end.

[James Lykins:]

You said you're doing this at an educational facility. Does that mean that this is the kind of project where, like the thermal facilities you could in essence become the experts in the industry and duplicate that at several different - I don't know if they're colleges or universities. Is that what you're thinking or is this kind of a one-off deal or what?

[Ed Graham:]

I think we're going to look at each project on their own. One of the real attractive features with this particular project is the grant money was already in place that's offset a lot of the cost, capital cost to construct it. And going forward we're going to have to look at some of the economic features. Certainly, the federal tax credit really positive, but also how the state programs will affect it. So, again, it's about the economics and the payback period, and if the right enhancements from the state and at the federal level are in place, we could do a number more of them.

[Operator:]

Your next question comes from Daniel Fidell - Brean Murray, Carret & Co.

[Daniel Fidell:]

You mentioned that you're 100% hedged on your pipe and storage capacity for the coming winter. Could you maybe just give us a little bit of color on the margin trends for each of those, pipe and storage, in your outlook as you see into 2009?

[Ed Graham:]

Sure. In terms of this winter season, pipeline capacity, particularly long-haul capacity into the market area has traded above $2 for a lot of the season so, after offsetting our cost, it's a pretty significant profit margin from pipeline capacity. Our underlying cost is less than half of that. In terms of storage spreads, we were fortunate to lock in a good amount of our storage early, but storage spreads really aren't as large as they once were. The pure commodity part of the storage probably, if it's more than $1.50 per decatherm it would be [lot]. The added feature we have, of course, in terms of part of our storage being in the market area, we also get the benefit of basis or having it already in the market area. So that's an added premium to it. As we look out to the 2009-2010 winter season, we have started to hedge both of those. I don't recall what percentages are hedged storage. As opportunities present themselves more towards the $1.50 range, we'll take advantage of those. In terms of pipeline capacity, it's remained very strong in terms of value, very close to $2 a decatherm out there, so we've been, again, very aggressive, as the market permits, locking that in as well.

[Daniel Fidell:]

Should we assume that, I guess on the last quarter, if I have my notes right, I think it was about 40% hedged on pipe and 10% [break in audio] how shall we be thinking about those numbers?

[Ed Graham:]

I apologize, Dan. You broke up a little bit on me, but I think if I understood your question, it's did we hedge some more from our last call.

[Daniel Fidell:]

Correct.

[Ed Graham:]

Yes, probably modestly on the storage side, significantly on the pipeline capacity side. I don't have a percentage exactly, but it's at least 60% or more hedged.

[Daniel Fidell:]

Just in terms of the CIP, is that working pretty well? It's been in place for several years now. I'm just wondering in terms of, after a number of years these things tend to, from a technical standpoint, maybe get a little bit out of whack. Any thought in terms of going in for a true-up on the CIP or any other rate activity you're considering at this point?

[Ed Graham:]

Sure, Dan. That's a great question. First, in terms of how well the CIP has worked, clearly, in the discussion today, I talked about how it protected $9 million of net income for South Jersey Gas. In terms of the benefit to customers, over the two years it's been in effect there's been reduction in energy consumption of about 6%. And as we look at the impact for customers, it's enabled customers to conserve about 45 million therms of gas and save about $50 million of gas costs. So a great plus to customers and obviously good benefit to our shareholders. Interesting that you brought that up. A couple of things that are in play is clearly the energy master plan makes reference to it, but probably more significantly the governor, in a recent economic stimulus speech, talked about how utilities could promote green jobs and how we could invest and further the benefits of job creation and efficiency. One of the key step off points really is putting in place a decoupling or a conservation incentive tariff and both the governor's office and the Board of Public Utilities has been in discussion with us on how that should work. As far as future looking, I think there's certainly the opportunity to make that permanent or certainly extend it well into the future, either on a stand-alone basis or, as we've talked about at other times, as part of some of the other activities it could create a comprehensive rate case. Whichever would be the best approach, we'll consider.

[Operator:]

(Operator Instructions) Your next question comes from Ryan Rosenthal - Sidoti & Co.

[Ryan Rosenthal:]

First, could you discuss the New Jersey energy master plan and potentially the opportunities that SJI's regulated and non-regulated businesses may have as a result of the plan?

[Ed Graham:]

Sure. The energy master plan laid out a number of objectives and the overarching goal is to reduce energy consumption by 20% by the year 2020, as well as promote the use of renewable energy by the year 2020. And one of, I think, the key components will be CHP or combining power, often referred to as co-generation. And, in fact, some of the stimulus to making that even more economic for customers is already under way. There is legislation that's moving through both the House and Senate to provide $450 per kilowatt hour grants or credits towards the building of these projects. They're also exploring other means to be able to offer gas cost stabilization as well as federal support in terms of tax credits. So the energy master plan see CHP as a real driver going forward. It does also refer to renewables and, as we start to see how the programs shape up, whether it's solar or even for higher electric generation from landfills, we'll again evaluate how that further enhances economics there. On the utility side, I think it really supports the continuation of decoupling or CIP towers in place, and it's also starting to identify other ways that natural gas can be the bridge towards achieving some of the energy savings and the positive effect in terms of the carbon footprint. So South Jersey Gas and Natural Gas is a real key component going forward in the energy master plan.

[Ryan Rosenthal:]

Considering that your business relies heavily on derivatives for risk management, has there been a greater concern about counterparty risk in this environment, especially given that you've achieved some gains, unrealized gains as they might be?

[Ed Graham:]

We've always been extremely conscious in terms of who we would do physical transactions with, and in terms of our hedging with financial instruments, we're almost exclusively doing transactions through the NYMEX. So we're really being careful to protect ourselves on both fronts.

[Operator:]

Your next question comes from Roger Liddell - Ingalls & Snyder.

[Roger Liddell:]

I'd like to follow up on actually the last two questions, which touched on the conservative incentive program and efficiency investments. If it became clear to you that there was a significant, maybe even a major opportunity in crossing the meter into, well, if not residential customers, at least larger facilities - schools, colleges, the fire house, town hall, hospitals, etc.  if that business opportunity was really clear, would you do it under CIP or would you set it up as an independent unit? How would you exploit that opportunity?

[Ed Graham:]

Well, I think in terms of what is being envisioned in this economic stimulus plan of the governor's, I think the utilities are a key part of developing the programs and certainly there can be profit earned within the utility, but I think a great opportunity to actually perform the work will be outside the utility. And in our case, it would be either our client service business for the households or, at the larger scale, obviously, CHP or renewables through Marina. In fact, what we see is a direction, in terms of how to create savings, but also job creation, is to really utilizing effective audits at either the residential and commercial level. And the state, I think, is really ready to stand by and support it with the proper rebates and financing programs to really make it economic for households and for commercial businesses. So I guess it would be - the short of the answer is I see a good opportunity being the facilitator within the utility and profiting and actually completing the work on the non-regulated side and profiting.

[Roger Liddell:]

And is there some constraint that presents itself right now in terms of how quickly you exploit this and are any other utilities elsewhere in the country coming by and checking out best practices with you?

[Ed Graham:]

Well, in terms of the ability to exploit further, in some of the larger markets and certainly CHP, I was alluding to some of the state's legislative action that will really help for efficient operators and builders of plants significant credit. That $450 per kilowatt credit that would be provided by the state really amounts to about 30% of the capital investment in a plant, so immediately, if it's constructed properly and efficiently operated over a four-year period, you would get back 30% of your capital investment. Over and above that, the federal tax credits are attractive as well. So for us I think things are already supporting our opportunities on the larger side. In terms of what to do on the smaller residential, there are some programs - and really, they're over and above the CIP; the CIP, conservation incentive program, has been more focused on education, although there are some rebate programs. But what's really contemplated now is to really increase the support - greater rebates for higher efficiency equipment, certainly find ways to also look at the rest of the house. Maybe some of the biggest payback for homeowners will be on the efficiency side of properly insulating the house and caulking windows and doing a lot of things complementary to putting in more efficient equipment. That's being looked at right now since the governor's speech, I guess, that took place in October. And I'm very confident that the governor would like to see the utilities get behind and make that a reality by the beginning of the year.

[Roger Liddell:]

I just wanted to clarify. You were saying $450 a kilowatt hour. Could that be actually $450 a kilowatt in terms of capacity or do I misunderstand it?

[Ed Graham:]

No, you're correction's right. Yes, it's per - $450 per.

[Operator:]

I'm showing no further questions in the queue. I'd like to turn the call over to Ed Graham for closing remarks.

[Ed Graham:]

Well, again, thank you for joining us on the call and if there are further questions or information you're looking for, please contact Steve Clark, our Treasurer. And he can be reached at 6095619000, Extension 4260 or by e-mail at [e-mail]. Thank you and have a nice afternoon.

[Operator:]

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.