Good morning, welcome to the New Jersey Resources second quarter fiscal 2018 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Dennis Puma, Director of Investor Relations. Please go ahead, sir.
Thank you, Laura, good morning, everyone. Welcome to New Jersey Resources second quarter fiscal 2018 conference call and webcast. I'm joined here today by Larry Downes, our Chairman and CEO, Steve Westhoven, our Executive Vice President and Chief Operating Officer, and Pat Migliaccio, our Senior Vice President and CFO, as well as other members of our senior management team. As you know, certain statements in today's call contain estimates and other forward-looking statements within the meaning of the securities laws. We wish to caution listeners of this call that the current expectations, assumptions, and beliefs forming the basis for our forward-looking statements include many factors that are beyond our ability to control or estimate precisely, which could cause results to materially differ from our expectations as found on slide one.
These items can be found in the forward-looking statement section of today's earnings release, furnished on Form 8-K, and on our most recent Forms 10-K and Q filed with the SEC. We do not, by including this statement, assume any obligation to review or revise any particular forward-looking statement referenced herein in light of future events. Turning to slide two, we will be referring to certain non-GAAP financial measures, such as net financial earnings, or NFE. We believe that NFE provides a more complete understanding of our financial performance. However, NFE is not intended to be a substitute for GAAP. Our non-GAAP financial measures are discussed more fully on item seven of our 10-K. I'd also like to point out that there are slides accompanying today's discussion, which are available on our website and were furnished on our Form 8-K filed this morning.
With that said, I'd like to turn the call over to our Chairman and CEO, Larry Downes. Larry?
Thanks, Dennis, good morning, everyone. Thanks for being with us here this morning. I think as you know from our news release, we had a strong second quarter. If you look at slide three, we reported net financial earnings, or NFE, for the quarter of $142.1 million, or $1.62 per share. That compared with the $1.21 per share for the second quarter of last year. NJR Energy Services is having an excellent year. It was the primary net financial earnings driver this quarter, making a significant contribution of $72.8 million, which compared with $15.7 million during the same quarter last year. Strong demand and market volatility from the extremely cold weather we experienced in late December and early January drove those results.
New Jersey Natural Gas and our other subsidiaries performed in line with our expectations. We reaffirmed our fiscal 2018 earnings guidance range of $2.55-$2.65 per share. Moving to slide four, you can see our anticipated sources of net financial earnings for fiscal 2018. Aside from the net financial earnings related to the revaluation of deferred taxes, which is shown in the red on the pie chart, the largest contribution will come from our regulated businesses. We expect that New Jersey Natural Gas and NJR Midstream will contribute between 40%-55% in annual net financial earnings. We currently anticipate that Energy Services will contribute between 20%-30% of net financial earnings in fiscal 2018. Moving to slide five, we continue to target a strong annual dividend growth rate of between 6%-8%, with a payout ratio goal of between 60%-65%.
We believe that this performance will keep our balance sheet strong and provide a competitive current return to our share owners. We will reinvest earnings to support our expected growth in new natural gas and clean energy infrastructure investments and reduce our future external equity needs. With that, I'll turn the call over to our Chief Operating Officer, Steve Westhoven. Steve?
Thanks, Larry, good morning, everyone. I'd like to begin today by updating you on progress at New Jersey Natural Gas. Slide six provides details on the strong customer growth at our utility. For the six months ended March 31st, we recorded a 13% increase in customer additions over last year. The majority of this customer growth was from new construction, particularly in Ocean County. We now expect 65% of our new customer additions to come from new construction over our three-year planning period, running from fiscal 2018 through 2020. Between now and 2020, we expect to add 26,000-28,000 new customers, representing an average annual growth rate of 1.7%. Based on current rates, we estimate that this growth will add cumulative utility gross margin of approximately $16 million.
Turning to slide seven, we are also growing through our investment in two BPU-approved infrastructure programs, SAFE 2 and NJ RISE. These programs help us to ensure the safety and reliability of our system and have annual recovery mechanisms, which provide current returns on our invested capital. SAFE 2 began in fiscal 2017, we have replaced about 91 miles of unprotected steel main to date, including 22 miles in fiscal 2018. We expect to have over 72% of our unprotected steel main replaced by the end of the fiscal year. Moving on to NJ RISE. We completed a secondary natural gas distribution main between Brick and Manahawkin and reinforced a regulator station on Long Beach Island. We also continue to work on a secondary natural gas distribution main to the seaside barrier island, which is expected to be completed in June of 2018.
In addition, we have installed more than 11,400 excess flow valves in storm-prone areas of our service territory since the program's inception. Our last two RISE projects are in the permitting phase, with expected completion dates in fiscal 2019. On March 29th, 2018, we filed our annual petition with the BPU, requesting a base rate change in the amount of $6.9 million for the recovery of capital costs through June of this year. Recently, the BPU approved new regulations for future infrastructure programs, which will pave the way for standardized regulatory process going forward. A more detailed summary of these changes can be found in our appendix on slide 18. I'd like to give a brief update on the Southern Reliability Link. We continue to progress through the easement and permitting process, we currently anticipate SRL will be in service sometime in 2019. Moving to slide eight.
I'd like to update you on our wind assets. In the beginning of March, we announced that we are selling our interest in the Two Dot Wind Farm for $18.5 million to NorthWestern Energy. We are awaiting FERC approval and expect to record a pre-tax gain of about $1 million. Over time, we found it increasingly difficult to find onshore wind projects that fit our risk-return criteria, we have now committed to sell our remaining wind assets. We will update you as more information becomes available. Our target is to complete this process in fiscal 2019. We remain committed to clean energy, Larry will speak later about how CEV is aligned with the state policy and Governor Murphy's clean energy agenda. Slide nine illustrates the results of our SREC hedging strategy.
You can see that all of our SREC sales from facilities currently in operation and under construction for energy year 2018 are nearly 100% hedged. More importantly, we have made significant increases in our hedging activities for energy years 2019 and 2020. We are now over 80% hedged at an average price of $190 per SREC for energy year 2019. We are approaching 70% hedged for energy year 2020, at an average price of $186 per SREC. New clean energy legislation is awaiting the governor's signature, which supports new solar development in New Jersey. As a result, New Jersey SREC pricing has remained strong. I'd now like to turn the call over to Pat for some more details on the financials.
Thanks, Steve, and good morning, everyone. I'd like to begin on slide 10 with the NFE waterfalls. The key drivers of net financial earnings for the three months ended March 31st are as follows. New Jersey Natural Gas's quarterly NFE were flat due to the higher utility gross margin net of taxes, which was offset by increased O&M expenses as well as lower BGSS incentives. NJR Midstream was down modestly relative to the second quarter of 2017, due primarily to lower AFDC. We began recording AFDC for the first time last year in the second quarter, which included a catch-up entry. We also had to record a true-up to AFDC this quarter, reflecting the first modification of PennEast's capital structure to 50/50.
The decrease at NJR Clean Energy Ventures was due primarily to fewer tax credits recognized during the quarter as compared to last year, which is the result of our expected sale-leaseback financings for all of our commercial solar assets in 2018. For NJR Energy Services, the significant increase in NFE was driven by colder weather in early January, which resulted in increased demand for natural gas and higher volatility, allowing NJR Energy Services to capture additional margin from natural gas price spreads. For the six months ended March 31st, New Jersey Natural Gas saw an increase in gross margin net of taxes that was only partially offset by the higher O&M expenses, which is mainly overtime resulting from the colder weather. Both our NJR Midstream and CEV segments improved over the prior year as a result of the deferred tax revaluation associated with tax reform.
The increase in NJR Energy Services for the six months ended March 31st was also the result of the colder weather. Turning to slide 11, I'll walk you through some of the factors that will have an impact on NFE in 2018 and beyond. The first items are the shifts in our forecasted capital expenditures for our PennEast and Southern Reliability Link projects. While the PennEast project continues to target an in-service date in 2019, the delay in receiving the FERC certificate has had the ripple effect of delaying land access, surveys, and permit applications. All of which means that the commencement of construction may be delayed to 2019. As such, we've adjusted our capital plan to reflect construction commencing in 2019. Also, as Steve mentioned, SRL continues to progress through the easement and permitting process. We expect the project to be in service in 2019.
For both these projects, NJR expects a decline in the amount of AFDC in fiscal 2018 and fiscal 2019. As we discussed last quarter, low corporate tax rates have and will continue to have a net positive effect on NFE in fiscal 2018, fiscal 2019, and beyond. Additionally, as a result of the significant benefit from our deferred tax revaluation and also NJRES's performance this year, we've taken certain actions to benefit the company and enhance returns. To the extent we can, we will shift SREC deliveries from fiscal 2018 to fiscal 2019 to take advantage of the lower overall tax rate. We are utilizing sale-leaseback financing for all of our commercial solar projects in 2018 and are also accelerating certain O&M expenses into fiscal 2018.
As Larry mentioned, we reaffirm guidance for fiscal 2018, and these items taken together continue to support a long-term NFE growth rate of 6%-8%. Moving to slide 12, the changes to PennEast and SRL have an impact on our capital plan. The updated capital plan on this slide reflects the latest timing assumptions for both projects, with no other substantive changes. Moving to slide 13, I want to update you on our financing assumptions. We originally forecasted about $83 million of new equity in fiscal 2018. In the first quarter, we raised about $23 million of new equity through the waiver discount feature of our dividend reinvestment plan or DRIP. We expect that our needs for the balance of the fiscal year will be about $15 million, which we plan on raising through the DRIP.
The reduced need for equity financing is due to the outperformance of energy services and the benefits from tax reform. While we're reflecting equity needs in 2019 and 2020, that will likely be impacted by the results of our potential wind asset sales. In early March, NJR and NJNG priced a combined private placement debt offering. Proceeds from the combined offerings will be used to offset upcoming maturities during 2018 and fund capital expenditures. With both of these offerings, we've completed our external debt financing for the remainder of the fiscal year. I'll now turn the call back to Larry for some closing remarks.
Thanks, Pat. You may recall on last quarter's call, I talked about our strategy to provide our customers with reliable, affordable and clean energy services. To execute that strategy, we remain focused on natural gas, energy efficiency, and clean energy investments. Today, I wanted to spend just a few minutes updating you on where New Jersey is with its energy agenda, and importantly, how that agenda aligns with our strategy. In early April, the New Jersey legislature passed clean energy bills to advance solar energy, reduce greenhouse gases, and expand energy efficiency in our state. Those bills are currently awaiting Phil Murphy's signature. The legislation sets important clean energy goals for New Jersey that by 2025, 35% of the state's energy will come from renewable energy sources, and by 2030, 50% of the state's energy will come from renewables.
We believe that our state is on the path to achieve those goals. I think it's also important to note that New Jersey already has one of the largest solar markets in the nation, which is supported by public policy and driven by customer demand. Phil Murphy has made clear his strategy to build a robust clean energy economy that will drive job growth and create new energy investment opportunities. The strategy includes developing more solar and offshore wind, investing in energy efficiency, advancing energy storage, modernizing the grid, and furthering the adoption of alternative fuel vehicles. As you can see, a number of the Governor's priorities are directly aligned with the strategy that we have been pursuing for more than a decade. I want to make three points today about our state's clean energy strategy, and the first one is the importance of energy efficiency.
New Jersey has long recognized the significant positive benefits that can come from energy efficiency, our state's new legislative goals more than triple the current pace of savings from energy efficiency. We have a strong foundation to build on. Since 2006, we have helped our customers reduce their energy usage by more than 10%, and they have also saved more than $380 million. Our SAVEGREEN Project, which has been in place since 2009, has been critical to generating these results. In March, we advanced our energy efficiency strategy by filing a petition with the New Jersey Board of Public Utilities to invest $341 million over the next six years. Through this proposal, we're looking forward to bringing the benefits of energy efficiency to more homeowners, business owners, and public entities, as well as small businesses, low to moderate income customers, and seniors.
Energy efficiency investments in our customers' and shareholders' best interests, they also assist the state in achieving its energy policy goals. The second point I want to focus on relates to the market potential for solar in New Jersey. I'd remind you that the solar market began in earnest in New Jersey nearly a decade ago, and today, solar investments have produced enough energy to power the equivalent of nearly 400,000 homes in New Jersey. Since 2009, we have invested more than $600 million in solar, and we currently expect to invest another $500 million more over the next four years. As one of New Jersey's largest providers, we believe that the solar industry represents a significant economic opportunity for our state. In fact, according to the National Renewable Energy Laboratory, the investment for New Jersey's solar market could reach $40 billion over coming decades.
The third point that I want to focus on is the critical role that natural gas must play in the state's transition to a clean energy economy. Today, in addition to being the fuel of choice to meet customer needs for heat and hot water, natural gas powers more than half of the electricity generated in New Jersey. Natural gas represents the largest share of the state's generation mix and is nearly double the levels from a decade ago. In the future, natural gas will support affordable growth in renewables as we add more resources, including solar and wind, to our state's generation mix. Natural gas generation has the added benefit of adjusting quickly to the intermittent nature of renewables, which provides grid reliability as we add more solar and wind and new technologies.
I'd also like to share with you some facts about what natural gas has already done to accelerate New Jersey's transition to a cleaner energy future. Since 2008, lower natural gas prices have saved New Jersey customers more than $5.5 billion. At the same time, solar and energy efficiency incentives have cost customers about $4 billion, which means that low natural gas prices have allowed us to affordably accelerate our clean energy investment strategy in the state, and at the same time, have saved New Jersey residents more than $1 billion. Going forward, natural gas prices are expected to remain low, which should keep our energy shift affordable. When we consider all of these facts, I think it is very clear that natural gas will continue to be an important part of the state's transition to a cleaner energy economy.
Before we go to questions, I want to say thank you, as always, to our more than 1,000 employees for their outstanding work. These dedicated women and men are the foundation of our company and the driving force behind our results. As always, I am proud of everything that they do. In fact, tonight, I will have the pleasure of honoring 24 of our employees who have worked with us for the past 25 years at our annual Lamplighters event. I just can't say enough about our employees and the work that they do every day to serve our customers and grow our businesses. I also want to invite you to visit our website and read our 2017 corporate sustainability report that highlights our commitment to environmental stewardship, economic growth, and social responsibility.
Again, thank you all for joining us here today. We would welcome your questions and comments.
Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Our first question will come from Dennis Coleman of Bank of America Merrill Lynch.
Good morning, everyone. This is actually Sammy on for Dennis.
Good morning, Sammy.
Congratulations on the really strong results. We were actually wondering, it is such a strong quarter, but the fiscal year 2018 guidance is unchanged. Are there any offsetting factors for the year that we should be thinking about? Or what should we look for in the next two quarters in terms of your expectations?
Sammy, this is Pat Migliaccio. As you know, we don't provide quarterly guidance, but in looking at how we typically perform in the second half of the fiscal year, you can expect that New Jersey Natural Gas will post a very modest loss. In addition, NJR Energy Services earnings tend to be extremely weighted towards the front half of the year, whereas the storage and transportation contracts that they have tend to be rated over the last 12 months. A good portion of that loss in the back half of the year is attributable to NJR Energy Services. Finally, in the first quarter, on this call, I referenced certain of the opportunistic tax planning activities that contribute about $0.20 to $0.30 of that offset. Those things taken together get us back to the midpoint of the guidance range.
That is helpful. More specifically for SRL, it looks like the in-service date is extended to 2019 from the fiscal year first quarter 2019, most of the CapEx is also pushed to 2019. Could you speak about what might have caused the additional delay?
Sammy, this is Steve. We're working through the process of obtaining the necessary permits and right of entry to the joint base. We expect to achieve those this fiscal year with construction starting. We'll put the pipe in the ground and have that in service in 2019. That's the current plan looking forward.
Okay. All right. Thank you.
The next question will come from Shahriar Pourreza of Guggenheim Partners.
Morning, guys.
Morning, Shar.
Just let me focus on the clean energy standards. Obviously, it's a big change in direction for New Jersey. New Jersey has somewhat been trailing other states. First and foremost, what's taking the Governor so long to sign the legislation?
Shar, this is Larry. I think.
Hey, Larry.
You have to ask him that question. There is a lot of elements to the legislation, as you know, and I would just imagine that he and his staff are going through the deliberative process as they evaluate the bill. I do think at least what we focus on is his clear commitment to cleaner energy and to really do that over an extended period of time. We feel that New Jersey has been a leader in the area of clean energy, and it is important to focus not only on the statistics that I gave on the solar market, but also energy efficiency. When you look at these areas, New Jersey has not only been a leader but was a first mover in those areas.
Given, I think, just the overall characteristics in the state as they relate to solar, the state has done a really good job there and has been responsive to the changes in the market that have come from the growth in solar to take a longer-term view to facilitate, we think, a continued path of growth in that market.
Shar, this is Pat Migliaccio. The only other thing I would add is that even though the legislation hasn't been signed, we have seen resulting strength in SREC prices in outer years. As Steve pointed out in his remarks, have been aggressively hedging our expected production in both energy year 2019 and energy year 2020 at these price levels.
Shar, Larry, just one other point, I am talking from the strategy point of view. When you look at the longer-term goals, they may seem aggressive, but we believe that there is a path here to achieve those goals. It is clearly longer term, and it is going to
It's going to really require improvement in technologies. When you look at how we're positioned and the things that have already been done, the state is off to a good start. Although it's aspirational, I think it's also realistic where the governor is trying to drive us to.
Got it. Just since you touched on SRECs, is there any sense whether you could see a change in that market, either from a construct or administrative standpoint? Because I think part of the mandate that the BPU has to look at as a result of these standards is whether they should see any changes in the SREC markets.
Sorry, this is Stephen Westhoven. As the energy legislation is drafted, it does require the BPU to have a closing period on projects that are built prior to the legislation going into action. Essentially, that is going to make a change in the market. You'll grandfather existing projects, and then there'll have to be a new market, probably similar to the one that we see now, going forward in establishing the solar builds in the future. There is going to be a change, and like Pat had referenced, I think that change is reflected somewhat in your forward SREC curve being supportive that this legislation is supportive of the market going forward.
Got it. You touched a little bit on sort of the mandates, whether it's storage or offshore wind. Do you guys have any sense on what the incentives or penalties could look like as a result of this legislation? What do you see that's palatable?
I think it's too early to tell how that's going to evolve and how that will transpire. You do have some big investments that need to be made, particularly-
Right
in offshore wind. I think it's something we have to watch and develop over time.
Got it. Just from a legality standpoint, do you guys have any sense on whether storage could be seen as a retail product as these mandates sort of kick in there? Because I think the BPU has some flexibility there on whether storage should be seen as sort of, again, a power deregulated product or something that could be part of the retail rate structure.
I think that, very similarly, is way off in the future. I think the technology has to evolve in order to create the situation in which the question you just asked becomes meaningful. I think that's something we're going to have to wait and watch that develop and see how that creates an opportunity for us.
Got it. Thanks, guys. That's all I had. Thanks.
Thanks, Joe.
Next we have a question from Joe Zhu of Avon Capital Advisors.
Hey, morning, Larry. Morning, Pat and Steve. Congratulations on a good quarter.
Hey, Joe.
Thanks, Joe. Good morning.
Morning. I got a quick question on the wind side. Now that you're planning to sell your existing wind portfolio and stating it is increasingly difficult to find a good onshore wind project to develop, would you mind sharing some of your thoughts on the competition landscape on the wind side? Is it because of margin squeeze from other developers, or is it because of the market is shrinking? Why you make this conclusion? Thank you.
Joe, I think it's a combination of a number of those events. Certainly scale is important when you're developing wind assets, and we've seen some big players moving through that market. As these markets become developed, other risks come into play. Basis risks between the point in which your wind farm is operating and where you can hedge that towards becomes an important item as well. When you factor all these together, we weren't able to find the projects to continue to develop this business and really pushed us to explore these other opportunities for us.
Joe, the only thing I'd add is I think you've seen, at least more recently, a lot more investment, both on the regulated utility side with the rate-basing these wind investments, also infrastructure and pension funds have come in with lower cost of capital than some of the strategics. That's also putting some pressure on it as well.
Understood. Thank you very much. Also, when you are looking at monetizing this wind portfolio, would you share some of your thoughts on timing and what valuation metrics you're looking at?
Yeah. We're going through the process now, Joe, as information becomes available, and it's appropriate to share, we will. We're expecting to close in 2019.
Are you going to sell as a portfolio or are you going to sell single asset, like asset by asset?
As I said, we're working through the process, so that is yet to be determined.
Okay, great. Thank you very much.
Thanks, Joe.
Again, if you would like to ask a question, please press star then one at this time. This will conclude our question and answer session. I would like to turn the conference back over to Larry Downes for any closing remarks.
I'll turn it over to Dennis. Okay. Thank you, Laura. Thank you everyone for joining us this morning. As a reminder, a recording of this call is available on our website. As always, we appreciate your interest and investment in New Jersey Resources. Enjoy your weekend. Have a great day. Bye.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.