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SJI > SEC Filings for SJI > Form 10-Q on 7-Aug-2012All Recent SEC Filings

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Form 10-Q for SOUTH JERSEY INDUSTRIES INC


7-Aug-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements and Risk Factors - Certain statements contained in this Quarterly Report may qualify as "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact included in this Report should be considered forward-looking statements made in good faith and are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. Words such as "anticipate", "believe", "expect", "estimate", "forecast", "goal", "intend", "objective", "plan", "project", "seek", "strategy" and similar expressions are intended to identify forward-looking statements. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the statements. These risks and uncertainties include, but are not limited to, the following: general economic conditions on an international, national, state and local level; weather conditions in our marketing areas; changes in commodity costs; changes in the availability of natural gas; "non-routine" or "extraordinary" disruptions in our distribution system; regulatory, legislative and court decisions; competition; the availability and cost of capital; costs and effects of legal proceedings and environmental liabilities; the failure of customers, suppliers or business partners to fulfill their contractual obligations; and changes in business strategies.

A discussion of these and other risks and uncertainties may be found in the Company's Annual Report on Form 10-K for the year ended December 31, 2011 and in other filings made by us with the Securities and Exchange Commission (SEC). These cautionary statements should not be construed by you to be exhaustive and they are made only as of the date of this Quarterly Report on Form 10-Q, or in any document incorporated by reference, at the date of such document. While South Jersey Industries, Inc. (SJI or the Company) believes these forward-looking statements to be reasonable, there can be no assurance that they will approximate actual experience or that the expectations derived from them will be realized. Further, SJI undertakes no obligation to update or revise any of its forward-looking statements, whether as a result of new information, future events or otherwise.

Critical Accounting Policies - Estimates and Assumptions - Management must make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and related disclosures. Actual results could differ from those estimates. Five types of transactions presented in our condensed consolidated financial statements require a significant amount of judgment and estimation. These relate to regulatory accounting, derivatives, environmental remediation costs, pension and other postretirement employee benefit costs, and revenue recognition. A discussion of these estimates and assumptions may be found in our Form 10-K for the year ended December 31, 2011.

New Accounting Pronouncements - See detailed discussions concerning New Accounting Pronouncements and their impact on SJI in Note 1 to the condensed consolidated financial statements.

Regulatory Actions -Other than the changes discussed in Note 7 to the condensed consolidated financial statements, there have been no significant regulatory actions since December 31, 2011. See detailed discussion concerning Regulatory Actions in Note 10 to the Consolidated Financial Statements in Item 8 of SJI's Annual Report on Form 10-K as of December 31, 2011.

Environmental Remediation -There have been no significant changes to the status of the Company's environmental remediation efforts since December 31, 2011. See detailed discussion concerning Environmental Remediation in Note 15 to the Consolidated Financial Statements in Item 8 of SJI's Annual Report on Form 10-K as of December 31, 2011.


Table of Contents

RESULTS OF OPERATIONS:

SJI operates in several different reportable operating segments. Gas Utility Operations (SJG) consists primarily of natural gas distribution to residential, commercial and industrial customers. Wholesale Energy Operations include the activities of South Jersey Resources Group, LLC (SJRG) and South Jersey Exploration, LLC (SJEX). South Jersey Energy Company (SJE) is involved in both retail gas and retail electric activities. Retail Gas and Other Operations include natural gas acquisition and transportation service business lines. Retail Electric Operations consist of electricity acquisition and transportation to commercial and industrial customers. On-Site Energy Production consists of Marina Energy, LLC ("Marina's") thermal energy facility and other energy-related projects. Appliance Service Operations includes South Jersey Energy Service Plus, LLC (SJESP's) servicing of appliances under warranty via a subcontractor arrangement as well as on a time and materials basis, and the installation of residential and small commercial HVAC systems. The Retail Energy Operations caption includes Retail Gas and Other, Retail Electric, On-Site Energy Production and Appliance Service Operations.

Net Income for the three months ended June 30, 2012 increased $4.3 million to $10.3 million compared with the same period in 2011 primarily as a result of the following:

The income contribution from Marina for the three months ended June 30, 2012 increased $5.5 million to $6.0 million due primarily to the timing of the investment tax credit available on renewable energy facilities as compared to the prior year.

The income contribution from SJG for the three months ended June 30, 2012 increased $1.6 million to $3.2 million due to an increase in Capital Investment Recovery Tracker (CIRT) related earnings.

The income contribution from SJE for the three months ended June 30, 2012 increased $1.1 million to $2.9 million due primarily to the change in unrealized gains and losses on forward financial contracts used to mitigate price risk on electric as discussed under Operating Revenues - Nonutility below.

The income contribution from SJRG for the three months ended June 30, 2012 decreased $2.7 million to a net loss of $1.7 million due primarily to lower daily trading and swing supply margins and higher transportation and storage demand charges as discussed under Gross Margin - Nonutility below. The change in unrealized gains and losses on derivatives used by SJRG to mitigate natural gas commodity price risk, as discussed below, also contributed to the decrease.

Net Income for the six months ended June 30, 2012 increased $6.9 million to $64.4 million compared with the same period in 2011 primarily as a result of the following:

The income contribution from Marina for the six months ended June 30, 2012 increased $6.8 million to $16.4 million due primarily to the timing of the investment tax credit available on renewable energy facilities as compared to the prior year.

The income contribution from SJG for the six months ended June 30, 2012 increased $4.4 million to $38.3 million due to an increase in CIRT-related earnings along with an increase in residential customers.

The income contribution from SJESP for the six months ended June 30, 2012 decreased $2.4 million to a net loss of $0.1 million due primarily to proceeds received in the first six months of 2011 from a provider of homeowner assistance services in accordance with an agreement with the Company that gives them the exclusive right to renew the home appliance repair contracts at SJESP.

The income contribution from SJRG for the six months ended June 30, 2012 decreased $2.2 million to $4.5 million due primarily to lower daily trading and swing supply margins and higher transportation and storage demand charges as discussed under Gross Margin - Nonutility below.

A significant portion of the volatility in operating results is due to the impact of the accounting methods associated with SJI's derivative activities. The Company uses derivatives to limit its exposure to market risk on transactions to buy, sell, transport and store natural gas and to buy and sell retail electricity. The Company also uses derivatives to limit its exposure to increasing interest rates on variable-rate debt.


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The types of transactions that cause the most significant volatility in operating results are as follows:

            SJRG purchases and holds natural gas in storage to earn a profit
             margin from its ultimate sale in the future. SJRG uses derivatives
             to mitigate commodity price risk in order to substantially lock-in
             the profit margin that will ultimately be realized. However, gas
             stored in inventory is accounted for at the lower of average cost or
             market; the derivatives used to reduce the risk associated with a
             change in the value of the inventory are accounted for at fair
             value, with changes in fair value recorded in operating results in
             the period of change. As a result, earnings are subject to
             volatility as the market price of derivatives change, even when the
             underlying hedged value of the inventory is unchanged. Additionally,
             volatility in earnings is created when realized gains and losses on
             derivatives used to mitigate commodity price risk on expected future
             purchases of gas in storage are recognized in earnings when the
             derivatives settle, but the cost of the related gas in storage is
             not recognized in earnings until the period of withdrawal. This
             volatility can be significant from period to period. Over time,
             gains or losses on sale of gas in storage will be offset by losses
             or gains on the derivatives, resulting in the realization of the
             profit margin expected when the transactions were initiated.



            SJE uses forward contracts to mitigate commodity price risk on fixed
             price electric contracts with customers. In accordance with
             accounting principles generally accepted in the United States of
             America (GAAP), the forward contracts are recorded at fair value,
             with changes in fair value recorded in earnings in the period of
             change. Several related customer contracts are not considered
             derivatives and therefore are not recorded in earnings until the
             electricity is delivered. As a result, earnings are subject to
             volatility as the market price of the forward contracts change, even
             when the underlying hedged value of the customer contract is
             unchanged. Over time, gains or losses on the sale of the fixed price
             electric under contract will be offset by losses or gains on the
             forward contracts, resulting in the realization of the profit margin
             expected when the transactions were initiated.

As a result, management also uses the non-generally accepted accounting principles ("non-GAAP") financial measures of Economic Earnings, Economic Earnings per share, Non-Utility Economic Earnings, Wholesale Energy Economic Earnings and Retail Energy Economic Earnings when evaluating the results of operations for its nonutility operations. These non-GAAP financial measures should not be considered as an alternative to GAAP measures, such as net income, operating income, earnings per share from continuing operations or any other GAAP measure of liquidity or financial performance.

We define Economic Earnings as: Income from continuing operations, (1) less the change in unrealized gains and plus the change in unrealized losses, as applicable and in each case after tax, on all commodity derivative transactions and the ineffective portion of interest rate derivative transactions that we are marking to market, and (2) less realized gains and plus realized losses, as applicable and in each case after tax, on all commodity derivative transactions attributed to expected purchases of gas in storage to match the recognition of these gains and losses with the recognition of the related cost of the gas in storage in the period of withdrawal.

Economic Earnings is a significant performance metric used by our management to indicate the amount and timing of income from continuing operations that we expect to earn after taking into account the impact of derivative instruments on the related transactions. Specifically, we believe that this financial measure indicates to investors the profitability of the entire derivative related transaction and not just the portion that is subject to mark-to-market valuation under GAAP. Considering only the change in market value on the derivative side of the transaction can produce a false sense as to the ultimate profitability of the total transaction as no change in value is reflected for the non-derivative portion of the transaction.

Economic Earnings for the three months ended June 30, 2012 increased $2.7 million to $8.6 million compared with the same period in 2011, primarily as a result of the following:

The income contribution from Marina for the three months ended June 30, 2012 increased $4.5 million to $5.7 million due primarily to the timing of the investment tax credit available on renewable energy facilities as compared to the prior year.

The income contribution from SJG for the three months ended June 30, 2012 increased $1.6 million to $3.2 million due to an increase in CIRT related earnings.

The income contribution from SJRG for the three months ended June 30, 2012 decreased $1.8 million to a net loss of $0.7 million due primarily to lower daily trading and swing supply margins and higher transportation and storage demand charges as discussed under Gross Margin - Nonutility below.


Table of Contents

Economic Earnings for the six months ended June 30, 2012 increased $3.9 million to $58.7 million compared with the same period in 2011, primarily as a result of the following:

The income contribution from Marina for the six months ended June 30, 2012 increased $6.2 million to $16.0 million due primarily to the timing of the investment tax credit available on renewable energy facilities as compared to the prior year.

The income contribution from SJG for the six months ended June 30, 2012 increased $4.4 million to $38.3 million due to an increase in CIRT-related earnings along with an increase in residential customers.

The income contribution from SJRG for the six months ended June 30, 2012 decreased $2.5 million to $3.7 million due primarily to lower daily trading and swing supply margins and higher transportation and storage demand charges as discussed under Gross Margin - Nonutility below.

The income contribution from SJESP for the six months ended June 30, 2012 decreased $2.4 million to a net loss of $0.1 million due primarily to proceeds received in the first six months of 2011 from a provider of homeowner assistance services in accordance with an agreement with the Company that gives them the exclusive right to renew the home appliance repair contracts at SJESP.


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The following table presents a reconciliation of our income from continuing operations and earnings per share from continuing operations to Economic Earnings and Economic Earnings per share for the three and six months ended June
30 (in thousands except per share data):

                                            Three Months Ended             Six Months Ended
                                                 June 30,                      June 30,
                                           2012            2011           2012           2011
Income from Continuing Operations      $    10,832     $    6,245     $   65,043     $   58,076
Minus/Plus:
Unrealized Mark-to-Market Gains on
Derivatives                                 (2,267 )         (352 )       (6,465 )       (3,470 )
Realized Losses on Inventory Injection
Hedges                                          52              -             76            173
Economic Earnings                      $     8,617     $    5,893     $   58,654     $   54,779

Earnings per Share from Continuing
Operations                             $      0.36     $     0.21     $     2.14     $     1.94
Minus/Plus:
Unrealized Mark-to-Market Gains on
Derivatives                                  (0.08 )        (0.01 )        (0.21 )        (0.12 )
Realized Losses on Inventory Injection
Hedges                                           -              -              -           0.01
Economic Earnings per Share            $      0.28     $     0.20           1.93     $     1.83

Non-Utility Income from Continuing
Operations                             $     7,596     $    4,626     $   26,769     $   24,160
Minus/Plus:
Unrealized Mark-to-Market Gains on
Derivatives                                 (2,267 )         (352 )       (6,465 )       (3,470 )
Realized Losses on Inventory Injection
Hedges                                          52              -             76            173
Non-Utility Economic Earnings          $     5,381     $    4,274     $   20,380     $   20,863

Wholesale Energy (Loss) Income from
Continuing Operations                  $    (1,489 )   $    1,242     $    4,309     $    7,270
Minus/Plus:
Unrealized Mark-to-Market Losses
(Gains) on Derivatives                         967            103           (914 )         (727 )
Realized Losses on Inventory Injection
Hedges                                          52              -             76            173
Wholesale Energy Economic Earnings     $      (470 )   $    1,345     $    3,471     $    6,716

Retail Energy Income from Continuing
Operations                             $     9,085     $    3,384     $   22,460     $   16,890
Minus/Plus:
Unrealized Mark-to-Market Gains on
Derivatives                                 (3,234 )         (455 )       (5,551 )       (2,743 )
Retail Energy Economic Earnings        $     5,851     $    2,929     $   16,909     $   14,147


Table of Contents

The effect of derivative instruments not designated as hedging instruments under GAAP in the condensed consolidated statements of income (see Note 12 to the condensed consolidated financial statements) is as follows (gains (losses) in thousands):

                                               Three Months Ended            Six Months Ended
                                                    June 30,                     June 30,
                                               2012           2011          2012          2011
        Gains on energy related commodity
contracts                                  $    3,308      $   1,657     $  10,279     $   6,132
        Gains (losses) on interest rate
contracts                                          84           (250 )         220            11
             Total before income taxes          3,392          1,407        10,499         6,143
             Income taxes (A)                  (1,391 )         (577 )      (4,305 )      (2,519 )
           Total after income taxes             2,001            830         6,194         3,624
  Unrealized mark-to-market gains (losses)
on derivatives
  held by affiliated companies, net of tax
(A)                                               266           (478 )         271          (154 )
  Total unrealized mark-to-market gains on
derivatives                                     2,267            352         6,465         3,470
  Realized losses on inventory injection
hedges, net of tax (A)                            (52 )            -           (76 )        (173 )
  Total reconciling items between income
from continuing
  operations and economic earnings         $    2,215      $     352     $   6,389     $   3,297

(A) Determined using a combined statutory tax rate of 41%


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The following tables summarize the composition of selected SJG data for the three and six months ended June 30 (in thousands, except for degree day data):

                                      Three Months Ended         Six Months Ended
                                           June 30,                  June 30,
                                        2012          2011         2012       2011
Utility Throughput - dt:
Firm Sales -
Residential                            2,294          2,514      10,889      13,755
Commercial                               638            639       2,617       3,434
Industrial                                36             27         162         182
Cogeneration & Electric Generation       418            434         494         554
Firm Transportation -
Residential                              274            317       1,240       1,570
Commercial                               920            877       3,165       3,636
Industrial                             3,064          3,191       6,494       6,636
Cogeneration & Electric Generation     1,903          1,125       4,065       3,526

Total Firm Throughput                  9,547          9,124      29,126      33,293

Interruptible Sales                        2              9           2          12
Interruptible Transportation             317            372         741       1,064
Off-System                             1,080          1,551       5,551       3,455
Capacity Release                      17,019         17,504      33,986      27,659

Total Throughput - Utility            27,965         28,560      69,406      65,483




                                      Three Months Ended        Six Months Ended
                                           June 30,                 June 30,
                                       2012         2011         2012       2011
Utility Operating Revenues:
Firm Sales -
Residential                        $    33,024    $ 34,036    $ 146,653  $ 148,888
Commercial                               7,229       7,741       29,291     34,541
Industrial                                 381         574        1,634      2,294
Cogeneration & Electric Generation       1,525       2,692        1,928      3,501
Firm Transportation -
Residential                              2,158       2,313        8,081      8,863
Commercial                               3,936       3,482       13,049     13,187
Industrial                               5,188       4,270       10,608      8,665
Cogeneration & Electric Generation       1,241         745        3,242      2,487

Total Firm Revenues                     54,682      55,853      214,486    222,426


Table of Contents

                                             Three Months Ended            Six Months Ended
                                                  June 30,                     June 30,
                                            2012            2011           2012         2011
Interruptible Sales                              42            161             50          215
Interruptible Transportation                    338            328            816          962
Off-System                                    3,054          7,314         18,883       17,448
Capacity Release                                787          1,228          3,846        3,899
Other                                           274            303            532          560
                                             59,177         65,187        238,613      245,510
Less: Intercompany Sales                       (121 )         (217 )         (355 )     (6,151 )
Total Utility Operating Revenues             59,056         64,970        238,258      239,359
Less:
Cost of Sales                                20,286         28,042        106,551      110,682
Conservation Recoveries*                      1,540          1,447          4,842        4,702
RAC Recoveries*                               1,911          1,592          3,823        3,183
EET Recoveries*                                 843            635          1,555        1,144
Revenue Taxes                                   884          1,156          3,375        5,029
Utility Margin                          $    33,592     $   32,098     $  118,112   $  114,619

Margin:
Residential                             $    18,723     $   19,676     $   65,616   $   78,475
Commercial and Industrial                     9,892          9,239         27,480       30,566
Cogeneration and Electric Generation          1,165            765          2,129        1,540
Interruptible                                    21             39             52           87
Off-system & Capacity Release                   196            233          1,096          928
Other Revenues                                  515            386            772          642
Margin Before Weather Normalization &
Decoupling                                   30,512         30,338         97,145      112,238
CIRT Mechanism                                  763            626          1,530        1,192
CIP Mechanism                                 2,212          1,040         19,233        1,014
EET Mechanism                                   105             94            204          175
Utility Margin                          $    33,592     $   32,098     $  118,112   $  114,619

Degree Days:                                    367            376          2,297        2,871

*Represents expenses for which there is a corresponding credit in operating revenues. Therefore, such recoveries have no impact on our financial results.

Throughput - Utility - Total gas throughput decreased 0.6 MMdts, or 2.1%, for the three months ended June 30, 2012, compared with the same period in 2011. This decrease was realized primarily in the Capacity Release and Off-System Sales (OSS) markets. Following an unusually warm winter season in the region, the demand for both Capacity Release and OSS declined in the second quarter and combined for a decrease of 1.0 MMdts for the period. Partially offsetting that decline in usage was higher electric generation sales throughput, which increased 0.8 MMdts, or 69.2%, as a result of the excessive heat during the second quarter. As the second quarter of 2012 was one of the warmest on record in the region, higher electric consumption for air conditioning drove the demand for greater natural gas consumption by the region's electric producers.


Table of Contents

Total gas throughput increased 3.9 MMdts, or 6.0%, for the six months ended June 30, 2012, compared with the same period in 2011. This increase was realized primarily in the Capacity Release and OSS markets which increased 6.3 MMdts and
2.1 MMdts, respectively, during the six months ended June 30, 2012, as compared . . .

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