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SJI > SEC Filings for SJI > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for SOUTH JERSEY INDUSTRIES INC


8-Nov-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 September 30, 2012 increased $7.2 million to $2.0 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 September 30, 2012 increased $3.0 million to $3.6 million due primarily to the timing of the investment tax credit available on renewable energy facilities as compared to the prior year.

The loss from SJRG for the three months ended September 30, 2012 decreased $2.8 million to a net loss of $2.6 million due primarily to strong margins earned on transportation contracts in 2012 as compared to losses in the prior year 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 under Operating Revenues - Nonutility below also contributed to the decrease in the net loss.

The income contribution from SJE for the three months ended September 30, 2012 increased $1.1 million to $0.5 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.

Net Income for the nine months ended September 30, 2012 increased $14.0 million to $66.4 million compared with the same period in 2011 primarily as a result of the following:

The income contribution from Marina for the nine months ended September 30, 2012 increased $9.8 million to $20.0 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 nine months ended September 30, 2012 increased $5.2 million to $38.8 million due primarily to an increase in CIRT-related earnings along with an increase in residential customers.

The income contribution from SJE for the nine months ended September 30, 2012 increased $2.3 million to $6.5 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 SJESP for the nine months ended September 30, 2012 decreased $2.8 million to a net loss of $0.2 million due primarily to proceeds received in the first nine 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.


Table of Contents

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.

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 derivative transactions, 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, and (3) less the impact of transactions or contractual arrangements where the true economic impact will be realized in a future period. 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 and transactions or contractual arrangements where the true economic impact will be realized in a future period. 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.


Table of Contents

Economic Earnings for the three months ended September 30, 2012 increased $3.6 million to $4.1 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 September 30, 2012 increased $2.3 million to $3.5 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 SJRG for the three months ended September 30, 2012 increased $1.6 million to a net loss of $0.5 million due primarily to strong margins earned on transportation contracts in 2012 as compared to losses in the prior year as discussed under Gross Margin - Nonutility below.

Economic Earnings for the nine months ended September 30, 2012 increased $7.5 million to $62.7 million compared with the same period in 2011, primarily as a result of the following:

The income contribution from Marina for the nine months ended September 30, 2012 increased $8.5 million to $19.5 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 nine months ended September 30, 2012 increased $5.2 million to $38.8 million due primarily to an increase in CIRT-related earnings along with an increase in residential customers.

The income contribution from SJESP for the nine months ended September 30, 2012 decreased $2.8 million to a net loss of $0.2 million due primarily to proceeds received in the first nine 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 SJE for the nine months ended September 30, 2012 decreased $1.7 million to $1.3 million due primarily to the expiration of a significant school board contract as discussed under Gross Margin - Nonutility below.


Table of Contents

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 nine months ended September 30 (in thousands except per share data):

                                            Three Months Ended
                                              September 30,              Nine Months Ended September 30,
                                           2012            2011             2012                 2011
Income (Loss) from Continuing
Operations                             $     2,164     $   (5,203 )   $       67,207       $       52,873
Minus/Plus:
Unrealized Mark-to-Market
(Gains)/Losses on Derivatives                2,004          5,677             (4,460 )              2,207
Realized (Gains)/Losses on Inventory
Injection Hedges                              (110 )          (50 )              (34 )                123
Economic Earnings                      $     4,058     $      424     $       62,713       $       55,203

Earnings per Share from Continuing
Operations                             $      0.07     $    (0.17 )   $         2.20       $         1.76
Minus/Plus:
Unrealized Mark-to-Market
(Gains)/Losses on Derivatives                 0.06           0.19              (0.15 )               0.07
Realized (Gains)/Losses on Inventory
Injection Hedges                                 -          (0.01 )                -                 0.01
Economic Earnings per Share            $      0.13     $     0.01               2.05       $         1.84

Non-Utility Income from Continuing
Operations                             $     1,639     $   (4,873 )   $       28,408       $       19,287
Minus/Plus:
Unrealized Mark-to-Market
(Gains)/Losses on Derivatives                2,004          5,677             (4,460 )              2,207
Realized (Gains)/Losses on Inventory
Injection Hedges                              (110 )          (50 )              (34 )                123
Non-Utility Economic Earnings          $     3,533     $      754     $       23,914       $       21,617

Wholesale Energy (Loss) Income from
Continuing Operations                  $    (2,432 )   $   (5,233 )   $        1,876       $        2,036
Minus/Plus:
Unrealized Mark-to-Market
(Gains)/Losses on Derivatives                2,233          3,420              1,319                2,693
Realized (Gains)/Losses on Inventory
Injection Hedges                              (110 )          (50 )              (34 )                123
Wholesale Energy Economic Earnings     $      (309 )   $   (1,863 )   $        3,161       $        4,852

Retail Energy Income from Continuing
Operations                             $     4,071     $      360     $       26,532       $       17,251
Minus/Plus:
Unrealized Mark-to-Market
(Gains)/Losses on Derivatives                 (229 )        2,257             (5,779 )               (486 )
Retail Energy Economic Earnings        $     3,842     $    2,617     $       20,753       $       16,765


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
                                                September 30,             Nine Months Ended September 30,
                                              2012          2011             2012                2011
(Losses) Gains on energy related
commodity contracts                       $   (3,614 )   $  (8,543 )   $       6,665       $        (2,411 )
     Gains (Losses) on interest rate
contracts                                         53          (309 )             273                  (298 )
             Total before income taxes        (3,561 )      (8,852 )           6,938                (2,709 )
             Income taxes (A)                  1,460         3,629            (2,845 )               1,111
           Total after income taxes           (2,101 )      (5,223 )           4,093                (1,598 )
  Unrealized mark-to-market gains
(losses) on derivatives
  held by affiliated companies, net of
tax (A)                                           97          (454 )             367                  (609 )
  Total unrealized mark-to-market
(losses) gains on derivatives                 (2,004 )      (5,677 )           4,460                (2,207 )
  Realized gains (losses) on inventory
injection hedges, net of tax (A)                 110            50                34                  (123 )
  Total reconciling items between income
from continuing
  operations and economic earnings        $   (1,894 )   $  (5,627 )   $       4,494       $        (2,330 )

(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 nine months ended September 30 (in thousands, except for degree day data):

                                              Three Months Ended          Nine Months Ended
                                                September 30,               September 30,
                                              2012            2011         2012       2011
Utility Throughput - dt:
Firm Sales -
Residential                                  1,327            1,226       12,216     14,981
Commercial                                     585              516        3,202      3,950
Industrial                                      18               24          180        206
Cogeneration & Electric Generation             834            1,014        1,328      1,568
Firm Transportation -
Residential                                    171              162        1,411      1,732
Commercial                                     552              538        3,717      4,174
Industrial                                   3,051            2,976        9,545      9,612
Cogeneration & Electric Generation           3,400            1,584        7,465      5,110

Total Firm Throughput                        9,938            8,040       39,064     41,333

Interruptible Sales                              -                1            2         13
Interruptible Transportation                   264              307        1,005      1,371
Off-System                                   1,176            1,455        6,727      4,910
Capacity Release                            16,488           18,220       50,474     45,879

Total Throughput - Utility                  27,866           28,023       97,272     93,506




                                             Three Months Ended            Nine Months Ended
                                               September 30,                 September 30,
                                            2012            2011           2012          2011
Utility Operating Revenues:
Firm Sales -
Residential                             $    25,618     $   25,906     $   172,271   $  174,794
Commercial                                    7,571          8,153          36,862       42,694
Industrial                                      327            582           1,961        2,876
Cogeneration & Electric Generation            3,298          5,450           5,226        8,951
Firm Transportation -
Residential                                   1,864          1,862           9,945       10,725
Commercial                                    2,802          2,804          15,851       15,991
Industrial                                    5,239          4,710          15,847       13,375
Cogeneration & Electric Generation            2,170            379           5,412        2,866

Total Firm Revenues                          48,889         49,846         263,375      272,272


Table of Contents

                                             Three Months Ended
                                               September 30,              Nine Months Ended September 30,
                                            2012            2011              2012                2011
Interruptible Sales                               -             14                   50                 229
Interruptible Transportation                    278            282                1,094               1,244
Off-System                                    4,051          6,727               22,934              24,175
Capacity Release                                786          1,345                4,632               5,244
Other                                           247            268                  779                 828
                                             54,251         58,482              292,864             303,992
Less: Intercompany Sales                       (252 )         (274 )               (607 )            (6,425 )
Total Utility Operating Revenues             53,999         58,208              292,257             297,567
Less:
Cost of Sales                                20,801         27,242              127,352             137,924
Conservation Recoveries*                      1,259            691                6,101               5,393
RAC Recoveries*                               1,912          1,590                5,735               4,773
EET Recoveries*                                 797            604                2,352               1,748
Revenue Taxes                                   650            832                4,025               5,861
Utility Margin                          $    28,580     $   27,249     $        146,692    $        141,868

Margin:
Residential                             $    14,484     $   13,839     $         80,100    $         92,314
Commercial and Industrial                     8,385          7,984               35,865              38,550
Cogeneration and Electric Generation          1,620            973                3,749               2,513
Interruptible                                    12             21                   64                 108
Off-system & Capacity Release                   213            241                1,309               1,169
Other Revenues                                  409            412                1,181               1,054
Margin Before Weather Normalization &
Decoupling                                   25,123         23,470              122,268             135,708
CIRT Mechanism                                  756            719                2,286               1,911
CIP Mechanism                                 2,586          2,961               21,819               3,975
EET Mechanism                                   115             99                  319                 274
Utility Margin                          $    28,580     $   27,249     $        146,692    $        141,868

Degree Days:                                     26             21                2,323               2,892

*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 0.2 MMdts, or 0.6%, for the three months ended September 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 summer months and combined for a decrease of 2.0 MMdts for the third quarter. Partially offsetting that decline in usage was higher electric generation transportation throughput, which increased 1.8 MMdts, or 114.6%, as a result of the excessive . . .

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