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SJI > SEC Filings for SJI > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for SOUTH JERSEY INDUSTRIES INC


3-May-2013

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, 2012 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, 2012.

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, 2012. 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, 2012.

Environmental Remediation -There have been no significant changes to the status of the Company's environmental remediation efforts since December 31, 2012. 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, 2012.


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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. 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 March 31, 2013 decreased $11.2 million to $42.9 million compared with the same period in 2012 primarily as a result of the following:

The income contribution from SJRG for the three months ended March 31, 2013 decreased $9.3 million to a net loss of $3.0 million due primarily to 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, along with lower storage and daily trading margins as described in Gross Margin - Nonutility below.

The income contribution from SJE for the three months ended March 31, 2013 decreased $2.5 million to $0.7 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.

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.


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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. Economic Earnings for the three months ended March 31, 2013 decreased $1.6 million to $48.4 million compared with the same period in 2012, primarily as a result of the following:

The income contribution from SJRG for the three months ended March 31, 2013 decreased $3.3 million to $1.0 million due to lower storage and daily trading margins as described in Gross Margin - Nonutility below.


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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 months ended March 31 (in thousands except per share data):

Three Months Ended March 31, 2013 2012 Income from Continuing Operations $ 43,337 $ 54,211 Minus/Plus:
Unrealized Mark-to-Market (Gains)/Losses on Derivatives 4,098 (4,198 ) Realized (Gains)/Losses on Inventory Injection Hedges 120 24 Net Loss from Affiliated Companies, Not Part of Ongoing Operations (A) 906 - Other (25 ) - Economic Earnings $ 48,436 $ 50,037

Earnings per Share from Continuing Operations $ 1.36 $ 1.79 Minus/Plus:
Unrealized Mark-to-Market (Gains)/Losses on Derivatives 0.13 (0.14 ) Realized (Gains)/Losses on Inventory Injection Hedges - - Net Loss from Affiliated Companies, Not Part of Ongoing Operations (A) 0.03 - Other - - Economic Earnings per Share $ 1.52 $ 1.65

Non-Utility Income from Continuing Operations $ 7,823 $ 19,173 Minus/Plus:
Unrealized Mark-to-Market (Gains)/Losses on Derivatives 4,098 (4,198 ) Realized (Gains)/Losses on Inventory Injection Hedges 120 24 Net Loss from Affiliated Companies, Not Part of Ongoing Operations (A) 906 - Other (25 ) - Non-Utility Economic Earnings $ 12,922 $ 14,999

Wholesale Energy Income from Continuing Operations $ (2,868 ) $ 5,797 Minus/Plus:
Unrealized Mark-to-Market (Gains)/Losses on Derivatives 3,962 (1,881 ) Realized (Gains)/Losses on Inventory Injection Hedges 120 24 Wholesale Energy Economic Earnings $ 1,214 $ 3,940

Retail Energy Income from Continuing Operations $ 10,691 $ 13,376 Minus/Plus:
Unrealized Mark-to-Market (Gains)/Losses on Derivatives 136 (2,317 ) Net Loss from Affiliated Companies, Not Part of Ongoing Operations (A) 906 - Other (25 ) - Retail Energy Economic Earnings $ 11,708 $ 11,059

(A) Resulting from the termination of the contract at LVE Energy Partners, LLC to design, build, own and operate a district energy system and central energy center for a planned resort in Las Vegas, Nevada.


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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
                                                                     March 31,
                                                                 2013          2012
(Losses) Gains on energy related commodity contracts         $   (7,049 )   $   6,971
Gains (Losses) on interest rate contracts                           525           136
             Total before income taxes                           (6,524 )       7,107
             Income taxes (A)                                     2,675        (2,914 )
           Total after income taxes                              (3,849 )       4,193
  Unrealized mark-to-market gains (losses) on derivatives
  held by affiliated companies, net of tax (A)                     (249 )           5
  Total unrealized mark-to-market (losses) gains on
derivatives                                                      (4,098 )       4,198
  Realized gains (losses) on inventory injection hedges, net
of tax (A)                                                         (120 )         (24 )
  Net Loss from Affiliated Companies, Not Part of Ongoing
Operations (B)                                                     (906 )           -
  Other                                                              25             -
  Total reconciling items between income from continuing
  operations and economic earnings                           $   (5,099 )   $   4,174

(A) Determined using a combined statutory tax rate of 41% (B) Resulting from the termination of the contract at LVE Energy Partners, LLC to design, build, own and operate a district energy system and central energy center for a planned resort in Las Vegas, Nevada.


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The following tables summarize the composition of selected SJG data for the three months ended March 31 (in thousands, except for degree day data):

                                      Three Months Ended
                                           March 31,
                                        2013          2012
Utility Throughput - dt:
Firm Sales -
Residential                           11,070          8,595
Commercial                             2,516          1,979
Industrial                               154            126
Cogeneration & Electric Generation       145             76
Firm Transportation -
Residential                            1,628            966
Commercial                             2,986          2,245
Industrial                             3,567          3,430
Cogeneration & Electric Generation     2,082          2,162

Total Firm Throughput                 24,148         19,579

Interruptible Transportation             434            424
Off-System                             1,713          4,471
Capacity Release                      13,815         16,967

Total Throughput - Utility            40,110         41,441




                                      Three Months Ended
                                          March 31,
                                      2013          2012
Utility Operating Revenues:
Firm Sales -
Residential                        $  108,124    $ 113,629
Commercial                             23,635       22,062
Industrial                              1,628        1,253
Cogeneration & Electric Generation        783          403
Firm Transportation -
Residential                             9,289        5,923
Commercial                             11,331        9,113
Industrial                              5,944        5,420
Cogeneration & Electric Generation      2,234        2,001

Total Firm Revenues                   162,968      159,804

Interruptible Sales                         -            8


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                                                    Three Months Ended
                                                        March 31,
                                                    2013          2012
Interruptible Transportation                           540          478
Off-System                                           6,682       15,829
Capacity Release                                     3,687        3,059
Other                                                  221          258
                                                   174,098      179,436
Less: Intercompany Sales                              (447 )       (234 )
Total Utility Operating Revenues                   173,651      179,202
Less:
Cost of Sales                                       77,156       86,265
Conservation Recoveries*                             5,324        3,302
RAC Recoveries*                                      2,178        1,912
EET Recoveries*                                        996          712
Revenue Taxes                                        2,243        2,491
Utility Margin                                   $  85,754     $ 84,520

Margin:
Residential                                      $  59,512     $ 46,893
Commercial and Industrial                           21,279       17,588
Cogeneration and Electric Generation                 1,230          964
Interruptible                                           24           31
Off-system & Capacity Release                          685          900
Other Revenues                                         266          257
Margin Before Weather Normalization & Decoupling    82,996       66,633
CIRT Mechanism                                         742          767
CIP Mechanism                                        1,891       17,021
EET Mechanism                                          125           99
Utility Margin                                   $  85,754     $ 84,520

Degree Days:                                         2,457        1,930

*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 1.3 MMdts, or 3.2%, for the three months ended March 31, 2013, compared with the same period in 2012. This decrease was realized primarily in the Capacity Release and OSS markets which decreased 3.2 MMdts and 2.8 MMdts, respectively, during the three months ended March 31, 2013, as compared with the same period in 2012. Due to colder weather experienced in the region during the first quarter of 2013, SJG experienced an increased demand by its firm customers, thereby creating fewer opportunities for both Capacity Release and off-system sales outside of SJG's territory during the winter months. Firm throughput increased 4.6 MMdts, or 23.3%, during the three months ended March 31, 2013, compared to the same period in 2012. This is most apparent in the heat sensitive residential and commercial markets whose total throughput increased 4.4 MMdts, or 32.0%, as a result of weather that was 27.3% colder for the three months ended March 31, 2013, as compared with the same period last year. Also contributing to higher firm throughput was customer growth. The Company added 5,693 customers over the twelve month period ended March 31, 2013, which represents a growth rate of 1.6%.


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Conservation Incentive Program (CIP) - Utility - The effects of the CIP on SJG's net income for the three months ended March 31, 2013 and 2012 and the associated weather comparisons were as follows ($'s in millions):

                                            Three Months Ended
                                                March 31,
                                          2013               2012
Net Income Benefit:
CIP - Weather Related               $        (0.5 )     $         6.5
CIP - Usage Related                           1.6                 3.6
Total Net Income Benefit            $         1.1       $        10.1

Weather Compared to 20-Year Average       Average        21.4% warmer
Weather Compared to Prior Year       27.3% Colder        22.7% warmer

Operating Revenues - Utility - Revenues decreased $5.6 million, or 3.1%, during the three months ended March 31, 2013, compared with the same period in the prior year after eliminating intercompany transactions. Lower Off-System Sales (OSS) volume resulted in a $9.1 million, or 57.8%, reduction in OSS revenues during the three months ended March 31, 2013, compared with the same period last year. As reflected in the Margin-Utility table above, the impact of changes in OSS and capacity release activity do not have a material impact on the earnings of SJG, as SJG is required to share 85% of the profits of such activity with the ratepayers. Total firm revenue increased $3.2 million, or 2.0%, during the first quarter of 2013 versus the same period in 2012. As stated under "Throughput-Utility," colder weather increased firm sales volume significantly compared with prior year; however, associated firm revenue only increased slightly. This is the result of lower gas costs being passed through to those customers, as SJG reduced its BGSS rate by 18.0% in October 2012. In addition, SJG gave a refund of $9.4 million to its periodic BGSS customers in January 2013, which further reduced revenue. While changes in gas costs and BGSS recoveries/refunds may fluctuate from period to period, SJG does not profit from the sale of the commodity. Therefore, corresponding fluctuations in Operating Revenue or Cost of Sales have no impact on Company profitability, as further discussed below under the caption "Margin-Utility."

Operating Revenues - Nonutility - Combined revenues for SJI's nonutility businesses, net of intercompany transactions, decreased $13.7 million, or 14.3% for the three months ended March 31, 2013 compared with the same period in 2012.

SJE's revenues from retail gas operations, net of intercompany transactions, increased $15.8 million, or 87.2% for the three months ended March 31, 2013 compared with the same period in 2012. Excluding the change in unrealized gains and losses recorded on forward financial contracts of $(0.5) million, revenues increased $16.3 million for the three months ended March 31, 2013 compared with the same period in 2012. The increase in revenues for the three months ended March 31, 2013 compared with the same period in 2012 was mainly due to a 21.9% increase in the average monthly New York Mercantile Exchange (NYMEX) settle price, along with an 86.8% increase in sales volumes, which was due to the impact of acquiring a retail gas marketing book in the third quarter of 2012 and temperatures that were colder than the first quarter of 2012. As of March 31, 2013 and 2012, SJE was serving 3,149 and 1,647 retail gas customers, respectively, with sales volumes totaling 7,997,253 and 4,282,402 dekatherms, respectively.

Market conditions continue to make it difficult to be competitive in the small commercial market. We continue to focus our marketing efforts on the pursuit of non-heat-sensitive commercial customers in an effort to mitigate price volatility and weather risk.

SJE's revenues from retail electric operations, net of intercompany transactions, decreased $19.2 million, or 39.4%, for the three months ended March 31, 2013 compared with the same period in 2012. Excluding the impact of the net change in unrealized gains and losses recorded on forward financial contracts due to price volatility of $3.6 million, revenues decreased $15.6 million, or 34.6%, for the three months ended March 31, 2013 compared with the same period in 2012.


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A summary of SJE's revenues from retail electricity is as follows (in millions):

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