10-Q 1 sjg10q.txt SOUTH JERSEY GAS COMPANY FORM 10-Q P/E 6/30/04 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to ________________ Commission File Number 000-22211 SOUTH JERSEY GAS COMPANY (Exact name of registrant as specified in its charter) New Jersey 21-0398330 (State of incorporation) (IRS employer identification no.) 1 South Jersey Plaza, Folsom, NJ 08037 (Address of principal executive offices, including zip code) (609) 561-9000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] As of August 9, 2004 there were 2,339,139 shares of the registrant's common stock outstanding. All common shares are owned by South Jersey Industries, Inc., the parent company of South Jersey Gas Company. ================================================================================ SJG-1 PART I -- FINANCIAL INFORMATION Item 1. Financial Statements-- See Pages 3 through 17 SJG-2 SOUTH JERSEY GAS COMPANY CONDENSED STATEMENTS OF INCOME (UNAUDITED) (In Thousands) Three Months Ended June 30, ----------------------------------- 2004 2003 ----------------------------------- Operating Revenues $ 73,991 $ 75,547 ---------------- --------------- Operating Expenses: Gas Purchased for Resale 46,428 49,347 Operations 11,829 10,807 Maintenance 1,439 1,483 Depreciation 6,303 5,870 Energy and Other Taxes 1,983 2,131 ---------------- --------------- Total Operating Expenses 67,982 69,638 ---------------- --------------- Operating Income 6,009 5,909 Other Income and Expense (8) 22 Interest Charges 4,348 4,509 ---------------- --------------- Income Before Income Taxes 1,653 1,422 Income Taxes 830 753 ---------------- --------------- Net Income Applicable to Common Stock $ 823 $ 669 ================ =============== The accompanying footnotes are an integral part of the financial statements. SJG-3 SOUTH JERSEY GAS COMPANY CONDENSED STATEMENTS OF INCOME (UNAUDITED) (In Thousands) Six Months Ended June 30, ----------------------------------- 2004 2003 ----------------------------------- Operating Revenues $ 274,114 $ 315,483 ---------------- --------------- Operating Expenses: Gas Purchased for Resale 182,665 228,211 Operations 24,337 21,299 Maintenance 2,784 2,940 Depreciation 12,466 11,657 Energy and Other Taxes 6,711 7,159 ---------------- --------------- Total Operating Expenses 228,963 271,266 ---------------- --------------- Operating Income 45,151 44,217 Other Income and Expense 559 (96) Interest Charges 8,668 9,294 ---------------- --------------- Income Before Income Taxes 37,042 34,827 Income Taxes 15,513 14,724 ---------------- --------------- Net Income Applicable to Common Stock $ 21,529 $ 20,103 ================ =============== The accompanying footnotes are an integral part of the financial statements. SJG-4 SOUTH JERSEY GAS COMPANY CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (In Thousands) Three Months Ended June 30, ----------------------- 2004 2003 ----------- ---------- Net Income Applicable to Common Stock $ 823 $ 669 ----------- ---------- Other Comprehensive (Loss) Income, Net of Tax:* Change in Fair Value of Investments (26) 193 Change in Fair Value of Derivatives 4 (14) ----------- ---------- Other Comprehensive (Loss) Income - Net of Tax* (22) 179 ----------- ---------- Comprehensive Income $ 801 $ 848 =========== ========== Six Months Ended June 30, ----------------------- 2004 2003 ----------- ---------- Net Income Applicable to Common Stock $ 21,529 $ 20,103 ----------- ---------- Other Comprehensive (Loss) Income, Net of Tax:* Change in Fair Value of Investments (301) 153 Change in Fair Value of Derivatives 4 70 ----------- ---------- Other Comprehensive (Loss) Income - Net of Tax* (297) 223 ----------- ---------- Comprehensive Income $ 21,232 $ 20,326 =========== ========== * Determined using a combined statutory tax rate of 40.85%. The accompanying footnotes are an integral part of the financial statements. SJG-5
SOUTH JERSEY GAS COMPANY CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) (In Thousands) Six Months Ended June 30, ------------------------------- 2004 2003 ------------- -------------- Cash Flows from Operating Activities: Net Income Applicable to Common Stock $ 21,529 $ 20,103 Adjustments to Reconcile Net Income to Cash Flows Provided by Operating Activities: Depreciation and Amortization 13,632 12,816 Provision for Losses on Accounts Receivable 461 936 Revenues and Fuel Costs Deferred - Net 12,784 19,653 Deferred and Non-Current Income Taxes and Credits - Net 6,326 529 Environmental Remediation Costs - Net (1,216) 3,095 Gas Plant Cost of Removal (400) (306) Changes in: Accounts Receivable 25,515 18,986 Inventories 9,317 1,202 Prepayments and Other Current Assets 756 (418) Prepaid and Accrued Taxes - Net (15,423) 2,817 Accounts Payable and Other Accrued Liabilities 9,326 (5,156) Other - Net 861 (461) ------------- -------------- Net Cash Provided by Operating Activities 83,468 73,796 ------------- -------------- Cash Flows from Investing Activities: Capital Expenditures and Salvage (32,055) (23,618) ------------- -------------- Net Cash Used in Investing Activities (32,055) (23,618) ------------- -------------- Cash Flows from Financing Activities: Net Repayments of Lines of Credit (59,500) (34,400) Principal Repayments of Long-Term Debt (6,773) (15,658) Payments for Issuance of Long-Term Debt (42) (70) Additional Investment by Shareholder 15,000 - ------------- -------------- Net Cash Used in Financing Activities (51,315) (50,128) ------------- -------------- Net Increase in Cash and Cash Equivalents 98 50 Cash and Cash Equivalents at Beginning of Period 3,210 3,580 ------------- -------------- Cash and Cash Equivalents at End of Period $ 3,308 $ 3,630 ============= ============== The accompanying footnotes are an integral part of the financial statements.
SJG-6
SOUTH JERSEY GAS COMPANY CONDENSED BALANCE SHEETS (In Thousands) (Unaudited) June 30, December 31, -------------------------------- -------------- 2004 2003 2003 -------------- -------------- -------------- ASSETS Property, Plant and Equipment: Utility Plant, at original cost $ 924,497 $ 867,801 $ 894,654 Accumulated Depreciation (218,042) (202,460) (209,831) -------------- -------------- -------------- Property, Plant and Equipment - Net 706,455 665,341 684,823 -------------- -------------- -------------- Investments: Available-for-Sale Securities 4,601 3,657 4,497 Investment in Affiliate - 1,082 - -------------- -------------- -------------- Total Investments 4,601 4,739 4,497 -------------- -------------- -------------- Current Assets: Cash and Cash Equivalents 3,308 3,630 3,210 Accounts Receivable 48,901 63,790 48,412 Unbilled Revenues 4,454 6,112 31,070 Provision for Uncollectibles (3,112) (3,225) (3,263) Natural Gas in Storage, average cost 48,906 40,274 59,432 Materials and Supplies, average cost 4,768 3,450 3,559 Prepaid Taxes 17,361 10,974 2,661 Prepaid Pension 16,695 - 18,206 Other Prepayments and Current Assets 3,072 3,853 2,317 -------------- -------------- -------------- Total Current Assets 144,353 128,858 165,604 -------------- -------------- -------------- Regulatory Assets: Environmental Remediation Costs: Expended - Net 5,363 3,375 4,147 Liability for Future Expenditures 52,177 48,211 50,983 Gross Receipts and Franchise Taxes 1,146 1,589 1,367 Income Taxes - Flowthrough Depreciation 7,130 8,108 7,619 Deferred Fuel Cost - Net - 11,941 1,720 Deferred Postretirement Benefit Costs 3,213 3,591 3,402 Societal Benefit Costs 5,053 7,531 7,529 Other Regulatory Assets 1,033 551 732 -------------- -------------- -------------- Total Regulatory Assets 75,115 84,897 77,499 -------------- -------------- -------------- Other Non-Current Assets: Unamortized Debt Discount and Expense 6,162 5,461 6,383 Accounts Receivable - Merchandise 5,411 3,538 4,671 Other 2,697 4,352 2,805 -------------- -------------- -------------- Total Other Non-Current Assets 14,270 13,351 13,859 -------------- -------------- -------------- Total Assets $ 944,794 $ 897,186 $ 946,282 ============== ============== ============== The accompanying footnotes are an integral part of the financial statements.
SJG-7
SOUTH JERSEY GAS COMPANY CONDENSED BALANCE SHEETS (In Thousands) (Unaudited) June 30, December 31, -------------------------------- -------------- 2004 2003 2003 -------------- -------------- -------------- Capitalization and Liabilities Common Equity: Common Stock, Par Value $2.50 per share: Authorized - 4,000,000 shares Outstanding - 2,339,139 shares $ 5,848 $ 5,848 $ 5,848 Other Paid-In Capital and Premium on Common Stock 170,317 135,317 155,317 Accumulated Other Comprehensive (Loss) Income (18) (8,466) 279 Retained Earnings 129,885 101,851 108,356 -------------- -------------- -------------- Total Common Equity 306,032 234,550 269,800 -------------- -------------- -------------- Preferred Stock: Redeemable Cumulative Preferred - Par Value $100 per share, Authorized 41,966 shares, Outstanding 16,904 shares 8% Series 1,690 1,690 1,690 -------------- -------------- -------------- Long-Term Debt 257,008 221,713 263,781 -------------- -------------- -------------- Total Capitalization 564,730 457,953 535,271 -------------- -------------- -------------- Current Liabilities: Notes Payable 27,700 119,500 87,200 Current Maturities of Long-Term Debt 5,273 8,423 5,273 Accounts Payable 51,843 39,076 40,954 Deferred Income Taxes - Net 3,463 14,563 6,694 Customer Deposits 8,328 7,143 7,957 Environmental Remediation Costs 5,806 4,852 7,630 Taxes Accrued 8,598 15,563 9,321 Derivatives - 24 7 Interest Accrued and Other Current Liabilities 7,480 6,436 9,414 -------------- -------------- -------------- Total Current Liabilities 118,491 215,580 174,450 -------------- -------------- -------------- Deferred Credits and Other Non-Current Liabilities: Deferred Income Taxes - Net 128,016 104,275 118,894 Environmental Remediation Costs 46,371 43,359 43,353 Regulatory Liabilities 63,937 47,522 49,880 Pension and Other Postretirement Benefits 11,404 16,256 11,336 Investment Tax Credits 3,300 3,645 3,471 Other 8,545 8,596 9,627 -------------- -------------- -------------- Total Deferred Credits and Other Non-Current Liabilities 261,573 223,653 236,561 -------------- -------------- -------------- Commitments and Contingencies (Note 5) Total Capitalization and Liabilities $ 944,794 $ 897,186 $ 946,282 ============== ============== ============== The accompanying footnotes are an integral part of the financial statements.
SJG-8 Notes to Condensed Financial Statements (Unaudited) Note 1. Summary of Significant Accounting Policies: The Entity - South Jersey Industries, Inc. (SJI) owns all of the outstanding common stock of South Jersey Gas Company (SJG). SJG reclassified some previously reported amounts to conform with current year classifications. In our opinion, the condensed financial statements reflect all adjustments, which are of a normally occurring nature, needed to fairly present SJG's financial position and operating results at the dates and for the periods presented. Our business is subject to seasonal fluctuations and, accordingly, this interim financial information should not be the basis for estimating the full year's operating results. These financial statements should be read in conjunction with SJG's 2003 Form 10K. Equity Investments - We classify equity investments purchased as long-term investments as Available-for-Sale Securities on our balance sheets and carry them at their fair value with any changes in unrealized gains or losses included in Other Comprehensive (Loss) Income. Estimates and Assumptions - We prepare our financial statements to conform with generally accepted accounting principles. Management makes estimates and assumptions that affect the amounts reported in the financial statements and related disclosures. Therefore, actual results could differ from those estimates. Regulation - SJG is subject to the rules and regulations of the New Jersey Board of Public Utilities (BPU). We maintain our accounts according to the BPU's prescribed Uniform System of Accounts (See Note 2). SJG follows the accounting for regulated enterprises prescribed by the Financial Accounting Standards Board (FASB) Statement No. 71, "Accounting for the Effects of Certain Types of Regulation." In general, Statement No. 71 allows deferral of certain costs and creation of certain obligations when it is probable that such items will be recovered from or refunded to customers in future periods. Capitalized Interest - SJG capitalizes interest on construction at its BPU-approved rate of return on rate base (See Note 2). SJG's capitalized interest totaled $0.2 million and $0.1 million in the three month periods and $0.3 million in each of the six month periods ended June 30, 2004 and 2003, respectively. Derivative Instruments and Hedge Accounting - SJG accounts for its derivatives under the guidance of FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended. This statement establishes accounting and reporting standards for derivative instruments, including those embedded in other contracts, and for hedging activities. It requires that all derivatives, whether designated as hedging relationships or not, must be recorded on the balance sheet at fair value unless the derivative contracts qualify for the normal purchase and sale exemption. If the derivative is designated as a fair value hedge, we recognize the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk in earnings. If the derivative is designated as a cash flow hedge, we record the effective portion of changes in the fair value of the derivative in Accumulated SJG-9 Other Comprehensive (Loss) Income and recognize it in the income statement when the hedged item affects earnings. We recognize ineffective portions of changes in the fair value of cash flow hedges in earnings. No commodity related activities of SJG are considered subject to the fair value recognition requirements of Statement No. 133, as amended. In May 2003, we entered into an interest rate swap contract that effectively fixed the interest rate at 2.24% through May 20, 2004 on $20.0 million of our debt outstanding under bank credit agreements. We entered into this interest rate swap agreement to hedge the exposure to increasing rates with respect to our variable rate debt. The differential paid as a result of this swap agreement was accrued as interest rates changed and recognized as an adjustment to interest expense. We accounted for this interest rate swap as a cash flow hedge. We have also identified other physical transactions that qualify as derivatives. Management believes, however, based on its interpretation of guidance issued, that as these derivative contracts relate to the purchase and sale of natural gas, they qualify for the normal purchases and normal sales exception and, therefore, are not required to be marked to market. New Accounting Pronouncements - In January 2003, SJG adopted FASB Statement No. 143, "Accounting for Asset Retirement Obligations," which establishes accounting and reporting standards for legal obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. We have certain easements and right-of-way agreements that qualify as legal obligations under Statement No. 143. However, it is our intent to maintain these agreements in perpetuity; therefore, no change in SJG's current accounting practices is required related to these agreements. SJG recovers certain asset retirement costs through rates charged to customers as an approved component of depreciation expense. As of June 30, 2004 and 2003, SJG had accrued amounts in excess of actual removal costs incurred totaling $47.3 million and $43.5 million, respectively, which, in accordance with Statement No. 143, are recorded as Regulatory Liabilities on the condensed balance sheets. The adoption of this statement did not materially affect SJG's financial condition or results of operations. In January 2003, the FASB issued Interpretation No. (FIN) 46, "Consolidation of Variable Interest Entities." FIN 46 clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to certain entities in which equity investors do not have the characteristics of controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Management has adopted FIN 46 and accordingly determined that SJG Capital Trust, which was established for the sole purpose of issuing $35 million of mandatorily redeemable preferred securities, could no longer be consolidated into SJI's financial statements effective July 1, 2003. These securities were redeemed in November 2003. Prior periods were restated to report the original equity investment amount in SJG Capital Trust as a separate $1.1 million investment in an affiliate and the $36.1 million subordinated debenture to SJG Capital Trust as debt on its condensed balance sheet rather SJG-10 than the $35 million of mandatorily redeemable preferred securities as previously reported. The adoption of FIN 46 did not impact SJG's net income or retained earnings for the periods reported. The Company is not a party to any variable interest entities covered by FIN 46. In December 2003, the FASB revised Statement No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." This revised statement requires certain interim period disclosures about pension and other postretirement benefit plans (See Note 4). Regulatory Assets & Regulatory Liabilities - All significant regulatory assets are separately identified on the condensed balance sheets under the caption Regulatory Assets. Each item that is separately identified is being recovered through utility rate charges without a return on investment over the following periods: Years Remaining Regulatory Asset As of June 30, 2004 Environmental Remediation Costs: Expended - Net Various Liability for Future Expenditures Not Applicable Gross Receipts and Franchise Taxes 3 Income Taxes - Flowthrough Depreciation 7 Deferred Fuel Costs - Net Various Deferred Postretirement Benefit Costs 9 Societal Benefit Costs Various Various The remaining assets reflected under the caption Other Regulatory Assets are being recovered from ratepayers as approved by the BPU (See Note 6). Regulatory Liabilities consisted of the following items (in thousands): June 30, December 31, 2004 2003 2003 ----------- ---------- ----------- Deferred Revenues - Net $ 11,063 $ - $ - Excess Plant Removal Costs 47,320 43,462 45,241 Overcollected State Taxes 5,268 3,774 4,353 Other 286 286 286 ----------- ---------- ----------- Total Regulatory Liabilities $ 63,937 $ 47,522 $ 49,880 =========== ========== =========== Deferred Revenues - Net reflects the overrecovery of gas costs from ratepayers under SJG's gas cost clauses (See Note 2). Excess Plant Removal Costs represent amounts accrued in excess of actual utility plant removal costs incurred to date (See New Accounting Pronouncements). All other amounts are subject to being returned to ratepayers in future rate proceedings. SJG-11 Statements of Cash Flows - For purposes of reporting cash flows, highly liquid investments with original maturities of three months or less are considered cash equivalents. Note 2. Regulatory Actions: In January 1997, the BPU granted SJG rate relief, which was predicated in part upon a 9.62% rate of return on rate base that included an 11.25% return on common equity. This rate relief provided for the recovery of cost of service, including deferred costs, through base rates. Additionally, our threshold for sharing pre-tax margins generated by interruptible and off-system sales and transportation increased. As a result of this case, we kept 100% of pre-tax margins up to the threshold level of $7.8 million. The next $750,000 was credited to customers through the Basic Gas Supply Service (BGSS) clause. Thereafter, we kept 20% of the pre-tax margins as we had historically. See Note 6 for information regarding the July 7, 2004 approval of SJG's base rate increase. Effective January 10, 2000, the BPU approved full unbundling of SJG's system. This allows all natural gas consumers to select their natural gas commodity supplier. As of June 30, 2004, 106,179 of our residential customers were purchasing their gas commodity from someone other than SJG. Customers choosing to purchase natural gas from providers other than the utility are charged for the cost of gas by the marketer, not the utility. The resulting decrease in our revenues is offset by a corresponding decrease in gas costs. While customer choice can reduce utility revenues, it does not negatively affect our net income or financial condition. The BPU continues to allow for full recovery of prudently incurred natural gas costs through the BGSS. Unbundling did not change the fact that SJG still recovers cost of service, including certain deferred costs, through base rates. In December 2001, the BPU approved recovery of SJG's October 31, 2001 underrecovered gas cost balance of $48.9 million plus accrued interest since April 1, 2001 at a rate of 5.75%. As of June 30, 2004, the remaining deferred underrecovered balance totaled $1.9 million. During 2002, the BPU convened a gas policy group to address Basic Gas Supply Service (BGSS), which is the gas supply service being provided by the natural gas utility. In December 2002, the BPU approved the proposed BGSS price structure. The BGSS-approved price structure replaced the Levelized Gas Adjustment Clause (LGAC) pricing structure. The LGAC was structured to reset gas charges to consumers once per year. The BGSS resets gas prices monthly for larger customers, and for smaller customers permits multiple resets each year, if certain conditions are met. With the implementation of BGSS in March 2003, customers can make more informed decisions about choosing an alternate supplier by having a utility pricing structure that more currently reflects market conditions. Further, BGSS provides us with more pricing flexibility, through self-implementing rate changes under certain conditions and limitations, conceptually resulting in the reduction of over/under-recoveries. LGAC-related mechanisms, such as deferred accounting treatment, the sharing of pre-tax margins generated by interruptible and off-system sales and transportation, and the allowance for full recovery of prudently incurred natural gas costs, remain in place under BGSS. SJG-12 In August 2002, SJG filed for a Societal Benefits Clause (SBC) rate increase. The SBC recovers costs related to BPU-mandated programs and environmental remediation costs that are recovered through our Remediation Adjustment Clause (RAC); energy efficiency and renewable energy program costs that are recovered through our New Jersey Clean Energy Programs; consumer education program costs; and the interim low income program costs. In August 2003, the BPU approved a $6.7 million increase to our SBC, effective September 1, 2003. This approval increased the annual recovery level of $6.7 million to $13.4 million. Also in August 2002, SJG filed a petition with the BPU to transfer its appliance service business from the regulated utility into a newly created unregulated company. As filed, the newly created company would have the flexibility to be more responsive to competition and customer needs by expanding and modifying its service offerings in an unregulated environment. See Note 6 for additional information on the approval of SJG's petition. In September 2002, SJG filed with the BPU to maintain its current BGSS rate through October 2003. However, due to price increases in the wholesale market, in February 2003, we filed an amendment to the September 2002 filing. In April 2003, the BPU approved a $16.6 million increase to our annual gas costs recoveries. In March 2003, the BPU approved a statewide Universal Service Fund (USF) program on a permanent basis. In June 2003, the BPU established a statewide program through which funds for the USF and Lifeline Credit and Tenants Assistance (Lifeline) Programs would be collected from customers of all electric and gas utilities in the state. The BPU ordered that utility rates be set to recover a total statewide USF budget of $33.0 million, and a total Lifeline budget of $72.0 million. Recovery rates for both programs were implemented on August 1, 2003. In April 2004, SJG made its annual USF filing, along with the state's other electric and gas utilities, proposing a statewide USF budget of $105.5 million. The proposed statewide budget was updated to $113.0 million and filed with the BPU in May 2004. In June 2004, the BPU approved the budget of $113.0 million with new rates being implemented effective July 1, 2004. In July 2003, SJG made its annual BGSS filing, as amended, with the BPU. Due to further price increases in the wholesale market, we filed for a $24.0 million increase to our annual gas cost revenues. In August 2003, the BPU approved SJG's price increase on a provisional basis, subject to refund with interest, effective September 1, 2003. In August 2003, SJG filed a base rate case with the BPU to increase its base rates to obtain a certain level of return on its invested capital. The rate case was approved on July 7, 2004 (See Note 6). We had not sought a base rate increase from the BPU since the implementation of its base rate case approval in January 1997. Also in August 2003, the BPU approved SJG's previously filed petition for the recovery of a $5.7 million Temperature Adjustment Clause (TAC) deficiency, effective September 1, 2003. As of June 30, 2004, the deferred TAC deficiency has been reduced to $1.3 million. SJG-13 In February 2004, SJG filed notice with the BPU to reduce its gas cost revenues by approximately $5.0 million, via a rate reduction, in addition to providing for a $21.8 million bill credit to customers. Both the rate reduction and bill credit were approved and implemented in March 2004. In June 2004, SJG made its annual BGSS filing with the BPU requesting a $4.9 million increase in gas cost recoveries. Filings and petitions described above are still pending unless otherwise indicated. Note 3. Retained Earnings: Restrictions exist under various loan agreements regarding the amount of cash dividends or other distributions that we may pay on our common stock. As of June 30, 2004, these restrictions did not affect the amount that may be distributed from SJG's retained earnings. We received equity infusions of $15.0 million during the first quarter of 2004 and $20.0 million during 2003 from SJI. Contributions of capital are credited to Other Paid-In Capital and Premium on Common Stock. Future equity contributions will occur on an as needed basis. Note 4. Pensions & Other Postretirement Benefits: We participate in the defined benefit pension plans and other postretirement benefit plans of SJI. The pension plans provide annuity payments to the majority of full-time, regular employees upon retirement. Newly hired employees in certain classifications do not qualify for participation in the defined benefit pension plan. The other postretirement benefit plans provide health care and life insurance benefits to some retirees. On December 8, 2003, the President signed into law the Medicare Prescription Drug, Improvement and Modernization Act (the "Act") of 2003. In accordance with FASB Staff Position No. 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003," issued in December 2003, management elected to defer any financial impact resulting from the Act pending the availability of more information. With the assistance of the company's actuary, management has determined that the Act has no impact on the postretirement benefit plans of SJI. Net periodic benefit cost for the three and six months ended June 30, 2004 and 2003 related to the pension and other postretirement benefit insurance plans consisted of the following components (in thousands):
Pension Benefits Three Months Ended Six Months Ended June 30, June 30, 2004 2003 2004 2003 -------- ------- ------ ------ Service Cost $ 672 $ 579 $ 1,344 $ 1,158 Interest Cost 1,274 1,205 2,548 2,410 SJG-14 Expected Return on Plan Assets (1,580) (1,241) (3,160) (2,482) Amortization of Transition Obligation - 16 - 32 Amortization of Loss and Other 388 402 776 804 --------- --------- --------- --------- Net Periodic Benefit Cost $ 754 $ 961 $ 1,508 $ 1,922 ========= ========= ========= =========
Other Benefits Three Months Ended Six Months Ended June 30, June 30, 2004 2003 2004 2003 -------- ------- ------ ------ Service Cost $ 341 $ 290 $ 682 $ 580 Interest Cost 603 476 1,206 952 Expected Return on Plan Assets (351) (202) (702) (404) Amortization of Transition Obligation 189 144 378 288 Amortization of Loss and Other 37 74 74 148 --------- --------- --------- --------- Net Periodic Benefit Cost $ 819 $ 782 $ 1,638 $ 1,564 ========= ========= ========= =========
Contributions - SJG expects to make no contributions to its pension plan and contribute approximately $3.6 million in equal quarterly installments to its other postretirement benefit plans in 2004. Note 5. Commitments and Contingencies: Construction and Environmental Commitments - Our estimated net cost of construction and environmental remediation programs for 2004 totals $67.7 million. Commitments were made regarding some of these programs. Gas Supply Contracts - SJG, in the normal course of conducting business, has entered into long-term contracts for natural gas supplies, firm transportation and gas storage service. During the next 12 months, no contracts are expiring that would have a material negative impact, either alone or in combination, on SJG. The transportation and storage service agreements between us and our interstate pipeline suppliers were made under Federal Energy Regulatory Commission approved tariffs. Our cumulative obligation for demand charges and reservation fees paid to suppliers for these services is approximately $4.2 million per month, recovered on a current basis through the BGSS. Pending Litigation - We are subject to claims arising in the ordinary course of business and other legal proceedings. We accrue liabilities related to these claims when we can determine the amount or range of amounts of likely settlement costs for those claims. Management does not currently anticipate the disposition of any known claims to have a material adverse effect on SJG's financial position, results of operations or liquidity. SJG-15 Environmental Remediation Costs - We incurred and recorded costs for environmental cleanup of sites where the Company or its predecessors operated gas manufacturing plants. We stopped manufacturing gas in the 1950s. We successfully entered into settlements with all of our historic comprehensive general liability carriers regarding the environmental remediation expenditures at our sites. Also, we have purchased a Cleanup Cost Cap Insurance Policy limiting the amount of remediation expenditures that we will be required to make at 11 of our sites. This Policy will be in force until 2024 at 10 sites and until 2029 at one site. The following minimum future cost estimate was not reduced by projected insurance recoveries from the Cleanup Cost Cap Insurance Policy. Since the early 1980s, we accrued environmental remediation costs of $141.0 million, of which $88.8 million has been spent as of June 30, 2004. With the assistance of a consulting firm, we estimate that future costs to clean up our sites will range from $52.2 million to $162.6 million. We recorded the lower end of this range as a liability. It is reflected on the 2004 condensed balance sheet under the captions Current Liabilities and Deferred Credits and Other Non-Current Liabilities (See Note 1). Recorded amounts include estimated costs based on projected investigation and remediation work plans using existing technologies. Actual costs could differ from the estimates due to the long-term nature of the projects, changing technology, government regulations and site-specific requirements. We have two regulatory assets associated with environmental costs. The first asset is titled Environmental Remediation Cost: Expended - Net. These expenditures represent what was actually spent to clean up former gas manufacturing plant sites. These costs meet the requirements of FASB Statement No. 71. The BPU allows us to recover expenditures through the RAC (See Note 2). The other asset titled Environmental Remediation Cost: Liability for Future Expenditures relates to estimated future expenditures determined under the guidance of FASB Statement No. 5, "Accounting for Contingencies." We recorded this amount, which relates to former manufactured gas plant sites, as a deferred debit with the corresponding amount reflected on the condensed balance sheets under the captions, Current Liabilities and Deferred Credits and Other Non-Current Liabilities. The recorded deferred debit is a regulatory asset under Statement No. 71. The BPU's intent, evidenced by current practice, is to allow us to recover the deferred costs after these costs are spent over 7-year periods. As of June 30, 2004, we reflected the unamortized remediation costs of $5.4 million on the condensed balance sheet under the caption Regulatory Assets. Since implementing the RAC in 1992, we have recovered $40.8 million through rates (See Note 2). Note 6. Subsequent Events: Rate Case Settlement - On July 7, 2004, the BPU granted SJG a base rate increase of $20.0 million, which was predicated in part upon a 7.97% rate of return on rate base that included a 10.0% return on common equity. SJG expects the settlement of the case to provide an incremental $8.5 million on an annualized basis to net income. SJG was also permitted recovery of regulatory assets contained in its petition. SJG-16 Included in the base rate increase was a change to the sharing of pre-tax margins on interruptible and off-system sales and transportation. SJG will now recover through its base rates $7.8 million that it had previously recovered through the sharing of pre-tax margins. As a result, the sharing of pre-tax margins will begin from dollar one, with SJG retaining 20% as it has historically. Moreover, SJG will now share pre-tax margins from on-system capacity release sales, in addition to the interruptible and off-system sales and transportation. Effective July 1, 2006, the 20% retained by SJG will decrease to 15% of such margins. As part of the tariff changes, SJG further expanded its choices available to commercial and industrial customers. SJG added two electric generation services for small and large users, and restructured its existing Firm Electric Service so it is applicable to electric generation. The addition of these services allowed SJG to eliminate its existing cogeneration services since these services will be provided under one of the three electric generation services, based on the customer needs. SJG also split its existing commercial service into two classes to separate large and small users, resulting in two distinct price structures. As part of the overall settlement, SJG provided customers with an offsetting $38.9 million rate reduction. These reductions are being provided to customers through the company's various clauses and will not negatively impact the company's net income. Pending Audits - The BPU has issued an order under which it will perform a competitive services audit and a management audit that includes a focused review of SJG's gas supply and purchasing practices. The audits, which will commence later in 2004, are mandated by statute to be conducted at predetermined intervals. Appliance Service Business - On July 23, 2004, the BPU approved SJG's petition to transfer its appliance service business from the regulated utility. In anticipation of this transfer, SJI had formed South Jersey Energy Service Plus, LLC, (SJESP) to perform appliance repair services after BPU approval of the transfer. SJESP will purchase certain assets required to perform such repair services from SJG. In addition, SJESP will assume certain liabilities from SJG. The final price will be determined at the date of transfer which is currently expected to be on September 1, 2004. The agreement also calls for SJESP to pay an additional $1.5 million to SJG. This $1.5 million will be credited to customers through the RAC and will have no earnings impact on SJG. The approval of SJG's proposal will have no effect on the provision of safety-related or emergency-related services to the public. The services being transferred include only non-safety related, competitive appliance services. Financing Activities - SJG redeemed, at par, its 7.7% Medium Term Note (MTN) due 2015 on July 15, 2004. Subsequently, on August 4, 2004, SJG issued $40.0 million of debt under its MTN program established in 2002. The debt was issued at an average interest rate of 5.66% and an average maturity of 17 years. This represents the final amount authorized to be issued under the 2002 MTN program. SJG-17 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Unaudited) Overview South Jersey Gas Company (SJG) is a regulated natural gas utility. SJG distributed natural gas in the seven southernmost counties of New Jersey to 306,953 customers at June 30, 2004 compared with 298,877 customers at June 30, 2003. SJG also: o sells natural gas and pipeline transportation capacity (off-system sales) on a wholesale basis to various customers on the interstate pipeline system; o transports natural gas purchased directly from producers or suppliers for its own sales and for some of its customers; and o services appliances via the sale of appliance warranty programs as well as on a time and materials basis. Forward-Looking Statements - This report contains certain forward-looking statements concerning projected financial and operating performance, future plans and courses of action and future economic conditions. All statements in this report other than statements of historical fact are forward-looking statements. These forward-looking statements are made based upon management's expectations and beliefs concerning future events impacting the company and involve a number of risks and uncertainties. We caution that forward-looking statements are not guarantees and actual results could differ materially from those expressed or implied in the forward-looking statements. Also, in making forward-looking statements, we assume no duty to update these statements should expectations change or actual results and events differ from current expectations. A number of factors could cause our actual results to differ materially from those anticipated including, but 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; legislative, regulatory and court decisions; competition; the availability and cost of capital; costs and effects of legal proceedings and environmental liabilities; the failure of customers or suppliers to fulfill their contractual obligations; and changes in business strategies. Critical Accounting Policies Estimates and Assumptions - As described in the footnotes to our condensed financial statements, management must make estimates and assumptions that affect the amounts reported in the financial statements and related disclosures. Actual results could differ from those estimates. Four types of transactions presented in our condensed financial statements require a significant amount of judgment and estimation. These relate to regulatory assets, environmental remediation costs, pension and postretirement employee benefit costs and unbilled revenues. SJG-18 The New Jersey Board of Public Utilities (BPU) has reviewed and approved, through specific orders, all of the items shown as regulatory assets. In recording these costs as regulatory assets, management believes the costs are probable of recovery under existing rate-making concepts that are embodied in current rate orders received by SJG. However, ultimate recovery is subject to BPU approval. An outside consulting firm assists us in estimating future costs for environmental remediation activities. We estimate future costs based on projected investigation and work plans using existing technologies. Developing a single reliable estimation point is not feasible because of the amount of uncertainty involved in the nature of projected remediation efforts and the long period over which remediation efforts will continue. Therefore, we estimate the range of future costs at $52.2 million to $162.3 million. In preparing financial statements, we record liabilities for future costs using the lower end of the range. We update estimates each quarter to take into account past efforts, changes in work plans and remediation technologies. The costs of providing pension and other postretirement employee benefits are impacted by actual plan experience as well as assumptions of future experience. Employee demographics, plan contributions, investment performance, and actuarial assumptions concerning return on plan assets, discount rates and health care cost trends all have a significant impact on determining our projected benefit obligations. Actuarial assumptions are evaluated annually with the assistance of our investment manager and actuary and adjusted accordingly. These adjustments could result in significant changes to the net periodic benefit cost of providing such benefits and the related liability recognized by SJG. A majority of SJG's customers have their meters read on a cycle basis throughout the month. As a result, recognized revenues include estimates as described below. Revenue Recognition - SJG bills customers monthly for gas delivered and recognizes those revenues during the month. For SJG customers that are not billed at the end of each month, we make an accrual to recognize estimated revenues for gas delivered from the date of the last meter reading to the end of the month. We bill our customers at rates approved by the BPU. We defer and recognize revenues related to SJG's appliance service contracts over the full 12-month term of the contract as earned. The BPU allows us to recover gas costs in rates through the Basic Gas Supply Service (BGSS) price structure (which replaced the Levelized Gas Adjustment Clause). We defer over/under-recoveries of gas costs and include them in subsequent adjustments to the BGSS rate or other similar rate recovery mechanism. These adjustments result in over/under-recoveries of gas costs being included in rates during future periods. As a result of these deferrals, utility revenue recognition does not directly translate to profitability. While we realize profits on gas sales during the month of providing the utility service, significant shifts in revenue recognition may result from the various recovery clauses approved by the BPU (See Recent Regulatory Actions) without shifting profits between periods, as these clauses provide for recovery of costs on a dollar-for-dollar basis. SJG-19 New Accounting Pronouncements - See detailed discussions concerning New Accounting Pronouncements and their impact on SJG in Note 1 to the condensed financial statements. Temperature Adjustment Clause - A Board of Public Utilities approved Temperature Adjustment Clause (TAC) increased(decreased) SJG's net income by $0.9 million and $(1.0) million for the three months ended and $0.2 million and $(2.4) million for the six months ended June 30, 2004 and 2003, respectively. The clause is designed to mitigate the effect of variations in heating season temperatures from historical norms. While we record the revenue and income impacts of TAC adjustments as incurred, cash inflows or outflows directly attributable to TAC adjustments generally do not begin until the next clause year. Each TAC year begins October 1. Recent Regulatory Actions - In August 2002, SJG filed for a Societal Benefits Clause (SBC) rate increase. The SBC recovers costs related to BPU-mandated programs and environmental remediation costs that are recovered through SJG's Remediation Adjustment Clause; energy efficiency and renewable energy program costs that are recovered through SJG's New Jersey Clean Energy Programs; consumer education program costs; and the interim low income program costs. In August 2003, the BPU approved a $6.7 million increase to SJG's SBC, effective September 1, 2003. This approval increased the annual recovery level of $6.7 million to $13.4 million. Also in August 2002, SJG filed a petition with the BPU to transfer its appliance service business from the regulated utility into a newly created unregulated company. On July 23, 2004, the BPU approved SJG's petition to transfer its appliance service business from the regulated utility. In anticipation of this transfer, SJI had formed South Jersey Energy Service Plus, LLC (SJESP), to perform appliance repair services after BPU approval of the transfer. SJESP will purchase certain assets required to perform such repair services from SJG. In addition, SJESP will assume certain liabilities from SJG. The final price will be determined at the date of transfer which is currently expected to be on September 1, 2004. The agreement also calls for SJESP to pay an additional $1.5 million to SJG. This $1.5 million will be credited to customers through the RAC and will have no earnings impact on SJG. The approval of SJG's proposal will have no effect on the provision of safety-related or emergency-related services to the public. The services being transferred include only non-safety related, competitive appliance services. It is anticipated that SJESP will have the flexibility to be more responsive to competition and customer needs by expanding and modifying its service offerings in an unregulated environment. In September 2002, SJG filed with the BPU to maintain its current Basic Gas Supply Service (BGSS) rate through October 2003. However, due to price increases in the wholesale market, in February 2003, SJG filed an amendment to the September 2002 filing. In April 2003, the BPU approved a $16.6 million increase to SJG's annual gas cost revenues. In March 2003, the BPU approved a statewide Universal Service Fund (USF) program on a permanent basis. In June 2003, the BPU established a statewide program through which funds for the USF and Lifeline Credit and Tenants Assistance (Lifeline) Programs would be collected from customers of all electric and gas utilities in the state. The BPU ordered that utility rates be set to recover a total statewide USF budget of $33.0 million, and a total Lifeline budget of $72.0 million. Recovery rates for both programs were SJG-20 implemented on August 1, 2003. In April 2004, SJG made its annual USF filing, along with the state's other electric and gas utilities, proposing a statewide USF budget of $105.5 million. The proposed statewide budget was updated to $113.0 million and filed with the BPU in May 2004. In June 2004, the BPU approved the budget of $113.0 million with new rates being implemented effective July 1, 2004. In July 2003, SJG made its annual BGSS filing, as amended, with the BPU. Due to further price increases in the wholesale market, SJG filed for a $24.0 million increase to its annual gas cost revenues. In August 2003, the BPU approved SJG's price increase on a provisional basis, subject to refund with interest, effective September 1, 2003. In August 2003, the BPU approved SJG's previously filed petition for the recovery of a $5.7 million Temperature Adjustment Clause (TAC) deficiency, effective September 1, 2003. As of June 30, 2004, the deferred TAC deficiency has been reduced to $1.3 million. Also in August 2003, SJG filed a base rate case with the BPU to increase its base rate to obtain a certain level of return on its investment of capital. We had not sought a base rate increase from the BPU since the implementation of its base rate case approval in January 1997. On July 7, 2004, the BPU approved an increase to SJG's base rates totaling $20.0 million, which was predicated in part upon a 7.97% rate of return on rate base that included a 10.0% return on common equity. SJG expects the settlement of the case to provide an incremental $8.5 million on an annualized basis to net income. SJG was also permitted recovery of regulatory assets contained in its petition. Included in the base rate increase was a change to the sharing of pre-tax margins on interruptible and off-system sales and transportation. SJG will now recover through its base rates $7.8 million that it previously had recovered through the sharing of pre-tax margins. As a result, the sharing of pre-tax margins will begin from dollar one, with SJG retaining 20% as it has historically. Moreover, SJG will now share pre-tax margins from on-system capacity release sales, in addition to the interruptible and off-system sales and transportation. Effective July 1, 2006, the 20% retained by SJG will decrease to 15% of such margins. As part of the tariff changes, SJG further expanded service choices available to commercial and industrial customers. SJG added two electric generation services for small and large users, and restructured its existing Firm Electric Service so it is applicable to electric generation. The addition of these services allowed SJG to eliminate its existing cogeneration services since these services will be provided under one of the three electric generation services, based on customer needs. SJG also split its existing commercial service into two classes to separate large and small users, resulting in two distinct price structures. As part of the overall settlement, SJG provided customers with an offsetting $38.9 million rate reduction. These reductions are being provided to customers through the company's various clauses and will not negatively impact the company's net income. In February 2004, SJG filed notice with the BPU to reduce its gas cost revenues by approximately $5.0 million, via a rate reduction, in addition to SJG-21 providing for a $21.8 million bill credit to customers. Both the rate reduction and bill credit were approved and implemented in March 2004. In June 2004, SJG made its annual BGSS filing with the BPU requesting a $4.9 million increase in gas cost recoveries. Pending Audits - The BPU has issued an order under which it will perform a competitive services audit and a management audit that includes a focused review of SJG's gas supply and purchasing practices. The audits, which will commence later in 2004, are mandated by statute to be conducted at predetermined intervals. Filings and petitions described above are still pending unless otherwise indicated. Additional discussion concerning Regulatory Actions can be found in Notes 2 and 6 to the condensed financial statements. Environmental Remediation - We incurred and recorded costs for environmental clean up of sites where SJG or its predecessors operated manufactured gas plants (MGP). SJG stopped manufacturing gas in the 1950s. We successfully entered into settlements with all of SJG's historic comprehensive general liability carriers regarding environmental remediation expenditures at former MGP sites. As part of these settlements, SJG purchased an insurance policy that caps its remediation expenditures at 11 of these sites. The insurance policy is in force until 2024 at 10 sites and until 2029 at one site. We believe that all costs incurred net of insurance recoveries relating to the MGP sites will be recovered through rates under SJG's Remediation Adjustment Clause (RAC). The RAC currently permits SJG to recover incurred costs in equal installments over 7-year periods with carrying costs. As of June 30, 2004, SJG has $5.4 million of remediation costs not yet recovered through rates. Other matters are incorporated by reference to Note 5 to the condensed financial statements included as part of this report. Competition - SJG's franchises are non-exclusive. Currently, no other utility provides retail gas distribution services within our territory. We do not expect any other utilities to do so in the foreseeable future because of the extensive investment required for utility plant and related costs. SJG competes with oil, propane and electricity suppliers for residential, commercial and industrial users. The market for natural gas sales is subject to competition due to deregulation. We enhanced SJG's competitive position while maintaining margins by using an unbundled tariff. This tariff allows full cost-of-service recovery, except for the variable cost of the gas commodity, when transporting gas for our customers. Under this tariff, SJG profits from transporting, rather than selling, the commodity. SJG's residential, commercial and industrial customers can choose their supplier while we recover the cost of service through transportation service (see Customer Choice Legislation). Customer Choice Legislation - All residential natural gas customers in New Jersey can choose their gas supplier under the terms of the Electric Discount and Energy Competition Act of 1999. As of June 30, 2004, 106,179 SJG residential customers chose a natural gas commodity supplier other than the utility. This number increased from 95,410 at June 30, 2003 as marketers were SJG-22 able to offer natural gas at prices competitive with those available under regulated utility tariffs. Customers purchasing natural gas from providers other than SJG are charged for gas costs by the marketer, not SJG. The resulting decrease in SJG's revenues is offset by a corresponding decrease in SJG's gas costs. While customer choice can reduce utility revenues, it does not negatively affect SJG's net income or financial condition. The BPU continues to allow for full recovery of prudently incurred natural gas costs through the Basic Gas Supply Service clause as well as other costs of service including deferred costs, through tariffs. Results of Operations Operating Revenues - Revenues decreased $1.6 million during the second quarter compared with the same period in 2003. The decrease was primarily due to two factors. First, weather was 37.8% warmer during the quarter than last year, which resulted in a reduction in utility sales volume. Second, there was an 11.3% increase in the number of residential customers purchasing their gas from a source other than SJG. The decline in customers who purchased their natural gas from SJG directly impacted utility revenues. However, since gas costs are passed on directly to customers without any profit margin added by SJG, the increased customer usage of gas marketers did not impact SJG's profitability. Providing an offset to the factors noted above were a significant increase in Off-System Sales (OSS) during the quarter, the addition of 8,076 customers and several rate increases over the past 12 months (See Recent Regulatory Actions). Revenues decreased $41.4 million for the six months ended June 30, 2004 compared with the same period last year. The year-to-date decrease was primarily due to three factors. First, weather was 9.8% warmer than last year resulting in lower utility sales. Second, OSS revenues decreased $31.3 million as a direct result of lower sales volume and lower prices for natural gas in this market in 2004 compared with the same period in 2003. Finally, there was an increase in the number of residential customers purchasing their gas from a source other than SJG. Partially offsetting these negative factors were the impact of 8,076 additional customers and several rate increases over the past 12 months as discussed earlier. As a result of SJG's Temperature Adjustment Clause (TAC), revenues from utility ratepayers are closely tied to 20-year normal temperatures calculated under the clause and not actual temperatures. While the clause significantly reduces fluctuations in revenues related to temperature, as a general rule, revenues continue to be positively impacted by colder weather and negatively impacted by warmer weather. Weather during the second quarter of 2004 was 37.8% warmer than in 2003 and 19.9% warmer than the 20-year TAC average. Weather during the first six months of 2004 was 9.8% warmer than in 2003 and 0.7% warmer than the 20-year TAC average. The following is a comparison of operating revenue and throughput for the three and six months ended June 30, 2004 vs. the same periods ended June 30, 2003: SJG-23
Three Months Ended Six Months Ended June 30, June 30, 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Operating Revenues (thousands): Firm Residential $ 17,967 $ 25,699 $ 99,108 $ 115,007 Commercial 5,014 7,287 28,980 34,717 Industrial 715 973 3,032 3,340 Cogeneration & Electric Generation 2,004 1,969 2,423 3,291 Firm Transportation 13,540 13,142 46,409 41,202 ----------- ----------- ----------- ----------- Total Firm Operating Revenues 39,240 49,070 179,952 197,557 ----------- ----------- ----------- ----------- Interruptible 469 558 757 1,049 Interruptible Transportation 269 300 564 495 Off-System 31,024 22,985 86,376 111,715 Capacity Release & Storage 1,937 1,510 4,664 2,813 Other 1,052 1,124 1,801 1,854 ----------- ----------- ----------- ----------- Total Operating Revenues $ 73,991 $ 75,547 $ 274,114 $ 315,483 =========== =========== =========== =========== Throughput (MMcf): Firm Residential 1,801 2,449 9,289 10,504 Commercial 587 793 3,018 3,522 Industrial 24 43 116 148 Cogeneration & Electric Generation 218 240 243 348 Firm Transportation 6,562 6,427 18,774 17,490 ----------- ----------- ----------- ----------- Total Firm Throughput 9,192 9,952 31,440 32,012 ----------- ----------- ----------- ----------- Interruptible 54 96 88 132 Interruptible Transportation 589 547 1,165 958 Off-System 4,789 3,744 12,622 15,474 Capacity Release & Storage 13,533 10,402 25,195 16,395 ----------- ----------- ----------- ----------- Total Throughput 28,157 24,741 70,510 64,971 =========== =========== =========== ===========
Gas Purchased for Resale - Gas purchased for resale decreased $2.9 million in the second quarter primarily as a result of weather that was 37.8% warmer than the same period last year and the continued migration of customers from sales to transportation service as described under Operating Revenues. As a result of these two factors, firm sales volume decreased by 25.4% for the quarter. Significantly offsetting these negative factors were increased Off-System Sales (OSS) during the quarter compared with last year. Increased sales volume resulted in an additional $8.0 million in gas costs for the period. In addition, customer additions and increased gas cost recoveries approved by the BPU contributed substantially to offsetting the impact of the warmer weather and customer migration to transportation services. SJG-24 Gas purchased for resale decreased $45.5 million for the six months ended June 30, 2004 compared with 2003 due principally to a significant decrease in sales volumes and lower gas costs for OSS. Gas Costs associated with OSS decreased by $23.4 million as compared with the same quarter last year. Unlike gas costs associated with OSS, changes in the unit cost of gas sold to utility ratepayers do not directly affect cost of gas sold. We defer fluctuations in gas costs to ratepayers not reflected in current rates to future periods under a BPU-approved Basic Gas Supply Service (BGSS) price structure, formerly known as the Levelized Gas Adjustment Clause. SJG also experienced a decrease in gas costs as a result of the continued migration of customers from sales to transportation services as previously discussed. As a result of this migration and the impact of warmer weather, firm sales volume decreased by 12.8% for the six months ended June 30, 2004 compared to the same period last year. Gas supply sources include contract and open-market purchases. SJG secures and maintains its own gas supplies to serve its sales customers. We do not anticipate any difficulty renewing or replacing expiring contracts under substantially similar terms and conditions. Operations - A summary of net changes in operations (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2004 vs. 2003 2004 vs. 2003 ------------- ------------- Other Production Expense $ (7) $ (5) Transmission - 35 Distribution (131) (228) Customer Accounts and Services 1,130 3,962 Sales (73) (51) Administration and General 103 (675) ----------- ----------- Total Operations $ 1,022 $ 3,038 =========== =========== Customer Accounts and Services expense increased significantly in 2004 as a result of the BPU-approved increase in SJG's Societal Benefits Clause (SBC) in August 2003 (See Recent Regulatory Actions). With this approval, recoveries and a corresponding charge to expense for previously deferred costs under SJG's New Jersey Clean Energy Programs increased by $1.4 million in the second quarter and $4.4 million for the six months ended June 30, 2004 when compared with the respective periods in 2003. The BPU-approved SBC clause allows for full recovery of these deferred costs including carrying costs and, as a result, the increase in expense has no impact on SJG's net income. This increase was partially offset by lower bad debt expense during 2004 as a result of a March 2004 BGSS refund improving SJG's accounts receivable aging (See Recent Regulatory Actions). SJG-25 Administrative and General (A&G) expenses decreased in the six months ended June 30, 2004 compared with the same period of 2003 primarily because of lower pension expense, lower insurance expense and cost control measures implemented throughout the company. Pension expense decreased $414,000 from 2003 to 2004 as a result of SJG making a $9.1 million pension plan contribution in December 2003 as well as an improvement in investment returns throughout 2003 (See Note 4 to the condensed financial statements). Insurance expense was reduced by $340,000 in the first quarter of 2004 by lowering SJG's reserve for outstanding claims following a period of favorable settlements that were not appealed as anticipated. Significant increases in healthcare costs during the second quarter resulted in higher A&G for the three months ended June 30, 2004. Other Operating Expenses - A summary of principal changes in other operating expenses (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2004 vs. 2003 2004 vs. 2003 ------------- ------------- Maintenance $ (44) $ (156) Depreciation 433 809 Energy and Other Taxes (148) (448) Depreciation was higher due to SJG's increased investment in property, plant and equipment. The decrease in Energy and Other Taxes relate primarily to lower revenue-based taxes and decreases in taxable volumes of gas sold and transported by SJG (See table under the caption, "Operating Revenues"). Other Income and Expense - Other income and expense was higher during the six months ended June 30, 2004 compared with 2003 due to a pre-tax gain of $686,000 on SJG's postretirement healthcare plan trust. The movement of plan assets to a new investment manager triggered the recognition of gains on investments. Interest Charges - Interest charges decreased in both the three and six month periods ended June 30, 2004 compared with the respective periods of the prior year due to reductions in short-term rates on line of credit borrowings, the refunding of higher priced, fixed rate, long-term debt with lower cost debt, and a lower total debt level. These refundings occurred primarily during the second half of 2003 and were financed with long-term debt issuances under our Medium Term Note program at significantly lower interest rates compared with the previous long-term interest rates. We have incurred debt primarily to expand and upgrade SJG's gas transmission and distribution system, and to support seasonal working capital needs related to gas inventories and customer receivables. Income Taxes - SJG's total income taxes applicable to operations differ from the tax that would have resulted by applying the statutory federal and state income tax rates to pre-tax income as a result of various deferred tax items. The account of Income Taxes - Flowthrough Depreciation, as shown on the condensed balance sheets, is amortized at a rate of $245,000 per quarter and is SJG-26 the primary cause of these differences. Due to the seasonal nature of our operations, these tax variances may appear larger relative to the pre-tax income during the second and third quarters when operating results are historically lower. Net Income Applicable to Common Stock - Net income increased $154,000, or 23%, to $823,000 in the second quarter of 2004 as compared with $669,000 in the same period of 2003. For the six months ended June 30, 2004, net income increased $1.4 million, or 7%, to $21.5 million compared with $20.1 million last year. Reasons for the increase in net income in 2004 are discussed in detail above. Liquidity and Capital Resources - Liquidity needs at SJG are driven by factors that include natural gas commodity prices; the impact of weather on customer bills; lags in fully collecting gas costs from customers under the Basic Gas Supply Service charge; the timing of construction and remediation expenditures and related permanent financings; mandated tax payment dates; and both discretionary and required repayments of long-term debt. We first seek to meet liquidity needs with net cash provided by operating activities. Net cash provided by operating activities varies from year to year primarily due to the impact of weather on customer demand and related gas purchases, inventory utilization and gas cost recoveries. We utilize short-term borrowings under credit facilities provided by commercial banks to supplement cash from operations where necessary. Bank credit available to SJG totaled $176.0 million at June 30, 2004, of which $27.7 million was used. Those bank facilities consist of a $100.0 million revolving credit facility that expires in August 2006 and $76.0 million of uncommitted bank lines. The revolving credit facility was established in August 2003 with a syndicate of banks to enhance the liquidity position of SJG. Based upon the existing credit facilities and a regular dialogue with our banks, we believe that there will continue to be sufficient credit available to meet our business' future liquidity needs. SJG supplements its operating cash flow and credit lines with both debt and equity capital. Over the years, SJG has used long-term debt, primarily in the form of First Mortgage Bonds and Medium Term Notes (MTN), secured by the same pool of assets as the First Mortgage Bonds, to finance its long-term borrowing needs. These needs are primarily capital expenditures for property, plant and equipment. SJG's registration of a $150.0 million MTN program with the Securities and Exchange Commission became effective in December 2002. In July 2003, SJG issued $85.5 million of long-term debt under the program. In September 2003, SJG issued an additional $24.5 million of MTNs. SJG issued the remaining $40.0 million of notes under the MTN program in August 2004 at an average interest rate of 5.66% and an average maturity of 17 years. All proceeds of the issues were used to refinance short-term debt outstanding to commercial banks and for the redemption of certain high-rate First Mortgage Bonds. Maturities of long-term debt in 2004 have totaled $6.8 million. In addition, SJG called $15.0 million of its 7.7% Medium Term Notes for redemption in July 2004. No additional maturities are scheduled or redemptions are anticipated for the remainder of 2004. Maturities of long-term debt over the next five calendar years are $5.3 million per year in 2005 through 2007, $1.5 million in 2008 and $0 in 2009. SJG-27 SJG's capital structure was as follows: As of As of June 30, December 31, 2004 2003 2003 ------ ------ ------ Common and Preferred Stock Equity 51% 40% 43% Long-Term Debt 44% 39% 43% Short-Term Debt 5% 21% 14% --- ----- ---- Total 100% 100% 100% ==== ==== ==== SJG typically experiences seasonal fluctuations in leverage as short-term debt has historically peaked in the November to January period in support of high inventory and receivable levels. The seasonal low point for short-term debt incurred in support of working capital usually occurs between the end of March and the end of May each year. The ratios presented in the chart above reflect a conscious effort by management to increase the percentage of equity in SJG's capital structure over the past year. SJI contributed $15.0 million and $20.0 million of capital to SJG during 2004 and 2003, respectively. Contributions of capital are credited to Other Paid-in Capital and Premium on Common Stock. Capital Expenditures, Commitments and Contingencies Capital Expenditures - SJG has a continuing need for cash resources and capital, primarily to invest in new and replacement facilities and equipment and for environmental remediation costs. Net construction and remediation expenditures for the first six months of 2004 amounted to $31.9 million. We estimate the net costs for 2004, 2005 and 2006 at approximately $67.8 million, $54.9 million and $50.5 million, respectively. Commitments and Contingencies - SJG has certain commitments for both pipeline capacity and gas supply for which it pays fees regardless of usage. Those commitments as of June 30, 2004 averaged $44.8 million annually and totaled $233.2 million over the contracts' lives with expirations ranging from one to 13 years. We expect to renew each of these contracts under renewal provisions as provided in each contract. SJG recovers all prudently incurred fees through rates via the Basic Gas Supply Service clause. SJG's long-term, senior secured debt is rated "A" and "Baa1" by Standard & Poor's and Moody's Investor Services, respectively. These ratings have not changed in the past five years. The following table summarizes our contractual cash obligations and their applicable payment due dates (in thousands): SJG-28
Up to Years Years More than Contractual Obligations Total 1 Year 2 & 3 4 & 5 5 Years ----------------------- ----- ------ ----- ----- ------- Long-Term Debt $ 262,281 $ 5,273 $ 10,543 $ 1,500 $ 244,965 Operating Leases 761 357 310 71 23 Construction Obligations 8,454 8,454 - - - Commodity Supply Purchase Obligations 233,178 43,746 80,906 68,413 40,113 Other Purchase Obligations 3,762 3,059 703 - - ----------- ----------- ----------- ----------- ----------- Total Contractual Cash Obligations $ 508,436 $ 60,889 $ 92,462 $ 69,984 $ 285,101 =========== =========== =========== =========== ===========
Expected environmental remediation costs are not included in the table above due to the subjective nature of such costs and time of anticipated payments. SJG expects to make no contributions to its pension plan and contribute approximately $3.6 million in equal quarterly installments to its other postretirement benefit plans in 2004. SJG is subject to claims arising in the ordinary course of business and other legal proceedings. We accrue liabilities related to claims when we can determine the amount or range of amounts of likely settlement costs for those claims. Management does not currently anticipate the disposition of any known claims to have a material adverse effect on SJG's financial position, results of operations or liquidity. Ratio of Earnings to Fixed Charges - The company's ratio of earnings to fixed charges for each of the periods indicated is as follows: Twelve Months Ended June 30, Year Ended December 31, -------------- -------------------------------------------------------- 2004 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- ---- 3.6x 3.3x 2.9x 2.6x 2.6x 2.5x The ratio of earnings to fixed charges represents, on a pre-tax basis, the number of times earnings covers fixed charges. Earnings consist of net income, to which has been added fixed charges and taxes based on income of the company before discontinued operations. Fixed charges consist of interest charges and preferred securities dividend requirements and an interest factor in rentals. SJG-29 Item 3. Quantitative and Qualitative Disclosures About Market Risks of the Company (Unaudited) Commodity Market Risks - SJG is a regulated utility. As such, we recover gas commodity costs under the Basic Gas Supply Service Clause that is part of our tariff and are protected from gas cost fluctuations by the clause. Interest Rate Risk - Our exposure to interest rate risk relates primarily to short-term, variable rate borrowings. Our short-term, variable rate debt outstanding at June 30, 2004 was $27.7 million and averaged $33.2 million for the first six months of 2004. A hypothetical 100 basis point (b.p.), or 1%, increase in interest rates on our average variable rate debt outstanding would result in a $196,000 increase in our annual interest expense, net of tax. We chose the 100 basis point increase for illustrative purposes, as it provides a simple basis for calculating the impact of interest rate changes under a variety of interest rate scenarios. Over the past five years, the change in basis points (b.p.) of our average monthly interest rates from the beginning to end of each year was as follows: 2003 - 31 b.p. decrease; 2002 - 74 b.p. decrease; 2001 - 383 b.p. decrease; 2000 - 83 b.p. increase; and 1999 - 81 b.p. increase. For June 2004, our average interest rate on variable rate debt was 1.54%. SJG primarily issues long-term debt at fixed rates and, consequently, interest expense on existing debt is not significantly impacted by changes in market interest rates. SJG prepaid, at par, $1.5 million of 8.6% debenture notes in February 2004 and $15.0 million of 7.7% Medium Term Notes in July 2004. SJG-30 Item 4. Controls and Procedures SJG management, including the Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective in ensuring that all material information required to be filed in this quarterly report has been made known to them in a timely fashion. There have been no significant changes in internal controls, or in factors that could significantly affect internal controls, subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation. No change in SJG's internal control over financial reporting occurred during SJG's second fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. SJG-31 PART II -- OTHER INFORMATION Item l. Legal Proceedings Information required by this Item is incorporated by reference to Part I, Item 1, Note 5, beginning on page 15. Item 6. Exhibits (a) Exhibits Exhibit No. Description 31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Exchange Act. 31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) of the Exchange Act. 32.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(b) of the Exchange Act as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code). 32.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14(b) of the Exchange Act as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code). SJG-32 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOUTH JERSEY GAS COMPANY (Registrant) Dated: August 9, 2004 By: /s/ Edward J. Graham ----------------------------------------- Edward J. Graham President & Chief Executive Officer Dated: August 9, 2004 By: /s/ David A. Kindlick ----------------------------------------- David A. Kindlick Executive Vice President & Chief Financial Officer SJG-33 Exhibit 31.1 CERTIFICATION I, Edward J. Graham, certify that: 1. I have reviewed this report on Form 10-Q for the period ended June 30, 2004, of South Jersey Gas Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2004 /s/ Edward J. Graham ------------------------------------------- Edward J. Graham President & Chief Executive Officer SJG-34 Exhibit 31.2 CERTIFICATION I, David A. Kindlick, certify that: 1. I have reviewed this report on Form 10-Q for the period ended June 30, 2004, of South Jersey Gas Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2004 /s/ David A. Kindlick -------------------------------------------- David A. Kindlick Executive Vice President & Chief Financial Officer SJG-35 Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the filing of the Quarterly Report on Form 10-Q of South Jersey Gas Company (the "Company") for the period ended June 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Edward J. Graham, Chief Executive Officer of the Company, hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. ------------------------------- Name: Edward J. Graham Title: Chief Executive Officer August 9, 2004 SJG-36 Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the filing of the Quarterly Report on Form 10-Q of South Jersey Gas Company (the "Company") for the period ended June 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, David A. Kindlick, Chief Financial Officer of the Company, hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ David A. Kindlick ------------------------------ Name: David A. Kindlick Title: Chief Financial Officer August 9, 2004 SJG-37