10-Q 1 sji10q0904.txt SOUTH JERSEY INDUSTRIES FORM 10-Q FOR PERIOD ENDING 9/30/04 =============================================================================== 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 September 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 1-6364 SOUTH JERSEY INDUSTRIES, INC. (Exact name of registrant as specified in its charter) New Jersey 22-1901645 (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 [X] No [ ] As of November 2, 2004, there were 13,792,371 shares of the registrant's common stock outstanding. =============================================================================== SJI-1 PART I -- FINANCIAL INFORMATION Item 1. Financial Statements -- See Pages 3 through 22 SJI-2 SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (In Thousands Except for Per Share Data)
Three Months Ended September 30, ---------------------------- 2004 2003 ------------- ------------ Operating Revenues: Utility $ 70,186 $ 53,267 Nonutility 58,015 36,868 ------------- ------------ Total Operating Revenues 128,201 90,135 ------------- ------------ Operating Expenses: Cost of Gas Sold - Utility 47,808 34,910 Cost of Sales - Nonutility 51,309 30,332 Operations 14,813 12,914 Maintenance 1,465 1,391 Depreciation 5,753 6,459 Energy and Other Taxes 1,772 1,414 ------------- ------------ Total Operating Expenses 122,920 87,420 ------------- ------------ Operating Income 5,281 2,715 Other Income and Expense: Equity in Affiliated Companies 269 170 Other 183 6 ------------- ------------ Total Other Income and Expense 452 176 ------------- ------------ Interest Charges 5,143 5,836 Income (Loss) Before Income Taxes 590 (2,945) Income Taxes 152 (1,327) ------------- ------------ Income (Loss) from Continuing Operations 438 (1,618) Discontinued Operations - Net (184) (426) ------------- ------------ Net Income (Loss) Applicable to Common Stock $ 254 $ (2,044) ============= ============ Basic Earnings Per Common Share: Continuing Operations $ 0.03 $ (0.13) Discontinued Operations - Net (0.01) (0.03) ------------- ------------ Basic Earnings Per Common Share $ 0.02 $ (0.16) ============= ============ Average Shares of Common Stock Outstanding - Basic 13,795 12,604 Diluted Earnings Per Common Share: Continuing Operations $ 0.03 $ (0.13) Discontinued Operations - Net (0.01) (0.03) ------------- ------------ Diluted Earnings Per Common Share $ 0.02 $ (0.16) ============= ============ Average Shares of Common Stock Outstanding - Diluted 13,914 12,604 Dividends Declared per Common Share $ 0.405 $ 0.385 ============= ============ The accompanying footnotes are an integral part of the financial statements.
SJI-3 SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (In Thousands Except for Per Share Data)
Nine Months Ended September 30, ---------------------------- 2004 2003 ------------- ------------ Operating Revenues: Utility $ 335,504 $ 337,571 Nonutility 232,745 138,605 ------------- ------------ Total Operating Revenues 568,249 476,176 ------------- ------------ Operating Expenses: Cost of Gas Sold - Utility 221,676 231,943 Cost of Sales - Nonutility 208,240 121,231 Operations 44,431 37,581 Maintenance 4,249 4,331 Depreciation 19,111 18,225 Energy and Other Taxes 8,732 8,734 ------------- ------------ Total Operating Expenses 506,439 422,045 ------------- ------------ Operating Income 61,810 54,131 Other Income and Expense: Equity in Affiliated Companies 692 549 Other 1,042 (45) ------------- ------------ Total Other Income and Expense 1,734 504 ------------- ------------ Interest Charges 15,076 15,115 Income Before Income Taxes 48,468 39,520 Income Taxes 19,651 16,345 ------------- ------------ Income from Continuing Operations 28,817 23,175 Discontinued Operations - Net (466) (728) Cumulative Effect of a Change in Accounting Principle - Net - (426) ------------- ------------ Net Income Applicable to Common Stock $ 28,351 $ 22,021 ============= ============ Basic Earnings Per Common Share: Continuing Operations $ 2.11 $ 1.87 Discontinued Operations - Net (0.03) (0.06) Cumulative Effect of a Change in Accounting Principle - Net - (0.04) ------------- ------------ Basic Earnings Per Common Share $ 2.08 $ 1.77 ============= ============ Average Shares of Common Stock Outstanding - Basic 13,639 12,412 Diluted Earnings Per Common Share: Continuing Operations $ 2.10 $ 1.85 Discontinued Operations - Net (0.04) (0.06) Cumulative Effect of a Change in Accounting Principle - Net - (0.03) ------------- ------------ Diluted Earnings Per Common Share $ 2.06 $ 1.76 ============= ============ Average Shares of Common Stock Outstanding - Diluted 13,741 12,508 Dividends Declared per Common Share $ 1.215 $ 1.155 ============= ============ The accompanying footnotes are an integral part of the financial statements.
SJI-4 SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (In Thousands) Three Months Ended September 30, ------------------------ 2004 2003 ---------- ---------- Net Income (Loss) Applicable to Common Stock $ 254 $ (2,044) ---------- ---------- Other Comprehensive (Loss) Income, Net of Tax:* Change in Fair Value of Investments (53) 83 Change in Fair Value of Derivatives - Other (279) 396 Change in Fair Value of Derivatives - Energy Related 1,152 (7,436) ---------- ---------- Other Comprehensive Income (Loss) - Net of Tax* 820 (6,957) ---------- ---------- Comprehensive Income (Loss) $ 1,074 $ (9,001) ========== ========== Nine Months Ended September 30, ------------------------ 2004 2003 ----------- ---------- Net Income Applicable to Common Stock $ 28,351 $ 22,021 ----------- ---------- Other Comprehensive (Loss) Income, Net of Tax:* Change in Fair Value of Investments (354) 236 Change in Fair Value of Derivatives - Other 150 177 Change in Fair Value of Derivatives - Energy Related 4,028 (7,622) ----------- --------- Other Comprehensive Income (Loss) - Net of Tax* 3,824 (7,209) ----------- --------- Comprehensive Income $ 32,175 $ 14,812 =========== ========== * Determined using a combined statutory tax rate of 40.85%. The accompanying footnotes are an integral part of the financial statements. SJI-5 SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In Thousands) Nine Months Ended September 30, ------------------ 2004 2003 --------- --------- Cash Flows from Operating Activities: Net Income Applicable to Common Stock $ 28,351 $ 22,021 Adjustments to Reconcile Net Income to Cash Flows Provided by Operating Activities: Depreciation and Amortization 20,740 20,639 Unrealized Loss (Gain) on Derivatives - Energy Related 1,870 (1,902) Provision for Losses on Accounts Receivable 123 1,226 Revenues and Fuel Costs Deferred - Net 8,048 17,373 Deferred and Non-Current Income Taxes and Credits - Net 10,185 1,570 Environmental Remediation Costs - Net (216) 3,366 Gas Plant Cost of Removal (679) (514) Changes in: Accounts Receivable 69,976 50,843 Inventories (31,839) (42,453) Other Prepayments and Current Assets 1,529 (731) Prepaid and Accrued Taxes - Net (19,786) 952 Accounts Payable and Other Accrued Liabilities (8,955) (2,033) Other - Net Assets (5,999) (5,206) Other - Net Liabilities (4,778) 6,290 --------- -------- Net Cash Provided by Operating Activities 68,570 71,441 --------- -------- Cash Flows from Investing Activities: Investment in Affiliate (245) (104) Affiliate Repayment of Loan 680 495 Purchase of Available-for-Sale Securities (105) (238) Proceeds from Sale of (Purchase of) Restricted Investments 4,022 (10,332) Capital Expenditures (49,797) (43,908) --------- --------- Net Cash Used in Investing Activities (45,445) (54,087) --------- --------- Cash Flows from Financing Activities: Net Repayments of Lines of Credit (44,400) (115,100) Proceeds from Issuance of Long-Term Debt 40,000 116,000 Principal Repayments of Long-Term Debt (21,773) (18,811) Dividends on Common Stock (16,645) (14,402) Proceeds from Sale of Common Stock 23,373 17,361 Payments for Issuance of Long-Term Debt (359) (1,629) --------- --------- Net Cash Used in Financing Activities (19,804) (16,581) --------- --------- Net Increase in Cash and Cash Equivalents 3,321 773 Cash and Cash Equivalents at Beginning of Period 4,364 4,291 --------- --------- Cash and Cash Equivalents at End of Period $ 7,685 $ 5,064 ========= ========= The accompanying footnotes are an integral part of the financial statements. SJI-6 SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands)
(Unaudited) September 30, December 31, --------------------------------- --------------- 2004 2003 2003 -------------- ---------------- --------------- Assets Property, Plant and Equipment: Utility Plant, at original cost $ 938,827 $879,842 $ 894,654 Accumulated Depreciation (221,158) (206,212) (209,831) Nonutility Property and Equipment, at cost 67,854 64,381 65,768 Accumulated Depreciation (3,574) (1,941) (2,326) -------------- ---------------- --------------- Property, Plant and Equipment - Net 781,949 736,070 748,265 -------------- ---------------- --------------- Investments: Available-for-Sale Securities 4,680 4,105 4,550 Restricted - 12,412 4,022 Investment in Affiliates 2,232 3,036 2,191 -------------- ---------------- --------------- Total Investments 6,912 19,553 10,763 -------------- ---------------- --------------- Current Assets: Cash and Cash Equivalents 7,685 5,064 4,364 Accounts Receivable 58,788 68,916 98,221 Unbilled Revenues 11,547 6,794 42,892 Provision for Uncollectibles (2,886) (3,351) (3,565) Natural Gas in Storage, average cost 98,691 84,605 69,596 Materials and Supplies, average cost 6,356 3,494 3,612 Prepaid Taxes 14,594 8,831 2,661 Prepaid Pension 17,224 - 19,690 Derivatives - Energy Related Assets 25,186 17,052 23,472 Derivatives - Other 713 2,352 565 Other Prepayments and Current Assets 5,205 6,029 4,268 -------------- ---------------- --------------- Total Current Assets 243,103 199,786 265,776 -------------- ---------------- --------------- Regulatory and Other Non-Current Assets: Regulatory Assets 74,023 87,572 75,780 Derivatives - Energy Related Assets 4,881 3,043 4,212 Derivatives - Other - 19 - Unamortized Debt Discount and Expense 8,965 7,891 9,037 Contract Receivables 14,657 10,542 11,289 Other 5,490 3,716 1,081 -------------- ---------------- --------------- Total Regulatory and Other Non-Current Assets 108,016 112,783 101,399 -------------- ---------------- --------------- Total Assets $ 1,139,980 $ 1,068,192 $ 1,126,203 ============== ================ =============== The accompanying footnotes are an integral part of the financial statements.
SJI-7 SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands)
(Unaudited) September 30, December 31, ---------------------------------- --------------- 2004 2003 2003 --------------- ---------------- --------------- Capitalization and Liabilities Common Equity: Common Stock $ 17,260 $ 15,885 $ 16,536 Premium on Common Stock 209,019 167,221 186,316 Accumulated Other Comprehensive Income (Loss) 7,295 (13,110) 3,471 Retained Earnings 103,344 85,621 91,638 --------------- ---------------- --------------- Total Common Equity 336,918 255,617 297,961 --------------- ---------------- --------------- Preferred Stock of Subsidiary 1,690 1,690 1,690 --------------- ---------------- --------------- Long-Term Debt 327,008 328,560 308,781 --------------- ---------------- --------------- Total Capitalization 665,616 585,867 608,432 --------------- ---------------- --------------- Minority Interest 196 - - --------------- ---------------- --------------- Current Liabilities: Notes Payable 68,400 96,400 112,800 Current Maturities of Long-Term Debt 5,273 8,423 5,273 Accounts Payable 64,878 64,316 80,254 Customer Deposits 8,434 7,340 7,957 Environmental Remediation Costs 16,424 5,066 7,865 Taxes Accrued 4,087 8,235 11,940 Derivatives - Energy Related Liabilities 9,369 20,323 18,809 Derivatives - Other 2,476 436 1,505 Deferred Income Taxes - Net 10,964 12,095 11,537 Deferred Contract Revenues 4,820 4,391 4,183 Interest Accrued and Other Current Liabilities 15,474 18,231 10,167 --------------- ---------------- --------------- Total Current Liabilities 210,599 245,256 272,290 --------------- ---------------- --------------- Deferred Credits and Other Non-Current Liabilities: Deferred Income Taxes - Net 135,341 106,498 121,922 Investment Tax Credits 3,215 3,558 3,471 Pension and Other Postretirement Benefits 12,816 19,869 12,431 Environmental Remediation Costs 39,406 47,043 47,001 Derivatives - Energy Related Liabilities 3,095 2,580 1,875 Derivatives - Other 1,563 2,234 1,853 Regulatory Liabilities 60,667 48,652 49,970 Other 7,466 6,635 6,958 --------------- ---------------- --------------- Total Deferred Credits and Other Non-Current Liabilities 263,569 237,069 245,481 --------------- ---------------- --------------- Commitments and Contingencies (Note 9) Total Capitalization and Liabilities $ 1,139,980 $ 1,068,192 $ 1,126,203 =============== ================ =============== The accompanying footnotes are an integral part of the financial statements.
SJI-8 Notes to Condensed Consolidated Financial Statements (Unaudited) Note 1. Summary of Significant Accounting Policies: Consolidation - The condensed consolidated financial statements include the accounts of South Jersey Industries, Inc. (SJI) and its subsidiaries. We eliminated all significant intercompany accounts and transactions. SJI reclassified some previously reported amounts to conform with current year classifications. In our opinion, the condensed consolidated financial statements reflect all adjustments, which are of a normal recurring nature, needed to fairly present SJI's financial position and operating results at the dates and for the periods presented. Our businesses are 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 SJI's 2003 Form 10K and annual report. Equity Investments - We classify equity investments purchased as long-term investments as Available-for-Sale Securities on our condensed consolidated balance sheets and carry them at their estimated fair value with any unrealized gains or losses included in Accumulated Other Comprehensive Income (Loss). SJI, either directly or through its wholly owned subsidiaries, currently holds a 50% non-controlling interest in two affiliated companies and accounts for the investments under the equity method. We include the operations of these affiliated companies in the statements of condensed consolidated income under the caption, Equity in Affiliated Companies. 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 - South Jersey Gas Company (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. 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 these 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. SJG's capitalized interest amounted to $0.2 million and $0.1 million for the three months, and totaled $0.6 million and $0.4 million for the nine months, ended September 30, 2004 and 2003, respectively. Marina Energy LLC (Marina) also capitalized interest in 2003 during the construction of its thermal energy facility based on the actual cost of borrowed funds. Marina's capitalized interest totaled $-0- and $1.8 million for the three and nine months ended September 30, 2003, respectively. SJG's amounts are included in Utility Plant and Marina's amounts are included in SJI-9 Nonutility Property and Equipment on the condensed consolidated balance sheets. All capitalized interest is reflected on the condensed consolidated statements of income as a reduction of Interest Charges. Energy Trading Activities and Derivative Instruments - South Jersey Resources Group, LLC (SJRG) manages its portfolio of purchases and sales, as well as natural gas in storage, using a variety of instruments that include forward contracts, swap agreements, option contracts and futures contracts. SJRG's contracts are accounted for at fair value under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended. Under this method of accounting, SJRG measures the fair value of the contracts and records these as Derivatives - Energy Related Assets or Derivatives - Energy Related Liabilities on our condensed consolidated balance sheets. For the three months ended September 30, 2004 and 2003, we recorded the net unrealized pre-tax (loss) gain of $(1.4) million and $1.1 million, respectively. For the nine months ended September 30, 2004, we recorded a net unrealized pre-tax (loss) gain of $(1.9) million and $1.9 million, respectively. These unrealized losses and gains on energy-related contracts, determined under the mark-to-market method, are included in Operating Revenues - Nonutility, except to the extent that they are designated cash flow hedges and are recorded through Accumulated Other Comprehensive Income (Loss). On October 25, 2002, the Emerging Issues Task Force (EITF) rescinded its consensus in Issue No. 98-10, "Accounting for Contracts Involved in Energy Trading and Risk Management Activities," effective for transactions entered into after that date, with a cumulative effect adjustment for previously existing transactions to be recognized in the quarter beginning January 1, 2003. As a result of the rescission, SJI only marks-to-market those energy-related contracts that meet the definition of a derivative in Statement No. 133, as amended. Energy-related contracts that do not meet the definition of a derivative are accounted for using the accrual basis of accounting. The effect of this change in accounting resulted in a net charge of $426,338 shown as a Cumulative Effect of a Change in Accounting Principle - Net in 2003. Contracts to hedge physical gas in storage are designated as cash flow hedges and we account for them accordingly. We include these balances on the condensed consolidated balance sheet under the caption Derivatives - Other. At inception, and as of September 30, 2004, we calculated these hedges to be highly effective; therefore, we record the related unrealized gain or loss, net of taxes, in Accumulated Other Comprehensive Income (Loss). We entered into interest rate swap agreements to hedge the exposure to increasing rates with respect to our variable rate debt. The differential to be paid or received as a result of these swap agreements is accrued as interest rates change and is recognized as an adjustment to interest expense. These interest rate swaps are accounted for as cash flow hedges. As of September 30, 2004 and 2003, the market value of these swaps was $(1.6) million and $(2.3) million, respectively, which represents the amount we would have to pay the counterparty to terminate these contracts as of those dates. These balances are included on the condensed consolidated balance sheets under the caption Derivatives - Other. As of September 30, 2004 and 2003, we calculated the swaps to be highly effective; therefore, we record the related unrealized gain or loss on the hedge, net of taxes, in Accumulated Other Comprehensive Income (Loss). In November 2001, we entered into two interest rate swap contracts. The first swap effectively provides us with a fixed interest rate of 4.08% on $20 million of Marina's tax-exempt Series A variable rate bonds for a 10-year SJI-10 period. The second swap effectively fixed the interest rate on $9.0 million of Marina's taxable Series B variable rate bonds at 4.55% for a 6-year period. The notional amount of this second swap decreases by $3.0 million per year beginning in December 2005. In January 2002, Marina issued an additional $10.0 million of taxable Series B variable rate bonds. In April 2002, we entered into an interest rate swap contract that effectively fixed the interest rate on these bonds at 4.62% for a 4-year period. The notional amount of this swap decreased to $8.0 million in December 2003, then decreases to $3.9 million in December 2004, and terminates in December 2005. We determined the fair value of derivative investments by reference to quoted market prices of listed contracts, published quotations or quotations from independent parties. Stock Compensation - Prior to 2003, SJI valued stock options to employees using the intrinsic value method. Effective in 2003, SJI adopted the policy of accounting for this compensation using the fair value based method on a prospective basis. At this time, SJI has no stock options outstanding. New Accounting Pronouncements - In January 2003, SJI 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. SJG has 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 of September 30, 2004 and 2003, SJG had accrued amounts in excess of actual removal costs incurred totaling $47.4 million and $44.4 million, respectively, which, in accordance with Statement No. 143, are recorded as Regulatory Liabilities on the condensed consolidated balance sheets. The adoption of this statement did not materially affect SJI's financial condition or results of operations. In December 2003, the FASB revised Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46R), which clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." This interpretation provides guidance on the identification and consolidation of variable interest entities (VIEs), whereby consolidation is achieved through means other than through control. SJI has completed its assessment of FIN 46R and has determined that it does not have any VIEs. In August 2003, the EITF reached a consensus on Issue No. 03-11, which provides guidance on whether to report realized gains or losses on physically settled derivative contracts not held for trading purposes on a gross basis, and realized gains or losses on derivative contracts that net settle on a net basis. The new guidance is applicable for financial statement periods after September 30, 2003. Management believes the portion of SJRG's operations that are not currently being presented on a gross basis meet the definition of "trading" in SJI-11 accordance with EITF No. 02-03, and are, therefore, reported "net." There was no impact to our financial statements as a result of adopting EITF No. 03-11 effective October 1, 2003. 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. Regulatory Assets & Regulatory Liabilities -Regulatory Assets consisted of the following items (in thousands):
Years Remaining As of September 30, December 31, September 30, 2004 2004 2003 2003 ------------------------------------------------------------- Environmental Remediation Costs: Expended - Net Various $ 4,392 $ 3,058 $ 4,147 Liability for Future Expenditures - 51,919 48,211 50,983 Income Taxes - Flowthrough Depreciation 7 6,886 7,864 7,619 Deferred Fuel Costs - Net Various - 14,221 - Postretirement Benefit Costs 8 3,119 3,496 3,402 Gross Receipts and Franchise Taxes 2 1,035 1,478 1,367 Societal Benefit Costs Various 5,802 7,870 7,529 Other - 870 1,374 733 ------------------------------------------ Total Regulatory Assets $ 74,023 $ 87,572 $ 75,780 ==========================================
Each item separately identified above is being recovered through utility rate charges without a return on investment over the period indicated. All assets reflected within the above caption "Other" are being recovered from ratepayers as approved by the BPU (See Note 6). Regulatory Liabilities consisted of the following items (in thousands): September 30, December 31, 2004 2003 2003 ------------------------------------------ Deferred Revenues - Net $ 9,130 $ - $ 90 Excess Plant Removal Costs 47,419 44,446 45,241 Overcollected State Taxes 3,832 3,920 4,353 Other 286 286 286 ------------------------------------------ Total Regulatory Liabilities $ 60,667 $ 48,652 $ 49,970 ========================================== Deferred Revenues - Net reflects the overrecovery of gas costs from ratepayers under SJG's gas cost clauses (See Note 6). 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 SJI-12 subject to being returned to ratepayers in future rate proceedings. 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. Divestitures and Affiliations: Divestitures - In 1996, Energy & Minerals, Inc. (EMI), an SJI subsidiary, sold the common stock of The Morie Company, Inc. (Morie), its sand mining and processing subsidiary. In 1997, R&T Group, Inc., SJI's construction subsidiary, sold all its operating assets, except some real estate. SJI conducts tests annually to estimate the environmental remediation costs for properties owned by South Jersey Fuel, Inc. (SJF), an EMI subsidiary, from its previously operated fuel oil business. SJI reports the environmental remediation activity related to these properties as discontinued operations. This reporting is consistent with previous years. Summarized operating results of the discontinued operations for the three and nine months ended September 30 were (in thousands): Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 ---------------------------------------- Loss before Income Taxes: Sand Mining $ (219) $ (211) $ (646) $ (640) Construction - (8) - (24) Fuel Oil (64) (478) (70) (499) Income Tax Credits 99 271 250 435 ---------------------------------------- Loss from Discontinued Operations - Net $ (184) $ (426) $ (466) $ (728) ======================================== Earnings Per Common Share from Discontinued Operations - Net $ (0.01) $ (0.03) $ (0.03) $ (0.06) ======================================== Losses from sand mining are mainly comprised of environmental remediation and product liability litigation associated with Morie's prior activities. Affiliations - In January 1999, SJI and Conectiv Solutions, LLC formed Millennium Account Services, LLC (MAS) to provide meter reading services in southern New Jersey. Each company holds a 50% interest in MAS. In 1999, SJE and Energy East Solutions, Inc. (EES) formed South Jersey Energy Solutions, LLC (SJES) to market retail electricity and energy management services. SJES began supplying retail electricity during 2000, and ceased active operations in May 2002. In January 2003, SJES became a wholly owned subsidiary of SJE when EES redeemed its 50% interest upon payment of $54,686, their capital deficit balance, to SJES. SJI-13 In 2000, SJE and GZA GeoEnvironmental, Inc. formed AirLogics, LLC to market a jointly developed air monitoring system designed to assist companies involved in environmental cleanup activities. Each company holds a 50% interest in Air Logics, LLC. In April 2004, Marina and DCO Energy, LLC formed AC Landfill Energy, LLC (ACLE) to develop and install a 1,400-kilowatt methane-to-electric power generation system at a county-owned landfill in Egg Harbor Township, NJ. Marina owns a 51% interest in ACLE and consolidates ACLE's balance sheet and results of operation accordingly. The project is estimated to generate 12,000,000 kilowatt-hours per year, enough energy to power 1,000 homes for a year. In addition to providing another revenue stream for Marina, this project will also contribute to improving air quality. When methane gas is recovered as an energy source, it helps to reduce air pollution. Commercial operation of the plant is targeted for December 2004. Note 3. Common Stock: SJI has 20,000,000 shares of authorized Common Stock. The following shares were issued and outstanding: 2004 2003 ---------------------------- Beginning Balance, January 1 13,229,001 12,206,474 New Issues During Year: Dividend Reinvestment Plan 547,151 468,151 Employees' Stock Ownership Plan - 1,511 Stock Option, Stock Appreciation Rights and Restricted Stock Award Plan 32,056 32,005 ---------------------------- Ending Balance, September 30 13,808,208 12,708,141 ============================ We credited the par value ($1.25 per share) of stock issued in 2004 and 2003 to Common Stock. We credited the net excess over par value of approximately $22.7 million and $16.8 million, respectively, to Premium on Common Stock. Earnings Per Common Share - We present basic Earnings Per Share (EPS) based on the weighted-average number of common shares outstanding. EPS are presented in accordance with FASB Statement No. 128, "Earnings Per Share," which establishes standards for computing and presenting basic and diluted EPS. The incremental shares required for inclusion in the denominator for the diluted EPS calculation were 102,219 and 96,555 shares for the nine months ended September 30, 2004 and 2003, respectively. Incremental shares for the three months ended September 30, 2004 were 119,386. Because they would have an antidilutive effect on EPS, incremental shares of 105,783 for the three months ended September 30, 2003 are not included in the denominator for a diluted EPS calculation. These shares relate to restricted stock and were calculated using the treasury stock method. Stock Option, Stock Appreciation Rights and Restricted Stock Award Plan - Under this plan, no more than 306,000 shares in the aggregate may be issued to SJI's officers and other key employees. No options or stock appreciation rights may be granted under the Plan after November 22, 2006. At September 30, 2004 and SJI-14 2003, SJI had no options outstanding. No options were granted in 2004 or 2003. No stock appreciation rights were issued under the Plan. In the first nine months of 2004 and 2003, we granted 21,899 and 30,810 restricted shares, respectively. These restricted shares vest over a 3-year period and are subject to SJI achieving certain performance targets. Dividend Reinvestment Plan (DRP) and Employees' Stock Ownership Plan (ESOP) Newly issued shares of common stock offered through the DRP are issued directly by SJI. All shares offered through the ESOP were also issued directly by SJI. As of September 30, 2004, SJI reserved 1,131,825 shares of authorized, but unissued, common stock for future issuance to the DRP. As of October 1, 2003, the ESOP was terminated. Note 4. Financial Instruments: Restricted Investments - SJRG maintains a margin account with a national investment firm to support its risk management activities. As of September 30, 2004, SJRG had a payable balance of $4.0 million in this account due to changes in the market value of outstanding contracts. This balance is reflected under the caption Accounts Payable on the condensed consolidated balance sheet. Note 5. Segments of Business: Information about SJI's operations in different industry segments for the three and nine months ended September 30 is presented below (in thousands):
Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 ----------------------------------------------------------- Operating Revenues: Gas Utility Operations $ 72,231 $ 58,490 $ 346,345 $ 373,973 Wholesale Gas Operations 2,569 2,322 11,355 8,320 Retail Gas and Other Operations 33,167 27,282 158,377 120,516 Retail Electric Operations 18,054 2,863 52,227 4,286 On-Site Energy Production 4,883 5,447 15,997 7,447 ------------------------------------------------------------ Subtotal 130,904 96,404 584,301 514,542 Intersegment Sales (2,703) (6,269) (16,052) (38,366) ------------------------------------------------------------ Total Operating Revenues $ 128,201 $ 90,135 $ 568,249 $ 476,176 ============================================================ Operating Income: Gas Utility Operations $ 2,828 $ (1,047) $ 47,979 $ 43,169 Wholesale Gas Operations 877 2,055 3,280 5,326 Retail Gas and Other Operations 475 12 5,663 3,966 Retail Electric Operations 44 58 1,059 (15) On-Site Energy Production 1,426 1,844 4,627 2,323 General Corporate (369) (207) (798) (638) ------------------------------------------------------------ Total Operating Income $ 5,281 $ 2,715 $ 61,810 $ 54,131 ============================================================ SJI-15 Depreciation and Amortization: Gas Utility Operations $ 5,745 $ 7,192 $ 19,377 $ 20,008 Wholesale Gas Operations 4 3 11 9 Retail Gas and Other Operations 38 28 105 77 Retail Electric Operations - - - - On-Site Energy Production 430 467 1,247 524 Discontinued Operations - 7 - 21 ------------------------------------------------------------ Total Depreciation and Amortization $ 6,217 $ 7,697 $ 20,740 $ 20,639 ============================================================ Property Additions: Gas Utility Operations $ 15,316 $ 13,296 $ 47,392 $ 36,956 Wholesale Gas Operations - 2 15 2 Retail Gas and Other Operations 53 36 180 192 Retail Electric Operations - - - - On-Site Energy Production - 1,520 1,554 6,806 ----------------------------------------------------------- Total Property Additions $ 15,369 $ 14,854 $ 49,141 $ 43,956 ============================================================
September 30, 2004 2003 ----------------------------- Identifiable Assets: Gas Utility Operations $ 953,868 $ 907,524 Wholesale Gas Operations 60,597 63,013 Retail Gas and Other Operations 40,244 29,677 Retail Electric Operations 12,198 1,992 On-Site Energy Production 82,789 71,437 Discontinued Operations 413 2,354 ----------------------------- Subtotal 1,150,109 1,075,997 Corporate Assets 36,937 41,437 Intersegment Assets (47,066) (49,242) ------------------------------ Total Identifiable Assets $ 1,139,980 $ 1,068,192 ============================== Gas Utility Operations consist primarily of natural gas distribution to residential, commercial and industrial customers. Wholesale Gas Operations consist of SJRG's activities. Retail Gas and Other Operations include natural gas acquisition and transportation service companies and HVAC installation services. Given the recent growth of SJE's retail electric operations, which include SJE's electricity acquisition and transportation to retail, commercial and industrial customers, management now considers this a separate reporting segment. On-Site Energy Production consists of Marina's energy-related projects. SJI's interest expense relates primarily to SJG's and Marina's borrowing and financing activities. Note 6. Regulatory Actions: Base Rates - 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 SJI-16 cost of service, including deferred costs, through base rates. Additionally, SJG's threshold for sharing pre-tax margins generated by interruptible and off-system sales and transportation increased. As a result of this case, SJG 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, SJG kept 20% of the pre-tax margins as it had historically. 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. The increase was effective July 8, 2004 and designed 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 and a reduction in its composite depreciation rate from 2.9% to 2.4%. 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 now recovers 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 now begins from dollar one, with SJG retaining 20% as it has historically. Moreover, SJG now shares 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 overall settlement effective July 8, 2004, SJG provided customers with an offsetting $38.9 million rate reduction. These reductions were provided to customers through SJG's various clauses and did not negatively impact SJG's net income. Under those clauses, costs incurred by SJG were billed to customers on a dollar-for-dollar basis. 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 commenced in October 2004, are mandated by statute to be conducted at predetermined intervals. Management does not currently anticipate the outcome of these audits to have a material effect on SJI's financial position, results of operations or liquidity. Appliance Service Business - On July 23, 2004, the BPU approved SJG's petition and related agreements 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 purchased certain assets and assumed certain liabilities required to perform such repair services from SJG for the net book value of $1.2 million on September 1, 2004. The agreements also called for SJESP to pay an additional $1.5 million to SJG. This $1.5 million was credited by SJG to customers through the Remediation Adjustment Clause (RAC) and had no earnings impact on either SJG or SJI. This newly created company will have the flexibility to be more responsive to competition and customer needs in an unregulated environment. Furthermore, the transfer will have no effect on the provision of safety-related or emergency-related services to the public since the transferred services include only non-safety related, competitive appliance services. SJI-17 Other Regulatory Matters - 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 (RAC); 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. 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, 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 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, SJG filed for a $24.0 million increase to their 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 October 2004 the provisional rate increase was made final. 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 September 30, 2004, the deferred TAC deficiency has been reduced to $1.2 million. 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. In October 2004 the requested increase was approved on a provisional basis. Filings and petitions described above are still pending unless otherwise indicated. SJI-18 Note 7. Pensions & Other Postretirement Benefits: SJI has several defined benefit pension plans and other postretirement benefit plans. The pension plans provide annuity payments to the majority of full-time, regular employees upon retirement. Newly hired employees in certain classifications and companies 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 nine months ended September 30, 2004 and 2003 related to the pension and other postretirement benefit plans consisted of the following components (in thousands):
Pension Benefits Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 -------------------------------------------------------- Service Cost $ 734 $ 667 $ 2,204 $ 1,931 Interest Cost 1,424 1,387 4,274 4,015 Expected Return on Plan Assets (1,773) (1,428) (5,321) (4,136) Amortization of Transition Obligation - 18 - 54 Amortization of Loss and Other 443 462 1,331 1,338 ------------------------------------------------------ Net Periodic Benefit Cost $ 829 $ 1,106 $ 2,489 $ 3,202 ======================================================
Other Postretirement Benefits Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 -------------------------------------------------------- Service Cost $ 378 $ 525 $ 1,132 $ 1,163 Interest Cost 630 863 1,888 1,909 Expected Return on Plan Assets (352) (367) (1,052) (809) Amortization of Transition Obligation 193 193 579 579 Amortization of Loss and Other 44 205 132 297 ------------------------------------------------------ Net Periodic Benefit Cost $ 893 $ 1,420 $ 2,679 $ 3,140 ======================================================
SJI-19 Contributions - SJI is evaluating the impact of making contributions to its pension plan and expects to contribute approximately $3.6 million in equal quarterly installments to its other postretirement benefit plans in 2004. Note 8. Retained Earnings: Restrictions exist under various loan agreements regarding the amount of cash dividends or other distributions that SJG may pay on its common stock. As of September 30, 2004, SJG's restrictions did not affect the amount that may be distributed from SJI's retained earnings. Note 9. Commitments and Contingencies: Construction and Environmental - SJI's estimated net cost of construction and environmental remediation programs for 2004 totals $81.0 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 SJG and our interstate pipeline suppliers were made under Federal Energy Regulatory Commission approved tariffs. SJG's 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 - SJI is 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. SJI has been named in, among other actions, certain product liability claims related to our former sand mining subsidiary, a breach of contract claim with a vendor, and a class action suit regarding the proximity of gas meters to driveways. Management does not currently anticipate the disposition of any known claims to have a material adverse effect on SJI's financial position, results of operations or liquidity. Parental Guarantees -As of September 30, 2004, SJI had issued $159.6 million of parental guarantees on behalf of its subsidiaries. Of this total, $110.5 million expire within one year, $10.0 million expire within thirteen to twenty-four months and $39.1 million have no expiration date. The vast majority of these guarantees were issued as a guarantee of payment to third parties with whom our subsidiaries have commodity supply contracts. As of September 30, 2004, these guarantees support $23.6 million of the Accounts Payable recorded on our condensed consolidated balance sheet. As part of our risk management policy, we also require parental guarantees from counterparties as applicable. These arrangements are typical in our industry. SJI has also issued two parental guarantees totaling $6.8 million related to Marina's construction activity. Standby Letters of Credit - SJI provided a standby letter of credit to Marina District Development Corporation in support of Marina's contractual SJI-20 obligations to construct the thermal energy plant and to supply heat, hot water and cooling to Borgata Hotel Casino & Spa. The plant began commercial operations in July 2003. Accordingly, as called for in the contract, the letter of credit totaled $2.5 million as of September 30, 2004 and was subsequently cancelled in October as all contractual obligations were met. As of September 30, 2004, SJI also provided $46.0 million of standby letters of credit from four commercial banks supporting the variable rate demand bonds issued through the New Jersey Economic Development Authority to finance Marina's thermal plant project. The letter of credit agreement contains certain financial covenants measured on a quarterly basis. SJI was in compliance with these covenants as of September 30, 2004. Also, as of September 30, 2004, SJI has issued four letters of credit totaling $8.8 million to two different utilities. These letters were posted to enable SJE to market retail electricity and retail gas within the respective utilities' service territories. Contract Modification - On September 27, 2004, Marina signed an agreement with Borgata to amend the terms of the original contract dated December 12, 2000. As provided under this new agreement, Marina paid Borgata $3.5 million on September 28, 2004 to remove the liquidating damages provision for foregone revenues from the Energy Services Agreement and eliminate the requirement for a Letter of Credit from the Operations Agreement. Marina will amortize this $3.5 million on a straight-line basis over the remaining 18.75 years of the original contract. Environmental Remediation Costs - SJI incurred and recorded costs for environmental cleanup of sites where SJG or its predecessors operated gas manufacturing plants. SJG stopped manufacturing gas in the 1950s. SJI and some of its nonutility subsidiaries also recorded costs for environmental cleanup of sites where SJF previously operated a fuel oil business and Morie maintained equipment, fueling stations and storage. SJI successfully entered into settlements with all of its historic comprehensive general liability carriers regarding the environmental remediation expenditures at the SJG sites. Also, SJG purchased a Cleanup Cost Cap Insurance Policy limiting the amount of remediation expenditures that SJG will be required to make at 11 of its sites. This Policy will be in force until 2024 at 10 sites and until 2029 at one site. The minimum future cost estimate discussed below was not reduced by projected insurance recoveries from the Cleanup Cost Cap Insurance Policy. Since the early 1980s, SJI accrued environmental remediation costs of $149.1 million, of which $93.3 million has been spent as of September 30, 2004. With the assistance of a consulting firm, we estimate that future costs to clean up SJG's sites will range from $51.9 million to $192.3 million. We recorded the lower end of this range as a liability. It is reflected on the 2004 condensed consolidated balance sheet under the captions Current Liabilities and Deferred Credits and Other Non-Current Liabilities. 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. The major portion of accrued environmental costs relate to the cleanup of SJG's former gas manufacturing sites. SJI-21 SJG has 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 Statement No. 71. The BPU allows SJG to recover expenditures through the RAC (See Note 6). 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 regulatory asset under Statement No. 71 with the corresponding amount reflected on the condensed consolidated balance sheet under the captions Current Liabilities and Deferred Credits and Other Non-Current Liabilities. The BPU's intent, evidenced by current practice, is to allow SJG to recover the deferred costs after those costs are spent over 7-year periods. As of September 30, 2004, we reflected SJG's unamortized remediation costs of $4.4 million on the condensed consolidated balance sheet under the caption Regulatory Assets. Since implementing the RAC in 1992, SJG has recovered $43.5 million through rates. With Morie's sale, EMI assumed responsibility for environmental liabilities estimated between $2.7 million and $8.8 million. The information available on these sites is sufficient only to establish a range of probable liability and no point within the range is more likely than any other. Therefore, EMI has accrued the lower end of the range. Changes in the accrual are included in the statements of condensed consolidated income under the caption Loss from Discontinued Operations - Net. SJI and SJF estimated their potential exposure for the future remediation of four sites where fuel oil operations existed years ago. Estimates for SJI's site range between $13,800 and $77,200, while SJF's estimated liability ranges from $1.2 million to $4.9 million for its three sites. We recorded the lower ends of these ranges on the condensed consolidated balance sheet under Current Liabilities and Deferred Credits and Other Non-Current Liabilities as of September 30, 2004. Note 10. Subsequent Events: On October 1, 2004, SJG and a large utility customer executed an agreement for the buy-out of the customer's long-term energy contract. This settlement will contribute approximately $1.6 million to SJG's net income in the fourth quarter of 2004. On November 5, 2004, SJG's largest bargaining unit voted to ratify a new, four year contract. The contract will cover the period from the expiration of the old contract on January 15, 2005 through January 14, 2009. Terms of the deal include wage increases ranging from 3% to 3.5% over the life of the contract, health care plan redesign, the establishment of caps on payments for post-retirement medical benefits, and the implementation of separate wage and benefit packages for new hires. With this agreement, all of SJG's unionized personnel are operating under agreements that run through at least January 2008. SJI-22 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Unaudited) Overview South Jersey Industries, Inc. (SJI) is an energy services holding company that provides a variety of products and services through the following wholly owned subsidiaries: 1) South Jersey Gas Company (SJG) is a regulated natural gas utility. SJG distributed natural gas in the seven southernmost counties of New Jersey to 308,205 customers at September 30, 2004 compared with 299,609 customers at September 30, 2003. SJG also: * sells natural gas and pipeline transportation capacity (off-system sales) on a wholesale basis to various customers on the interstate pipeline system; * transports natural gas purchased directly from producers or suppliers for its own sales and for some of its customers; and * serviced appliances via the sale of appliance warranty programs as well as on a time and materials basis through September 1, 2004, at which time the business line was transferred out of SJG and into South Jersey Energy Service Plus, LLC. 2) South Jersey Energy Company (SJE) acquires and markets natural gas and electricity to retail end users and provides total energy management services to commercial and industrial customers. SJE also markets an air quality monitoring system through AirLogics, LLC. SJE and GZA GeoEnvironmental, Inc., an environmental consulting firm, each have a 50% equity interest in AirLogics. 3) South Jersey Resources Group, LLC (SJRG) markets wholesale natural gas storage, commodity, and transportation in the mid-Atlantic and southern states. SJRG also conducts price-risk management activities. 4) Marina Energy LLC (Marina) develops and operates energy-related projects. Marina's largest project, the development of a facility to provide cooling, heating and hot water to Borgata Hotel Casino & Spa in Atlantic City, began commercial operations in July 2003. 5) South Jersey Energy Service Plus, LLC (SJESP) installs residential and small commercial HVAC systems and services appliances via the sale of appliance warranty programs as well as on a time and materials basis in Southern New Jersey. SJI also has a joint venture investment with Conectiv Solutions, LLC in Millennium Account Services, LLC (Millennium). Millennium provides meter reading services to SJG and Conectiv Power Delivery in southern New Jersey. SJI-23 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 in our utility and nonutility activities; the availability and cost of capital; our ability to maintain existing joint ventures to take advantage of marketing opportunities; 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 consolidated 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. Five types of transactions presented in our condensed consolidated financial statements require a significant amount of judgment and estimation. These relate to regulatory assets, energy trading activities, environmental remediation costs, pension and other postretirement employee benefit costs and unbilled revenues. The New Jersey Board of Public Utilities (BPU) has reviewed and approved, through specific orders, most 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. SJI recognizes assets or liabilities for those energy-related contracts that qualify as derivatives that are entered into by its non-regulated subsidiary, SJRG, when it executes contracts. We record contracts at their fair value in accordance with FASB Statement No. 133. We adjust the fair value of the contracts each reporting period for changes in the market. We derive the fair value for most of the energy-related contracts from markets where the contracts are actively traded and quoted. For other contracts SJI uses published market surveys and, in certain cases, independent parties to obtain quotes concerning the contracts' current values. Market quotes tend to be more plentiful for contracts maturing in two years or less. Very few of our contracts extend beyond two years. SJI-24 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 $55.9 million to $206.1 million. In preparing financial statements, SJI records 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 assumptions concerning return on plan assets, discount rates and health care cost trends all have a significant impact on determining our projected benefit obligations. We evaluate these assumptions annually with the assistance of our investment manager and actuary and we adjust them accordingly. These adjustments could result in significant changes to the net periodic benefit costs of providing such benefits and the related liabilities recognized by SJI. A majority of SJG and SJE 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 and SJRG bill customers monthly for gas delivered and recognize those revenues during the month. SJE bills customers monthly for gas and electricity deliveries. For SJG and SJE retail customers that are not billed at the end of each month, we make an accrual to recognize estimated revenues for gas/electricity delivered from the date of the last meter reading to the end of the month. We bill SJG customers at rates approved by the BPU. SJE and SJRG customers are billed at rates negotiated between the parties. We defer and recognize revenues related to SJESP's appliance service contracts over the full 12-month term of the contract as earned. The BPU allows SJG to recover gas costs in rates through the Basic Gas Supply Service (BGSS) price structure (which replaced the Levelized Gas Adjustment Clause). SJG defers over/under-recoveries of gas costs and includes 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 SJG realizes 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 Regulatory Actions) without shifting profits between periods, as these clauses provide for recovery of costs on a dollar-for-dollar basis. New Accounting Pronouncements - See detailed discussions concerning New Accounting Pronouncements and their impact on SJI in Note 1 to the condensed consolidated financial statements. SJI-25 Temperature Adjustment Clause - A Board of Public Utilities approved Temperature Adjustment Clause (TAC) increased(decreased) SJG's net income by $0.2 million and $(2.4) million for the nine months ended September 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. 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 (RAC); 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 and related agreements 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 purchased certain assets and assumed certain liabilities required to perform such repair services from SJG for the net book value of $1.2 million on September 1, 2004. The agreements also called for SJESP to pay an additional $1.5 million to SJG. This $1.5 million was credited to customers through the RAC and had no earnings impact on either SJG or SJI. 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. Furthermore, the transfer has no effect on the provision of safety-related or emergency-related services to the public since the services transferred include only non-safety related, competitive appliance services. 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 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. SJI-26 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 October 2004 the provisional rate increase was made final. 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 September 30, 2004, the deferred TAC deficiency has been reduced to $1.2 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. SJG 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. The increase was effective July 8, 2004 and 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 and a reduction in its composite depreciation rate from 2.9% to 2.4%. 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 now recovers 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 begins from dollar one, with SJG retaining 20% as it has historically. Moreover, SJG now shares 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 effective July 8, 2004, SJG provided customers with an offsetting $38.9 million rate reduction. These reductions were provided to customers through SJG's various clauses and did not negatively impact SJG's net income. Under those clauses, costs incurred by SJG were billed to customers on a dollar-for-dollar basis. 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. In October 2004 the requested increase was approved on a provisional basis. SJI-27 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 commenced in October 2004, are mandated by statute to be conducted at predetermined intervals. Management does not currently anticipate the outcome of these audits to have a material effect on SJI's financial position, results of operations or liquidity. Filings and petitions described above are still pending unless otherwise indicated. Additional discussion concerning Regulatory Actions can be found in Note 6 to the condensed financial statements. Environmental Remediation - SJI incurred and recorded costs for environmental cleanup of sites where SJG or its predecessors operated manufactured gas plants (MGP). SJG stopped manufacturing gas in the 1950s. SJI and some of its nonutility subsidiaries also recorded costs for environmental cleanup of sites where we previously operated a fuel oil business and also where we maintained equipment, fueling stations and storage. 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 SJG's 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 September 30, 2004, SJG had $4.4 million of remediation costs not yet recovered through rates. Other matters are discussed in detail in Note 9 to the condensed consolidated 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 SJG's territory. SJG does 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 September 30, 2004, 103,121 SJI-28 SJG residential customers chose a natural gas commodity supplier other than the utility. This number increased from 98,149 at September 30, 2003 as marketers were 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. SJI has benefited from customer choice legislation as SJE has successfully competed for and profited from its gas commodity customers. Results of Operations Operating Revenues - Utility - Revenues increased $16.9 million during the third quarter compared with the same period in 2003. The increase was due to several factors. First, revenue from a major customer increased by $3.1 million as their consumption more than doubled in comparison with the third quarter of 2003. It should be noted that a corresponding increase in margin would not result from such increased sales based on SJG's tariff. Second, gas cost recoveries under the BGSS increased significantly due to the BGSS increase effective September 1, 2003. Gas costs charged to the BGSS rose by $7.5 million when compared to the same quarter last year. As a result of the increased recoveries, SJG recognized previously deferred overcollections (revenue) in an amount equal to the increase in gas costs. This process, as previously described under the caption "Revenue Recognition," resulted in a significant shift in revenue into the third quarter of 2004 without a corresponding impact on SJG's profitability. Third, SJG's recovery of previously deferred costs under its New Jersey Clean Energy Program increased revenues by $0.9 million. As there is a corresponding increase in expense (see discussion of Operations), there is no resulting impact on SJG's net income. Finally, the addition of 8,596 customers also contributed to the revenue increase (See Regulatory Actions). Revenues decreased $2.1 million for the nine months ended September 30, 2004 compared with the same period last year. The year-to-date decrease was primarily due to three factors. First, OSS revenues decreased 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. Second, weather was 9.8% warmer than last year resulting in lower utility sales. Finally, there was an 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. Partially offsetting these negative factors were the impacts of 8,596 additional customers and higher rates in effect over a majority of the past 12 months. 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 third quarter of any year generally has little impact on revenues during the period. Weather during the first nine months of 2004 was 9.8% warmer than in 2003 and 0.6% warmer than the 20-year TAC average. SJI-29 The following is a comparison of operating revenue and throughput for the three and nine months ended September 30, 2004 vs. the same periods ended September 30, 2003:
Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 ------ --------------------------------- Operating Revenues (Thousands): Firm Residential $ 23,052 $ 16,523 $ 122,160 $ 131,529 Commercial 7,331 5,595 36,311 40,311 Industrial 787 661 3,819 4,002 Cogeneration & Electric Generation 5,503 2,384 7,926 5,675 Firm Transportation 10,921 8,933 57,331 50,135 -------------------------------------------------- Total Firm Operating Revenues 47,594 34,096 227,547 231,652 -------------------------------------------------- Interruptible 421 268 1,178 1,317 Interruptible Transportation 369 252 933 747 Off-System 20,934 21,532 107,310 133,247 Capacity Release & Storage 2,184 1,559 6,848 4,372 Other 729 783 2,529 2,638 Intercompany Sales (2,045) (5,223) (10,841) (36,402) --------------------------------------------------- Total Operating Revenues $ 70,186 $ 53,267 $ 335,504 $ 337,571 ================================================== Throughput (MMcf): Firm Residential 1,051 912 10,340 11,416 Commercial 429 395 3,447 3,917 Industrial 15 13 131 161 Cogeneration & Electric Generation 701 341 944 689 Firm Transportation 5,794 5,541 24,568 23,031 -------------------------------------------------- Total Firm Throughput 7,990 7,202 39,430 39,214 -------------------------------------------------- Interruptible 40 38 128 170 Interruptible Transportation 581 511 1,746 1,469 Off-System 3,349 3,945 15,971 19,419 Capacity Release & Storage 14,462 12,613 39,657 29,008 -------------------------------------------------- Total Throughput 26,422 24,309 96,932 89,280 ==================================================
SJI-30 Operating Revenues - Nonutility - Nonutility operating revenues increased by $21.1 million and $94.1 million in the third quarter and first nine months of 2004, respectively, compared with the same periods of 2003. Most of the increases were due to SJE's revenues from the sale of retail electricity which increased by $15.2 million and $47.9 million for the third quarter and first nine months of 2004, respectively, compared with the same periods of 2003. SJE was the successful bidder on a contract to supply retail electricity to over 400 school districts located throughout the state of New Jersey beginning in November 2003. Sales of retail gas by SJE increased $4.1 million and $34.4 million for the third quarter and first nine months of 2004, respectively, compared with the same periods of 2003. These increases were due mainly to higher gas prices, colder temperatures in the first quarter of 2004 and the addition of over 500 commercial customers over the last twelve months. Marina's revenues remained consistent for the third quarter and increased $8.5 million for the first nine months of 2004, respectively, compared with the same periods of 2003. This increase resulted from sales of thermal energy to Borgata Hotel Casino & Spa, which opened in July 2003, and other on-site energy production projects. Cost of Gas Sold - Utility - Cost of gas sold - utility increased $12.9 million in the third quarter of 2004 compared with the same period in 2003. This primarily resulted from increased sales volume to a major customer and a significant increase in gas costs during the three-month period ended September 30, 2004 compared with the same period in 2003 as discussed under "Operating Revenues". In addition, customer growth has contributed toward the increased consumption in firm sales to both the residential and commercial markets. Cost of gas sold - utility decreased $10.3 million for the nine months ended September 30, 2004 compared with 2003 due principally to a significant decrease in sales volumes and lower gas costs for Off-System Sales. Unlike gas costs associated with Off-System Sales, changes in the unit cost of gas sold to utility ratepayers do not always 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 in the residential and commercial markets decreased by 10.1% for the nine months ended September 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. SJG does not anticipate any difficulty renewing or replacing expiring contracts under substantially similar terms and conditions. Cost of Sales - Nonutility - Cost of sales - nonutility increased $21.0 million and $87.0 million in the third quarter and for the first nine months of 2004 compared with the respective prior year periods due mainly to SJE's gas and electric customer growth and Marina's operations as described in the Operating Revenues - Nonutility section. SJI-31 Operations Expense - A summary of net changes in operations expenses (in thousands): Increase (Decrease) Three Months Ended Nine Months Ended September 30, September 30, 2004 vs. 2003 2004 vs. 2003 --------------------------------------- Utility: Other Production Expense $ (29) $ (34) Transmission - 35 Distribution 67 (161) Customer Accounts and Services (67) 3,895 Sales (23) (74) Administration and General 470 (275) --------------------------------- Total Utility 418 3,386 -------------------------------- Nonutility: Wholesale Gas 17 191 Retail Gas and Other 912 1,166 On-Site Energy Production 348 1,887 -------------------------------- Total Nonutility 1,277 3,244 -------------------------------- Corporate 204 220 -------------------------------- Total Operations $ 1,899 $ 6,850 ================================ 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 Regulatory Actions). With this approval, recoveries and a corresponding charge to expense for previously deferred costs under SJG's New Jersey Clean Energy Programs (NJCEP) increased by $0.9 million in the third quarter and $5.3 million for the nine months ended September 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. Lower bad debt expense during 2004 completely offset the previously noted increase for the quarter, and partially offset the year-to-date NJCEP increase. A March 2004 BGSS refund improved SJG's accounts receivable aging significantly during the year (See Regulatory Actions). As a result, SJG benefited from lower uncollectible account write-offs coupled with the ability to reduce its reserve for future doubtful accounts. Administrative and General (A&G) expenses increased in the three months ended September 30, 2004 compared with the same period of 2003 primarily as a result of deferred cost amortizations approved as part of SJG's July 2004 rate case settlement. The resulting amortizations of approximately $0.2 million for the three months ended September 30, 2004 were included in rate recovery from its customers and has no impact on SJG's net income. In addition, SJG has incurred significant expense during the third quarter to improve controls to ensure compliance with both SEC and New Jersey Board of Public Utility rules and SJI-32 regulations. Partially offsetting these increases during the quarter and throughout 2004 is the continued reduction in pension expense as a result of SJG making a $9.1 million pension contribution in December 2003. Nonutility Retail Gas and Other Operations expense increased for the third quarter and nine months ended September 30, 2004 compared with the respective prior year periods primarily due to the growth of our HVAC installation business which was partially offset by lower retail gas customer acquisition costs. On-Site Energy Production Operations expense increased in the third quarter and for the nine months ended September 30, 2004 compared with the respective prior year periods due to the start of commercial operations for Marina's thermal energy plant in July 2003 and the Mannington cogeneration project which began in January 2004. Other Operating Expenses - A summary of principal changes in other consolidated operating expenses (in thousands): Increase (Decrease) Three Months Ended Nine Months Ended September 30, September 30, 2004 vs. 2003 2004 vs. 2003 ------------- ------------- Maintenance $ 74 $ (82) Depreciation (706) 886 Energy and Other Taxes 358 (2) Depreciation decreased significantly during the third quarter of 2004 as a result of SJG's lower depreciation rates approved by the BPU as part of its recent rate case settlement. SJG's composite depreciation rate was reduced from 2.9% to 2.4% effective July 8, 2004. Year-to-date results reflect a net increase due to SJG's increased investment in property, plant and equipment and the depreciation on Marina's thermal plant beginning with the start of commercial operations in July 2003. The increase in Energy and Other Taxes during the quarter relates primarily to increases in taxable volumes of gas sold and transported by SJG and higher revenue-based taxes (See table under the caption, "Operating Revenues - Utility"). Other Income and Expense - Other income and expense was higher in the first nine months of 2004 compared with the first nine months of 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 the third quarter and the first nine months of 2004 compared with the respective periods of the prior year due primarily 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 SJG's Medium Term Note program at significantly lower interest rates compared with the previous long-term interest rates. The decreases were partially offset by interest incurred by Marina that was previously permitted to be capitalized during the construction phase of the thermal energy plant. We have incurred debt primarily to expand and upgrade SJG's gas transmission and SJI-33 distribution system, to construct the Marina Energy thermal plant, and to support seasonal working capital needs related to gas inventories and customer receivables. Cumulative Effect of a Change in Accounting Principle - Net - On October 25, 2002, the Emerging Issues Task Force rescinded its consensus in Issue No. 98-10 effective for transactions entered into after that date, with a cumulative effect adjustment for previously existing transactions to be recognized in the quarter beginning January 1, 2003. As a result of the rescission, SJI only marks-to-market those energy-related contracts that meet the definition of a derivative in Statement No. 133. Energy-related contracts that do not meet the definition of a derivative are accounted for using the accrual basis of accounting. The effect of this change in accounting resulted in a net charge of $426,338 shown as a Cumulative Effect of a Change in Accounting Principle - Net. Furthermore, management has designated any contract entered into after December 31, 2002 to hedge physical gas in storage as a cash flow hedge and accounts for them accordingly. At inception, and as of September 30, 2004, we calculated these hedges to be highly effective; therefore, we record the related unrealized gain or loss, net of taxes, in Accumulated Other Comprehensive Income (Loss). Net Income Applicable to Common Stock - Net income increased $2.3 million to $254,000 for the quarter ended September 30, 2004 as compared with a $2.0 million loss for the quarter ended September 30, 2003. Net income increased $6.3 million, or 28.7%, to $28.4 million for the nine months ended September 30, 2004 as compared with $22.0 million for the nine months ended September 30, 2003. Reasons for the increase in net income in 2004 are discussed in detail above. Liquidity and Capital Resources - Liquidity needs at SJI 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; working capital needs of our energy trading and marketing activities; 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 SJI totaled $266.0 million at September 30, 2004, of which $77.2 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 available to SJG, as well as a $60.0 million revolving credit facility that expires in August 2007 and $30.0 million of uncommitted bank lines available to SJI. The amount of the revolving credit to SJI was increased by $20.0 million and the expiration date was extended to 2007 in August 2004. The revolving credit facilities contain certain financial covenants measured on a quarterly basis. SJI and SJG were in compliance with these covenants as of September 30, 2004, 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. SJI-34 SJI 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. Under a $150.0 million MTN program established in December 2002, SJG issued $85.5 million of long-term debt in July 2003. 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. We used proceeds of all of the issues to refinance short-term debt outstanding to commercial banks and for the redemption of certain high-rate securities. During 2004, maturities of long-term debt have totaled $6.8 million. In addition, SJG redeemed $15 million of its 7.7% Medium Term Notes 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. Between September 2001 and January 2003, Marina issued $20 million of tax-exempt, and $25 million of taxable, variable rate demand bonds (VRDB's) through the New Jersey Economic Development Authority. The tax-exempt and taxable bonds mature in 2031 and 2021, respectively. Investors in the bonds receive liquidity and credit support via letters of credit provided by a syndicate of four commercial banks. The expiration dates of the underlying letters of credit that provide liquidity support for the weekly remarketing of the VRDB's were extended from September 2005 to September 2007 in August 2004. We used the proceeds of these bond issuances to fund project development and construction costs for the thermal energy plant constructed by Marina to serve Borgata Hotel Casino & Spa which opened in July 2003. SJI has been raising equity capital through its Dividend Reinvestment Plan (DRP). Participants in SJI's DRP receive newly issued shares. We offer a 2% discount on DRP investments because it is the most cost-effective way for us to raise equity capital in the quantities we are seeking. Through the DRP, SJI raised $22.2 million of equity capital by issuing 547,151 shares for the nine months ended September 30, 2004. We anticipate raising approximately $25 million of equity capital through the DRP in 2004. SJI's capital structure was as follows: As of As of September 30, December 31, 2004 2003 2003 ------ ------ ----- Common and Preferred Stock Equity 46% 37% 41% Long-Term Debt 44% 48% 43% Short-Term Debt 10% 15% 16% ---- ---- ---- Total 100% 100% 100% ==== ==== ==== SJI 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 SJI-35 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 SJI's capital structure over the past year. Capital Expenditures, Commitments and Contingencies Capital Expenditures - SJI 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 nine months of 2004 amounted to $50.0 million. We estimate the net costs for 2004, 2005 and 2006 at approximately $81.0 million, $57.2 million and $52.1 million, respectively. Commitments and Contingencies - SJI made certain commitments to Borgata Hotel Casino & Spa relating to the development of Marina's thermal energy project. In the event that certain construction milestones were not met, SJI was obligated to make specific payments to Borgata, per the construction contract. As construction was completed and commercial operations began in July 2003, SJI's obligation under the contract was reduced to $2.5 million and remained at that level as of September 30, 2004. This financial obligation was subsequently cancelled in October as all contractual obligations were met. SJI is obligated on the letters of credit supporting the variable rate demand bonds issued through the New Jersey Economic Development Authority by Marina. A syndicate of four commercial banks has issued $46.0 million of letters of credit to provide liquidity for these bonds. The letter of credit agreement contains certain financial covenants measured on a quarterly basis. SJI was in compliance with these covenants as of September 30, 2004. Contract Modification - On September 27, 2004, Marina signed an agreement with Borgata to amend the terms of the original contract dated December 12, 2000. As provided under this new agreement, Marina paid Borgata $3.5 million on September 28, 2004 to remove the liquidating damages provision for foregone revenues from the Energy Services Agreement and eliminate the requirement for a Letter of Credit from the Operations Agreement. Marina will amortize this $3.5 million on a straight-line basis over the remaining 18.75 years of the original contract. SJG has certain commitments for both pipeline capacity and gas supply for which it pays fees regardless of usage. Those commitments as of September 30, 2004 averaged $44.7 million annually and totaled $221.7 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. SJI-36 The following table summarizes our contractual cash obligations and their applicable payment due dates (in thousands):
Up to Years Years More than Contractual Obligations Total 1 Year 2 & 3 4 & 5 5 Years ----- ------ ----- ----- ------- Long-Term Debt $ 332,281 $ 5,273 $ 10,543 $ 1,500 $ 314,965 Operating Leases 881 445 367 50 19 Construction Obligations 10,700 10,700 - - - Commodity Supply Purchase Obligations: Utility 221,686 43,174 80,340 66,092 32,080 Nonutility 186,012 169,901 16,111 - - Other Purchase Obligations 4,297 3,594 703 - - ----------- ----------- ----------- ----------- ----------- Total Contractual Cash Obligations $ 755,857 $ 233,087 $ 108,064 $ 67,642 $ 347,064 =========== =========== =========== ========== ===========
Expected environmental remediation costs are not included in the table above due to the subjective nature of such costs and time of anticipated payments. SJI expects to make no contributions to its pension plan and to contribute approximately $3.6 million in equal quarterly installments to its other postretirement benefit plans in 2004. As of September 30, 2004, SJI had issued $159.6 million of parental guarantees on behalf of its subsidiaries. Of this total, $110.5 million expire within one year, $10.0 million expire within thirteen to twenty-four months and $39.1 million have no expiration date. The vast majority of these guarantees were issued as guarantees of payment to third parties with whom our subsidiaries have commodity supply contracts. As of September 30, 2004, these guarantees support $23.6 million of the Accounts Payable recorded on our condensed consolidated balance sheet. As part of our risk management policy, we also require parental guarantees from trading counterparties, as applicable. These arrangements are typical in our industry. SJI has also issued two parental guarantees totaling $6.8 million related to Marina's construction activity. On January 5, 2004, Marina paid $2.7 million to purchase a cogeneration facility in Salem County, NJ and will lease back the facility to a large manufacturer located on the same site over an 8-year lease. Marina also entered into an 8-year operating contract to operate and manage the facility. In April 2004, Marina and DCO Energy, LLC formed AC Landfill Energy, LLC (ACLE) to develop and install a 1,400-kilowatt methane-to-electric power generation system at a county-owned landfill in Egg Harbor Township, NJ. Marina owns a 51% interest in ACLE and consolidates ACLE's balance sheet and results of operations accordingly. The project is estimated to generate 12,000,000 kilowatt-hours per year, enough energy to power 1,000 homes for a year. In addition to providing another revenue stream for Marina, this project will also contribute to improving air quality. When methane gas is recovered as an energy source, it helps to reduce air pollution. Commercial operation of the plant is targeted for December 2004. SJI-37 SJI 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. Among other actions, SJI was named in certain product liability claims related to our former sand mining subsidiary. Management does not currently anticipate the disposition of any known claims to have a material adverse effect on SJI's financial position, results of operations or liquidity. Item 3. Quantitative and Qualitative Disclosures About Market Risks of the Company (Unaudited) Commodity Market Risks: Certain regulated and unregulated SJI subsidiaries are involved in buying, selling, transporting and storing natural gas for their own accounts as well as managing these activities for others. These subsidiaries are subject to market risk due to price fluctuations. To hedge against this risk, we enter into a variety of physical and financial transactions including forward contracts, swaps, futures and options agreements. To manage these transactions, SJI has a well-defined risk management policy approved by our board of directors that includes volumetric and monetary limits. Management reviews reports detailing activity daily. Generally, we enter into derivative activities described above for risk management, not speculative, purposes. SJG and SJE complete commodity transactions on a physical basis only and do not enter into financial derivative positions directly. SJRG manages risk for these entities as well as for its own portfolio by entering into the types of transactions noted above. It is management's policy, to the extent practical, within predetermined risk management policy guidelines, to have limited unmatched positions on a deal or portfolio basis while conducting these activities. As a result of holding open positions to a minimal level, the financial impact to SJRG of changes in value of a particular contract is substantially offset by an opposite change in the related hedge transaction. As of September 30, 2004, SJRG had $12.9 million of accounts receivable under sales contracts. Of that total, 75% were with companies rated investment-grade, or were guaranteed by an investment-grade-rated parent or were with companies where we have a collateral arrangement. The remainder of the accounts receivable were within approved credit limits. SJRG and SJE entered into certain contracts to purchase, sell, and transport natural gas. We recorded net unrealized pre-tax (loss) gain on these energy related derivative contracts of $(1.4) million and $1.1 million for the quarters ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004, we recorded net unrealized pre-tax (loss) gain of $(1.9) million and $1.9 million, respectively. These amounts are included as a component of Operating Revenues - Nonutility. SJRG's and SJE's contracts are typically less than 12 months long. The fair value of these contracts determined under the mark-to-market method as of September 30, 2004 is as follows (in thousands): SJI-38 Assets Maturity Maturity Source of Fair Value < 1 Year 1-3 Years Total ---------- ----------- ----------- Prices Actively Quoted NYMEX $ 17,922 $ 2,064 $ 19,986 Other External Sources Basis 7,264 2,817 10,081 ----------- ----------- ----------- Total $ 25,186 $ 4,881 $ 30,067 =========== =========== =========== Liabilities Maturity Maturity Source of Fair Value < 1 Year 1-3 Years Total ---------- ----------- ----------- Prices Actively Quoted NYMEX $ 3,339 $ 1,204 $ 4,543 Other External Sources Basis 6,030 1,891 7,921 ----------- ----------- ---------- Total $ 9,369 $ 3,095 $ 12,464 =========== =========== =========== NYMEX (New York Mercantile Exchange) is the primary national commodities exchange on which natural gas is traded. Basis represents the price of a NYMEX natural gas futures contract adjusted for the difference in price for delivering the gas at another location. A reconciliation of SJI's estimated net fair value of energy-related derivatives follows (in thousands): Net Derivatives - Energy Related Assets, January 1, 2004 $ 7,000 Contracts Settled During Nine Months Ended September 30, 2004, Net (5,132) Other Changes in Fair Value from Continuing and New Contracts, Net 15,735 ------------- Net Derivatives - Energy Related Assets, September 30, 2004 $ 17,603 ============= 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 September 30, 2004 was $68.4 million and averaged $51.2 million for the first nine 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 $302,000 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 - 28 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 September 2004, our average interest rate on short-term, variable rate debt was 1.64%. 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 redeemed, 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. The only other long-term debt outstanding, exclusive of that issued by the utility, consists of the New Jersey Economic Development Authority bonds used to finance the construction of Marina's thermal energy plant. Those bonds were issued at floating rates that reset weekly. Subsequent to issuance, we entered SJI-39 into interest rate swap contracts that, as of September 30, 2004, effectively fixed the rate on $20.0 million of tax-exempt debt at 4.08% through 2011 and $17.0 million of taxable debt at 4.59% through 2007. The amount of the swap on the taxable debt reduces annually, with a $3.1 million reduction that will occur in December 2004. Item 4. Controls and Procedures SJI 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. No change in SJI's internal control over financial reporting occurred during SJI's third fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. PART II -- OTHER INFORMATION Item l. Legal Proceedings Information required by this Item is incorporated by reference to Part I, Item 1, Note 9, beginning on page 20. SJI-40 Item 6. Exhibits (a) Exhibits Exhibit No. Description 10.1 Three-Year Revolving Credit Agreement for SJI. 10.2 First Amendment to Three-Year Revolving Credit Agreement for SJG. 10.3 Third Amendment to Amended and Restated Letter of Credit and Reinbursment Agreement for Marina Energy and SJI. 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). SJI-41 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 INDUSTRIES, INC. (Registrant) Dated: November 9, 2004 By: /s/ Edward J. Graham -------------------------------------- Edward J. Graham President & Chief Executive Officer Dated: November 9, 2004 By: /s/ David A. Kindlick -------------------------------------- David A. Kindlick Vice President & Chief Financial Officer SJI-42