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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.
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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.
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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