South Jersey Industries Form 10-Q for June 30, 2006
 




UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

(Mark one)
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006

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) 
 
Common Stock
 
($1.25 par value per share)
New York Stock Exchange
(Title of each class)
(Name of exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act: None

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
            Large accelerated filer [X]            Accelerated filer [ ]            Non-accelerated filer [ ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
 
 As of August 1, 2006, there were 29,232,801 shares of the registrant’s common stock outstanding.




 




 
 



PART I — FINANCIAL INFORMATION



Item 1. Financial Statements — See Pages 2 through 24


SJI -1



SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES
         
           
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
         
(In Thousands Except for Per Share Data)
             
               
   
Three Months Ended 
 
   
June 30, 
 
     
2006
 
 
2005
 
               
Operating Revenues:
             
    Utility
 
$
95,107
 
$
84,759
 
    Nonutility
   
60,425
   
69,280
 
               
        Total Operating Revenues
   
155,532
   
154,039
 
               
Operating Expenses:
             
    Cost of Sales - Utility
   
66,141
   
53,787
 
    Cost of Sales - Nonutility
   
47,484
   
57,114
 
    Operations
   
14,742
   
16,131
 
    Maintenance
   
1,365
   
1,511
 
    Depreciation
   
6,396
   
5,971
 
    Energy and Other Taxes
   
1,891
   
2,117
 
               
        Total Operating Expenses
   
138,019
   
136,631
 
               
Operating Income
   
17,513
   
17,408
 
               
Other Income and Expense
   
646
   
(55
)
               
Interest Charges
   
(6,217
)
 
(4,922
)
               
Income Before Income Taxes
   
11,942
   
12,431
 
               
Income Taxes
   
(5,044
)
 
(5,091
)
               
Equity in Affiliated Companies
   
331
   
215
 
               
Income from Continuing Operations
   
7,229
   
7,555
 
               
Loss from Discontinued Operations - Net
   
(63
)
 
(182
)
               
        Net Income
 
$
7,166
 
$
7,373
 
               
Basic Earnings Per Common Share:
             
    Continuing Operations
 
$
0.248
 
$
0.270
 
    Discontinued Operations - Net
 
$
(0.002
)
$
(0.006
)
               
        Basic Earnings Per Common Share
 
$
0.246
 
$
0.264
 
               
Average Shares of Common Stock Outstanding - Basic
   
29,162
   
27,953
 
               
Diluted Earnings Per Common Share:
             
    Continuing Operations
 
$
0.247
 
$
0.268
 
    Discontinued Operations - Net
 
$
(0.002
)
$
(0.006
)
               
        Diluted Earnings Per Common Share
 
$
0.245
 
$
0.262
 
               
Average Shares of Common Stock Outstanding - Diluted
   
29,226
   
28,180
 
               
Dividends Declared per Common Share
 
$
0.2250
 
$
0.2125
 
               
The accompanying notes are an integral part of the consolidated financial statements.
             
 
SJI -2

SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES
             
               
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
             
(In Thousands Except for Per Share Data)
             
               
   
Six Months Ended 
 
   
June 30, 
 
     
2006
 
 
2005
 
               
Operating Revenues:
             
    Utility
 
$
364,628
 
$
296,926
 
    Nonutility
   
155,880
   
185,683
 
               
        Total Operating Revenues
   
520,508
   
482,609
 
               
Operating Expenses:
             
    Cost of Sales - Utility
   
267,201
   
195,762
 
    Cost of Sales - Nonutility
   
129,540
   
160,255
 
    Operations
   
32,409
   
36,328
 
    Maintenance
   
2,770
   
3,004
 
    Depreciation
   
12,738
   
11,844
 
    Energy and Other Taxes
   
6,622
   
7,275
 
               
        Total Operating Expenses
   
451,280
   
414,468
 
               
Operating Income
   
69,228
   
68,141
 
               
Other Income and Expense
   
794
   
329
 
               
Interest Charges
   
(12,583
)
 
(10,227
)
               
Income Before Income Taxes
   
57,439
   
58,243
 
               
Income Taxes
   
(23,854
)
 
(24,205
)
               
Equity in Affiliated Companies
   
710
   
409
 
               
Income from Continuing Operations
   
34,295
   
34,447
 
               
Loss from Discontinued Operations - Net
   
(229
)
 
(326
)
               
        Net Income
 
$
34,066
 
$
34,121
 
               
Basic Earnings Per Common Share:
             
    Continuing Operations
 
$
1.179
 
$
1.236
 
    Discontinued Operations - Net
 
$
(0.008
)
$
(0.012
)
               
        Basic Earnings Per Common Share
 
$
1.171
 
$
1.224
 
               
Average Shares of Common Stock Outstanding - Basic
   
29,097
   
27,876
 
               
Diluted Earnings Per Common Share:
             
    Continuing Operations
 
$
1.176
 
$
1.226
 
    Discontinued Operations - Net
 
$
(0.008
)
$
(0.012
)
               
        Diluted Earnings Per Common Share
 
$
1.168
 
$
1.214
 
               
Average Shares of Common Stock Outstanding - Diluted
   
29,163
   
28,102
 
               
Dividends Declared per Common Share
 
$
0.4500
 
$
0.4250
 
               
The accompanying notes are an integral part of the consolidated financial statements.
             
 
SJI -3



SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES
         
           
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
         
(In Thousands)
         
           
   
Three Months Ended
 
   
June 30,
 
 
 
2006
 
2005
 
           
           
           
Net Income
 
$
7,166
 
$
7,373
 
               
Other Comprehensive Income (Loss), Net of Tax:
             
               
    Change in Fair Value of Investments
   
(67
)
 
121
 
    Change in Fair Value of Derivatives - Other
   
879
   
(1,271
)
    Change in Fair Value of Derivatives - Energy Related
   
(832
)
 
(4,538
)
               
        Other Comprehensive Income (Loss) - Net of Tax
   
(20
)
 
(5,688
)
               
Comprehensive Income
 
$
7,146
 
$
1,685
 
               
               
               
               
               
               
   
Six Months Ended 
 
   
June 30, 
 
     
2006
 
 
2005
 
               
               
               
Net Income
 
$
34,066
 
$
34,121
 
               
Other Comprehensive Income (Loss), Net of Tax:
             
               
    Change in Fair Value of Investments
   
90
   
78
 
    Change in Fair Value of Derivatives - Other
   
2,103
   
(886
)
    Change in Fair Value of Derivatives - Energy Related
   
3,665
   
(4,581
)
               
        Other Comprehensive Income (Loss) - Net of Tax
   
5,858
   
(5,389
)
               
Comprehensive Income
 
$
39,924
 
$
28,732
 
               
The accompanying notes are an integral part of the consolidated financial statements.
             
 
 
SJI -4


SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES
         
           
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
         
(In Thousands)
         
   
Six Months Ended
 
   
June 30,
 
   
2006
 
2005
 
           
Cash Flows from Operating Activities:
             
  Income from Continuing Operations
 
$
34,295
 
$
34,447
 
     Adjustments to Reconcile Income from Continuing Operations
             
      to Net Cash Provided by Operating Activities:
             
    Depreciation and Amortization
   
13,684
   
13,287
 
    Unrealized Gain on Derivatives - Energy Related
   
(3,761
)
 
(2,117
)
    Provision for Losses on Accounts Receivable
   
335
   
1,925
 
    Stock-Based Compensation Charge
   
468
   
745
 
    Revenues and Fuel Costs Deferred - Net
   
4,844
   
(4,943
)
    Deferred and Noncurrent Income Taxes and Credits - Net
   
258
   
6,208
 
    Environmental Remediation Costs - Net
   
(3,513
)
 
(797
)
    Gas Plant Cost of Removal
   
(670
)
 
(443
)
    Changes in:
             
        Accounts Receivable
   
78,259
   
49,594
 
        Inventories
   
4,243
   
9,988
 
        Other Prepayments and Current Assets
   
(625
)
 
(1,389
)
        Prepaid and Accrued Taxes - Net
   
(5,529
)
 
(1,972
)
        Accounts Payable and Other Accrued Liabilities
   
(90,114
)
 
(24,682
)
        Other Assets
   
(1,008
)
 
6,858
 
        Other Liabilities
   
10,562
   
461
 
    Discontinued Operations
   
12
   
(462
)
               
Net Cash Provided by Operating Activities
   
41,740
   
86,708
 
               
Cash Flows from Investing Activities:
             
    Net (Purchase of) Proceeds from Sale of Restricted Investments
   
(21,284
)
 
12,041
 
    Capital Expenditures
   
(42,253
)
 
(38,802
)
    Net Other
   
(650
)
 
395
 
               
Net Cash Used in Investing Activities
   
(64,187
)
 
(26,366
)
               
Cash Flows from Financing Activities:
             
    Net Repayments of Lines of Credit
   
(2,700
)
 
(38,775
)
    Proceeds from Issuance of Long-Term Debt
   
41,400
   
-
 
    Principal Repayments of Long-Term Debt
   
(2,334
)
 
(12,788
)
    Dividends on Common Stock
   
(13,116
)
 
(12,127
)
    Proceeds from Sale of Common Stock
   
2,535
   
4,683
 
    Payments for Issuance of Long-Term Debt
   
(1,286
)
 
(100
)
    Premium for Early Retirement of Long-Term Debt
   
-
   
(184
)
    Redemption of Preferred Stock
   
-
   
(1,690
)
               
Net Cash Provided by (Used in) Financing Activities
   
24,499
   
(60,981
)
               
Net Increase (Decrease) in Cash and Cash Equivalents
   
2,052
   
(639
)
Cash and Cash Equivalents at Beginning of Period
   
4,884
   
5,272
 
               
Cash and Cash Equivalents at End of Period
 
$
6,936
 
$
4,633
 
               
               
Supplemental Disclosures of Non-Cash Investing Activities:
             
    Capital Expenditures acquired on account but unpaid as of June 30
 
$
7,419
 
$
9,710
 
               
The accompanying notes are an integral part of the consolidated financial statements.
             
 
SJI -5


SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES
         
           
CONSOLIDATED BALANCE SHEETS
         
(In Thousands)
         
               
   
(Unaudited) 
       
   
June 30, 
   
December 31,
 
 
 
 
2006
 
 
2005
 
Assets
             
               
Property, Plant and Equipment:
             
    Utility Plant, at original cost
 
$
1,055,207
 
$
1,030,028
 
       Accumulated Depreciation
   
(248,236
)
 
(241,242
)
    Nonutility Property and Equipment, at cost
   
104,609
   
94,623
 
       Accumulated Depreciation
   
(7,033
)
 
(6,061
)
               
        Property, Plant and Equipment - Net
   
904,547
   
877,348
 
               
Investments:
             
    Available-for-Sale Securities
   
5,817
   
5,642
 
    Restricted
   
29,518
   
8,234
 
    Investment in Affiliates
   
1,473
   
2,094
 
               
        Total Investments
   
36,808
   
15,970
 
               
Current Assets:
             
    Cash and Cash Equivalents
   
6,936
   
4,884
 
    Accounts Receivable
   
106,357
   
139,142
 
    Unbilled Revenues
   
12,756
   
59,066
 
    Provision for Uncollectibles
   
(5,370
)
 
(5,871
)
    Natural Gas in Storage, average cost
   
128,492
   
117,542
 
    Materials and Supplies, average cost
   
2,989
   
4,758
 
    Deferred Income Taxes - Net
   
-
   
624
 
    Prepaid Taxes
   
17,781
   
13,061
 
    Derivatives - Energy Related Assets
   
19,758
   
24,408
 
    Other Prepayments and Current Assets
   
6,054
   
5,415
 
               
        Total Current Assets
   
295,753
   
363,029
 
               
Regulatory and Other Noncurrent Assets:
             
    Regulatory Assets
   
119,382
   
121,483
 
    Prepaid Pension
   
28,920
   
30,075
 
    Derivatives - Energy Related Assets
   
8,145
   
5,080
 
    Derivatives - Other
   
3,041
   
-
 
    Unamortized Debt Issuance Costs
   
8,181
   
7,147
 
    Contract Receivables
   
13,920
   
14,766
 
    Other
   
6,692
   
6,814
 
               
        Total Regulatory and Other Noncurrent Assets
   
188,281
   
185,365
 
               
            Total Assets
 
$
1,425,389
 
$
1,441,712
 
 
The accompanying notes are an integral part of the consolidated financial statements.
             
 
SJI -6

 
               
SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES
             
               
CONSOLIDATED BALANCE SHEETS
             
(In Thousands)
             
               
   
(Unaudited)
 
 
 
 
 
 
 June 30,
 
 
December 31,
 
 
 
 
2006
 
 
2005
 
Capitalization and Liabilities
             
               
Common Equity:
             
    Common Stock
 
$
36,471
 
$
36,228
 
    Premium on Common Stock
   
234,939
   
231,861
 
    Accumulated Other Comprehensive Loss
   
(2,942
)
 
(8,801
)
    Retained Earnings
   
155,306
   
134,357
 
               
        Total Common Equity
   
423,774
   
393,645
 
               
Long-Term Debt
   
358,133
   
319,066
 
               
        Total Capitalization
   
781,907
   
712,711
 
               
Minority Interest
   
458
   
394
 
               
Current Liabilities:
             
    Notes Payable
   
144,600
   
147,300
 
    Current Maturities of Long-Term Debt
   
2,363
   
2,364
 
    Accounts Payable
   
74,811
   
179,023
 
    Customer Deposits and Credit Balances
   
21,144
   
12,534
 
    Environmental Remediation Costs
   
24,418
   
18,165
 
    Taxes Accrued
   
6,725
   
7,456
 
    Derivatives - Energy Related Liabilities
   
28,375
   
21,957
 
    Deferred Income Taxes - Net
   
4,529
   
-
 
    Deferred Contract Revenues
   
3,886
   
5,077
 
    Dividends Payable
   
6,565
   
-
 
    Interest Accrued
   
6,260
   
6,258
 
    Other Current Liabilities
   
3,359
   
6,078
 
               
        Total Current Liabilities
   
327,035
   
406,212
 
               
Deferred Credits and Other Noncurrent Liabilities:
             
    Deferred Income Taxes - Net
   
168,642
   
169,423
 
    Investment Tax Credits
   
2,633
   
2,795
 
    Pension and Other Postretirement Benefits
   
18,263
   
18,941
 
    Asset Retirement Obligations
   
23,363
   
22,588
 
    Environmental Remediation Costs
   
32,368
   
42,489
 
    Derivatives - Energy Related Liabilities
   
9,206
   
4,895
 
    Derivatives - Other
   
-
   
491
 
    Regulatory Liabilities
   
55,159
   
54,002
 
    Other
   
6,355
   
6,771
 
               
      Total Deferred Credits
             
              and Other Noncurrent Liabilities
   
315,989
   
322,395
 
               
Commitments and Contingencies (Note 11)
             
               
          Total Capitalization and Liabilities
 
$
1,425,389
 
$
1,441,712
 
               
The accompanying notes are an integral part of the consolidated financial statements.
             
 
SJI -7


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:   

Consolidation— The consolidated financial statements include the accounts of South Jersey Industries, Inc. (SJI), its wholly owned subsidiaries and subsidiaries in which we have a controlling interest. We eliminate all significant intercompany accounts and transactions. In our opinion, the consolidated financial statements reflect all normal and recurring adjustments 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 2005 Form 10-K and annual report.

Equity Investments— We classify marketable equity investments purchased as long-term investments as Available-for-Sale Securities on our consolidated balance sheets and carry them at their fair value. Any unrealized gains or losses are included in Accumulated Other Comprehensive Loss. SJI, through a wholly owned subsidiary, currently holds a 50% non-controlling interest in one affiliated company and accounts for the investment under the equity method. We include the operations of this affiliated company on a pre-tax basis in the statements of consolidated income under Equity in Affiliated Companies.

Estimates and Assumptions— We prepare our consolidated financial statements to conform with accounting principles generally accepted in the United States of America. Management makes estimates and assumptions that affect the amounts reported in the consolidated financial statements and related disclosures. Therefore, actual results could differ from those estimates. Significant estimates include amounts related to regulatory accounting, energy derivatives, environmental remediation costs, pension and other postretirement benefit costs, and revenue recognition.

Regulation— South Jersey Gas Company (SJG) is subject to the rules and regulations of the New Jersey Board of Public Utilities (BPU). SJG maintains its 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.
 
Revenues— Gas and electric revenues are recognized in the period the commodity is delivered and customers are billed monthly. For SJG and South Jersey Energy Company (SJE) retail customers not billed at the end of each month, we record an estimate to recognize unbilled revenues for gas and electricity delivered from the date of the last meter reading to the end of the month. South Jersey Resources Group, LLC’s (SJRG) gas revenues are recognized in the period the commodity is delivered and customers are billed monthly. We defer and recognize revenues related to South Jersey Energy Service Plus, LLC (SJESP) appliance service contracts seasonally over the full 12-month terms of the contracts. Revenue related to services provided on a time and materials basis is recognized on a monthly basis as the jobs are completed. Marina Energy LLC (Marina) recognizes revenue on a monthly basis as services are provided and for on-site energy production that is delivered to its customers.

The BPU allows SJG to recover all prudently incurred gas costs through the Basic Gas Supply Service clause (BGSS). SJG collects these costs on a forecasted basis upon BPU order. SJG defers over/under-recoveries of gas costs and includes them in the following year's BGSS filing. SJG pays interest on the net overcollected BGSS balances at the rate of return on rate base utilized by the BPU to set rates in its last base rate proceeding.

SJI -8



 SJG's tariff also includes a Temperature Adjustment Clause (TAC) and a Societal Benefits Clause (SBC). Within the SBC are a Remediation Adjustment Clause (RAC), a New Jersey Clean Energy Program (NJCEP), a Universal Service Fund (USF) program, and a Consumer Education Program (CEP) which was terminated in April 2006. The TAC provides stability to SJG’s earnings and its customers’ bills by normalizing the impact of extreme winter temperatures. The RAC recovers environmental remediation costs of former gas manufacturing plants and the NJCEP recovers costs associated with our energy efficiency and renewable energy programs. The USF is a statewide customer assistance program that utilizes utilities as a collection agent. The CEP recovered costs associated with providing education to the public concerning customer choice. TAC adjustments affect revenue, earnings and cash flows since colder-than-normal weather can generate credits to customers, while warmer-than-normal weather can result in additional billings. RAC adjustments affect revenue and cash flows but do not directly affect earnings because SJG defers and recovers related costs through rates over 7-year amortization periods. NJCEP, CEP and USF adjustments also affect revenue and cash flows but do not directly affect earnings, as related costs are deferred and customer credits are recovered through rates on an ongoing basis.

Accounts Receivable and Provision for Uncollectible Accounts— Accounts receivable are carried at the amount owed by customers. A provision for uncollectible accounts is established based on our collection experience and an assessment of the collectibility of specific accounts.

Property, Plant and Equipment— For regulatory purposes, utility plant is stated at original cost, which may be different than SJG’s cost if the assets were acquired from another regulated entity. Nonutility plant is stated at cost. The cost of adding, replacing and renewing property is charged to the appropriate plant account.

Depreciation— SJG depreciates utility plant on a straight-line basis over the estimated remaining lives of the various property classes. These estimates are periodically reviewed and adjusted as required after BPU approval. The composite annual rate for all depreciable utility property was approximately 2.4% in 2005 and 2.3% for the first six months of 2006. Except for retirements outside the normal course of business, accumulated depreciation is charged with the cost of depreciable utility property retired, less salvage. Nonutility property depreciation is computed on a straight-line basis over the estimated useful lives of the property, ranging up to 50 years. Gain or loss on the disposition of nonutility property is recognized in net income.

Capitalized Interest— SJG capitalizes interest on construction at the rate of return on rate base utilized by the BPU to set rates in its last base rate proceeding. Marina capitalizes interest on construction projects in progress based on the actual cost of borrowed funds. SJG’s amounts are included in Utility Plant and Marina’s amounts are included in Nonutility Property and Equipment on the consolidated balance sheets. Interest Charges are presented net of capitalized interest on the consolidated statements of income. SJI capitalized interest as follows (in thousands):


   
June 30,
2006
 
 June 30,
2005
 
 
         
Quarter Ended:
         
 SJG
 
$
109
 
$
253
 
 Marina
   
302
   
48
 
 Total
 
$
411
 
$
301
 
 
         
Six Months Ended:
         
 SJG
 
$
208
 
$
543
 
 Marina
   
616
   
69
 
 Total
 
$
824
 
$
612
 


Impairment of Long-Lived Assets— We review the carrying amount of long-lived assets for possible impairment whenever events or changes in circumstances indicate that such amounts may not be recoverable. For the six months ended June 30, 2006 and the year ended December 31, 2005, no significant impairments were identified.

SJI -9



Derivative Instruments— Certain SJI subsidiaries are involved in buying, selling, transporting and storing natural gas and buying and selling retail electricity for their own accounts as well as managing these activities for other third parties. These subsidiaries are subject to market risk due to commodity price fluctuations. To manage this risk, our companies enter into a variety of physical and financial transactions including forward contracts, swap agreements, options contracts and futures contracts.

SJI structured its subsidiaries so that SJG and SJE transact commodities on a physical basis and typically do not directly enter into positions that financially settle. SJRG performs this risk management function for these entities and enters into the types of financial transactions noted above. As part of its gas purchasing strategy, SJG uses financial contracts to hedge against forward price risk. The costs or benefits of these contracts are included in SJG’s BGSS, subject to BPU approval. As of June 30, 2006 and December 31, 2005, SJG had $18.3 million and $(0.5) million of costs (benefits), respectively, included in its BGSS related to open financial contracts (See Regulatory Assets & Liabilities).
 
Management takes an active role in the risk management process and has developed policies and procedures that require specific administrative and business functions to assist in identifying, assessing and controlling various risks. Management reviews any open positions in accordance with strict policies to limit exposure to market risk.

SJI accounts for derivative instruments in accordance with FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended. We record all derivatives, whether designated in hedging relationships or not, on the consolidated balance sheets at fair value unless the derivative contracts qualify for the normal purchase and sale exemption. In general, if the derivative is designated as a fair value hedge, we recognize the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk in earnings. We currently have no fair value hedges. If the derivative is designated as a cash flow hedge, we record the effective portion of the hedge in Other Comprehensive Income (Loss) and recognize it in the income statement when the hedged item affects earnings. However, due to the application of regulatory accounting principles under FASB Statement No. 71, derivatives related to SJG’s gas purchases are recorded through the BGSS rather than Other Comprehensive Income (Loss). We recognize ineffective portions of cash flow hedges immediately in earnings. For the three and six months ended June 30, 2006, and 2005, the ineffective portions of the derivatives designated as cash flow hedges were not material. We formally document all relationships between hedging instruments and hedged items, as well as our risk management objectives, strategies for undertaking various hedge transactions and our methods for assessing and testing correlation and hedge ineffectiveness. All hedging instruments are linked to the hedged asset, liability, firm commitment or forecasted transaction.

We also assess whether these derivatives are highly effective in offsetting changes in cash flows or fair values of the hedged items. We discontinue hedge accounting prospectively if we decide: to discontinue the hedging relationship; determine that the anticipated transaction is no longer likely to occur; or, if we determine that a derivative is no longer highly effective as a hedge. In the event that hedge accounting is discontinued, we will continue to carry the derivative on the balance sheet at its current fair value and recognize subsequent changes in fair value in current period earnings. Unrealized gains and losses on the discontinued hedges that were previously included in Accumulated Other Comprehensive Loss will be reclassified into earnings when the forecasted transaction occurs, or when it is not probable that it will occur. During the six months ended June 30, 2005, $1.3 million of unrealized gain on derivatives previously designated as cash flow hedges, was reclassified into Operating Revenues - Nonutility because we determined that the anticipated hedged transaction was no longer likely to occur. SJI has elected to designate certain energy-related derivative instruments as cash flow hedges, which protect against the price variability of our forecasted sales and purchases of natural gas. Based on the amount recorded in Accumulated Other Comprehensive Loss at June 30, 2006, we expect $0.3 million to be recorded as a decrease in revenues in the next twelve months. As of June 30, 2006, hedges for future forecasted transactions exist into 2007.

SJI -10



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, options contracts and futures contracts. SJI measures the fair value of the contracts and records these as Derivatives — Energy Related Assets or Derivatives — Energy Related Liabilities on our consolidated balance sheets. For those derivatives not designated as hedges, we recorded the net unrealized pre-tax loss of $(1.2) million, and $(2.0) million in earnings during the three months ended June 30, 2006 and 2005, respectively, which are included with realized gains and losses in Operating Revenues — Nonutility. For the six months ended June 30, 2006 and 2005, we recorded the net unrealized pre-tax gain of $3.8 and $2.1 million, respectively which are included with realized gains and losses in Operating Revenues Nonutility.

SJI presents revenues and expenses related to its energy trading activities on a net basis in Operating Revenues — Nonutility in our consolidated statements of income consistent with Emerging Issues Task Force (EITF) Issue No. 02-03, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities.” There is no effect on operating income or net income from the above presentation.

From time to time we enter into interest rate derivatives and similar agreements to hedge exposure to increasing interest rates with respect to our variable-rate debt. We have designated and account for these interest rate derivatives as cash flow hedges. As of June 30, 2006, SJI’s active interest rate swaps were as follows:

 Amount
   
Fixed
Interest Rate  
   
 Start Date
   
 Maturity
   
 Type
   
 Obligor
 
 $        6,000,000
*
 
4.550
%
 
 
11/19/2001
 
 
12/01/2007
 
 
Taxable
 
 
Marina 
 
 $        3,900,000
 
 
4.795
%
 
 
12/01/2004
 
 
12/01/2014
 
 
Taxable
 
 
Marina
 
 $        8,000,000
 
 
4.775
%
 
 
11/12/2004
 
 
11/12/2014
 
 
Taxable
 
 
Marina
 
 $      20,000,000
 
 
4.080
%
 
 
11/19/2001
 
 
12/01/2011
 
 
Tax-exempt
 
 
Marina
 
 $      14,500,000
 
 
3.905
%
 
 
03/17/2006
 
 
01/15/2026
 
 
Tax-exempt
 
 
Marina
 
 $           500,000
 
 
3.905
%
 
 
03/17/2006
 
 
01/15/2026
 
 
Tax-exempt
 
 
Marina
 
 $           330,000
 
 
3.905
%
 
 
03/17/2006
 
 
01/15/2026
 
 
Tax-exempt
 
 
Marina
 
 $      12,500,000
**
 
3.430
%
 
 
12/01/2006
 
 
02/01/2036
 
 
Tax-exempt
 
 
SJG
 
 $      12,500,000
**
 
3.430
%
 
 
12/01/2006
 
 
02/01/2036
 
 
Tax-exempt
 
 
SJG
 
 $        7,100,000
 
 
4.895
%
 
 
02/01/2006
 
 
02/01/2016
 
 
Taxable
 
 
Marina 
 
                                   
                                   
                                   
*
Amount reduced to $6.0 million on 12/01/05, and further reduces to $3.0 million on 12/01/06
**
SJG entered into these forward-starting swaps in anticipation of the issuance of $25.0 million of auction-rate bonds that were issued in April 2006.
   

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. As of June 30, 2006 and December 31, 2005, the market values of these swaps were $3.0 million and $(0.5) million, respectively, which represent the amounts we would receive from (have to pay to) the counterparties to terminate these contracts as of those dates. We include these balances on the consolidated balance sheets under Derivatives — Other. As of June 30, 2006 and December 31, 2005, we determined that the swaps were highly effective; therefore, we recorded the changes in fair value of the swaps along with the cumulative unamortized costs, net of taxes, in Accumulated Other Comprehensive Loss.

We determined the fair value of derivative instruments by reference to quoted market prices of listed contracts, published quotations or quotations from unrelated third parties.

SJI -11



Stock-Based Compensation Plans—Under the Amended and Restated 1997 Stock-Based Compensation Plan that was amended and restated by our Board of Directors and approved by our shareholders in April 2005, no more than 1,000,000 shares in the aggregate may be issued to SJI's officers, non-employee directors and other key employees. The plan will terminate on January 26, 2015, unless terminated earlier by the Board of Directors. No options were granted or outstanding during the six months ended June 30, 2006, and 2005. No stock appreciation rights have been issued under the plan. In the first six months of 2006, and 2005, we granted 42,982 and 38,316 restricted shares, respectively. Restricted shares vest over a 3-year period and are subject to SJI achieving certain performance targets as compared to a peer group average. The actual amount of shares that are ultimately awarded is dependent upon the final peer group average and may range from between 0% to 150% of the original share units granted.
On January 1, 2006, SJI adopted FASB Statement No. 123(R), “Share-Based Payment”, which revised FASB Statement No. 123, and superseded Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees”. Statement No. 123(R) requires SJI to measure and recognize stock-based compensation expense in its financial statements based on the fair value at the date of grant for its share-based awards, which currently include restricted stock awards containing market and service conditions. In accordance with Statement No. 123(R), SJI is recognizing compensation expense over the requisite service period for: (i) awards granted on, or after, January 1, 2006 and (ii) unvested awards previously granted and outstanding as of January 1, 2006. In addition, SJI is estimating forfeitures over the requisite service period when recognizing compensation expense. These estimates can be adjusted to the extent to which actual forfeitures differ, or are expected to materially differ, from such estimates.

As permitted by Statement No. 123(R), SJI chose the modified prospective method of adoption; accordingly, financial results for the prior period presented were not retroactively adjusted to reflect the effects of this Statement. Under the modified prospective application, this Statement applies to new awards and to awards modified, repurchased, or cancelled after the required effective date. Compensation costs for the portion of awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is rendered based on the grant-date fair value.

The Company measures compensation expense related to restricted stock awards based on the fair value of the awards at their date of grant. Compensation expense is recognized on a straight-line basis over the requisite three-year service period for awards that ultimately vest, and is not adjusted based on the actual achievement of performance goals. The Company estimated the fair value of officers’ restricted stock awards on the date of grant using a Monte Carlo simulation model.

The following table summarizes the nonvested restricted stock awards outstanding at June 30, 2006 and the assumptions used to estimate the fair value of the awards (adjusted for the June 2005 two-for-one stock split):

 
 
 
Grant
 
 
Shares
 
 
Fair Value
 
 
Expected
 
 
Risk-Free
 
 
 
 
Date
 
 
Outstanding
 
 
Per Share
 
 
Volatility
 
 
Interest Rate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Officers -
 
 
   Jan. 2004
 
 
42,135
 
$
20.105
 
 
16.4%
 
 
2.4%
 
 
 
 
Jan. 2005
 
 
35,221
 
$
25.155
 
 
15.5%
 
 
3.4%
 
 
 
 
Jan. 2006
 
 
39,076
 
$
27.950
 
 
16.9%
 
 
4.5%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Directors -
 
 
   Dec. 2003
 
 
  4,560
 
$
19.738
 
 
-
 
 
-
 
 
 
 
Dec. 2004
 
 
  5,220
 
$
24.955
 
 
-
 
 
-
 
 
 
 
Dec. 2005
 
 
  6,340
 
$
29.970
 
 
-
 
 
-
 

Expected volatility is based on the actual daily volatility of SJI’s share price over the preceding 3-year period as of the valuation date. The risk-free interest rate is based on the zero-coupon U.S. Treasury Bond, with a term equal to the three-year term of the Officers’ restricted shares. As notional dividend equivalents are credited to the holders, which are reinvested during the three-year service period, no reduction to the fair value of the award is required. As the Directors’ restricted stock awards contain no performance conditions and notional dividend equivalents are credited to the holder, which are reinvested during the three-year service period, the fair value of these awards are equal to the market value of shares on the date of grant.

SJI -12



The following table summarizes the total compensation cost for the six months ended June 30, 2006 and 2005 (in thousands):

 
 
2006
 
2005
 
Officers
     
$
459
 
$
936
     
Directors
       
66
   
50
     
Total Cost
     
$
525
 
$
986
     
Capitalized
       
(57
)
 
(241
)
   
Net Expense
     
$
468
 
$
745
     

As of June 30, 2006, there was $1.6 million of total unrecognized compensation cost related to nonvested share-based compensation awards granted under the restricted stock plans. That cost is expected to be recognized over a weighted average period of 1.7 years.
 
Prior to the adoption of Statement No. 123 (R), SJI applied Statement No. 123, as amended, which permitted the application of APB No. 25. In accordance with APB No. 25, SJI recorded compensation expense over the requisite service period for restricted stock based on the probable number of shares expected to be issued and the market value of the Company’s common stock at the end of each reporting period. As a result of SJI’s previous accounting treatment, there have been no excess tax benefits recognized since the inception of the Plans.

The adoption of Statement No. 123(R) resulted in a decrease in stock-based compensation expense of $$14,654 for the six months ended June 30, 2006. This change in expense would have had no impact on SJI’s Earnings Per Share or cash flows for the year ended December 31, 2006.

The following table summarizes information regarding restricted stock award activity during the six months ended June 30, 2006:

 
 
Officers *
 
Directors *
 
 
 
 
 
Nonvested Shares Outstanding, January 1, 2006
 
143,734
 
16,120
 
 
 
 
 
Granted
 
42,983
 
-
Vested**
 
(61,620
-
Cancelled/Forfeited
 
(8,665
-
 
 
 
 
 
Nonvested Shares Outstanding, June 30, 2006
 
116,432
 
16,120
 
 
 
 
 
*   excludes accrued dividend equivalents.
 
 
 
 
** actual shares awarded upon vesting, including dividend equivalents and
    adjustments for performance measures, totaled 101,009 shares.

During the six months ended June 30, 2006 and 2005, SJI awarded 101,009 shares at a market value of $2.9 million and 74,574 shares at a market value of $2.0 million, respectively. The Company has a policy of issuing new shares to satisfy its obligations under these plans (See Note 3); therefore, there are no cash payment requirements resulting from the normal operation of this plan. However, a change in control could result in such shares becoming nonforefeitable or immediately payable in cash.

New Accounting Pronouncement — In July 2006, the FASB issued Interpretation No. 48 “Uncertainty in Income Taxes” (FIN 48). This Interpretation provides guidance on the recognition and measurement of uncertain tax positions in the financial statements. The effective date of FIN 48 is January 1, 2007; however, we do not anticipate its adoption to materially affect SJI’s consolidated financial statements.

SJI -13



Regulatory Assets & LiabilitiesRegulatory Assets at June 30, 2006 and December 31, 2005, consisted of the following items (in thousands):

 
     
Years Remaining
as of
June 30, 2006
   
June 30,
2006
   
December 31,
2005
Environmental Remediation Costs:
 
 
 
 
 
 
 
 
 
Expended — Net
 
 
Various
 
$
12,860
 
$
9,350
Liability for Future Expenditures
 
 
Not Applicable
 
 
52,863
 
 
56,717
Income Taxes — Flowthrough
 
 
 
 
 
 
 
 
 
Depreciation
 
 
5
 
 
5,174
 
 
5,663
Deferred Fuel Costs — Net
 
 
Various
 
 
18,562
 
 
21,237
Deferred Asset Retirement Obligation Costs
 
 
Not Applicable
 
 
20,498
 
 
19,986
Deferred Postretirement Benefit Costs
 
 
7
 
 
2,457
 
 
2,646
Societal Benefit Costs
 
 
Various
 
 
4,000
 
 
2,691
Premium for Early Retirement of Debt
 
 
Various
 
 
1,613
 
 
1,694
Other
 
 
Not Applicable
 
 
1,355
 
 
1,499
Total Regulatory Assets
 
 
 
 
$
119,382
 
$
121,483

All significant regulatory assets are separately identified above and are being recovered through utility rate charges. SJG is currently permitted to recover interest on its Environmental Remediation Costs and Societal Benefit Costs while the other assets are being recovered without a return on investment over the period indicated. Some of the assets reflected within the above caption “Other” are currently being recovered from ratepayers as approved by the BPU. Management believes the remaining deferred costs are probable of recovery from ratepayers through future utility rates.

Over/under collections of gas costs are monitored through SJG’s BGSS mechanism. Net undercollected gas costs are classified as a Regulatory Asset and net overcollected gas costs are classified as a Regulatory Liability. Derivative contracts used to hedge our natural gas purchases are included in the BGSS, subject to BPU approval. The offset to the change in fair value of these contracts is recorded as a component of the regulatory asset, Deferred Fuel Costs - Net, if we are in a net undercollected position, or as a component of the regulatory liability, Deferred Gas Revenues - Net, if we are in a net overcollected position. As of June 30, 2006, costs related to derivative contracts increased Deferred Fuel Costs - Net by $18.3million. As of December 31, 2005, benefits related to derivative contracts reduced Deferred Fuel Costs - Net by $0.5 million.
 
Regulatory Liabilities at June 30, 2006 and December 31, 2005 consisted of the following items (in thousands):
 
 
 
June 30,
 
December 31,
 
 
 
2006
 
2005
 
Excess Plant Removal Costs
 
48,271
 
48,071
 
Overcollected State Taxes
 
 
4,111
 
 
4,025
 
Other
 
 
2,777
 
 
1,906
 
Total Regulatory Liabilities
 
$
55,159
 
$
54,002
 

Excess Plant Removal Costs represent amounts accrued in excess of actual utility plant removal costs incurred to date, which SJG has an obligation to either expend or return to ratepayers in future periods. All other regulatory liabilities are subject to being returned to ratepayers in future rate proceedings.

Cash and Cash Equivalents— For purposes of reporting cash flows, highly liquid investments with original maturities of three months or less are considered cash equivalents.

SJI -14



Reclassifications— SJI reclassified some previously reported amounts to conform with current period classifications. We determined that certain realized hedge gains related to our natural gas purchases were recorded as an offset to our inventory costs as of December 31, 2005. Accordingly, we increased Natural Gas in Storage, average cost by $4.2 million, decreased Deferred Income Taxes — Net in Current Assets by $1.7 million and increased Accumulated Other Comprehensive Loss by $2.5 million as of December 31, 2005. We determined that certain customer accounts receivable were in a credit position and accordingly, reclassified $3.1 million included in Accounts Receivable as of December 31, 2005 to Customer Deposits and Credit Balances. We also determined that certain acquisitions of property and equipment made on account were reflected as cash capital expenditures in the statement of cash flows, and have reduced cash flows used in investing activities with a corresponding reduction in cash provided by operating activities of approximately $4.6 million for the six months ended June 30, 2005. These amounts are considered immaterial to the overall presentation of our consolidated financial statements.

2.  DISCONTINUED OPERATIONS, AFFILIATIONS AND CONTROLLING INTERESTS:

DISCONTINUED OPERATIONS — 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. 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.
 
Summarized operating results of the discontinued operations for the three and six months ended June 30, were (in thousands):

 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2006
 
2005
 
2006
 
2005
 
Loss before Income Taxes:
 
   
 
       
 
   
 
 
Sand Mining
$
(86
)
$
(259
)
 
$
(229
)
$
(471
)
Fuel Oil
 
(11
)
 
(20
)
 
 
(123
)
 
(30
)
Income Tax Benefits
 
34
 
 
97
 
 
 
123
 
 
175
 
Loss from Discontinued Operations — Net
$
(63
 
)
$
(182
 
)
 
$
(229
)
$
(326
 
)
Earnings Per Common Share from
 
 
 
 
 
 
 
 
   
 
 
 
Discontinued Operations — Net:
 
 
 
 
 
 
 
 
   
 
 
 
Basic and Diluted
$
(0.002
 
)
$
(0.006
 
)
 
$
(0.008
)
$
(0.012
 
)

Affiliations— SJI and Conectiv Solutions, LLC formed Millennium Account Services, LLC to provide meter reading services in southern New Jersey. SJE and GZA GeoEnvironmental, Inc (GZA). formed AirLogics, LLC (AirLogics) to market a jointly developed air monitoring system designed to assist companies involved in environmental cleanup activities. On June 30, 2006, SJE sold its entire interest in AirLogics for $1,450,000, resulting in an after-tax gain of $219,000. We account for our investment in these affiliated companies under the equity method.

Controlling Interests— Marina and DCO Energy, LLC (DCO) formed AC Landfill Energy, LLC (ACLE) to develop and install a 1,600-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 accounts for ACLE as a consolidated subsidiary. Commercial operation of the initial system began in March 2005. An additional 1,900-kilowatt system is under construction at the site and is expected to be operational in the third quarter of 2006.

In March 2005, Marina and DCO formed WC Landfill Energy, LLC (WCLE) to develop and install a 3,800-kilowatt methane-to-electric power generation system at a county-owned landfill in White Township, NJ. Marina owns a 51% interest in WCLE and accounts for WCLE as a consolidated subsidiary. Commercial operation of the plant is targeted to begin in the fall of 2006.

SJI -15



3.  COMMON STOCK:

SJI has 60,000,000 shares of common stock authorized. Share-related information for prior periods is reported on a retroactive basis reflecting the stock split, which was completed on June 30, 2005, throughout this Report.

The following shares were issued and outstanding:
 
     
June 30, 
       
December 31, 
 
     
2006 
       
2005 
 
Beginning Balance, January 1
 
 
28,982,440
 
Beginning Balance, January 1
 
 
27,759,936
 
New Issues During Period:
 
 
 
 
New Issues During Year:
 
 
 
 
Dividend Reinvestment Plan
 
 
93,222
 
 Dividend Reinvestment Plan
 
 
1,141,590
 
Stock-Based Compensation Plan
 
 
101,009
 
 Stock-Based Compensation Plan
 
 
80,914
 
Ending Balance, June 30
 
 
29,176,671
 
Ending Balance, December 31
 
 
28,982,440
 

We credited the par value ($1.25 per share) of stock issued during the six months ended June 30, 2006 and the year ended December 31, 2005 to Common Stock. We credited the net excess over par value of approximately $3.1 million and $34.1 million, respectively, to Premium on Common Stock.

Earnings Per Common Share— We present basic EPS based on the weighted-average number of common shares outstanding. EPS is 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 64,427 and 227,016 shares for the three months, and 65,938 and 226,215 shares for the six months ended June 30, 2006 and 2005, respectively. These shares relate to SJI’s restricted stock as discussed below.

Dividend Reinvestment Plan (DRP)— Newly issued shares of common stock offered through the DRP are issued directly by SJI. As of June 30, 2006, SJI reserved 1,502,800 shares of authorized, but unissued, common stock for future issuance to the DRP.

4.  LONG-TERM DEBT:

In March 2006, Marina issued $16.4 million of tax-exempt, variable-rate bonds through the New Jersey Economic Development Authority (NJEDA), which mature in March 2036. Proceeds of the bonds were used to finance the expansion of Marina’s Atlantic City thermal energy plant. The interest rate on all but $1.1 million of the bonds has been effectively fixed via interest rate swaps at 3.91% until January 2026. The variable interest rate on the $1.1 million portion of the bonds that remain unhedged was 4.02% as of June 30, 2006.

In April 2006, SJG issued $25.0 million of secured tax-exempt, auction-rate debt through the NJEDA to finance infrastructure costs that qualify for tax-exempt financing. The auction rate, which resets weekly, was set at 3.79% as of June 30, 2006. In anticipation of this transaction, SJG previously entered into forward-starting interest rate swap agreements that effectively fixed the interest rate on this debt at 3.43%, commencing December 1, 2006 through January 2036. The debt was issued under SJG’s medium-term note program. An additional $115.0 million of medium-term notes remains available for issuance under that program.

5.  FINANCIAL INSTRUMENTS:

Restricted Investments— In accordance with the terms of Marina’s and SJG’s loan agreements, we were required to escrow unused proceeds pending approved construction expenditures. As of June 30, 2006, the escrowed proceeds totaled $18.3 million. There were no escrowed proceeds as of December 31, 2005 as the related debt was issued during 2006.

SJRG maintains a margin account with a national investment firm to support its risk management activities. As of June 30, 2006 and December 31, 2005, the balance of this account was $11.2 million and $8.2 million, respectively, due to changes in the market value of outstanding contracts.

SJI -16


6.  SEGMENTS OF BUSINESS:

SJI operates in several different operating segments. Gas Utility Operations (SJG) consists primarily of natural gas distribution to residential, commercial and industrial customers. Wholesale Gas Operations include SJRG’s activities. SJE is involved in both retail gas and retail electric activities. Retail Gas and Other Operations include natural gas acquisition and transportation service business lines. Retail Electric Operations consist of electricity acquisition and transportation to commercial and industrial customers. On-Site Energy Production consists of Marina’s thermal energy facility and other energy-related projects. Appliance Service Operations includes SJESP’s servicing of appliances via the sale of appliance service programs as well as on a time and materials basis, and the installation of residential and small commercial HVAC systems.

Information about SJI's operations in different operating segments for the three and six months ended June 30 is presented below (in thousands):
 
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
 
   
 
 
 
2006
   
2005
   
2006
   
2005
 
Operating Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gas Utility Operations
 
$
105,006
 
$
86,083
 
$
382,087
 
$
300,620
 
Wholesale Gas Operations
 
 
6,297
 
 
3,282
 
 
20,646
 
 
14,842
 
Retail Gas and Other Operations
 
 
34,709
 
 
41,060
 
 
93,772
 
 
115,547
 
Retail Electric Operations
 
 
11,629
 
 
16,846
 
 
24,665
 
 
39,544
 
On-Site Energy Production
 
 
5,002
 
 
5,196
 
 
11,492
 
 
10,566
 
Appliance Service Operations
 
 
3,576
 
 
3,768
 
 
7,350
 
 
7,193
 
Corporate and Services
   
3,020
   
509
   
6,190
   
1,049
 
Subtotal
 
 
169,239
 
 
156,744
 
 
546,202
 
 
489,361
 
Intersegment Sales
 
 
(13,707
)
 
(2,705
)
 
(25,694
)
 
(6,752
)
Total Operating Revenues
 
$
155,532
 
$
154,039
 
$
520,508
 
$
482,609
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating Income:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gas Utility Operations
 
$
9,560
 
$
10,133
 
$
52,740
 
$
53,293
 
Wholesale Gas Operations
 
 
4,458
 
 
2,141
 
 
9,527
 
 
6,841
 
Retail Gas and Other Operations
 
 
(202
)
 
1,987
 
 
(180
 
2,290
 
Retail Electric Operations
 
 
1,574
 
 
427
 
 
2,082
 
 
861
 
On-Site Energy Production
 
 
1,486
 
 
1,889
 
 
3,507
 
 
3,513
 
Appliance Service Operations
 
 
498
 
 
1,090
 
 
1,250
 
 
1,788
 
Corporate and Services
 
 
139
 
 
(259
)
 
302
 
 
(445
)
Total Operating Income
 
$
17,513
 
$
17,408
 
$
69,228
 
$
68,141
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and Amortization:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gas Utility Operations
 
$
6,195
 
$
6,169
 
$
12,524
 
$
12,238
 
Wholesale Gas Operations
 
 
2
 
 
3
 
 
5
 
 
7
 
Retail Gas and Other Operations
 
 
3
 
 
3
 
 
5
 
 
6
 
Appliance Services Operations
 
 
58
 
 
46
 
 
115
 
 
82
 
On-Site Energy Production
 
 
461
 
 
455
 
 
922
 
 
901
 
Corporate and Services
 
 
52
 
 
26
 
 
113
 
 
53
 
Discontinued Operations
 
 
-
 
 
-
 
 
-
 
 
-
 
Total Depreciation and Amortization
$
6,771
 
$
6,702
 
$
13,684
 
$
13,287
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Property Additions:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gas Utility Operations
 
$
16,255
 
$
18,193
 
$
29,249
 
$
30,295
 
Wholesale Gas Operations
 
 
-
 
 
-
 
 
3
 
 
-
 
Retail Gas and Other Operations
 
 
5
 
 
-
 
 
5
 
 
3
 
Appliance Service Operations
 
 
125
 
 
30
 
 
170
 
 
57
 
On-Site Energy Production
 
 
6,715
 
 
7,652
 
 
9,460
 
 
13,043
 
Corporate and Services
   
180
   
2
   
388
   
7
 
Discontinued Operations
 
 
-
 
 
-
 
 
-
 
 
-
 
Total Property Additions
 
$
23,280
 
$
25,877
 
$
39,275
 
$
43,405
 
 
SJI -17



 
 
 
 
 
 
 
 
June 30,
2006
 
December 31,
2005
 
 
 
   
Identifiable Assets:
 
 
 
 
 
 
 
Gas Utility Operations
 
$
1,165,892
 
$
1,167,398
 
Wholesale Gas Operations
 
 
115,499
 
 
124,922
 
Retail Gas and Other Operations
 
 
34,899
 
 
50,880
 
Retail Electric Operations
 
 
4,464
 
 
7,751
 
Appliance Service Operations
   
13,260
   
13,624
 
On-Site Energy Production
 
 
119,833
 
 
105,822
 
Discontinued Operations
 
 
400
 
 
408
 
Subtotal
 
 
1,454,247
 
 
1,470,805
 
Corporate and Services
 
 
73,679
 
 
70,379
 
Intersegment Assets
 
 
(102,537
)
 
(99,472
)
Total Identifiable Assets
 
$
1,425,389
 
$
1,441,712
 

7.  REGULATORY ACTIONS:

Base Rates— On July 7, 2004, the BPU granted SJG a base rate increase of $20.0 million effective July 8, 2004, which was predicated in part upon a 7.97% rate of return on rate base that included a 10.0% return on common equity. SJG was also permitted to recover regulatory assets contained in its petition and to reduce its composite depreciation rate from 2.9% to 2.4%.
 
Pending Audit— In 2004, the BPU commenced a competitive services audit and a management audit that included a focused review of SJG’s gas supply and purchasing practices. The BPU is mandated by statute to conduct such audits at predetermined intervals. In February 2006, the audit reports were released by the BPU for comments. The recommendations contained in these audits have no material effect on SJG’s financial statements.
 
Other Regulatory Matters
In December 2004, the BPU approved the statewide funding of the NJCEP of $745.0 million for the years 2005 through 2008. Of this amount, SJG will be responsible for approximately $25.4 million over the 4-year period. Amounts not yet expended have been included in the Contractual Cash Obligations table included in Note 11.
 
In February 2005, SJG filed notice with the BPU to provide for an $11.4 million bill credit to customers. The bill credit was implemented in March 2005. In June 2005, SJG made its annual BGSS filing with the BPU requesting a $17.1 million, or 6.3% increase in gas cost recoveries in response to increasing wholesale gas costs. In August 2005, the BPU approved SJG’s requested increase, effective September 1, 2005, on an interim basis.

In October 2005 SJG filed a petition with the BPU to implement a Pipeline Integrity Management Tracker (Tracker) along with the three other natural gas distribution companies in New Jersey. The purpose of the Tracker is to recover costs to be incurred by SJG as a result of new federal regulations, which are aimed at enhancing public safety and reliability. The regulations require that utilities use a comprehensive analysis to assess, evaluate, repair and validate the integrity of certain transmission lines in the event of a leak or failure. The New Jersey utilities are requesting approval of the Tracker since the new regulations will result in ongoing incremental costs. We anticipate that a large portion of the incremental cost is dependent upon overall assessment results, and therefore cannot be specifically predicted at this time.

In November 2005, SJG made its annual SBC filing, requesting a $6.1 million reduction in annual recoveries.

In November 2005, SJG also filed a BGSS Motion for Emergent Rate Relief in conjunction with the other natural gas utilities in New Jersey. This filing was necessary due to substantial increases in wholesale natural gas prices across the country. In December 2005, the BPU approved an $85.7 million increase to SJG’s rates, effective December 15, 2005, on an interim basis.

SJI -18



In November 2005, SJG also made its annual TAC filing, requesting a $1.0 million increase in annual revenues. The increase will recover the cash related to the net TAC deficiency resulting from warmer-than-normal weather for the 2003-2004 winter, partially offset by colder-than-normal weather for the 2004-2005 winter. The 2003-2004 TAC was resolved as part of SJG’s global settlement, which was approved by the BPU in March 2006.

In December 2005, SJG made a filing proposing to implement a Conservation and Usage Adjustment (CUA) Clause, on a 5-year pilot basis. The primary purpose of the CUA is to promote conservation and to base SJG’s profit margin on its number of customers rather than the amount of natural gas it distributes to its customers. This structure will allow SJG to aggressively promote conservation programs without negatively impacting its financial stability. The proposed CUA would replace SJG’s existing TAC, but continue to protect customers and the Company from significant temperature variations from normal.

In March 2006, the BPU approved a global settlement, effective April 1, 2006, fully resolving SJG’s September 2004 SBC filing, 2003-2004 TAC, 2004-2005 BGSS filing and certain issues in the 2005-2006 BGSS filing. The net impact is a $4.4 million reduction to annual revenues; however, this reduction has no impact on net income as there will be a dollar-for-dollar reduction in expense. In addition, a pilot storage incentive program was approved. This program began during the second quarter of 2006 and will continue for three summer injection periods through 2008. It is designed to provide SJG with the opportunity to achieve BGSS price reductions and additional price stability. It will also provide SJG with an opportunity to share in the storage-related gains and losses, with 20% being retained by SJG, and 80% being credited to customers.

In June 2006, SJG made its annual BGSS filing with the BPU requesting a $19.7 million decrease in gas cost recoveries in response to decreasing wholesale gas costs and an $11.5 million benefit derived from the release of a storage facility and the liquidation of its low-cost base gas made available during the second quarter. This represents a 4.6% rate reduction and is pending BPU approval for implementation on October 1, 2006.

In July 2006, SJG made its annual USF filing, along with the state’s other electric and gas utilities, proposing to increase annual statewide gas revenues to $115.3 million, an increase of $68.5 million. Under the proposal, SJG’s annual USF revenues will increase to $13.0 million, which represents a $7.7 million increase in annual USF revenues.

Filings and petitions described above are still pending unless otherwise indicated.
 
8.  PENSION & 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 do not qualify for participation in the defined benefit pension plans. New hires are eligible to receive an enhanced version of SJI’s defined contribution plan. Certain SJI officers also participate in a non-funded supplemental executive retirement plan (SERP), a non-qualified defined benefit pension plan. The other postretirement benefit plans provide health care and life insurance benefits to some retirees.

The BPU authorized SJG to recover costs related to postretirement benefits other than pensions under the accrual method of accounting consistent with FASB Statement No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." SJG deferred amounts accrued prior to that authorization and are amortizing them as allowed by the BPU. The unamortized balance of $2.5million at June 30, 2006 is recoverable in rates. SJG is amortizing this amount over 15 years, which started January 1998.

SJI -19



Net periodic benefit cost for the three and six months ended June 30, 2006 and 2005 related to the employee and officer pension and other postretirement benefit plans consisted of the following components (in thousands):


   
Pension Benefits
 
   
Three Months Ended
June 30,
     
Six Months Ended
June 30,
 
       
   
2006
 
2005
     
2006
 
2005
 
Service Cost
 
$
729
 
$
787
       
$
1,584
 
$
1,618
 
Interest Cost
   
1,821
   
1,652
         
3,607
   
3,371
 
Expected Return on Plan Assets
   
(2,354
)
 
(2,345
)
       
(4,618
)
 
(4,284
)
Amortization of Loss and Other
   
628
   
837
         
1,421
   
1,500
 
Net Periodic Benefit Cost
   
824
   
931
         
1,994
   
2,205
 
Capitalized Benefit Costs
   
(238
)
 
(243
)
       
(637
)
 
(629
)
Net Periodic Benefit Expense
 
$
586
 
$
688
       
$
1,357
 
$
1,576
 
                                 


   
Other Postretirement Benefits
 
   
Three Months Ended
June 30,
     
Six Months Ended
June 30,
 
       
   
2006
 
2005
     
2006
 
2005
 
Service Cost
 
$
198
 
$
45
       
$
396
 
$