South Jersey Industries Form 10-Q September 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 September 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 November 1, 2006, there were 29,279,288 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
 
   
September 30,
 
     
2006
 
 
2005
 
               
Operating Revenues:
             
Utility
 
$
73,541
 
$
89,053
 
Nonutility
   
59,520
   
67,918
 
               
Total Operating Revenues
   
133,061
   
156,971
 
               
Operating Expenses:
             
Cost of Sales - Utility
   
50,840
   
66,428
 
Cost of Sales - Nonutility
   
45,774
   
56,002
 
Operations
   
15,596
   
15,332
 
Maintenance
   
1,454
   
1,456
 
Depreciation
   
6,646
   
6,052
 
Energy and Other Taxes
   
1,783
   
1,733
 
               
Total Operating Expenses
   
122,093
   
147,003
 
               
Operating Income
   
10,968
   
9,968
 
               
Other Income and Expense
   
639
   
(51
)
               
Interest Charges
   
(7,462
)
 
(5,326
)
               
Income Before Income Taxes
   
4,145
   
4,591
 
               
Income Taxes
   
(1,830
)
 
(2,092
)
               
Equity in Affiliated Companies
   
196
   
183
 
               
Income from Continuing Operations
   
2,511
   
2,682
 
               
Loss from Discontinued Operations - Net
   
(149
)
 
(191
)
               
Net Income
 
$
2,362
 
$
2,491
 
               
Basic Earnings Per Common Share:
             
Continuing Operations
 
$
0.086
 
$
0.095
 
Discontinued Operations - Net
 
$
(0.005
)
$
(0.007
)
               
Basic Earnings Per Common Share
 
$
0.081
 
$
0.088
 
               
Average Shares of Common Stock Outstanding - Basic
   
29,225
   
28,244
 
               
Diluted Earnings Per Common Share:
             
Continuing Operations
 
$
0.086
 
$
0.094
 
Discontinued Operations - Net
 
$
(0.005
)
$
(0.007
)
               
Diluted Earnings Per Common Share
 
$
0.081
 
$
0.087
 
               
Average Shares of Common Stock Outstanding - Diluted
   
29,320
   
28,459
 
               
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)
             
               
   
Nine Months Ended
 
   
September 30,
 
     
2006
 
 
2005
 
               
Operating Revenues:
             
Utility
 
$
438,168
 
$
385,980
 
Nonutility
   
215,400
   
253,600
 
               
Total Operating Revenues
   
653,568
   
639,580
 
               
Operating Expenses:
             
Cost of Sales - Utility
   
318,041
   
262,189
 
Cost of Sales - Nonutility
   
175,314
   
216,258
 
Operations
   
48,005
   
51,661
 
Maintenance
   
4,224
   
4,460
 
Depreciation
   
19,384
   
17,895
 
Energy and Other Taxes
   
8,405
   
9,008
 
               
Total Operating Expenses
   
573,373
   
561,471
 
               
Operating Income
   
80,195
   
78,109
 
               
Other Income and Expense
   
1,434
   
278
 
               
Interest Charges
   
(20,045
)
 
(15,553
)
               
Income Before Income Taxes
   
61,584
   
62,834
 
               
Income Taxes
   
(25,684
)
 
(26,297
)
               
Equity in Affiliated Companies
   
906
   
593
 
               
Income from Continuing Operations
   
36,806
   
37,130
 
               
Loss from Discontinued Operations - Net
   
(378
)
 
(517
)
               
Net Income
 
$
36,428
 
$
36,613
 
               
Basic Earnings Per Common Share:
             
Continuing Operations
 
$
1.263
 
$
1.326
 
Discontinued Operations - Net
 
$
(0.013
)
$
(0.018
)
               
Basic Earnings Per Common Share
 
$
1.250
 
$
1.308
 
               
Average Shares of Common Stock Outstanding - Basic
   
29,140
   
27,999
 
               
Diluted Earnings Per Common Share:
             
Continuing Operations
 
$
1.260
 
$
1.315
 
Discontinued Operations - Net
 
$
(0.013
)
$
(0.018
)
               
Diluted Earnings Per Common Share
 
$
1.247
 
$
1.297
 
               
Average Shares of Common Stock Outstanding - Diluted
   
29,215
   
28,221
 
               
Dividends Declared per Common Share
 
$
0.6750
 
$
0.6375
 
               
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
 
   
September 30,
 
     
2006
 
 
2005
 
               
               
               
Net Income
 
$
2,362
 
$
2,491
 
               
Other Comprehensive Income (Loss), Net of Tax:
             
               
Change in Fair Value of Investments
   
109
   
100
 
Change in Fair Value of Derivatives - Other
   
(1,780
)
 
892
 
Change in Fair Value of Derivatives - Energy Related
   
12,769
   
(8,503
)
               
Other Comprehensive Income (Loss) - Net of Tax
   
11,098
   
(7,511
)
               
Comprehensive Income (Loss)
 
$
13,460
 
$
(5,020
)
               
               
               
   
Nine Months Ended
 
   
September 30,
 
     
2006
 
 
2005
 
               
               
               
Net Income
 
$
36,428
 
$
36,613
 
               
Other Comprehensive Income (Loss), Net of Tax:
             
               
Change in Fair Value of Investments
   
199
   
178
 
Change in Fair Value of Derivatives - Other
   
323
   
7
 
Change in Fair Value of Derivatives - Energy Related
   
16,435
   
(13,084
)
               
Other Comprehensive Income (Loss) - Net of Tax
   
16,957
   
(12,899
)
               
Comprehensive Income
 
$
53,385
 
$
23,714
 
               
               
               
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)
             
   
 Nine Months Ended
 
   
      September 30,
 
     
2006
 
 
2005
 
               
Cash Flows from Operating Activities:
             
Income from Continuing Operations
 
$
36,806
 
$
37,130
 
Adjustments to Reconcile Income from Continuing Operations
             
to Net Cash Provided by Operating Activities:
             
Depreciation and Amortization
   
20,811
   
20,166
 
Unrealized (Gain) Loss on Derivatives - Energy Related
   
(3,093
)
 
1,361
 
Provision for Losses on Accounts Receivable
   
468
   
1,670
 
Stock-Based Compensation Charge
   
702
   
1,135
 
Revenues and Fuel Costs Deferred - Net
   
12,254
   
(8,003
)
Deferred and Noncurrent Income Taxes and Credits - Net
   
2,683
   
19,282
 
Environmental Remediation Costs - Net
   
(5,485
)
 
(2,116
)
Gas Plant Cost of Removal
   
(1,096
)
 
(679
)
Changes in:
             
Accounts Receivable
   
103,454
   
58,320
 
Inventories
   
(31,650
)
 
(42,508
)
Other Prepayments and Current Assets
   
(855
)
 
(1,417
)
Prepaid and Accrued Taxes - Net
   
(13,490
)
 
(12,413
)
Accounts Payable and Other Accrued Liabilities
   
(99,744
)
 
16,437
 
Other Assets
   
(8,207
)
 
7,280
 
Other Liabilities
   
10,691
   
2,504
 
Discontinued Operations
   
470
   
(487
)
               
Net Cash Provided by Operating Activities
   
24,719
   
97,662
 
               
Cash Flows from Investing Activities:
             
Net (Purchase of) Proceeds from Sale of Restricted Investments
   
(22,797
)
 
3,993
 
Capital Expenditures
   
(58,377
)
 
(69,624
)
Other
   
(650
)
 
635
 
               
Net Cash Used in Investing Activities
   
(81,824
)
 
(64,996
)
               
Cash Flows from Financing Activities:
             
Net Borrowings From (Repayments of) Lines of Credit
   
28,300
   
(20,800
)
Proceeds from Issuance of Long-Term Debt
   
41,400
   
10,000
 
Principal Repayments of Long-Term Debt
   
(2,405
)
 
(22,810
)
Dividends on Common Stock
   
(13,116
)
 
(11,872
)
Proceeds from Sale of Common Stock
   
4,271
   
16,368
 
Payments for Issuance of Long-Term Debt
   
(1,270
)
 
(289
)
Premium for Early Retirement of Long-Term Debt
   
-
   
(184
)
Redemption of Preferred Stock
   
-
   
(1,690
)
               
Net Cash Provided by (Used in) Financing Activities
   
57,180
   
(31,277
)
               
Net Increase in Cash and Cash Equivalents
   
75
   
1,389
 
Cash and Cash Equivalents at Beginning of Period
   
4,884
   
5,272
 
               
Cash and Cash Equivalents at End of Period
 
$
4,959
 
$
6,661
 
               
               
Supplemental Disclosures of Non-Cash Investing Activities:
             
Capital Expenditures unpaid as of September 30.
 
$
5,134
 
$
8,015
 
Proceeds from sale of Investment in Affiliate not yet received.
 
$
1,450
 
$
-
 
               
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)
       
   
September 30,
   
December 31,
 
     
2006
 
 
2005
 
Assets
             
               
Property, Plant and Equipment:
             
Utility Plant, at original cost
 
$
1,067,676
 
$
1,030,028
 
Accumulated Depreciation
   
(253,021
)
 
(241,242
)
Nonutility Property and Equipment, at cost
   
104,999
   
94,623
 
Accumulated Depreciation
   
(7,721
)
 
(6,061
)
               
Property, Plant and Equipment - Net
   
911,933
   
877,348
 
               
Investments:
             
Available-for-Sale Securities
   
6,030
   
5,642
 
Restricted
   
31,031
   
8,234
 
Investment in Affiliates
   
1,694
   
2,094
 
               
Total Investments
   
38,755
   
15,970
 
               
Current Assets:
             
Cash and Cash Equivalents
   
4,959
   
4,884
 
Accounts Receivable
   
81,925
   
138,139
 
Unbilled Revenues
   
12,290
   
59,066
 
Provision for Uncollectibles
   
(5,353
)
 
(5,871
)
Natural Gas in Storage, average cost
   
150,973
   
117,542
 
Materials and Supplies, average cost
   
2,976
   
4,758
 
Deferred Income Taxes - Net
   
-
   
624
 
Prepaid Taxes
   
22,355
   
13,061
 
Derivatives - Energy Related Assets
   
39,278
   
24,408
 
Other Prepayments and Current Assets
   
6,279
   
5,415
 
               
Total Current Assets
   
315,682
   
362,026
 
               
Regulatory and Other Noncurrent Assets:
             
Regulatory Assets
   
142,425
   
122,486
 
Prepaid Pension
   
28,341
   
30,075
 
Derivatives - Energy Related Assets
   
30,035
   
5,080
 
Derivatives - Other
   
527
   
-
 
Unamortized Debt Issuance Costs
   
8,028
   
7,147
 
Contract Receivables
   
13,408
   
14,766
 
Other
   
6,951
   
6,814
 
               
Total Regulatory and Other Noncurrent Assets
   
229,715
   
186,368
 
               
Total Assets
 
$
1,496,085
 
$
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)
       
   
September 30,
   
December 31,
 
     
2006
 
 
2005
 
Capitalization and Liabilities
             
               
Common Equity:
             
Common Stock
 
$
36,551
 
$
36,228
 
Premium on Common Stock
   
236,834
   
231,861
 
Accumulated Other Comprehensive Income (Loss)
   
8,156
   
(8,801
)
Retained Earnings
   
151,089
   
134,357
 
               
Total Common Equity
   
432,630
   
393,645
 
               
Long-Term Debt
   
358,078
   
319,066
 
               
Total Capitalization
   
790,708
   
712,711
 
               
Minority Interest
   
483
   
394
 
               
Current Liabilities:
             
Notes Payable
   
175,600
   
147,300
 
Current Maturities of Long-Term Debt
   
2,347
   
2,364
 
Accounts Payable
   
52,294
   
179,023
 
Customer Deposits and Credit Balances
   
38,119
   
12,534
 
Environmental Remediation Costs
   
19,153
   
18,165
 
Taxes Accrued
   
3,575
   
7,456
 
Derivatives - Energy Related Liabilities
   
45,094
   
21,957
 
Deferred Income Taxes - Net
   
14,153
   
-
 
Deferred Contract Revenues
   
5,420
   
5,077
 
Dividends Payable
   
6,579
   
-
 
Interest Accrued
   
4,922
   
6,258
 
Other Current Liabilities
   
3,399
   
6,078
 
               
Total Current Liabilities
   
370,655
   
406,212
 
               
Deferred Credits and Other Noncurrent Liabilities:
             
Deferred Income Taxes - Net
   
171,885
   
169,423
 
Investment Tax Credits
   
2,551
   
2,795
 
Pension and Other Postretirement Benefits
   
18,613
   
18,941
 
Asset Retirement Obligations
   
23,676
   
22,588
 
Environmental Remediation Costs
   
42,985
   
42,489
 
Derivatives - Energy Related Liabilities
   
12,086
   
4,895
 
Derivatives - Other
   
507
   
491
 
Regulatory Liabilities
   
55,230
   
54,002
 
Other
   
6,706
   
6,771
 
               
Total Deferred Credits
             
and Other Noncurrent Liabilities
   
334,239
   
322,395
 
               
Commitments and Contingencies (Note 11)
             
               
Total Capitalization and Liabilities
 
$
1,496,085
 
$
1,441,712
 
               
The accompanying notes are an integral part of the consolidated financial statements.
             
 

 
SJI -7


NOTES TO 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, annual report.

Equity Investments — Marketable equity securities that are purchased as long-term investments are classified as Available-for-Sale Securities and carried at their fair value on our consolidated balance sheets. Any unrealized gains or losses are included in Accumulated Other Comprehensive Income (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 (GAAP). 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 to customers. For SJG and South Jersey Energy Company (SJE) retail customers that are not billed at the end of the 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. We 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 pursuant to 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 (See Note 12 - Subsequent Events). 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 nine months of 2006. Except for retirements outside of 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 of $0.2 million and $0.4 million for the three months ended September 30, 2006 and 2005, respectively. For the nine months ended September 30, 2006 and 2005, SJI capitalized interest of $1.0 million in each period.

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 nine months ended September 30, 2006 and the year ended December 31, 2005, no significant impairments were identified.

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, through SJRG 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 September 30, 2006 and December 31, 2005, SJG had $14.0 million and $(0.5) million of costs (benefits), respectively, included in its BGSS related to open financial contracts (See Regulatory Assets & Liabilities).

SJI -9



 
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. We recognize ineffective portions of cash flow hedges immediately in earnings. 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. For the three and nine months ended September 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 Income (Loss) will be reclassified into earnings when the forecasted transaction occurs, or when it is not probable that it will occur. During the nine months ended September 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 Income (Loss) at September 30, 2006, we expect $4.4 million to be recorded as an increase in revenues in the next twelve months. As of September 30, 2006, hedges for future forecasted transactions exist into 2008.

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 $(0.7) million, and $(3.5) million in earnings during the three months ended September 30, 2006 and 2005, respectively, which are included with realized gains and losses in Operating Revenues — Nonutility. For the nine months ended September 30, 2006 and 2005, we recorded the net unrealized pre-tax gain of $3.1 million and a net unrealized pre-tax loss of $(1.4) 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.” The above presentation has no effect on operating income or net income.

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

SJI -10



 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 September 30, 2006, the net market values of these swaps were not significant. As of December 31, 2005, the market values of these swaps were $(0.5) million which represent the amounts we would have had to pay to the counterparties if the contracts had been terminated on that date. We include this balance on the consolidated balance sheets under Derivatives — Other as of December 31, 2005. As of September 30, 2006 and 2005, we determined that the swaps were highly effective; therefore, we recorded the changes in fair value of the swaps, net of taxes, in Accumulated Other Comprehensive Income (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.

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 nine months ended September 30, 2006, and 2005. No stock appreciation rights have been issued under the plan. In the first nine months of 2006, and 2005, we granted 42,983 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.

SJI -11



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 September 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.

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

   
2006
 
2005
 
Officers
 
$
689
 
$
1,427
 
Directors
   
99
   
75
 
Total Cost
 
$
788
 
$
1,502
 
Capitalized
   
(86
)
 
(367
)
Net Expense
 
$
702
 
$
1,135
 

As of September 30, 2006, there was $1.3 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 1.3 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 change in stock-based compensation expense for the nine months ended September 30, 2006 resulting from the adoption of Statement No. 123(R) was not significant.

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

SJI -12




 
 
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, September 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 nine months ended September 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.

Regulatory Assets & Liabilities Regulatory Assets at September 30, 2006 and December 31, 2005, consisted of the following items (in thousands):
 
 
 
Years Remaining
as of
September 30, 2006
 
September 30,
2006
 
December 31,
2005
 
Environmental Remediation Costs:
             
Expended — Net
   
Various
 
$
14,833
 
$
9,350
 
Liability for Future Expenditures
   
Not Applicable
   
58,216
   
56,717
 
Income Taxes — Flowthrough
               
Depreciation
   
5
   
4,930
   
5,663
 
Deferred Fuel Costs — Net
   
Various
   
23,445
   
21,237
 
Deferred Asset Retirement Obligation Costs
   
Not Applicable
   
20,743
   
19,986
 
Deferred Postretirement Benefit Costs
   
6
   
2,362
   
2,646
 
Societal Benefit Costs
   
Various
   
5,682
   
2,691
 
Temperature Adjustment Clause Receivable
   
Various
   
9,269
   
1,003
 
Premium for Early Retirement of Debt
   
Various
   
1,573
   
1,694
 
Other
   
Not Applicable
   
1,372
   
1,499
 
Total Regulatory Assets
     
$
142,425
 
$
122,486
 

All significant regulatory assets are separately identified above and are or will be 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 included in 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 September 30, 2006, costs related to derivative contracts increased Deferred Fuel Costs - Net by $14.0 million. As of December 31, 2005, benefits related to derivative contracts reduced Deferred Fuel Costs - Net by $0.5 million.
 

SJI -13



Regulatory Liabilities at September 30, 2006 and December 31, 2005 consisted of the following items (in thousands):
 
 
 
September 30,
 
December 31,
 
 
 
2006
 
2005
 
Excess Plant Removal Costs
 
48,286
 
48,071
 
Overcollected State Taxes
 
 
4,151
 
 
4,025
 
Other
 
 
2,793
 
 
1,906
 
Total Regulatory Liabilities
 
$
55,230
 
$
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. The Overcollected State Taxes will be credited to the BGSS clause and returned to customers as a condition of a recent settlement (See Note 12- Subsequent Events). 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.

New Accounting Pronouncements — 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. Management is currently evaluating the impact that the adoption of this interpretation will have on the Company’s consolidated financial statements.

In September 2006, the FASB issued its Staff Position (FSP) on “Accounting for Planned Major Maintenance Activities”. This FSP prohibits the use of the accrue-in-advance method of accounting for planned major maintenance activities in annual and interim financial reporting periods. This FSP is effective the first fiscal year beginning after December 15, 2006. Management does not anticipate that this FSP will have a material affect on the Company’s consolidated financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. This statement is effective in fiscal years beginning after November 15, 2007. Management is currently evaluating the impact that the adoption of this statement will have on the Company’s consolidated financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”. The new statement requires a calendar year-end company with publicly traded equity securities that sponsors a postretirement benefit plan to fully recognize, as an asset or liability, the overfunded or underfunded status of its benefit plans in its 2006 year-end balance sheet and recognize changes in the funded status in the year in which the changes occur (reported in Other Comprehensive Income (Loss)). The new standard will also require a company to measure its plan assets and benefit obligations as of its year-end balance sheet date, effective for fiscal years ending after December 15, 2008. Management is currently evaluating the impact that the adoption of this statement will have on the Company’s consolidated financial statements; however, this statement does not have an impact on the computation of benefit expense recognized in the income statement.

Reclassifications — Certain amounts from prior years have been reclassified to conform to the current year presentation. In addition $6.3 million of declared dividends were removed from Dividends on Common Stock within financing activities, with an offsetting decrease in Changes in Accounts Payable and Other Accrued Liabilities within operating activities in the Statement of Cash Flows for the nine months ended September 30, 2005. These amounts did not impact previously reported revenue, net income or earnings per share and are considered immaterial to the overall presentation of our consolidated financial statements.

SJI -14



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 nine months ended September 30, were (in thousands):
 
   
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
     
2006 
 
 
2005 
 
 
2006 
 
 
2005 
 
Loss before Income Taxes:
                 
Sand Mining
 
$
(218
)
$
(237
)
$
(447
)
$
(708
)
Fuel Oil
   
(11
)
 
(58
)
 
(134
)
 
(88
)
Income Tax Benefits
   
80
   
104
   
203
   
279
 
Loss from Discontinued Operations — Net
 
$
(149
)
$
(191
)
$
(378
)
$
(517
)
Earnings Per Common Share from
                 
Discontinued Operations — Net:
                 
Basic and Diluted
 
$
(0.005
)
$
(0.007
)
$
(0.013
)
$
(0.018
)

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 $1.5 million, resulting in an after-tax gain of $0.2 million. 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 began commercial operation in August 2006. Construction on an additional 1,900-kilowatt system will begin in the fourth quarter of 2006 and is expected to be operational in the fourth quarter of 2007.

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 fourth quarter of 2006.

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:
 
 
 
September 30,
2006 
 
Beginning Balance, January 1
   
28,982,440
 
New Issues During Period:
     
Dividend Reinvestment Plan
   
156,980
 
Stock-Based Compensation Plan
   
101,009
 
Ending Balance, September 30
   
29,240,429
 


SJI -15



We recorded the par value ($1.25 per share) of stock issued during the nine months ended September 30, 2006 in Common Stock and recorded the net excess over par value of approximately $4.9 million in 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 94,735 and 214,427 shares for the three months, and 75,537 and 222,136 shares for the nine months ended September 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 September 30, 2006, SJI reserved 1,369,042 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 3.74% as of September 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 3.40% as of September 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 September 30, 2006, the escrowed proceeds, including interest earned totaled $18.5 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 September 30, 2006 and December 31, 2005, the balance of this account was $12.5 million and $8.2 million, respectively, due to changes in the market value of outstanding contracts.

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.

SJI -16


 
Information about SJI's operations in different operating segments for the three and nine months ended September 30 is presented below (in thousands):

  
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
 
 
 
 
 
 
2006
 
 
2005
 
 
2006
 
 
2005
 
Operating Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gas Utility Operations
 
$
87,714
 
$
89,702
 
$
469,802
 
$
390,322
 
Wholesale Gas Operations
 
 
9,245
 
 
6,340
 
 
29,891
 
 
21,182
 
Retail Gas and Other Operations
 
 
26,044
 
 
33,422
 
 
119,816
 
 
148,969
 
Retail Electric Operations
 
 
14,263
 
 
19,099
 
 
38,928
 
 
58,643
 
On-Site Energy Production
 
 
7,955
 
 
7,964
 
 
19,447
 
 
18,530
 
Appliance Service Operations
 
 
3,611
 
 
3,457
 
 
10,961
 
 
10,650
 
Corporate and Services
 
 
2,910
 
 
23
 
 
9,099
 
 
1,072
 
Subtotal
 
 
151,742
 
 
160,007
 
 
697,944
 
 
649,368
 
Intersegment Sales
 
 
(18,681
)
 
(3,036
)
 
(44,376
)
 
(9,788
)
Total Operating Revenues
 
$
133,061
 
$
156,971
 
$
653,568
 
$
639,580
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating Income:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gas Utility Operations
 
$
2,907
 
$
3,602
 
$
55,647
 
$
56,896
 
Wholesale Gas Operations
 
 
3,449
 
 
2,866
 
 
12,975
 
 
9,707
 
Retail Gas and Other Operations
 
 
65
   
(234
)
 
(115)
   
2,056
 
Retail Electric Operations
 
 
1,412
   
253
   
3,494
   
1,114
 
On-Site Energy Production
 
 
2,621
   
3,104
   
6,128
   
6,617
 
Appliance Service Operations
 
 
426
   
688
   
1,676
   
2,476
 
Corporate and Services
 
 
88
   
(311
)
 
390
   
(757
)
Total Operating Income
 
$
10,968
   
9,968
   
80,195
   
78,109
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and Amortization:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gas Utility Operations
 
$
6,381
 
$
6,339
 
$
18,905
 
$
18,577
 
Wholesale Gas Operations
 
 
2
   
4
   
7
   
11
 
Retail Gas and Other Operations
 
 
2
   
3
   
7
   
9
 
Appliance Services Operations
 
 
60
   
47
   
175
   
129
 
On-Site Energy Production
 
 
622
   
459
   
1,544
   
1,360
 
Corporate and Services
 
 
60
   
27
   
173
   
80
 
Total Depreciation and Amortization
$
7,127
 
$
6,879
 
$
20,811
 
$
20,166
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Property Additions:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gas Utility Operations
 
$
10,416
 
$
23,543
 
$
39,665
 
$
53,838
 
Wholesale Gas Operations
 
 
-
 
 
2
 
 
3
 
 
2
 
Retail Gas and Other Operations
 
 
3
 
 
3
 
 
8
 
 
6
 
Appliance Service Operations
 
 
72
 
 
53
 
 
242
 
 
110
 
On-Site Energy Production
 
 
305
 
 
6,047
 
 
9,765
 
 
19,090
 
Corporate and Services
 
 
61
 
 
3
 
 
449
 
 
10
 
Total Property Additions
 
$
10,857
 
$
29,651
 
$
50,132
 
$
73,056
 


SJI -17



 
     
 September 30,
2006
   
December 31,
2005
 
     
Identifiable Assets:
 
 
 
 
 
 
 
 
 
 
Gas Utility Operations
   
$
1,196,422
       
$
1,167,398
 
Wholesale Gas Operations
     
150,562
         
124,922
 
Retail Gas and Other Operations
     
38,612
         
50,880
 
Retail Electric Operations
     
3,238
         
7,751
 
Appliance Service Operations
     
15,103
         
13,624
 
On-Site Energy Production
     
121,344
         
105,822
 
Discontinued Operations
     
450
         
408
 
Subtotal
     
1,525,731
         
1,470,805
 
Corporate and Services
     
94,586
         
70,379
 
Intersegment Assets
     
(124,232
)
       
(99,472
)
Total Identifiable Assets
   
$
1,496,085
       
$
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%.
 
BPU 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 final BPU order accepting the recommendations of the auditor with some minor revisions was signed in August 2006. The recommendations contained in these audits have no material effect on these 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. Costs incurred to date are not considered significant. 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 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.

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In December 2005, SJG made a filing proposing to implement a Conservation and Usage Adjustment (CUA) Clause, on a five-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. In October 2006, the BPU approved the CUA as a three year pilot program and renamed it the Conservation Incentive Program (CIP) (See Note 12).

In March 2006, the BPU approved a global settlement, effective April 1, 2006, fully resolving SJG’s September 2004 SBC filing, 2003-2004 TAC filing, 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. Total storage-related gains for the three and nine months ended September 30, 2006 were $0.8 million and $1.6 million, respectively.

In June 2006, SJG made its annual BGSS filing with the BPU requesting a $19.7 million or 4.6% 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.  Due to the continuing decrease in wholesale gas costs subsequent to our June 2006 filing, an agreement to utilize gas from a released storage facility for this upcoming winter, and a credit to gas costs for previously overcollected state taxes (See Notes 1 and 12), the BPU approved a $38.7 million, or 8.6%, annual decrease in gas cost recoveries in September 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 $2.4 million at September 30, 2006 is recoverable in rates. SJG is amortizing this amount over 15 years, which started January 1998.

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

SJI -19


 

 
Pension Benefits
 
 Three Months Ended
Nine Months Ended
 
September 30,
September 30,
 
   
2006
   
2005
   
2006
   
2005
 
Service Cost
 
$
793
 
$
809
 
$
2,377
 
$
2,428
 
Interest Cost
   
1,804
   
1,686
   
5,411
   
5,056
 
Expected Return on Plan Assets
   
(2,309
)
 
(2,142
)
 
(6,928
)
 
(6,427
)
Amortization of Loss and Other
   
710
   
750
   
2,131
   
2,250
 
Net Periodic Benefit Cost
   
998
   
1,103
   
2,991
   
3,307
 
Capitalized Benefit Costs
   
(319
)
 
(314
)
 
(956
)
 
(943
)
Net Periodic Benefit Expense
 
$
679
 
$
789
 
$
2,035
 
$
2,364
 
 
                         
 
Other Postretirement Benefits
 
 Three Months Ended
 Nine Months Ended
 
September 30,
September 30,
     
2006
   
2005
   
2006
   
2005
 
Service Cost
 
$
302
 
$
227
 
$
698
 
$
681
 
Interest Cost
   
1,024
   
539
   
1,966
   
1,616
 
Expected Return on Plan Assets
   
(645
)
 
(399
)
 
(1,343
)
 
(1,198
)
Amortization of Loss and Other
   
291
   
34
   
351
   
103
 
Net Periodic Benefit Cost
   
972
   
401
   
1,672
   
1,202
 
Capitalized Benefit Costs
   
(398
)
 
(124
)
 
(594
)
 
(373
)
Net Periodic Benefit Expense
 
$
574
   
277
 
$
1,078
 
$
829
 
 
Capitalized benefit costs reflected in the table above relate to SJG’s construction program.
 
Future Benefit Payments — The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid during the following years (in thousands):
 
 
 
Pension Benefits 
 
Other
Postretirement
Benefits 
 
2006
 
$
5,937
 
$
2,262
 
2007
   
6,028
   
2,490
 
2008
   
6,132
   
2,636
 
2009
   
6,256
   
2,733
 
2010
   
6,369
   
2,891
 
2011-2015
   
35,830
   
14,537
 


Contributions — SJI does not expect to make any contributions to its pension plan in 2006; however, changes in future investment performance and discount rates may ultimately result in a contribution during the fourth quarter. SJG has a regulatory obligation to contribute approximately $3.6 million annually to its other postretirement benefit plans’ trusts, less costs incurred directly by the company.

9.    RETAINED EARNINGS:

SJG is restricted as to the amount of cash dividends or other distributions that may be paid on its common stock by an order issued by the BPU in July 2004, that granted SJG an increase in base rates. Per the order, SJG is required to maintain total common equity of no less than $289.2 million. SJG’s total common equity balance was $353.7 million at September 30, 2006.

Various loan agreements also contain potential restrictions regarding the amount of cash dividends or other distributions that SJG may pay on its common stock. As of September 30, 2006, SJG’s loan restrictions did not affect the amount that may be distributed from either SJG’s or SJI’s retained earnings.

SJI -20