SJI-3.31.13-10Q

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 March 31, 2013
OR
o
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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x   No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer   x
 
Accelerated filer      o
Non-accelerated filer     o (Do not check if a smaller reporting company)
 
Smaller reporting company      o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x
As of May 1, 2013 there were 31,960,311 shares of the registrant’s common stock outstanding.




TABLE OF CONTENTS
 
 
PageNo.
 
 
PART I
FINANCIAL INFORMATION
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
PART II
OTHER INFORMATION
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 6.
 
 
 


Table of Contents

Item 1. Unaudited Condensed Consolidated Financial Statements
 
SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In Thousands Except for Per Share Data)
 
Three Months Ended
March 31,
 
2013
 
2012
Operating Revenues:
 
 
 
Utility
$
173,651

 
$
179,202

Nonutility
81,980

 
95,630

Total Operating Revenues
255,631

 
274,832

Operating Expenses:
 

 
 

Cost of Sales - (Excluding depreciation)
 

 
 

 - Utility
77,156

 
86,265

 - Nonutility
75,145

 
70,603

Operations
32,689

 
27,782

Maintenance
3,422

 
3,192

Depreciation
11,407

 
9,604

Energy and Other Taxes
3,833

 
3,878

Total Operating Expenses
203,652

 
201,324

Operating Income
51,979

 
73,508

 
 
 
 
Other Income and Expense
3,869

 
1,873

Interest Charges
(4,708
)
 
(5,493
)
Income Before Income Taxes
51,140

 
69,888

Income Taxes
(7,772
)
 
(15,884
)
Equity in (Loss) Earnings of Affiliated Companies
(31
)
 
207

Income from Continuing Operations
43,337

 
54,211

Loss from Discontinued Operations - (Net of tax benefit)
(471
)
 
(136
)
Net Income
$
42,866

 
$
54,075

 
 
 
 
Basic Earnings Per Common Share:
 

 
 

Continuing Operations
$
1.365

 
$
1.792

Discontinued Operations
(0.015
)
 
(0.004
)
Basic Earnings Per Common Share
$
1.350

 
$
1.788

 
 
 
 
Average Shares of Common Stock Outstanding - Basic
31,757

 
30,249

 
 
 
 
Diluted Earnings Per Common Share:
 

 
 

Continuing Operations
$
1.362

 
$
1.788

Discontinued Operations
(0.014
)
 
(0.005
)
Diluted Earnings Per Common Share
$
1.348

 
$
1.783

 
 
 
 
Average Shares of Common Stock Outstanding - Diluted
31,811

 
30,323

 
 
 
 
Dividends Declared per Common Share
$
0.443

 
$
0.403


The accompanying notes are an integral part of the unaudited condensed consolidated financial statements
 
 
 
 

1

Table of Contents

SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(In Thousands)
 
 
Three Months Ended
March 31,
 
2013
 
2012
Net Income
$
42,866

 
$
54,075

 
 
 
 
Other Comprehensive Income (Loss), Net of Tax:*
 

 
 

 
 
 
 
Unrealized (Loss) Gain on Available-for-Sale Securities
(274
)
 
351

Unrealized Gain on Derivatives - Other
66

 
190

Other Comprehensive Income (Loss) of Affiliated Companies
5,014

 
(2,282
)
 
 
 
 
Other Comprehensive Income (Loss) - Net of Tax*
4,806

 
(1,741
)
 
 
 
 
Comprehensive Income
$
47,672

 
$
52,334

 
 
 
 

* Determined using a combined statutory tax rate of 41%.

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

2

Table of Contents

SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Thousands)
 
 
Three Months Ended March 31,
 
2013
 
2012
Net Cash Provided by Operating Activities
$
55,886

 
$
42,159

 
 
 
 
Cash Flows from Investing Activities:
 

 
 

Capital Expenditures
(40,604
)
 
(45,387
)
Net Proceeds from Sale (Purchase) of Restricted Investments in Margin Account
7,931

 
(4,538
)
Investment in Long-Term Receivables
(1,947
)
 
(1,480
)
Proceeds from Long-Term Receivables
2,402

 
2,293

Purchase of Company Owned Life Insurance
(372
)
 

Investment in Affiliate
(1,076
)
 
(16,286
)
Advances on Notes Receivable - Affiliate
(498
)
 
(10,011
)
Repayment of Notes Receivable - Affiliate
58,249

 
3,796

Other

 
(567
)
 
 
 
 
Net Cash Provided by (Used in) Investing Activities
24,085

 
(72,180
)
 
 
 
 
Cash Flows from Financing Activities:
 

 
 

Net (Repayments of) Borrowings from Short-Term Credit Facilities
(90,500
)
 
23,300

Payments for Issuance of Long-Term Debt
(11
)
 
(172
)
Proceeds from Sale of Common Stock
7,244

 
2,902

 
 
 
 
Net Cash (Used in) Provided by Financing Activities
(83,267
)
 
26,030

 
 
 
 
Net Decrease in Cash and Cash Equivalents
(3,296
)
 
(3,991
)
Cash and Cash Equivalents at Beginning of Period
4,638

 
7,538

 
 
 
 
Cash and Cash Equivalents at End of Period
$
1,342

 
$
3,547


The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

3

Table of Contents

SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In Thousands)
 
 
March 31,
2013
 
December 31,
2012
Assets
 
 
 
Property, Plant and Equipment:
 
 
 
Utility Plant, at original cost
$
1,693,041

 
$
1,658,790

Accumulated Depreciation
(378,765
)
 
(373,199
)
Nonutility Property and Equipment, at cost
331,699

 
328,638

Accumulated Depreciation
(39,423
)
 
(36,208
)
 
 
 
 
Property, Plant and Equipment - Net
1,606,552

 
1,578,021

 
 
 
 
Investments:
 

 
 

Available-for-Sale Securities
7,892

 
7,538

Restricted
9,973

 
17,903

Investment in Affiliates
77,230

 
75,825

 
 
 
 
Total Investments
95,095

 
101,266

 
 
 
 
Current Assets:
 

 
 

Cash and Cash Equivalents
1,342

 
4,638

Accounts Receivable
279,061

 
195,293

Unbilled Revenues
42,707

 
40,938

Provision for Uncollectibles
(6,953
)
 
(5,924
)
Notes Receivable - Affiliate
39,357

 
39,495

Natural Gas in Storage, average cost
43,466

 
55,517

Materials and Supplies, average cost
2,609

 
2,618

Prepaid Taxes
1,796

 
26,187

Derivatives - Energy Related Assets
22,330

 
24,242

Other Prepayments and Current Assets
15,903

 
11,833

 
 
 
 
Total Current Assets
441,618

 
394,837

 
 
 
 
Regulatory and Other Noncurrent Assets:
 

 
 

Regulatory Assets
335,089

 
352,656

Derivatives - Energy Related Assets
8,461

 
12,297

Unamortized Debt Issuance Costs
8,033

 
8,226

Notes Receivable-Affiliate
65,535

 
117,188

Contract Receivables
13,990

 
13,985

Other
53,898

 
52,964

 
 
 
 
Total Regulatory and Other Noncurrent Assets
485,006

 
557,316

 
 
 
 
Total Assets
$
2,628,271

 
$
2,631,440

 
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

4

Table of Contents

SOUTH JERSEY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In Thousands)
 
 
March 31,
2013
 
December 31,
2012
Capitalization and Liabilities
 
 
 
Equity:
 
 
 
Common Stock
$
39,836

 
$
39,567

Premium on Common Stock
353,530

 
345,807

Treasury Stock (at par)
(167
)
 
(182
)
Accumulated Other Comprehensive Loss
(26,299
)
 
(31,105
)
Retained Earnings
410,891

 
382,127

 
 
 
 
Total Equity
777,791

 
736,214

 
 
 
 
Long-Term Debt
601,400

 
601,400

 
 
 
 
Total Capitalization
1,379,191

 
1,337,614

 
 
 
 
Current Liabilities:
 

 
 

Notes Payable
248,400

 
338,900

Current Portion of Long-Term Debt
25,000

 
25,000

Accounts Payable
217,517

 
193,331

Customer Deposits and Credit Balances
16,005

 
17,757

Environmental Remediation Costs
23,215

 
21,026

Taxes Accrued
8,918

 
2,156

Derivatives - Energy Related Liabilities
20,222

 
23,828

Deferred Income Taxes - Net
8,906

 
10,812

Dividends Payable
14,102

 

Interest Accrued
6,142

 
6,635

Pension Benefits
1,236

 
1,272

Other Current Liabilities
7,342

 
11,127

 
 
 
 
Total Current Liabilities
597,005

 
651,844

 
 
 
 
Deferred Credits and Other Noncurrent Liabilities:
 

 
 

Deferred Income Taxes - Net
300,611

 
289,489

Investment Tax Credits
553

 
618

Pension and Other Postretirement Benefits
94,710

 
105,168

Environmental Remediation Costs
88,638

 
91,072

Asset Retirement Obligations
39,754

 
39,385

Derivatives - Energy Related Liabilities
4,301

 
5,403

Derivatives - Other
12,062

 
13,462

Regulatory Liabilities
73,598

 
56,517

Finance Obligation
21,388

 
21,646

Other
16,460

 
19,222

 
 
 
 
Total Deferred Credits and Other Noncurrent Liabilities
652,075

 
641,982

 
 
 
 
Commitments and Contingencies  (Note 11)


 


 
 
 
 
Total Capitalization and Liabilities
$
2,628,271

 
$
2,631,440

 
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

5

Table of Contents

 Notes to Unaudited Condensed Consolidated Financial Statements

1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

GENERAL - South Jersey Industries, Inc. (SJI or the Company) currently provides a variety of energy related products and services primarily through the following subsidiaries:

South Jersey Gas Company (SJG) is a regulated natural gas utility. SJG distributes natural gas in the seven southernmost counties of New Jersey.

South Jersey Energy Company (SJE) acquires and markets natural gas and electricity to retail end users and provides total energy management services to commercial and industrial customers.

Marina Energy, LLC (Marina) develops and operates on-site energy-related projects.

South Jersey Resources Group, LLC (SJRG) markets natural gas storage, commodity and transportation assets on a wholesale basis in the mid-Atlantic, Appalachian and southern states.

South Jersey Energy Service Plus, LLC (SJESP) services residential and small commercial HVAC systems, provides plumbing services and services appliances under warranty via a subcontractor arrangement as well as on a time and materials basis, and the installation of small commercial HVAC systems.

South Jersey Exploration, LLC (SJEX) owns oil, gas and mineral rights in the Marcellus Shale region of Pennsylvania.

BASIS OF PRESENTATION — The condensed consolidated financial statements include the accounts of SJI, its wholly-owned subsidiaries and subsidiaries in which we have a controlling interest. We eliminate all significant intercompany accounts and transactions. In management’s opinion, the condensed consolidated financial statements reflect all normal and recurring adjustments needed to fairly present SJI’s financial position,operating results and cash flows at the dates and for the periods presented. SJI’s 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. As permitted by the rules and regulations of the Securities and Exchange Commission (SEC), the accompanying unaudited condensed consolidated financial statements contain certain condensed financial information and exclude certain footnote disclosures normally included in annual audited consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). These financial statements should be read in conjunction with SJI’s 2012 Annual Report on Form 10-K for a more complete discussion of the Company’s accounting policies and certain other information.

Certain reclassifications have been made to the prior period segment disclosures to conform to the current period presentation. In all periods presented, net receivables between the Discontinued Operations segment and the Corporate and Services segment have been reclassified in the Identifiable Assets Segment disclosure in Note 6.

REVENUE AND THROUGHPUT-BASED TAXES — SJG collects certain revenue-based energy taxes from its customers. Such taxes include New Jersey State Sales Tax and Public Utilities Assessment (PUA). SJG also collects a throughput-based energy tax from customers in the form of a Transitional Energy Facility Assessment (TEFA). State sales tax is recorded as a liability when billed to customers and is not included in revenue or operating expenses. TEFA and PUA are included in both utility revenue and cost of sales and totaled $2.2 million and $2.5 million for the three months ended March 31, 2013 and 2012, respectively. The TEFA is subject to a planned phase-out which decreases the assessment in increments of 25% in 2012 and 2013 and is eliminated after December 31, 2013.
 
GAS EXPLORATION AND DEVELOPMENT - The Company capitalizes all costs associated with gas property acquisition, exploration and development activities under the full cost method of accounting. Capitalized costs include costs related to unproved properties, which are not amortized until proved reserves are found or it is determined that the unproved properties are impaired. All costs related to unproved properties are reviewed quarterly to determine if impairment has occurred. No impairment was recorded during the three months ended March 31, 2013. During the three months ended March 31, 2012, the Company recorded $1.1 million of impairment charges within Other Income and Expense on the condensed consolidated statement of income due to a reduction in the expected cash flows to be received from certain shallow wells in the Marcellus region. As of March 31, 2013 and December 31, 2012, $8.9 million and $9.0 million, respectively, related to interests in proved and unproved properties in Pennsylvania, net of amortization, is included with Nonutility Property and Equipment and Other Noncurrent Assets on the condensed consolidated balance sheets.

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Table of Contents

 
TREASURY STOCK – SJI uses the par value method of accounting for treasury stock. As of March 31, 2013 and December 31, 2012, SJI held 133,687 and 145,414 shares of treasury stock, respectively. These shares are related to deferred compensation arrangements where the amounts earned are held in the stock of SJI.

INCOME TAXES — Deferred income taxes are provided for all significant temporary differences between the book and taxable bases of assets and liabilities in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 740 - “Income Taxes”.  A valuation allowance is established when it is determined that it is more likely than not that a deferred tax asset will not be realized. Investment tax credits related to renewable energy facilities of the non-regulated entities are recognized on the flow through method, which may result in variations in the customary relationship between income taxes and pre-tax income for interim periods.

NEW ACCOUNTING PRONOUNCEMENTS — Other than as described below, no new accounting pronouncement issued or effective during 2013 and 2012 had, or is expected to have, a material impact on the condensed consolidated financial statements.

In January 2012, the FASB issued Accounting Standards Update (ASU) 2011-11, Enhanced Disclosure Requirements Concerning Offsetting of Financial Assets and Financial Liabilities. This ASU amends ASC 210-20 to add disclosure requirements in respect of the offsetting of financial assets and financial liabilities. In February 2013, the FASB issued ASU 2013-01 Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which amends and clarifies the scope of the balance sheet offsetting disclosures required through ASU 2011-11. The new guidance is effective for fiscal years beginning on or after January 1, 2013. The adoption of this guidance modified the disclosures around derivative instruments, but did not have an impact on the Company's financial statement results.

In February 2013, the FASB issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This ASU expands the disclosure requirements in ASC 220 and requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective lines in net income. The ASU requires an entity to present information about significant items reclassified out of accumulated other comprehensive income by component either on the face of the statement where net income is presented, or as a separate disclosure in the notes to the financial statements. The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012. The adoption of this guidance modified the disclosures around accumulated other comprehensive income, but did not have an impact on the Company's financial statement results.


2.
STOCK-BASED COMPENSATION PLAN:

Under the Amended and Restated 1997 Stock-Based Compensation Plan, no more than 2,000,000 shares in the aggregate may be issued to SJI’s officers (Officers), non-employee directors (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 three months ended March 31, 2013 and 2012.  No stock appreciation rights have been issued under the plan. During the three months ended March 31, 2013 and 2012, SJI granted 56,464 and 40,709 restricted shares to Officers and other key employees, respectively.   These restricted shares vest over a three-year period and are subject to SJI achieving certain market and earnings-based performance targets as compared to a peer group average, which can cause the actual amount of shares that ultimately vest to range from between 0% to 150% of the original share units granted. Grants containing market-based performance targets have been issued in each of the last three years and use SJI's total shareholder return (TSR) relative to a peer group to measure performance. Beginning with 2012, grants containing earnings-based targets have also been issued. These new grants are based on SJI's earnings per share (EPS) growth rate relative to a peer group to measure performance. During the three months ended March 31, 2013 and 2012, SJI granted 12,285 and 9,904 restricted shares, respectively, to Directors.  Shares issued to Directors in 2011 vest over a three-year service period and contain no performance conditions. Shares issued to Directors in 2012 and 2013 vest over twelve months and contain no performance conditions. As a result, 100% of the shares granted generally vest.

See Note 2 to the Consolidated Financial Statements in Item 8 of SJI’s Annual Report on Form 10-K as of December 31, 2012 for the related accounting policy.


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Table of Contents

The following table summarizes the nonvested restricted stock awards outstanding at March 31, 2013 and the assumptions used to estimate the fair value of the awards:

 
Grant Date
 
Shares Outstanding
 
Fair Value Per Share
 
Expected Volatility
 
Risk-Free Interest Rate
Officers & Key Employees -
Jan. 2011 - TSR
 
40,227

 
$
50.940

 
27.5
%
 
1.01
%
 
Jan. 2012 - TSR
 
20,389

 
$
51.230

 
22.5
%
 
0.43
%
 
Jan. 2012 - EPS
 
20,389

 
$
56.930

 
N/A

 
N/A

 
Jan. 2013 - TSR
 
28,232

 
$
44.380

 
21.1
%
 
0.40
%
 
Jan. 2013 - EPS
 
28,232

 
$
51.180

 
N/A

 
N/A

 

 


 
 
 
 
 
 
Directors -
Jan. 2011
 
7,332

 
$
52.940

 

 

 
Jan. 2013
 
12,285

 
$
51.740

 

 


Expected volatility is based on the actual volatility of SJI’s share price over the preceding three-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’ and other key employees’ restricted shares. As notional dividend equivalents are credited to the holders, 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 dividends are paid or credited to the holder during the requisite service period, the fair value of these awards are equal to the market value of the shares on the date of grant.

The following table summarizes the total stock-based compensation cost for the three months ended March 31, 2013 and 2012 (in thousands):

 
Three Months Ended
March 31,
 
 
2013
2012
 
Officers & Key Employees
$
573

$
523

 
Directors
191

127

 
Total Cost
764

650

 
 
 
 
 
Capitalized
(63
)
(58
)
 
Net Expense
$
701

$
592

 

As of March 31, 2013, there was $4.8 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under the restricted stock plans. That cost is expected to be recognized over a weighted average period of 2.0 years.

The following table summarizes information regarding restricted stock award activity during the three months ended March 31, 2013, excluding accrued dividend equivalents:

 
Officers &Other Key Employees
 
Directors
 
Weighted
Average
Fair Value
Nonvested Shares Outstanding, January 1, 2013
81,005

 
27,688

 
$
51.292

Granted
56,464

 
12,285

 
$
48.488

Vested

 
(20,356
)
 
$
45.809

Nonvested Shares Outstanding, March 31, 2013
137,469

 
19,617

 
$
50.775



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During the three months ended March 31, 2013 and 2012, SJI awarded 66,077 shares to its Officers and other key employees, which had vested at December 31, 2012, at a market value of $3.3 million, and 33,322 shares, which had vested at December 31, 2011, at a market value of $1.9 million, respectively. Also, during the three months ended March 31, 2013 and 2012, SJI awarded 12,285 and 9,904 shares to its Directors at a market value of $0.6 million for each period. The Company has a policy of issuing new shares to satisfy its obligations under these plans; therefore, there are no cash payment requirements resulting from the normal operation of these plans. However, a change in control could result in such shares becoming nonforfeitable or immediately payable in cash.  At the discretion of the Officers, Directors and other key employees, the receipt of vested shares can be deferred until future periods.  These deferred shares are included in Treasury Stock on the condensed consolidated balance sheets.

3.
DISCONTINUED OPERATIONS AND AFFILATIONS:

Discontinued Operations consist of the environmental remediation activities related to the properties of South Jersey Fuel, Inc. (SJF) and the product liability litigation and environmental remediation activities related to the prior business of The Morie Company, Inc. (Morie). SJF is a subsidiary of Energy & Minerals, Inc. (EMI), an SJI subsidiary, which previously operated a fuel oil business. Morie is the former sand mining and processing subsidiary of EMI. EMI sold the common stock of Morie in 1996.

SJI conducts tests annually to estimate the environmental remediation costs for these properties.

Summarized operating results of the discontinued operations for the three months ended March 31, were (in thousands, except per share amounts):

 
Three Months Ended
March 31,
 
 
2013
 
2012
 
(Loss) Income Before Income Taxes:
 
 
 
 
Sand Mining
$
(72
)
 
$
(196
)
 
Fuel Oil
(652
)
 
(14
)
 
Income Tax Benefits
253

 
74

 
Loss from Discontinued Operations — Net
$
(471
)
 
$
(136
)
 
Earnings Per Common Share from
 
 
 
 
Discontinued Operations — Net:
 
 
 
 
Basic
$
(0.015
)
 
$
(0.004
)
 
Diluted
$
(0.014
)
 
$
(0.005
)
 

AFFILIATIONS — The following affiliated entities are accounted for under the equity method:

Energenic – US, LLC (Energenic) - Marina and a joint venture partner formed Energenic, in which Marina has a 50% equity interest. Energenic develops and operates on-site, self-contained, energy-related projects.

Potato Creek, LLC (Potato Creek) - SJI and a joint venture partner formed Potato Creek, in which SJI has a 30% equity interest.  Potato Creek owns and manages the oil, gas and mineral rights of certain real estate in Pennsylvania.

LVE Energy Partners, LLC (LVE) - In March 2013, substantially all of the assets of Marina's joint venture, LVE, an entity in which Marina has a 50% equity interest, were sold. As a result of the transaction, Marina received cash proceeds of $57.6 million. See Note 11.

During the first three months of 2013 and 2012, the Company made investments in, and provided net advances to, unconsolidated affiliates, excluding the cash proceeds from LVE as discussed above, of $1.1 million and $22.5 million, respectively. The purpose of these investments and advances was to cover certain project related costs of affiliates and to develop landfill gas-fired electric production facilities, solar and thermal energy projects.  As of March 31, 2013 and December 31, 2012, the outstanding balance on these Notes Receivable – Affiliate was $104.9 million and $156.7 million, respectively. Approximately $99.4 million of these notes are secured by property, plant and equipment of the affiliates, accrue interest at 7.5% and are to be repaid through 2025. The remaining $5.5 million of these notes are unsecured, and are either non-interest bearing or accrue interest at variable rates and are to be repaid when the affiliate secures permanent financing.


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SJI holds significant variable interests in these entities but is not the primary beneficiary. Consequently, these entities are accounted for under the equity method because SJI does not have both a) the power to direct the activities of the entity that most significantly impact the entity’s economic performance and b) the obligation to absorb losses of the entity that could potentially be significant to the entity or the right to receive benefits from the entity that could potentially be significant to the entity. As of March 31, 2013, the Company had a net asset of approximately $76.9 million included in Investment in Affiliates and Other Noncurrent Liabilities on the condensed consolidated balance sheets related to equity method investees, in addition to Notes Receivable – Affiliate as discussed above. SJI’s maximum exposure to loss from these entities as of March 31, 2013 is limited to its combined equity contributions and the Notes Receivable-Affiliate in the amount of $183.2 million.

4.
COMMON STOCK:

The following shares were issued and outstanding at March 31:

 
2013
Beginning Balance, January 1
31,653,262

New Issues During the Period:
 

Dividend Reinvestment Plan
137,546

Stock-Based Compensation Plan
78,363

Ending Balance, March 31
31,869,171


The par value ($1.25 per share) of stock issued was recorded in Common Stock and the net excess over par value of approximately $7.7 million was recorded in Premium on Common Stock.

EARNINGS PER COMMON SHARE (EPS) — Basic EPS is based on the weighted-average number of common shares outstanding.  The incremental shares required for inclusion in the denominator for the diluted EPS calculation were 53,574 and 73,271 for the three months ended March 31, 2013 and 2012, respectively. These shares relate to SJI's restricted stock as discussed in Note 2.

DIVIDEND REINVESTMENT PLAN (DRP) —The Company offers a DRP which allows participating shareholders to purchase shares of SJI common stock by automatic reinvestment of dividends or optional purchases.Shares of common stock offered by the DRP have been issued directly by SJI from its authorized but unissued shares of common stock. The Company raised $7.2 million and $2.9 million of equity capital through the DRP during the three months ended March 31, 2013 and 2012, respectively.

5.
FINANCIAL INSTRUMENTS:

RESTRICTED INVESTMENTS — In accordance with the terms of certain Marina and SJG loan agreements, unused proceeds are required to be escrowed pending approval of construction expenditures. As of both March 31, 2013 and December 31, 2012, the escrowed proceeds, including interest earned, totaled $1.3 million.

The Company maintains margin accounts with selected counterparties to support its risk management activities. The balances required to be held in these margin accounts increase as the net value of the outstanding energy related contracts with the respective counterparties decrease. As of March 31, 2013 and December 31, 2012, the balances in these accounts totaled $8.7 million and $16.6 million, respectively. The carrying amounts of the Restricted Investments approximate their fair values at March 31, 2013 and December 31, 2012, which would be included in Level 1 of the fair value hierarchy (See Note 13 - Fair Value of Financial Assets and Financial Liabilities).

LONG-TERM RECEIVABLES — SJG provides financing to customers for the purpose of attracting conversions to natural gas heating systems from competing fuel sources.  The terms of these loans call for customers to make monthly payments over a period of up to five years with no interest.  The carrying amounts of such loans were $14.0 million and $13.6 million as of March 31, 2013 and December 31, 2012, respectively. The current portion of these receivables is reflected in Accounts Receivable and the non-current portion is reflected in Contract Receivables on the condensed consolidated balance sheets. The carrying amounts noted above are net of unamortized discounts resulting from imputed interest in the amount of $1.4 million and $1.3 million as of March 31, 2013 and December 31, 2012, respectively.  The annual amortization to interest is not material to the Company’s condensed consolidated financial statements.  The carrying amounts of these receivables approximate their fair value at March 31, 2013 and December 31, 2012, which would be included in Level 2 of the fair value hierarchy (See Note 13 - Fair Value of Financial Assets and Financial Liabilities).


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CREDIT RISK - As of March 31, 2013, approximately $6.4 million, or 20.9%, of the current and noncurrent Derivatives – Energy Related Assets are with a single retail counterparty. This counterparty has contracts with a large number of diverse customers which minimizes the concentration of this risk. A portion of these contracts may be assigned to SJI in the event of a default by the counterparty.

FINANCE OBLIGATION - During 2010, ACB Energy Partners LLC (ACB), a wholly-owned subsidiary of Energenic, of which Marina has a 50% equity interest, completed construction of a combined heat and power generating facility to serve, under an energy services agreement, a thermal plant owned by Marina. Construction period financing was provided by Marina. Due to its continuing involvement in the facility, Marina is considered the owner of the facility for accounting purposes. As a result, the Company included costs to construct the facility within Nonutility Property, Plant and Equipment on the condensed consolidated balance sheets of $23.6 million as of both March 31, 2013 and December 31, 2012, respectively. In addition, the Company included repayments from ACB to Marina on the construction loan within the Finance Obligation on the condensed consolidated balance sheets. Marina does not have a fixed payment obligation to ACB; as a result, the Finance Obligation is classified as a noncurrent liability on the condensed consolidated balance sheets. The costs to construct the facility and the repayments of the construction loan are amortized over the term of the energy services agreement. The impact on the condensed consolidated statements of income is not significant. As a result, the Company recorded $21.4 million and 21.6 million, net of amortization, within Finance Obligation on the condensed consolidated balance sheets at March 31, 2013 and December 31, 2012, respectively.

FINANCIAL INSTRUMENTS NOT CARRIED AT FAIR VALUE - The fair value of a financial instrument is the market price to sell an asset or transfer a liability at the measurement date. The carrying amounts of SJI's financial instruments approximate their fair values at March 31, 2013 and December 31, 2012, except as noted below.
For Long-Term Debt, in estimating the fair value, we use the present value of remaining cash flows at the balance sheet date. We based the estimates on interest rates available to SJI at the end of each period for debt with similar terms and maturities (Level 2 in the fair value hierarchy, see Note 13 - Fair Value of Financial Assets and Financial Liabilities). The estimated fair values of SJI's long-term debt, including current maturities, as of March 31, 2013 and December 31, 2012, were $674.0 million and $682.3 million, respectively.  The carrying amounts of SJI's long-term debt, including current maturities, as of both March 31, 2013 and December 31, 2012, was $626.4 million.


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6.
SEGMENTS OF BUSINESS:

SJI operates in several different reportable operating segments which reflect the financial information regularly evaluated by the chief operating decision maker. Gas Utility Operations (SJG) consists primarily of natural gas distribution to residential, commercial and industrial customers. Wholesale Energy Operations include SJRG’s and SJEX'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 under warranty via a subcontractor arrangement as well as on a time and materials basis, and the installation of small commercial HVAC systems.  The Retail Energy Operations caption includes Retail Gas and Other, Retail Electric, On-Site Energy Production and Appliance Service Operations. The accounting policies of the segments are the same as those described in the summary of significant accounting policies.  Intersegment sales and transfers are treated as if the sales or transfers were to third parties at current market prices.

Information about SJI’s operations in different reportable operating segments is presented below (in thousands):

 
Three Months Ended
March 31,
 
 
2013
 
2012
 
Operating Revenues:
 
 
 
 
Gas Utility Operations
$
174,098

 
$
179,436

 
Wholesale Energy Operations
6,216

 
17,642

 
Retail Energy Operations:
 
 
 
 
Retail Gas and Other Operations
34,113

 
18,192

 
Retail Electric Operations
30,729

 
50,187

 
On-Site Energy Production
9,096

 
7,901

 
Appliance Service Operations
3,308

 
3,282

 
Subtotal Retail Energy Operations
77,246

 
79,562

 
Corporate & Services
8,480

 
6,714

 
Subtotal
266,040

 
283,354

 
Intersegment Sales
(10,409
)
 
(8,522
)
 
Total Operating Revenues
$
255,631

 
$
274,832

 

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Three Months Ended
March 31,
 
 
2013
 
2012
 
Operating Income:
 

 
 

 
Gas Utility Operations
$
57,795

 
$
58,855

 
Wholesale Energy Operations
(5,157
)
 
10,672

 
Retail Energy Operations:
 
 
 
 
Retail Gas and Other Operations
28

 
(152
)
 
Retail Electric Operations
464

 
4,944

 
On-Site Energy Production
(1,173
)
 
(338
)
 
Appliance Service Operations
(14
)
 
(441
)
 
Subtotal Retail Energy Operations
(695
)
 
4,013

 
Corporate and Services
36

 
(32
)
 
Total Operating Income
$
51,979

 
$
73,508

 

 
 
 
 
Depreciation and Amortization:
 

 
 

 
Gas Utility Operations
$
11,024

 
$
10,962

 
Wholesale Energy Operations
51

 
53

 
Retail Energy Operations:
 
 
 
 
Retail Gas and Other Operations
22

 
8

 
On-Site Energy Production
3,012

 
2,004

 
Appliance Service Operations
74

 
84

 
Subtotal Retail Energy Operations
3,108

 
2,096

 
Corporate and Services
225

 
164

 
Total Depreciation and Amortization
$
14,408

 
$
13,275

 

 
 
 
 
Interest Charges:
 

 
 

 
Gas Utility Operations
$
2,961

 
$
4,189

 
Wholesale Energy Operations
52

 
86

 
Retail Energy Operations:
 
 
 
 
Retail Gas and Other Operations
76

 
38

 
On-Site Energy Production
1,403

 
1,019

 
Subtotal Retail Energy Operations
1,479

 
1,057

 
Corporate and Services
1,508

 
721

 
Subtotal
6,000

 
6,053

 
Intersegment Borrowings
(1,292
)
 
(560
)
 
Total Interest Charges
$
4,708

 
$
5,493

 

 
 
 
 
Income Taxes:
 

 
 

 
Gas Utility Operations
$
20,771

 
$
20,977

 
Wholesale Energy Operations
(1,981
)
 
3,981

 
Retail Energy Operations:
 
 
 
 
Retail Gas and Other Operations
272

 
184

 
Retail Electric Operations
190

 
2,020

 
On-Site Energy Production
(11,564
)
 
(11,174
)
 
Appliance Service Operations
4

 
(163
)
 
Subtotal Retail Energy Operations
(11,098
)
 
(9,133
)
 
Corporate and Services
80

 
59

 
Total Income Tax Expense
$
7,772

 
$
15,884

 

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Three Months Ended
March 31,
 
 
2013
 
2012
 
Property Additions:
 
 
 
 
Gas Utility Operations
$
37,042

 
$
40,656

 
Wholesale Energy Operations
9

 
4

 
Retail Energy Operations:
 
 
 
 
Retail Gas and Other Operations
2

 
53

 
On-Site Energy Production
2,577

 
5,297

 
Subtotal Retail Energy Operations
2,579

 
5,350

 
Corporate and Services
738

 
405

 
Total Property Additions
$
40,368

 
$
46,415

 

 
March 31, 2013
 
December 31, 2012
Identifiable Assets (See Note 1):
 
 
 
Gas Utility Operations
$
1,831,674

 
$
1,786,459

Wholesale Energy Operations
212,264

 
204,358

Retail Energy Operations:
 
 
 
Retail Gas and Other Operations
42,414

 
39,481

Retail Electric Operations
24,892

 
21,919

On-Site Energy Production
488,859

 
543,416

Appliance Service Operations
2,813

 
3,244

Subtotal Retail Energy Operations
558,978

 
608,060

Discontinued Operations
1,865

 
2,290

Corporate and Services
277,434

 
334,798

Intersegment Assets
(253,944
)
 
(304,525
)
Total Identifiable Assets
$
2,628,271

 
$
2,631,440



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7.
RATES AND REGULATORY ACTIONS:

SJG is subject to the rules and regulations of the New Jersey Board of Public Utilities (BPU). In January 2013, the BPU approved an extension of the current Energy Efficiency Program (“EEP I”) to June 30, 2013 and approved additional investments of up to $2.5 million.

Also in January 2013, SJG credited the accounts of SJG's periodic BGSS customers with refunds totaling $9.4 million due to gas costs that were lower than projected.

In July 2012, SJG filed a petition to implement a five-year, $250.0 million Accelerated Infrastructure Replacement Program (“AIRP”). SJG proposed spending an incremental $50.0 million per year on the accelerated replacement of its cast iron and bare steel main and service infrastructure and was seeking a return on program investments as it had under prior Capital Investment Recovery Tracker ("CIRT") programs. SJG's CIRT III program expired on December 31, 2012. In February 2013, the parties executed a Stipulation agreeing to $35.3 million per year of incremental capital spending for four years, totaling $141.2 million under the AIRP. The BPU approved the Stipulation in February 2013.

In March 2013, SJG filed a joint petition with New Jersey Natural Gas requesting modifications to, and the continuation of, the Conservation Incentive Plan (“CIP”) program effective October 1, 2013.

There have been no other significant regulatory actions or changes to SJG's rate structure since December 31, 2012. See Note 10 to the Consolidated Financial Statements in Item 8 of SJI's Annual Report on Form 10-K as of December 31, 2012.

8.
REGULATORY ASSETS & REGULATORY LIABILITIES:

There have been no significant changes to the nature of the Company’s regulatory assets and liabilities since December 31, 2012 which are described in Note 11 to the Consolidated Financial Statements in Item 8 of SJI’s Annual Report on Form 10-K as of December 31, 2012.

Regulatory Assets consisted of the following items (in thousands):

 
March 31, 2013
 
December 31, 2012
Environmental Remediation Costs:
 
 
 
Expended - Net
$
32,784

 
$
37,892

Liability for Future Expenditures
108,013

 
107,410

Deferred Asset Retirement Obligation Costs
30,390

 
30,199

Deferred Pension and Other Postretirement Benefit Costs
95,897

 
95,897

Conservation Incentive Program Receivable
18,629

 
31,686

Societal Benefit Costs Receivable
12,900

 
12,801

Premium for Early Retirement of Debt
1,035

 
1,075

Deferred Interest Rate Contracts
6,885

 
7,761

Energy Efficiency Tracker
12,556

 
12,306

Pipeline Supplier Service Charges
8,355

 
8,771

Other Regulatory Assets
7,645

 
6,858

 
 
 
 
Total Regulatory Assets
$
335,089

 
$
352,656


CONSERVATION INCENTIVE PROGRAM (CIP) RECEIVABLE – The decrease in this receivable is primarily the result of colder weather experienced in the region during the 2012-2013 winter season compared with the prior winter season. The CIP tracking mechanism adjusts earnings when actual usage per customer experienced during the period varies from an established baseline usage per customer. 


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Regulatory Liabilities consisted of the following items (in thousands):

 
March 31, 2013
 
December 31, 2012
Excess Plant Removal Costs
$
43,567

 
$
45,593

Deferred Revenues - Net
27,533

 
10,924

Other Regulatory Liabilities
2,498

 

 
 
 
 
Total Regulatory Liabilities
$
73,598

 
$
56,517

 
DEFERRED REVENUES – NET – 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 natural gas purchases are also included in the BGSS, subject to BPU approval.  The BGSS increased from a $10.9 million regulatory liability at December 31, 2012 to a $27.5 million regulatory liability at March 31, 2013, primarily due to gas costs recovered from customers exceeding the actual cost of the commodity. SJG typically overcollects during the winter season when throughput is high and undercollects during the summer season when throughput is low.

9.
PENSION AND OTHER POSTRETIREMENT BENEFITS:

For the three months ended March 31, 2013 and 2012, net periodic benefit cost related to the employee and officer pension and other postretirement benefit plans consisted of the following components (in thousands):
 
 
Pension Benefits
 
Three Months Ended
March 31,
 

2013

2012
 
Service Cost
$
1,378

 
$
1,189

 
Interest Cost
2,332

 
2,399

 
Expected Return on Plan Assets
(2,989
)
 
(2,760
)
 
Amortizations:
 
 
 

 
Prior Service Cost
63

 
63

 
Actuarial Loss
2,171

 
1,755

 
Net Periodic Benefit Cost
2,955

 
2,646

 
Capitalized Benefit Costs
(1,167
)
 
(980
)
 
Total Net Periodic Benefit Expense
$
1,788

 
$
1,666

 

 
Other Postretirement Benefits
 
Three Months Ended
March 31,
 
 
2013

2012
 
Service Cost
$
311

 
$
293

 
Interest Cost
700

 
768

 
Expected Return on Plan Assets
(588
)
 
(558
)
 
Amortizations:
 
 
 

 
Prior Service Credits
(71
)
 
(71
)
 
Actuarial Loss
459

 
380

 
Net Periodic Benefit Cost
811

 
812

 
Capitalized Benefit Costs
(322
)
 
(302
)
 
Total Net Periodic Benefit Expense
$
489

 
$
510

 


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Capitalized benefit costs reflected in the table above relate to SJG’s construction program.

SJI contributed $25.0 million and $12.7 million to the pension plans in January 2012 and 2013, respectively. No additional contributions are expected to be made to the pension plans during 2013. Payments related to the unfunded supplemental executive retirement plan (SERP) are expected to approximate $1.3 million in 2013. SJG also has a regulatory obligation to contribute approximately $3.6 million annually to the other postretirement benefit plans’ trusts, less direct costs incurred.

See Note 12 to the Consolidated Financial Statements in Item 8 of SJI’s Annual Report on Form 10-K as of December 31, 2012, for additional information related to SJI’s pension and other postretirement benefits.

10.
UNUSED LINES OF CREDIT:
 
Credit facilities and available liquidity as of March 31, 2013 were as follows (in thousands):

Company

Total Facility

Usage

Available Liquidity

Expiration Date
SJG:

 

 

 

 
Commercial Paper Program/Revolving Credit Facility

$
200,000


$
67,000


$
133,000


May 2015
Uncommitted Bank Lines

10,000


3,600


6,400


August 2013












Total SJG

210,000


70,600


139,400


 












SJI:

 

 

 

 









Revolving Credit Facility (B)

$
400,000


$
150,400


$
249,600


February 2018 (A)
Term Line of Credit

50,000


50,000




November 2013












Total SJI

450,000


200,400


249,600


 












Total
 
$
660,000

 
$
271,000

 
$
389,000

 
 

(A) Includes letters of credit outstanding in the amount of $22.6 million.

(B) In February 2013, SJI increased its revolving credit agreement from $300.0 million to $400.0 million while extending its term until February 2018.
The SJG facilities are restricted as to use and availability specifically to SJG; however, if necessary, the SJI facilities can also be used to support SJG’s liquidity needs. Borrowings under these credit facilities are at market rates. The weighted average interest rate on these borrowings, which changes daily, was 1.02% and 1.06% at March 31, 2013 and 2012, respectively. Average borrowings outstanding under these credit facilities, not including letters of credit, during the three months ended March 31, 2013 and 2012 were $317.3 million and $351.6 million, respectively. The maximum amounts outstanding under these credit facilities, not including letters of credit, during the three months ended March 31, 2013 and 2012 were $369.5 million and $377.8 million, respectively.

The SJI and SJG facilities are provided by a syndicate of banks and contain one financial covenant limiting the ratio of indebtedness to total capitalization (as defined in the respective credit agreements) to not more than 0.65 to 1, measured at the end of each fiscal quarter. SJI and SJG were in compliance with this covenant as of March 31, 2013.

SJG manages a commercial paper program under which SJG may issue short-term, unsecured promissory notes to qualified investors up to a maximum aggregate amount outstanding at any time of $200.0 million.  The notes  have fixed maturities which vary by note, but may not exceed 270 days from the date of issue. Proceeds from the notes are used for general corporate purposes.  SJG uses the commercial paper program in tandem with the $200.0 million revolving credit facility and does not expect the principal amount of borrowings outstanding under the commercial paper program and the credit facility at any time to exceed an aggregate of $200.0 million.


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11.
COMMITMENTS AND CONTINGENCIES:

GUARANTEES — The Company has recorded a liability of $0.3 million which is included in Other Noncurrent Liabilities with a corresponding increase in Investment in Affiliates on the condensed consolidated balance sheets as of March 31, 2013 for the fair value of the following guarantees:

In April 2007, SJI guaranteed certain obligations of LVE Energy Partners, LLC (LVE) an unconsolidated joint venture in which Marina has a 50% equity interest.  LVE entered into a 25-year contract with a resort developer to design, build, own and operate a district energy system and central energy center for a planned resort in Las Vegas, Nevada.  LVE began construction of the facility in 2007 and expected to provide full energy service in 2010 when the resort was originally scheduled to be completed.  LVE suspended construction of the district energy system and central energy center in January 2009 after the resort developer’s announcement that it was delaying the completion of construction of the resort.

In March 2013, the resort developer purchased substantially all of the assets of LVE. As a result, the guarantees provided by SJI of certain performance obligations of LVE under the operating agreements between LVE and the resort developer were canceled.

During the three months ended March 31, 2013 the Company received $57.6 million of repayments of advances from LVE. As of March 31, 2013, the Company had remaining unsecured Notes Receivable - Affiliate of approximately $5.5 million due from LVE on the condensed consolidated balance sheets related to this project. During 2013, SJI provided support to LVE of approximately $0.4 million to cover interest and other project related costs.

As a result of the construction delay and the sale of substantially all of the assets, management has evaluated the investment in LVE and concluded that the fair value of this investment continues to be in excess of the carrying value as of March 31, 2013.

SJI and its joint venture partner have guaranteed the repayment of interest rate derivative contracts held by LVE which mature in November 2013. As of March 31, 2013 the amount required to satisfy these contracts is approximately $5.5 million. LVE is expected to have sufficient resources to satisfy these interest rate derivative contracts upon the liquidation of its remaining assets. SJI and its partner in this joint venture have entered into reimbursement agreements that secure reimbursement for SJI of a proportionate share of any payments made by SJI on this guarantee.

SJI has guaranteed certain obligations of WC Landfill Energy, LLC (WCLE) and BC Landfill Energy, LLC (BCLE), unconsolidated joint ventures in which Marina has a 50% equity interest through Energenic. WCLE and BCLE have entered into agreements through 2018 and 2027, respectively, with the respective county governments to lease and operate facilities that will produce electricity from landfill methane gas.  Although unlikely, the maximum amount that SJI could be obligated for, in the event that WCLE and BCLE do not meet minimum specified levels of operating performance and no mitigating action is taken, or are unable to meet certain financial obligations as they become due, is approximately $4.2 million each year.  SJI and its partner in these joint ventures have entered into reimbursement agreements that secure reimbursement for SJI of a proportionate share of any payments made by SJI on these guarantees.  SJI holds variable interests in WCLE and BCLE but is not the primary beneficiary.

In February 2011, ACR Energy Partners, LLC (ACR), a wholly-owned subsidiary of Energenic, of which Marina has a 50% equity interest, entered into a 20 year contract with a developer to build, own and operate a central energy center and energy distribution system for a new hotel, casino and entertainment complex in Atlantic City, New Jersey. The complex commenced operations in April 2012 and as a result, ACR is providing full energy services to the complex. Marina and its joint venture partner have agreed to provide a $5.0 million letter of credit to support certain operating performance obligations of ACR under the operating agreements between ACR and the developer. SJI and its partner in this joint venture have entered into reimbursement agreements that secure reimbursement for SJI of a proportionate share of any payments made by SJI to or on behalf of ACR.


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In May 2012, UMM Energy Partners, LLC (UMM), a wholly-owned subsidiary of Energenic, of which Marina has a 50% equity interest, entered into a 30 year contract with a public university to build, own and operate a combined heating, cooling and power system for its main campus in New Jersey. The system is expected to be completed during the second half of 2013. Marina and its joint venture partner are obligated to make capital contributions to UMM, through Energenic, totaling approximately $10.0 million. In addition, SJI has guaranteed certain obligations of UMM under the operating and lease agreements between UMM and the university, for the terms of the agreements, commencing with the first year of operations. SJI has guaranteed up to $2.2 million for the first year. This amount is adjusted each year based upon the Consumer Price Index. SJI has also guaranteed certain construction obligations of UMM during the construction period, the majority of which are supported by a surety bond. SJI and its partner in this joint venture have entered into reimbursement agreements that secure reimbursement for SJI of a proportionate share of any payments made by SJI on these guarantees.

As of March 31, 2013, SJI had issued $5.1 million of guarantees on behalf of an unconsolidated subsidiary. These guarantees generally expire within the next two years and were issued to enable our subsidiary to market retail natural gas.

COLLECTIVE BARGAINING AGREEMENTS — Unionized personnel represent approximately 46.0% of our workforce at March 31, 2013. The Company has collective bargaining agreements with two unions that represent these employees: the International Brotherhood of Electrical Workers (IBEW) Local 1293 and the International Association of Machinists and Aerospace Workers (IAM) Local 76.  SJG employees represented by the IBEW operated under a collective bargaining agreement that was set to expire February 28, 2013, however a new collective bargaining agreement was agreed to and commenced on March 1, 2013 and runs through February 28, 2017. SJESP employees represented by the IBEW operate under a collective bargaining agreement that runs through February 28, 2014. The remaining unionized employees represented by the IAM operate under a collective bargaining agreement that expires in August 2014.

STANDBY LETTERS OF CREDIT — As of March 31, 2013, SJI provided $22.6 million of standby letters of credit through SJI’s revolving credit facility to enable SJE to market retail electricity and for various construction activities. The Company has also provided $87.6 million of additional letters of credit under separate facilities outside of the revolving credit facility to support variable-rate demand bonds issued through the New Jersey Economic Development Authority (NJEDA) to finance the expansion of SJG’s natural gas distribution system and to finance Marina's initial thermal plant project.  

PENDING LITIGATION — The Company is subject to claims arising in the ordinary course of business and other legal proceedings. The Company has been named in, among other actions, certain product liability claims related to our former sand mining subsidiary. We accrue liabilities related to these claims when we can reasonably estimate the amount or range of amounts of probable settlement costs or other charges for these claims. The Company has accrued approximately $3.1 million related to all claims in the aggregate as of both March 31, 2013 and December 31, 2012. Management does not believe that it is reasonably possible that there will be a material change in the Company's estimated liability in the near term and does not currently anticipate the disposition of any known claims that would have a material effect on the Company's financial position, results of operations or cash flows.

ENVIRONMENTAL REMEDIATION COSTS — SJI incurred and recorded costs for environmental cleanup of 12 sites where SJG or its predecessors operated gas manufacturing plants. SJG stopped manufacturing gas in the 1950s. SJI and some of its nonutility subsidiaries also recorded costs for environmental cleanup of sites where SJF previously operated a fuel oil business and Morie maintained equipment, fueling stations and storage. There have been no changes to the status of the Company’s environmental remediation efforts since December 31, 2012 as described in Note 15 to the Consolidated Financial Statements in Item 8 of SJI’s Annual Report on Form 10-K as of December 31, 2012.


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Table of Contents

12.
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 third parties. These subsidiaries are subject to market risk on expected future purchases and sales due to commodity price fluctuations. The Company uses a variety of derivative instruments to limit this exposure to market risk in accordance with strict corporate guidelines.  These derivative instruments include forward contracts, swap agreements, options contracts and futures contracts. As of March 31, 2013, the Company had outstanding derivative contracts intended to limit the exposure to market risk on 20.9 MMdts (1 MMdts = one million decatherms) of expected future purchases of natural gas, 19.7 MMdts of expected future sales of natural gas, 1.1 MMmwh (1 MMmwh = one million megawatt hours) of expected future purchases of electricity and 1.0 MMmwh of expected future sales of electricity. In addition to these derivative contracts, the Company had basis and index related purchase and sales contracts totaling 66.1 MMdts.  The value of these contracts are not significant as of March 31, 2013. These contracts, which have not been designated as hedging instruments under GAAP, are measured at fair value and recorded in Derivatives — Energy Related Assets or Derivatives — Energy Related Liabilities on the condensed consolidated balance sheets. The net unrealized pre-tax gains and losses for these energy related commodity contracts are included with realized gains and losses in Operating Revenues – Nonutility.

The Company has also entered into interest rate derivatives to hedge exposure to increasing interest rates and the impact of those rates on cash flows of variable-rate debt. These interest rate derivatives, some of which have been designated as hedging instruments under GAAP, are measured at fair value and recorded in Derivatives - Other on the condensed consolidated balance sheets. Beginning in July 2012, hedge accounting was discontinued for these derivatives. As a result, unrealized gains and losses on these derivatives, that were previously included in Accumulated Other Comprehensive Loss on the condensed consolidated balance sheets, will be reclassified into earnings over the remaining life of the derivative. These derivatives are expected to mature in 2026.

There have been no other significant changes to the Company’s active interest rate swaps since December 31, 2012 which are described in Note 16 to the Consolidated Financial Statements in Item 8 of SJI’s Annual Report on Form 10-K as of December 31, 2012.

The fair values of all derivative instruments, as reflected in the condensed consolidated balance sheets as of March 31, 2013 and December 31, 2012, are as follows (in thousands):

Derivatives not designated as hedging instruments under GAAP
 
March 31, 2013
 
December 31, 2012
 
 
Assets
 
Liabilities
 
Assets
 
Liabilities
Energy related commodity contracts:
 
 
 
 
 
 
 
 
Derivatives – Energy Related – Current
 
$
22,330

 
$
20,222

 
$
24,242

 
$
23,828

Derivatives – Energy Related – Non-Current
 
8,461

 
4,301

 
12,297

 
5,403

Interest rate contracts:
 
 
 
 
 
 

 
 

Derivatives - Other - Non-Current
 

 
12,062

 

 
13,462

Total derivatives not designated as hedging instruments under GAAP
 
30,791

 
36,585

 
36,539

 
42,693

 
 
 
 
 
 
 
 
 
Total Derivatives
 
$
30,791

 
$
36,585

 
$
36,539

 
$
42,693



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The Company enters into derivative contracts with counterparties, some of which are subject to master netting arrangements, which allow net settlements under certain conditions. The Company presents derivatives at gross fair values on the condensed consolidated balance sheets. As of March 31, 2013 and December 31, 2012, information related to these offsetting arrangements were as follows (in thousands):
As of March 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
Description
 
Gross amounts of recognized assets/liabilities
 
Gross amount offset in the balance sheet
 
Net amounts of assets/liabilities in balance sheet
 
Gross amounts not offset in the balance sheet
 
Net amount
 
 
 
 
Financial Instruments
 
Cash Collateral Posted
 
Derivatives - Energy Related Assets
 
30,791

 

 
30,791

 
(16,962
)
(A)

 
13,829

Derivatives - Energy Related Liabilities
 
(24,523
)
 

 
(24,523
)
 
16,962

(B)
79

 
(7,482
)
Derivatives - Other
 
(12,062
)
 

 
(12,062
)
 

 

 
(12,062
)

As of December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
Description
 
Gross amounts of recognized assets/liabilities
 
Gross amount offset in the balance sheet
 
Net amounts of assets/liabilities in balance sheet
 
Gross amounts not offset in the balance sheet
 
Net amount
 
 
 
 
Financial Instruments
 
Cash Collateral Posted
 
Derivatives - Energy Related Assets
 
36,539

 

 
36,539

 
(12,975
)
(A)

 
23,564

Derivatives - Energy Related Liabilities
 
(29,231
)
 

 
(29,231
)
 
12,975

(B)
6,347

 
(9,909
)
Derivatives - Other
 
(13,462
)
 

 
(13,462
)
 

 

 
(13,462
)

(A) The balances at March 31, 2013 and December 31, 2012 were related to derivative liabilities which can be net settled against derivative assets.

(B) The balances at March 31, 2013 and December 31, 2012 were related to derivative assets which can be net settled against derivative liabilities.

The effect of derivative instruments on the condensed consolidated statements of income for the three months ended March 31, 2013 and 2012 are as follows (in thousands):

 
 
Three Months Ended
March 31,
 
Derivatives in Cash Flow Hedging Relationships
 
2013
 
2012
 
Interest Rate Contracts:
 
 
 
 
 
Gains recognized in AOCL on effective portion
 
$

 
$
136

 
Losses reclassified from AOCL into income (a)
 
$
(112
)
 
$
(186
)
 
Gains (losses) recognized in income on ineffective portion (a)
 

 

 

(a) Included in Interest Charges


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Table of Contents

 
 
Three Months Ended
March 31,
 
Derivatives Not Designated as Hedging Instruments under GAAP
 
2013
 
2012
 
(Losses) gains on energy related commodity contracts (a)
 
$
(7,049
)
 
$
6,971

 
Gains on interest rate contracts (b)
 
525

 
136

 
 
 
 
 
 
 
Total
 
$
(6,524
)
 
$
7,107

 

(a)  Included in Operating Revenues - Non Utility
(b)  Included in Interest Charges

Net realized losses associated with SJG’s energy-related financial commodity contracts of $1.5 million and $5.0 million for the three months ended March 31, 2013 and 2012, respectively,are not included in the above table. These contracts are part of SJG’s regulated risk management activities that serve to mitigate BGSS costs passed on to its customers. As these transactions are entered into pursuant to, and recoverable through, regulatory riders, any changes in the value of SJG’s energy related financial commodity contracts are deferred in Regulatory Assets or Liabilities and there is no impact to earnings.

Certain of the Company’s derivative instruments contain provisions that require immediate payment or demand immediate and ongoing collateralization on derivative instruments in net liability positions in the event of a material adverse change in the credit standing of the Company. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a liability position on March 31, 2013, is $8.5 million.   If the credit-risk-related contingent features underlying these agreements were triggered on March 31, 2013, the Company would have been required to settle the instruments immediately or post collateral to its counterparties of approximately $3.4 million after offsetting asset positions with the same counterparties under master netting arrangements.

13.
FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES:

GAAP establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques.  The levels of the hierarchy are described below:

Level 1:  Observable inputs such as quoted prices in active markets for identical assets or liabilities.

Level 2:  Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly; these include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3:  Unobservable inputs that reflect the reporting entity’s own assumptions.

Assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of financial assets and financial liabilities and their placement within the fair value hierarchy.


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Table of Contents

For financial assets and financial liabilities measured at fair value on a recurring basis, information about the fair value measurements for each major category is as follows (in thousands):

As of March 31, 2013
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Available-for-Sale Securities (A)
$
7,892

 
$
7,892

 
$

 
$

Derivatives – Energy Related Assets (B)
30,791

 
9,271

 
12,717

 
8,803

 
$
38,683

 
$
17,163

 
$
12,717

 
$
8,803

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives – Energy Related Liabilities (B)
$
24,523

 
$
6,010

 
$
11,337

 
$
7,176

Derivatives – Other (C)
12,062

 

 
12,062

 

 
$
36,585

 
$
6,010

 
$
23,399

 
$
7,176


As of December 31, 2012
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Available-for-Sale Securities (A)
$
7,538

 
$
787

 
$
6,751

 
$

Derivatives – Energy Related Assets (B)
36,539

 
9,404

 
16,205

 
10,930

 
$
44,077

 
$
10,191

 
$
22,956

 
$
10,930

 
 
 
 
 
 
 
 
 Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives – Energy Related Liabilities (B)
$
29,231

 
$
5,399

 
$
15,664

 
$
8,168

Derivatives – Other (C)
13,462

 

 
13,462

 

 
$
42,693

 
$
5,399

 
$
29,126

 
$
8,168


(A) Available-for-Sale Securities include securities that are traded in active markets and securities that are not traded publicly.  The securities traded in active markets are valued using the quoted principal market close prices that are provided by the trustees and are categorized in Level 1 in the fair value hierarchy.  The remaining securities consist of funds that are not publicly traded.  These funds, which consist of stocks and bonds that are traded individually in active markets, are valued using quoted prices for similar assets and are categorized in Level 2 in the fair value hierarchy.

(B) Derivatives – Energy Related Assets and Liabilities are traded in both exchange-based and non-exchange-based markets. Exchange-based contracts are valued using unadjusted quoted market sources in active markets and are categorized in Level 1 in the fair value hierarchy. Certain non-exchange-based contracts are valued using indicative price quotations available through brokers or over-the-counter, on-line exchanges and are categorized in Level 2. These price quotations reflect the average of the bid-ask mid-point prices and are obtained from sources that management believes provide the most liquid market. For non-exchange-based derivatives that trade in less liquid markets with limited pricing information, model inputs generally would include both observable and unobservable inputs. In instances where observable data is unavailable, management considers the assumptions that market participants would use in valuing the asset or liability. This includes assumptions about market risks such as liquidity, volatility and contract duration. Such instruments are categorized in Level 3 as the model inputs generally are not observable.

Significant Unobservable Inputs - Management uses the discounted cash flow model to value Level 3 physical and financial forwards, which calculates mark-to-market valuations based on forward market prices, original transaction prices, volumes, risk-free rate of return and credit spreads. Inputs to the valuation model are reviewed and revised as needed, based on historical information, updated market data, market liquidity and relationships, and changes in third party pricing sources. The validity of the mark-to-market valuations and changes in mark-to-market valuations from period to period are examined and qualified against historical expectations by the risk management function. If any discrepancies are identified during this process, the mark-to-market valuations or the market pricing information is evaluated further and adjusted, if necessary.


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Table of Contents

Level 3 valuation methods for natural gas derivative contracts include utilizing another location in close proximity adjusted for certain pipeline charges to derive a basis value. The significant unobservable inputs used in the fair value measurement of certain natural gas contracts are forward prices developed based on industry standard methodologies. Significant increases (decreases) in these forward prices for purchases of natural gas would result in a directionally similar impact to the fair value measurement and for sales of natural gas would result in a directionally opposite impact to the fair value measurement. Level 3 valuation methods for electric represent the value of the contract marked to the forward wholesale curve, as provided by daily exchange quotes for delivered electricity. The significant unobservable inputs used in the fair value measurement of electric contracts are fixed contracted electric load profiles; therefore no change in unobservable inputs would occur. Unobservable inputs are updated daily using industry standard techniques. Management reviews and corroborates the price quotations to ensure the prices are observable which includes consideration of actual transaction volumes, market delivery points, bid-ask spreads and contract duration.

(C) Derivatives – Other are valued using quoted prices on commonly-quoted intervals, which are interpolated for periods different than the quoted intervals, as inputs to a market valuation model. Market inputs can generally be verified and model selection does not involve significant management judgment.

The following table provides quantitative information regarding significant unobservable inputs in Level 3 fair value measurements (in thousands):

Type
Fair Value at March 31, 2013
Valuation Technique
Significant Unobservable Input
Range [Weighted Average]
 
Assets
Liabilities
 
 
 
Forward Contract - Natural Gas
3,369
5,174
Discounted Cash Flow
Forward price (per dt)

$(0.41) - $0.15 [$(0.13)]
Forward Contract - Electric


5,434
2,002
Discounted Cash Flow
Fixed electric load profile (on-peak)
21.6% - 100.0% [55.4%]
Fixed electric load profile (off-peak)
0.0% - 78.4% [44.7%]

Transfers between different levels of the fair value hierarchy may occur based on the level of observable inputs used to value the instruments from period to period.  During the three months ended March 31, 2013, there were no transfers between levels within the fair value hierarchy, including no transfers in or out of Level 3.

The changes in fair value measurements of Derivatives – Energy Related Assets and Liabilities for the three months ended March 31, 2013, using significant unobservable inputs (Level 3), are as follows (in thousands):

 
Three Months Ended
March 31, 2013
 
Three Months Ended
March 31, 2012
Balance at beginning of period
$
2,762

 
$
(5,958
)
Total (losses) gains realized/unrealized included in earnings
(701
)
 
169

Settlements
(434
)
 
3,831

 
 
 
 
Balance at March 31
$
1,627

 
$
(1,958
)

Total losses for 2013 included in earnings that are attributable to the change in unrealized losses relating to those assets and liabilities included in Level 3 still held as of March 31, 2013, is $(0.7) million.  These losses are included in Operating Revenues-Nonutility on the condensed consolidated statements of income.


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Table of Contents

14.
LONG-TERM DEBT:

In 2011, SJG received approval from the BPU to issue up to $200.0 million in long-term debt under its MTN program by September 2014. At March 31, 2013, $80.0 million was available under this program.

In February 2012, SJG called its $35.0 million, 7.7% MTN's due April 2027 at par plus a 2.0% premium. The early redemption occurred concurrently with the issuance in April 2012 of $35.0 million, 3.74% Series D MTN's due April 2032.

The Company did not issue any long-term debt during the three months ended March 31, 2013.

15.
ACCUMULATED OTHER COMPREHENSIVE LOSS:

The following tables summarize the changes in accumulated other comprehensive loss (AOCL) for the three months ended March 31, 2013 (in thousands):

 
Postretirement Liability Adjustment
 
Unrealized Gain (Loss) on Derivatives-Other
 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Other Comprehensive Income (Loss) of Affiliated Companies
 
Total
Balance at January 1, 2013 (a)
$
(23,437
)
 
$
(2,962
)
 
$
294

 
$
(5,000
)
 
$
(31,105
)
   Other comprehensive income before reclassifications

 

 
215

 

 
215

   Amounts reclassified from AOCL (b)

 
66

 
(489
)
 
5,014

 
4,591

Net current period other comprehensive income (loss)

 
66

 
(274
)
 
5,014

 
4,806

Balance at March 31, 2013 (a)
$
(23,437
)
 
$
(2,896
)
 
$
20

 
$
14

 
$
(26,299
)

(a) Determined using a combined statutory tax rate of 41%.
(b) See table below.


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Table of Contents

The following table provides details about reclassifications out of AOCL for the three months ended March 31, 2013:

 
Amounts Reclassified from AOCL (in thousands)
 
Affected Line Item in the Condensed Consolidated Statements of Income
Three Months Ended March 31, 2013
 
Unrealized Loss on Derivatives-Other - interest rate contracts designated as cash flow hedges
$
112

 
Interest Charges
   Income Taxes
(46
)
 
Income Taxes (a)
 
$
66

 
 
 
 
 
 
Unrealized Gain on Available-for-Sale Securities
$
(827
)
 
Other Income
   Income Taxes
338

 
Income Taxes (a)
 
$
(489
)
 
 
 
 
 
 
Loss of Affiliated Companies
$
8,475

 
Equity in Loss of Affiliated Companies
   Income Taxes
(3,461
)
 
Income Taxes (a)
 
$
5,014

 
 
 
 
 
 
Losses from reclassifications for the period net of tax
$
4,591

 
 


26

Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements and Risk Factors — Certain statements contained in this Quarterly Report may qualify as “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact included in this Report should be considered forward-looking statements made in good faith and are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. Words such as “anticipate”, “believe”, “expect”, “estimate”, “forecast”, “goal”, “intend”, “objective”, “plan”, “project”, “seek”, “strategy” and similar expressions are intended to identify forward-looking statements. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the statements. These risks and uncertainties include, but are not limited to, the following: general economic conditions on an international, national, state and local level; weather conditions in our marketing areas; changes in commodity costs; changes in the availability of natural gas; “non-routine” or “extraordinary” disruptions in our distribution system; regulatory, legislative and court decisions; competition; the availability and cost of capital; costs and effects of legal proceedings and environmental liabilities; the failure of customers, suppliers or business partners to fulfill their contractual obligations; and changes in business strategies.

A discussion of these and other risks and uncertainties may be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 and in other filings made by us with the Securities and Exchange Commission (SEC). These cautionary statements should not be construed by you to be exhaustive and they are made only as of the date of this Quarterly Report on Form 10-Q, or in any document incorporated by reference, at the date of such document. While South Jersey Industries, Inc. (SJI or the Company) believes these forward-looking statements to be reasonable, there can be no assurance that they will approximate actual experience or that the expectations derived from them will be realized. Further, SJI undertakes no obligation to update or revise any of its forward-looking statements, whether as a result of new information, future events or otherwise.

Critical Accounting Policies — Estimates and Assumptions — Management must make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and related disclosures. Actual results could differ from those estimates. Five types of transactions presented in our condensed consolidated financial statements require a significant amount of judgment and estimation. These relate to regulatory accounting, derivatives, environmental remediation costs, pension and other postretirement employee benefit costs, and revenue recognition. A discussion of these estimates and assumptions may be found in our Form 10-K for the year ended December 31, 2012.

New Accounting Pronouncements — See detailed discussions concerning New Accounting Pronouncements and their impact on SJI in Note 1 to the condensed consolidated financial statements.

Regulatory Actions —Other than the changes discussed in Note 7 to the condensed consolidated financial statements, there have been no significant regulatory actions since December 31, 2012. See detailed discussion concerning Regulatory Actions in Note 10 to the Consolidated Financial Statements in Item 8 of SJI’s Annual Report on Form 10-K as of December 31, 2012.

Environmental Remediation —There have been no significant changes to the status of the Company’s environmental remediation efforts since December 31, 2012. See detailed discussion concerning Environmental Remediation in Note 15 to the Consolidated Financial Statements in Item 8 of SJI’s Annual Report on Form 10-K as of December 31, 2012.


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Table of Contents

RESULTS OF OPERATIONS:

SJI operates in several different reportable operating segments. Gas Utility Operations (SJG) consists primarily of natural gas distribution to residential, commercial and industrial customers. Wholesale Energy Operations include the activities of South Jersey Resources Group, LLC (SJRG) and South Jersey Exploration, LLC (SJEX). South Jersey Energy Company (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 Energy, LLC ("Marina's") thermal energy facility and other energy-related projects. Appliance Service Operations includes South Jersey Energy Service Plus, LLC (SJESP’s) servicing of appliances under warranty via a subcontractor arrangement as well as on a time and materials basis.  The Retail Energy Operations caption includes Retail Gas and Other, Retail Electric, On-Site Energy Production and Appliance Service Operations.

Net Income for the three months ended March 31, 2013 decreased $11.2 million to $42.9 million compared with the same period in 2012 primarily as a result of the following:

The income contribution from SJRG for the three months ended March 31, 2013 decreased $9.3 million to a net loss of $3.0 million due primarily to the change in unrealized gains and losses on derivatives used by SJRG to mitigate natural gas commodity price risk, as discussed under Operating Revenues - Nonutility below, along with lower storage and daily trading margins as described in Gross Margin - Nonutility below.

The income contribution from SJE for the three months ended March 31, 2013 decreased $2.5 million to $0.7 million due primarily to the change in unrealized gains and losses on forward financial contracts used to mitigate price risk on electric as discussed under Operating Revenues – Nonutility below.

A significant portion of the volatility in operating results is due to the impact of the accounting methods associated with SJI’s derivative activities. The Company uses derivatives to limit its exposure to market risk on transactions to buy, sell, transport and store natural gas and to buy and sell retail electricity. The Company also uses derivatives to limit its exposure to increasing interest rates on variable-rate debt.
 
The types of transactions that cause the most significant volatility in operating results are as follows:

SJRG purchases and holds natural gas in storage to earn a profit margin from its ultimate sale in the future. SJRG uses derivatives to mitigate commodity price risk in order to substantially lock-in the profit margin that will ultimately be realized. However, gas stored in inventory is accounted for at the lower of average cost or market; the derivatives used to reduce the risk associated with a change in the value of the inventory are accounted for at fair value, with changes in fair value recorded in operating results in the period of change. As a result, earnings are subject to volatility as the market price of derivatives change, even when the underlying hedged value of the inventory is unchanged. Additionally, volatility in earnings is created when realized gains and losses on derivatives used to mitigate commodity price risk on expected future purchases of gas in storage are recognized in earnings when the derivatives settle, but the cost of the related gas in storage is not recognized in earnings until the period of withdrawal. This volatility can be significant from period to period. Over time, gains or losses on sale of gas in storage will be offset by losses or gains on the derivatives, resulting in the realization of the profit margin expected when the transactions were initiated.

SJE uses forward contracts to mitigate commodity price risk on fixed price electric contracts with customers. In accordance with accounting principles generally accepted in the United States of America (GAAP), the forward contracts are recorded at fair value, with changes in fair value recorded in earnings in the period of change. Several related customer contracts are not considered derivatives and therefore are not recorded in earnings until the electricity is delivered. As a result, earnings are subject to volatility as the market price of the forward contracts change, even when the underlying hedged value of the customer contract is unchanged. Over time, gains or losses on the sale of the fixed price electric under contract will be offset by losses or gains on the forward contracts, resulting in the realization of the profit margin expected when the transactions were initiated.


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Table of Contents

As a result, management also uses the non-generally accepted accounting principles (“non-GAAP”) financial measures of Economic Earnings, Economic Earnings per share, Non-Utility Economic Earnings, Wholesale Energy Economic Earnings and Retail Energy Economic Earnings when evaluating the results of operations for its nonutility operations. These non-GAAP financial measures should not be considered as an alternative to GAAP measures, such as net income, operating income, earnings per share from continuing operations or any other GAAP measure of liquidity or financial performance.

We define Economic Earnings as: Income from continuing operations, (1) less the change in unrealized gains and plus the change in unrealized losses, as applicable and in each case after tax, on all derivative transactions, and (2) less realized gains and plus realized losses, as applicable and in each case after tax, on all commodity derivative transactions attributed to expected purchases of gas in storage to match the recognition of these gains and losses with the recognition of the related cost of the gas in storage in the period of withdrawal, and (3) less the impact of transactions or contractual arrangements where the true economic impact will be realized in a future period.
Economic Earnings is a significant performance metric used by our management to indicate the amount and timing of income from continuing operations that we expect to earn after taking into account the impact of derivative instruments on the related transactions and transactions or contractual arrangements where the true economic impact will be realized in a future period. Specifically, we believe that this financial measure indicates to investors the profitability of the entire derivative related transaction and not just the portion that is subject to mark-to-market valuation under GAAP. Considering only the change in market value on the derivative side of the transaction can produce a false sense as to the ultimate profitability of the total transaction as no change in value is reflected for the non-derivative portion of the transaction.
Economic Earnings for the three months ended March 31, 2013 decreased $1.6 million to $48.4 million compared with the same period in 2012, primarily as a result of the following:

The income contribution from SJRG for the three months ended March 31, 2013 decreased $3.3 million to $1.0 million due to lower storage and daily trading margins as described in Gross Margin - Nonutility below.






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Table of Contents

The following table presents a reconciliation of our income from continuing operations and earnings per share from continuing operations to Economic Earnings and Economic Earnings per share for the three months ended March 31 (in thousands except per share data):

 
Three Months Ended
March 31,
 
 
2013
 
2012
 
Income from Continuing Operations
$
43,337

 
$
54,211

 
Minus/Plus:
 
 
 
 
Unrealized Mark-to-Market (Gains)/Losses on Derivatives
4,098

 
(4,198
)
 
Realized (Gains)/Losses on Inventory Injection Hedges
120

 
24

 
Net Loss from Affiliated Companies, Not Part of Ongoing Operations (A)
906

 

 
Other
(25
)
 

 
Economic Earnings
$
48,436

 
$
50,037

 
 
 
 
 
 
Earnings per Share from Continuing Operations
$
1.36

 
$
1.79

 
Minus/Plus:
 
 
 
 
Unrealized Mark-to-Market (Gains)/Losses on Derivatives
0.13

 
(0.14
)
 
Realized (Gains)/Losses on Inventory Injection Hedges

 

 
Net Loss from Affiliated Companies, Not Part of Ongoing Operations (A)
0.03

 

 
Other

 

 
Economic Earnings per Share
$
1.52

 
$
1.65

 
 
 
 
 
 
Non-Utility Income from Continuing Operations
$
7,823

 
$
19,173

 
Minus/Plus:
 
 
 
 
Unrealized Mark-to-Market (Gains)/Losses on Derivatives
4,098

 
(4,198
)
 
Realized (Gains)/Losses on Inventory Injection Hedges
120

 
24

 
Net Loss from Affiliated Companies, Not Part of Ongoing Operations (A)
906

 

 
Other
(25
)
 

 
Non-Utility Economic Earnings
$
12,922

 
$
14,999

 
 
 
 
 
 
Wholesale Energy Income from Continuing Operations
$
(2,868
)
 
$
5,797

 
Minus/Plus:
 
 
 
 
Unrealized Mark-to-Market (Gains)/Losses on Derivatives
3,962

 
(1,881
)
 
Realized (Gains)/Losses on Inventory Injection Hedges
120

 
24

 
Wholesale Energy Economic Earnings
$
1,214

 
$
3,940

 
 
 
 
 
 
Retail Energy Income from Continuing Operations
$
10,691

 
$
13,376

 
Minus/Plus:
 
 
 
 
Unrealized Mark-to-Market (Gains)/Losses on Derivatives
136

 
(2,317
)