SJI-3.31.14-10Q

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, 2014
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, 2014 there were 32,978,971 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,
 
2014
 
2013
Operating Revenues:
 
 
 
Utility
$
210,329

 
$
173,651

Nonutility
139,872

 
81,980

Total Operating Revenues
350,201

 
255,631

Operating Expenses:
 

 
 

Cost of Sales - (Excluding depreciation)
 

 
 

 - Utility
103,077

 
77,156

 - Nonutility
125,061

 
75,145

Operations
39,350

 
32,689

Maintenance
3,259

 
3,422

Depreciation
14,991

 
11,407

Energy and Other Taxes
1,953

 
3,833

Total Operating Expenses
287,691

 
203,652

Operating Income
62,510

 
51,979

 
 
 
 
Other Income and Expense
2,368

 
3,869

Interest Charges
(7,084
)
 
(4,708
)
Income Before Income Taxes
57,794

 
51,140

Income Taxes
(11,869
)
 
(7,772
)
Equity in Earnings (Loss) of Affiliated Companies
2,286

 
(31
)
Income from Continuing Operations
48,211

 
43,337

Loss from Discontinued Operations - (Net of tax benefit)
(313
)
 
(471
)
Net Income
$
47,898

 
$
42,866

 
 
 
 
Basic Earnings Per Common Share:
 

 
 

Continuing Operations
$
1.47

 
$
1.36

Discontinued Operations
(0.01
)
 
(0.01
)
Basic Earnings Per Common Share
$
1.46

 
$
1.35

 
 
 
 
Average Shares of Common Stock Outstanding - Basic
32,765

 
31,757

 
 
 
 
Diluted Earnings Per Common Share:
 

 
 

Continuing Operations
$
1.47

 
$
1.36

Discontinued Operations
(0.01
)
 
(0.01
)
Diluted Earnings Per Common Share
$
1.46

 
$
1.35

 
 
 
 
Average Shares of Common Stock Outstanding - Diluted
32,842

 
31,811

 
 
 
 
Dividends Declared Per Common Share
$
0.47

 
$
0.44


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,
 
2014
 
2013
Net Income
$
47,898

 
$
42,866

 
 
 
 
Other Comprehensive Income, Net of Tax:*
 

 
 

 
 
 
 
Unrealized Gain (Loss) on Available-for-Sale Securities
62

 
(274
)
Unrealized Gain on Derivatives - Other
66

 
66

Other Comprehensive (Loss) Income of Affiliated Companies
(18
)
 
5,014

 
 
 
 
Other Comprehensive Income - Net of Tax*
110

 
4,806

 
 
 
 
Comprehensive Income
$
48,008

 
$
47,672

 
 
 
 

* 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,
 
2014
 
2013
Net Cash Provided by Operating Activities
$
49,232

 
$
55,886

 
 
 
 
Cash Flows from Investing Activities:
 

 
 

Capital Expenditures
(60,254
)
 
(40,604
)
Net Proceeds from Sale of Restricted Investments in Margin Account
7,444

 
7,931

Investment in Long-Term Receivables
(2,053
)
 
(1,947
)
Proceeds from Long-Term Receivables
1,981

 
2,402

Purchase of Company Owned Life Insurance
(230
)
 
(372
)
Investment in Affiliate

 
(1,076
)
Advances on Notes Receivable - Affiliate
(342
)
 
(498
)
Repayment of Notes Receivable - Affiliate
3,228

 
58,249

 
 
 
 
Net Cash (Used in) Provided by Investing Activities
(50,226
)
 
24,085

 
 
 
 
Cash Flows from Financing Activities:
 

 
 

Net Repayments of Short-Term Credit Facilities
(29,600
)
 
(90,500
)
Proceeds from Issuance of Long-Term Debt
30,000

 

Payments for Issuance of Long-Term Debt
(210
)
 
(11
)
Proceeds from Sale of Common Stock
5,157

 
7,244

 
 
 
 
Net Cash Provided by (Used in) Financing Activities
5,347

 
(83,267
)
 
 
 
 
Net Increase (Decrease) in Cash and Cash Equivalents
4,353

 
(3,296
)
Cash and Cash Equivalents at Beginning of Period
3,818

 
4,638

 
 
 
 
Cash and Cash Equivalents at End of Period
$
8,171

 
$
1,342


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,
2014
 
December 31,
2013
Assets
 
 
 
Property, Plant and Equipment:
 
 
 
Utility Plant, at original cost
$
1,846,704

 
$
1,816,804

Accumulated Depreciation
(398,954
)
 
(392,029
)
Nonutility Property and Equipment, at cost
495,433

 
486,332

Accumulated Depreciation
(57,968
)
 
(52,009
)
 
 
 
 
Property, Plant and Equipment - Net
1,885,215

 
1,859,098

 
 
 
 
Investments:
 

 
 

Available-for-Sale Securities
8,829

 
8,716

Restricted
35,670

 
43,115

Investment in Affiliates
80,324

 
78,273

 
 
 
 
Total Investments
124,823

 
130,104

 
 
 
 
Current Assets:
 

 
 

Cash and Cash Equivalents
8,171

 
3,818

Accounts Receivable
362,675

 
253,566

Unbilled Revenues
53,841

 
47,594

Provision for Uncollectibles
(6,725
)
 
(5,854
)
Notes Receivable - Affiliate
6,536

 
8,908

Natural Gas in Storage, average cost
15,299

 
57,786

Materials and Supplies, average cost
2,851

 
2,798

Deferred Income Taxes - Net
23,978

 
30,609

Prepaid Taxes
1,220

 
9,431

Derivatives - Energy Related Assets
58,123

 
56,327

Other Prepayments and Current Assets
25,248

 
17,915

 
 
 
 
Total Current Assets
551,217

 
482,898

 
 
 
 
Regulatory and Other Noncurrent Assets:
 

 
 

Regulatory Assets
309,290

 
296,081

Derivatives - Energy Related Assets
18,439

 
26,451

Unamortized Debt Issuance Costs
8,732

 
7,803

Notes Receivable-Affiliate
39,563

 
39,907

Contract Receivables
14,554

 
14,595

Notes Receivable
7,882

 
7,882

Other
60,086

 
60,036

 
 
 
 
Total Regulatory and Other Noncurrent Assets
458,546

 
452,755

 
 
 
 
Total Assets
$
3,019,801

 
$
2,924,855

 
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,
2014
 
December 31,
2013
Capitalization and Liabilities
 
 
 
Equity:
 
 
 
Common Stock
$
41,028

 
$
40,894

Premium on Common Stock
406,397

 
401,011

Treasury Stock (at par)
(162
)
 
(186
)
Accumulated Other Comprehensive Loss
(20,650
)
 
(20,760
)
Retained Earnings
438,429

 
406,041

 
 
 
 
Total Equity
865,042

 
827,000

 
 
 
 
Long-Term Debt
710,400

 
680,400

 
 
 
 
Total Capitalization
1,575,442

 
1,507,400

 
 
 
 
Current Liabilities:
 

 
 

Notes Payable
324,300

 
353,900

Current Portion of Long-Term Debt
21,000

 
21,000

Accounts Payable
295,730

 
259,757

Customer Deposits and Credit Balances
15,112

 
15,546

Environmental Remediation Costs
27,184

 
16,695

Taxes Accrued
9,677

 
3,234

Derivatives - Energy Related Liabilities
89,892

 
77,993

Dividends Payable
15,510

 

Interest Accrued
6,219

 
6,363

Pension Benefits
1,241

 
1,275

Other Current Liabilities
6,858

 
9,210

 
 
 
 
Total Current Liabilities
812,723

 
764,973

 
 
 
 
Deferred Credits and Other Noncurrent Liabilities:
 

 
 

Deferred Income Taxes - Net
321,827

 
319,368

Investment Tax Credits
307

 
360

Pension and Other Postretirement Benefits
58,776

 
57,370

Environmental Remediation Costs
96,708

 
106,734

Asset Retirement Obligations
41,925

 
41,687

Derivatives - Energy Related Liabilities
20,274

 
22,131

Derivatives - Other
7,890

 
6,676

Regulatory Liabilities
48,158

 
60,949

Finance Obligation
20,420

 
20,656

Other
15,351

 
16,551

 
 
 
 
Total Deferred Credits and Other Noncurrent Liabilities
631,636

 
652,482

 
 
 
 
Commitments and Contingencies  (Note 11)


 


 
 
 
 
Total Capitalization and Liabilities
$
3,019,801

 
$
2,924,855

 
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.

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

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

South Jersey Energy Service Plus, LLC (SJESP) services residential and small commercial HVAC systems, installs 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.

BASIS OF PRESENTATION — The condensed consolidated financial statements include the accounts of SJI, its wholly-owned subsidiaries and subsidiaries in which SJI has a controlling interest. SJI eliminates 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 2013 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 periods regulatory assets disclosure to conform to the current period presentation. The deferred pipeline integrity cost and Allowance for Funds Used During Construction ("AFUDC") - equity related deferrals previously included in "Other Regulatory Assets" were reclassified to the line items "Pipeline Integrity Cost" and "AFUDC - Equity Related Deferrals", respectively, in the regulatory asset table in Note 8.

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). State sales tax is recorded as a liability when billed to customers and is not included in revenue or operating expenses. The PUA is included in both utility revenue and cost of sales and totaled $0.4 million for both the three months ended March 31, 2014 and 2013. In prior years, SJG had collected a throughput-based energy tax from customers in the form of a Transitional Energy Facility Assessment (TEFA). The TEFA was eliminated effective January 1, 2014.
 
IMPAIRMENT OF LONG-LIVED ASSETS - SJI reviews 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 three months ended March 31, 2014 and 2013, no impairments were identified.


6

Table of Contents

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, 2014 or 2013. As of both March 31, 2014 and December 31, 2013, $8.9 million 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.
 
TREASURY STOCK – SJI uses the par value method of accounting for treasury stock. As of March 31, 2014 and December 31, 2013, SJI held 129,929 and 148,890 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 Marina 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 2014 or 2013 had, or is expected to have, a material impact on the condensed consolidated financial statements.

In July 2013, the FASB issued Accounting Standards Update (ASU) 2013-11, Balance Sheet Presentation of an Unrecognized Income Tax Benefit for a Net Operating Loss or Tax Credit Carryforward. This ASU provides that a liability related to an unrecognized tax benefit should be offset against a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of this guidance 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, 2014 and 2013.  No stock appreciation rights have been issued under the plan. During the three months ended March 31, 2014 and 2013, SJI granted 67,874 and 56,464 restricted shares, respectively, to Officers and other key employees.  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 use SJI's total shareholder return (TSR) relative to a peer group to measure performance. Grants containing earnings-based targets 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, 2014 and 2013, SJI granted 11,610 and 12,285 restricted shares, respectively, to Directors.  Shares issued to Directors 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, 2013 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, 2014 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. 2012 - TSR
 
18,640

 
$
51.23

 
22.5
%
 
0.43
%
 
Jan. 2012 - EPS
 
18,640

 
$
56.93

 
N/A

 
N/A

 
Jan. 2013 - TSR
 
25,898

 
$
44.38

 
21.1
%
 
0.40
%
 
Jan. 2013 - EPS
 
25,898

 
$
51.18

 
N/A

 
N/A

 
Jan. 2014 - TSR
 
32,686

 
$
44.32

 
20.0
%
 
0.80
%
 
Jan. 2014 - EPS
 
32,686

 
$
54.44

 
N/A

 
N/A

 
 
 
 
 
 
 
 
 
 
Directors -
Jan. 2014
 
11,610

 
$
54.51

 
N/A

 
N/A

 

 


 


 


 



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 the three months ended March 31, 2014 and 2013 (in thousands):

 
Three Months Ended
March 31,
 
2014
2013
Officers & Key Employees
$
581

$
573

Directors
158

191

Total Cost
739

764

 
 
 
Capitalized
(70
)
(63
)
Net Expense
$
669

$
701


As of March 31, 2014, there was $5.0 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 2.1 years.

The following table summarizes information regarding restricted stock award activity during the three months ended March 31, 2014, excluding accrued dividend equivalents:

 
Officers &Other Key Employees
 
Directors
 
Weighted
Average
Fair Value
Nonvested Shares Outstanding, January 1, 2014
94,192

 
19,617

 
$
50.73

  Granted
67,874

 
11,610

 
$
50.13

  Cancelled/Forfeited
(7,618
)
 

 
$
50.24

  Vested

 
(19,617
)
 
$
52.19

Nonvested Shares Outstanding, March 31, 2014
154,448

 
11,610

 
$
50.30



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Performance targets during the three-year vesting period were not attained for the January 2011 grant that had vested at December 31, 2013. As a result, no shares were awarded in 2014. During the three months ended March 31, 2013, 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. Also, during the three months ended March 31, 2014 and 2013, SJI granted 11,610 and 12,285 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,
 
2014
 
2013
Loss Before Income Taxes:
 
 
 
Sand Mining
$
(380
)
 
$
(72
)
Fuel Oil
(102
)
 
(652
)
Income Tax Benefits
169

 
253

Loss from Discontinued Operations — Net
$
(313
)
 
$
(471
)
Earnings Per Common Share from
 
 
 
Discontinued Operations — Net:
 
 
 
Basic and Diluted
$
(0.01
)
 
$
(0.01
)

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 had a 50% equity interest, were sold. As a result of the transaction, Marina received cash proceeds of $57.9 million in 2013. LVE was dissolved prior to December 31, 2013. See Note 11.

During the first three months of 2014, the Company received net repayments from unconsolidated affiliates of $2.9 million. During the first three months of 2013, the Company made investments in, and provided net advances to, unconsolidated affiliates of $1.1 million, excluding the cash proceeds related to the sale of LVE as discussed above. As of March 31, 2014 and December 31, 2013, the outstanding balance on these Notes Receivable – Affiliate was $46.1 million and $48.8 million, respectively. These notes are secured by property, plant and equipment of the affiliates, accrue interest at 7.5% and are to be repaid through 2025.


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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, 2014, the Company had a net asset of approximately $79.5 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, 2014 is limited to its combined equity contributions and the Notes Receivable-Affiliate in the amount of $125.6 million plus the guarantees discussed in Note 11.

4.
COMMON STOCK:

The following shares were issued and outstanding:

 
2014
Beginning Balance, January 1
32,715,042

New Issues During the Period:
 

Dividend Reinvestment Plan
95,662

Stock-Based Compensation Plan
11,610

Ending Balance, March 31
32,822,314


The par value ($1.25 per share) of stock issued was recorded in Common Stock and the net excess over par value of approximately $5.4 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 77,224 and 53,574 for the three months ended March 31, 2014 and 2013, 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 $5.2 million and $7.2 million of equity capital through the DRP during the three months ended March 31, 2014 and 2013, 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 March 31, 2014 and December 31, 2013, the escrowed proceeds, including interest earned, totaled $1.4 million and $1.3 million, respectively.

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, 2014 and December 31, 2013, the balances in these accounts totaled $34.3 million and $41.8 million, respectively. The carrying amounts of the Restricted Investments approximate their fair values at March 31, 2014 and December 31, 2013, 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 $15.0 million as of both March 31, 2014 and December 31, 2013. 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 $1.3 million as of both March 31, 2014 and December 31, 2013.  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, 2014 and December 31, 2013, 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, 2014, approximately $14.6 million, or 19.0%, of the current and noncurrent Derivatives – Energy Related Assets are with a single, investment-grade rated 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. As substantially all of the costs of constructing the facility were funded by the financing provided by Marina, Marina was considered the owner of the facility for accounting purposes during the construction period. When an entity is considered the accounting owner during the construction period, a sale of the asset effectively occurs when construction of the asset is completed. However, due to its continuing involvement in the facility through its equity interest in Energenic, Marina continues to be considered the owner of the facility for accounting purposes under ASC Topic 360 Property, Plant and Equipment. As a result, the transaction is being accounted for as a financing arrangement under ASC Topic 840 Leases and therefore the Company has included costs to construct the facility within Nonutility Property, Plant and Equipment on the condensed consolidated balance sheets of $23.7 million as of both March 31, 2014 and December 31, 2013. 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 $20.4 million and $20.7 million, net of amortization, within Finance Obligation on the condensed consolidated balance sheets at March 31, 2014 and December 31, 2013, 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, 2014 and December 31, 2013, 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, 2014 and December 31, 2013, were $759.3 million and $713.2 million, respectively.  The carrying amounts of SJI's long-term debt, including current maturities, as of March 31, 2014 and December 31, 2013, were $731.4 million and $701.4 million, respectively.


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6.
SEGMENTS OF BUSINESS:

SJI operates in several different reportable operating segments. These segments are as follows:

Gas utility operations (SJG) consists primarily of natural gas distribution to residential, commercial and industrial customers.
Wholesale energy operations include the activities of SJRG and SJEX.
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. 
 
In the first quarter of 2014, SJI began grouping its non-utility operations into two areas: Energy Group and Energy Services. Energy Group includes wholesale energy, retail gas and other, and retail electric operations. Energy Services includes on-site energy production and appliance service operations. Due to this grouping, some of the Company's prior period numbers were recast to conform with the current period presentation. However, no changes were made to the specific operating segments. 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,
 
2014
 
2013
Operating Revenues:
 
 
 
Gas Utility Operations
$
210,545

 
$
174,098

Energy Group:
 
 
 
     Wholesale Energy Operations
35,372

 
6,216

Retail Gas and Other Operations
51,506

 
34,113

Retail Electric Operations
40,393

 
30,729

     Subtotal Energy Group
127,271

 
71,058

Energy Services:
 
 
 
On-Site Energy Production
11,346

 
9,096

Appliance Service Operations
2,654

 
3,308

Subtotal Energy Services
14,000

 
12,404

Corporate & Services
7,871

 
8,480

Subtotal
359,687

 
266,040

Intersegment Sales
(9,486
)
 
(10,409
)
Total Operating Revenues
$
350,201

 
$
255,631


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Three Months Ended
March 31,
 
2014
 
2013
Operating Income:
 

 
 

Gas Utility Operations
$
63,440

 
$
57,795

Energy Group:
 
 
 
     Wholesale Energy Operations
(1,655
)
 
(5,157
)
Retail Gas and Other Operations
1,968

 
28

Retail Electric Operations
(54
)
 
464

     Subtotal Energy Group
259

 
(4,665
)
Energy Services:
 
 
 
On-Site Energy Production
(1,260
)
 
(1,173
)
Appliance Service Operations
(95
)
 
(14
)
  Subtotal Energy Services
(1,355
)
 
(1,187
)
Corporate and Services
166

 
36

Total Operating Income
$
62,510

 
$
51,979


 
 
 
Depreciation and Amortization:
 

 
 

Gas Utility Operations
$
12,676

 
$
11,024

Energy Group:
 
 
 
     Wholesale Energy Operations
40

 
51

Retail Gas and Other Operations
22

 
22

     Subtotal Energy Group
62

 
73

Energy Services:
 
 
 
On-Site Energy Production
5,775

 
3,012

Appliance Service Operations
67

 
74

  Subtotal Energy Services
5,842

 
3,086

Corporate and Services
219

 
225

Total Depreciation and Amortization
$
18,799

 
$
14,408


 
 
 
Interest Charges:
 

 
 

Gas Utility Operations
$
4,342

 
$
2,961

Energy Group:
 
 
 
     Wholesale Energy Operations
121

 
52

Retail Gas and Other Operations
126

 
76

     Subtotal Energy Group
247

 
128

Energy Services:
 
 
 
On-Site Energy Production
2,128

 
1,403

Corporate and Services
1,850

 
1,508

Subtotal
8,567

 
6,000

Intersegment Borrowings
(1,483
)
 
(1,292
)
Total Interest Charges
$
7,084

 
$
4,708



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Three Months Ended
March 31,
 
2014
 
2013
Income Taxes:
 

 
 

Gas Utility Operations
$
22,527

 
$
20,771

Energy Group:
 
 
 
     Wholesale Energy Operations
(553
)
 
(1,981
)
Retail Gas and Other Operations
936

 
272

Retail Electric Operations
(22
)
 
190

     Subtotal Energy Group
361

 
(1,519
)
Energy Services:
 
 
 
On-Site Energy Production
(11,025
)
 
(11,564
)
Appliance Service Operations
(23
)
 
4

Subtotal Energy Services
(11,048
)
 
(11,560
)
Corporate and Services
29

 
80

Total Income Taxes
$
11,869

 
$
7,772

 
 
 
 
Property Additions:
 
 
 
Gas Utility Operations
$
32,531

 
$
37,042

Energy Group:
 
 
 
     Wholesale Energy Operations
2

 
9

Retail Gas and Other Operations
168

 
2

     Subtotal Energy Group
170

 
11

Energy Services:
 
 
 
On-Site Energy Production
9,149

 
2,577

Corporate and Services
778

 
738

Total Property Additions
$
42,628

 
$
40,368


 
March 31, 2014
 
December 31, 2013
Identifiable Assets:
 
 
 
Gas Utility Operations
$
1,969,673

 
$
1,909,126

Energy Group:
 
 
 
     Wholesale Energy Operations
325,400

 
331,182

Retail Gas and Other Operations
70,832

 
50,384

Retail Electric Operations
27,510

 
25,496

     Subtotal Energy Group
423,742

 
407,062

Energy Services:
 
 
 
On-Site Energy Production
597,942

 
576,315

Appliance Service Operations
2,240

 
1,812

Subtotal Energy Services
600,182

 
578,127

Discontinued Operations
1,753

 
1,068

Corporate and Services
410,010

 
406,245

Intersegment Assets
(385,559
)
 
(376,773
)
Total Identifiable Assets
$
3,019,801

 
$
2,924,855



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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 November 2013, SJG filed a base rate case with the BPU to increase its base rates to obtain a certain level of return on its capital investments. In March 2014, SJG filed an update to the original filing and expects the base rate case to be concluded during 2014.

In January 2014, SJG credited the accounts of its periodic Basic Gas Supply Service (BGSS) customers with refunds totaling $11.2 million based on a projected over collection, at that time, due to lower gas costs.

There have been no other significant regulatory actions or changes to SJG's rate structure since December 31, 2013. See Note 10 to the Consolidated Financial Statements in Item 8 of SJI's Annual Report on Form 10-K as of December 31, 2013.

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, 2013 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, 2013.

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

 
March 31, 2014
 
December 31, 2013
Environmental Remediation Costs:
 
 
 
Expended - Net
$
26,590

 
$
29,945

Liability for Future Expenditures
119,604

 
119,492

Deferred Asset Retirement Obligation Costs
31,347

 
31,142

Deferred Pension and Other Postretirement Benefit Costs
59,284

 
59,284

Deferred Gas Costs - Net
34,008

 

Conservation Incentive Program Receivable

 
10,526

Societal Benefit Costs Receivable
5,528

 
10,408

Premium for Early Retirement of Debt

 
955

Deferred Interest Rate Contracts
4,735

 
3,735

Energy Efficiency Tracker
7,470

 
10,420

Pipeline Supplier Service Charges
6,690

 
7,106

Pipeline Integrity Cost
2,962

 
2,902

AFUDC - Equity Related Deferrals
8,631

 
7,810

Other Regulatory Assets
2,441

 
2,356

 
 
 
 
Total Regulatory Assets
$
309,290

 
$
296,081


DEFERRED GAS COSTS - 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 change from a $19.1 million regulatory liability at December 31, 2013 to a $34.0 million regulatory asset at March 31, 2014 was due to the actual cost of the commodity incurred during the first quarter exceeding the gas costs recovered from the customers as a result of higher prices.

CONSERVATION INCENTIVE PROGRAM (CIP) RECEIVABLE – The CIP tracking mechanism adjusts earnings when actual usage per customer experienced during the period varies from an established baseline usage per customer. Actual usage per customer was greater than the established baseline during the first three months of 2014 resulting in a payable that is recorded in the table below as a regulatory liability. The change from a receivable to a related payable is primarily the result of colder weather experienced in the region during the first quarter of 2014.


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Table of Contents

SOCIETAL BENEFIT COSTS RECEIVABLE - This regulatory asset primarily represents the deferred expenses under the New Jersey Clean Energy Program, which is a mechanism designed to recover costs associated with energy efficiency and renewable energy program. The decrease in the asset is due to colder weather experienced in the region during the first quarter of 2014 resulting in increased recoveries of the deferred expense.

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

 
March 31, 2014
 
December 31, 2013
Excess Plant Removal Costs
$
39,647

 
$
40,029

Deferred Revenues - Net

 
19,067

Conservation Incentive Program Payable
6,193

 

Other Regulatory Liabilities
2,318

 
1,853

 
 
 
 
Total Regulatory Liabilities
$
48,158

 
$
60,949

 
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. See "Deferred Gas Costs - Net" above.

CONSERVATION INCENTIVE PROGRAM PAYABLE – The CIP tracking mechanism adjusts earnings when actual usage per customer experienced during the period varies from an established baseline usage per customer. See "Conservation Incentive Program (CIP) Receivable" above.
 

9.
PENSION AND OTHER POSTRETIREMENT BENEFITS:

For the three months ended March 31, 2014 and 2013, 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,
 
2014

2013
Service Cost
$
1,285

 
$
1,378

Interest Cost
2,695

 
2,332

Expected Return on Plan Assets
(3,265
)
 
(2,989
)
Amortizations:
 
 
 

Prior Service Cost
43

 
63

Actuarial Loss
1,426

 
2,171

Net Periodic Benefit Cost
2,184

 
2,955

Capitalized Benefit Costs
(854
)
 
(1,167
)
Total Net Periodic Benefit Expense
$
1,330

 
$
1,788



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Other Postretirement Benefits
 
Three Months Ended
March 31,
 
2014

2013
Service Cost
$
250

 
$
311

Interest Cost
740

 
700

Expected Return on Plan Assets
(687
)
 
(588
)
Amortizations:
 
 
 

Prior Service Cost (Credits)
38

 
(71
)
Actuarial Loss
243

 
459

Net Periodic Benefit Cost
584

 
811

Capitalized Benefit Costs
(209
)
 
(322
)
Total Net Periodic Benefit Expense
$
375

 
$
489


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

SJI contributed $12.7 million to the pension plans in January 2013. No contributions are expected to be made to the pension plans during 2014. Payments related to the unfunded supplemental executive retirement plan (SERP) are expected to approximate $1.3 million in 2014. 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, 2013, for additional information related to SJI’s pension and other postretirement benefits.

10.
LINES OF CREDIT:
 
Credit facilities and available liquidity as of March 31, 2014 were as follows (in thousands):

Company

Total Facility

Usage

Available Liquidity

Expiration Date
SJG:

 

 

 

 
Commercial Paper Program/Revolving Credit Facility

$
200,000


$
47,700


$
152,300


May 2018
Uncommitted Bank Lines

10,000




10,000


August 2014












Total SJG

210,000


47,700


162,300


 












SJI:

 

 

 

 









Revolving Credit Facility

400,000


293,800


106,200


February 2018 (A)












Total SJI

400,000


293,800


106,200


 












Total
 
$
610,000

 
$
341,500

 
$
268,500

 
 

(A) Includes letters of credit outstanding in the amount of $17.2 million.


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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 1.06% and 1.02% at March 31, 2014 and 2013, respectively. Average borrowings outstanding under these credit facilities, not including letters of credit, during the three months ended March 31, 2014 and 2013 were $332.2 million and $317.3 million, respectively. The maximum amounts outstanding under these credit facilities, not including letters of credit, during the three months ended March 31, 2014 and 2013 were $390.7 million and $369.5 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, 2014.

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.

11.
COMMITMENTS AND CONTINGENCIES:

GUARANTEES — The Company has recorded a liability of $0.7 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, 2014 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 had 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.

In 2013, the Company received 1) $57.9 million of repayments of advances to LVE; and 2) a $7.9 million note receivable from a third party, which is recorded in the condensed consolidated balance sheets as of March 31, 2014. As of December 31, 2013, LVE was dissolved and the Company incurred a $0.8 million charge to write-off the remaining interest in 2013.

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 December 2013, SJI entered into agreements to guarantee certain obligations of WCLE, SC Landfill Energy, LLC, SX Landfill Energy, LLC, FC Landfill Energy, LLC, and AC Landfill Energy, LLC (collectively, the "Landfills"), unconsolidated joint ventures in which Marina has a 50% equity interest in each through Energenic. The landfills have entered into long-term debt agreements which run through 2020. Although unlikely, SJI could be liable through the guarantees for 50% of the outstanding debt along with any interest related to the debt in the event the landfills 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. As of March 31, 2014, 50% of the currently outstanding debt is $9.4 million. As a result, the Company has recorded a liability of $0.5 million for the fair value of the guarantees, 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, 2014.

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Table of Contents


In February 2011, ACR Energy Partners, LLC (ACR), a wholly-owned subsidiary of Energenic, in 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.

In May 2012, UMM Energy Partners, LLC (UMM), a wholly-owned subsidiary of Energenic, in 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 commenced commercial operations in September 2013. 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 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, 2014, SJI had issued $6.4 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 45.0% of our workforce at March 31, 2014. 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 and SJESP employees represented by the IBEW operate under a collective bargaining agreement that runs through February 2017. The remaining unionized employees are represented by the IAM and operate under a collective bargaining agreement that expires in August 2014.

STANDBY LETTERS OF CREDIT — As of March 31, 2014, SJI provided $17.2 million of standby letters of credit through SJI’s revolving credit facility to enable SJE to market retail electricity and for various construction and operating 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 $2.9 million and $3.0 million related to all claims in the aggregate as of March 31, 2014 and December 31, 2013, respectively. 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, 2013 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, 2013.


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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, 2014, the Company had outstanding derivative contracts intended to limit the exposure to market risk on 30.3 MMdts (1 MMdts = one million decatherms) of expected future purchases of natural gas, 20.4 MMdts of expected future sales of natural gas, 1.0 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 has basis and index related purchase and sales contracts totaling 30.8 MMdts.  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 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 (AOCL) on the 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 significant changes to the Company’s active interest rate swaps since December 31, 2013 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, 2013.

The fair values of all derivative instruments, as reflected in the condensed consolidated balance sheets as of March 31, 2014 and December 31, 2013, are as follows (in thousands):

Derivatives not designated as hedging instruments under GAAP
 
March 31, 2014
 
December 31, 2013
 
 
Assets
 
Liabilities
 
Assets
 
Liabilities
Energy related commodity contracts:
 
 
 
 
 
 
 
 
Derivatives – Energy Related – Current
 
$
58,123

 
$
89,892

 
$
56,327

 
$
77,993

Derivatives – Energy Related – Non-Current
 
18,439

 
20,274

 
26,451

 
22,131

Interest rate contracts:
 
 
 
 
 
 

 
 

Derivatives - Other
 

 
7,890

 

 
6,676

Total derivatives not designated as hedging instruments under GAAP
 
76,562

 
118,056

 
82,778

 
106,800

 
 
 
 
 
 
 
 
 
Total Derivatives
 
$
76,562

 
$
118,056

 
$
82,778

 
$
106,800



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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, 2014 and December 31, 2013, information related to these offsetting arrangements were as follows (in thousands):
As of March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
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
 
$
76,562

 
$

 
$
76,562

 
$
(39,526
)
(A)
$

 
$
37,036

Derivatives - Energy Related Liabilities
 
$
(110,166
)
 
$

 
$
(110,166
)
 
$
39,526

(B)
$
17,275

 
$
(53,365
)
Derivatives - Other
 
$
(7,890
)
 
$

 
$
(7,890
)
 
$

 
$

 
$
(7,890
)

As of December 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
 
$
82,778

 
$

 
$
82,778

 
$
(28,082
)
(A)
$
(498
)
 
$
54,198

Derivatives - Energy Related Liabilities
 
$
(100,124
)
 
$

 
$
(100,124
)
 
$
28,082

(B)
$
29,639

 
$
(42,403
)
Derivatives - Other
 
$
(6,676
)
 
$

 
$
(6,676
)
 
$

 
$

 
$
(6,676
)

(A) The balances at March 31, 2014 and December 31, 2013 were related to derivative liabilities which can be net settled against derivative assets.

(B) The balances at March 31, 2014 and December 31, 2013 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, 2014 and 2013 are as follows (in thousands):

 
 
Three Months Ended
March 31,
Derivatives in Cash Flow Hedging Relationships under GAAP
 
2014
 
2013
Interest Rate Contracts:
 
 
 
 
Losses recognized in AOCL on effective portion
 
$

 
$

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

 
$


(a) Included in Interest Charges


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Three Months Ended
March 31,
Derivatives Not Designated as Hedging Instruments under GAAP
 
2014
 
2013
Losses on energy related commodity contracts (a)
 
$
(28,601
)
 
$
(7,049
)
(Losses) gains on interest rate contracts (b)
 
(214
)
 
525

 
 
 
 
 
Total
 
$
(28,815
)
 
$
(6,524
)

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

Net realized gains associated with SJG's energy-related financial commodity contracts of $2.4 million and losses of $1.5 million for the three months ended March 31, 2014 and 2013, 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, 2014, is $38.4 million.   If the credit-risk-related contingent features underlying these agreements were triggered on March 31, 2014, the Company would have been required to settle the instruments immediately or post collateral to its counterparties of approximately $28.3 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, 2014
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Available-for-Sale Securities (A)
$
8,829

 
$
8,829

 
$

 
$

Derivatives – Energy Related Assets (B)
76,562

 
7,109

 
28,935

 
40,518

 
$
85,391

 
$
15,938

 
$
28,935

 
$
40,518

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives – Energy Related Liabilities (B)
$
110,166

 
$
5,732

 
$
58,945

 
$
45,489

Derivatives – Other (C)
7,890

 

 
7,890

 

 
$
118,056

 
$
5,732

 
$
66,835

 
$
45,489


As of December 31, 2013
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Available-for-Sale Securities (A)
$
8,716

 
$
8,716

 
$

 
$

Derivatives – Energy Related Assets (B)
82,778

 
4,385

 
27,182

 
51,211

 
$
91,494

 
$
13,101

 
$
27,182

 
$
51,211

 
 
 
 
 
 
 
 
 Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives – Energy Related Liabilities (B)
$
100,124

 
$
4,236

 
$
52,772

 
$
43,116

Derivatives – Other (C)
6,676

 

 
6,676

 

 
$
106,800

 
$
4,236

 
$
59,448

 
$
43,116


(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 consist of 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 consist of 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, 2014
Valuation Technique
Significant Unobservable Input
Range [Weighted Average]
 
Assets
Liabilities
 
 
 
Forward Contract - Natural Gas
$31,078
$38,549
Discounted Cash Flow
Forward price (per dt)

$(2.01) - $4.70 [$(0.78)]
Forward Contract - Electric


$9,440
$6,940
Discounted Cash Flow
Fixed electric load profile (on-peak)
8.06% - 100.00% [55.03%]
Fixed electric load profile (off-peak)
0.00% - 91.94% [44.97%]

Type
Fair Value at December 31, 2013
Valuation Technique
Significant Unobservable Input
Range [Weighted Average]
 
Assets
Liabilities
 
 
 
Forward Contract - Natural Gas
$
41,444

$
36,043

Discounted Cash Flow
Forward price (per dt)

$(1.75) - $6.05 [$(0.79)]
Forward Contract - Electric


$
9,767

$
7,073

Discounted Cash Flow
Fixed electric load profile (on-peak)
8.06% - 100.00% [54.55%]
Fixed electric load profile (off-peak)
0.00% - 91.94% [45.45%]


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Table of Contents

The changes in fair value measurements of Derivatives – Energy Related Assets and Liabilities for the three months ended March 31, 2014 and 2013, using significant unobservable inputs (Level 3), are as follows (in thousands):

 
Three Months Ended
March 31, 2014
Balance at beginning of period
$
8,095

Other changes in fair value from continuing and new contracts, net
(12,124
)
Settlements
(942
)
 
 
Balance at end of period
$
(4,971
)


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

Other changes in fair value from continuing and new contracts, net
(701
)
Settlements
(434
)
 
 
Balance at end of period
$
1,627


Total losses for 2014 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, 2014, is $12.1 million.  These losses are included in Operating Revenues-Nonutility on the condensed consolidated statements of income.

14.
LONG-TERM DEBT:

In January 2014, SJG issued $30.0 million aggregate principal amount of 4.23% Medium Term Notes due January 2030.

The Company did not issue any other long-term debt during the three months ended March 31, 2014.


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15.
ACCUMULATED OTHER COMPREHENSIVE LOSS:

The following tables summarize the changes in accumulated other comprehensive loss (AOCL) for the three months ended March 31, 2014 (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, 2014 (a)
$
(18,503
)
 
$
(2,697
)
 
$
397

 
$
43

 
$
(20,760
)
   Other comprehensive income before reclassifications

 

 
62

 

 
62

   Amounts reclassified from AOCL (b)

 
66

 

 
(18
)
 
48

Net current period other comprehensive income (loss)

 
66

 
62

 
(18
)
 
110

Balance at March 31, 2014 (a)
$
(18,503
)
 
$
(2,631
)
 
$
459

 
$
25

 
$
(20,650
)

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

The following table provides details about reclassifications out of AOCL for the three months ended March 31, 2014:

 
Amounts Reclassified from AOCL (in thousands)
 
Affected Line Item in the Condensed Consolidated Statements of Income
Three Months Ended
March 31, 2014
 
Unrealized Gain on Derivatives-Other - interest rate contracts designated as cash flow hedges
$
112

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

 
 
 
 
 
 
Loss of Affiliated Companies
$
(31
)
 
Equity in Loss of Affiliated Companies
   Income Taxes
13

 
Income Taxes (a)
 
$
(18
)
 
 
 
 
 
 
Losses from reclassifications for the period net of tax
$
48

 
 



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, 2013 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, 2013.

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, 2013. 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, 2013.

Environmental Remediation —There have been no significant changes to the status of the Company’s environmental remediation efforts since December 31, 2013. 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, 2013.


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Table of Contents

RESULTS OF OPERATIONS:

SJI operates in several different reportable operating segments. These segments are as follows:

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. 
 
In the first quarter of 2014, SJI began grouping its non-utility operations into two areas: Energy Group and Energy Services. Energy Group includes wholesale energy, retail gas and other, and retail electric operations. Energy Services includes on-site energy production and appliance service operations. Due to this grouping, some of the Company's prior period numbers were recast to conform with the current period presentation. However, no changes were made to the specific operating segments.

Net Income for the three months ended March 31, 2014 increased $5.0 million to $47.9 million compared with the same period in 2013 primarily as a result of the following:

The income contribution from the gas utility operations at SJG for the three months ended March 31, 2014 increased $2.1 million to $37.6 million due primarily to increases in the accelerated infrastructure programs and customer growth over the prior year.

The income contribution from the wholesale energy operations at SJRG for the three months ended March 31, 2014 increased $2.0 million to a net loss of $1.1 million due primarily to a $15.5 million increase resulting from higher storage volumes sold and higher daily trading margins as described in Gross Margin - Energy Group below, partially offset by a $13.5 million change in unrealized gains and losses on derivatives used by the wholesale energy operations to mitigate natural gas commodity price risk, as discussed under Operating Revenues - Energy Group 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:

The wholesale energy operations at SJRG purchases and holds natural gas in storage to earn a profit margin from its ultimate sale in the future. The wholesale energy operations 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 injected into 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 the 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.

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Table of Contents


The retail electric operations at SJE uses forward contracts to mitigate commodity price risk on fixed price electric contracts with customers. In accordance with 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.

As a result, management also uses the non-generally accepted accounting principles (“non-GAAP”) financial measures of Economic Earnings and Economic Earnings per share 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. With respect to the third part of the definition of Economic Earnings, for the three months ended March 31, 2014 and 2013:

For the three months ended March 31, 2013, Economic Earnings excludes a $0.9 million loss (net of tax) from affiliated companies, not part of ongoing operations. This adjustment is the result of the termination of the contract at LVE Energy Partners, LLC ("LVE," see Note 11 to the condensed consolidated financial statements) and is being excluded because substantially all of the assets of LVE have been sold and LVE is no longer considered part of the ongoing operations of the Company. LVE was dissolved prior to December 31, 2013; as such there was no gain/loss from affiliated companies not part of ongoing operations for the three months ended March 31, 2014.

Economic Earnings includes additional depreciation expense on a solar generating facility. During 2012 an impairment charge was recorded within Income from Continuing Operations on a solar generating facility which reduced its depreciable basis and recurring depreciation expense. This impairment charge was excluded from Economic Earnings and therefore the related reduction in depreciation expense is being added back.

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, 2014 increased $17.7 million to $66.2 million compared with the same period in 2013, primarily as a result of the following:

The income contribution from the wholesale energy operations at SJRG for the three months ended March 31, 2014 increased $15.5 million to $16.5 million due to higher storage volumes sold and higher daily trading margins as described in Gross Margin - Energy Group below.

The income contribution from the gas utility operations at SJG for the three months ended March 31, 2014 increased $2.1 million to $37.6 million due primarily to increases in the accelerated infrastructure programs and customer growth over the prior year.




29

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,
 
2014
 
2013
Income from Continuing Operations
$
48,211

 
$
43,337

Minus/Plus:
 
 
 
Unrealized Mark-to-Market (Gains)/Losses on Derivatives
17,658

 
4,098

Realized (Gains)/Losses on Inventory Injection Hedges
322

 
120

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

 
906

Other (B)
(25
)
 
(25
)
Economic Earnings
$
66,166

 
$
48,436

 
 
 
 
Earnings per Share from Continuing Operations
$
1.47

 
$
1.36

Minus/Plus:
 
 
 
Unrealized Mark-to-Market (Gains)/Losses on Derivatives
0.54

 
0.13

Realized (Gains)/Losses on Inventory Injection Hedges
0.01

 

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

 
0.03

Economic Earnings per Share
$
2.02

 
$
1.52


The effect of derivative instruments not designated as hedging instruments under GAAP in the condensed consolidated statements of income (see Note 12 to the condensed consolidated financial statements) is as follows (gains (losses) in thousands):

 
Three Months Ended
March 31,
 
2014
 
2013
Losses on energy related commodity contracts
$
(28,601
)
 
$
(7,049
)
(Losses) gains on interest rate contracts
(214
)
 
525

                         Total before income taxes
(28,815
)
 
(6,524
)
                         Income taxes (C)
11,771

 
2,675

                     Total after income taxes
(17,044
)
 
(3,849
)
  Unrealized mark-to-market losses on derivatives
   held by affiliated companies, net of tax (C)
(614
)
 
(249
)
   Total unrealized mark-to-market losses on derivatives
(17,658
)
 
(4,098
)
   Realized losses on inventory injection hedges, net of tax (C)
(322
)
 
(120
)
   Net Loss from Affiliated Companies, Not Part of Ongoing Operations (A)

 
(906
)
   Other (B)
25

 
25

   Total reconciling items between income from continuing
   operations and economic earnings
$